This past week, we found out that the Intermediate People’s Court in Fujian, China issued a preliminary injunction against Micron in favor of Taiwan-based UMC and Fujian-based Jinhua. See the great article by IAM here. The injunction covers “certain Crucial and Ballistix-branded DRAM modules and solid state drives. The surprising aspect was not necessarily that an injunction was issued (this happens in over 95% of Chinese patent wins) but that this was a PRELIMINARY injunction ("PI"). Like most jurisdictions, including the US, it is difficult in China to obtain a PI. The main reason is proving infringement and that the patent holder will be irreparably harmed. Specifically, Chinese courts generally consider the following factors in determining whether to issue PIs in patent cases:
whether there is patent infringement;
whether the patent holder will be irreparably harmed in a manner for which monetary damages are inadequate compensation if the infringing act is not enjoined;
whether the patent holder has provided an adequate bond; and
whether issuance of a PI would prejudice the public interest.
Many sources seem to assume that there was some political forces at play in the Fujian court's decision. I do not dispute that surely the plaintiffs here had the hometown advantage. However, I believe the power of this advantage is not as significant as others may assume. There is a reason that in the Eastern District of Texas was popular as a venue. Similarly, there is a reason that large companies like Google have contributed a fortune in lobbying the US government to ensure they can be sued only in Northern California or Delaware. In any case, a leading US semiconductor has been -- at least temporarily -- enjoined from making, using, selling, importing, or exporting its products.
So if there are political forces are play, what are they? Well, I predicted them here:
To reiterate, China is very likely to use its patent enforcement system to catch up in areas of technology it feels are important. China sees its huge foreign dependence for semiconductors as a national security issue. This is entirely reasonable given that semiconductors are the brains behind every device we use these days, including surveillance, computing, and artificial intelligence.
The Chinese patent litigation play could several ways. For one, NPEs attacking foreign competitors to Chinese companies will help. A more "Jedi mind trick" play, though, is to for Chinese companies to simply attack their foreign competitors in patent litigation. When the Chinese company wins the case and gets their injunction, that's when the magic comes in. With their boot on the neck of their foreign competitor, they can name their price for settlement. This price could come in terms of money, but it could mean sharing sensitive technologies -- technologies that China cannot buy due to the US increased protectionism and the Committee on Foreign Investment in the United States (CFIUS). Because settlements are generally confidential and not reported, such forced technology transfer may fly under the US radar.
No matter how important the "home field advantage" was in the latest Micron case, it likely played some role. Fortunately for Micron, the patents covered only a portion of its products. But this is not the end -- far from it. At some point, the US may find that it would have been easier to simply approved the purchase of Micron by Tsinghua Unigroup.
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I have said many times that China is now the best place in the world to enforce patents. While the Chinese system is very good and getting better every day, there are some limitations. All three of these should be obvious, but in recent conversations with folks at IPBC Global in San Francisco, I realized that it may be worth pointing these out.
Specifically, in China, you will win if you have all three of these. Also, you will still likely win if you have two out of these three (and that ain't bad). But if you have only one or none of these, even China cannot save you.
1. First, you should have good patents. Note I did not say perfect, or even near-perfect patents. As long as you can make a reasonable argument to a judge regarding infringement and validity (which are adjudicated separately in China), you should be fine. I could go on for hours about a quality patent is, but suffice it to say the bar is far lower in China than it is in the US or Europe.
2. Second, you should have good counsel. For foreign companies, executives, and in-house counsel, this can be difficult. Language barriers are compounded by cultural obstacles and unfamiliarity with Chinese law and procedure. One way to deal with such challenges is to hire foreign counsel (eg, US companies hire their typical US litigation counsel) to manage local Chinese counsel. However, in addition to increased costs and inefficiencies, such an approach can lead to mistrust among the legal team. Further, the foreign legal team is usually no better equipped to deal with either the language and cultural differences or the lack of understanding of the Chinese legal system. Because of these problems, more and more companies are bypassing foreign firms and hiring Chinese law firms directly. Although this solves the lack of coherency and trust among the legal team, there is still a cultural, linguistic and legal understanding gap. Plus, without the help of an international law firm, choosing a Chinese law firm can be confusing due to lack of data and connections. For patent litigation, there are still only around ten firms I would trust. These are good firms technically and legally, but the passionate "win at all costs" attitude of top US lawyers is generally not there. Further, the levels of service even at top Chinese are lower than at foreign firms. Do not expect an answer overnight, and do not expect anyone to work on a holiday. There are exceptions, as some firms (including mine) are hiring experienced foreign patent litigators for their strategy prowess as well as for case and client management. Nonetheless, no Chinese firm is up to the quality of my former firms Weil Gotshal or McKool Smith or other top foreign law firms. They will get there, but it will take a few years.
One trap for the unwary involves how most Chinese law firms are organized and how their attorneys are compensated. First, it is important to understand that the titles of ‘partner’, ‘senior partner’ and similar designations can mean little to nothing. It is very easy to hire an attorney into a Chinese law firm as a so-called ‘partner’, because most partners draw no salary. Indeed, many firms in China have doubled in size overnight simply by adding names at no additional expense. Therefore, many partners are not experienced lawyers and do not have high-quality experience. This dovetails with the other issue: how most Chinese firms compensate their lawyers. Most Chinese law firms pay their partners on an extreme eat-what-you-kill system. Partners receive no salary, but keep between 70% and 85% of the business they bring in. This is great for lawyers with a lot of business, as it enables them to get rich fast. However, if a partner needs help from associates or staff, he or she must pay them out of his or her own pocket. This structure creates an incentive for partners in Chinese firms to:
continue bringing in work; and
not seek help from associates or staff.
This is especially true for contingency fee cases, because the partner must pay for any extra work himself or herself upfront, but will not receive revenue until much later, if at all. The result is that many companies which believe that they are hiring a firm with a plethora of lawyers are hiring only a single partner who refuses to work with other lawyers or staff. I have been involved in cases when I was in-house where the Chinese attorney was significantly overburdened, but refused to seek help because of what this would cost. Obviously, this can be a serious problem and adversely affect a case.
Clients should obtain a written explanation of how their Chinese counsel are compensated. If this is not forthcoming, they should seek other counsel. If the firm uses an extreme eat-what-you-kill model, then the client should contract not with it, but with the specific attorneys it wishes to work with, including associates. The client can also contract with attorneys from multiple firms – although this may lead to inefficiencies and unwillingness to work together. Alternatively, the client can simply refuse to hire any firm with such a system. Some Chinese firms have adopted a more team-oriented approach, but they are hard to find.
3. Third, if you want to win (or just stay sane) you should have plenty of patience, especially before filing. Like US law on declaratory judgments (DJs), Chinese law allows a party that has been threatened with an infringement action to file a pre-emptive lawsuit to prove non-infringement. This procedure is rarely used in China, largely because of the prerequisite actions that are generally required before filing such a declaratory judgment action. No specific act or regulation has set clear rules for non-infringement declarations. However, the Supreme People’s Court has issued guidelines and judicial interpretations on this subject. These provide that the following conditions should generally be met before bringing proceedings to obtain a declaration:
A warning letter should be sent to the alleged infringer by the patent owner.
A letter should be sent to the patent owner by the alleged infringer, in which the alleged infringer denies the infringement and urges the patent owner to exercise the right to sue.
The patent owner does not withdraw the warning or institute a lawsuit within one month of receiving this letter (or within two months of the date on which the alleged infringer posts its reply letter to the patent owner).
Unlike under US law, this effectively gives a patentee time to file a litigation after sending a warning letter. This area of law is likely to evolve over the next few years; but for now, a declaratory judgment action is difficult to use by an accused infringer without a tactical mistake by the patent owner. Importantly, this provides no disincentive for the patent owner to contact and negotiate with the accused infringer before filing a lawsuit.
Given this lack of meaningful DJ jurisdiction, it is no wonder that Chinese judges expect that the patent owner has not just contacted the defendant before filing, but also reached a reasonable impasse in negotiations. For non-standard essential patent (non-SEP) cases, that impasse can happen very quickly. For example, if the alleged infringer simply does not respond after a few contacts, then the patentee has no choice but to file. Such a non-responsive party can also be quickly sued in a SEP case since there is no other option. If the accused infringer does respond and enter negotiations, then SEP and non-SEP cases differ. In non-SEP cases, if the patentee subjectively believes that the negotiations are not going anywhere, or the would-be defendant is lowballing them, then this is a sufficient impasse to file that patent litigation. However, for SEP cases, the bar is higher. China has seen two SEP plaintiffs seek an injunction, and both patent owners were granted the injunction. My colleague, Austin Chang, has previously summarized the IWNCOMM v. Sony case on this blog. See also this excellent IAM article for additional information on the IWMCOMM case. The second adjudicated SEP injunction case found Huawei being granted an injunction against Samsung. IAM also published another great article in which Allen & Overy Shanghai partner David Shen analyzed why the injunction was issued. Although there are many issues involved in both the IWNCOMM and Huawei cases (including that both companies are Chinese, as are over 90% of patent plaintiffs in China), the take-home message is simple. The party most at fault for the impasse in negotiations will likely lose the SEP injunction battle. Put another way, the more reasonable party will prevail. In IWNCOMM, although IWNCOMM did not provide claim charts to Sony, the court found that the patentee has no duty to provide claim charts if the intended licensee possesses sufficient documents to determine the likelihood of infringement. In this case, Sony had been uncooperatively asking IWNCOMM to provide claim charts since the parties began its negotiation in 2009 all the way through 2015 at the same time that Sony had, in its possession, sufficient documents to make a determination regarding infringement of the disputed patent. The court determined that such intentional delay warranted IWNCOMM’s request for an injunction.
In the Huawei case, the court found that Samsung employed delay tactics in the cross-license negotiation and took improper positions. Further, the court held that the license rate proposed by Huawei met the FRAND obligation since the offers were not excessively far above the global aggregate rate range (which was redacted by the court). Again, the message was to be reasonable and honest with the court.
Based on Huawei and IWNCOMM, it is clear that if an SEP owner wants an injunction in China, they must be patient and reasonable. These is no specific timetable for this. Many defendants will try to string the patent owner along for years. This is clearly unacceptable. But the defendant must have an objectively reasonable opportunity to analyze the patents involved and whether the offer by the patentee qualifies as FRAND. Note the word OBJECTIVELY. Although time will tell, common sense dictates that a party should need no more than a few months in this regard. That is, if the patent owner provides to the accused infringer claim charts and/or information about other licenses previously granted and also offers to have its technical staff discuss the patents, their reads, and the license offer, then a delay more than a 2-4 months is likely unreasonable on the part of the accused infringer. Other factors can also impact this equation, including the attitude of the defendant during discussions, how long it takes to schedule calls/meetings, and the life of the patents. However, like I said earlier, if a defendant simply will not respond or communicate with the SEP owner, then clearly an impasse has been reached and a lawsuit may be justifiably filed.
For SEP cases, patience is a required part of the triangle. For non-SEP cases, it is just advisable.
In conclusion, the rule of three is a triangle in which the strength or weakness of each corner can be offset by the others. The ideal case is one with perfect patents, top counsel, and a very patient client, but perfection is not required (or expected). To be safe, make sure you have two out of the three, or even better, a decent portion of all three.
China has done an amazing job of going from worst to first in patent enforcement in less than five years. I have frequently spelled out the numerous advantages to litigating patents in China, including win rates (including for foreigners), virtually guaranteed injunctions (combined with the large manufacturing market in China), short time to trial, low cost of litigation, validity challenges infrequently successful, and just general support of innovation. While the Chinese government has stated its strong support for IP and punishing infringers, many major Chinese companies have not received the memo.
In my experience over the last year, talking to all but the most sophisticated Chinese tech companies before litigation is often useless (you still need to do it, but don't expect a successful or even reasonable negotiation). I have had Chinese companies tell me that they don't have to pay a license to a foreign company because they are Chinese. I have also had folks laugh when we gave them the amount of prior licenses from other licensees. I have even had Chinese lawyers call our clients (and me) derogatory names, thinking that I did not understand Mandarin. None of this is helpful for China as it attempts to reach the next stage of its path toward technological and economic dominance.
Make no mistake, litigation in China is the great equalizer. The statements I have heard that Chinese companies cannot lose in litigation are about 3-5 years stale. It is just no longer true. Patent litigation by foreign companies against Chinese companies is very successful with good patents and strong lawyers (along with reasonable strategy and some patience). But while foreign companies are realizing the power and excellence (and danger of being a defendant) of the new patent enforcement system in China, ironically, many Chinese companies are not. As a result, it is very likely that Chinese companies will have to be sued before any deal is struck.
This is not good for anyone. If a party has a strong patent and a good infringement read, a deal should be made without the cost of litigation. In China, the penalty for infringement is generally greater once litigation is started as China has in some ways already endorsed the idea of a "Panduit kicker" which increases a royalty to compensate the plaintiff for the trouble of obtaining a royalty through litigation mentioned in Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1152 (6th Cir. 1978) but rejected in Marhurkar v. C.R. Bard, 79 F.3d 1572 (Fed. Cir. 1996). Further, most patent owners will provide a discount for early settlement. In fact, many patent owners will also apply a "China discount" because profit margins in China are often lower than in the US or Europe. But once litigation begins, all bets are off the table.
In addition to exposing accused infringers to greater damages and settlement values, this lack of willingness to deal fairly by Chinese companies is also bad for China. China has done an amazing job of creating the best patent enforcement system in the world in a short time. One of the reasons it has done so is so that foreign companies will feel empowered to invest capital and know-how locally. Only through this investment and sharing can Chinese companies quickly develop important technologies such as semiconductors. If domestic companies continue the "but you can't sue us because we are Chinese" mantra, regardless of whether they ultimately lose in court, most foreign businesses will just assume nothing has changed in China.
Further, China needs a robust licensing market to take its place at the top of the world in technology. This means that everyone plays by the same rules. Parties already have to play by the same rules in court, but they should also do so in negotiations outside of litigation. Ultimately, China cannot insist on having a seat at the table if it will not play by the existing rules. One of these rules is paying for a license when needed. It just makes no sense for China to think it can take the positives of integrating into the high-tech international market without also accepting the negatives of paying for licenses.
This will take care of itself in time through court cases, but for now it is a bit frustrating. It is, though, a natural consequence of the quick growth of the patent system in China. By definition, no Chinese attorney (that has not worked abroad) has more than a few years experience in high-stakes patent licensing and litigation because until about three years ago, the market did not exist. Therefore, even some of the top Chinese companies have in-house counsel and executives that have no idea how to value ip and negotiate a license.
Again, this is a natural growing pain and will take care of itself as more and more large-scale litigations make their way through court. But for now, foreign companies should be prepared to be frustrated in pre-litigation negotiations for the most part. I hope with some big cases over the next year, this will change. After all, a big loss by a Chinese company will be a short-term loss for "China, Inc." but will pave the way for long-term growth and success for China and its economy. I suspect the government realizes this, because unlike the West that thinks quarter-by-quarter, China plays the long game and plans well. That's why they are where they are.
I will be chairing a panel on litigating and licensing patents in China on Tuesday, October 24 at LES 2017. Please come by, email me at firstname.lastname@example.org or text me at 713-498-6047 if you would like to meet!
I. Overview The good news is that China’s entire civil litigation system has significantly improved, not just its patent enforcement system. Contracts are fairly and effectively enforced between foreign and Chinese parties. This means that if the contract is breached, a foreign company can get monetary damages and/or injunctive relief from a Chinese court so long as a foreign company: (1) executes a valid contract with a Chinese company, (2) that contract is sufficiently straightforward that a Chinese court can make a ruling of fact without significant investigation, and (3) the contract is not subject to China’s Technology Import Export Regulation (“TIER”), or the foreign company builds in a business advantage to incentivize the Chinese company not to escape the contract via TIER. This brief memorandum addresses TIER and some ways to possibly deal with it, best practices for forming joint ventures with Chinese companies, and how to protect core and non-core IP in China.
II. China’s Technology Import Export Regulation (TIER) A. TIER Restrictions Licensing is the primary means by which technology flows into markets and it may also set the stage for joint additional advances. The challenge to parties negotiating a licensing agreement is to find terms that are mutually beneficial, so that agreement is in the interest of both sides. Especially in the context of high technology, and associated intellectual property, it is critical that the parties have great flexibility in arriving at mutually beneficial terms as the market and circumstances demand.
Unfortunately, China’s Technology Import Export Regulation imposes rigidities as they relate to certain key terms, making it more difficult for the parties to reach agreement. The Chinese government, via the Ministry of Commerce (MofCOM) has mandated certain conditions be a part of any license of technology into China, regardless of whether those terms are in the parties’ contract, or even if these terms are specifically contradicted by contract. TIER mandates that foreign licensors fully indemnify Chinese licensees, surrender ownership to any improvements, and not prohibit marketing rights of Chinese licensees.
The first potential problem with TIER pertains to indemnity terms, which govern which party should bear the burden if the licensee’s right to the licensed technology is challenged by a third party. Given the wide variety of circumstances, there is no single best approach to indemnity terms, which should be left to the parties to address in a mutually beneficial manner. TIER, however, inflexibly imposes all indemnity risks on the foreign licensor.
Interestingly, many open source licenses are incompatible with TIER because they mandate that no indemnity is provided. For example, most open source licenses do not provide any warranties of non-infringement or any provisions for indemnification and some licenses specifically disclaim any warranty or indemnification. This obviously contradicts TIER and requires a violation of either the open source license or TIER. As use of open source-licensed code grows in China, this will be an important issue. Although TIER does not have a strong record of enforcement, open source licenses do. Indeed, the penalties for violation of such license terms can be draconian, including enjoining distribution and use of the software, as well as damages and attorneys fees.
The second potential problem with TIER pertains to rights in technology improvements developed by the licensee. A licensor will often desire to have shared rights in improvements, in exchange for giving the licensee more favorable terms, such as by lowering any royalty payment. A licensor unable to share in improvements developed by the licensee risks being locked out by the new development, and so it may conclude that it cannot reach a deal with a Chinese partner due to the great uncertainty created by TIER. Absent the flexibility to negotiate shared access to improvements, a technology licensor may choose to avoid China completely, or to deal with an affiliated company that it can trust. Again, many open source licenses require any derivative works, including improvements, to be freely available to the public, so that the parties must violate either the open source license or TIER.
The third concern pertains to licensing parties’ allocation of marketing rights. The business-driven bargaining in a licensing transaction often involves allocating market rights between a licensor and a licensee. For example, a given technology transaction may give a Chinese company the exclusive marketing rights in China and a U.S. company the exclusive marketing rights in North America. However, TIER prohibits licensing agreements that “unreasonably restrict[s] the export channels” of the licensee. Under this TIER provision the licensing parties cannot freely negotiate allocation of market rights according to their business needs and proposed level of license fees. Absent the flexibility to allocate marketing rights, a foreign licensor and a Chinese licensee may have to forgo their licensing partnership despite interest by both.
B. Ways of Managing TIER Restrictions There are very few cases in China in which TIER has been asserted by China or Chinese companies to void specific provisions of a contract. Although this is good news, it is still not all that comforting to foreign businesses forced to accept uncertainty in licensing technology into China. There are a few ways of managing the potential dangers of TIER.
First, it is clear that if a Chinese company voids important contract provisions using TIER, then that company will have significant problems ever working with a foreign company again. Foreign licensors, and foreign partners in general, will no longer trust such a Chinese entity to abide by its word. Such a consequence would be, therefore, bad for the Chinese entity as well as the foreign entity. Presumably, a Chinese company would only void the contract provisions via TIER in an instance where the value of doing so is very high – higher than the loss of future ability to work with foreign companies. Therefore, it may be possible to avoid such a case by providing business incentives (such as additional revenue, equity, or geographic share) to the Chinese partner in the event that the deal leads to great commercial success.
A foreign company may also be able to protect itself by simply writing the TIER restrictions into the contract and valuing them properly. Alternatively, the licensor could simply accept the risk of TIER and go along with the contract as if TIER were not a factor. There are also other means of possible protection (in addition to the general “best practices” mentioned in the next section. For example, instead of licensing to a company in China, it may be possible to license to a Chinese company outside the PRC. The foreign entity could provide a written contract provision prohibiting import of the technology into China, but with the unwritten understanding that the licensor will not object to such import so long as the licensee does not attempt to exploit TIER to change the contract. While this is not exactly fair for the Chinese company, neither is TIER, and it shifts the uncertainty from the licensee to the licensor. While not a perfect solution, it does reallocate the trust issue to the Chinese side.
Another option (at least for technology involving open source licensed technology) would be to contract to terms violating TIER, and then if anything goes wrong, seek to have the Free Software Foundation sue the Chinese company for violation of the open source license. This would be risky, and would require a very close relationship with the FSF and open source community. There are other possible creative solutions involving the foreign licensor using its own Chinese-owned subsidiary as the contracting party, or insisting that the licensee be a non-Chinese entity. The problem with all of these is that they have not been tested, because TIER itself has not been effectively tested. As with most business deals, it depends on the amount of risk that is tolerable to both sides.
III. Best Practices on Joint Ventures/Technology Licensing with Chinese Companies A. Overview While there is no guarantee that any contract will not be violated, there are many things that a foreign licensor can do to maximize its chances of making itself whole in the event that the contract is breached. Courts, judges, and arbitrators in China are getting more sophisticated each day. Also, such forums are generally quite fair and effective in enforcing foreign parties’ rights in China. However, the more complex the issue, the less clear the outcome and the slower the process. Therefore, several best practices should be followed in addition to general best practices regarding technology licensing outside of China.
B. Make the contract simple: define breach and liquidated damages Although courts in China are more sophisticated than ever, they are burdened with a huge number of cases. They also are more reticent to give injunctive relief of large damages if they are not sure they are correct in their judgment. Therefore, make it easy for them: make the contract simple. Define specifically what constitutes a breach and what the penalty should be. Liquidated damages are a must. Make it so that all the aggrieved party has to show is: (1) there is a contract, (2) the contract was breached, and (3) the parties agreed at the outset what the penalty for such a breach would be. This should lead to a very fast and effective judgment.
C. Define “Confidential Information” (“CI”) clearly and put the onus on the licensee to show that information is not Confidential Information Courts in the US get bogged down in determining what is CI under contracts. Chinese courts have the same problem. A solution to keeping up with what falls under CI is to make every bit of information provided to the Chinese partner fall under the definition. The contract should provide that all information is assumed to be CI, unless the Chinese party objects in writing within a specific period, say two weeks from receipt. There should be a provision for determining disputes quickly, including destruction of any material or information provided to the licensor that cannot be agreed as to confidential nature. Then, the licensor should provide a regular report to the licensee listing the information that it has sent the licensor and that it has received from the licensee as not constituting CI. Such a process would allow a judge of any dispute to quickly determine what was CI and provide quick redress.
D. Choices of venue and law and right to enforce judgment in China Although the courts and arbitrators in China can now generally be trusted, if the licensee is particularly well connected, it may make sense to dictate that the choices of law and venue be in the licensor’s jurisdiction with the right to enforce any resulting judgment or adjudication in China.
E. Get a full list of officers, executives, and principals The licensor should obtain a notarized list of officers, executives, and principals, with photos. The guards against the possibility that licensor’s CI and IP could end up in another company headed or run by the principals of the licensee. Depending on the size of the licensee and its reputation, it is very possible for the licensee to close down, move, and start up again under a new company name. Proving that this has happened will be much easier if the licensor has a list of those holding power at the original licensee. It is probably also worthwhile to get a list of lead engineers on the project.
F. Have in-document translations of each section The contract may be in either English or Chinese, whichever the parties prefer. It is important to have in-document translations of each section. This allows for easier negotiation and for easier adjudication. One language should be controlling (likely the language corresponding to choice of venue). It may be helpful to get a notarized official translation of each section. This is not required, but for large deals is likely worth it.
G. Lay a trap Foreign licensors of software may want to lay a trap by including in comments to the code or elsewhere specific information linking the code to the licensor. This way, in case the licensee ever tries to argue that the code is theirs, they will have a hard time explaining why links to the licensor are there.
IV. Top IP issues when forming a joint venture in China A. Keep control One key to protecting IP in any deal with a Chinese partner is to make sure that the foreign entity will control the joint venture. Since most foreign investors wish to maintain control over their Chinese joint venture entity, this issue is usually paramount. Often foreigner make the mistake of assuming that Chinese joint ventures are managed according to a Western model, under which the board of directors has controlling power over the company. Most foreign investors strive to obtain a 51% ownership interest in the equity joint venture, assuming this gives them the right to elect the entire board and thereby control the company. After winning the struggle for percentage ownership of the joint venture, foreign investors will frequently allow the Chinese side to appoint the equity joint venture’s two key management positions, the Legal Representative and the General Manager. But these “concessions” are all part of the Chinese side’s plan, and effectively render board control meaningless.
Control over a Chinese joint venture actually comes from the following:
The power to appoint and remove the China joint venture’s Legal Representative.
The power to appoint and remove the General Manager of the China joint venture company. The joint venture agreement must make clear that the General Manager is an employee of the joint venture company employed entirely at the discretion of the Legal Representative (whom you have the power to appoint and remove). Note that this agreement will be enforced under Chinese law and its official version should therefore be in Chinese.
Control over the company seal, or “chop.” The joint venture partner that controls the joint venture’s registered company seal has the power to make binding contracts on behalf of the joint venture company and to deal with the joint venture company’s banks and other key service providers. The annals of history are filled with foreign companies getting shut out of their China joint ventures after losing control of the seal.
The Chinese side to a joint venture will typically refuse to give the foreign party the above three measures of control. It will argue that it should control the joint venture for reasons of both efficiency and expertise. In many cases, it also will claim that it cannot bring its political connections, or guan xi, into play unless its own people fill the Legal Representative and General Manager slots. This argument is usually just a smoke screen for the Chinese side trying to secure the true levers of joint venture control.
If you want control over your China joint venture, you should follow the rules set forth above. Otherwise you might find yourself in a venture with no legal right to guide it.
B. Safeguard intellectual property the traditional way Multinational companies still struggle to protect their intellectual property in China, and joint ventures are particularly vulnerable. Companies have traditionally had some success with more pragmatic, operational efforts, including the following:
Bringing only older technology to China. This approach works for products that may have been available in developed markets for some time but are still competitive in China’s market. It also works in industries—such as bacteria streams for fermentation, vaccines, and certain motor engines—where innovation cycles are short.
Keeping the secrets at home. Multinationals can protect their intellectual property by delivering equipment or technology ready to be installed, without detailed design specifications. Negotiating agreements to do so can signal a lack of trust in the local partners, however, and can increase costs if spare parts and maintenance must be provided from overseas.
Keeping critical intellectual property completely out of a joint venture. Some companies have set up joint ventures that are restricted to those steps in the value chain that involve limited intellectual property, like assembling, packaging, or tailoring. Such an approach is feasible only when local innovation lags behind global standards and, obviously, when the critical intellectual-property component can easily be separated into a step of the value chain.
Charging for intellectual property up-front. Some multinationals have chosen to sell their intellectual property to joint ventures, either through up-front cash payments or licensing fees. This approach can be challenging to execute, for while it resonates well with local companies, they generally are willing to pay for technology up front only at a significant discount.
C. Manage talent Most leading multinationals learned from the first round of joint ventures in China that getting the right managers in place was critical. Many of these companies had simply dispatched available executives—often not top performers but rather average executives searching for new challenges. Most of these executives therefore had limited credibility with the corporate parent and were ill-prepared to manage demanding joint-venture partners. Today, experienced multinationals recognize that a successful joint venture requires credible, high-performing executives supported by strong local teams.
Yet with so many companies competing for the best local candidates, those men and women can afford to be choosy, and they understandably prefer leading companies that have a strong image and offer good prospects for career progression. So today, joint ventures must not only invest in their corporate brands but also partner with top universities to sponsor undergraduate and graduate students and to establish a training platform for current employees. CEIBS, a leading business school in China (and itself a joint venture), has more than 80 corporate sponsors, which provide funding and in return can recruit on campus and send their executives on advanced training courses.
Finally, companies must continue their commitment even after candidates are hired. In our observation, this means sending some of a multinational’s best people to the joint venture to create a strong team, compensating employees at or above relevant market rates, and fast-tracking the advancement of high performers—even breaking away from more tenure-based advancement systems.
D. Improved and New Intellectual Property In the growth and development of a JV, new IP will come about, and these will be regarded as belonging to the Joint Venture. Therefore, it is also up to the JV to assign it or to apply for protection. If the foreign investor only holds a minority stake in the JV, then s/he may find themselves in a weak position regarding control over new IPRs. It is recommended to deal with these matters in the joint venture agreement before they become problems. *Note the prior discussion of TIER in this regard.
E. Investment Capital Contribution The transfer of technology or IP of a foreign investor into a joint venture can serve as a contribution of capital. Depending on the investment sector of the JV, the transfer can make up a certain percentage of the JV. Although there are some exceptions, the maximum limit is usually 20%.
F. License/Royalty Fees Licensing or royalty fees from the transfer of IP in a joint venture deserves close attention. In China, royalties are subject to income withholding tax and business tax. Also, in some sectors, the royalty rate may have a ceiling, such as the 0.3% royalty rate ceiling of sales revenue in the retail sector for the use of a trademark.
You might assume that these challenges would be caused by some undefinable “Chinese” element. You already knew how to manage U.S. prosecution, performed by the outside U.S. law firms, and in theory you can apply that learned expertise to managing the process in China. But this is not U.S.-style patent prosecution in another place. The working language will be Chinese in addition to English, the communications will generally be over long distances, 12 to 15 time zones away, and you will have to deal with significant differences in laws, practices, and cultures. This article provides a roadmap and tips for making this process productive and successful.
The Increasing Value of a Strong Chinese Patent Portfolio At the outset, it’s worth noting that the value of a strong Chinese patent portfolio has been steadily increasing, and therefore trying to get a clear understanding of what’s involved in building IP in China can be very worthwhile. Companies trying to increase their presence in China should recognize this and budget for their IP work in ways that match their opportunities and aspirations.
Like the U.S., Chinese markets are extremely (and increasingly) competitive, requiring a very strong patent position in most sectors. But unlike the general decrease in value of patents in the U.S. over the past ten years (beginning with the weakening of injunctive relief in eBay Inc. v. MercExchange, LLC), patent owners in China still enjoy a robust regime of protection: injunctions are readily granted when a patent is held valid and infringed, and damages for patent infringement have been on the rise. Accordingly, Chinese patent prosecution is a good investment, likely to generate significant returns from markets where innovation is properly protected. Lost in Translation Patent applications originally drafted in English need to be translated into Chinese for Chinese patent prosecution. Because of the inherent danger of precise meanings lost in translation from one language to another, quality control for translation is very important. As Learned Hand put it, “Words are chameleons, which reflect the color of their environment.” An English term can be translated into a number of different Chinese terms, depending on contexts and fields. Thus, even though the quality of machine translation has greatly improved, and professional translation vendors could be used at reduced rates as compared to those charged by patent law firms, to ensure high quality translation of patent application documents, there is no substitute for bilingual patent attorneys who are fluent in both English and Chinese and also understand the relevant technologies, thereby enabling them to properly contextualize claims and descriptions. To provide a simple example of the risks of machine translation, as of today, the powerful Google Translate still translates the English words “Chinese patent prosecution” into the Chinese words that actually mean “Chinese patent litigation.”
Because of the language barrier, this phenomenon of “lost in translation” repeats itself often during day-to-day management of Chinese patent prosecution. For example, one in-house counsel I know asked for a copy of translated claims of an issued Chinese patent, but instead received the translation of a set of different claims presented during prosecution. Another in-house counsel has told me that for most routine patent prosecution matters, the English of his Chinese patent attorneys is sufficient, because with experience they can just follow templates; but they are just not adequate when working on more complicated matters such as invalidation proceedings, or when conducting live discussions during conference calls.
Ideally, the “lost in translation” challenge can be overcome by working with top Chinese IP firms with patent attorneys who are fluent in both Chinese and English and fully familiar with both Chinese and U.S. patent laws. Moreover, the Chinese patent attorneys will be able to further improve the quality of translation if they have more background information about the inventions and the planned patent portfolios, because having a big picture helps to provide a fuller context for accurate translation.
Long Distance, Time Differences, Less Frequent Client Visits and Reduced Face Time In addition to the language barrier, long distance and time zones can hinder smooth communications and management of the process. Attorneys at U.S. outside law firms generally are available to meet with clients upon request. Relationship partners take every opportunity to visit their clients, because face time, even in the age of social networking and virtual reality, is still important to build and maintain trust. Phone calls between outside counsel and clients in the U.S. occur spontaneously, or can be easily scheduled during normal business hours.
This is not so easy for Chinese outside law firms. Lacking a permanent post in the U.S., Chinese lawyers generally only occasionally visit their U.S. clients when coming here to attend a conference, resulting in comparatively limited face time and limited opportunities to strengthen the relationship. And due to time differences, U.S. clients typically can’t pick up the phone to call their lawyer in China, and arranged teleconferences typically occur at odd hours for participants from one side of the Pacific or the other.
Solutions to this problem can include U.S. clients’ setting up offices in China, Chinese law firms’ setting up offices in the U.S., improved videoconferencing quality, and more frequent visits between U.S. clients and Chinese law firms. Borrowing the tagline from the 2003 movie Lost in Translation, “Sometimes you have to go halfway around the world to come full circle.”
Cultural Differences This is the more subtle part of the interactions between Chinese law firms and U.S. in-house counsel. It should be noted that the Chinese culture is constantly evolving, but differences can be stark. Some in-house counsel wish their Chinese outside law firms could be more proactive and think strategically from the client’s perspective. Other companies have noted inefficient legal advice and billing, where the Chinese law firms provided unsolicited analyses that the clients don’t need (or are not actually helpful).
Sometimes what’s acceptable in one culture may be frowned upon in the other. Without a sufficient understanding of the culture and background, and opportunities for fuller explanations where appropriate, some advice provided by Chinese law firms could even raise ethical concerns in the minds of the U.S. in-house counsel.
Cultural misunderstandings between U.S. clients and Chinese law firms can be reduced by giving each other the benefit of doubt, slowing down and providing fuller background when discussing sensitive matters, and making efforts to learn about each other’s culture. Obviously, using people who are already familiar with both the U.S. and Chinese cultures to help manage the process will make this easier.
Differences in Laws and Practices Based on feedback from a number of U.S. companies, the differences in laws and practices between the U.S. and Chinese patent systems do not pose special problems for routine patent prosecution matters, because they are already well understood by the top Chinese IP firms. Moreover, the Chinese patent system has matured and is moving closer to EPO and JPO. By the time substantive prosecution starts in China, similar rejections have often been addressed in other jurisdictions, arguments are already mapped out, and what worked in Japan or Europe generally will work in China, too. That said, in the last few years, more and more rejections made by SIPO could no longer be overcome by simply using the same arguments that had worked before EPO and JPO.
To be clear, differences in laws and practices are important for U.S. clients to understand in order for them to build strong global patent portfolios — for example, the procedure for patent prosecution before SIPO is complex, and different from that before USPTO, and therefore it’s important to work with a top Chinese IP firm having personnel that know it like the back of their hands. It’s just that the top Chinese IP firms already understood the issues well and can help their U.S. clients in substantially the same way, without qualitative differences. Where the differences are well known, process management is relatively straightforward. However, new difficulties can arise when there are changes in Chinese laws and practices.
Rapidly Evolving Chinese IP Landscape The Chinese patent system, like the Chinese economy and market, has come a long way in three short decades since the first Patent Law in 1984, the first Amendment of Patent Law in 1992, the second Amendment of Patent Law in 2000 (as a result of China’s expected entry into WTO in 2001), the third Amendment of Patent Law in 2008, to the currently contemplated fourth Amendment of Patent Law (with draft first published in 2015 for comment), and is still moving rapidly, creating opportunities for the prepared and traps for the unwary.
In addition to changes in patent laws, China has experienced rapid development of its court system. In November and December 2014, three specialized IP courts were established in Beijing, Shanghai, and Guangzhou, where IP case filings are most concentrated. Two years later, in January and February 2017, four new specialized IP tribunals, similar to the three specialized IP courts, were established in Nanjing, Suzhou, Chengdu, and Wuhan, technology and manufacturing centers where patent case filings are more concentrated. The establishment of a national appellate IP court, similar to the U.S. Court of Appeals for the Federal Circuit, is currently under consideration. The source of all these changes is China’s expressed desire to become a strong intellectual property rights (IPR) country so as to promote the development of an innovation-driven economy. With this prevailing policy as a premise, the value of a strong Chinese patent portfolio will only increase in the foreseeable future, and efforts by companies to better manage their Chinese patent prosecution will be well rewarded.
Liaoteng Wang is the Managing Partner in the Silicon Valley office of Beijing East IP, a top Chinese IP firm headquartered in Beijing. Prior to embarking on his legal career, Liaoteng was an accomplished scientist, having received his B.S. degree from Beijing’s Tsinghua University and Ph.D. degree from UW-Madison, and published his scientific discovery in the world-renowned journal Nature. After receiving his J.D. degree from UW-Madison in 2005, Liaoteng interned for Judge Rader at the U.S. Court of Appeals for the Federal Circuit, practiced law at the Silicon Valley offices of top international law firms, and worked as an in-house general counsel for an Intel-backed startup and a top global technology company, before joining forces with his friends and alums at Beijing East IP in 2016 to provide premier IP legal services to clients worldwide.