WTO Panel Report on Consistency of Chinese Intellectual Property Standards

On March 20, 2009, the World Trade Organization (WTO) Dispute Settlement Body adopted the report of the dispute settlement panel in China – Measures Affecting the Protection and Enforcement of Intellectual Property Rights (China – IPR).[1] The report addressed three claims brought by the United States alleging that certain Chinese measures are inconsistent with the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).[2] The panel upheld, at least in part, two of the three U.S. claims, but found that the United States did not present sufficient evidence to support its most important allegation, i.e., that certain volume and value thresholds established for defining criminal counterfeiting and piracy are inconsistent with TRIPS.

Previous dispute settlement decisions had touched on the general enforcement obligations in TRIPS, but only in a superficial way. The panel in the China-IPR dispute was thus faced with a series of novel questions, and, as would be expected, the standards adopted by the panel merit further refinement. For example, while the report draws a roadmap for framing future claims regarding criminal thresholds, it is less clear how a government could apply some of the standards before bringing a claim. Still, the report may provide a basis for further engagement with China on the issue of IPR enforcement and may, therefore, ultimately lead to stronger IPR protection.

Criminal Thresholds

Under Chinese law, acts of counterfeiting and piracy are criminal only if the amount of infringing material exceeds certain quantity or value thresholds, e.g., 500 copies of a DVD or approximately $7,000 worth of counterfeit goods.[3] The United States alleged that the thresholds create a safe harbor for businesses engaged in commercial activities such as distribution of infringing products and are inconsistent with Article 61 of the TRIPS Agreement, which requires the criminalization of “wilful trademark counterfeiting or copyright piracy on a commercial scale.” In support of this claim, the United States provided, along with the measures themselves, industry reports detailing the volume of infringing material seized during police raids (which in many cases fell below the thresholds) and other anecdotal data.[4]

The critical issue with respect to this claim was the meaning of the phrase “commercial scale,” a term never before interpreted by a WTO panel or the Appellate Body. The panel concluded that “commercial scale” activity means something different than “commercial” activity. Specifically, the term “commercial scale” implies a certain size threshold and not a qualitative assessment of the purpose of the activity. Furthermore, according to the panel, the threshold cannot be interpreted in the abstract but varies with respect to individual products and markets. According to the panel, “counterfeiting or piracy ‘on a commercial scale’ refers to counterfeiting or piracy carried on at the magnitude or extent of typical or usual commercial activity with respect to a given product in a given market.”[5] In any given case, commercial scale “may be large or small. The magnitude or extent of typical or usual commercial activity relates, in the longer term, to profitability.”[6]

Despite the panel’s reference to profitability, there is no indication that the panel believed that profitability is the critical defining characteristic for “commercial scale” activity.  In fact, the panel appeared to conclude that the profitability or purpose of an individual operation is irrelevant.  Under the standard enunciated by the panel, the critical question is whether the infringing activity is equal to or larger than the usual size of a business operation with respect to a given product or market. While the panel recognized that the Chinese measures “exclude certain commercial activity from criminal procedures and penalties,” it found that this was insufficient to prove that the measures are inconsistent with TRIPS.[7]

The panel emphasized the importance of evidence to establish a claim that quantitative thresholds are inconsistent with Article 61. It found that “the United States did not provide data regarding products and markets or other factors that would demonstrate what constituted ‘a commercial’ scale in the specific situation in China’s marketplace.”[8] According to the panel, the press articles that the United States provided were merely anecdotal, while the raid data did not provide enough context to assess how the seized quantities related to typical or usual commercial activity with respect to the market and product at issue.[9]

While the panel report provides a roadmap for litigating future claims, it possibly fails to provide clear guidance for governments seeking to ensure that national laws comply with their TRIPS obligations, at least to the extent that they wish to use thresholds. (In fact, very few countries use thresholds as opposed to more qualitative standards). If “commercial scale” differs for each product and market, then lawmakers attempting to comply with TRIPS Article 61 will seemingly be required to define criminal counterfeiting and piracy by (1) devising separate thresholds for each product and market; (2) setting a uniform threshold at the lowest level of commercial scale activity for any product or market covered by the law; or (3) eliminating thresholds altogether in favor of a qualitative definition of commercial scale activity.

The first option appears untenable as a practical matter, and any such system would be complex and inconsistent. Two acts of piracy or counterfeiting could involve different products, but result in identical levels of infringement. Under the standard adopted by the panel, the TRIPS Agreement might require that one type of activity be criminalized and the other not, depending on whether the activity was larger or smaller than usual commercial activity with respect to the product or market in question.

The second option – a single, least-common-denominator threshold – is likely more workable in that it only requires one threshold. However, unless the government could conduct a comprehensive review of all relevant products and markets within its jurisdiction to identify the lowest permissible threshold, the default threshold would likely need to be very low (or zero) to ensure that all commercial scale activity is captured. Those who support strong IP protection may prefer this policy, though it is not clear that this was the result the panel intended.

The third option – a qualitative threshold – may be the best way forward, though “commercial scale” does not readily lend itself to a simple qualitative definition if, as the panel suggests, the term is wholly divorced from the question of whether the underlying activity serves a commercial purpose.

Copyright Protection Denied for Prohibited Works

The second claim focused on the fact that China denies copyright protection to works containing content deemed to be prohibited, e.g., content that would disrupt public order or social stability, or “jeopardize social ethics or fine national cultural traditions.”[10] The United States claimed that Article 5(1) of the Berne Convention, which is incorporated into the TRIPS Agreement, requires copyright protection for such works. The United States also asserted that the Chinese law is inconsistent with TRIPS Article 41.1, which requires the availability of specified enforcement procedures. Finally, the United States argued that, by denying copyright protection to prohibited works, the Chinese law foreclosed the availability of such procedures.

The panel upheld the U.S. claims, concluding that there is no contradiction between, on the one hand, censoring works and, on the other hand, providing copyright protection to the censored material.[11]

Release of Seized Counterfeit Goods Into the Stream of Commerce

China’s customs regulations give customs authorities the following options for disposing of IPR-infringing goods seized at the border: (i) Customs may hand the goods over to public welfare bodies for public welfare undertakings; (ii) if the holder of the intellectual property wishes to buy the goods, Customs may sell them; (iii) if the first two options are not possible, and if Customs can “eradicat[e] the infringing features,” then the goods may be auctioned; or (iv) when eradication is impossible, Customs may destroy the goods.[12]

The United States argued that the customs regulations are inconsistent with Article 59 of the TRIPS Agreement, which requires that competent authorities have the authority to order destruction or disposal of infringing goods. The United States asserted that the Chinese regulations created a “compulsory scheme” that precluded destruction or proper disposal of infringing goods if one of the first two options listed above were possible.[13] The panel rejected China’s claim that customs authorities were not authorized to destroy or properly dispose of infringing goods in large part based on China’s clarification of the powers granted to its authority.

The panel accepted the U.S. claim that the third option in the Chinese regulations is inconsistent with TRIPS Article 46, (as referenced in TRIPS Article 59), stating that “the simple removal of the trademark unlawfully affixed shall not be sufficient, other than in exceptional circumstances, to permit release of the goods into the channels of commerce.”[14]

One point in the panel’s reasoning is of particular interest. TRIPS Article 59 requires that competent authorities “shall have the authority to order the destruction or disposal of infringing goods in accordance with the principles set out in article 46.” The panel report made it clear that “[t]he obligation is to ‘have’ authority not an obligation to ‘exercise’ authority.”[15] According to the panel, “the obligation that competent authorities ‘shall have the authority’ to make certain orders is not an obligation that competent authorities shall exercise that authority in a particular way, unless otherwise specified.”[16] The United States had not challenged the manner in which China applied its customs regulations, but only the regulations as such. Thus, this statement does not preclude a future WTO claim, based on appropriate factual evidence, that the authority granted to an enforcement authority is never used and is effectively a nullity. Such a claim might be based not only on Article 59 but also Article 41 of the TRIPS Agreement, which requires that enforcement procedures be “available . . . so as to permit effective action against any act of infringement. . . .” Assembling the necessary evidence could be challenging, however.

Conclusion

China will now have a reasonable period of time to implement the panel’s recommendations with respect to the latter two claims discussed above. The two claims that the United States won are relatively discrete, and China can comply with the related rulings through surgical amendments to its regulations. Whether the panel’s finding on the thresholds claim will have a significant impact on China’s IPR enforcement regime remains to be seen. Significantly, the panel did not find that China’s criminal enforcement scheme was consistent with TRIPS Article 61, but only that United States had failed to prove its claims. Consequently, the panel report gives a roadmap for future challenges that should be of interest to private parties adversely affected by China’s current thresholds or any other thresholds of a similar nature. At the very least, the report may provide a basis for further constructive dialogue with China.

About the Author

James Mendenhall, an ASIL member, is partner in the International Trade and Dispute Resolution group in the law firm of Sidley Austin LLP in Washington, D.C., concentrating in international trade policy and litigation. His bio is available at http://www.sidley.com/mendenhall_james/.

Endnotes