Resources Profile - Edward E Lehman - Lawyer

INTRODUCTION TO INTELLECTUAL PROPERTY IN THE PEOPLE’S REPUBLIC OF CHINA

Generally speaking, property rights obtained through patents, trade secrets, trademarks, copyrights, and the law of unfair competition have come to be known, collectively, as "intellectual property." Derived and revised from the already existing regulations and international conventions, the latest versions of the Patent Law, Trademark Law, and Copyright Law have come into effect in 2001. As with the rest of the countries in the world, most types of IP can be registered and protected in the People’s Republic of China. Furthermore, developing along with new technology and the Internet, domain names are now considered as a supplementary type of intellectual property.

The below is applicable generally to IP protection and may be used for a number of different operations in China, whether it be trade, distribution, provision of services, solely within China or for goods which will be fully exported and sold in foreign markets.
A. TRADEMARK
1) General Information

Mainland China employs a centralized trademark registration system, the “first-to-file” and single-class system for trademark registrations. This means that the owner of a trademark in a foreign jurisdiction has no priority in China unless and until it has filed its marks. The exception is “well-known” foreign trademarks, such as Coca-Cola or McDonalds, though, the applicability of this category is limited to only the largest and most famous of marks. Therefore, even though a trademark is registered outside China, in almost all cases it will not be protected in China (unless in the case of well-known marks). The same trademark, if used for different products, should be registered in a number of appropriate classes.

The Trademark Office of the P.R.C. is responsible for the registration and overall administration of trademarks in China. If the application proceeds smoothly without any office intervention, it will take about a year and a half to fully register the trademark.

2) Trademark Filing
Filing Requirements

a. Name and address of the applicant, and a Chinese translation for the name and address;
b. 10 reproductions of the trademark (not beyond 10cm x 10cm, but no less than 5cm x 5cm). If color is claimed, two reproductions in black & white are required in addition to the 10 colored ones;
c. A list of goods/services to be covered by the filing (if priority is to be claimed, the goods/services should be the same as those which are shown on the priority documents); and
d. Power of Attorney duly executed by the applicant.
3) Trademark Registration and Use
Upon approval of registration, the term of validity for a trademark will be ten years from the registration date. However, the registrant is obligated to use their registration during this ten-year period for at least three consecutive years. (Failure to do so may result in cancellation.)

The exclusive right to use of a registered trademark is limited to the classes in which the trademark is registered. When using the registered mark, the registrant should not alter its appearance nor its details without authorization of the Trademark Office. A new application must be made whenever there is an alteration of the registered trademark, or an extension of the goods designated. Where a registered trademark is used, the characters “registered trademark” may be indicated on goods, packages of goods, description of goods or other ancillary items. The registered mark may also use the ® symbol which should be placed on the upper- or lower- right hand corner.

Renewal must be filed before expiration of validity. The Trademark Office permits an extension of six months for late filing. However, extra official fees must be paid.

4) Trademark Protection

In China, when discussing trademark protection, we usually refer to the protection of registered trademarks or unregistered, but well-known or famous trademarks. Little protection is granted to unregistered marks. Therefore, registration is the first step to protect your IP.

Trademark Law and the Implementation of the Trademark Law of the P. R. C. are the basis and main regulations for the protection of a trademark. Members of the Paris Convention provide broader protection to well-known marks. If your mark is proved to be a well-known mark under the Convention, you may seek protection under this Convention when an infringement occurs.

There are a number of options available when one suspects infringement of their product:

a. Administrative action: Issued by the local Administration of Industry and Commence, this will be a prompt action, much as the name indicates, to force cessation of infringement. However, very little compensation or indemnity may be collected.
b. Courts: If the registrant, as the victim of infringement, has collected sufficient evidence, it may bring an action directly in court. Civil courts can order the infringer to cease the infringing activity, eliminate the negative effects caused by the infringement, and further award compensation for losses.
c. Customs: Customs may also stop the import or export of products with suspicious trademarks, under the requirement that the registrant provides the necessary evidence or documents. (To be clear, the trademark owner must make a filing with Chinese customs.)
d. Criminal: Serious acts of trademark infringement may be punished by criminal courts, rather than administrative bodies. The Public Security Bureau and Prosecutors are the authorities in charge of investigation and prosecution in criminal tribunals..

5) Trademark’s Function

The basic function of a trademark is to distinguish the goods or services of one natural person, legal person or any other organization from those of another. However, as a type of intellectual property, trade activity in commercial society endows the trademark holder with a potentially valuable asset.

The trademark’s value may be increased by the registrant’s direct and indirect use. The registrant may also collect profits through the sale of their products/services with their trademark. To some degree, the price of products/services are determined by recognition of the trademark attached. Correspondingly, the registrant may collect funds through indirect use, such as licensing, or franchising.

6) Trademark License

Among the methods of indirect use of a trademark, the license is a very important and effective method for the registrant. Licensing means the registrant enters into an agreement with another party, in which registrant allows them to commercially use or develop the trademark for a period of time. In return, the registrant receives money- either a one-time payment or continuous payments called royalties. The power to make this agreement is based on the premise of entitlement to intellectual property rights. Licenses can rapidly increase the fame of a trademark without much investment. Further, the registrant can collect extra royalties as an additional source of income.

License Agreements must be prudently executed in writing and enforced with particular concern. When a trade secret is involved, a nondisclosure agreement must be signed as a necessary supplementary agreement. When a registered trademark is involved, recording of the license agreement with the Chinese Trademark Office is required. Currently, only license agreements for registered trademarks can be recorded with the Trademark Office, which further entitles the licensee to remit royalties out of China.

B. PATENT PROTECTION
In China, patents are divided into three types: invention, utility model, and design. The Patent Law of China defines the three types of patents as follows:

a. An “Invention” patent is defined as any new technical solution relating to a product, a process or improvement thereof;
b. A “Utility model” is any new technical solution relating to shape, structure, or a combination of a product, which is fit for practical use;
c. A “Design” patent is defined as any new design in the shape, pattern, color, or combination thereof, of a product, which creates an aesthetic feeling and is fit for industrial application.

An invention patent refers to “the new technical solution relating to a product, a process or improvement thereof”, which may include inventions or innovative processes. The requirements for invention patents are more stringent than in other categories. Correspondingly, protection for an invention patent, once obtained, is the most extensive among the three types of patents. The process may take 4-6 years for an applicant to obtain a patent after filing; this period may be lengthened if the applicant is a foreign entity.

Utility model patents focus on the specific use of the end product and design patents on the physical features of the product. Compared to invention patents, utility model and design patents are relatively easy to obtain. Since no substantive examination is conducted during the filing procedure, these patents are granted within 8-14 months from the filing date. However, utility model and design patents can also be revoked easily when subjected to the scrutiny of a revocation petition. One reason for this is the requirement that a product must be “novel”. If products were put on the market several years prior to the application, the “novelty” of the products would be lost, an opening that an opposing company may exploit during revocation proceedings.

In addition, as China is a contracting party to the Patent Cooperation Treaty, it is a good practice to file any patents under this regime in order to enable a company to take advantage of the PCT priority date (though it must be made clear that the patent must enter the national phase for each country independently in the sense that there has to be individual registration in each country designated).
C. COPYRIGHTS
In China, copyright protection arises in an “original” work of authorship “fixed” in a tangible medium of expression. Registration with the China Copyright Office is recommended, especially if you wish to file an infringement suit. The copyright owner has five exclusive rights in a copyrighted work, these being the right of reproduction, modification, distribution, public display, and public performance. This is a measure that can proactively prohibit competitors from using a company’s promotional materials/text on packaging to promote their own product.
To be clear, in China, copyright works are automatically protected upon their creation, under the law. However, they may be recorded at the Copyright Bureau, which will issue the owner a certificate of ownership. Armed with this document, the owner will have a significant advantage in the event of future disputes involving the ownership of materials. Pictures, technical blueprints or drawings, designs, written materials, electronic materials such as web pages and computer software can all be recorded at the Copyright Bureau.
D. TRADE SECRETS AND CONFIDENTIAL INFORMATION
In China, a trade secret is defined as information of any sort that is
a. valuable to its owner,
b. not generally known; and
c. that has been kept secret by its owner.
It includes information, formulae, patterns, compilations, programs, devices, methods, techniques, databases, or processes that derive independent economic value from not being generally known or readily ascertainable and is subject to reasonable efforts to maintain its secrecy.
A trade secret owner has the right to keep others from misappropriating and using the trade secret. In China, many trade secret cases involve former employees who steal employer’s trade secrets and Foreign Invested Enterprise partners. Discovery of protected information through independent research, or reverse engineering (taking a product apart to see how it works) is not considered misappropriation.

Trade secret protection endures so long as the requirements for protection (generally, value to the owner and secrecy) continue to be met. Protection is lost, however, if the owner fails to take reasonable steps to maintain secrecy.

Confidential information is information not known to third parties, or the general public, and is deemed and defined by the individual entity as confidential by certain means, usually in writing.

Typically, prudent companies enter into stringent employment, non- disclosure, non-compete, trade secret, conflict of interest, and related agreements in order to avoid later problems.
E. CONCLUSION

As you may see from the above, protection/registration of IP is an essential aspect to protect your company in China. Further, given the lead times for registration, it is advisable to file applications as early as possible. At a minimum, prior to entering the Chinese market in any way other than for simple exploratory visits, it is recommended to file your marks so that you will have priority of registration when the rights are actually granted.

INTRODUCTION TO DUE DILIGENCE IN CHINA:
As most people know, conducting a comprehensive due diligence is an essential (often time-consuming) step to ensure not only success in the China market, but also preventing outright failure. In comparison to the legal environment in more economically developed countries such as the United States or member countries of the EU, in which the accounting books and financial records of a company are somewhat reliable, Chinese companies often suffer from a lack of transparency and rigid organizational structure.
As such, one’s method of conducting due diligence must bear in mind such factors, and may require verification from two to three different sources (depending on the importance of the information).
At the outset of any investigation, a company must assess how risky/important this deal is to their company in terms of investment (of time, money, reputation, and other resources) as well as other factors such as the risk of IP misappropriation, etc. Once this is determined, a rough budget must be set. As a rough guide and although there are some who will state otherwise, a comprehensive legal due diligence for the purposes of a merger or acquisition will cost around US$10,000 and up, while a comprehensive accounting/financial due diligence will be slightly more (based on high-end Chinese firm rates and international firms). However, for trade transactions which require substantially less investigations, costs could range from US$1,000 and up.

A. DUE DILIGENCE PROCESS:

Conducting due diligence in China must often be done by Chinese professionals, not simply because of language, but also cultural and other sensitivities to slight abnormalities which may reveal larger problems. As such, it is our recommendation that companies do engage local advisors, whether they be from international firms with offices in China or local firms.

Typically, the process will proceed as follows (we outline a comprehensive due diligence procedure, other less intensive transactions will warrant lesser investigations/steps where appropriate):

a. A Memorandum of Understanding or Letter of Intent outlining the main heads of agreement that will be signed between Chinese party and foreign party, often accompanied by a formal appendix with specific agreements pertaining to the due diligence activity such as an exclusivity agreement and confidentiality agreement.
b. Party will serve the counter-party with a due diligence document request list, setting out various documents/certificates which are required from company.
c. Review of the returned documents, and analysis of issues. Request of further documentation based on the findings.
d. Independent verification through the following sources:
i) Conduct interviews with management;
ii) Review registrations with local Administration of Industry and Commerce, as well as other relevant government filings;
iii) Site survey;
iv) Environmental audit. This would be particularly relevant for the sale which you are conducting, with the factory’s potential environmental impacts;
v) Verification with banks; and
vi) Employment of investigative/valuation agencies, where necessary.

B. INFORMATION REVIEWED:
Like other jurisdictions, there are certain areas of the company which must be reviewed. We set out the areas of particular importance below:
1) Corporate organization:
a. Corporate structure; and
b. Corporate approvals by relevant government organizations.

Note: Corporate structures are very dissimilar to that of other countries, therefore, it is important to understand the basics of Chinese corporate law in order to understand the implications of findings.

2) Land:
a. Land use rights;
b. Building ownership rights; and
c. Environmental compliance.

Note: Chinese land ‘ownership’ is very unique in that it allows for a system of long-term leases of the land itself, and full ownership rights to the land. Documents must be investigated carefully, particularly, if the land and/or property is of substantial value in relation to the transaction.

3) Debts: Loans, guarantees and mortgage contracts.

Note: China does not yet have a strong central credit reporting system for companies. As such, any reports offered must be verified against independent sources in order to confirm the same, as the initial report may simply lack information regarding the company, resulting in a positive report when, in fact, there are a number of outstanding liabilities.

4) IP rights: Ensure that IP registrations are properly conducted, company is free from violation of others' IP rights, licensing agreements are properly concluded, etc.

5) Material contracts: Particularly, if you are merging or acquiring the company as a going concern, the company must be very careful to ensure that they fully understand obligations and investigate any outstanding commitments and/or liabilities thereunder.

Note: Chinese contracts are often very brief due to the nature of business relations in China. While this is acceptable to some point, it can be seen as very risky in the event that relations turn 'sour'. There are a number of options available to mitigate such risks.

6) Tax filings and payment: Ensure that taxes have been appropriately filed and necessary payments have been made. (This will have to be conducted in coordination with an accounting firm.)

7) Regulatory/legal compliance:

8) Special permits and other approvals: This category is often based on the business scope of the target or counter-party to the transaction.

9) Employee matters: A strong workforce is particularly important in China, given the concentration of foreign investment in labor-intensive sectors and vast population for the service business.

10) Pending litigation/claims: This investigation, as litigation is often difficult to predict, is accompanied by strong warranty clauses assuring the counter-party that there are no outstanding or expected litigations or claims; and

11) Insurance coverage.

OVERVIEW OF FOREIGN INVESTMENT IN CHINA:

A. INTRODUCTION:

China has, in the more recent past, made great strides to liberalize its economy. However, it is still a centrally-planned market, and all foreign businesses operating in China are subject to approval by the government. Decisions related to the same are based on the Catalogue for the Guidance of Foreign Direct Investment, which categorizes businesses, based on business scope/activities, into four different categories: 1) encouraged, 2) restricted, 3) prohibited, and 4) permitted (for those businesses which are not listed in the Catalogue). (Enterprises established in Western regions are subject to the Catalogue for Priority Industries for Foreign Investment in Central and Western Regions.)

Businesses which fall under the ‘encouraged’ category may enjoy quicker approval, beneficial treatment, and better tax policies, along with government support. On the other hand, those in the ‘restricted’ category are often subject to maximum shareholding percentages for the foreign party, forcing joint ventures with Chinese companies. While it may have been commonplace a decade ago to find that your business was in the 'restricted' or 'prohibited' category, these are now reserved mainly for public-infrastructure-type businesses such as banks and telecommunications, as well as those seen to threaten Chinese national interest. The result is that most businesses are allowed to freely operate in China, relatively free to select their preferred establishment method. Relevant to readers is the fact that the trade and distribution market in China has been recently liberalized in 2004, and foreign operators in China are now more free than ever to conduct operations.

Given the previous, it is best for one to consult the Catalogue as the first step in establishing an enterprise. On the likely assumption that the business is not subject to maximum foreign shareholding percentages or prohibited, the foreign investor is allowed to select among a wide range of business establishment options, with the large majority of considerations flowing from business strategy and requirements rather than legal restrictions.

B. LOCATION OF INVESTMENT:

China is the third-largest country in the world and the world’s most populated nation. Further, there are over 56 different ethnic groups around China, in addition to the majority Han. Given these factors and the tremendous differentiation in wealth among the regions, China entrants must be sure to treat China as a multiplicity of markets, as opposed to a single nation-market.

Of particular interest to foreign companies are the cities of Beijing, Shanghai, Guangzhou, and Shenzhen, which account for the majority of foreign investment into China. Though these are prime markets for burgeoning consumer goods retailers and distributors, the cost of doing business in these areas (including labor) are increasing, resulting in the move West by many foreign companies.

China can be divided into four major regions which somewhat mimic economic wealth and geography (major cities therein are set out in brackets): 1) South and Southeast China (Guangzhou, Shenzhen and Xiamen), 2) East China (Shanghai, Nanjing, Suzhou and Ningbo), 3) North and Northeast China (Beijing), and 4) Central and Western China (Chongqing, Chengdu and Xian). As a general rule, wealth in these regions is the highest in zone one and descends through to zone four.

Within these areas are a number of special zones established by the Chinese government to spur foreign investment and technological development, including: 1) Special Economic Zones (Xiamen, Shenzhen, Hainan, Zhuhai and Shantou); 2) Coastal Open Cities (Dalian, Qinghuangdao, Tianjin, Yantai, Zingdao, Lianyuangang, Nantong, Shanghai, Ningbo, Wenzhou, Fuzhou, Guangzhou, Zhanjiang, and Beihai); 3) Economic and Technological Development Zones (ETDZs) (54 in various cities); 4) Special Development Zones (Shanghai's Pudong, Hainan's Yangpu Peninsula, and Chongqing); 5) High-Technology Development Zones (HTDZs) (54 in various cities); 6) Central and Western regions.

Due to new tax regulations, these zones are becoming less attractive for tax reasons, though offer strong infrastructure support and facilities.

C. TYPES OF ENTERPRISES:

In the following section, we outline, in a simple manner, various options one may consider in order to establish a presence in China.

1) Representative Office:
Often regarded as the quickest and easiest way to start a business in China, it must be made clear that a representative office ("RO") is not allowed to directly engage in business activities. Permitted activities include negotiating contacts, rendering advice, market research and general collection of information, all on behalf of the head office. As such, it cannot:
1. invoice or accept payment;
2. enter into contracts directly or on behalf of the foreign company, or
3. arrange for importation of the foreign company’s products.
With the exception of more minor items such as telephone lines and an RO bank account, all contracts and forms should be signed by head office and contain the address of the head office.

Generally, the requirements for establishing an RO are not overly stringent, and so long as the company is in good standing in its home country, there should not be any complications. (RO's of parent companies which engage in certain industries are subject to much stricter regulation.) The registration of an RO is a two-stage process, first, obtaining the Certificate of Approval, and, second, registering with various other government authorities. In the first stage, the company must engage an intermediary company which is authorized to file RO documents on behalf of foreign companies. The intermediary or another registration service provider will assist the company to prepare a number of simple documents, which serve to introduce the RO to Chinese authorities. Notably among these documents is the requirement for an office lease in the Chinese city of registration, with a minimum lease term of one year. (Due to recent changes, it is essential to ensure that the property which the foreign company rents is commercial in nature and, in the case of certain cities, permitted to house foreign companies. Offices in locations other than those set out cannot be registered as RO's.)

Once the Approval Certificate is obtained, the RO must conduct a number of other registrations, including the tax bureau, public security bureau, customs bureau, and foreign exchange bureau.

Thereafter, the RO may conduct its operations in the normal manner, and may hire foreign employees (called “representatives”) and engage a Chinese labor services provider for local hires. This dual system results from the RO not having legal status, so, although, it may select its Chinese employees, it must hire them on a long-term or short-term basis, but only through the labor services company.

Registration for RO’s is generally valid for three years, and any changes of a substantive nature, such as change in office address or change in representatives must be registered with the appropriate authorities.

In practice, representative offices are often used to conduct trade activities. There is a fine line between what is considered to be directly engaging in business and liaison services, so an RO must be mindful not to go too far and violate PRC laws, or they may be subject to fine or be forced to cease operations in China.

2) Joint Venture:

The earliest form of company formation is the joint venture, through promulgation of the first Joint Venture law in 1979. Though modified and supplemented various times, the basic concept remains the same, in that this type of company is simply a limited liability legal person cooperative venture between at least one Chinese party and at least one foreign party. Generally, foreign party involvement is not less than 25%, though may not exceed 50% in certain sensitive industries.

While this form was the preferred method for a number of years, it is somewhat decreasing in popularity with many companies choosing to ‘go at it alone’, though there remain obvious advantages to partnering (at least in the early stages of entry). Joint ventures are divided into Equity Joint Ventures and Cooperative Joint Ventures, with the latter providing more flexibility in terms of share structuring and revenue division. We explain the difference below.

a. Equity Joint Venture;

Equity Joint Ventures were the preferred method by the government in the past due to the rigid structure in which proportionate risk/capital investment equates to proportionate shareholding and profit division. First introduced in 1979 at the beginning of China’s “Opening Up”, this area of law is very well regulated, though somewhat stringent as compared to current standards. In order to enjoy any beneficial tax programs afforded by the Chinese government, it is generally required that the foreign investor own a minimum of 25% of the joint venture. To be clear, if China company invests US$6 million of registered capital and foreign company invests US$4 million, then under this structure, share ownership will be 60% and 40%, respectively.

While it is recommended that efforts should be made to stay away from this structure, this will be subject to negotiations with the Chinese party as well as may be required under Chinese law due to the company's scope of business operations.

b. Contractual Join Venture:

More recent than the Equity Joint Venture, the Contractual Joint Venture was established through promulgation of the Contractual Joint Venture Law in 1988, which allows for more flexibility in terms of shareholding and profit-sharing. Unlike Equity Joint Ventures which require shares to be divided in proportion to capital investment, Contractual Joint Ventures are dictated by contract, and shareholding and revenue division may be disproportionate to capital investment.

(Contractual Joint Ventures, in this sense, must be kept separate from other references to contractual joint ventures in which the relationship, though similar, takes place between two PRC companies, one or more foreign parties and/or one or more local Chinese companies.)

The reasons for establishing a joint venture, regardless of type, from our perspective are as follows:

1) Law:

In some areas such as telecommunications or other restricted industries, it is required that the Chinese party hold a certain minimum percentage of shares, often 50% or greater. In these circumstances, the foreign parties have no choice but to comply if they would like to enter the Chinese market. However, there are a number of methods which foreign companies may strategically use to ensure greater security and control of their investments.

2) Circumstance:

China is a very unique market and due to a number of cultural and political factors, is very much unlike any other country/market in the world. In order to navigate various regulatory hurdles as well as challenges specific to the market such as establishing one's own distribution chain, foreign companies may opt to partner with a company which is knowledgeable about the market, so as to get a ‘leg up’ on the competition.

This strategy has been successfully implemented by French grocer Carrefour, though their decision to select such a model may have been forced through legal requirements at that time rather than selected. (BestBuy has recently announced a joint venture with a major Chinese electronics seller.) Chinese partners bring experience, real estate and established distribution channels to the foreign party, giving it a 'running start' in the competitive Chinese market.

3) Connections:

Similar to that of Japan and Korea, China is a market which requires guangxi or connections in order to successfully grow a business. Finding a local partner who has strong connections will assist any new entrant into the Chinese market.

4) Existing Organizations:

In many instances, Chinese companies will contribute their existing organization and employees to the joint venture. Provided you sign a non-compete agreement with the existing Chinese company, this will allow you to obtain a portion of an organization which has been previously built. (Along with this, you will be inheriting a corporate culture, which could be a good or bad thing, so ensure that you do your due diligence comprehensively.)

In this way, you will most certainly benefit from a quicker start-up as well as lower cost of recruiting key employees. Provided you send a competent manager to protect your interests, this could lead to substantial cost savings.

5) Reduced Costs:

Particularly in the instance of production-oriented enterprises, using a joint venture structure may actually lead to cost savings, as the Chinese party will have an existing enterprise, operating factory, trained staff, and logistics partners, among other things. Through partnering with a Chinese manufacturer, the foreign purchaser/trading partner may align their interests in an effective manner.


While there are a number of positives, these must naturally be weighed against negatives, which we see as follows:
1) Clash of (Corporate)Cultures:

As it is only natural that two organizations have varying perspectives on business and strategy (compounded by cultural factors), there are instances in which there will be conflict.



2) Inability to Expand:

Due to the previous factor, and the fact that Chinese companies often do not have access to capital in the amounts that foreign companies do, Chinese partners may be resistant to increases in registered capital through re-investment of funds or newly contributed capital.

3) IP Theft:

As the Chinese partner and the foreign partner are running a joint business, the foreign party may feel more secure to reveal their trade secrets and other forms of intellectual property. While many Chinese companies are learning to respect such intangible forms of property, they may take your product/process and replicate it in another factory or business which they operate.

However, this is an inescapable truth in China, as the same may happen in a WFOE, however, in this instance, with employees (often senior level) rather than companies.

4) Overvaluation of Chinese Partner’s Assets:

When foreign companies come to China, they are unfamiliar with valuation in China and the worth of certain properties. Certain Chinese companies may take advantage of this fact, and attempt to overvalue their assets when contributing capital to the company's capital.

As in all business structures, both in China and elsewhere around the world, each corporate formation has its advantages and disadvantages. The key, if a company decides to joint venture with a Chinese company, is to ensure that a comprehensive due diligence is undertaken, including an analysis of the company's corporate culture and its management, so as to ensure that there is a strong match between the parties, optimistically resulting in synergies between the organizations. Further, after the deal is concluded, foreign companies must be committed to China for the long-term and expend adequate resources (including frequent visits by top management) in order to support local expat/Chinese national managers.

3) Wholly Foreign Owned Enterprise:

Increasingly popular over the years, foreign companies are using this form of venture to enter and expand in the Chinese market. Promulgated in 1986, the Law of the PRC on Wholly Owned Foreign Enterprises (WFOE(s)) greatly liberalized China's economy for foreign direct investment. A WFOE is a wholly owned company by one or more foreign individuals or legal persons.

Over the years, more and more business areas have shifted out of the prohibited and restricted categories into the permitted and encouraged, which increasingly allows for WFOEs.

Though very similar to a standard limited liability corporation once operational, establishment of WFOEs are still subject to governmental approval. 'Incorporation' is a two-stage process: 1) application to the Ministry of Commerce or its branch office; and 2) registration with a number of authorities such as the national and local tax bureau, foreign exchange bureau, public security bureau, and obtaining the company’s business license at the Administration for Industry and Commerce.

Generally, in the first stage, so long as documents are carefully prepared and the application is compliant with minimum (prevailing) capital and other requirements, approval is not difficult, particularly if the company is involved in a relatively simple business area such as consulting or manufacturing. (Although, in smaller, less open jurisdictions, there may be some 'back and forth' with government approvals prior to approval.) If the project application is successful, a Foreign Investment Approval Certificate will be issued to the enterprise.

The company will then obtain an enterprise identity code which it will require to register with a number of authorities, the major ones of which are as below:

1) Public security bureau;
2) Foreign exchange bureau;
3) Customs;
4) National tax bureau;
5) Local tax bureau;
6) Statistics bureau;
7) Administration for Industry and Commerce (Business license).

Thereafter, the WFOE operates in a manner similar to that of enterprises in other countries, subject to unique tax requirements to China, including an annual audit.

The major reason for establishing a WFOE is the greater control which a foreign company has on operations and expansion of the business. This, however, must be balanced against the possible higher costs and longer lead times before the company is profitable, in addition to the greater levels of reliance on China staff (though unscrupulous staff may always be replaced while replacement of a joint venture partner would be much more difficult).

4) Joint Stock Companies:

The formation of a joint stock limited liability company is a pre-requisite for listing on a Mainland stock exchange. Much like the Western 'corporation’, ownership of a joint stock company is divided into shares as opposed to shareholding percentages in other Chinese limited liability business formations. This allows one to freely dispose of shares without requiring prior approval of government authorities.

Although this structure is attractive, it is still in its formative stages and the requirement of RMB 30 million for FIE's (the Company Law of 2005 reduced registered capital requirements from RMB 10 million to RMB 5 million for domestic joint stock companies). Further, there are a number of other formalities which make formation of such a structure for new China entrants difficult and impractical.

5) Holding Companies:

Holding companies or ‘investment companies’ as they are referred to in Chinese serve much the same function as they do in other countries, an overall structure which consolidates investments under one organization. While not difficult to accomplish in other countries, this is rather difficult in China, requiring either of the following:

a. Worldwide assets of US$400 million and US$10 worth of investments in China; or
b. Investment of over US$30 million and 10 or more projects or companies in China.

As can be seen from the requirements, this structure is limited to China’s largest MNC’s and is not a likely strategy for many in the short-term. (Recent studies have shown that there are approximately 250 of such foreign companies in China.)

D. TAXES

The basic framework for income taxation of FIEs is set out in the PRC Foreign Investment Enterprise and Foreign Enterprise Income Tax Law and implementing rules. The present FIE taxation law provides for equal treatment of all FIE structures, subject to tax concessions offered by economic and free trade zones, which vary depending on the defined scope of business. The regular corporate income tax rate is 33%, composed of a 30% national plus a 3% local tax.

Further, depending on whether the enterprise sells goods or services, it will be subject to an additional tax per transaction, termed Value Added Tax (VAT) or business tax, respectively. VAT is charged in respect of product type sold, and varies from 0% to 17%, though the majority of goods fall in the 17% category. Business tax, on the other hand, varies with the type of service provided, ranging from 0% to around 5%. Remission of taxes collected takes place on, generally, not less than a monthly basis.

E. INTELLECTUAL PROPERTY

Protection of a foreign investor’s IP rights should be at the forefront of its plans to establish a business entity in the PRC. Recently (especially with the PRC’s accession to WTO) there is a greater recognition of the value of IP rights and greater protection offered. However, IP enforcement still has not reached the level that is normally enjoyed in developed countries. Therefore, it is imperative for foreign investors to take appropriate measures in the PRC to ensure that all of its IP is given maximum protection.

a. Patent Protection

In the PRC, patents are divided into three types: invention, utility model, and design. The Patent Law of the PRC defines the three types of patents as follows:

• “Invention” patent is defined as any new technical solution relating to a product, a process or improvement thereof;
• “Utility model” is any new technical solution relating to shape, structure, or a combination of a product, which is fit for practical use; and
• “Design” patent is defined as any new design in shape, pattern, color, or a combination thereof, of a product, which creates an aesthetic feeling and is fit for industrial application.


b. Trademark Protection

In the PRC, as in most jurisdictions, trademarks and service marks are words, names, symbols, or devices used by manufacturers and service providers to identify their goods and services and to distinguish their goods and services from those manufactured and sold by others.

A trademark that resembles a trademark already used in PRC as likely to cause confusion or mistake may not be registered. In addition, trademarks which are descriptive of functions, quality, or characteristics of goods or services must meet special requirements before they will be protected.

A mark, either in Roman letters, Cyrillic letters, or Chinese characters, is registered with the Chinese Trademark Office, which grants the owner a proprietary right in the name or mark to the exclusion of all others for use on the registered goods or services. It protects a trademark holder’s commercial identity in PRC (goodwill, reputation, and advertising investment). The validity of the registered trademark is ten years and renewable 6 months prior to expiration.

The PRC is a first-to-file jurisdiction for trademarks. This means that the holder of a trademark in a foreign jurisdiction has no priority in PRC unless and until it has filed its marks. The sole exception is “well-known” foreign trademarks, such as Coca-Cola or McDonalds. Therefore, even though a trademark is registered outside PRC, in almost all cases, it is not protected in PRC.

Foreign investors may also have several additional brand names other than their corporate name and logo, such as product names which are sufficiently unique to be used as trademarks. If a prior registration blocks registration of a mark used by a foreign investor, there are several legal actions available to resolve the matter.

Because the PRC is a first-to-file jurisdiction, it is imperative that new marks are filed quickly, even before the actual product or service is introduced. It is possible that a disgruntled employee or competitor, with knowledge of new operations, could file a mark first. Therefore, whenever a foreign investor introduces a new product or service, it should register the relevant trademarks immediately.

c. Trade Secret Protection

In the PRC, a trade secret is defined as information of any sort that is valuable to its owner, not generally known, and efforts have been made by its owner to maintain its secrecy. It includes information, formulae, patterns, compilations, programs, devices, methods, techniques, databases, or processes that derive independent economic value from not being generally known or readily ascertainable and are subject to reasonable efforts to maintain secrecy.

A trade secret owner has the right to prevent others from misappropriating and using the trade secret. Sometimes misappropriation is the result of industrial espionage. In PRC, however, most trade secret cases involve former employees who steal employer’s trade secrets, hackers, end users, retailers, and FIE partners. Trade secret owners have recourse only against misappropriation. Discovery of protected information through independent research, or reverse engineering is not considered misappropriation.

Trade secret protection endures so long as the requirements for protection (generally, value to the owner and secrecy) continue to be met. The protection is lost, however, if the owner fails to take reasonable measures to maintain the information’s secrecy.

Typically, FIEs enter into stringent employment, non-compete, trade secret, conflict of interest, and related agreements in order to avoid later problems.
d. Domain Name Protection
It is advisable that foreign investors register all their domain names with the Chinese country code, “.com.cn” or .”.cn” . To ensure that other companies do not reserve the domain name in the PRC with the intention of publicizing counterfeit products or cyber squatting, a foreign investor should register their domain name both in Chinese and English in the PRC. Domain names should be registered with the PRC Internet Network Information Center (CNNIC) in Beijing.

F. CONCLUSION

The following was designed to provide a brief introduction to issues which a foreign investor should consider before investing into China. It is highly recommended that foreign investors, before making any substantive decisions, consult a professional services organization such as a law firm or consulting company which may assist them in further defining their entry structure.