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

To continue my musing on the topic of governmental, executive intrusion to the freedom of contract in China, I intend to discuss the origin of such power to regulate contract formation, and to shed a little on how the power has been exercised in some locales in China.

Legislative Designation of Executive Power to Regulate Contracts

Article 127 of the Contract Law of the P. R. China designates contract enforcement authorities to departments of the Industry and Commerce Administration and other relevant administrative agencies. However, such authority and power is restricted to “monitoring and handling illegal acts that harm the State or public interests through the conclusion of a contract, in accordance with the relevant laws and regulations.” See 16 Minn. J. Int’l L. 115, 142.


工商行政管理部门和其他有关行政主管部门在各自的职权范围内，依照法律、行政法规的规定，对利用合同危害国家利益、社会公共利益的违法行为，负责监督处理；构成犯罪的，依法追究刑事责任。

In other words, these administrative institutions and agencies are granted a restrictive authority to monitor and handle illegal activities associated with contracts. By inference, they do not have the power to invalidate either contracts or contract clauses unless a crime or illegal acts are involved which injure the State or public interests.

The Exercise of Executive Power in Regulating Contracts

In practice, however, local Industry and Commerce Administration departments enjoy greater power and authority than what is defined in Article 127 of the Contract Law. “Monitor” and “handle” were the two key words that define powers designated, but the power and authority exercised by the Beijing Municipal Department of Industry and Commerce, to my mind, far exceed powers granted by the Contract Law.

For instance, the Circular Regarding Intensifying the Supervision of Contract Terms and Provisions (“Beijing Order”) mandates the usage of form contracts drafted by Department of Industry and Commerce alone or along with other administrative agencies. Such form contracts cover a wide range of commercial agreements:
1. landlord-tenant contracts;
2. home renovation contracts;
3. utilities contracts;
4. business operations training contracts;
5. TV, communications services contracts;
6. Consumer loans, life and property insurance contracts;
7. Travel, transportation contracts;
8. Automobile purchase, lease, and repairs contracts;
9. franchise contracts;
10. Supermarkets transactions contracts.

These contracts, according to the Beijing Order, are under scrutiny. And the governmental scrutiny manifests in two ways. First, contracting parties are encouraged to adopt the form contracts already drafted and circulated for use. Second, parties engaged in the above-list commercial activities can expect to be targeted in inspection. Violations of local enforcement regulations can result in heavy penalties.

Conclusion

The People’s Congress through the Contract Law grants Industry and Commerce Administration and other agencies the power to monitor and handle illegal acts associated with contracts. In reality, however, the power has been expanded beyond its designated sphere of law enforcement. It morphed into the power to draft form contracts for use in a wide range of commercial transactions. Although the use of such draft contracts is not yet mandatory, it surely would not surprise a business person in China when they do some day.

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

In yesterday’s post, I examined local rules affecting the freedom of contract, especially the Beijing and Shanghai Orders that declare certain contractual terms and provisions per se illegal and void. The local municipal governments' power to interfere with parties’ contract in this fashion led me to conclude that the basic spirit of freedom of contract has been violated by the Orders. Today, I want to continue the discussion by observing the stipulations on the topic of contract validity in the Contract Law of the P. R. China. [note: my comments are largely based on the article written by Professor Steven Hsu published in the Minnesota Journal of International Law. See 16 Minn. J. Int’l L. 115]

Per Se Void Contracts

Contracts, pursuant to Chapter Three of the Contract Law of P. R. China, can be invalid and void in the following five circumstances:

1). Contract executed through fraud or under duress, thereby harming the interest of the State;

2). Contract between parties who have colluded in bad faith, thereby harming the interest of the State, the collective, or an innocent 3rd party;

3). The contracting parties have hidden an illegal purpose under the disguise of a legitimate contract;

4). The contract harms public interests; or

5). The contract violates a mandatory provision of laws or administrative regulations.

Per Se Void Contract Clauses/Terms

Individual contract clauses, likewise, can also be per se invalid if they violate public policy or interests. Even though the rest of the contract can remain enforceable, clauses that meet the following description are per se invalid according to Article 53 of the Contract Law of P. R. China:

1). Clauses that exclude a party’s liability for personal injury sustained by the other party; and

2). Clauses that exclude a party’s liability for damages sustained by the other party through the other party’s intentional misconduct or gross negligence.

Voidable Contracts

Some contract, in contract with per se invalid contract, may be invalidated or voided by the injured parties through either judicial action or arbitration. Void contracts are, pursuant to Article 54, the following type of contracts:

1). The ones that are entered into with material mistake;

2). The ones that are clearly unfair upon execution.

3). The ones entered into when one party was under duress or was defrauded by the other.

The aggrieved party may petition a people’s court to either reform or cancel the contract. Alternatively, the same party may pursue redress through arbitration. But, the petitioned court or tribunal cannot cancel the contract if the remedy sought is a reformation.

Who Has the Authority to Invalidate Contracts?

Obviously, tribunals and courts with proper jurisdiction have the authority to invalid contracts or contract clauses. But the sticky question is—What legal standard shall the adjudicating institution apply where the local statutes/regulations differ from those of the central government?

To be continued…

Freedom of Contract in China: Not So Fast Yet

Freedom of contract plays a crucial rule in most commercial activities, and the basic idea is that both parties get the benefit of their bargain in exchange for the imposed contractual duties. Simply put, you “pay” for what you bargained for in the contract. In order for this basic form of commercial tool to work effectively and efficiently, the parties to the contract must have the freedom to decide what is good and bad for itself, free of other interferences and influences.

However, things do not work 100% well in reality. In the United States, courts sometime step in to declare certain terms and provisions null and void because the enforcement of which violates equity, fairness, or public policy in general. A detailed discussion of this topic is beyond the scope of this post.

In the same vein, contracts can be under scrutiny in China, thus being subject to governmental, administrative interference under the umbrella of consumer rights protection.

For example, the City of Shanghai enacted a municipal statute on July 13, 2000. (ordinance)—Regulations on the Supervision of Contract Terms and Provisions. (上海市合同格式条款监督条例) Similarly in Beijing, the Municipal Administration of Industry and Commerce issued an administrative order, which was blessed by the city government. Titled Circular Regarding Intensifying the Supervision of Contract Terms and Provisions, the order resembles the Shanghai statute. (关于加强北京市合同监督管理若干意见的通知) Hereafter, I refer to the above-mentioned municipal rules as “orders.”

According to the Orders, the following terms and provisions are per se illegal:

A. Terms and provisions that shield the drafting party from the following liability:

1. Liability arising out of personal injury to consumers;
2. Liability arising out of damages to consumer’s property due to intentional tort or gross negligence;
3. Warranty liability provided to consumers along with sale of products or services;
4. Liability due to the drafting party’s breach of contract;
5. Other liabilities under the law due to the drafting party’s breach of contract

B. Terms and provisions that increase consumers’ liability:

1. Unreasonable amount of liquidated damages or contractual damages;
2. Responsibility of operational risks that rightfully belong to the drafting party;
3. Other terms or provisions that unlawfully increase consumers’ liability

C. Terms and provisions that extinguish the following consumers’ rights:

1. The right to lawfully amend or rescind the contract;
2. The right to demand liquidated damages or actual damages;
3. To exercise the right of contract interpretation;
4. The right to litigate in the event of a dispute.
5. Any other consumers’ rights guaranteed under the law.

As a consumer, I am not against the protection of consumer rights. But the pervasive hand-on, in-you-face type of governmental interference in the contractual process, in my humble opinion, is an affront to the basic idea of freedom of contract. Even if there are instances of fraud, unfair contractual practices, governmental interference, like the Orders, is arguably not the most efficient means of correction, and I’d argue that the market itself is in the long term, which includes the consumers at large in a burgeoning market economy.

As a lawyer friend always says:"A litigation lawyer would die for a good argument." However true that might be, the reality of doing deals in China, especially in two of China's largest and important cities Beijing & Shanghai, demands foreign and domestic companies alike to draft contracts carefully so as to avoid the contracts being deemed void.

How to Protect Your Trade Secrets in China?

There are four major regimes of intellectual property: trademark, patent, copyright, and trade secret. Trade secrets are the oldest and probably not most recognized form. Your trade secret is likely one of the most important things that gives you an edge in your success and survival amongst fierce competition. If you take your business into China, that still rings true. Thus, an understanding of the law of trade secrets in the P. R. China is essential in order for your to protect your trade secrets.

Unlike the United States, China does not have an unified body of law addressing the protection of trade secrets; in stead, trade secret protection laws are scattered in a few pieces of legislation, and the complexity of which warrants dedicated attention.

Definition of Trade Secret

Trade secret is defined as, pursuant to Several Regulations on Prohibiting Actions of Infringing Trade Secrets (《关于禁止侵犯商业秘密行为的若干规定》)

any formula, pattern, device, machine, process, technique, compilation of information, or program (referred to collectively as proprietaryinformation)

Regulations/Laws on Trade Secret

An article I ran into succinctly and accurately lays out the relevant laws on trade secret, I will try to shorten the pithy parts of it.

1. Article 10 of the Anti-Unfair Competition Law states that a competitor is prohibited from using the following measures to infringe upon another's trade secrets:a) To acquire the owner’s trade secret by theft, intimidation, or other improper approaches;b) To disclose, use, or allow others to use the owner's trade secrets that have been obtained through the above methods;c) To disclose, use or allow others use the trade secrets which breach the agreement or requirements of the owner.

It is considered a trade secret infringement for any third party to acquire, use or disclose another's trade secrets under the condition that he acknowledges the existence of illegal behavior as set forth in the above clauses.
Article 25 of the Anti-Unfair Competition Law further stipulates the penalties for violations under Article 10.

2. Article 22 of Labor Law of the P. R. China allows an employer to include a clause in an employment contract clause that affords protection for the employer's trade secrets. And a typical such clause appears in the form of a confidentiality agreement, which prohibits an employee from disclosing the employer’s trade secrets at the end of his/her employment.

3. Article 118 of the General Principle of Civil Law, Article 43 of the PRC Contract Law, and Article 219 of the Criminal Law.

Protective Measures

The same article quoted above suggests excellent ways to protect your trade secrets. It states:

it is important to keep the trade secrets conforming to the special features that are prescribed by the law, that is, unknown to the public, with business value and kept in secret. In the event of a breach, this allows for a legal basis for prosecution. For example, if a company leaves the trade secrets in unlocked file cabinets in unrestricted areas of the company, or leaves the documents disclosing trade secrets in garbage cans without shredding the documents, then they have more difficulty establishing that the trade secret was to remain unknown to the public or has high commercial value. It is sometimes surprising how many companies are susceptible to such a simple mistake. It is quite easy and inexpensive to establish such internal protective measures and with a documented policy on how such materials are to be handled, there becomes a point of reference for a court to base prosecution on.

Then, it provides practical steps to safeguard your trade secrets:

A. Maintain documentation that you are the legitimate owner of the trade secrets that you seek to protect.

B. Establish an internal trade secrets protection system:
Have a written trade secret plan and follow the plan
Train your employees on the protection of trade secrets
Sign and enforce confidentiality agreements

Trademark Protection in China—More Steps Forward

On the heels of the Starbucks v. Shanghai Starbuck case, another foreign trademark holder doing business in China had its day in court and won. Of course, this is only in the trial court; appeals might follow.

In this case the plaintiff is the French company Lacoste, trademark holder of the famous “Crocodile” clothing trademark. Lacoste registered the “Crocodile” mark in October 1980, and the China Trade Mark Office, according to a Chinese report, put this mark in question on the list of “Famous Trademarks to Be Targeted for Protection.” (《全国重点商标保护名录》)

Defendants are three Chinese companies: Guangzhou Tai Crocodile Clothing Co., Ltd. (“Guangzhou Crocodile”), and two other sellers of Guangzhou Crocodile’s clothes. Curiously enough, Guangzhou Crocodile had its trademark “Golden Crocodile” registered, which can be described as a crocodile crouching in water waves, and with the Chinese Character “金鳄”next to them, which means “golden crocodile.” According to the facts of the case, Golden Crocodile places the crocodile portion of its mark in the prominent areas of clothes, while sews on the water wave and the Chinese characters in the background, which bear the same colors as the materials used for clothes as a whole. The intention of this, I guess, is to display the crocodile prominently, and let the rest of the mark fade away into the background.

Lacoste sued, joining the three defendants, in Beijing’s First Intermediate People’s Court for trademark infringement and trademark dilution, and it further pleaded for an injunction, public notice of such infringement, seeking also damages in the amount of ￥1,000,000.

Congratulations to Lacoste. It pretty much wrote its own ticket in its pleadings because the Court gave it basically all it asked for: infringement and dilution of the Crocodile mark by Guangzhou Crocodile; cessation of production by Guangzhou Crocodile; destruction of all infringing clothes; damages in the amount of ￥760,000; a public apology to be issued by the three defendants on the China Industry & Commerce Times.

Yes, this is a sweet victory for Lacoste and its lawyers. While the board members of Lacoste celebrate with French wine, I celebrate this case with this blog post for the following reasons:

1. The court carefully examined the circumstances of Defendant Guangzhou Crocodile’s use of its own mark; it focused on Guangzhou Crocodile’s misuse of its mark, and held that the misuse of a legitimate trademark, in certain circumstances, could constitute infringement of another’s trademark.

2. The Court cited a case out of Changchun Intermediate People’s Court. In that case, the Crocodile trademark was held to be a “famous mark.” The Court cited this holding in part to bolster the fact that Lacoste has an indeed famous mark, which is entitled to legal protection in China.

3. The Court extended infringement liability to sellers of products that infringed on the trademark holder’s rights. In its opinion, the Court expressed in strong language that the two co-defendants, as sellers of clothing, failed to investigate thoroughly the legitimacy of Guangzhou Crocodile’s use of its trademark, and such an obviously subjective failure to investigate resulted in sales that violated the rights of Lacoste. And such a gross failure to investigate warrants civil liability (negligence, tort liability).

4. The remedies handed out by the Court are appropriate. Even though the Court did not grant the full amount sought in damages by Lacoste, it imparted more value to Lacoste and trademark holders than the ￥24,000 can buy in China—a clear message that reads: “Don’t Mess with Legitimate Trademarks of Others!”

Cheers! À votre santé ! 干杯!!

Importing Food from China: Due Diligence Necessary

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

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

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

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

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

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

Precautionary Measures to Take:

A. Conduct Due Diligence

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

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

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

B. Contractual Protection

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

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

Franchise in China (IV): Detailed Registration Procedures

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

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

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

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

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

Step 3
Change Password (修改密码)

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

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

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

It is that simple!