China distributorsClients sometimes come to our China lawyers with an apparent conundrum. They have found a Chinese distributor for their product, and both sides are ready to begin selling products in China right away. As in, tomorrow. So far so good. But our client sells a branded product, and they haven’t registered their brand as a trademark in China. Not so good.

The client knows (perhaps from reading this blog) that the only realistic way to get trademark rights in China is by registering them, because China is a first-to-file country.

And then they learn that it usually takes 12-18 months to register a trademark in China. At this point they become concerned about the nontrivial period when their distributor will be selling their branded product in China without any sort of trademark protection.

They should be concerned. But not too concerned, as long as they file their China trademark application right away and enter into a written agreement with their Chinese distributor. The distribution agreement should contain provisions stating that the trademark belongs to the client and the distributor may use the mark in China, but will not file any competing applications, oppositions, or invalidations.

The distribution agreement should also include appropriate contractual language protecting the IP more generally. And if you want this agreement to work to protect your trademark in China, it is much better for it to be in Chinese.

A distribution agreement with the above provisions (along with countless others, of course) will sufficiently protect your IP as against your China distributor. The remaining concern, which cannot be addressed in a distribution agreement, is infringement by a third party while the trademark application is pending.

Without a valid registration in China, there usually isn’t much you can do to stop a third party from using “your” mark. But any legitimate Chinese company is going to shy away from a strategy that only gives them 12 months to establish and profit from a brand name, after which it must stop using it or risk paying damages. That leaves the counterfeiters, for whom 12 months is more than enough time to make a profit, but who aren’t going to be interested until a brand has developed enough name recognition to be worth ripping off. Still, yet another reason to file a trademark application now. Because the distributor is going to be the one who really bears the brunt of any infringement in China. Sophisticated Chinese distributors know this and so we often have situations where American or European companies come to us after having been instructed by their potential or actual distributors to file their trademarks in China.

One final note: many foreign companies do not create a Chinese brand name before selling their product in China, only to discover that a name has been created for them and registered as a trademark – often by their Chinese distributor. If you haven’t already come up with a Chinese name for your product, do so now, and also make sure your distribution agreement requires the distributor to assign to you any Chinese-language marks that relate to your product that it has already registered.

China employment lawyerAs I have previously written a China employer must pay its employee statutory severance when that employee resigned because of the employer’s failure to pay his or her compensation on time or in full. For example, when an employer owes an employee three months’ salary, the employee can probably unilaterally terminate the employment relationship and demand all unpaid salary owed to him or her. What constitutes  “on time payment” can often be tricky.

Note that in most places in China, employers must pay their employee at least once every month. One question I am often asked is what happens when the employer and the employee contractually agree on a longer payment cycle? In those circumstances, can the employee quit and get statutory severance? The short answer is usually yes. Let’s take a look at an actual recent case in Shenzhen.

In this case, the employer and employee entered into an employment contract explicitly stating that the employer would pay the employee on the 20th of each month for the employee previous month’s services. The employer was never late in making payment as per the terms of this contract and the employee never objected to the payment terms. But after working for the employer for a while, the employee quit his job and sued the employer for having failed to timely pay him. The company asserted two defenses to the employee’s claims: (1) the principle of freedom of contract should apply and the parties’ written arrangement on the payment cycle should be upheld; and (2) many employers have financial troubles and pay their employees late and making employers strictly comply with this employee payment law would be unduly harsh for China employers.

The Shenzhen court found against the employer and for the employee.

The court cited the applicable employee payment regulations in Shenzhen, which essentially require pay dates be no later than seven days after any agreed payment cycle. In other words, an employee must be paid no later than by the seventh day following the month in which he or she provided the service. And if for some reason the employer is unable pay by the agreed payment date, it may extend that date for up to five days. If after that the employer is still having financial difficulties, it must obtain written consent from either the labor union or the employee to extend the payment date even further, but in no event may the employer be more than 15 days late in paying.

The court went on to say that even though the regulations allow an employer to make late payment under certain circumstances, this is a very specific exception to the general rule and the employer in this case violated the law by routinely paying late without justification and without following the rules for late payment. Because the employer violated the late payment law, the employee’s termination was caused by the employer’s failure to compensate him on time. The employee was therefore entitled to tens of thousands of RMB in statutory severance — an amount based on the employee’s total years of service for the employer and his monthly salary.

The employer in this case probably never thought it would have to pay this money because it performed its obligations pursuant to the terms of its contract with its employee.

There is much to be learned from this case about China employment law, including the following:

  • It pays to have a qualified lawyer conduct an HR audit of your company and to have this done before your employment problems arise. I would estimate that at least 80 percent of the China employment problems for which my law firm is retained involve issues we easily would have spotted with a simple and relatively inexpensive HR audit. But instead of a relatively leisurely and inexpensive audit, we are instead confronting an angry employee (oftentimes employees) who is threatening to sue or has already sued. One of the first things our China employment lawyers do on a China HR audit is to review our clients employment contracts and the employer rules and regulations to make sure what is in those critical documents actually accords with all applicable laws, including most importantly, the local laws.
  • Timely pay your employees and in full. To do this, you need to know what your local jurisdiction means by “timely.”
  • Many China employment laws cannot simply be contracted away. It is important that you know what can be changed by contract and what cannot be and it is important that you also realize that all of this can vary depending on where you are and even depending on the type of employee with which you as the employer are contracting. Just by way of a quick example, you will generally have more flexibility in contracting with a COO you are paying USD$40,000 a month than with a factory worker you are paying less than USD$40,000 a year.
  • And just to throw in one more that is very much based on a recent employment matter I just handled: just because other employers (especially Chinese employers) get away with it does not mean you will too.
  • If anything, China gets tougher on employers every year and that — unfortunately — is even more true of foreign companies doing business in China.

China Joint VenturesAn old saying about lawyers is that we do well when the economy is rising and when the economy is falling and we do especially well when big changes are expected. Flat and steady we don’t like. The same holds true for China lawyers.

Well our China lawyers have lately been working nearly around the clock on forming WFOEs and working on Joint Ventures for American and European companies that want to set up a business in China, oftentimes because they see doing so as providing them cover should a trade war ensue. They are of the view that having a China business will make them less susceptible to duties and tariffs and blockages. We are seeing the same thing with Chinese companies seeking to enter the United States and Europe, either on their own or by buying American or European companies.

Today’s post focuses on China Joint Ventures for the simple reason we have not written on joint ventures since July of 2016, and that post mostly focused on how distributer contracts can be a great alternative. As part of our return to joint ventures, we will focus on the basics with this point.

As we so often point out, China joint ventures are notorious for their high failure rate. An old Chinese saying often applied to joint ventures is “same bed, different dreams.” This Chinese saying (同床异梦) actually predates joint ventures and it applies to any sort of partnership without a meeting of the minds. American companies and Chinese companies far too often rush into joint ventures without ever discussing their respective dreams. The sooner you seek to discern whether you and your potential China joint venture partner share the same dreams, the sooner you will know whether to keep spending time and money in trying to do the joint venture deal, or simply walk away.

So towards that end, we compiled a list of questions for our clients to discuss with their potential Chinese joint venture partner to help determine whether there is enough commonality to move forward in trying to enter into the joint venture deal.

  • Why are you seeking to accomplish with our joint venture?
  • What will you do for, and with, the joint venture?
  • What will your company do to advance the business of the joint venture and what exactly do you want our company to do to advance the business of the joint venture?
  • Who will make business decisions for the joint venture, and what mechanisms will we use for reaching a decision? Who will control what? Who will make what decisions? The more specific you get here, the better.
  • What will we each contribute to the joint venture? Property? Technology? Intellectual property? Money? Know-how? Employees?
  • If the joint venture loses money, who will be responsible for putting more money in?
  • How will we resolve disputes? Chinese companies love responding to this with something along the lines of “we will work out any issues among ourselves and if that fails, we will have a special meeting to try to resolve everything. That sort of answer is essentially meaningless. The answer you want is the one that explains exactly how day to day disputes will be resolved so the joint venture does not collapse?
  • Can either of us use confidential JV information for our own business? Can our own businesses compete with the JV? Can our own businesses do business with the JV?
  • How and when will the joint venture end? What if one of us wants to buy the other one out?

Posing these questions puts dreams to the test. For the better.

For more on China joint ventures, check out Joint Venture Jeopardy and Avoiding Mistakes in China Joint Ventures.

Doing business in China
China businesses can have a changing of the guards too

Late last year, a Foxconn executive was criminally charged in China with having stolen 5,700 iPhones and I am guessing most companies doing business in China never thought twice about this. They should.

When one of our China lawyers tells a client about how important it is to have a contract with their Chinese counter-party that makes clear who owns what and what must be kept confidential, our clients sometimes respond by insisting they know and trust the owner of the Chinese company and so such a contract or provision will not be necessary.

So what is the connection between the 5700 stolen iPhones and the reaction our clients sometimes convey to our China attorneys? Here goes.

The meaning of the Foxconn story is that a company is more than one person. Yes, your friend may never steal your trade secrets, but his or her employees or subcontractors very well might and if you want to encourage your friend from preventing such thefts and set yourself up for compensation if one occurs, you need something in your contract that does those things. Also, how many times have you had a friend or ally leave or even sell the company with which you are conducting business and then the new person claims no knowledge of previously agreed upon matters? And is it really beyond the realm of possibility that at some point your relationship with this person might sour?

So though friendship is of great importance, a written contract can be more long-lasting and provide better or at least additional protections. And who does not want that?

China employee terminationWhen a China employer and one of its employees end their employment relationship, one of the most important things the employer must do is provide the former employee with a Proof of Termination of Employment Relationship document. This employer obligation is stipulated in the PRC Labor Contract Law (and in many local regulations as well). The Law says that if you as employer fail to perform this obligation, you can be subject to both administrative corrective orders and to damages.

Let’s consider an actual recent case in Beijing (simplified a bit for this post). An employee and employer entered into a contract for a 3-year term and it came to a natural end on May 3, 2014. Employee’s base salary was 16,000 RMB/month. The parties terminated the employment relationship on May 5, 2014. Employee alleged that Employer refused to provide a Proof of Termination of Employment Relationship document. Employee began working for a different employer (Employer B) on May 7, 2014. Due to the Employer’s failure to provide a Proof of Termination document, Employer B issued a termination notice on May 27, 2014 and the parties formally terminated their contract on May 30, 2014. On July 29, 2014 Employee received a job offer from a prospective employer. However, on August 8, 2014 Prospective Employer provided a notice of its decision not to extend employment due to Employee’s failure to provide a Proof of Termination of Employment Relationship document. Employer B paid Employee 22000/month and Prospective Employer offered the same rate.

Employee brought a labor arbitration claim and Employer was ordered to provide a Proof of Termination document. There was some disagreement as to whether Employee contributed to the non-issuance of this document. Employer still refused to provide a Proof of Termination document. Employee sued in court and asked for RMB 113,034.48 in damages or almost 6 months of salary.

Beijing Chaoyang District People’s Court sided with Employee and found the Employer’s failure to provide a Proof of Termination document caused Employee damages but did not agree that the amount of damages should be RMB 113,034.48. Without providing much analysis the Chaoyang court awarded the employee RMB 40,000. Employee appealed and the appellate court (Beijing Third Intermediary People’s Court) affirmed the lower court’s decision. It held that the damages Employee claimed were not actual, definitive, or inevitable losses and after considering the total circumstances of the case and the parties’ fault, the lower court’s decision was appropriate.

Bottom line: Perform your employer obligations at the time of employee termination, including most importantly, issuing your terminated employees a Proof of Termination of Employment document.

 

China contract lawyerOne of our China lawyers got an email the other day from a US company saying the following:

I read one of your blog posts saying that it almost always makes sense to draft a contract with a Chinese company in the Chinese language and to say that Chinese law applies and the dispute will be resolved in a Chinese court. Here is my contract which I will be translating into Chin00606ese. As you can see, it says Chinese law will apply. I also have chosen the Shanghai People’s Court as the Court because I understand that is the best court in China. Can you quickly tell me if you agree with what I have done here.

I was “nominated” to respond to this email and I did so as follows:

Sorry, but there is no way we can give you any legal advice without knowing a lot more about your goals with this contract, your fears with this contract (preferably ranked) and more about you and your Chinese counter-party. What I can tell you from five minutes skimming your contract is that translating a contract into Chinese and saying Chinese law applies does not make the contract appropriate for China. This contract has many provisions that do not make sense for China and will never be enforced and other provisions that are probably harmful to you. Your listing of a specific court in China is probably not a good idea, nor is your provision calling for a cooling off period before you can sue.

Let me break down and briefly explain the concerns I quickly noted in my email because the problems (and even the number of problems) in this contract are incredibly typical of what our China attorneys often see in contracts drafted by people — including lawyers — without substantial real world China contract drafting experience.

  1. Translating a contract into Chinese does not make the contract appropriate for China. It just doesn’t. Just as is true of every language and of every country, there are certain words and phrases that courts just know and if you nail the phrase exactly you will likely have no problem and if you do not come close to nailing the phrase at all you may or may not have a problem. But if you come close to nailing the phrase, but don’t, you are likely to have a major problem because the court will think the contract is specifically intended not to nail the phrase and specifically intended to call for something different than the usual. Then of course there are all the times where people put in provisions that simply will not work under Chinese law.
  2. Listing a specific Chinese court for your dispute is usually a mistake. Chinese courts tend to ignore any attempt by contracting parties to dictate where a matter will be litigated. Chinese courts usually determine jurisdiction based on the nature of the claim, the amount of the claim, the location of the parties, and the location of the witnesses to the dispute. If your choice of Chinese court jurisdiction is wrong (and it probably will be because China has speciality courts and complicated jurisdictional rules) your mistake could raise questions about the validity of Chinese Court jurisdiction or create other confusions.  The reason for crafting a dispute resolution clause is to avoid the expense, time, and  uncertainty of where and how your disputes will be resolved. Trying to get too specific about the Chinese court will likely only delay resolution and increase uncertainty and expense.
  3. Cooling off periods usually do not make sense. Suppose your Chinese manufacturer has started making and selling your product all around the world. Do you really want to be unable to bring a lawsuit to stop that as quickly as possible? Do you really think if this happens it will make sense for your company to have to spend 60 days “amicably” trying to resolve your dispute with this company and then have to spend another few months choosing a mediator and then an additional 4-10 months trying to reach agreement via mediation? Of course not.

What are you seeing out there?

China employment contractEmployers in China are presumed to have greater bargaining power than their employees and therefore China’s labor laws tend to provide China employees with substantial protections and China courts typically favor employees in disputes with their employers, especially foreign employers. If you as a foreign employer want to avoid legal problems, you should strive to hew to the employment laws, especially when it comes to drafting your employment contracts.

China employment contracts are not a time to get creative and a recent court case out of Guangdong confirms this. In this case, an employee and a Guangzhou-based employer entered into an employment contract for a fixed term (more on this later). The parties explicitly agreed on a contract damages provision stating that if either party terminates the contract without good cause before the end of the contract term, the breaching party shall pay the other party 200% of the employee’s salary for the remainder of the term. This provision was intended to be effective both ways: it did not just apply to the employer.

The contract was properly executed and the employer eventually terminated the employee before the end of the term — about four years into employment, with about six years remaining on the term. The employee then sued the employer for double damages for unlawful termination and for the contract damages per the employment contract: 200% of salary for the six years remaining on the term. The employer argued that it was entitled to damages because the employee had deceived them in securing his job by falsely claiming to be a foreign expert.

The appellate court ruled that Chinese law prohibits imposing a penalty on employees unless an exception applies, which it rarely does and it did not in this case. The appellate court also upheld the damages provision as applied to the employer and held the employer liable for the contract damages. The court ruled that the damages provision as applied to the employee was illegal whereas that same provision as applied to the employer did not violate any laws. The employer therefore owed the employee 200% of his salary.

In reaching its decision, the court noted that China’s labor laws allow for penalties against employees in only the following two circumstances:

  • Pursuant to an education reimbursement agreement, an employer can require its employee reimburse the company for the education expenses if the company pays major expenses for an employee’s employment-related education or training, but the employee quits the company upon completion of the training.
  • Pursuant to a non-compete agreement, an employer can require an employee pay a penalty to the company if the employee violates any non-compete terms by, for example, working for a competitor after leaving employment.

Except for the two circumstances above, an employer and an employee may not agree on any provision that requires the employee pay a penalty to the employer.

Bottom line: Chinese laws are strict about when an employer can impose a penalty on an employee and employers typically cannot contract around China employment laws. For these reasons, it rarely makes sense to draft an employment contract with provisions that purport to do otherwise.

China contract lawyersDespite all that you may have read about China’s economy being on the downswing and despite all that you may have read about China factories closing, our China lawyers are starting to see distinctly tougher negotiating by China factories. We attribute this to the following:

  1. To greatly simplify, ten years ago China factories made socks and rubber duckies and with thousands of factories capable of making these things competition was incredibly intense. On top of this, price was oftentimes the foreign buyer’s only real concern. Today, China factories are making incredibly complicated products and oftentimes few or sometimes only one China factory has the capability to make the exact product the foreign buyer wants. Sometimes a China factory even holds a patent for some aspect of the product and so that factory is the only factory that can produce the product with that one aspect. Needless to say, being unique or nearly unique increases pricing power.
  2. To again greatly simplify, ten years ago, there were a number of China factories that knew little to nothing about pricing. It would not be an exaggeration to say that our China lawyers oftentimes dealt with China factories that did not even know their costs, leading us to often joke that they would make up for their selling widgets at a dollar under their costs by selling massive quantities of widgets. Most of those factories either wised up or no longer exist.
  3. Read all you like about factories closing in China, but recognize that there are plenty of profitable China factories these days with very good long term relationships with good stable foreign buyers. Those China factories are in no rush to take on your production on bad terms.

So what we are seeing now is a power shift, with Chinese factories more and more often gaining the upper hand. In subtle ways, this is making our job as China lawyers more difficult, while increasing legal fees for our clients. In the old days, our typical scenario would be that we would draft a manufacturing agreement (a/k/a OEM or ODM contract), send it to the Chinese company and get it back signed within 24 hours. Nowadays, it is far more common for us to receive pushback from the Chinese company on terms, including on terms to which the Chinese company previously agreed with our client. Needless to say, one of the more common push-backs is on price, with the Chinese factory oftentimes saying something like, we quoted $5 per widget with the understanding that we would have 90 days to produce after receiving the PO and now you are asking for 45 days (even though the email trail reveals that our client had made clear it was 45 days all along).

We are also seeing increased toughness even in the pre-quoting stage from China companies. About a month ago, I received an email from a foreign buyer telling me that a potential supplier was saying that it would sign an NNN Agreement with the foreign buyer agreeing not to use any secret information provided by the foreign buyer to compete with the foreign buyer, but if the foreign buyer ended up using another supplier to make its widgets, it would not be bound by the NNN Agreement. In other words, it would be free to use the foreign buyer’s top secret information to compete with it. The foreign buyer asked if something like this would work, to which I replied as follows:

No, this will not work. Not at all. This could be terrible for you. Imagine this scenario. Imagine you get quotes from five other good manufacturers ranging from $5 per widget to $7 per widget, but this one Chinese company is quoting you at $12 per widget. Do you pay the obviously inflated $12 per widget price, because if you do not, that Chinese company can (and likely will, otherwise why is it’s price quote so out of line with everyone else’s) will start making your widgets and competing directly with you. So you can see why this is not acceptable. We have actually never heard of a Chinese company making this sort of proposal so you should not face this situation with any other potential suppliers.

But then yesterday, one of our China lawyers got a similar email from a foreign buyer asking us essentially the same question. I discussed all of this with co-blogger Steve Dickinson and his response was “that’s what’s so cool about Chinese companies. They tell you what they are going to do. These two Chinese companies are saying if you don’t choose us we will steal your product. The choice is up to you. It’s up to our clients to listen”

I guess that is true. To which I can only ask whether you our readers agree that doing business in China and with China is only getting tougher.

For more on China manufacturing pricing, check out China Manufacturing Agreements: Binding Contract or Contract Terms.

China trademark takedown
China trademark takedowns

China’s lack of an affirmative trademark use requirement allows trademark owners to register marks in more classes and covering more products and services than what they actually sell. Starbucks is a prime example of a company that has taken full advantage of this strategy by (for example) registering “STARBUCKS” as a trademark in all 45 classes of goods and services.

The benefits of registering in a whole host of China trademark classes really comes into play when dealing with infringing goods on Alibaba and other e-commerce platforms. Many of our clients have found that infringement starts with their core lineup of products but quickly moves to things they haven’t released and perhaps never will. Any consumer product is fair game for knockoff artists. If they can imagine it, or more precisely if they can imagine someone buying it, it will turn up on Alibaba.

Though Alibaba is responsive when you request a takedown for a product covered by your trademark registration, they often will decline to take action if the product is outside the scope of your registration. So if an enterprising Chinese merchant began selling Game of Thrones brand deodorant on Alibaba, HBO might only succeed with a takedown request if it had already registered a trademark covering deodorant.

Registering your trademark is the only realistic way to gain trademark protection in China, and that protection is limited by the classes and subclasses of goods and services covered by your registration. If you want protection for other products, you need to register in the appropriate classes and subclasses to cover those products.

Registering in all 45 classes is not a realistic strategy for most company. But when devising your IP strategy for China, you should think about not just the products and services you intend to sell in China, but also the ones you don’t want someone else to sell under your name.

China media and entertainment lawOur Beijing-based entertainment attorney, Mathew Alderson, will be speaking on a panel at Southwestern Law School in Los Angeles on January 19th. The panel is entitled “China and Hollywood: Distribution and Censorship in a Cross-Pacific Partnership“.

Mathew’s panel is part of the Southwestern Law School’s 14th Annual Media Law Conference, whose theme this year is: Keeping the Beat in a Crazy Year: Blurred Lines and Border Crossings.

Mathew’s panel will focus on how to work within China’s legal system on new productions and on how to deal with the unique challenges China presents when doing productions there. The event will be moderated by Covington’s Nicholas Francescon. The other panelists will be J. Martin Willhite, General Counsel and COO of Legendary Pictures, and Sheri Jeffrey from Hogan Lovells. The Conference is presented by the Biederman Entertainment and Media Law Institute and the Media Law Resource Centre.

If you are interested in China media and entertainment law or media and entertainment law generally (particularly IP law), you should go. The conference runs from 1 pm until 7 pm, with the post-event reception scheduled to last until 8 p.m. Go to this link to register.

We hope to see you there.