Counterfeiting in China:
Silk Market Fakes
By Joseph T. Simone, Jr.

A new strategy holds promise for fighting fakes

The sale of counterfeit well-known American and European fashion brands in Beijing's notorious Silk Street Market over the last decade has been emblematic of China's difficulties in providing effective enforcement of intellectual property (IP) rights.

Foreign governments and industry associations, including the Quality Brands Protection Committee (QBPC), have long pressed for greater use of criminal enforcement to fight counterfeiting. The PRC Ministry of Public Security's recent Mountain Eagle Campaign, which began in November 2004, together with reports from the field by many multinationals, suggests that China is finally beginning to get serious about criminalizing counterfeiting by factories and large-scale wholesalers.

But efforts to bring criminal prosecutions against retailers of fakes in burgeoning shopping malls (such as the rebuilt Silk Street Market) are for now just a pipe dream. The obstacles are many, but the principal ones are both practical and legal. Police lack adequate resources, training, and political support. But even if they did not, the Criminal Code itself precludes the use of criminal sanctions against violations that are deemed too small in scale.

The Supreme People's Court and the Supreme People's Procuratorate issued a judicial interpretation in December 2004 clarifying that criminal prosecutions may be pursued only if a vendor is found to have sold or offered for sale fakes in an amount that exceeds designated thresholds, the lowest of which is ¥50,000 (about $6,300).

In the absence of criminal sanctions for retailers, brand owners have for years been resigned to relying on administrative sanctions, which have not proved to be much of a deterrent. Fines imposed by the local administrations of industry and commerce (AICs) have rarely been more than a light slap on the wrist and have provided no incentive for infringers to reveal the source of counterfeits. Consequently, most brand owners had, until recently, abandoned all hope of eliminating fakes in retail outlets like the Silk Street Market.

New strategies

Since early October 2005, visitors to the Silk Street Market and certain other markets in Beijing have been surprised at the lack of visibility of fakes of 48, mainly European, luxury brands listed in two AIC notices prohibiting the sale of counterfeits of those brands. Local AICs throughout China have intermittently issued notices and lists of "specially protected" brands, but with little short-term, let alone long-term, impact. So most observers have assumed that the recent cleanup in the Beijing markets would be temporary and that any improvements in the short term would be a standard reaction to AIC pressure to look good while high-level European and American delegations are in town.

But the recent cleanup of the Silk Street Market could, if all goes well, mark the beginning of real change. The lack of visibility of fakes of the 48 brands is the direct result of a new enforcement initiative by five European brand owners acting under the umbrella of QBPC's Luxury Goods Industry Working Group (IWG). In addition to lobbying the Beijing AIC and other government divisions, the IWG has been targeting landlords, not just vendors.

The legal basis for landlord liability in China is fairly simple: By knowingly providing business premises to counterfeiters, the landlord may be held liable for aiding and abetting, or "providing convenient conditions" (tigong bianli tiaojian). What's more, by issuing tax receipts (fa piao), the landlord may be found directly responsible for the offenses as if he or she were the actual vendor of fakes.

In mid-September, the IWG members, which include the makers of brands such as Burberry, Chanel, Gucci, LVMH, and Prada, filed civil actions against the Silk Street Market's landlord, Beijing Haosen Clothing Co. Ltd. A rash of publicity in the local and international press quickly followed, as did expressions of concern to central and local central by the US and European embassies.

The use of so-called "landlord liability" strategies is relatively new in China, but it has been successful in the United States and other more developed countries. In the United States, the strategy was initially adopted to combat the sale of counterfeits in flea markets. More recently, it has been used to deal with the sale of fakes in established offices and apartment blocks on Canal Street and elsewhere in New York City. The IWG decided the time was right to test a similar strategy in China.

Gathering evidence

Prior to instituting their civil actions, the IWG members made notarized purchases of fake goods from numerous vendors in the Silk Street Market and sent warning letters to the landlord with a deadline for responding. Predictably, the warnings were ignored, after which the brand owners worked closely with the Beijing and Chaoyang District AICs in the hope that the authorities would agree to threaten the landlord with administrative sanctions, in parallel with the pending civil actions.

The AICs in Beijing had previously been reluctant to impose administrative fines on landlords. But following the issuance of penalties against two landlords by the Xicheng District AIC in May 2005, and legal research by the municipal-level AIC that confirmed the legality of these sanctions, other district-level AICs began to feel more comfortable in admonishing Beijing Haosen and other landlords.
Rumors that the Chaoyang District government officials were protecting Beijing Haosen and its charismatic owner, Zhang Yongping, had circulated for some time. But in the last few months of 2005, pressure from a number of directions apparently created cracks in the wall of protection. Following several visits in late September and early October by the head of the Beijing municipal AIC's Trademark Division, Zhang finally seemed to get the message.

Beijing Haosen's written defense to the pending civil actions contains an impressive list of measures it has taken to "rectify" the market. These include the termination of 12 Haosen managers (some of whom had been tasked with monitoring the market for counterfeiting), the eviction of the five vendors that are the subject of the pending civil actions, the collection of written undertakings not to sell fakes from more than 100 other vendors found to be selling counterfeits of the 48 brands, and the imposition of contractual fines, worth more than $50,000 in total, on various vendors.

Today, visitors to the Silk Street Market can still purchase fakes of the protected brands but few are openly displayed, at least during weekdays, and many vendors are visibly afraid of handling these products. The Luxury Goods IWG arranged further notarized purchases of fakes and provided the evidence to the Beijing court handling the pending civil actions to demonstrate that the landlord's efforts, however helpful, were still inadequate.
Brand owners hope that Beijing Haosen will act swiftly in the future to terminate the leases of vendors found selling fakes. But they are also anticipating the need for continued pressure against Beijing Haosen from AICs. The IWG may also need to file additional civil actions if real change is not forthcoming.

Landlord cooperation

The ultimate goal of the Luxury Goods IWG is to convince Beijing Haosen and other landlords to become "partners" in anticounterfeiting efforts by adopting a series of agreed protocols and procedures for dealing with vendors found handling fakes of their brands. If satisfactory cooperation can be achieved in Beijing, the IWG will then roll out similar initiatives in other major cities in China-the next obvious target being Guangzhou, where the bulk of China's counterfeit fashion products are sourced, both for domestic sale and for export.

The Luxury Goods IWG hopes to convince Beijing Haosen and other landlords to insert a "two-strike" rule into their lease agreements with vendors. Under the rule, lessees found selling fakes would be suspended from operating in the market for 30 days following a first offense and terminated following a second offense. The IWG also hopes that, as part of any protocol, landlords will agree to use forfeited security deposits to fund market surveys and other enforcement work. Clearly, government support for these negotiations will be essential.

The Silk Street Market project has naturally attracted the interest of other foreign fashion and apparel companies, many of which are hoping to join forces in a broader enforcement campaign that targets landlords. Brand owners in other industry sectors, including information technology, cosmetics, and sports equipment, are studying the Luxury Goods IWG's progress.

Working together and with local governments

To exploit the landlord liability strategy effectively, companies in any particular sector must consider the benefits of working in coalitions rather than going it alone. Companies that combine their financial and political capital have a much higher chance of enjoying support from municipal and county governments. Most of the retail and wholesale markets in China where counterfeits are traded are owned directly or indirectly by local governments, and thus a quick decision by local government and party organs may be all that is needed to activate effective landlord liability programs.

Brand owners will also need to commit adequate resources to ensure that targeted markets are regularly revisited. Regular monitoring should help to educate landlords that the activities of their lessees are being scrutinized not only by the AICs (whose enthusiasm has a tendency to wane over time) but also by brand owners themselves. With luck, some-if not all-of the costs of market surveys and negotiations with landlords can be paid from the rental deposits that have been forfeited by vendors of fakes that are identified in prior sweeps.

As the CBR went to press, the Beijing No. 2 Intermediate People's Court was expected to issue a decision in the pending civil actions brought by the Luxury Goods IWG in late December 2005 or early 2006. The court's decision is likely to attract considerable publicity, which will, one hopes, serve to reinforce the PRC government's commitment to targeting landlords, and not just vendors, in future enforcement work in retail and wholesale markets.

Consumer education

Consumers who buy fake apparel, sports equipment, and fashion accessories are supporting criminal syndicates, undermining market opportunities for smaller legitimate players, and denying the government needed tax revenues. At the same time, however, the purchase of fakes in the Silk Street Market and elsewhere is increasingly regarded as a form of entertainment for the growing flocks of tourists and expatriate residents in China.

Unlike in France and Italy, the purchase of fakes by consumers is still legal in China. Perhaps the time is ripe to amend the law so that the knowing purchase of counterfeit and pirated products constitutes an administrative offense or misdemeanor warranting a hefty fine. Not just in China, but globally.

In the meantime, educational programs are sorely needed in China to convince employees of multinational companies, hotel clients, travel agents and tour operators, and even those working in embassies and visiting government delegations to stay away from markets that thrive mainly through trade in fakes.

Source: This is an excerpt from an article originally published in the Jan, 2006 issue of the China Business Review.