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Quick Question Friday, China Law Answers, Part XXII

Posted in Basics of China Business Law, Legal News

China lawyers

Because 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 or phone calls 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 provides some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

Just one question this week and it came in about ten minutes ago. But it is a really good one. It is from a friend of mine who teaches business at a University in Shanghai, and it is the following:

Greetings from Shanghai!

You wrote in a recent blog post,” one lesson should be clear from this: if your brand is at all famous and you have the means, strongly consider the Starbucks approach and register your brand in all 45 classes”
My question is – how does Starbucks avoid getting some (or most) of these 45 registrations cancelled after 3 years because of non-use?

My students here in Shanghai often ask me this question.

Thank you for your insight.

Our China trademark lawyer, Matthew Dresden gave this answer:

1. It is true that three years after the registration date, Starbucks’ trademarks could be challenged for non-use (for those goods and services that they are not actually using in commerce). But in China, trademark owners do not have to affirmatively prove use, so these marks will remain valid (and can be renewed after 10 years) unless and until someone files a non-use cancellation against them.

2. Moreover, if Starbucks wants to foreclose the possibility that a third party would cancel these trademarks for non-use, at about the three-year mark they could file new trademark applications in the at-risk classes. Once those applications proceed to registration (and they inevitably would), they would have a new three-year window during which the marks could not be challenged.

3. Note that the above two steps would apply to any company. If we’re talking about Starbucks in particular, they have established that they are a well-known brand and could also fight trademark squatters that way. But that’s a defensive action, and Starbucks has made the tactical decision that it is better to play offense than defense.

For more on China trademarks, check out the following, all of which were written within the last month:

China Trademarks: Facebook FTW

Posted in Basics of China Business Law, China Business

China TrademarksUnlike Apple (which lost a big trademark case) and Under Armour (which had to contend with an annoying trademark copycat), Facebook had a pretty good week in China. In a case decided in late April (but not publicized until last week), the Beijing High People’s Court invalidated Zhongshan Pearl River Beverages’ three trademark registrations for “face book” and sent them back to the Trademark Review and Adjudication Board (TRAB) for reconsideration.

Many of the news stories I’ve read about this case characterize it as a sign that Facebook’s charm offensive may be working—in sharp contrast to Apple’s recent travails, which portend poorly for Apple’s future in China. I find this narrative a bit facile. I think both the Apple and Facebook cases were decided correctly according to Chinese trademark law, and the analysis doesn’t need to go any further. It’s convenient to put a political spin on the outcomes, but it’s hardly necessary.

Apple lost its case because Xintong Tiandi Technology submitted a trademark application for IPHONE just a few months after Apple announced the iPhone in San Francisco, and years before the iPhone went on the market in China. Apple was unable to provide sufficient evidence to the court that IPHONE was a well-known brand at the time of the application, which is why Apple lost.

In contrast, Zhongshan Pearl River’s applications for “face book” was submitted on Jan. 24, 2011. (To be precise, the applications were submitted by Liu Hongqun, the company’s marketing director.) By 2011, Facebook had been widely covered in the Chinese media for years; it wasn’t even blocked in China until 2009. Moreover, the Beijing High Court deemed Liu Hongqun a trademark squatter, noting that he had previously attempted to register trademarks for other famous brands such as 黑人, the alarmingly racist toothpaste that you can still find in stores all over Asia. In other words, the court wasn’t inclined to give Liu the benefit of the doubt, and it had enough evidence to find that Facebook was a well known mark at the time of Liu Hongqun’s application.

I also would be reluctant to call the Facebook trademark decision a harbinger of better IP protection for non-Chinese brands. Facebook is a huge, powerful company, and it was quite well-known even back in 2011. How many other companies are as big as Facebook? Still, one lesson should be clear from this: if your brand is at all famous and you have the means, strongly consider the Starbucks approach and register your brand in all 45 classes. I haven’t talked to anyone at Facebook about it, but I am certain they would have gladly paid extra costs upfront to avoid the hassle and cost of having to litigate this case.

It’s also worth remembering that Apple has earned, and is still earning, billions of dollars every year in China. Facebook still isn’t allowed to operate there. So tell me again, how is Facebook coming out ahead here?

Doing a Deal in China? Get a Company Search Report First

Posted in Basics of China Business Law, China Business, China Film Industry

China LawyersDue diligence is an investigation of a business or person prior to entering a contract. It often involves a comprehensive appraisal to establish assets and liabilities or to evaluate commercial potential. Though due diligence is important anywhere, it is doubly so in China where things are often not what they seem.

A failure to undertake due diligence is usually a factor, if not the decisive factor, in losses suffered by foreigners in their dealings with Chinese businesses. My firm’s China lawyers regularly encounter contracts signed with non-existent Chinese companies. We see deals with companies that are not owned or controlled by the people who handled the negotiations or made the promises. We see deals with companies that can never lawfully do what they promised to do. All of these problems could have been avoided with a basic company search report. By the time they came to light it was too late to fix them.

China company search reports are an important part of due diligence. They can confirm whether the Chinese company exists and, if so, whether it is in good standing with all of its annual filings up to date. Critically for enforceable contract formation, search reports confirm the full name and registered address of a company. A company search report will identify the individuals with effective control over the management and operations of the company. It will identify the stockholders. It will confirm the business scope, i.e., the business activities in which the company may lawfully engage. Depending on the relevant industry or business activity, lawful operations may require a number of other permits or licenses. These too can be found as part of the search process. In many cases, company search reports can garner other useful information published by the authorities.

Most of the important records are publicly available at the national Administration of Industry and Commerce (AIC) or the AIC offices in the municipality or the province where the relevant company is registered. The search process is relatively straightforward for anyone with the expertise and language skills. Searches should only ever be based on publicly available records but the information revealed should nonetheless be regarded as sensitive. Particular care should always be taken to ensure that captured information could not be regarded as secret.

So when things go wrong, don’t blame your Chinese counter-party if you never even bothered to check things out. China has a good system in place for anyone who cares to use it. In our experience, reputable Chinese businesspeople are untroubled by company searches and will readily provide key documents and information to make your search faster and easier. All you need to do is ask politely at the right time.

Doing Business in China: Structuring Your Deal and Protecting Intellectual Property: May 24 Webinar

Posted in Basics of China Business Law, China Business, Events
Doing Business in China          Doing Business in China: May 24 Webinar

On May 24, China Law Blog’s own Dan Harris will be putting on a webinar on the legal aspects of doing business in China, with a focus on how to structure your Chinese operations and deals so as to protect your IP. This webinar is being put on by CommercialLawWebAdvisor, which describes it as follows:

Companies often cannot afford not to do business in China. Whether producing goods there or selling to the Chinese market, companies that engage in business with Chinese partners need up-to-date legal advice on how to protect their technology and other intellectual property (IP) interests from being counterfeited, pirated, or otherwise misappropriated. As IP theft is one of the top issues facing businesses operating in China, there are substantial risks companies must identify and address proactively to protect their valuable IP assets. Deals made in China can threaten IP rights not just in China, but in markets around the world. Understanding the Chinese IP landscape and how to manage the pertinent issues can go a long way to safeguarding your client’s valuable IP interests.

Please join Dan Harris as he explores the nuts and bolts of constructing a good business deal with a Chinese partner, what your agreements should include, and how to manage the Chinese IP rights framework to minimize your client’s IP-related risks.

WHAT YOU WILL LEARN
This webinar will cover:

  • How to choose a good Chinese partner
  • Identifying the IP assets that need protection
  • How to structure your deal
  • Drafting your deal papers
  • Drafting China employee contracts to protect your IP
  • IP registrations: What you should know about trademarks, patents, copyrights, and licensing agreements

YOUR CONFERENCE LEADER
Your conference leader for “Doing Business in China: Structuring Your Deal and Protecting Intellectual Property” is Dan Harris. Dan is an attorney with Harris Moure, PLLC, in Seattle. He is internationally regarded as a leading authority on legal matters related to doing business in China and in other emerging economies in Asia. Forbes Magazine, Business Week, Fortune Magazine, BBC News, The Wall Street Journal, The Washington Post, The Economist, CNBC, The New York Times, and many other major media players have looked to him for his perspective on international law issues.

Dan writes and speaks extensively on Chinese law with a focus on protecting foreign businesses and his China Law Blog is regarded as one of the best law blogs on the web today. The ABA Journal recently named the China Law Blog to its Blawg Hall of Fame (a designation given to the top 20 law blogs of all time).

This session is recommended for corporate and in-house counsel, as well as attorneys advising companies or organizations and intellectual property attorneys and any business looking at tightening up its China legal situation. Find out more about costs and registration here, and note that China Law Blog readers can use promo code cw16dbc to get a $35 discount on the event.

We look forward to “seeing” you there.

China Institutes New Student Intern Rules

Posted in Legal News

China Labor Law“It just goes to show you. It’s always something. If it’s not one thing, it’s another.” Roseanne Roseannadanna (Gildner Radner)

Now I know Roseanne Roseannadanna was never referring to China’s labor laws when she would say the above, but considering how frequently they change (especially lately) she should have been. China wants its labor laws to more closely correspond to its current economic situation and more closely jibe with a modern service economy and it is moving at full force to achieve that.

Last month, China’s Ministry of Education, Ministry of Finance, Ministry of Human Resources and Social Security, State Administration of Work Safety, and Insurance Regulatory Commission jointly promulgated the Administrative Measures on Regulation of Hiring of Career School Student Interns (职业学校学生实习管理规定). This post highlights a few key aspects of these new Measures, with a focus on how they might impact you as a China employer.

The Measures apply to students enrolled at senior-high-level career schools and college-level career schools. China has three levels of career schools: junior high (for students who have completed elementary school), senior high (for students who have graduated from junior high) and college (for students who have completed their senior high school studies). Career schools are usually meant for technicians, production/service workers and elementary school teachers. These new Measures do not apply to normal universities. Many foreign businesses (including many of our law firm’s clients) hire in substantial numbers students from all levels of these schools.

Prior to commencement of an internship, an employer entity hiring a student intern must allow the school to conduct an onsite inspection to gather the following information: the entity’s basic information, the nature and content of the internship, the intern’s responsibilities, working and health conditions, and work safety measures. The hiring entity must limit the number of student interns at its workplace to no more than ten percent and the number of student interns at a particular position cannot exceed twenty percent of the total number of workers at similar positions. These restrictions apply only to student interns hired to work relatively independently (“working interns”) and do not apply to those who are merely shadowing.

The duration of the internship should usually be for six months. Before the internship can start, the school, the hiring entity and the student must enter into a three-party agreement, that should include, at minimum, the following:

  • The parties’ basic information (generally include their legal names, contact addresses and phone numbers, and the ID number of the student)
  • The term/duration of the internship
  • The workplace
  • The type of work the intern will be doing and the relevant requirements
  • The hours and shifts of the internship
  • Vacation and rest days
  • Lodging and accommodation
  • The intern’s compensation and method of payment
  • Applicable provisions on labor protection, work safety and health conditions, and occupational hazard prevention measures
  • Evaluation and examination of the intern
  • Liability for breach of agreement
  • Insurance for the intern and applicable provisions addressing accidents, injury, and death.

If the student is under 18, a legal guardian’s written consent is also required. If the student is under 16, you cannot hire him or her as a working intern. Even students over the age of 16 cannot be hired as working interns if the student is still in his or her freshman year at the school. Just as a bit of a side-note, we have lately been getting involved with video gaming contracts involving “employees” under the age of 18 and whether or not they are void due to the “employee” being a minor. Some of these contracts are for surprisingly (to us lawyers anyway) large amounts.

The provincial/municipal education administrative departments and labor bureaus are expected to come up with detailed implementing rules pursuant to these Measures. This means that as with almost all aspects of Chinese employment laws, you need to keep in mind that local rules will also apply.

China Trademarks and My Favorite (Uncle) Martian

Posted in Basics of China Business Law, China Business

China trademark

It’s been a wild week in China trademark news. We’ve already written about Apple’s defeat in the “IPHONE” trademark case. But the story that just keeps getting better is the Uncle Martian/Under Armour trademark row.

The story began last week, when Fujian-based Tingfeilong Sporting Goods, a low-end sneaker manufacturer, debuted its new “Uncle Martian” line of athletic apparel and footwear and released a bunch of photos on Weibo. Anyone with even a passing knowledge of sportswear brands can see that the central part of the Uncle Martian logo is nearly identical to the Under Armour logo. Every news story I’ve read has the same take: half dismay, half incredulity at yet another Chinese ripoff of a famous American brand. And it only fans the flames when Tingfeilong issues who, me? denials that disclaim any similarity to Under Armour, while simultaneously posting a scan of Under Armour’s Hong Kong subsidiary on its website as if the companies were connected, along with photos of Under Armour gear with the “Uncle Martian” logo crudely photoshopped in.

But I think the media are missing the point by failing to see this for what it actually is: a brilliant and very conscious marketing ploy by Tingfeilong that has already been successful beyond their wildest dreams. Tingeilong has to know it cannot prevail in a trademark infringement lawsuit brought by Under Armour. I checked the Chinese Trademark Office database and Under Armour has clear ownership of its logo in Class 25, which covers clothing. (Its brand control in other classes of goods is not as strong as it should be, but that’s another story.)

On the other hand, the CTMO only shows one trademark registration on file for “Uncle Martian.” It is also in Class 25, and it was registered on June 6, 2007 by someone named Ma Chenbing, whose registered address was a high school dormitory in Shantou (a city in Guangdong Province). Yes, a high school dorm. Believe me, I have the same questions as you.

If there’s an application on file for Uncle Martian’s copycat logo, it hasn’t shown up yet on the CTMO website. And I don’t think it ever will. I predict Tingfeilong will milk this media coverage for as long as it can, and then as soon as Under Armour gets serious with a lawsuit, Tingfeilong will stop using the copycat logo and just keep the Uncle Martian name. It may not become an China Trademarksinternational brand, but Tingfeilong was never going to compete on quality. And after all this news coverage, I bet a lot more people will be interested. I’m not sure how big the market is for ironic t-shirts in China, but this American would totally buy one.

Meanwhile, the other component of the Uncle Martian logo, the laurel wreath around the almost-interlocking letters, is an equally blatant ripoff of the Fred Perry logo. Where’s the outrage from the UK? Wake up, mods!

 

 

Note: The above photos are from RocketNews24

China Employment Law: The Basics on New Hires

Posted in Basics of China Business Law

China employment law

If you plan to bring on new China employees, there are a number of employment law issues you should consider. This post briefly discusses a few of these issues.

If your new hire had a previous job in China, you should require your new hire to provide proof (usually consisting of a document from his or her previous employer) that the previous employment relationship ended properly. This is not a legal requirement, but rather, for your own benefit. You want your employee to be dedicated to working for just you and so you want to make sure he or she will not continue working for some other employer. You would be surprised (or maybe you wouldn’t) at how often someone seeks to secretly hold two jobs in China, especially for two different WFOEs. To that same end, you will also want to make clear in your offer letter and in your contract and in your rules and regulations that holding more than one job is prohibited. We see it all the time in China: an employee believes he or she is underpaid and so they get a second job or start their own side business in competition with yours. Though you may not care if your employee is selling Gucci bags on WeChat, you will want to make sure your employee’s moonlighting does not adversely affect work performance or your company. You want to make it easy to terminate an employee whose extracurriculars is harming your business.

Before you bring on any new China employee, you should also make sure there are no unresolved issues between your new hire and his or her previous employer. One issue that comes up often is the non-compete. If you did not ask your new hire if he or she ever signed a non-compete with the previous employer, you may be at risk. It does not matter if the new hire is a relatively low level employee; it is still possible the employee signed a non-compete. If you are considered a competitor under that non-compete, your hiring this person could subject you to liability. Get your potential hire to provide you with a copy of any non-compete agreement and a copy of his or her current or previous labor contract. Chinese courts have upheld the validity of one sentence non-compete provisions in labor contract.

You also should confirm whether your new China hire has completed the hand-over and exit procedures of his or her previous employer. Many China employers require their employees cooperate during the exit process and a failure to do so could subject the employee to liability. We have found it very helpful to learn how new hires handled these exit procedures because how they did so can tell you a lot about them.

It also makes sense to try to determine whether your potential new employee gave adequate notice of leaving to his or her previous employer. If he or she did not, the previous employer can sue your new hire for damages, which is not something you want new employees to be bogged down with during their first few months with your company. And how they treated their previous employer will be a good indication of how they will treat you.

Once your new hire officially starts working for you under a written labor contract, you can now sit back and relax and revel in your ability to recruit great new talent, right? Not exactly. Under China employment law, your new hire can leave just by giving you 3 days notice and this notice need not be in writing. Don’t bother trying to enlarge this notice requirement either as you cannot make it any longer than what the law requires.

Do not forget to have your new hire’s social insurance and employee files properly transferred and set up in a timely manner. The probation period is considered part of the employment period, and just because an employee will not complete his or her probation period for six months does not mean you can wait that long to pay his or her social insurance.

Oh, and lastly, keep in mind that if an “employee” has been working for you as a dispatched worker, he or she should not be considered a new hire for purposes of China’s labor laws. Therefore, you may not set an additional probation period for this employee when he or she becomes your direct hire.

For more on what it takes to incorporate new hires in China, check out China Employment Contracts: Ten Things To Consider and if you ever start getting comfortable with China’s employment laws, I urge you read this. We think it a good idea for you to audit your employment situation yearly.

China’s Trademark Laws vs. the Biggest Company in the World, or Apple’s Cruelest Month

Posted in Basics of China Business Law, China Business, Legal News
Don't be late in filing for your China trademark

Don’t be late in filing for your China trademark!

After the month it just had, Apple is probably sick of hearing T.S. Eliot references. First China cut off access to iTunes movies and books. Then Apple reported a 26% drop in quarterly sales in China, Hong Kong, and Taiwan, after which Apple’s stock price took a header. Topping it all off, last week China’s Legal Daily reported Apple’s defeat in a trademark-infringement case, in which the Beijing High People’s Court upheld the validity of Xintong Tiandi Technology (Beijing) Co., Ltd.’s trademark application for “IPHONE” covering leather goods such as handbags, belts, and yes, cellphone cases. This decision was an affirmation of a Dec. 16, 2013 decision by the Trademark Review and Adjudication Board (TRAB), and a subsequent decision by the Beijing No. 1 Intermediate People’s Court, on appeal from the TRAB.

Apple’s chief argument in the trademark case was that “IPHONE” is a well-known trademark in China, and therefore any third-party registration – regardless of the product or service – should be invalidated. The TRAB and the Chinese court both rejected this argument, and if you look at the timeline, it was a fairly easy call.

Apple had submitted a trademark application for “IPHONE” on October 18, 2002, and received a registration on November 21, 2003. This trademark registration was in Trademark Class 9 only, covering computer hardware and computer software. Apple first announced the iPhone in public on January 9, 2007 at the Macworld Expo in San Francisco. The first iPhones were available later that year in the U.S., but did not arrive in China until October 30, 2009, after Apple signed a deal with China Unicom.

Meanwhile, on September 29, 2007, Xintong Tiandi Technology (Beijing) Co., Ltd. submitted a trademark application for IPHONE in Class 18 for leather goods.

The only substantive question before the TRAB, the Beijing No. 1 Intermediate People’s Court, and the Beijing High People’s Court, was this: was “IPHONE” a well-known trademark at the time that Xintong Tiandi filed its application? As we have discussed numerous times (see here, here, and here), it is extremely difficult to prove you have a well-known trademark in China. Generally speaking, to succeed the mark needs to be widely known to the general public in China. And in October 2007 — two years before the first iPhone was sold in China — the mark “iPhone” was not well-known to China’s general public. Accordingly, Apple was held to have had no basis to invalidate Xintong Tiandi’s trademark application.

We can take a few simple lessons from this case:

  1. If you really don’t want to see your trademark on some random products in China, submit a trademark application to cover more products than what you will be selling. Starbucks has done a great job with this “offensive” strategy in China, filing trademark applications in all 45 classes of goods and services. For brand-conscious companies, this is just the cost of doing business. Would you rather see “your” brand on a line of diapers or lawn furniture? And it almost always makes sense to file for China trademarks in China, not in Madrid. See China Trademarks. Register Them In China Not Madrid.
  1. Regardless of what you might think, your trademark is almost certainly not well known in China. There are only a handful of non-Chinese brands that would qualify as well known trademarks, and they already have trademark registrations in China. You might have the most famous natural foods store in America, but in China, you might as well be a guy from Inner Mongolia with a backyard chicken coop. You think I just made that up, but on a hunch I checked the CTMO website and someone from Hohhot has in fact registered a trademark for “Whole Foods Market” to cover eggs. Only eggs! There’s got to be a story there. See Think You Have A Well Known China Trademark. Think Again.
  1. If you’re going to file trademark applications in China, do it before you make a big public announcement. The general public in China may not follow all the latest press releases, but you can bet someone in China does, and that someone could very easily file an application for “your” trademark before you ever come to market in China. This applies to movie studios announcing their summer tentpoles just as much as it does to tech companies debuting their new gadget. We’ve said it before and we’ll say it again. China is a first to file country and this means (with very few exceptions) that whoever files for a trademark first gets it. See Register Your Trademark In China: Now. Just Ask Mike.
  1. If you’re going to file a China trademark application early, don’t file too early. By filing in 2002 but not announcing its product until 2007, Apple exposed itself to a non-use cancellation action. If one of their competitors had bothered to check the CTMO database, they could have filed a non-use cancellation on “IPHONE” the day after Apple’s announcement in 2007, and then Apple would have been in deep, deep trouble. See China IP Protection: The Force Is Strong With This Blog Post.

Xintong Tiandi’s trademark application will proceed to registration on May 14, 2016, so in about a week you can buy an IPHONE cellphone case from Xintong Tiandi to protect your iPhone. Actually, you can buy one right now, but next week Xintong Tiandi can start legally using the ® symbol on its goods. The Quartz piece on this topic has some nice pictures of those goods, taken from Xintong Tiandi’s website (which is sometimes offline). You might notice that Xintong Tiandi is already using the ® symbol. I guess they were optimistic.

China trademark problems. Don’t let them happen to you.

China Due Diligence and China Business Licenses

Posted in Legal News

China Due Diligence

Our China lawyers are always asking our clients to secure a copy of their Chinese counter-party’s China business license because a quick review of that license so often provides us with valuable information. I was reminded of that today when I came across a 2012 email while doing a company search. This email is from one of our China attorneys to the client (I was cc’ed), setting forth what we learned just from looking at the Chinese company’s business license, a copy of which our client had.

Just by way of a bit of background, the license was actually for a WFOE (not a Chinese domestic company) and we were looking at the license because our client was trying to determine what had gone on with the Chinese WFOE that was owned by a US company in which it was an investor. I have stripped the email of any identifiers, but you can still get the point.

 

The China Business License you provided us stated as follows:

  1. Company name: _____________in Chinese]. No English language equivalent is given in the documents (which is unusual), but this translates as ____________(Beijing) International Trading Company Limited.
  1. Company address: Beijing City, Dongcheng District__________________. This is a prestigious location in the center of a high-end retail/office district.
  1. Registered Capital: $600,000 US. The amount is high because high registered capital is required for trading companies. A Chinese CPA must verify all registered capital contributions. You should obtain a copy of the verification. Note also that all WFOEs must undergo an annual audit and file an annual tax return. We should obtain a copy of the audit and the filed tax return(s).
  1. Representative Director: __________. This person has primary authority for all company operations. We should ensure that you have complete control over this person together with the company seals/chops, bank accounts/bankcards and primary company documents. We should also immediately determine 1) who is the general manager and 2) who are the members of the board of directors.
  1. Formation date: 8/–/2011. Inspected and approved: 9/–/2012. It is good that the company has been formally inspected. It means someone at the company is trying to follow proper procedure.
  1. Scope of Business: Wholesale for various consumer goods; financial and business management; import and export of goods and technology, including export-import agency. This is a very broad scope of business that allows for them to do consulting business in addition to trading. This is somewhat unusual and is a very good thing for you since it maximizes the flexibility of the WFOE. However, this scope of business does NOT allow the WFOE to operate as an advertising agency (see discussion below). On the other hand, the existing scope of business allows you to advise your customers on where and how they should place advertising and you can charge a fee for the service. You can also act as an intermediary in arranging with an advertising agency for placement. However, you cannot contract directly to place the advertising. Only an advertising agency can do that.
  1. Shareholder: _______________ Holding Company. This appears to be the proper shareholder.

Advertising Agency Issue. Here is a brief review of the advertising agency rules. To place advertising in China, a company must be a licensed advertising agency. Foreign companies are permitted to form a wholly foreign owned advertising agency but the rules for doing so are quite strict. The primary rule is that you must prove that 85% of your income over the last 3 years comes from advertising. How you “prove” this is not stated in the rules. There are also special rules for advertising companies related to staffing and registered capital that add extra burdens. The main issue, however, is the one I raised above. You cannot simply amend your current scope of business to add operation as an advertising agency as an additional item within the scope. Instead, you must form an entirely separate company, with a separate office address, staff, registered capital and the rest. As we discussed, you can, of course, enter into contracts between your Chinese entities that would allow you to offer an integrated package of services to your customers.

But beneath that integrated package you will need to maintain a strict separation between the entities. Thus the person who formed the existing WFOE trading company did not make a mistake with respect to the scope of business. Rather, no one has taken the additional step of forming the additional company that would act as an advertising agency

China and The Internet of Things: Who Owns What?

Posted in Basics of China Business Law, China Manufacturing, Internet, Legal News
China IoT. Who owns what?

                          China IoT. Who owns what?

China (Shenzhen mostly) remains the primary destination for manufacturing of small electronic consumer products. And since Internet of Things (IoT) products are red hot, this means our China lawyers are getting a steady diet of China IoT legal matters.

The issue we see on a day to day basis is this: the IoT product has now reached the mass production stage and is being produced in large quantities. Now that it has a commercial product, the U.S. buyer now seeks financing for its young company. The financier (be it angel, VC, private equity, or even someone’s father-in-law) then asks: who really owns the intellectual property in the product? Do you own it, does the Chinese factory own it, or does some third party own it? It is always awkward for the (usually) young entrepreneur to answer that question. However, with the rise of the Internet of Things (IoT), the question has become even more difficult to answer in a definitive way.

How did we get to this point? The process has worked its way through three general stages:

Stage One. In the good old days (say 1981 to 1995), the situation was simple. There were two possibilities. In the first, the Chinese manufacturer made a standard consumer product. The U.S. buyer merely purchased that existing product and perhaps required the manufacturer take the extra step of placing the U.S. buyer’s own trademark/logo on the product. In that setting, ownership of the intellectual property was clear: the Chinese manufacturer owned the product design and the U.S. buyer owned its trademark/logo. In the second, the product was a long standing, well developed product of the U.S. buyer. The buyer brought the completed product to the Chinese manufacturer and contracted with the manufacturer to make a copy. In that setting, ownership of the intellectual property was clear: the U.S. buyer owned all of the intellectual property and the Chinese manufacturer owned nothing.

The simplicity of the relationship encouraged the lazy practice of documenting the entire manufacturing relationship through simple purchase orders. NNN agreements, product development agreements and OEM agreements were seldom used, since the IP ownership was clear and the price and delivery terms were taken care of by the purchase order. This lazy approach then led to the subsequent disasters resulting from product defects. But that is an issue for another post.

Stage Two. In stage two (1995 to 2015), a new form of relationship developed. U.S buyers began coming to China with no completed project in mind. Instead, they came to China with a product idea or proposal. The buyer then worked with the manufacturer to co-develop the product. In some cases the role of the Chinese manufacturer was simply to take a completed prototype and then commercialize that prototype for mass production. In these cases, the U.S. buyer arrived with little more than a very basic idea, and the two sides worked to co-develop the product.

Normally, the Chinese manufacturer offered to perform all of the development work at its own expense, with the implied agreement that the manufacturer would be the exclusive manufacturer of the product. This co-development process typically proceeded using the same lazy “purchase order only” approach from stage one. This lazy approach then has led to the typical issues we see today that make answering the “who owns what” question so difficult. In order to do the co-development process properly, the parties must define their relationship with three agreements: 1) NNN Agreement, 2) Development Agreement and 3) OEM Agreement.

Where these agreements do not exist, as is common, a set of standard issues arises: Who owns the product design? Who owns the molds and other tooling? Who owns the manufacturing know-how and similar trade secrets? If the buyer decides to have the product made by a different factory, what compensation is owed to the manufacturer who co-developed the product? What is the obligation of the manufacturer to comply with price and quantity requirements of the buyer? If the manufacturer terminates its relationship with the buyer and manufacturers the product under the manufacturer’s own trademark/logo, is this a violation? Absent clear, written agreements, all of these questions have very unclear answers. In that unclear situation, the Chinese factory will generally be in the strongest position and in the event of a dispute the Chinese factory will typically prevail.

Stage Three. In stage three (2015 to today), we arrive at the IoT era. In the design, development and manufacture of consumer products for the IoT market, the already unclear and problem-filled relationships of the stage two era have now become magnified. In the IoT era we are now just entering, a whole new set of issues has arisen. In the stage two era, there was at least the simplicity of two entities designing and/or manufacturing a single product. In the IoT era, the situation is much more complex. In most of the IoT projects we have seen over the last six months, the development process has expanded to include the following:

1. Product “concept” from the U.S. buyer.

2. Product external design, from an international design firm.

3. Internal design and function, owned by:

a. The U.S. buyer;

b. The Chinese manufacturer;

c. The provider of sensors and other components required to connect the IoT product to an outside network.

4. Design of the IoT product “app” (usually for a smart phone). This then involves two completely separate sets of software: the communication sending software residing on the IoT product and the communication receiving software residing on the application in possibly multiple forms. In the same manner as the internal design, these software components may be written/designed by multiple parties: the U.S. buyer, the Chinese manufacturer and (quite often) third party software design firms.

So now consider: the product is complete, manufacturing is ready to start, and the U.S. buyer goes out for funding. The funding source then says: who owns this IoT product? Who owns its underlying IP? What we have found when we ask the U.S. buyers is that they usually don’t know. And their initial backers and sourcing companies don’t know either.

As you can imagine, the “we don’t know” response does not sit well with sources of serious financing. Even worse, when the U.S. buyer is now pushed to answer the question, they more often than not find out that the answer is that it is not clear who owns the new product, but what is clear is that the one entity that clearly does NOT own the rights to the product is the U.S. buyer. Even worse, it is often not possible to fix the situation when this stage is reached.

So the message is that as the manufacturing setting becomes more complex, it becomes even more important to enter into clear written agreements that answer the obvious questions in advance. It makes little sense to devote time, energy and money on developing an IoT product that someone else will own.

For more on the issues we are saying involving China and the Internet of Things, check out the following: