Harris Bricken
by

How New Balance Ran Into A Wall In China

Has the Boston-based athletic-shoe maker made a mistake by fighting a two-decade trademark battle?

It was the kind of verdict that makes Western business leaders want to tear out their hair.

The New England shoe company New Balance had been tied up in litigation for a year and a half in the southern Chinese city of Guangzhou, having been sued for trademark infringement—sued for using its own name.

A man named Zhou Lelun had brought New Balance to court for using his trademark, Xin Bai Lun, a rough translation of New Balance. Zhou’s relatives had first applied for a trademark on New Balance’s translated Chinese name all the way back in 1994. At the time, it was common among a certain class of Chinese entrepreneurs to register foreign company names in the trademark office and then to propose negotiations, or file lawsuits, when the companies expanded to China.

Never mind the fact that Zhou made few, if any, shoes under the name, or that New Balance had been selling shoes out of Boston’s northwest side since the 1960s. Experts on Chinese trademark law were pretty sure the company was headed for disappointment.

Sure enough, in April 2015, the hammer came down. The Guangzhou court ruled for Zhou. And that was less shocking to the bands of lawyers working for multinationals in China than the damages New Balance was ordered to pay. New Balance’s business boomed, the judge contended, because of its name, Xin Bai Lun, and that name belonged to Zhou. The judge ordered New Balance to pay half of its profits in China from the time Zhou received the trademark, in 2011, till the time of the lawsuit in late 2013.

The total came to $15.8 million.

New Balance disagreed with the ruling for a host of reasons, one of which was that the company barely used the Xin Bai Lun name except on some advertisements and websites, never on shoes. It said the name hardly constituted a trademark. The company has hired a new counsel and appealed the decision. But so far New Balance has lost the fight it picked—and as it waits for a higher court’s ruling, it’s worth asking whether it’s time for them to bow out.

China’s trademark laws, though relatively advanced, break with Western ones in several key ways. The most important one: China is a first-to-file country. “This means that whomever files a trademark first gets it,” says Dan Harris, a partner at Harris Bricken in Seattle focusing on China, regardless of whether another company is already making a product with the same name in, say, America.

New Balance is hardly the only company losing trademark battles in China. Earlier this month a Beijing court ruled that a Chinese leather goods company that has been stamping “IPHONE” onto its wallets has more rights to the word than the $500 billion maker of actual iPhones. Apple  AAPL 1.51%  has been fighting a trademark case against Xintong Tiandi since 2012 over the name it coined—so far to no avail. Last year, Michael Jordan unsuccessfully sued a Chinese shoemaker who expropriated his Chinese name Qiaodan and his famous flying silhouette to create a line of popular basketball shoes. (His Airness has appealed the case to China’s Supreme Court.) And Tesla’s expansion in China was cast in doubt two years ago before it came to an agreement with the Chinese trademark owner of its name.

New Balance stands out, though, for the sheer amount of time it has spent litigating in Chinese courtrooms—almost two decades. And despite all that history, it now finds itself fresh off its biggest court loss. The case illustrates both how far a foreign brand can go in protecting its name and the downside of an aggressive strategy in China. Other brands might want to pay attention.

New Balance has never had it easy in China. Like other apparel brands, its shoes became prime targets for counterfeiters when China’s rising middle class discovered (and then demanded) Western goods in the 1990s.

In 1995, New Balance licensed a Taiwanese factory boss named Horace Chang to make sneakers for the Chinese market from inside China. Chang found success selling ‘classics,’ a less-expensive and more stylish alternative to New Balance’s high-tech running shoes. The shoes were a hit: Soon the company’s signature slanting ‘N’ logo was spotted around China’s biggest cities.

In 1999, Chang visited New Balance headquarters in Boston and told executives he was expecting sales inside China to quadruple that year to 250,000 pairs. But the New Balance execs told him to pull back: The company wanted to scale back “classic” sales, in order to preserve its identity as a performance running shoe brand.

The response didn’t sit well with Chang. The entrepreneur doubled down on making classics once he got back to China, ordering materials to make 450,000 pairs. New Balance sought an injunction against Chang, but the company was handed two legal defeats—first in a Shenzhen court, then on appeal.

By 2000 Chang had started his own brand called Henkees, a copycat of New Balance complete with an approximation of its angled N. And by then a more worrying trend had developed for New Balance: other copycat brands were getting slicker. One appeared in 2005 called New Bar Lun, an obvious imitation of New Balance, complete with store displays and logos whose designs were practically lifted from New Balance’s U.S. materials.

Since then, the rise of Alibaba’s Taobao shopping site has made earlier counterfeiting efforts in China look quaint. As many as 90% of the New Balance listings on the huge bazaar are for counterfeit or dubious goods, New Balance estimates. In fact, New Balance says it doesn’t have any authorized retailers on Taobao: The few genuine listings come from people who may have bought the wrong size shoes. “You go onto Taobao, you see New Balance had 300,000 listings last time I looked,” says Ed Haddad, New Balance’s former vice president of intellectual property, now retired. “How do you fight them all?”(“We will take immediate action if any suspicious listings are found out or upon notification,” said an Alibaba spokesperson in a written statement. “We thus strongly invite rights holders to work with us to identify counterfeit listings.”)

The fakes have made New Balance’s business prospects in China as mixed as its legal record. The privately held company says that its international revenues rose around 25% in 2015 as total global sales hit $3.7 billion. Legitimate versions of its shoes appear in China. But counterfeits are racking up untold tens of millions of dollars in additional sales.

Even as New Balance mulls the daily question of when and how to fight counterfeits, there’s been the long-running headache of the Zhou case.In 2003, as the Boston footwear company’s revenues continued to grow, it began usingXin Bai Lun as its company name in advertisements. That name was slightly different than Bai Lun, the translated name Zhou’s relatives had filed for back in the ‘90s. But in 2004, Zhou went back to the trademark office to apply for New Balance’s new name. The company fought to block his registration, but it lost the case, and in July 2011, Zhou was granted rights to Xin Bai Lun. With New Balance continuing to use Xin Bai Lun in advertisements and other materials, Zhou sued New Balance for trademark infringement.

(Fortune left several messages with a person in Zhou’s Guangzhou office who said she would report the interview requests to Zhou, but Zhou never responded. The magazine also sent an interview request to Zhou’s listed home address and received no response.)

New Balance knew using the same name that Zhou had trademarked could open it to trouble. Harris, the Seattle attorney, puts it this way: “If someone else registers what you think to be ‘your’ trademark, you should not use that trademark or you are setting yourself up to be sued…and you will almost certainly lose that case.”

Many companies have avoided using “their” trademark if someone beats them to it in China. An intellectual property lawyer working in China, who asked not to be identified, was baffled that New Balance hadn’t simply picked a different Chinese translation for its brand name. Oracle and BMW, for instance, have chosen Chinese brand names that sound nothing like their English ones. BMW’s, Bao Ma, means “precious horse.” Oracle’s is Jia Gu Wen, a reference to one of the oldest languages in China.

New Balance could have avoided liability, attorneys say, by simply stripping Xin Bai Lunfrom the few ads and materials it appeared on.

The reason New Balance didn’t settle or change names traces back to the brand’s desire to fight for change in China. “In the end you have two choices,” says Dan McKinnon, the company’s head of global brand protection, who is based in Boston. “You play by what’s fair and ultimately get to the point to fight the fight. Or you try to play by the Chinese rules, which make no sense in the context of global trademark laws. Just because someone claims they own our house … sorry, this is ours.” In other words, settlement isn’t in New Balance’s DNA.

That way of thinking works well in developed markets like the U.S., where trademark laws are old and backed by a mature court system. But it can backfire in China. “Taking a legal aggressive strategy like people do in the U.S. sometimes doesn’t work very well” says Shaun Rein, founder of China Market Research Group in Shanghai. “You have to adhere to the Chinese codes, not what the international norms are. The questions in China are: Do you want to prove you’re right? Or do you want to make money?”

In court, Zhou’s argument was perfectly straightforward: New Balance knowingly violated his trademark. After all, it had fought him earlier in the decade to prevent him from getting it in the first place. That was the argument that appeared to win the day with the Guangzhou court in April 2015.

“Those are good arguments,” admits Gordon Gao, a partner at Fangda Partners in Beijing and New Balance’s new outside counsel in China. Gao is working on New Balance’s current appeal, and he says that it has become clear that New Balance’s side didn’t have all the information it needed during the previous round of litigation.

Gao found evidence that Zhou had accumulated trademarks for loose translations of several famous international brands—Dunhill, Hugo Boss, Enzo, and others—proving that New Balance wasn’t an isolated target.

He also found that Zhou had registered a phony company in Hong Kong, a common practice in the 1990s in China by businessmen who then used their “foreign company” to win trademarks or bank loans inside China. If Zhou told customers inside China that his products were foreign-made, he probably didn’t mention that the foreign owner was himself.

Why this didn’t persuade Guangzhou court falls on New Balance. “It was our own fault a little bit,” Gao says today. The new points made in the appeals case seem to support New Balance’s argument today that Zhou entered his trademark in bad faith. Bad faith is an exception in Chinese law targeting so-called trademark squatters. It holds if someone registers a trademark knowing the name is being used by others, as New Balance was using Xin Bai Lun in 2003, the trademark can be invalidated.

However, several IP lawyers today in China say the bad faith exception is difficult to prove in Chinese court, and that in this case, it’s complicated by the fact that Zhou has held Bai Lun since back in the 1990s. These lawyers generally think that New Balance’s best strategy may have been to pay Zhou for his trademark and move on–something New Balance says it has never considered.

The reason New Balance fakes are ubiquitous in China is because of the brand’s growing popularity among consumers like Wen Fei. The 44-year-old recently bought one genuine pair and one fake pair of New Balance. “I know they are copycats,” she says, “but who cares, if they are similar?”

Counterfeit consultants say Nike  NKE 1.93% , Adidas, and Under Armour UA 2.77%  all suffer from roughly the same degree of counterfeiting in China. “Part and parcel, it is because of the increase in our market share in China,” McKinnon says of the rise of New Balance fakes.

New Balance admits that unpleasant reality, but denies another: its name was copied for the same reason. Just as it can’t close all the counterfeiters, it can’t stop all its trademark copycats.

The company’s appeal was supposed to have been decided by December 2015, but as of this May New Balance was still waiting. Still, the company recently got some potentially good news in a related ruling that concerned another foreign trademark case. In 2012, the largest vintner in Europe, Castel Group, was ordered to pay $5 million for violating a Chinese trademark of the translated Castel name, owned by a Chinese Spanish national. But on appeal earlier this year, China’s Supreme Court reduced the damages to $80,000, signaling that the previous fine was excessive. New Balance’s judgment could be similarly cut.

Nonetheless, a reversal of the earlier decision remains a longshot. And even if its fine is reduced, New Balance will need to change its name—and pay for a fight it didn’t need to start.