The people’s court

Ballooning patent portfolios, new IP courts and intense tech-sector competition mean that activity in China’s litigation space is heating up. Could this become the next major forum for high-stakes patent battles?

As 2014 drew to a close, Guangzhou’s 21st Century Business Herald broke the news of the opening salvo in a much-anticipated patent fight. According to its report, telecommunications giants ZTE and Huawei had sent letters to smartphone upstarts Xiaomi, Oppo and Vivo to notify them of WCDMA infringement. The freewheeling Herald’s would-be scoop went unconfirmed by the companies involved; in fact, Huawei’s head of intellectual property, Jason Ding, took to Sina Weibo to deny its veracity. Whether the story was a false rumour, a trial balloon or a warning shot, it briefly went viral in China – a response which suggests that the country may be on the cusp of a new and perhaps contentious stage of its IP evolution.

No matter how you look at it, the data confirms that patent litigation in China is on the rise. According to Rouse’s China IP Litigation Analysis (CIELA) service, the number of civil patent infringement cases accepted at first instance roughly trebled between 2006 and 2013. In the most recent year for which data was available, the courts accepted over 10,000 cases (including appeals) and handed down over 4,500 judgments. These impressive statistics belie the notion that domestic small and medium-sized enterprises (SMEs) still lack IP awareness. But so far, there have been few headline-grabbing patent spats involving China’s new corporate giants – whether between themselves or against Western competitors. There are plenty of good reasons for this; but there are also many who expect that the relative peace between major companies will be shattered sooner rather than later.

This is the background against which several intriguing developments in the Chinese IP sphere have been unfolding in recent months. The second half of 2014 saw the authorisation and speedy establishment of three dedicated IP courts in Beijing, Shanghai and Guangzhou. Under discussion for years, the specialised bodies were finally announced shortly before the Central Committee of the Communist Party made a raft of judicial reforms the centrepiece of its fourth plenary session in October.

Then there was the saga of US chipmaker Qualcomm, which was finally resolved in February 2015. The company agreed to pay a $975 million fine and adjust its royalty rates to settle a 14-month probe by Chinese authorities which found it to be in violation of antitrust laws. Speculation about the potential effects of the investigation on the Chinese patent environment had been rampant; those effects can now be expected to play out for real.

Developments overseas are also influencing the debate on the future of intellectual property in China. The America Invents Act, inter partes reviews and rulings such as the Supreme Court decision in Alice v CLS Bank have combined to put downward pressure on litigation levels in the United States, prompting much discussion over whether other jurisdictions will pick up the slack. Most of this has centred on Europe, where the inauguration of the Unified Patent Court (UPC) will allow plaintiffs to seek a single injunction covering a mature commercial market of 500 million people. However, that same logic has now got some forward-thinking practitioners looking further east.

Injunction, injunction, injunction

As in most other jurisdictions, the patent litigation calculus in China is presently founded on the possibility to obtain injunctive relief. “I tell clients that getting an injunction should always be the primary driver,” says Benjamin Bai, head of the China IP practice in Allen & Overy’s Shanghai office. Damages do feature in the big picture, but the real prize is the ability to exclude infringers from certain markets. Especially when litigation is a continuation of licensing negotiations by other means, the disruption caused by an injunction will invariably get the attention of an opponent at the highest levels of management.

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Benjamin Bai, partner and head of China IP practice, Allen & Overy

“I’m of the view that 20, maybe even 10 years from now, China will be the centre for global patent disputes”

Last December this point was made abundantly clear to Xiaomi, one of the biggest Chinese success stories of recent years, when it found itself temporarily enjoined from selling devices in India. The order stemmed from a dispute with Ericsson over standard-essential patents. The Swedish chipmaker claimed that it had tried for three years to obtain a licence to the patents on fair, reasonable and non-discriminatory (FRAND) terms, but had been stonewalled by the Chinese company. But when a Delhi judge was persuaded to ban the import, sale and advertisement of its devices in India, Xiaomi quickly broke its silence, saying that it was open to working with Ericsson to resolve the matter.

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William ‘Skip’ Fisher, partner, Hogan Lovells

“The IP courts have experienced judges who are on the leading edge of Chinese technical IP jurisprudence. Companies have more confidence than before that a run-of-the-mill case will be decided fairly”

It is worth asking why Ericsson chose India – itself not a common forum for international patent disputes – as the venue in which to press its claims. The country’s respected judiciary and status as a neutral site were no doubt contributing factors; but more importantly, this was the ideal consumer market in which to make Xiaomi sit up and take notice. The Chinese company has focused on expansion in emerging economies such as India and Russia, tapping into soaring demand for low-cost smartphones with high functionality. From an IP perspective, such jurisdictions were previously considered a relatively safe bet for the patent-shy Xiaomi; but that no longer looks so certain.

“I’ve got to tip my hat to Ericsson,” says Guy Proulx, chairman and CEO of Transpacific IP. “They had the guts to litigate in India and fired a shot across the bows of a major Chinese company.”

Of course, the only consumer market that can match India in size is China. Virtually every argument for the long-term importance of China as a litigation venue rests on the notion that an injunction covering its 1.3 billion citizens will only become more valuable as the market matures. And for as long as China makes and the world takes, court orders have the added benefit of preventing many infringing goods from being manufactured in the first place.

But many Western corporates worry that even if they can persuade a Chinese court to issue an injunction, it may go unenforced. “Enforcement of court judgments is a problem,” Bai acknowledges, “but not a showstopper.” In this regard, he suggests that a distinction should be drawn between the different types of infringer. First there are the large companies which are publicly listed in China or elsewhere; these are unlikely to dodge a court order outright. The same goes for what Bai calls “wannabe” companies – those angling to go public or expand internationally at some point in the future. Below this level, however, things become more problematic; small-scale enterprises, for example, may prove reluctant to shut down their factories. Bai recounts a typical case which he led against a small company that was supplying infringing products to a larger manufacturer. While his client successfully obtained an injunction, the infringer’s lawyer responded that the company planned to dissolve; the judge issued a stern warning not to do so while litigation was pending. According to Bai, these cases can still be managed with vigilance: such infringers could shut down and restart, but they may be deterred if they know that another suit will inevitably follow. Then there are the true ‘mom and pop’ outfits, which usually are not worth going after in the first place.

I tell clients that getting an injunction should always be the primary driver

Other practitioners would agree with Bai that the enforcement of injunctions does vary, but that the courts can take strong action where they have the will. So what does robust enforcement look like? King & Wood Mallesons’ Denning Jin presented one example in the firm’s China Law Insight blog. In 2012 a Belgian company obtained a preliminary injunction from the Shanghai No 1 Intermediate People’s Court against a Guangdong enterprise that was displaying and selling infringing wares at a major international trade exhibition. Several days later, the court learned that the infringer had flouted its order. Jin detailed its reaction: “The court quickly assembled a group of more than 10 judges and bailiffs to go to the expo centre and enforce the order. At the expo centre, enforcement was obstructed by employees of the infringer. In response, the judges took the employees to court and punished the Guangdong company and certain individuals through fines and detention.”

It is thus evident that a persistent and forceful judge can go a long way towards ensuring that rulings are respected. And if future patent infringement suits are filed mainly with the specialised IP courts and heard by China’s best and most experienced IP judges, the enforcement situation will likely improve further. That in turn should boost confidence in China as a viable proposition for foreign companies. In the words of Kasim Alfalahi, senior vice president and chief IP officer at Ericsson: “China is already promising and the foundation of the patent system is in place. If enforcement can become more efficient, then China will become a very important IP market.”

China’s new IP courts

On August 31 2014 the Standing Committee National People’s Congress approved the establishment of specialised IP courts in Beijing, Shanghai and Guangzhou. While they are billed as IP courts, they are strongly oriented towards technologically complex ‘hard IP’ cases; although the Beijing court will likely hear many Trademark Review and Adjudication Board (TRAB) appeals. This is intended as a three-year pilot, although the prominence accorded to the courts in the Supreme People’s Court’s most recent five-year plan suggests that they could become a lasting fixture.

According to the Supreme People’s Court, the specialised IP courts have first-instance jurisdiction over the following cases:

  • civil and administrative cases involving patents, plant varieties, integrated circuit designs, technical secrets, computer software and other technology cases;
  • administrative cases involving copyright, trademarks and unfair competition against the administrative actions of State Council departments or other departments above county level; and
  • civil cases involving the recognition of well-known trademarks.

The courts will hear IP-related appeals against first-instance judgements of the basic people’s courts in their jurisdictions. Decisions of the specialised IP courts can be appealed to the IP tribunals of the higher people’s courts in Beijing, Shanghai and Guangdong respectively.

The development has been welcomed by foreign enterprises. According to Kasim Alfalahi, senior vice president and chief IP officer at Ericsson: “It’s always a positive thing when you have courts which are specialised. It just shows how IP is becoming more and more important to China.” Brian Hinman, chief IP officer at Royal Philips, echoed this sentiment in a statement which read in part: “The set-up of the new IP court system shows that China has realized the importance of IP and the need for a strong IP enforcement system for the further development of Chinese economy. We are looking forward to seeing the new IP courts grow in experience and we expect that the consistency of the decisions rendered will increase. This will give us greater confidence in the Chinese IP judicial system.”

In a public appearance this February, Judge Wu Xielin, head of the Shanghai IP Court, indicated that a healthy proportion of patent infringement suits on his docket had already been filed by foreign (mostly US) companies – perhaps up to 40%. William ‘Skip’ Fisher of Hogan Lovells suggests that many multinationals are now more optimistic about the judicial system: “The IP courts have experienced judges who are on the leading edge of Chinese technical IP jurisprudence. Companies have more confidence than before that a run-of-the-mill case will be decided fairly.”

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Damage control

In the meantime, the meagre nature of Chinese damages awards is another obstacle to the jurisdiction becoming a preferred forum for plaintiffs. Although the maximum statutory damages award was doubled in 2008, it still stands at a paltry Rmb1 million ($160,000); and William ‘Skip’ Fisher of Hogan Lovells in Shanghai notes that for a variety of reasons, the vast majority of awards are “not even close” to this sum. Indeed, according to CIELA data, in disputes between Chinese companies the average award issued is just Rmb100,000.

The challenge of winning damages is not just a matter of judicial discretion or law; it is also closely tied to issues surrounding the collection of evidence. In the absence of US-style discovery, plaintiffs find it difficult to demonstrate the losses caused by infringement. That said, notes Fisher, “there have been vast improvements in mechanisms for patentees to prove infringement going back several years”. These include measures such as evidence preservation requests, which shift the burden of producing evidence slightly towards the defendant.

“The tools are out there, but they’re not widely used,” continues Fisher. “It’s a matter of getting individual courts to use these mechanisms more willingly. Of course, plaintiffs need to present a strong case; but courts can meet them halfway just by using the tools that already exist to uncover evidence that is in the possession of defendants.” While no one is advocating the introduction of US-style discovery, it appears that once again, a little more proactivity from the judiciary could go a long way. This will thus be another issue that will be closely scrutinised in the new IP courts.

For those hoping for a new approach to damages, the latest draft revisions to China’s Patent Law – which have been sent to the State Council for approval – have proved a mixed bag. The Rmb1 million cap on statutory damages has been retained – somewhat surprisingly, given last year’s uplift of the corresponding sum under the Trademark Law to Rmb3 million. However, the revisions would introduce the concept of punitive damages, allowing for compensatory damages (based on “actual losses suffered” or “illegal gains obtained”) to be trebled in case of wilful infringement.

Further progress in this regard has come in the form of a recent Supreme People’s Court amendment of an interpretation on the Patent Law that it issued back in 2001. According to Fisher, the document “sheds a bit more light on calculating damages” based on factors such as the volume of infringing products sold and the infringer’s operating profits. But ultimately, he says, this ties back into the evidence collection issue: “The amendment helps in the sense that it gives the courts some guidance on calculating; but ultimately they need to get the information by which the calculations can be made – either by allowing the plaintiff to get it or by requiring the infringer to produce it.”

Figure 1. Accepted and decided civil patent infringement cases

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Source: CIELA by Rouse from “China’s Innovation Quotient: Trends in patenting and the globalization of Chinese innovation”, Thomson Reuters

Qualcomm settles with trust-busters

On February 9 2015 Qualcomm announced that it had reached a settlement with China’s National Development and Reform Commission (NDRC) following an investigation in which the regulator found the US chipmaker’s patent licensing practices to be in violation of the Anti-monopoly Law. Qualcomm agreed to pay a fine of Rmb6.088 billion ($975 million) and implement a rectification plan which it laid out as follows:

  • Qualcomm will offer licences to its current 3G and 4G essential Chinese patents separately from licences to its other patents, and will provide patent lists during the negotiation process. If Qualcomm seeks a cross-licence from a Chinese licensee as part of such an offer, it will negotiate with the licensee in good faith and provide fair consideration for such rights.
  • For licences of Qualcomm’s 3G and 4G essential Chinese patents for branded devices sold for use in China, Qualcomm will charge royalties of 5% for 3G devices (including multimode 3G/4G devices) and 3.5% for 4G devices (including 3-mode LTE-TDD devices) that do not implement CDMA or WCDMA, in each case using a royalty base of 65% of the net selling price of the device.
  • Qualcomm will give existing licensees an opportunity to elect to take the new terms for sales of branded devices for use in China as of January 1 2015.
  • Qualcomm will not condition the sale of baseband chips on the chip customer signing a licence agreement with terms that the NDRC found to be unreasonable or on the chip customer not challenging unreasonable terms in its licence agreement. However, this does not require Qualcomm to sell chips to any entity that is not a Qualcomm licensee and does not apply to a chip customer that refuses to report its sales of licensed devices as required by its patent licence agreement.

Outside looking in

The new IP courts, and their approach to both injunctions and damages, will have a significant influence on the fortunes of companies doing business in China. But to predict whether these forums will likely play host to big-ticket patent fights in the coming years, one first needs to understand the different factors that inform the decision to litigate.

For foreign players, a primary concern is the nature of the Chinese legal system itself. For all the progress that has been made over the past decade, all the attention given to legal development at last year’s plenum and all the revisions to domestic laws of late, there remains a distinct lack of transparency and Western-style judicial independence. For many multinationals, this shrouds the prospect of litigation in a thick veil of uncertainty. But is this attitude justified?

As a starting point, it is worth remembering that there is no such thing as a dead cert in patent litigation anywhere in the world; the decision to take up arms is always underpinned by a complex risk/reward analysis. But Bai suggests that foreign companies should not be unduly deterred by systemic considerations when the potential benefits of stopping an infringer in China are so great. “Whether you win a lawsuit or not doesn’t really depend on the macro-system, but critically on the one or two judges who hear your case,” he adds. “This is why we are closely watching for complicated cases to show up in the new specialised IP courts, so that we can get a better sense of the judges.”

Another common apprehension is that Western companies will not get a fair run against local defendants. Of course, this concern is not unique to China; few plaintiffs would prefer to sue an infringer in its own backyard. As elsewhere, says Bai, “there are judges who go out of their way in both directions; but I have never subscribed to the idea that there is a systematic bias against foreign companies in China”. The statistics back him up: according to the latest data from CIELA, foreign plaintiffs had a 75% win rate against Chinese companies, while Chinese plaintiffs had just a 63% win rate against their peers. Moreover, the average damages awards handed down to foreign companies are 72% higher than those in favour of local players. While this does not prove that the courts actually favour foreign plaintiffs, it clearly explodes the myth of widespread bias against them.

Some Western SMEs have discovered this already and the results they have secured may help to convince bigger corporations that they too can get a fair hearing. One recent example involved Oregon-based hoist manufacturer Warn Industries, which sued two Chinese companies after discovering that markets around the world were being flooded with cheap lookalikes of its products. The Beijing No 3 Intermediate People’s Court ruled in its favour, stopping production of the infringing products at the source. Utah-based furniture manufacturer Lifetime Products is another US company that has likewise prevailed in the Chinese courts against a local company. Commenting on that case at IBPC China, Asia Pulp & Paper’s head of IP Jeffrey Lindsay said: “If a small company from Utah can go to China, sue a large Chinese company and win, then the system works.”

Proulx suggests that foreign SMEs may have more room to manoeuvre in China’s legal environment: “Small companies have a lot more freedom in terms of trying different approaches. That’s not to say it is easy: you have to be careful, pick a place and have some luck, but it is absolutely worth doing.”

It is not only as plaintiffs that foreign enterprises may increasingly see the inside of Chinese courtrooms. “From the defensive side, Western companies will have more of a target on their backs as the patent portfolios of both domestic and foreign companies mature in size and quality,” warns Fisher. As Chinese companies become more sophisticated in their approach to intellectual property, they can be expected to challenge big market entrants. Just ask Apple, which has been battling Shanghai Zhizhen Network Technology over the Siri voice recognition system since 2012. Zhizhen obtained a Chinese patent for its own personal assistant platform, Xiao i, well before Siri was introduced and sued the Cupertino company for infringement in a Chinese court. The suit is still ongoing, although Apple has suffered a couple of setbacks so far. The case confirms that whatever foreign companies may think of the Chinese justice system, they ignore it at their peril.

Figure 2. Win rate and mean statutory compensation comparison – foreign and domestic plaintiffs

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Foreign v Chinese

Chinese v Chinese

Foreign v Chinese

Chinese v Chinese

Win rate

Compensation

Source: CIELA by Rouse from “China’s Innovation Quotient: Trends in patenting and the globalization of Chinese innovation”, Thomson Reuters

The elephant in the room

Another key consideration for rights holders is the fallout from the Qualcomm imbroglio. For much of the past year, stakeholders watched cautiously as the National Development and Reform Commission (NDRC) investigated the US chipmaker for anti-competitive patent licensing activities, eventually slapping it with a $975 million fine and significantly restricting its licensing practices [for details, see the boxout on page 44]. But while Qualcomm’s fate no longer hangs in the balance, plenty of questions remain as to how the settlement will affect both domestic and foreign players going forward.

Multinationals have doubtless since been anxiously scouring their China strategies for anything which might attract the attentions of the regulators. Proulx warns that antitrust compliance is a new fact of life for rights holders in China: “The Qualcomm case means you now have to take a hard look at licensing practices.” Alfalahi suggests that Ericsson for one is reasonably confident on that front, not least thanks to its deep roots in the local market: “We have been in China for more than 100 years; we invest a lot in China and maintain a large R&D presence. We have been in the market for a long time and have always had a balanced and fair approach to licensing.”

Many others, though, are wary. The 2015 China Business Climate Survey, published jointly by the US Chamber of Commerce and Bain & Company, found that although 86% of respondents agreed that IP enforcement had improved over the past five years, 47% cited “inconsistent regulatory interpretation/unclear law” as a key business challenge, up 8% on the previous year. The outcome of the Qualcomm investigation will only add fuel to this particular fire.

As regards the settlement’s local impact, much speculation has centred on whether patent wars could break out among Chinese companies in the mobile space. According to sources including Reuters, the agreement with the NDRC ended a practice known as ‘reverse licensing’, whereby even the smallest Qualcomm licensee could gain free access to the patent portfolios of all other licensees – including filing giants ZTE and Huawei. This provided a measure of protection to patent-strapped companies such as Xiaomi. It also effectively prevented any two Qualcomm licensees in China from pursuing infringement claims against each other in the domestic courts. If that provision has indeed gone out the window, then the truce between big Chinese technology firms could soon go with it.

That same Reuters report suggested that ZTE lawyers has sent letters to half a dozen handset makers seeking royalties; so perhaps there was a kernel of truth to the 21st Century Business Herald story after all. Not that this would be the first time that the Shenzhen-based company has taken the fight to a compatriot: it is currently litigating against fellow telecoms titan Huawei in Europe, for example, over a FRAND dispute that has made it all the way to the European Court of Justice (ECJ). The new reality in the telecoms space following the NDRC’s Qualcomm decision suggests that in future, such disputes may play out closer to home.

That would mark a sea change in Chinese litigation trends. “There are lots of small companies that go after each other for relatively small damage amounts”, says Fisher, “but we haven’t seen as many big-ticket cases between large competitor companies. But I think that’s slowly changing.” In part, this is down to the inflated portfolios that have resulted from government incentives to encourage patenting in recent years: senior management are eager to find new ways to make those assets pay, whether by generating revenue or by excluding competitors from the market. This thinking has been accompanied by a new focus on quality, given the need for robust rights that can hold up to scrutiny in court. What in some cases may once have been regarded as an easy way to get a tax break has thus now become a fundamental aspect of business strategy. Xiaomi CEO Lei Jun was speaking about the mobile industry, but he might as well have been speaking about the whole Chinese market, when he remarked: “The fight for intellectual property is a rite of passage in the process of a smartphone company’s growth.”

And it is not just at the larger companies that the gloves are coming off. Small Chinese handset maker Oppo recently delivered a veiled warning to an even lesser-known rival in the Chinese mobile market called iNew, which had produced a phone with a rotating camera that multiple reviewers labelled a ‘clone’ of an earlier Oppo design. But it was not until six months later, when Polaroid slapped its branding on the iNew device, that Oppo raised a public fuss, blasting Polaroid (although, interestingly, not iNew) for infringing its intellectual property. Why did Oppo pick a fight with the US company, but not its Chinese partner? Perhaps it was sensitivity over pursuing a compatriot; perhaps Qualcomm-licensee Oppo was waiting to assess the fallout from the NDRC settlement; or perhaps it was just a chance to gain some easy publicity in the Western media. Regardless, it underscores the fact that it is not just household names in China that are now seriously weighing their licensing and litigation options.

“I think there is real potential for major litigation in [the telecommunications and mobile devices] space,” predicts Proulx. “These companies are competing head to head and it is about market share and share price.” “You’re already seeing it with the social media companies and computer platforms,” agrees Fisher. “So I think the answer is yes – big Chinese companies will start to sue their competitors more, and I don’t think it will come as a surprise.”

This being China, however, it is important to consider how the central government might view a rash of litigation among the tech companies that are the stars of its drive to become an innovation and consumption-based economy. Is it possible that government pressure may also have been keeping the genie in the bottle thus far? Now that one variable – Qualcomm’s reverse licensing policy – has been removed, we may soon find out.

Looking ahead

In the meantime, all the signs would indicate that China will only grow in importance as a forum for patent disputes. To Bai, it all comes down the consumer market: “I am of the view that 20, maybe even 10 years from now, China will be the centre for global patent disputes. The driver for that is the Chinese consumer market. Whether you look at pharmaceuticals, wireless or semiconductors, there has been a paradigm shift; if you pick one place to fight patent wars, it will be China. If the IP environment here improves as much in the next decade as it has over the past decade, it will be a world leader.”

When Proulx started operating in Asia 11 years ago, people assigned almost no value to Chinese patents; that has now changed significantly. “The path we are on today, even with the Qualcomm events, I would have to agree 100% that China could become one of the most important judicial venues within the next decade relative to Asia,” he suggests.

Fisher concurs: “You’ve got the maturing market and the incentive to exclude competitors from that market is strong; you’ve got companies that have more and more IP rights to assert, and other companies being forced to defend themselves against others. There is a rising level of confidence in being able to get a positive outcome, which right now is mostly still an injunction. Things are starting to come together.”

Action plan

There will be plenty of intriguing developments to follow in China over the next year. Make sure you aren’t caught by surprise:

  • Ensure that your portfolio is solid. This means more than simply designating China in a Patent Cooperation Treaty application, as Guy Proulx of Transpacific IP warns: “Often the level of care and concern put into a Chinese patent is several notches lower than for US or Europe. Then when you go to identify strong patent families, you may see that the Chinese patent is missing some key elements or claims and you end up with something that is not as strong”.
  • Watch vigilantly for infringement. Even for small and medium-sized enterprises, it is worth devoting some resources to monitoring this crucial market for infringement. As the experiences of several US small businesses show, a satisfactory outcome may be more achievable than you think.
  • Pay attention to the new specialised IP courts. Things to watch out for include damages awards, plaintiff win rates, foreign win rates, availability and enforcement of injunctions, attitudes towards evidence preservation and enforcement of judgments.
  • Don’t sleep on antitrust. The new Anti-monopoly Law is already an integral part of the new Chinese IP landscape. Patent licensing activities should be rigorously reviewed for compliance.

Jacob Schindler is a reporter for IAM, based in Hong Kong

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