Is China's Legal System Getting Safer for Multinationals?

Apple Inc’s embroilment in a trademark dispute over its enormously popular iPad tablet computer has once again focused attention on China’s legal system, which is perceived as the place where non-Chinese companies go to lose cases.

Ever since multinationals began moving into China in force in the 1970s, too often they have found that joint-venture partners simply seize their copyrights and begin manufacturing their own equipment, and that occasionally the western partner can be arrested or driven from the company.

Apple aside – in a case, however, where the US-based electronics firm may have slipped up -- look no further than Kawasaki Heavy Industries Ltd., Siemens AG, Alston SA and Bombardier Inc. who complain that rail companies that were once junior partners in building China’s high-speed rail system have appropriated their technology and are selling it to companies outside China. Kawasaki is now suing China South Locomotive & Rolling Stock Industry Group, known as CSR.

Neither of these cases is unique by any means. Yet, despite these spectacular infringements, there is some sense that the country’s legal system is being upgraded. The days are largely gone when, in the 1980s, a defendant’s temerity in bringing a lawyer with him to court famously resulted in the court ordering the lawyer;'s removal and having him tied to a tree outside, according to an Asian Wall Street Journal story at the time.

Legislative activity has grown across social, economic and commercial fields, according to a series of reports issued to clients last week by Research-Works, the Shanghai-based independent economic research firm, with a legal profession beginning to develop and with many foreign firms now having a presence in China. There are now several hundred national laws. The legal system is based on civil law, not case law.

“While further steps towards reforms are taking place, however, there are a number of constraints. Some of these reflect the fundamental nature of China’s political system, others are more to do with the lack of appropriate resources or personnel,” the report’s author, Timothy Summers, noted.

The judicial system is not independent. It remains under Communist Party leadership, with power exercised through the Political and Legal Commission, headed by a Politburo Standing Committee member, Zhou Yong Kang.

“Many foreign law firms have set up shops in China and many Chinese law students or lawyers have been to places outside for exchange and training,” said Frankie Leung, a Los Angeles-based lawyer who has lectured extensively in China. “However, when the two systems come into contact, we realize that there are fundamental differences which are disguised by superficial resemblances. For example, when we talk about how courts decide on cases, we see judges in black robes sitting on high benches. What we don't realize is that the role of judges in the trial is different and their ways of conduct hearings are different. Even their training or philosophy of adjudication is different. The Chinese reject the concept of presumption of innocence and their appreciation of procedural justice is not the same.“

“This is not the only guiding principle for judicial work – Hu Jintao has spoken of the need for judicial work to reflect the people’s interests and the constitution and laws – but party leadership has been stressed repeatedly over recent years,” according to the Research-Works report. “There are no signs of any meaningful judicial independence emerging (even though the principle is stated in the State Constitution).”

“Rule of law” (fazhi) in the Chinese context remains more a case of “rule by law” -- using the law to meet political or administrative objectives rather than making all and sundry subject to the same laws.

Implementation of laws is heavily passed down to local levels, with the result that whatever legislation is passed in Beijing is interpreted by local courts as they choose. The Communist Party and People’s Congresses decide on judges and the interpretation of the law at the local level. It is difficult for anyone, foreign or not, to win a case in another geographical jurisdiction.

Corruption remains widespread and professional standards are low. Although the legal profession has developed quite rapidly, the number of lawyers is still low given the size of the country and economy: judges often have no background in law. This is more a reflection of the inadequate historical development of the legal system rather than any deliberate policy: indeed, one of the policy goals is to improve professionalism.

Lack of judicial capacity also encourages the use of administrative measures by the government or public security to resolve cases. These points taken together mean that implementation of legislation is, at best, inconsistent. This creates a difficult environment for foreigners and indeed Chinese to operate in, and undermines confidence in the court system. As a result, alternative means of dispute resolution are often sought, including administrative decisions.

When it comes to criminal law, the problems are more substantial: access to lawyers is often limited or non-existent, according to Research-Works. Again there are some tentative signs of reform, such as the decision in 2007, by the Supreme Court to review all death penalties, and the writing of “human rights” into criminal law, announced at the weekend during the National People’s Congress press conference.

Although many of the system’s innovations are real, Leung says. the ideological basis of the system has not advanced. For example, lawyers are not permitted to defend politically sensitive cases without permission. Civil rights lawyers are often victims and are threatened. In litigation, when a private party confronts a powerful one, the weaker one either gives up the fight or knows which one the court will favor. These are openly accepted scenarios.

The Legal Environment for Foreign Business

Apple’s legal tussle with Proview (Shenzhen) has attracted plenty of attention. It seems the US giant purchased what it thought were global rights to the “iPad” trademark in 2009 from Proview Taiwan, without realizing that the company did not actually own the trademark in mainland China, although Apple contends that Proview intentionally steered Apple away from the real owner of the trademark. . That was owned by Proview (Shenzhen), and in late 2011 a court in the southern Chinese city overturned a Hong Kong judgment that Proview should transfer the trademark to Apple.

A further judgment is awaited following an appeal to a higher court in Guangdong. Apple has accused Proview of not honoring its agreement, though it seems that Apple may have slipped up, the Research-Works report says. In any case, the consequences for Apple have been substantial, with online stores suspending sales after one local government department responsible for industry and commerce confiscated stock.

Proview has sought a halt to the import of the iPad 3, highlighting the link between judicial and administrative power. Although it has sued Apple in several locations, in late February a Shanghai court rejected Proview’s request for a temporary halt to sales.

One thing this reveals is the local variation in the legal system in China. Furthermore, it suggests that foreign companies do have chances to win cases as well as lose them. While home advantage still counts, it is no longer the case that foreign businesses are destined to lose in the Chinese courts. In a judgment in 2010, for example, the Isle of Man-based Strix, a manufacturer of electric kettle components, won an award for damages against two companies which had infringed its patents.

The broader implication is not just the overall attractiveness of China as a location for foreign businesses. It tells us something about the nature of the political and economic environment and the extent of reform. The system has undergone dramatic changes over the last two decades, including China’s gradual integration into the international legal order.

The most substantial example of this integration was China’s accession to the World Trade Organization in 2001, the Research-Works report notes. “From the outside this was mainly about the opening up of China’s markets in a carefully-calibrated way but domestically the legal and regulatory implications were perhaps even more important.”

China’s position is that WTO commitments need domestic legislation to be binding. This allowed the central government to use WTO accession to oblige provinces or ministries to remove trade barriers and liberalize various aspects of the economy. Under WTO regulations the government is obliged to publish a complete set of laws, regulations, rules and policy measures related to foreign trade and investment.

There has been substantial progress as a result. However, limited transparency remains a major source of concern for foreign businesses, and features regularly in the complaints of European and American Chambers of Commerce. The frustrations are more intense because central and provincial regulations still emerge with little time for consultation, and sometimes with retroactive effect.

“Ultimately the loudest voices in these areas are likely to be domestic companies,” the report notes. “The vast majority of patents are filed by Chinese companies, and if indigenous innovation is really to take off, the quality of the legal system will need to improve further."

The Party and the Law

The more fundamental constraint to an effective system remains the Communist Party, according to Research-Works. The political link between legal and judicial affairs and security and social stability is highlighted by the fact that the same Politburo Standing Committee member is responsible for all these areas.

Each court has a judicial committee reporting within the legal and political cone of party work. Each committee is headed by the president of the court. Its role is to discuss difficult cases and related issues, acting as a channel for political and personal influence. There is little sign of change.

“Indeed, some legal observers have suggested that the Party's 'leadership' role has been emphasized more under the current head of the judiciary (the President of the Supreme Court) than his predecessor,” Research-Works notes. “The fact that the legal and judicial system operate under party guidance has particular implications in a country where the party-state plays a prominent role in the economy and society."

Party officials themselves are outside the jurisdiction of the state judicial apparatus, at least when it comes to activities in their Party capacity. Their misdemeanors are dealt with by party inspection and disciplinary commissions at the central and local levels. Only a small number of party cases are handed over to the procuratorate to be considered for trial, maybe as few as percent.

The cases which most often come to attention are corruption investigations of one sort or another, the reports note. There is no single law on corrupt practices. Party disciplinary rules are increasingly clear as to prohibited behavior. All cases involving CCP members are initially dealt with through the CCP disciplinary bodies, rather than the legal system.

If party members are suspected of such actions, they will first be investigated by the Party's committees, and if detained they are questioned at a designated time and place, not in police detention. Many lose their party membership as a punishment. In 2010 32,000 left the party, the report continues, most of them stripped of their membership.

It is the close relationships between local party organs and judicial organs at that level that create the opportunity for interference.

“As with government, the judicial system operates on a geographical hierarchy, from basic courts at the county level up through intermediate (municipal or prefectural) and higher (provincial) courts, to the Supreme Court at the national-level. The center's legal and judicial influence dissipates at the local levels, with one consequence being different interpretations and applications of the law,” Research-Works says.

The IPR case involving Strix may have been won by the foreign company because it chose to sue in Beijing municipal court, not in the home location of the companies that had been infringing its patents. This limited the scope for those companies to use their local connections to influence the process.

“Although there is nothing in principle to stop a company taking a state-owned enterprise to court, if they can find a lawyer to take the case, the Party-state relationships with both the company and judiciary make the chances of victory very slim,” the report continues. “Cases brought against non-state enterprises are much more likely to be successful. Finally, the party's influence is particularly strong in areas where there are special courts: military matters, railway and water transport, and forestry.

In the long run, said Frankie Leung, “ the ideological basis of China's legal system has not advanced. For example, lawyers are not permitted to defend political sensitive cases without permission. Civil rights lawyers are victims and they are threatened. In litigation, when a private party has to confront a powerful party they either give up the fight or they know the court will favor the powerful party. These are openly accepted scenarios. Are there still litigation in China. Yes, there are. Are there court rooms. There are. I am talking about the soft ware and the intangibles and not what you can feel and touch."