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?

This is part II of our series consisting of a law school paper by Daniel Reiter on the legal issues involved in sourcing product from China.  Part I can be found here.

Patents

We advise Mango to register its patent as an “invention” under the Patent Law of the People’s Republic of China, which is analogous to a utility patent in the US. Patent protection in China is subject to novelty, inventiveness and practicability. The qualified patent agent (which, like a trademark agent, is required for patent registration) can also assist and advise the client throughout the process.[17] The registered patent agent can also assist in translating Office Actions, issued only in Mandarin, into English.[18]

Mango will also want to take steps to protect its patent from infringement. Patent infringement in China, under Article 57 of the Patent Law, includes manufacture of the patent without authorization of the owner.[19] It is essential to ensure that Silverwolf employees do not begin manufacturing knockoff Orange Boxes and selling them in violation of the patent.[20] Mango can do this by including a clause in the manufacturing agreement prohibiting the manufacturer from stealing the patent.[21]

Tariffs on Imports

Mango will be required to comply with the applicable customs laws of the US and pay the appropriate tariff on its imported goods. The Harmonized Tariff Schedules of the United States (“HTSUS”) provides the applicable tariff rates and statistical categories for all merchandise imported into the US. There are three steps in tariff calculation.

  1. Customs classification — under which category of the HTSUS does the good fall?
  2. Tariff valuation — what is the price of the good for which the tariff is applied?
  3. The country of origin allows the importer to determine from what country the good comes from for customs purposes.[22]

In addition to exporting the finished WEAs from China, Mango may need to import materials and parts into China in order to make the WEAs. Mango will be required to comply with the pertinent import laws of the PRC. Under the Customs Law of the People’s Republic of China, both importers and exporters must register with Customs before filing declarations. Importers are required to file declarations with Customs at the port of entry within 14 days of the goods’ arrival. Exporters are to file declarations within 24 hours before the goods are loaded for shipment.[23] China’s tariff rates are determined by the origin of the goods and via its tariff codes, the Harmonized Commodity Description and Coding System (“HS”), which is a “multipurpose international product nomenclature developed by the World Customs Organization.”[24]

Mango will also be required to comply with a Value-added Tax (“VAT”) on some of its imported goods. Under the Provisional Regulation of the People’s Republic of China on Value-added Tax, “All units and individuals which and who, in the territory of the People’s Republic of China … import goods, shall be the taxpayers of value-added tax … and should pay the value-added tax in accordance with this Regulation.”[25] The VAT applies to imports of goods within China of 24 specified items.[26]  Metal mineral products used to make the Orange Boxes, which fall onto the specified list, will be taxed at 13% and other off-list materials used to make the Orange Boxes will be taxed at 17%.[27] The VAT does not apply to exported goods.[28]

 Import and Export Issues: National Security

Since Mango will be transferring technology to foreign nationals, it will need to comply with certain export controls promulgated by the US government for purposes of national security. Specifically, Mango will need to ensure the patents and know-how it is licensing to Silverwolf are not subject to the US Department of Commerce’s Export Administration Regulations (“EAR”), the US Department of State’s International Traffic in Arms Regulations (“ITAR”), or the US Department of State’s Arms Export Control Act (“AECA”).

If the technology is determined to be an export-controlled material under the EAR or ITAR, it will be unlawful for Mango or its agents to disclose the “Export-Controlled Materials” orally or visually to any foreign persons.[29] Therefore, if the WEA technology is determined to be an “Export-Controlled Material,” Mango may need to abandon its plans to have the technology manufactured overseas. Still, as discussed below, counsel does not find it likely that the WEA technology will be determined an “Export-Controlled Material.” Moreover, even if the technology is subject to certain export controls, a license can be obtained to allow Mango to continue with its plans.

The Commerce Department’s EAR administers the export of US origin goods and technology.[30] Mango’s technology is new and is intended for retail consumer purposes; it is not entirely clear whether the WEA technology should be subject to licensing before export. Still, it is possible it will be subject to such licensing because WEAs may serve a “dual-use” application — a technology capable of being used for both civilian and military purposes.[31] Moreover, commercial items that may not have an obvious military application may be subject to the EAR.[32]

WEA technology is not specifically numerated on the Commerce Control List (“CCL”), and will likely not be subject to a license. However, the spirit of EAR would leave counsel to believe Commerce may classify the WEA technology under EAR99, the portion of the CCL which applies to technologies not specifically numerated in the EAR (and items not controlled by another agency).[33]

Mango will also need to reference the Commerce Country Chart to identify the “reasons for control” of certain items being exported to China.[34] Because the WEA is not specifically listed in the CCL, it is not clear whether it falls under one of the reasons for control subject to export to China. In addition, Mango will not be subject to any “person-based” controls because Silverwolf, the potential end-user, is not included on any of the pertinent lists (Entity List, Treasury Department Specially Designated Nationals and Blocked Persons List, The Unverified List, or Denied Persons).[35] Mango will need to apply for an export license unless it determines its technology is outside the scope of the CCL or another agency’s controls (see below).[36] We believe Mango should apply for an export license with Commerce regardless of its determination because of the novelty and unique characteristics of the WEA technology, and the uncertainty as to whether Commerce would consider it a dual-use item.

In addition to Commerce’s CCL, Mango’s WEA technology may be subject to the US State Department’s Defense Export Controls of the AECA.[37] WEA’s are not listed in the US Munitions List. However, there is a section for miscellaneous articles.[38] Because of the novelty and uniqueness of the WEA technology, we advise Mango to file a Commodity Jurisdiction request to determine whether the technology is subject to export controls under the AECA and ITAR.[39]

 Shipping

Mango has determined that it will be shipping the Orange Boxes via boat and truck. Silverwolf will load the packaged Orange Boxes onto trucks leased by the China Ground Shipping Company, a state-owned enterprise with a fabulous reputation for efficiency. From there, the goods will be loaded onto the Water Lily, a ship Mango contracted from American Sea Shippers, Inc. The Water Lilly will deliver the goods to a port in New York, NY, where they will be unloaded onto a truck operated by American Logistics, LLC. The truck will then deliver the goods to a warehouse owned by Mango in Newark, NJ. There are three important bodies of law that may govern this transaction — the United Nations Convention on Contracts for the International Sale of Goods (“CISG”), the Carriage of Goods by Sea Act (“COGSA”), and potentially the International Commercial Terms.

First, the United Nations Convention on Contracts for the International Sale of Goods (“CISG”) applies to the sale of goods between parties whose places of business are in different contracting states.[40] Both the US and China are signatories to the CISG.[41] The CISG will apply to this transaction unless the parties decide to “opt-out” of the CISG, which they may do under Article 6.[42] According to Article 6, parties may expressly state in their contract that it is not to be governed by CISG.[43] It is also important to note that the CISG is not all encompassing as certain types of transaction and portions of transactions are excluded from outside its scope. Therefore, domestic law or a choice of law analysis may come into play if a dispute arises.[44]

Second, the Carriage of Goods by Sea Act (“COGSA”) will apply to the shipment of the goods while at sea. COGSA is a mandatory US law governing the bill of lading (“B/L”), a document that functions as a receipt, contract of carriage, and document of legal title during the shipment of goods. The B/L is an agreement that runs between the shipper and carrier.[45] COGSA deals with those aspects of the B/L concerning the carrier’s obligations to transport and protect the goods during carriage. It limits the liabilities of damaged goods to $500 per package unless the parties agree otherwise. In addition, the parties may contract to extend COGSA to the inland portion of the shipment.[46]

We advise Mango to include two important clauses in the bill of lading, subject to negotiations. First, the Clause Paramount is a provision that specifies which jurisdiction’s law will govern the agreement.  Second, an Intermodal Clause should also be included. COGSA only applies “tackle-to-tackle,” but an Intermodal Clause allows the parties to extend the limitations of liability under COGSA to the land portion of the shipment.[47]

Finally, the parties may agree to implement International Commercial Terms (“Incoterms”) into the sales contract. Incoterms are a form of soft law and are promulgated by the International Chamber of Commerce (ICC) – Incoterms only apply when the parties agree to include them in the sales contract. Incoterms allocate certain tasks and the risk of loss during delivery to the buyer and seller of the goods (Mango and Silverwolf, respectively). The agreement between Mango and Silverwolf calls for the release of the goods by Silverwolf at its factory to Mango (through its leased shipping companies). Therefore the proper Incoterm to use in the instant case is the three letter EXW, short for Ex Works.[48] 

Arranging Payment

In negotiating a method of payment with Silverwolf, the manufacturer, it is advised that Mango arrange for payment via a letter of credit, as bank transfers create substantial risks. Letters of credit tend to be more favorable to the buyer, and for this reason, Silverwolf may be unwilling accept payment via this method.[49] Still, not all is lost as there are certain steps Mango can take to mitigate risk when making payment via bank transfer. This is especially true in this instant case because there is a prior relationship between Mango’s CFO and the manufacturer.

A letter of credit is a financing device that ensures payment to the seller of goods (in this case Silverwolf).[50] A letter of credit allows a buyer to purchase goods even if it does not have the financing on hand because it is an undertaking between the buyer and an issuing bank — it is not a transaction that runs directly between the buyer and seller. The “applicant,” usually the buyer, has its “issuing bank” promise to honor drafts on itself against the presentation of specified documents, which usually includes the B/L and a commercial invoice. The “beneficiary” of the letter of credit, usually the seller, arranges its local “confirming bank” to engage with the issuing bank to receive reimbursement from the issuing bank after it pays the seller. Letters of credit are usually governed by the Uniform Customs and Practice for Documentary Credit (“UCP”), a form of soft law incorporated into the contract by the contracting parties.[51]

A letter of credit can protect Mango because it allows a buyer to cancel when a supplier does not ship on the agreed upon time, allows a buyer to cancel when a supplier does not match the specifications or there are to many defects, and allows a buyer to cancel when the documents do not fully conform to the letter of credit’s requirements.[52] A bank’s ability to refuse payment for even the tiniest of discrepancies is called the “strict compliance principle.”[53]

If Silverwolf requires that payment be arranged via bank transfer, there are certain steps Mango can take to limit risks. The standard form of bank transfer payment in China is called “30/70 TT,” which means a 30% down payment is to be made upon placement of the order, with the remaining 70% to paid upon shipment.[54] The risk involved here is that 100% of the payment is to be made before shipment, which means inspection may not occur until arrival; therefore, seeking reimbursement for a non-conforming good may be difficult. In addition, even if inspection is done before shipment, a 30% down payment will have already been made, and a refund of the 30% may become difficult.[55]

However, Silverwolf and Mango’s CFO do have a history, so the likelihood of this occurring may be lower than most alternative manufacturers, but the risk still exists. To mitigate this risk, Mango should inspect the goods as early in the process as possible, should not make the second 70% payment until after the inspection, and once the relationship is further established seek to arrange a different method of payment.[56]

Conclusion

            Mango’s plan to source its manufacturing of WEAs is quite feasible, but certain expenses should be taken into consideration including numerous legal expenses, taxes and tariff’s, and shipping costs. Through negotiations many risks can be mitigated, but there remain numerous challenges and uncertainties. Therefore, counsel advises Mango to continue with its current plan to source 25% of its manufacturing of WEAs, but to wait at least several years to build relationships and gain experience before it decides to source an even larger percentage of its WEAs for manufacturing.

 

[17] Embassy of the United States Beijing, China, Patent, http://beijing.usembassy-china.org.cn/iprpatent.html.

[18] This is general knowledge I occurred during an internship at an IP Agency in China in 2011.

[19] Chow, supra note 12, at 433.

[20] Letter from Stephen Y. Chow, Adjunct Professor of Law at Suffolk University Law School  (Dec. 26, 2012) (on file with author).

[21]  Dan Harris, China Manufacturing Agreements. Watching The Sausage Get Made, China Law Blog (Apr. 26, 2011) http://www.chinalawblog.com/2011/04/china_manufacturing_agreements_watching_the_sausage_get_made_1.html.

[22] Daniel Reiter, International Business Transactions outline (This outline was prepared in connection with a Fall 2011 International Business Transactions class taught by Professor Christopher Gibson at Suffolk University Law School. The sources used in preparing the outline include class notes taken by the author, class slides distributed by the professor, the class text book, and other materials)(on file with author).

[23] Helen Wong, Doing Business in China, HSBC Bank Company, http://www.hsbc.com/1/content/assets/business_banking/110328_hsbc_doing_business_in_china.pdf.

[24] World Customs Organization, What is the Harmonized System (HS)?, http://www.wcoomd.org/en/topics/nomenclature/overview/what-is-the-harmonized-system.aspx

[25] Provisional Regulation of the People’s Republic of China on Value-added Tax, Art. 1,

http://english.ccpit.org/Contents/Channel_101/2006/0525/847/content_847.htm.

[26] Richard Hoffman, China’s VAT System, Beijing Review (Aug. 6, 2009) http://www.bjreview.com.cn/business/txt/2009-08/03/content_210354.htm. See Also Press Release, Tax Policy Department, Ministry of Finance, Briefing of VAT Under China’s Tax System (March 13, 2007) (http://www.china.org.cn/english/LivinginChina/202770.htm).

[27] Press Release, Tax Policy Department, Ministry of Finance, Briefing of VAT Under China’s Tax System (March 13, 2007) (http://www.china.org.cn/english/LivinginChina/202770.htm).

[28] Id.

[29] Miami University, Export-Controlled Materials and Information,

http://www.units.muohio.edu/compliance/exportcontrol/.

[30] International Business Transactions outline, supra note 22.

[31] Ian F. Fergusson, The Export Administration Act: Evolution, Provisions, and Debate, Cong. Res. Service, July 15, 2009, at 1.

[32] Introduction to Commerce Department Export Controls, Department of Commerce’s Bureau of Industry and Security, http://www.bis.doc.gov/licensing/exportingbasics.htm.

[33] ECCN Questions and Answers, Department of Commerce’s Bureau of Industry and Security, http://www.bis.doc.gov/licensing/do_i_needaneccn.html#qfour SEE ALSO http://www.ecfr.gov/cgi-bin/text-idx?c=ecfr&sid=c5cc9a1c749a6f225283bdfa124431d0&rgn=div9&view=text&node=15:2.1.3.4.45.0.1.3.87&idno=15.

[34] Introduction to Commerce Department Export Controls, supra note 32

[35] International Business Transactions outline, supra note 22. See also Introduction to Commerce Department Export Controls, supra note 32.

[36] Introduction to Commerce Department Export Controls, supra note 32.

[37] Getting Started with Defense Trade: The Directorate of Defense Trade Controls (DDTC) and the Defense Trade Function, http://www.pmddtc.state.gov/documents/ddtc_getting_started.pdf.

[38] 22 C.F.R. § 121.1

[39] Commodity Jurisdiction, U.S. Department of State Directorate of Defense Trade Controls, http://pmddtc.state.gov/commodity_jurisdiction/index.html.

[40] 1980 – United Nations Convention on Contracts for the International Sale of Goods (CISG), UNCITRAL, http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980CISG.html. See also International Business Transactions outline, supra note 22.

[41] Status: 1980 – United Nations Convention on Contracts for the International Sale of Goods (CISG), UNCITRAL, http://www.uncitral.org/uncitral/en/uncitral_texts/sale_goods/1980CISG_status.html

[42] United Nations Convention on Contracts for the International Sale of Goods art 6.

[43] International Business Transactions outline, supra note 22.

[44] Id.

[45] Ussually the seller also acts as the shipper, but in this case Mango has agreed to handle all aspects of shipment.

[46] International Business Transactions outline, supra note 22.

[47] Id.

[48] Id.

[49] Dan Harris, Using Letters Of Credit With China Suppliers, China Law Blog (Nov. 20, 2012) http://www.chinalawblog.com/2012/11/using-letters-of-credit-with-china-suppliers.html.

[50] When I say “letter of credit,” I mean a “general letter of credit” as apposed to a back-to-back letter of credit or a standby letter of credit, which I do not discuss.

[51] International Business Transactions outline, supra note 22.

[52] Using Letters Of Credit With China Suppliers, supra note 49.

[53] International Business Transactions outline, supra note 22.

[54] Dan Harris, China Manufacturing Payment Terms. Limit Your Risks, China Law Blog (Nov. 11, 2012) http://www.chinalawblog.com/2012/11/china-manufacturing-payment-terms.html.

[55] Id.

[56] Id.

This is the final part of a series arising from a speech I gave last month at a biotechnology conference in Washington DC.

In How To Protect Your IP From China. Part 1, I mostly looked at the risks China poses to intellectual property and very generally on how companies can determine how those risks should influence their actions.

In How To Protect Your IP From China. Part 2, I mostly focused on what I, as a lawyer, look at in trying to protect my clients’ IP from China and what you, the company, should be looking at and doing to protect your own IP.

In How To Protect Your IP From China. Part 3, I looked at the negotiating tactics Chinese companies so often employ in an effort to take advantage of your intellectual property.

In How To Protect Your IP From China. Part 4, I wrote on the basics of what goes into Chinese contracts, particularly those related to protecting your intellectual property.

In this part 5, I discuss some of the most common situations companies face where they must focus on protecting their IP.

  • Employees

Confidentiality agreements. In China, unlike in the United States, it is the norm to have a written employment contract with all employees. This is because not having a written agreement can lead to having to pay a year or more in salary to anyone you terminate.  You should use the written contract to your advantage by putting in a confidentiality provision that sets out your company information that must be kept confidential. Confidentiality agreements can protect company information that may not rise to the level of a trade secret, but they cannot be so broad as to protect everything.  China actually has very sophisticated trade secret laws — they come the US’s Uniform Trade Secrets Act — and the courts there are not bad at all in ruling favorably in favor of employers on confidentiality and trade secret cases.  But for you to be able to prevail, just as in the United States, the information you are seeking to keep confidential must have commercial value and you must make a reasonable effort to keep it away from the public.

Non Compete Agreements – These generally work in China only with very high level employees.  Very high level. And even then, they are enforceable only if they are: (1) not too long in duration and no longer than two years; (2) not too large in terms of geographic scope: and (3) do not restrain too much the employee’s opportunity to pursue his or her occupation.  Now here’s the real kicker on these:  you must pay your employee for the non-compete after his or her termination.  Limited to two years.  Typically, you must pay 20 to 50% of the employee’s salary, with the amount depending on the location in China.

Nonsolicitation agreements. Nonsolicitation agreements prevent employees from soliciting customers, former co-workers and/or agents upon separation from the company. These are usually enforced by China’s courts so long as they only prevent solicitation of the employer’s customers or accounts that existed at the time the employee left and so long as they are limited in duration and in geographic area.

It can be critical — especially for your employees doing R&D — that your employee contracts set forth who owns any intellectual property your employees help develop. You want a provision in your contract making clear that all IP developed by your employees belongs to the company and you want that because in China you run the real risk of your employees claiming ownership of what they developed. We also like to see a provision in the employee manual saying that any IP developed by company employees belongs to the company.

Contracts with your Chinese Distributers, Manufacturers, Joint Venture Partners, and Licensees should include the same sort of provisions relating to non-compete, non-solicition, and non-disclosure and they also should be clear about who owns what with respect to any IP.

 

  • Licensing Contracts

Three things you should be thinking about if you are licensing your IP to a Chinese company.

  1. Be careful about getting paid based on sales, unless you have some really good way of knowing what the sales really are.
  2. Get what you need to do the deal before you relinquish the technology.  Figure that the Chinese company will stop paying you after it has secured your technology.
  3. Register your licensing agreement with the proper governmental agency.  If you don’t, you run the risk of not being able to sue on it.
  • IP Registrations 

Just as in the US, you should register your IP in China to protect it.  There is no way can I go into great detail on what you can and should do to protect your IP in China through registration, but what I can tell you is that it almost always makes sense to do something.  Earlier I talked about how bad China is on IP and that is true, but if you have not done the proper registrations, you pretty much have zero chance of protecting your IP.  If you have done the proper registration, your chances are considerably better.

China’s IP registration and protection system is in many ways not all that different from that in the US.  Just as is the case here, China has patents, trademarks and copyrights.

Patents. China has invention patents, utility patents and design patents.  Invention patents are thoroughly reviewed before they are granted and so they can take quite a while.  Because of this, many companies will secure a quicker utility or design patent while waiting until their invention patent comes through.  Couple things you need to know about patents in China. First, if you do not file for your patent in China within a year of filing for it in the United States, you will be too late. China is a signatory of the Patent Cooperation Treaty and the Paris Convention, but Chinese patent lawyers tell me that it is better to file your patent in China.

China has had compulsory licensing of patents since 2001, but earlier this year the Chinese government came out with detailed criteria for the granting of compulsory licenses and that threw many into a panic, believing that the government was instituting compulsory licensing for the first time. These new rules really did not change much of anything and as far as I know, China has not in the last ten years required any company to compulsorily license its IP.

Trademarks are unique names, symbols, or logos. Can include colors. We trademarked a particular color of screws for a client. Don’t underrate trademarks in China. These work in China. China is a first to file country, not a first to use country, so generally, whoever files first for a trademark gets it. Trademarks cannot be place names. This is a bigger problem than you might initially think.  Another problem is that the people at China’s trademark office usually view acronyms as images and so if your company name is something like EVO and someone else has already registered the company name ECO, there is a very good chance your EVO name will be rejected as conflicting with ECO, because to someone who cannot read English, the two names look too much alike.  What this means is that if you have a two or three letter company or brand name, you had better try to register it now because it will only get tougher.  We used to get these approved all the time, but in the last year, we are succeeding only around 50 percent of the time.

Copyrights.  A lot cheaper and easier to obtain than patents and they last a lot longer. Very similar to the US. You do not need to file for a copyright in China to have a China copyright, as they arise automatically upon creation of a work created or first published in China, but you do need to have a registered copyright to sue on it and that’s the catch. In China, it takes so long to secure the registration of a copyright that if you are going to want to protect your copyright in China, you should file for it right away, because if you wait until you have a problem to file for the copyright, you may have a one-year lag before you can do much about it. Just like in the US, you don’t have to reveal all of your material in the copyright filing.  This is particularly important for something like computer code.

Stopping IP Theft.  If you have registered IP, and someone in China tries to use it without authorization, you can seek an administrative remedy by trying to get the Chinese government to do something about it or you can sue for damages. You also can try to get Chinese customs to stop any violating goods from leaving the country and, if you have your IP registered here, you can try to get US customs to stop it from entering into the US.

 

Stan Abrams has a thought pondering post up on his China Hearsay blog, entitled, “DMAX: This is What Happens to Foreign Technology Companies in China.” The post is on a Chinese rival to IMAX, called DMAX and Stan concludes his post by saying he expects “to see this written up as a case study for some business or law school out there. Looks textbook.”

I agree and I disagree. I agree that it looks textbook and that’s because what is going on here happens pretty much every day in China. But because this sort of thing happens pretty much every day in China, I’m less certain that this particular example will make the textbooks. That being the case, I will do the case analysis right here and now.

Factual Background (as taken from this China Daily article): 

DMAX, a large film screen made with Chinese independent technology, on Monday was put into commercial use in a cinema in the eastern province of Anhui, as developers hope to break the IMAX monopoly in China’s booming film market.

According to Yang Xuepei, head of the institute, while embodying the country’s independent core technology of big screen motion pictures production and image optimization, DMAX is also compatible with the most advanced technology overseas. Its 2D and 3D screening quality are as good as large screens of foreign brands.

Factual Issues:  Does IMAX have any patents in China? They have a whole slew of them in the United States.  Is DMAX violating any IMAX patents? Did IMAX register its name as a trademark in China? I am guessing that it did. If IMAX registered its name in China, does the name “DMAX” violate IMAX’s China trademark?  I am thinking that it does. Did DMAX improperly receive any IMAX trade secrets? What are DMAX’s plans?  Just China or the rest of the world too?  What is the pricing difference between the two technologies?  What about quality and service?

Legal Issues: If DMAX is using any IMAX patents or trade secrets, we should expect IMAX to sue DMAX in China. I would expect IMAX will be suing DMAX in China for trademark infringement.

I wish I could claim the above as original scholarship, but my analysis pretty much tracks Stan’s:

A lot of questions here, but we’ve got a booming domestic market and a foreign company that is pretty much in a monopoly position because of its superior technology. Sound familiar?

Yes, this sort of situation has occurred over and over in China. What usually happens is that a domestic competitor emerges that (at first) competes on price. I’m wondering whether IMAX has patent protection over its tech and whether DMAX will be looking at any infringement suits in the future. If not, were there trade secrets involved? I’m speculating, of course. It’s possible that there are no IP issues here at all and that DMAX is a solid citizen. And if there are IP problems, I wouldn’t want to be IMAX — the owners of DMAX seem to be heavy hitters (e.g. “China Film Co.” — part of China Film Group?).

At the very least, though, there’s got to be a trademark issue here, yeah? After all, “IMAX” and “DMAX” are 75% identical. I might do a quick trademark search tomorrow and see what I can find on these guys.

If IMAX did not protect its IP by registering it in China, the lesson is that it should have, if it could have. The problem with patents in China is that one must register one’s patent in China within one year of having registered it elsewhere. So if some IMAX’s US patents are, let’s say, ten years old, and it never even really considered China until a few years ago, it would not have been able to register at least some of its patents in China at all. That is not the case with trademarks and if IMAX did register its name in China, it probably does have some recourse against DMAX.  I say “probably” though because DMAX will probably argue that the max portion of the name is fairly generic and so it is not infringing at all.  IMAX will argue that it is no coincidence that DMAX’s name is only one letter of its own and they are selling the same product. At minimum, a company should — if it can — register its patents in China and its trademarks as well. Chinese law is actually pretty good at protecting trade secrets and so if IMAX can show that DMAX secured its technology from IMAX improperly, it may make sense for IMAX to sue for trade secret theft.

But maybe DMAX did not violate any laws or infringe on any registrations. If that is the case, IMAX’s only recourse would be to outshine DMAX on quality and/or service because it is not likely going to be able to beat DMAX on price.

Is there a lesson to be learned here?  There has to be, but it is not quite clear yet exactly what it is. In the meantime, about all we can tell you is that if you have patents or trademarks that you want protected in China, register them right away. And if you have trade secrets you want to keep secret, make sure you have systems in place to maximize the likelihood of that happening. Chinese companies are constantly on the lookout for the next big thing and they are a lot more likely to find it at your company than by their own innovation. You should assume copying of your product is going to occur in China and you should prepare accordingly.

We have been handling way more than the usual number of disputes between our clients and Chinese companies. In a number of these cases, our clients paid money to Chinese factories with whom they had been doing business for years and the Chinese factories simply refused to send over any product. These Chinese companies claimed that our clients owed money for previous deliveries (in which the costs supposedly went up) or for Chinese taxes/duties for which our client is supposedly responsible. These cases (and others like it) are no doubt due to the increasing number of Chinese factories facing economic difficulties. In none of these cases did our client have a good OEM Agreement in place, which gave the Chinese companies at least some basis for their claims.

Be that as it may, the Chinese companies (pretty much without exception) threatened to sue our clients and one of them threatened to freeze our client’s China trademarks, copyrights and/or patents and then take that IP once they prevail. In the case with the IP threat, our client’s only China asset was its registered intellectual property so the risk was very real.

A recent Chinese case allowed a Chinese plaintiff to “freeze” a Chinese trademark belonging to a foreign company, Castel. The Re:Marks on Copyright and Trademark Blog wrote of this case in a post entitled, “French CASTEL (卡斯代尔) Company Frozen out of China?” and noted the following risk stemming from this case:

[T]he decision is of particular note for foreign entities who do not have significant assets in China.  Typically, such entities may have considered themselves insulated from the risk of litigation in China due to a lack of assets in China.  However, even foreign entities without significant assets in China very often have trademarks in China.  Those trademarks are now in the firing line if the foreign entity ever gets sued, whether for trademark infringement or for other causes of action, particularly where the foreign entity has limited assets in China.  Of course, this equally applies to foreign plaintiffs who seek to recover damages against Chinese defendants.

How can you prevent your Chinese IP from being taken from you? Probably the best way is not to put your China IP in the name of a company that does business in or with China. Instead, you should think about creating a new company (it can be based in the United States or anywhere else) to own “your” IP in China. In turn, that new special purpose company can then license its China IP to your company that does business in or with China. That way, one of your companies will still own the IP in China, but if your company that does business in or with China encounters legal problems with a Chinese company, the Chinese company will not be able to just seize that company’s China-based IP.

If your IP is already in the name of a company that does business in or with China, you should consider assigning that IP to another company and then licensing it back. Doing this is not going to be without its complications and costs, but it beats losing your China IP.

What do you think?

Fascinating article up on the Wall Street Journal, written by Geoff Nairn and entitled, “Patents are a Virtue,” and subtitled, “China is a land of opportunity for business, but it is also a land of counterfeiting and intellectual property theft.” The article is on counterfeiting in China and the various innovative ways companies act to prevent it.

The article has a sidebar, entitled, “An ABC to Losing Your IP,” that lists out three things companies often do to cause them to lose their intellectual property in China. The Journal attributes this list to our blog, but because it has been so modified for the article, I am not even sure from what post(s) they came. In any event, I love the list, so here goes:

A: Failing to use employee invention agreements. These specify that any invention made using the company’s time, material or facilities belongs to the company, not to the employee.

B: Thinking that patents are the only IP that matters. Western companies underestimate the importance and value of trademarks and trade-secret agreements in China.

C. Neglecting the three Ns. Non-disclosure agreements stop suppliers disclosing IP to third parties. Non-use agreements stop Chinese contract manufacturers setting up as your competitors. Non-circumvention accords stop contractors selling direct to your customers.

What do you think?

Though i keep saying this, I will say it again: there are now a number of really good practice-oriented English language books on Chinese law. I can remember not so long ago when people would ask me to recommend books to help them better understand what they needed to know regarding China Law and my answer was always the same: James Zimmerman’s China Law Deskbook. Zimmerman’s book has since been updated and it is still considered to be the best, all-encompasing English language reference book on Chinese law, but now there are all sorts of excellent and more specialized books to supplement it. 

Patent Litigation in China, by Douglas Clark, through the Oxford Press, is yet another such book. This is an excellent book. I actually was not planning to read the whole thing, but (and I know this makes me sound like a nerd), I ended up enjoying it so much that I did.

Neither I nor my firm do any patent work, believing that only lawyers who do it 100% of the time should do it at all. However, as counselors to mostly small and medium sized businesses that do business in and with China and internationally, we find ourselves serving as the nternational law gatekeepers for our clients. By this I mean that they look to us not just for our advice on the areas of law in which we actually practice, but for our assistance in spotting relevant legal issues and referring them to top-tier people even in those areas outside our ken.

Patents is probably the prime example of this.

Virtually every time we get a new client who is doing business in or with China we ask them about their intellectual property. Do you have any trademarks, patents or copyrights, we ask? What about trade secrets? What IP is it important that we protect from theft in China? If they have any patents or if what they are doing sounds as though a patent might make sense, we refer them out to the specialists. But for us even to know when and to whom a referral is warranted, we have to stay at least somewhat current on what goes on in the patent law world.

Patent Litigation in China is good for knowing what is going on in the China patent world and it is great for knowing what to do in that world if you believe someone is infringing on your patent or if someone believes you are infringing on theirs. It is also an excellent book to read just for getting a sense of how China’s courts operate (which as I am always saying, is likely to be quite a bit better than most believe it is, particularly in the context of business litigation involving foreign companies).

This book is very much aimed at the legal practicioner, not the businessperson, but if you are a businessperson imbroiled in a China patent dispute, I recommend this book for you as well. 

I really liked how Clark provides both a solid foundation of China’s relevant patent and patent litigation laws (including a large Appendix section that provides English language English translations of the “Patent Law, the Implementing Regulations of the Patent Law, Interpretations by the Supreme People’s Court on Several Issues regarding Legal Application in the Adjudication of Patent Infringement Cases; Several Provisions of the Supreme People’s Court for the Application of Law to Pre-Trial Cessation of Infringement of Patent Right; [and] Several Provisions of the Supreme People’s Court on Issues Relating to Application of Law to Adjudication of Cases of Patent Disputes”), along with his own analysis based on real-life experiences. 

The book’s own blurb accurately describes it as follows:

Patent Litigation in China, by Douglas Clark, provides U.S. and other non-Chinese practitioners with an overview of the patent litigation system in China. Strategic commentary is provided to enable those contemplating or involved in patent litigation in China to better comprehend the risks and challenges they face, as well as to ensure better decision-making by those responsible for bringing or defending patent actions. The book covers the tests for patentability grounds for invalidating patents before focusing on evidence gathering, litigation strategy and procedure, as well as considering defenses and remedies. The key differences between the Chinese, U.S. and other more mature patent systems are highlighted throughout the book.
If you are looking for a book that delivers on the above, I highly recommend Patent Litigation in China.

This post is part I of what is going to be a multi-part, somewhat irregular series on protecting your IP in China. This part I and tomorrow’s part II, were written by Steve Dickinson, and are based in large part on a talk Steve gave last week in Qingdao. Over the last couple of years, “creative services” have been probably the greatest growth area for our firm and so our intellectual property and licensing work has only continued to grow in importance.

For pretty much all of our creative services clients (these are companies mostly in the software, gaming, entertainment, media, art and film industries) intellectual property makes up the overwhelming bulk of the value of their business. Therefore, it is always a surprise to us how many of them seem to treat their intellectual property in China is an optional or secondary matter when it really should be the first issue they consider when approaching the China market. Though IP is usually of somewhat less importance for our clients not in creative services, they too tend to undervalue its importance. 

This series is intended to emphasize the importance of protecting IP in China and to set out a program for for creating, protecting and monetizing intellectual property. Without a clear program on this issue, disaster is certain to follow in China.

The first step is to get clear what we are talking about when we use the term “intellectual property.” IP is not patents, trademarks, copyright etc. These are simply tools for protecting intangible assets. It is the same for real property: a deed is not land, it is a tool used to establish and protect an ownership interest in land.

So what is intellectual property?

  • A better term is intangible property or intangible assets. This includes everything about your business that has value that cannot be reduced to a physical asset or to a monetary cash flow.
  • For creative industries, IP can include virtually all of the assets of the business:
    • Music
    • Film
    • Books and magazines
    • Research and analysis
    • Design of any kind: interior design, clothing design, product design
    • Architecture and engineering
    • Software of all kinds: industrial, retail, video games, phone “apps”
  • For traditional industrial firms, it includes
    • Inventions
    • Formulas
    • Industrial processes and know how
  • For all businesses, it includes:
    • Brand and image
    • Business planning and corporate strategy
    • Pricing plans

For most modern businesses, intangible property forms a major portion of their value. For many businesses, such as those in creative services, it forms the core of the value of the company. Consider the stars of the modern business world: Apple, Microsoft, IBM, Boeing, Siemens, Nestle, General Electric, Dow Chemical, Starbucks, Amazon, SAP. Is their value in their real estate holdings? In their factories and office buildings? No, the value of these companies is almost entirely in their intangible assets.

However, even for hard asset, resource based companies, IP is still a major component in their company value. Take the mining companies that have dealt with China for the past ten years. A major portion of their value lies in their pricing plans, their internal data on their resources, their techniques of extraction and transport, their future exploitation plans and the like. This explains why the primary battle between these companies and the Chinese over the past several years has centered on the attempts of both sides to acquire data to aid in the struggle over control of the market.

The message is obvious: active and careful cultivation of your intangible assets is mandatory to survive in the modern business world. This means taking the steps necessary to secure the rights, to protect the rights, and then to secure the rights for your own use or to package those rights for monetization.

Most businesses are constrained by the traditional categories for intellectual property and do not effectively consider the tools that available to protect intangible assets. There is much more to IP protection than the traditional IP tools.

The traditional intellectual property tools are:

  1. Patents
  2. Trademarks
  3. Copyrights
  4. Trade Secrets

Though these tools are essential in the IP world, there is a far wider set of techniques that can be used, including the following:

  1. Secrecy and refusal to disclose
  2. Licensing and trade secrecy agreements: limited and controlled disclosure
  3. Trade secrecy and related agreements with employees and joint venture partners
  4. Physical techniques such as encryption and related data protection techniques

Many companies believe that since they have done what is necessary to secure their rights in North America and Europe, there is nothing special they need to do in China. This is a mistake.

The key concept is that all IP protection is local. You cannot rely on what you have done elsewhere. You must deal with your IP by making use of the Chinese system. You must act within China for both creation of rights, enforcement of rights and monetary exploitation of rights. You must deal with China the way it is, rather than hoping to rely on a perhaps more perfect system that simply does not exist in China.

Since all IP protection is based on local law and practice, you must adopt an effective and realistic protection program for the country in which you are operating. If you are in China, you must consider the situation in China. The fact is that China is currently the most dangerous country in the world with respect to protection of intangible assets does not mean you can afford to throw up your hands and do nothing. China’s IP risks can be managed, if 1) you assess the risks in a realistic way and 2) you take practical steps for protection.

Tomorrow, we discuss specifics.

Clients, potential clients and the press are always asking me what foreign companies that do business in China need to know to stay out of legal trouble. 

Next time I get such a question, I will refer them to the list below as it sets out the most common legal issues foreign companies face when doing business with or going to China. This list is not meant to be exhaustive.

Are You Operating Legally? China has all sorts of requirements for doing business in China. The basic (non-technical) rule is that If you are going to be doing business in China for anything more than weeks at a time, you probably need to form a legal entity to do so. This entity can be a WFOE, a JV, or a representative office. It is important to note that some businesses that are perfectly legal in the United States or in Europe are illegal in China.

Are Your Contracts Enforceable? It almost always pays to have a written contract and it is usually best to have that contract be in Chinese. Very generally speaking, if it is not spelled out clearly in your contract, there is a good chance the court will find it does not exist; Chinese contract law is far less willing to imply things than western law. 

Are You Protecting Your Intellectual Property/Trade Secrets? IP registrations in your own country will not typically extend to China. To secure protection of your trademarks and patents in China you must register them in China. China is actually pretty good at protecting trade secrets that have been marked out by contract for protection.

Are Those Payments Legal? The United States vigorously enforces the Foreign Corrupt Practices Act (FCPA), which penalizes improper payments to foreign officials by U.S. companies. In certain situations, U.S. companies can be liable under the FCPA for payments made by their Chinese partners. The most common situation is when the U.S. company uses the Chinese company as a distributor of the U.S. company’s products. Know these laws and know how to avoid running afoul of them. I understand Canada and most European countries have somewhat similar corrupt practices acts. China even has its own ant-bribery statutes.

Is It Legal For You To Sell It?  At least twice, companies have called me to draft sales contracts for their technology product sales to China where what they were selling would probably be illegal to export to China. U.S. export control laws prohibit the sale of certain products to China at all and other products (certain types of software are a good example of this) can be sent to China only with a validated license 

What Happens If Your Product Injures Someone? This would not have made the list a few years ago, but in light of the recent issues surrounding toxic foods and dangerous products coming from China, it deserves to now. There are two main ways you can protect yourself from this: by contract and through insurance.

Antitrust/Labor/Tax/Termination of Business Issues. If you are going to be doing business with China or, even more so, within China, these issues are often relevant, particularly since Chinese laws on these can be so different from those to which you are accustomed.

Anything else?

A couple weeks ago, I did a post entitled, No IP Enforcement In China. That Cannot Be True, in which I talked about how it is just not true that Chinese courts will not enforce a foreign company’s intellectual property rights against a Chinese defendant.

I then discussed a recent high profile and high damage case won by a British tea kettle company, ,and concluded that post by saying that the “next time someone says China never enforces patent rights held by foreigners, you tell them that cannot be true.

Seems I am not the only one who thinks so as the Wall Street Journal just ran an by Jones Day attorney Benjamin Bai, entitled, “Yes, China Does Protect Intellectual Property: Multinational companies just need to take better advantage of opportunities to defend their patents.

The article notes that “the picture isn’t as bleak as you might think” and that [t]he key is for foreign businesses to understand how IP protection works in China and to take better advantage of the protections that exist.” It then notes how patent applications in China grew to 947,000 in 2009 from 252,000 in 2002, making the Chinese Patent Office the third-busiest patent authority in the world, after Japan and the United States. China also is now the most litigious country in the world for IP disputes—with 24,406 suits filed as compared to about 8,000 in the U.S.

Foreigners have been slower to embrace Chinese patents and Bai thinks this is because they wrongly believe they cannot prevail in IP litigation in Chinese courts:

But foreign companies can also win in Chinese courts. Neoplan, a German bus company, won an award of $3 million in January 2009 against two Chinese companies for their infringement of its design patent on buses. This case represents the largest infringement damages award ever obtained by a foreign company in China and compares well to the average patent infringement damages award of less than $50,000. Last month, a Beijing court ordered two Chinese companies to pay a combined $1.3 million in damages to a British manufacturer of electric kettle components.

Anecdotal evidence suggests the recent win rate for multinational companies in IP suits in China has been greater than 50%. In some cities the win rate exceeds 90%. While it may be premature to declare victory based on these statistics, they do suggest that it is a mistake to assume that multinational companies cannot win IP suits in China.

Foreign companies just need to know how to take advantage of these trends. Too many have made the mistake of not applying for patents and trademarks in China. Foreign patents and trademarks are not enforceable in China, just as Chinese patents and trademarks are not enforceable in the United States. Multinationals also should be willing to enforce their Chinese IP rights against infringers. Litigation success requires more than a mere willingness to sue. An in-depth understanding of the Chinese judicial system and relevant legal doctrines and an ability to maneuver through the intricacies of law and politics in China are essential for foreign companies enforcing IP rights there.

I agree.