Fighting brand ripoffs
New Balance's case shows how hard it can be to protect your intellectual property when your products are made by subcontractors overseas.
NEW YORK (FORTUNE) - Late last month, a remarkable, seven-year-old dispute between New Balance Athletic Shoe and a former overseas contractor unexpectedly sprang back to life.
The case began in 1999 when the Boston-based shoe company tried to terminate one of its Chinese outsourcers, Horace Chang - and Chang refused to be terminated. The Chinese courts have consistently sided with Chang in the suit - one in which, according to a New Balance attorney, an appeals judge unsuccessfully sought a payoff from the company.
But on March 28, the High Court for Guangdong province unexpectedly granted a hearing to reconsider a decision it had rendered more than a year earlier, resuscitating a case New Balance had assumed to be over. (This is an excerpt from a story that ran in the May 1, 2006 issue of FORTUNE. To read the entire article, click here or go to www.fortune.com.)
The litigation stems from an embarrassing problem that brandowners often encounter but seldom acknowledge: unauthorized production by authorized overseas contractors. Beginning in the early 1990s, Taiwanese contractor Horace Chang was licensed to manufacture New Balance shoes for export at his factory in Guangdong Province in mainland China, near Hong Kong. In 1995 New Balance also licensed Chang to distribute a line of New Balance shoes in mainland China. But in 1999, New Balance decided to phase out that line. It terminated Chang's contracts as of the end of 1999 - or so it thought.
"He continued to sell," says Ed Haddad, New Balance's vice president for intellectual property, "and was actively trying to sell product outside the country: in Taiwan, Hong Kong, Italy, Germany." (Chang declined to be interviewed by Fortune, citing the ongoing litigation.)
To stop Chang, New Balance sued him in the Shenzhen Intermediate People's Court for Guangdong Province. But in February 2002, New Balance lost. The court ruled that while New Balance had terminated its licenses with Chang's Hong Kong operating company, it had failed to do so with respect to Chang's Guangdong factory. And though that factory was never licensed to distribute New Balance shoes, the court found that its license to make shoes carried an implied license to distribute - and even a right to do so without paying any royalties.
New Balance appealed to the Guangdong Province High Court, which held oral argument that same summer. Then New Balance heard nothing for many months. Eventually New Balance attorney Harley Lewin, of New York's Greenberg Traurig, hired an investigator to make inquiries. Finally, word came back through two intermediaries, Lewin recounts: "For $300,000, we could have our decision."
"We were on the head of a pin," he recalls. "Clearly, we weren't going to do it. But you're being asked directly by the tribunal hearing your case." As politely as he could, he responded that, no, New Balance really couldn't do anything like that.
More weeks passed. Lewin made more inquiries. Word came back again. "The price was down to a hundred grand," he says. New Balance again refused.
In September 2003, the lead judge on the three-judge panel contacted New Balance through a different intermediary. He asked for $100,000 again, and then came down to $50,000, according to Lewin. This time, New Balance reported the request to the provincial supervisory bureau for courts. In April 2004, after no action had been taken, New Balance petitioned the court to replace the judge. The judge was then removed from the case (without explanation), but not from the bench.
Asked about Lewin's allegations by phone, the replaced judge told FORTUNE, "That's impossible. Are you interviewing me? You cannot interview me like this," and hung up. In response to a letter outlining the accusations, a court public affairs staffer said foreign media had to direct inquiries to the Foreign Ministry.
In January 2005, the High Court finally ruled: It affirmed Chang's victory. In late spring 2005, New Balance petitioned for a rehearing. It heard nothing for almost a year. Then on March 28, 2006, out of the blue, the court granted a hearing on the petition. Lewin, who had previously assumed the case was over, says he has no idea what prompted the court to act. Originally the court set the hearing for April 24, but the court has subsequently postponed it indefinitely, Lewin says.
The case is almost moot at this point, as there are only small quantities of Chang's New Balance shoes still on sale in Shanghai today. Today, New Balance has a more pressing concern, according to Haddad: a competitor that launched in 2005 under the brandname New Barlun.
New Barlun uses packaging, logos, store displays, and slick advertising brochures that are, by Western standards, audacious ripoffs of New Balance's. New Balance has sued New Barlun in the local court for Fujian province, and is awaiting a decision.
Notwithstanding all the challenges, New Balance has never considered withdrawing its factories from China. The economic allure is too compelling and, as Haddad points out, its products would've been counterfeited in China to some degree no matter where the company made them.
Haddad does advise Western companies to monitor their supply chains as closely as they can, however. "If you don't do your up-front due diligence in managing the supply chain," he says, "you're just going to be subject to problems." But after a pause, he adds a weary coda: "Not that you won't be even then."
This is an excerpt from a story that ran in the May 1, 2006 issue of FORTUNE. To read the entire article, click here or go to www.fortune.com.