Grey Market Goods and ChinaIn this projected 4-part series we’ll take a closer look at grey market goods and China. In part 1, we discussed what grey market goods are and why manufacturers get so worked up about them. Today, in part 2, we’ll look at how grey market goods are regulated in China. In part 3, we’ll look at how grey market goods are regulated in the United States. And in part 4, we’ll look at grey market goods and Chinese factories, and what foreign companies can do to protect themselves.

Part 2: How Are Grey Market Goods Regulated in China?

One of the minor mysteries of modern China is how every mall has so many luxury-brand stores that seem never to have anyone shopping inside. I’ve read numerous explanations for this disparity, none of them entirely satisfactory: the shops are loss leaders in an effort to build brand loyalty in China; the shops are highly subsidized by mall owners to bring in other tenants and/or to give them face; all of the sales are made after hours to Party officials’ relatives and mistresses; people just aren’t paying attention at the right time.

But one answer for the empty stores, surely, is the enormous size of China’s grey market for luxury goods. In 2015, Chinese citizens spent $22.5 billion on luxury goods purchased in China – and more than twice that amount abroad.

As noted in part 1, grey market goods exist because there’s a market for them, and that market exists because grey market goods are either cheaper or have better availability. But in China there’s a third driver of the grey market: quality. It’s ironic because in the US, grey market goods have a strong whiff of caveat emptor; if you buy a product outside the normal channels you accept the risk that it might be lower quality. But in China, the calculus is flipped: because counterfeiting is so rampant, the chance of buying a fake is considered to be much lower if the goods come from overseas.

Historically, a significant proportion of grey market luxury goods in China have come via daigou, personal shoppers (usually young Chinese women) who live or travel overseas and purchase luxury goods for well-heeled clients in China. I’ve seen this in action: at Seattle Premium Outlets’ Burberry Store, you sometimes have to wait in line just to get in the store, only to be ignored when it becomes clear you’re not there to drop twenty thousand bucks.

Other grey market goods in China are purchased directly by consumers, either while traveling overseas, or from foreign reseller sites like eBay. Grey market goods can also be found on Chinese e-commerce sites like Taobao and 1688.com; these goods are usually purchased “on spec” overseas and then resold in China. (The daigou as impersonal shopper.) Baby formula and iPhones have, at various times, been extremely popular grey market goods in China.

Grey market goods are legal in China, or at least not an infringement of the brand owner’s IP rights. Indeed, Shanghai’s Free Trade Zone has a car dealership that specializes in grey market automobiles.

But many grey market goods in China run afoul of the law in another way: customs fraud. When the goods are brought into China, they are not declared at all or are declared at lower values. Defrauding Chinese customs is an essential part of many a daigou’s profit margin, because China has historically imposed significant duties on a range of luxury imports.

China has attempted to crack down on illegal grey market importation through a number of means, including (1) higher taxes on goods brought in by travelers as part of their luggage, (2) lower taxes on goods imported through legitimate channels; and (3) increased penalties for those caught falsifying customs declarations.

The effectiveness of these measures is a bit hard to gauge: some reports say the measures are eliminating large-scale daigous; others suggest that the enforcement is both haphazard and overbroad, and that when Chinese people attempt to order directly from overseas retailers, the packages are frequently rejected at the border, with the result being that people are even more reliant on daigous to get the products they want.

On a certain level, foreign brand owners might not be that concerned about grey market imports in China – Christian Louboutin gets paid whether a pair of pumps is bought in Shanghai or in Houston and then taken to Shanghai and resold. But they should be concerned, for several reasons. First, they want to be seen as cooperating with the Chinese government on tax and customs issues. Second, having to deal with so many purchases by Chinese travelers overseas is a drain on resources (staffing, marketing, logistics) and distorts the worldwide revenue stream. Third, sometimes the prices in China, even accounting for taxes and tariffs, are higher than they are abroad — although a number of brands have normalized prices in China in an attempt to dissuade gray market sales. Fourth, the daigou phenomenon increases the amount of intermediation between brands and their consumers, which is exactly the opposite of what companies want. How can you market to customers when you don’t know who they are? And how can you control your brand identity when you are not the seller?

In part 3 of this series, we’ll look at how the United States regulates grey market goods.

Grey Market GoodsIn this projected 4-part series we’ll take a closer look at grey market goods and China. In part 1, we’ll consider what grey market goods are and why manufacturers get so worked up about them. In part 2, we’ll look at how grey market goods are regulated in China. In part 3 we’ll look at how grey market goods are regulated in the United States. And in part 4, we’ll look at grey market goods and Chinese factories, and what foreign companies can do to protect themselves.

Part 1: What are grey market goods, and why do they matter?

Grey market goods are authentic goods sold by unauthorized means. Unauthorized does not necessarily mean illegal; it simply means the goods are coming from someone other than (1) the original manufacturer or (2) a third party to whom the manufacturer has granted permission to resell the goods.

E-commerce has made all manner of grey market goods readily available. When I purchase Gillette razor blades on Amazon for delivery in the United States, the cheapest sellers are all offering grey market blades packaged for sale overseas (typically, Asia, Eastern Europe or South America). Although it’s unclear if these blades are exactly the same as what I would buy at a drugstore in the U.S., the price difference is significant enough that I’m willing to take the chance. And that’s just one example. Any product that has a significant difference in price or availability across different countries is likely to be sold on the grey market. And the flow of goods could go in any direction; it just depends on price and the demand. As China’s consumer class has grown in strength, so has the market for grey market goods. Products as disparate as Apple’s iPhone and Pfizer’s Viagra did significant business in China as grey market goods before they were officially available there.

Grey market goods are hardly a creation of the Internet, though.

A Vancouver, BC man named Michael Hallatt grew tired of waiting for Trader Joe’s to come to Canada, and since 2012 he has operated a store in Vancouver called Pirate Joe’s that stocks nothing but goods bought at Trader Joe’s stores in Washington State. All of the goods are purchased at retail prices in Washington and then marked up for sale in Canada. Trader Joe’s has been trying to shut Hallatt down for years, and has sued him for trademark infringement, unfair competition, false designation of origin, and false advertising.

Two weeks ago Pirate Joe’s announced it was closing its doors, which would have made the lawsuit moot, but at the end of last week Hallatt reversed course and announced on the PJ’s website that he was back in business. What makes Pirate Joe’s story interesting for IP attorneys is how it calls into question the limits of grey market sales. Hallatt certainly seems to enjoy tweaking Trader Joe’s and skirting the edge of the doctrine, but as the Freakonomics blog pointed out in 2013, reselling Trader Joe’s goods is no different than reselling goods on eBay or at a yard sale. The case is still pending.

In another well-known story, Costco purchased large quantities of Omega Seamaster watches from an authorized reseller in Europe, then resold them in the U.S. as grey market goods. Because the prices in Europe were so much cheaper than the retail prices in the U.S., Costco was able to add its usual markup and still price the watches at a substantial discount. Omega sued, but after a protracted battle, Costco prevailed in 2015.

It may be self-evident that the reason grey market goods exist is because there’s a market for them: grey market goods are either cheaper than the goods available through standard channels (e.g., the Omega watches at Costco and the Gillette razor blades on Amazon) or they are simply unavailable through standard channels (e.g., the goods at Pirate Joe’s). A reasonable argument can be made that grey market goods are in fact good for many manufacturers, because they increase brand recognition and product loyalty. And profits! All of these products have been sold by the manufacturer at a price (if not a use) they deemed acceptable.

Nonetheless, grey market goods are often decried by original manufacturers for reasons including the following:

  1. Grey market goods are often difficult to distinguish from counterfeit goods, which harms the reputation of the brand and the manufacturer.
  2. Grey market goods are often customized for the particular market for which they are made, and are unsuitable for use in other markets. This too harms the reputation of the brand and the manufacturer.
  3. Grey market goods often have different warranty protection — or none at all — when sold or used outside the market for which they were made. This causes customer frustration and dissatisfaction.
  4. Grey market goods sometimes are of lower quality (hence the lower price), which harms the reputation of the brand and the manufacturer.
  5. Grey market goods often interfere with the business expectations of the original manufacturer and its licensees.

In Part 2 of this series, we’ll examine how China regulates grey market goods.

China licensing agreements
China Licensing Agreements: The 101

As IP protection in China continues to grow stronger, foreign companies are seeking to access the Chinese market in increasingly sophisticated ways. For many such companies, a license agreement makes the most sense, and to no one’s surprise at our firm, we have been drafting more than ever before. But just because a license agreement makes sense doesn’t mean ANY license agreement will work. You need an agreement specifically drafted for use in China.

1. Require an upfront payment. It makes sense to require Chinese licensees to make an upfront payment. An upfront payment shows good faith on the part of the licensee, and also motivates the licensee to monetize the licensor’s IP. Even more important, an upfront payment establishes that the Chinese side is actually able to make payments. This sounds trivial, but we have stopped counting the number of deals that fell apart because the Chinese side’s bank refused to make payment because of a license agreement’s content. (Deals involving Chinese educational institutions are particularly tricky.) Even a payment as small as a few thousand dollars can be sufficient to provide an adequate test, but ideally it would be more than $50,000 so you can be sure the payment was not made under the annual $50,000 exemption. And the payment should be from the company that executed the agreement. If you get a payment from an individual (like the licensee’s CEO) or a related company, chances are that the company is just playing games.

2. Register the agreement with the relevant Chinese authorities. Every license agreements in China should be registered, and in many cases registration is mandatory. For instance, any technology transfer agreement for technology on MOFCOM’s “restricted” list must be approved by MOFCOM before the agreement can become effective and the technology can be imported legally. Almost every bank in China requires license agreements to be registered with the relevant IP authority before approving payments: trademark license agreements must be registered with the Chinese Trademark Office (CTMO); patent license agreements must be registered with the State Intellectual Property Office (SIPO); and copyright license agreements must be registered with the Copyright Protection Centre of China (CPCC). And any patent, trademark, or copyright license agreement must be registered before it can be recorded with Chinese customs – which is particularly important if you want Chinese customs to help with anti-infringement work and if you don’t want them to seize your licensee’s goods.

In general, you want the Chinese side to handle all registrations and for the license not to be effective until they have provided proof of such registration. The one exception to the former is trademark licenses, which are required by regulation to be handled by the licensor. Either way, the license agreement should provide that the license will not be effective until proof of registration is provided. This requirement goes hand in hand with requiring upfront payments, and serves as a good test of whether the agreement was properly registered. Registration takes at least a few days, so if you receive payment on the same day the agreement was executed, you know the agreement was not registered and the licensee is not being straight with you. Though you want the Chinese side to handle all license registrations (except trademark licenses), it is incumbent upon you to make sure that this was actually done.

3. Limit the territory to China. This is not an absolute requirement but often makes practical sense: Chinese licensees will often ask for rights to numerous ASEAN countries, but it generally makes sense for you to make them prove themselves in China before granting them rights to Malaysia or Vietnam or wherever. Also, China may not statutorily prohibit gray market sales, but you can contractually prohibit your licensee from selling extraterritorially via a well-drafted contract provision.

4. Include strong language on confidentiality and IP protection. Your license agreement should make clear that the IP belongs to you, not to your licensee, and that your licensee is not allowed to misuse the IP or to take any actions that would interfere with your ownership of the IP. And upon termination, the IP will all return to you. The proper language is critical to protect you from someone challenging your trademark three years down the road for non-use.

5. Make sure you own the relevant IP. This should go without saying: you can’t license something you do not actually own. But I am still going to say it, because we are regularly asked to help companies license IP they don’t actually own in China. For patents and trademarks, ownership in the U.S. or Europe is of little or no relevance to ownership in China; the way to own IP in China is to register it. Putting this requirement in the license agreement places the obligation on the licensor, but it’s an obligation you should be happy to shoulder.

6. Ensure the agreement is written in Chinese, governed by Chinese law, and requires dispute resolution in Chinese courts. For all the usual reasons.

Any questions?

 

 

Eight Reasons to File Your China Trademark
Eight Reasons to File Your China Trademark

Spring is coming to an end, but it’s not too late to conduct a little spring cleaning. First on the list: get your IP in order and register your trademarks in China. The following are 8 reasons to do so.

1. Because you are having branded goods manufactured in China, and don’t want them seized for trademark infringement. China is a first-to-file jurisdiction for trademarks and this means that if you don’t register your trademark, someone else could and probably will. Trademark squatters with particularly bad intent will register the trademarks of foreign companies manufacturing goods in China, and then hold those companies for ransom by threatening to seize their goods for trademark infringement. Export-only manufacturing in China generally constitutes infringing trademark use and so even if you are just manufacturing your product in China for sale elsewhere, failing to register your trademark used on that product puts you at great risk of losing your brand name or your logo to someone else in China and not being able to continue having your product made in China. Why expose yourself to that kind of risk?

2. Because you want to take down infringing listings on Chinese e-commerce sites. If you only have a trademark registration in the US or EU or some other jurisdiction outside China, you should be able to submit takedown requests to foreign-facing sites like Alibaba. But to remove listings from domestic Chinese e-commerce sites like Taobao and 1688.com you almost always need a Chinese trademark registration. Many other e-commerce or social networking sites require a Chinese trademark registration and every site will take action more quickly with one. Do you really want to spend your time arguing with DHgate’s customer service representatives? Do you really want to take the risk of having someone selling products with your name on them all around the world (or even just in China)?

3. Because you want to enter into a licensing agreement with a Chinese distributor. If you are going to license your products to a Chinese distributor and those products will be sold in China under the same brand name, then you need to own that brand name in China. You can’t license something you don’t own. A good Chinese distributor will insist that you register the trademark first; a less experienced (or shady) distributor might register your trademark “on your behalf” without telling you.

4. Because you want to sell goods in China. This is an absolute no-brainer. If you are selling branded products in China without having registered a trademark, there is a near 100% chance someone else will register your trademark in China and then come after you for trademark infringement. China does not recognize common-law trademarks and only has minimal recognition for “famous” marks. Just register your trademarks. And register the Chinese-language version of your trademarks, too.

5. Because you want to have counterfeit goods seized by Chinese Customs. With few exceptions, a foreign trademark has no relevance in China. It certainly means nothing to Chinese Customs. Would U.S. Customs and Border Patrol seize goods based on a Chinese trademark registration? Not a chance. And the only way to have Chinese Customs seize infringing goods is to first have a Chinese trademark registration, and then register that trademark again with Chinese customs.

6. Because you want to file a lawsuit in China against notorious counterfeiters. This seems obvious but is sometimes overlooked. You do not have any trademark rights in China unless you have registered your trademark in China. If you attempt to file a lawsuit in China for trademark infringement without actually owning the trademark in China that is allegedly being infringed, you will be laughed out of court. You would be surprised (or maybe you wouldn’t) how often our China IP lawyers are asked to sue a Chinese company for trademark infringement, only to discover that the company that engaged us has no China trademark and hence no basis for a claim of infringement.

7. Because even though you’re not selling goods in China, you might want to someday. It’s no mystery that China is the biggest market in the world, with monstrous buying power and a rapidly growing consumer class. It’s the rare company that can say it is categorically uninterested in selling to China for the foreseeable future. Currently it takes at least a year from the trademark application date to the registration date, and that assumes everything goes smoothly. Having a trademark registration in hand will make it that much easier for you to enter the Chinese market.

8. Because you want to make your company a more attractive buyout target. This goes hand in hand with the above reason. The annals of history are rife with tales of companies who found out too late that a trademark squatter had already registered their trademark in China. Don’t be that company. A company that has its IP all zipped up will always be more attractive as a buyout target. We have represented many a smart company that registers trademarks in China for no other reason than to increase its value to investors.

China defamation lawMaking a biopic – a biographical movie about real people– is complicated. And one of the biggest concerns is liability for defamation. In an ideal world, filmmakers would get everyone depicted in the movie to sign a release. But that’s often impractical: people want too much money, too much control over how they are depicted, or both. And that assumes filmmakers can even find the people in question. It’s understandable; nobody wants to see the embarrassing things they’ve done memorialized onscreen. But a movie without conflict isn’t much of a movie.

In the United States, filmmakers have two main legal tools at their disposal when countering allegations of defamation. First, the truth is a defense to defamation. Even if Ike Turner didn’t like how he was depicted in What’s Love Got To Do With It, that he did in fact beat his wife insulated the filmmakers from liability. Second, you can’t defame someone who is dead. Which (in part) explains The Brittany Murphy Story and many of the other biopics on Lifetime.

But in China, the law on defamation is markedly different. Truth is not a defense, and you can defame someone even if they’re dead. That can (and does) have a chilling effect on biopics in China.

Chinese defamation law is not specifically spelled out as such, but has been developed from Articles 101 and 102 of the General Principles of the Civil Law (enacted in 1987), and several subsequent supporting documents: the Supreme People’s Court’s Answers to Certain Issues Concerning Trials of Cases Involving the Right to Reputation (released in 1993), Understanding and Application of the 1993 AnswersInterpretation of Certain Issues Concerning Trials of Cases Involving the Right to Reputation (released in 1998), and Understanding and Application of the 1998 Interpretation.

As explained in the 1993 Answers, defamation exists if (i) the defendant has committed an illegal act, (ii) the plaintiff’s reputation has been damaged, and (iii) the illegal act caused the damage. Such defamation exists in three circumstances:

  1. Written or oral insults or libel that damage a person’s reputation;
  2. Unauthorized disclosure of personal information that damages a person’s reputation; or
  3. A news report containing “gross error” that damages a person’s reputation.

In Understanding and Application of the 1993 Answers, the SPC clarified that truth was NOT a defense to defamation. If a work insults and damages a person’s reputation, it is defamatory regardless of whether it is true.

The 1993 Answers state that either the allegedly defamed person or their close relatives (defined as spouses, parents, children, siblings, grandparents, and grandchildren) have standing to sue. That rules out almost anyone alive from 1950 onward as a character that can be included without fear of liability.

To be sure, the difficulty in securing effective injunctive relief in China does not create the same sense of urgency to get releases as in the United States. But the existence of the defamation laws, along with the often heavy hand of the Chinese government overseeing content, no doubt explains why so many biopics in China are either hagiographies or set in ancient times. Why take the risk of depicting real people unless the Chinese government has specifically asked you to do so?

Perhaps emboldened by the not particularly artist-friendly laws, a recent lawsuit attempted to extend the protection against defamation to an absurd conclusion. A woman with the same name as a character referenced in Feng Xiaogang’s 2016 movie I Am Not Madame Bovary sued the filmmakers for defamation, alleging that her reputation and health had suffered because a character with her name was described as a slatternly woman of low morals. The character in question, Pan Jinlian, isn’t even in the movie per se – she’s a femme fatale from the classic Chinese novel, Water Margin, who is merely mentioned as a counterpoint to the film’s lead character. This would be like someone named Mata Hari suing a film that mentioned the World War I temptress/spy. If Ms. Pan has a complaint against anyone, it’s her parents for naming her after the character in the novel.

It’s one of the more ridiculous arguments I’ve heard, but at the same time it’s oddly encouraging for two reasons. First, it’s encouraging because the case was dismissed quickly; the judge noted that the character in the movie refers to the character in the book, not to anyone in China that happens to have the same name. Second, it’s encouraging to see that people in China feel confident enough in their legal system to bring a lawsuit when they have been aggrieved, even for something as nonsensical as this.

But if the characterization had been a little closer to the truth, the outcome might have been different.

Another recent Chinese movie, Dearest, was based on a true story about a couple whose child was kidnapped. The woman who was the basis for the lead character alleged the movie made things up about her life and suggested she was unchaste. She threatened to sue for defamation, but the director managed to resolve the dispute with a personal apology. It’s not always going to be that simple.

Even if a movie is not considered defamatory in the United States, it still might be considered defamatory in China. And the Chinese distributor/exhibitor would be held liable. As the Chinese media market continues to grow, and as the Chinese court system continues to gain strength and credibility, I wouldn’t be surprised to see many more defamation lawsuits in China, especially as US studios launch more partnerships with Chinese film companies to create Chinese-language content for the local market.

The bottom line for filmmakers is that getting releases has become all but mandatory. Especially for movies likely to be shown in China.

China copyright law

Okay, maybe not spectacular. But definitely real.

An article in yesterday’s Wall Street Journal, How a Plague on the Movie and Music Industries Became Their Chief Protector in China: Chinese search giant Baidu’s transition to creator and buyer of content has changed its priorities, sums up the change that is happening with China IP protection and enforcement:

Chinese search giant Baidu Inc. BIDU 3.47% was once a scourge of Hollywood and the U.S. music industry, which accused it of being a pipeline for pirated content.

Today when Baidu is involved in a copyright infringement case, chances are it is the one casting the blame.

Baidu’s about-face in the copyright fight reflects its emergence as a creator and buyer of content, a transition that continued recently when the company struck a deal to license original shows from Netflix Inc. NFLX 0.85% Other Chinese media companies are undergoing similar transformations, upending how entertainment is protected in the world’s second-largest economy, legal analysts say.

This article quotes Mathew Alderson, our lead China media and entertainment lawyer on how intellectual property protection in China is moving from something that was formerly done to make foreign companies and governments happy to something China now sees as economically important.

“One of the old rationales for copyright protection…is that it provides an incentive to invest. We are seeing that in play here in China,” said Mathew Alderson, a partner and entertainment lawyer at Harris Bricken in Beijing. “Copyright is no longer something imposed on China by the U.S. It is now a tool in Chinese hands.”

The Wall Street Journal notes that in the last ten years China’s courts have seen a 15-fold increase in copyright-related lawsuits:

One way to measure the change is by the escalating flood of lawsuits aimed at protecting intellectual property.

Nearly 87,000 copyright-related cases were filed in China last year, according to data compiled by China’s Supreme People’s Court, a 15-fold increase from 2006. These cases include claims of illegal distribution, or unauthorized reproduction, of written content, videogames, movies and TV shows.

And here’s the point that stems from this massive increase in copyright lawsuits in China: the companies that are bringing these lawsuits are not doing so for their health. They are spending time and money on these lawsuits because they believe that the economic rewards from doing so will be greater than their costs. They have rationally decided that China’s enforcement of its copyright laws warrants this conclusion.

All this is leading to big changes in how Hollywood and Western TV studios are handling their content these days, with most of them choosing to license their content to Chinese companies (like Baidu and Tencent), rather than work at getting that content into China on their own:

For Hollywood studios, striking deals with Chinese partners is much easier than trying to defend their copyrighted content on their own, said Eric Priest, a University of Oregon School of Law professor who researches copyrights and the Chinese entertainment industry.

“If you’re a content producer with an office in Hollywood, you aren’t going to be familiar with where Chinese netizens are getting unlicensed content,” Mr. Priest said. “You won’t be familiar with the shadowy set-top manufacturers who are installing apps that people buy that allow direct access to unlicensed content. You’re going to be much better off with a partner in China that can do that.”

 

Also just last week, a Beijing court awarded Tencent more than US $1 million in damages in a copyright infringement case. The defendant in the case was Baofeng Technology, a high-profile streaming site and manufacturer of VR hardware. Baofeng has been found liable for copyright infringement numerous times previously (including for unauthorized distribution of films, television, and the most recent World Cup), but that’s surely in part because it’s so visible. After its 2015 IPO on the Shenzhen exchange, Baofeng soared to a valuation of more than US$8 billion, and although its current valuation is closer to US$1 billion, it is a real company, with real assets.

In the case decided last week, Baofeng was found to have streamed the first 6 episodes of season 3 of The Voice of China without permission from Tencent, which had licensed exclusive streaming rights. The Voice of China (or whatever name it’s going by these days) is one of the most popular programs in China and it generates significant revenue for all of the companies involved with it. Tencent wanted to protect its investment.

Tencent’s victory in the litigation regarding The Voice of China is of a piece with other recent lawsuits regarding enforcement of motion picture copyrights in China, including Disney’s victory over a film that ripped off the anthropomorphic vehicles from Cars, decisions holding private cinema operators liable for exhibiting content without permission, and the recent controversy and lawsuit regarding Wolf Warriors 2. Copyright owners in China no longer have to just grin and bear it.

I hate to say we told you so on this, but we told you so on this Way back in early 2013, in China Intellectual Property Law. A Radio Interview For World Intellectual Property Rights Day, Dan Harris of my firm predicted that this day would come and explained why:

China is a lot better compared to ten years ago. I think very little of that has to do with the WTO. I think that China is better because China is getting wealthier, and because Chinese companies are starting to care more about IP. I am of the view that countries start doing well with IP when its own powerful companies really start caring about it. And I’ve seen this progression happen in Japan, I’ve seen this progression happen in Korea, I’ve read about how this progression happened in the United States. The reality is nobody is going to be able to force China to improve its IP from the outside, but big companies within China like Haier, like Huawei, like Lenovo — companies that care about their own IP — are going to be able to force China to improve. That’s what’s happening. And as more big companies come to the fore in China, China’s IP is going to continue to improve. And there’s not much that can be done to rush it. In fact, if anything China’s IP is improving nicely. Meaning, it’s improving at least as fast as Korea’s did, at least as fast as Japan’s did, and probably as fast as the US’s did, but the US was a long time ago.

In other words, China — like pretty much most countries, is a lot more likely to do what it perceives to be in its own self interest than to do something just because other countries are telling it that it should/must.

Granted, the legal principles in these cases are straightforward and from what I’ve seen, the facts patterns leave little room for interpretation. When the defendants explain why they weren’t infringing the copyright, they tend to sound like Vanilla Ice explaining why “Ice Ice Baby” wasn’t a blatant copy of “Under Pressure.” (I can’t wait to see who will be the Chinese Robin Thicke and state that they couldn’t possibly be liable for copyright infringement because they were drunk on baijiu throughout production.)

The point is not that Chinese courts are establishing new rights, but that they are enforcing the rights that already exist for copyright owners – and doing so in a meaningful way. Both Chinese and foreign copyright owners are turning to Chinese courts to enforce their rights, and are prevailing. At least with the easy cases.

In future posts, I will discuss what you can and should do to protect and enforce your copyrights in China.

China copyrights works for hireOver the past several years, an increasing amount of creative work has been outsourced to China: everything from special effects for movies to programming for video games to architectural designs for transit-oriented developments. These creative works are protected by copyright, but not always in a way companies expect. And because so much work in China occurs without a legally enforceable contract, once companies realize their IP portfolio is not nearly as robust as they thought, it’s often too late to do anything about it.

As a general rule, the creator of an original work (e.g., a song, movie, or video game) owns the copyright in that work. This is true in the United States and in China and in most every other country in the world. The main exception to the general rule is for “works for hire,” which are works commissioned and paid for by a third party. But this is not a clear-cut exception: it depends on the facts, and it depends on which country you’re in.

In the United States, a company will own the copyright to a “work for hire” by an employee if the work was made within the scope of that employee’s employment. A company will own the copyright to a “work for hire” by an independent contractor if the work was specially ordered or commissioned for use via a signed agreement that specifically states that the work is a work for hire and such work falls into one of nine statutorily defined categories (including motion pictures, translations, tests, and instructional texts). Many commissioned works (e.g., photography, software, and product design) do not fall into one of the statutory categories, and for those the company will need to have a signed contract that explicitly assigns the copyright. Even in the absence of a signed agreement, the company can argue that it has an implied license, but that’s not a great position to be in.

In China, the presumptions are somewhat different. China’s Copyright Law states that an employee will own the copyright to anything they create during the course of employment, except for engineering designs, product designs, maps, and computer software, and other works created mainly with the employer’s resources. For all other works, the employer essentially has a two-year exclusive license to use the copyrighted material, and thereafter a non-exclusive license. If an employer (a WFOE, say) wants to impose a different requirement on its employees, it needs specific language in a signed contract with the employee that assigns all rights in any “work for hire” to the employer. That contract should be in Chinese and governed by Chinese law, and it should be signed at the beginning of employment.

For “independent contractors” (whether individuals or entities), the contractor will own the copyright unless there is a specific agreement between the parties in which the contractor agrees to assign the copyright to the commissioning entity. And yes, this contract ought to be in Chinese and governed by Chinese law also.

This all sounds reasonably straightforward but a vast number of entities – including huge multinationals – still operate in China without proper agreements with their employees, let alone their “independent contractors.” These companies are essentially operating on the honor system, and sooner or later they’re going to pay by losing valuable rights.

China IP lawyerClients often ask us which of their entities should own their IP (patents, trademarks and copyrights) in China. The basic answer is usually simple: whichever entity will be using the IP in China.

There are some perfectly legitimate reasons for wanting to separate the ownership and exploitation of IP rights – reasons related to tax, liability, or corporate structure. But in the vast majority of situations, the only time IP ownership matters in China is when you are trying to enforce your IP rights. Chinese lawyers are expert at creating delay, and they know exactly how to exploit evidentiary gaps. And if you are attempting to bring an enforcement action in China but the plaintiff is not the registered owner of the IP, expect your dispute to take much longer than usual.

The Chinese lawyer on the other side will likely argue that someone who is not the registered owner of the IP cannot bring an action to enforce the IP rights and the mere fact the companies are under common control won’t be sufficient. A properly drafted license agreement might be sufficient – so long as the agreement is written in Chinese, registered with the appropriate authorities in China, enforceable under Chinese law, notarized, and authenticated by the Chinese Embassy, and so long as you do not run into any use issues. See China Trademarks: When (and How) to Prove Use of a Mark in Commerce. You can probably guess how often all of these things are done and done right by American and European companies. Most of the IP license agreements we are asked to review – no matter whether the company that comes to us is a two-person startup or a Fortune 100 company – are in English and governed by the laws of whatever country the plaintiff is in.

You better believe the Chinese lawyer for the Chinese company you sue in China for infringing on your China IP will be questioning each link in the evidentiary chain of your IP and pointing out each potential problem. If you’re lucky, you’ll have the chance to fix each of these problems in time before you sue, but doing so could add weeks or months or years to the process. And meanwhile, the infringing party will be going about their business using “your” IP. It’s death by a thousand (paper) cuts, and it’s a losing game.

Unless you have a really good reason to split ownership and use of your China IP into different entities, just keep it simple and use one company.

China WFOE complianceWhen I was in high school, a friend got a job at a liquor store, and was often asked to work there by himself. Soon enough, word got around and (human) nature took its course, as the store became extremely popular with a certain segment of the school. My friend hadn’t sought or even anticipated this sort of attention; he was 16 years old and just wanted some extra cash. But when the store got cited for multiple infractions, it came as no surprise to anyone. As my friend observes to this day, “What sort of business owner lets a teenager run a liquor store by himself?”

I was reminded of this story when I read the news that Disney had terminated Meng Dekai, International Special Project Director in China, upon discovering that he had signed numerous unauthorized deals for new Disney projects in provincial cities that few people outside China have ever heard of, including Zhengzhou, Hefei, and Baotou.

Meng had been at this since at least 2009, and in addition to signing deals on behalf of Disney, it came out that Meng had also formed a number of companies with names similar to Disney’s Chinese name and registered a number of trademarks that were similar to those registered by Disney.

It’s unclear what Meng’s master plan was. Yes, Disney knockoffs are rampant in China, notwithstanding the Chinese government’s one-year campaign (tied to the opening of Shanghai Disneyland last year) specifically designed to combat counterfeit Disney products. But it’s one thing to sell knockoff Mickey Mouse backpacks at a mall in Nanchang, where you could clear out in a day if you had to. It’s quite another to build and operate a theme park. Even if Meng received massive kickbacks from the local governments, it’s hard to imagine how he expected to get away with this. It’s also hard to understand why government officials of these lesser-known cities bought the snake oil Meng was selling.

When the China practice group at my firm saw this story, we just shook our heads ruefully, because this is the same problem, writ large, that we see all the time when companies go to China. Once companies have established a presence in China (e.g., a WFOE), a foundational question is: how are they actually going to do business in China, and who will have the authority to act on their behalf?

We regularly conduct audits of firms’ China operations, and the disconnect between the parent company and the WFOE can be shocking. We regularly turn up everything from FCPA violations to employees who cannot be terminated because they were engaged without written contracts to company seals that have been missing for years. And pretty much once a month, we hear from an American or a European company that has just learned (usually via an anonymous email) that one of its employees (usually a trusted senior employee) is secretly operating a competing business on the side. Sometimes though there’s no bad intent on behalf of the Chinese employees; it’s just that there’s no clear oversight and they are operating the “Chinese way.” This is a recipe for disaster, even under the best circumstances. And if you’ve got someone untrustworthy holding the reins in China, things can go from bad to worse in a hurry. See also China Compliance: Don’t Rely on Your China Staff and China Compliance: Don’t Rely on your China Staff, Part II.

Many foreign companies are in a quandary because of personnel or geography or both: they want to have one of “their” people managing operations on the ground, but none of “their” people are willing and/or knowledgeable enough to move to China. And so they end up delegating authority to a Chinese employee who is unprepared and/or unwilling to manage the operations in accordance with the parent company’s wishes.

It’s an awkward situation, and made worse by the quirks of Chinese corporate law, which require every WFOE to decide three things:

  1. the identity of the legal representative, a person with the ability and obligation to act on behalf of the WFOE;
  1. the identity of the general manager, a person who is in charge of the WFOE’s day-to-day operations; and
  1. the location of the company seal, a physical artifact that makes a document legally binding on the WFOE.

The most efficient solution is to appoint a single person as the legal representative and general manager, and have that person be resident in China and in possession of the seal. But this solution places a tremendous amount of authority with a single person, and many foreign companies are understandably reluctant to do so unless they have someone in China that they trust implicitly. As a result, the typical solution is that the legal representative is an employee of the parent company who lives outside China but is tasked with overseeing Chinese operations, the general manager is a Chinese national who lives in China, and the seal is held by a trusted third party in China like an accountant. Yes, it’s as inefficient as it sounds, but it’s usually better than the alternatives. Many of these problems have their genesis when the WFOE is formed without any legal advice on how to handle (and mitigate) these three decisions.

I don’t know what sort of contracts Mr. Meng signed on behalf of Disney, but they better hope he didn’t have access to the company seal and wasn’t the legal representative of the Disney entity he was representing. Right now, this story is just bad publicity, but it may end up costing them millions. And (because every good China Law Blog post ends with a moral) it’s also an instructive story for every company operating in China. How much do you really know about what’s going on in your Chinese office?

China trademark registrationFor many years, China has sought to wield the sort of “soft power” that comes naturally to many other developed nations: power not from military or economic might, but from having ideas and cultural exports that are popular in other countries. China has no shortage of ideas or culture, but few people outside China are interested in either, with the notable exception of Chinese food.

Most people outside China can’t name a single Chinese brand. Not one Chinese brand! It’s sad, but perhaps not that surprising. I’ve seen a range of explanations, usually some variation on the following: China doesn’t understand foreign markets; China doesn’t care about foreign markets; China can only copy products, not create them; and China’s authoritarian government stifles creativity. All of these explanations have some element of truth, but aren’t the whole truth. And though China hasn’t broken through on the world stage yet, to many observers it’s only a matter of time.

In fact, it may have already happened. The hottest thing in popular music is the app musical.ly, which allows users to create and share a 15-second video of them lip-syncing to a popular song. As a recent Rolling Stone headline put it, musical.ly has become “too big for pop to ignore,” and it is not only a way for existing pop stars to connect with their fans but also a platform for new stars to emerge. The app has more than 133 million users worldwide, is massively popular in the US (the company claims half of all US teens are users), and is a serious rival to Snapchat, Twitter, and Instagram. And it is 100% Chinese, developed in Shanghai by two Chinese programmers who returned to China after working in California.

Did the founders of musical.ly crack the code, or just get lucky? It’s too early to tell, but thus far the one place where musical.ly has launched and failed to catch on is … wait for it … China. Meanwhile, do the millions of American teens using musical.ly know it’s a Chinese app? Do they even care? My guess is that very few know, and even fewer care. And that’s just the way China should want it. Only when Chinese products are accepted on their own merits can they form the basis for soft power.

Meanwhile, musical.ly waited until September of last year to file for trademark protection in China, which is about two years too late considering that the app was launched in 2014. Luckily for them, no trademark squatters filed in the interim; a bit shocking to me, but perhaps that’s the upside of not being successful in China. I’m not sure if it’s gratifying or discouraging to see Chinese firms make the same mistakes as foreign firms when it comes to trademarks in China, but I’m leaning toward the latter. Especially when the Chinese firms are backed by VC money and represented by multinational law firms. What are they thinking?