Saving the special relationship

The 10-minute phone call between President-elect Donald Trump and Taiwanese President Tsai Ing-wen last December was probably responsible for many collective hours of lost sleep among US business executives. In a post-election environment characterised by uncertainty, it was the clearest sign yet that the man whose campaign promises included a 45% tariff on Chinese goods and a crackdown on IP theft might be about to radically alter relations with China.

China’s state-run Global Times thundered that “Trump will shake the foundation of US firms doing business in China if the US walks away from its long-standing position that the Chinese mainland and Taiwan belong to one China”. While Trump’s subsequent affirmation of that policy in a call with Xi Jinping lowered the temperature significantly, many US businesspeople in China still feel that the foundations of their world have shifted.

Early appointments certainly point towards a hard line on IP theft and similar issues. Commerce Secretary Wilbur Ross decried China’s protectionism during his Senate confirmation hearings; while Trump’s pick for US trade representative, Robert Lighthizer, is a long-time critic of Chinese trade policy. Maureen Ohlhausen, acting chair of the Federal Trade Commission (FTC), has specifically indicated concern over antitrust policies in Asia which have “undermined” US IP rights by allowing “the taking of American proprietary technologies without due payment”.

Actual policy developments have been thin on the ground. An executive order signed by the president has called for stronger enforcement of IP laws (among others). And in Congress, Republican Representative Steve King of Iowa has introduced a bill which would require the US trade representative to estimate the annual loss of revenue to US rights holders attributable to Chinese infringement and then slap the equivalent duty on Chinese imports.

However, Bill Perry – a trade lawyer with Harris Bricken who runs the US China Trade War blog – maintains that this is not a warm-up for an escalating conflict over tariffs and market access. “Trump has a tendency to make outlandish statements and negotiate down,” he points out. “I believe there’s a deal, not a trade war.” Perry predicts that some kind of negotiated settlement might address key IP issues, including technology transfers, which are sometimes required of US companies in exchange for market access in China.

For corporates, too, the worst fears of an all-out trade war seem to have abated somewhat. In fact, some companies are even starting to welcome this tougher line. Traditionally, the US business community has sought to restrain assertive US policies towards China, fearing retrenchment and retribution from Beijing. However, this view was premised on the idea that China will gradually continue to open up on its own; surveys show that many in the foreign business community are becoming increasingly sceptical of this assumption. For many, reciprocity is the new watchword, while there is a growing sense that US companies have little to lose from the US government taking a more muscular approach to intellectual property and other trade issues.

Whatever happens on the trade front, the IP nexus between China and the United States has never been more important. Chinese tech players have a voracious appetite for overseas investment; as they seek to catch up on the IP front, they are a key part of the buy side in the US patent market. Meanwhile, US companies are engaging with the Chinese IP system in greater numbers as patent rights weaken at home. Recent litigation developments indicate that any US company manufacturing its goods in China could be extremely vulnerable to IP risks there.

ITC in the spotlight

Observers in both countries expect the US International Trade Commission (ITC) to become an increasingly important venue for US-China IP disputes. “You’ve got to prepare for more Section 337 actions if you’re a Chinese company,” warns Perry.

This would probably be true no matter what the outcome of the 2016 election, given the key advantages that ITC proceedings now enjoy over district court litigation. The forum’s general exclusion orders provide the type of injunctive relief which is difficult to obtain post-eBay; investigations will not be stayed pending an inter partes review; while multiple infringers can be named in one complaint.

Last year the ITC instituted 54 infringement investigations – the highest number since 2011 – and practitioners expect this number to rise again in 2017. As usual, Chinese companies were targeted more than firms from any other country. “I was actually surprised why it took so long for parties to start filing more cases before the ITC,” says Lei Mei of Mei & Mark. “It will continue to be a very attractive forum in light of inter partes review.”

Figure 1. ITC Section 337 investigation initiated by year

Source: Lex Machina

The ITC is bipartisan and independent, although the president does have the option of effectively vetoing exclusion orders, as President Obama did in a 2013 ruling which would have barred imports of certain Apple devices based on patent infringement. Typically, the IP cases heard by the ITC are less politicised than those dealing with dumping and countervailing duties. Despite this, Mei points out that “Trump may encourage some companies to perceive that US companies may be able to have an advantage in the ITC. But whether that will be a significant factor in terms of increased filings remains to be seen”.

Stanford Professor Mark Lemley raises the issue of whether the Trump administration could “move the ITC’s jurisdiction back to its roots by insisting on a real domestic industry requirement”. This could effectively bar non-US companies from the country’s most pro-plaintiff patent forum. Some Chinese companies, notably Ninebot, have derived great value from their US patent portfolios by obtaining ITC rulings against Chinese rivals. However, making it harder for foreign companies to use the ITC to enforce their patents will not improve the value of US patent rights.

IP theft

Much of the rhetoric surrounding China and intellectual property from members of the Trump administration with a protectionist bent accuses individual companies and the country as a whole of engaging in systematic IP theft – sometimes phrased as ‘stealing technology’. The concern does not seem to be so much about actual patent infringement or even under-licensing – looking more closely at the context in which it is used, this widespread accusation is really about trade secrets and other confidential information. “I think the issue of stealing trade secrets is going to be huge in US litigation and particularly in Section 337 disputes,” Perry predicts.

Interestingly, a long-running trade secret battle which has been litigated in both China and the United States recently prompted a turf war between the Chinese government and a US federal court over jurisdiction. The resolution – which occurred just days before Trump’s inauguration – means that US companies may continue to find ITC hearings a powerful remedy for any alleged trade secret theft which takes place in China.

The dispute stemmed from claims by US chemical company SI Group that numerous employees in China misappropriated its trade secrets to benefit Chinese competitor Sino Legend. Several years of litigation in China, involving at least four civil suits, proved unfruitful for SI. It then filed a Section 337 complaint based on the same alleged trade secret violations and the ITC found in its favour, issuing an exclusion order.

After the Court of Appeals for the Federal Circuit upheld the ruling, China’s Ministry of Commerce took the unusual step of appearing as an amicus party (represented by renowned trade secret expert James Pooley), arguing forcefully that “in wrongly interpreting Section 337 of the Tariff Act to allow the ITC to bar imports into the United States based on alleged actions conducted, and adjudicated, wholly within the borders of China, the ITC has impugned the sovereignty of China and refused to accord the comity expected of a trade partner”. Despite this, the US Supreme Court denied certiorari in January, meaning that Sino Legend has run out of rope.

Figure 2. US service exports to China in 2015

Note: “Other” includes other business services; maintenance and repair services; telecommunications, computer and information services; government goods and services; and insurance services

Source: US Department of Commerce, Bureau of Economic Analysis.

The US Patent and Trademark Office’s Mark Cohen points out that the different results in the US and China cases and the controversy they sparked over jurisdiction come down to the fact that the two countries have taken quite different paths when it comes to trade secrets. “Chinese courts emphasise similarities of technology between the parties,” he explains, “while US courts rely more on unfair access to the technology by the alleged misappropriator.” In addition, the lack of pre-trial discovery in China makes it hard to substantiate charges. So the ITC may remain the preferred venue for US companies which discover that their intellectual property has been stolen.

Hacking and cybercrime often get lumped into accusations of IP or technology theft levelled against China – Perry told IAM that there have already been some interesting Section 337 complaints based on one or both of these. “One of the big issues still flying around is the complaint filed by US Steel against numerous Chinese steel producers,” he recalls; US Steel raised allegations of trade secret theft via hacking, among other antitrust claims. “I think the antitrust element will wash away, but what could stick is the claim against Bao Steel on cyber hacking. The big question is: if a company hacks you to steal technology, can you bring a Section 337 case? I think you can.”

The antitrust portion of US Steel’s case was dismissed and on February 15 it also withdrew its claims relating to hacking, citing an “unbearable burden” of proof. In Perry’s view, the result shows that IP investigations conducted by the ITC are significantly less tilted in favour of US companies: “An ITC 337 case is not an anti-dumping and countervailing duty case at Commerce where US Steel has a major advantage over the foreign companies.”

CFIUS looms large

Regardless of whether we see increased litigation between US and Chinese companies in the United States (especially ITC cases), there are real questions as to whether Chinese tech companies will face greater barriers when it comes to investing in the United States under the new administration. As emerging players from China snap up US companies and talent in an attempt to reach US consumer markets and set up bases in Silicon Valley and elsewhere, they have also dedicated resources to buying US patent assets. A change in the investment environment could affect demand for patents and stall the larger M&A deals which have resulted in significant portfolios coming under Chinese control.

A more assertive Committee on Foreign Investments in the United States (CFIUS) is one shift that could happen fairly quickly. “We do believe there will be more CFIUS reviews, as that’s a politically sensitive area of practice,” Mei predicts. Opposition within the inter-agency body has previously resulted in deals which involved major technology and patent portfolios being sidelined, such as the proposed $3.3 billion acquisition of Philips’ US-headquartered lighting unit Lumileds by a Chinese consortium in 2015, as well as a string of mooted chip industry takeovers which were quickly abandoned. Chinese investors have had more luck targeting European tech firms; if US regulators become even tougher, the China-Europe deal pipeline could get even busier, with possible knock-on effects for the patent market. That is, if European regulators do not move to tighten things up at home.

A copy of the new administration’s draft trade policies leaked before the inauguration hinted at potential changes to the CFIUS process itself: the document stated that within his first 200 days in office, the president “would order CFIUS to review...reciprocity in international corporate takeovers (i.e. whether a US company would be able to buy a Chinese company like a Chinese company would be able to buy a US company)”. Given China’s tight restrictions on foreign investment in the tech sector, such a move could prove a longer-term barrier to Chinese tech investments in the United States. “It’s possible we’ll see changes to the CFIUS process,” Perry concedes. “Companies want to know why Chinese companies can invest here in sectors they are barred from entering in China. That’s an issue that could be picked up by the US trade representative during work on the bilateral investment treaty with China.”

In a note to clients, the CFIUS practice at Covington & Burlington stated confidently that the Trump administration will not take a softer position on investment than the Obama administration, which was described as “hands off” when it came to the CFIUS. So it is worth remembering that it was its Obama-era incarnation which forced Huawei to sell patents and other intellectual property it had acquired in a $2 million deal with 3Leaf in 2011. It is not unthinkable that a Trump administration CFIUS could devote similar attention to patent and IP-led deals; any indication of that would certainly have repercussions for the patent transactions marketplace.

Outlook for patent deals

Assuming that they can, deal makers expect the Chinese to continue to play a significant role in driving the market for US patent assets. “Chinese companies are still looking to acquire international patents,” explains Guy Proulx, CEO and chair of Transpacific IP. “It’s not necessarily ramping up, but they’re getting a better sense of what the market bears and becoming more adept at building a portfolio.” Mei explains that, regardless of the investment environment, US courts are still attractive to some Chinese companies which want to take on domestic rivals: “They will continue to look for opportunities to pick up portfolios, especially in standards. I’m not sure whether the new administration will have an impact on that.”

Mei believes that, if anything, Chinese regulations play as significant a role as US ones in restricting outbound Chinese acquisitions. “China is tightening foreign currency rules and often won’t allow money to leave the country,” he argues, noting that this policy will only get tougher if Chinese authorities see the risk of a trade war in which they will need a significant arsenal of foreign reserves. However, in terms of direct influence on patent transactions, he suggests that the weakening of US patent rights – particularly Section 101 issues – is a bigger factor than any trade-related or political concerns.

“There are buyers in the marketplace now where everything is driven by having European and Chinese counterparts, where they used to be driven by US rights,” agrees Proulx. While plenty of Chinese companies still want to enter the United States, some have taken the temperature of the market and concluded that they can wait and see when it comes to licensing in, relying on measures such as inter partes reviews should lawsuits become an issue.

Erick Robinson of Beijing East IP maintains that concentrating on their home market first makes sense for Chinese companies of any size. “My advice for start-ups and even larger companies is to focus on China, because the potency of a Chinese patent is greater than a US patent. I tell Chinese clients to focus on the domestic market, because that will get you the international market.”

Chinese responses

As unpredictable as the Trump administration may be, trying to gauge possible Chinese responses presents its own challenges. “It truly was very interesting to me that while the Chinese state press is saying things like ‘Trump is an ignorant child’ and ‘Watch out, we can retaliate,’ the officials themselves are keeping pretty quiet,” observes Perry. “That’s smart.”

However, it does not take much imagination to envision the ways in which big US businesses in China could be disrupted if relations sour. “Most of my clients are nervous,” admits Robinson. “We don’t know which way this is going. I hope Trump will find ways to create win-wins with China, but if he does create negatives that China then responds to, US firms will need an even better understanding of the market to protect themselves.”

Antitrust is one of the first levers that comes to mind. When a new probe of GM was announced just days after the phone call between Trump and Tsai, the media did not hesitate to make a connection between the two events. Regulators – particularly the National Development and Reform Commission – have not taken their eyes off the patent licensing space since settling with Qualcomm in 2015. Perry points out that any company making lots of money in China is exposed. “When they look at how to retaliate, the big, bright target is high tech. Maybe where they get you is with intellectual property.”

However, close observers of the patent business in China say that the prospect of continued attention from the commission to patent licensing was already likely, independent of Trump and any trade frictions. A number of probes are thought to be underway, while over the last year or two a few US companies have been invited to discuss their patent licensing practices with regulators behind closed doors. This will remain a live issue which will be watched closely by companies on both sides.

Another interesting question is how often North American companies avail of China’s judicial system. Mei admits that while Chinese courts can be used to open up an additional front in a broader patent war, he is still cautious about recommending them to US clients. He points to recent comments by the chief judge of the Supreme People’s Court, who roundly rejected the concept of judicial independence, as a reminder that ‒ for all its advances ‒ China has a fundamentally different system and the government still influences cases of every stripe. Such concerns could be contributing to the growing prominence of ITC disputes, as mentioned earlier.

However, others point out that US and other foreign companies already enjoy an excellent success rate in Chinese patent courts – especially the new specialised benches – and see little risk of a top-down effort to change that. “I don’t think the environment should cause companies to have second thoughts about enforcing patents in China,” insists Robinson. “As long as it’s a good case and it’s about foreign companies that are competitors of China’s ‘national champions’.” Perceptions of a tough environment for US tech could also spur growth in certain types of litigation. Consider the case filed by US-based non-practising entity GPNE against Apple in Shenzhen; to the extent that politics plays any role in this, it is unlikely to favour the defendant.

For businesses which have already forged positive, longstanding connections in China, any instability in relations could have a silver lining by hurting them less than competitors. “If Trump makes life difficult for foreign companies,” Robinson observes, “then those with a solid foundation will have a bigger advantage.” Intel, which owns 20% of Tsinghua Unigroup, is a good example of just such a friend to China. Large Chinese companies understand this game only too well – similar overtures have already been made in the opposite direction, with Alibaba and Foxconn both announcing plans to create jobs in the United States.

Waning influence?

One of the few concrete outcomes of Trump’s election is that the Trans-Pacific Partnership deal is now dead in the water. The 12-nation agreement was mainly a counterweight to Chinese influence in the region and contained numerous IP provisions which would have had significant ramifications in some Southeast Asian markets. Its abandonment raises questions as to what degree the United States will continue to be able to influence IP developments in the East.

Campaigning for the deal, President Obama often warned: “If we don’t write the rules for global trade, China will.” The Middle Kingdom will get its first shot at doing so through the Regional Comprehensive Economic Partnership, a competing trade deal being negotiated by the Association of Southeast Asian Nations (ASEAN), Australia, China, India, Japan, Korea and New Zealand. With both India and China at the table, many have expected this deal to have little impact on the IP space. However, there are some indications to the contrary.

The most recent leaked draft – dated October 2015 – sidesteps many of the most controversial pharmaceutical issues by providing for so-called ‘TRIPs flexibilities’ for less-developed signatories on the issue of compulsory licensing. However, on other subjects it appears to be shaping up to be unexpectedly strong ‒ so much so that Electronic Frontiers Foundation and Knowledge Economy International (which are not known for favouring maximalist IP policies) have described it as “a carbon copy” of the Trans-Pacific Partnership deal and “just as bad, if not worse” when it comes to intellectual property. Its take on software is particularly interesting: Japan appears to be pushing for strong protection of software patents – an issue that remains controversial in India, where computer programs per se are not patentable. It would be interesting to know how China – home to a very strong software patent regime – is negotiating on this point.

China certainly will not push IP protection across the region in the same way that the United States has, as it has never been a key part of its trade policy and sophisticated rights holders are not as big a constituency among the country’s economic players. Looking at bilateral deals which China has agreed with countries such as Australia, we can expect it to cleave to the Agreement on Trade-Related Aspects of Intellectual Property Rights, plus maybe a few extra protections on top. However, China does have a genuine interest in helping to promote the advancement of Asia’s less developed economies. Given the sizeable IP portfolios that its companies have built and their increasing business ties across ASEAN, this is a matter of simple self-interest.

Within China, it may be a similar story. While trade may loom large, intellectual property may not be near the top of the list of priorities awaiting Ambassador Terry Branstad when he arrives in Beijing pending Senate confirmation. However, many US companies feel that the IP environment is improving – even if China’s overall business climate is not. As Chinese companies amass larger IP portfolios, this progress should have its own momentum – a promising thought in uncertain times.