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Danone v. Wahaha — Which Of Us Is The Most China Rookie?

China lawyers for joint ventures

‘You sit by yourself grasshopper. What do you think of?’ -Master Po
‘My mother, my father. Both gone. I am alone.’
‘You hear the flock of birds flying overhead? You hear the fish? The beetle?’ To all of this the young Caine nods. ‘In this crowded place you feel alone. Which of us is the most blind?”

Kung Fu, Episode 1.

Lawyers (myself included) are loath to weigh in on someone else’s pending legal matter for fear of being proven wrong by not having all of the facts. So despite having received a couple of emails from readers suggesting I discuss the brouhaha between Groupe Danone and Wahaha (yes, that was an attempt to rhyme), I had read nothing more than a few headlines.

I started reading some articles today on it though and my eyes just about popped out of my head.

By way of very brief background, Danone is a food conglomerate based in France, the maker of Danone dairy products and Lu biscuits, and the bottler of Evian and Volvic water.  Wahaha is China’s leading and best known domestic beverage company.  It was also the focus of a full chapter in James McGregor’s book, One Billion Customers (a true must-read for anyone doing business in China).

In a Xinhua story, entitled, Fight between beverage giants spills out in public, [link no longer exists] Wahaha’s president, Zong Qinghou, is quoted as saying that “the original agreement between the two beverage giants was never approved by China’s trademark office and so is not in force or effect.” Wahaha’s president says Wahaha signed the contract, but admits it is not valid because it was never properly recorded.

In a letter posted on one of China’s major web portals, Sina.com, Zong said a trademark-license contract must be approved by the Trademark Office of the State Administration For Industry and Commerce but he never submitted the original which restricts China’s largest drink producer from independently expanding.

“We did sign the contract,” admitted the president of the Hangzhou-based conglomerate. “At the time, Wahaha was only focused on management concerns and the interests of employees and knew nothing about capital operations.”

“My ignorance and breach of duty brought trouble to the development of the Wahaha brand,” said Zong.

“Wahaha has fallen into a trap deliberately set by Danone,” he said.

Near as I can piece together from this article and from another article in the Wall Street Journal, it appears the joint venture agreement between Wahaha and Danone had Wahaha licensing all rights to its name and other trademarks to the Danone-Wahaha joint venture.  It also appears Danone either thought Wahaha was going to record this licensing agreement with the government or never even realized such a recordation would be required.

Now if what it appears (from the above) to me to have happened here did in fact happen here, Danone has fallen victim to one of the oldest tricks in the book. I describe it as such because back in the “pre-China days” when licensing IP in Japan was so popular, Japanese companies commonly did this to foreign companies in Japan, and Chinese companies now commonly do this to foreign companies in China. The “this” that was commonly done was intentionally failing to record an IP licensing agreement so as to prevent any licensing transfer from actually taking place.

In China today, some IP licenses must not only be recorded for the licensing transfer to take effect, they must first be approved by the government. I understand there was a time in China when all IP licensing needed not only to be recorded with the government, but also pre-approved by the government and I think this may have been the case back when the Danone-Wahaha licensing agreement came into effect, but I do not know if the newer laws on this operate retroactively or not.

Wahaha seems now to be justifying its actions to the Chinese media by going on the offensive, claiming Danone “trapped it” into licensing out its important, Chinese, IP. The thing is that if the licensing agreement was never recorded, Wahaha may well be entitled to prevail under the prevailing interpretation of Chinese law.

I find it very interesting that the Western media and blogosphere have so far completely ignored this licensing recordation requirement and are instead focusing on how Wahaha “breached” its agreements with Danone. But if the licensing transfer never in fact took place, we must start at least raising questions as to whether Wahaha actually breached its agreement with Danone at all. I say “raise” questions because I am woefully short of sufficient facts to give any answers to this question. There is also no way I am going to engage in the hundreds of hours of legal research that will likely prove necessary to answer this question once armed with the facts.

Not only is this Danone-Wahaha fight interesting for what it appears to teach regarding Chinese IP licensing laws, it is also a fascinating story of what can (and nearly always does) go wrong with Chinese joint venture deals.  In a Wall Street Journal article written by James T. Areddy, entitled, Danone’s China Deal Goes Sour: French Food Firm Accuses A Leading Businessman Of Undermining Venture, Areddy talks about how Danone is accusing Wahaha of undermining their joint venture with “a mirror organization” of manufacturers and distributors.  The article calls this dispute an opportunity to take “a rare peek at tension inside a joint venture between a Chinese company and its foreign partner,” and that is exactly what this is.

Emmanuel Faber, president of Danone Asia Pacific accuses Wahaha of producing “the whole range of our [the JV’s] products.” Wahaha responds to this by stressing its Chinese roots:

Danone’s accusations follow a report Mr. Zong released last week on a Chinese Web site that accused Danone of trying to take control of businesses he owns and saying terms of their existing agreements are unfair.

Mr. Zong founded the Wahaha group in the late 1980s. In 1996, he and Danone started to set up a series of joint ventures to sell products under the Wahaha name. Danone says that in China, it now owns 51% of 38 joint ventures in partnership with Mr. Zong, who remains chairman of the joint venture’s umbrella company.

When Danone and Mr. Zong struck their initial deal in 1996, joint ventures were often required to do business in China or were seen as a quick way for entry into the market. But increasingly, foreigners have tried to go into China on their own, concerned by stories of partnerships gone awry.

The stakes for both sides are high. Danone’s main toehold in China is Wahaha, and the accusations challenge the integrity of one of China’s most famous consumer brands, which remains closely identified with its founder, Mr. Zong. China represented 10% of Danone’s global business last year, and the company says 75% of the ‘1.4 billion ($1.9 billion) in Chinese revenue it reported last year came from legitimate sales of Wahaha products.

Yet, Danone now estimates Mr. Zong’s own operations sold nearly as much as the joint ventures. The calculation is based partly on Mr. Zong’s own assertion that his private businesses rival the joint venture in size.

Wahaha does not appear to deny any of these accusations, but instead invokes Chinese nationalism in its defense, saying that if Wahaha signed a contract requiring Wahaha to do X, then Danone must now sign a contract requiring Danone to do X:

In his online comments, the 61-year-old Mr. Zong pitted himself as a defender of China against Danone. He didn’t specifically address some of the company’s assertions. Instead, Mr. Zong said it is unfair that Danone has separate joint ventures in China making juice and milk under other brand names that compete with the Wahaha-branded products. “So these terms are unfair and need to be revised. Either you call off the restrictions on us, or I add restrictions on you,” Mr. Zong said.

The extent of Wahaha’s “mirror operations” appears to be so huge and so intertwined with the operations of the Danone-Wahaha joint venture, that virtually nobody is capable of figuring out who is who and who owns what anymore:

Mr. Faber said yesterday that Wahaha products are being made at factories owned and managed by Mr. Zong’s family interests that haven’t been approved under the joint venture. Some of these products are secretly fed into the joint venture’s existing sales network, the Danone executive said; others are sold separately. “It’s normal that employees, distributors and others would get confused,” Mr. Faber said.

My favorite quote from the article, because I am constantly telling our clients to be on guard for this, is that the Danone-Wahaha joint venture is using factories secretly owned by Mr. Zong’s family to do outside manufacturing for the joint venture:

In addition, he [Mr. Faber] said, some factories designated as third-party manufacturers for the joint venture are secretly owned by Mr. Zong’s family.

Using a joint venture to enrich relatives is probably the oldest, the simplest, and the most common joint venture trick known to man. It is nearly always the first example my law firm’s China lawyers give to clients for why they must be so careful when considering a China joint venture.

Here goes.  Typically, the reason for a joint venture is to make profits by taking advantage of a local company’s on the ground knowledge and expertise.  Typically, this means the local, in this case Chinese, company will be in charge of hiring and/or subcontracting out.

The goal of both the foreign and the Chinese company is to make as much money as possible from the joint venture. This “common goal” leads the foreign company to believe its interests are aligned with its Chinese joint venture partner, when in reality, nothing could be further from the truth. The foreign company is expecting to profit from the joint venture’s sales. The Chinese company, however, may very well be planning to profit from its right to operate the joint venture.

The joint venture company may need only 25 employees, but the Chinese company goes out and hires 50 relatives. The joint venture may be able to hire good employees at $150 per month, but the Chinese company goes out and hires 500 employees at $250 per month to get $100 monthly kickbacks from each of them. Company A may be the best outside company to make a component part for the joint venture and it can do so at $1 a part. The joint venture company, however, goes out and contracts with company C to make the component part at $2 a part because company C is secretly owned by the owner of the Chinese company in the joint venture.

It goes on and on, but it is tricks like these that make profitable joint ventures about as rare as a coconut in Antarctica.

Beware the joint venture.

For previous posts on the China joint ventures pitfalls, check out the following:

33 responses to “Danone v. Wahaha — Which Of Us Is The Most China Rookie?”

  1. I just wrote an article on this one. To me the interesting thing is not that some foreign firm got scammed in a joint venture (which as you say Dan is hardly surprising – although Mr Zong suggests Danone has profited quite nicely in the decade it’s been running so far, which is more than many other foreign JV investors can claim).
    What was interesting was the way in which Mr Zong has instead of relying on arguing the type of legal contortions you describe in court has chosen to launch his campaign with the public – and indeed via the internet rather than the press. Why? I could think of a couple of reasons that might apply:
    1) He’s afraid that legally he hasn’t got a leg to stand on, and thinks that court and government officials are going to be vulnerable to pressure from public opinion.
    2) He’s concerned that, being a private sector kind of guy, the government’s going to be less concerned about his travails than they would over big state-owned firms subject to foreign takeover bids (Xugong etc). Protecting plutocrats doesn’t exactly chime with the harmonious society, even if it does with the whole “Chinese brands” campaign.
    Be interested to hear what everyone else thinks. Perhaps we need to get imagethief to comment?

  2. Fascinating.
    Re: the IP licensing issue, the fact that Wahaha “breached” its contract might be viewed as yet another example of “China has no rule of law.” But it seems like they tricked Danone into signing a contract unenforceable under the law, so a different interpretation might be that in fact the rule of law is strong enough not to create exceptions for such a contract.

  3. A heartwarming tale of new China!
    One similar story – most probably apocryphal – doing the rounds on the legal circuit when I was there a while back was of the local client who asked, in all innocence, whether under English law they could escape being bound by a commercial contract by sending an actor to the signing meeting instead of a director.

  4. Great coverage here. I found that the 21????? ran a very insightful story on this last weekend and covered all the juicy details including how holding companies were set up under his wife and daughter, which in some cases were located on the same factory grounds as the JV operations.
    The Wahaha guy claimed that the French company would not let him invest into the inland economy and only wanted to focus on the east coast. Claiming that it was his duty to help carry out the open up the west policy and invest in China’s interior he went about setting up 61 seperate companies under the Wahaha name to invest into China’s interior which not part of the joint venture.
    Link to the Chinese article: ( I am going to translate it and post it on my blog)

  5. David —
    Maybe. But then again, was it a trick or was it really Danone’s responsiblity to make sure it was filed and Danone just did not know this was required? Did Wahaha say, “we will file it, don’t worry, and then did not?” If so, shouldn’t Danone at least have checked up on it at some point?
    I can tell you that in the last six months alone we have had domestic US patent lawyers come to us with what they thought were “air-tight” Chinese licensing agreements and we have had to tell them they were not valid because they had never been registered. Fortunately, we were able to get both licensing agreements filed without much loss to either of the US companies involved. Domestic lawyers need to understand that just because something is so routine and makes so much sense over here (or elsewhere) in no way means things will be the same way in China.

  6. Beefeater —
    I believe it. Reminds me of a favorite Russian trick: having an unauthorized person sign a contract or signing a contract that requires a seal without a seal.
    US law can be very “informal” in that it is quick to allow oral contracts, oral modifications of contracts, no seals, no registration (of most things), etc. Other countries can be very different. China actually strikes me as less tied to legal formalities than, let’s say, Russia, but it definitely has more formalities thant he US. The US generally elevates substance over form, but many other countries do not and American domestic lawyers oftentimes have trouble getting their heads around that.

  7. venture160 —
    I will certainly be watching out for your blog post. Ahh, the old “I was doing it strictly for the motherland and to save us all from the evil foreigners defense.” Profit, of course, never played a role. Wahaha heard the call of the West; that is all.

  8. So my question from a previous post remains – should the Chinese bar institute tougher professional responsibilities requirements and prohibit people from advising on Chinese law without being licensed? Isn’t part of the danger the “practice without a license” by the lawyers? That includes not knowing how things work there. Anyone can read statutes.
    Where were Danone’s lawyers? I mean, a company should take all these costs (legal, due diligence) and factor them into the business plan rather than getting excited at the first sight of the 10 cents / hr rate they needed to pay Chinese workers.
    And a company should have a recourse against its lawyers if these lawyers represent themselves as professionals and fail to notice these simple procedures to the company’s detriment.

  9. I bet Zong Qinghou thought the JV terms were “fair” when he signed the original deal and Danone were investing their money and knowledge.
    It reminds me of a similar experience that I had a few years setting up a company with a Chinese partner. After we began generating revenues he told me that he thought the terms of our deal were very unfair and needed to be changed or he might take the technology he had developed – strangely enough he had never thought to raise this issue of “unfairness” when I was the one investing money to build the company.
    We resolved our differences and managed to sell the company and, on a positive note, I learnt a lot about doing business here.

  10. Dan,
    I would think (hope?) that under the contract between Danone and Wahaha, Danone’s in-house attorneys would have been wise enough to put in the standard boilerplate clause that gave/maintained/retained to Danone the job of registering the contract at issue with the government so as to avoid such a set-up by Wahaha? By doing so they (Danone) would have been more in control of their own destiny.
    Can one sue their own in-house attorney for malpractice? 🙂

  11. Duncan —
    I completely agree. This is a fascinating story for so many reasons.
    It is possible Mr. Zong is trying to garner public favor even though the law favors Wahaha (I do NOT know if this is true or not) because he is worried that with the Olympics coming up and China still wanting to encourage FDI the courts will actually favor Danone BECAUSE it is foreign. There was a favorable decision about a year ago for Starbucks and Steve is convinced the ruling was only because Starbucks is so visible to foreigners.
    I too would love to get more comments on this and I will e-mail ImageThief to get him to check in, either here or on his own blog.

  12. David —
    Whoa there. First thing, let’s not shoot all the lawyers.
    1. It is not clear Danone made any mistakes.
    2. If Danone made any mistakes, it is not clear those mistakes were made by Danone’s lawyers.
    There are good lawyers and bad lawyers in every country in the world. Licensing can only do so much.

  13. Chris —
    Did Danone even know of the registration requirement?
    Never heard of a company suing its in-house lawyer, but I certainly am aware of such lawyers getting fired.

  14. The purported TM licensing agreement is not a ‘registration’ per se, but rather a recordation. It’s been a while since I looked at this issue, but if memory serves, there is no penalty for not recording the licensing agreement with the relevant government authorities.
    In the last 2-3 years, there was Xiamen court decision on this very issue, and that court agreed that while license agreements *should* be recorded with the relevant authorities, they seldom are. While this court decision is non-binding for other cases, they did indicate that there is no real threat of an unrecorded agreement being invalid. Their decision is under appeal but the general principle was that as long as a license agreement conforms to the contract law, then it is considered valid regardless of recordation status. It will be interesting to see how this plays out in the Wahaha case. The Xiamen case was a HK company and local company dispute.

  15. Interesting to see that Zong Qinghou is playing a media game and particularly that he is using ‘nationalist’ arguments. Chinese companies seem to be taking the nationalism angle more and more.
    In the Danone/Starbucks/JV type situation, there seems to be tension between nationalism on the one hand, with many Chinese feeling that local companies deserve to be favoured whether they are right or wrong, and China’s international business credibility on the other.
    I think the nationalism card will be played more and more by Chinese businesses. I notice that it doesn’t only apply to nationalism in China – Nanjing Automobile Corporation, the buyers of MG (an English sports car maker), are planning to re-start production at MG’s historic home, Longbridge near Birmingham, and have very shrewdly appealed to British patriotism to help ensure the success of the venture. To me, this looks like a very clever move, and it could make all the difference in aligning the marque’s history and pedigree with its future under Chinese ownership.
    Will be interesting to see how both stories pan out.

  16. dianainshanghai —
    Very interesting and what you say probably helps explain why Wahaha feels it necessary to drum up nationalist sentiment as well.
    You are right to call it recordation, not registration.
    I have no real basis for saying this, but it has always been my impression that recordation is far more important for patents than for trademarks. Do you have that same sense?

  17. Check the letter posted on Sina yesterday by Danone’s President of AP. He appears to be saying clearly that Danone is going to go to litigation.
    Maybe clip it out and paste it here for discussion..

  18. Freshfields set up the original JV on behalf of Danone back in the late 1990’s. They, not Danone’s in-house, is going to take the heat for this…..they’re trying to un-screw it right now….

  19. Rich Donnington —
    Wow! Freshfields is a first rate firm so I do not see how this could have happened. Many countries have this requirement (and even more used to) so international lawyers (even those not terribly familiar with China) know at least to watch out for this. I have seen lawyers make this mistake many times (not just in China) but every time they were domestic lawyers or IP lawyers, never international lawyers, much less a firm so highly regarded as Freshfields.
    Perhaps there is some other explanation here?

  20. The Danone – Wahaha brewhaha
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  21. I think Chinese companies will increasinly have the ability to play the Nationalist card.
    When is the Xiamend appeal decision expected?

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