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Where To Locate In China? Or Why Weifang Isn’t Suzhou.

Posted in Basics of China Business Law, Legal News

I am constantly telling our clients that just because something happens one way in Shanghai does not mean it is going to happen the same way in Datong.  It is more than cliche to say that China is a big and diverse country.  Shanghai has some of the most sophisticated infrastructure in the world, while some people still live in caves in rural Henan.

But people often forgot that this applies to the Chinese legal system too. Some courts use strong international standards, while some…not so much.  When helping our clients decide where in China (or even Vietnam or elsewhere in Asia) to locate their businesses, the quality of the legal structure is a factor, the extent of which is going to depend on the nature of the business.  We have talked a number of software and gaming companies from locating “out in the provinces” to save money by convincing them that they need to balance their intellectual property risks against those savings.

I was starkly reminded of that the other day after learning the details of an IPR dispute ongoing in China right now that underscores how much the location of your court can influence the court decisions rendered.

The case involves Knowles Electronics, a US company that makes many of the components in the smartphone or tablet you’re reading this on now. They are the company that made the microphone used by Neil Armstrong during the moon landing.

The other company is GoerTek, a Chinese competitor from Weifang, Shandong.

The case involves competitors fighting with each other in courts from Suzhou to Weifang over the IP to tiny microphones. And also unidentified men accompanied by armed police officers who are alleged to have come to the factory and caused disruption of operations.

We’ll get there.

I won’t bore you with too many of the details. If you are a regular reader you probably get the gist. I’ll just lay out a few to set the stage:

  • Knowles began filing Microelectromechanical Systems (“MEMS”) patents in the US the early 2000s and beginning in 2003, it sold millions in the highly popular early Motorola RAZR phones.
  • Nearly all high-end smartphones in the market—Apple, Samsung, Blackberry—today use Knowles MEMS technology.
  • Major competitors in the market, like Chinese company AAC Technologies Holdings, Inc., license the technology from Knowles, indicating there is little dispute in the market about who owns the technology.
  • Knowles has a major MEMS manufacturing facility in Suzhou and it sold its 15 millionth microphone produced in China in 2004, and 100 millionth the next year.
  • In 2008, GoerTek began producing products similar to MEMS microphones.

So it appears GoerTek is claiming to own technology that either Knowles pioneered or that was in the public domain before GoerTek sought patents, and the two companies have been disputing the IP for some time.

Knowles filed suit in the US and has also taken action at the US International Trade Commission. GoerTek countered by filing suit in its hometown of Weifang.  Knowles sued GoerTek in Suzhou, where Knowles has major operations.

This using multiple lawsuits to jockey for position/best venue is nothing new.  We lawyers even have a name for it: forum shopping.

Here’s the rub.

In its Weifang home court, GoerTek procured an Evidence Preservation Order and a Property Preservation Order within five days of filing the case, which is “highly unusual,” particularly given the complex nature of the claims.

Then on July 31, Weifang officials went to Knowles’ factory in Suzhou to execute the preservation order, which normally would mean securing just enough evidence to show infringement.  But in this case, the Weifang officials allegedly seized a large number of Knowles microphones in what seems to have been an effort to disrupt Knowles’ operations.  The Weifang court also imposed restrictions on the disposition of some of Knowles’s Suzhou assets, even though there was little chance Knowles would just up and leave a country in which it had been operating for twenty years.  Are you getting the picture here?

But China is a big country, and Suzhou — a hotbed of foreign investment — is not Weifang.  Officials in places like Suzhou oftentimes understand that if their region/country is going to move from being the factory to becoming a sophisticated and high-end research and manufacturing country, IP rights will need to be respected.

Many top-tier companies have set up shop in Suzhou and the way that Suzhou courts tend to handle their international cases is one of many reasons why it remains a prime investment destination, even though its costs are on the high side for China.

Knowles brought an action before a Suzhou court and filed a petition for an Evidence Preservation Order against GoerTek. The Suzhou court spent about a month examining Knowles’ petition and then issued its own Evidence Preservation Order.  A representative from the Suzhou court then went to Weifang to execute the order against Goertek, but Goertek denied him entrance.

In the meantime, the Weifang court fined Knowles RMB 1 million for having failed to comply with the earlier Suzhou raid that involved the seizure of so many Knowles microphones.

What does all of this mean for you and your intellectual property in China? What does all of this mean for your plans for doing business in China? It means that just as you need to think long and hard about taking your IP overseas at all and just as you need to think long and hard about taking your IP to China, you also need to think long and hard about where you operate in China.

Cause like we are always saying: China is a big country, and that means that you can end up in an innovative, forward-looking jurisdiction or you can end up in a city from old China where friends and guanxi still trump the rule of law.  It also means that a lot more than costs should go into your decision on where to locate.

The good news is that by-the-book efforts like those of the Suzhou courts do show that slow but sure progress is being made in China’s legal system, but partly cloudy skies/areas clearly do remain.

What do you think?

  • goosemcgoose

    What was the final outcome? If Knowles loses, then it shows you that it doesn’t really matter where you base your operations in China, someone from afar could still come and screw you.

  • bystander

    Hmm. Maybe I’m missing something, but doesn’t this case illustrate the fact that carefully choosing your location in China might end up … not helping you at all? In this case, some Chinese manufacturer, with no relation to Knowles at the time that the latter set up shop in China, sued them in a jurisdiction that Knowles wisely avoided operating in. And the suit stuck, at least to the point of creating a big headache for Knowles. What’s the moral? My takeaway is that the whole business of venue-hopping in China is quite common and seldom ends well for the foreign interest. (I’ve seen this kind of thing happen in other, non-manufacturing, areas of business as well.)

  • PaulR

    Unidentified armed men disrupting operations. Unequal legal protections and corrupt insider dealing among local companies and governments. Pirated IP common among business competitors. Government ordered seizure of products.

    You haven’t made a case for investing in Suzhou over Weifang. You’ve made a case for avoiding China entirely.

  • ScottLoar

    Chinese scoreboard:

    Visitors 0, Home team wins again!

  • Karl Metzner

    Because Weifang is considered the kite capital of the world (or at least China), Knowles should not try to reject any of GoerTek’s requests or inquiries on this matter by telling them to “go fly a kite,” which could be misconstrued as a gesture of amity, or even an invitation to partake in a favorite local pastime together.

  • Sandee Huberman

    Do you have, or can you recommend, a listing of the better places to do business in China? I am considering working with a manufacturer in Changzhou, which is west of Shanghai and Suzhou, on the way out to Nanjing. Is that whole corridor considered “better” or does it go downhill the further west one travels? Thanks for all the great advice! I’m sure I’ll be back!

  • IP Comment

    Without more details, It’s hard to comment on this case. For example, the correct forum for a claim of patent infringement – assuming that this is a patent infrgment case – in China is where infringement takes place or the defendant is domiciled. Here we see that infringement and the defendant are both located in Suzhou. That said, how can a Weifang Court claim to be the forum for this hearing? In addition, what rights are being claimed by both parties? There are also two appeals available, to the next two higher level courts, for the losing party and this would take the matter out of Weifang. Too many missing details.

  • CDHS, LLC