Want Lasting Relationships in China? Start with Mutual Trust (Republish)

First of all, if you have not read Jack Perkowski’s Managing The Dragon, you are missing a tremendous resource like a lawyer missing a copy of the Black’s Law Dictionary.  Yea, it is that good.  I bought that book and could not put it down for an entire day…

Besides offering insights on doing business in China from the ground up in that book, Jack consistently updates his blog with amazing nuggets of practical “how-to-dos.”  In a recent post, Managing the Dragon discussed “Building Relationships in China,” which topic is a perennial item for people interested in or mystified by China.  In the post, when asked by a Korean reader of his excellent book on how to build lasting relationships in China, Jack states from personal experience, trial and error:

Before discussing specifics, keep in mind that establishing a level of trust with your Chinese counterparts should be your overriding long-term goal. When I first came to China, everyone emphasized the importance of “mutual trust.” In fact, it was said so many times that I began to think of it as a platitude, just like motherhood and apple pie. “Of course,” I thought to myself, “who could possibly be against ‘mutual trust’?” The longer I’m in China, though, the more I appreciate the wisdom of that advice. Once a level of mutual trust is achieved, life becomes a great deal easier. Mutual trust is not something that can be achieved overnight. It takes years, but it’s important to get started right away. How do you do it? It’s simple, do what you say you are going to do, and treat your partner withrespect, openness and candor. If you do this consistently over a long period of time, mutual trust will follow.

(Emphasis added)

I could not agree more about the absolute importance of “mutual trust”. 

First, why is there a a need for trust?  Despite China’s opening up and decades of business dealing between the Chinese and “westerners” in general, there is still a lack of trust in at the start of a business relationship.  Historically, business people in China do not enjoy a reputation as being trustworthy, honest, and forthright, and people generally approach them with caution.  We have the recent product quality scandals as adequate proof of an actual lack of trustworthiness on the part of many business people.  This need for trust is, in a sense, heightened with respect to foreigners because of the vast differences: culture, language, world view, educational background, to name a few.  On  a personal level, doubts and questions are legitimate when people of vastly different backgrounds try to forge relationships.  Where business people intend to engage in investments and commercial transactions with Chinese parties, doubts and questions are not only inevitable but also warranted.  

Second, how do you build mutual trust?  Jack’s prescription calls for “respect, openness and candor.”  Once again, he is 100% right on the money.  To echo Jack’s point, I tell a story.  In the not so distant past, the relationship between the U.S. and China came to a historical low when the U.S. led NATO forces “mistakenly” bombed the Chinese Embassy building in the former Belgrade, Yugoslavia, sending Chinese college students into a frenzy of hatred and confusion towards Americans.  Students protested in front of foreign (European and American) consulates; they smashed windows of KFC and McDonald’s restaurants; and they painted huge American national flags on roads for Chinese students and cars to trample…They were angry, their emotions were raw, and the government allowed them to vent to show the outrage at the manifestly wrong American policy and actions in Yugoslavia.  Although angry and hurt, college students still had to go to their English classes, taught by American professors. 

One of my friends was teaching at a large university in China at that time, and her experience offers some unique insights into how mutual trust is built in China, even against a difficult political backdrop.  One day after the bombing incident, she knew that she had to do something about it in class, but she did not know what to say.  The most important thing she had in mind was to be open to the students, to let them express their thoughts and emotions.  When she stepped into her classroom, the students were obviously emotional, and she noticed that a few officials from the college’s administration were sitting in the back (maybe for her safety; maybe for other reasons).  To begin, she said something to the effect: I don’t know what exactly happened in Belgrade, I don’t understand why it happened, I don’t think it should have happened, and I am so sorry for the loss (of lives and face) that you have suffered.  I am willing to listen to whatever you want to say.  After that, she began to invite her students to talk about what they thought and how they felt.  Very soon, the dynamics of the classroom transformed.  Students were expressing themselves, instead of brewing inside with hatred.  Even the officials in the back of the classroom relaxed.  Needless to say, from thereon, her status in the school changed.  Students became more open, and they came to her to discuss other matters.  And significantly, her employment contract was extended for another year.

What does this experience of a foreign teacher suggest?  Be open to the Chinese party that you are dealing with.  Don’t be afraid of talking about tough issues.  But, when you are talking about them, respect what they want to express.  Perhaps you don’t agree with them and perhaps you don’t understand their emotions, positions or arguments, but you need to show basic respect for their right to express themselves.  Then, be candid about your thoughts as well.  Let them know what you are thinking, and show some vulnerability, show them that you are a human being, with doubts, frustrations, and concerns.  But when you are expressing yourself, use sound judgment about what you say.  Gauge your audience so that your statements do not put them off.  Remember, mutual trust comes not in one day, but through a long, incremental process.  While you need to be candid, don’t try to rush things.

In sum, building relationships in China takes time and effort.  But one needs to work on creating mutual trust with openness, respect, candor, and wisdom.  Before all that, check out Jack’s post.

Basics about Setting Up Business in China (Republish)

A few days ago, I ran into this article intended for Australians who want to set up business in China.  It discusses eight (8) basic elements that each businessperson  needs to know before charging into China.  I thought it was pretty good, and would like to share below.

1.  You have more than one way to skin the cat.  Namely, you can do joint ventures, wholly foreign owned enterprise, or a representative office.  Each form of business entity has its own advantages and disadvantages, and they have been well discussed by folks at China Law Blog and China Briefing.  Not to keep beating the dead horse, but you need to know that a representative office is not a really good way to go if you want to conduct business on the ground in China.

2.  Articulate clearly what you intend to do in China.  If you have a business idea/concept, you need to be able to articulate how you plan to execute that big plan, how you intend to make money.  A vague idea will not do.  This is so because when you fill out all your application materials, you have to draft, by yourself or through your lawyer, a feasibility study, which has to be somewhat detailed in describing your business.

3.   Pick your spot in China.  Even though China is big, places suitable for your business might be few.  Take full advantage of the tax breaks on the table courtesy of the Chinese government.  Western and central provinces still have nice tax cuts to hand out.

4.  Put down your minimum registered capital.  The local industry and commerce bureau office/administration where you submit your application will determine, pursuant to your business plans and feasibility study, how much minimum capital you need to inject.  You may contribute a part of your IP or equipment toward that registered capital, but they set the cash-equipment ratio for you.

5.  Treat your Articles of Association seriously.  This is a very important piece of governing document for your business in China because the business scope therein may impact your ability to repatriate profits back home.  If your actual business scope is larger than the scope described in the AOA, problems may arise since you are technically doing part of your business illegally.

6.  Take care of your labor relations.  Enough has been said and discussed about China’s Labor Employment Law.  Even though enforcement is pretty lax right now due to the global economic crisis, don’t count on the Chinese government to cut you some slack all the time.  Do it right from the start.

7.  Know your local partner.  Dances with Wolves might be romantic, but it is also dangerous.  No kidding, go ask Danone, Inc. if you have doubts about this.  If you want control of the joint venture, make sure you know exactly what it means to control a business in China from a legal stand point, i.e. stock ownership, having a trustworthy local manager, be in charge of that all powerful corporate seal, etc.

8.  Develop local relationships.  This includes relationships with your employees, staff, local government officials, suppliers, etc.  An earlier postdiscuss how to do this.

These are very basic stuff for preparing to do business in China, and I’d like to add the following:

9.  Protect your intellectual property.  If you got intellectual property components in your business, treat like they are yours.  China will protect your IPR in trademarks, patents, copyrights and trade secrets if you take the initial steps toward safeguarding them through proper registration, recordation, and non-compete/nondisclosure agreements.  I disagree with assertions that China has no IP laws.

10.  Be patient.  Things WILL take longer than you planned.  Simple as that.  I’m not saying that the Chinese are inefficient or incompetent; I am saying that things will go wrong, little things, like renting a place for your business and the landlord has no proof of land ownership, like you don’t have a board resolution for something.  Similarly, things will be different with handling your local staff.  They have different experiences and expectations, and you have yours.  It takes time to mesh.

11.   Find the nuance.  China changes quickly.  Its laws, regulations, macro socio-economic factors all change constantly.  It’s hard to imagine a business will thrive in an country with impactful yet nuanced changes in its business and legal environments.  The Chinese government adjusts its macro economic policies constantly in accordance with local and global shifts.  For example, when the economic situation got worse in the last two quarters, China quickened the pace for granting business license to foreigners (Read China Law Blog’s latest post.); when China wanted to slow down exporting and start to make its growth more sustainable, it stopped the VAT rebates to exporters (available yet again recently), and put a ban on certain manufacturing in parts of China.  To be able to survive China, a businessperson must be constantly on the lookout for nuanced changes in China.

12.  What can you do for China?  ”Ask not what your country can do for you; ask what you can do for your country.”  While you contemplate business success in China, ask yourself what you can do for China.  It maybe creating jobs, generating tax revenue, contributing to charity, setting up university scholarships, making available internship opportunities for local students, or whatever.  Small measures of kindness, small gestures of friendship will make you a “hero,” rich and successful ultimately assuming you do 1-12.  The Chinese almost “deify” foreigners that do stuff for China.  Consider the Flying Tigers, Dr. Henry Norman Bethune.  Of course, you don’t need to be a savior, just do something while you make money.

Debunking the Myths about Doing Business in China

Debunking the Myths about Doing Business in China

Business Week came out with an article titled, China: Debunking the Myths. The authors, Charles Bien and Brian Renwick, lay out eight common myths, and shed light on them. Very interest stuff.


MYTH ONE: "Western companies should view the rapid development of the Chinese economy as a competitive threat to which they are vulnerable."

[As globalization increasingly link all nations and markets, i.e. U.S. subprime problems, this view seems quite simplisti. But, in an election year in the U.S., this view might generate good will among some voters.]

MYTH TWO: "The position of Asian superpower can be won by either China or India, not both."

[A Chinese saying has it that “there can be only one tiger in a mountain.” Will that be a self fulfilling prophesy?]
MYTH THREE: "China is a huge, single market with weak local competition."
[If investors get beyond the big first-tier cities, this myth will probably disappear real quick.]

MYTH FOUR: "China has a consistent management culture, which is ripe for introducing human-resource best practices."

MYTH FIVE: "Multinationals wishing to establish operations in China should hire Chinese 'returnees' who have valuable international experience, a non-Chinese perspective, and non-Chinese business education."

[Not all “sea-turtles” d/b/a “returnees” are born equal. An Asian appearance does not make you Chinese, I guess.]

MYTH SIX: "The 'war for talent' is a Western phenomenon. No such war for talent exists in China where supply of talent outstrips demand among leading firms."

[What kind of talent are ye talkin’ about? So, it depends.]

MYTH SEVEN: "Since the reunification of Hong Kong and the People's Republic of China, the administrative and business relationships are seamless."

MYTH EIGHT: "China is a low-cost manufacturer, not a platform for product and service innovation and the development of its own intellectual property."

[Change the “is” into “was.”]

Read the full article here.

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.

Smart China Exit Strategy: Leave but Don’t Burn Your Bridges

China Law Blog (the “CLB”) has just come out with an excellent post regarding how investors should deal with the changing investment circumstances/environment in China. Most fittingly, CLB titled its post as “China Changes. Don't Over-React. Don't Under-React.”

To substantiate its argument, CLB borrows some pearls of wisdom from the China Business Blog, which recently posits the following on how one should respond to changes occurring in China:

1) Don’t over-react
The recent changes in China are not a death knell for global business. What is happening here are just the normal growing pains of a developing economy showing signs of budding maturity and the problems that go along with it.

2) Don’t under-react
China IS going to be a growing consuming market and it WILL suck up a lot of raw material and energy resources. And this WILL have an impact on other nations and economies by making these resources more expensive. It is a reality. It is happening. Sitting and complaining about it is NOT going to help. What emergency plans do you have that address potential future scenarios involving a growing China?

3) Don’t over or under-react, but DO REACT
Many a fortune cookie tells us, in some form, that in the midst of great chaos one may find great opportunity. Well, now seems a time of – if not GREAT chaos – then of some modicum of chaos in global markets. So how can you react and take advantage of it?

4) Look at all of your options
The lesson here is that companies should certainly consider their growth possibilities in China. It is (and will remain for some time) the most compelling market in the world. However, companies should not look at China at the cost of ignoring other markets. If the changes in China are motivating companies to consider all of their options, then I think this is possibly a good thing and is healthier for everyone involved.

In pure simplicity and brevity, CLB translates the above into—“use your head” when dealing with a changing China.

CLB’s advice is most poignant and relevant in light of the way some Korean companies are handling recent changes in China. Reportedly, some Korean companies decided to withdraw from the China, thus causing a pretty noticeable exodus. Nothing wrong with leaving, but it is problematic when they leave illegally (Chinese only). Some “escaped” in the middle of the night, and apparently the problem is so severe that the Korean Foreign Ministry has stepped in to help the exiting companies leave legally.

True, the cost of doing business in China has risen due to a host of economic and legal factors. Inflation keeps rising; labor costs are getting higher accordingly; tax breaks are disappearing; land control is getting tighter; and then there is the “cursed” labor contract law. For some, a quick exit might be the right and appropriate reaction to the changing investing environment; for others, it might not. But, before jumping onto the exodus wagon, it is crucial to analyze the appropriate measures to take, with professional help if necessary. Examine the motives, methods, reasons, and options for exiting.

It is bad enough to leave China illegally, presumably for not settling accounts with supplies, employees, and not paying taxes. It is worse to find out afterwards that China is actually still the place to be, and that you have already burned your bridges in China.

To end, I quote CLB—“Use your head.”

"China Hearsayworthy" and Signs of China JV Trouble

The always prolific and thoughtful China Hearsay came out with something quite entertaining, and with a bit of southern accent: You Know You’re [Your China JV Is] in Trouble When the . . .

[For a sampling:]

JV partners haven’t spoken to each other for 7 years.
CFO is the wife of the local partner.
Foreign investor has never visited the JV and forgot what city it’s in.
Local partner claims he is son of a PLA general.
Neither party can remember who was supposed to file the application docs.

Stan points out five more signs dooming a China joint venture. Of course, not all of these signs will be present in all JV failures, but some definitely are in the Danone-Wahaha joint venture fallout.

China’s Foreign Investment Guide Catalogue Revised

November 7, 2007 marks an important date for foreign investment policies in China, as reported by the China Briefing Blog and elsewhere (in Chinese):

The Ministry of Commerce and the National Development and Reform Commission jointly released the latest Catalogue for the Guidance of Foreign Investment Industries today.

The catalogue, approved by the state council, will take effect on December 1 according to the NDRC’s website. The new catalogue replaces a catalogue that came into effect in 2004.

While continuing to encourage foreign investment towards the hi-tech, equipment manufacturing and new material industries, the catalogue adds service-outsourcing and modern logistics to the service industry in an effort to fulfill China’s commitment to the WTO.

Overseas investment targeting conventional manufacturing industries in which China has mastered advanced technologies and has competent production capacity is no longer encouraged in the new catalogue.

Under pressure to clean up a growing environmental catastrophe, Beijing is pushing FDI towards developing clean production, reproducible energy, and ecological protection. Foreign capital is not permitted in the exploration of rare and non-reproducible mineral resources, or in high consuming and polluting industries.

Hoping to further spur development away from the booming coast, the revised catalogue drops the article limiting foreign investment in the central and western regions of China. Introducing foreign capital will also be considered in rejuvenating Northeast China and other historical industrial bases.

These revisions to the Investment Guide Catalogue are consistent with recent changes in other Chinese laws and regulations. For example, China revised it tax code to unify tax rates for domestic and foreign-originated companies, while at the same time providing tax incentives for clean and environmentally friendly industries. In addition, China modified its catalogue of export products to limit the export of inexpensive and labor-intensive goods, with the purpose of adjusting trade imbalance with its trading partners and addressing environmental concerns.

Here is the revised Investment Guide Catalogue in Chinese [I have not been able to find an English version]; here is the old Investment Guide Catalogue in English as of 2004. Be sure to note the differences.
**********************************************************************************
Update:

The English version of the Revised Foreign Investment Guide Catalogue can be found below:

Here, for an unofficial translation.

So far, I have not been able to find an official translation. Generally, one should be able to find official translations of important laws and regulations at http://www.fdi.gov.cn/pub/FDI_EN/default.htm

If a reader finds the official translation, would you please leave the URL of the site in your comment to this post? Thanks!

China and the WTO: Six Years of what?

It has been almost 6 years since China ascended into (or shall I say onto) the WTO. And what a six years it has been for China and the other member countries of the WTO! For optimists, the six years have been a period of remarkable progress in terms of regulatory reformation and unprecedented market access into China. A recent report brought forth by China Trade Gateway rings such an optimistic tone, yet with restrained hope for more reforms to be undertaken by China.

First off, the report shows some notable benefits that China has harvested from its entry into the WTO. Contrary to fears of many Chinese, foreign competition resulting from the WTO has increased domestic companies ability to survive an ever more competitive market. For example:

[T]he price of imported vehicles are getting lower but at the same time cars made in China are increasing their market share more, banking reforms are coming into place, the insurance sector is finally improving, the entertainment industries are opening up to the West, but also Chinese movies and music are targeting Western audiences.

Along the same line, many Chinese companies have “selectively adopted” Western practices, such as “management principles and customer service, which leads to a beneficial integration in companies, and in the long term into the consciousness of Chinese people.” I agree with this observation and believe the Chinese will catch up with some Western companies soon, adopting and adapting to skills, methods, and technologies brought by foreign firms.

Second, WTO member countries have also mutually benefited from China. Most obviously, improved market access means more opportunities to invest in sectors and industries previously inaccessible. Retail, franchising and other means of distribution have become bright spots for investment due to more friendly governmental regulations. In all, according to this report, “China has reviewed more than 2,000 trade related laws and regulations…and has abolished over 700 of them, amending others to bring the country into compliance.” As reflected in figures released by the World Bank, “the Chinese economy contributes to 13 percent of the world's economic growth.” Furthermore, the report cites that a total of “USD 57.94 billion was remitted out of China as profits” in a span of five years following China’s entry to the WTO. These are impressive figures and presumably rewarding profits.

Third, areas of outstanding concerns exist despite the mutually beneficial relationship between China and other member countries. Cited by the Europeans and the Americans, the following areas remain problematic and contentious:

China's enforcement, the transparency and consistency of Intellectual Rights Protection, the currency evaluation of the renminbi, existing trade barriers in China for agricultural products through Sanitary and Phytosanitary measures, continuous interferences of the state in certain industries, such as telecommunications and for example the steel industry, as well as recent import tariffs on foreign auto parts. On the other hand, China still faces protection from the US and European governments in industries they feel threatened by, leading to high anti-dumping cases.

Finally, looking beyond the haze of remaining issues, the author of the report sees promising opportunities ahead in many major industries and areas. Examples include banking & financial services sector, telecommunication, distribution and retail sectors, services as well as mergers and acquisitions.

The future sure looks good in the eyes of this report, does it? Read the full article here.

“Corruption Threatens China’s Future”

Just read Dr. Pei Minxin’s article titled Corruption Threatens China’s Future published under the auspices of the Carnegie Endowment for International Peace. This comprehensive piece details the extent, causes, impact of corruption in China.

A. Extent of corruption in China

People generally know that corruption is rampant in China, but how bad is it? How much does it cost China? According to Dr. Pei’s research, China’s National Audit Agency measured misused governmental funds at a whopping $170 billion (yes, that is in U.S. dollars) from 1996-2005, representing about 8% of “on-budge spending for this period.” While acknowledging the difficulty of accurately measuring the exact dollar amount of corruption, Dr. Pei did come up with a unique formula to arrive at a concrete number.

To estimate roughly the direct cost of corruption, we can suppose that 10 percent ofgovernment spending, contracts, and transactions is used as kickbacks and bribes or is simply stolen. The Chinese government’s procurement budget in 2005 was 300 billion yuan. The so-called administrative spending in China’s official budget, about 20 percent of the total spending (470 billion yuan in 2003), is another juicy target. If 10 percent of the procurement budget and administrative spending is stolen or misused, this would amount to
0.65 percent of gross domestic product. Sales of land user rights by the government generated 580 billion yuan in 2005. Bribes to local officials could easily amount to 10–2percent of the revenues generated (58–116 billion yuan, or 0.5–1.0 percent of GDP). In 2003, the state-owned entities spent 2.1 trillion yuan (19 percent of the GDP) on fixed asset investments. If 10 percent were stolen, it would cost nearly 2 percent of GDP. Based on the conservative assumption that 10 percent of the land lease revenues, fixed investments, and government spending is stolen or misused, the direct costs of corruption in 2003
could be 3 percent of GDP, roughly $86 billion, an amount exceeding the government’s entire spending on education in 2006.

Based on his formula, the direct cost of corruption in 2003 to $86 billion, an amount larger than the Chinese government’s entire spending on education in 2006 (emphasis added). [all I can think of is how many schools could have been established, how many teachers in rural China could have been paid on time, and how many first rate research labs could be set up…]

B. Causes of corruption in China

Dr. Pei then pointed out some characteristics of corruption in China, to wit:

Corruption in China is concentrated in the sectors with extensive state involvement: infrastructural projects, sale of land user rights, real estate, government procurement, financial services, and heavily regulated industries. The absence of a competitive political process and a free press in China makes these high risk sectors even more susceptible to fraud, theft, kickbacks, and bribery.

In other words, wherever governmental control and interferences are the greatest, corruption is likely to result for lack of political transparency. In addition, a “partially reformed economy”, lack of enforcement of laws and regulations, and the government’s inability to adopt an effective regime to combat corruption all contribute to the festering of corruption in China. His analysis on the root causes of corruption in China is the most incisive that I have read so far.

C. Impact of corruption

Dr. Pei argues that corruption affects China and the rest of the world. Domestically, corruption fuels “China’s rapid increase in socioeconomic inequality and the public’s perception of social injustice.” And, “the indirect costs of corruption—efficiency losses; waste; and damage to the environment, public health, education, the credibility of key public institutions, and the morale of the civil service—are incalculable.” Additionally, the impact of corruption in China could spill over to foreign countries, and it could be manifested in areas such as global public health and the environment. Therefore, Dr. Pei calls on western countries to assist China in fighting corruption, specifically by urging it to reform its political and legal systems, sharing information with China, and increasing legal cooperation with China.

A great read if you care about this stuff, but I doubt that the situation will improve unless fundamental changes occur within China’s political system. Until then, anything done by the Chinese government is like a band-aid on a malignant tumor. For example, the newly established cabinet level—The National Corruption Prevention Bureau of P.R. China.

“Mandarinize” Your Arbitration Clause for China

Someone once analogized international arbitration in China to playing the Chinese Chess. Here it goes:

Chinese Chess or Xiangqi has been played for thousands of years. The game shares common ancestry with the more familiar International Chess, but it also has differences that make it unique. Likewise, resolving disputes by arbitration in China is similar to that conducted at any major international arbitration centre - except that there are some features unique to China.

Despite the Chinese government’s grand visions for improving China’s legal system and the actual incremental progress in its judicial process, most international investors still prefer arbitration to solve their disputes arising out of their China-related transactions. Arbitration, undoubtedly, can be an efficient, private, and economical way to solve disputes that preserves cross-border relationships and confidentiality. However, satisfactory arbitration results very often hinge on the content of the arbitration clause/agreement itself. To reduce the risk of arbitration proceedings going awry in China, foreign investors must know the rules of the game in China and adjust their strategies accordingly.

A. To gauge whether an arbitration clause/agreement is China ready, it is very important that one includes the following provisions:

1. Clear expression of intention to arbitrate

2. Specification of an arbitration institution

For example, Shanghai sub-branch of the CIETAC

3. Scope of the matters to be arbitrated

Note that certain matters are not arbitrable in China, such as labor issues, family law related issues, and other administrative disputes.

In the recent disputes between Wahaha v. Danone, one of the arguments made by Wahaha to arbitrate in China was that there was a labor dispute between Mr. Zong and Danone, despite on-going parallel arbitration proceedings in Stockholm.

4. Language with which to arbitrate

For foreign parties, the most convenient language might be English, but make sure it is specified in this provision.

5. Governing law

To avoid uncertainties, parties should specify the substantive laws governing the interpretation of their agreement. It is, however, important to select laws of a jurisdiction with close reasonable connection to the transactions, and the governing law should be one sufficiently sophisticated to resolve the disputes. Additionally, make sure that the selected law allows the disputes to be arbitrated.

6. Situs/Location of Arbitration

The seat of arbitration should be specified (See above # 2). The CIETAC has multiple branches in China.

Some foreign investors, who want to skirt arbitration in China, should note that an attempt to arbitrate outside China will fail if such “foreign” parties are in fact organized under the Chinese law, i.e. wholly foreign-own enterprises. Nonetheless, parties, one of whom is foreign in the eyes of the Chinese courts, can agree to arbitrate outside China.

7. Choice and number of arbitrators

This is probably one of the most important provisions in the arbitration clause because the panel controls and determines the outcome of the arbitration. At the same time, this is probably the area about which foreign parties feel most uneasy about arbitration in China. Professor Jerome Cohen’s thoughts on Time to Fix China’s Arbitration, although a little outdated, shed light on the very issue. Subsequent to complaints and criticism regarding the formation of an arbitral tribunal, the CIETAC revised its rules (Chinese here; English here, giving parties more freedom in choosing the presiding arbitrator outside CIETAC’s list of arbitrators (subject to confirmation by the president of the commission).

To maximize neutrality, parties should agree to jointly appoint a presiding arbitrator from a neutral country. As is the norm, three arbitrators will suffice to constitute a panel.

B. Optional provisions for a China-ready arbitration clause:

1. Procedural rules

The CIETAC allows the parties to under rules of other arbitration institution, i.e. the ICC. However, ad hoc arbitration is not permitted in China.

2. Confidentiality

Article 40 of the Arbitration Law and Article 33 of the CIETAC’s Rules address confidentiality of the proceedings. Regarded as hallmark of arbitration, confidentiality is extremely important to parties involved, so a provision detailing the parties’ duty of confidentiality is neither excessive nor repetitive in spite of the above statutory and institutional guarantee of confidentiality.

3. Interim Relief

Only courts in China have the authority to grant interim relief in a pending arbitration. Typically, a party seeking relief must submit its request to the arbitration commission, which will in turn refer the request to a court with proper jurisdiction. A provision regarding interim relief is enforceable to the extent that it comports with the Chinese law.

4. Discovery

Recognized as another characteristic of arbitration, discovery is very limited to evidence supporting proponent's claims and refuting those of opponent's. Generally, written evidence is preferred in China, but parties may agree to have live testimony, which is probably better for a U.S. party. For an excellent read on this, check this out.

Dispute resolution should be a key component of planning for any international transaction, no matter how unlikely disputes may seem from the outset. As it is often said in China, one should always 未雨绸缪, meaning to prepare for a rainy day. In China-related transactions, one should prepare for resolving disputes in the contracting stage; and more importantly, one should prepare a China-ready method of dispute resolution. A careful examination of one’s arbitration clause might just save a lot of trouble in the future.

For additional reading materials on arbitration in China, I recommend this.

Giddy up Partner: One More Way to Strike Gold in China

Soon, foreign investors would be able to invest in the form of partnership in China.

Currently, an investor can form a joint venture company (equity or cooperative), wholly foreign owned company, or representative office. With the impending promulgation of the 《外商投资合伙企业管理办法》(Foreign Investment Partnership Measures), a foreigner, either natural person or entity, can form a investment partnership with a local Chinese partner (Draft of the law in Chinese, here).

Chine Economic Review put out a nice article on some of the details of the law. It states:

The draft law reduces initial investment capital in comparison with forming a Joint venture or wholly foreign-owned Co.;

The draft law applies to “general partnerships and limited partnerships”;

Foreign-invested partnership has unlimited liability for partners;

Tax wise, foreign-invested partnership is a pass-through entity, where the partnership is not taxed, but the partners are taxed individually in accordance with individual tax law;

To invest in sectors inaccessible to a wholly-foreign owned Co., a foreign investor need to partner up with at least one Chinese party who has more than 50% in stake;

Foreign partners can contribute IP, cash, or reap property rights;

In terms of currency repatriation, no funds can leave China before the liquidation of the partnership (does this make sense?);

Distribution of profits and losses can be agreed upon in the partnership agreement as long as such distribution is reasonable.

In terms of the significance of this new law, the article wraps up by saying:

The creation of a new category of foreign investment in China is not an everyday occurrence. While certain restrictions that apply to foreign investors do not apply to domestic Chinese investors, draft rules such as the FIPL signal a significant change in China’s attitude towards business.

I agree that this law reflects a big step towards opening up more to foreign investors, but to those who want to partner up with a local entity or person (required), you probably want to stay clear of the sectors where foreign partners can only hold a minor stake. Without control, you are subject to the mercy of your Chinese partner(s), which can be a very bumpy ride to riches.

Full article here.

Astute Advice for All Advocates Dealing with China

I just read through the feature article in the May 07 issue of the New England In-House. Titled “Made in China: In-House Lawyers Confront Explosion of Chinese Business Activity”, this is a well researched article with insightful advice that transcends the in-house counsel circle. I tip my hat to John Cunningham for packing so much good stuff in so little space. His article proceeds in five subsections: cultural adaptation, laws & regulations, potential risks, China’s lures & attractions, and due diligence & planning.

He starts off by establishing the background of his article: "The China boom is in full swing, and sooner or later your company will be doing business in China. If you aren’t there now, one of your competitors probably is."

Citing the explosive growth of the Chinese market and its attractions to U.S. companies, Cunningham advises that:

in-house lawyers have to get up to speed now on the intricacies of doing business in China – from bridging the cultural divide to knowing the key differences between U.S. and Chinese laws and regulations.

Then he delves into “crossing the cultural divide” by stating that adapting to the Chinese culture is “perhaps the biggest hurdle” for many foreign firms. To illustrate how to adapt, Cunningham has a few excellent quotes from some experienced China hands (Zhong guo tong, 中国通):

“You must be flexible in your approach to business, and learn to do things the Chinese way,” said Edward Epstein, who works in the new Shanghai office ofAtlanta-based Troutman Sanders.

For example, “time is not money there,” Epstein explained. “And deadlines can’t be
used as a negotiating lever because they just have to get comfortable with you.”

“You must establish a relationship before you negotiate a contract, because in China you only do business with friends,” said Lucia Lian of Goulston & Storrs in Boston...and “you should never talk business during meals.”

Cunningham wraps up the cultural adaptation part with:

“Companies who fail don’t adjust to Chinese culture and values, don’t understand the [Foreign Corrupt Practices Act], don’t localize supply, don’t train and promote Chinese to top levels of their business, or don’t make a commitment that top management physically go there at least four times a year,” Daniels said. [Jack Daniels with Eastbridge Partners]

With respect to Chinese laws and regulations, the article stresses the differences between the U.S. and China; it calls for good Chinese counsel in any “entry team”, because,

For Americans, the Chinese system may look similar, but it is not. While both the U.S. and Chinese systems have central, provincial and local levels of government, and many written regulations, the similarities end there.

Because China has a civil law system, the codes, statutes, and regulations are readily available in Chinese on Chinese websites. Two big problems are inherent: the ability to read and understand them; the accurate interpretation of the law. With assistance of a China-trained lawyer, the first problem will dissolve, but the second problem presents greater challenges, since,

“The rule of law means something different in China,” said Robert Woll of WilmerHale’s Beijing office. “It is more of a planning and control mechanism than a predictor of outcomes. The regulatory framework looks very complex, but you have to understand the agency motivations more than the language to get interpretations
right.”

Additionally,

Epstein explained: “An enforcement or approval authority interprets the law with
great discretion there, and that can work in your favor or it can work against you. You can often get an approval in one place and a rejection in another based on the same law.”

Other legal issues with potential for trouble in China-related deals, dealt with in the article, include IP protection, dispute resolution, U.S. anti-corruption law (FCPA), export controls, anti-dumping enforcement. He cautions that U.S. companies need to take these into careful consideration.

Risks abound in a China deal, but the most salient point made in the article is “vetting your partners in any transaction”, which I touched upon in one of my past posts. Another good point made here is the mindset about doing business in China, which is, according to Lian (a bilingual lawyer from China), not just about competition and is also about building relationships.
Cunningham then highlights the lures of the China market. An expanding middle class of more than 200 million is a big piece of consumer pie to grab. Besides the known areas of attraction such as, real estate development, venture capital, low cost manufacturing, sectors like financial services, alternative energy could present huge opportunities because of government incentives and market potential. Therefore, "weaving China into investment strategies is now practically a given."

However, he also cautions:

The best time to go is before you’re pressured into it – when you have good markets and technology, but have time to plan your future in China.

Because of the lure of the China market, Cunningham offers wise counsel through his China experts:

“China has a seductive appeal, but you can’t check your common sense at the
border,” warned Edward Epstein.

(It is hard to imagine that people would do that, but stranger things have happened. Really.)

Cunningham then quotes Samuel Shafner of Burns & Levinson in Boston, who suggests that Americans heed the Art of War-- Know yourself and your enemy, and he said:“It is much more important to have intelligence on the ground in China than anywhere else in the world. You have to find people who know China, who know your business and are trustworthy.”

Beyond that, tax and currency repatriation should also be part of the due diligence and strategic planning.

Overall, this article is an excellent checklist for those in China-related deals, not just in-house lawyers.

Read the whole article here.

Levi’s Looking Pretty in Chinese Court Despite Painful Lesson

As Dan Harris stated repeatedly in his China Law Blog (“CLB”), Chinese trademark law is “simple and effective” when enforced. Clothing giant Levi Strauss & Co.’s (“Levi’s Co.) recent victory in a Shanghai court would further bolster Dan’s averment, but its triumph came with a unique twist. So let’s just call the victory “bitter sweet.”

Levi’s Co. is known for its jeans in America and beyond. (My first pair of jeans in the U.S was a pair of blue Levi’s, which still go well with my boots.) In 1974, Levi’s Co. registered its LEVI’S trademark with the Chinese Trademark Office and has kept the registration effective by renewing and adding more categories of clothing related to the trademark since then.

Levi’s Co. entered into a distribution relationship with Shanghai Beizi Clothing Company, Ltd. (“Beizi Clothing”) some time before 2005. (I have not been able to verify the exact starting date.) And Beizi Clothing was to be a non-exclusive distributor of Levi’s products, probably in Shanghai (for lack of information, this fact might be a little off.).

In June 2006, a branch office of the Shanghai Administration of Industry & Commerce (“SHAIC”) caught Beizi red-handed in selling counterfeit Levi’s jeans. After investigation, the SHAIC issued an administrative order, penalizing it for selling counterfeit products. Soon after, Levi’s Co. woke up from this nightmare and sued for trademark infringement in the Shanghai 1st Intermediate People’s Court. Levi’s Co. asked for an injunction, civil damages in the amount of 500,000 yuan, and a public apology in the Morning News (a local newspaper).

The Court hammered Beizi Clothing, taking the SHAIC’s administrative order as a prima facie case for trademark infringement. With some feeble attempts to challenge the “famousness” of Levi’s brand, Beizi Clothing was ordered to cease all infringement activities, pay 100,000 yuan, and issued a public apology.

Sounds like a slam dunk for Levi’s Co.? Right! Easy case. But doesn’t this whole thing bother anyone? By now, you might be thinking what I am thinking now—“What the hell was Levi’s Co. thinking in picking this unscrupulous distributor?”

Besides that thought, a few other Chinese idioms keep echoing in my head: “引狼入室” and “同床异梦”.

Let me explain. The first idiom literally means leading a wolf into your bedroom, and if you do that you might have to face the consequences of a devious company (pun intended.) The second one gets even better, which means sleeping in the same bed but with different dreams. It applies to relationships where parties only superficially cooperate, while they actually possess different visions about their relationship.

Ok, I know that Levi Strauss & Co. is incorporated in Delaware and headquartered in San Francisco, and that it is unfair for me to expect it to know traditional Chinese wisdom. But, could Levi’s Co. have done a better job of choosing a local Chinese partner? I think so and I run the risk of Monday morning quarterbacking (hindsight wisdom). However, for the sake of good corporate governance, any foreign company selecting partners in China should bear in mind choosing your partner carefully. Find yourself a friend, not a foe. To do that, you got to abide by Ten Commandments for doing business in China as compiled by ChinaSolved.

Wahaha & Danone Dispute: “The Good, The Bad, and The Ugly”

To my fellow Texans, “the good, the bad, and the ugly” may mean the University of Texas at Austin, the Texas A & M University at College Station, and the University of Oklahoma, depending on where your loyalty lies.

To those following Danone’s dispute with Wahaha Group, this unique expression bears extraterritorial meaning.

Back in 1996, the Danone + Wahaha joint venture (“Marriage” as the Chinese media puts it) seemed rosy, promising, and “good”. Danone had the capital, international management know-how, a world renowned brand name, and much more; Wahaha Group, on the other hand, had an evolving Chinese brand, the local market, and Zong Qinghou, Wahaha’s charismatic chief. As expected, the joint venture grew into something quite respectable, 39 sub-joint ventures and controlling market share in China’s beverage business.

A lot of “bad” surfaced ever since early spring 2007. Arbitration claims have been filed by both sides in China and Sweden; Danone sued Wahaha in a state court in Los Angeles. In response to attacks from Danone on both sides, Danone threatened to sue three foreign board members on the joint venture board, alleging breach of fiduciary duty.

The “ugly” is coming in like waves in this growing international show of will and force. First, responding to Wahaha’s arbitration petitions in the Hangzhou Arbitration Commission, Danone has filed counter claims. [full report here] According to Danone’s attorney Randal Lewis, so far
“there has been no circumstance or event that is sufficient to result in the termination of the rights and obligations of the parties under the Trademark Transfer Agreement.”

Second, Danone’s litigation lawyer in the case pending in Los Angeles, which is against Ever Maple Trading and Hangzhou Hongsheng Beverage Co, said that Danone has a witness who can testify against Zong. [full report here.] The witness, named Chen Zhonghua, claims that Zong forged Chen’s signature to set up companies overseas that compete against the Danone-Wahaha joint venture. If the “marriage” metaphor about the joint venture has any merits, this would the stage of the divorce where parties dig out as much dirt as possible against each other. [by the way, as of July 13, 2007 based on this Chinese report, Zong’s wife and daughter sued individually in L.A. have refused service of process.] Boy, this is getting ugly or what.

Third, Wahaha has joined forces with another party in another lawsuit against Mr. Qin Peng of Danone in the Intermediate People’s Court in Shenyang, Liaoning Province. [read about it here.] Wahaha Beverage Ltd. and Shenyang Lingdong Shiye Development, Ltd., respective shareholders of Wahaha Group, filed derivative suit against Qin Peng for breaching his fiduciary duty by serving on the board of other companies competing against the joint venture. They base their complaint on Article 149 and 152 of the Company Law of the P. R. China (2005), which provides shareholders a right to file a derivative suit against board members for breaching their fiduciary duty to the company.

More dirt out there?

Wikipedia has a pretty good entry on this dispute.

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.)

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.