Distributorship in China: Conventional Wisdom

Inadequate for Unique Legal Challenges

 

by May Y. Hao

June 7, 2003

 

Many companies desire to sell their products in China.  Some sell their products through a subsidiary or a joint venture in China; others do not intend to set up an independent entity in China (whether wholly or jointly owned); instead, they use one or more distributors in China to sell their products.

 

Most companies selling their products in China through a distributor are familiar with common issues arising in a distributorship, such as exclusivity, scope of services, protection of confidential information, price and price adjustment, fee payment, risk of losses, etc.  Large companies normally have good legal advisors who can also help anticipate peculiar issues in a distributorship in the Chinese legal environment. Small to medium sized companies, however, tend to rely on their conventional wisdom and they often are ill-equipped to deal with legal issues that do not regularly arise in a domestic distribution relationship.

 

In the past two months, two clients approached me: one is a US company and one is a Chinese company.  Both clients encountered issues relating to a distributorship in China.  Their experience illustrates the complexities of some of the legal issues in a distributorship in China. 

 

The US client is a manufacturer of a certain product. Two years ago, it entered into a non-exclusive distribution agreement with a Chinese company to market and sell its product in China.  The Chinese distributor, as authorized, further engaged another Chinese sub-distributor to sell the product.  Before the sub-distribution arrangement was made, this sub-distributor had registered a trademark in China which was identical to the trademark used, yet never registered either in China or in the United States, by the US manufacturer.  The US manufacturer was aware of this fact, but never discussed the issue with either the Chinese distributor or the sub-distributor.

 

Now, the US manufacturer intends to use another Chinese distributor to sell the same product in China.  The Chinese sub-distributor told the US manufacturer that while the US manufacturer may engage other Chinese companies to distribute its product, these other Chinese distributors may not use the trademark registered by the sub-distributor without its prior consent.  The US manufacturer was very concerned; among other issues, it felt it was under the effective control of this Chinese sub-distributor regarding its proposed expansion of distributorship in China.

 

The Chinese client is a distributor engaged by an Illinois company more than three years ago.  After the initial few months’ experience in marketing and selling the product of the Illinois company in China, the Chinese distributor found itself in a disadvantageous position because while other Chinese companies were selling similar products manufactured by other foreign companies in the name of the relevant foreign manufacturers, this Chinese company was selling the product as a “middleman”, namely, a distributor.

 

Advised by its Chinese legal counsel, the Chinese distributor proposed to the Illinois company that the Chinese distributor register an entity in China using the name of the Illinois company and distribute the product in the name of such newly registered entity.  The Chinese distributor assured the Illinois company that the relationship between the two companies would continue to be that of distributorship as provided in the distribution agreement.  The Chinese distributor also signed a written statement to the effect that it expressly assumes all the legal and financial risks arising in connection with this newly registered entity. The Illinois company, which is a medium-sized company, reviewed the proposal and signed off on the arrangement. 

 

Most recently, the Illinois company is contemplating setting up a subsidiary in southern China. In this process, it realized that the company’s name has been used and registered in China by its Chinese distributor.  To avoid potential legal problems, it requested that its Chinese distributor cease using its name. The Chinese distributor, as expected, felt that this is unfair. It argues it used the name of the Illinois company with the express consent of the Illinois company and that it is a breach of contract for the Illinois company to ask it to stop using its name in China.

 

When setting up a distributorship in China, a company should learn to be sensitive to its own business decisions: different business decisions may have vastly different legal implications, particularly in a different legal system.  For example, in the first case, the US manufacturer was not sure whether it could legally challenge the Chinese sub-distributor for using the trademark owned by the US manufacturer based on the US trademark law. Chinese Trademark Law adopts a “first to file” system (with certain exceptions), so the Chinese sub-distributor presumably had the right to apply for a trademark that was used yet not registered in China.  

 

If a company is not well equipped in dealing with unfamiliar legal issues, it should seek legal advice as early as possible in order to reduce and control the potential risks. v

 

May Y. Hao provides legal services to companies involved in China-related transactions.  Ms. Hao received the Master of Laws degree from China University of Political Science & Law in Beijing in 1988 and a JD degree from Northwestern University School of Law in 1993. After graduation from Northwestern, she practiced law with three leading US law firms, White & Case (New York and Hong Kong), Baker & McKenzie and Mayer, Brown, Rowe & Maw (formerly known as Mayer, Brown & Platt). She can be contacted at sradvisors@gmail.com.