Multi-level marketing in ChinaMulti-level marketing* is hot. Selling products to Chinese consumers is hot. All this means multi-level companies are interested in going into China. But as the following portion from a memorandum one of our China lawyers wrote, multi-level marketing in any form is prohibited in China. This prohibition is based on the Regulations for the Prohibition of Pyramid Selling (2005).

Article 7 of the Pyramid Selling regulations prohibits certain multi-level marketing sales as follows:

  • Payment to promoters based on the recruitment of other promoters, rather than based on sales to customers.
  • Requirement that recruiters and promoters pay a direct fee or indirect fee to participate.
  • Creation of a multi-level relationship where promoters on higher levels are paid based on the performance of promoters at lower levels.

The prohibition on such multi-level marketing is absolute and is not related to the product or service. Any kind of compensation related to such multi-level marketing systems is prohibited regardless of the type of business. There are no exceptions. To comply with the prohibitions on certain multi-level marketing sales, any compensation system for Chinese employees must follow the following basic rules:

  • Employment must be concluded pursuant to a written employment agreement. The first term of the typical employment agreement must typically be for from one to six years. After the expiry of the first term, the employer can decide whether or not to continue the employment relationship. If employment continues, there is no fixed term. It is very difficult to terminate employees. Many disputes arise regarding such terminations after the first term. If there are any irregularities in the compensation system, such irregularities will be used by the employee to extract a benefit from or harm the employer as an act of revenge. For this reason, extreme care in following the law in this area is required.
  • Employees must earn a base salary per month at least equal to the local minimum wage.
  • An employee’s remaining salary can be based on commissions and bonuses. The commission/bonus system must be carefully designed so as not to violate the prohibition on certain types of multi-level marketing sales. The rules for payment must be clearly stated and must be followed carefully. Most importantly, the commission/bonus must be based on sales to third-party customers. A commission/bonus cannot be based on recruitment of new employees or the sales performance of employees other than the recipient of the bonus.
  • It is acceptable for the bonus of a manager to be based on the performance of that manager’s group or division within the company. However, this performance must be based on sales to customers and not on recruitment or on services/sales to other employees or divisions of the company. It is, however, easy for such bonuses to fall afoul of the multi-level marketing sales regulations, and foreign companies are regularly fined for breaking the rules in this area. Care in designing this type of bonus is therefore required.
  • Employees must be provided with a suitable work location. It is, however, acceptable for the employees to choose to work from home. Employees can make direct sales calls to business customers. Employees may make contact with non-business consumers in public locations. Door-to-door direct sales to consumers are typically (though not always) prohibited.
  • All income of employees must be properly reported and all taxes and social benefits must be paid to the appropriate Chinese authorities, including tax and benefits on commission/bonus payments. PRC taxes and benefits are quite high. The amount varies by district but generally approximates 40% of the total salary paid.
  • It is not permissible for Chinese individuals to own shares of a WFOE. Thus, no part of the compensation can be based on the promise of future share ownership in the WFOE. In the same way, without specific approval, no Chinese individual can own shares in a foreign company. Thus, a promise of participation in a future IPO cannot form a part of compensation.
  • Under very limited circumstances, it is possible to create an employee stock option plan that will provide for ownership of the foreign parent of a WFOE. Such plans must be formally approved by the relevant government agencies. As with the United States, China taxes the capital gains on this kind of stock transaction and there is a regulatory burden involved in ensuring that proper reporting is done. This is especially the case for non-public companies that are providing for stock in a future IPO. Thus, while such a system is legally possible in China, the program must be carefully prepared and must be approved in advance.

As is true of so much about doing business in China, there are workarounds, but none are great.

* Multi-level marketing (sometimes called network marketing) is usually defined as a strategy that encourages a company’s distributors to recruit new distributors by paying the  distributors a percentage of their recruits’ sales.

China AttorneysBecause 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 most common questions we will get asked will be something like the following:

I paid my supplier in China X dollars for Y product and the quality is so bad I cannot even use it. Do I have a good case against them and what would you charge us to pursue it.

My response is usually something like the following:

Do you have a written contract with this Chinese supplier?

Is it in Chinese?

Is chopped/sealed by your Chinese manufacturer?

Does it provide for disputes to be resolved in China?

Does it clearly specify what you will be buying and its quality requirements?

Does it clearly provides that any failure to satisfy the product requirements will lead to you being entitled to specific monetary damages against the Chinese company?

If your existing contract provides for all of the above (or at least the first four), we can help and we’d be happy to do so. If you do not have at least the first four above, our chances of being able to help you are not so good and it probably will not make sense for you to hire us.

If you want to protect yourself in the future, I would urge you to use an appropriate Manufacturing Agreement (a/k/a OEM agreement or product supply agreement) the next time around. You can find out more about our Manufacturing Agreements here, here, here, and here.

I should also note that we have been dealing with a massive increase in companies that are losing their ability to have their products manufactured in China entirely because their suppliers there are registering their trade names and then preventing their products from leaving China. If you put your company or your brand name on your products (or on their packaging) you should immediately register your brand/product name and logo as a trademark in China, if you have not already done so. As we discuss here, this is true even if you will not be selling your product in China. I mention this because when foreign companies start having problems with their Chinese manufacturers (like what you are having) the Chinese manufacturer often will go off and register the foreign companies brand names as their own trademarks in China so as to gain leverage against the foreign company. Therefore — and I know this will probably surprise you — the one thing I would urge you to do immediately is to make sure your brand names are registered as trademarks in China and if they are not, to do so immediately.

 I hope the above proves helpful to you. If you have any additional questions, please don’t hesitate.

What are you seeing out there?

China employment law auditChinese employees constantly litigate overtime claims against their China employers. Many foreign employers in China assume their employees have the burden of proving overtime was actually incurred. But they are only sort of correct. The governing judicial interpretations (i.e., Interpretation (III) of the PRC Supreme People’s Court of Several Issues on the Application of Law in the Trial of Labor Dispute Cases) shift the burden to the employer if the employee produces evidence showing the employer holds the relevant evidence. What does this mean in practice? In employee-favorable jurisdictions like Beijing, it means that if an employee has just minimal evidence of having put in overtime without getting paid for having done so, the courts will require the employer prove the employee’s overtime claims are untrue. The Beijing courts take this position because they know employers often verbally transmit their overtime requirements/requests and thereby leave their employee with no good evidence of having worked overtime. On the other hand, the employer’s mandatory attendance records usually show who worked when.

The Beijing courts have recognized that copies of work shift schedules signed by a supervisor were enough to shift the burden of proof to the employer and even declarations and witness testimony. But even where the employee comes forward with sufficient evidence to shift the burden to the employer, the employer can still prevail if it can produce sufficient evidence to rebut the employee’s overtime evidence. For example, the courts have accepted wage payment acknowledgment forms signed by an employee who specifically acknowledges having been paid in full and had no issues concerning such payments and fully accepted the amount.

Many China employers also assume that if their employees follow an order to work overtime and then do not object to the wages received, they have accepted that no overtime pay is owed to them. This is WRONG. Employees do not need to file a complaint or voice any rejection right away. Generally speaking, they have one year until after their employment is terminated to sue for overtime wages. And sue they do, which is all the more reason why it is so important to get your departing Chinese employees to sign settlement agreements with you making clear they have no wage claims. See China Employee Termination: Avoid These Mistakes.

What all of this means in real life is that employees can and often do keep minimal evidence of unpaid overtime and patiently wait for years before taking any legal action. They can (and do) also unilaterally terminate the employment relationship and sue their employer for severance and damages or they can wait until they are terminated or the employment term has expired. In other words, if you have not been properly handling your employee overtime and compensation correctly, you could be sued for years of unpaid overtime pay. Our China employer audits often find lingering potential overtimes claims and we typically advise our clients to clean those up right away while they still have leverage over their employees, rather than waiting for the nearly inevitable claims once the employees have left.

“Clever” employers may argue that their local labor authorities have told them that they are obligated to keep employee wages records on file for  only two years in case of audits, so everything will be fine if they do just that. Wrong. Yes, this does mean you have fulfilled that specific employer obligation/law, but that law is not intended to prevent employees from pursuing you for overtime wages going back more than two years. Also note that like pretty much everything else involving China employment law, even the amount of time you must keep your employee wage records can vary.

The bottom line on employee overtime claims in China is that China employers should just assume they will end up having the burden of proof on overtime claims and should therefore start both cleaning up past problems and preparing for future problems.

 

China manufacturing trademarkLast year, in Your China Factory as your Toughest Competitor, I wrote about how our China lawyers have “gotten more calls in the last year from companies whose China factories are now directly competing with them than in probably the three years before that combined.” I went on to explain how “Chinese factories are more confident now than they have ever been about going out into the world with their own products, and more willing to toss their foreign customers to the curb early. Amazon and Alibaba do not help matters as we are getting roughly a call a week from someone whose product is being sold on Amazon and/or Alibaba by their Chinese factory.”

The other day I secured permission to write about a sourcing company that contacted us regarding this problem for one of its clients that makes IoT (Internet of Things) products in China. The below is our email correspondence (stripped of any possible identifiers):

IoT Product Sourcing Company: I’ve got an interesting story for you which could potentially mean some China contract work for your team. One of our best clients currently has a written contract with its China manufacturer, but it was written for them by their regular attorney who does not know China and it is badly written. We told our client this going in, however it’s tricky telling our client that their contract is not good, or even that their colleagues have no idea what they are doing. I’m sure you can relate but it’s especially tough for us because we are not lawyers and we do not want our clients ever to think that we are providing them with any legal advice, but like I said, we figured from the contract that they would eventually have problems and now they are.

We have a factory producing a products for us. Various kinds of fairly high end IoT industrial products. Quite profitable too. The contract in place details minimum order quantities annually and clauses related to exclusivity for Spain, France and Italy. During the past 16 months our client has failed to meet the minimum order requirements so its exclusivity is now uncertain. The main reason for their not meeting the minimum order requirements is problems the Chinese factory had with packing the products in a way that protects them during shipment and also problems with the products themselves. These issues have been sorted out now and my client is ready to move ahead with large orders every month. There are also molds involved that are worth well over a million RMB in total.

My client received an email from the factory last week saying they will be attending the ____________ trade fair in __________ and they want my client to send a sales person to represent them. Just to be clear, the Chinese factory wants to show my client’s products in Europe, with a focus on selling it in Spain, France and Italy! This email was quite amusing as they also asked my client for some information regarding how to install the products and requested my client send them a technical person to give more details about the whole system. They offered even to pay for this technical help. My client is a concerned but I find it amusing because the Chinese company has no idea what testing or standards are required in Europe as they manufacture almost exclusively domestic products. It would be a bit like a factory in China exhibiting in the US and telling Home Depot (their client) that they were going to help Home Depot sell its own products. But at the same time, I also know that this Chinese company is probably just one technical and marketing person away from being able to sell my clients products all over the world for 30 to 40% less.

I am curious on your thoughts and I was thinking of the below, but would be open to more:

1.  NNN contract. It may be too late for this as I am not sure the Chinese supplier would be keen to sign a new contract at this point. From their point of view, they already have a great contract.

2.  Trademark in China. Just reading a bit on your site it seems to me my client should be doing this, or really should already have done this.

3.  Have you heard of a trade show barring a supplier from attending because they are selling essentially stolen products?

Please let me know what you think when you have some time.

My response was as follows:

My first advice to you would be to stay completely away from ALL of the legal issues and let your client deal with all of these issues itself. Your client should not expect you to give it legal advice and your doing so just increases the odds of your being blamed when things go wrong and of your being sued and losing on the same grounds.

I would need to know more to be able to provide all options but I can say that separate and apart from what has been transpiring between your client and its factory, your client has indeed made a big mistake by not having already registered its trademark(s) in China. That is the one thing above all else that anyone manufacturing in China MUST must do. See Manufacturing in China: Trademark Registration Should be the First Thing You Do.

As for the issue regarding the factory, a trademark will shut down rival sales as the factory could still sell the same products under a different name, but at least it can stop it from selling your client’s products under your client’s name! We also should talk more as patents in China and elsewhere might be possible, and if they are, they might help. [It turned out the company was too late to secure any patents]. You can try to get the fairs to block this China factory, but I do not see how that will happen because near as I can tell, the China factory is acting legally because it is not violating any contract or any registration.

I cannot recommend doing anything with the factory without getting the whole story because I am scared to death of what could happen here. One part of me says your client should tell its Chinese factory to “sign a new (good) contract now or we walk,” but the other part of me says that would be crazy because this will likely cause the Chinese factory to say, “great, and we keep the molds because they belong to us” and we keep making your products and now we add your brand name to them them because there is nothing to stop us from doing so. And what will your client then do? By the time it has new molds made and starts even trying to fight back, it will likely have lost all or nearly all market share to its factory.  I say this because I presume that the contract your client has with its China factory does not make clear that the molds belong to your client nor provide any real incentives to prevent the factory from hanging on to them. But really, the bottom line is that unless your client wants to retain us so we can get all the facts and figure out step by step what it can do there is really nothing we can do but speculate. A

The email address for the sourcing company no longer works and so I have no update on what eventually happened, but I very much doubt any good result.

What should you do to prevent the above? The following three things are key:

  1. Choose your China manufacturer wisely. Due diligence is the answer to this.
  2. Make your China manufacturer sign a contract making clear that you own the molds, that you own the products and that it will not compete with you.
  3. Register your trademarks in China and with China Customs, register your patents in China and register both of these wherever you sell your products.

Grey Market Goods and ChinaIn this projected 4-part series we’ll take a closer look at grey market goods and China. In part 1, we discussed what grey market goods are and why manufacturers get so worked up about them. Today, in part 2, we’ll look at how grey market goods are regulated in China. In part 3, we’ll look at how grey market goods are regulated in the United States. And in part 4, we’ll look at grey market goods and Chinese factories, and what foreign companies can do to protect themselves.

Part 2: How Are Grey Market Goods Regulated in China?

One of the minor mysteries of modern China is how every mall has so many luxury-brand stores that seem never to have anyone shopping inside. I’ve read numerous explanations for this disparity, none of them entirely satisfactory: the shops are loss leaders in an effort to build brand loyalty in China; the shops are highly subsidized by mall owners to bring in other tenants and/or to give them face; all of the sales are made after hours to Party officials’ relatives and mistresses; people just aren’t paying attention at the right time.

But one answer for the empty stores, surely, is the enormous size of China’s grey market for luxury goods. In 2015, Chinese citizens spent $22.5 billion on luxury goods purchased in China – and more than twice that amount abroad.

As noted in part 1, grey market goods exist because there’s a market for them, and that market exists because grey market goods are either cheaper or have better availability. But in China there’s a third driver of the grey market: quality. It’s ironic because in the US, grey market goods have a strong whiff of caveat emptor; if you buy a product outside the normal channels you accept the risk that it might be lower quality. But in China, the calculus is flipped: because counterfeiting is so rampant, the chance of buying a fake is considered to be much lower if the goods come from overseas.

Historically, a significant proportion of grey market luxury goods in China have come via daigou, personal shoppers (usually young Chinese women) who live or travel overseas and purchase luxury goods for well-heeled clients in China. I’ve seen this in action: at Seattle Premium Outlets’ Burberry Store, you sometimes have to wait in line just to get in the store, only to be ignored when it becomes clear you’re not there to drop twenty thousand bucks.

Other grey market goods in China are purchased directly by consumers, either while traveling overseas, or from foreign reseller sites like eBay. Grey market goods can also be found on Chinese e-commerce sites like Taobao and 1688.com; these goods are usually purchased “on spec” overseas and then resold in China. (The daigou as impersonal shopper.) Baby formula and iPhones have, at various times, been extremely popular grey market goods in China.

Grey market goods are legal in China, or at least not an infringement of the brand owner’s IP rights. Indeed, Shanghai’s Free Trade Zone has a car dealership that specializes in grey market automobiles.

But many grey market goods in China run afoul of the law in another way: customs fraud. When the goods are brought into China, they are not declared at all or are declared at lower values. Defrauding Chinese customs is an essential part of many a daigou’s profit margin, because China has historically imposed significant duties on a range of luxury imports.

China has attempted to crack down on illegal grey market importation through a number of means, including (1) higher taxes on goods brought in by travelers as part of their luggage, (2) lower taxes on goods imported through legitimate channels; and (3) increased penalties for those caught falsifying customs declarations.

The effectiveness of these measures is a bit hard to gauge: some reports say the measures are eliminating large-scale daigous; others suggest that the enforcement is both haphazard and overbroad, and that when Chinese people attempt to order directly from overseas retailers, the packages are frequently rejected at the border, with the result being that people are even more reliant on daigous to get the products they want.

On a certain level, foreign brand owners might not be that concerned about grey market imports in China – Christian Louboutin gets paid whether a pair of pumps is bought in Shanghai or in Houston and then taken to Shanghai and resold. But they should be concerned, for several reasons. First, they want to be seen as cooperating with the Chinese government on tax and customs issues. Second, having to deal with so many purchases by Chinese travelers overseas is a drain on resources (staffing, marketing, logistics) and distorts the worldwide revenue stream. Third, sometimes the prices in China, even accounting for taxes and tariffs, are higher than they are abroad — although a number of brands have normalized prices in China in an attempt to dissuade gray market sales. Fourth, the daigou phenomenon increases the amount of intermediation between brands and their consumers, which is exactly the opposite of what companies want. How can you market to customers when you don’t know who they are? And how can you control your brand identity when you are not the seller?

In part 3 of this series, we’ll look at how the United States regulates grey market goods.

antidumping duties against ChinaEarlier this month I wrote about it was not clear whether the U.S. antidumping order on garlic from China helped domestic garlic producers. One of the unusual consequences of this garlic antidumping order was that the California garlic producers had worked out an arrangement that allowed Chinese garlic to be imported from one “fair” supplier (Harmoni), while blocking the vast majority of all other Chinese garlic sourced from “unfair” suppliers.

The latest Department of Commerce (DOC) annual administrative review threatened to destroy that cozy arrangement between the California garlic growers and Harmoni because a couple of New Mexico garlic growers had filed a request seeking DOC review of Harmoni. The DOC had accepted the New Mexico growers’ review request and had initiated a review of Harmoni. Harmoni did not respond to the DOC’s questionnaires, so DOC issued a preliminary determination finding Harmoni would be subject to a 376% dumping rate. But the DOC was still considering arguments that the New Mexico garlic grower’s review request for Harmoni was invalid and should not have been accepted by DOC in the first place.

Last week, the DOC issued its final determination for this garlic review, and concluded that the review request filed by the New Mexico garlic growers was not legitimate and therefore its review for Harmoni and its 375% dumping rate would be rescinded. As a result, Harmoni is able to maintain its zero dumping rate and continue supplying California garlic growers with Chinese garlic.

The DOC rejected the New Mexico garlic growers’ review request because new information submitted after the preliminary determination called into question the credibility of their assertion that they were actually domestic garlic producers. For example, contrary to specific statements made on behalf of the New Mexico garlic growers, the DOC pointed to the record information showing Chinese garlic growers were in fact extensively involved in planning the New Mexico growers’ review request and had both directly and indirectly compensated the New Mexico growers and the U.S. attorney for participating in this review. One of the two New Mexico garlic growers dropped his support for the Harmoni review request and then submitted a bombshell statement admitting that his small garlic farm in New Mexico did not really compete with Chinese garlic. “Our stated moral high ground – ‘leveling the playing field,’ etc., etc. – inevitably came with a ‘wink, wink’ whenever we talked about it.” DOC concluded that “material misrepresentations” by the New Mexico garlic growers had tainted all their statements and information submitted by them and so it could not rely on any of the garlic production information demonstrating the New Mexico garlic growers were in fact domestic producers.

So in the end, the California garlic growers got the DOC decision they wanted, which was to keep Harmoni out of the DOC review process. This allows Harmoni, to continue reaping the benefits from being the only remaining Chinese garlic company with a zero dumping rate. This also allows the California garlic growers to remain protected by incredibly high dumping rates that block most “unfair” Chinese garlic from sold in the United States, while still giving them direct access to cheaper Chinese garlic from the sole “fair” Chinese garlic supplier — Harmoni. In the end though, U.S. consumers bear the cost of protecting the handful of California fresh garlic producers still surviving.

I’m sure there will be other attempts to break down the antidumping barriers that block most Chinese garlic from the U.S. market and keep U.S. garlic prices the highest in the world. Perhaps garlic growers in Minnesota or some other state will file another review request targeting Harmoni.

Someone should.

China copyright lawI spoke in Beijing last week at a conference on legal protection of sports broadcasts, organized by the National Copyright Administration of China (NCAC) and the United States Patent and Trademark Office. Other speakers included Chinese judges, Chinese and American lawyers and academics, sports league and broadcaster general counsel, and American and European IP officials. What follows is based on the speech I gave at the conference.

Copyright in sports broadcasts is not explicitly recognized in China by statute, though it has been recognized in some Chinese copyright cases. One of the ongoing debates in China copyright circles is whether explicit statutory recognition ought be given to copyright in sports broadcasts. Any such recognition would involve introducing a new class of copyright subject matter or the expansion of an existing class.

The introduction or expansion of a class of copyright subject matter is often rationalized as limiting free riding and providing an incentive to invest. In the absence of a clear sports broadcast copyright in China, one might therefore expect to find at least some evidence of market failure. However, a quick look at the business of broadcasting certain sports in China indicates a strong market — perhaps even a bubble.

Consider, for instance, Chinese Super League matches. China broadcast rights are, I understand, currently held by an associate of China Media Capital for a five-year term ending in 2021. Rights for the first two years were reportedly acquired for 300 million USD. Rights for years three, four and five were reportedly acquired for a total of one billion USD. In an indication this was a good deal for the head-licensee, Le TV committed to paying 414 million USD for a two-year sub-license, though Le TV subsequently defaulted and, as I understand it, the rights now lie with online TV service PPTV.

Now consider English Premier League matches. China broadcast rights are, I understand, currently held by Super Sports for a six-year term ending in 2020. These rights were reportedly acquired for 65 million USD. Note that this figure represents an assessment of market value made in 2013. For the three years commencing in 2020, PPTV has reportedly bid 700 million USD. This makes China the Premier League’s largest foreign broadcast market.

If these deals are any indication, the market is apparently already behaving as though sports broadcasts are protectable. But there is no proprietary foundation for this protection. The present foundation is contractual. The organizer of the game, a sports league, is the source of all rights in the game. The sports league relies on the “economics of exclusion” — the ability to monetize by controlling access to a sporting venue, in much the same way a theatrical exhibitor of a motion picture controls access to a movie theatre. In some cases, and in some courts, copyright protection has been recognized in China but a consistent jurisprudence has not emerged. The more readily available legal means of protection involve anti-unfair competition laws or the use of administrative or even criminal sanctions. Chinese tort laws and “related rights” laws are also invoked by rights holders when they fight piracy. Whatever the actual or potential legal redress for piracy may be, in assessing the applicable law in China it must be appreciated that a sports broadcast is always a special type of broadcast presenting unique challenges.

What makes sports broadcasts special is that the viewer wants to watch a game as it is played at the venue from which the broadcast is being made. The replay or the highlights are not as valuable as the live feed. The threat posed by illegal downloads after a game concludes is minimal. From a technical perspective, a live broadcast of any kind involves the compression of pre-production and post-production into a seamless and immediate production. That production, and the broadcasting of it, must occur simultaneously. Incidentally, sports leagues report that the advent of hand-held live streaming technology is not a major threat to their businesses because the quality of the stream lacks the production values of a professional broadcast.

The unique challenge of a sports broadcast is that satisfactory relief from a pirated version must be swift. It must be pre-emptive (in advance of the game) or instantaneous (well before the game ends and, ideally, within the first quarter hour). In either case, only urgent injunctive relief can ever be entirely satisfactory. Non-urgent preliminary injunctive relief will not solve the problem, and damages and accounts of profits are insufficient remedies.

Even if sports broadcasts are accorded clear and consistent protection under Chinese copyright law, it is fair to say that uniform urgent injunctive relief (as opposed to preliminary injunctive relief) is still largely beyond the capacity of the Chinese legal system. Therefore, the recognition of copyright in a sports broadcast would not, of itself, solve the underlying need for urgent relief. Still, China’s legal system in its present form does allow rights-holders to tackle repeat offenders, and the large Chinese platforms are already mostly respectful of broadcast rights anyway. In many ways, the real challenges are presented by the smaller, and often ephemeral, pirate sites. Even if these pirate sites can be identified and located, the people behind them nearly always lack substantial assets and are therefore rarely worth pursuing. To be effective in the present environment a sports league (or its local partner) needs a team of Chinese-qualified in-house litigators who understand the piracy landscape and are capable of engaging in guerrilla warfare using technological as well as legal or administrative means.

Despite the existence of these other means, despite evidence pointing to a strong market, and despite the inherent limitations of an action for copyright infringement in China, there is little doubt that explicit statutory recognition of sports broadcast copyright would provide greater certainty and support greater market efficiency. This is especially so if this statutory recognition were given to a broad-based, technology-neutral right embracing traditional broadcasting as well as streaming.

Industry stakeholders are not resisting the recognition of such a sports broadcast copyright. There is apparently a broad consensus among broadcasters and sports leagues on the issue. There is apparently no division between foreign and Chinese interests on this point either. Nor is a sports game sensitive — it is not subject to the kind of censorship, quotas, and approvals processes applicable to motion picture or episodic content. Nonetheless, there is ongoing resistance to the recognition of copyright in sports broadcasts. Resistance has arisen, I understand, because recognition of copyright in sports broadcasts would require the NCAC to change its understanding of the meaning of a copyright “work” and the applicable standards of “originality.” Absent market failure this issue is perhaps not viewed as a major priority. Whatever the reason, until the NCAC resolves this and other current issues it cannot present a coherent solution to the State Council Legislative Affairs Office (SCLAO). The SCLAO is therefore not in a position to recommend final legislation to the National Peoples Congress. The discussion has been bogged down for nearly a decade. All the while, the sports broadcasting industry is getting further and further ahead of the law.

As an important source of or influence on China’s copyright law, the Berne Convention, with its focus on works and authorship, provides a frame of reference for a consideration of the underlying problem in China. China became a party to the Berne Convention in 1992. Berne sets a number of minimum standards applicable to works and authors. A broadcast right is among those rights that must be recognized as exclusive rights of authorization. Authors enjoy the exclusive right of authorizing the broadcasting of their works.

China’s current copyright law has been in effect since 2010. It too applies to “works,” which include, among other things, works of literature, art, natural sciences, social sciences, engineering and technology, which are created in certain “forms.” With the exception of computer software, these forms are limited to specific kinds of works enumerated in the law. The sixth form in the list is “cinematographic works and works created by a process analogous to cinematography.” The ninth and final form in the list is “other works as provided for in laws and administrative regulations.” The rights comprising copyright in these works include the broadcast right. China also recognizes related, neighboring or “small” rights in other subject matter including video recordings. The protection given to these other subject matter is lower than that given to works. The standard of originality expected of a video recording is much lower than that applicable to cinematographic works.

In China, the sports broadcast copyright controversy arises for two reasons. First, because a game of sport is not generally seen as a “work,” so there is no broadcast of a work when a game is broadcast. Second, because even if it is accepted (as it is in the United States) that a broadcast always requires the simultaneous making of a recording, any such recording is insufficiently original to be regarded as a cinematographic work. There is little disagreement on the first reason. The real debate is about the second reason. The competing considerations on this point have been ventilated in the leading Chinese cases. Basically, the debate boils down to whether modern-day live broadcasts, with their professional directors, multi-camera units and advanced editing techniques, are producing content sufficiently original to qualify as a copyright work. It seems obvious to anyone with even a basic understanding of the production process that sports broadcasts are a form of entertainment every bit as sophisticated and entertaining as motion picture or episodic content, the originality of which is already recognized in China.

It will be seen, then, that the minimum standards of Berne, as reflected in Chinese copyright law concerning “works,” are at risk of becoming impediments to the recognition or creation of other copyright subject matter. There is an opportunity here for China to go its own way over and above minimum standards.

Other nations have, of course, gone their own ways and I want to mention two that have found instructive solutions to the problem of “works”: The United States and Australia. Both are obviously common law countries. There are many others, including civil law countries. Incidentally, as a last resort, those who oppose grafting common law principles to the Chinese legal context are fond of saying that German law is the proper source of Chinese copyright law and German law is inconsistent with the common law point of view on the points at issue. The trouble is that claims of this kind are generally made without a German copyright lawyer on hand to clarify the point. A German copyright expert would obviously make a welcome addition to future panels dealing with this issue.

The United States became a party to Berne in 1989. US copyright law is concerned with protecting “original works of authorship.” The recognized works include motion pictures and other audiovisual works. In US jurisprudence, sports games are not “authored” in the relevant sense so they are not “works.” Even so, sports broadcasts in the United States are entitled to copyright protection. The key to their protection is that the broadcasting of a game is understood as always involving the “fixing” of an audiovisual work, and the fact that this fixing occurs simultaneously with a transmission does not matter. This elegant solution was applied in 1976 and obviously did not prevent the US from later joining the Berne Convention.

Australia became a party to Berne in 1928. Australian copyright law is concerned with protecting “works” and “subject matter other than works.” The scope of protection for subject matter other than works is lower than that for traditional works, but this has not stopped them being treated as full copyright subject matter. Subject matter other than works include sound recordings, cinematograph films, and broadcasts. Copyright in a television broadcast is the exclusive right to make a cinematograph film or sound recording and to re-broadcast or communicate to the public otherwise than by re-broadcasting. The maker of the broadcast is the copyright owner. In Australia, copyright protection applies to the signal itself. There is no need to stretch the definition of “work” to include a broadcast. There is no need for the broadcast to contain a work.

These two examples demonstrate how a nation can recognize a certain type of copyright without compromising the minimum standards of Berne or being strangled by a debate about originality standards.

The sports broadcast problem could be solved in China if broadcasts were recognized as involving the fixing of a cinematographic work, of a work created by a process analogous to cinematography, or even of a video recording. Alternatively, some form of recognition could arise within the existing category of “other” works or through the mooted inclusion of a new general category of “audiovisual” works. These solutions would involve minimal disruption to China’s existing copyright system. All they would require would be an acknowledgement that a modern sports broadcasts satisfies a minimum standard of originality. It would not be necessary for a game of sport to be deemed a copyright work. Ultimately, though, these solutions would need to embrace a broad-based, technology-neutral definition of broadcast and they would need to depend on continued improvement in the availability and efficacy of urgent injunctive relief for copyright infringement.

Picture for China Cybersecurity law 101

China’s Cybersecurity Law (CSL) became effective on June 1, 2017 and it regulates the construction, operation, maintenance and use of networks, as well as network security supervision and management within mainland China. The Cyberspace Administration of China (CAC) is the primary governmental authority supervising and enforcing the CSL.

The CSL regulates cybersecurity from different aspects, including network operation security, network information security, as well as monitoring, early warning, and emergency responses.

1. Network Operations Security

Under the CSL, all network operators are required to perform the following duties to protect their networks from interference, damage, or unauthorized visits, as well as to prevent data leaks, thefts or falsification:

  • Create internal security management systems and operating policies, appointing dedicated network security persons;
  • Adopt technological measures to prevent computer viruses, cyber-attacks, network intrusions and other harmful activities;
  • Monitor and record network operational status and network security incidents, and retain relevant network logs for at least six months;
  • Take measures to classify data, back up and encrypt important data.

The CSL states that China has (or will have) a tiered network security protection system and network operators must perform the above duties to ensure network security and to meet the requirements of such a system. This indicates network operator obligations vary depending on their tier.

China currently has two existing network security related tiered protection systems. One is the Computer Information Systems Security Tiered Protection (计算机信息系统安全等级保护制度), the other is Telecommunication Networks Security Tiered Protection (通信网络安全分级保护制度), though the contents of these two overlap regarding network security. Both of these protection systems put computer information systems or telecom networks into five levels of protection, depending on a system’s importance in national security, economic development, and social life, and potential damages to these aspects in the event of network interference. Whether the tiered system mentioned in the CSL will be similar to these two existing systems or a completely new one is not yet clear. But these systems and related national standards likely will be helpful guides to understanding the concept of China’s tiered protection system.

Critical Information Infrastructure Operators

Critical information Infrastructure (CII) and CII operators must comply with more stringent requirements on top of those applicable to all network operators. The CSL provides for the State to implement key protections for CII in public communication and information services, power, traffic, water, finance, public service, electronic government affairs, and other CII that may endanger national security, national welfare and the people’s livelihood, or the public interest in the event of destruction, malfunction or data leakage. No clear definition of CII is found in the CSL and the catchall language leaves plenty of room for interpretation.

However, there is a Network Security Check Practice Guide (网络安全检查操作指南, the “Guide”) created by the CAC[1] before the CSL became effective that may give some guidance in determining CIIs. The Guide lists out fourteen industries[2] and a few key businesses in each industry. If a network or information system is mainly used to support any of these key businesses in  corresponding industry and meets other specific conditions, such a network or system will likely be deemed to be a critical information infrastructure.  For example, online shopping is a key business in the telecommunication and the Internet industry, according to this Guide. One of the conditions for a platform to be determined as a CII is that the platform has more than 10 million registered users or more than 1 million active users.

Though a clear definition and scope of CII have not yet been clarified, the CSL does require CII operators comply with the following, in addition to the requirements for all network operators:\

— Annual security assessment

CII operators shall review their networks’ security and assess potential risk at least once a year, either by themselves or through a third-party service provider.

— Procurement Security Review

When purchasing network products and services, CII operators must sign a security and confidentiality agreement with their vendor, clearly setting out the duties and responsibilities for security and confidentiality. If a vendor procurement may impact national security, CII operators must also go through a national security review by the State network administration (CAC) and other relevant departments of the State Council. The Security Assessment Measures for Network Products and Services provides further details in this regard, which became effective on the same day as the CSL.

— Data localization

CII Operators are required to keep within mainland China all personal information and important data collected and generated within mainland China. They are not allowed to transmit such data overseas without firs passing a security review.

The Draft Data Transfer Measures released in April 2017 (“First Draft”) appear to expand the scope of undertakings for such data localization and security review requirements to non-CII operators, which raised concerns for many foreign companies doing business in China. In a revised draft of the First Draft in May (“Second Draft”), this localization requirement was removed. The Second Draft focuses only on security assessment of cross border data transfer.

— Other requirements

Other requirements for CII operators include the following:

  • Set up dedicated security management and persons responsible for security management, and conduct security background checks on those responsible persons and of personnel in critical positions.
  • Regularly educate, train, and evaluate employees on cybersecurity;
  • Back up important systems and databases in preparation for disasters;
  • Establish emergency response plans for network security incidents and perform drills periodically; and other obligations by law or administrative regulations.

2.  Network Information Security

“Network Information Security” essentially refers to the protection of personal information collected and stored by network operators. All network operators are subject to the following requirements when collecting and using personal information:

  • Maintain strict confidentiality of collected user information.
  • Collect and use personal information legally, properly, and only to the extent the collection is necessary.
  • Disclose the purpose, method, and scope of collection and use, and obtain consent from the person whose personal information is to be collected; personal information irrelevant to the service provided shall not be collected.
  • Networker operators shall not disclose, alter, or destroy collected personal information.
  • In the event of data breach or a likely data breach, network operators must take remedial actions, promptly inform users, and report to the competent government agencies according to relevant regulations.
  • In case of illegal or unauthorized collection and use of personal information, a person is entitled to ask a network operator to delete such personal information; when information collected is wrong, an individual can request correction.

3. Monitor, early warnings and Emergency Response.

 In terms of establishing cybersecurity monitoring, early warnings of potential risk and emergency response plans, the CSL also sets out the responsibilities of the CAC, network operators, local government, and industry specific departments.

——————–

[1] We found different versions of this Guide on the Internet (websites of universities, local governments, etc.), each of which claims to have been released by the CAC. However, the CAC website did not itself have its own guidance on its website when we looked for it.

[2] The different versions of the Guidance we saw are substantially similar. As for the industries listed, one version includes education, news websites, and commercial platforms as key businesses industries, while another does not have these three lists 11 industries. We refer to the former version only for the purpose of this blog post.

Shanghai employment law
Life is RELATIVELY good for Shanghai employers

As I have previously written, one of the best grounds for terminating a China-based employee without having to pay severance is serious breach of employer rules and regulations. I have also written how employers may have no remedy against an employee if they have no specific provisions in their rules and regulations justifying the termination of an employee for serious wrongdoing. But in Shanghai, employers may be able to terminate an employee who has acted in bad faith so long as they have reasonable grounds for doing so pursuant to their rules and regulations.

Let’s look at a recent Shanghai case whose facts I have simplified a bit for this post. The employee was hired to work as a sales assistant. The employee submitted a request to the employer to take 15 personal days because her mother-in-law was sick and she needed to attend to her. The employer approved this request but then learned that the employee went on vacation abroad for about 5 days during the 15-day period. The employer then issued a termination notice, citing a serious breach of labor disciplines based on the employee having deceived her employer to secure her personal days. The employer’s rules and regulations stated that employees could be terminated for dishonest behavior. The employee brought a claim against the employer for unlawful termination and won, but the arbitrators did not award the amount of damages the employee was hoping to get. So both parties were dissatisfied with the arbitral award and sued each other. The employee lost at trial and then lost again on appeal. The employee argued that she had planned to do some international traveling before she asked for the personal days but because her mother-in-law fell ill, she decided to postpone her trip. But when her mother-in-law got well about 5-6 days into her personal leave, she then decided to go on her trip as originally planned. She argued that because she was not getting paid during her personal days and because her employer had already approved her request to take those days off, she should have had the freedom to arrange her own time and basically do whatever she wanted during her personal days.

The court held that even though the employee rightfully went on personal days to take care of her sick mother-in-law, when that basis for her leave ceased to exist, the employee should have performed her duty of good faith and complied with basic professional ethics as an employee and reported her new situation to her employer. Her failure to inform her employer about her planned trip and her using her personal days to go on vacation violated the duty of good faith she owed to her employer. The employer terminated her according to its rules and regulations and there was nothing unlawful about such a termination. The court did not talk about how seemingly harsh the employer’s termination decision was.

Don’t read this case to mean that your rules and regulations do not need to be reasonably specific for it to be held enforceable. Shanghai courts — more so than probably anywhere else in China — dislike employees who act in bad faith. Nonetheless, if you don’t have a set of enforceable rules and regulations, you will still find it virtually impossible to terminate a problem employee.

China bribery. Don't. Just Don't.
China bribery. Don’t. Just Don’t.

Earlier this week I gave a talk before the Chinese Chamber of Commerce in Cleveland. One of the things I talked about was how it is wrong to contend that contracts are not needed in China because of court corruption.

I talked of how most Americans don’t understand court corruption. Otherwise they would not so frequently say that there is no point in bringing a lawsuit in such and such a court because it’s corrupt. Corruption influences (sometimes greatly) court cases, but neither as often nor as much as so widely believed. When dealing with court corruption, one has to be sensitive to location, type of case, and relative influence of the parties. In other words, a $300,000 breach of contract case between a foreign company and a Chinese private company is much more likely to get a “fair trial” in a Chinese court in Shanghai than a case against a massive China State Owned Entity involving stolen trade secrets that might have military applications in the small Chinese city in which that SOE is based and employs a large percentage of the town Sometimes this is due to corruption and sometimes this is due to what lawyers commonly call getting “home-towned.” There are Wall Street lawyers who are as afraid of going to trial in a rural Alabama court as US companies are of going to trial in China.

But when Americans think of a corrupt court they usually think of the opposing party paying a judge in cash for the ruling of their dreams. But it is rarely that simple. I was taught the “finer points” of court corruption by a very smart, very honest Russian lawyer friend of mine who practiced law in the Russian Far East. What he explained to me works pretty much the same way in most of the other emerging market countries of which I am aware with a less than pristine court system — or at least that is what lawyers in some of these countries have told me.

My schooling on Russian court corruption was in “real time” as it involved a real case and a real client. It has been many years so I may be a bit off on the numbers and it is possible things have changed in Russia since then and it is also possible this information held true only for this one region in Russia. It is also possible the Cleveland Cavaliers will sign me to a multi-million dollar contract within the next few months.

My client had a contract with a Russian company under which the Russian company clearly owed my client $2 million, but the Russian company was refusing to pay and all but challenging my client to sue it in a Vladivostok court, the only place my client could pursue its claims. Legally, my client’s case was about as close to a slam-dunk winner as you are likely to see in a business dispute. But my client was rightfully concerned how corruption would influence its case.

Our Russian local counsel explained how we should view the case, corruption warts and all, and he did so by explaining the following:

Nine of the fifteen judges are corrupt. The other six are not. But I still like our case even before one of the corrupt ones. First off, there is a very good chance the opposing side will not offer any bribe at all. Second, our case is so strong it is possible that even if offered, none of the corrupt judges will take it. Third, if any do take the bribe, it will be really high because no judge wants to be thought of as corrupt and ruling against our client in this case will definitely raise eyebrows.

The Russian company will probably need to pay the lower court judge approximately $300,000 for the ruling it wants. And then we can appeal to a three judge appellate panel, made up of judges from throughout the province. A lower percentage of the appellate judges are corrupt and those that are require large payments, especially on a case like this. The odds of all three of our appellate judges being corrupt are quite low. The odds of the Russian company having close connections with any of the appellate judges are lower than when all of the judges are based in its home city. This means that to try to bribe two of the three judges will be very risky and very expensive. Risky because people sometimes do go to jail on bribery charges. Expensive because we are talking about 3 appellate judges. So in the end, I estimate that for the Russian company to be assured of winning through the appellate level, it will need to pay maybe a million dollars. And that ignores our ability to at least try to appeal to the Supreme Court in Moscow.

These numbers are just estimates but this means that even though corruption is a factor, we cannot allow our client to panic in the face of it. We can settle this case on good terms and that is what we should be trying to do. The Russian company would rather pay us to eliminate risk than pay a bunch of judges and take on new risks.

We ended up settling the case and at a figure not all that much lower than what it would have been in the United States.

I am not by any means trying to minimize the impact of corruption; I am merely trying to show that it oftentimes is not as overwhelming as it may initially appear.

Note also that we never discussed our client paying a bribe to anyone. That is always the worst alternative because it puts people at real risk of going to jail without anything close to a guarantee it will even work. When our Russian lawyer said that people in Russia rarely get arrested for bribery, he was talking about Russians, not foreigners. Do you really think you have the savvy to engage in risk-free bribery in a foreign country? I can tell you that none of our firm’s China lawyers would ever make that claim.

When I talked about the above at my Cleveland talk, an audience member, Kimberly Kirkendall, commented that in her experience many of the times where she was aware of someone having paid a bribe in China they had done so essentially because they wanted to, not because it was necessary they do so. We then talked of how some companies seem almost to delight in paying bribes but that our China lawyers — believe it or not — had never once been asked to pay a single bribe in China, even though we are constantly dealing with the Chinese government to register trademarks and copyrights and WFOEs and Joint Ventures. Kimberly commented on how foreigners sometimes brag about paying bribes and how troubled she was by that. I then mentioned how stupid and risky it is to pay bribes in China.

I spoke with Kimberly after the event and learned of her extensive experience and of how she had recently written on China bribery. When I got back to my computer I read what Kimberly had written and I loved it, and with her permission, I am running an excerpt from it below.

 

In China 30 years ago it was very common to incentivize someone to do their job by giving them a gift. Why? The China of the late 1980’s and into the 90’s was a communist economy that relied on 95% government controlled business. And in that communist economy there was very little difference between the salary for the GM of a factory and the guy who mopped the floor. So how were they compensated for their relative value to the organization? The GM could “gift” some of the company’s products to someone else, who often then re-gifted that to someone they wanted to influence and so on and so forth. By gifting them, the GM was able to get a slightly larger apartment, or their child in a better school, or some other economic benefit. People recognized their relative power in the economy by giving and/or accepting gifts. Sometimes cash, but frankly there wasn’t a lot of cash to go around. Much of this was actually bartering, trading your goods/access/influence for someone else’s.

In the booming late 1990’s and into the early 2000’s, as people were allowed to own a business in China, things changed a bit. How do you move a government owned or controlled economy to a privately held one? Where do individuals get the money to buy apartments or companies if they weren’t making much cash beforehand? In this period of transition there were many instances of people using their power and influence for economic gain. From how these government companies were taken private (and ownership and shares divided up) to how people came up with the money to buy apartments or build new ones. In this environment people in high positions saw the money being made and they wanted their share – and now there was the cash to pay them.

Towards the late 2000’s and into today, we are looking at a China where many people (but not all) are in a position to make money in direct ways. Through entrepreneurship, increased education and wages, investment, taking risks on new ventures, or changing jobs to accelerate their careers. Much of the population are no longer stuck in a powerless place where bribes are their only way to obtain value from their position of authority. Certainly it still exists, and there are still people who feel that they can’t get ahead so they exact a little extra money on the side.

When I hear that a US company has used bribes I start wondering about the reason for the bribe. Was it a payment to someone to do his or her job or a payment for them not to do their job? In almost every instance these days, it seems it is the foreigner who initiates the bribe. The below examples of matters on which I personally worked highlight the important difference between these two reasons.

Example: A U.S. company was importing components from China, using both its own team in China to find suppliers and control the orders and a trading company. The US management came to be for help in figuring out why some in their company were claiming that they needed to use a trading company for some of their China business, even though the trading companies were increasing costs by taking their own payments from the transactions. They wanted to know why they were paying a trading company to buy and export goods when they could do all of that themselves. It turned out that a group within the company wanted to utilize lower HTS custom codes for export to save money and Chinese Customs didn’t agree with that custom code classification. The US company was using the trading company to pay China customs a bribe so they could export their products under the “wrong” code and save money. In other words, there was no need to pay bribes, just a desire.

Example: A company was setting up a factory in China and the local government was concerned about air emissions from its manufacturing process. In the U.S. the company had shown that emissions were well within range of EPA guidelines. The local Chinese agency was not convinced and asked for more tests and documentation. The company was left with options – see if there was an “economic incentive” that would encourage the regulatory official to approve the paperwork, or spend a few months and thousands of dollars doing the research to prove their manufacturing met the guidelines. They chose the “economic incentive” route. Again though, an example of a company choosing to pay a bribe out of a desire to get a government official not to do his or her job, not a bribe necessary to get that official to actually do his or her job.

The point I am trying to make here is that the excuse foreigners make about having no choice but to pay a bribe rarely if ever holds true. The foreign companies I hear about paying bribes had plenty of choice; they simply chose wrong. They were not responding to a request for money but offering money as an incentive for a Chinese worker to deviate from his or her professional responsibility.