China IP lawyers

I am not a big fan of filing Madrid Protocol applications for China. In certain situations, they can work well, but when they don’t work (which is fairly often, especially when applications are filed without forethought) the trademark registration process takes longer and costs more than just filing a national application. See China Trademarks. Register Them In China Not Madrid.

Filing a priority application in China is another matter. As part of the IP modernization begun under Deng Xiaoping’s leadership, China acceded to the Paris Convention in 1984. Under the Convention, if you file a trademark application in one Paris Convention country, and then file an application on a priority basis in another Paris Convention country within 6 months of the date of the original application, you can claim the first filing date as the date for your subsequent applications as well. For example, if you filed a trademark application in the United States on May 1, 2017, you would have until November 1, 2017 to file a trademark application for the same goods/services in China and still be able to claim the May 1, 2017 filing date for your China trademark application.

The vast majority of countries in the world are signatories to the Paris Convention, so the convention has wide-ranging effect. Priority filing is particularly important in first-to-file countries – most notably China – where there often truly is a race to the trademark office between legitimate IP owners and unsavory trademark squatters. See Register Your China Trademark or Go Home.

Priority filing can be an extremely useful tool for China trademark protection, but there are a couple common misconceptions about it. First, priority filing will not improve your odds of registration. The only thing priority filing does in China is establish an earlier filing date. An application filed on a priority basis is considered a national application, and once it is submitted it goes through the same examination process as any other national application. In other words, if you have priority filing for a brand name or a logo that has already been registered as a trademark in China, you will not succeed in getting your brand name or your logo registered in China.

Second, priority filing is not the only option for filing in China. Sometimes clients will contact our China IP lawyers in a frantic rush because they have received notice that they have only a few days before the priority filing window closes on their trademark, and they believe that once that window closes they will not be able to file a trademark application in China at all. Not so! The only effect of the priority window closing is that you cannot claim an earlier filing date. Going back to the earlier example, if you filed a trademark application in the United States on May 1, 2017, and then filed an application in China for the same goods/services after November 1, 2017, the deemed filing date in China would be the actual filing date for China. Priority filing changes the deemed filing date, nothing else.

Another important point regarding priority filing is that priority filings are limited to the same goods/services as in the original application. In this way, priority filing is similar to Madrid Protocol filing, and often not well suited to filing in China. But if the application only covers a narrow range of clearly stated goods/services, and those are the only goods/services that you care about protecting in China, it will work just fine. Priority filing cannot be used for the “Starbucks strategy” of covering all goods/services. But if you use it to establish a beachhead and cover the most important goods/services, it will usually dissuade the first wave of squatters.

Because the description of goods and services for trademarks in the United States (and for many other countries as well) is often quite different than the description of goods and services for China trademarks, for clients interested in filing in both countries I generally recommend filing concurrent applications without regard to priority. But for clients who first file in the United States (or some other Western country) and then realize belatedly that they ought to protect their IP in China as well, a priority filing can be ideal. More than once, a priority application has meant the difference between securing a China trademark registration and having to deal with a trademark squatter with superior rights.

China box office numbersAs reported by numerous media outlets, the MPAA-requested audit of the Chinese box office numbers is complete and the numbers ain’t pretty. Chinese theaters underreported 2016 box office results by 9%, which given the 25% revenue share for quota movies, means that US studios have been underpaid by about $40 million.

I don’t know anyone who follows the Chinese movie business who was surprised by these results. No, I take that back. Many people (myself included) were surprised the number wasn’t considerably higher. One possible explanation is that PricewaterhouseCoopers conducted the audit, and after the Oscars debacle they were probably triple-checking their results and eliminating anything they couldn’t justify six ways from Sunday. And even with that, they still found a 9% discrepancy.

The full audit results haven’t been publicly released; all we know is that the auditors looked at data for 29 films in a handful of theaters and then extrapolated the results across China’s more than 40,000 screens. Such extrapolation, based on statistical sampling, is commonplace and perfectly normal, but I have to wonder what a full audit would have found. Without putting too fine a point on it, a lot of strange things happen in China’s third and fourth-tier cities. Even as it is, the audit found a whole host of irregularities, including unreported screenings, unreported ticket sales, and counting box office revenue as concession sales. No word on whether the audit turned up more instances of ascribing ticket sales from US films to Chinese films – which is what happened in 2015 when an alleged $11 million in ticket sales for Terminator: Genisys were instead attributed to the Chinese propaganda film The Hundred Regiments Offensive.

So what now? One argument is that the audit helps the United States in its ongoing negotiation to increase the quota and the revenue share, but it’s also likely that it hurts. China already knew it had massive problems with movie accounting and had taken steps earlier this year with a very public punishment of 326 cinemas for box office fraud. Being called out in the press like this by foreigners is a tremendous loss of face. Then again, $40 million is a lot to leave on the table.

It’s easy to understand the studios’ frustration that led to the audit. Box-office fraud in China has been rampant for years, and even the box-office revenue that is reported takes eons to get paid. And as China’s box office continues to grow, the revenue share becomes an increasingly important part of studios’ bottom line. Long gone are the days when revenue from China is just a nice bonus for US studios; indeed without China, some movies wouldn’t be made at all.

I’m reminded of the opening lines of Annie Hall: “There’s an old joke. Two women are at a Catskill mountain resort, and one of ’em says, ‘Boy, the food at this place is really terrible.’ The other one says, ‘Yeah, I know; and such small portions.’” That’s essentially how the studios feel about their relationship with Chinese movie theaters – full of underreported revenue and unhappiness, and they hope it never ends.

Of course, if the studios actually see the $40 million in additional revenue, the audit will be worth it. Either way, we can expect to see more of them.

And it’s not like the US studios are the only ones who should be conducting audits. We work with accounting firms that audit Chinese film and television productions on behalf of Western investors, and the extent (and creativity) of the financial shenanigans is astounding. For most of these audits, there’s no political or reputational element; it’s just common sense.

If you’re dependent on your Chinese partner to account for and remit revenues (be it in the movie industry or otherwise), an audit should be part of your repertoire too.

Check your China employment contracts
Check your China employment contracts

Do you check your employment contracts? A company in Shenzhen wasn’t careful in checking theirs and it had to pay an employee nearly 150,000 RMB as contract damages for unpaid wages and an additional nearly 3,000 RMB for overtime compensation. In the end, this company had to pay this one employee nearly 50 times more than what was actually owed. Before I discuss this case and what you should do to prevent the same thing from happening to you, let’s quickly review relevant China employment laws.

An employee can demand its employer pay contract damages pursuant to the parties’ employment agreement. The law only imposes restrictions on employers imposing contract damages (similar to and called liquidated damages in some countries) on their employees, but an employee can collect contract damages from an employer under certain circumstances. At the time of termination, unless there is a law to the contrary, the employee can demand contract damages in addition to the applicable statutory severance. But again, be careful, this is just the general law in Guangdong tvince and there may be exceptions and, as is pretty much always true when dealing with China employment laws, there are local variances.

Now back to the case I mentioned above. In that case, the Shenzhen employer and the employee entered into an employment contract under which the employer agreed to pay its employee 50 times any missed/miscalculated base salary and overtime pay. In other words, for every Yuan the employer is short in wage payments, the employee must be paid 50 RMB as a penalty. When the employment relationship went awry, the employee sued and sought nearly 150,000 RMB in contract damages for having been shorted a bit under 3,000 RMB owed to him. The trial court — The People’s Court in Baoan District — sided with the employer on this claim, concluding that this damages provision did not comply with the employment law and the amount far exceeded the actual amount owed to the employee. It then applied a “fair” standard for damages and ordered the employer to pay the owed wages plus an additional 25% of those wages as damages.

The employee appealed, arguing that the Baoan court had no legal basis for its ruling. The employee argued that the employer intentionally included this damages clause in the employment contract to make the job look more enticing and it would not be fair to allow the employer to be released from a contractual obligation it had created. The employee also argued that China’s freedom of contract laws called for enforcing the contract.

The Shenzhen Intermediate People’s Court determined the damages clause did not violate any mandatory laws or social interests and it reflected the parties’ true intent. The employer was the more powerful party and the employee an ordinary worker with only minimal bargaining power. The contract damages provision was therefore enforceable against the employer and the employee was entitled to the full amount of contract damages.

If the Shenzhen employer had been careful about what it allowed into this employment contract it could have avoided this penalty altogether. Our China employment lawyers regularly audit the employment records of foreign employers in China and this means we frequently see employment contract provisions that heavily favor the employee. One of the most common things we see is for the English to say one thing (that’s good for the employer) and the Chinese to say another (that’s good for the employee). This is a problem because the Chinese language controls.

Do your employment contracts contain a “surprise” clause that would potentially expose you to unwanted liabilities? Now is the time to check to make sure.

 

China AttorneysBecause of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

One of the questions our China attorneys pretty much never get is the following: I have been using factory X in China for the last seven years to make our widgets and though it was rocky at the start, we eventually built up a great relationship and they have been doing a great job for us for the last five or so years. But the reason I am calling you is because they have asked us about becoming the exclusive China distributer for our widgets and I was wondering whether you think that is a good idea.

Everything but the final question about whether we think it a good idea happens often; the asking us whether it is a good idea is the part that never happens, but maybe it should.

Let me explain.

We are China lawyers, not China business consultants and for that reason we are not the logical people to ask about something like how to choose a distributer in China. But we have been in the China law business for so long that certain things have become obvious to us even though we lack an MBA. And the issues involved in granting an exclusive distributorship to your Chinese manufacturer is just one of those things that is almost always not the best way to go.

But what I usually am thinking (and often say) is something like the following:

I understand that you have a really good relationship with your widget manufacturer and I am not in any way downgrading the value of that, because that is of huge value. But if you are truly serious about maximizing your widget sales in China you maybe should consider whether using your manufacturer as your exclusive distributer is the best way to do that. I say that for two reasons. One, the typical Chinese manufacturer knows zero about consumer marketing, distribution or sales. They know only how to manufacture which is not the same thing. They are usually engineers, not businesspeople or salespeople or logistics people. Two, it is rarely a good idea to grant anyone an exclusive distributorship in China for the simple reason that China is a big country and the odds are slim that the company best at marketing and selling your widgets in Shanghai will be the same company as the company that would be best at doing those things in Chengdu. See China Distribution Agreements: Exclusivity Is NOT Required.

But if you do not want to spend the time and money to find another possible China distributor because all you want is either to keep your manufacturer happy or just make a few extra dollars, then what you are proposing should be fine.

Your thoughts?

China employment lawyer
Buy the paperback version. NOW.

China employment law is technical and getting technicaler (yes, I made up that last word but you know what I mean). See China Employment Law: Local and Not So Simple. It is one of the most consistent problem areas for foreign companies doing business in China and it has become a massive growth area for our law firm.

Our typical attorney-client interaction usually goes something like this:

  1. Foreign employer company contacts my law firm because it has terminated an employee and that employee has either sued or threatened to sue, oftentimes over a technical violation by the foreign employer.
  2. One of our China employment lawyers looks at the case and determines that the foreign company employer did in fact violate Chinese law in the termination and in that investigation learns that the foreign company employer committed multiple violations and if the employee were to pursue litigation or his or her administrative remedies, he or she would no doubt prevail.
  3. We explain the above to the foreign company employer and learn that the problems we enumerated hold true for all employees.
  4. The foreign company employer asks our law firm to remedy its problems and we explain that before we start remedying just the problems that came to the forefront from this one termination, we should conduct an employer audit to determine what other employment problems need fixing. See China Employment Compliance and Audits: THE New Big Thing.
  5. We conduct an employer audit and that invariably (like every single time) generates a laundry list of problems and then we fix them, one by one.

Why do foreign company employers have so many employment problems in China? Think about how the typical small to mid-sized companies starts in China. They go into China with maybe one or two foreign employees and one or two Chinese employees, none of whom is remotely knowledgeable about Chinese employment laws (on the local, regional or national level) and all of whom are — naturally — more focused on getting the business off the ground than on complying to the letter of the multiple sets of employment laws. And anyway, at this point they are usually a tight-knit group of founding employees who view themselves as much as founders as they do employees. But when the company grows, little changes on the China employment compliance front, mostly because nobody realizes how important it is to make the changes and because even if they did, there is nobody in-house who knows how to do it. So it gets kicked down the road until there is an expensive and embarrassing employment problem.

Our firm is then called more often by someone high up in the U.S. or the Europe or the Australia office than by someone on the ground in China. The person who calls us (might be the head of HR, the CFO or the CEO) has started to look at what is going on in China and sought answers from China and received inadequate responses and has now started to worry, rightfully so.

All of the above is my incredibly long-winded way of saying that foreign companies need to get on top of their China employment situations and stay there. Employer audits are the way to go in most situations, but in the meantime and as a supplement, it is critical that someone at your company understand China employment law basics. Someone at your company needs to know enough not to be able to solve every issue, but to spot the issues before they blow sky-high.

And we have just the book for that and I am writing about it today because it just came out in paperback (the Kindle version came out a few weeks ago).

Our lead China employment lawyer, Grace Yang recently had published The China Employment Law Guide and you really really really should buy it and put it on your shelf. And when I say put it on your shelf, I mean you should buy the softcover version (not the Kindle version) so you can literally put it on your shelf. Heck, get more than one copy and give it to everyone in your company who manages your employees or plays any role in their hiring or their firing. This is a book that is meant to be used for background and for reference and as a decision-making guide. Get it now!

Just a little bit about Grace Yang, its author. Grace grew up in Beijing and excelled at and graduated from China’s best law school there — Beijing University. She then came to the United States to attend the University of Washington law school where she again excelled and graduated. Grace is my firm’s lead China employment and labor lawyer and she is the lawyer at our firm to whom everyone else goes for China employment and labor law questions. Grace is a licensed U.S. lawyer (she is licensed in both Washington and New York) and she splits her time between Seattle and Beijing.

Anyway, did I tell you that you should buy the book? Of course I did and you should.

 

China tradmark squatter
China trademarks. Very crowded.

The United States and China are the two busiest jurisdictions in the world for trademarks, with radically different approaches. The USPTO requires applications to be narrow in scope: the identification of goods/services can only include goods/services the applicant is actually using or has a bona fide intent to use, and before the application can proceed to registration the applicant must provide proof of such use. Subsequently, in order to maintain a valid registration, trademark owners must provide proof of continued use.

China, meanwhile, strongly prefers goods/services be identified according to the Nice Classification system, and it has no requirement that an applicant prove use at any time. The one exception is the non-use cancellation proceeding, by which a third party can challenge a trademark registration. Following such a challenge, if the trademark owner cannot provide proof of use within the three prior years, the trademark registration will be cancelled. But absent a third party challenge, the trademark will remain valid. The Chinese Trademark Office (CTMO) does not conduct sua sponte investigations.

Over the past 10-15 years, China has encouraged trademark applications in both explicit and implicit ways. In an interview last year with WIPO, Zhang Rao, the Commissioner of the State Administration for Industry and Commerce (SAIC), which oversees the CTMO, identified five factors driving the large numbers of trademark applications:

  1. The Chinese government’s goal of boosting “mass entrepreneurship and innovation.”
  2. The implementation of the 2014 Trademark Law, which was an improvement on the previous trademark law.
  3. SAIC authorities’ and market regulators’ work to create a level playing field for all regarding trademark rights.
  4. SAIC’s efforts to improve the efficiency and accessibility of trademark applications, with a particular focus on online applications.
  5. Extensive outreach efforts to increase public awareness of the value of registered IP.

To Zhang’s comments I would add:

  1. Because it is difficult to invalidate a trademark registration in China because of bad faith, it incentivizes trademark squatters to file trademark applications “on spec,” and similarly incentivizes legitimate brand owners to file far more trademark applications in far more classes than they would (or could) file in other jurisdictions.
  2. The Chinese government has operationalized its goal of boosting innovation (Zhang’s first point above) with a numerical pay-for-play scheme: more filings = more money. Mark Cohen’s China IPR Blog has commented on this strategy numerous times with respect to patents; I don’t know for certain if trademarks have been promoted the same way but wouldn’t be surprised.

For all of these reasons and more, China has seen a staggering increase in the number of trademark applications: more than 760,000 trademark applications were filed in 2006, and that number increased to 2.8 million in 2015. In the US, the second busiest trademark jurisdiction, fewer than 400,000 trademark applications were filed in 2006, and slightly more than 500,000 in 2015. (The statistics are from WIPO using class count data: an application in two classes counts as two applications, an application in three classes counts as three applications, etc.) And China continues to widen the gap; in 2016, more than 3.6 million applications were filed.

Meanwhile, the CTMO has been hiring a number of young, inexperienced trademark examiners whose default position is to reject any application that seems like it might conflict with a previously filed trademark.

This all adds up to an increasingly inhospitable environment for filing trademark applications in China. Every new trademark application is another potential conflict for subsequently filed applications. Our China trademark team has seen an uptick in rejections in our day-to-day work, and though it’s hard to prove causation it sure doesn’t feel like a coincidence.

To make things even more complicated, there’s a disjunction between the standard for trademark infringement and the standard for trademark registration, with the latter being considerably more strict. That has led to a number of trademarks that are in a strange sort of limbo: too similar to existing marks to be registered, but not so similar as to constitute infringement were they to be used. This effectively places such trademarks in the public domain. If a company’s goal is simply to manufacture products in China without fear of someone else interfering with production or exports, all is well. But if the goal is establish a brand name in China, the only answer is to find a new brand name.

The moral of the story is that to succeed with trademarks in China you must register your trademarks both early and often, and conduct meaningful searches before filing each and every application. Even if a trademark squatter doesn’t take your exact mark, one of the millions of new trademark applications each year might block your application on other grounds.

 

China WFOE
Photos from Hong Kong Free Press

According to the Hong Kong Free Press (and a number of other newspapers) The Shanghai government this week “ordered the closure of one of the city’s top maternity hospitals saying that it was illegally built on land owned by the armed forces, according to an official notice.”

According to the article, the hospital, Shanghai Redleaf International Women’s and Children’s Hospital, was “founded by Canadian investors” and it had “signed a 20-year lease for prime real estate owned by the military on central Shanghai’s Huaihai Road and started catering to foreigners and wealthy Chinese more than four years ago.” But because “The People’s Liberation Army has been banned from commercial activities since 1998” the hospital was being forced to close. The HK Free Press says this “hospital is one of the largest private business affected by the so-called de-commercialisation of the military to date.” The article then quotes the district government as saying “There exists a matter of illegal construction of building at the Redleaf Hospital. It must be rectified duly in accordance with relevant laws.”

Not surprisingly many patients and hospital employees were not happy with the closure:

A gynecologist who was vacating her workplace Sunday afternoon said that the owners, a Canadian couple, had invested billions [of RMB, presumably] into the clinic. “They had all the right documents and invested so much money… it just doesn’t seem fair,” she said.

Christine Cheng had been working as a nurse at Redleaf’s gynecology department for almost two years. “We spent a lot of money and work building this, and now the government wants us to move… We didn’t do anything bad,” she said.

When news transpired last Thursday that the upscale facility would be forced to close, some of the about 300 staff affected hung banners outside the main building criticizing the facility’s imminent closure.

The banners said that while the hospital supported the government, it shouldn’t be forced to move, adding that it wasn’t a “soft tomato” — a Chinese expression for a pushover. Police arrived on the scene shortly afterward and ordered that the banners be removed.

Louise Roy, director of patient support services at Ferguson Women’s Health, a clinic that rents facilities inside the Redleaf complex, said that staff first heard about the possibility of a closure several months ago, although they were never given confirmation or a specific date. “They’ve told us nothing — absolutely nothing,” Roy said. “We came in this morning, like [we do] every day. Then we saw staff gathered outside where the banners were hung, and then the police came.”

Several women who were being treated at the hospital were clearly upset as they collected their medical records before closure.

“I found out from a friend,” said a 32-year-old patient named Jennifer who would not give her last name because of privacy concerns. She said that she had moved to Shanghai from the U.S. recently and was planning to deliver her child at Redleaf in three months. “I have friends who are due in two weeks or a month — I don’t know what they are going to do,” she said.

Wang Jue, PR supervisor, said that one patient in labor arrived at Redleaf over the weekend and was turned away by government officials. She arrived at another clinic just 10 minutes before giving birth.

Redleaf’s services have been highly sought-after by those who can afford them. A standard cesarean section delivery at the hospital costs 120,000 yuan, and a prenatal package is priced at 24,000 yuan.

Patients have been referred to a temporary clinic while Redleaf is working on a more permanent solution.

I do not know what happened with this hospital beyond what I read in the newspapers. I can though discuss some of what my firm’s China lawyers have seen in possibly similar situations over the years and I do so below.

Maybe fifteen years, a very savvy foreign businessperson came to my law firm with a proposed deal that involved our client building a hotel. Just about everything about the deal was perfect. The location was perfect. The cost was perfect. The deal with the landlord was perfect. There was just one flaw: the land on which the hotel was to be built was owned by the military and that made the entire deal 100% illegal.

We explained the clear illegality of the deal (in writing of course) to our client, who already knew it. But like I said, this was a long time ago and our client was very savvy. His response was something like the following:

Yes, I know this deal is illegal and I know that means I am at risk of the government coming in and shutting us down the day after (or even before) we build the hotel. But we’ve run all the numbers on this and the numbers tell us that all we need to do for this deal to be an economic positive is last three years and every year after that the hotel will be a cash cow. So even though I know full well all the risks, I am willing to take them because I am willing to bet we can last at least three years.

The client did the deal and ended lasting for around eight years before shutdown and ended up making a lot of money. The client’s eight year tenure ended around 7-8 years ago and for probably the last ten years our China lawyers have simply said “no” to such deals, as they have simply become too risky. This does not mean our firm has not continued to see a slew of deals and WFOE formations we know violate China law. I can hear myself saying the following to the companies that bring us such deals and WFOE formations simply because I have said it so many times in my China law career:

What you are doing is illegal and you will get caught. When will you get caught? I don’t know that. It could be tomorrow or it could be a year from now. It probably will be in less than two years from now. Maybe if you had come to me ten years ago with this deal (or WFOE formation) I would not have been so unrelentingly negative about it, but China has changed. China has become incredibly serious about enforcing its laws (at least as against foreign companies, which are the only clients we have in China) and so we see every day what happens to foreign companies that are doing business in China or with China. Not only has China gotten more serious about enforcing its laws, it has gotten way better at enforcement. China is highly computerized and its various agencies and governmental bodies are quite sophisticated at communicating with each other.

We need to change your deal (or your WFOE formation). We are not going to put our reputation on the line for this sort of deal.

Oh, and one more thing. When you go back to your Chinese counterpart or to your own China employees/people on this, they will tell you I am exaggerating or I am naive or I just flat out “don’t know China.” I would never claim “to know China” because I don’t, but I do know is what happens to foreign companies that violate China law and I also know that at least once a month one of our China attorneys gets a call from a foreign company in trouble for having violated some law in China. And when I say trouble I mean they are facing millions of dollars in fines or closure of their operations or in some cases arrest and criminal charges.

Most of the time, the client then explains that they didn’t know that their deal (or WFOE) would be illegal (or as they often put it, “so illegal”). Some of the time though they do view us as naive or as overcautious and they move on.

In 2010, in Cracking Down On Illegal Land Use In China. Do You Really Still Feel Lucky, Foreign Punk? I wrote about foreign companies

The following is an amalgamation of a number (maybe 5 or 6) of conversations I have had over the years with people wanting to register a WFOE (Wholly Foreign Owned Entity) in China fast:

Potential Client: Can you help me register a WFOE in China.

Me: Yes. Not a problem. Do you have a lease yet? Do you know that a legitimate lease is required for the approval of a WFOE?

Potential Client: I know that but we are in a real hurry here.

Me:  Okay. But do you have a lease.

Potential Client: We have a lease but I don’t think it technically will qualify.

Me: What do you mean?

Potential Client: The land is zoned agricultural but my Chinese partner has secured all the okays to allow us to use it for our factory.

Me: Not a good idea. Trust me on that.

Potential Client: The factory has been there for two years without a problem and my Chinese partner assures me that the local government is fine with it.

Me: Don’t do it. Right now, the local government is okay with it. But what if the current mayor is pushed out next week on corruption grounds. Do you really want to be in a situation where you have spent a large amount of money on a space that gets shut down?

Potential Client: I am in a hurry and this is the only space that works.

Me: Are you sure? You are in a hurry, but is it really going to be worth the few months if you get shut down?

Potential Client: I am not going to get shut down. My Chinese partner is incredibly connected.

Me: Incredibly connected to the current local administration, MAYBE, but as I said, that administration could be out the door next week. Beijing checks on these things too and if they see that your facility is illegal, Beijing could see to its shut-down. I just don’t think it a good idea to go into a WFOE illegally and my firm cannot be a part of that.

Potential Client: That’s ridiculous. This is how business is done in China. Are you really saying you won’t take us.

Me: Yes. We won’t take you because we do not want our reputation damaged when you get shut down and we won’t take you because we do not want to be blamed when you get shut down.

Potential Client: Well I am sure I will have no trouble finding someone to help me on this. Good-bye.

I know that at least one of these companies did end up getting shut down (within about a year) because someone at the company who had sided with me on the company not going forward emailed me to tell me of this.

Now might be a good time for you to read the following:

Just yesterday, in China Law as California Law: There be Wolves out There, I wrote of how common it is for Chinese consumers and employees to sue foreign companies and I concluded that post with the following admonition on the importance of knowing and abiding by China law:

Yes, doing business in China is difficult and its laws are complicated, but that is true of pretty much every country I know. Be it California or China, it’s on you. People the world over — and that most certainly includes China — are ultra-litigious and that is not going to change soon if ever. Your defense to this is to know the laws and abide by them, to the letter. Saying that the laws are difficult or that there are bad people out there does not cut it and you ought to know that. Oral agreements in China are not worth the paper on which they are not printed and written agreements drafted by anyone not experienced with Chinese language contracts have no greater value.

You have been warned (yet again).

Today’s post is another warning.
 

 

China trademarkI have had a number of conversations over the last few months with American and European start-up companies looking to sell their high end products into China. Most of these calls touched on pretty much the same things and so it occurred to me to write about the issues we discussed, as they apply broadly to many such companies. The following issues seemed to come up nearly every time, as they should:

  1. What sort of entity should we have in China? In both instances I talked of how time-consuming and expensive it is to form a WFOE in China and how they should delay forming a WFOE in China until such time as they truly needed one, and of how that time might never come. See How to Form a WFOE in China, Part 12: Do You Really Even Need One?
  2. When should we register our trademarks and where and who should own those registrations? My response was that you should register your trademarks before anyone outside your inner circle might learn of them. I then lectured them on the dangers of not using a qualified lawyer for such registrations and on how it is a myth that trademark registrations are easy. I then gave a couple of horror stories of companies that had botched their trademark registrations in China and in the United States, and ended up going broke because of that. I told them that foreign entities can own China trademarks and there are even advantages to doing it that way. I told them that in addition to registering their English language names and their logos, they should probably get a Chinese language name and register that as well. See Register Your Trademark In China, All Things Considered
  3. What’s it like selling on Alibaba? We talked about the legal requirements/legal issues they likely would confront if they sought to sell their products on Alibaba and the major differences between Tmall and Taobao.
  4. Do we need a China WFOE to get a WeChat business account? Yes.
  5. What about setting up offshore entities to save on taxes? Unless you have a lot of money right now, it makes better sense to spend your time and your money focusing on growing revenues and profits, and not on worrying about paying taxes on profits years down the road. I’ve had many clients wonder why their previous attorneys or accountants had set up complicated and multi-country entities but I’ve never had a client bemoan their having been late to do so.
  6. What do we need to do to hire people in China? Get a WFOE. Please. See Doing Business in China with Deportation or Worse Hanging Over Your Head.
  7. What about customs issues? We are happy to help, but usually the much cheaper way to handle these is to have your China distributer or reseller (if you end up going one of those routes) be in charge of this or you bring in a third party logistics company to assist.
  8. Anything else? Yes. Take it upon yourself to try to figure out any rules specific to your particular product. You can pay your lawyers to do this now and in the future, but that usually isn’t necessary.

 

China IP lawyers
Elephants are so noble. Trade wars far less so.

I have been called by reporters at least a half dozen times in the last couple of weeks regarding the Trump Administration’s planned investigation of China’s IP practices. But what I tell these reporters fits so badly with THE narrative that my name is not showing up in print. Sorry, but I can’t help it.

Here’s the situation. The Trump Administration is claiming that China’s government forces American companies to relinquish its IP to China and my problem is that despite my firm having worked on literally hundreds of China transactions that involve IP, I have very little proof of this. So no real story there.

Here though is the story as seen from my eyes and from the eyes of the China attorneys at my firm, readily conceding that we have not seen even close to everything.

We have never been involved in a China transaction where it has been clear to us that the Chinese government has forced our client to relinquish its IP to China. We have though been involved in a million transactions where the Chinese party on the other side — sometimes a State Owned Entity, but way more often not — has vigorously and aggressively sought to get our client to part with its IP for a very low price. Is the Chinese government behind this sort of pressure? Don’t know? Probably sometimes, but probably most of the time not. If the transaction involves rubber duckies, we can assume not. If it involves next generation computer chips, well that is probably a very different story.

Anyway, as we write on here so often, there are many terrible technology transfer and other sorts of IP deals to be had with Chinese companies and we have too often — even against our China attorneys’ clear counsel to our clients not to do it — seen our clients make bad deals that will involve them turning over their IP with little to no chance of receiving full value for it. But these companies have not been forced, not in the sense that any government was forcing them to do anything. These companies were simply willing to take huge risks either because they could not grasp the risks or because they felt they had no other choice for financial reasons.

In Three Myths of China Technology Transfers, we wrote about how our clients all too often forge ahead with bad deals and why, and we nowhere mention government compulsion:

A Chinese company that intends to violate a licensing agreement and run off with the foreign company’s IP will usually have a very clear plan. What the China lawyers in my office call the Standard Plan works as follows. First, the Chinese company will negotiate in a way that guarantees a weak license that cannot be enforced against them by the foreign party. The tricks used to do this are quite standardized. Second, the Chinese company will ensure that it does not make any (or else it makes very few) payments until after it has already received the technology. If the Chinese company makes any payment at all, it will make a minimal number of payments, usually late and in violation of the agreement and then once it has received enough of the technology it seeks, it will cease making any payments entirely.

When our China attorneys encounter a Chinese company clearly working on the Standard Plan, we warn our clients. However, it is also typical for our clients to nonetheless want to forge on ahead. The client will usually explain how their situation is unique and that means the Chinese could not possibly be planning to breach.

We discuss again in China Technology Transfers: The Relationship and Deal Structure Myths how it is that American companies lose their IP to Chinese companies and we again leave out government force:

Due to a partnership relationship, the foreign side often wrongly believes it is somehow better protected against IP theft. The foreign side then lets down its guard, only to learn that its China partner has appropriated its core technology. This sense of partnership is most common with SMEs and technology startups, especially those companies whose owner is directly involved in the relationship with the Chinese entity.

In China and The Internet of Things and How to Destroy Your Own Company I rant about technology companies that literally destroy themselves by failing to do enough to protect their IP from China:

Well for what it is worth, I will no longer describe technology companies as a whole as our dumbest clients when it comes to China. No, that honor now clearly belongs to a subset of technology companies: Internet of Things companies. And mind you, we love, love, love Internet of Things companies. For proof of this, just go to our recent post, China and the Internet of Things: A Love Story. Internet of Things (a/k/a IoT) companies are sprouting all over the place and they are booming. Most importantly for us, they need a ton of legal work because just about all IoT products are being made in China, more particularly, in Shenzhen. And just about all IoT products need a ton of complicated IP assistance.

So then why am I saying they are so dumb about China? Because they are relinquishing their intellectual property to Chinese companies more often, more wantonly, and more destructively than companies in any other industry I (or any of my firm’s other Chinese lawyers) have ever seen. Ever. And by a stunningly wide margin.

I then list out the following as “my prime example, taken from at least a half dozen real life examples in just the last few months”:

IoT Company: We just completed our Kickstarter (sometimes Indiegogo) campaign and we totally killed it and so now we are ready to get serious about protecting our IP in China.

One of our China Lawyers: Great. Where are you right now with China?

IoT Company: We have been working with a great company in Shenzhen. Together we are working on wrapping up the product and it should be ready in a few months.

China Lawyer: Okay. Do you have any sort of agreement with this Chinese company regarding your IP or production costs or anything else?

IoT Company: We have an MOU (Memorandum of Understanding) that talks about how we will cooperate. They’ve really been great. They have told us that they would enter into a contract with us whenever we are ready.

China Lawyer: Can you please send us the MOU? Have you talked about what that contract will say?

IoT Company: Sure, we can send the MOU. It’s one page. No, we haven’t really talked much beyond just what we need to do to get the product completed.

China Lawyer: Okay, we will look at your MOU and then get back to you with our thoughts.

Then, a day or two later we a conversation like the following ensues:

China Lawyer: We looked at your “MOU” and we have bad news for you. We think there is a very good chance a Chinese court would view that MOU as a contract. (For why we say this, check out Beware Of Being Burned By The China MOU/LOI) And the Chinese language portion of the MOU — which is all that a Chinese court will be considering — is very different from the English language portion. The Chinese language portion says that any IP the two of you develop (the IoT company and the Chinese manufacturer) belongs to the Chinese company. So what we see is that as things now stand, there is a very good chance the Chinese company owns your IP. This being the case, there is no point in our writing a Product Development Agreement because your Chinese manufacturer is not going to sign that.

IoT Company: (And I swear we get this sort of response at least 90 percent of the time) I’m not worried. I think you have it wrong. I’m sure that they will sign such an agreement because we orally agreed on this before we even started the project.

China Lawyer: That’s fine, but I still think it makes sense for you to at least make sure that the Chinese company will sign a new contract making clear that the IP associated with your product belongs to you, because if they won’t sign something that says that, there is no point in our drafting such a contract and, most importantly, there is no point in your paying us to do so.

So far not a single such IoT company has been able to come back to us with an agreement from their Chinese manufacturer to sign.

Again, no government force, just an overzealous and insufficiently careful foreign company.

Now before anyone excoriates me for ignoring reality, let me say that I have read about instances where the Chinese government has “forced” foreign companies to turn over their IP to China; high speed rail is an often cited example of that. And I do not doubt that it happens in critical industries (nuclear power would be another example). And I am also not unaware of how China is increasingly forcing foreign companies to store their data in China, which absolutely puts technology at risk. But even in these instances the foreign company has some choice. Not good choices, I know. And arguably it is no choice at all when the decision is between doing business in China or not. The last thing I want to do is get all philosophical on anyone regarding what constitutes choice so I will leave it to our individual readers to determine for themselves where on the continuum of force and choice they want to put any and all of the above.

There is plenty to complain about how China protects IP and there is plenty to complain about how China protects foreign companies that do business in China or with China, but I am just not sure complaining about forced IP transfers goes at the top of that list for most American companies. When I talk with American and European and Australian companies about China their biggest legal complaint is invariably how expensive it is for them to comply with China laws and how they resent that their Chinese competitors generally are not held to the same legal standards.

A couple of years ago, I gave the following testimony before The US-China Economic and Security Review Commission of the United States Congress:

I was introduced as an expert, and I’d like to qualify that by saying do not think of myself as an expert. I am just a private practice lawyer who represents American and Australian companies and some European and Canadian companies as well in China.

I’m going to tell you a little bit about what we do so you can get a little bit better perspective of where I’m coming from on this. The bulk of my firms’ clients are small and medium-size businesses, mostly American businesses, but some European and Australian and Canadian businesses as well. Most of them have revenues between 100 million and a billion a year. Our clients are mostly tech companies, manufacturing companies and service businesses.

About 20 percent of our work is for companies in the movie and entertainment industry. We have some clients in highly-regulated industries, like health care, senior care, banking, insurance, finance, telecom and mining, but those companies make up less than ten percent of our client base.

Most of the China work we do for our clients is relatively routine. We help them register as companies in China. We register their trademarks and copyrights in China. We draft their contracts with Chinese companies. We help them with their employment, tax and customs matters. We oversee their litigation in China, and we represent them in arbitrations in China. We help them buy Chinese companies.

For our clients, the big anti-foreign issue is whether they will be allowed to conduct business at all in China as that is certainly not always a given. Certain industries in China are shut off or limited to foreign businesses acting alone. For our clients, publishing and movies are most prominent.

Essentially anything that might allow for nongovernmental communication to or between Chinese citizens is problematic, but it is not clear to me that these limitations are intended to be anti-foreign, as China does not really want any private entities, foreign or Chinese, engaging in these activities without strict governmental oversight.

So do these limits against foreign companies arise from anti-foreign bias or just the Chinese government’s belief that it can better control Chinese companies? To our clients, that distinction doesn’t matter.

On day-to-day legal matters, our clients are almost invariably treated pursuant to law, and so long as they abide by the law, they seldom have any problems. The problem for our clients isn’t so much how the Chinese government treats them; it’s how they are treated as compared to their Chinese competitors who are less likely to abide by the laws and more likely to get away with it.

I have no statistics on this. I doubt there are any statistics on this, but I see it and I hear it all the time.

I see it when one of our clients buys a Chinese business that has half of its employees off the grid and has facilities that are not even close to being in compliance with use laws, and I know foreign companies cannot get away with that.

And I hear it from Chinese employees of our clients who insist that there is no need for our clients to follow various laws. They insist there is no need to follow various laws and to do so is stupid. Is this disparity due to anti-foreign bias or is it due to corruption? Again, for our clients, the answer is irrelevant.

Is the Trump administration’s IP investigation a negotiating ploy done as much to get at disparate treatment as it is to get at forced technology transfers? I do not think it is, but some who know more about such things tell me it may be.

CNN was the only one of the media companies that both interviewed me on the above issues and ended up quoting me and I like how it handled the issue in its article, President Trump is set to crank up the pressure on China over trade:

Beijing has other ways of getting its hands on valuable commercial information. Officials often insist on taking a close look at technology that foreign companies want to sell in China.

“Chinese government authorities jeopardize the value of trade secrets by demanding unnecessary disclosure of confidential information for product approvals,” the American Chamber of Commerce in China said in a report published in April.

Some experts say that handing over technology has effectively become a cost of doing business in China — a market too big for most companies to ignore.

“Many Chinese companies go after technology hard and the tactics they use show up again and again, leading us to believe there is some force (the government?) teaching them how to do these things,” said Dan Harris, a Seattle-based attorney who advises international companies on doing business in China.

“The thing is that the foreign companies that give up their technology usually do so at least somewhat of their own volition,” he told CNNMoney. “Yes, maybe they need to do so to get into China, but they also have the choice not to go into China, right?”

Closing the stable door?

Other analysts say that the U.S. administration is coming to the problem too late.

“Intellectual property (IP) theft is yesterday’s issue,” wrote Lewis of the Center for Strategic and International Studies.

“In part because of past technology transfer and in part because of heavy, sustained government investment in science and research, China has developed its own innovative capabilities,” he wrote.

“Creating new IP in the United States is more important than keeping IP from China.”

These are really complicated issues and I realize the above is more of a stream of consciousness “thoughts dump” than a coherent position paper. So more than ever, I’d love to hear your thoughts in the comments below.

Direct marketing in ChinaBecause we are one of very few law firms that represent foreign companies doing direct marketing in China we get quite a few emails from companies (and even individuals) regarding China’s direct marketing laws. Long story short, China does not particularly like direct marketing and its direct marketing laws are so restrictive that the industry there has little in common with direct marketing in the United States or even Europe.

The other day, one of our China lawyers received an email from a potential client with a link to a United States government site describing China’s direct marketing laws. The email was short and merely asked whether the information on this site was accurate or not.

It is accurate and current and and helpful and important and to the point and for those reasons I reprint it in full below.

Direct selling is defined by Chinese regulators as a type of business model involving the recruitment of direct marketing sales agents or promoters and the selling of products to end-consumers outside fixed business locations or outlets.

As part of China‘s WTO commitment, the Chinese Government agreed to allow market access for wholesale or retail trade services away from a fixed location. However, these new regulations are quite restrictive, especially in regards to multi-level marketing (MLM) organizations, which are characterized as illegal pyramids under these regulations.  Sales promoters earn commission only according to their sales performance and the proportion of payment to sales promoters should not exceed 30 per cent of the income generated from sales.  Furthermore, commission paid to a salesman is not allowed to be calculated based on the MLM structure, and language exists requiring the construction of fixed location service centers in each area where sales occur for the purpose of after-sales service and consultation. To obtain a direct sales license from the government, further barriers exist as evidenced by a three-year foreign experience rule, a required RMB 20-100 million (USD 2.9-14.5 million) bond deposit and a RMB 80 million (USD 11.6 million) registered capital threshold, among other requirements. Nonetheless, several major international companies have had success in overcoming these barriers. Having said this, the Chinese Government has remained slow to approve direct-sales license applications for new entrants over the past few years. In general, the Chinese central government and the relevant authorities at central and local levels tend to heavily regulate and supervise this industry.

Any questions?