Groupon's Chinese daily deals business Gaopeng said on Monday it had sold counterfeit luxury watches by accident and will compensate its irate buyers in its latest struggle in expanding in the potentially lucrative market.

The joint venture between Groupon and China's top Internet firm, Tencent Holdings, said counterfeit Tissot watches, a brand owned by the world's largest watch maker Swatch Group, were sold on its website last month for 690 yuan ($109), less than one-fourth of its original price of more than 3,000 yuan.

After an investigation into the Tissot watch incident, Gaopeng found the merchant...had given us fake agent qualification documents, Gaopeng said in a statement.

We are outraged and we have begun legal proceedings. We hope to protect the interests of consumers and Gaopeng through legal methods.

Hundreds of people had bought the watches through the deal, local media reported, but complaints soon arose when buyers found the watch and its accessories to be of poor quality. Gaopeng declined to comment the details of the deal.

The incident has exposed the failure of our quality control personnel in the examination and vetting of our merchants. We have seriously dealt with the relevant personnel, Gaopeng said, adding that it will refund customers an additional 200 yuan for the fracas.

Tissot officials could not be reached for comment, but local media reported that Tissot said in a statement all watches examined from the Gaopeng deal were proven to be fake.

Groupon is the world's largest daily deals site operator and its chief executive Andrew Mason took the firm public last week, valuing his three-year-old business at nearly $20 billion.

But the firm has struggled to crack into China, where local brands dominate.

Gaopeng, the eighth largest player in the country, shut 10 offices in August and laid off hundreds of staff as competition in the group-buying sector heated up.

Lashou, the country's leading daily deals website, filed in October its plans to raise up to $100 million in an initial public offering on Nasdaq to expand its marketing efforts and delivery systems.

($1 = 6.339 Chinese yuan)

(Reporting by Melanie Lee; Editing by Jacqueline Wong and Miyoung Kim)