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May 27, 2006
AUDIO: Introduction to Intellectual Property Rights in China
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May 26, 2006
A Brief Introduction to Intellectual Property Rights in China
[Editor’s note: The audience at the World Trade Week panel on Wednesday was populated by small and mid-sized American business owners in the New York City area, most of whom had just begun to contemplate entry into the China market. My remarks were aimed at providing them – as well as the internet audience -- with introductory information on intellectual property rights in China. More experienced readers may not find the following text suitable in its entirety, but the story at the top is kinda fun.
Here comes the disclaimer: this is general information not intended as legal advice specific to any individual’s particular situation. The use of “you” and “your” below does not refer to the reader personally, but reflects the choice of an informal substitute suitable for an oral presentation, rather than the stiffer “one.” That last sentence was totally pedantic, wasn’t it?]
Remarks by Rich Kuslan at World Trade Week, New York, May 24, 2006
Today, I’d like to speak to you about Intellectual Property (IP) Rights – what value, if any, does knowing what these rights are, have for you, when doing business in China? Let’s get to some possible answers by way of a story.
A Funny Thing Happened to Me on the Way to the Chinese Market
Recently in China, a friend introduced me to a medium-sized Chinese auto parts importer. Let’s call him Mr. Liu. Mr. Liu’s business was growing and he was looking internationally for sources of branded product to import. To be a bit clearer, he was looking for product with a popular international, i.e., non-Chinese, brand name on it. Chinese customers often are more likely to have confidence in and purchase foreign branded parts. What Mr. Liu wanted had to be imported, and not procured domestically, so that it would display unopened packaging that could genuinely say on it “original import packaging” or in Chinese 原装进口。
This sounded like it was going to be too easy. I introduced Mr. Liu to a major, well-respected American parts distributor, whom I knew well, let’s call him Bob, who quoted an excellent introductory price on product made in the manufacturer’s factory in the United States. I’d expected a favorable response to this offer, and yet the response was less than pleasant. Mr. Liu told me that he could purchase the same product (same model number and specifications) with the same company brand on it made in Korea at a significant discount. I approached Bob, who, after a pregnant pause, told me that none of the maker’s factories were located in Korea. In other words, the Korean product referred to by Mr. Liu was counterfeit.
Back to Mr. Liu. When he said he wanted foreign branded product, he didn’t mean that it had to be made by the company that actually owned or had been granted rights to manufacture the popular brand. The product had to appear to be correctly branded so that it would “persuade” the Chinese consumer that he was buying genuine parts. Mr. Liu told me straightforwardly that the Korean product was nearly 60% cheaper and almost as good as the American product. Best of all, it was branded with the very persuasive name and logo of the American maker. You can guess the outcome of this story. No sale. But the American company was now aware of counterfeiters stealing market share and not doing so by exporting counterfeits to the U.S., but to other nations and specifically posing a threat to future business potential in China. Bob and the parts maker were extremely interested in tracking the counterfeit product to the Korean factory.
Imagine the damage to your reputation and revenue potential when fakes of lesser quality invade a market you have high hopes for。
The more fascinating story I heard from Mr. Liu, was this. A Chinese auto parts maker exported product made in its Chinese factories to be re-packaged outside of China and then re-imported as so-called “genuine foreign-made” imported product. I have not been able to confirm this story, but I believe it. Such things happen.
Protection Against IP Infringement in China
If you have a product or a service you wish to sell into Asia, you have intellectual property that others can make use of to their commercial advantage while harming your interests. So, what can you do to protect yourself from intellectual property infringement in China? What are the challenges you might face? And what likelihood of achieving the results you set out to achieve?
Uh, oh!
Let me preface this discussion with the results of a recent American Chamber of Commerce study. According to their survey of U.S. companies in China, 55% said they were hurt by violations of intellectual property rights and 41% believed counterfeiting of their products increased in 2005. I note this despite 1) increased US and European pressure on the Chinese government to curtail IP infringement and 2) objective confirmation of increased Chinese government activity to do so. So you can see where I am going… You can assume that protection of your IP interests will be an uphill battle, but one that you must engage in for your own benefit, if you should wish to survive and even perhaps thrive in the Chinese business environment.
What is intellectual property anyway? There are many definitions, so let’s describe it in a general way. Briefly, it refers to just about anything you can think up and express, and which you might be able to make some money from. In this country, and in most others, the government protects assets created by the intellect in a variety of forms, for example, in patents for inventions and designs and the like; in trademarks, like the brand names and their logos; and in copyrights, of stories, songs, films, etc., even of pantomimes. In other words, the person who comes up with these imaginative inventions of the mind has certain rights in them and others can’t make use of them, generally speaking, without permission, usually procurable by the payment of money. That is why Gucci and Louis Vuitton get hopping mad when they see counterfeits sold openly without their permission or the payment of license fees, in many Chinese markets, like the infamous Xiang Yang market of Shanghai, which, by the way, the Shanghai government has promised to shut down on June 30. Wonder where it will move to?
What can you do to protect yourself against the theft of these intangible assets? You can put valuables, like coins and jewelry, in a safe deposit box in the bank. But to make commercial use of them, by selling them, for example, they must be displayed, and you’d go to great lengths to ensure that physical valuables are not easily stolen by someone who sees what you’ve got.
If you intend to sell your product or service in China; or even if you have a product or service not yet for sale in China, but which you do not wish to see counterfeited somewhere in the world to your disadvantage, you will need to proactively guard against theft of your IP and monitor to make sure no one is stealing it. But, if theft occurs, that when you become aware of it, you go after the thief vigilantly. Otherwise, among other things, a claim to rights in those IP assets may vitiate.
Forms of IP in China and the Administering Agencies
Let’s briefly describe the several important forms of IP in the Chinese environment and what government agency administers them. [Editor’s Note: For the sake of simplicity, I chose not discuss trade secrets in this talk.]
First, for you to enforce your rights, patents and trademarks must be registered in China. Copyrights, on the other hand, do not have to be registered, but it may be worthwhile to register them. More on this in a moment.
Some detail on patents. Patents come under the purview of the State Intellectual Property Office (SIPO) 国家知识产权局in Beijing, which examines patents at the national level, and runs the administration of the local SIPO offices, including the provincial offices which usually direct enforcement. If you do not have a registered company office in China, you may not submit patents on your own, but must use the services of a local patent agent. Usually, your stateside law firm will help you find a patent agent.
Trademarks are registered, administered and enforced by the Trademark Office, under the State Administration for Industry and Commerce (SAIC) 工商局.
A note for those who do not register their trademarks in China, and find their trademarks under attack, the Anti-Unfair Competition Law, administered by the Fair Trade Bureau under the SAIC umbrella, may provide some relief, albeit obtained with difficulty, where your company name has been used without your permission, or someone has represented his product (a counterfeit of yours) as being genuine when it was not.
Copyrights may be registered with the National Copyright Administration for a duration of 50 years (or author’s life plus 50 years). What happens if you don’t register? Well, then, prove the date rights inured to you – something simplified greatly by production of the official certificate from the copyright administration itself.
Formal registration of patents trademarks and copyrights aren’t the only methods of IP protection. Other methods include confidentiality agreements concluded prior to negotiations, as well as contractual licensing that specifically penalizes distributors who make use of your IP without permission and/or payment. But in China the use documentation is generally a weak stricture upon behavior, certainly necessary but much less effective and far more difficult to enforce in China than in the U.S. Not simply because the courts and law are of suspect reliability. But Chinese are extraordinarily flexible. Often, Chinese will approach companies with whom they’ve has only recently concluded protracted negotiations with a written contract only to ask that terms be changed – wasn’t the negotiation supposed to prevent that, think Americans? Chinese think, well, no, the situation has changed, so our agreement should as well.
An IP Protection Strategy in Brief
Let’s widen the discussion to include other things you can do as a part of an IP protection strategy as you expand your China business. Fundamentally, we are talking about three things: Protection, Monitoring and Vigilant Prosecution.
Protection
You need to know what you have before you can protect it. What IP assets do you have? Which of these do you need to protect? And how do you protect them? Here are a few suggested activities.
1) Identify and catalog your IP assets.
2) Determine what, if any, of these assets are already in use in Chinese markets.
3) Determine what you must protect, what you can but don’t have to protect and how to protect them.
4) Determine possible methods by which you’ll remain vigilant if infringement be found.
5) Register your IP assets as necessary.
First, the IP audit – have you really thought hard about what IP assets you have? If you haven’t done so already, an IP audit will allow you to determine what intellectual property you have that needs to be protected – for example, a name, logo or design you use to identify and distinguish a product or service. When has it been in use? Is it currently in use? Do you plan to use it in future? If so, where have you used or plan to use it? Have you registered it? Where? Etc. Once you’ve catalogued your IP assets, you’ll be better able to plan the next steps of an IP strategy, part of which is calculating estimated costs of protecting your IP assets.
People naturally wish to keep cost down to a minimum, but here a penny saved may make you pound foolish. Why? Several reasons, but here’s one. China is a first to file nation, unlike the US, meaning that the first one to the Trademark Office in China with, for example, the application for your design logo will become the registered holder of rights in that logo, even if that isn’t you and even if you’ve used it in commerce first.
This happens to even the biggest companies. Remember the 1992 Olympic Games in Barcelona where, it was rumored that a major worldwide athletic gear maker, based in the U.S., paid a great deal of money to a Spanish company that owned its trademark in Spain, because the Spanish company had filed first. Just because your market entry plan doesn’t have you actually doing business in China for a while, doesn’t mean someone else won’t come along and beat you to the punch. Perhaps it has already happened, but you don’t know about it.
The cost to register a trademark in China, going through a domestic US law firm, is generally around $1,000, a lot cheaper than having to pay the expense later for a cancellation proceeding. Major companies have run into this situation – where someone other than the true owner of a trademark has registered that mark in China. The foreign company is then forced to fight it out by proving it has a prior claim by virtue of its being a famous name brand (a claim that, if proven, can trump certain claims to brand names held others) – so, are you like a Gucci or a Starbucks in your industry?
That said, however, it may not be a good idea to register in China every patent you own. You may not wish to publicize through the patent system your invention or design lest it fall into the hands of those who might infringe upon it. You, your R&D people and your attorneys will need to consider whether the registration of your patent is more rather than less advantageous to you, depending on your plans to use that patent in China, its value to you, the likelihood of its unlicensed use, etc.
A note: you should not permit under any circumstances, your distributor or your potential distributor to register your IP. Ideally, you will have conducted your IP review and taken steps to protect yourself before you enter into negotiations. Why? You may find yourself foreclosed from using your own brand. Companies have discovered, after severing ties to a belligerent on non-performing distributor, that the distributor registered the IP in its own name, and was selling counterfeit product it made itself.
Monitoring
You can’t put all your eggs in one basket and expect your distributor to monitor your market for you. It may turn out that your distributor is the one who is making unlicensed or impermissible usage of your IP. Briefly, there are several ways to monitor the market:
1) Spend time in the market searching for products/services like yours. If you keep your eyes open, you will very likely find something.
2) Hire a clipping service in China to return any articles and ads containing important keywords relevant to you – your company name, logo, products, etc.
3) Where greater expense is justified, the services of a full-time investigator, like Kroll, may be of value.
Vigilant Prosecution
Once you become aware of the infringement of your IP in China, there are two routes you can follow in China, with a third route possible in certain circumstances.
1) an administrative action against the infringer
2) a civil action, that is, a lawsuit you initiate, against the infringer
3) in egregious cases, a criminal action led by the Public Security Bureau may be launched against the infringer. Very often these cases carry with it strong political overtones, and they are unlikely if the volume of infringement is small.
Administrative Actions
An administrative action in China goes through government channels of administration. The government agency you go through depends on the form of the IP involved.
1) Trademarks: the AIC at the local level accepts trademark infringement complaints. The AIC also accepts unfair competition complaints. As to patents, you can request the local office of SIPO to initiate an investigation of patent infringement. As to both trademarks and patents, fines, injunctions and confiscation of infringed product can issue, but you will not receive payment of damages, or your fees and expenses involved in pressing these administrative actions. (On a side note, the trademark office is reportedly severely understaffed. An example: at least 30,000 case backlog, opposition exam filings, that is, contesting trademarks held by others, that were filed in 2005 will, it’s estimated, most likely be processed by 2014.)
2) The Chinese Customs can stop cross-border shipments (exports and imports) of infringing product, but you must first register with the Customs Office and pay a fee of about USD250 per mark). You must also first know that there will be a shipment of infringing goods and then notify Customs as well as post a bond while product is warehoused awaiting a decision on confiscation. The entire cost, including raids and cost of investigation by a private service run several thousand dollars at a minimum.
A note administrative actions relating to copyright initiated by foreign IP holders have, I have heard, not been particularly successful.
Civil Actions
A civil action is a lawsuit in the Chinese courts, held before a judge, and is also a possible avenue of attack on an IP infringer.
Differences Between Administrative and Civil actions
There are several major differences between administrative and civil actions.
• Administrative actions proceed faster that lawsuits.
• Evidentiary requirements in administrative actions are less strict.
• Administrative actions are usually cheaper, perhaps a tenth the cost of a major lawsuit.
• However, you may be awarded damages in a lawsuit, if you win. You get nothing except the possibility of action against the infringer with an administrative action.
Depending on the locality where you begin an administrative action, you may find a lack of competence in the local administrative office as well as resistance to your claim of infringement, simply because the infringer is also local. The larger cities, such as Shanghai, usually evince a higher level of competence.
A Few Notes on Lawsuits in China
In a civil action, the discovery process, such as we have in the U.S., does not exist in the Chinese system, so the gathering of evidence from the other party in preparation for trial is simply not possible. You may have greater difficulty finding evidence therefore. However, a judge can actively look for evidence.
In addition, Chinese courts do not follow the system of precedent – that is, looking to established case law to understand the meaning of regulations. Instead, judges may interpret statutes very differently.
And corruption in the court system is rife. In sum, you are in quite a different legal environment from that which you know in your home country.
A Final Recommendation
While you should be represented by competent counsel, you also should strive to learn as much about the conditions existing in your target markets and not simply leave the detail up to the “experts.” Your own knowledge, gained from personal experience, will help you better gauge the right course of action, especially in those situations where the right decision seems just outside of your reach – a phenomenon you will often encounter in China.
Posted by Richard at 4:38 PM | Comments (1)May 19, 2006
ABI Podcast Downloads More Popular Than Ever
Our podcasts are downloaded nearly 1,500 times each day. We get especially heavy usage through iTunes. A heartfelt thanks to all of our podcast listeners! To listen to the podcast archive, click this link.
Posted by Richard at 6:16 PM | Comments (0)Announcement: World Trade Week NYC
On Wednesday, May 24, from 2 to 4 pm, I will speak at World Trade Week New York City. during the Expanding Markets in Eastern Asia: China, Japan and Korea panel. I'll focus on intellectual property issues relevant to that topic, and welcome readers to a chat after the panel.
Posted by Richard at 5:32 PM | Comments (1)May 16, 2006
Study: 60% of Chinese Ph.D. Candidates Admit to Plagiarism, Bribery
In a story related to yesterday's post, as well as the HanXin （汉芯）chip scandal, the Christian Science Monitor reports on a Chinese government study of 180 Ph.D. candidates which found that fully 60% admitted to plagiarism and bribery. Can it be possible? Are Chinese academic standards really so very low, when Western instructors both in Chinese and American institutions of higher learning have generally viewed their Chinese students as upon the proverbial pedestal?
If true, American companies building R&D facilities in China, several of whom have been clients, need to pay heightened attention to the trustworthiness of the work their new hires purport to have performed as well as the reliability of results obtained in their own labs.
For modern-day mainland Chinese, does the goal and one's pursuit of it validate any means of obtaining it, including the purposeful obscuration of the truth?
Posted by Richard at 1:45 PM | Comments (2)May 15, 2006
Audio: Ernst and Young Retracts China Bad Loans Report
Click the link to hear today's post.
Ernst and Young Retracts China Bad Loans Report
Last Friday, in a stunning turn of events, Ernst and Young announced the retraction of its May 3 report on China's NPL (non-performing loan) exposure. Claiming that the report had not gone through internal review, Ernst and Young further stated that the report "contained errors" requiring retraction of the study in toto. In doing so, E&Y has bowed lower than any western firm one can remember in recent times, offering in addition to the public shame of retraction, its profuse apology as well as sincere regrets.
And what errors, if errors they be. But are they? The global accounting firm had estimated NPLs for the four largest banks (CCB, ICBC, ABC, BOC) at US$358 billion. The press release notes that the "official level" of NPLs, that issued by the Central Bank, is but US$133 billion, a third of the E&Y figure. An error that large in official Chinese statistics is entirely believable -- the Chinese government recently revised upwards its GDP statistics by 16.4%. But when studied by professional economists at a respected global company?
Here's what Jack Rodman, a managing director at E&Y, said when the report was issued, before the retraction:
"I think the numbers will be a big surprise because China has been giving the impression (with its banks listing overseas) that the problem is behind us," said Jack Rodman, a managing director with E&Y. "China has not really resolved the issue - they have just moved it from one state enterprise to another."
Wow! It was refreshing to hear so bold a comment uttered by an executive representative of a major western business operating in China. (We have been writing in a similar vain for a number of years.) But then came the muzzling of those who felt it safe to speak in earnest. What happened?
Read the press release carefully, as it appears to have been drafted with great care. Within this work of fine draftsmanship (I heartily commend the writer), one finds an explanation to its global readership. May I paraphrase?
"We, a global leader in professional services committed to restoring the public's trust in financial accounting, told the world Chinese big four NPLs hit 358, but we were on the receiving end of some serious heat from the central bank the week it was issued, even though they characteristically didn't announce us by name. And, anyway, we're auditors for two of those banks, so what could we do? We haven't any choice but to kow-tow if we want to keep the business -- this is China and we're in it up to our double chins. Ok, here's the official number: $133 billion. We're not saying explicity that we avow the truth of that number, but it is the official version. Can you dig it?"
Sadly, none of the western press seems to have picked up on anything but the exact wording of the press release, making it appear as though E&Y was entirely at fault. At least, in the near term, their bold assertion may work to harm their reputation in the eyes of those who without China business experience. E&Y press relations people outside of China may wish to pitch the rest of the story, off the record, to their media contacts at some point.
[UPDATE (May 16, 2006): Bloomberg discusses why this is such a sensitive issue for the Chinese government here. A quote from the article:
"Chris Ruffle, a Shanghai-based fund manager, won't buy Bank of China shares when the nation's No. 2 lender goes public this month. As a Bank of China customer, he's all too familiar with the bank's failings...Banks are the weakest part of the Chinese economic system, so buying into them doesn't make sense to me.'"Posted by Richard at 1:21 PM | Comments (2)
May 10, 2006
The Continuing Chinese Attraction for Reverse Mergers
[Editor's note: Chinese approached me at different times last year, asking about reverse mergers and backdoor listings. These are legal methods whereby a private company merges with a listed shell company, thus becoming a listed company itself.
According to practitioners, Chinese salivate over the idea of going public in the U.S. and have been attaching themselves to the form like limpet mines on a U-Boat. This Wall Street Transcript panel entitled "China’s Obsession with Reverse Mergers" devoted a panel on just this topic last year. This Heller Ehrman white paper, "U.S. Listing Options for Hong Kong and Chinese Companies," dated August, 2003, shows dissemination of the idea that reverse mergers are possibilities for Chinese companies, but note the firm's distinct, well-reasoned hesitation in recommending the form.
I as well was not encouraging to my guests, not least because of the reputation traditionally attached to those who make use of the reverse merger. But the Chinese with whom I spoke noted with distinct relish what they believed was a faster and cheaper avenue by which they could be listed in the U.S, which assumpion is not necessarily the case. More importantly, they believed that the reverse merger would eliminate burdensome disclosure requirements the IPO process presented. Remember that many Chinese companies have serious financial difficulties which due diligence often exposes -- the Black Scrim of Death for many who lust to list.
Then the SEC issued rules last year compelling the production of additional financial documentation in the event of a reverse merger. One might think that would have stopped the show for Chinese companies, but, according to China Confidential's investigative reporting, it hasn't. With gratitude to its anonymous author who has kindly consented, we reproduce the post in full below.]
From China Confidential
More Chinese Firms Likely to Go Public in US
New rules governing Initial Public Offering (IPO) issuances could encourage more Chinese companies to go public in the United States through so-called reverse mergers with listed or over-the-counter (OTC) shell companies.
The rules, which the China Securities Regulatory Commission (CSRC) released in draft form before the week-long Labor day holidays, are aimed at upgrading the quality of listings.
The CSRC wants companies to have accumulated profit of at least 30 million yuan (approximately $3.7 million) and combined revenues of no less than 300 million yuan over the preceding three-year period prior to floating shares.
In contrast with China and most countries in the world, securities laws in the US are based on disclosure, not merit, though the nation's leading stock exchanges--the New York Stock Exchange, NASDAQ, and the American Stock Exchange--all have their own rules and requirements governing listings and related matters. The US Securities and Exchange Commission (SEC), the agency responsible for administering federal securities laws, has no profitability rule. It does not approve the prospectus, or registration statement, of a company--issuer in securities parlance--seeking to sell shares in an IPO or secondary public offering. Instead, the SEC clears a company's registration statement--an important distinction.
After clearing the Commission, as US securities lawyers say, the registration statement is "declared effective" and the issuer is then free to trade on an electronic trading system known as the OTC Bulletin Board, where the only meaningful listing requirements, apart from basic corporate governance rules, are the filing of quarterly and annual reports with the SEC, including audited financial statements, and timely disclosure of all materially important events and developments through special SEC filings and the preparation and dissemination of press releases.
"Disclosure is the operative word," says a New York-based US securities lawyer. "The US system is designed to provide a level playing field for all investors. Everyone is supposed to have access to the same information before making investment decisions."
For small to mid-cap domestic and foreign issuers, the reverse merger method--whereby a publicly traded shell issues so many shares to acquire an operating company that it becomes the surviving entity--has historically been a popular fast-track alternative to typically more time consuming, costlier IPOs. But because reverse mergers have also often been abused by shady penny stock promoters and brokerage firms, the SEC recently tightened rules for these deals, requiring merged companies to file audited financial statements within days of closing their transactions.
Despite predictions to the contrary, the new SEC rules have not been a significant deterrent to Chinese companies seeking to go public in the US by merging with shells.
"All the filing requirement did was weed out smaller, suspect companies," a veteran Wall Street investment banker tells China Confidential. "Companies that want to go public but are not large enough to qualify for traditional IPOs are still drawn to reverse mergers."
Securities lawyers who have represented Chinese and other foreign issuers report that their clients are usually surprised by the relative ease with which it is possible for virtually any company with more than a few hundred shareholders to go public in the US, though the country's ongoing reporting requirements--and civil and criminal penalties for misrepresentation and corporate mismanagement--seem severe to many overseas executives.
"It's the cost of going public that shocks them," says one high-priced New York lawyer. "Depending on the size of the company and the complexity and nature of its business and financial history, a reverse merger could easily exceed $300,000 in legal and accounting fees."
Posted by Richard at 2:33 PM | Comments (2)May 4, 2006
Food and Beverage Franchising Study Available
Among the more useful of the quasi-marketing documents put out by the big firms is one entitled "Franchising Opportunities in China, Japan and Singapore," prepared by PWC for the APEC Secretariat. Please don't spend the $60 APEC wants you to dole out for this study since it is available free of charge here. [UPDATE: THIS STUDY IS NO LONGER AVAILABLE AT THIS LINK.]
Many readers have found their way to the Asia Business Intelligence website by way of keyword searches at Google and Baidu for "franchise Asia" and the like, so this study is something to peruse that is directly applicable to that need.
That said, the Chinese section of the study appears to incorporate an odd amalgam of sources varying in trustworthiness from Euromonitor to the Chinese statistics bureau. Not all is new information -- some 3 years old -- and you'll find some of the grammar strange in places (a translation?). Nonetheless, the study is a beginning, at least for those who are just beginning to think about operating food and beverage franchises in China.
Posted by Richard at 8:10 PM | Comments (8)
