G2000 v. 2000: Do Fear the Domino Effect

In my previous post, I indicated that G2000 has a much bigger problem ahead. Here is why.

Only one issue might be on appeal at the Zhejiang Higher People’s Court --the 20 million Yuan in damages for Plaintiff. No matter how the Court decides, Defendant G2000 will desperately want another bite at the apple regarding the validity of Plaintiff’s “2000 ” mark, but that is just a fanciful wish. In Chinese trademark litigations, as well as other civil trials, parties only get one appeal, which already occurred at the Beijing Higher People’s Court. Second, Beijing 1st Intermediate People’s Court and the Beijing Higher People’s Court have the exclusive jurisdiction on administrative trademark cases, which renders Defendant’s fanciful wish even more distant from reality. In short, Plaintiff’s “2000 ” mark is valid for the goods/services registered for, and that is written in the stone as of now, unless Plaintiff somehow forfeits it at a later date. But that is not the concern here.

So, what do all these mean to G2000, the big Hong Kong fashion company, the successful and expanding international franchisor?

IT IS ALL BAD NEWS for a number of reasons!

First, obviously, G2000 will be ordered to cease the use of the “G2000” mark on its ties, socks, belts, and scarves. Well, relatively speaking, this is no big deal since what franchisees can do to G2000 is a tremendous headache. Since trademark, in most cases, is the core of a franchise system, uncertainty in the trademark casts a very long shadow on the franchise system itself. If the G2000 mark violates the rights of another with respect to the types of goods complained of, G2000’s franchise system suffers a major loss in its family of trademarks, and that translates into a major loss in revenues.

Second, Chinese franchisees can sue G2000 for violating the Chinese franchise regulations. Pursuant to the Regulations on the Administration of Commercial Franchise, a franchisor must disclose to prospective franchisees the status of its intellectual property, and its disclosures must be complete, accurate, and truthful. See Arts. 22-23. If in the unfortunate event that G2000 did not disclaim or disclose the status of its litigations on the “G2000” mark, it could find itself in a heap of trouble with the Chinese franchise regulators (AICs, and the Ministry of Commerce). The administrative penalties for violation of these Regulations can be substantial. See id., Art. 24-29. What is worse, franchisees could sue G2000 for breach of contract, fraud, and repudiation of the contract because of the failure to disclose. See id.

Third, as part of the domino effect (if number 2, above, occurs), G2000’s entire franchise system in China will be in jeopardy. It will have to deal with possible lawsuits from its some 436 franchisees. In addition, the named co-defendants won’t want to share the blame for the joint and several liability in the original law suit. Furthermore, G2000’s image, no matter how bright and attractive, will have been tarnished not only among its consumers, but more importantly among prospective franchisees. Growth and expansion in China through franchising, the fastest growing method of product distribution in China, will suffer at the minimum a slow down.

As one can see, one big mistake, especially in a company’s overall IP strategies in China, could have far-reaching impact on its bottom line. In this age of globalization and commercialization, intellectual property, trademark in this case, is of utter importance. Without a comprehensive, proactive, and sound IP strategy, franchisors march into China at their own peril.

G2000 v. 2000: Is 20 Million Yuan Enough for Trademark Infringement?

I thought I have blogged about almost everything interesting on Chinese Trademark Law. But, I was wrong. In the case of G2000 v. 2000, the Hangzhou Intermediate People’s Court showed Chinese Trademark Law is still more interesting than the Leifeng Pagoda in Hangzhou, and the Hong Kong star sex scandal.

(Disclaimer: After a reasonable search, I have not been able to locate the actual opinion of the Court. The content of this post is based on multiple news sources, here and here. Surprisingly, the Hangzhou Intermediate Court does not have a website while other intermediate courts of lesser importance in Zhejiang Province have.)

First, this is a somewhat complicated trademark infringement case involving one plaintiff and multiple defendants. And the defendants have appealed the decision to the Zhejiang Higher People’s Court; therefore, the outcome of the case as laid down below could change, depending upon the Court’s prospective decision.

The Parties:
Plaintiff is an individual, Mr. Zhao Hua, in the business of manufacturing and selling socks, ties, and scarves. He acquired by assignment and still owns the trademark “2000” (Registration # 1094814), which was first registered by the original owner in 1997. And it was registered for Class 25 Goods (Clothing, footwear, headgear), including the following categories: socks, gloves, scarves, ties, belts, sashes, and veils.

Defendants:
Defendant is G2000 (纵横二千集团), a Hong Kong company, in the fashion/clothing business with corporate and franchised units scattered in many Asian countries/regions. It manufactures and sells its full lines of products including casual, formal and informal clothing and accessories for men and women. In addition, it also franchises its business concepts internationally.

In 1992, Defendant registered the “G2000” mark in China for use covering clothing, shoes and headwear. (carefully note the different types of goods registered for as compared to those registered for by the Plaintiff under its 2000 mark.)

In 1997, Defendant registered the same G2000 mark for handbags, shopping bags, and straps (手袋、购物袋、背带等).

In 2002, Defendant registered the G2 mark for clothing, neckties, socks, scarves, belts, etc. (服装、领带、袜、围巾、腰带等)

In May 2002, Defendant filed an action in the China Trademark Office to cancel plaintiff’s trademark (2000), then it unsuccessfully appealed to the China Trademark Review and Adjudication Board (the “TRAB”). Finally, it brought an administrative action pursuant to Article 33 of Chinese Trademark Law 2001 in the Beijing First Intermediate People’s Court, challenging the TRAB’s decision, but to no avail. On final appeal in 2005, the Beijing Higher People’s Court affirmed the administrative decision, holding that Plaintiff’s mark is valid for the types of goods so registered under Nice 25 Class.

Co-defendants are Shanghai Heyuan Clothing, Ltd. (上海和缘服装有限公司) and Guangzhou Qianying Clothing, Ltd. (广州千盈服装有限公司), and Zhejiang Yintai Department Store, Ltd. (浙江银泰百货有限公司), all of which are Defendant’s franchisees in China (or they might be area developers, or sub-franchisors. The exact legal relationship between co-defendants and the defendant is not clear to me.).

Brief Facts:

Facts of this legal saga lasting more than eight years are complicated. Back in 2000, Plaintiff sent a demand letter (cease & desist letter) to Defendant and co-defendant Shanghai Heyuan Clothing, Ltd., alleging trademark infringement with respect to the use of G2000 in connection with their sale of socks, gloves, ties and scarves. Between 2000 and 2006, Plaintiff also sought redress by filing multiple complaints with local Administration Industry and Commerce (“AIC”) in Beijing, Guangzhou, and other cities, but apparently achieved little (Doesn’t this make you think twice about the efficacy of AICs?). And to gather evidence, in the span of 10 months from May 2005 to March 2006, Plaintiff purchased allegedly infringing goods at various stores and locations sold by Defendant’s/co-defendants’ G2000 specialty units in Beijing, Shanghai, Hangzhou, Ningbo, and other places.

Plaintiff, I assume, filed this action soon after the Beijing Higher People’s Court handed down its decision against G2000 in 2005. The timing was pretty good on the part of the Plaintiff since the Beijing Court’s decision eliminated some uncertainty as to the validity of his trademark rights in 2000 for the goods registered for.

Additionally, it is important to note that Defendant operates a widespread network of company-owned and franchised units (reportedly 436 units in China), selling goods under the G2000 trademark. Of course, “goods” as referred to include those types that Plaintiff was seeking for relief.

Issue:

Whether Defendants’ use of the G2000 trademark for ties, socks, belts, and scarves (领带、袜子、腰带、围巾) caused confusion with Plaintiff’s goods bearing the 2000 mark among consumers?

Holding:
The Court held that Defendants infringed on Plaintiff’s rights, but for lack of access, no detailed analysis is available (Chinese courts, as do many courts in civil law jurisdictions, do not provide detailed analysis for their decisions, unlike their counterparts in common law jurisdictions. Exceptions, like the Starbucks v. Shanghai Copycat, do exist.).

My Thoughts & Reactions:

The court’s award of damages in this case is intriguing. Plaintiff pleaded for damages totaling 20,000,000 Yuan (that is right, 20 million). And the Court ordered the Defendants to turn over the figures for total sales, profits, etc. for the goods complained of in the relevant period of time, but the Defendant failed to do so. Generally, Chinese courts award damages to a plaintiff in an IP infringement case to the extent of a defendant’s illegal profits as proven, rather than losses sustained by the plaintiff. See Kate C. Hunter, Here There Be Pirates: How China is Meeting Its IP Enforcement Obligations Under TRIPS, 8 San Diego Int’l L. J. 523, 547. In addition, if the illegal profits or plaintiff’s losses cannot be accurately ascertained, the statutory maximum award of damages is 500,000 Yuan. See Chinese Trademark Law, Art. 56. Therefore, in an act rarely seen in Chinese courts, the Court awarded a whopping 20 million Yuan to the Plaintiff. Further, given the intertwined relationships among the Defendants, the Court held them jointly and severally liable. (for more discussion on awarding damages, please visit China Law Blog's post here.)

Obtaining sufficient damages in IP infringement cases is of paramount importance, if not the paramount one. After all, without proper compensation, a plaintiff’s glorious victory in the people’s courts can only be a “feel-good” occurrence, without much substance. (However, that is not to say that winning is not important.) Perspective and purpose affect one’s reactions to a major score in the courts. If a plaintiff’s main goal is to make a statement to actual and prospective infringers, and to enjoin current infringements, a win deserves much celebration. However, if a plaintiff’s main goal is to seek redress and obtain monetary and equitable relief, a win unsupported with lost profits waters down sweetness.

On appeal, the bone of contention, as I expect, would be that award of 20 million in damages to plaintiff. Of course, Defendants will try to set aside that amount, citing that it exceeds the statutory maximum; whereas, the plaintiff might argue that the 20 million award is appropriate given the scope and extent of violations, in addition to their failure to turn over documents within their control to ascertain the exact amount of damages.

Insofar as infringement is considered, it is a classic example of reverse confusion issue. According to Joel R. Feldman,

[i]n reverse confusion cases, a junior user (defendant) adopts a mark already in use by the senior user (plaintiff). However, the junior user dwarfs the senior user through advertising and other expenditures used to promote the mark. While the senior user has a “property” interest in protecting the mark, the public may benefit more from the junior user’s adoption of the mark because they only identify the mark with the junior user and are not confused by the dual uses of the mark.

Like any trademark infringement case, the key for Plaintiff is to establish confusion. Here, the fact is that the Defendant registered the G2000 before Plaintiff (his predecessor) registered the “2000” mark, but Defendant’s mistake was not to register its mark to cover more types of goods, specifically ties, socks, belts, and scarves. Instead, it only registered it for clothing, shoes and headwear. It is very easy to see what happened here. As Defendants’ business grew and expanded in China, it wanted to use the mark for ties, socks, belts and so forth, but found out, albeit regrettably, that it was too late to register. However, it was too lucrative not to go ahead with the expansion into more products with the coveted and profitable “G2000” mark. The fact it filed an objection/cancellation action with the Trademark Office speaks for itself. Although one might contend that plaintiff might have had ulterior motives when it registered the “2000” for the categories of goods under Class 25, plaintiff (or its predecessor) did so within the bounds of the Chinese Trademark Law at that time. And it did so because Defendant had failed to obtain trademark rights large and extensive enough to exclude others like the plaintiff from using the “2000 ” mark for any reason. And it did so, arguably, on account of Defendant’s failure to develop a comprehensive IP strategy before G2000 became highly profitable.

On the topic of a comprehensive IP strategy, G2000, I think, failed miserably. In addition to what I discussed above, it relied too heavily on the legal approach for its overall IP enforcement/strategy. Once its opposition/cancellation action failed through the entire legal process, it should not have pretended that “2000” problem does not exist. (This is simply for the sake of argument since I am assuming that Defendants did not attempt to buy out Plaintiff.) Should it have employed other means and strategies to make this headache go away? Should it have reached some kind of settlement agreement with respect to damages, or the use of the “2000” / “G2000” mark?

I think it should have done something more proactive to avoid a much, much bigger problem that is waiting for G2000. And if the appeal gets affirmed, or vacated on the issue of damages (assuming that is the only issue on appeal), the legal standing of Defendant’s “G2000” mark is still in doubt with respect to the categories of goods in question, thus jeopardizing its entire franchise system in China.

Next post will discuss the impact of this case on G2000’s franchise system.

The Supreme People's Court's 2-18-08 Judicial Explanation on Trademarks, Enterprise Names, and Other Prior Existing Rights

(The following is my attempt at translating the SPC's latest Judicial Explanation regarding the issues/conflicts between registered trademarks, enterprise names and other prior existing rights. If I have mis-interpreted any part of the Judicial Explanation, please kindly point out in your comments. Thanks! In addition, I will write a following post on the impact of this Judicial Interpretation.)


People's Republic of China The Supreme People's Court Notice
Law Explanation (Fashi)(2008)(3) Provisions on Several Issues in Hearing Cases Regarding the Conflict between Prior Existing Civil Rights and Registered Trademarks & Enterprise Names adopted on February 18, 2008 by the Supreme People's Court Judicial Committee meeting No. 1444. It is hereby announced that it will go into effect on March 1, 2008.

February 20, 2008中华人民共和国
最高人民法院公告
法释〔2008〕3号

《最高人民法院关于审理注册商标、企业名称与在先权利冲突的民事纠纷案件若干问题的规定》已于2008年2月18日由最高人民法院审判委员会第1444次会议通过。现予公布，自2008年3月1日起施行。

二○○八年二月十八日

To correctly resolve civil disputes involving the conflict between registered trademarks & business names and prior existing civil rights, these provisions are hereby instituted in accordance with the PRC Civil Procedure Law, General Principles of Civil Law, the PRC Trademark Law and the PRC Anti-Unfair Competition Law, as well as trial practices.

为正确审理注册商标、企业名称与在先权利冲突的民事纠纷案件，根据《中华人民共和国民事诉讼法》、《中华人民共和国民法通则》、《中华人民共和国商标法》和《中华人民共和国反不正当竞争法》等法律的规定,结合审判实践，制定本规定。

Article One Provided that requirements under Article 108 of the PRC Civil Procedure Law are met, People’s Court should accept cases filed by plaintiffs on the basis that defendants’ use of letters, graphics in defendants’ registered mark violated Plaintiffs’ existing copyright, patent right in packaging design, rights in business names, etc.

Where Plaintiff brings a lawsuit on the ground that another’s registered mark used in approved categories goods/services are similar or identical to her mark, People’s court should refer plaintiff to relevant administrative bodies for resolution, in accordance with Article 111 (3). However, where plaintiff bring a lawsuit on the grounds that another’s use of its registered mark is beyond the categories of goods/services registered for, or where another uses a registered mark by transforming its distinctive features, disassembling it or re-configuring it, the people’s court shall accept such cases.


第一条 原告以他人注册商标使用的文字、图形等侵犯其著作权、外观设计专利权、企业名称权等在先权利为由提起诉讼，符合民事诉讼法第一百零八条规定的，人民法院应当受理。

　　原告以他人使用在核定商品上的注册商标与其在先的注册商标相同或者近似为由提起诉讼的，人民法院应当根据民事诉讼法第一百一十一条第（三）项的规定，告知原告向有关行政主管机关申请解决。但原告以他人超出核定商品的范围或者以改变显著特征、拆分、组合等方式使用的注册商标，与其注册商标相同或者近似为由提起诉讼的，人民法院应当受理。

Article Two Where Plaintiff brings lawsuits, pursuant to PRC Anti Unfair Competition Law Article 5 (3), on the ground that another’s use of a business name is same or similar to her prior existing business name, which use is sufficient to cause consumer confusion as to the source of the goods/service, the people’s courts should accept such cases.

原告以他人企业名称与其在先的企业名称相同或者近似，足以使相关公众对其商品的来源产生混淆，违反反不正当竞争法第五条第（三）项的规定为由提起诉讼，符合民事诉讼法第一百零八条规定的，人民法院应当受理。

Article Three The people's court shall, in accordance with the plaintiff's claim and the nature of controversial legal relationship under civil law, and in accordance with the Civil Causes of Action (Provisional), ascertain the cause of the conflict in civil disputes between registered trademarks or enterprises and prior existing civil rights, and apply appropriate law accordingly.


第三条 人民法院应当根据原告的诉讼请求和争议民事法律关系的性质，按照《民事案件案由规定（试行）》，确定注册商标或者企业名称与在先权利冲突的民事纠纷案件的案由，并适用相应的法律。

Article Four Where the use enterprise name complained of infringe on the exclusive right of registered marks, or constitute unfair competition, the people's court, in accordance with the plaintiff's petition and specific circumstances of the case, may assign civil liabilities, such as enjoining defendant from using such name, correcting such use, etc.

第四条 被诉企业名称侵犯注册商标专用权或者构成不正当竞争的，人民法院可以根据原告的诉讼请求和案件具体情况，确定被告承担停止使用、规范使用等民事责任。



　　

Move Over, Administrative Regulations!

Mr. Ma wanted to tour some of the most beautiful places in central China with his son. He always wanted to visit those places himself, and he longed for his son to tag along so that he may appreciate the natural and historical beauty of these places too. The only time to go is, of course, during the week long May Day holiday when the entire country travels and vacations. Mr. Ma knew that the trip would be expensive, tiresome, and crowded, but he did not care, because he really wanted to go and figured this year would be the year. So, he called a traveling agency and booked the tour for two. Upon paying the necessary amount to and signing a contract with the traveling company, Mr. Ma was pregnant with excitement about touring the sites with his son, despite the inconveniences that he foresaw.

The tour lived up to its hype for the most part, and Mr. Ma enjoyed almost all the sites he visited, except for two. His tour guide, an agent of the traveling agency—Shanghai Chunqiu Huangpu Traveling Agency, had decided that visits to those two sites would be replaced by a shopping trip instead. When Mr. Ma confronted the agent and the agency about skipping the two sites, they pretty much thumbed their noses at him, telling him that a distant glance at those two places would be just as gratifying as walking through them with thousands of people. Mr. Ma insisted that those two sites were included in the contract, but to no avail.

Mr. Ma was outraged and decided to sue under the contract for damages. But the real issue was what laws/regulations should apply to determine the appropriate amount of damage. The plaintiff argued the Contract Law of China should apply since the parties had a valid contract governing their relationship, while the defendant averred that the Standards for Compensation on Traveling Quality Guarantee (Provisional) (“Compensation Standards”), issued by the National Tourism Administration in 1997.

Plaintiff pleaded for specific performance of the contract, i.e. tour of the sites skipped by the defendant. In the alternative, he asked for monetary damages in the amount of 5,890 Yuan (amount that it would cost the plaintiff to travel to those sites in an alternative tour), in addition to attorney’s fees totaling 4,000 Yuan. The defendant, on the other hand, answered that the proper damage under the Compensation Standards should be 280 Yuan, the value of admissions to the two sites plus relevant compensation.

The Court ruled in favor of Mr. Ma, but denied all that he desired. It held that the Contract Law should apply, and the defendant should compensate Mr. Ma for the economic damages resulting from the breach of contract. Specific performance of the contract, given the nature of the contract and the circumstances, is not the proper remedy. Rather, the defendant should pay Mr. Ma 2,400 Yuan, on account of the contractual provisions regarding transportation, admission tickets, lodging, and tour guide fees. And the Court specifically pointed out that it came out with the amount because the parties did not stipulate the method and amount of damages in case of breach by either party.

That is the story, but it does not end here.

Although insignificant in the amount of damages, this case is very significant in a few aspects:

1. The Court refused to apply the Compensation Standards even though they were directly applicable to the facts of this case. So, it can be inferred that in case of a direct conflict between the Contract Law and an administrative regulation the former prevails. Theoretically, it has always been the case, but it is less obvious in reality. The Court made the theory alive, which entitles the Court a pat on the back.

2. More consumers are choosing to exercise their legal rights and are not afraid of doing so in courts. Mr. Ma represents one of those individuals that do not let a wrongdoer walk free without putting up a fight. His attorney’s fees are probably more than the compensation he received. But that is kinda beside the point here.

3. The Court was very competent in reaching its decision. It looked at the plain language of the contract, excluded force majeure as an excuse for the breach, and reached an equitable decision for lack of contractual provisions on damages.

Remember that China currently has more than 10,000 regulations of various hues? If Chinese courts start to follow the example of this Shanghai court, those regulations that conflict with Chinese laws might have to really MOVE OVER. And that might not be a bad thing at all.

IP Piracy: Does China Deserve the Bad Name?

The answer is more likely a “yes” than “no” for the average consumer exposed to the media’s persistent portrayal of China.

Assuming that you live in the West, you probably have heard the usually song and dance from the media—China is undergoing drastic changes, BUT its record on intellectual property is atrocious.

Now, Tim Johnson of the China Rises Blog (added to my blogroll) came out with a post, titled Is China unfairly bashed on piracy? In his post he urges a fresh look, posing the question: “Is it possible that the media have got it wrong?”

Then, he went on to cite a research report by a law professor out of Thomas Jefferson Law School:

That’s what a professor at the Thomas Jefferson School of Law in San Diego says [The media might have got it wrong]. He’s written a 24-page report that essentially says China, taken as a whole, is not the leading global pirate. When figures are adjusted for population, China's rates of intellectual property violation are lower than those of many other countries, including the United States.

Read his entire post and the underlying report; maybe a new perspective will change the way you view China’s piracy sin.

China Forces Corporate Social Responsibility Down Chinese Exporters’ Throat

The idea of corporate governance and responsibility seems to be gaining quite a bit of traction lately in China.

In the wake of China’s product quality/safety/reputation perfect storm, discussions, new policies and governmental actions regarding corporate governance and responsibility are taking place in China in many spectrums of the society.

The Chinese government has taken a slew of actions to address food safety, and the quality of export products.

Recently, China Vortex, a blog authored by China expert Paul Denlinger, did an excellent post, titled Are Chinese Corporate Earnings Inflated? The post examines the discussions of corporate responsibility by former Chinese official, and it states that such discussions signal “strong internal pressure in China to make corporations more accountable…” [I have added China Vortex to the blogroll.]

I left a comment there:

The days of high corporate earnings without internalizing the externalities related to such income appear, at least in theory, to be nearing their end, at least to the exporters. As you might be aware of already, China has introduced tougher environmental regulations, specifically targeting exporters. Basically, the rules spell out this message–if you pollute, you don’t export for as long as it takes you to clean up.

For concerned people, like Mr. Xu Shanda, this means an advancement of their cause for corporate responsibility, at least in the export industries as of now. The following is an excerpt of the
above-mentioned article by Jane Spencer of [Wall Street Journal] on Nov. 1, 2007:

“China is introducing new antipollution regulations for its booming export industry, in an unusual collaboration between thegovernment’s environmental-enforcement arm and the Ministry of Commerce.
The rules could affect thousands of Chinese suppliers that make goods for multinational companies. Earlier this week, Zhang Lijun, vice director of China’s State Environmental Protection Administration, said export manufacturers that violate China’s pollution laws would be forced to close for one to three years. The policy will be enforced jointly by SEPA and the Ministry of Commerce. The ministry said the prices of Chinese exports are artificially low because factories aren’t …”

This is a good move, and it would be better to expand the rules to cover non-export companies too. After all, a polluter is a polluter, regardless of the nature of the underlying operations. Internalizing externalities should be party of every company’s cost of operations.

Besides, the Nankai University Business School just hosted the 4th International Symposium of Corporate Governance, highlighting current academic research and discourse about corporate governance and social responsibility around the world. One international symposium does not make Chinese corporations improve their governance, nor does it shape them up to be more socially responsible. However, such exchanges of ideas very likely will lead to policy shifts inside China on the very issue of corporate social responsibility, especially in the greater context of growing awareness on the consequences of corporate irresponsibility and a government touting sustainable growth and social harmony.

Even though China has not had its version of Enron and Worldcom, it has the ever-worsening environmental disaster, caused by countless irresponsible corporate polluters. To maintain sustainable growth, policy-makers in China have no other options other than adopting new rules and regulations to cause the birth of responsible corporate governance within companies in China. An international symposium is a good step forward, but definitely not the only step. For a list of papers presented in the symposium, read this (Chinese only). And keep your eyes peeled for policy adjustments on corporate social responsibility in China as it will affect a lot of players out there.

Franchisors: Beware of Advertising Minefield in China

When I first finished translating China’s new Regulations on the Administration of Commercial Franchise (“Franchise Regulations”) in the spring of 2007, I feared that some franchisors would easily get confused over the provisions relative to advertising. That fear was not unfounded because one franchisor’s battle wounds in Beijing could reveal that dangers lurk in the new Franchise Regulations.

With respect to advertising, Article 17 provides in subsection 2 that:

A franchisor shall not engage in fraudulent and misleading activities in the course of advertising and publicizing a franchise. In its advertising, the franchisor shall not include content concerning a franchisee’s earnings results in the franchise operation. [Please note that the text is extracted from my translation, and it may differ slightly from other versions out there.]

Clearly, the Franchise Regulations prohibit a franchisor from general fraudulent and misleading statements in its advertising. “Don’t promise what you cannot deliver” is the basic message. At the same time, however, a franchisor in China is also forbidden from stating anything about profit margins, or earnings forecast. It translates into--Don’t say anything about how much money a franchisee can expect to make in a given amount of time from running a franchise. Simple enough, right?

Not really, because the same Franchise Regulations require a franchisor to disclose financial performance assessment of the franchise to prospective franchisees in its mandatory disclosure document. See Article 22 (8); see also Measures on the Administration of Information Disclosure of Commercial Franchise (“Disclosure Guidelines”) Article V (8) (ii).

To put the rules on advertising about earnings in a nutshell, a franchisor shall not advertise about the earnings forecast or financial performance of the franchise; but, the franchisor shall make mandatory disclosures about the earnings forecast or financial performance of the franchise to perspective franchisees in a written disclosure document. If a franchisor sticks to the rules in a nutshell, it should be able to stay clear of the mines in the advertising field.

In the United States, this kind of statements about profit margins or financial performance is commonly referred to as earnings claims under 16 C.F.R. § 436.9 (c) (2006) (the “New FTC Franchise Rules”), which is prohibited unless the franchisor has included earnings claims in its Item 19 of the Franchisor Disclosure Document (“FDD”) pursuant to 16 C.F.R. § 436.5 (s). And under the New FTC Franchise Rules, the inclusion of the Item 19 in the FDD is totally optional. Most franchisors stay clear of making earnings claims in Item 19 to avoid the added cost of providing substantiating data, and to shun possible fraud and/or misrepresentation lawsuits by franchisees arising out of such earnings claims.

Last week, a Chinese franchisor in Beijing fell victim to (or got stung by, depending on your perspective) the Article 17 of the Franchise Regulations. According to a Chinese report (Chinese only), the franchisor runs a franchise specializing in children’s haircuts. Allegedly, the franchisor handed out publications containing statements about the franchise, such as, “running a franchise, annual gross income 48, 200 Yuan, annual total costs 10,800 Yuan.” A franchisee signed a franchise agreement with the franchisor, paying a total fee of 22,800 Yuan. After operating a franchise unit for a few months, the franchisee discovered that actual operational results did not measure up to forecasts in the franchisor’s advertisement. So, the franchisee reported the franchisor to the Beijing Haidian District Office of the Administration of Industry & Commerce, which ruled that the franchisor violated Article 17 of the Franchise Regulations.

The final outcome of the case includes a rescission of the contract, return of the 22,800 Yuan, and an administrative penalty of 30,000 Yuan.

I would like to think that this is a simple case of statutory misinterpretation rather than one of corporate greed. Assuming it is the former, I would hope that franchisors remember the rule in a nutshell-- a franchisor shall not advertise about the earnings forecast or financial performance of the franchise; but, the franchisor shall make mandatory disclosures about the earnings forecast or financial performance of the franchise to perspective franchisees in a written disclosure document.

Will the New Chinese Food & Drug Resolution Be Enforced Resolutely?

If there is one vivid way to describe the crisis faced by the “made-in-China” label, it has to be the ancient Chinese idiom “四面楚歌”, meaning besieged on all sides and surrounded by “enemy” battle cry.

Against the backdrop of intense domestic and international pressure, on July 26, 2007, Premier Wen Jiabao signed a new executive order, titled Special Rules on the Supervision of Food and Drug Regulations (“Special Rules”) (in Chinese only).

To a cynical China watcher, this law represents another manifestation of the all-too-familiar syndrome in Chinese authority’s response to problems—when existing laws and regulations are not enforced against certain problems, more new laws and regulations are thrown at problems resulting from a lack of such enforcement.

If you are do think so, I’d argue that this seemingly familiar pattern was woven with a different fabric. And let me explain why.

Textually speaking, the Special Rules packs some potent new measures unseen in a host of existing laws, regulations, measures, rules, circulars, and opinions (almost impossible to calculate the total number and no wander enforcement has been…), to wit:

a. calls for coordinated actions amongst ministries of agriculture, public health, quality inspection, commerce, industry and commerce, and medical quality control. Each has the power to crack down food and drug quality violations in accordance with its designated authority;

b. specifies the administrative authorities and power of the above-mentioned ministries/departments in connection with executing quality regulations;

c. any person or entity has the right to report quality violations;

d. establishes food quality violation recording system to track repeat offenders;

e. increases administrative penalties for violations (where amount in question exceeds 10,000 yuan, the violator will be fined 10 to 20 times of the amount in controversy.)

f. requires distributors/sellers to establish mandatory quality inspection system to record purchase and sale information relative to products distributed or sold;

g. requires producers to recall problematic products;
h. ties food quality regulation results with evaluation of county-level officials;

i. specifies incentives and penalties for importing high or low quality products.

In a political sense, the Special Rules pronounce a loud and clear message—an admission that the existing regulatory scheme is too fraught with overlapping responsibility among ministries to be effective, too ambiguous to enforce, and too toothless to have a bite. Each ministry has a portion of authority in food and drug quality control, and authorities have been dispersed among six ministries. Down to the provincial or county level, the sharing and overlapping of authorities severely hinders effective enforcement of existing rules because no one has clear understanding of what they can do and no one wants to take responsibility. To a large extent, the quality woes of China can be blamed on this ineffective distribution of power and authority. The problem is compounded with relatively insignificant consequences for quality violations.

Special Rules clearly states that ministries/departments must act in concert, and they all have identical authorities in their execution of the Special Rules. Of course, the sharing of enforcement power problem is still not eliminated, but the newly created Food & Drug Special Group under the State Council and the specification of enforcement authorities are two mitigating factors.

To put things in a historical context, China is at a very critical stage of development where sharp social conflict exist between and among segments of the society. Harmony cannot be cultivated when people cannot even trust what goes into their stomach. As a Chinese proverb puts it nicely, food is of first priority ("民以食为天") (literally means people regard food as important as the sky). Food quality concern is not just an international trade problem; this is one that affects the very fiber of the Chinese society, and the stability of the country as a whole, for which the CCP has sworn to maintain. Therefore, I believe (and hope) that the government has the critical impetus to enforce the Special Rules.

Examined in a purely economic sense, export will in the near future continue to be a major engine for the growth and development for China. When the world’s faith in “made in China” is shaken, the consequences are as clear as the Tibetan blue sky. The United States already issued a ban on certain Chinese seafood imports, which is a billion dollar industry. Without drastic measures, the image of Chinese products could spiral further down, thus jeopardizing China’s economic bottom line—export. China has no other option other than enforcing quality control laws, now.

Historical records of the idiom—“besieged on all sides” account an impossible and hopeless situation for General Xiang Yu. His beloved wife committed suicide amid intense pressure. Most of his brave soldiers suffered low morale due to enemy’s siege. Seeing a complete loss of support, General Xiang Yu killed himself by the Wu River. What distinguishes the current Chinese government from General Xiang Yu is that the situation is not impossible and hopeless. EU’s chief consumer protection, Meglena Kuneva, went to China last week for joint efforts to solve problems; likewise, the American food and drug safety team is in China with the purpose—to develop an agreement on food and drug safety in cross-border trade.


Short of a complete loss of hope and support home and abroad, the current government is no General Xiang Yu. However, continued hope and support depend on China itself. Do you think the Chinese leaders know that?

Safe Motorola Cell Phone + Deadly Battery: Who Is Liable for Tort Damages?

I have been following a high profile consumer death incident in China involving a Motorola cell phone. Here is the gist of the story reported widely in China lately (in Chinese only). On, June 19, 2007, a welder named Xiao Jinpeng (肖金鹏) (“Xiao”) with a mining company out in Gansu Province suffered a fatal injury when his Motorola cell phone exploded while on the job. It turned out that the battery was the culprit. The battery of his phone exploded under high temperature, which broke Xiao’s ribs, and one of the broken ribs pierced his heart.

Soon after the incident, Motorola (China Division) sent its investigators and lawyers to figure out what exactly happened. A governmental report came out stating that this is a case of work place death caused by shoddy cell phone battery. Xiao’s family received 130,000 Yuan in compensation from his company, but according to the Law of the People's Republic of China on Protection of the Rights and Interests of the Consumers (“Consumer Rights Protection Law”) (Chinese) and the Product Quality Law of the P. R. China (“Product Quality Law”) (Chinese), Xiao’s family is also entitled to damages from the sell and manufacturer of the cell phone battery.

According to the Product Quality Law, a seller and manufacturer have comparative tort liability for injuries or death caused by products in question.

With respect to injury or damages to property caused by products with defects, the seller is personally liable when selling products with unknown manufacturers:

Article 42

A seller shall be liable for a personal injury or damage to the other's property caused by a product's defect resulted from the fault of the seller.

A seller shall be liable for damage if he can not give the producer or the supplier of the defective product.

An injured person may seek compensation from both the seller and manufacturer:

Article 43
If the defect of a product causes personal injury or damage to other's property, the injured or damaged person may claim compensation from the producer of the product or may also claim compensation from the seller of the product. If the compensation lies to the liability of the producer of the product but the seller of the product has made the compensation, the seller of the product has the right to seek the compensation from the producer of the product. If it lies to the liability of the seller of the product but the producer of the product has made the compensation, the producer of the product has the right to seek the compensation from the seller of the product.

Article 44

If the defect of a product causes personal injury to the injured person, the injurer shall compensate for the medical expenses, the nursing fees during the period of treatment and income lost due to the miss of work; if it causes the disability of the injured person, the injurer shall pay the fees for self-aid tools, living allowance, compensation for the disability and the living expenses for the persons the injured person supports; and if it causes the death of the injured person, the injurer shall pay the funeral expenses, the pension for the family of the deceased and the living expenses necessary for the persons supported by the deceased before his death.

If the defect of a product causes damage to the property of the injured person, the injurer shall restore the damaged property to its original state or pay compensation according to the market price. If the injured person suffers other substantial damages therefrom, the injurer shall be liable therefor.

[note: the above statutory texts are extracted from the website of Lehman & Hu. For the full texts of the laws quoted here, go here]

Upon further investigation, Motorola has stated in the Chinese media that the battery involved in the case is not genuine Motorola batter; therefore, it should not bear liability for Xiao’s death. In that case, if true, Xiao’s family could only go after the seller of the cell phone, who could then trace the provider of the battery. At the same time, it is not beyond all reason that Xiao probably chose to purchase the shoddy battery when the original battery became unusable. In all possibilities, tracking down the persons liable for producing and selling these types of fake, low-quality battery will very difficult because of the lack of quality regulation enforcement and wide spread practices of the selling and buying of substandard products in China.

Wahaha Goes on the Offensive

On July 2, 2007, the chief of Wahaha Group, Zong Qinghou, announced in a press conference that Wahaha would sue three foreign members on the Danon-Wahaha joint venture companies' board within 30 days.

In the past few months since May 2007, Wahaha has been busy defending itself against Danon’s assault on several fronts. On May 9, Danon submitted its disputes with Wahaha Group and Zong Qinghou to arbitration in Stockholm; on June 4, Danon sued two companies managed by Zong’s wife and daughter in a California state court. On June 18, Zong feebly pulled a punch by declaring the trademark transfer agreement with Danon invalid, and submitted that to the Hangzhou Arbitration Commission.

Then Wahaha Group hired the biggest law firm in China -- King & Wood to pull off something big. If Wahaha does what it said, it will file a derivative action against 3 foreign board members: Emmanuel Faber, Francois Caquelin, Qing Peng (秦鹏). The thrust of its allegations is that these three Danon-Wahaha joint venture board members violated Company Law of the P. R. China. It will, allegedly, claim that the defendants violated their duty to be loyal to the joint venture companies as board members by serving on competitor companies’ boards. Wahaha reportedly would seek damages in the amount of 1 million yuan.

If this is the only substantive blaming stone that Wahaha and Zong have got to cast at Danon, the legal ramifications of this derivative action for Danon is less than what the Chinese media have done. Given nationalistic sentiments against Danon (the “foreign devil”), many distributors of Danon-Wahaha joint venture companies have ceased to sell and distribute their products. Legal fees and judicial assessment of damages against Danon would do far less damages than consumer sentiments. After all, that is what ultimately makes or breaks a company.

The saga continues; stay tuned.

American Passport & China Franchise Registration

What do getting an American passport and registering a franchise in China have to do with each other? Normally, I would say NOTHING unless you have to register your franchise personally in China (which by the way is totally unnecessary).

Now, I think one word accurately describes them both---hard.

If you are an American and you need a passport to travel this summer, my deepest sympathy goes to you for what will have to endure to acquire it. Images of people encircling a passport office in the summer heat makes me feel lucky about my passport experience in China seven years ago.

The Bush Administration initiated a new security rule requiring all U.S. citizens to show their I.D. and proof of U.S. citizenship at border crossing. (Read about it here.) This requirement threw Americans quiet a bit, and a large number of Americans began to apply for a passport at the beginning of 2007. Passport offices, faced with a sudden increase of applications, are not equipped with the necessary personnel and equipment to process the applications, thus generating a back log of applications. When travelers figured out that if they do not do something to speed up the application process, they would not be able to leave the country as planned. Hence, the long lines.

The root of the problem is governmental regulations without the requisite resources to carry them out.

Chinese franchise regulators have created just the same problem. Three pieces of franchise regulations went into effect on May 1, 2007:

Regulations for the Administration of Commercial Franchising Operations
Commercial Franchise Registration Management Measures
Commercial Franchise Information Disclosure Management Measures

These new regulations did away with pre-approval in order to franchise in most industries in China. However, they impose mandatory registration and disclosure duties on franchisors. For American franchisors, registration and disclosure are nothing new because disclosure is required under the FTC Franchise Rule, and 15 states require registration as well. Registration of franchises, however, is new to both Chinese franchisors and regulators in that it has not been done before, and administrative glitches abound, to say the least.

Both local and central governments are not adequately equipped and prepared to implement the registration rules. Registration of a franchise in China involves a large quantity of paper work to be reviewed by regulators, and documents filed by franchisors are to be archived by the government. In addition, franchisors are required to amend material changes and file annual reports with the regulators. These mandates inevitably necessitate personnel, equipment, office space, and other resources.
A lack of planning and preparation is not the end of the story. At the end of 2006, China has about 26,000 franchise systems in place according to an industry report. Mandatory registration requirement means all of the 26,000 plus franchise systems must be registered before May 2008 to avoid administrative penalties. Imagine the amount of documents, the volume of phone calls, and number of inquiries that the regulators would have to keep up with. I am not even counting all of those foreign franchisors impatiently waiting to cash in before the 2008 Olympic gold rush.

The Chinese franchise regulators are not prepared, if not overwhelmed, to carry out rules made by the government.

With due respect to regulators in China and the U.S or elsewhere, regulating personal or commercial activities ain’t as simple as passing a law (sorry to state the obvious). Before making people do or not do something, it benefits all if the government would do a little bit more planning.

Please!

Licensing Your Trademark in China: One More Thing to Remember

I am on a “trademark” crusade, so I want to beat this dead horse of a topic again.

If you have not registered your trademark in China (the Chinese translation of your mark, including Chinese characters, pinyin, any proprietary pictures, graphics, etc.), you should not even consider signing any licensing agreement at all. Many China bloggers have repeatedly discussed this topic, and I loathe restating the obvious.

Assuming you have done your homework and registered your trademark with the Chinese Trademark Office (“CTMO”), you still have one more regulatory hoop to jump through—submit your licensing agreement to the CTMO and local Industry and Commerce Administration agencies. (Trademark Law of China Article 43)

Please add the above to your due diligence checklist. The failure to notify the CTMO will result in serious consequences. First, you will be subject to administrative penalty for failure to do so. Second, failure to notify the CTMO will unnecessarily make your attempt to enforce the license agreement more difficult. If you did not even follow the Chinese law while doing business there, invoking the protection of the Chinese law will of course make your life a little more complicated. Third, your trademark is likely the most valuable asset, and not doing what is necessary to protect it is just simply not good business practice.

Further assuming that you have done all of the above, your next job is to vigilantly watch the quality of products or services provided under the trademark license. A failure to monitor the quality of products or services under your trademark also bears consequences. Poor quality of products or services under your trademark might cause your licensing to be considered as naked licensing, which could theoretically strip you of your rights in the trademark. In addition, poor quality associated with your trademark might also subject you to administrative monetary penalties. (See Id.)

Pepsi’s Storm in China Rages on

In my last post about Pepsi’s “Blue Storm” trademark infringement litigation, I summarized the Zhejiang Province People’s Supreme Court’s holding. The Court basically ruled Shanghai Pepsi Co., Ltd. (“SH Pepsi”), one of Pepsi’s joint ventures in China, infringed on Lanye’s rights in the “Blue Storm” trademark, and it ordered SH Pepsi to pay damages in the amount of ¥ 3 million. It also ordered a public apology to be issued by SH Pepsi in a Zhejiang newspaper. The deadline for SH Pepsi to comply with the orders has passed.

SH Pepsi is in the process of applying for the Zhejiang Province People’s Supreme Court to reconsider its decisions. So, it seems that the storm continues.

On the one hand, I understand why SH Pepsi has determined to storm on. It probably has spent millions in the “Blue Storm” advertisement campaign, which might have involved contracts that obligate Pepsi. Given the high stakes, SH Pepsi does not want to and cannot afford to throw in the white tower yet.

On the other, SH Pepsi’s perseverance in this case, judged from the outside, seems misplaced. Litigation of this scale and consequence generates bad press from all sides. Often times, big companies try to avoid bad press at all costs. Pepsi apparently does not share the same PR strategy here.

One more thing about this case that keeps bugging me is why Lanye did not join the other Pepsi joint ventures in China in the lawsuit. They are all involved in the same alleged infringement in various parts of the country. For the life of me, I failed to see the reason behind it other than legal malpractice.

Chinese Franchise Regulation: What Next?

With the promulgation of three pieces of key legislation, the Regulations, the Disclosure Management Measures (“Disclosure Guidelines”), and the Registration Management Measures (“Registration Guidelines”), the Chinese government has made significant strides in creating a systematic, efficient, and predictable franchise regulation regime. Undoubtedly, a well-established regulatory system in a dynamitic and relatively new product/service distribution model—franchise will theoretically lead to greater success for franchisors and franchisees alike.

The recent published 2007 China Franchise Industry Report [Chinese only] provides detailed statistics on the tremendous growth of franchising in China. To illustrate, China boasts of franchise systems in excess of 2,600, and franchised units exceeded 200,000 by the end of 2006. All that growth happened in a matter of nine years, starting in 1997 with the enactment of an interim franchise adminitration regulation.

China currently has already two great things going for exponential growth of the franchise scene: a fairly well-established regulatory regime coupled with a market ripe for affordable, proven business investment opportunities.

So, what is left in the regulatory puzzle?

In comparison with the U.S. franchise regulations, China has not compiled a Uniform Franchise Circular Offering (“UFOC”), which is the standard information disclosure document for franchisors. The FTC has officially adopted the UFOC format with some changes in 2007, and franchisors to franchise in the U.S. will have to comply with the mandatory disclosure requirements by 2008. Will China institute a standard, uniform disclosure document similar in nature to the UFOC? Or will it elect to just let the Disclosure Guidelines and the Regulations serve as the regulatory blueprint for franchisor disclosure? The Chinese Ministry of Commerce issued some opinions during a press conference on June 15, 2007 relative to the implementation of the Disclosure Guidelines and Registration Guidelines.

In the conference, the speaker stated that: “the Ministry of Commerce will continue to improve regulations on disclosure and registration systems…” This is not a definitive answer as to whether a UFOC like document will be instituted in the future.

In addition, the speaker also indicated that on the agenda of the Ministry of Commerce with respect to franchising regulation are the following:

1. to continue research into franchise contract regulation so as to effectively avoid contract fraud;

2. to continue to look for solution to balance the rights and interests of both franchisors and franchisees; and

3. to ensure and guide the healthy development of the franchise industry in China.

While the Ministry of Commerce work on its "to improve-and-renew-agenda", the current regulatory regime should be sufficient to protect the interests of franchisors and franchisees.

Wahaha's China arbitration request granted despite pendency of Swedish and U.S. lawsuits

Brad Luo's articles have illustrated the escalation of the trademark dispute between China's beverage giant, Wahaha, and the French company, Danone. The dispute centers around the ownership of trademarks used by 39 joint ventures which have evolved contractually between the companies since 1996. Danone claims that Wahaha has been using the trademark to unfairly compete with Danone and the joint ventures; Wahaha claims that the trademark transfer contracts, under which the joint ventures operate, was never approved by China's trademark authority and are void.

Choice of venue issues are complex in multi-national lawsuits and there is no great statutory relief in certain venues which will protect parties from multi-venue fights. This has proven to be a problem for foreign companies contracting with Chinese entities, in particular. An example is the case of China National Metal Products Import/Export Company vs. Apex Digital, 379 F.3d 796 (9th Circuit 2004). Apex Digital (Apex) is a California corporation that imports consumer electronic goods from China which it sells under its own brand name to retailers in the United States. In 2000, Apex entered into a series of contracts to purchase DVD Players from China National Metal Products Import/Export Company (Metal). Each of the contracts contained the following identical arbitration clause:

All disputes from or in connection with this Contract shall be submitted to the China International Economic and Trade Arbitration Commission ("CIETAC") for arbitration which shall be conducted by the Commission in Beijing or by its Shenzhen Sub-Commission in Shenzhen or by its Shanghai Sub-commission in Shanghai at the Claimant's option in accordance with the Commission's arbitration rules in effect at the time of applying for arbitration. The arbitral award is final and binding upon both parties.

In March 2001, Apex filed a Statement of Claims concerning nine (9) of the purchase orders at the Shanghai sub-commission and the case was accepted. A week later, Metal decided that Beijing would be a better venue and filed a Statement of Claims concerning eight (8) of the purchase orders with CIETAC in Beijing.

Not surprisingly, Apex objected and requested consolidation of all claims into the already commenced Shanghai arbitration. CIETAC rejected Apex's objection and held that CIETAC could entertain both arbitrations at the same time, in different forums because the arbitrations were not "entirely the same." The difference? The Shanghai arbitration involved one additional contract.

The Beijing arbitration panel, unsurprisingly, ruled in favor of Metal as it had predicted. Metal sought enforcement in the United States. The United States District Court held, and the Ninth District affirmed, that the United States had to defer to CIETAC's internal rules to determine the validity of arbitral awards and had to enforce the Beijing decision.

Given the fact that the Wahaha/Danone dispute has been filed in three global forums, it raises serious questions: What do the joint venture contracts say about dispute resolution, venue selection, consolidation of disputes (if anything)? What happens if the Chinese tribunal rules in favor of Wahaha (that the IP transfer wasn't approved by the China Trademark Office) - will it void the contract in full or just negate the trademark transfer issues?

The Apex case exemplifies the impact of the dispute resolution clauses on the relationship and mechanisms to resolve disagreements. The agreement should always specify one institution for dispute resolution and, moreover, the issue of case consolidation should be taken into consideration when drafting contracts between multi-national parties. In Apex, CIETAC was asked to consolidate cases but refused to do so. Such refusal to consolidate cases is not improper in China. Thus, the only protection in these type of disputes is either to include a clause in the initial contract which expressly agrees to the consolidation of any cases concerning the transaction or the parties; or the warring entities can find a way to agree to consolidate the cases after a dispute arises.


In the Wahaha/Danone case, it is unlikely that Wahaha is going to agree to consolidate the cases in any venue other than Hangzhou. Hangzhou is the capital of China's eastern Zhejiang province and is home turf for Wahaha and Zong Qinghou. As the former chairman and founder of Wahaha (in the late 1980's), Zong has been the target of the allegations made by Danone and the primary catalyst for the escalated battle between the companies in the past 2 months.

Wahaha v. Danone: My Arbitration is Better Than Yours

Ok, this is getting really interesting!

Remember that Danone submitted the whole dispute to the Stockholm Institute of Arbitration on May 9, 2007? The arbitration is pending there in Sweden.

Remember that Wahaha also applied to have the Wahaha trademark transfer portion of the dispute with Danone arbitrated in the Hangzhou Arbitration Commission (“HAC”) on June 13, 2007?

In my last post, I was not sure whether HAC would take the case since the matter, on a bigger scale, is pending in Sweden.

But, surprise!! HAC accepted the petition for arbitration the very next day on June 14, 2007.

According to a report, Wahaha wants the HAC to determine whether the trademark transfer agreement, as a matter of law, is void since the Chinese Trademark Law requires such transfer to be approved by the China Trademark Office at the time of transfer (1996).

My hunch is that this might be Wahaha’s strongest argument. Wahaha Group in fact competed against Wahaha-Danone joint ventures; Wahaha Group actually used the trademark without the approval of the joint venture pursuant to the joint venture agreement. Therefore, without attacking the legality of the contract, Wahaha will have a very tough job in convincing the tribunals or a jury.

The next question that I anticipate to be raised after the “verdict” on the transfer issue is whether the contract in its entirety will be held as void. In my previous post, I discussed that Chinese Contract Law allows per se illegal clauses to be stricken in an otherwise enforceable contract. Assuming that the trademark transfer agreement is held as void by the HAC, will the original joint venture agreement (“Original Agreement”) survive the ordeal?

From a legal perspective, the rest of the Original Agreement should stand and continue to be effective given Article 56 of the Chinese Contract Law. But the really issue is what good is there for Danone if the Trademark transfer portion of the contract is void. Without the right to the Wahaha trademark, Danone’s joint ventures in China would only be a shell without its core value with which the Chinese consumers identify. Of course, Danone can rely on its own trademarks acquired elsewhere, but that is the topic of another day.

Wahaha v. Danone: Partnership at Grace’s End

When Danone Asia Pte Ltd. (“Danon Asia”) and other Danone subsidiaries located in Asia submitted the dispute to arbitration in Sweden, things between the two partners have turned from the good, to the bad, then to the ugly. And Danone has hired the British law firm Freshfields to represent it in the Swedish arbitration deal. As a side note, Article 26 of the Joint Venture Agreement stipulates that disputes between the contracting parties, if unresolved, are to be arbitrated in the Arbitration Institute of the Stockholm Chamber of Commerce.

My research reveals some of the details of Danone’s contentions and complaints in the arbitration. The plaintiffs/petitioners are: Danon Asia, Jinjia Investments Ltd., Myen Ltd., Novalc Ltd. The defendants/respondents are: Wahaha Group Ltd., Wahaha Shiye Ltd., Hangzhou Food Ltd., Hangzhou Wahaha Investments Ltd.

The pith of Danone’s complaints is that Wahaha Group and its non-joint venture companies violated the original Joint Venture Agreement (“Original Agreement”) between Danone and Wahaha Group, and that such violation consequently resulted in the infringement of the trademark transfer clauses of the Original Agreement. Danone alleged that the defendants, without approval from the joint venture companies, manufactured products that are same as those of the joint venture companies. These products competed against the joint venture companies’ products, injuring the interests of the joint venture companies.

In addition to the corporate defendants, Danone also joined Mr. Zong, the former chairman of the board of directors of the joint venture companies and the man behind all the non-joint venture companies, as a defendant in the arbitration. Danone, expectedly, complained of Zong’s violation of the non-compete agreement (“NCA”) and non-disclosure agreement (“NDA”). And it also alleged that Zong created conflict of interests, violating his duty to the joint venture company as a board member.

In an attempted strategic move, Zong submitted the same case to the Hangzhou Arbitration Commission on Wednesday (June 13, 2007), hoping to capture a little bit of the home-court advantage. He avers that the trademark transfer clause in the Original Agreement is void for violation of the Chinese law at the time of contract in 1996, and that Danone fraudulently induced Wahaha into the contract.

From a legal stand point, Zong is caught in a tight spot. First, his choice of venue for arbitration is against the express provisions of the Original Agreement, notwithstanding his “need” of a friendly forum. Second, the disputes have already been accepted by the Stockholm Arbitration Institute, where Zong and the other four non-joint venture companies are defendants. So, whether the Hangzhou Arbitration Commission will dismiss the petition remains a very curious legal and possibly political riddle.

And then, to make thing a little more uncomfortable for Mr. Zong, Danone lit a fire in his back yard where he could not even get to. Danone’s lawsuit in Los Angeles against Ever Maple Trading Ltd., Hangzhou Hongsheng Beverage Co Ltd., and Zong’s daughter & wife really added “insult to injury.” Zong’s immediate response to this suit is to resign his position on the Danon-Wahaha Joint Venture board, which demonstrates how enraged he might have been. Aside from making him comfortable, Danone’ choice of forum in California could not have been better since here Danone is immune from the heat of nationalism manipulated by Zong, local politics in Hangzhou (the city is a shareholder of Wahaha Group, remember?), and unpredictable courts.

Good move, Danone! Smile…

[Tomorrow, I will talk about what I think Danone did wrong. Don’t laugh yet.]

Wahaha v. Danone: Who Will Have the Last Laugh?

The Wahaha and Danone dispute appears to have been kicked into high gear.

Following Danone’s lawsuit in California state court against a subsidiary company of Wahaha, the former board director of the Danon-Wahaha Joint Venture, Zong Qinghou, announced on June 13, 2007 in a press conference that he would submit the dispute between Wahaha and Danone to arbitration in China. Specifically, the dispute involves a trademark transfer agreement Wahaha and Danone. The venue of arbitration is the Hangzhou Arbitration Commission.

In order to follow the development of dispute, which has gone global literally, it is better grasp the chronology of the relationship between Wahaha and Danone.

First, the occasion warrants a brief intro of the players. Danone is currently one of the world’s leading global corporations in fresh dairy products and bottled water, and its production and sales spans around the world. Wahaha is a bit more complicated. Wahaha Group consists of three large blocks of corporate entities. The first is the original Wahaha Group Ltd., and the City of Hangzhou owns 46% of the stock, and the rest of stocks of the company are unevenly distributed among Mr. Zong, the management, and employees (before 2000, Wahaha Group was a solely state-owned enterprise). The second one is the Wahaha-Danone Joint Equity Venture Group. Wahaha Group Ltd. Controls 49% of the shares, and Danone holds 51%. The third bunch is a host of non-joint venture companies established and operated in essence by Wahaha Group Ltd. and Hangzhou Wahaha Food Products Ltd.

Second, the following is the chronology of the relationship between Danone and Wahaha.

1. 02/29/1996-----Joint Venture Agreement between Wahaha Group Ltd. and Danone, including trademark transfer agreement, non-compete agreement, and confidentiality agreement

2. 03/28/1996-----Wahaha Group Ltd., Danone, and a Hong Kong enterprise agreed to form five joint ventures in China.

3. 04/1996-----Mr. Zong became the chairman of board of directors of the said five joint ventures.

4. From 1996—2007, the original five joint ventures evolved into 39 joint ventures, and everybody made a ton of money.

5. Problems began to surface in 2000 after the reorganization of Wahaha Group Ltd., which became a private entity with the Hangzhou government holding 46% of its stocks. The reorganized Wahaha Group Ltd. began to establish its own joint ventures and separate subsidiary entities, which totaled 17 entities in a span of six years. Apparently, Wahaha Group Ltd. used the Wahaha-related trademark in violation of the Wahaha-Danone Joint Venture Agreement.

6. Danone kept quiet with respect to Wahaha Group’s use of the trademark and apparent breach of the non-compete agreement inherent in the Joint Venture Agreement.

7. In late 2006, Danone initiated an offer to buy all of Wahaha Group Ltd.’s companies which are developed outside of the Joint Venture Agreement, and Wahaha Group Ltd. rejected the offer. The dispute went public in early 2007, escalating into a full blown fight over the ownership and usage of the Wahaha trademark.

8. 05/09/2007, Danone Asia submitted the disputes with Wahaha Group Ltd. with respect to the Joint Venture Agreement to the Stockholm Arbitration Institute.

9. 06/04/2007, Danone sued, in the Superior Court of Los Angeles County, Ever Maple Trading, a company based in the British Virgin Islands, and Hangzhou Hongsheng Beverage, as well as two individuals related to these companies. The two companies are believed to have ties with Wahaha Group Ltd. and Mr. Zong.

10. 06/05/2007, Mr. Zong tendered his resignation as the chairman of the board of directors of the Wahaha-Daone Joint Venture.

11. 06/13/2007, Mr. Zong announced his plan to submit the trademark dispute arising out of the Joint Venture Agreement to the Hangzhou Arbitration Commission.

As can be seen, the facts of this dispute are complicated and convoluted, and both parties are engaging in interesting tactics to gain procedural advantages. I am trying to get my hands on the Joint Venture Agreement to see exactly what they agreed to in 1996. Tomorrow, I will blog about the thrust of both parties’ contentions in their respective arbitration, trial proceedings.

Choice of Law and Contracts in China

Disputes happen. It certainly happens to foreign companies doing business in China. The multinational company Danone is in a huge one now.

I think it is safe to say that conflicts and disputes are unavoidable in doing business in a foreign country, but one can control the risks involved and minimize the damages thereunder. Choice of law in contracts with foreign parties can be of strategic importance if and when disputes arise in commercial activities.

Article 126 of the Contract Law of China governs foreign-related contracts. It provides that “parties to a foreign related contract may choose the applicable law for the resolution of their disputes, unless the law provides otherwise.” As it is clear from the contract code itself, the contracting parties' express provision on choice of law will be enforceable in case of a dispute later. Whether to choose Chinese law, the law of your own residing jurisdiction, or a neutral third jurisdiction is a difficult decision. The best thing to do is to get competent counsel who understands, comprehensively, the laws and regulations of all the three possible jurisdictions. Only upon a careful examination of all the applicable laws of the various possibilities can one make an educated choice.

The Contract Law of China also contemplates that if the parties fail to expressly state in the contract the choice of law, the disputes between the parties shall be governed by law of the country with the closest connection (nexus) to the contract. Simple it might seem, but the two words “closest connection” have generated voluminous commentaries among contract law and international law scholars. Some suggest that the connection is one that should be assessed in terms of both the quantity and quality of the connections, while other suggest that the presiding judge over the case should have wide discretion to determine by weighing the interest of the parties involved. Still others argue that the contracting parties’ intent warrants some consideration in determining what law governs. My two cents worth on this is that if the scholars cannot figure it out over years of research, the contracting parties REALLY need to expressly provide the choice of law clause for their own good.

Not all contracts in China can be governed by laws selected by the parties. According to the Contract Law, the following three types of contracts shall be governed by the law of P. R. China:

Chinese-foreign joint equity venture contracts to be performed in China
Chinese-foreign cooperative joint venture contracts to be performed in China
Chinese-foreign contracts for joint exploration and development of natural resources in China

If you really do not want a piece of the Chinese law over your contract, consider structuring your business deals around the contract law by avoiding forming a joint venture in China. But a deal, as I understand, is often more complicated than that.

For more on Chinese Contract Law, check out my earlier posts.

Freedom of Contract in China: Not So Fast Yet

Freedom of Contract in China: Not So Fast Yet (II)

Freedom of Contract in China: Not So Fast Yet (III)

Freedom of Contract in China (IV): The Role of the People's Court

Chinese “David” Brought Down American “Goliath” for Trademark Infringement

Pepsi "Blue Storm" Litigation in China

Zhejiang Province Supreme People’s Court rendered its fascinating opinion after months of trial. This case involves yet another two beverage companies. It seems that the beverage industry in China is a highly contentious one in light of the Starbucks case and the Wahaha v. DANONE dispute. Before I digress further, let me get on with the tale of “David” and “Goliath” in modern day Chinese battle ground for market share and trademark protection.

Plaintiff / appellant is a little known alcohol & beverage company named “Lanye Alcohol Beverage Co., Ltd.”, hereafter “Lanye” and/or “Chinese David.”

Defendant / appellee is the well known Shanghai Pepsi Cola Beverage Co., Ltd, hereafter “Pepsi” and/or “Goliath.”

Another Defendant / appellee is a local supermarket that sells beverage drinks, including Pepsi Cola. And the company’s name is Hangzhou Lianhua Group, Ltd. (hereafter “seller”.)

On December 14, 2003, Lanye registered its trademark “蓝色风暴” with the Chinese Trademark Office, which can be translated as “blue storm.” The registered trademark consists of the Chinese characters, phonetic spelling of the characters, and graphic designs associated with the trademark. Lanye produces bear, bottled water, cola, etc.

In 2005, Pepsi began using the Chinese characters in its massive advertising campaign in China. The characters were also printed next to the well known Pepsi trademark itself to promote the Pepsi coke.

Guess what? Lanye sued Pepsi for trademark infringement. One of the reasons for initiating the suit was that local Industry & Commerce Administration where Lanye is located seized its beverage drinks because Lanye was suspected of infringing on Pepsi’s trademark. (How can anyone stomach that?)

The Hangzhou Intermediate People’s Court held for Pepsi on two operative issues:

a. whether Pepsi’s use of “Blue Storm” constitutes trademark infringement according to the Trademark law since Pepsi utilizes its own well-known trademark in connection with the Lanye’s trademark in question

b. whether Pepsi’s use of “Blue Storm”caused confusion among consumers, thus injuring the plaintiff.

On appeal, the Supreme People’s Court reversed the lower court’s holding on both issues. On the first issue, the court cites Article Three of the Implementation Measures of the Chinese Trademark Law, stating that trademark use is a broad concept, which encompasses the use on product, product packaging, company stationery, product advertisement, and trade shows. Therefore, Pepsi’s use of the “Blue Storm” falls within the purview of trademark use.

In addition, whether a logo constitutes a trademark is determined by the function of the logo in commercial activities. If the logo is capable of assisting consumers in distinguishing products or the origins of services received, the logo is a trademark. Based on discovery, Pepsi’s use of the “Blue Storm” did function as a tool for consumer to identify the logo with the overall brand name of Pepsi, irrespective of the Pepsi trademark.

With respect to the issue of consumer confusion, the court concluded that Pepsi’ use of “Blue Storm” as a trademark did create confusion among consumers relative to Lanye’s registered trademark. The Court noted that because of Pepsi’s extensive use of “Blue Storm” Lanye’s registered trademark has all but lost its value and function—brand name identification for Lanye.

In its conclusion, the court ordered Pepsi to pay ¥ 3,000,000 to Lanye and to issue public notice of the infringement. The Seller was, according to the court a bona fide purchaser, not liable for monetary damages, but has the responsibility to stop selling any infringing products manufactured by Pepsi. Curisously enough, the Court did not order the destruction of the existing infringing Pepsi cokes; it reasoned that would be impractical and would constitute waste.

For some reason, this case did not generate a lot of hype. Maybe Pepsi has done a good job of P.R. so that the embarrassment will not expand back home. After all, being held accountable for infringing on the trademark of a little known local company is not as tasty as a Pepsi Coke.

A few observations about the case:

a. Not all Chinese courts are willing to bend over backwards to protect foreign companies if they do not follow the Chinese law.

b. Chinese companies are getting savvy about protecting their IP rights.

c. Why Pepsi failed to perform a basic check on the “Blue Storm” with the Chinese Trademark Office totally and completely beats me.

d. Even if you own your own registered trademark and you are a big company, you still cannot take the trademark of another small company without due process of law. Not in America, not in China either.

e. Don’t assume anything, especially when you are a foreign company in China.