Legal News: Eye on China Quarterly Newsletter offers companies helpful insight as they successfully navigate China’s complex and ever-changing legal and regulatory environment. In this issue, we focus on the following topics:
The Wild, Wild East: Strategies to Combat Counterfeiting in China
Consider this simple word-association exercise: “counterfeit.” For many, the first word that may come to mind is “China.” Indeed, when it comes to counterfeit goods and brand piracy, China is the number one source of infringing products. While considerable strides have been made in recent years to promote intellectual property (IP) protection in China, two obstacles continue to hinder enforcement efforts: an administrative and judicial inability (or unwillingness) to enforce IP laws, and an overall lack of administrative and judicial transparency. Other problem areas also include local protectionism and corruption, lack of public awareness, and low penalties, which can result in “whack-a-mole”-style enforcement.
Despite these problems, progress has been made to promote the enforcement of IP in China, largely due to growing political pressure from the West, and the fact that China is emerging as an innovator nation. However, in response, smart counterfeiters have adapted by developing sophisticated techniques, making them more difficult to identify and thus more difficult to shut down. As such, implementation of an aggressive anti-counterfeiting program is essential to any company that produces consumer products, whether it be in the apparel, electronics, pharmaceuticals, or entertainment industry. This article sets forth the components of an effective anti-counterfeiting program — and a number of best practices for implementing such a program — that will reduce the amount of counterfeit goods on the market and allow companies to recapture lost revenue and avoid brand dilution.
Be Proactive, Not Reactive
Effective IP registration and portfolio management is the first component to a successful anti-counterfeiting program. However, while obtaining a significant portfolio of trademarks and patents well in advance of commercial use is essential, it requires aggressive monitoring and proactive measures to prevent IP misuse and infringement. Specifically, aggressive monitoring will involve establishing a global watch service, tailored to each company’s specific needs, to track the sale of counterfeit goods, trademark misuse, domain name registrations, and the like. Additionally, any information that is gathered should be entered into a database system, including data relating to seizures and enforcement activities, so that the IP owner can properly adjust to market shifts and thereby formulate a coordinated strategy.
It is common for companies to overlook, or at least underestimate, the importance of promoting an aggressive anti-counterfeiting program, resulting in a reactionary approach to instances of counterfeit activity in which companies feel compelled to file suit immediately upon discovery. To better illustrate the futility in this approach, counterfeiters can be analogized to a Lernaean hydra, such that an IP owner who initiates enforcement proceedings against one counterfeiter after the first sighting will ultimately fail to curtail the counterfeit goods from propagating because he or she did not cut off all the heads. This inability to completely eliminate a counterfeiting operation is due in large part to the fact that Chinese counterfeiters consider seizures, fines, and injunctions to be simply part of the cost of doing business, and as such they are usually able to resume counterfeiting operations with little difficulty. In this regard, rather than focusing on metrics like “seizure numbers” or the total number of lawsuits filed, an effective anti-counterfeiting program will facilitate targeted action to identify, cripple, and more preferably eliminate the counterfeiters at the source.
Other important proactive measures include working with government liaisons from agencies such as police authorities, U.S. Customs and Border Protection, and the National Intellectual Property Rights Coordination Center (IPR Center). The latter represents a joint effort on the part of 15 government agencies to promote IP enforcement, and operates in part to share information, perform interdictions, and conduct investigations. Additionally, having “boots on the ground” in the form of trusted local service providers (i.e., private investigators, IP counsel) in China is critical for investigatory and shutdown efforts to be successful. Unfortunately, in order to identify trusted local service providers, thorough screening and mechanisms to safeguard against conflicts of interest and exploitation are required. If used properly, however, these proactive measures can provide systemic anti-counterfeiting effects and reduce the cost of enforcing IP in China.
Many foreign companies tend to be unfamiliar with the rules of civil procedure and evidence in China, which differ widely from the U.S.-style civil discovery. More specifically, Chinese courts base their decisions almost entirely upon the presentation of a substantial body of written and physical evidence that the plaintiff must produce up front and submit with the complaint. This requires a considerable amount of investigatory work to be conducted in order to locate manufacturing sites, make notarized purchases of counterfeit goods, and uncover the main players responsible for running the counterfeiting operations. Other considerations that impact the overall return on IP enforcement include identifying liquid assets for which requests to the court can be made to freeze on an ex parte basis, which requires ascertaining bank account numbers and the location of the assets to be frozen.
As discussed above, having trusted investigators on the ground is vital to successfully identifying and shutting down the key players in a counterfeiting scheme. This sort of “detective” work can be frustrating for domestic corporate clients who may demand immediate action upon first discovering an infringer. However, continuing the investigation after first discovery in order to gather additional intelligence pertaining to manufacturing sites, suppliers, sub-contractors, distribution channels, and customers is critical if a brand owner wants to eliminate the problem at the source. In this respect, comprehensive database management and the use of third-party intelligence programs to run data sets and analyses are key elements to properly coordinating anti-counterfeiting efforts and, additionally, to stay within a fixed budget by avoiding wasteful spending through “whack-a-mole”-style enforcement.
The Four Paths to Enforcement
While China’s legal system provides IP owners with a full range of options for relief, the results can be a mixed bag depending on the particular avenue taken, and are often poorly navigated via trial and error by inexperienced practitioners. In brief, China’s legal framework prescribes routes for IP enforcement through administrative, civil, criminal, and customs enforcement.
Best Practices for Implementing an Anti-Counterfeiting Program
Developing and managing an effective anti-counterfeiting program can be a difficult task because it requires a significant amount of strategic planning, thorough investigation, and precision in execution. The most common problems that stifle brand owners’ attempts to stop counterfeiters typically stem from a failure to prioritize actions against counterfeiters and an inability to properly scale legal budgets to achieve desired goals. As such, gathering intelligence and understanding the counterfeit market landscape in China, which includes monitoring sophisticated counterfeiters that attempt to circumvent enforcement efforts, is critical to achieve any measurable success.
One rising trend that has resulted in favorable dispositions is joint actions wherein multiple brand owners join together to bring civil, criminal, and administrative actions against infringers. Notable advantages to pursuing joint actions include the collective pooling of resources, intelligence, and political and economic clout. This was perhaps best demonstrated by a group of European luxury brand owners, including LVMH, Gucci, and Chanel, who in 2004 embarked on a joint enforcement effort to reduce counterfeiting in Chinese retail and wholesale markets by targeting landlords of major markets. This ultimately led to the assembly of an even larger coalition of apparel, sports, and fashion brands that since coming together has obtained civil and criminal judgments against infringers, and also secured a series of agreements guaranteeing certain additional protections for IP rights.
In summary, IP enforcement in China is completely different from that of the United States and other Western nations. Moreover, the changing tides in response to political and economic realities are moving China toward stronger IP protection, thereby increasing the efficacy of administrative, civil, criminal, and customs enforcement and resulting in stiffer penalties and greater recoupment of lost profit. With so much in flux, the development and implementation of an effective anti-counterfeiting program requires the careful consideration of a multiplicity of factors and unique strategies in order to successfully reduce and prevent the proliferation of counterfeit goods.
Trade Secret Protection in China: A Perspective From China and Hong Kong
With the tremendous amount of cross-border business being conducted in the Peoples Republic of China (China) and Hong Kong, foreign companies are constantly seeking the best way to protect their proprietary information in connection with these cross-border transactions. Unless the choice of law is governed by the Chinese statutory law, it is common for parties to a commercial contract to select Hong Kong law as the governing law. This strategy has implications not only for the commercial relationship between the parties but also for the protection of proprietary information and trade secrets. This article examines trade secret protection under the laws of both China and Hong Kong, and discusses the difference between them and the implications for cross-border transactions.
Definition of a “Trade Secret” in Hong Kong and China
As a former British colony, Hong Kong has adopted a common law approach, particularly in trade secret protection. There is no statutory definition of “trade secret” or “confidential information.” The right to trade secret protection arises from contracts or the common law of “confidentiality.” Unlike Hong Kong’s approach, which emphasizes case law and precedents, China defines “trade secret” as “the utilized technical information and business information which is unknown by the public, which may create business interests or profits for its legal owners, and also is maintained as secret by its legal owners.” This is consistent with China’s civil law approach.
The subject of trade secret protection in China refers to both technical and business information. Although it is subject to some limitations, such as secrecy, the scope of this definition is broad and abstract. In contrast, Hong Kong provides more definitive terms for trade secret protection. For example, the Hong Kong Intellectual Property Department provides a list of protectable information that has commercial value, such as formulas, methods, technologies, designs, product specifications, business plans, and client lists. In this regard, one has a relatively clear picture of the information protectable under common law.
Similarities and Differences
In both jurisdictions, the information at issue must be confidential in nature to be protected by law as trade secrets. Chinese law refers it as “unknown to the public.” According to China’s Supreme People’s Court, “unknown to the public” means that the information is unknown to, and is difficult to be obtained by, the relevant personnel in the relevant field. In addition, the Supreme People’s Court has enumerated certain exceptions to the definition of “trade secret,” including:
With respect to Hong Kong, the major case in point is Saltman Engineering Co. v. Campbell Engineering Co. Ltd  65 RPC, where the court stated that the following factors should be considered in determining what constituted a trade secret:
Although China and Hong Kong have different definitions for trade secret, the laws of these two jurisdictions are similar. For example, both China and Hong Kong exclude the information that is common knowledge for the personnel within a particular industry. In addition, both China and Hong Kong recognize the information, which is protected as a trade secret, must have commercial value. The information that can be reproduced at little or no cost or can be easily obtained is not a trade secret.
Similarly, China and Hong Kong require owners to take measures to maintain the confidentiality of the information. If an owner treats the information casually, the law will not protect it. In evaluating the level of confidentiality, Hong Kong law considers how far the owner takes measures to preserve the secrecy of the information, and the ease or difficulty with which the information can be properly acquired by others. The China’s Supreme People’s Court takes the position that, in order to qualify for trade secret protection, the owner must adopt proper protection measures suitable for the commercial value or other specific situation to prevent information leakage.
Although both jurisdictions require the information to be valuable, they differ as to whom the information must be valuable. To be protected as a trade secret, Chinese law requires that the information be “capable of bringing about benefits to the owner, and having practical applicability.” The China’s Supreme People’s Court explains it as the relevant information that has actual or potential commercial value, and can bring competitive advantage for the owner. Under Hong Kong law, in addition to the owner, the information will be protectable if it also is valuable to the owner’s competitor.
Protection of Trade Secret in Hong Kong and China
The remedies available in both in China and Hong Kong for breaching confidence include injunction and damages. In Hong Kong, remedies further include an accounting of profits by the misappropriator, and return of the materials containing the confidential information. China includes an accounting of profits as part of recoverable damages. When calculating damages, the amount is first based on the owner’s loss caused by the misappropriator. When it is difficult to measure the amount of loss, which often is the case, Chinese law allows a court to set damages at the amount of profit made by the misappropriator as a result of its improper use of the trade secret. Chinese law also permits the victim to recover any reasonable costs resulting from investigating the misappropriation or unfair competition made by the misappropriator. In China, theft of trade secrets also has criminal implications. According to China Criminal Law, a person acquiring a trade secret via theft, lure by promise of gain, threat, or other improper means, which results in significant losses to the owner, is guilty of a crime punishable by a fixed-term of imprisonment, criminal detention, or fine.
Practical Consequences for Foreign Companies
As discussed above, one can see that trade secrets are treated similarly in both Hong Kong and China. However, Hong Kong has a more mature legal system and better legal environment than China. Because Hong Kong is a former British colony, the English language is more commonly used than in China. In addition, an arbitration award made in Hong Kong is enforceable in a Chinese court. Western companies, especially those from the United Kingdom and the United States, are more familiar with a common law system. As a result, foreign companies usually are more inclined to choose a Hong Kong forum for dispute resolution and Hong Kong law as the governing law.
In China, commercial contracts involving a foreign element or party are permitted to choose the jurisdiction, the governing law, and the method of dispute resolution. Chinese Civil Procedure Law requires that the chosen jurisdiction shall have an actual connection with the disputed contract. The actual connection can be the places where the parties to the contract are domiciled, the place where the contract will be performed, the place where the contract is to be signed, or the place where the subject of the contract is be located. If there is no actual connection with Hong Kong, Chinese law will disregard the choice of law provision. Although China’s courts recognize and enforce Hong Kong court judgments in civil and commercial cases, a choice of law violating Chinese law will make a Hong Kong court’s judgment unenforceable in China. As a result, a commercial contract between a foreign and Chinese party, where the parties desire to use Hong Kong law, must have an actual connection with Hong Kong. The easiest way to make the actual connection with Hong Kong is to have the contract executed in Hong Kong.
As the trade secret laws in Hong Kong and China are substantially similar, foreign companies oriented toward choosing Hong Kong law for commercial reasons can feel comfortable that Hong Kong law will provide protection for their confidential information.
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Legal News: Eye on China Quarterly Newsletter is part of our ongoing commitment to providing legal insight to our clients and our colleagues preparing to do or doing business in China, or expanding into the United States. If you have any questions about this publication or would like to discuss the topics presented here, please contact your Foley attorney or the following:
James C. Chapman
Partner, Private Equity & Venture Capital and Transactional & Securities Practices
Palo Alto, California
James F. Ewing
Partner, IP Department
Vice Chair, Chemical, Biotechnology & Pharmaceutical Practice
Andrew S. Baluch
Special Counsel, IP Department,
Vice Chair, Patent Office Trials Group
Richard S. Florsheim
Partner, IP Department
Chair, Industry Teams Department
Chair, China Practice
Selig D. Sacks
Co-Chair, U.S./Greater China Corporate Practice
New York, New York
Stephen A. Bent
Partner, IP Department
Zhu Julie Lee
Partner, International Business Transactions Practice
Robert Q. Lee
Partner, Transactional & Securities and China Practices
Orlando and Miami, Florida
Steven J. Rizzi
Partner, IP Department
New York, New York
Foley & Lardner LLP is licensed to operate in China as a foreign law firm. Under Ministry of Justice regulations, foreign law firms in China are permitted to advise clients on certain aspects of international transactions and to provide consultation concerning the impact of the Chinese legal and regulatory environment; foreign law firms in China are not permitted to practice Chinese law. The content of this communication does not constitute an opinion on Chinese law nor does it constitute legal advice, but is based on our research and our experience advising clients on international business transactions in China.