Intellectual Property Rights in China
By Klaus Koehler, Managing Director, Klako Group

Intellectual Property Rights in China

"If you can make it, they can fake it!" - A common phrase used in China. China's economic boom is not only about the nine percent annual growth rate. The counterfeiting business accounts for approximately USD $24 billion in lost sales per year. Intellectual property rights (IPR) is an important issue for many foreign investors. Many companies are concerned about IPR issues and one of their many concerns is whether they should still do business in China without exposing their company to an intellectual property nightmare?

Counterfeit products are everywhere, not only China. Name any major branded product - from software and cars to music and prescription drugs - and there is a forgery somewhere in the world. Problem is that lately it has become more difficult to spot the fakes causing a serious competitive threat to foreign companies. According to the Worlds Customs Organization, counterfeiting accounts for five to seven percent of global merchandise trade, equivalent to lost sales of as much as an estimated USD $512 billion in 2004. While counterfeit products is a worldwide issue, it is most recognized in China, which is home to two-thirds of the world's fake and pirated goods. In 2004, China confiscated 85 million counterfeit publications, from books and movies to computer discs.

For the Chinese pirating goods, manufacturing knock-offs and violating intellectual property rights is a winning strategy as it allows them to save costs on brand building, advertising and R&D, leading directly into profit-making.

Although counterfeiting is illegal, the Chinese government is in a predicament because, to put it simply, fakes have been and continue to be good for the economy. Estimates indicate that in 2004, counterfeit products accounted for nearly eight percent of the nations GDP. Furthermore, the profits earned from counterfeiting and violations of intellectual property rights are critical to local economies. Counterfeiting absorbs large numbers of workers, generates substantial revenues and provides tax revenues. For years, Chinese authorities turned a blind eye to counterfeiting on the grounds that it helped spread developing technology and essentially it is a "victimless" crime. The Chinese have a tendancy to borrow, not steal, and copying technologies is not seen as ethically wrong.

An important reason for the continuous problem in counterfeiting, is that local governments continue to support the trade in counterfeit goods. The central government has yet to crack down on them. China established the Administration of Industry and Commerce (AIC) as a branch of each local government aimed at promoting, regulating and policing commercial activity. Typically, the AIC invests its own funds in establishing wholesale markets and collects rent from the wholesale distributors. The AIC issues business licenses to proprietors and once a business is up and running, the agency collects management fees. On the other hand, the AICs are charged with policing and enforcing the very markets in which they and the local governments have a substantial investment and financial interest. In fact as the production of counterfeit goods increased these markets became distribution centers. Today, local governments are both directly and indirectly involved in the counterfeiting trade. For example, the local AIC in Yiwu has invested millions of dollars in constructing the wholesale markets that sell counterfeit goods. The AIC charges monthly management fees to the businesses that sell these illegal goods. Shutting down the market would result in a direct loss of revenue for the AIC.

However the Chinese government is taking things more seriously. It is difficult to slow down or even prevent IPR infringements as the whole process of counterfeiting is a consequence of globalization itself. Globalization is the spread of capital and technical know-how to new markets, which in turn contributes low-cost labor to create the ideal export machine, manufacturing cheap-stuff and moving up the value chain. That's the story of China. Now in turn that's the story of Fake Goods. Counterfeiting involves skilled labor, smart distribution, and product savvy without worrying about costly details such as research and brand building.

And as a result many fakes are so good that even companies require forensic scientists to distinguish whether the goods are fake or not. Shanghai Mitsubishi Elevator Co Ltd discovered a counterfeit elevator after a building owner asked the company for a maintenance contract.

Sometimes it is also easy to find the counterfeiters. Many markets are tourist hotspots, such as Ziyuangang market in Guangzhou or Xiangyang Market in Shanghai, indoor or outdoor shopping markets that offer row upon row of fake Gucci, Prada, Louis Vuitton and more. Each shop has a few samples but offers vast catalogues of goods that can be delivered. Fakes even have grades of quality and can be exported. Goods are usually disguised before they reach the final destination. For example, Shanghai customs officials were inspecting a Dubai-bound shipment of motorcycles labeled with the brand name Honling. When the inspectors peeled back stickers on the machines cases, they found Yamaha engraved on the casting.

IPR Enforcement

While the counterfeiters are piling up on profits, the multinationals are spending ever more on stopping them. LVMH Moet Hennessy Louis Vuitton for example, spent USD $16 million in 2004 on investigations, busts and legal fees. GM has seven full-time staffers investigating around the globe and Pfizer has five people working in Asia alone.

The biggest challenge is getting cooperation from China. For years the Chinese have always turned a blind eye, except when it concerned local companies. In 2004, 15 infants died from phony milk powder. The ringleader was sentenced to eight years in prison. But when the victim is a company not an individual, the courts are far less severe. In June 2004, a Guangdong businessman was found guilty of producing fake windshields under 15 difference brand names, including GM, DaimlerChrysler and Mitsubishi Motors. He was fined just USD $97,000 and given a suspended sentence.

Now China is toughening its legal sanctions. In December 2004, Beijing lowered the threshold for criminal prosecution of counterfeiters. Prior to the changes, an individual needed to have USD $12,000 worth of goods on hand before police could prosecute. It was easy to avoid this rule as goods were then spread in various locations. Today that threshold stands at USD $6,000 for counterfeiters caught with one brand and USD $3,600 for those with two or more and can be sentenced to less than three years in jail with the additional possibility of a fine. And those caught trading more than 5,000 pirated discs will receive sentences of up to seven years imprisonment. And in late January 2005, Beijing began the trial of two Americans who are accused of selling USD $840,000 in knockoff CDs and DVDs made in China over the internet. The two could face up to 15 years in jail if convicted.

A specific example is of a Lebanese national who was caught in March 2005 on suspicion of manufacturing fake cosmetics, he most likely did not expect any criminal charges. His company had already offered to pay USD $120,000 hoping to quietly settle the case. This hope was based on his previous experiences of being caught in 2003 and 2004 by the Quality Supervisory Authorities of another two cities in the province for manufacturing counterfeit Hugo Boss perfume and Miswak toothpaste. In both incidents, punishment included confiscation of the products, fines and orders to stop manufacturing. In this case, both he and his accomplices were arrested. It is reported that the company produced 43 different markets, including P&G, Unilever and Henkel as well as Boss, Chanel and Lancome. He could not provide evidence that the brand owners had authorized him to manufacture. For the previous 6 months the company delivered containers of goods worth USD $700,000 to countries in the Middle East. A stockpile of goods valued at USD $241,000 were found in the warehouse.

One main issue is that too many counterfeiters are connected to local officials, who see the business as a major source of employment and pillars of the local economy. A raid last August 2004 in Fujian Province, where police found a dirt-covered hatch hiding a stairway that led into a pitch-black cave stocked with a rolling machine, cigarette paper and a die for stamping Marlboros and Double Happiness packaging. But the counterfeiters themselves were gone with the cigarettes.

Avoidance of IPR Infringements

There is no single or simple solution to protecting intellectual property in China. The ideal checklist includes obtaining comprehensive local protection in the form of patents, copyrights or trademarks for the products, lobbying with the growing number of protection agencies, and developing sensible business strategies that IP risk into account.

A minimum requirement for protecting intellectual property is to ensure that your patents, copyrights and trademarks are registered in conformance with China's domestic legal requirements, which differ in a few important areas from commonly accepted norms. For example, Chinese law allows patents to be granted on the basis of "utility model" and of "design". Neither requires the detailed substantive examination that is generally regarded as the hallmark of patent applications. But both must be done to protect your rights. Also understand and protect yourself against the first-to-file rule in China. The rule means the same trademark can be filed by a local company either for use in counterfeiting or as a tactic to squeeze a multinational for cash.

By doing this, IPR owners remove a procedural obstacle if legal action becomes necessary because enforcing copyright infringement requires proof in three forms - evidence of IPR infringement, a power of attorney (providing the applicant with the right to request such action on behalf of the multinational corporation) and the registration certificate.

Companies that have been in China for some time know the importance of developing relationships with the four main enforcement agencies that oversee IPR infringements:

" The Administration of Industry and Commerce (AIC);
" The Administration for Quality Supervision, Inspection and Quarantine;
" The General Administration of Customs; and
" The Public Security Bureau (police).

Determining which agency to turn to when there is an IPR violation depends on the circumstances. For example, if counterfeit goods are being exported, contact the customs agency, if a distributor is carrying counterfeit goods, the AIC is supposed to take action.

As improvements are made in the legal system concerning trademarks and as the general public's awareness about trademarks is heightened, applications for trademark registration in China have increased. In 2004, 588,000 applications were filed for trademark registration - 136,000 more than the previous year - and an increase of 30 percent. In 2004, the AICs across China investigated and dealt with 51,851 law-violation cases involving trademarks. Of these 5,494 concerned foreign trademarks. Of the 51,851 cases investigated, 11,680 were common violations of the trademark laws and regulations. The rest of the cases were trademark infringement or counterfeiting. They confiscated and disposed of 38, 951, 800 pieces of illegal trademark logos, confiscated 280,800 tools such as molds or press plates used for the infringement and confiscated and destroyed 5,638.53 tons of items that had been used for the infringement. They transferred to judicial organs 96 cases involving 82 people to pursue their criminal responsibilities.

Outlook

Foreign companies who decide to establish their entity in China should take all precautions to avoid possible IPR Infringements. If the companies register all their patents and trademarks, it does not necessarily mean they are safe but it is a step forward to being protected.

If you require assistance with the above subject, please contact us at info@klako.com with your detailed questions.

All information in this report is verified to the best of our ability and is assumed to be correct at time of release; however, Klako Group does not accept responsibility for any losses arising from reliance on the information provided within.