Header graphic for print

China Law Blog

China Law for Business

China: Do Just One Thing Redux. Trademarks.

Posted in Basics of China Business Law

More than three years ago, we did the following post, entitled, China: Do Just One Thing. Trademarks.

From time to time I get calls from start-up companies about to embark on manufacturing in China. They are calling to ask what they need to do “to protect themselves.”

I tell them about NNN Agreements and how they can help prevent potential manufacturers from replicating their product. And I tell them about how important it is that they have an OEM Agreement with their Chinese manufacture

Then I tell them how if they do nothing else, they should immediately register their trademarks in China. This one usually surprises them and they often think I have misunderstood what they are planning for China. They at first do not understand why I am emphasizing the need for their filing a trademark in China when they have no plans to sell their product in China. I then explain the following to them:

China is a first to file country, which means that, with very few exceptions, whoever files for a particular trademark in a particular category gets it. So if the name of your company is XYZ and you make shoes and you have been manufacturing your shoes in China for the last three years and someone registers the XYZ trademark for shoes, that other company gets the trademark. And then, armed with the trademark, that company has every right to stop your XYZ shoes from leaving China because they violate its trademark.

Then they understand.

A recent CNN Article, Brand wars: Battling China’s trademark “squatters” does a really good job of emphasizing with examples why registering your trademark is so important in China. The article talks about how there are companies and individuals who register in China the trademarks for rising brands (or logos) outside China:

Savvy to China’s complex trademark laws, these individuals target valuable foreign brands and register them as trademarks in China.

When international companies want to launch their products on the Chinese market, they’re often left with little choice but to cough up huge sums to buy back the trademark, rebrand their product or fight for the right to use the brand through lengthy legal battles.

The article talks of how Penfolds, an Australian winery, “is currently at the center of a legal dispute over the use of its own name in China” after “a notorious squatter” registered Penfolds’ Chinese name, “Ben Fu — a transliteration that means ‘chasing prosperity.’”

The article goes on to discuss similar issues companies like Tesla, Pfizer, and Castel Frères have had with China trademark squatters and then nicely outlines what foreign companies can do to avoid such problems, including first and foremost “immediately” figuring out what trademarks should be protected in China and then securing that protection through registration.

For more on China trademarks, check out the following:

Stiffed By Your China Manufacturer? It’s Probably Your Own Fault.

Posted in Basics of China Business Law, Legal News

In the last five years, the China lawyers at my firm have been contacted literally hundreds of times by foreign companies (mostly American, Canadian, British, German and Australian) that have received bad product or no product from their suppliers in China. And no exaggeration, I cannot remember a single time where the foreign company did not bear at least some responsibility for its own problems.

What are these foreign companies doing wrong, and so often?  Two things.

First, buying product from companies that they do not really know, or at least do not know well. We have written so often on what it takes to conduct due diligence on Chinese companies that instead of rehashing all that again here, I will simply refer you to the following posts:

The second thing that consistently gets foreign companies in trouble with their Chinese manufacturers is failing to have a written contract that actually makes sense for China. I have recently gotten into email discussions with a few companies that I have for years been telling need a contract with their Chinese manufacturers. These company (years after we last communicated) recently wrote me after having lost six figure amounts due to having received bad quality product from their Chinese manufacturers. Each of them asked if my law firm would consider suing their Chinese manufacturers on a contingency fee basis and I responded by saying that we would not take their cases on even a 100% contingency (i.e. my law firm getting every penny of whatever we collected on their behalf) because the lack of a good contract made these cases not worth our time.

The US companies then usually complain by email how difficult it now is for small businesses buying product from China — the below is a composite of some of these emails:

Those of us who are small business people and who are almost forced to deal with Chinese manufacturers because of price have been forgotten about as we have many problems that the Chinese manufacturers take advantage of and we do not have the funds to solve those problems.

My industry is _____ and the Chinese in this industry pretty well know that a North American company has little chance of winning legally in China, and just as little a chance of collecting when we win a suit in North America.  These suits are very costly and most of us bow out and take our loss and lose customers. Chinese companies won’t even sign the agreements we give to them.

Most under 35 Chinese business people are only concerned with themselves and are not interested in building a business relationship that lasts.  As long as they get their money they do not care who gets burned as they usually have many customers and orders to replace the ones they lose.

I hope one day these business people will understand how important quality and on time delivery means to our industry but I personally do not think it will ever happen.

The Chinese government wants foreign trade but does nothing to protect us. They only protect the Chinese even though it is blatant to see how they let them get away with such dishonest business practices.

My typical response is something like the following:

I disagree. You have chosen not to spend the money upfront to protect yourself and now you are complaining about the inevitable problems that result from that.  You are choosing to do business with China as though it has not changed in the last twenty years, when in fact it has and the smart ______ companies (even the smaller ones) are using contracts and other legal protections to account for that. It is on that which I will write.

The China lawyers in my firm have done literally hundreds of contracts (mostly NNN and OEM Agreements) with Chinese manufacturers in the last three years, not a single Chinese company has refused one.  There are three main reasons for having a contract with your Chinese manufacturer

1.  To create clarity.
2.  To avoid litigation.
3.  To win in court.
You are focusing only on the third, when it is the second one that is most important. The right contract causes the Chinese supplier to comply because it wants more than anything to avoid being sued because it knows if it is sued that it will lose.
But in the end whether it makes sense for you to have a good contract drafted with your Chinese suppliers depends on how much you are spending and how much you are losing due to problems. But generally, if you are not going to do what it takes to protect yourself from all of the problems you describe, you should seriously look into moving your production back home or to some other, cheaper country. Because doing what you are doing seems no longer to be working and, if anything, it will only get worse.
 Nuff said….

China Commercial Contracts: Writing the Contract Damage Provision

Posted in Basics of China Business Law, Legal News

In our standard commercial contracts we often include a specific damage amount for certain (not all) violations of the contract terms. We work with our clients to ensure that such provisions are not a penalty, but rather an honest assessment of what real damages might result from the breach. This system has worked well in China and actually helps prevent litigation due to the certainty of result these contract damage provisions provide.

Common law lawyers often express concern about such contract damage provisions based on the general common law aversion to “liquidated damages.” This concern shows a lack of understanding of how the Chinese civil law system works in the realm of contact damages. The Chinese side will also often object. Their reason is clear: they understand the effectiveness of such provisions and they want to escape from this very real threat.

The term “liquidated damages” is a common law term that has no meaning in the PRC. PRC contract law provides for “contract damages.” Though contract damages are both permitted and encouraged, they cannot be imposed as a penalty. For this reason, in recent cases and under guidance from the PRC Supreme Court, Chinese courts have indicated that a defendant is free to argue that the contract damages are too high and that the court should award a lower amount. The court is then free to accept this argument and award the lower amount. However, the presence of the contract damages provisions does not in any way serve to invalidate the contract or the basic notion of awarding contract damages.

Note also that under PRC law, the plaintiff always has the right to argue for an amount higher than the contract damage amount. That is, the contract damage amount is treated as a floor, not a ceiling. Though the concept is a floor from the plaintiff’s point of view, the Supreme Court recently held that the defendant is also free to dig a basement, allowing for an award lower than the contract damage amount. Though these recent interpretations obscure the concept of contract damage amounts, we still include contract damages in PRC contracts for two reasons: 1) We want a set number when we contact the breaching party and having contract damages allows give us a specific damage amount to discuss and 2) we want a specific number to use for a prejudgement attachment of assets.

We also provide for contract damages because though China has no law/equity distinction (unlike common law countries), injunctive relief generally does not work well in China. We therefore want to have an agreed contract damage amount in cases where the actual amount of damages is difficult/impossible to calculate. In these cases where there is no clear monetary damage (the classic common law injunctive relief situation), the PRC courts generally have NOT allowed defendants to argue that no relief should be awarded. For this reason, though there is risk that the PRC court will reduce the contract damage amount, the risk is for a lower award. The risk is not that there will be no damage award at all or that the contract will be invalidated. Chinese courts very much prefer making a monetary award as an alternative to issuing an order (injunction) that they know they cannot enforce.

The basic legal rules for dealing with China contract damages are as follows:

In accordance with the PRC Contract Law, if the agreed contract damage amount is lower than the actual amount of damage, then the plaintiff can argue for a higher amount. On the other hand, if the agreed contract damage amount is substantially higher than the actual amount of damage, then the defendant can argue for a lower amount. (Article 14 约定的违约金低于造成的损失的,当事人可以请求人民法院或者仲裁机构予以增加;约定的违约金过分高于造成的损失的,当事人可以请求人民法院或者仲裁机构予以适当减少)

Therefore, the plaintiff always has the right to argue for an amount higher than the contract damage amount and that the contract damage amount is not a ceiling. Unfortunately for the plaintiff, the contract damage amount is also not treated as a floor.

Pursuant to Interpretation II of the Supreme People’s Court of Several Issues Concerning the Application of the PRC Contract Law (《最高人民法院关于适用〈中华人民共和国合同法〉若干问题的解释(二)》), if the defendant argues that the actual damage is lower than the contract damage and thus should be lowered, the court will consider it on the basis of actual damage, and will take into account the parties’ actual performance, degree of fault, parties’ expectation, and other factors and will apply the principles of fairness and good faith in making a ruling. (Article 29 当事人主张约定的违约金过高请求予以适当减少的,人民法院应当以实际损失为基础,兼顾合同的履行情况、当事人的过错程度以及预期利益等综合因素,根据公平原则和诚实信用原则予以衡量,并作出裁决).

The threshold for “substantially higher (过高)” is 30%: if the contract damage amount is more than 30% higher than the actual amount of damage, then it is deemed to be substantially higher than the actual damages. In principal, the contract damage amount should only be lowered if it meets this “substantially higher” threshold. However, the situation is not that clear. Chinese judges fundamentally believe in doing “justice,” which means that they will not necessarily follow the judicial interpretation strictly and may adjust the amount as he or she sees fit. The plaintiff has the burden to prove its actual damage, and if the judge is not satisfied that plaintiff has met its burden of proof, the judge may lower the amount even though the 30% threshold is not met. This is one of the many areas of uncertainty plaguing the Chinese litigation system.

Bottom Line:  Despite the risk that the court may end up adjusting the amount, contract damages oftentimes make sense in Chinese contracts. The key is choosing the right amount for your contract damages; one that is neither too high nor too low.

China Dispute Resolution Clauses. Choose Certainty Over Flexiblity.

Posted in Basics of China Business Law, Legal News

When my firm’s China lawyers draft a contract concerning China, we nearly always use a simple and clear dispute resolution provision:

  1. The contract is governed by Chinese law.
  2. Chinese language controls.
  3. Disputes will be resolved in China.

On the third point, we work with our client to choose either litigation in the PRC courts or arbitration in China. We point out that the client must pick one method: litigation or arbitration, but not both. What is known in logic as the exclusive or.

In discussing the dispute resolution clause, clients often propose a flexible dispute resolution provision such as the following:

  • Plaintiff has the option to choose arbitration or litigation. Once plaintiff chooses, defendant must comply.
  • Litigation or arbitration will occur in defendant’s home location; the Chinese party must be sued in China and the U.S. party must be sued in the United States.

In the 80s and 90s, most U.S. entities were reluctant to allow themselves to be sued in China. As a result, many contracts from that era included such “flexible” dispute resolution provisions. However, with the growth of sophisticated court litigation and arbitration in China in the post 2000 era, it quickly became clear that such a flexible approach is a mistake. In many cases, U.S. parties using such provisions have found themselves with no remedy of any kind. In other cases, working through the issues has resulted in substantial delay.

It is for these reasons that we write our China contracts to provide for one (and only one) method of dispute resolution and one forum for that process. We reject flexibility in favor of certainty. When the time to pursue dispute resolution arises, we want to be able to move quickly and decisively. In addition, during contract negotiation we do not want to waste time on these issues when the legal and practical best practice is already clear.

PRC Arbitration Law requires that the agreement to arbitrate must include, among other things, the parties’ intent to arbitrate and the arbitration institution where they will arbitrate. A dispute resolution provision is likely to be viewed as invalid if it lacks either of the above. If the dispute resolution provision gives the plaintiff a choice of the dispute resolution method, there is substantial risk that the provision will be held to be fatally vague. For example, pursuant to Article 7 of the Interpretation of the Supreme People’s Court Concerning Several Issues on the Application of the PRC Arbitration Law (最高人民法院关于适用《中华人民共和国仲裁法》若干问题的解释), an optional provision like this will mean that the agreement to arbitrate is invalid.(第七条当事人约定争议可以向仲裁机构申请仲裁也可以向人民法院起诉的,仲裁协议无效).

Of course, this rule only comes into effect if the respondent objects. If a party submits an application with the arbitration institution to arbitrate the matter, and the respondent does not object before the first arbitration hearing, then the arbitration may proceed. (第七条但一方向仲裁机构申请仲裁,另一方未在仲裁法第二十条第二款规定期间内提出异议的除外) This may not happen often in the real world. Chinese lawyers are masters of delay. Once the defendant/respondent has lawyered up, it become almost a certainty that it will object to arbitration on the grounds that the arbitration agreement is invalid.

In the early 2000 era, this result often meant that the plaintiff was simply denied a remedy. The situation in this regard has improved. Most recently, PRC courts have taken the reasonable position that even though the arbitration agreement is considered invalid, the plaintiff will still have access to the court. However, this result comes after substantial delay, which places the plaintiff in a weak position at the start of litigation.

Given this result, most experienced Chinese litigators agree with our position that a flexible dispute provision like this is almost meaningless because the very reason to have a dispute resolution provision is to clarify what will happen should any dispute arise. Choosing a dispute resolution provision that is not clear defeats the purpose of drafting such a provision.

The approach that provides that the place of dispute resolution as the location of the defendant is legal and enforceable in both China and the U.S, but it is impractical. The first issue concerns governing law and language. It is not very practical to litigate a Chinese language/Chinese law contract in a U.S. court. Chinese parties have become quite sophisticated and they are aware of this issue. For this reason, Chinese parties typically refuse to accept such a provision which then results in a lot of fruitless and costly discussion over a provision that made no practical sense from the beginning.

We also do not like the provision that prohibits an actual lawsuit unless and until the parties have spent 30 days “amicably” trying to resolve their dispute and then mediated their dispute.  Nine times out of ten this sort of provision only drives up costs and increases delay.  If your Chinese counter-party has breached your contract with it, do you really want to be required to have to spend 30 days trying to work it out and then another 6-8 months seeking agreement by mediation?  No, you don’t, especially since you can always propose such actions after the breach in the rare case that it would make sense for you to do so.

The China Bank Switch Scam Lives On. No Surprise.

Posted in China Business, Legal News

I got an email from my law firm’s banker today saying the following:

I just wanted to inform you of a type of fraud we are seeing happen in regards to wire transfers.  We have had customers who have received emails from their normal vendors they send wires to informing our clients that the bank account of the vendor has changed and to send it to a new account number.  However, in these cases the vendor’s email was hacked and once the wire is sent it is very rare that we can recall the wire once the money is sent in these situations.  We just want to ensure if you do receive an email from any vendor that they have a change in their account numbers you are wiring money to; please confirm with them over the phone verbally just in case.  Let me know if you have any questions.
My first thought was “no shit,” but then I decided to respond by letting her (our banker) know that my law firm could help, so I responded with the following:
We are well aware of this fraud as we have dealt with literally a dozen of these for companies that have been victimized by it in just the last year alone.
We are constantly writing about it on our China Law Blog, as you can see from the below:
We help the scammed company deal with its insurance issues and, more importantly, we try to work out a deal with the vendor that has in many instances allowed the fraud to have been perpetrated by allowing outsiders (or insiders!) to hack in to its computers. We have handled these frauds for people out as little as $40,000 and as much as $4 million and our work on this just keeps increasing.
If any your customers need help, please let them know about us because I’m guessing we do more of this work than anyone. We also provide training to our clients on how to avoid these sorts of frauds. I have cc’ed our compliance lawyer, Chris Priddy, on this, as he is the one who leads this sort of work.

China Representative Offices. Be Careful.

Posted in Basics of China Business Law, Legal News

For every 100 Wholly Foreign Owned Entities (WFOEs) and Joint Ventures (combined) my firm helps set up in China, it only sets up one Representative Office. Why so few, when Rep Offices are the easiest entity for foreigners to form in China? Because their inherent limitations mean they seldom are the best way for our client companies to go into China.

Representative Offices are aptly named — they are the China representative of the foreign company. A Rep Office is not considered a separate legal entity under Chinese law and it is limited by law to performing “liaison” activities. It cannot sign contracts nor bill customers. It cannot supply parts nor perform after-sales services for a fee. It cannot earn any money in China nor take any payments from a Chinese person or business for any reason.

Representative Offices are pretty much limited to engaging in the following:

  • Conducting research
  • Promoting their foreign company owner
  • Coordinating their foreign company owner’s activities in China
  • Other activities that do not and are not intended to generate a profit in China

Because forming a Rep Office in China is faster, cheaper, and easier than forming a WFOE (see The Agony And The Ecstasy Of Forming A China Subsidiary Company — WFOE), companies often consider forming a Rep Office in China to test the waters there, with the intention of switching over to a WFOE once it becomes clear China will be viable for them. We generally discourage this approach because “switching” from a Rep Office to a WFOE is not really a switch at all. It involves two steps: (1) shutting down the Rep Office and (2) forming a WFOE from scratch. Because the cost of forming a Rep Office, shutting down the Rep Office, and then forming a WFOE will be considerably higher than just forming a WFOE, forming a Rep Office with the later intention of forming a WFOE seldom makes sense. Companies will almost always be better off just biting the bullet and forming the WFOE straight away. Whenever one of our clients suggests this sort of approach, I tell them that “as lawyers we love it because it allows us to charge for the WFOE, charge (a lot) to shut down the WFOE, and then charge again for the Rep Office, but that other than that, it is a bad idea.”

Companies sometimes contact our China lawyers believing they need a Rep Office because they need a Chinese entity to sell their product into China. Not necessarily. In many situations, companies can sell their product into China without having any in-country footprint. For more on that, check out the following:

But sometimes a Rep Office does make sense. My firm once set up a Rep Office for an American company selling American-made equipment with an average transaction value of $2 million. This company had no plans to manufacture its equipment in China, and already had an arrangement with a Chinese company to repair its equipment in China. All it wanted was an on-the-ground China presence to improve its sales and to let its customers and potential customers know it was serious enough about China to commit to having an office there.

There are three basic requirements for forming a China Rep Office:

  • There must be a lease on an approved space for a period of at least one year beyond the approval date of the Rep Office. Since many jurisdictions accept leases only from a small group of approved office buildings, care is required. Shanghai, for example, is one such jurisdiction. The lease must be registered, which also can cause problems in some jurisdictions.
  • There must be a designated Chief Representative to manage Rep Office affairs.
  • There must a foreign entity (typically a limited liability company or a corporation) for the China Rep Office to represent. Private individuals and partnerships cannot establish a Rep Office in China. In addition, most jurisdictions in China do not allow newly formed entities to form a Rep Office.

The local approval authorities usually issue their decisions on Rep Office approval in about thirty days, at which point the Rep Office must do many of the other things typically required of businesses in China. However, in some cities, the decision can take much longer, depending on the whims of the local officials.

The following three things make Rep Offices unattractive:

  • Even though Rep Offices are not permitted to earn income in China, they are subject to taxation. There is at least a 10% tax on the gross expenses of the Rep Office. If the Rep Office is large and has a number of employees, this tax can be quite high.
  • A Rep Office is not permitted to hire Chinese nationals directly; such hiring must be done indirectly through contracting with a Chinese employment agency such as FESCO. Such contracts are generally unattractive for foreign companies.
  • A Rep Office is limited to four foreigners , each of whom is called a representative. The Rep Office hires these people directly and they are treated as normal employees under China’s employment law system. That is, they are to be hired pursuant to a written contract and their taxes and social benefits must be paid.

The bottom line on Rep Offices is to look before you leap and not get seduced by their relative ease of formation.


How To Sell To China. Sometimes You Can’t Just Walk In.

Posted in China Business

When we first started this blog, the media was obsessed with “doing business in China stories.” Nearly every week there would be a good first person account from someone recounting what it is/was like to do business in China. I often found those pieces quite helpful as they tended to deal with on the ground specifics and I always feel like I am channelling Ronald Reagan by taking the example of one business and extrapolating it to a massive and diverse country.

Here is a partial list of some of those posts:

Most importantly, we always love it when someone with real on the ground China business (not China law) experience sets forth some of the same China maxims as us.

Today’s “writ large” post is by Jeff Holtmeier.  Jeff is the Managing Partner of China-US Business Development Corporation, a Cincinnati-Beijing-Shenzhen Consultancy with whom my firm’s China lawyers have worked on a number of matters. Jeff recently assisted a medical group in getting its innovative eye care product into China. Having worked with a large number companies that have sought to do the same thing, I can vouch for how difficult that is. Selling product or services to China’s medical industry is far different than selling a consumer product and I thought it would be informative to have Jeff explain how he and his team pulled this off.

So without further ado, I give you Jeff’s brief case study on getting through to China’s hospitals.

 

Selling your product or service in China is a challenge that typically requires a combination of market demand and market knowledge. Sometimes it also requires meeting the right people.  This is particularly true when your product is aimed at a relatively closed market like hospitals.

In late summer 2013, a small, fast-growing medical technology company from the Midwest sought my company’s assistance in developing the Chinese market for their diabetic retinopathy telemedicine platform – an innovative cloud based software platform that allows remote diagnoses of a person’s risk of diabetes-related blindness. What both distinguishes this platform and makes it so promising for China is that its tests can be performed by any qualified retinal specialist from a smartphone, tablet or PC. The company had already found success in the U.S. by selling to primary care medical providers, and was looking for something similar in China—where an estimated 140 million people suffer from diabetes, and many of the nearly 20,000 publicly operated hospitals have neither the access to sophisticated technology nor the available retinal specialists to interpret the massive volume of images.

We began by researching China’s diabetic population, and quickly determined that the best potential buyers for my client’s product would be ophthalmological hospitals. But our client could not simply walk into the hospital and ask to talk with its purchasing department, so I spent some time researching the target hospitals and identifying the key decision-makers, and then worked my Chinese contacts for proper introductions.

Through “a business associate of a business associate,” we set up a meeting with one of China’s most respected doctors of ophthalmology and his colleague, the director of one of the largest eye institutes in China. (No matter how large the organization in China, the top executive always makes the decisions.) The doctor liked our product and he liked us, and he subsequently invited us to present my client’s product to his hospital’s executive team. He also made personal introductions to other leading Chinese ophthalmologists.

Later, one of these ophthalmologists introduced my client to the chairman of a large eye hospital in Henan. The hospital’s chairman loved the product and the following day asked our client to provide a MOU for their consideration, which we delivered two weeks later upon our return to the U.S. Less than six months after our initial contact with the hospital in Henan, my client’s company licensed the use of its first platform in China.

By identifying a large, untapped customer base, by being willing to spend the time and money necessary to get proper introductions into a relatively closed industry, and then working to secure meetings with key the decision makers, my client is well on the road to success in China.

China IP Protection Is Possible

Posted in Basics of China Business Law, Legal News

Virtually every U.S. company doing business in or with China has intellectual property requiring protection from China. Yet far too many of these companies treat their intellectual property in China as an optional or secondary matter when it really should be one of the first issues they consider when approaching the China market.

Let’s first get clear what we mean by “intellectual property.” IP is not patents, trademarks, copyrights, etc. These are simply tools for protecting intellectual property

So what is intellectual property?

  • A better term might be intangible property or intangible assets. This includes everything about your business that has value that cannot be reduced to a physical asset or to a monetary cash flow, with the exception of things like Goodwill or reputation.
  • For creative industries, IP can include virtually all of the assets of the business:
    • Music
    • Film
    • Books and magazines
    • Research and analysis
    • Design of any kind: interior design, clothing design, product design
    • Architecture and engineering
    • Software of all kinds: industrial, retail, video games, phone “apps”
  • For traditional industrial firms, it includes:
    • Inventions
    • Formulas
    • Industrial processes and know how
  • For all businesses, it includes:
    • Brand and image
    • Business planning and corporate strategy
    • Pricing plans

IP is a substantial portion of the value of most modern businesses.. For many businesses, such as those in creative services, it forms the core of the value of the company. Consider the stars of the modern business world: Apple, BMW, Microsoft, IBM, Boeing, Siemens, Nestle, General Electric, Dow Chemical, Starbucks, Amazon, and SAP. Huge portions of their value is in their intangible assets.

However, even for hard asset, resource-based companies, IP is still a major component in their company value. Take the mining companies that have dealt with China for the past ten years. A major portion of their value lies in their pricing plans, their internal data on their resources, their techniques of extraction and transport, their future exploitation plans and the like. This explains why the primary battle between these companies and their Chinese competitors centers on the attempts of both sides to acquire data to aid in the struggle over control of the market.

Active and careful cultivation of intangible assets is mandatory to survive in the modern business world. There is much more to protecting intangible assets than the traditional IP tools.

The traditional intellectual property tools are:

  1. Patents
  2. Trademarks
  3. Copyrights
  4. Trade Secrets

Though these tools are essential in the IP world, there is a far wider set of techniques that can be used, including the following:

  1. Secrecy and refusal to disclose
  2. Licensing and trade secrecy agreements
  3. Trade secrecy and related agreements with employees and joint venture partners
  4. Physical techniques such as encryption and related data protection techniques

Many companies believe that since they have done what is necessary to secure their rights in North America and Europe, there is nothing special they need to do in China. This is a mistake.

The key concept is that IP protection is local. Since all IP protection is based on local law and practice, you must adopt an effective and realistic protection program for the country in which you are operating. If you are in China, you must consider the situation in China. China is currently the most dangerous country in the world when it comes to protecting intangible assets, but that does not mean you can afford to throw up your hands and do nothing. China’s IP risks can be managed, if you realistically assess the risks and  take practical steps for protection.

To protect your IP in China you must make use of the Chinese system. You must act within China for creation of rights, enforcement of rights, and monetary exploitation of rights. You must deal with China the way it is, rather than hoping to rely on a perhaps more perfect system that simply does not exist in China.

China IP protection can be divided into the following four categories in terms of the effectiveness of the system of legal protection:

  • Patent and trademark protections generally work well in China for protecting against large scale infringement, though small time infringement is difficult to prevent.
  • Contractual measures (such as trade secrecy agreements, non-disclosure agreements, licensing agreements, and technology transfer agreements) work in China if — and only if — properly implemented. For what should go into a China contract, check out Drafting China Contracts that Work.
  • Software copyright. China has a specific regime for software protection by copyright. The system is shockingly effective for commercial software. The system has had limited success in protecting retail software.
  • Copyright in creative works. Copyright protection in China has not worked well at protecting creative works in the retail sector. Virtually all movie, film, and music products are cheaply available in China on a wide scale in pirated form. On the other hand, copyright is effective in China for specific violations of copyright in a business to business setting. However, effective protection of copyright requires careful attention to the Chinese registration regulations. It does little good to rely on the general right of copyright for creative works.

Businesses must focus on the realistic risks within China. The risks vary depending on the type of intellectual property. The general situation is as follows.

1. If your IP has value, and if it can be copied with minimal effort, it will be copied and you should prepare for this . The following assets are particularly susceptible to copying in China:

  • Trademarks, trade names, and logos.
  • Exterior product design (design patent and copyright).
  • Books, photos, reports, drawings/plans — any other medium that can be photocopied and reproduced.
  • Any material that can be copied in digital form: music, film, CAD drawings.

2. The Chinese seldom put much effort into independent copying of inventions and other technical IP that cannot be copied easily. If intangible assets cannot easily be copied, the Chinese will usually wait to be trained by the foreign business. They will seldom appropriate foreign technology on their own initiative. As a result, the motivation of many Chinese companies that work with foreign businesses is to acquire technology, trade secrets, and know-how via training from the owner of the IP. This occurs in virtually any area where Chinese companies work with foreign businesses:

  • Technology licensing projects;
  • Joint venture manufacturing or services;
  • OEM manufacturing;
  • Product design and development agreements;
  • Employee training; and
  • Distribution and sales agreements.

Most technology, know-how, and trade secrets are lost in China to companies and employees that have been trained by the foreign owner of the intangible asset. Usually this loss could have been prevented with proper agreements and business practices.

No protection in China will be perfect and American companies often discover that their preferred and customary method of technology protection is not available in China:

  • Patent protection is often not available because of the China rule requiring that China patents must be filed within one year of the patent having been filed elsewhere.
  • Copyright protection is often not effective for easily copied digital media.

Faced with this, many American companies simply give up and operate in China with no protection at all. This virtually always leads to disaster in China. The correct approach is to work to find an alternative form of protection. This can be achieved in many ways, including the following:

  • Licensing agreements;
  • Secrecy and non-use agreements;
  • Technical controls, such as encryption; and
  • Direct manufacture rather than OEM or joint venture.

Many American businesses think China has no IP laws and that Chinese companies do not file lawsuits. This is a mistake. Chinese companies actually tend to be quite adept at using the Chinese IP system to their own benefit, including employing the following tactics:

  • If the American side fails to register its intellectual property in China, a Chinese entity will register the IP in its own name. In this way, the Chinese company cuts the American company out of the American company’s own market. This happens regularly with trademarks, patents, and commercial copyrights.
  • Many American companies mistakenly believe that China does not have a developed IP protection system. They therefore do not adequately investigate to ensure that they are not infringing the rights of others in their operations in China. This is especially of concern when the American company hires a Chinese contractor to perform services or engages in cooperative design or manufacturing operations with a Chinese company. The American company only learns later that it has infringed on the IP of another. The resulting damages can be significant. For how this can play out on the trademark front, check out When To Register Your China Trademark? Ask Tesla.

There is IP protection in China and if you are going to be doing business in or with China, it behooves you to figure out how best to protect your intangible assets.

How To Form A China WFOE: Hong Kong Parent Company Is Optional

Posted in Basics of China Business Law, Legal News

I was cc’ed on the following email the other day from one of our China lawyers responding to a client who wanted to know the “benefits” of forming a Hong Kong company to own its China WFOE, as opposed to its just forming its China WFOE directly in China. I am publishing it below because it provides such a good and blissfully succinct explanation of the pros and cons of forming a Hong Kong company to own a China WFOE. The key takeaway should be that whether it makes sense to have a Hong Kong entity be the parent of a planned China WFOE truly depends on the individual situation.

 

The question you ask is a complicated one. Generally speaking, there are two basic reasons for establishing a subsidiary in Hong Kong to be the direct parent of a WFOE in China: (1) tax benefits and (2) ease of incorporation.

(1) The tax benefits depend on a number of factors, such as the country where the parent company is incorporated, the tax treaties between that country and Hong Kong (if any), the tax treaties between that country and China (if any), the type of work done by the WFOE, the amount of profit the WFOE is projected to make, the amount of money the WFOE plans to repatriate to the home country, and so forth. Sometimes there are no tax benefits; it is something to discuss with your international accountant beforehand. If you need any assistance in finding the right accountant to work with you on this, please let us know as we can certainly make some referrals for you.

(2) Ease of incorporation has to do with the substantial (and often nonsensical) documentary requirements of the Chinese authorities. For a variety of mundane reasons, it is almost always easier and faster to submit documentation from a Hong Kong parent company than from a U.S. company.

Forming a Hong Kong company also has disadvantages. You will have to pay for incorporating a separate entity, and to maintain that entity you will have to file annual reports, pay taxes, and do all the other things required of Hong Kong corporations. All of this is relatively easy and cheap, but it’s an additional layer of complexity. Also, while incorporating a Hong Kong company is easy, opening a Hong Kong bank account is not. It takes time, a lot of documentary evidence, and an in-person appearance at the bank by at least one representative of the Hong Kong company.

The above discussion presumes that the Hong Kong company is a mere shell company that has no employees and no operations outside of its ownership of the Chinese WFOE.

Happy to discuss further if you’d like.

When To Register Your China Trademark? Ask Tesla.

Posted in Basics of China Business Law, Legal News

Electric car maker Tesla Motors is being sued in China for trademark infringement, in what Reuters calls “a surprise development that casts a shadow over CEO Elon Musk’s ambition to expand rapidly in the world’s biggest auto market.”  The plaintiff is seeking a court order stopping all Tesla sales and marketing activities in China and around four million dollars compensation. The plaintiff claims to own the “Tesla” car trademark for China because he registered it in 2006, well before Tesla came to China.

Even without digging deeper into the facts and the law surrounding this particular case, we can most emphatically tell you that it should be instructive on at least one thing: if you are ever planning to sell (or even manufacture) your product in China, it behooves you to at least explore registering your trademark(s) in China right now. China is a first to file country, which means that whomever first secures a trademark generally gets it.

What this means in real life is that if you are right now selling ABC Widgets in the United States (where you have a registered trademark, or not) and you do not own the trademark for ABC Widgets in China, someone in China can go off and relatively cheaply register the name ABC for widgets in China. What this then means is that if you, let’s say, two years from now want to sell your ABC Widgets in China, you will need to buy or license the ABC Widgets trademark from its owner in China or sue to try to get it.

In our experience, buying trademarks from Chinese companies is typically quite difficult and quite costly and oftentimes does not result in a sale. Read the Tesla article or read about Apple’s issues with the iPad name in China to see what we mean. And pursuing litigation over a trademark in China is also typically quite difficult and quite costly, and quite risky as well.

By far the fastest, cheapest, easiest, safest way to make sure that you can use “your” trademark in China is to register it before anyone else does. When should that be? Pretty much as soon you have both an inkling that you will need/want to use your trademark in China.

For more on the importance of registering trademarks in China and on how to register a trademark in China, check out the following: