Importing Food from China: Due Diligence Necessary

In one of my previous posts, I discussed the food and drug safety laws and the weak enforcement of them. Here I want to address what a foreign importer could do in light of the less than perfect track record of the Chinese food & drug producers/exporters.

More often than not, most people in the U.S. do not realize the extent of America’s dependence on Chinese food imports. According to a news report from National Public Radio last week,

China has become the leading supplier of many food ingredients, such as apple
juice, a primary sweetener in many foods; garlic and garlic powder, a major
flavor agent; sausage casings and cocoa butter.

China now supplies 80 percent of the world's ascorbic acid — vitamin C. It's used as a preservative and nutritional enriching agent in thousands of foods. One-third of the world's vitamin A now comes from China, along with much of the supply of vitamin B-12 and many health-food supplements, such as the amino acid lysine.

The fact of the matter of is globalization has linked people together in amazing ways, and food imports from China will continue to grow despite the bad press and weak Chinese law enforcement.

However, foreign import companies can take effective measures to reduce risks of exposure to liability and loss of credibility to customers. Preventive measures seem especially sensible and prudent to do following the massive pet food recall in the United State. I have not heard or read about lawsuits filed by pet owners, but one can expect the sellers and importers of the pet foods to have suffered a decrease in consumer confidence in the pet food.

Precautionary Measures to Take:

A. Conduct Due Diligence

· Refer to the United States Food & Drug Administration Website for updated information on food refusals by country of origin. It also makes sense to speak to FDA officials to find out who the repeat Chinese offenders are and stay away from them when importing from China.

· Check with U.S. Customs and Border Protection (Commercial Enforcement Division) to ascertain whether a certain Chinese exporter has a history or record of exporting substandard food or food ingredients to the U.S.

· Before executing a contract, travel to the producer’s manufacturing facility in China to examine the method, process, and overall food quality. This might be the most expensive way to conduct due diligence, but it is probably the most effective simply because you will be able to find out the salient problems.

B. Contractual Protection

· Provide in the contract that the delivery of food or food products with dissatisfactory quality pursuant to United States standards constitutes a material breach of the contract

· Indemnify yourself in the contract in case of latent food quality issues

Franchise in China (IV): Detailed Registration Procedures

Based on information provided by the Ministry of Commerce, a registering franchisor shall follow the following procedures sequentially to properly register.

Step 1
Obtain Username and Password to access the Ministry of Commerce official Website (获取登录号)

1. If franchising is to occur within the boundaries of provinces, autonomous regions, or municipalities, the franchisor or its agent may hand deliver relevant documents to appropriate registering agencies in the province, autonomous region or municipality to obtain username and password. Or, username and password may also be obtained if same documents are mailed to the appropriate registering agencies.

2. If franchising is to occur beyond the boundaries of provinces, autonomous regions, or municipalities, the franchisor or its agent may hand deliver relevant documents to the Department of Commercial Reform and Development located in Dongcheng District, Dong An Meng Dajie to obtain username and password. Or, username and password can be obtained if same documents are mailed to the same office.

Step 2
Sign In at the following URL http://txjy.syggs.mofcom.gov.cn/ (登录系统)

Step 3
Change Password (修改密码)

The initial password assigned to all franchisor are the identical numbers of 000000, so the system will automatically prompt a user to change its password.

Step 4
Fill in the forms and upload documents required under the Registration Guidelines (填报备案资料)

Upon completing the above 4 steps, click on “申报备案” to submit the data and files entered and uploaded.

It is that simple!

China FDA: Will the Monkeys Behave Now?

Yesterday, the breaking news out of China concerns the fate of the Chinese top Food & Drug administrator. News reports around the world relayed his death sentence:

The Beijing No. 1 Intermediate People's Court convicted Zheng Xiaoyu (郑筱萸) of
taking bribes in cash and gifts worth more than $832,000 when he was director of
the State Food and Drug Administration.

The sentence seems harsh for a crime of embezzlement, which occurs very frequently among corrupt officials in China. And the amount over which Zheng was convicted was $832,000 seems small in contrast with other convicted Chinese officials who had been handed much lighter sentences. One has to wonder if there is a political motivation behind this high profile case at this very sensitive time when the whole world is wary of food and drug exports from China. In recent memory, Chinese food and drugs have grabbed headlines world wide:

--Poisonious baby formula
--Pet food with chemical toxic--melamine
--Chinese toothpaste with lethal chemical sold in the Dominican Republic
--Chinese cough mixture with lethal chemical sold in Panama
--Frozen Chinese cat fish with banned antibiotics sold in the Sourthern states of the U.S.

The list can go on and on, but you get the picture. A consumer has to wonder about what exactly is the Chinese government doing to food and drug safety, and how the laws on food and drug safety are enforced in China. State Food and Drug Admisinstration is in charge of enforcing food and drug safety laws and regulations in China.

Chinese laws on food and drug safety:

《医疗器械监督管理条例》自2000年4月1日起施行
Regulations of Medical Equipment Supervision Management, Effective on April 1, 2000
http://www.sda.gov.cn/cmsweb/webportal/W4249/A19565.html

《中华人民共和国药品管理法》2001年12月1日
Drug Management Law of the P.R. China, Effective on December, 1, 2001
http://www.sda.gov.cn/cmsweb/webportal/W68210/A21847.html

《中华人民共和国药品管理法实施条例》, 2002年9月15
Implementation Regulations of the Drug Management Law of P.R. China, Effective on September, 15, 2002
http://www.sda.gov.cn/cmsweb/webportal/W68210/A12160102.html


《食品安全监管信息发布暂行管理办法》2004年10月22日
Interim Regulations on the Information Management of Food Safety Supervision, Effective October 22, 2004
http://www.sda.gov.cn/cmsweb/webportal/W28413144/A64000404.html

Like many things in China, the extent and pace of regulations far exceed those of enforcement. In the face of mounting international pressure and the very image of Chinese exports, the Chinese government went back to its bag of tricks, the Chinese idioms for a quick solution to the rampant, dangerous, and downright embarrassing problems of food and drug safety—“kill the chicken to scare the monkeys so that they may behave” (杀鸡儆猴).

Aside from the death sentence of Mr. Zheng, the Chinese government is undertaking some measures to step up the enforcement of its food and drug safety measures.

1. to advance completely the implementation of an accountability system in the supervision of food safety;
2. to effectively grasp the food safety work in rural areas;
3. to strengthen the monitoring of food safety;
4. to further the establishment of a food safety credibility system;
5. to strengthen food safety education and awareness;
6. to launch comprehensive food safety evaluations;
7. to quicken the establishment of an food safety emergency response system.

Without sounding negative or pessimistic, I just want to air my wariness of yet more measures issued by the central government in an effort to strengthen the enforcement of existing laws and regulations. Obviously, the above-mentioned seven steps all look and sound like effective things to do to combat a ever-worsening problem, but the fundamental mechanism for effective enforcement of laws and regulations can not simply be established by the death of a corrupt and incompetent top enforcement chief, nor can it be accomplished by issuing yet another order to be enforced with the hope of better enforcement. This is circular logic.

What really needs to happen in enforcing existing laws and regulation is not more laws about enforcement; rather enforcement of laws and regulations require a system in which the enforcers of such laws and regulation have sufficiently independent power to carry out its duties, yet at the same time being checked by another government entity, the courts.

Franchise in China--Opportunities & Challenges Come Along with the New Law (III)

More Interpretative Problems

A. Franchisor Disclosure Amendments

Disclosure Guidelines states:

Article Seven With respect to changes to information provided in the
registration, a franchisor shall petition the registering agency to amend such
changes within thirty days of such changes.

Obviously, the letter of the law requires "changes" to be amended, but the sticky issue here is what do "changes" encompass. All changes, material and immaterial? Or just material?

It puzzles that that the government would impose the heavy burden of amending just any changes on a franchisor, especially foreign franchisors who operates in many countries with a high frequency of immaterial changes to the franchise system. But I am not in the position to twist arms with the express provisions in the Chinese law. So I consulted with a Chinese franchise lawyer based in Mainland China. He noticed the ambiguity in the Registration Guidelines too, and he opines that the "changes" referred to in Article Seven of the Registration Guidelines only encompass immaterial changes. Since he is in the process of writing an article on the same topic, I will wait for him to disclose his reasoning behind the interpretation even though I agree with him.

B. "Where exactly do I register?"--Franchisor

Article Three Relevant departments, in charge of commercial regulations in the
Ministry of Commerce, Provinces, Autonomous Regions, and Municipalities, are the
proper registration agencies. If franchising operations are within Provinces,
Autonomous Regions, and Municipalities, shall register the franchise in the
departments in charge of commercial regulations; if franchising operations cross
boundaries of Provinces, Autonomous Regions, and Municipalities, the franchise
shall be registered in the relevant department of the Ministry of Commerce.

Franchising to occur within provinces (省），autonomous regions (自治區），municipalities (直轄市), a franchisor needs to register in government agencies in charge of regulating commerce, and the cities must be the ones what have administrative districts (設區市).

Franchising to occur beyond geographical boundaries of provinces (省），autonomous regions (自治區），municipalities (直轄市), a franchisor needs to register with the Ministry of Commerce.

This rule begs the question: "If a franchisor wants to franchise within its province and beyond, does it have to register with the local agencies and the Ministry of Commerce?" According to a Chinese franchise lawyer, the answer to this question is affirmative.

Franchise in China--Opportunities & Challenges Come Along with the New Law (II)

Franchisor Registration

A. Timing of Registration

According to Article Six of the Registration Guidelines, “a franchisor shall register the franchise with governing registration agency within fifteen (15) days of the date of the execution of the first franchise contract with a franchisee in China.” In the same vein as the analysis above, “days” refer to calendar days rather than business days. And those franchisors already in operations in China have till May 1, 2008 to register their franchises.

B. Required Documents for Registration

Before initiating the registration process, it is advisable for a franchisor to ascertain with which agency to register the franchise. China has a complex administrative structure in that it is divided into provinces, autonomous regions, and municipalities, which are under direct control of the central government. As stated in Article Three of the Registration Guidelines, franchising to take place within provinces, autonomous regions, or municipalities shall be registered in the highest administrative agencies in charge of commercial regulations; whereas franchising to occur beyond or across boundaries of provinces, autonomous regions, and municipalities shall be registered with the Ministry of Commerce of China. Deciding the right place to register a franchise is a crucial first step in the registration process.

After choosing the right place, the next thing a franchisor need to know, naturally, is what documents to prepare for registration. Article Five of the Registration Guidelines is devoted to specifying the requisite documents for registration with any registering agency. Article Five requires the following:

(1) Basic information about the franchise.

(2) Basic information about the geographical distribution of all the franchised units in China.

(3) A copy of the franchisor’s marketing plan.

(4) A copy of the franchisor’s corporate business license or other important documents evidencing eligibility.

(5) A copy of the registrations of the franchisor’s trademarks, patents or other business resources related to the franchising operations.

(6) Documents provided by a commercial regulatory department in a city with administrative districts, evidencing a franchisor’s compliance with Article 7 Section 2 of the Regulations; with respect to company-operated units located outside China, a franchisor shall provide documents evidencing same (including Chinese Translation), which shall be notarized and certified by a Chinese Consulate located in the administrative region as such company-operated units.

The above section does not apply to a franchisor in franchising operations before May 1, 2007, but such a franchisor shall provide a copy of the first franchise agreement executed by both the franchisor and a franchisee inside China.

(7) Sample Franchise Contract.

(8) Table of contents of the Franchise Operation Manual (Must include the page number of each chapter and the total number of pages. With respect to the Franchise Operation Manual accessible via franchise system intranet, provide the estimated pages after printing.).

(9) With respect to franchising of services or products subject to pre-approval pursuant to relevant laws and regulations, a franchisor must provide documents evidencing such approval by relevant government agency.

(10) Franchisor’s affidavit, signed and sealed by legal agent of such franchisor.

A foreign franchisor needs to pay special attention to (6) of Article Five. The Regulations regrettably kept the “two company-operated units for at least one year” requirement (“2 + 1 Requirement”). It is an eligibility requirement whereby only franchisors with two existing company-operated units in operations for over a year can franchise in China. As onerous as it might be, the Registration Guidelines clarified the uncertainty inherent in the Registrations as to whether a foreign franchisor can satisfy the “2 +1” requirement with units in operations in its home country. And the answer is affirmative.

Item (6) suggests that in order to satisfy the requirement, a franchisor, however, has to have the assertion that it has two company-operated units in operation for over a year notarized and certified by a local Chinese Consulate. The Registration Guidelines do not address how item (6) works if the two company-operated units are located in two geographical places far away from each other, for instance Seattle, Washington and Houston, Texas. Shall the two units be notarized and certified by just one consulate or two? To avoid the potential problem of non-compliance, the author suggests that they be certified by the consulate administratively responsible for the location where the unit is.

C. Method of Registration

For ease of management, registration of franchise has gone hi-tech in China. A franchisor can directly fill out items (1)—(3) on the Chinese version of the Ministry of Commerce website: http://txjy.syggs.mofcom.gov.cn/, the rest of the items can be submitted on the same site in PDF format. But in order to start the process, a franchisor has to create an account and password. The English version of the website does not yet have the registration management data base running yet as of May 16, 2007, but the laws have gone into effect for 16 days. Navigating the Ministry of Commerce website is not exactly a breeze even for the author whose native language is Mandarin Chinese. Therefore, a attempting to register in the Chinese government database could present considerable difficulties to a foreign franchisor who has limited knowledge of the Chinese language.

In the unfortunate event that a registering agency finds deficiency in registration documents, the franchisor may be required to submit additional supplemental materials seven days following the initial round of registration. And if the franchisor submits materials as requested by the agency, the agency, according to Article Ten of the Registration Guidelines, is required to register the franchise within ten days of the submission of additional materials. Given the time difference, vast geographical distance, and language barriers, it might in reality take longer than ten days if a problem occurs in the registration process unless the foreign franchisor has local counsel inside China.

D. Changes after Registration

A registered franchisor is also required to file changes and annual reports with the registering agency. Article Seven of the Registration Guidelines mandates that “with respect to changes to information provided in the registration, a franchisor shall petition the registering agency to amend such changes within thirty days of such changes.” (Emphasis added) “Changes” are not modified by any adjectives, therefore, it means any changes, material or immaterial. It seems, undoubtedly, very burdensome to amend any changes with the registering agency. However, the critical word “petition” might be the word that decreases the burden to amend. After changes occur in the franchise system, the franchisor should petition the agency to amend. It is up to the agency to either grant the petition or deny the petition to amend. Logically, if the petition is granted, then amendment becomes mandatory; if not, amendment would be unnecessary. Of course, absent a clear and transparent demonstration of the standards to be used by the agency in its evaluation of the petitions, the franchisors would not know what types of changes ought to be amended and what not to.

Franchisors’ annual report filing seems less problematic than amendments. The bright line rule requires an annual filing before March 31. Article Eight of the Registration Guidelines states that the annual filing report should include basic information regarding new, cancelled, renewed or amended franchise contracts in the past year. Even though the law does not require that amended contracts be offered to future prospective franchisees, the annual filings become public information listed in the Ministry of Commerce website, which is easily accessible for any interested prospective franchisees.

Franchise in China--Opportunities & Challenges Come Along with the New Law (I)

Franchisor Disclosures

A. Timing of Disclosure

Consistent with the Regulations, Article Four of the Disclosure Guidelines requires a franchisor deliver a written disclosure document to a prospective franchisee at least thirty days (30) before the execution of a franchise contract. In addition, the franchisor must also concurrently provide a copy of the franchisor’s sample contract. Nothing regarding first meeting, contemplated in the current U.S. FTC Franchise Rule, is mentioned in the Disclosure Guidelines. Rather, it is the number of days that is the focal point of the time of delivery. Further, Disclosure Guidelines do not mention whether the days are either calendar or business days, but the author believes it is probably safe to assume that the thirty days refer to business days, which is consistent with the new U.S. FTC rule (replacing the ten business days with fourteen days.). In Mandarin Chinese, calendar days and working days have clear distinctions. Calendar days are typically shortened as “days”, whereas working days cannot be shortened. The exact language used in the Disclosure Guidelines is “Days.”

B. Content of the Disclosure Document

Article Five of the Disclosure Guidelines lays out the basic format of the necessary components of a disclosure document. In terms of functionality, the Article Five requirements resemble the current FTC disclosure format. Note that China does not currently have an equivalent of the Uniform Franchise Offering Circular (“UFOC”) in the United States. The following is a summary of the twelve items required under Article Five:

1. Basic information about the franchisor and its franchising activities;
2. Basic information about the franchisor’s business operational resources;
3. Basic information about franchise fees and charges;
4. Information about the pricing, conditions of products, services, and equipments to be provided by the franchisor;
5. Information about continuous training to be provided by the franchisor;
6. Franchisor’s methods and content of guidance for and supervision of franchisee in its operations;
7. Information about the investment budget for a franchise outlet;
8. Information about franchisees inside Mainland China;
9. Abstracts of the franchisor’s audited financials of the most recent two years;
10. Information about major litigations and arbitrations involving the franchisor in its franchising activities;
11. Information about major violations of operations not in compliance with the law, and major criminal violations; and
12. Franchise contract.

C. Areas of Concern for Franchisors

One area of concern for an international franchisor stems from information disclosure about franchisees inside China. If a foreign franchisor already has outlets in China, the franchisor needs to state the number of current franchisees, their geographic distribution, authorized operational areas as well as whether such areas are protected by exclusivity. In addition, earnings claims are required under Section 8 of Article Five, which departs from the current FTC Rule on earnings claims. An interpretative problem arises if a foreign franchise does not have franchise outlets in China yet. Should the franchisor provide earnings claims based on data collected from operational outlets inside the franchisor’s home country? The author does not believe that such earnings claims would be acceptable in China for a number of reasons.

First, Section 8 of Article Five clearly states that article requires information about franchisees inside Mainland China. Obviously, franchisees outside China fall outside the purview of this section. Second, subsection 2 of Section 8 demonstrates a concern for geographical relevance of earnings claims based on data collected inside China since it requires the franchisor to state conspicuously that such claims may differ from actual operational results of other prospective franchisees. Inferentially, earnings claims based on data collected outside China create a greater market relevance issue for any prospective franchisees in China who seek to rely on any indications of profitability.

Another point of concern for franchisors is the ambiguous ban on making earnings claims in a franchisor’s advertisements. Article Six provides: “A franchisor shall not engage in fraudulent and misleading conduct in its marketing and advertising; a franchisor’s advertisement shall not contain propaganda for any individual franchisee’s operational earning results.” Its prohibition of advertisement featuring an individual franchisee’s earnings has sound reasoning because such an advertisement would mislead prospective franchisees where such advertised earnings do not have market relevance to prospective franchisees.

However, Article Six is silent with respect to advertisement using average earnings data. A strict reading of Article Six would lead a reasonable reader to conclude that earnings data based on average operational results of franchisees does not constitute “propaganda for any individual franchisee’s operational earning results” within the meaning of this Article. In contrast to ads based on a specific franchisee’s earning results, ads using average earning results of many franchisees, presumptively, do not have the same mal-effects. (The author doubts the logic of Article Six, but strict reading of a Chinese statute without legislative history does not allow other interpretations absent further administrative opinions on this topic.)

D. Protections for Franchisors

Any franchisor should rightfully have the reason to be concerned about confidentiality before making disclosures to prospective franchisees, especially in a foreign country. In a country like China, where protection of intellectual property is by no means adequate, a franchisor should, however, not retreat from a risk of exposure to IP violation by locals. In fact, a reassuring trend in China has been developing, which ought to dispel some of the fear about rampant IP theft in China. Fore example, Article Seven of the Disclosure Guideline emphatically states that a franchisor has the right to require a prospective franchisee to sign a confidentiality agreement prior to making any disclosures.

Furthermore, Starbucks' victory speaks for itself with respect to IP protection in China. Additionally, reports of widespread IP violations without redress in China typically occur in the sectors of commerce, where the government does not have an effective enforcement framework. However, in commercial sectors, such as franchising, both the courts and the administrative agencies have demonstrated the willingness and will to enforce IP laws rigorously to create a friendly investment environment for foreign capital.

Franchise in China--Opportunities & Challenges Come Along with the New Law

With the recent promulgation of the Commercial Franchise Information Disclosure Management Measures (“Disclosure Guidelines”) and Commercial Franchise Registration Management Measures (“Registration Guidelines”), the Chinese franchise regulatory framework is basically complete. The two Guidelines were drafted and promulgated in accordance with the Regulations of the Commercial Franchise Operations (“Regulations”), and they supplement the Regulations with specific details on its enforcement. Even though the two Guidelines have eliminated a lot of uncertainty in the Regulations, they still have potential pitfalls for foreign franchisors in their compliance measures. The next two blogs aim to to expose the areas where dangers lurk in a franchisor’s attempt to comply with the Guidelines.

China Admits Law Enforcement Is Lagging Behind

The Starbucks Court in Shanghai did it in grand style! It explained the law, upheld the law, and actually ENFORCED it by following through all the way until "Copycat" Shanghai Starbuck Ltd. changed its corporate name and took down all signage that created confusion with Starbucks Co. of Seattle Washington.

As I was enjoying a few moments of reverie about enforcement of laws, especially in IP protection, I came across this (in Chinese only) today, which kind of woke me up and brought me back to reality. Since Mr. Harris at Chinalawblog has decided to continue the theme of "copycats," I thought I might just copy him by carry on the discussion about the enforcement of laws and court rulings in China.

No doubt about it, China's legislative efforts in recent years have ushered in a stunning array of very important laws and regulations in international and domestic commerce, foreign trade, and basic civil codes. For instance, just this year quite a number of them were promulgated, the Private Property Law, the new Corporate Tax Law, the new Franchise Law, and the Partnership Law (to be effective on June 1, 2007), to name just a few.

While all of us can be and are actually pysched about these new laws, the reality of enforcement on the ground remains a huge problem, which is in almost stark contrast with the progress that China has made in legislating.

Reasons abound for the lack of advancement and progress in enforcement. The above quoted article states a few:

1. rampant local protectionism challenges the authority of laws.
2. the unwillingness and lack of resolve to follow laws and the seeming immunity for not complying with laws all discredit the actual authority of laws.
3. the lack of a basic and fundamental framework of the rule of law permeats the society which creates a challenging environment for law enforcement.

The article then goes on to substantiate with actual examples of how law enforcement lags behind, but it falls short of expressing or even suggesting what can be done about this phenomonon.

So, it got me thinking what exactly needs to be done in China to ensure the enforcement of laws, regulations, and court orders.

To answer that question, I think that one needs to go a little further than simply examine the obvious--what the U.S. or the West does to achieve enforcement, because copying (gosh, I'm getting a little nervous about using the word "copy" now.) what the U.S. does might not work too well. (Reasons I will explain later)

With that said, I think there need to be a two-step approach to analyze the issue...

--to be continued

America Didn't Get What She Wanted; Now What?

I am no economist, nor politician, neither a VIP of some giant international corporation, but I am a little worry now. What is America going to do to China now that the second round of high level trade talks between the U.S. and China came to a close without accomplishing much of what the Americans wanted?

An Associated Press report pretty much sums up the "disappointing" results of this round of trade talks. With Secretary Henry Paulson hosting a delegation of high level Chinese officials, the two sides touched up a wide array of trade issues between the parties. They, as I think, agreed to continue to disagree on some of the thorniest issues:

1. the undervaluation of the Chinese currency--"Renminbi" (or "Yuan");
2. the failure of Chinese government in its protection of intellectual properties;
3. American companies' access to the Chinese market, especially in the financial services sector.

Aside from the disagreements that remain, the parties did agree on the following, which might make some happy in the U.S.:

1. the number of daily passenger flights between the U.S. and China will be doubled in 2012 from the current 10 to 23 in five years;
2. an increase of the number of cargo flights will also increase;
3. a slight expansion of financial services to enter into China.

Given the strong sentiments involved and forceful arguments advanced by both sides on these tough unresolved issues, I am uneasy about what might happen in the next 18 months. Once again, I am no politician or economist, but I do want to voice what I sense might happen.

First, the United States will continue to push for a quickened pace for the appreciation of the Chinese Renminbi for a couple of obvious reasons. The trade deficit with China is simply too large to overlook; it was a whopping $232.5 billion in 2006 according to the above cited AP report, which is reportedly larger than U.S. trade deficit with any country in history. In addition, an attack on China makes good political fodder in an election year.

Second, China, on the other hand, is unlikely to back down on its position to let the Renminbi rise on the scale and in the pace that the United States wants. That is an enormous 40% (this is the figure most frequently quoted and used in the context of the Chinese currency undervaluation.) in a short period of time. Even though what constitutes a "short period of time" is not specifically defined or made public by U.S. lawmakers, it seems that patience is running very thin for many who have subscribed to Paulson's saged notion of patience in dealing with the Chinese. Probably many complicated political, economical, and social factors in China contribute to the Chinese government's unwillingness to appease the United States in the currency issue. Very simply, the idea or the perception by others that China is appeasing the United States or is giving in to intense U.S. pressure does not go very well in an increasingly nationalistic society. It might also be worthy noting that export is still and probably will remain a key factor in creating jobs and generating revenue for China, and a sudden rise in the value of the Chinese currency as desired by the United States will have unimaginable impact on the economic health of the country as a whole. Without sounding any more stupid in my layman's analysis of the Chinese government's hesitance to agree with the U.S. on the currency issue, I think it is not too difficult to have a general idea that China will not at any time soon budge on this one.

OK, here is the simple way to put what I labored so hard to get across in the last two LONG paragraphs--the U.S. really wants China to do something because it thinks that the desired action by China would solve a host of other related issues, but China does not want to do it because it either does not want to bend its knees or it simply cannot do it right now in the way the U.S. wants it, or both.

Absent some middle ground between the current positions held by China and some lawmakers in the U.S., I'm afraid that some serious trade war may arise in the foreseeable future in light of the political landscape and environment. Surely, I hope that I' wrong. But if my fear bears some legitimate and logical reasons, I hope politicians in both countries will look at the bigger picture of building a truly symbiotic relationship benefiting both sides without resorting to another "war."

Commercial Franchise Information Disclosure Management Measures --Chinese Franchise Regulation

商业特许经营信息披露管理办法

As discussed below, this law came out on the same date as the "Registration Measures", and it similarly contains a few areas of ambiguities, which I am in the process of writing.

MINISTRY OF COMMERCE
OF
THE PEOPLE’S RUBLIC OF CHINA
16TH ORDER 2007

Commercial Franchise Information Disclosure Management Measures has been promulgated during the 6th meeting of the Ministry of Commerce. It shall go into effect on May 1, 2007.

Minister of Commerce

Bo Xi Lai
April 30, 2007

Commercial Franchise Information Disclosure Management Measures

Article One To protect the bilateral rights of franchisors and franchisees, the Disclosure Measures have been promulgated pursuant to the Regulations of Commercial Franchising Operations (“Regulations”).

Article Two The Disclosure Measures apply to all commercial franchising operations inside the People’s Republic of China.

Article Three The affiliated companies in the Disclosure Measures refer to franchisor’s parent company, subsidiaries controlled directly or indirectly by the franchisor who owns either all the stocks or the majority of stocks, or companies controlled directly or indirectly by the franchisor who owns either all the stocks or the majority of stocks.

Article Four Pursuant to the Regulations, a franchisor shall provide written disclosure of information in accordance with Article Five of the Disclosure Measures thirty days before the execution of a franchise contract with a franchisee, and shall provide a prospective franchisee a copy of the franchise contract.

Article Five A franchisor shall disclose the following information:

1. Information regarding the franchisor and the franchise.

(1) The name, mailing address, contact information, registered agent, president, registered capital, operational scope of the franchisor; and information about company directly-operated units, including the total number of units, addresses, and telephone numbers.

(2) A brief introduction of the franchisor’s experience in franchising.

(3) The franchisor’s registration status.

(4) If the affiliated companies provide products and services to franchisees, basic information of such affiliated companies shall be disclosed.

(5) Information about the franchisor’s or affiliated companies’ bankruptcy or applications for bankruptcy.

2. Basic information about the franchisor’s operational resources.

(1) In written form, provide a prospective franchisee with information that can show the franchisor’s corporate name and business resources related to franchising operations, such as registered trademarks, corporate logo and symbols, patents, proprietary technologies, and operational model.

(2) If the above-mentioned operational resources belong to the franchisor’s affiliated company, basic information about the affiliated company shall be disclosed. Meanwhile, the franchisor shall disclose and explain how the franchise system will be dealt with if the contract, between the franchisor and the affiliated company granting the franchisor such operational resources, terminates.

(3) Information about the litigation or arbitration involving the franchisor’s (of its affiliated company) operational resources, such as registered trademarks, corporate logo and symbols, patents, and proprietary technologies.

3. Basic information about franchise fees

(1) The types, amount, standard, method of payment of fees charged by the franchisor and third parties. If such information cannot be disclosed, the franchisor shall state the reasons thereof. If the standards for fees are not uniform, the franchisor shall disclose the highest and lowest fees, and state the reasons thereof regarding such discrepancy.

(2) The conditions for collecting and returning security deposit; time and method of return of such security deposit.

(3) If a fee is required of a prospective franchisee prior to the execution of the franchise agreement, the franchisor shall state in writing the purpose, condition of return, and method of return of such a fee.

4. Conditions and prices of products, services, and equipments provided to a franchisee.

(1) Whether a franchisee must purchase products, services, and equipments from the franchisor or its affiliated company; the price, conditions thereof for such purchase.

(2) Whether a franchisee must purchase products, services, and equipments from suppliers designated (or approved) by the franchisor.

(3) Whether the franchisee may choose other suppliers, and conditions for such other suppliers.

5. Information about providing continuous services to franchisees.

(1) The specific content and method of providing professional training as well as the specific plans of execution of such training. In addition, also provide information about the location, method, and length of such training.

(2) Specific content of technical support; information referencing the table of contents as well as the relevant page numbers of the franchise operations manual.

6. Information about the methods and content of a franchisor’s guidance for and supervision on a franchisee.


[to obtain the full text of my translation, please e-mail me or leave a comment with a request for same.]

The full text of the law in Chinese can be accessed here.

Commercial Franchise Registration Management Measures--Chinese Franchise Regulation

商业特许经营备案管理办法

This new law, yet another importance piece of regulation in the Chinese franchise realm, came into effect on May 1,2007. It was signed into law on April 30, 2007, just one day before the effective date of the Regulations of Commercial Franchising Operations of the People's Republic of China. There seems to have quite a few areas of ambiguity, as does the Commercial Franchise Disclosure Management Measures, which I will post next.

MINISTRY OF COMMERCE
PEOPLE’S REPUBLIC OF CHINA
15TH ORDER 2007

Commercial Franchise Registration Management Measures has been promulgated during the 6th meeting of the Ministry of Commerce. It shall go into effect on May 1, 2007.

Minister of Commerce
Bo Xi Lai
April 30, 2007

Commercial Franchise Regisitration Management Measures

Article One To strength the regulatory management of commercial franchising, and to maintain orders in the franchising market, the Measures have been promulgated pursuant to the Regulations of Commercial Franchising Operations (“Regulations”).

Article Two The Measures apply to all commercial franchising operations inside the People’s Republic of China.

Article Three Relevant departments, in charge of commercial regulations in the Ministry of Commerce, Provinces, Autonomous Regions, and Municipalities, are the proper registration agencies. If franchising operations are within Provinces, Autonomous Regions, and Municipalities, shall register the franchise in the departments in charge of commercial regulations; if franchising operations cross boundaries of Provinces, Autonomous Regions, and Municipalities, the franchise shall be registered in the relevant department of the Ministry of Commerce.

The management of franchise registration shall be implemented in a national network. Franchisors in compliance with the Regulations shall register their franchise through the governmental website: www.mofcom.gov.cn

Article Four Any person or entity has the right to report activities in violation of the Measures to agencies in charge of franchise registration.

Article Five A franchisor petitioning for registration shall provide the following documentation to the registering agency:

(1) A brief introduction of the franchise.

(2) A brief introduction of the distribution of all the franchised units in China.

(3) A copy of the franchisor’s marketing plan.

(4) A copy of the franchisor’s corporate business license or other important documents evidencing eligibility.

(5) A copy of the registrations of the franchisor’s trademarks, patents or other business resources related to the franchising operations.

(6) Documents provided by a commercial regulatory department in a city with administrative districts, evidencing a franchisor’s compliance with Article 7 Section 2 of the Regulations; with respect to company-operated units located outside China, a franchisor shall provide documents evidencing same (including Chinese Translation), which shall be notarized and certified by a Chinese Consulate located in the administrative region as such company-operated units.

The above section does not apply to a franchisor in franchising operations before May 1, 2007, but such a franchisor shall provide a copy of the first franchise agreement executed by both the franchisor and a franchisee inside China.

(7) Sample Franchise Contract.

(8) Table of contents of the Franchise Operation Manual (Must include the page number of each chapter and the total number of pages. With respect to Franchise Operation Manual accessible via franchise system intranet, provide the estimated pages after printing.).

(9) With respect to franchising of services or products subject to pre-approval pursuant to relevant laws and regulations, franchisor must provide documents evidencing such approval by relevant government agency.

(10) Franchisor’s affidavit, signed and sealed by legal agent of such franchisor.

The above-listed items (1) through (3) shall be filled out directly on the website; items (4) through (10) shall be submitted electronically via the website in PDF format.

To get the complete translation, please e-mail me or leave a comment with your address. My e-mail address is：bluo@vernongoodrich.com

To access the complete texts of the law in Chinese, go here.

STARBUCKS v. SHANGHAI COPYCAT

The latest news report out of China marks a sweet victory for STARBUCKS in its legal battle with a Shanghai Coffee house--Shanghai Starbuck Coffee Ltd.

After the Shanghai 2nd Intermiediate Court's affirming its own decision to hold Shanghai Starbuck Coffee liable for trademark infringement and unfair competition on January 4,2007, Shanghai Starbuck hesitated to change its business name as ordered. The court followed through on its order and forced it to change its corporate name. After almost four months of game play, Shanghai Starbuck finally did change its name to "Shanghai Fang Yun Coffee Ltd." (上海芳韵咖啡馆有限公司）

This is yet another unprecedented step in Chinese court's progress in enforcing IP rights in China. The court not only handed down a victory to STARBUCKS but also saw through the actual enforcement of its own orders.

To help readers understand the history of the entire case, the following is my brief of this fascinating IP case in China.


In re STARBUCKS

Parties:
Plaintiffs / Appellees: Starbucks Co. and Shanghai Unified Coffee, Ltd.

Defendants/ Appellants: Shanghai Xing Bake Coffee, Ltd. and Shanghai Xing Bake Coffee, Ltd. Nanjing Road Branch.

Facts:

A. Plaintiffs:
Starbucks Co. registered the name and pictures associated with its trademark “STARBUCKS” in 1996 in P.R. China; it then registered 30 types of products associated with “STARBUCKS” in 1997; and it registered more services and products associated with the trademark “STARBUCKS” in China.

On February 1, 1999, Starbucks Co. first registered the Chinese version of Starbucks—“Xing Bake” [星巴克] in Taiwan, however it did not begin the registration of “Xing Bake” in China until 1998. While waiting for an approval for the registration of “Xing Bake”, Starbucks began its massive advertising with the trademark “STARBUCKS” and “Xing Bake”. In addition, the first Starbucks chain store began operation in Beijing in January 1999.

Starbucks Co. registered the “Xing Bake” [星巴克] trademark on December 28, 1999.

On March 23, 2000, Starbucks entered into a contract with co-plaintiff Shanghai Unified Coffee, allowing it the legal right to use the trademarks “STARBUCKS”, “Xing Bake” [星巴克], and other unregistered trademark.


B. Defendants:
While Starbucks Co.’s application for the trademark “Xing Bake” [星巴克] was pending, the defendants pre-registered the corporate name “Xing Bake” [星巴克] and gained approval. On March 9, 2000, Shanghai Xing Bake Coffee, Ltd. was incorporated, whose principal business is the sale of beverages, western style meals, and retail alcoholic drinks. And it formed its branch office, the co-defendant, on July 1, 2003.

They printed “Starbuck Coffee” on its price list, and they used characters “Xing Bake Coffee” in their store front and advertising billboards.

C. Lawsuit:
The plaintiffs sued the defendants for trademark infringement and unfair competition in the trial court, Shanghai Intermediary Court.

D. Procedural History:
The trial court held that the defendants violated the plaintiffs’ trademark rights and engaged in unfair competition.

On appeal, the Supreme Court of Shanghai affirmed and required the appellants to issue a public apology, pay damages and attorneys fees to the appellees.

On motion to reconsider by the appellants, the Supreme Court again affirmed.

Issues:
1. Whether the appellant’s successful pre-registration of the corporate name “Xing Bake” defeats the appellees’ claim of trademark infringement?

[Holding: No.]

2. Whether the appellant’s usage of the corporate name “Xing Bake” and “Starbuck Coffee” constitute unfair competition?

[Holding: Yes.]

Analysis:

1. Pre-registration of the corporate name “Xing Bake” [星巴克]
a. This pre-registration of corporate name constitutes subjective bad faith because the president of the future company Shanghai Xing Bake Coffee, Ltd. acknowledged to a major Chinese newspaper in 2003 that the trademark and name “Xing Bake” [星巴克] is very famous and the Starbucks Co. has been very successful. So he decided to race the Starbucks Co. to the corporation name registration office.

b. The trademarks “STARBUCKS” and “Xing Bake” [星巴克] have been widely known in China prior to the appellants’ corporate name registration.

c. Starbucks Co.’s usage of and attainment of relevant rights to “Xing Bake” [星巴克] are earlier than Shanghai Xing Bake Coffee, Ltd. Further, the appellant’s registration of the corporate name “Xing Bake” [星巴克] with the express knowledge that such registration was inconsistent with rights of others violated Trademark Law of China. And the appellant’s behavior violated the basic commercial ethics—equality, honesty and good faith.

2. Unfair Competition
a. The appellants’ use of “ Starbuck”, although different from the appellees’ trademark “STARBUCKS” constituted a confusion considering prominence and reputation of the appellees’ trademark. In addition, “Starbuck” is the key element of the appelees’ trademark.

b. The appellants’ pictorial emblems—one small circle inside a bigger one, green background color, and two stars embedded inside the overlapped area of the two circles generated confusion with the appellees’ trademark “STARBUCKS” and other registered trademarks.


Brad Luo’s Comments:

1. Why didn’t Starbucks Co. register the Chinese version of “STARBUCKS”-- “Xing Bake” [星巴克] at the same time it did in Taiwan? Why didn’t it register as soon as such a trade name became known in Chinese? It could have avoided all these litigation had it done so.

Coupled with Pfizer’s recent loss in a Chinese court for failing to be the first one to register the Chinese version of “Viagra”—“Weige” [伟哥] (meaning “Great Man”), the Chinese courts are speaking clearly and loudly—REGISTER YOUR TRADEMARKS EARLY, BOTH IN ENGLISH AND CHINESE. Also, it is important to know that the trademark registration regimes in mainland China, Taiwan, Hong Kong and Macau are independent of each other, and that a trademark owner needs to register the mark throughout the Greater China area.

2. It is settled law that China is a “first register first served” jurisdiction with respect to trademarks. However, the Supreme Court of Shanghai mentioned in dicta that Starbucks Co. did use the Chinese version “Xing Bake” [星巴克] first. Does this mean that courts in China will start looking into who first used a trademark or trade name? It is too early to tell. But the safest thing is to REGISTER FIRST!

Heavier Penalties for Violations of the New Chinese Franchise Law

Under the new Chinese Franchise regulation, here are the requirements and penalties for breach thereof:

Article 7---2 Units in Operation for 1 Year

A franchisor shall have at least two directly-operated units under operation for more than one year.

Penalties for Breach of Article 7

Article 24 A franchisor, who is unqualified under Section 2 of Article 7, yet conducts franchising operations, shall be subject to an ordered correction from commerce regulatory authorities, confiscation of profits, a monetary fine between 100,000 and 500,000 yuan, and a public reprimand.

Entities or individuals other than registered enterprises, who conducts franchising operations, shall be subject to an order from regulatory authority to cease illegal operations, confiscation of profits, and a monetary fine between 100,000 and 500,000 yuan.

Article 8---Registration

Article 8 The franchisor shall register a franchising operation with commerce regulatory bodies pursuant to the Regulation within 15 days of its first franchise contract.

Penalties for Breaching Article 8

Article 25 A franchisor, failing to register with appropriate commerce regulatory authorities pursuant to Article 8, shall be subject to an order from such regulatory authorities to register the franchise within a specified time and a monetary fine between 10,000 and 50,000 yuan; if the franchisor fails to register within the specified time, it shall be subject to a monetary fine between 50,000 and 100,000 yuan and a public reprimand.

No doubt that the increase in the amount of penalties is intended to discourage violations of the rules as specified in the new law. However, from the view point of a United States consumer (franchisee), the administrative penalties do not seem too high. Yet at the same, the franchisee is entitled to traditional contract damages if a breach occurred.

If a reader knows whether Chinese contract law allows exemplary damages for a breach of contract in connection with a tort like fraud, please let me know. In the mean time, I will do some research on this topic after my final exams in early May, 2007.

New Chinese Franchise Law Effective Now

As of May 1, 2007, the new Regulations of Commercial Franchise Operations of China is effective.

Coupled with the rush of investments before the 2008 Olympics games in Beijing, this new law is expected to generate a lot franchising activities in China. Read this article in Dallas Business Journal.

Here is a list of the new laws that went into effect on May 1, 2007. (In Chinese only)