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?

Where Art Thou, Chinese Anti-trust Law?

Ok, I know that is a rhetorical question. Here, I blogged about the legislative progress in China’s Anti-Monopoly Law. But the recent chain of events in China only highlights the urgent need for the promulgation of a comprehensive antitrust law in China.

Collusions in price fixing in beef noodles and milk products caught people’s attention and caused quiet a few controversies.

Now, instant Raman noodles are the most recent consumer product that fell prey to, as I suspect, price fixing by major producers in China. Leading producers like Master Kang and President have lifted prices of their noodles by about 20%. Others are following the lead. They blamed the price hike on rising food material costs.

Behind the façade of inflation, in the form of food price increases, is a more culpable factor—horizontal price fixing. And this got me plenty concerned for very personal reasons.

1. Raman noodles are the staple food for college students. When I was getting my undergraduate degree in China, I lived on that stuff of various flavors: spicy beef, fresh seafood, comforting chicken…Poor and cheap students cannot afford to buy noodles that cost more than 1.5 yuan. I am talking about empathy here.

2. Raman noodles are a source for many small business owners. I sold Raman noodles in my dorm to make money, and many others too. For a cent on the dollar, we made a little cash enough for occasional movies and date nights. If the prices of all brands rose for more than 20%, fewer people could afford to buy a package to stave off late-night hunger. That would potentially kill the dormitory grocers' opportunity for entertainment and romance. Serious consequences!!

So, what is horizontal price fixing? Under the U.S. federal law, it is defined as:

Horizontal price fixing is any arrangement among competitors that interferes with the setting of price by open market forces. These price fixing claims arise from competitors’ concerted action to charge pre-set minimum or maximum prices for their goods or services. Horizontal price fixing can violate Sections 1 and 3 of the Sherman Act, which proscribe concerted action in restraint of trade, as well as Section 5 of the Federal Trade Commission Act, which prohibits unfair methods of competition in or affecting commerce, and Section 2 of the Sherman Act, which prohibits conspiracies or combinations to monopolize.

To prove an antitrust claim, the plaintiff must show evidence of agreement between or among manufacturers. And uniform price increases could be one result of such an agreement in restraint of trade.

China Anti-trust Law, you can help this situation (at least cause a serious investigation into the noodle monsters’ pricing hikes). Would you come out soon?

Until then, eat more rice.

Investors in Labor Intensive Goods: Where is Your Future?

China just made a move that puts Chinese exports of labor intensive goods in a bind. According to this report, “China will curb exports of cheap labor-intensive, low-value-added products to force manufacturers into making higher-quality goods, in a move to narrow the world's largest trade surplus and reduce environmental damage.” If you have invested, plan to invest in labor intensive manufacturing in China, you definitely need to be concerned, and should read this order by the Ministry of Commerce.

Due to spats with western countries over China’s uncomfortably large trade surplus, the Chinese government has started to take measures to ease concerns of the EU and the U.S. This order is ostensibly one of them.

Highlights of this order:

1. Imposed restrictions on more commodities in processing trade for export; the commodities include: plastic/plastic-based products, cloth, furniture, and metal processing

2. “Raise a levy on companies that import metals, plastic and textiles into China for use in products that will in turn be shipped abroad.”


3. “A total of 1,853 types of commodities including copper, lead, zinc and cloth will be added to the restricted category, requiring importers to deposit half of their payable levies including duty and value-added tax at the customs office, according to the trade ministry's statement.”

4. With respect to commodities restricted from import, the importer must pay "standing book deposit=import tariff and VAT of import link of all commodity restricted from import * 50%"


5. With respect to commodities restricted from export, the amount of standing book deposit due equals to the "registered sum of bonded imported materials * (registered sum of commodity restricted from export / registered sum of commodity restricted for processing trade)* composite tax rate * 50%"

6. This order applies to eastern regions /provinces/municipalities only, and they are: Beijing, Tianjin, Shanghai, Liaoning, Hebei, Shandong, Jiangsu, Zhejiang, Fujian, and Guangdong.

7. The order goes into effect on August 23, 2007, and those already acquired permission for processing prior to July 23, 2007 are grandfathered.

So what does this mean to companies in this business of manufacturing low-value-added commodities for export?

My thoughts are:

1. It is time to upgrade your technology so that you bypass the effect of this order.

2. It is time to move out of the statutory eastern region and go westward where the order offers an exception.

3. It is time to rethink your business strategy in light of this order and the new Chinese Corporate Tax Law, which levies a uniform corporate rate of 25% (with exceptions for high tech, alternative energy, or areas related to environmental protection).

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.

BIS China Rule Compliance: Document and Information List on VEU Application

Along with the implementation of the BIS China Rule, the VEU application becomes a new practice area for attorneys in the cross border transactions, especially related to China. This article, with reference to BIS official publication, intends to address some basic filing document and information issues related to the VEU application.

I: Where to File?
An Advisory Opinion Request for Authorization Validated End-User (VEU) should be filed to apply for the Validated End User (VEU) status. The request for authorization should be filed to the Office of Exporter Services at BIS Department of Commerce with attention to the End-User Review Committee.

II: Who Can File?
As currently the VEU program applies only to Chinese companies, the Chinese companies can apply directly for the VEU authorization. US companies can also file the VEU applications on behalf of Chinese companies to whom they have export business relations. Generally, in determining the eligibility of the VEU status, the following criteria apply:
• Any end user in the PRC may apply to use Validated End-User authorization. All applications will be considered on the merits.

• Subsidiaries of U.S. or foreign companies in the PRC, as well as Chinese companies, may apply to receive products that might otherwise need an individual license.

• End users must demonstrate a record of using sensitive, U.S.-origin commodities, software or technology responsibly and must only be involved in civilian activities.


III: Document and Information List on VEU Application

According to the Supplement No. 8 to part 748 of the EAR and the template published in the BIS website, the following documents and information shall be provided with the filing of the VEU application:

1: General Information
The proposed VEU candidates’ name (including business operating name if applicable); company physical address (P.O. box address only not sufficient); contact persons and telephone, fax numbers; email address and company website if applicable; filing company information other than the candidate company if applicable, candidate multiple location list in the eligible destination if applicable.

2: Structure, Ownership and Business Activities of the Candidate Company
An overview description of the structure, ownership and business activities of the candidate company should be provided in the request of the VEU status. These shall include the operating and organizing structure of the company (closely held or publicly held companies, partnership etc.), the ownership (state owned, foreign owned, joint-venture, privately owned etc.), business activities and nature of the business (including any activity or relations with either government or military organizations.)


3: Item(s) Description Proposed for VEU Authorization
The items proposed for VEU application and their intended end-uses should be listed, including the description of the items and the relevant Export Control Classification Number (ECCN) and the Commodity Classification Automated Tracking System (CCATS) number, if BIS has previously classified the item. The application should also describe how the validated end-user will use the item(s) received under VEU authorization. If the items received under VEU authorization will be used at a location different from the location(s) listed in the General Information section of this submission, identify such location(s). Also identify any items that will be reexported or transferred after they are received under VEU authorization, and the destination(s) in which they will ultimately reside.

4: Information on Record Keeping and Compliance
The system in place to ensure compliance with VEU authorization requirements related to the items received under VEU authorization should be described. As recommended by BIS, the Validated End-Users should maintain records relating to: the specific location to which the items were exported or reexported; the end-use of such items; and the ECCN(s) of such items. The record keeping requirements are set forth in §748.15(e) of the EAR.

5: Certification
The application for VEU authorization must also include an original statement, which can be provided as a letter attached to the advisory opinion request, on letterhead of the prospective validated end-user, signed and dated by a person who has authority to legally bind the prospective validated end-user, certifying that the end-user will comply with all VEU requirements. According to the Template, this statement must include acknowledgement by the prospective end-user that it:

1) Has been informed of and understands that the item(s) it may receive as a validated end-user will be exported in accordance with the EAR and that use or diversion of such items contrary to the EAR is prohibited;
2) Understands and will abide by all authorization VEU end-use restrictions, including the requirement that items received under authorization VEU will only be used for civil end-uses and may not be used for any activities described in part 744 of the EAR;
3) Will comply with VEU recordkeeping requirements; and
4) Agrees to allow on-site reviews by U.S. Government officials to verify its compliance with the conditions of the VEU authorization.

6: Additional Information
Any helpful and supporting information has been encouraged to be included in the application package for VEU authorization. This kind of information may include, but not limited to, background information other than general information of the candidate company, China law and policy information about the company ownership, structure and operations (expert affidavit can be used whenever necessary), technical or marketing literature about the related items and product or promotional information about line of business, the business relation history of the import and export companies etc.

With that, “I Pronounce You Famous and Well-known!”

Your trademark, is probably one of your most valuable assets. It rings more true if your mark has established remarkable secondary meaning in relevant market where you sell your product or service with that mark. In one of my past posts, I discussed Chinese law on trademark dilution, which is the exclusive method of protecting a famous trademark in China in terms of invoking legal actions.

This post primarily focuses on the legal standard for what constitutes a famous or well-known trademark in China. A trademark owner needs to go no further than China’s Trademark Law (2001), Implementing Regulations of Trademark Law (2002) (promulgated by the State Council) (“Implementing Regulations”), and the Interim Measures for the Recognition and Management of Well-Known Trademarks (1998) (promulgated by the State Administration of Industry and Commerce) (“Interim Measures”) [Chinese only].

According to the Interim Measures, the Trademark Office (part of the State Administration of Industry and Commerce) has the exclusive jurisdiction over the registration and management of well-known trademarks. See Article Three. To register a well-known trademark in China, an applicant must show evidence as follows:

1. the volume of product sales in connection with the registering trademark in China;
2. the main economic indicators associated with the products bearing the trademark (production volume, sales volume, profit, market shares)and comparative ranking of the products in the Chinese market;
3. the sales volume of products in connection with the trademark in foreign countries and regions;
4. the amount of advertising related to the mark;
5. the earliest date and length of continuous use of the trademark;
6. the registration status of the mark in China and elsewhere; and
7. other documentation establishing the famousness of the mark.

(The translation is mine.)

By requiring relevant market data of the mark in China, the Interim Measures set a relatively high bar in recognizing a well-known trademark prior to China’s assent to the WTO.

The amended Trademark Law (2001) and the subsequent Implementing Regulations mark a change in famous trademark law. Specifically, the Trademark Law does not stipulate that the Trademark Office has the exclusive jurisdiction over the registration and management of famous trademarks even though the Trademark office still has the exclusive administrative jurisdiction over the registration of trademarks in China. Of course, this leaves open the question of whether a foreign trademark owner can utilize the People’s court to ascertain whether a mark is famous in China (will be addressed later).

Pursuant to the Trademark Law, in order to get a “well-known” status for your trademark, a registrant must show the Trademark Office:

1. reputation of the mark to the relevant public;
2. time for continued use of the mark;
3. consecutive time, extent and geographical area of advertisement of the mark;
4. records of protection of the mark as a well-known mark; and
5. any other factors relevant to the reputation of the mark.

See Art. 14; Implementing Regulations, Art. 5.

In comparison, the amended Trademark Law covertly removes the requirements that the mark be famous inside China, with the exception of item one where the reputation of the mark is tied to the “relevant public.” This change, to a certain extent, reflects a general shift of attitude toward foreign famous trademarks. Of course, to register a famous mark in China, one still has to go through the normal procedures of hiring a local trademark agent, and present the requisite proof.

With that said, the next question, naturally, would be whether one has to register a mark with the Trademark Office in order to get the corresponding protection afforded to a famous mark. It is a fair question. In China, a trademark owner has two courses of action against infringement: through a local bureau of industry and commerce; or through a local People’s court.

Based on my observation, an owner can get a “famous” status for his mark. In Starbucks v. Shanghai Copycat, Starbucks Co. did exactly that, and the court was willing to hand out that label to it. In fact, a search on the well-known trademarks database in the China Trademark Office website revealed that Starbucks Co. has not registered its mark as a famous one. Absent errors in the database, Starbucks Co. is relying on the Shanghai court’s ruling as an official declaration of the well-known status for the “Starbucks” mark.

Should you do as Starbucks did? If you don’t mind paying high litigation cost, and if you have a stomach for unpredictability, copy what Starbucks did.

Danone Group to Make Things Personal

According to a report, on July 19, 2007, four subsidiary companies of Danone, NOVALC Pte. Ltd., Festine Pte. Ltd., Jinja Investments Pte. Ltd. and Myen Pte. Ltd., initiated legal proceedings to file a derivative action against Zong Qingou, the former board chairman of the Danone-Wahaha joint venture. He resigned in June 2007 amid the intensifying disputes with Danone.

Essentially, this new lawsuit will be directly against Zong for his “illegal” activities while serving on the board of directors of the joint venture. The four shareholders of the joint venture will more than likely allege that Zong breached his fiduciary duty as a board member by engaging in competitive activities that injured the interests of the shareholders.

In addition, Danone also asserted claims directly against Zong in its Stockholm arbitration. [But I haven’t heard anything from that case lately.]