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UNCLAS SECTION 01 OF 04 GUANGZHOU 000043 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM, EEB/TPP, S/P, INL, INR/EAP 
STATE PASS USTR CHINA OFFICE 
STATE PASS USPTO 
 
 
E.O. 12958: N/A 
TAGS: ETRD EIND KIPR ELAB ECON PGOV CH
SUBJECT: South China Rule of Law Retreating in the Face of Economic 
Downturn 
 
REF: A) 2008 GUANGZHOU 618; B) 2008 GUANGZHOU 732; C) 2008 GUANGZHOU 
704 
 
(U) This document is sensitive but unclassified.  Please protect 
accordingly. Not for release outside U.S. government channels. Not 
for internet publication. 
 
¶1. (SBU) Summary: Is the rule of law yet another casualty of the 
economic downturn in south China?  That's what international firms 
and other concerned observers are afraid of, and the signs are 
pointing somewhat ominously in the direction of turning back the 
clock.  A large multinational toy firm was told to overpay for its 
own assets that were seized after its supplier's bankruptcy in 
October, 2008 - extorted as it were.  The western company was told 
that if it didn't follow instructions, the assets, including 
proprietary tooling and other intellectual property, would be sold 
at local auction to the highest bidder.  International business and 
law contacts separately report that Chinese judges and arbitrators 
are explicitly warning plaintiffs that enforcement of legal 
judgments in business disputes may not meet their expectations in 
cases that would destabilize defendant companies and their local 
employees.  Separately, local media reports announced that the 
Guangdong Communist Party's (CPC) Disciplinary Inspection Committee 
and the Guangdong Procuratorate have each announced measures to ease 
law enforcement efforts in cases where punishment might impact the 
ability of a major firm to maintain economic growth.  Internet chat 
rooms are buzzing with questions about what it all means and 
decrying the retreat from rule of law advances of recent years.  End 
summary. 
 
Possession Is Still the Law 
--------------------------- 
 
¶2. (SBU) Local government actions cleaning up after factory closures 
in Guangdong have raised critical questions about rule of law for 
international business people in south China.  In the case of Smart 
Union, the toy manufacturer whose closure made headlines when 
workers demanded back pay, some major western customers took 
precautions to remove proprietary tooling and other products before 
the factory closed on October 15 (ref A), but others were not so 
lucky.  One such company is now facing escalating local government 
demands that the major western toy company buy back its own 
proprietary tooling, contracted materials and products that Smart 
Union had been manufacturing when the Hong Kong-invested firm shut 
down.  In addition, the price quoted by the local government in this 
case is double what the western firm says they're worth, and 
resolution of the case has been delayed multiple times as the 
government has added new requirements and fees each time it appeared 
that a settlement was near. 
 
¶3. (SBU) Local corporate counsel for the western toy company called 
the local government's actions "an extortion," and has devoted much 
of the last three months to resolving this case.  The lawyer said 
local government officials see his company's seized assets as an 
opportunity to recoup some of the RMB 24 million (USD 3.5 million) 
in back pay that the local government was forced to pay Smart Union 
workers.  The western firm has met and corresponded with local 
 
GUANGZHOU 00000043  002 OF 004 
 
 
officials representing the township government, Communist Party 
leadership and the courts, in addition to lobbying the central 
government's Ministry of Commerce and other higher-level officials 
at the municipal and provincial governments, but to no avail. 
Although the western company has had success in negotiating a lower 
price for the assets, the local government has repeatedly imposed 
new requirements like monthly storage fees at twice the market price 
and other onerous requirements related to temporary storage of the 
western company's assets.  At each stage of negotiations, local 
government officials reiterate that noncompliance will result in the 
western company's "unclaimed" property being sold at auction to the 
highest bidder, which would violate local law and existing 
contracts, including China's laws and regulations protecting 
intellectual property, according to the western firm's lawyer. 
(Note: we expect more cases like this in the future.  In some 
instances, local governments will seek funds from western companies 
up front in the event that they go out of business; that way, the 
governments will have funds in reserve to cover costs to pay off 
workers.  It remains an open question whether the governments will 
in fact keep these monies in reserve or use them for other purposes. 
End Note.) 
 
Enforcement Judgments Hampered 
------------------------------ 
 
¶4. (SBU) Other business and legal contacts have also reported that 
legal resolution of commercial disputes, especially intellectual 
property rights (IPR) civil cases, has measurably weakened as court 
officials express doubts about enforcing judgments that might cause 
defendant companies to go out of business or shed local workers. 
Corporate counsel for a well-known U.S. technology firm recently 
told econoff that despite submitting a binding arbitration judgment 
to a Shenzhen court for enforcement against a local Chinese company 
that was found to violate the U.S. firm's IPR, the court repeatedly 
delayed or avoided taking action in the case.  Although persistent 
efforts by the U.S. firm eventually secured the desired outcome, the 
judge in the case initially told plaintiff lawyers that it was 
unreasonable to expect enforcement of the arbitration decision if it 
meant the defendant company's workers would face unemployment. 
 
¶5. (U) The U.S. company's experience might represent a broader trend 
in IPR enforcement, in which Chinese media reported December and 
January announcements by Supreme People's Court (SPC) Third Division 
Court Vice President Kong Xiangjun that the SPC is studying "new 
adjustments" to its IP policy to help domestic companies "survive" 
the current economic crisis.  Kong suggested that rather than 
insisting on immediate cessation of IP infringement, a new "public 
interest" test may be introduced to determine whether cessation 
would "violate public interest."  Such a decision would potentially 
mean that the normal "cease and desist" orders might be forgone in 
favor of monetary fines, even as the infringing behavior would be 
allowed to continue uninterrupted.  One major news outlet also 
reported that the SPC has already distributed the new guidelines 
internally even as the policy deliberations continue. 
 
All in the Name of "Safeguarding Economic Growth" 
--------------------------------------------- - 
 
GUANGZHOU 00000043  003 OF 004 
 
 
 
¶6. (SBU) Guangdong officials have publicly announced their own plans 
to loosen law enforcement efforts in cases that might jeopardize 
growth and jobs.  The Guangdong Province Communist Party 
Disciplinary Committee issued guidance at the beginning of January 
calling for cautious consideration of affected companies' stability 
when handling disciplinary cases related to senior management of 
state-owned enterprises (SOEs) and publicly-listed companies.  The 
Guangdong Procuratorate went even further, issuing ten measures to 
help local enterprises facing economic difficulties, including a 
measure to postpone actions against company management committing 
"small crimes."  (Note: Please see paragraph 10 for a complete list 
of the ten measures. End note.)  A spokesperson for the Guangdong 
Procuratorate told reporters that an example of the new policy might 
involve a company executive who was caught accepting bribes of RMB 
110,000 (USD 16,000), but was not detained by authorities because he 
was in the middle of negotiating an important deal with a Japanese 
company.  The spokesperson said that if the suspect was the only 
person able to answer the Japanese company's technical questions, 
the Procuratorate would delay arresting him in the interests of the 
company's growth and stability, and to insure success of the deal. 
(Comment: This example could just as easily involve negotiations 
with a U.S. company.  The scenario inevitably leads to the foreign 
company unwittingly making a deal with a Chinese partner who has 
serious legal liabilities.  End comment.) 
 
¶7. (SBU) The same press report goes on to announce that prosecutors 
at all levels of government in Guangdong Province have received 
official instructions to apply the principles of economic growth and 
stability in all cases involving corporate managers and other 
technical staff to avoid arrests and detentions that would 
negatively impact overall company stability and normal operations. 
The guidelines give flexibility to prosecutors to decide not to 
detain or arrest individuals involved in a host of crimes, including 
giving or accepting bribes and private use of SOE resources. 
 
Netizens Question the Effects of Leniency 
----------------------------------------- 
 
¶8. (SBU) Internet chat rooms erupted with questions and comments 
about "discounted rule of law" shortly after the Guangdong 
government announced its measures to safeguard economic growth.  One 
posting declared that the measures were tailored to favor SOE senior 
management and likened the new policies to the "feudalist tradition" 
of "the ministers may not be punished."  Another asked where the 
line would be drawn between "normal crimes" and felonies, pointing 
out that rule of law efforts would be in vain if the principles 
could be pushed aside whenever a "special situation" occurred.  One 
chat room comment suggested that many SOEs would be saved or be 
better off if their top managers were arrested.  (Note: Consulate 
Guangzhou first reported these developments in its blog, South China 
SEZ: http://www.intelink.gov/communities/state/ 
southchinasez/archives/on_line_buzz_1519.html .  End note.) 
 
Comment: Real World Get Out of Jail Free Card? 
--------------------------------------------- - 
 
 
GUANGZHOU 00000043  004 OF 004 
 
 
¶9. (SBU) The subjective standards being introduced by provincial and 
local authorities to "help" companies weather the global financial 
crisis have turned back the clock on some of the important 
achievements of China's reform and opening and introduce structural 
problems into the economic and legal systems that will be hard to 
repair when the economy eventually recovers.  The fact that 
government officials are determined to ignore these possible 
consequences even as netizens and foreign business leaders sound the 
alarm indicates how seriously troubled China's leadership is with 
the potential threat to social stability posed by the economic 
downturn. 
 
¶10. (U) The ten measures announced by the Guangdong Procuratorate 
are: 
-- Guangdong Procuratorate must play its role in enterprise 
development to guarantee steady and relatively fast economic growth 
-- Carefully handle cases with small and medium enterprises (SMEs) 
and cases of corporate graft to balance law enforcement with 
enterprise survival and development, workers' livelihood and social 
stability 
-- Improve work processes by carefully investigating reports and 
tips of enterprise irregularities to balance law enforcement with 
enterprise survival and development 
-- Intensify law enforcement efforts in areas that harm businesses 
such as money laundering and counterfeiting, white collar crimes 
related to financial products and real estate, and IPR enforcement 
to promote enterprise innovation 
-- Crack down on bribery and embezzlement among public servants and 
SOE employees 
-- Be proactive in preventing bribery and embezzlement cases, 
especially among large infrastructure projects 
-- Strengthen the supervision of case filing for economic crimes, 
especially when enterprises are involved 
-- Try to be flexible when applying the law on economic crimes; try 
to balance the normal operations of the enterprise and the legal 
rights of the public 
-- Use comprehensive methods to solve conflicts caused by the 
economic crisis 
-- Improve service to enterprises by improving the handling of 
economic crimes involving enterprises, the reporting and 
coordinating system of economic crimes, communications with PSB and 
courts, contacts with enterprises, and familiarity with problems 
that affect economic development and arouse dissatisfaction of the 
public. 
 
GOLDBERG