Chinese IP

China Piracy and Counterfeiting: Do They Even Matter?

China Law Blog - Sat, 09/23/2017 - 23:07

Of course they do, but not always and not for every company doing business in China or with China.

Let me explain.

I just read an article on Engadget, entitled EU withheld a study that shows piracy doesn’t hurt sales, and subtitled, “The $430,000 study’s conclusions perhaps didn’t fit what it wanted to hear.” To grossly summarize, the study indicated that of books, movies, music and games, only blockbuster movies were negatively impacted by piracy. The study indicated that game sales may actually be aided by piracy.

I have from time to time been known to question the dollar losses often attributed to counterfeiting as well. The most commonly cited number is that United States companies lose $600 billion a year to counterfeiting. But the problem with this number is that it is based at least in part on an analysis that says every counterfeit purchased gives rise to a dollar lose equivalent to the real item that was counterfeited. This is usually true (especially when the buyer does not realize it is buying a counterfeit), but is this really true when someone buys a fake Rolex watch for $55 or a fake Gucci purse for $15? I don’t think so.

But let me be crystal clear here. I am not in any way condoning piracy or counterfeiting as both of those things are not only economically damaging, they can reduce innovation and be downright dangerous. Do you want fake brakes in your car? How does counterfeit medicine sound to you? No, all I am saying is that the extent and the damages caused by these things — as a whole — is sometimes over-dramatized. And that, as I will explain below, can have real-world business consequences.

Piracy and counterfeiting and the lack of strong IP protection in China are huge issues. They are a huge issue for some companies, a big issue for some companies, an issue for some companies, and really not much of an issue at all for other companies. Nonetheless, for most (not all) companies they are not a valid reason for ignoring China entirely.

Really, only a small percentage of companies need to worry much about IP theft in China. It exists, of course, but how much impact does it really have on your business? With very few exceptions, my firm’s China clients have either not been hit with piracy/counterfeiting or are too focused on making money from their own products to worry about it much. It is not nearly as much of an impediment to profits as believed.

Too often companies are so afraid of being copied that they fail to do things they should be doing. I can tell you that far more of my law firm clients have expressed the wish that they had gone into China to manufacture or sell their products sooner than have suffered negative IP consequences from having done so.

And on the flip side, every few months a company will come to one of our China lawyers overly concerned with their China IP protections after having read our blog. Oftentimes, they will believe they are too late and other times they will give us a long list of the IP protections they are convinced they need, usually including one or more of the following:

  1. NNN Agreement
  2. Product Development Agreement
  3. Contract Manufacturing Agreement
  4. Trademark Registration
  5. Trademark Registration with China Customs
  6. Design Patent Registration
  7. Copyright Registration
  8. And much more

And maybe 10 percent of the time they are coming to us with an astronomical quote from some other law firm for all of the above contracts and IP registrations. But here’s the kicker. Well under 1 percent of the time does a company need all of the above, and even less than that does it need all of the above immediately. Most of the time, in fact, the typical company doing a typical China deal or transaction usually needs less than half of these. And guess what? Probably 25 percent of the time none of the above makes sense for the company either because none of these things will be effective or because the company is too early (or worse, too late) or because the company would simply be better off spending its money elsewhere, at least in the short term.

So the point of this winding post is simply this: there is no one size fits all when it comes to best practices for protecting your IP from China and you should not let scare tactics and big numbers scare you into believing otherwise. Instead, treat China and China IP protection the way you treat the rest of your business and weigh the costs and the benefits of your IP actions accordingly.

 

Categories: Chinese IP

China Manufacturing: To Broker or not to Broker, That is the Question

China Law Blog - Thu, 09/21/2017 - 05:58

Many companies start outsourcing their products from China using a broker/sourcing agent. Tomes have been written about the pros and the cons of using a sourcing agent versus dealing directly with a Chinese manufacturer and I have no intention of rehashing all that here. My relatively succinct and simple and mostly unhelpful view is as follows:

About 45 percent of all sourcing agents are corrupt. About 45 percent of all sourcing agents are incompetent/worthless. About 10 percent of all sourcing agents are invaluable.

I cannot tell you how many times a client has retained one of our China lawyers to assist in making the switch from using a sourcing agent to going direct with a brand new and far cheaper factory only to have the old factory tell our client it can now reduce its prices by 30-40 percent because it will no longer need to kickback 30 to 40 percent to the sourcing agent. I also cannot tell you how many times a client or a potential client has given us some completely invalid reason as to why their sourcing agent is so clearly different from the rest. We commonly hear that such and such sourcing agent must be good and honest because it is being used by some competitor or because it has an office in the United States. If only it were that clear-cut.

One of the legal issues we often must resolve is whether our client who is using a sourcing agent would be better off contracting with that sourcing agent for the manufacturing of its product, or contracting directly with the Chinese factory, while still paying the sourcing agent for its services. One of our China lawyers recently explained to a client some of the things the client should consider in determining whether to contract with its sourcing agent or to contract directly with its Chinese manufacturer, as per the below, with any identifiers stripped off:

You raise the usual and standard issues related to this kind of contract. To start, it makes no sense to have essentially the same a contract with two parties. You must choose with whom you are going to contract. Will it be your sourcing agent or will it be the Chinese factory? You must contract with the entity that will issue the invoice for the product and in this case (unless we change things), that is your sourcing agent. But if you contract with your sourcing agent, you can and you should also have a contract with the Chinese factory that deals with issues like ownership of intellectual property, ownership and control of the materials, non-circumvention and non-compete and similar. See China NNN Agreements. However, many Chinese factories are not willing to enter into that kind of contract if they are not the direct seller of the product.

The old way was to enter a contract with the sourcing agent, loading all of the liability on it. Since Sourcing Company X is a U.S. company, operating in this way is pretty much just like making a purchase from any U.S. company that outsources its manufacturing around the world. The question is: can Sourcing Company X perform? Does it have the resources to do the work and the asset base to deal with any problems?

As you have figured out, there can be many problems with the “old way.” If you are purchasing from a huge company like Apple, you don’t really care about who their ultimate suppliers are because you know Apple will do the work and you know Apple will stand behind the products and has the resources to handle pretty much anything that can go wrong. For a small company like Sourcing Company X, your analysis is quite different and is more difficult.

There are two issues: First, what happens when everything goes right? If Sourcing Company X takes care of everything, then using them makes sense. Many companies fail to consider what happens when things go right. If you end up doing all the work in China, why bother with Sourcing Company X.

Second, what happens when things go wrong? As you know, things going wrong is standard operating procedure for China manufacturing. If there is a defect, can you rely on Sourcing Company X to fix things? If there is a late delivery or a short delivery, can you rely on Sourcing Company X to address this in a way that does not require your staff travel to China? Can Sourcing Company X ensure that the fabrics and other materials are properly processed and securely stored and maintained in China in a situation where you have no direct contract with the China factory? What if the China factory goes bankrupt: what happens to the materials then? Will Sourcing Company X remain liable in that situation?  Can Sourcing Company X ensure all payments will be made to the factory and to the suppliers of the factory? Can Sourcing Company X ensure that the Chinese factory and its suppliers and the suppliers to its suppliers will not steal your IP or circumvent you by going directly to your customers? If circumvention happens, will Sourcing Company X aggressively take care of the issue and does it have the financial resources to cover for liability?

On these issues, if you conclude that the answer is yes in each case, then you should contract with Sourcing Company X. The more difficult situation is if you conclude that Sourcing Company X may not be fully able to deal with these issues. In that situation, you then have to consider whether you are better off with a contract with a Chinese company that will require you to litigate in a Chinese court to deal with the issues or better off with Sourcing Company X here in the U.S. and insured here as well. See also China Contracts, But With Whom?

As you can see, the matter is complex. In my experience, I find large companies with a presence in China prefer to contract directly with the Chinese factories. And this is the modern trend. However, smaller companies that do not have the time or the people on the ground in China still often use companies like Sourcing Company X to secure their products from China. The problem with companies like Sourcing Company X is they often refuse to enter into a reasonable contract. If Sourcing Company X is willing to enter into a reasonable contract, that is one matter resolved in its favor.

 

We have to assess two issues: a) can Sourcing Company X really perform and b) if you contract with a single Chinese factory, does that really put you into a better position if something goes wrong. You will need to make this decision based on your own business judgment, since you are the one with direct contact with the players. We can help you with this by conducting due diligence/background checks on the two companies.

Please let me know if you need more information from me on this matter.

 

 

Categories: Chinese IP

Service Payments from China: Avoid the VAT Tax Trap

China Law Blog - Tue, 09/19/2017 - 10:15

Consider the following situation. Your company is a service provider. Let’s say your business assists domestic and foreign entities register drugs with the FDA. You are contacted by a Chinese entity to do a registration. Having read China Law Blog (See Getting Money out of China: It’s Complicated), you submit a written, signed invoice to the Chinese entity and you require payment in advance. Within five days, you receive payment.

But, you are surprised to see your payment amount has been reduced by 6 percent. You complain to your Chinese client, and your Chinese client explains that the 6% was deducted as VAT tax on the payment, upon the demand of the local tax authority. You explain that all services were performed in the United States. No services were performed in China. For this reason, there is no basis for the Chinese tax authorities to impose any tax of any kind. The Chinese side explains: we agree, but if we had complained, our payment to you would have been denied and you would not have received any payment at all.

This has become a standard scenario for service providers that provide services to Chinese entities. It applies to all types of services:

  • Legal services
  • IP registration services
  • Product and advertising design services
  • Software development services
  • Environmental consulting services
  • Architectural services, both structural and landscape.

In all these areas, the Chinese foreign exchange banks will refuse to make any payment without documentation. Often the request for documentation is onerous and can cause considerable delay. Finally, when approval for payment is received, the foreign exchange bank then requires a deduction from the payment be made.

Now get this: the amount of the deduction varies from bank to bank and from region to region. We have seen deductions range from 5% to 40%. What is the reason for this wide variation? Since there is no legal basis for the deduction, its amount and its supposed basis vary. This variation means there is no way to predict in advance the amount of the deduction. Even within the same bank for the same services we have seen the amount of the deduction vary from payment to payment, depending on the attitude of the bank at the time and the identity of the bank officer and the local tax office personnel involved in the transaction. Of course, the status of the payer in the local economy is a factor. An SOE that is the sole employer in a small town is treated differently than a small privately owned business in Shanghai.

Our China lawyers constantly get calls seeking help from American and European service providers whose payments have been held up by China’s banks. We tell them the following: “we can help you get the money out, but it will be net of taxes and we do not know what that amount will be.” A classic good news/bad news scenario.

What though can you as the foreign service provider do to eliminate this tax deduction risk? The only solution is to put all of the payment risks onto your Chinese customer by providing in your service contract that all payments must be made net of taxes and fees. If the amount of the invoice is $60,000, the service provider must receive $60,000. All taxes and fees are paid by the Chinese customer on behalf of the foreign service provider. This approach places the risk where it belongs: on the Chinese side. The Chinese government/foreign exchange bank is imposing the fee. The Chinese payer is the only party that can object to the fee and argue it should not be imposed or should be reduced. You as a foreign entity receiving payment have no standing and no power to impact the decision of the Chinese authorities, but your Chinese customer does. Placing the risk on the Chinese payer is, therefore, the only practical way to deal with this issue.

It is essential to deal with this issue in advance in the written service contract and in the written invoice for services. If the written documents are silent, the Chinese side will fall back to the basic rule that VAT and income tax is the liability of the foreign party and make little to no effort to prevent or reduce it. Though this rule has no application to arbitrary and illegal exactions imposed by foreign governments, the foreign service provider will always lose on this kind of claim.

So this then leads to the following rules for performing services for Chinese entities:

1. Execute a written service agreement.

2. Provide a written, signed invoice for every payment.

3. Provide in the agreement and invoice that payments are net of taxes and fees.

4. Do no work until after full payment is received.

Service providers outside China normally operate with a relaxed contracting and billing system. The rules for China are very different and contrary to service provider culture. Moreover, many Chinese entities will resist following the rules. My response to all this is: So what? As my first law firm boss explained to me: there is only one thing worse than working. That is working and not getting paid. If you want to get paid by a Chinese customer, you need to follow the rules.

Categories: Chinese IP

China Employee Mutual Terminations: How to do it Right

China Law Blog - Mon, 09/18/2017 - 06:36

Terminating a China-based employee without severance is generally a difficult thing to do. Even terminating a probationary employee can be tricky. See China Employee Probation: All is NOT What it Seems. Mutual terminations with settlement agreements and claim releases are usually the safest route for employers to take.

For a mutual termination to work well you should put the terms and conditions surrounding such termination to writing even if both parties (employer and employee) have reached a mutual understanding through friendly consultation. Without a written agreement, the employer is at great risk of later legal action by the employee for the exact same issues you settled verbally.

How should you as the employer proceed to effectuate a mutual termination? You initiate the process by coming up with an initial severance amount and a list of any additional matters that need to be resolved with the employee. You then approach the employee and ask him or her if she would be agreeable to a mutual termination with your proposed terms, which will include among other things, a fair amount of severance. In our experience, Chinese employees usually will agree to a mutual termination as they prefer receiving a quick payout to many months of contentious litigation. We normally suggest our clients talk to the employee themselves during the initial stages (with our employment lawyers coaching them in the background). It can often be a mistake for an employer to bring its lawyers into employee termination negotiations too early as doing so can make things more confrontational and indicate to the employee that the amounts at stake may be higher than he or she initially realized.

As you are nearing the end of your negotiations with your employee, you should inform the employee that you will be providing a written agreement that contains all agreed-upon terms for the employee to review and sign.

You will next want to provide the employee with a hard copy of the mutual termination agreement and give him or her time to review it and ask any questions. We make our employee termination agreements clear, reasonable and concise, and China employees usually sign them with little to no fuss. Make sure your agreement covers all relevant issues regarding your specific employee. Sometimes, your employee may want you to leave out certain things for various reasons or put in something that is not true. For example, your employee may want to make it ambiguous about the mutual nature of the termination. You need to say no and inform him or her that the agreement must be clear about the termination being mutual. You need to proceed with extreme care. It is not uncommon for foreign companies to call our law firm after they have been sued by an employee a month or two after believing they just settled with that very same employee.

Do not issue the mutual termination agreement to your employee before you have communicated with the employee regarding the termination and have agreed on the issues. Nor should you make the employee sign an agreement on the spot that he or she has not previously reviewed; the mutual termination agreement should not come to the employee as a total surprise.

Finally, make sure both parties fully execute the agreement and then you should be sure to fulfill your obligations under the agreement, such as wiring the employee his or her full severance payment. Retain one original copy of the fully executed agreement for your records. You must also meet all your other obligations with respect to the employee departure, such as transferring the employee’s social insurance.

Do not treat the mutual termination agreement as a “mere formality” as this document is key to your protection. It should be in Chinese as the official language (preferably with English as well for you) and you as the employer need to know exactly what it says and agree with all of its terms. It is common for Chinese employees to draft Chinese-only agreements “merely as a formality” and try to get you to sign off on that. These employee-drafted termination agreements virtually never protect the employer and they often lead result in the employee coming back to the employer for more money a few weeks later.

Don’t skip the formal mutual termination agreement just because the employee you are terminating is in a “special” status. For example, even if the employee is on probation, so long as it’s a mutual termination, you should enter into a written mutual termination agreement with that employee. Just because the probation/employment period is short does not mean you should not handle the termination properly. You should document ALL employee terminations in writing

Did you handle your employee terminations properly? Now is the time to check to make sure.

 

Categories: Chinese IP

China and Bitcoin and Its Lesson for Everyone: Don’t Fight the Trend

China Law Blog - Sun, 09/17/2017 - 08:14
China Law: Don’t fight the trend

China Bystander (a very thoughtful deep-dive type China blog that has been churning out truly excellent posts since 2007) just did a story, entitled, China Cracks Down On Cryptocurrencies. The story begins with what I see as its money quote:

The default position of Chinese authorities is that if it exists, it should be regulated. Cryptocurrencies are a prime example.

Exactly.

I was a big fan of uber-investor Martin Zweig who would often talk about how the “trend is your friend” and how “you don’t fight against the trend.” That advice applies to Chinese law and business. A CEO I know will every five years put the basics of China’s Five Year Plans on a small card, get the card laminated and then keep that card in his wallet at all times. He does this so that he can easily check all of his company’s proposed actions against the Five-Year plan to make sure it coincides with it or at least does not contradict it. In other words, he makes sure his company acts in harmony with China’s plans, not against them. Smart. Very Smart.

Our China lawyers constantly get phone calls/emails from potential clients (it is almost always potential clients and not actual clients) convinced they have found a “workaround” for some Chinese law and they want us to confirm their workaround will work. When we immediately express our serious doubts, they express their serious doubts about hiring us. This indicates to us they do not really want an objective answer to their question regarding the viability of their workaround, they just want confirmation of it, preferably in writing and they move on.

Anyway, This sort of interaction happens quite often and the following are the most common instances:

1. Getting more than $50,000 out of China. We get at least 2-3 emails every week from someone wanting to know if we can help their Chinese counter-party get x millions of dollars out of China, usually to buy real property or to invest in an American or European business. See Getting Money out of China: It’s Complicated and while you are at it, you might as well check out parts 2, 34, 5 and  6 of that series.

About half of those emails include some “new” idea for getting the money out and about half of those involve a long explanation as to why that idea is legal under Chinese law. Our response is essentially to point out that if it were easy to get money out of China legally, people would be doing it AND their Chinese counter-party would be contacting a Chinese lawyer to do it, not having the American/European side do the contacting. About half the new ideas involved cryptocurrencies, usually Bitcoin. Our position on all of these ideas, especially the Bitcoin ones, has always been that if China is not now blocking them, it will soon and those who facilitated such transfers when the facilitating was perceived as relatively good could face serious consequences.

Starting a few months ago we started getting communications from frantic foreigners whose bitcoin accounts had been frozen in China asking our help to unfreeze them. Starting about a month ago, we started getting communications from people who were having their associates arrested for actions tied in with Bitcoin (but not for using Bitcoin directly). Things like conducting business in China without an entity and without paying taxes. More than one caller who had millions of dollars in Bitcoin frozen AND one or more associates on the ground in China would insist that they were not conducting business in China because all they were doing was sending money out of China and that is not conducting business.

What people need to realize about China law is that when it comes to something like this, China is just not a particularly big fan of these sorts of arguments. In other words, don’t fight the trend.

2. Using Third-Party Hiring Agencies to Avoid Having to Form a China WFOE. Nope, not going to recommend this. No way, no how. Way back in 2015, I wrote an article for Forbes Magazine, entitled, China’s Tax Authorities Want You. In this article, I talked about the illegality of foreign companies hiring Chinese “independent contractors” directly, rather than by forming a WFOE and having their WFOE do the hiring. This is illegal 999 times out of 1000 and China hates hates hates companies that do this. China hates this because it means it does not collect the approximately 40% of salaries employers are supposed to pay in taxes and social benefits nor does it collect the approximately 25% of salaries that is to be paid by China employees.

Couple the hate with the opportunity to collect large amounts of money and you can see why China is hyper-zealous about hunting down companies engaged in these arrangements. Far be it though for foreign companies to simply comply by forming a China WFOE and using their WFOE to hire employees in China legally. No, they want us to tell them whether it is legal for such and such third-party hiring agency to hire employees for them in China.

The answer is really complicated because it depends on so many factors, including the third party hiring agency (a whole boatload of companies (mostly foreign companies operating outside China) have jumped into this business without being licensed to engage in it and much depends on who you which to see hired, their position, the number of people you wish to see hired, the length of time you intend for your third-party hiring agency to employ someone and then on top of all this, the city and perhaps even the district. In the end, it would almost certainly cost more to 1) conduct due diligence on the hiring agency 2) figure out the legality of the specific situation, 3) pay the 10 to 15% premium/commission these third-party hiring agencies typically require, 3) deal with the contracts between you and the third-party hiring agency and the contracts between the third-party hiring agencies and the employees you want to be hired (because the third-party hiring agency drafts these contracts to protect itself, not your company).

Far be it though for foreign companies to simply comply by forming a China WFOE and using their WFOE to hire employees in China legally. No, they want us to tell them whether it is legal for such and such third-party hiring agency to hire employees for them in China. The answer is really complicated because it depends on so many factors, including the third party hiring agency (a whole boatload of companies (mostly foreign companies operating outside China) have jumped into this business without being licensed to engage in it and much depends on who you which to see hired, their position, the number of people you wish to see hired, the length of time you intend for your third-party hiring agency to employ someone and then on top of all this, the city and perhaps even the district. In the end, it would almost certainly cost more to 1) conduct due diligence on the hiring agency 2) figure out the legality of the specific situation, 3) pay the 10 to 15% premium/commission these third-party hiring agencies typically require, 3) deal with the contracts between you and the third-party hiring agency and the contracts between the third-party hiring agencies and the employees you want to be hired (because the third-party hiring agency drafts these contracts to protect itself, not your company).

The answer is really complicated because it depends on so many factors, including the third party hiring agency (a whole boatload of companies (mostly foreign companies operating outside China) have jumped into this business without being licensed to engage in it and much depends on who you which to see hired, their position, the number of people you wish to see hired, the length of time you intend for your third-party hiring agency to employ someone and then on top of all this, the city and perhaps even the district. In the end, it would almost certainly cost more to 1) conduct due diligence on the hiring agency 2) figure out the legality of the specific situation, 3) pay the 10 to 15% premium/commission these third-party hiring agencies typically require, 3) deal with the contracts between you and the third-party hiring agency and the contracts between the third-party hiring agencies and the employees you want to be hired (because the third-party hiring agency drafts these contracts to protect itself, not your company).

Most importantly, the odds are overwhelming that what is being proposed is illegal in any event and if it isn’t clearly illegal, it will be so disfavored that you could end up getting in trouble anyway. And again, that’s the point. Don’t fight the trend.

3. China Representative Offices. China does not like them and way back in 2010, I wrote a post, entitled, The Slow Death Of The China Rep Office. They are still alive and China still does not like them and they almost never make sense for a foreign company looking to go into China. China does not like them and our China lawyers do not like them because they are legal only under very limited circumstances. Since the Chinese government does not like them, you are at some risk even if you are just on the legal side of the legality/illegality line and you are also always at risk of China’s tightening its Rep Office laws and shutting you down. The trend says don’t do it.

4. Variable Interest Entities/VIEs. Way back in 2011, in VIEs In China. The End Of A Flawed Strategy, we made clear our distaste for VIEs and why our law firm refused to handle that sort of work. This position angered many (especially those who were profiting off VIEs) but our position was based on the strong belief that China would eventually make clear its prohibition against them and at that time those who had gone into China as VIEs would suffer. It took longer than we expected, but it did happen in 2015 and we wrote about that in China VIEs Are Dead. Done. Over. Stick A Fork In Them and as we had predicted, the consequences were dire for many companies. Again, the trend.

As China attorneys, we see our job as more than just knowing what the law says now. Our job also encompasses our knowning what the Chinese government things about what our client’s are proposing to do and counseling our clients on that as well. Our job is to help our clients stay on trend.

Your thoughts?

Categories: Chinese IP

Quick Question Friday: China Law Answers, Part XLIII

China Law Blog - Fri, 09/15/2017 - 09:16

Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

One of the questions our China attorneys pretty much never get is the following: I have been using factory X in China for the last seven years to make our widgets and though it was rocky at the start, we eventually built up a great relationship and they have been doing a great job for us for the last five or so years. But the reason I am calling you is because they have asked us about becoming the exclusive China distributer for our widgets and I was wondering whether you think that is a good idea.

Everything but the final question about whether we think it a good idea happens often; the asking us whether it is a good idea is the part that never happens, but maybe it should.

Let me explain.

We are China lawyers, not China business consultants and for that reason we are not the logical people to ask about something like how to choose a distributer in China. But we have been in the China law business for so long that certain things have become obvious to us even though we lack an MBA. And the issues involved in granting an exclusive distributorship to your Chinese manufacturer is just one of those things that is almost always not the best way to go.

But what I usually am thinking (and often say) is something like the following:

I understand that you have a really good relationship with your widget manufacturer and I am not in any way downgrading the value of that, because that is of huge value. But if you are truly serious about maximizing your widget sales in China you maybe should consider whether using your manufacturer as your exclusive distributer is the best way to do that. I say that for two reasons. One, the typical Chinese manufacturer knows zero about consumer marketing, distribution or sales. They know only how to manufacture which is not the same thing. They are usually engineers, not businesspeople or salespeople or logistics people. Two, it is rarely a good idea to grant anyone an exclusive distributorship in China for the simple reason that China is a big country and the odds are slim that the company best at marketing and selling your widgets in Shanghai will be the same company as the company that would be best at doing those things in Chengdu. See China Distribution Agreements: Exclusivity Is NOT Required.

But if you do not want to spend the time and money to find another possible China distributor because all you want is either to keep your manufacturer happy or just make a few extra dollars, then what you are proposing should be fine.

Your thoughts?

Categories: Chinese IP

THE China Employment Guide, Now in Paperback: Run, Don’t Walk

China Law Blog - Thu, 09/14/2017 - 08:45
Buy the paperback version. NOW.

China employment law is technical and getting technicaler (yes, I made up that last word but you know what I mean). See China Employment Law: Local and Not So Simple. It is one of the most consistent problem areas for foreign companies doing business in China and it has become a massive growth area for our law firm.

Our typical attorney-client interaction usually goes something like this:

  1. Foreign employer company contacts my law firm because it has terminated an employee and that employee has either sued or threatened to sue, oftentimes over a technical violation by the foreign employer.
  2. One of our China employment lawyers looks at the case and determines that the foreign company employer did in fact violate Chinese law in the termination and in that investigation learns that the foreign company employer committed multiple violations and if the employee were to pursue litigation or his or her administrative remedies, he or she would no doubt prevail.
  3. We explain the above to the foreign company employer and learn that the problems we enumerated hold true for all employees.
  4. The foreign company employer asks our law firm to remedy its problems and we explain that before we start remedying just the problems that came to the forefront from this one termination, we should conduct an employer audit to determine what other employment problems need fixing. See China Employment Compliance and Audits: THE New Big Thing.
  5. We conduct an employer audit and that invariably (like every single time) generates a laundry list of problems and then we fix them, one by one.

Why do foreign company employers have so many employment problems in China? Think about how the typical small to mid-sized companies starts in China. They go into China with maybe one or two foreign employees and one or two Chinese employees, none of whom is remotely knowledgeable about Chinese employment laws (on the local, regional or national level) and all of whom are — naturally — more focused on getting the business off the ground than on complying to the letter of the multiple sets of employment laws. And anyway, at this point they are usually a tight-knit group of founding employees who view themselves as much as founders as they do employees. But when the company grows, little changes on the China employment compliance front, mostly because nobody realizes how important it is to make the changes and because even if they did, there is nobody in-house who knows how to do it. So it gets kicked down the road until there is an expensive and embarrassing employment problem.

Our firm is then called more often by someone high up in the U.S. or the Europe or the Australia office than by someone on the ground in China. The person who calls us (might be the head of HR, the CFO or the CEO) has started to look at what is going on in China and sought answers from China and received inadequate responses and has now started to worry, rightfully so.

All of the above is my incredibly long-winded way of saying that foreign companies need to get on top of their China employment situations and stay there. Employer audits are the way to go in most situations, but in the meantime and as a supplement, it is critical that someone at your company understand China employment law basics. Someone at your company needs to know enough not to be able to solve every issue, but to spot the issues before they blow sky-high.

And we have just the book for that and I am writing about it today because it just came out in paperback (the Kindle version came out a few weeks ago).

Our lead China employment lawyer, Grace Yang recently had published The China Employment Law Guide and you really really really should buy it and put it on your shelf. And when I say put it on your shelf, I mean you should buy the softcover version (not the Kindle version) so you can literally put it on your shelf. Heck, get more than one copy and give it to everyone in your company who manages your employees or plays any role in their hiring or their firing. This is a book that is meant to be used for background and for reference and as a decision-making guide. Get it now!

Just a little bit about Grace Yang, its author. Grace grew up in Beijing and excelled at and graduated from China’s best law school there — Beijing University. She then came to the United States to attend the University of Washington law school where she again excelled and graduated. Grace is my firm’s lead China employment and labor lawyer and she is the lawyer at our firm to whom everyone else goes for China employment and labor law questions. Grace is a licensed U.S. lawyer (she is licensed in both Washington and New York) and she splits her time between Seattle and Beijing.

Anyway, did I tell you that you should buy the book? Of course I did and you should.

 

Categories: Chinese IP

China Contract Jurisdiction: Tokyo, Geneva, Toronto, South Carolina and Being Too Clever By Half

China Law Blog - Wed, 09/13/2017 - 09:28
Oh no, yet another bad jurisdiction clause

Our China lawyers see a lot of contracts with China companies written by lawyers outside our law firm and by one of the parties themselves. We mostly see these contracts when someone writes us to see if they have a viable lawsuit against their Chinese counter-party. Unfortunately, it is the rare instance where their contract has set up the foreign company (usually an American or European company) for a good lawsuit. Truth be told, very few law firms know how to write good contracts for China and pretty much no non-lawyers do.

Typically, the most obvious and easily spotted flaw is in the jurisdiction clause and boy have we seen some doozies on that front, especially lately. Over the years, our China attorneys have dealt with the following, the facts of which have been modified so as to negate any possibility of anyone recognizing the specific matter:

1. Tokyo Jurisdiction. A company comes to us after learning its Chinese manufacturer has started producing for itself and selling (very successfully) the company’s newest version of its core product. I read the contract and one provision in particular to expressly state that any future iterations of the core product would belong to the Chinese company and I mentioned this to the potential client. The potential client then told me that when it had complained to its Chinese manufacturer about IP theft, the Chinese manufacturer cited to the same provision and said the product now belonged to them. Ugh.

To make matters worse, the contract called for all disputes to be resolved in “Tokyo Superior Court.” I asked the potential client how the heck it was decided Tokyo Superior Court would be the venue for any disputes and the potential client explained it as follows:

The Chinese company asked for disputes to be resolved by arbitration in Beijing and my lawyer said that we wouldn’t stand a chance there and so we refused. The Chinese company then proposed Singapore or Hong Kong arbitration and my lawyer countered with Tokyo Superior Court because it was the opposite [both with respect to the type of forum — arbitration versus court — and the location] as what the other side wanted.

Ugh. I then explained how no country other than China will allow for a lawsuit in its courts that has zero to do with its country and because this case would involve a US-based company going up against a China-based company on an issue with zero relevance to Japan, there is just no way a Japanese court will allow itself to be a free (or nearly free) public forum for this dispute. I did not even bother to mention that there is no such thing as the Tokyo Superior Court or that even if the US company sued in Tokyo, got its case heard in Tokyo (which will never ever happen) and then won in Tokyo, no court in China would ever enforce the judgment because the Tokyo court had no and should never have asserted jurisdiction. Ugh. The US company might be able to convince a Chinese court to take the case, but I doubt it, simply because China very much tends to enforce contracts no matter how silly they may be and I would guess most Chinese courts would toss the case for not having been filed in Tokyo as per the contract.

2. Toronto Jurisdiction. This is one of my favorites. I get an angry email from someone that essentially said as follows:

I read your blog regularly and carefully and you were wrong about Canada and that makes me wonder what else you have been wrong about. I read one of your posts where you talked about how you like to propose Canada for disputes because Chinese companies often will agree to that. Well the Chinese company we work with did agree to that but when it came time for us to actually sue them there, all of the Canadian lawyers told us that we couldn’t.

Future communications revealed that this company had — based on my having extolled the virtues of proposing Canada for arbitrations — believed it could list the Toronto courts as the jurisdiction for disputes between its US-based company and its Chinese counterpart. Just as would have been true in the Tokyo instance above, there is no way a Toronto court will hear a dispute between two foreign companies on a matter that has no relevance to Canada. Fortunately, the Canadian lawyers to whom this company went realized that and chose not to waste the US company’s time and money pursuing litigation there. I had to point out that we constantly emphasize that dispute resolution provisions must be fact and situation specific and that there is a big difference between what can be done in arbitration and what can be done in a foreign country’s courts. I didn’t — but I should have — point out the disclaimer here on our website:

The China Law Blog is for educational purposes and to give a general information and a general understanding of Chinese law. It is not intended to provide specific legal advice. By using this blog you understand there is no attorney client relationship between you and our law firm. You should not use the China Law Blog as a substitute for competent legal advice from a licensed attorney.

Ugh.

3. Split Jurisdiction.  We get this one fairly often. The contract provides that the Chinese company must sue the United States company in a U.S. court and the U.S. company must sue the Chinese company in a Chinese court. The thinking behind this is logical but its execution is so flawed that we avoid these provisions like the plague.

These provisions initially seem to make sense because this sort of split jurisdiction appears to greatly favor the U.S. company. If the Chinese company seeks monetary damages from the American company, it must go through the trouble of suing the American company in a U.S. court and, presumably, the U.S. company will get a fair trial there. And on the flip side, the American company can sue the Chinese company in a Chinese court, which is (90 percent of the time, anyway) exactly where the U.S. company should want to be. For why this is the case, check out China Enforces United States Judgment: This Changes Pretty Much Nothing.

But there is a giant flaw to the above analysis. Chinese courts typically hold that this kind of split jurisdiction means there is in fact no jurisdiction in China, so you really want jurisdiction in China, your agreement should  be 1) be governed by Chinese law, 2) be written in Chinese and 3) provide for exclusive jurisdiction in China. This is not black letter law. This is just what actually happens on the ground in China and this is why our firm’s China attorneys provide for all three of these in all contracts where it is critical our client have the right to sue in China.

But once again there is no clear answer as to what might be best for any given company’s specific situation. To properly evaluate whether you go with Chinese law in a Chinese Court (which is what we nearly always end up choosing to do), you need to consider your most important concerns. Is it more important you have an effective remedy against the Chinese company with which you are contracting or is it more important you make it as difficult as possible for the Chinese side to sue you? If your primary goal is to be able to enforce this contract against a Chinese company, you should provide for exclusive jurisdiction in China and Chinese law should apply and the contract should be in Chinese. But if your primary goal is to prevent the Chinese side from suing, you should provide for exclusive jurisdiction in the United States. But if you do this, you must realize that because China does not enforce U.S. judgments, the U.S. agreement will  be useless as a means of enforcement against the Chinese party. It is these preferences that should help decide the best jurisdiction provision for your contract. In any event, the split jurisdiction approach generally does not work.

This is all a very difficult and must be considered carefully. There is no simple answer. A hard choice has to be made. The first thing I look at when someone shows me an agreement is its jurisdiction provision. In most cases, the US lawyer has screwed up and made it impossible for the US company to enforce the contract and that stops things right there. We must avoid that result if the client in fact wants to enforce in China. If, however, this is that rare instance where the client is only concerned about preventing a lawsuit, a US jurisdiction clause with a US choice of law provision would be fine. In that case, a Chinese version is not required, but I still recommend it because at least then the Chinese counter-party will be able to understand it fully and that alone is important for making sure that it and our client are on the same page before they start doing business with each other.

4. Geneva Chamber of Commerce Arbitration. A very good existing client of ours came to us with a contract calling for arbitration before the “Arbitration Institute of the Geneva Chamber of Commerce.” Problem was that the Geneva Chamber of Commerce neither had an Arbitration Institute nor did the Chamber handle international arbitration. In this case, our client had taken a contract my law firm had written for them and made a few changes and simply re-used it on another deal. The contract my firm had written had called for disputes to be resolved before the Arbitration Institute of the Stockholm Chamber of Commerce (at least I think that was what it said), which at that time (and today) was a very common forum for resolving disputes between Russian and American companies. So when my client went off and did an agreement with a Spanish company and the Spanish company refused to have the disputes handled in Stockholm, my client just switched “Geneva” for “Stockholm” and called it a day. Back then, the Geneva Chamber of Commerce did no arbitration. Zero. So when it came time for my client to pursue arbitration my firm’s arbitration lawyers had to conduct massive research to determine how even to commence arbitration before an arbitral body that did not exist. We ended up deciding to file with the Swiss Arbitration Association in Geneva, figuring we could argue that is what the parties meant and that arbitral body would want to keep the case. The opposing side vigorously contested our choice of forum and only many briefs and many dollars later did we prevail.

5. South Carolina Arbitration in Chinese Under British Law. Yes you read it right and if you are not stunned by this, you should read it again. This is my all time favorite. U.S. company comes to us with an arbitration clause mandating arbitration in South Carolina, in Chinese, under British law. When I talked about how much it would cost to get three Mandarin-speaking arbitrators to South Carolina (assuming the other side doesn’t argue for some other Chinese language) and the need to use two lawyers (one who is experienced with arbitration and another who is fluent in Chinese) and the added costs of researching and arguing British law, the U.S. company — wisely — chose not to pursue the case. When I asked the company how they came up with such a provision they explained that they had taken it from one of their previous agreements. I didn’t say a word, but what I will say now is that a provision like this is a great way to discourage arbitration and sometimes that  can make sense, but such a provision is a disaster if you are the one that ends up needing to sue.

Bottom Line: Jurisdiction clauses in international contracts are complicated and important and there is no one size fits all.

Categories: Chinese IP

China Employment Contracts: Be Careful with the Penalty Provision

China Law Blog - Tue, 09/12/2017 - 05:58

One of the more important things you should know about China employment law is that employees have many rights they CANNOT contract away. An employment contract in China (and pretty much every other country as well) is not a regular commercial contract where the parties have significant freedom to agree on anything. In China employment contracts are not governed by China’s Contract Law; rather, they are governed by the Labor Contract Law (among other numerous employee-friendly labor and employment laws, regulations, rules, directives, etc.). This is a critical distinction often missed to the peril of foreign employers in China.

Because Chinese employees are rarely free to contract away the vast majority of their rights, you as an employer need to think long and hard before trying to contractually (or otherwise) impose an extra burden or penalty on your employee. Generally, employees in China may bear no more obligations beyond those stipulated by law. For example, consider this somewhat classic example: can you have an employment contract that mandates your employees will automatically pay you a certain amount of salary if they fail to give at least 30 days written notice before resigning? Say, you try to be fair by asking each employee to pay you one day’s salary for each day he or she fails to give notice up to 30 days. Will such an employment contract provision be enforceable under Chinese law?

It depends on your locale, but generally speaking, in most locales, unless an exception applies (which I will explain below), this sort of arrangement constitutes a penalty against the employee and is therefore unenforceable under Chinese law. China’s Labor Contract Law says that so long as an employee provides 30 days written notice, he or she can terminate their employment relationship, with or without cause. This is generally interpreted as meaning that an employer cannot legally make it more difficult by essentially imposing a penalty for an employee terminating the employment contract early.

In this situation employers commonly argue that since the law is silent on what happens when an employee fails to the provide 30 days written notice the parties should be free to enter into their own agreement on this issue. In most locales, this argument has been stricken down for two reasons: (1) the law does NOT give an employer the right to penalize an employee for failing to give 30 days written notice; and (2) the employer already has the right to pursue the employee if the employer suffers actual damages as a result of the employee’s failure to give adequate notice. The burden is on the employer to show the damages and the causal connection between the employee’s behavior and such damages. So what if the employee gave only 20 days notice? If the employer suffers no harm, it would not be fair to penalize the employee for being 10 days short on giving resignation notice. Such an arrangement, without more, constitutes a penalty under Chinese laws and will not be deemed enforceable.

What are the exceptions? A penalty payable by the employee may be upheld under one of the following two circumstances:

  • Pursuant to an education reimbursement agreement (sometimes called a service period agreement), an employer can require its employees reimburse the company for the education expenses if the company pays major expenses for an employee’s employment-related education or training, but soon after the training is complete, the employee quits.
  • Pursuant to a non-compete agreement, an employer can require an employee pay a penalty to the employer for violating non-compete terms by joining a competitor after leaving employment.

In jurisdictions that prohibit penalize employees for shortened termination notice, it does not matter if the employer can prove it was the employee who insisted on this penalty arrangement. It also does not matter if the clause is in bold and in perfect Chinese.

If you have already invested a lot of time and money on one or more of your employees or you are planning to do so, you should consider adding a provision to your employment contract on education reimbursement. If your employee assures you not to worry because he or she will not leave you hanging and as proof of this offers to pay you for leaving without 30 days notice, you should know that what the employee will almost certainly not be enforceable. It’s just like when you present an unenforceable NDA (as opposed to a China-centric NNN) to your Chinese counterpart, and they are of course to happy to sign it, knowing it will carry no legal force in China.

Trust me when I tell you our Chinese lawyers constantly see Chinese individuals and companies willingly and knowing propose and then sign agreements knowing full well they are not enforceable!

Do your China employment contracts pass legal muster? Now is the time to check to make sure.

By the way, my book on China employment law, The China Employment Law Guide: What You Need to Know to Protect Your Company, just came out in paperback and you can buy it for the low low price of only $19.95 on Amazon. I realize this is considerably more than the Kindle price, but my intention with the book is for foreign employers and for expat employees to have this book available to them as a ready reference and that will be much better accomplished on a bookshelf in paperback form than on a Kindle or your computer. 

 

Categories: Chinese IP

Does China Have Too Many Trademarks?

China Law Blog - Mon, 09/11/2017 - 05:58
China trademarks. Very crowded.

The United States and China are the two busiest jurisdictions in the world for trademarks, with radically different approaches. The USPTO requires applications to be narrow in scope: the identification of goods/services can only include goods/services the applicant is actually using or has a bona fide intent to use, and before the application can proceed to registration the applicant must provide proof of such use. Subsequently, in order to maintain a valid registration, trademark owners must provide proof of continued use.

China, meanwhile, strongly prefers goods/services be identified according to the Nice Classification system, and it has no requirement that an applicant prove use at any time. The one exception is the non-use cancellation proceeding, by which a third party can challenge a trademark registration. Following such a challenge, if the trademark owner cannot provide proof of use within the three prior years, the trademark registration will be cancelled. But absent a third party challenge, the trademark will remain valid. The Chinese Trademark Office (CTMO) does not conduct sua sponte investigations.

Over the past 10-15 years, China has encouraged trademark applications in both explicit and implicit ways. In an interview last year with WIPO, Zhang Rao, the Commissioner of the State Administration for Industry and Commerce (SAIC), which oversees the CTMO, identified five factors driving the large numbers of trademark applications:

  1. The Chinese government’s goal of boosting “mass entrepreneurship and innovation.”
  2. The implementation of the 2014 Trademark Law, which was an improvement on the previous trademark law.
  3. SAIC authorities’ and market regulators’ work to create a level playing field for all regarding trademark rights.
  4. SAIC’s efforts to improve the efficiency and accessibility of trademark applications, with a particular focus on online applications.
  5. Extensive outreach efforts to increase public awareness of the value of registered IP.

To Zhang’s comments I would add:

  1. Because it is difficult to invalidate a trademark registration in China because of bad faith, it incentivizes trademark squatters to file trademark applications “on spec,” and similarly incentivizes legitimate brand owners to file far more trademark applications in far more classes than they would (or could) file in other jurisdictions.
  2. The Chinese government has operationalized its goal of boosting innovation (Zhang’s first point above) with a numerical pay-for-play scheme: more filings = more money. Mark Cohen’s China IPR Blog has commented on this strategy numerous times with respect to patents; I don’t know for certain if trademarks have been promoted the same way but wouldn’t be surprised.

For all of these reasons and more, China has seen a staggering increase in the number of trademark applications: more than 760,000 trademark applications were filed in 2006, and that number increased to 2.8 million in 2015. In the US, the second busiest trademark jurisdiction, fewer than 400,000 trademark applications were filed in 2006, and slightly more than 500,000 in 2015. (The statistics are from WIPO using class count data: an application in two classes counts as two applications, an application in three classes counts as three applications, etc.) And China continues to widen the gap; in 2016, more than 3.6 million applications were filed.

Meanwhile, the CTMO has been hiring a number of young, inexperienced trademark examiners whose default position is to reject any application that seems like it might conflict with a previously filed trademark.

This all adds up to an increasingly inhospitable environment for filing trademark applications in China. Every new trademark application is another potential conflict for subsequently filed applications. Our China trademark team has seen an uptick in rejections in our day-to-day work, and though it’s hard to prove causation it sure doesn’t feel like a coincidence.

To make things even more complicated, there’s a disjunction between the standard for trademark infringement and the standard for trademark registration, with the latter being considerably more strict. That has led to a number of trademarks that are in a strange sort of limbo: too similar to existing marks to be registered, but not so similar as to constitute infringement were they to be used. This effectively places such trademarks in the public domain. If a company’s goal is simply to manufacture products in China without fear of someone else interfering with production or exports, all is well. But if the goal is establish a brand name in China, the only answer is to find a new brand name.

The moral of the story is that to succeed with trademarks in China you must register your trademarks both early and often, and conduct meaningful searches before filing each and every application. Even if a trademark squatter doesn’t take your exact mark, one of the millions of new trademark applications each year might block your application on other grounds.

Categories: Chinese IP

Offshore Entities and China: Keep it Simple Stupid.

China Law Blog - Fri, 09/08/2017 - 10:17

Many years ago, a client came to us with what it claimed to be and initially looked to be a relatively uncomplicated international dispute. But the more we dug into this company’s “relatively uncomplicated international’ dispute, the more compicated it became. But what was interesting was that the complications were not so much stemming from the dispute itself, but from the myriad and confusing and diverse and related and somewhat related chain of offshore holding companies this client had.

It had nearly fifty (yes, 50) such companies and when we asked why, they mumbled something about prior lawyers and accountants. When we asked how their having so many companies was working for them, their answer was anything but positive. It was costing them a fortune to keep these companies alive and to figure out their taxes and to pay people to do these sorts of things. It should not take a genius to figure out why international lawyers and international accountants like offshore entities so much. I can only imagine how much the international lawyers and accountants made from forming and then providing legal and accounting services to 50 companies.

To make a long story short, the international lawyers at my firm were able to quickly reduce the number of these companies down to four, saving our client a veritable lifetime of hassle and expense.

Now obviously the above is an extreme example, but for every five or so companies that come to us every year with a stray and unwanted offshore entity, there have been zero (ever) that have said, “gee I wish I had formed an offshore entity” years ago. Not one. Ever.

We are often asked about the benefits of forming an offshore entity for doing business with China or for acting as a holding company for forming a China WFOE. Our typical response is to determine whether the company has or is likely to have the sort of profits that will make forming such a company worthwhile and whether forming such a company will provide real monetary benefits. We are not big believers in spending money to form and maintain a company to delay taxes on profits that may never be realized. And then, if there is enough there, we turn them over to our tax lawyer, but most of the time no such entity is formed. If the company is in a high liablity industry it sometimes makes sense then as well to set up and operate an offshore entity, but again this too is rare.

Bottom Line: Offshore entities rarely make sense for SMEs and when they do, keep it simple.

Categories: Chinese IP

China Closes Prominent International Hospital: YOUR Most Important Lesson for the Year

China Law Blog - Thu, 09/07/2017 - 07:29

 

Photos from Hong Kong Free Press

According to the Hong Kong Free Press (and a number of other newspapers) The Shanghai government this week “ordered the closure of one of the city’s top maternity hospitals saying that it was illegally built on land owned by the armed forces, according to an official notice.”

According to the article, the hospital, Shanghai Redleaf International Women’s and Children’s Hospital, was “founded by Canadian investors” and it had “signed a 20-year lease for prime real estate owned by the military on central Shanghai’s Huaihai Road and started catering to foreigners and wealthy Chinese more than four years ago.” But because “The People’s Liberation Army has been banned from commercial activities since 1998” the hospital was being forced to close. The HK Free Press says this “hospital is one of the largest private business affected by the so-called de-commercialisation of the military to date.” The article then quotes the district government as saying “There exists a matter of illegal construction of building at the Redleaf Hospital. It must be rectified duly in accordance with relevant laws.”

Not surprisingly many patients and hospital employees were not happy with the closure:

A gynecologist who was vacating her workplace Sunday afternoon said that the owners, a Canadian couple, had invested billions [of RMB, presumably] into the clinic. “They had all the right documents and invested so much money… it just doesn’t seem fair,” she said.

Christine Cheng had been working as a nurse at Redleaf’s gynecology department for almost two years. “We spent a lot of money and work building this, and now the government wants us to move… We didn’t do anything bad,” she said.

When news transpired last Thursday that the upscale facility would be forced to close, some of the about 300 staff affected hung banners outside the main building criticizing the facility’s imminent closure.

The banners said that while the hospital supported the government, it shouldn’t be forced to move, adding that it wasn’t a “soft tomato” — a Chinese expression for a pushover. Police arrived on the scene shortly afterward and ordered that the banners be removed.

Louise Roy, director of patient support services at Ferguson Women’s Health, a clinic that rents facilities inside the Redleaf complex, said that staff first heard about the possibility of a closure several months ago, although they were never given confirmation or a specific date. “They’ve told us nothing — absolutely nothing,” Roy said. “We came in this morning, like [we do] every day. Then we saw staff gathered outside where the banners were hung, and then the police came.”

Several women who were being treated at the hospital were clearly upset as they collected their medical records before closure.

“I found out from a friend,” said a 32-year-old patient named Jennifer who would not give her last name because of privacy concerns. She said that she had moved to Shanghai from the U.S. recently and was planning to deliver her child at Redleaf in three months. “I have friends who are due in two weeks or a month — I don’t know what they are going to do,” she said.

Wang Jue, PR supervisor, said that one patient in labor arrived at Redleaf over the weekend and was turned away by government officials. She arrived at another clinic just 10 minutes before giving birth.

Redleaf’s services have been highly sought-after by those who can afford them. A standard cesarean section delivery at the hospital costs 120,000 yuan, and a prenatal package is priced at 24,000 yuan.

Patients have been referred to a temporary clinic while Redleaf is working on a more permanent solution.

I do not know what happened with this hospital beyond what I read in the newspapers. I can though discuss some of what my firm’s China lawyers have seen in possibly similar situations over the years and I do so below.

Maybe fifteen years, a very savvy foreign businessperson came to my law firm with a proposed deal that involved our client building a hotel. Just about everything about the deal was perfect. The location was perfect. The cost was perfect. The deal with the landlord was perfect. There was just one flaw: the land on which the hotel was to be built was owned by the military and that made the entire deal 100% illegal.

We explained the clear illegality of the deal (in writing of course) to our client, who already knew it. But like I said, this was a long time ago and our client was very savvy. His response was something like the following:

Yes, I know this deal is illegal and I know that means I am at risk of the government coming in and shutting us down the day after (or even before) we build the hotel. But we’ve run all the numbers on this and the numbers tell us that all we need to do for this deal to be an economic positive is last three years and every year after that the hotel will be a cash cow. So even though I know full well all the risks, I am willing to take them because I am willing to bet we can last at least three years.

The client did the deal and ended lasting for around eight years before shutdown and ended up making a lot of money. The client’s eight year tenure ended around 7-8 years ago and for probably the last ten years our China lawyers have simply said “no” to such deals, as they have simply become too risky. This does not mean our firm has not continued to see a slew of deals and WFOE formations we know violate China law. I can hear myself saying the following to the companies that bring us such deals and WFOE formations simply because I have said it so many times in my China law career:

What you are doing is illegal and you will get caught. When will you get caught? I don’t know that. It could be tomorrow or it could be a year from now. It probably will be in less than two years from now. Maybe if you had come to me ten years ago with this deal (or WFOE formation) I would not have been so unrelentingly negative about it, but China has changed. China has become incredibly serious about enforcing its laws (at least as against foreign companies, which are the only clients we have in China) and so we see every day what happens to foreign companies that are doing business in China or with China. Not only has China gotten more serious about enforcing its laws, it has gotten way better at enforcement. China is highly computerized and its various agencies and governmental bodies are quite sophisticated at communicating with each other.

We need to change your deal (or your WFOE formation). We are not going to put our reputation on the line for this sort of deal.

Oh, and one more thing. When you go back to your Chinese counterpart or to your own China employees/people on this, they will tell you I am exaggerating or I am naive or I just flat out “don’t know China.” I would never claim “to know China” because I don’t, but I do know is what happens to foreign companies that violate China law and I also know that at least once a month one of our China attorneys gets a call from a foreign company in trouble for having violated some law in China. And when I say trouble I mean they are facing millions of dollars in fines or closure of their operations or in some cases arrest and criminal charges.

Most of the time, the client then explains that they didn’t know that their deal (or WFOE) would be illegal (or as they often put it, “so illegal”). Some of the time though they do view us as naive or as overcautious and they move on.

In 2010, in Cracking Down On Illegal Land Use In China. Do You Really Still Feel Lucky, Foreign Punk? I wrote about foreign companies

The following is an amalgamation of a number (maybe 5 or 6) of conversations I have had over the years with people wanting to register a WFOE (Wholly Foreign Owned Entity) in China fast:

Potential Client: Can you help me register a WFOE in China.

Me: Yes. Not a problem. Do you have a lease yet? Do you know that a legitimate lease is required for the approval of a WFOE?

Potential Client: I know that but we are in a real hurry here.

Me:  Okay. But do you have a lease.

Potential Client: We have a lease but I don’t think it technically will qualify.

Me: What do you mean?

Potential Client: The land is zoned agricultural but my Chinese partner has secured all the okays to allow us to use it for our factory.

Me: Not a good idea. Trust me on that.

Potential Client: The factory has been there for two years without a problem and my Chinese partner assures me that the local government is fine with it.

Me: Don’t do it. Right now, the local government is okay with it. But what if the current mayor is pushed out next week on corruption grounds. Do you really want to be in a situation where you have spent a large amount of money on a space that gets shut down?

Potential Client: I am in a hurry and this is the only space that works.

Me: Are you sure? You are in a hurry, but is it really going to be worth the few months if you get shut down?

Potential Client: I am not going to get shut down. My Chinese partner is incredibly connected.

Me: Incredibly connected to the current local administration, MAYBE, but as I said, that administration could be out the door next week. Beijing checks on these things too and if they see that your facility is illegal, Beijing could see to its shut-down. I just don’t think it a good idea to go into a WFOE illegally and my firm cannot be a part of that.

Potential Client: That’s ridiculous. This is how business is done in China. Are you really saying you won’t take us.

Me: Yes. We won’t take you because we do not want our reputation damaged when you get shut down and we won’t take you because we do not want to be blamed when you get shut down.

Potential Client: Well I am sure I will have no trouble finding someone to help me on this. Good-bye.

I know that at least one of these companies did end up getting shut down (within about a year) because someone at the company who had sided with me on the company not going forward emailed me to tell me of this.

Now might be a good time for you to read the following:

Just yesterday, in China Law as California Law: There be Wolves out There, I wrote of how common it is for Chinese consumers and employees to sue foreign companies and I concluded that post with the following admonition on the importance of knowing and abiding by China law:

Yes, doing business in China is difficult and its laws are complicated, but that is true of pretty much every country I know. Be it California or China, it’s on you. People the world over — and that most certainly includes China — are ultra-litigious and that is not going to change soon if ever. Your defense to this is to know the laws and abide by them, to the letter. Saying that the laws are difficult or that there are bad people out there does not cut it and you ought to know that. Oral agreements in China are not worth the paper on which they are not printed and written agreements drafted by anyone not experienced with Chinese language contracts have no greater value.

You have been warned (yet again).

Today’s post is another warning.
 

 

Categories: Chinese IP

China Law as California Law: There be Wolves out There

China Law Blog - Wed, 09/06/2017 - 09:44
China litigation: there be wolves out there.

A loyal reader sent me a Bloomberg News article, titled China’s Grocery Trolls Make Giant Piggy Banks of Wal-Mart and Carrefour. The article was how grocery “trolls” purchase food from China’s large grocery store chains, knowing the food does not comply with China’s Food Safety Law. The buyer of the out of compliance food then sues the grocery store chain for ten times the purchase price and, apparently, usually wins:

Xue Yanfeng went shopping in a Carrefour SA supermarket in western China in May 2015 and bought 20 bottles of honey for a total of 892 yuan ($134). He then left the supermarket with his groceries and sued the French company. In court filings, Xue alleged the nutritional labels said each 100-gram serving contained 1,326 kilojoules of energy. But, according to his calculations using nutritional data on the label, each serving contained only 1,102.

Xue, who couldn’t be reached for comment, argued that the error violated China’s Food Safety Law, which guaranteed him compensation of 10 times the purchase price. The Xinjiang court agreed, and a week after his purchases it awarded him a refund of 892 yuan and compensation of 8,920 yuan.

That was one of 40 lawsuits Xue has filed against supermarkets and retailers for violating the Food Safety Law since late 2015, when China introduced a strengthened version to tackle the country’s well-publicized food safety woes. The new version removed a clause in the previous law that said victims must prove personal injury or loss to be eligible for compensation. The change has spawned a cottage industry of professional complainers who’ve developed sophisticated operations to challenge food manufacturers and retailers for compensation.

I immediately thought of California’s Proposition 65, which is constantly snaring unwary businesses for failing to provide adequate notice of the potential harm their products may cause. Ironically, Chinese companies are prime targets under this California law because they so often are unwilling to pay lawyers in drafting the required notices.

I then thought of the similarities between California’s and China’s employment laws, both of which are also classic traps for the unwary. Years ago a very large Chinese company sought help from my one of my firm’s California lawyers in drafting a settlement agreement with a soon-to-be terminated California employee. We quoted a very low fee (these agreements are a piece of cake) but the Chinese company thought it too high so it pushed on by itself. A month later, the Chinese company called us back, this time to retain us for sure. It turned out that the by-now terminated employee knew California law and that his settlement agreement did not comply with one certain provision in that law. So even though our client had paid him $100,000+ as a severance and unpaid commissions, he was now suing them for $50,000+ in unpaid commissions, plus his attorneys’ fees. Our client had zero chance of prevailing in this lawsuit and it settled quite quickly for the full $50,000+ and it also had to pay its attorneys fees, which were at least five times higher than they would have been for us to draft the simple settlement agreement, correctly. NOTE: I have changed the facts of this matter so as to remove any possible identifier.

We see this same sort of thing on the China employee front as well. See China Employee Termination: Avoid These Mistakes and China Employee Terminations: Don’t Get Lazy. Just as in California, there are a boatload of China employees who will agree to a termination or other settlement (either in writing or orally), get paid under the settlement and then walk down the street, retain a lawyer and then sue (with really good cause) for more.

This happens with Sinosure matters also. See How to Survive Your China Manufacturer Dispute. Sinosure Too. A foreign company  allegedly owes money to a Chinese manufacturer and Sinosure (China’s export insurance company) comes calling to collect. The foreign company then contacts its manufacturer to resolve the matter. The Chinese manufacturer and the foreign company orally (or via an ineffective writing) agree to resolve the matter with the foreign company usually paying anywhere between 70 to 90% of what is allegedly owed. Then when Sinosure calls again, the foreign company explains how the matter has been resolved and Sinosure essentially says, like hell it has.

The other day a British company wrote me after having fallen for a fake settlement with its manufacturer for the second time in the last year. When I essentially chewed them out for having messed up once and then instead of seeking legal help the second time, merely “doubling down on their initial mistake,” their response was to say that “obviously foreign companies cannot get a fair shake in China, where it would seem everyone is out to rip you off.” I respond to that comment now (because there was no point then). Not exactly. If you are going to do business in China it is incumbent upon you to know the laws and if you do not know the laws to get help from someone who does.

Yes, doing business in China is difficult and its laws are complicated, but that is true of pretty much every country I know. Be it California or China, it’s on you. People the world over — and that most certainly includes China — are ultra-litigious and that is not going to change soon if ever. Your defense to this is to know the laws and abide by them, to the letter. Saying that the laws are difficult or that there are bad people out there does not cut it and you ought to know that. Oral agreements in China are not worth the paper on which they are not printed and written agreements drafted by anyone not experienced with Chinese language contracts have no greater value.

You have been warned (yet again).

Categories: Chinese IP

China Enforces United States Judgment: This Changes Pretty Much Nothing

China Law Blog - Tue, 09/05/2017 - 13:55
Move Along. Nothing to see here.

The China legal world was abuzz this last weekend about a Chinese court in Wuhan enforcing a California judgment against a couple of Chinese citizens. On one level this is indeed a huge deal, but on a practical level, this really does not change anything with respect to what you as an American company should put in your China contracts in terms of where your disputes should be resolved.

At least not yet, and likely not for a very long time.  

Since this blog’s inception, we have preached how terrible it is to draft a contract with a Chinese entity that calls for disputes between the parties to be resolved in the United States. That has not changed.

About a year ago, in Enforcing US Judgments in China. Not Yet, I wrote of how China had never enforced a United States court judgment.

At least once a month, one of my firm’s China lawyers will get a call or an email from a U.S. lawyer seeking our help in taking a U.S. judgment (usually a default judgment) to China to enforce. The thinking of the U.S. lawyer is that all we need do is go to a China court and ask it to convert the U.S. judgment into a Chinese judgment and then send out the Chinese equivalent of a sheriff to the Chinese company and start seizing its assets until it pays.

As we have consistently written, nope, nope, nope.

I then went on to discuss how my firm’s China lawyers are often called on to conduct research on this very issue (usually for lawyers or companies wanting to prove to their insurance company or to a court that it would be futile for them to pursue enforcement of their United States judgment in China) and I pulled a large section from a recent memorandum on that topic:

Article 282 of the PRC Civil Procedure Law, requires all of the following conditions be met for enforcement of a foreign judgment to be recognized in China:

The foreign judgment has taken legal effect in the jurisdiction in which it was rendered.

The country where the deciding court is located has a treaty with China or is a signatory to an international treaty to which China is also a signatory or there is reciprocity between the countries.

The foreign judgment does not violate any basic principles of Chinese law, national sovereignty, security, or social public interest.

Though China is a signatory to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, it is not a signatory to any international treaty on recognition and enforcement of foreign court judgments. There is no bilateral treaty between China and the U.S. on recognition and enforcement of foreign court judgments. There also is no bilateral treaty between the two countries on civil or commercial judicial assistance.

Even judgments from countries that have an enforcement treaty with China are oftentimes not enforced in China. For example, China and Australia entered into an agreement on reciprocal encouragement and protection of investments in 1988 that mandates both countries promulgate laws recognizing and enforcing each other’s judgments. But in response to a 2007 request by the Guangdong Province High People’s Court for instructions regarding an application by an Australian plaintiff for recognition and enforcement of an Australian court judgment, the Supreme People’s Court of China rejected enforcement. Since there was no international treaty to which China was a signatory nor any treaty between China and Australia on mutual recognition and enforcement of court judgments, nor any reciprocity between the two countries, the application should be rejected.

Since China is not a signatory to any international treaty on recognition and enforcement of foreign court judgments nor is there any treaty between China and the U.S. regarding judgment enforcement, the only possible way to get a U.S. judgment enforced in China would be if there were reciprocity between the two countries, but there isn’t.

In considering the question of reciprocity, a Chinese court will consider whether there is any precedent indicating reciprocity. In other words, the court will seek to determine whether there are any prior cases where a U.S. court recognized or enforced a Chinese court’s decision. If there are no examples of a U.S. court having enforced a Chinese judgment, the Chinese court will almost certainly rule against enforcing the U.S. judgment because the reciprocity requirement will not have been met.

In 1994, the Dalian Intermediate People’s Court considered a Japanese party’s application to recognize and enforce a Japanese judgment and two rulings. The application was eventually referred to China’s Supreme People’s Court for guidance and the SPC held that because there was no multilateral or bilateral treaty governing such matters between China and Japan and because the two countries had not established reciprocity, the Japanese judgment would not be recognized or enforced by a Chinese court. This case confirms China requires factual reciprocity, not presumed reciprocity.

But are there any examples of a U.S. court enforcing a Chinese Judgment? On August 12, 2009, the United States District Court for the Central District of California issued a judgment enforcing a $6.5 million dollar Chinese judgment against an American corporate defendant under California’s version of the Uniform Foreign Money Judgments Recognition Act and in 2011, the Ninth Circuit Court of Appeals affirmed the district court’s decision. The plaintiffs in that case were Hubei Gezhouba Sanlian Industrial Co. Ltd. and Hubei Pinghu Cruise Co. Ltd., two PRC companies located in Hubei Province. The plaintiffs won a judgment against Robinson Helicopter Company Inc., a California corporation, at the Higher People’s Court of Hubei Province. The United States District Court for the Central District of California held that the PRC judgment was final, conclusive and enforceable under PRC laws and the plaintiffs were therefore entitled to an issuance of a domestic judgment in the amount of the PRC judgment.

This was the first time a U.S. Court recognized and enforced a PRC judgment, but it does not necessarily mean a Chinese court will invoke the principle of reciprocity to recognize and enforce a U.S. court judgment. First, the enforcing court in that case is in California (though it was federal court), and the laws usually differ from state to state in the U.S., so it’s uncertain whether a Chinese court will deem the U.S., as a country, to have established a reciprocal relationship with China. Second, since the enforcing court was a federal court, it’s also not clear whether a Chinese court will deem a state court’s judgment enforceable in China. Third, the enforcing court is not the U.S. Supreme Court, thus, a Chinese court may not deem it to amount to reciprocity at the highest judicial level between the two countries. Finally, that case involved a U.S. defendant who had previously argued that only China had jurisdiction over the case, so it hardly could be deemed unfair for a U.S. court to rule on enforcing the Chinese judgment.

Chinese courts tend to be more willing to recognize and enforce foreign divorce judgments involving Chinese citizens so they don’t have to initiate a separate divorce proceeding. However, since this is not a divorce case, it almost certainly is not relevant.

We have not been able to find a single instance where a Chinese court enforced a U.S. non-divorce judgment.

This memorandum does not address the possibility of your suing the Chinese company directly in China and there are times where doing so makes sense.

In conclusion, a U.S. court judgment against ______________ will almost certainly not be recognized or enforced in China. Unless ___________ has assets in the U.S. or in some country other than China that enforces US judgments, a US judgment will probably not be collectable against this company in any way.

Earlier this year, in Is Now the Time to Take Your U.S. Judgment to China? I pondered whether China might be ready to start enforcing U.S. judgments and I talked of how I would love to see someone take such a judgment to a Chinese court to test this out:

I find it hard to believe that this decision regarding [enforcing] the Singapore judgment did not receive a thorough vetting from on high and maybe it does signal a change in enforcement of foreign judgments in China. I for one would love to test it out, but I would want to do it with the perfect case, or something close to it. The perfect case would be a Chinese defendant company that is a real bad hombre (sorry to use a Trump line, but I just cannot help it) who cheated someone in a commercial dispute and then got sued in a U.S. federal court and fought and lost on the merits. Ideally the judgment is for millions of dollars and the Chinese company has the wherewithal to pay it. I know it is asking too much but if the Chinese defendant appealed the lower court’s ruling and lost on appeal also, well that would be the icing on the cake.

I will now discuss the Wuhan (Liu Li v. Tao Li and Tong Wu) case and explain why it has not changed the risk equation for enforceability to impact how you should be writing your contracts with Chinese companies.

This Wuhan case was before the Intermediate People’s Court of Wuhan City. The case sprung from a commercial dispute involving a plaintiff (a Chinese citizen) who paid USD$125,000 to two Chinese citizen defendants for shares in a California company and then got nothing, not even a return phone call. Plaintiff then sued defendants for fraud in Los Angeles Superior Court. Defendants were served with the complaint and summons in this case but they ignored it and the Los Angeles court granted plaintiff a default judgment. Note this was a dispute between Chinese Nationals on both sides and the dispute involved a United States sale of stock. In other words, the fact that it was a United States sale of stock means that it was wholly appropriate for a US court to reach a decision in the case and the fact that the dispute was entirely between Chinese Nationals gives a Chinese court every incentive in the world to enforce the judgment. The additional fact that the defendants certainly appear to be “bad hombres” (I apologize again for using that line but since I started with it I have to continue with it) is all the more reason to expect enforcement.

Plaintiff then took that default judgment to the Wuhan court to have it enforced there. The Wuhan court ruled it had jurisdiction because the defendants live and have assets there. The court ruled defendants had notice of the Los Angeles action and it also held that the Los Angeles judgment did not violate any basic principles of Chinese law, national sovereignty, security, or social public interest.

Most importantly, the court found reciprocity between China and the United States (California?) and it also held that it should not consider the merits of the Los Angeles court’s ruling, beyond determining that it did not violate any China basic principle. The court found reciprocity based on the Robinson Helicopter case I discuss above. For more on the Robinson Helicopter case see Your Company Can Be Sued In China And That Matters.

This all sounds good right? But for the following reasons I am of the view that this changes little.

  1. This is just one case and it comes from an intermediate court in Wuhan. Are you willing to risk a $30 million contract by making it subject to U.S. court jurisdiction based on this one case out of Wuhan?
  2. Did this decision depend on reciprocity with California as opposed to the United States as a whole? If you are a Texas company are you going to be willing to risk a $30 million contract by making it subject to Texas court jurisdiction?
  3. The underlying case involved a dispute between two groups of Chinese nationals. The case only makes sense if the defendants have property in Wuhan. So the Wuhan court just takes this a dispute between two Chinese that should properly be settled in China. There is always a chance a Chinese court will enforce an arbitration award or a foreign judgment when the parties on both sides are Chinese. It is not at all clear this case can or will be extended to enforce a judgment in a dispute between a foreign party and a Chinese national and the Chinese side appears in China and strongly opposes enforcement.
  4. The the bad act in the underlying lawsuit occurred in the U.S. It is normal for there to be jurisdiction in the place where the bad act will occur. So this case is perfectly normal. Why would you sue someone in China for a stock transaction violation that takes place in the U.S.? It is just a strange accident of fate that the seller/defendant also had presence and assets in China. In fact, it is probable that the entire transaction was illegal under Chinese law because Chinese citizens are supposed to have government approval before investing overseas and it is doubtful these defendants had that approval. This likely illegality also probably colored the Wuhan court’s decision.
  5. Even if you get past the various hurdles above, there is a final hurdle which essentially neuters one’s ability to sue a Chinese company in the United States and then use that judgment to collect in China: service of process. China’s Central Authority and its courts have over the last few years begun dragging their feet so much when it comes to Hague Service of Process that those lawyers who do it (and one of the China lawyers in my firm does these all the time) have been discussing among themselves whether it is even possible. It seems China is taking years to effect Hague service of process on Chinese defendants in U.S. cases and it is quite possible that it is no longer effecting such service at all. Without proper service (or at best, with service that takes two to three years), how valuable is suing a Chinese company in the United States?

This Wuhan case arose from a highly unusual and unique situation. When our China attorneys insist on China-centric contracts, we are focusing exclusively on business activity taking place entirely or primarily in China. For example, take this same lawsuit. What if the stock were stock in a Chinese entity and the transfer was supposed to take place in China? Would it make sense to take that law suit to Los Angeles? And if it were to be brought in Los Angeles, would a Chinese court really be likely to enforce the judgment that results from it? Same for failure to deliver product manufactured in China. Same for violations of IP agreements or for violations of reseller agreements and for violations of JV agreements and so on and so on. If you are going to enter into a contract with a Chinese company and some or all of the goods and services covered by the contract are going to be made or provided in China, your situation is going to be 180 degrees different from the situation that gave rise to this Wuhan case.

What is the best way to resolve a dispute in China? Even if we were living in a fantasy world where service of process in an American dispute can be made quickly and easily (or even at all) against a Chinese defendants and the Chinese courts promptly enforce those monetary awards from U.S. courts, you must consider the cost and expense of a U.S. litigation. Consider the problem of evidence and proof if your contract is mostly or all about China. Consider all of these things and then ask yourself whether setting up your contract to require litigation in a U.S. court and then enforcement of any eventual judgment in that court would make sense for you on any particular contract, or even ever? In what circumstances would having to go to two courts be a good contracting strategy?

In the case where a tort has occurred in the U.S., the situation is more complex. The product was made in China but the damage occurred in the U.S. In that setting, a law suit in the U.S. makes legal sense. However, the question then whether the U.S. is the best place to sue? Is it likely that a U.S. style products liability award will be enforced in China against an unwilling defendant? These are important issues and far more likely to be situation specific than the issue of what to put in your contract. So in this respect, this Wuhan case does make it more difficult to figure out the proper way to proceed in China for certain kinds of legal disputes.

But not typically for commercial contracts regarding matters that will mostly or exclusively take place in China. China is not a colony of the United States or of any other country. We are no longer in the early 20th century where China was carved up into foreign spheres of interest and where foreign law was applied against the Chinese people. China is a modern country with an increasingly developed legal system. China is not what it was in the 1980s, where there was virtually no legal system that could be used to resolve disputes. The Chinese know this and its courts fervently believe this and they are offended by foreign parties who insist on applying foreign law and foreign dispute resolution to matters 100% conducted in China. For this reason, it will almost certainly never be the case that China’s courts will enforce foreign judgments for what is truly a China-centered business dispute. For example, if you enter into a Joint Venture arrangement with a Chinese company and you think you can resolve your intra-company joint venture disputes in the United States and have a Chinese court enforce that resolution, you will almost certainly be sadly mistaken. If foreign companies are going to do business in China, they need to be prepared to accept having their disputes resolved in China.

At this point, it would be a mistake for anyone to draft a contract with a Chinese company with a jurisdiction provision calling for disputes to be resolved in U.S. courts. Unless and until there is that certainty, or unless your Chinese counter-party truly has assets in the United States (See Suing Chinese Companies and Citizens in the United States and in Canada: When it Makes Good Sense), it would behoove you to draft your contracts with Chinese companies to have disputes resolved in a Chinese court or, in some cases, before a China-qualified arbitral body. See Is Your China Contract Worthless?

But, if you already have a contract that calls for U.S. court jurisdiction, it would absolutely make sense for you to consider moving forward with litigating it in a U.S. court and trying to effect Hague service of process on the Chinese defendant(s). And then if you succeed in effecting Hague service and in securing a U.S. court judgment, you take that judgment to a Chinese court to have it enforced, perhaps you even do the same if you get the U.S. court judgment even without having effected Hague service.

But to count on this one decision on which to base future US-China contracts? No, that would not be smart.

What are your thoughts?

Categories: Chinese IP

Chinese Brand Names, Copycats, and Soundalikes

China Law Blog - Mon, 09/04/2017 - 08:41

We’ve been writing for years about the need to register Chinese-language versions of your trademarks. Back in 2015 I wrote, “If you care about your brand in China, it’s not enough just to register your English-language brand. You also need to select a Chinese name and register that as a trademark in China. Otherwise, you’ll forfeit not only the right to use your Chinese brand name, but the ability to choose it in the first place.” See Don’t Be Like Mike: Register Trademarks In CHINESE.

Picking a Chinese name is tricky, and simply being fluent in Chinese does not make someone an expert in Chinese-language branding any more than being fluent in English makes a random American an expert in English-language branding. Far too often we see companies delegate this important decision to their “guy in China,” with predictably middling results. Yes, it’s better than having a non-native speaker pick the Chinese brand name by using Google Translate, but that’s not saying much. We work with several branding companies that specialize in this work.

Typically, a foreign company’s Chinese name falls into one of the following categories:

  1. A direct translation. (This usually only works with companies that use actual, translatable words in their name.) This is what Microsoft has done: 微软, Chinese characters for “micro” and “soft.”
  2. A transliteration, in which the Chinese characters approximate the sound of the English-language name. This is what Google has done: 谷歌, Chinese characters that make the sounds “gu” and “ge.”
  3. A new name with a positive connotation with no obvious connection to the English-language antecedent. This is what Pfizer has done: 辉瑞, Chinese characters that make the sounds “hui” and “rui” and mean “brilliant and auspicious” (more or less).
  4. A combination of the above. This is what Starbucks has done: 星巴克, the Chinese character for “star” and Chinese characters that make the sounds “ba” and “ke” (“bucks,” more or less).

Selecting your Chinese name is just the first step, though. You then need to register the mark as a trademark, and you also need to think about copycat or soundalike marks. Because China has a limited number of syllables, it is easy to come up with homophones to a foreign company’s Chinese name – especially when that Chinese name is a transliteration. This makes it even more difficult to protect your Chinese name. Chinese trademark examiners might reject a mark that has all of the same characters as yours except one, but if the mark has all different characters and they just have similar pronunciations, the mark is much more likely to be approved.

Where we see this most often is the following scenario: a foreign company has a word mark, and that is what they register in the U.S., Europe and China. They incorporate this word mark in a logo that is slightly distinctive – say an oval around the text and in a specific color. The foreign company is careful, and comes up with a Chinese language version of their mark that they register in China. Then a Chinese entity registers two completely different Chinese characters, often with a similar sound, which they then insert into a graphic with the same shape and the same colors. In this way, the Chinese entity produces a deceptively similar trademark without infringing on the specific word mark the foreign company registered.

This is a problem, and it’s made even worse when (1) the client has only registered the Chinese-language version as a word mark or (2) the logo is too generic to be protectable as such.

What can you do? If you’re going to have a logo, make it distinctive, and make sure you register that too. And when you come up with a Chinese-language name, think about also registering other Chinese-language names with characters that have similar sounds and/or meanings. It’s a prophylactic measure akin to registering multiple domain names – annoying, but better than the alternative path of brand dilution or litigation. Trademark owners should also seek, via contract, to constrain their Chinese manufacturers, distributors, and other business partners (especially their distributers and resellers) from registering any trademarks similar in any way (including soundalikes and marks with similar meanings). This won’t affect the trademark squatters, but a significant percentage of trademark infringement comes from current or former business partners.

Bottom Line: Think through what you are trying to accomplish in China with both your English language and Chinese character branding and your logo and take steps to protect those things. Now.

Categories: Chinese IP

Guangdong’s New Employment Laws

China Law Blog - Sun, 09/03/2017 - 08:08

Guangdong Province (home to Shenzhen, Guangzhou, and Dongguan, among others) recently came out with new employment laws. The provincial High People’s Court recently released a document entitled the Answers to Difficult Questions regarding Adjudication of Labor Disputes Cases, with the primary goal of making the province’s labor adjudication more consistent. This post discusses a few of its key provisions and I will be writing more about this new law in future posts.

If during the course of the employment relationship, an employer suffers damages as a result of an employee’s gross negligence or intentional wrongdoing, the employer may pursue the employee for a single sum payment at the time of termination. However, the damages will be limited to direct economic losses suffered by the employer, and the court will consider the nature and degree of the employee’s conduct in determining the damages to the employer and it will not allow the employer to impose its own operational risks on the employee.

An employee leaving employment because of employer wrongdoing or abuse (such as failure to provide necessary labor protections or labor conditions), must clearly provide to the employer the reason why he or she was allegedly forced to terminate the employment contract. If the employee fails to notify the employer that he or she is terminating the employment relationship on grounds of employer wrongdoing or abuse, the employee cannot (in most cases) later demand statutory severance for employer abuse/wrongdoing. Though this new rule is employer-friendly, we still advise our employer clients to try to figure out why an employee is leaving. Even if the employee may be barred from suing for statutory severance, he or she may still sue for other issues, such as unresolved overtime pay or vacation penalties. Your goal as an employer is usually going to be to try to resolve all problems with a departing employee without getting sued.

When an employer moves its location, it constitutes major changes of the objective circumstances on which the employment contract was concluded, and for that reason, the employer must consult with the employee and reach an amendment to the parties’ contract. If the parties are unable to reach agreement, the employee can terminate the contract and demand the employer pay him or her statutory severance. However, if the employer’s move does not have any obvious (whatever that means) impact on the employee and the employer has taken reasonable measures to accommodate the employee (such as providing a company shuttle or paying the employee transportation subsidies), the employee’s demand for statutory severance may be denied as there is insufficient ground for the employee to unilaterally terminate the contract. This is not exactly new either, but it is worth repeating that it is virtually always safer to reach a written agreement (in Chinese!) with your employee before you change any clause of their employment contract.

An employee can demand its employer pay contract damages pursuant to the parties’ employment agreement. The applicable employment laws impose restrictions on employers imposing contract damages (similar to and called liquidated damages in some countries) on their employees, but they do not prevent an employee from collecting contract damages from the employer under certain circumstances. Unless there is a law to the contrary, the employee can demand contract damages in addition to statutory severance (or double statutory severance in the case of unlawful termination). If a contract is being proposed by the employee (which is rare but does happen from time to time), the employer should be careful in checking whether there is such a provision that specifies contract damages payable by the employer (note that we generally recommend our clients not use any contract presented to them by an employee). On the flip side, when an employee — especially an expat — gets to negotiate his or her own employment package, they should consider whether it makes sense to include a contract damages clause in their contract.

Stay tuned for more on the new employment law developments in Guangdong.

Categories: Chinese IP

Selling Your Product into China: Eight Key Questions

China Law Blog - Fri, 09/01/2017 - 05:58

I have had a number of conversations over the last few months with American and European start-up companies looking to sell their high end products into China. Most of these calls touched on pretty much the same things and so it occurred to me to write about the issues we discussed, as they apply broadly to many such companies. The following issues seemed to come up nearly every time, as they should:

  1. What sort of entity should we have in China? In both instances I talked of how time-consuming and expensive it is to form a WFOE in China and how they should delay forming a WFOE in China until such time as they truly needed one, and of how that time might never come. See How to Form a WFOE in China, Part 12: Do You Really Even Need One?
  2. When should we register our trademarks and where and who should own those registrations? My response was that you should register your trademarks before anyone outside your inner circle might learn of them. I then lectured them on the dangers of not using a qualified lawyer for such registrations and on how it is a myth that trademark registrations are easy. I then gave a couple of horror stories of companies that had botched their trademark registrations in China and in the United States, and ended up going broke because of that. I told them that foreign entities can own China trademarks and there are even advantages to doing it that way. I told them that in addition to registering their English language names and their logos, they should probably get a Chinese language name and register that as well. See Register Your Trademark In China, All Things Considered
  3. What’s it like selling on Alibaba? We talked about the legal requirements/legal issues they likely would confront if they sought to sell their products on Alibaba and the major differences between Tmall and Taobao.
  4. Do we need a China WFOE to get a WeChat business account? Yes.
  5. What about setting up offshore entities to save on taxes? Unless you have a lot of money right now, it makes better sense to spend your time and your money focusing on growing revenues and profits, and not on worrying about paying taxes on profits years down the road. I’ve had many clients wonder why their previous attorneys or accountants had set up complicated and multi-country entities but I’ve never had a client bemoan their having been late to do so.
  6. What do we need to do to hire people in China? Get a WFOE. Please. See Doing Business in China with Deportation or Worse Hanging Over Your Head.
  7. What about customs issues? We are happy to help, but usually the much cheaper way to handle these is to have your China distributer or reseller (if you end up going one of those routes) be in charge of this or you bring in a third party logistics company to assist.
  8. Anything else? Yes. Take it upon yourself to try to figure out any rules specific to your particular product. You can pay your lawyers to do this now and in the future, but that usually isn’t necessary.

 

Categories: Chinese IP

China-US Trade Wars and the IP Elephant in the Room

China Law Blog - Wed, 08/30/2017 - 08:13
Elephants are so noble. Trade wars far less so.

I have been called by reporters at least a half dozen times in the last couple of weeks regarding the Trump Administration’s planned investigation of China’s IP practices. But what I tell these reporters fits so badly with THE narrative that my name is not showing up in print. Sorry, but I can’t help it.

Here’s the situation. The Trump Administration is claiming that China’s government forces American companies to relinquish its IP to China and my problem is that despite my firm having worked on literally hundreds of China transactions that involve IP, I have very little proof of this. So no real story there.

Here though is the story as seen from my eyes and from the eyes of the China attorneys at my firm, readily conceding that we have not seen even close to everything.

We have never been involved in a China transaction where it has been clear to us that the Chinese government has forced our client to relinquish its IP to China. We have though been involved in a million transactions where the Chinese party on the other side — sometimes a State Owned Entity, but way more often not — has vigorously and aggressively sought to get our client to part with its IP for a very low price. Is the Chinese government behind this sort of pressure? Don’t know? Probably sometimes, but probably most of the time not. If the transaction involves rubber duckies, we can assume not. If it involves next generation computer chips, well that is probably a very different story.

Anyway, as we write on here so often, there are many terrible technology transfer and other sorts of IP deals to be had with Chinese companies and we have too often — even against our China attorneys’ clear counsel to our clients not to do it — seen our clients make bad deals that will involve them turning over their IP with little to no chance of receiving full value for it. But these companies have not been forced, not in the sense that any government was forcing them to do anything. These companies were simply willing to take huge risks either because they could not grasp the risks or because they felt they had no other choice for financial reasons.

In Three Myths of China Technology Transfers, we wrote about how our clients all too often forge ahead with bad deals and why, and we nowhere mention government compulsion:

A Chinese company that intends to violate a licensing agreement and run off with the foreign company’s IP will usually have a very clear plan. What the China lawyers in my office call the Standard Plan works as follows. First, the Chinese company will negotiate in a way that guarantees a weak license that cannot be enforced against them by the foreign party. The tricks used to do this are quite standardized. Second, the Chinese company will ensure that it does not make any (or else it makes very few) payments until after it has already received the technology. If the Chinese company makes any payment at all, it will make a minimal number of payments, usually late and in violation of the agreement and then once it has received enough of the technology it seeks, it will cease making any payments entirely.

When our China attorneys encounter a Chinese company clearly working on the Standard Plan, we warn our clients. However, it is also typical for our clients to nonetheless want to forge on ahead. The client will usually explain how their situation is unique and that means the Chinese could not possibly be planning to breach.

We discuss again in China Technology Transfers: The Relationship and Deal Structure Myths how it is that American companies lose their IP to Chinese companies and we again leave out government force:

Due to a partnership relationship, the foreign side often wrongly believes it is somehow better protected against IP theft. The foreign side then lets down its guard, only to learn that its China partner has appropriated its core technology. This sense of partnership is most common with SMEs and technology startups, especially those companies whose owner is directly involved in the relationship with the Chinese entity.

In China and The Internet of Things and How to Destroy Your Own Company I rant about technology companies that literally destroy themselves by failing to do enough to protect their IP from China:

Well for what it is worth, I will no longer describe technology companies as a whole as our dumbest clients when it comes to China. No, that honor now clearly belongs to a subset of technology companies: Internet of Things companies. And mind you, we love, love, love Internet of Things companies. For proof of this, just go to our recent post, China and the Internet of Things: A Love Story. Internet of Things (a/k/a IoT) companies are sprouting all over the place and they are booming. Most importantly for us, they need a ton of legal work because just about all IoT products are being made in China, more particularly, in Shenzhen. And just about all IoT products need a ton of complicated IP assistance.

So then why am I saying they are so dumb about China? Because they are relinquishing their intellectual property to Chinese companies more often, more wantonly, and more destructively than companies in any other industry I (or any of my firm’s other Chinese lawyers) have ever seen. Ever. And by a stunningly wide margin.

I then list out the following as “my prime example, taken from at least a half dozen real life examples in just the last few months”:

IoT Company: We just completed our Kickstarter (sometimes Indiegogo) campaign and we totally killed it and so now we are ready to get serious about protecting our IP in China.

One of our China Lawyers: Great. Where are you right now with China?

IoT Company: We have been working with a great company in Shenzhen. Together we are working on wrapping up the product and it should be ready in a few months.

China Lawyer: Okay. Do you have any sort of agreement with this Chinese company regarding your IP or production costs or anything else?

IoT Company: We have an MOU (Memorandum of Understanding) that talks about how we will cooperate. They’ve really been great. They have told us that they would enter into a contract with us whenever we are ready.

China Lawyer: Can you please send us the MOU? Have you talked about what that contract will say?

IoT Company: Sure, we can send the MOU. It’s one page. No, we haven’t really talked much beyond just what we need to do to get the product completed.

China Lawyer: Okay, we will look at your MOU and then get back to you with our thoughts.

Then, a day or two later we a conversation like the following ensues:

China Lawyer: We looked at your “MOU” and we have bad news for you. We think there is a very good chance a Chinese court would view that MOU as a contract. (For why we say this, check out Beware Of Being Burned By The China MOU/LOI) And the Chinese language portion of the MOU — which is all that a Chinese court will be considering — is very different from the English language portion. The Chinese language portion says that any IP the two of you develop (the IoT company and the Chinese manufacturer) belongs to the Chinese company. So what we see is that as things now stand, there is a very good chance the Chinese company owns your IP. This being the case, there is no point in our writing a Product Development Agreement because your Chinese manufacturer is not going to sign that.

IoT Company: (And I swear we get this sort of response at least 90 percent of the time) I’m not worried. I think you have it wrong. I’m sure that they will sign such an agreement because we orally agreed on this before we even started the project.

China Lawyer: That’s fine, but I still think it makes sense for you to at least make sure that the Chinese company will sign a new contract making clear that the IP associated with your product belongs to you, because if they won’t sign something that says that, there is no point in our drafting such a contract and, most importantly, there is no point in your paying us to do so.

So far not a single such IoT company has been able to come back to us with an agreement from their Chinese manufacturer to sign.

Again, no government force, just an overzealous and insufficiently careful foreign company.

Now before anyone excoriates me for ignoring reality, let me say that I have read about instances where the Chinese government has “forced” foreign companies to turn over their IP to China; high speed rail is an often cited example of that. And I do not doubt that it happens in critical industries (nuclear power would be another example). And I am also not unaware of how China is increasingly forcing foreign companies to store their data in China, which absolutely puts technology at risk. But even in these instances the foreign company has some choice. Not good choices, I know. And arguably it is no choice at all when the decision is between doing business in China or not. The last thing I want to do is get all philosophical on anyone regarding what constitutes choice so I will leave it to our individual readers to determine for themselves where on the continuum of force and choice they want to put any and all of the above.

There is plenty to complain about how China protects IP and there is plenty to complain about how China protects foreign companies that do business in China or with China, but I am just not sure complaining about forced IP transfers goes at the top of that list for most American companies. When I talk with American and European and Australian companies about China their biggest legal complaint is invariably how expensive it is for them to comply with China laws and how they resent that their Chinese competitors generally are not held to the same legal standards.

A couple of years ago, I gave the following testimony before The US-China Economic and Security Review Commission of the United States Congress:

I was introduced as an expert, and I’d like to qualify that by saying do not think of myself as an expert. I am just a private practice lawyer who represents American and Australian companies and some European and Canadian companies as well in China.

I’m going to tell you a little bit about what we do so you can get a little bit better perspective of where I’m coming from on this. The bulk of my firms’ clients are small and medium-size businesses, mostly American businesses, but some European and Australian and Canadian businesses as well. Most of them have revenues between 100 million and a billion a year. Our clients are mostly tech companies, manufacturing companies and service businesses.

About 20 percent of our work is for companies in the movie and entertainment industry. We have some clients in highly-regulated industries, like health care, senior care, banking, insurance, finance, telecom and mining, but those companies make up less than ten percent of our client base.

Most of the China work we do for our clients is relatively routine. We help them register as companies in China. We register their trademarks and copyrights in China. We draft their contracts with Chinese companies. We help them with their employment, tax and customs matters. We oversee their litigation in China, and we represent them in arbitrations in China. We help them buy Chinese companies.

For our clients, the big anti-foreign issue is whether they will be allowed to conduct business at all in China as that is certainly not always a given. Certain industries in China are shut off or limited to foreign businesses acting alone. For our clients, publishing and movies are most prominent.

Essentially anything that might allow for nongovernmental communication to or between Chinese citizens is problematic, but it is not clear to me that these limitations are intended to be anti-foreign, as China does not really want any private entities, foreign or Chinese, engaging in these activities without strict governmental oversight.

So do these limits against foreign companies arise from anti-foreign bias or just the Chinese government’s belief that it can better control Chinese companies? To our clients, that distinction doesn’t matter.

On day-to-day legal matters, our clients are almost invariably treated pursuant to law, and so long as they abide by the law, they seldom have any problems. The problem for our clients isn’t so much how the Chinese government treats them; it’s how they are treated as compared to their Chinese competitors who are less likely to abide by the laws and more likely to get away with it.

I have no statistics on this. I doubt there are any statistics on this, but I see it and I hear it all the time.

I see it when one of our clients buys a Chinese business that has half of its employees off the grid and has facilities that are not even close to being in compliance with use laws, and I know foreign companies cannot get away with that.

And I hear it from Chinese employees of our clients who insist that there is no need for our clients to follow various laws. They insist there is no need to follow various laws and to do so is stupid. Is this disparity due to anti-foreign bias or is it due to corruption? Again, for our clients, the answer is irrelevant.

Is the Trump administration’s IP investigation a negotiating ploy done as much to get at disparate treatment as it is to get at forced technology transfers? I do not think it is, but some who know more about such things tell me it may be.

CNN was the only one of the media companies that both interviewed me on the above issues and ended up quoting me and I like how it handled the issue in its article, President Trump is set to crank up the pressure on China over trade:

Beijing has other ways of getting its hands on valuable commercial information. Officials often insist on taking a close look at technology that foreign companies want to sell in China.

“Chinese government authorities jeopardize the value of trade secrets by demanding unnecessary disclosure of confidential information for product approvals,” the American Chamber of Commerce in China said in a report published in April.

Some experts say that handing over technology has effectively become a cost of doing business in China — a market too big for most companies to ignore.

“Many Chinese companies go after technology hard and the tactics they use show up again and again, leading us to believe there is some force (the government?) teaching them how to do these things,” said Dan Harris, a Seattle-based attorney who advises international companies on doing business in China.

“The thing is that the foreign companies that give up their technology usually do so at least somewhat of their own volition,” he told CNNMoney. “Yes, maybe they need to do so to get into China, but they also have the choice not to go into China, right?”

Closing the stable door?

Other analysts say that the U.S. administration is coming to the problem too late.

“Intellectual property (IP) theft is yesterday’s issue,” wrote Lewis of the Center for Strategic and International Studies.

“In part because of past technology transfer and in part because of heavy, sustained government investment in science and research, China has developed its own innovative capabilities,” he wrote.

“Creating new IP in the United States is more important than keeping IP from China.”

These are really complicated issues and I realize the above is more of a stream of consciousness “thoughts dump” than a coherent position paper. So more than ever, I’d love to hear your thoughts in the comments below.

Categories: Chinese IP

Setting up a Direct Marketing Company in China: I Approve of This Message

China Law Blog - Tue, 08/29/2017 - 07:41

Because we are one of very few law firms that represent foreign companies doing direct marketing in China we get quite a few emails from companies (and even individuals) regarding China’s direct marketing laws. Long story short, China does not particularly like direct marketing and its direct marketing laws are so restrictive that the industry there has little in common with direct marketing in the United States or even Europe.

The other day, one of our China lawyers received an email from a potential client with a link to a United States government site describing China’s direct marketing laws. The email was short and merely asked whether the information on this site was accurate or not.

It is accurate and current and and helpful and important and to the point and for those reasons I reprint it in full below.

Direct selling is defined by Chinese regulators as a type of business model involving the recruitment of direct marketing sales agents or promoters and the selling of products to end-consumers outside fixed business locations or outlets.

As part of China‘s WTO commitment, the Chinese Government agreed to allow market access for wholesale or retail trade services away from a fixed location. However, these new regulations are quite restrictive, especially in regards to multi-level marketing (MLM) organizations, which are characterized as illegal pyramids under these regulations.  Sales promoters earn commission only according to their sales performance and the proportion of payment to sales promoters should not exceed 30 per cent of the income generated from sales.  Furthermore, commission paid to a salesman is not allowed to be calculated based on the MLM structure, and language exists requiring the construction of fixed location service centers in each area where sales occur for the purpose of after-sales service and consultation. To obtain a direct sales license from the government, further barriers exist as evidenced by a three-year foreign experience rule, a required RMB 20-100 million (USD 2.9-14.5 million) bond deposit and a RMB 80 million (USD 11.6 million) registered capital threshold, among other requirements. Nonetheless, several major international companies have had success in overcoming these barriers. Having said this, the Chinese Government has remained slow to approve direct-sales license applications for new entrants over the past few years. In general, the Chinese central government and the relevant authorities at central and local levels tend to heavily regulate and supervise this industry.

Any questions?

Categories: Chinese IP

China Trademarks, after New Balance

China Law Blog - Mon, 08/28/2017 - 05:58
Does New Balance’s recent trademark victory portend a new China IP balance?

What should we make of the most recent New Balance decision?

As widely covered in the press, a Suzhou court last week awarded the Boston-based athletic equipment company New Balance $1.5 million in damages in a trademark infringement case. Zheng Chaozhong, Xin Ping Heng Sporting Goods Limited Company and Bo Si Da Ke Trading Limited, who sold “New Boom” branded footwear in China, were found liable for infringing New Balance’s stylized “N” trademark and otherwise deceiving consumers as to the source of goods.

The decision has been rightly lauded as a landmark: the damages are the highest amount ever awarded to a foreign company in a trademark infringement case (and tied with the highest amount awarded to any company). Though rare, this sort of case sends a strong message both to those who would infringe on others’ trademarks and those who try to stop them. \

It’s important to keep things in perspective, though. How strong a message does this decision actually send? New Balance has sold shoes in China since 1995, and according to one report has more than 2000 stores there. The “New Boom” brand is only one of many Chinese knockoffs; I can only imagine how many lawsuits New Balance is pursuing in China. As another of the China attorneys in my firm put it, this win by New Balance shows progress but it isn’t groundbreaking.

I remember buying New Balance shoes when I was a graduate student in Shanghai. I went to a branded New Balance store adjoining a relatively high-end mall, but despite the location and the salesman’s almost self-righteous assurance, along with my Chinese classmates’ concurrence, I still wasn’t confident the shoes were authentic. I ended up purchasing a pair, and was happy I did, but you can see the problem. I was a discerning consumer, I wanted to buy genuine goods and I was willing to pay the going price, but because there were so many knockoffs on the market, I almost didn’t buy anything.

So yes, this is a great decision for owners of IP, but until it becomes commonplace it won’t send a strong message to foreign brands. And from what I’ve seen, this case is about as blatant a case of infringement as the Under Armour/Uncle Martian matter. In the United States, the infringing party would have been slapped with a temporary restraining order, soon followed by a permanent injunction, and this case wouldn’t even have made the local news.

This decision is yet another step in the right direction, and as both foreign and domestic companies continue to protect their interests in China through the legal system, I think we’ll see more decisions like this. But let’s not overstate things. This is just a Chinese court enforcing Chinese trademark law in a straightforward case. Foreign companies still need to be vigilant about protecting their IP rights in China, and that means registering their trademarks in China, monitoring the China Trademark Gazette and Chinese social media to try to spot infringers, submitting takedowns to Alibaba and other e-commerce sites, and filing lawsuits.

We must take the Chinese trademark system as it is, not how we want it to be.

Categories: Chinese IP

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