China Law Insight : China Law Insight: China Commercial and Intellectual Property Lawyers and Attorneys, Full Service Law Firm: King & Wood

Overview of discovery in US litigation

The scope of discovery in China is far more restricted than in the US.  Under PRC procedural rules, a litigant must only present sufficient evidence to support its own claim or defense. In China, a party is rarely required to produce evidence to support the other's claim or defense, and third parties generally are under no obligation to provide any evidence for the litigation.  Judges and arbitrators can order the production of such evidence but obtaining it from the other side is often difficult. In contrast, the US Federal Rules of Civil Procedure ("Federal Rules") allow a litigant to collect from its opponent non-privileged evidence relevant to its own claim or defense, even if disclosure would be adverse to the producing party.[1] Common forms of evidence include documentary evidence produced in response to requests for production of documents, oral testimony through depositions, and written testimony through answers to interrogatories. 

PRC companies with a presence in the US are often surprised to learn that despite not being a party to the suit, they may be compelled to produce evidence for the litigation. Under the Federal Rules, if a party is within the court's jurisdiction, a court may order a third party, through a subpoena, to produce documents or submit to a deposition. A PRC party may be within the court's jurisdiction if it has assets, a branch office, or affiliate company in the US or if it conducts business in or travels to the US. PRC law, however, strictly prohibits US attorneys and agencies from taking depositions on PRC soil without approval from PRC authorities. Depositions of PRC individuals are often taken voluntarily in Hong Kong or other countries accessible to the deponent. Depositions may also be conducted at the US embassy or consulate, which is considered US soil.

Compliance with a discovery request or subpoena is mandatory. Failure to comply can result in civil and even criminal sanctions. A third party beyond the US court's jurisdiction is generally under no obligation to comply with a litigant's request for information. The failure of a party to litigation to respond to discovery will adversely affect that party's ability to prove its case. The court may take an adverse inference from the failure to produce, e.g. if the defendant refuses to produce an email that the other side contends demonstrates liability, the court may take the adverse inference that if the email had been properly produced it would have proven liability on that point. Thus, failing to produce and refusals to produce key documents may undermine counsel's ability to prosecute or defend the case. 

A major focus of discovery is looking for evidence that shows a weakness or inconsistency in the other side's case. As counsel, we look for inconsistencies to show the other side is not being truthful or candid with the court. A witness who testifies for example that an event did not occur might be cross examined with an email or document that confirms the event. As counsel, we can use such evidence to argue that if the witness is lying about this issue the court should find the witness' testimony on other issues equally unreliable. Litigants in US litigation quickly learn that a lie or half truth is easily discerned. 

Parties must also be conscious of issues of spoliation of evidence. At the start of litigation or threatened litigation, counsel will ask the company to issue a litigation hold notice. This is a notice to everyone in the company that physical and electronic documents have to be retained until the litigation is completed. If documentary evidence is lost or destroyed after litigation is threatened or commenced, the other side will use this as proof that the party destroyed evidence adverse to its case. Effectively creating and maintaining a litigation hold in China is difficult because so many companies have employees that may use non-company servers for emails exchanges. Similarly, employees tend to use SMS messaging rather than emails. Such messages are often irretrievable. Again this may give the opponent the chance to argue that supporting evidence of a claim never existed or that damaging evidence was destroyed or intentionally sent via text rather than email.  

Discovery of information located in China

Under US law, documents located abroad may be obtained pursuant to the Federal Rules or the Hague Convention. The US party will argue for discovery under the Federal Rules because it will be faster and result in broader disclosure of information. The PRC party will aim for discovery though the Hague Convention to limit the scope and avoid the risk of disclosing information in violation of PRC law. 

Discovery pursuant to the Federal Rules. If the Federal Rules are applied, all requested information must be produced unless there is a valid basis to object to disclosure. Parties commonly object to disclosure on the basis that information is a privileged communication between attorney and client, is attorney work product, or would be unreasonable and unduly burdensome to produce. The objecting party must have a good faith basis and specifically state its reasons for the objection. Importantly, a successful objection may narrow the scope of disclosure but may not fully defeat the request.  

A US branch office or affiliate of a PRC company may also be the conduit for obtaining documents located in China. Under the Federal Rules, all non-privileged documents within a party's possession, custody, or control must be produced, even if they are located in a separate offshore legal entity. The US entity may be deemed to have control over requested documents if it has the "practical ability" to obtain them.[2] 

Discovery pursuant to the Hague Convention. To obtain discovery under the Hague Convention, the US court must submit a Letter of Request to the PRC Ministry of Justice. The letter is forwarded to the PRC Supreme Court for review, which may take six to twelve months. Like many civil law countries which view US discovery as overly broad, the court will only order production of documents with a "direct and close connection with the subject matter of the litigation."[3] The court may also limit the scope of the request, or reject the request altogether, if disclosure would violate PRC law or state sovereignty, security, or public interest. If approved, the letter will be forwarded to a lower PRC court for execution.

Considerations for PRC litigants and third parties

Unless there is a compelling reason to apply the Hague Convention, discovery will be conducted under the Federal Rules. The party seeking application of the Hague Convention has the burden of persuading the court that it is the proper channel for discovery. A US court will consider a number of factors, including the importance of the information sought, the degree of specificity of the request, whether the information originated in the US, the viability of the Hague Convention as an alternative means to obtain the information, and the US and Chinese interests at stake.[4]  Historically, US courts have been reluctant to order discovery under the Hague Convention because they view it as time consuming, expensive, and ineffective. 

Though PRC law prohibits US litigants from obtaining evidence in China by any means other than the Hague Convention or diplomatic channels, this alone will not be enough to convince a US court to deviate from the Federal Rules.[5] The PRC party must demonstrate that disclosure of the information without consent from PRC authorities would result in a genuine threat, not just a mere possibility, of civil or criminal penalties. The PRC party will need to point to actual instances of enforcement when the type of information sought was disclosed in violation of PRC law. The US court must also be convinced that application of the Hague Convention will result in production of discoverable information and that China's interest in protecting the information outweighs the US interests at stake. At the onset of US litigation, PRC parties should consider the nature of information which may be requested, whether such information is protected by PRC law, and potential exposure to penalties if disclosed without approval. 

Seek application of the Hague Convention early in the proceedings.Foreign litigants often wait too late to object to requests for protected information. Under the Federal Rules, if a litigant or third party refuses to produce requested information, it must notify the requesting party of its reasons for doing so. If information is withheld without a valid objection, the requesting party may ask a court to compel production of such information. Waiting until the requesting party has involved the court is generally not a successful strategy for the objecting party, as the objection may be waived or viewed as a last ditch effort to delay or avoid discovery.[6]  Involving the court early in pre-trial proceedings may place a PRC party in a better position to narrow disclosure or persuade the court to order discovery under the Hague Convention. 

Consider whether the information sought is protected by PRC law. Before seeking application of the Hague Convention, a PRC party should consider whether the information sought is protected by PRC law.  State secrets, trade secrets, and bank secrets are common forms of protected information. In addition to establishing the paramount interests of China in protecting the information and a real exposure to liability for unlawful disclosure, the PRC party will also need to demonstrate it has undertaken measures to prevent disclosure of the protected information.[7]

State secrets.  SOE's and parties involved in sensitive industries such as telecommunications, banking, information technology, energy, and natural resources are particularly at risk for possessing state secrets.[8] The PRC Law on Guarding State Secrets prohibits a company or individual from disclosing information considered to be a state secret. PRC authorities take an expansive view of information deemed state secrets and even information relating to the internal policies and procedures of a SOE may be considered state secrets under PRC law. A PRC party in possession of potentially sensitive information may want to consult with PRC authorities in advance to determine if any of the information should be designated a state secret. This may reduce exposure to adverse consequences for unlawful disclosure and strengthen an objection to disclosure in US proceedings.

Trade secrets. Requested information often includes internal company emails, documents, and information containing confidential and proprietary company information. A PRC party should consider whether the information sought includes trade secrets owned by it or a third party. If owned by a third party, disclosure of trade secrets may be prohibited by PRC law and application of the Hague Convention may be appropriate. If owned by the PRC party, an objection to disclosure may also be raised. The information may still be discoverable if the requesting party can show the information is not privileged, is relevant and necessary to the litigation, and may not be obtained by other means. In such case, the PRC party may ask the court to issue a protective order to prohibit public disclosure of the information and use of the information for any purpose other than the litigation.  

Recent US cases

In two recent cases, the US branches of PRC banks were ordered to produce bank records of PRC defendants, the disclosure of which is prohibited by PRC law. These cases represent the uncertainty PRC parties face when subject to US discovery and the competing views US courts may take when asked to apply the Hague Convention.

In Tiffany v. Andrew, plaintiffs brought a trademark infringement suit against PRC defendants in the Southern District of New York and requested defendants' bank records from the New York branches of Bank of China, China Merchant's Bank, and ICBC.[9] The banks agreed to produce records located in New York but refused to produce records located in China because disclosure was prohibited by PRC law. The US branches also argued the records located in China were beyond their control. Though the court considered records held by the PRC headquarters to be within the control of the US branches, the banks were successful in persuading the court to apply the Hague Convention. In doing so, the court dismissed what it considered to be outdated notions that the Hague Convention was time consuming and unlikely to lead to discoverable information. Instead, it was persuaded by new evidence that PRC authorities have and are willing to execute Letters of Requests and viewed the Hague Convention as a viable means to obtain evidence in China. The court also viewed the PRC interests in protecting confidential bank records and existence of harsh penalties for violating PRC bank secrecy laws to outweigh the US interest in enforcing intellectual property rights.  The banks' status as third parties, not parties to the litigation, was also an important factor in favor of the banks' arguments.

Less than one month later, however, a judge in the same judicial district reached the opposite conclusion. In Gucci America, Inc. v. Weixing Li, also a trademark infringement action involving PRC defendants, Bank of China's New York branch was again asked to produce bank records located in China.[10]  Unlike the Tiffany case, the court was not persuaded the Hague Convention would lead to production of discoverable evidence. It was also unconvinced that Bank of China faced a real threat of liability for disclosing account records in violation of PRC law.  The court viewed the US interest in protecting intellectual property to be dominant to the PRC interest in protecting bank secrets and compelled production of the account records under the Federal Rules.

In a third recent matter, (US Securities and Exchange Commission v. Deloitte Touche Tohmatsu CPA Ltd., Miscellaneous Action No. 11-0512 GK/DAR (US DC DC January 4, 2012)), the US District Court for the District of Columbia, Magistrate Judge Deborah A. Robinson has issued a show cause order to the Chinese entity Deloitte Touche Tohmatsu CPA Ltd., requiring that the defendant show cause as to why it has failed to produce certain evidence. Deloitte has sought the approval of the PRC authorities to release the information and the PRC authorities have apparently advised that such production would be in violation of PRC law. It remains to be seen what accommodation will ultimately be reached in this case where US and PRC interests are in clear opposition. 

Final remarks

As one can see, these discovery battles will continue to be fought on a case by case basis. US courts view discovery as a tool to "make a trial less a game of blind man's bluff and more a fair contest with the basic issues and facts disclosed to the fullest practicable extent."[11]   Accordingly, US judges are reluctant to limit the scope of discoverable information that a litigant or third party must produce. The likelihood of convincing a US court to narrow disclosure and apply the Hague Convention is uncertain and will depend on the circumstances of each case. Chinese litigants may find navigating the US discovery maze difficult. The key to success is understanding the challenges. We strongly recommend that if you are involved in litigation you train the employees handling the case regarding the US litigation and discovery process, the obligations and the risks. Only then can the team effectively deal with these issues in a proactive and successful way.

Parties and Transaction. The proposed transaction was announced as early as January, 2011 as part of President Hu Jintao's state visit to the United States ³.  GE China and CSCLC are to establish a 50/50 JV mainly to license coal-water slurry (CWS) gasification technology to industrial and power projects in China. GE Infrastructure Technology, another subsidiary of GE will license GE's CWS gasification technology to the proposed JV.

The parent company of CSCLC - Shenhua Group Corporation Limited (Shenhua Group) is a State-owned mining and energy company in China. Its core businesses include production and supply of coal, electricity and heat, as well as rail and port transportation services.

Relevant Market. MOFCOM paid close attention to the market in which the proposed JV will be active, and found that this transaction might exclude or restrict competition in the CWS gasification technology licensing market. Considering the significant differences between CWS gasification technology and other coal gasification technologies, MOFCOM was of the view that CWS gasification technology licensing market constitutes a separate relevant product market.

Since the propose JV will only be active in China and the Chinese licensees only acquire such technology on the China market, MOFCOM found that the relevant geographic market is China.

Competitive Assessment. Apparently, market share, market concentration level and market entry are still the major factors MOFCOM considered in its competitive assessment process.

MOFCOM indentified that China's CSW gasification technology licensing market is highly concentrated with only three major players – CWS gasification technology provided by GE Infrastructure Technology, multi-nozzle-mounted CWS gasification technology jointly developed by Yankuang Group and East China University of Science and Technology, and multi-component slurry gasification technology provided by the Northwest Research Institute of Chemical Industry. It was noted by MOFCOM that GE's CWS gasification technology has the highest share in this market.

MOFCOM further looked into an adjacent market involved in this transaction. Since CWS gasification technology has specific requirements for the properties of the raw coal, operators of CWS gasification projects need to have a reliable supply of the specific coal. MOFCOM noted that in 2010, Shenhua Group was the largest supplier of raw coal that is suitable for CWS gasification projects.

MOFCOM also found that there are significant barriers for entry into the CWS gasification technology market due to the complexity of the technology, high investment cost, existing IP rights and long R&D and industrialization cycles. 

In light of the above, MOFCOM concluded that the proposed JV is likely to restrict competition in the CWS gasification technology market by making use of the dominant position of Shenhua Group in the raw coal market.

Remedies.  In order to solve the competition concerns, MOFCOM requested CSCLC and Shenhua Group not to compel licensees of CWS gasification technology to use JV's technology by restraining the supply of raw coal, or by conditioning such supply on licensing of JV's technology, nor to raise the cost of such supply for those using other technologies.

Comments
 
There are a few points about this decision that are worth mentioning. As mentioned above, it is the first conditional merger control decision where an SOE is involved. If read together with the recent antitrust probe of China Telecom and China Unicom by the National Development and Reform Commission⁴, it appears that contrary to protectionism accusations from overseas, Chinese antitrust enforcement agencies are indeed increasing their antitrust scrutiny of SOEs.

It is also the first conditional clearance of a joint venture project. Whether JV is caught by China's merger control regime is not expressly stipulated in the AML. However, based on our experiences, MOFCOM considers joint ventures to be a type of notifiable transactions under the AML. This decision officially affirmed MOFCOM's position in this regard.

Furthermore, this is the first time MOFCOM defined a technology licensing market. This decision (as well as the previous decision on Alpha V/Savio deal) has become more detailed in terms of competitive analysis. It is also interesting to note that MOFCOM imposed behavioral remedies in this case after it requested divestiture in the Alpha V/Savio case. All these suggest that MOFCOM is getting increasingly sophisticated and holds a flexible and pragmatic approach towards merger remedies.

1. See our article entitled MOFCOM's 8th Conditional Clearance - Alpha V/Savio Deal.    

2. A copy of MOFCOM's Announcement [2011] No. 74 could be found here (in Chinese): http://fldj.mofcom.gov.cn/aarticle/zcfb/201111/20111107824342.html.

3. See the press release of the deal on GE's website:

http://www.genewscenter.com/Press-Releases/GE-and-Shenhua-Announce-Formation-of-Cleaner-Coal-Technology-Joint-Venture-in-China-2ddd.aspx.

4.See our article entitled Earlier Rumor Confirmed: China Telecom and China Unicom under Antitrust Investigation  on details of this incident.

Fact

From the news and other public available sources, we understand that the antitrust investigation may focus on whether China Telecom abused its dominance in broadband backbone network market by charging other broadband access network operators a price for using its backbone network that is much higher than the price China Telecom charge the other internet operators, for the purpose of squeezing out the other access network operators.
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• China Telecom's position in the market of broadband backbone network services and broadband access network services

The broadband backbone network is the principal data routes that connect different networks among cities, countries or even continents. In China, there are only two nationwide duopolists running backbone networks, i.e. China Telecom and China Unicom. In fact, rather than competing with each other, China Telecom monopolizes the backbone network service market in South China, while China Network monopolizes  the market in North China.
 

Broadband access networks are built to approach the broadband end-users such as families and enterprises. China Telecom and China Unicom also are big players in providing access network services, whereas other operators such as Great Wall Broadband, China Railcom and China Mobile are active as well. Since all of these broadband access network operators have to connect to the broadband backbone network, they are heavily dependant on broadband backbone network operators, i.e. China Telecom in South China, and China Unicom in North China. In particular, under  the Measures for Inter-network Settlement at Internet Exchange Center (hereinafter referred to as "Settlement Measures") promulgated by the Ministry of Industry and Information Technology (MIIT), these operators are required to pay backbone network access fees (access fees) to China Telecom and China Unicom.  Moreover, the cap of the access fees is also provided in the Settlement Measures.
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• China Telecom's alleged abusive conducts
  

As alleged in news reports, China Telecom may have charged competing access network operators an access fee that is three times or even a dozen times higher than other types of users such as internet content providers (ICPs). By forcing its rivals to pay much higher access fees, China telecom may thus be in a better position to expand its own business in providing broadband access network services. 

In practice, to avoid the hefty access costs, the other access network operators usually buy bandwidth from third parties (such as the ICPs), as the cost could be much lower. 

• Reported antitrust investigation
  

The investigation is said to be triggered by an August 2010 internal circular of China Telecom, under which China Telecom required its provincial branches to cut down connection to the backbone network if the access is achieved through buying the bandwidth from a third party.  The crackdown measures are reported to have adversely affected a wide range of broadband access network operators including many state-owned operators, and as a result affected thousands of internet end-customers.

It is reported that the antitrust investigation by "a relevant antitrust authority" started in the first half of 2011 and it has already carried out many rounds of inquiries and evidence collections with China Telecom. A number of access operators, research institutions and experts were also approached for verification. It is also reported that the authority has drawn a preliminary conclusion that the conducts of China Telecom as mentioned above can be found as constituting abuse of dominance. So far, there is no official response from any government authorities in this respect.

Comments

Since large state-owned enterprises in telecommunications, a traditionally highly concentrated industry, are involved, the news attracted lots of attention in spite that the sources and accuracy of the information still need to be verified.  Observers are pondering whether this is a sign that the Chinese competition authorities are ready and eager to show their teeth to large state-owned enterprises.
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• Whether an abuse of dominance can be found?

Assuming China Telecom's accused conducts truly existed, we consider that such behaviors are likely to be caught by Article 17(1) or Article 17 (6) of the AML. Article 17(1) of the AML provides that a dominant operator shall not abuse its dominance by charging unfairly high or low prices. Article 17(6) of the AML provides that a dominant operator shall not abuse its dominance by "implementing differential treatment for terms of transaction such as transaction price for similar trading counterparts without a valid reason".

As is the case for all abuse of dominance cases, the threshold issue would be to identify a relevant market and then to determine whether there is a dominant position in the relevant market. In addition, in relation to Article 17(1) of the AML, the key issue would be whether the access fee is unfairly high, which could be drawn by a comparison with China Telecom's relevant costs. In relation to Article 17 (6), it is still left to be argued whether the access network operators and other types of users are "similar trading counterparts" that deserve to be charged at the same price level.

To defend itself from both accounts, China Telecom may argue that the highest access fee it charges its rivals is still below the price cap set in the Settlement Measures by MIIT.  In other word, the price charged by China Telecom to other access network operators is still in compliance with the guidance price set by the government. 

We understand that this case is similar to the famous Deutsche Telekom case, in which Deutsche Telekom charged a higher access fee at wholesale level than at the retail level to force its competitors to charge their end-user higher price (so-called "margin squeeze"). This was found to be an abusive conduct by European Commission in 2003 and confirmed by the European Court in 2008 (Case T-271/03),  and the defendant's similar argument was not accepted by the European Court. The Court pointed out that compliance by Deutsche Telekom with the industrial regulation did not absolve it from responsibility under competition law. Besides, we also noticed that, according to the news report, it is China Telecom's crackdown measures (rather than the higher price charged) that triggered the possible investigation.  We consider that the crackdown itself may also be suspicious of violating Article 17 (3) of the AML which prohibits the dominant operators from refusing to transact with trading counterparts without a valid reason. The disputable point in this scenario is whether China Telecom has any valid reasons to prohibit resale of bandwidth if such resale does not violate any laws or regulations.
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• Who is the investigation authority and what are the possible results?
  

Although no public sources have identified the specific authority, we understand the proper investigation authority should be the National Development and Reform Commission ("NDRC") since the major conducts under the said antitrust investigation (i.e., charging the other access network operators a much higher access fee) are price-related.

According to Article 47 of the AML, once an operator was found guilty for abusing dominance, the anti-monopoly enforcement agency, who in this case is possibly NDRC, shall order the operator to stop the illegal act, confiscate its illegal income and impose a fine of 1% to 10% of the sales amount of the preceding year. If such penalties are to be imposed, it will not only be the first time for a fine to be imposed on a state-own enterprise under the AML but also will likely involve a huge sum of money, given that, according to the mid-term report published by China Telecom, the revenue generated from broadband access services in the first half of 2011 amounts to almost RMB30 billion. Furthermore, if fines were imposed here, it will be interesting to see how the "illegal income" and specific amount of fines would be determined, by considering the nature, extent and duration of the illegal acts according to Article 49 of the AML.
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• Will the fine be imposed to China Telecom.

Early this June, the European Commission imposed a fine on a Polish telecommunications company for abusing its dominant position on the Polish broadband market. We notice that the Polish case as well as the aforesaid Deutsche Telekom case shares many similarities with the reported China Telecom case although we doubt that the Chinese competition authorities would go that far as the European Commission and European Court.

On the other hand, stakeholders in the industry seem to hold a negative view on the antitrust investigation and the possible fines.  Some of them believe that the issue in the spotlight can only be addressed by revising the Settlement Measures which set a too high price cap for the access fee that is totally outdated. Some even believe that this issue can only be dealt with once and for all by reconstructing the whole broadband industry.  MIIT, who is responsible for updating the Settlement Measures and regulating the industry, may also be expected to adopt some measures to solve the issue. This brings us to the common problem of how the anti-monopoly enforcement agencies and industry regulators will cooperate with each other when antitrust issues come forth.

We will keep an eye on this case and follow up if there is any substantive development.

 Before the promulgation of the State-owned Assets Law, the Interim Regulations on Supervision and Administration of Enterprise State-Owned Assets ("Interim Regulations"), a set of administrative regulations promulgated by the State Council on May 27, 2003, had been the regulations governing state-owned assets with the highest authority since the establishment of the State-owned Assets Supervision and Administration Commission under the State Council ("SASAC") in 2003. The promulgation of the State-owned Assets Law fills the gap of state-level legislation on state-owned assets in China's legal regime and formalizes the mandatory administration and regulation of state-owned assets in China.

The promulgation of the State-owned Assets Law did not draw much attention compared with the Property Rights Law, which attracted extensive academic discussions, or compared with the Anti-monopoly Law, which caused panic among the industrial oligarchs. One of the reasons for such a subdued public reaction is that the State-owned Assets Law mainly focuses on summarizing existing regulations and rules regarding the administration of state-owned assets. It is silent on matters that the public is concerned about, such as the supervision of offshore state-owned assets and executive compensation at state-owned enterprises ("SOEs"). Nevertheless, the State-owned Assets Lawis important because it recapitulates the SOE reform and development of the last three decades. The law also amalgamates old regulations and suggests future directions for the administration of state-owned assets.

Impact on Mergers and Acquisitions by Foreign Investors

The separation of management and ownership in modern corporate structures is a persistent headache for SOEs and the state-owned equity and assets management system. The government management mechanism, which combines the ownership of macro-control and administrative power over state-owned assets, also causes problems. Furthermore, administrative regulations and rules regarding state-owned assets are of a lower jurisdiction than laws and are often enacted by different authorities. Such practicalities have made these regulations and rules inconsistent and inoperable. For these reasons, when merging or acquiring an SOE, foreign investors or private equity funds are often overburdened with complicated approval procedures with two or more authorities, even those that may not have the proper legal authority. Foreign investors and private equity funds are also concerned about the potential difficulties in restructuring the SOE upon merger or acquisition due to the intervention of the government, and therefore, tend to avoid or react negatively to the acquisition of SOEs.

The State-owned Assets Law improves the supervision of state-owned assets by refining the rules for SOE reforms, related party transactions, appraisal, and transfer of state-owned assets. The State-owned Assets Law also clarifies the responsibilities of SASAC and its local branch offices, and prohibits(10) the state-owned assets investor's interference with the operation of SOEs. All of these changes may increase the attractiveness of SOEs as acquisition targets for foreign investors.

For further insight, please read the full article, located here.