Impact of China’s new product liability laws

February 2012 | TALKINGPOINT | RISK MANAGEMENT

financierworldwide.com

FW hosts an online discussion focusing on China’s new product liability laws between Paolo Beconcini at CBM International Lawyers LLP, Eugene Chen at Hogan Lovells International LLP, and Honghuan Liu at Jun He Law.

FW: Could you explain why legislators introduced the recent changes to product liability laws in China? What were the underlying objectives?

Beconcini: Provisions contained in both the new tort law and the product liability section of the statute on the choice of law in foreign-related civil relationships were conceived and enacted in order for civil courts to properly respond to steadily growing legal challenges posed by both individual and large-scale defect-related accidents in recent years, and for plaintiffs to obtain more effective means of redress in such cases. Previously, there were no specific provisions regulating the choice of substantial law in foreign-related product liability cases. The new statute provides a set of rules favourable to the injured person, which are aimed at facilitating the victims’ access to Chinese civil courts and provide plaintiffs with the choice of flexible means of redress in complex cross-border product liability litigation. Also, by providing plaintiffs with a broader claim and damage compensation basis, the new tort law aims to provide consumers with more effective means of redress before civil courts against defective products.

Chen: After years of debate and consideration, the PRC Tort Liability Law came into force on 1 July 2010. It recognises various types of civil rights and interests, including right to life, right to health, right of name, right of reputation, right of publicity, right of ownership, right to beneficial use, copyright, patent right, right to exclusive use of trademark, right of discovery, right of shareholding, and right of property. In addition to principles generally applied to tort cases, the Law specifies seven types of tort liability – product liability, motor vehicle accident liability, medical liability, environmental pollution liability, liability for injuries caused by highly dangerous work/activities, liability for injuries caused by unruly animals, and liability for injuries caused by physical objects. The Tort Law was designed to collect several pre-existing lower-level regulations, rules and judicial interpretations and codify them at the highest level of legislation. Although it is considered a milestone in the PRC’s civil law system, with a few notable exceptions, it is largely repetitive of pre-existing law. Indeed, in the first year since the Law took effect, there have been few significant judgments that depart from the previously existing product liability regime.

Honghuan: The Law of the Application of Law for Foreign-Related Civil Relations of the PRC (the Choice-of-Law Statute) and the Tort Law of the PRC became effective on 1 April 2011 and 1 July 2011, respectively. When the Choice-of-Law Statute covers aspects of application of law and choice of law rules in foreign-related product liability cases; the Tort Law contains major adjustments to substantive law regarding product liabilities. As a basic law in the PRC, the Tort Law has actually been in the process of legislation for many years and finally provides a specific chapter dedicated to product liabilities in 2010. The new rules respond to the broad social attention to major product liability cases that occurred over the past several years in China and intend to consolidate the responsibilities of, and supervision over, potential tortfeasors.

FW: What are the key features of the new laws? Are there new liabilities for producers and sellers of defective products?

Chen: Three of the most significant provisions relating to product liability in the Tort Law relate to punitive damages, emotional distress damages, and a system of mandatory product recalls. The Tort Law contains a provision that allows an aggrieved party to claim punitive damages against manufacturers or distributors for loss of life or damage to health caused by defective products, if the products were produced or sold knowing that a defect existed. Punitive damages are a substantial deviation from China’s standard compensatory approach to product liability. The Tort Law is China’s first law that provides, in principle, unlimited punitive damages. The Tort Law’s provision for emotional and mental distress damages is also the first time such a measure of damages has been recognised at the highest level of legislation. Article 22 of the Tort Law now mandates that a claimant may seek compensation for mental damages where there is infringement on personal rights and interests which results in serious mental damages. For the first time, the Tort Law also introduces a general recall provision requiring manufacturers and distributors to adopt remedial measures such as providing warnings or recalling products in a timely manner if products in circulation are found to be defective.

Honghuan: The new laws are designed to increase the protection given to injured parties and the tort liabilities on tortfeasors, and will strengthen obligations for manufacturers and sellers especially in the pre-damages risk prevention phase. The new liabilities provide that when a product is defective but has yet to cause actual damages, a potential injured party has legal rights to ask a defendant to remove obstacles and to eliminate danger (sometimes referred to as ‘liabilities without damages’). When a product is found to be defective after it is put into circulation, the manufacturer or seller of that product must give timely warnings and recall the defective product, otherwise it will bear tort liabilities. The new laws also enlarge the scope of recall obligations to all products. Most importantly, the new laws allow punitive damages awarded to all kinds of product defects, whereas previously they were only allowed in specific areas such as food defects.

Beconcini: Before the enactment of the statute on choice of substantial law, plaintiffs in a product liability case before a Chinese People’s Court could only choose to apply the law of the place where the tort had occurred. According to article 45 of the statute, a plaintiff – Chinese or foreign – can now choose to have the Chinese People’s Court apply to his case either the substantial law of the place where he has his habitual residence or, alternatively, the law of the place of business of the defendant or the law of the place where the tort has taken place. However, if the defendant has no relevant business operation at the habitual residence of the plaintiff, the latter can only choose between the law of the place of business of the defendant or the law of the place where the tort has taken place. As a result, the plaintiff may thus increase the liabilities of the manufacturer and sellers, and their exposure to higher damage compensation by choosing the substantial law most favourable to his case. The new tort law presents several new features which increase the liabilities of manufacturers and sellers. Manufacturers and sellers have, for instance, a continuous duty to warn of defects, even after the product has been put into circulation.

FW: In what ways do the new product liability laws impact multinational firms with a presence in China?

Honghuan: The choice of law rules provided in the new laws – namely, article 45 of the Choice-of-Law Statute – will exert a significant impact on multinational companies, especially those which do not engage in business operation activities in China. Specifically, while the new laws changed the application rule from the previous lex loci delictis to lex loci domicilli, they also provide an option for the plaintiff to choose to apply the laws between the defendant’s main business place (for instance, the laws of a manufacturer’s home country) and the laws of the location where damages occur (such as China). And whether the defendants have actual business presence in China and/or engage in business operation activities in China will become a decisive factor on whether the plaintiff can exercise that option or not.

Beconcini: Product liability already constitutes a serious risk factor for multinationals doing business in China as is demonstrated by the ever increasing administrative investigations into product safety – see the Johnson & Johnson baby shampoo administrative investigation and the Chrysler and Toyota recalls, or the negative campaigns of consumer protection blogs and awareness groups, for example the public slandering of Siemens refrigerators in Beijing in November 2011. These risks will now be increased by a likely surge in product liability litigation which will threaten foreign manufacturers, together with their business organisation and partners in China. Unlike in the past, plaintiffs will soon become aware and make use of the remedies afforded by the new tort law and begin suing foreign manufacturers together with their distribution and retail partners in China. Also, new obligations such as the after-sale duty to warn and the plaintiff’s right to claim product recalls from the courts will force foreign manufacturers to implement even tighter internal quality controls and procedures, and ensure their implementation by their business partners in China.

Chen: The product liability sections of the Tort Law are largely repetitive of the legal principles enumerated in the PRC Product Quality Law. Under the Tort Law, defective products are products which contain unreasonable risks endangering the safety of persons or property. There are three major types of defective products: design defects, manufacturing defects, and failure to provide adequate warning or instruction. Products that fail to meet national or industrial standards for health and safety can also be deemed as defective products under PRC law. Manufacturers or distributors bear tortious liability for damage caused to others by their defective products. Multinational firms who are manufacturers or distributors must be constantly vigilant to make sure the quality of their products fully comply with applicable national or trade standards, as these standards can change quickly and without much notice. Moreover, multinational firms should be aware that the new provisions governing punitive damages, emotional distress damages, and product recall increase potential liability for claims in China.

FW: To what extent do the new laws influence intellectual property rights?

Beconcini: The statute on the choice of law contains important provisions concerning intellectual property rights. The law at the location where protection is sought will apply to the determination of ownership and content of IPR and infringement disputes. Considering that patent and trademark rights have no extraterritorial legal effect, the forum will always be that of the place where the disputed right is registered. Only in cases of patent infringement can the parties also agree to apply the law of the place where the infringement has occurred. As to transfer and licensing of IPR, the parties can agree on the applicable law or, if they do not, the provisions of law of contracts will apply.

Honghuan: The Choice-of-Law Statute has a specific chapter on choice of law rules in foreign related IP infringement actions. Particularly, article 48 and 50 provide that attribution and content of IP rights and liabilities for infringement on IP rights shall be governed by laws of “the places where protection is claimed”. While it is generally agreed that the term shall mean the law of “the places where the rights are registered” for IP rights which must be registered to have protection, such as patent and trademark; it is highly uncertain how courts will interpret the term if the rights involved are those which do not need registration to be protected, such as copyright and neighbouring right. A very possible outcome analysed from legislative history is that the term shall mean the laws of “the source country of the rights”.

Chen: Under the Tort Liability Law, for the first time, internet service providers (ISPs) are subject to joint and several liability, along with their users who infringe other’s intellectual property rights. ISPs have the obligation to take necessary measures to stop further infringement after the party whose rights are infringed so demands. The Tort Law restates and expands the scope of Article 4 of the PRC Supreme People’s Court Interpretation on ‘Several Issues Concerning the Application of Law in Hearing Cases Involving Copyright Disputes over Computer Network’ (the SPC Interpretation) of 2006. According to the SPC Interpretation, an ISP will be jointly liable with other infringing parties provided that the ISP infringes a copyright held by another party or abets or assists a third party to commit copyright infringement. Moreover, if an ISP is aware of copyright infringement or has been warned of such infringement by the copyright owner, yet fails to take adequate measures such as removing the content from the internet, then the ISP is also subject to joint and several liability. After the enactment of the Tort Law, the principles of the SPC Interpretation have not only been elevated to the highest level of legislation, but have also been expanded to include not only copyright, but generally all ‘intellectual property’ rights.

FW: In your opinion, do the new laws increase the likelihood of product liability litigation and the amount of compensation awarded to plaintiffs? Similarly, could they add to the cost and duration of legal proceedings?

Honghuan: Since the new choice of law rules set by the new laws allow the plaintiff to choose to apply the law under which she could get more damages, and since punitive damages are now enlarged to cover all products, motives for the plaintiff to file a case will definitely increase since she could get more money through compensation. On the other hand, since foreign laws will become more widely applied, the proof of foreign laws will become a common issue in future litigation. Thus, the proceedings can be prolonged and costs will increase. And multinational companies might have more incentives to settle with the plaintiff. Consequently, the new laws are likely to increase litigation brought by individual consumers.

Chen: Chinese courts do not publish their opinions widely. Yet those opinions that are available show that despite the new provisions of the Tort Liability Law, in the one and a half years since the Law went into effect, Chinese courts have not significantly changed their views on the quantification of product tort liabilities and the appropriate remedies. Although the Tort Law allows an aggrieved party to claim punitive damages or emotional distress damages, in practice Chinese courts tend to strictly interpret these provisions in product liability cases. This may be due to the fact that higher-level courts, such as the Supreme People’s Court, have not provided any substantial interpretation or guidance to actively support the application of punitive damages after the enactment of the Tort Law. The Intermediate People’s Court of Guangzhou held, in two food-related product liability cases in late 2010, that two elements must be met before the court grants punitive damages. First, the product was not compliant with food safety standards and the tortfeasor knew of the non-compliance; second, serious damage to life or health was actually incurred. Lack of either of these two elements will result in the court’s denial of punitive damages. Thus, there is a heavy burden on the plaintiff to prove that the manufacturer or the distributor ‘knowingly’ manufactured or sold defective products.

Beconcini: By expanding the protection of plaintiffs against defective products and by widening the liabilities of manufacturers and sellers alike, the new tort law will likely lead to increasing product liability litigation and damage compensations. More generally, both statutes under examination have been conceived and implemented with the explicit purpose of facilitating the victims’ access to civil courts and to providing plaintiffs with more efficient judicial remedies in product liability litigation. Furthermore, both the new provisions of the tort law on punitive damages and the possibility of plaintiffs to choose foreign laws with more favourable damage compensation norms may indeed result in a change in the traditional conservative stance of Chinese judges in point of damages. The new statute on the substantial choice of law may also add to the costs and duration of civil proceedings. Chinese courts will indeed face new complex legal challenges when interpreting foreign substantive laws and parties will engage in long disputes on these preliminary procedural and substantial matters, prolonging the duration and increasing the costs of proceedings. Translations will also add to increased costs and duration of the proceedings.

FW: Going forward, what are your predictions for how Chinese courts will interpret and implement the new laws? Do you anticipate consistency and stability, or an uncertain period for parties who do find themselves embroiled in product liability litigation?

Honghuan: Under the customs of PRC judicial practice the Supreme People’s Court of the PRC (PRCSCT) will enact Judicial Interpretations once a new law has been implemented for a while. Before that, the High Court in different regions may also publish interpretations to assist courts within its jurisdiction in understanding and implementing the new law. For the product liability regulations in the Tort Law, since most of them succeed the basic mechanisms of law, their implementation and interpretation should be relatively stable and consistent, except for the punitive damages part. On the other hand, since the Choice-of-Law Statute contains major adjustments which are different from previous rulings by the Chinese judges, it could take a period of time for the judges, especially those at the PRCSCT and each region’s High Court to publish their opinions on conflicts and ambiguities.

Beconcini: There is insufficient case law which may help to predict how civil courts will interpret key provisions of both laws under examination. For instance, it is uncertain how courts will determine the legal basis for calculating punitive damages. Also, for example, there is no way to predict how ‘recall’ claims will be handled by the courts. Regarding the statute on the choice of law, it is still uncertain whether Chinese judges will understand the norms on the burden of proof to be matters of procedural law and therefore not subjected to the statute. Considering that Chinese civil courts do not follow ‘precedents’, it is likely that for the time being they will develop and rely upon their own internal guidelines for interpreting both laws, which in turn may lead to inconsistencies among the different territorial jurisdictions. For these reasons, an uncertain period for parties who do find themselves embroiled in product liability litigation is to be expected, until binding guidelines and interpretations from the Supreme People’s Court are issued.

Chen: Because the new Tort Law mostly consolidates pre-existing lower-level legislation, rules, and guidances, Chinese courts have not changed substantially their views on how to handle product liability litigation or how to determine damages. For the most part, the published rulings since enactment of the Law seem consistent with those that precede the Law. However, we can expect the courts to develop newer attitudes and interpretations of the Tort Law, particularly as issues relating to class actions and product liability are debated in Europe and the US. Moreover, courts will be under increasing pressure and expectations from the Chinese public who see the Tort Law as a tool to protect against large scale product liability incidents, such as the melamine milk scandal. As with any major development in the law, though, there will inevitably be an uncertain period as courts grapple with how to interpret and implement the newer provisions of the Tort Law.

FW: What general advice would you give to foreign entities on avoiding potential product liability risks and liabilities associated with doing business in China?

Beconcini: Foreign entities should implement or improve strict manufacturing and distribution monitoring, and early warning systems for litigation, in order to properly manage emergencies related to product liability, thus avoiding or limiting irreparable legal damage and unwanted repercussions on the company’s brand name. In this respect, the creation or update of product recall plans, as well as after-sale defect warning systems, is paramount. All such systems should ideally be implemented throughout the whole company organisation, particularly including Chinese business partners. Contracts with distributors and retailers in China should also be adapted to the changed legislative framework. Furthermore, cooperation and lobbying with public authorities and care of the public relations aspects of product liability may be of great advantage, especially in relation to the implementation of effective recall plans or in the case of serious civil or criminal litigation.

Chen: Given the changing legal landscape and the general increase in risk, multinational companies doing business in China would be well advised to re-evaluate their sales or purchase contracts to ensure the hold harmless clauses, warranties, guarantees and disclaimers have been properly addressed and carefully tailored. In addition, it is also important to ensure products are fully compliant with any existing national and trade standards and enterprise standards, and that package labelling and manuals meet the standards set forth in applicable laws and regulations. Standards, laws and regulations can change quickly, and multinational companies are particularly slow to respond to regime changes, particularly where decision-making comes from foreign headquarters. Additionally, the advent of the Tort Liability Law has seen an increasing number of insurers offering product liability insurance in China. While awards in China have not exploded to the levels seen in Western jurisdictions, the trend is towards increasing damages, and as we have seen in other areas, the Chinese legal system can implement dramatic changes that take other systems an exponentially greater number of years to accomplish.

Honghuan: The new laws will definitely bring new perspectives to foreign manufacturers and sellers in PRC product liability litigation, and their public relations crisis management in China. Since the new laws are likely to increase their liabilities and the likelihood of litigation, foreign entities need to pay special attention to the manufacturing of their products, distribution systems, product recalls, litigation and public relations crisis management. They should also retain experienced in-house and outside counsels who know the law, instead of hiring ‘language attorneys’ or attorneys who claim to be ‘good at relationships’.

Paolo Beconcini is a partner at CBM International Lawyers LLP. He is an international attorney and specialises in the fields of intellectual property and product liability in China. Having resided in China since 2001, he advises and counsels German and multinational firms in intellectual property matters. He advises international clients on product liability litigation in China, as well as on product liability prevention and management, including recall planning in the automotive sector. He has authored several publications regarding China IP and product liability. He can be contacted on +86 136 1161 1284 or by email: pbeconcini@cbmlaw.com.

Eugene Chen is a partner at Hogan Lovells International LLP. Based in the Shanghai office, his practice focuses on cross-border disputes and investigations in the US, China, and elsewhere in Asia. Mr Chen has experience in representing Asian and Western companies in all matters of litigation, international arbitration and dispute resolution. His disputes practice includes compliance and FCPA investigations, large and small scale product liability suits, patent infringement litigation, trademark and copyright issues, commercial contract and unfair competition disputes, and US consumer class action lawsuits. Mr Chen can be contacted on +86 21 6122 3800 or by email: eugene.chen@hoganlovells.com.

Honghuan Liu is a partner at Jun He Law. Her practice areas include product liability litigation and product recall; trade secret and non-competition litigation; anti commercial bribery and FCPA government investigation; shareholder dispute litigation and arbitration; patent, trademark and copyright confirmation and infringement litigation; and bank and financial institution litigation, among others. Ms Liu acts as an arbitrator at Beijing Arbitration Commission and China International Economic and Trade Arbitration Commission, and in 2011 was ranked as a band one attorney in dispute resolution in Mainland China by Chambers and Partners. She can be contacted on +86 10 8519 2797 or by email: liuhonghuan@junhe.com.

THE PANELLISTS

Paolo Beconcini

CBM International Lawyers LLP

Eugene Chen

Hogan Lovells International LLP

Honghuan Liu

Jun He Law