China Anti-Counterfeiting System needs a Reevaluation

By Paolo Beconcini

Although manufacturing of counterfeits has been on the rise in countries like India for pharmaceutical products, Turkey and Vietnam for apparel and shoes, China remains the major host of manufacturing activities of counterfeit goods of all kinds. Counterfeits leave China and undertake long journeys by sea, air and road, often stop in intermediate destinations such as South East Asia, the Middle East and the Arabic peninsula, before landing in US and EU markets. Stopping counterfeits at their source in China was, is, and will remain, the first and most important step in any strategy.

A Brief Historic Introduction

Counterfeiting in China came with the opening of its market to foreign goods and investments in the wake of the post-Mao reforms of the late seventies, and early eighties. Chinese consumers became the target of foreign branding, developing a taste for western goods, while the state-planned economy switched to a growth model based on export manufacturing with a vast and underutilized industrial capacity. All of this met the insatiable demand for fakes from abroad to propel China to the top of the counterfeiting chain. Interestingly, even after the more recent changes on innovation and technology and the government policies pushing for increased self-reliance, counterfeiting, and the export of counterfeit goods, remains an essential feature in many regions’ economic development. In sum, demand for counterfeits in China and abroad has not abated in spite of China's modernization and the protection of trademarks in China still plays a central role in a foreign business strategy.

No wonder, therefore, that China’s response to counterfeiting has been a constant grievance in the trade disputes between China and the United States since the 1980s. As recently as 2018, China’s IP system’s alleged flaws were the immediate and formal cause for the escalation of the US trade sanctions that triggered the Trump administration's trade war with China. The trade dispute ceased in January 2020 when the two countries reached a new economic and trade agreement. This agreement contains a number of important IP reforms to which China has formally committed. In response to this, China accelerated the enactment of key legislations with the amendment of the Trademark, Patent and Copyright Laws. In 2020 alone, China began fulfilling many of the commitments taken up with the signing of the trade agreement with the US. For example, China enacted many of the China-US trade agreement stipulations in relation to pharmaceutical patents, trademark protection from squatters, evidence acquisition in IP cases, and trade secret protection, to name a few. Interestingly, the trade Agreement failed to address the shortcomings of the current system of enforcement tools available to right holders against counterfeiting factories, warehouses, logistics and sellers on the ground. This means that anti-counterfeiting enforcement in China has remain more or less the same since the early two thousands. What are the main four enforcement tools available to trademark holders against counterfeiting ground operations an targets in China?

China’s Enforcement System Against Counterfeiters on the Ground

This system developed most of its current traits in the aftermath of China’s accession to the WTO and the signature of its collateral agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). It offers four major enforcement tools: Administrative enforcement Custom and Border Protection, Criminal enforcement and civil judicial enforcement.

The Administrative and Criminal enforcement procedures are by far the most used by right holders in China due to their faster proceedings and lower cost compared to court proceedings, as they better adapt to the need for speedy and flexible enforcement actions against fluid and highly movable targets. They are also less expensive than civil lawsuits. Police raids and the ensuing criminal enforcement are also most coveted as they possess the highest degree of deterrence for the infringers. Administrative raids can hit smaller targets at a lower cost and less formal procedures that criminal actions. However, they lack deterrence. The role of lawsuits is far more complex. Traditionally, they have been shunned by right holders as they are too slow and expensive. However, they can add deterrence to administrative raids and custom seizures. Also, the possibility of structuring litigation fees allows a more creative use of civil litigation against targets that are normally immune from raids, like for example, online traders. For more info about the synergic strategies of these enforcement tools, see my previous blog: https://www.dhirubhai.net/pulse/golden-factors-effective-anti-counterfeiting-strategy-paolo-beconcini-q7b3c/?trackingId=4wCNpEAuTeS%2FrzxVbAbiaA%3D%3D.

What is not working in this system

It is a bit surprising that for the past 24 years there has been no important changes in the enforcement system against counterfeiters. This does not automatically means that the system works. Most of the recent reforms have concentrated mostly on online counterfeiting as that appeared to be an immediate priority to foreign brands.

Meanwhile, the administrative and criminal avenues of enforcement against counterfeiters have been under continuous critic by right holders. In particular, the current system presents obvious disfunctions:

a) It is highly inefficient and costly as most of the work of finding counterfeiters and brining them to justice is left to the right holders. There is little or no pro-active work by the Chinese enforcement agencies. They expect right holder to investigate targets and file complaint that are well packaged. I have experienced cases where even a small and pretextual legal challenge to the raid by the infringer caused the enforcement agency to suspend the raid action.

b) Administrative enforcement is ineffective. Fines are symbolic and do not deter infringers. Right holders are caught in a spiral of raids that ultimately do not really impact the infringers, but keep causing cost to right holders.

c) Criminal enforcers retain unbounded discretion and can decide not to take action without need to make rejection decisions and therefore without the right for the complainant to file review or appeals against such negative decisions.

d) Enforcement can be strongly affected by local economic and political factors. I recently experience reluctance of local administrative authorities to raid market stalls due to the slow down of the Chinese economy!

e) Too little weight is given to judicial proceedings because they are not effectively embedded in the anti-counterfeiting enforcement system. They are left on the side to be used only in very large, and therefore, very rare, cases.

Fallout

One of the biggest problems of the current system is that it is not readily accessible to Small and Middle Enterprises (SMEs) or emerging brands. They will have almost no ability, resources to initiate and maintain a long term enforcement strategies. The system is simply too complex and expensive for them. The result is that only big corporations can nowadays afford running meaningful anti-counterfeiting programs in China.

A second problem is compliance and transparency. Right holders often work with third or fourth hand information they cannot verify and decisions are often based on the trust they place on their service providers. However, the risks of running afoul of compliance regulations exist. Many brands have experienced such cases. This forces them to invest even more money to secure their pipeline from all negative fallout.

Thirdly, the administrative raids system, has no lasting impact on the counterfeiters because punishment and their temporary losses are no sufficient deterrent. If we then consider that administrative raids are the most used form of enforcement against counterfeiters in China, we can then understand why we are all left with the sense of frustration when we think about China anti-counterfeiting. A lot of raids but no long term impact.

What Reform?

All cases of counterfeiting should trigger criminal liability

Right now, a counterfeiter is criminally liable only if his/her infringement reaches the threshold of a certain severity. If that threshold is not reached, the infringers escape criminal liability! Ultimately, the determination of this threshold is left to the discretion of the enforcing police agency. Eliminating this discretional element and making counterfeiting a crime in all circumstances will automatically send a warning to counterfeiters and allow more effective enforcement. Right now, counterfeiters know how to parcel manufacturing and warehousing to avoid criminal liability. This loophole must be closed.

In practice this means ending administrative enforcement. Administrative raids, with no criminal liability, mere fines and no deterrence should come to an end. The change would surely put a strain on the police. However, this could be relieved if the administrative enforcers could continue their raiding job against smaller targets, with the difference that their raids would also automatically trigger a criminal liability for the infringers and give the right holder the right to pursue that criminal liability before the criminal court where he/she could also demand damage compensation by court mediation.

The system would not add cost because the criminal raids by the administrative agencies would still be practically identical to the old administrative raids. The key difference will be the triggering of an automatic criminal liability that the right holder can decide to enforce immediately before a criminal court by filing a criminal plea based on the raid action. The right holder could also choose not to enforce it. It could actually leverage such liability with CD letters that could settle matters to his benefit (including damage compensation and penalty clauses for repeating infringements).

With this reform, we could empower courts with the last word on all cases making the whole system more efficient and deterrence much higher and we would give right holders new weapons, like CD letters based on the leverage of criminal liability pleas, that could finally make warnings meaningful in China.

With this reform, we could empower courts with the last word on all cases making the whole system more efficient and deterrence much higher and would send a clear warning signal to counterfeiters. They may all end up to jail and pay damages even when they are caught with small quantities of fakes. This would also warn traders about the risks down their supply chain. Right now, they know that in most cases they can go away with a symbolic low fine and the loss of a shipment.

Although this reform would not automatically change the way cases are brought to the attention of the enforcing authorities, my point a) above, having judicial authorities assume a more central role in the system, making all infringers criminally liable will likely reduce the impacts of the factors I listed under b), c), d) and e) above. It would be certainly a very important step in the right direction to reform a system that has become too burdensome to right holders.