This article was originally published on IPWATCHDOG on June 9th, 2020. See the original publication here.
For months now, the news has been plastered with updates on COVID-19, the novel coronavirus that has upended lives and trickled into near every facet of the modern experience. In the midst of quarantines and “social distancing”, the question has been raised by political parties left and right if the U.S. should continue relying on countries like China to manufacture products ranging from lipsticks, sneakers to diabetes drugs, ventilators and masks. Amid criticism, China may no longer be the favored child when it comes to manufacturing consumer goods for the Western world; nevertheless, it would still be tough to come up with the second-best choice given other countries such as India are still crippled by and struggling with Covid19. The reality is, like it or not, China is and will still remain the dominant player when it comes to manufacturing products for the Western world at least for the next five years. Factories are operating at about 80-90% capacity now and ready to take orders. Covid19 highlights the legal iss, what are the legal issues to be concerned about in 2020 in addition to the safety/health of the workers and steady supply chain?
OEM stands for Original Equipment Manufacturer; this is the very business model that has been going on for decades allowing Western companies to manufacture products in China at a fraction of a cost and to sell them back to the U.S. marks at a high margin. This very process has triggered a spike of consumer consumption, aided by a steady decrease of prices for everyday products. However, during the process, China has also changed its role from being the “World’s Factory” to a retail giant, second only to the United States (2019). The rhetoric between the U.S. and China during the pandemic doesn’t exactly ease the tension between the countries. The Chinese government has long made it clear in its national policies such as “Belt & Road” and “Made in China 2025”, its priority is no longer serving as the back-door factory for global brands but to make brands of its own and to become an economy producing high value products and services. As such, the OEM industry is now taking a back seat. Interestingly, in a communist country where law is more of less dictated by the politics, the Chinese Supreme People’s Court (“SPC”) also breaks away from prior precedents, takes away the golden shield that used to insulate the OEM manufacturing to trademark infringement and open up OEM to a whole new legal risks and scrutiny.
The Key Question:
All the cases we will cover here center around one question: Is it considered trademark infringement to a third party’s registered trademark rights, under the Chinese law, if a Chinese manufacturer merely affixes a trademark to some finished goods and such goods will be exported overseas but the manufacturer itself or the party from which it takes order does not own the said trademark in China?
As an example, let’s say a US company (Cooper Inc.) is the owner of a successful pet toy brand called “CHESTER”; it has long engaged a Chinese company (Mr. Wang) in Shenzhen to manufacture and export the pet toys back to the US. Cooper Inc. does not own any trademarks in China. In fact, a third party owns the trademark “CHESTER” covering the pet toy category. To make things worse, let’s assume a third party (Ms. Piper) used to work for Mr. Wang and know exactly how profitable the Chester branded toys are; or Ms. Piper was the company that first received and processed Cooper Inc.’s order to make sample pet toys; or, Ms. Piper simply watches Shark Thank one day and loves Cooper CEO’s pitch and decides to register the brand in China.
- Question (1): Can Piper successfully bring a trademark infringement claim against Cooper Inc. given Piper is the owner of the CHESTER trademark in China and the products are manufactured in China?
- Question (2): Can Cooper Inc. defend the infringement claim by pointing out that it owns the CHESTER trademark in the destination country (USA) and as such, convince the Chinese customs to release the shipment so it can arrive in the US in time for Christmas?
- Question (3): Assuming Piper is still the trademark owner of the CHESTER brand in China for dog toys but she does not have the prior (bad faith) connection discussed above. A small factory in Shenzhen receives a purchase order to manufacture 1,000 CHESTER-branded pet toys which will be exported to Indonesia; the buyer is the dominant Indonesia pet company and it owns a “CHESTER” trademark in Indonesia, not China. Under such circumstances, can Piper still convince the Chinese customs to seize the Indonesia-bound shipment because she is the owner of the trademark in China? Can she succeed in bringing a trademark infringement lawsuit to stop the manufacturing even though the Indonesia company owns the trademark in the destination country?
- Question (4): Continuing on the fact scenario from Question (3), can the Shenzhen factory defend the infringement lawsuit and successfully get its shipment released and sent to Cooper Inc. in Jakarta by producing the trademark registration certificate issued by the Indonesia trademark office?
China, like most Asian countries, is a first to file country. In plain English, this means the IP ownership of a trademark belongs to someone who beats everyone else and registers the trademark first with China Trademark Office. The law is pretty clear-cut but it also disregards some prior “rights” such as a company which have been the one creating the brand and using the brand for years but simply omitted to register the mark in China. This also means there are a lot of opportunistic bad-faith players in China who are not the one first inventing or using the brand but are able to hold the real brandowners hostage because, under the Chinese law, these brand owners are the infringers to their own brand. If this is allowed to happen, this means a single rotten tomato is able to throw the entire OEM factory and hundreds of jobs at risk simply because he or she registers the trademark first in China. To avoid this from happening, the SPC made an exception in the Pretul and the Dongfeng cases to shield the OEM industry.
The Pretul (2015) case and the Dongfeng case (2017):
Historically, companies have been able to issue contracts to Chinese manufacturers for the production and export of trademark-affixed goods without being too concerned about the fact that their trademarks have long been taken and registered by some bad actors in China. This is because the OEM industry has been protected by two landmark SPC decisions discussed in the Pretul and the Dongfeng case.
Under the standard given in Pujiang Yahuan Lock Co Ltd v Focker Security Products International Limited ((2014) MinTiZi No 38) (the “PRETUL Case”), the act of affixing a mark to goods, without any intent to distribute or sell the goods in the domestic China market, did not constitute use of the mark. Put simply, OEM use is not trademark use because it is just only a physical mark-attachment and the resulting product will be tightly sealed and immediately bound for markets outside China which means such use cannot play the function of identifying the source of goods and there’s little possibility to cause consumer confusion in the Chinese market. Accordingly, in this context, it is not possible to infringe the Chinese owner’s trademark rights.
In December 2017, the SPC held a retrial of Jiangsu Chang Jia Jin Feng Power Machinery Co., Ltd v. Shanghai Diesel Engine Co. Ltd ((2016) Zui Gao Fa Min Zai No 339) (the “DONG FENG Case”), affirming the Pretul principle by applying the same standards discussed in the case. Once again, the SPC noted that the mere act of affixing a mark did not rise to the level of trademark infringement as it would not affect the normal identification and distinguishing function of the Chinese owner’s trademark rights
Under the twin standards of PRETUL and DONG FENG, OEM manufacturing factories could safely affix the trademarks of their clients to goods for export without concern of violating Chinese law (or bowing too much or paying the ransom to the third party who happens to be the first to register their trademark). Following these two cases, the Chinese manufacturing factories and plants from Shenzhen to Dalian are happy and busy to keep the machines running because (1) there’s little risk they would be sued for trademark infringements; and (2) there’s little risk their finished products will be questioned or stopped at the Chinese customs. If questioned, they can simply produce the OEM order or, take one step further, the registration certificate from the destination country such as the “CHESTER” registration certificate from the USA or Indonesia and the Chinese customs would release the shipment so the pet toys can go on their merry way to New York, Atlanta or Jakarta. The Western brand owners are happy as well – it’s frustrating their trademarks are taken in China. However, this poses small actual disruptions to businesses so long as their activities in China are narrowly focused on OEM only and they have no plan to market or sell such products to the domestic Chinese consumers.
Under the Pretul Case and the Dong Feng Case, OEM is a golden exception to trademark infringement. The twin standards discussed in both cases strike a delicate balance because the Law not only protects the Western brand owners but also the giant OEM industry in China that employs tens and thousands of people across South Eastern China. The unspoken reality is that most Western brands are already taken and registered by a bad faith third party in China; unless some ransom is paid, it is almost impossible to get the trademark back immediately under China’s registration-is-king principle. Further, although a brand owner could potentially rely on an invalidation action to get their trademark back, these legal proceedings take years. Businesses need assurances and a definite safe harbor that they could ship the products out of China without the risks such products being detained or seized at the Chinese border; the SPC understands this business concern and the market reality, which explains why they made OEM literally above the law. Under the Pretul and the Dongfeng principle the only thing one needs to worry about is to prove that the underlying business activities are indeed OEM which is not too difficult. One can achieve this goal by providing for example a contract between the parties and the contract specifically limits the use of the mark in the manufacturing stage along with relevant clause that specifies all products will be immediately sealed and shipped overseas.
The Honda Case (2019):
However, things took a different turn in 2019/2020.
In September 2019, the SPC decided Honda Motor Co Ltd v Chongqing Hengsheng Xintai Trading Co Ltd ((2019) Zui Gao Fa Min Zai No 138) (the “HONDA Case”), which departed from the prior jurisprudence articulated in the PRETUL and DONG FENG Cases. Here are some basic facts in the Honda Case:
- Honda, the famous Japanese car company, owns various HONDA trademark registrations in China (covering Class 12 products including vehicles and car parts).
- Two manufacturing companies in China were commissioned by a third company (called Burmese Meihua Company Limited) to manufacture and export 220 motorcycle parts in China and to ship them to Myanmar. These products will bear the trademark: “HONDAKIT & Design”. Meihua owns a Burmese trademark registration for “HONDAKIT” in Class 12.
- In 2016, the production was completed but it was stopped at the customs in China, suspecting infringement to Honda’s trademark rights. The shipment was released because the customs, upon showing of the Burmese trademark, was not able to determine if this case was indeed a trademark infringement case. Honda was notified and given an option to bring a court case if they were not happy with the customs’ decision.
- In 2016, Honda filed a trademark infringement lawsuit against the two companies in China who were in charge of manufacturing and exporting. The first court supported Honda’s position, finding infringement, and asked the defendants to pay Honda roughly US $43,000. In 2017, the second court dismissed an infringement claim, pointing out this was an OEM case and following the principles discussed in the Pretul and the Dong Feng Case, a trademark infringement could not be found in this type of case. Dissatisfied, Honda filed a retrial application with the SPC. In 2019, SPC issued a (shocking) retrial judgment confirming that although the facts in the case fit squarely in the OEM context, an infringement could still be possible. Indeed, SPC recognized infringement in the Honda case.
There are several factors in the Honda Case that support an infringement finding: (1) HONDA is an extremely popular and well-known trademark in China; as such, although average consumers will not be exposed to this type of trademark activity, the operators who affix the mark to the motorcycle parts should’ve known the HONDA trademark belongs to the Japanese car company; (2) there are several bad faith factors present in this case. For example, although the defendant does indeed own the trademark in the destination country, the trademark registered in the destination country does not match exactly the mark in use – for example, the mark used by the defendant has “HONDA” printed in larger size than “KIT” (while the mark registered has HONDAKIT printed in the same text) along with a wing design in red color over which Honda also owns a registration in China. Based on the above, although SPC did agree the relation between Meihua and the defendants was indeed an OEM arrangement, SPC went on to find infringement. Contrary to the Pretul and the Dongfeng precedents, just because the use of a trademark takes place in the OEM context does not mean the use is for sure infringement-free. The SPC took a “wholistic” view (and a very broad interpretation) and asked the decision-maker to look at all factors in determining infringement. The key word here is “access”. In the Honda case, SPC pointed out that consumer confusion is still likely because the resulting products from the OEM relationship could still be “accessed” by the relevant public, e.g. the operators of goods transportation, the Chinese consumers travelling abroad or making cross-border online shopping. Note that there is no discussion about actual confusion; when SPC is determined not to protect a bad-faith actor, an abstractedly possible confusion will do.
In conclusion, the golden shield is taken away by the SPC in the Honda case. Previously, under the Pretul/Dongfeng case, even though China follows the first-to-file principle, a trademark owner cannot successfully sue for infringement or cause a shipment to be detained simply because he/she owns the trademark in China. The Honda case rips apart that presumption. A party is able to successfully bring a lawsuit and cause shipment to be detained at the Chinese border as long as one owns the trademark, in China, for the underlying goods along with a whole strings of factors that tip the scale to his/her favor; the manufacturing party (or the party commissioning the products to be made) is no longer able to get the shipment released just because it owns the trademark in the destination country.
The Honda decision made it clear that a trademark infringement is no longer black and white in the OEM context; it is no longer presumed infringement free and can be insulated from China’s trademark law. Implicit in the decision and consistent with China’s national policies are the determination that China is no longer interested in being merely the World’s Factory; OEM is now open to scrutiny just like every other commercial activity and everything will be considered and weighted in the infringement (and national politics) equation.
So… What’s Next?
China’s trademark system is still full of bad-faith filings, where bad actors own multiple third parties’ trademarks, including some of the world’s most famous brands. Now, with the PRETUL-DONG FENG protection gone, Western companies manufacturing their products in China will face new scrutiny; everything is now in a “gray area”, with no guarantee of protection from China’s top court.
In 2020, despite multiple amendments to the Trademark Law, including the newly issued standards in determining infringements, little guidance has been given from SPC or China’s regulatory bodies on this OME issue. Chinese rightsholders are now encouraged to file for infringement lawsuits and to register “their” marks with the customs to trigger shipment seizure/detainment. Some of these cases are justified, just like the HONDA case, but others may be motivated by bad faith to hold a legitimate brandowners hostage. Following HONDA, a bad-faith trademark owner can now cause real business disruption by delaying a U.S.-bound shipment at the Chinese customs, unless the rightsholder is either willing to pay a ransom or spend six plus months in court. For example, a shipment valued at $2.5 million is detained at the customs port at Guangzhou; the U.S. brand owner does not have a Chinese trademark because the mark has long been taken by a Chinese individual named Linda Lin. Linda demands a payment of $200,000. The cost of a Chinese litigation is approximately $150,000; although there is certainly hope in winning the litigation, six months can mean delivery deadlines missed and business opportunities lost. OEM is a vital lifeline for the Western world and particularly for small businesses. Although OEM-infringement litigations will likely increase in China, the immediate threat is at the customs level which controls the ability to get products out of China; the lack of clarify in this process and assurance from the Chinese courts can literally and easily destroy small businesses. With the HONDA decision, the SPC has thrown out the clear rules that previously guided foreign direct investment, trade, and manufacturing choices.
If drawn into a trademark dispute, Western brand owners should establish whether there is an OEM arrangement; if there is no OEM arrangement and the trademark is taken by an aggressive third party, the brand owners have little remedy and are unlikely to prevail. If the arrangement is OEM, the trademark is well-known, and the used mark is more similar to the foreign trademark registration than to the Chinese registration, there could be a good case to overcome the dispute raised by the Chinese mark owner or questions from the customs, or both. The HONDA case has highlighted the importance of (1) exploring trademarks in China for both OEM and non-OEM purposes, (2) ensuring confidentiality throughout the OEM process to prevent exposure of the goods to the Chinese market, and (3) conducting trademark monitoring and risk assessment in advance. After all, this process directly implicates the global supply chain.
While the HONDA case precedent may be concerning, it is also subject to later reevaluation or discretionary regional enforcement. It remains to be seen what impact the HONDA case will have on OEM the OEM process but suffice it to say that China is moving beyond OEM.
