Streamlining Foreign Investment in the Shanghai Free Trade Zone.
Encouraging foreign investment is a key objective of the Shanghai Free Trade Zone. While the new rules apply initially only in the Free Trade Zone ("FTZ"), they provide an important glimpse into the possible future direction of PRC-wide investment rules.
On 27 September 2013, the State Council published the “General Scheme for the China (Shanghai) Pilot Free Trade Zone” (the “General Scheme”). The General Scheme aims to explore the feasibility of establishing an internationally compatible foreign investment management regime in the China (Shanghai) Pilot FTZ and guide the direction of future reform. Potential reform areas include shifting the government’s focus from pre-approval to in-process and postsupervision, establishing united, concentrated and comprehensive market supervision and law enforcement systems, and exploring and establishing the negative list management system.
The NPC and each level of government have promulgated relevant regulations to provide policy support.
These polices are designed to improve the foreign investment management system of the FTZ (and of China broadly). In particular, the policies aim to (i) streamline the administrative approval (filing) procedures and establish a “one stop shop” approval system, thus improve convenience and flexibility for foreign-invested projects and enterprises; and (ii) extend the field of foreign investment; reform the existing foreign investment approval management regime to a “negative list” regime (granting national treatment to the foreign investments not falling under the negative list); and shift the existing approval system to a filing system for foreign invested projects (with the exception of domestic investment projects specified by the State Council that remain subject to pre-approval).
Because the reforms are still in their early stages, the relevant policies are still largely macro policies without detailed implementation rules. In addition, the reform policies have been promulgated at two distinct levels – the central government level and the Shanghai government level. It remains to be seen whether detailed implementation rules will be promulgated; how the relevant policies will interlink with each other; and whether the scheme will allow project companies established in the FTZ to act as investment vehicles throughout China broadly.
China's Anti-Monopoly Law: Retrospect and Prospect on the Fifth Anniversary
Review of Merger Control and Merger Remedies Regime in China: From 2008-2013
Five years have passed since the enactment of China’s Antimonopoly Law on August 1, 2008. Before the Anti-monopoly Law went into effect, the Chinese governments and the public had spent more than ten years discussing the drafting and implementation of the Anti-monopoly Law. It goes without saying that during the past five years, significant changes have taken place in the legislation and enforcement of the Anti-monopoly Law, which has achieved both domestic and international recognition.
The Anti-monopoly Law is vital to the Chinese market economy. Its importance will only rise as perfects its legal system and market economy. As one of the pilot firms participating in the legislation of Chinese Anti-monopoly law and providing Anti-monopoly related services, we are fortunate to witness the rapid development of this legal regime and to expand our practice with it. During the past five years, we have built a sizable professional team providing the fullrange of Anti-monopoly legal services, covering merger review, Antimonopoly investigation and litigation, and Anti-monopoly compliance counseling. As a tribute to the fifth anniversary of the Anti-monopoly Law, we present a series of articles, to share with you years of invaluable experiences.
August 1st, 2008 marks the fifth anniversary of China’s Anti-Monopoly Law (“AML”). Along with debates and controversies, the AML is gradually taking root and has contributed to shaping the economic landscape and competition status in China.
During the past 5 years, the Ministry of Commerce (“MOFCOM”), the authority in charge of merger control, has cleared more than 640 cases, including 19 cases that were cleared with conditions and 1 case that was denied.1MOFCOM has been making continuous progress in improving its enforcement capabilities, which are highlighted by the increasingly mature merger remedy regime. This article presents an overview of the merger control regime, in particular the merger remedies regime in China from the perspective of practitioners.
Overview of Merger Control Regime and Cases Cleared with Conditions
As of June 30, 2013, MOFCOM received 754 cases in total, officially accepted 690 cases and cleared 643 of them, including 18 conditionally approved cases and forbidden case (Coca Cola’s acquisition of Huiyuan). The following chart indicates the yearly statistics of all cases cleared (with or without conditions) and cases conditionally approved by MOFCOM.
Industries Involved in Cases with Conditions and Types of Concentration
According to the Industrial Classification for National Economic Activities (GB/T 4754-2011) of the National Bureau of Statistics, 5 industry categories are involved in the 18 cases with conditions, including “manufacturing”, “production and supply of electricity, heating, gas and water”, “information transmission, software and information service industry”, “wholesale and retail”, and “mining industry”. In particular, a total of 12 cases relate to the manufacturing industry. (See Table 1 below)
Horizontal mergers usually are considered more likely to cause competition concerns. Similar as law enforcement authorities in other jurisdictions, MOFCOM pays closest attention to horizontal mergers. Among the 18 conditionally approved cases, 11 cases relate to horizontal mergers, and 1 case relates to both horizontal and vertical relationship. Only 4 cases relate to vertical relationship and the other 2 cases concern conglomerate relationship.
In November 2008, when the first conditional case (AB/Inbev) was issued, information disclosed in the final decision was very limited. Five years later in the Glencore/Xstrata (2013) case, not only did MOFCOM provide a detailed competition analysis of market share, market power, market entry and influence upon consumers, but also disclose, for the first time, the full text of the parties’ final commitment proposals. This shows that MOFCOM has made great progress in merger remedy practice, and has been making efforts to increase transparency of its law enforcement.
Types of Remedies
Although the AML is largely influenced by EU experiences, MOFCOM has gradually developed its own methodology and distinguished itself from its foreign counterparts. For example, MOFCOM was the only antitrust authority imposing conditions upon such global transactions as General Motor/Delphi (2009), Seagate/Samsung (2011), Google/ Motorola (2012) and Marubeni/Gavilon (2013) . In other transactions, such as WD/Hitachi (2012) and Glencore/Xstrata (2013), MOFCOM imposed conditions different from other jurisdictions. We hereby analyze the structural and behavioral conditions as follows:
MOFCOM has been relatively cautious in the application of structural conditions, which usually mandate the divestiture of the parties’ assets or businesses. Such reluctance may be prompted by MOFCOM’s intention to preserve the original structure of a transaction to the extent possible. Of the 18 conditionally cleared cases, 7 cases involve structural conditions and all of them are horizontal mergers.
Structural conditions in these cases include not only typical ones, i.e. divesture of existing independent business unit, but also relatively less common ones, such as divesture of assets, production capability, shares in affiliates and shareholders’ interests that do not constitute independent business unit.
In contrast to the experiences in some other major jurisdictions, MOFCOM employs a more receptive approach to conduct remedies. The majority of the 18 conditionally cases involve behavioral conditions. Some of the behavioral conditions are also frequently used by foreign authorities, such as the opening up commitment, non-discrimination terms, termination of exclusive contracts, and transitional assistance obligations. Some, on the other hand, are less common, such as the commitment of supply and service standard, prohibition of market expansion, hold-separate and prohibition of certain market behaviors.
In Seagate/Samsung (2011), WD/Hitachi (2012) and Marubeni/Gavilon (2013), MOFCOM imposed “hold separate” conditions requiring the merged parties to maintain operations independently. While the “hold separate” condition may be categorized as behavioral, MOFCOM has publicly expressed that such condition was intended to achieve similar effects as structural conditions.
Although some of the behavioral conditions imposed by MOFCOM are creative, proper supervision of these conditions has become a challenge. In Novartis/Alcon (2010), Uralkali/ Silvinit (2011), Seagate/Samsung (2011), Henkel/Tiande (2012), WD/Hitachi (2012), Google/Motorola (2012), Glencore/Xstrata (2013) and Marubeni/Gavilon (2013), MOFCOM requested the parties to engage an independent supervision trustee. In the Walmart (2012) and ARM (2012) cases, the decisions provide that MOFCOM is entitled to supervise either by itself or through the supervision trustee. In AB/Inbev (2008), General Motor/ Delphi (2009) and GE/Shenhua (2011), however, the decisions did not specifically mention the requirement for a supervision trustee.
Even in cases with supervision trustees, such difficulty still exists. For instance, in the WD/Hitachi (2012) case, MOFCOM requested the parties to maintain Viviti (Hitachi’s subsidiary operating the relevant business) as an independent competitor and to adopt safeguard measures to avoid exchange of competitive information. This condition places enormous burdens on the parties, in particular in light of integrations that are usually required of merging parties under applicable corporate and securities laws. Therefore, a balance has to be made to ensure that such supervision does not strip the conditions of their substance nor introduce unintended burdens on the obligors’ businesses.
Market Survey Instruments Adopted by MOFCOM
MOFCOM has adopted numerous market survey instruments in the merger review process, including written consultation, meetings, hearings, site investigation, entrusted investigation, face-to-face interview with relevant parties, telephone interview and questionnaire. In such market surveys, government authorities, relevant industry associations, competitors, upstream and downstream entities as well industry experts will be consulted on important issues in the cases. The weight MOFCOM gives to these opinions differs as shown in Chart 2 below.
Generally, opinions from government authorities are most influential on MOFCOM’s decision. MOFCOM usually seeks the opinion from the National Development and Reform Commission (“NDRC”), sometimes also from competent authorities in charge of different industries, for instance, from the Ministry of Industry and Information Technology (“MIIT”) for filings related to traditional and high-tech industries, and from the Ministry of Agriculture (“MOA”) for filings involving agricultural products. In addition, for filings involving foreign investment, MOFCOM usually consults with the relevant approval authorities for foreign investment, such as the Department of Foreign Investment Administration of MOFCOM and/ or local foreign investment approval authorities.
The review timeline and the MOFCOM decision may be affected by the opinions of other government authorities. For example, in the Marubeni/Gavilon (2013) case, the parties are required to “hold Marubeni Soybean Sub and Gavilon Soybean Sub separate from each other”. One could imagine that MOFCOM should have consulted the domestic soybean industry association and the MOA. Considering both MOFCOM and MOA are at the same administrative ranking, MOFCOM would be prone to give substance to MOA’s opinions.
Conclusion and Forecast
Looking back upon the past 5 years, MOFCOM’s achievements are widely recognized by domestic and international communities. Going forward, we expect that:
behavioral remedies will continue to be put equal weight as structural remedies;
innovation on the types of remedies will continue to be encouraged;
MOFCOM’s review process may be accelerated by introducing the “fast track” mechanism; and
Transparency of MOFCOM’s review process will be further enhanced.
With China becoming one of the “major” antitrust jurisdictions alongside the U.S. and Europe, both domestic and international companies should consider the implications of a MOFOM review and identify in advance the competition issues that their transaction may raise, before embarking on major transactions in China.
Appeal of Infringement Dispute of Patent for Invention on One of the 2012 Top 50 Typical Cases of Intellectual Property Protection in Chinese Courts — Harbin Industrial University Xinghe Industrial Co., Ltd v. Jiang Su Runde Pipe Industry Co., Ltd 2012
In April 2013, the Supreme People’s Court of the People’s Republic of China (the “Supreme People’s Court”) released the 2012 Top 50 Typical Cases of Intellectual Property Protection in Chinese Courts (Fa Ban  No. 44) as a referential document for fair and efficient adjudications for the People’s Courts. The document included an appeal case regarding a patent for invention infringement dispute (Case Number:  Su Zhi Min Zhong Zi No. 0021), which was represented by the IP Litigation Group of King & Wood Mallesons.
1. Case Brief
The Plaintiff, Harbin Industrial University Xinghe Industrial Co., Ltd (“Xinghe Co. Ltd”) filed its invention patent application entitled “Production and apparatus of a steel strip- reinforced plastic pipeline” with the State Intellectual Property Office (SIPO) of the People’s Republic of China, which granted the patent on April 4, 2007 (Patent No. ZL200510082911.4). The patent has three independent claims, covering the following subject matters respectively: 1) pipe product; 2) manufacturing method of the pipe; and 3) manufacturing apparatus of the pipe.
The Defendant, Jiang Su Runde Pipe Industry Co., Ltd (“Runde Co. Ltd”) was established in September 2009, producing and selling steel stripe reinforced plastic pipelines and its installments.
In October 2010, Xinghe Co. Ltd filed an action against Runde Co. Ltd with the Nanjing Intermediate People’s Court (the “Nanjing Court”) for infringement of its patent for invention. Xinghe Co. Ltd alleged that Runde Co. Ltd had been using its patented method and sales of steel strip reinforced plastic pipes, resulting in tremendous amount of damages and therefore, requested the Nanjing Court to stop the infringement immediately and to pay damages up to RMB 0.5 million. The Nanjing Court reckoned that Runde Co. Ltd.’s production of Pipe Products did not fall into the scope of claim 1 of the patent but did infringe claim 2 and 3. As a result, it ruled that Runde Co. Ltd had infringed patent rights in the First Instance Judgment and ordered it to cease such acts of infringement and pay damages of RMB 0.5 million.
Unsatisfied with the First Instance Judgment, Runde Co. Ltd appealed to the High People’s Court (the “Jiangsu Court”). The Jiangsu Court deemed at the Second Instance that the manufacturing method and apparatus used by Runde Co. Ltd did not fall into the protection scope of Xinghe Co. Ltd.’s patent. As a result, the Jiangsu Court overruled the First Instance Judgment.
2. Case Highlight
At First and Second Instance, both parties had been debating on “whether the title of the subject matter in a claim should limit the protection scope of a patent”. In particular, Claim 1 and Claim 2 of the patent at issue read as follows:
A plastic drainage pipe reinforced by steel strips, comprising a plastic pipe body and into which the steel strips are incorporated, and the reinforcing ribs are integrated with the plastic pipe body as a whole, wherein rectangular or circular holes are perforated on the steel strips or the surfaces of both lateral sides of the steel strip are pressed to form lines pattern; the plastic part between two ribs has convex shape; the pipe body has a spigot joint at one end of the pipe for jointing the pipes to each other, and the spigot joint has a jointing part where a sealing rubber ring is to be fixed or a sealant is to be used.
A method for making steel strip-reinforced plastic pipelines as described in Claim 1, characterized in that it includes the following steps: a) steel strips go through a composite mold where they are enwrapped by the plastic melt from a extruder, and profiled bands are formed after cooling, hardening and pulling, wherein the extruder and the composite mold are disposed in a right-angled arrangement; b) the profiled bands are transported to an installation site; c) the profiled bands are spirally wound and then welded to form plastic drainage pipes reinforced by steel strips; and d) a continuous pipeline is form by welding the pipes through a spigot joint provided at one end of each pipe.
With regard to Claim 1, the drainage pipes made by Runde Co. Ltd. lack the features of “the steel strips are perforated and pressed” and “the plastic part between two ribs has convex shape”, and thus it is undisputed that Runde Co. Ltd. does not infringe Claim 1. The main dispute centers around whether Runde Co. Ltd infringes Claim 2, provided that its method includes the four steps as recited in Claim 2. If the title of the subject matter of Claim 2 merely reads “a process of producing steel strip-reinforced plastic pipelines”, then the answer would most certainly be positive. Yet, the problem is that Claim 2 had in fact cited Claim 1. So a more complicated question arises: whether the title of the claimed subject matter should be regarded as a technical feature and hence limits the scope of Claim 2? Then, given that Claim 1 is not infringed, whether or not 2 is infringed or not?
At First Instance, the Nanjing Court thought that Runde Co. Ltd. had infringed Claim 2. The main reason for such judgment is that, firstly, there is no legal basis to deem the title of the claimed subject matter, “a method for making steel strip-reinforced plastic pipelines as described in Claim 1”, as a technical feature. Secondly, Claim 2 is not an independent claim rather than a dependent claim, so it is obviously against legal regulations when the defendant uses 1 to restrict the scope of Claim 2.
Having represented Runde Co. Ltd., we believe that the judgment of the Nanjing Court is debatable. Hence, we rebutted from different perspectives through appeals. Firstly, with regards to the related regulations of the Patent Law of the People’s Republic of China (the “Patent Law”) and the Implementing Regulations of the Patent Law (the “Implementing Regulations”), the title of the claimed subject matter, which is the basic component that composes the technical solution, is classified as a technical feature and should be taken into consideration when defining the patent’s scope of protection. Article 59 of the Patent Law states that “the scope of protection in the patent right for an invention or a utility model shall be determined by the contents of the patent claim. The specification and appended drawings may be used to interpret the patent claim.” Rule 21 of the Implementing Regulations of the Patent Law state that “An independent claim of an invention or utility model shall contain a preamble portion and a characterizing portion”, while the preamble portion indicates “the title of the claimed subject matter of the technical solution of the invention or utility model, and those technical features which are necessary for the definition of the claimed subject matter but which, in combination, are part of the most related prior art. The preamble portion and the characterizing portion together define the scope of protection of the invention or utility model”. The laws explicitly prescribe that the title of the claimed subject matter belongs to the preamble portion, which is an indispensable and inseparable part of the claim and defines the scope of protection together with the characterizing portion.
Moreover, according to patent examination practices, “steel strip-reinforced plastic pipelines as described in Claim 1” indeed restricts the definition of Claim 2. In the “Guidelines for Patent Examination 2010”, Part II Chapter 2 section 3.1.2, “in determination of scope of patent protection for such an independent claim containing reference to another claim, all the features of the claim referred to shall be taken into account, and their actual limiting effect shall depend on what final impact they may impose on the claimed subject matter of the independent claim”. In this case, we should consider the technical features of Claim 1, and the actual limiting effect should be reflected in the manner where the product’s special features influence the patented process. There are two aspects on which the product in Claim 1 influences the process in Claim 2. The first aspect is relating to the raw materials and intermediate products. The construction and meaning of the technical terminology, in this case “steel strip”, in both Claim 1 and 2 should be construed as having the same meaning. In particular, the steel strip recited in Claims 1 and 2 should both have perforated rectangular or circular holes formed on the steel strips or the surfaces of both lateral sides of the steel strip are pressed to form lines pattern, and the plastic part between two ribs has a convex shape. The second aspect is involving method steps, where the method should involve the corresponding steps of making rectangular or circular holes and molding the convex shape between two ribs. Without these steps, 2 could never produce the pipeline product mentioned in Claim 1, and therefore could not be named “a method for making steel strip-reinforced plastic pipelines as described in Claim 1”.
Furthermore, during the substantive examination, the patentee made amendment to Claim 2 by modifying the title of subject matter. The original version says, “method for making steel strip-reinforced plastic pipelines”, while the amended version specifically refers to Claim 1: “method for making steel stripreinforced plastic pipelines as described in Claim 1”. In doing so, the patentee manifestly limits the scope of Claim 2 to those methods through which the product described in Claim 1 is made. According to the doctrine of prosecution history estoppel, the patentee should not inappropriately broaden the scope of Claim 2 during litigation.
In addition, the rationale adopted by the Nanjing Court seems to be illogical. The First Instance Judgment says that Runde Co. Ltd.’s infringement did not fall into the scope of Claim 1 but did fall into that of Claim 2. According to Article 11 of the Patent Law, the scope of protection of the patent can be extended to products directly obtained by the patented method. When we look into the case, if Claim 2 is said to be infringed, then all pipeline products produced by the method described in Claim 2 should also infringe. Now that Claim 2 reads, “method for making steel stripreinforced plastic pipelines as described in Claim 1”, obviously this method produces a product described in Claim 1. As a result, we can see that if we start from the premise that Claim 2 is infringed, then the product directly obtained by Claim 2, i.e. Claim 1, should is also infringed. This reveals a huge contradiction in the judgment given by the Nanjing Court.
Finally, it is not difficult to spot out the absurdity of the First Instance Judgment from a patent drafting point of view. In practice, the following is common for claim drafting: Claim 1: A method for producing XX, which comprises steps XXX; Claim 2: The product obtained from the method of Claim 1. It is thus clear that Claim 2 only contains a title of the claimed subject matter, and according to the viewpoint of the Nanjing Court, a title of the claimed subject matter is not a technical feature. Hence Claim 2 does not include any technical features, whereas its scope of protection remains uncertain. This is obviously against the Patent Law.
The Jiangsu Court was eventually convinced by the above arguments and stated that the First Instance court erred in its ruling. The title of the claimed subject matter should be deemed as an essential technical feature and should be given full consideration when defining its protection scope. Consequently, it ruled that Runde Co. Ltd. did not infringe the patent at issue, and reversed the judgment of lower court .
3. Typical Significance
From 2008 onwards, the Supreme People’s Court, with reference to the recommendations from various High People’s Court, has announced the 10 major cases and 50 typical cases of judicial protection of intellectual property, aiming at promoting juridical protection towards intellectual property rights, displaying its successful outcomes and creating a favorable atmosphere for such development.
The Xinghe Co. Ltd. v. Runde Co. Ltd. case, as one of the 50 typical cases, relates to the issue of determination of patent scope, which is the premise and basis for patent infringement analysis. It is very common in practice to draft an independent claim by citing another independent claim. When ascertaining the protection scope of such a claim, the technical features of the cited claim should have limiting effects. The principle established by this case has brought high referential value to future cases of the same kind.
First Certification Mark Case –“ZHOUSHANDAIYU and device”
Zhoushan City Aquatic Product Alliance initiated a civil action against Beijing Shenmaren Food Sales Co. (“Shenmaren” ) , on the grounds that “ Zhoushan Jingxuan Daiyu” produced by Shenmaren with the indication of “ZHOUSHANDAIYU” prominently printed on the package would likely mislead the public and infringe upon the exclusive right of Zhoushan City Aquatic Product Alliance to use the mark. Zhoushan City Aquatic Product Alliance requested Shenmaren to cease the infringement and compensate for their losses.
Shenmaren defended that their products were made from Daiyu (“hairtail” in Chinese pinyin) in Zhoushan district, thus they were legitimate to use “ZHOUSHANDAIYU” and such use did not constitute infringement to the trademark right of Zhoushan Aquatic Product Alliance. Moreover, Shenmaren claimed that they also used their own mark “Xiaojiaolong” on the products, and thus their use of “ZHOUSHANDAIYU” would not cause confusion to the public. Upon hearing, Beijing First Municipal Intermediate People’s Court held that:
Whether Shenmaren infringes upon the exclusive right of the said certification mark should not depend on the likelihood of misleading the public on the origin of products but the likelihood of causing misrepresentation of a given quality of the products from that origin. Zhoushan Aquatic Product Al l iance’ s claim that Shenmaren’s prominent printing of “ZHOUSHANDAIYU” on the package would be likely to cause confusion to the public and infringe the exclusive right of using the certification trademark, was made based on a misunderstanding of law, and Zhoushan Aquatic Product Alliance virtually mixed up the certification marks and common trademarks. Whether the mark is prominently used or causes confusion as to the origin are irrelevant to the finds of infringement of Certification Mark. In this case, the mark “ZHOUSHANDAIYU and the device” is a geographical identification of the certification mark, certifying that the products bearing such mark come from Zhoushan territorial waters. Therefore, labeling Daiyu (“hairtail” in Chinese pinyin) originated from Zhoushan territorial waters as “Zhoushan Jingxuan Daiyuduan” is a legitimate way to use a geographical identification and does not infringe upon the exclusive right of Zhoushan Auqatic Product Alliance to use the certification mark.
The Court therefore rejected all claims of Zhoushan Aquatic Product Alliance. Zhoushan Auqatic Product Alliance disagreed with this judgment and appealed to the Beijing High People’s Court. According to Article 16 section 2 of the PRC Trademark Law, Article 6 and Article 49 of the Implementing Regulations of the Trademark Law on geographical indication, and Article 18 section 2 of the Administrative Measures Concerning the Registration of Collective Marks and Certification Marks on “legitimate use of geographical indication”, the Beijing High People’s Court held that Zhoushan Aquatic Product Alliance, as the registrant of the said certification mark, should permit natural person, legal person or other organizations to use the certification mark on goods tha t has met the requirement for use of said geographic indication. Moreover, any natural person, legal person or other organization who does not request authorization to use the certification mark may also duly use the geographic indication on the products it sells if such products met the condition, and Zhoushan Aquatic Product Alliance does not have the right to prohibit such use. However, Zhoushan Aquatic Product Alliance has the right to request the cease of the production and to bring a claim for infringement of certification mark when the goods bearing a geographical indication do not originate in the region indicated. The evidence presented by Shenmaren was insufficient to prove that the goods they sold originated from Zhejiang Zhoushan territorial waters. Under such circumstances, marking “Zhoushan Jingxuan Daiyuduan” on the products was regarded as an illegal use of the certification mark and such use constituted infringement to the exclusive right to use the said certification trademark. Shenmaren should bear the legal responsibilities to cease the infringing activities and to compensate the losses of Zhoushan Aquatic Product Alliance. The Beijing High People’s Court therefore supported the claims of Zhoushan Aquatic Product Alliance. This is the first certification mark infringement case, and the judgment has indicative effect on clarifying the criteria in finding infringement of certification mark which differ from those of other trademarks.
Eight Key Points about the Third Amendment to the PRC Trademark Law
The Standing Committee of the National People’s Congress passed the Third Amendment to the PRC Trademark Law (“Revised Trademark Law”) on August 30, 2013. The new Trademark Law will be implemented on May 1, 2014. Besides its share of critics, this revised PRC Trademark Law, in general, responds to the public concern on complex trademark prosecution procedures, rampant bad faith trademark squatters and difficult trademark protection. A detailed explanation of some key changes affecting brand owners and trademark practitioners is provided below
Expansion of Non-traditional Trademark Registration
The Revised Trademark Law proposes to accept non-traditional trademark registrations to cover sound.
This enlargement of trademark family may attract lot of new filings from those countries where sound mark has already been registrable. The examination criteria in the Chinese Trademark Office will be the next point of public attention. Unfortunately, the revised Trademark Law fails to cover single color trademark registration which was under heated discussion during this revision process.
Procedure Facilitation: Statutory time-limit for examination, electronic filing, multi-class application, Office Action and trademark renewal
This revision will be the first time in the PRC trademark history that sets a statutory time-limit for trademark examinations by both the Chinese Trademark Office (“CTMO”) and the Trademark Review and Adjudication Board (“TRAB”).
The CTMO has already allowed electronic filings for several years through a trial pilot program; however, this practice is now officially and explicitly written into the revised Trademark Law.
Furthermore, the Revised Trademark Law also simplifies the registration procedure by allowing an applicant to submit one application for a trademark in multiple classes. The current practice only allows the filing of one trademark in one class and additional trademark applications are required for additional classes.
Moreover, the proposed change to expend the use of office action which will offer trademark applicants an opportunity to present additional arguments or amendments to their application if required by the CTMO.
Lastly, a renewal application can be filed 12 months prior to expiration, compared to 6 months under the old law. The 6 month grace period will still exist.
All these changes will provide more conveniences and benefits to trademark applicants. However, it should be noted that some changes may affect the trademark strategy of trademark practitioners and owners, especially due to the new time limits of examination of various types of cases.
Unfortunately, the revised Trademark Law fails to extend the responding time to the rejection from CTMO which was previously proposed during this revision process. This together with failure in extending some other responding times by the brand owners may be disappointing to many brand owners and practitioners. Material Change in the Opposition Procedure
It is worth to mention that the CTMO’s opposition procedure is materially changed in the revised PRC Trademark Law. Firstly, it strictly limits the party that can file an opposition and the grounds for their opposition. In the past, any party could oppose any trademark on any grounds (i.e., absolute grounds or relative grounds), but the revised Trademark Law only allows the owner of a prior right or an interested party to lodge an opposition on relative grounds before the trademark is registered. This change may reduce the number of opposition cases and help alleviate the bad faith opposition filing problem.
Moreover, if an opposition claim is denied by the CTMO, the CTMO will allow immediate registration and the application will no longer be pending until it is resolved in the subsequent appellate procedure. An opposing party’s only recourse afterwards is through a new procedure – “invalidation”. As many oversea brand owners are generally the party who files these oppositions, this change will greatly affect the trademark strategy of oversea brand owners in China. If a brand owner loses their opposition filing, they can only attempt to invalidate the trademark and will face the disadvantageous situation where the bad faith applicant obtains the full registered trademark right during the whole invalidation process. Whether and how this problem can be tackled will remain to be further clarified in future implementing regulations and/or judicial interpretations and it is highly recommended for brand owners to put more focus on opposition first.
Efforts on Restraining Trademark Squatting The revised Trademark Law clearly prohibits the dealers, distributors, agents, and those who have business contacts with the brand owners to register the same or similar trademark on same or similar goods.
The new law also introduces in first time the responsibilities of trademark agencies. Besides the confidential duties and other obligations, the new version also prohibits the registration of trademark in the name of trademark agency beyond its business scope. It is a positive improvement to owners of famous brands because some trademark agencies in the past years registered many famous trademarks on behalf of their anonymous clients with bad faith.
Most eye-catchingly, the revised Trademark Law introduces the principle on good faith (so called “honest and trustworthy principle”) for trademark use and registration. The outstanding Article 7 which says that “The principle of honest and trustworthy should be followed when a trademark is used and filed for registration” seems to show forth the resolution to restrain trademark squatting on bad faith, because this article may be used as a safeguard to those bad faith registrations which cannot be stopped by other specific grounds set in the revised law.
A More Trademark Owner Friendly Protection System: Public Confusion; Increased Damages; Burden of Proof
Confusion in Trademark Infringement The revised Trademark Law introduces a confusion claim, for the first time in its history of legislation. Article 57.2 prohibits any party “without the consent of the owner of the registered trademark, to use a trademark that is similar to a registered trademark in relation to identical goods, or uses a trademark that is identical with or similar to a registered trademark in relation to similar goods, which can easily cause confusion.”
Although the principle of confusion has been used in the practice for a long time, it is the first time to be written in the law. It will help the AIC or the court to fairly decide trademark infringement cases when the marks are similar and/or the goods are similar.
The damage is the actual loss suffered by the trademark registrant, or the profit earned by the trademark infringer if the actual loss is hard to be determined. Where the actual loss and infringer’s profit are all hard to be determined, the damage can be determined according to the reasonable times of license fee. Under the current law, the trademark registrant can elect its actual loss or infringer’s profit.
Additionally, the disputed infringer will be required to provide its financial books as evidence to show the profits earned, which was difficult for trademark owners to obtain, failing to obtain these records meant that the only evidence the court would be able to use to calculate damages was based solely on the evidence that could be provided by the trademark owner.
The revised Trademark Law proposes punitive damages, which is the first time for punitive damages to be introduced in the Chinese IP laws. This intends to punish severe trademark infringement on bad faith, and the damages will be 1 to 3 times of above normal damages. Furthermore, the heavier penalties from AIC will be posted on those who implement trademark infringement activities more than twice within five years.
Furthermore, the revised Trademark Law proposes to increase the cap of statutory damage from RMB 0.5 million to RMB 3 million. It is a significant increase which may effectively restrain trademark infringement.
No Compensation on non-use Mark
It is also worth mentioning that the revised Trademark Law provides the possibility of no compensation to the trademark owner if the trademark owner cannot demonstrate its use of the mark in the past three years and cannot prove any other loss suffered. For brand owners, they must pay attention to the collection and reservation of use evidences in their routine work.
Right of Prior Use and Fair Use
The right of prior use is introduced in the revised Trademark Law. A person/entity may continue to use its trademark even after an identical or similar trademark is registered in identical or similar goods/services, if it has used the trademark before the application date of the trademark and obtained certain influence. However, the continued use is limited to the original scope, and the trademark registrant may ask the prior user to attach alterations to its trademark to differentiate the goods/services provided by the two.
However, no definition to “original scope” and “influence” is mentioned in the new law, and it may need to be further clarified in the forthcoming implementing regulations or judicial interpretations.
The revised Trademark Law stipulates that the trademark registrant cannot prevent others from using the generic name, picture, model type of the goods, or descriptive features of the goods, or geographic name which are comprised in the registered trademark. Under the new law, using these elements is deemed as a fair use and does not constitute infringement to trademark right.
The term “Well-known Trademark” should not be used in advertising and other business activities
There has been controversy in the past years regarding the use of well-known trademarks in large advertising campaigns and publications in China, which encouraged Chinese companies to compete for recognition of well-known trademarks. In order to stop this departure from legal nature, the Supreme People’s Court, CTMO and TRAB have enacted strict rules and practices for granting well-known status in recent years.
It is a significant move for the legislator to rule that the term “well-known mark” should not be used on goods, packages or containers of goods, or in advertising, exhibition or any other business activities, and the violation of the stipulation of the non-publicity clause is subject to monetary penalties. With the severe limitation on the commercial utilization of the title, the public can be now more optimistic about the real and proper legal functionality of “well-known trademark” in the Chinese laws and practices.
Conflict between Trademark and Trade Name
The revised Trademark Law makes it clear that the Anti-Unfair Competition law will be applied if any company uses a registered trademark, or a well-known unregistered trademark as its trade name and causes public confusion. In that, using other’s trademark in company name may be restrained.
Insights on Drafting Pharmaceutical Patents from the “Supreme People’s Court’s Annual Report of Intellectual Property Cases”
In April 2013, the Supreme People’s Court (“SPC”) issued the Annual Report of Intellectual Property Cases (“Annual Report”), which included 34 typical intellectual property and competition cases from 2012 and summed up 37 legal issues with universal significance. To assist pharmaceutical enterprises in drafting patent applications we have summarized the pharmaceutical patent cases in the Annual Report.
Case A: The Interpretation of Close-ended Claims and the Application of the Doctrine of Equivalents for Close-ended Claims
The Supreme Court held that:
“[c]lose-ended claims should be generally construed as compromising indicated compositions only and exclude other ingredients, though impurities are allowed within normal amounts. However, excipients are not impurities. If the patentee chose a close-ended claim, he clearly considered that any unmentioned component is out of the protection scope of the patent right. Moreover, in this situation the doctrine of equivalents of judging different technical features should no longer be applied.”
The patent was named "Adenosine triphosphate disodium and magnesium chloride frozen powder injection and its manufacturing method" with an application No. 200410024515.1. There was a close-ended Claim 2, which sought protection of a freeze-dried powder injection, comprising adenosine triphosphate disodium and magnesium chloride, with a weight ratio of 100 mg to 32 mg. Two companies sold drugs containing adenosine triphosphate disodium, magnesium chloride and other excipients, among which the weight ratio of adenosine triphosphate disodium and magnesium chloride is the same as Claim 2 of the patent. The patentee therefore filed a civil lawsuit, and the first instance court did not support the non-infringement defence of these two companies, arguing the existence of excipients. The second instance court revoked the judgment made by the first instance court, based on the No. 13268 Invalidation Decision issued by the Patent Reexamination Board. The Retrial Board revoked the judgment made by the second instance court and sustained the judgment of the first instance court. The SPC revoked the judgment of the first instance court and the pleadings of the patentee. According to the SPC, adverse consequences resulting from claims drafted in an inappropriate way causing the loss of a wider scope of protection that could have been possible should be borne by the patentee.
Case B: The Requirements for Acceptance of Additional Experimental Data Submitted after the Application Date Regarding the Examination of Creativeness of a Patent
The SPC pointed out that:
“[i]n the examination of inventiveness, if, after the application, the applicant submits experimental data to prove unexpected technical effects realized by the technical solution of the patent, such data can only be accepted if the technical effects to be proved are clearly disclosed in the original application documents of the patent.”
The invent ion patent of Company A, " a pharmaceut i cal compound for t reat ing diabetes" was declared invalid because of a creativeness problem in the patent validation procedure. Company A then presented experimental data to the Patent Reexamination Board to prove that the technical scheme of the patent had unexpected effects. But the Patent Reexamination Board did not adopt this experimental data, so Company A litigated. Both the first and second instance courts upheld the decision of the Patent Reexamination Board. Furthermore, the Supreme People’s Court rejected Company A’s application for retrial.
The application specification must sufficiently disclose either invention or utility models. Chemistry is a science of experiment, and the factors influencing invention results could be various, integrating and complicated. According to prior art, if persons skilled in the art cannot predict the functions or technical effects of the claimed technical solution, the description must record the corresponding experimental data clearly and completely, so that persons skilled in the art may utilize the technical solution, solve the technical problems and reach the expected technical effect. Technical solutions and technical effects undisclosed in the specification cannot usually be legal grounds for judging patentability. When the applicant submits experimental data after the application data to prove the inventiveness of the patent in comparison with prior art, such data can only be accepted if the technical effects to be proved are clearly disclosed in the original patent application documents.
Case C: Examination of Creativeness of Compounds with New Crystal Structures
The SPC held that
“[o]nly the technical effects from the records in the original application documents, or which can be directly concluded from the original application documents may be taken into consideration when determining the inventiveness of a patent.” Also, the SPC pointed out that ”compounds of similar structures” referred to in the “The Guidelines for Patent Examination” (“Guidelines”) only mean compounds with identical basic core structures or basic rings and do not involve the comparison of the compound’s microscopic crystal structure itself.”
Company B’s patent claim No. 1817143.5 aims to protect a crystalline compound. The Patent Reexamination Board declared the patent was wholly invalid on the grounds that the patent did not have the requisite inventiveness because the existing technology disclosed that this compound presently exists in another crystal structure, and the original application document failed to prove the technical effect of this compound. Both the first and second instance courts supported the invalidation decision, and the SPC revoked the retrial appeal of the patentee.
Microscopic crystal structures of crystalline compounds vary from case to case. A compound in a solid state may have different solid crystalline forms based on two or more different molecular arrangements. However, not all changes in a microscopic crystal structure will inevitably lead to prominent substantive features and obvious progress. Therefore, it cannot be concluded that a compound is not similar in structure based only on its difference in microscopic crystal structure, and therefore exempt from describing the creativeness of the patent from prior art (has unexpected technical effects).
The SPC held that “compounds of similar structure” referred to in the Guidelines only specifically means compounds with identical basic core structures or basic rings and does not involve the comparison of the microscopic crystal structure itself. Though crystalline compounds may show different physical or chemical characteristics due to their different molecular arrangements, they are still within the field of compounds. Therefore, the regulations regarding compounds provided in the Guidelines can be applied to determine the inventiveness of compounds with new crystal structures. The technical effects achieved by the crystals are the key factors contributing to their inventiveness. Only the technical effects from the records in the original application documents, or which can be directly concluded from the original application documents may be taken into consideration when determining the inventiveness of a patent.
1.If possible, the invention patents of chemical fields, especially those of pharmaceutical fields, should adopt open-ended claims. They should disclose the technical effects sufficiently in the description so as to broaden the scope of the protection and to enhance efficient enforcement of the patent right.
2.When the applicant submits experimental data after the application data, it should confirm whether the corresponding technical effects to be proved are clearly disclosed in the original application documents of the patent.
3.If the technical effect of a patent is difficult to predict for persons skilled in the art, we recommend recording the corresponding experimental data clearly and completely in the specification.
4.For examination of creativeness of compounds with a new crystal structure, the SPC pointed out that “compounds of similar structures” referred in the “The Guidelines” only specifically means, compounds with identical basic core structures or basic rings and does not involve the comparison of the compound’s microscopic crystal structure itself.
COMPLIANCE — THE NEW WATCHWORD FOR COMPANIES IN CHINA
In the past few months, allegations of a massive bribery scheme on the part of the Chinese unit of a famous British multinational pharmaceutical company have grabbed headlines in China and abroad. China’s Ministry of Public Security officially announced on July 11 that senior executives of this company are under criminal investigation on suspicion of using travel agencies to bribe government officials, hospitals, doctors, and medical industry associations in a scheme to increase sales. Some of the company’s senior executives and employees are also suspected of taking bribes from third party vendors.
According to the news reports, the national Ministry of Public Security began the investigation in late June, when local public security bureaus visited the company’s Shanghai, Changsha and Zhengzhou offices. Reportedly, company documents have been seized and some employees detained.
While this investigation is high-profile, it is by no means alone. In early July, the National Development and Reform Commission announced an investigation into the costs and prices charged by 60 domestic and international pharmaceutical companies operating in China.
These investigations of drug makers signal China's intention to push forward with reforms in the healthcare sector, which will impact all companies operating in that space.
It is not just healthcare companies that need to take note of these investigations. Companies in other sectors can have high compliance risks if they, for example, frequently use third party intermediaries or have a high degree of interaction with government officials or State-owned enterprises. Companies that fit this profile are advised to pay attention to enforcement trends and take proper responsive measures.
In the current regulatory climate, companies are advised to stay focused on their compliance programs to ensure that they are robust and fully implemented. Recommended steps include the following:
Review and revise internal policies and procedures on, among other things, hospitalities, “dawn raid” guidelines in the event of government inspections, employee handbooks and manuals; and the process for handling “whistleblowers;”
Prepare a training course for employees on how to handle investigations;
Conduct compliance and legal risk assessment;
Review and “stress-test” internal control procedures on, among other things, financial and accounting practices;
Conduct proactive internal audits and investigations of suspected violations;
Conduct detailed due diligence on third party intermediaries such as agents and sales representatives;
Take prompt action if faced with evidence or allegations of wrongdoings.
Companies should exercise caution when an investigation has been initiated before embarking on any internal assessment and audit process.
China’s Investigation into Drug Pricing: What You Need to Know
Under the drug pricing regime, drug manufacturers are required to fix drug prices that are subject to market regulation and to establish prices for new products which are subject to government-set or guided prices, except for special products for trial sales. Manufacturers also have the right to report or claim against actions that have infringed upon their rights of independent pricing. If a manufacturer is not satisfied with a punishment decision made by the authorities, the manufacturer has the right to apply for administrative review of the decision. If the manufacturer is not satisfied after administrative review, it may file suit in a people's court.
Manufacturer’s obligations under the drug pricing regime include setting prices according to the government’s requirements and cooperating with the government during investigations. Manufacturers also have the obligation to keep abreast of all relevant laws and regulations, including government guided-prices, government-set prices, legal price intervention measures, and any emergency measures adopted by the government; to provide any documents or other materials necessary to an investigation; to provide the pricing authority with information related to raw material costs and drug pricing; to fix and mark the retail prices of pharmaceuticals; and to avoid sudden excessive profits and any deceptive pricing harmful to the interests of patients.
Within the context of these rights and obligations, drug manufacturers need to cooperate fully with authorities during a pricing investigation. However, if investigators overstep their authority, manufacturers have recourse to administrative review of investigators’ actions. If unsatisfied with the result, manufacturers may file suit and air their grievances in court.
Who Can Initiate Class-action Lawsuits under the Draft Environmental Protection Law?
At the end of October 2013, the Standing Committee of China's National People's Congress (NPC) finalized the third draft of amendments to China's Environmental Protection Law (《环境保护法修正案（草案）》).
In light of the extensive debate so far, many speculate that the Law will undergo a fourth draft before the New Environmental Protection Law enters into force1. Such changes would constitute the first amendment to the Law since it came into force in 1989.
Luo Jianhua (骆建华), the former deputy head of the NPC's Environment Protection and Resources Conservat ion Commi t tee, explained that the amendments made so far emphasize seven key areas: i) the overall role of the law, ii) the responsibilities of local governments, iii) the sharing of environmental data, iv) preventing pollution related to farming in rural areas, v) public participation, vi) information transparency and vii) punishment2.
The issue that has taken center stage in the debate so far surrounds class-action law suits against environmental polluters. Under the current Law, the list of claimants that can initiate class-action law suits against polluters on behalf of the public is limited, with perhaps the best known being the quasi-governmental All-China Environment Federation (中华环保联合会).
In order to effectively address areas v), vi) and vii), many argued, during the public comment phase on the second draft that, that the list should be extended to cover more claimants. Doing so might help to create, in the words of lawmaker, “a law with teeth that can bite”3.
The third draft seems to reflect that the legislature is convinced by these arguments. It stipulates that “relevant organizations” must, in order to initiate an environmental class-action lawsuit, satisfy four conditions:
1.Be a national organization,
2.Be registered with the Civil Ministry,
3.Have been continuously active for at least 5 years, and
4.Have a “good standing”.
Currently 13 organizations satisfy the requirements (1) – (3). However, as the “good standing” condition gives the court a wide discretion to reject applications, it is difficult to determine who will be able to claim if the amendment is passed.
Class-action law suits generally are a contentious topic in many countries.
The United States is often accredited with introducing the concept as way to level the playing field between individual claimants and larger, often corporate, defendants. As such, there are several examples of an individual bringing a class-action lawsuit against an environmental polluter. Perhaps the best known involves residents of the town of Hinkley in California defeating The Pacific Gas & Electric Company in what became the basis of the Hollywood film Erin Brockovich.
In Canada, there is also precedence for classaction law suits. However the grounds on which to initiate such claims are far narrower. While it is possible in the U.S. to bring a claim for mental anguish or emotional distress4, such claims are unlikely to succeed in Canada. For example, in order for a member to raise a class action in Ontario, he must demonstrate that the class has “common issues”5. In light of pollution often having divergent effects on peoples’ health, such “common issues” have only been established in cases involving damage to property6.
In the United Kingdom class-action lawsuits are not possible. The most similar mechanism is the Group Litigation Order. This involves parties demonstrating to the court that their cases “give rise to common and related issues” and should therefore be managed collectively7. It is at the complete discretion of the Judge to award such an Order. In the most recent case involving an environmental pollutant, the Court of Appeal declined to group 500 individuals claiming damages on the ground that the parties’ cases were not sufficiently similar in law and in fact8. This case is often cited to demonstrate the difficulty in establishing such similarity.
German law is similarly restrictive in allowing multi-party litigation. With very few exceptions – environmental claims against non-governmental polluters not being one of them – German law does not recognize class-action law suits. The parties can however apply to have their cases managed collectively9.
On June 11 2013 the European Commission, the executive body of the European Union, issued a Recommendation10 indicating that within two years Member States should adopt a mechanism for “collective redress” so as to allow claimants to seek damages or injunctive relieve on a collective basis. It specifically states that the availability of such redress would be of value for environmental protection11. Therefore, despite the Recommendation being non-binding, it may result in class-action lawsuits against pollutants becoming available across Europe.
It is not yet possible to determine which organizations would be able to initiate classaction litigation under the third draft of the Environmental Protection Law. However moving away from a definitive list of claimants to a 4-stage test would make the law more flexible. While the status quo may be retained, it is also possible that more NGOs may be allowed to initiate proceedings. In any case, the public debate about extending the number of parties that can initiate class-action lawsuits against polluters is a welcome one. While this may foster access to justice, it may also create the “litigation culture” that the U.S. is often criticized for. Especially in the politically sensitive area of environmental protection, this may do more harm than good. The hesitation of the Canadian, UK and German legal systems in adopting classaction law suits demonstrates this risk.
Push For Soil Quality Regulations Will Have Consequence
With environmental pollution front and center in the Chinese press, the government in Beijing has moved to address at least one aspect of the problem – soil pollution. In a sign that new regulations on soil quality are on their way, the State Council recently issued a directive titled “Working Arrangement of the Recent Environmental Protection and Comprehensive Treatment of Soil.” Investors take note: the policies proposed by the Council will almost certainly impact existing and future investments in sectors such as manufacturing and heavy industry, as well as investments in geographic areas deemed to be ecologically sensitive.
A Council directive is intended to guide the drafting of legislation and is an important clue to the scope of future regulation. A number of the Council’s recommendations could significantly alter the current regulatory landscape. We expect regulation to be forthcoming on national, provincial and local levels in the following areas:
1) Regular monitoring of soil quality with deadlines for pollution clean-up. The Council recommends that soil quality be monitored around industrial and mining establishments that emit heavy metals and organic contaminants, as well as around facilities that process sewage, garbage, and hazardous waste. Any pollution would need to be controlled within prescribed deadlines.
2) Enhanced soil protection areas. The Council recommends that cultivated land and watersheds around reservoirs be granted priority protection. Within these areas, there would be a prohibition on new projects involving non-ferrous metals, leather products, lead-acid batteries, oil and coal, and chemicals and pharmaceuticals.
3) Measures to forbid various uses of polluted land. The Council recommends that construction permits, including those for new industrial projects, should not be issued for land that cannot meet certain soil quality tests. It further recommends that such land be barred from residential development and agricultural use.
4) Model Areas for Soil Control and Recovery. The Council recommends that heavily-polluted areas such as the Yangtze River Delta, the Pearl River Delta, and central and southern Liaoning be made into models for the control and treatment of soil pollution. Comprehensive treatment plans for these areas would be required by the end of 2013. Under this recommendation, investors with projects in these areas could potentially face new environmental regulations by the end of this year.
5) Increased Funding for Treatment of Soil Pollution. The Council recommends that governments increase funding for soil environmental protection. It further recommends that enterprises be held liable for the treatment costs of pollution they cause.
6) Enhanced Accountability. The Council recommends that local governments sign agreements with key enterprises to commit them to certain environmental targets. Failure to meet these targets would expose the enterprises to liability.
Recently, several additional developments have confirmed Beijing’s increased concern with environmental protection. First, China’s leaders at the 18th Communist Party Conference affirmed that environmental protection was as important an area of policy as the Party’s traditional concerns with economic, political, cultural, and social issues. In a meeting of the Central Committee’s Political Bureau this year, President Xi Jinping equated environmental protection with the protection of economic productivity.
Second, in early May, the Ministry of Environmental Protection, among others, promulgated a draft “Soil Environment Protection Law.” However, this draft is still confidential. Its provisions will be explored in our later newsletters when it is issued.
Additionally, in June, the Supreme People’s Court together with the Supreme People's Procuratorates issued the Interpretations on Certain Issues Concerning the Application of Law in Handling Criminal Cases of Environmental Pollution ( the “Interpretations”), which became effective on June 19, 2013. The Interpretations list 14 actions constituting “severe environmental pollution”, breach of which can carry the criminal penalties of imprisonment of no more than 3 years, criminal detention, and/ or penalty in accordance with Article 338 of the PRC Criminal Law. Some actions amounting to “severe environmental pollution” include illegal releasing, dumping, or disposing of dangerous waste of more than 3 tons, illegal releasing of pollutants 3 times above the national emission standard or local emission standard and causing loss or permanent damage to cultivated land, specially used forests of more than 0.8 acres or other land of more than 3.2 acres.
Moreover, the Interpretations also list actions constituting “exceptionally serious consequences”. These can carry fixed-term imprisonments of more than 3 years and less than 7 years and a fine in accordance with Article 338 of the PRC Criminal Law. The “exceptionally serious consequences” include causing loss or permanent damage to cultivated land, specially used forests of more than 2.5 acres or other land of more than 10 acres and causing property damage exceeding 1 million RMB or causing more than 1 death or severe disability.
These developments signal that changes are coming to China’s environmental regulatory regime. The Council’s directive on soil pollution and the newly implemented Interpretations are strong indications that, at the very least, existing and future projects will face enhanced regulatory scrutiny and criminal liabilities related to environmental pollution. Prudent investors should plan accordingly.
The Use of the VAM in an Equity Investment Scheme
The Haifu Case1 caused the Private Equity industry consternation until a clarifying judgment from the Supreme People’s Court of China (the “Supreme Court”) in December 2012. The Supreme Court overruled the second instance court’s opinion that PE investments are “joint risk sharing” and investors are not entitled to a guaranteed profit without regard to the performance of the business. The Supreme Court (i) recognized the legitimacy of the PE investment model, (ii) fully considered all the various interests of the project company, the creditors of the project company and the shareholders of the project company, (iii) distinguished VAM (Valuation Adjustment Mechanism) agreements between the project company and the shareholders from VAM agreements between the company shareholders, and affirmed the validity of the latter with certain prerequisites.
The Haifu Case has significant implications not only for PE firms, but also for the investment industry which may find guidance from it when designing equity investment structures.
I. How to withdraw capital from an equity investment? How to withdraw capital from a project company in a safe and appropriate manner is a key process in an equity investment scheme. In practice, the investment company will sign repurchase agreements with the shareholders of the project company whereby the shareholders are required to purchase for a premium the equity of the financier at the closing date of the project. This process is advantageous because it is common and companies are familiar with it. As for the shortcomings:
a. It is difficult to distinguish between a “regular equity repurchase for a premium” and a “loan arrangement under the name of an investment”. According to the Guidelines for Trust Companies to Operate a Private Equity Investment Trust Business2, a trust investor company can withdraw from an equity investment by the presale of its capital investment”. However, in the case of a real estate investment, this “withdraw capital” model may be deemed a “loan arrangement under the name of investment” and the investor company may be considered to be attempting to intentionally avoid the regulations of the ”four three two” provision (a qualified real estate developer must have four kinds of permission from the relevant government agencies, i.e., State-owned Land Use Permit, Land Use Permit, Building Permit and Building Construction Permit, and must possess a 30% equity fund and a second grade development qualification) implemented by banking regulation authorities.
b. The “withdraw capital” model leads to great uncertainty in the outcome of the judicial process. Based on years of experience engaging with judges of commercial courts at all levels, including the Supreme Court, in cases involving trust plan disputes, most judges are not very familiar with trust laws and prefer instead to adopt traditional civil law theory in their judgments. This leads to a different interpretation, i.e. – that the trust company invests capital but in fact, does not involve itself in the management of the business and also demands the repurchasing of its equity when it becomes due, and charges fixed returns (premium). All this brings the validity of the equity investment structure into question.
c. If a trust company adopts a “withdraw capital” model, documents such as the Equity Repurchase Agreement will be signed in advance with a financing party. However, if disputes arise, the financing party may deny the validity of related agreements by insisting that these agreements are not based on true intentions, thereby rendering the equity repurchase impracticable.
Apart from repurchase, there are other options available for withdrawing capital from equity investments, For instance a company can transfer its equity to third parties or by agreeing upon tag along rights. However, except by transferring the outstanding shares issued by listing companies, there is no certainty that an investing company can dispose of its equity or recover the trust fund successfully. In short, a VAM gives the equity investor certainty over the return of its investment. Without the VAM, the investor can only get a return of its investment by transfer of its shares to a third party by way of a tag along right, or an IPO or a negotiated sale—all of which are uncertain exits.
II. The feasibility of VAM as a method to withdraw capital from an equity investment.
Applying VAM to equity investments: the invest ing company may set VAM terms depending on performance, cash flow and profit objectives with the project company. When such conditions are satisfied, the investing company demands cash compensation or the repurchase of equity by the shareholders of the project company. There is no clear and definite legislation regarding the terms of VAM agreements, but following the judgment in the Haifu Case, the courts should support similar agreements as long as they do not adversely affect the interests of project companies or their creditors.
In theory, a VAM agreement is a valuation adjustment mechanism of a project company. It aims at (i) reducing the risk of the investors’ miscalculation of the equity value, and (ii) incentivising and binding the finance party to the investors. If the project company cannot achieve the profit objectives under the VAM agreement, the shareholders of the project company must compensate the investors. This will not cause any damage to the interests of the company, other shareholders or creditors or violate any mandatory provision of any laws, regulations, rules or policies. In addition, because of the uncertainty of realization of the assumed and pre-stated conditions, the VAM agreement differs greatly from the “regular repurchase” clause and to a certain extent helps the investing company reduce the risk of it being held that it is a “loan arrangement under the name of investment”.
In fact, situations where VAM was applied to investment structures occurred long before the Haifu Case. In the Trust Plan of Energy Investment Collection of CITIC Rongjin3, CITIC Trust made an arrangement with China Oceanwide Corporation (“China Oceanwide”) whereby: if the project company cannot obtain a mining permit and sell 8 million tons of ore a year, China Oceanwide will repurchase all the equity of the project company held by CITIC Trust as trust assets. Although this arrangement mainly aimed to recover the trust fund when the purpose of trust could not be realized, it could also be used when the project succeeded for the “normal” withdrawal of trust funds.
A fact worth emphasizing is that Chinese courts do not need to follow the precedents set by earlier cases or higher courts and different local people’s courts may hold different opinions and interpret VAM agreements differently. Considering the possibility that the Supreme Court may give a different judgment in a future case, the Haifu Case can therefore only be considered as a reference for investor companies.
III. Facts worth noting when VAM is used in withdrawing from an equity investment scheme.
A few points investor companies should note when signing a VAM agreement:
a. The terms of a VAM must not violate any mandatory provision of any laws, regulations, rules and policies or damage the legitimate rights of any other person.
In the Haifu Case, the Supreme Court ruled that the VAM agreement between the investors and the target company was invalid because it violates Article 8 of the PRC Sino-Foreign Equity Joint Venture Law4 on profit distribution, which in turn abused shareholders’ rights prohibited by Article 20 of the Company Law and jeopardized the interest of other shareholders and creditors of the company. Since China lacks specific laws regulating VAM agreements, investor companies must bear in mind the impact of potentially relevant provisions of the general law, as well as judicial decisions involving VAM agreements so as to mitigate the risk of a VAM agreement being invalidated.
b. Avoid gambling with the project company
It is recommended that the investor company should try to avoid entering into VAM agreements with the project company; otherwise, the investor company may expose itself to the court finding that the VAM agreement is invalid. In order to avoid this risk, the investor should instead consider entering into VAM agreements with the actual controller, the management board or other shareholders of the project company.
c. The VAM agreement must be fair and reasonable
The court will focus on the fairness and reasonableness of the VAM agreement whenever disputes arise. Therefore, it is advisable that the investor company explicitly identifies the basis for the investment pricing by reference to the target company’s operational status, industry key performance indicators, etc. The parties should also set fair and reasonable VAM terms and list clearly the method for calculating compensation or repurchase so as to avoid putting the VAM in danger of being recognized by courts as invalid or partially invalid due to its obvious unfair terms.
d. Consider a combination of an equity repurchase agreement, a tag along right and a VAM.
When designing the method of withdrawing capital from an equity investment, an investing company can combine a VAM agreement and an equity repurchase agreement with a tag along right. For instance, the trust company may set conditions in the VAM agreement to trigger the equity repurchase. Once the conditions are satisfied, the equity repurchase agreement signed in advance will become effective and the financing company can then recover its investment.
New Regulations on Alien’s Residence, Work, and Study in PRC
Benjamin is an American electric engineer. He holds two PhDs and has wide-ranging experience in the high-tech industry. He recently accepted a job offer from a large wellknown Chinese business, and is considering moving to China with his wife Rose and 19-year-old son Frank. While Rose would also like to work in China, Frank hopes to study oriental culture at a top Chinese university and work part-time during the summer and winter breaks in order to enrich his social experience. Now, the Benjamin family seek our advice about acquiring a visa to live, work and study in China.
On July 1st, 2013, the PRC Exit-Entry Administrative Law (the “Exit-Entry Administrative Law”) came into force. Its supporting regulation, the PRC Administrative Regulation of Entry and Exit of Aliens (the “Administrative Regulation”) will take effect on September 1, 2013.
1. Key Points of the Exit-Entry Administrative Law
In line with the “talents introduction” national policy, the Exit-Entry Administrative Law creates the “R type visa” as a new ordinary visa. The R visa will be issued to highlevel foreign talents and specialized talents sought by China in urgent matters. Therefore, in addition to a work visa (Z visa), Benjamin may qualify for the new R visa to enter and work in China. To obtain an R visa, Benjamin will have to submit the supporting documents required by the government’s high-level foreign talents’ attraction policy.
Unlike the old regulations , the Exit-Entry Administrative Law clarifies that a Chinese visa will not be issued to the following six applicants: (1) those who have been deported due to a criminal sentence or repatriation and the prohibition period of re-entry has not expired; (2) those with a serious mental disorder, infectious pulmonary tuberculosis or any other infectious disease that may seriously damage public health; (3) those who may imperil the national security and interests of China, disrupt public order, or commit other violations of law or criminal offences; (4) those who commit fraud when applying for a visa or who cannot show they have sufficient funds to cover all the necessary expenses for their stay in China; (5) those who fail to present relevant documents required by the visa issuer; or (6) those that match other criteria set out in the Exit-Entry Administrative Law. The Exit-Entry Administrative Law also provides circumstances under which a residence permit will not be issued.
The Exit-Entry Administrative Law specifies that the following will be regarded as illegal workers in China: (1) those who work in China without obtaining a work permit and a work-related residence permit as required; (2) those who work in China beyond the authorized scope prescribed on the work permit; (3) those foreign students who violate administrative regulations of off-campus work by working in China beyond the authorized scope of their job position or duration. Hence, Benjamin, as a foreign worker, must obtain the relevant work permit and residence permit to work in China and avoid punitive measures as a result of unlawful employment under PRC laws.
The Exit-Entry Administrative Law further adjusts the validity period of residence permits. For example, a nonwork- related residence permit and work-related residence permit will be valid for at least 180 days and 90 days respectively; and at most 5 years for both.
2. Key Points of the Administrative Regulation
The Administrative Regulation expands the category of ordinary visas from 8 types to 12 types. Each visa name comes from the initial letter of the Chinese Pinyin of the Mandarin characters for the subject matter of each type of visa. The original 8 types of ordinary visa first prescribed under the old regulation are: D (settlement), Z (employment), X (study), F (visiting), L (traveling), G (border crossing), C (crew members), and J (journalist). The Administrative Regulation adds another 4 types: M (commerce), Q (relatives), R (talents), and S (personal affairs). The Administrative Regulation also narrows the scope of the original F, X, and Z visas.
Thus, Benjamin’s wife Rose will no longer apply for a Z visa. Instead, she needs to apply for the new S visa to enter China. As for Frank, if he comes to China only to visit parents, he can also apply for an S visa. Alternatively, if Frank studies at a Chinese university, he can apply for an X1 visa for long-term study or an X2 visa for short-term study.
The new Administrative Regulation legalizes international students’ off-campus work or internships in China. When a foreign student who holds a residence permit for study works or interns off-campus, upon obtaining consent from his/her school, he/she must apply to the entry-exit administration of a competent public security authority. The entry-exit administration must endorse the place and period of the work or internship on the student’s residence permit. A foreign student who fails to obtain this endorsement may not take a part-time job or internship outside of campus. Thus, if Frank would like to find an off-campus internship during his winter and summer breaks, he should complete the above procedures. Otherwise, his internship will be deemed illegal employment and he will be punished.
Compared with the old regulations, the two new laws provide new content and state new issues the old regulations never addressed. The new laws provide clearer directions to foreigners about their residence, work and study in China. We wish the Benjamin family a wonderful life, work and study in China!
China Tax: Unveiling the International Secondment Arrangement
Over the years, it has been common practice for a multinational company (“Home Entity”) to dispatch expatriate employees (“Secondees”) to its affiliated enterprise in China (“Host Entity”) to hold senior management or other technical positions. Usually, the Home Entity and the Secondee retain the employment relationship. The Home Entity will pay the salary and social security contribution for the Secondee in the home country, and will be reimbursed by the Host Entity. A Chinese tax clearance certificate is usually required when the Host Entity makes the reimbursement payment, so the Chinese tax authority needs to determine whether the Home Entity constitutes an establishment/place of business (“taxable presence”) or a permanent establishment (“PE”) under the relevant tax treaty and thus be liable to Enterprise Income Tax (“EIT”) consequence in China. The tax authorities and the Host Entity may have different views due to the ambiguity of tax regulations in the assessment of taxable presence or PE for cross-border secondment arrangements. As a result, the Host Entity often has difficulty in obtaining the tax clearance certificate and cannot remit the payment to its overseas Home Entity. The situation is likely to change from June 1, 2013.
On April 19, 2013, the State Administration of Taxation (SAT) issued the Announcement on Issues Concerning Enterprise Income Tax on Services Provided by Nonresident Enterprises through Seconding Personnel to China (“Announcement 19”), which provides clearer guidance over the criteria for determining whether the Home Entity under a secondment arrangement will constitute a taxable presence or a PE in China. Announcement 19 is based on tax circular Guoshuifa  No.75 (Circular 75) and is a further development in respect of the PE assessment for international secondment in China. Where the Home Entity constitutes a taxable presence or a PE in China, (apart from Individual Income Tax (IIT) which usually apply to the Secondees) EIT will be imposed on the Home Entity. This new policy will significantly impact the tax cost of Home Entities and the pattern of structuring international assignments.
Based on the salient points of Circular 75 and the latest Announcement 19, we summarize below the issues concerning the assessment of taxable presence or PE under secondment arrangements.
Criteria determining the constitution of taxable presence or PE in China
According to Circular 75, if at the request of its PRC subsidiary, the overseas parent company dispatches personnel to work for the subsidiary, and such personnel enter into formal employment with the PRC subsidiary which has command over their work, and the work responsibilities and risks are entirely assumed by the subsidiary, instead of the parent company, then the activities of such personnel shall not trigger a taxable presence or a PE of the parent company in China. In this case, the fees paid, directly by the PRC subsidiary or indirectly through the parent company to such personnel, shall be deemed payroll expenses paid to the PRC subsidiary’s employees.
Moreover, Announcement 19 clearly states that, where the Home Entity dispatches personnel to render service in China, if the Home Entity bears all or part of the responsibilities and risks in relation to the work of the Secondees, and normally reviews and evaluates the job performance of the Secondees, the Home Entity shall be deemed as having a taxable presence in China. If the Home Entity is a tax resident of a country/region that has entered into tax treaty with China, such establishment and place of business may create a PE in China if the criteria of PE have been met under the applicable treaty provisions, for instance, the Secondees’ stay in China has exceeded 183 days or 6 months in any consecutive 12 month period.
When doing the above assessment, the following factors shall be taken into consideration:
The Host Entity makes payments to the Home Entity in the nature of management fees or service fees;
Payments from the Host Entity to the Home Entity exceed the Secondee’s salaries, bonus, social security contributions, and other expenses as advanced by the Home Entity;
Not all related expenses reimbursed by the Host Entity are paid to the Secondees, instead, the Home Entity retains a portion of such payments;
IIT has not been reported and paid based on the full amount of the Secondee’s salaries ; and
The Home Entity is the decision maker in terms of the number, the qualification, the remuneration and the working locations of the Secondees in China.
Generally speaking, if one of the above factors is met and the work of Secondees has substantial connection with the Home Entity, the Home Entity is likely to be assessed as having a taxable presence or a PE in China.
In addition, Announcement 19 stipulates that, if the Home Entity constitutes a taxable presence or a PE in China, the Host Entity and the Home Entity shall perform tax registration or recordfiling with the tax authorities, and file EIT based on the actual income generated in China, if it is not feasible to accurately calculate the taxable income, the tax authority is empowered to deem the taxable income in accordance with relevant regulations.
1. With the release of Announcement 19, it is expected that the tax authorities will strengthen their oversight of secondments between multinationals and their subsidiaries in China. It is suggested that enterprises review their existing secondment arrangements and assess the underlying tax risks. The bright side of Announcement 19 is that it provides greater certainty about the tax treatment of secondments, and will facilitate smoother tax clearance when Host Ent i t ies make reimbursement payments overseas.
2. Where PRC IIT is paid on the full amount of the Secondee’s salaries, then even if the Home Entity bears part or all of the expenses, it is not likely to create a taxable presence or a PE for the Home Entity because it does not bear the Secondee’s salary and does not derive a profit through the secondment arrangement.
3. This Announcement clarifies that where the Home Entity assigns its expatriate employees to China solely to exercise its shareholders’ rights and safeguard the shareholders’ interest, the Home Entity will not be deemed to have a taxable presence or a PE in China.
4. Enterprises should establish the factual background to substantiate the connection between the work of Secondees and the Host Entity. It is of vital importance to put in place proper documentation about the work reporting requirements and evaluation mechanism of job performance, The documentation should include: (1) relevant contracts of employment and/or secondment; (2) Secondee’s job description for the Home Entity or the Host Entity, including responsibilities, role, performance indicators and assumption of risk of the Secondees; (3) the terms governing payments to be made by the Host Entity to the Home Entity and accounting treatment, and the IIT filing and payment records of the Secondees in China; and (4) information about whether the Host Ent i ty t reats a Secondees’ expenses by way of offsetting intercompany accounts, waiver of creditor’s rights, related party transactions or other means, in lieu of reimbursement,
Announcement 19 becomes effective from June 1, 2013, and also applies to existing secondments where the tax treatment has not been confirmed or the reimbursement has not been made. It is suggested that enterprises shall assess the tax implications of Announcement 19 on their current secondments and, where needed consider restructuring the international assignment arrangement and put in place proper documentation to safeguard the parent company’s tax position and mitigate PRC tax risks.
2013 Chinese Outbound Investment Trends Overview -- Energy and Resources M&As
According to statistics released by China’s Ministry of Commerce, Chinese outbound investment will continue its robust upward trend during the latter half of 2013, with energy and resources-related deals dominating the scene. In 2012, China’s outbound direct investment reached a record high of $87.8 billion, making it for the first time one of the top three outward investors during the period. Of that amount, $13.54 billion flowed to the mining industry, and more than $1 billion to the energy and resources-related industries, in particular the production and supply of electricity, steam, gas and water1.
Before closing what is likely to be yet another record breaking year, this article attempts to summarize some of the latest trends and developments affecting Chinese outbound investment into the energy and resources sector generally from a geographical perspective, as well as the forces shaping such trends, and discuss some of the major challenges and risks facing Chinese investors who are riding or wish to hop on the wave of globalization.
Part I Chinese Outbound Investment Trends in Traditional Energy and Resources Industries
AFRICA/MIDDLE EAST: China has continued to maintain its great interests in Africa, thanks largely to the abundant energy and natural resources untapped in this continent and increasingly, the potentially huge market for competitively-priced Chinese industrial products. Nonetheless, despite the existence of individual opportunities in this part of the world, risky environments, a lack of technology and low per capital income levels make doing business difficult for foreign investors. By way of illustration, Angola, Nigeria and Kenya are ranked in the bottom three, while South Africa ranked 49, of the China Going Global Investment Index2, which balances opportunities against risks for 67 countries, recently published by Economist Intelligence Unit.
According to a white paper on Sino-Africa economic and trade cooperation published by the Information Office of the State Council, Chinese direct investment in Africa increased from $1.44 billion to $2.52 billion, with an annual growth of 20.5% from 2009 to 2012. To enhance the competitiveness of its investment, the Chinese government is providing special loans for small and medium-sized African companies wanting to coinvest with Chinese companies in Africa.
Recent blockbuster deals in this region include the acquisitions (i) by China National Petroleum Corporation of a 28.57% stake in Mozambique’s Eni East Africa for $4.2 billion; (ii) by China Petrochemical Corporation of a 20% stake in Nigeria’s Total Nigeria PLC, an offshore oil project, for $2.5 billion; and (iii) by a consortium (which includes, among others, Chinese investors Hebei Iron and Steel Group, Tewoo Group and Cadfund) of a 74.5% stake in South African copper producer Palabora Mining from mining giants Rio Tinto and Anglo American for $446 million.
US-based oil and gas producer Apache Corporation is selling a 33% stake in its Egyptian oil-and-gas business for $3.1 billion to state-owned Chinese oil giant Sinopec Group, to reduce its exposure to the recent political unrest in Egypt. The two have also formed a global strategic partnership to jointly pursue upstream oil and gas projects. The Apache deal is Sinopec's biggest overseas acquisition since it bought a stake in the Brazilian unit of Portuguese oil company Galp Energia SA for $5.19 billion in November of 2012.
NORTH AMERICA: Chinese foreign direct investment into Canada hit an all-time high in 2012, with most of tha going to the purchases of natural resource companies and projects. The much-debated $15.1 billion acquisition of Nexen Energy by Chinese stateowned CNOOC accounted for close to 60% of the total investment value that flowed into the region.
The latest sign of continued interest in Canada's oil patch by energy-hungry China can be seen in the acquisition of Novus Energy Inc. (NVS.V), a Canadian junior oil and gas company, by China's Yanchang Petroleum International Ltd. for around CAD232 million ($226 million) in September 2013.
It remains, however, to be seen if Chinese foreign investment into Canada will decline as a result of the current Canadian administration’s plan to tighten restrictions on foreign ownership of Canadian resources.
In the United States, Chesapeake Energy Corp. agreed to sell a stake in an oil and natural-gas field straddling the Oklahoma and Kansas border to China's Sinopec for $1 billion this summer, as the American company tries to recover from the global financial crisis with a Chinese cash injection3.
LATIN AMERICA: China’s hunger for energy resources and commodities has also led to a surge in Chinese outbound investment into Latin America. China’s list of targets is expanding beyond the more mature markets in Latin America such as Brazil and Chile to other up and coming hotspots such as Peru, Colombia and Ecuador.
Brazilian company Petrobras has recently sold a 35% stake in a Santos Basin oil exploration project to China's Sinochem Group Co., Ltd. for $1.54 billion, all of the shares it owned in a petrochemical company, as well as shares in a Gulf of Mexico bloc and a thermal energy company in Brazil.
In December 2012, Ecuador signed a $2 billion loan agreement with the China Development Bank and simultaneously, state-run company Petroecuador signed an eight-year contract to sell crude oil and fuel oil to Chinese companies. Chinese banks are frequently making these loan agreements with oil companies in Latin America4.
The same Ecuadorian company holds a 51% stake in a refinery project, in which China National Petroleum Corp, CNPC, are negotiating to acquire a 30% stake. These shares will be acquired from Venezuela's staterun oil firm Petroleos de Venezuela, PdVSA, who holds the remaining 49%.
CENTRAL ASIA: In addition, China has been making close ties with neighboring countries Russia and Kazakhstan. A Russia-China Investment Fund was established to jumpstart the investments in this region, where 70% of the investments will be in Russia and 30% in China5. The purpose of the fund is to improve infrastructure for transportation of minerals among others.
More recently, Chinese President Xi Jinping’s visit to Kazakhstan witnessed the signing of a series of deals worth a total of around $30 billion, including a $5 billion oil and gas deal under which China National Petroleum Corp will acquire a 8.33% stake in Kazakhstan's giant Kashagan offshore oil project6, further increasing China’s influence in post-Soviet Central Asia.
SOUTH EAST ASIA: We also expect Chinese investment in South East Asian countries like Indonesia and Malaysia to grow at an accelerated pace over the next few years due to their abundant natural resources. Mining and energy transactions in this region went up 15.7% from 2011 to 2012. China invested in 76 mining projects in ASEAN countries from January to April of this year and has signed seven mining cooperation agreements valued at about 16.3 billion yuan ($2.59 billion) with ASEAN countries during the China-ASEAN Mining Cooperation Forum and Exhibition recently7.
AUSTRALIA: A noteworthy trend reversal is taking place Down Under. Despite being China’s long-time favourite investment destination for resources, Australia has seen Chinese investment slip considerably in 2011 and 2012 in general. Statistics published by the Chinese Mining Industry Association8 show that, in the first half of 2013, Chinese outbound direct investment in Australia’s mining and resources sector totalled a mere AUD48 million, hitting lowest level since 2009. Multiple factors have led to such reversal. First, from a macroeconomic perspective, China’s slowing economy and the on-going structural change and economic rebalancing have led to the decline in Chinese demand for commodities. Secondly, from Chinese investors’ perspective, hindered by lack of execution capability for complicated cross-border transactions, only a handful of them have globalisation plans. Thirdly, from an Australian investment climate’s perspective, the country’s confusing and unpredictable foreign investment approval policy (especially policy towards foreign government-owned entities or investments in highly sensitive sectors such as agricultural), as well as the negative economic impact of the controversial carbon tax and mining resources tax on specific mining projects, have greatly deterred Chinese investment, shattering long-held beliefs that Australia is a sovereign-risk-free investment destination. In addition, constrained infrastructure capacity and labour shortage issues have thwarted Chinese mining investors’ ambitions to engage in large-scale investment. All these factors, coupled with the considerable losses suffered by them as a consequence of failed mining investments in this continent, have, to a certain extent, caused Chinese investors to lose confidence in Australia. At the same time, Chinese investors have found new supply alternatives for their natural resource demands. Regions like Canada, South Africa, South East Asia, Latin America and Central Asia are undoubtedly turning an increasing number of Chinese energy and resource investors away from Australia.
Part II Chinese Outbound Investment Trends in Clean and Renewable Energy Industries
Powered by policy support from the government, China’s cross-border investments in renewable energy have witnessed an unprecedented rate of growth in recent years. Over the past decade, China has made at least 124 investments in solar and wind industries in 33 nations around the world9, and will continue to lead the world in renewable energy investment.
AUSTRALIA, NORTH AMERICA AND EUROPE: Count r ies in these regions have a focus on renewable energy for investment. Some of them have implemented policies to attract domestic and foreign investments in this sector. For instance, to ensure its goal of achieving 35% renewable energy by 2035, Germany has implemented support mechanisms such as feed-in tariffs and priority connection to power grids. Other countries, like the United States, have tax credits and loan guarantees to make their markets for sustainable energy more lucrative. Cutting edge technologies and know-how offered by these regions are also an important factor in attracting foreign investment.
WIND POWER: China’s largest wind turbine manufacturer Titan Wind Energy Co. Ltd. announced in 2012 the acquisition of Vestas’ turbine manufacturing plant in Denmark. Titan Wind Energy had for long been Vestas’ supplier but because of this transaction, they have now become the owner of Vestas’ manufacturing facility in Denmark. To Titan Wind Energy, Europe offers the most promising outlook for offshore wind energy, which is still relatively underdeveloped in China.
Early this year, King & Wood Mallesons advised Guohua Energy Investment Corp, a wholly owned subsidiary of Shenhua Group, on its acquisition of a 75 % stake in Hydro Tasmania’s (a company owned by the State of Tasmania) 168-megawatt Musselroe wind farm project. The firm previously advised Guohua on its acquisition of a 75% stake in Hydro Tasmania’s Bluff Point 65-megawatt and Studland Bay 75-megawatt wind farms in Woolnorth, Tasmania in early 2012. Upon completion, the total installed wind power capacity of Guohua in Australia will exceed 300- megawatts.
SOLAR ENERGY: Another renewable energy magnet for Chinese outbound investments is solar energy. China is one of the world’s biggest solar panel manufacturers, four out of the ten biggest global solar panel companies are Chinese.
In a recent bid, Chinese company Trina Solar won the deal of supplying 1.1 million solar panels for a power plant in the desert of Nevada, United States. As well as exporting to the United States, Chinese investors have also shown a great deal of interest in American solar panel companies. China Solar Power Holdings Ltd. has recently acquired 100 % of the shares of ThinSilicon Inc., and a 51% stake in Terra Solar Global Inc.
European solar energy companies are under the radar of Chinese companies as well. Chinese solar polysilicon and wafer manufacturer LDK Solar acquired a 38% stake in Germany’s Sunways AG in 2012, adding to the 33% stake it purchased earlier in the year and providing China’s second-largest solarpolysilicon maker access to new technology and a distribution network in the world’s biggest photovoltaics market.
AFRICA: A recent trend worth mentioning is that Chinese investments in renewable energy in Africa are blooming. This appears to be largely due to the African governments’ efforts to open up their economies for private investments and the possibility of feed-in tariffs. Chinese companies Yingli Solar and Suntech Power have invested in solar plants, whereas Goldwind and Guodian Longyuan have invested in wind farm projects in South Africa, for that reason10. Moreover, Dongfang Electric, one of China’s largest manufacturers of power generators, is poised to build a 120-megawatt wind power facility at Aysha, in western Ethiopia, with financial support from the China Exim Bank11. Separately, just last month, Nigeria signed a $1.3 billion deal with two Chinese state companies, China National Electrical Equipment Corporation and Sinohydro Consortium, to build the Zungeru power plant in Niger state, also with financial backing from China Exim Bank. The hydroelectric plant is expected to add 700 megawatts electricity to Nigeria’s current 4600 megawatts12.
Part III Challenges Faced by Chinese Investors
Despite a slew of preferential incentives offered by the Chinese government, covering areas such as financing and equipment export, Chinese investors still face various challenges when investing abroad.
The foreign investment approval regime of a target country is commonly considered to be one of the major obstacles facing China’s overseas mining and resources investment projects. In one recent example, Chinese-owned Ralls Corporation in the US was denied access to buy a wind farm located near a navy area in Oregon, USA. National safety was cited as the reason for rejection. Another example is the Australian finance minister’s rejection of China Minmetals’s proposed acquisition of the assets of the Australian company OZ Minerals. Again, national security reasons were cited because part of the target assets is near a navy area. Consequently, but unsurprisingly, the foreign investment approval regime of a country has increasingly become one of the key factors to consider for Chinese investors when they invest overseas.
High taxes and labor issues can be a major stumbling block as well. As discussed earlier, Australia is one of the countries seeing a decrease in Chinese investments. When asked why, the Chinese Mining Association quoted high carbon tax as the main reason13. Because of high taxes, Australia is not able to compete with other mining markets like Africa, Norway, Kazakhstan or Russia. The new coalition government, which came into power in September 2013, has vowed to scrap the carbon tax and mining resource rent tax14. But the timetable for implementation and replacement policy have yet to be announced, not to mention that the new coalition government is facing its sternest test since election victory as the tensions between its conservative and liberal wings are beginning to surface. It remains to be seen how this leadership tussle would impact the government’s policy-making process.
Another general concern when entering a foreign market is the lack of knowledge of local laws and cultural differences. According to the analysis of an industrial insider, when investing abroad, Chinese companies tend to only focus on what they are going to invest and fail to consider every aspect of the investment as a whole.15
For example, CITIC Pacific was hit with a multi-fold budget blowout on its 2 billion ton magnetite iron ore project in Western Australia and is at the risk of being unable to recover the costs after the commencement of production. The underlying reason for this is its lack of knowledge of the migration policies and environment protection laws, as well as the characters of the magnetite in Western Australia. This is often compounded by Chinese investors’ lack of capability to efficiently restructure acquired assets and to execute complex cross-jurisdictional transactions.
Nonetheless, it needs to be pointed out that despite the above setbacks, we have seen positive signs of steady improvement. For example, more and more Chinese investors have taken the initiative to seek and rely on professional advice from financial, legal, technical and PR experts before embarking on their outbound investment journey. Also, Chinese companies are increasingly using consortiums as a form of acquisition vehicle, allowing industrial investors, EPC contractors and financial investors to combine their strengths and jointly execute an acquisition or investment. In addition, the participation of professional investors such as sovereign wealth funds and private funds has enabled Chinese outbound investments to be made in a more professional way.
According to a survey undertaken by PwC, during 1986 to 2006, as much as 67% of China’s outbound investments ended in failure. However, according to one news report, the official statistics published by the Ministry of Commerce at the end of 2012 showed that only a small fraction of China’s outbound investments ended in failure. In particular, of all the more than 2700 overseas companies owned by the central government, 80% broke even or made a profit, with only 20% reported losses. Despite this, Ministry of Commerce officials did admit in the same news report that Chinese outbound investments were exposed to high risks and there were quite a number of failed cases.16 Apparently, Chinese investors still have a long way to go before it begins to significantly bump up the success rate of overseas acquisitions.
Investing in Myanmar – Risks and Strategies for Chinese Entities
Myanmar’s incumbent president U Thein Sein took office on March, 2011 and since then the new government has become quasi-civilian, bringing an end to military rule. The new government has also undertaken economic and political reforms to encourage Western countries to suspend economic sanctions and to attract foreign investment.1
Currently, China is the largest investor in Myanmar, providing $20 billion in foreign direct investment according to the Directorate of Investment and Company Administration of Myanmar. Over many years, China and Chinese investors have established good relationships with Myanmar’s government and obtained a ‘head-start’ in this regard over many other foreign investors who until recently, were prohibited from investing in Myanmar. However, with the changing political, social and regulatory environment in Myanmar, Chinese investors must consider new strategies to ensure the longterm success of their investments.
I. Demand for “corporate social responsibility”
The New York Times recently reported2 that projects in Myanmar are “challenged more than ever by activists energized by Myanmar’s democratic opening” providing the following examples:
the Shwe Gas Movement is pressing for higher compensation for land taken for gas pipelines and for better paying jobs along the pipelines’ route;
monks have joined with ancestral landholders to stop a Chinese-led conglomerate from ‘leveling’ a fabled mountain embedded with copper;
violent protests were held against a mining project involving a Chinese company which promoted a government-established inquiry into the project.
Community challenges to foreign investment can have serious, even devastating effects on the investment. One Chinese hydropower company operating in Myanmar was asked to close operations because of concerns over practices that lead to fighting between the national army and Kachin rebels. The company was asked to leave Myanmar even though it initially invested with the approval of the Government.
These examples illustrate the increasing importance of “Western-style” corporate social responsibility practices (CSR) for Chinese outbound investors. This is because adopting CSR is an important step in strengthening the relationship between Chinese investors on the one hand, and foreign governments and local communities on the other. In this way, CSR can satisfy local communities and governments as well prevent a situation where an investor is effectively forced to abandon their investment. This is sometimes referred to as maintaining a ‘social licence’ to operate.
II. Corporate social responsibility CSR often requires companies to go beyond complying with local laws. For example, outbound investors need to consider the impact of extra-territorial regulation from their home jurisdiction, as well as the adoption of voluntary CSR codes and principles. In addition, investors should be sensitive to local expectations regarding labor relations and corporate activity, even if those expectations are not strictly enshrined in local law.
A. Extra-territorial regulation
Chinese companies are now subject to greater extra-territorial regulation from their home jurisdiction when investing abroad. This year, the Ministry of Commerce (MOFCOM) has published three new sets of rules to govern the extraterritorial conduct of Chinese companies:
a.Guidelines on the Environmental Protection in Outbound Investment and Cooperation (《对外投资合作环境保护指南》).
Pursuant to these Guidelines, which were issued on 18 February 2013, Chinese companies are encouraged to fulfill their responsibilities to support sustainable development and protect the environment in host countries. The Guidelines state that Chinese companies should comply with local environmental laws, and adopt practices that protect the environment in host countries. Companies are also encouraged to adopt a broader range of social values including respecting local cultural traditions and workers’ rights.
b.Key Working Points on Regulating the Conduct of Enterprises Engaged in Overseas Business and Preventing Overseas Commercial Bribery (《2013年 商务部规范企业境外经营行为，防治境外商业贿赂工作要 点》). The Key Working Points, which were issued on 27 February 2013, extend MOFCOM’s oversight of commercial bribery by Chinese companies operating abroad, including the adoption of best practice features of Western legal systems. The Key Working Points will increase regulation of Chinese companies’ employment of foreign workers. MOFCOM aims to promote the development of corporate culture within Chinese companies that engage in international business, and will look to publicise positive examples of business behavior.
c.Provisions on Regulating Competitive Conduct in Outbound Investment and Cooperation (《规范对外投资 合作领域竞争行为的规定》). These Provisions came into force on 17 April 2013 and are aimed at encouraging fair competition and upholding the orderly process of Chinese foreign investment.
China’s enactment of extra-territorial rules governing outbound investors reflects similar developments in Australia, the UK and the US, and follows the extension in 2011 of the PRC Criminal Law to prohibit Chinese citizens and companies from bribing foreign officials.
B.Voluntary codes and practices “Western-style” CSR also involves a series of voluntary initiatives and codes that companies can adopt. For example, companies from Australia, the UK and the US often align their overseas operations with the following standards:
a.UN Guiding Principles on Business and Human Rights: Implementing the “Protect, Respect, Remedy” Framework. The “Protect, Respect, Remedy” Framework, endorsed by the UN Human Rights Council, states that companies are responsible for the direct social impacts caused by their activities, as well as indirect social impacts linked to their operations, products or services through business relationships. The Guiding Principles recommend that companies publish a policy commitment to CSR, undertake due diligence on the social impacts of their operations, and develop remediation mechanisms for addressing adverse impacts.
b.Voluntary Principles on Security and Human Rights. The Voluntary Principles were developed by companies, governments and non-government organizations to assist the extractive sector with security operations. These Principles are not legally binding, but participating companies are expected to deal responsibly with public and private security forces and to consult openly with local communities.
c.Equator Principles. The Equator Principles are used by many of the world’s largest export credit agencies and financial institutions, including for example Industrial Bank Co., Ltd, to assess environmental and social risk in projects that they finance. Borrowers from these institutions are required to covenant in the financing documents that they will comply with the relevant requirements, as well as environmental and social laws in the project’s host country.
By identifying which voluntary initiatives are appropriate, and aligning their overseas operations as appropriate, Chinese outbound investors in Myanmar can help to meet the expectations of Government and the business community in the counties in which they are investing, and maintain their ‘social licence’ to operate.
III. Investment treaty protection
As well as contributing to the expectation that companies will demonstrate their commitment to various CSR standards, the events described above, can also be described as ‘political risk’ events. “Political risk” in foreign investment is the risk that an investment will be adversely affected by a host country’s political or regulatory decisions, or, the risk that the host country fails to provide a stable legal and regulatory environment and therefore significantly harms your investment.
Investment treaties provide protection against “political risk” events by giving investors the right to seek compensation from a foreign government for harm caused to foreign investments or suffered by foreign investors.
Without investment treaty protection, you take the risk of investing in a foreign country with no protections beyond those offered by that country’s domestic legal system. This can be a real concern in countries without stable, political environments and sophisticated legal systems. Accordingly, if you are investing in Myanmar (or another foreign jurisdiction), we recommend that you also obtain investment treaty protection.
B.China’s investment treaty with Myanmar China and Myanmar have entered into an investment treaty called “the Agreement on the Promotion and Protection of Investments between China and Myanmar” (China-Myanmar BIT). This treaty provides broad protection to Chinese investors in Myanmar including:
a. Full Protection and Security (FPS). This requires the Myanmar Government to exercise due diligence in ensuring a basic level of protection to Chinese investments. It might be breached if, for example, the Myanmar Government did not take adequate steps to protect protestors from causing physical damage to investments.
b. Fair and Equitable Treatment (FET). This protection is very broad and generally provides protection from court, tribunal or administrative decisions which do not afford the investor due process or are tainted with bias, fraud, dishonesty, or lack of impartiality, as well as, against “arbitrary” treatment and significant alterations to the legal and business environment in which it invested. It could be relied upon by a Chinese investor in Myanmar if the Myanmar Government revoked the investor’s business licence or undermined the investor’s expectation that its investment would be supported by the Government, generally, or in a particular manner.
c. Protection from unreasonable or discriminatory measures which harm the management , maintenance, use, enjoyment and disposal of the investments. This protection might be breached if the Myanmar government introduced regulations which severely restricted the management and operation of foreign investment in Myanmar.
d. Compensation for Expropriation or Nationalisation of investments without adequate compensation. This protection will also protect against acts or government measures which, over time, have the effect of nationalising or destroying the value of your investment.
e. Compensat ion for Damages and Losses. The treaty also gives Chinese investors rights to compensation equal to that provided to local investors or investors from any other state, when their investment suffers damages or losses from war, a state of national emergency, insurrection, riot or other similar events.
f. Repatriation of Investments and Returns. The treaty guarantees the ability of Chinese investors to transfer to China returns from their investment including profits, dividends, interests and other legitimate income, proceeds obtained from the total or partial sale or liquidation of investment and royalties in relation to intellectual property rights.
Similar protections can be obtained via the China- ASEAN Investment Agreement.
C. How to obtain protection Each investment treaty defines the investors and investments which will be protected, the protections provided and the rights of investors to seek redress for breach of these protections. The China-Myanmar BIT protects “every kind of asset” invested by Chinese nationals (including corporate and other economic entities) in Myanmar, in accordance with Myanmar laws and procedures. Whilst this provides broad protection, Chinese investors need to ensure that their investments meet the legal definition of ‘investment’ and, if a corporate or economic entity, that they have a sufficient connection with China.
IV. Conclusion and next steps There are pro-active steps Chinese investors can take to protect their foreign investments from social unrest and political risks. We recommend that Chinese investors adopt this pro-active approach, and thereby build stronger Government and community relationships. We also recommend that Chinese investors obtain investment-treaty protection as a last resort guarantee for their investments.