“Preparing For Battle: IP Considerations During Trade War”
Law360 09/25/18 Lori S. Meddings, Li Zhu
Early last week the United States government issued the final list of products coming into the U.S. from China on which the U.S. is going to impose significant tariffs. Many U.S. businesses will be affected, expanding the reach of the trade war on U.S. companies and their suppliers overseas. The impact of tariffs can create negative consequences for intellectual property rights holders due to the reaction that suppliers might have if demand drops, or margins are significantly cut. As Mao Zedong said, "Fight no battle unprepared." And to that end we consider the following intellectual property risks in the comments below: (1) counterfeiting, (2) infringement and unfair competition, and (3) gray market goods.
For many U.S. companies that source products from China, the sanctions have resulted in a lost partnership with a trusted ally. Despite what you may hear, there are a great number of Chinese manufacturers helping U.S. companies succeed. By allowing for greater margins while helping the U.S. business protect its valuable intellectual property and know-how, Chinese suppliers enjoy the benefit of repeat and consistent demand, and a win-win relationship is established. However, the trade war changes that dynamic and disrupts those relationships. When demand dries up or when U.S. companies begin demanding a lower price to offset the impact of tariffs for the goods the Chinese manufacturer is tooled up to supply, manufacturers will resort to other means in order to survive. With the experience, resources and know-how for manufacturing, these Chinese companies can venture into their own competing brands at best, or counterfeits at worst.
Another outcome might be proliferation of gray market goods — the trademark owner's genuine goods produced and distributed by the U.S. company's Chinese manufacturing partner for sale in another market. With the trade war, these goods may make their way to the U.S. due to the shortage of genuine goods intended for that market or an increased price of those goods. Depending on the nature of the product, it might be produced under different safety standards, may not have a warranty, or may not provide the same features. As far as gray market goods are concerned, consumers often don't get what they have paid for which will reflect negatively on the goodwill and brand value of the trademark holder.
Pre-Termination Due Diligence
As the trade war impacts a company's bottom line, one of the first places to look might be a change in the supply chain for goods manufactured in China. A complete assessment and audit of intellectual property assets and ownership of rights owned by a U.S. business and its suppliers is prudent before commencing (or even mentioning) termination of a current supply relationship. The audit should not be limited to China, but should also extend to key and emerging markets. Suppliers frequently take it upon themselves to register trademarks, secure patents, and otherwise control ownership of critical know-how and tools. Oftentimes this even occurs with knowledge of the U.S. business, and is done for convenience. Arranging for transfer of intellectual property rights should be addressed as early as possible before initiating the termination process.
It is also advisable to enter into an agreement preventing suppliers from applying for and registering the U.S. business' intellectual property rights, and imposing contractual liabilities on any exploitation of know-how and the production process. The days of handshake deals and mere good faith in long-standing relationships are behind us. And, once suppliers manage to become intellectual property rights holders, the rightful owner of those rights are subject to infringement liability. It will be an uphill battle to earn support from China's legal system when attempting to take back intellectual property rights given the current legal climate. Look-alike products from previous suppliers will flood to markets and directly compete with those of legitimate intellectual property rights owners.
Secure Trademark Rights in Key Markets, Especially First-to-File Countries
Counterfeiters today are so sophisticated and keep an eye on the global market, just as brand owners do. The trademark system in China and many other countries is based on first-to-file and does not take into account who is the most senior user of a trademark. This system creates legal loopholes for suppliers to file preemptive trademark applications at a very low cost and meet only minimal requirements. Efforts to retrieve the "stolen" trademarks could be futile and costs incurred could be astronomical. In countries where trademark rights are based on use, such as the U.S., the cost of fighting against trademark squatting is still high even though the chances of success are more favorable. Moreover, even in countries like the U.S. where rights are not based solely on registration, having a trademark registration in hand streamlines enforcement efforts, including online takedown of infringing products, and in the case, for instance, of recording with U.S. Customs in order to increase the likelihood of detaining counterfeit and infringing goods.
Install Surveillance for Registration and Use of Intellectual Property Rights
The earlier counterfeits and infringing products are discovered, the more legal options are available. Setting up global surveillance of trademark filings and domain registrations, and monitoring online marketplaces can help to nip infringement and counterfeits in the bud. These monitoring programs are cost-effective and efficient. Bear in mind that many countries have their own social media platforms; for example, the most popular social media platform in China is WeChat.
The importance of customs recordation and training is critical as well. Customs agencies of many countries primarily conduct ex officio actions, including China Customs. Through education and training, rights holders can literally put a spotlight on their intellectual property rights, vastly increasing the likelihood of action from customs officials. These safeguards are particularly important when the trademark rights are the look or design of a product or the packaging design itself, or when the products are not consumer brands or those otherwise well-known to the general population.
Seek Allies in Surveillance and Enforcement Actions
It is prudent to manage your expectations regarding the support U.S. brand owners can expect to receive from the Chinese government's law enforcement bodies when pursuing enforcement actions. If circumstances permit, conduct joint actions with local business partners other than suppliers, such as distributors and joint venture partners. Also, consider involvement in anti-counterfeiting industry groups — in the battlefield of fighting against inferior products and defending brand integrity, competitors in the same industry often become natural allies. It helps to keep up with trends and news of counterfeiting and unfair competition. According to official statistics, infringing machinery, equipment and other automation products and parts seized by China Customs increased by 348 percent in 2017. The alarmingly sharp increase calls for cooperation among brand owners, industry groups and governments.
Change Battlefields When Strategy Demands
As one can imagine, China Customs does not have the capacity to inspect all exports on behalf of brand owners of over 37,000 marks. Local customs agencies in other important markets play a vital role in any counterfeit enforcement strategy. Some countries' customs agencies have long-standing business relationships with the U.S. and well-trained officers. More importantly, major distributors in these markets that purchase large quantities of counterfeit goods can be stopped, bringing us back to a supply and demand scenario. An independent and impartial analysis of producers, exporters, distributors and retailers of counterfeits or infringing products across countries or even continents can allow for selection of the best jurisdictions for enforcement actions or a multijurisdictional approach. This beats playing an expensive whack-a-mole game with thousands if not hundreds of thousands of small factories in remote rural areas of China any day of the week.
While the uncertainty of the U.S.-China trade war continues, keeping the protection of intellectual property rights top of mind is critical to getting through the crisis, and paving the way to the other side.