Legal News: Eye on China Quarterly Newsletter offers companies helpful insight as they successfully navigate China’s complex and ever-changing legal and regulatory environment. In this issue, we focus on the following topics:
Domestic Anti-Bribery Enforcement May Be on the Rise in China: Multinationals Must Focus on Anti-Corruption Compliance
Another Potential Trap for the Unwary: Inventor Remuneration and Reward Under the Draft Rules on Inventor-Employee Inventions
Protection of IP Rights in China
Domestic Anti-Bribery Enforcement May Be on the Rise in China: Multinationals Must Focus on Anti-Corruption Compliance
By David W. Simon (firstname.lastname@example.org) and Robert H. Iseman (email@example.com)
Until recently, the primary risk that China’s culture of business corruption posed to multinationals was that they might run afoul of the FCPA or the UK Bribery Act. However, if one believes the current Chinese government’s stated prioritization of combating corruption, multinationals might now do well to focus on local Chinese anti-bribery enforcement as well. Various recent developments in the Chinese anti-corruption enforcement landscape suggest additional attention to anti-corruption compliance may be warranted. Not the least of these developments is the December 26, 2012 publication of a guidance and interpretation of Chinese criminal bribery law by China’s highest court. This article describes some of these recent developments, including the guidance, in an effort to analyze whether China’s local enforcement of its bribery laws poses a current and real risk for multinational companies doing business there.
China’s Culture of Corruption Spawns FCPA and Other Anti-Bribery Enforcement From Abroad
To set the stage, it is worth noting that enforcement of foreign anti-bribery laws such as the FCPA unquestionably poses a risk for multinationals operating in China. China’s tradition and culture of gift-giving and favor-exchanging, and its reputation for corruption in both the private sector and government-related business, is well-publicized and widely acknowledged. Corruption in China has been described as “baked into the cookies [there]”1 and “pervasive” in nature “with tentacles reaching into every sector of Chinese business, government, and society."2 "Business deals, especially in industries dominated by state-run companies, often succeed or fail based on one’s coziness with government officials.3 In fact, it has been reported that Chinese companies trying to operate in other countries have been surprised to find that bribery is not a common pre-requisite to doing business and are wary of dealings in which their position has not been secured by bribes.4
Add to this the fact that many businesses and industries in China are state-owned or controlled, and it is no surprise that China has been a hotbed of FCPA enforcement activity in recent years. In fact, for the period of 2006 through 2011, activities in China triggered the second-highest number of FCPA enforcement actions in the world.5 Further, The Trace Compendium lists approximately 50 FCPA-related incidents connected in whole or in part to China. These include both FCPA enforcement actions and companies’ public disclosures of internal investigations related to potential FCPA violations.6 And those are just the ones of which we are aware.
To give an example of the kinds of activities that create heightened FCPA risk in China, and the penalties that can result from those activities, some of the more notable FCPA enforcement actions in very recent years include the following:
Pfizer-Wyeth. In August 2012, the SEC filed separate complaints against Pfizer and Wyeth related to FCPA violations in approximately 10 different countries, including China.7 The allegations specifically related to China involved providing international travel, hospitality, and gifts (including cash) to state-owned hospitals and state-employed health care providers in exchange for prescribing Pfizer products, recommending Wyeth products to their patients, and otherwise using their influence to give Pfizer and Wyeth an unfair advantage in the market.8 For their violative activities in China and the other countries, Pfizer agreed to pay a $15 million penalty to resolve the DOJ’s investigation of FCPA violations, and Pfizer and Wyeth agreed to pay combined disgorgement of more than $45 million to the SEC.9
Maxwell Technologies. Maxwell Technologies was alleged to have paid more than $2.5 million to its Chinese sales agent from July 2002 through May 2009, which the agent used to bribe officials at Chinese state-owned entities in order to procure and retain supply contracts for Maxwell Technologies.10 In January 2011, Maxwell Technologies entered into a deferred prosecution agreement with the DOJ under which it agreed to pay an $8 million criminal fine in three installments over two years.11 Maxwell Technologies also settled SEC allegations, agreeing to pay disgorgement of $5.65 million and prejudgment interest of $696,314 in two installments over one year.12
IBM (Asia). In March 2011, the SEC charged IBM with violating FCPA books and internal control provisions by providing improper cash payments, gifts, travel, and entertainment to government officials in South Korea and China.13 The conduct in China was alleged to have occurred from at least 2004 to 2009, and involved more than 100 IBM China employees,14 engaging in a “widespread practice of providing overseas trips, entertainment, and improper gifts to Chinese government officials.”15 On the same day as the charge, without admitting or denying the allegations, IBM agreed to entry of a final judgment enjoining them from violating the FCPA books and records and internal controls provisions, and requiring them to pay $5.3 million in disgorgement, $2.7 million in prejudgment interest, and a civil penalty of $2 million.16
Biomet. In March 2012, the SEC and the DOJ filed actions against Biomet based on allegations of paying bribes to public doctors in China, Brazil, and Argentina between 2000 and 2008.17 The benefits conferred on Chinese government doctors included personal travel and conference sponsorships given in quid pro quo arrangements for becoming Biomet customers.18 Biomet agreed to disgorge more than $4.4 million and pay more than $1.1 million in prejudgment interest to settle the SEC complaint.19 Biomet also entered into a three-year deferred prosecution agreement with the DOJ under which it agreed to pay a $17.28 million criminal penalty and implement rigorous internal controls.20
Watts Water Technologies. The SEC alleged that Watts Water Technologies (Watts) violated the FCPA books and records and internal controls provisions between April 2006 and July 2009 in connection with its Chinese subsidiary (CWV) making improper payments to employees of Chinese state-owned design institutes that, in turn, recommend CWV’s infrastructure-related valve products to state-owned entities, and also drafted specifications that favored the CWV’s products.21 Watts agreed to pay $2.75 million in disgorgement, $820,791 in prejudgment interest, and a $200,000 civil penalty.22
Nordam Group, Inc. Nordam was alleged to have paid bribes to Chinese state-owned airlines23 in order to secure maintenance contracts with those airlines. In July 2012, Nordam signed a non-prosecution agreement with the DOJ under which it agreed to pay a $2 million penalty, cooperate with the DOJ for the term of the agreement, and submit period compliance efforts reports to the DOJ.24
Also of note, in early 2012 the British Serious Fraud Office (SFO) launched an investigation of Rolls-Royce’s activities in China.25 The allegations under investigation involve Rolls-Royce making improper payments to an executive working for two state-owned Chinese airlines to facilitate the sale of $2 billion in aircraft engines to those airlines.26 The SFO’s investigation of Rolls-Royce is ongoing.27
Brief Overview of Chinese Anti-Bribery Law and the Guidance
China has two different anti-corruption statutes, the People’s Republic of China (PRC) Criminal Code, which is a criminal law, and PRC Anti-Unfair Competition Law (AUCL), which is a commercial law.28 Both of these statutes prohibit bribery.29 Among other things, the PRC Criminal Code prohibits Chinese government functionaries from soliciting bribes, and also prohibits the offering or payment of bribes to government functionaries.30 Additionally, effective May 1, 2011, the PRC Criminal Code was amended to prohibit bribery of foreign government officials and of international public organizations, where the briber’s object is to secure an illegitimate commercial advantage.31 The intent of the May 2011 amendment was to create legislation similar to the FCPA and UK Bribery Act, and in fact that amendment has been referred to as “China’s FCPA.”32
Generally, Chinese anti-bribery legislation tends to lack specificity as to the elements that constitute a violation.33 This has allowed Chinese authorities broad latitude in pursuing and prosecuting potential violations, and also has complicated businesses’ and individuals’ efforts to structure their activities in a way that does not violate Chinese anti-bribery legislation.34 The May 2011 amendment to the PRC Criminal Code is no different, with observers noting that “elements of the law are vague, and questions remain about whether or not it will be used to prosecute state-owned companies.”35
On December 26, 2012, China’s Supreme People’s Court and Supreme People’s Procuratorate, respectively China’s highest court and highest prosecutorial body, issued a guidance to interpret existing criminal bribery laws and guide their enforcement (Guidance).36 The Guidance carries the force of law in China, and became effective on January 1, 2013.37 As stated in its introduction, the Guidance is specifically directed at criminal bribe-giving cases.38 Among other things, it fills in some details with respect to criminal bribery laws, including setting the monetary threshold for a bribe to a state functionary that will generate a criminal investigation (RMB 10,000 or approximately $1,600), and also the monetary thresholds and other factors that will trigger categorization as a “serious case” or a “very serious case,” among other designations.39 However, the practical difference among the various designations remains unclear.40 Among other additional provisions, the Guidance also provides potential value, including penalty reduction, for self-reporting or otherwise confessing wrongdoing.41
China’s Recent Domestic Anti-Corruption Enforcement Activity
China has been notoriously inconsistent in the enforcement of its anti-bribery laws. As observers have noted, “[t]here is no rule of law when it comes to enforcement. Courts are biased in favor of local defendants, and something you have been doing for years without a problem can suddenly turn into trouble.”42 China’s vague laws also allow for inconsistent and sometimes politically motivated enforcement.43 Some observers have noted that foreign companies, as well as companies in sensitive industries, such as pharmaceuticals and health care, come under disproportionate scrutiny.44 It has been estimated that of the 500,000 corruption investigations in China between 2000 and 2009, 64 percent involved foreign companies.45
In June 2010, Chinese authorities investigated Johnson & Johnson’s Shanghai operation in connection with alleged bribes paid to a former functionary of the Chinese state Food and Drug Administration.46
Also in 2010, Nike China’s marketing director was arrested in connection with allegedly procuring a contract to sponsor a Chinese soccer league by making improper payments to the former head of the league.47 The former head of the league and his deputy also were arrested on suspicion of taking bribes.48 Nike itself does not appear to be a target of the prosecution.49
In 2010, media reports indicated that Chinese authorities had detained certain persons, and were questioning others, including an Ericsson representative, in connection with alleged bribes paid to China Mobile executives.50
In 2011, Chinese authorities arrested the airline executive involved in the Rolls-Royce matter noted above in connection with the allegations that he had taken bribes from intermediaries working for Western companies.51
Some Chinese enforcement actions also have resulted in imprisonment for foreigners, albeit sometimes under murky circumstances. For example, in 2009, Chinese authorities investigated global mining company Rio Tinto’s alleged bribery of Chinese officials to obtain steel industry information, accepting bribes from Chinese steel mills, and theft of state secrets related to the steel industry.52 In 2010, Chinese officials arrested four Rio Tinto employees, including an Australian citizen.53 All were found guilty of accepting bribes and stealing trade secrets, and received prison sentences varying between seven and 14 years.54 According to The New York Times, the Rio Tinto case “[drew] international attention because of concerns that the four employees were arrested on trumped-up charges as well as worries about whether the employees could get a fair trial.”55 Among other cited ulterior motives for the prosecution were Rio Tinto’s declining a $19.5 million investment from one of China’s biggest mining companies the year before, and China’s “tough negotiations with foreign suppliers over iron ore prices” due to rising ore prices and a concern that foreign ore producers could fix ore prices and harm China’s large steel industry.56
In a separate instance in 2010, Chinese officials detained Australian businessman Matthew Ng, the chief executive of a successful Chinese company called Et-China, as well as Et-China’s chairman and CFO, based on various accusations, including bribing Chinese officials and embezzlement.57 In December 2011, all received prison sentences. Ng received a sentence of 14.5 years, of which two years were related to the bribery charge.58 Ng argued in court, but to no avail, that the accusations were fraudulent, orchestrated by a third party that wanted to acquire his company cheaply.59 Specifically, Ng claimed that he and his colleagues were offered release if they would allow Guangzhou Lingnan, Et-China’s local joint venture partner and the largest company owned by the local municipal government, to take control of Et-China at a discounted price — an offer that Ng said he and his colleagues refused.60 In March 2012, Ng effectively lost his appeal, achieving only a two-year reduction in his sentence.61
China’s New Anti-Corruption Focus
By most outward appearances, Xi Jinping, the Chinese communist party’s new general secretary, seems to have made fighting corruption his regime’s top priority since he entered office in November 2012.62 In fact, one observer referred to the month of December 2012 as “a month-long anti-corruption campaign.”63 This new anti-corruption focus is bolstered by Xi Jinping’s own bold public statements, such as that China must combat corruption in government at all levels, from the “tigers” (high-ranking officials) to the “flies” (lower-level officials),64 and that “[China] must have the resolve to fight every corrupt phenomenon, punish every corrupt official and constantly eliminate the soil which breeds corruption … .”65 Further, Xi Jinping has urged Chinese officials to “build a clean government, show self-discipline and restrain their relatives and associates.”66
Despite considerable skepticism over the sincerity of this new anti-corruption focus, it might be more than just words. For instance, the Chinese government has chosen Wang Oishan, who has made a career of cleaning up political and fiscal problems throughout China, to lead the corruption clean-up.67 Additionally, there has been a recent spate of investigations and enforcement actions against government officials. As washingtonpost.com described,
The most colorful cases have combined vast sums of ill-gotten wealth with a whiff of debauchery: a police chief who kept a pair of sisters as his mistresses, giving them police jobs and a city-funded apartment; an official taped having sex with an 18-year-old as part of an alleged blackmail scheme by a construction company; and an official given a suspended death sentence after accepting $7.5 million in bribes and keeping diaries chronicling his sexual encounters with 136 women, including the following “disgraced officials.” 68
CNN.com also recently provided several enforcement examples as follows:
A lowly bureaucrat who, despite a modest salary, has been found to be wearing expensive-looking watches on various occasions; Internet watchdogs have dubbed him "Brother Watch"
A senior official now known as “Uncle House,” who was found by government officials to own 21 houses despite being on a meager income
A district Communist Party chief in Chongqing, who was fired after being caught on video having sex with a young woman who was alleged to be a prostitute
The former chief of China Railway Container Transport, who was sacked and accused of receiving bribes of 47 million yuan ($7.5 million) between 2005 and 2010
The Sichuan provincial deputy secretary who was removed for alleged “serious discipline violations,” the most senior official to have fallen since the new leaders took over in November 201269
Moreover, on January 27, 2013, The New York Times reported that a senior Chinese official, the vice chairman of what the article referred to as the “national rubber-stamp legislature” was under investigation by the Chinese government.70 The article suggests this incident “could represent the first time a national political figure has been netted in China’s anti-corruption drive.”71 The article did not describe the details of the investigation or what kind of alleged activity was involved, and noted that no charges had been filed against the senior official.72
Additionally, on the corporate end, in January 2013, Chinese authorities detained a Foxconn manager in Shenzhen, China, on allegations that the manager had solicited and accepted bribes from suppliers in exchange for purchasing their products for Foxconn.73 Foxconn, also known as Hon Hai, is a Taiwanese company that assembles products for the likes of Apple, Sony, and Nokia.74 This may be an instance of enforcement of commercial bribery laws as it is unclear whether Chinese government functionaries were involved in giving or accepting the bribes.
The Guidance also appears to be part of this movement. Historically, Chinese authorities have prosecuted the bribe recipient, not the briber giver.75 However, the Guidance’s clear focus, as stated in its introduction and apparent throughout, is on the bribe giver.76 The Guidance, therefore, seems to mark a broadening shift in how China intends to enforce its anti-bribery legislation, at least in the criminal context.
The Chinese government also seems to be taking action on the cultural side. For instance, in February 2013, the Chinese government banned the airing of advertisements suggesting gift-giving before the lunar new year.77 The rationale is that encouraging people give expensive gifts to bosses sends the wrong message to a society that is battling widespread corruption.78 The Chinese jewelry industry estimates that one-third of all luxury goods in China are purchased as gifts, and one-tenth of them are used as bribes.79
Critics point out that the government’s efforts so far have focused primarily on cases that are high-profile because of their scandalous and salacious nature, but in fact primarily involve low- to middle-level officials.80 It seems they are catching more “flies,” albeit flashy ones, than they are “tigers,” which may indicate a form over substance approach to enforcement, and that the current efforts are really more for show.
Moreover, many of the government officials under current scrutiny or prosecution were identified through individual whistleblowers using an anonymous microblogging system called Weibo.81 However, a relatively new Chinese law, presented and passed in a matter of days, now requires Internet users to register under their real names.82 Although the law’s apparent purposes are to reduce Internet scams and spam email, and to “protect the public from baseless and libelous accusations,” it also has the effect of blunting the effectiveness of Weibo by forcing users to reveal their identities.83
What This All Means for Multinationals in China
Layered on top of the already aggressive enforcement efforts by the U.S. government against corrupt conduct taking place in China, ample evidence now exists to conclude that there is a strong, new domestic focus on anti-corruption in China as well. This new focus has manifested in new legislation, new legal guidance, multiple declarations from the current regime of intent to combat corruption, multiple current investigations and prosecutions of Chinese government officials, and even an attack on the culture of bribery through the banning of lunar new year gift advertising. Criticism and skepticism of the sincerity and motivation of this new anti-corruption directive appear to be well-founded, but that might not create much comfort for multinationals facing the current Chinese anti-corruption environment — nor should the apparent general lack of current enforcement activity directed at multinationals.
In fact, the apparent new zeal for corruption prosecution — especially for high-profile cases that provide an element of scandal or intrigue — combined with an uneven enforcement history and the lingering culture of corruption itself, would seem to make for a particularly high-risk environment. A prosecution motivated by corruption or a desire to make a show can be even more dangerous and carry harsher penalties than a legitimately motivated prosecution. If Matthew Ng’s side of the story is true, his circumstances provide a prime example of that. Indeed, the anti-bribery climate in China seems particularly perilous at the moment, and although multinationals do not currently seem to be principal targets, it would be wise to avoid being the first.
Another Potential Trap for the Unwary: Inventor Remuneration and Reward Under the Draft Rules on Inventor-Employee Inventions
By Song (Max) Lin (firstname.lastname@example.org)
On November 12, 2012, the State Intellectual Property Office of the People’s Republic of China (SIPO) issued the Draft Rules on Inventor-Employee Inventions (Draft Rules) for public comment. The Draft Rules, in their current form, affect a wide array of business and corporate entities and their employees. This article will focus on an issue that will be of particular importance to these entities and their employees: the provisions governing reward and remuneration.
Conflicts Between the Draft Rules and the Implementing Rules for the Patent Law
In 2009, China published the third amendment to the Patent Law and the Implementation Rules for the Patent Law (Implementing Rules). The Implementing Rules set forth the reward and remuneration framework for inventor-employee inventions. A discussion regarding the framework under the Implementing Rules can be found in the article titled, “A Potential Trap for the Unwary: Inventor/Creator Remuneration and Reward Under the Third Amendment.”1 Conflicts appear when comparing the framework established by the Implementing Rules to the proposed provisions set forth in the Draft Rules. As such, there has been some confusion regarding the relationship between the Implementing Rules and the Draft Rules, and further guidance is needed. Since guidance documents or transition measures have not been promulgated officially, this article seeks to reconcile the different provisions between the Implementing Rules and the Draft Rules.
The subject matter of the inventions covered under the Draft Rules is broader than that under the Implementing Rules. For example, work products such as patents, new plant varieties, integrated circuit layout design, and technical secrets fall under the subject matter of the Draft Rules. However, the Implementing Rules only govern inventions protected by patents. For inventions not protected by patents, the Draft Rules will be applicable when they are passed by the legislative authority in the future. For conflicts existing in the field of patent inventions, it is hoped the legislative authority will during the legislative process reconcile the conflicting provisions directed to the same subject matter as codified in the Implementing Rules and the Draft Rules. Given that the same legislative authority is promulgating the Implementing Rules and the Draft Rules, the legal hierarchy of the two Rules is the same. However, using the principle of “Priority of New Law Over Old Law,” the Draft Rules will likely preempt the Implementing Rules if conflicts remain.
The Contract-First Principle is applicable to both the Draft Rules and the Implementing Rules. The Contract-First Principle provides that an agreement between an entity and that entity’s inventor-employee or an entity’s policy statement is prioritized in guiding the distribution of the inventor-employee’s remuneration and reward.2 However, the second paragraph of Article 19 of the Draft Rules may appear to be contradictory to this principle by stipulating that “[a]ny agreement or policy eliminating or limiting the right to which the inventor is entitled in accordance with the Rules is invalid.” The purpose of this provision and the Draft Rules at large is to make sure that inventors enjoy certain rights, especially the right of reward and remuneration and a right of first refusal. Therefore, if an agreement or policy provides that the inventor-employee will not enjoy any rights to the inventor-employee’s invention, such agreement will be contrary to the purpose of the Draft Rules and will be invalidated. However, it is important to note that the word “limiting” is not clearly defined. As such, legal scholars are not sure whether any limitations, or what degree of limitations, to the inventor’s enjoyment of the right will hold the agreement or policy invalid. For example, entities may require that an inventor-employee work for such entity for a minimum period of time as a pre-condition of enjoying any inventor’s rights. In some instances, such a requirement may be reasonable given the business environment and business customs. However, if such reasonable limitations invalidate an agreement or policy, it could become burdensome for the entity and ultimately hurt innovation. As such, it is a good idea to delete the word “limiting” or leave an industry-specific third party to judge whether “limiting” is appropriate based on the entity’s business model rather than invalidating any agreement or policy directly.
When no agreement or policy statement between an entity and its inventor-employee exists, the Draft Rule provides for the following default rules:
Patent invention or new varieties of plant: Not less than 200 percent of the monthly average wages of the workers in entity
Other intellectual property: Not less than the monthly average wages of the workers in the entity3
On the other hand, the minimum rewards stipulated in the Implementing Rules are as follows:
Invention: Not less than 3,000 RMB (approximately $483)
Utility model or design: Not less than 1,000 RMB (approximately $161)4
In comparing the stipulated minimum rewards in the two rules, one can see that the amounts have been raised significantly. Though the monthly average wages of the workers in an entity depend on the specific entity’s economic profit, we can observe a general picture of the minimum rewards based on the social monthly average wages. For example, the Shanghai government had published that Shanghai’s 2011 average monthly salary is 4,331 RMB. This significantly raises the reward and has the potential to impose an onerous burden to the entity.
Further burdening the entity, rewards will usually be paid to the inventor-employee after the intellectual property right is granted, regardless of whether the inventor-employee’s invention is utilized or not. This is problematic because the value of an invention will not be realized until it is utilized, rather than when such invention is granted an intellectual property right. It is more reasonable to let entities hold the reward until the invention is utilized. However, neither the Implementing Rules nor the Draft Rules adopt this reasonable provision. It is clear that both the Implementing Rules and the Draft Rules are inclined to protect the inventor-employee’s rights because the entities automatically own the title to inventor-employee’s invention. However, it is recommended that the legislative authority balance the interests of the entity and inventor-employee by considering the developmental stage and economics of the Chinese entity. In its current form, the minimum reward in the Draft Rules may be too high for some entities to bear. Perhaps the level stipulated in the Implementing Rules is a better fit. Finally, it is unclear whether the “patent invention” in the Draft Rules refers only to “invention” or whether it includes “utility model and design.” In short, the Draft Rules need further clarification in addition to ensuring reasonable rewards.
With respect to legal remuneration, the Draft Rules provide:
Invention or new varieties of plant: Not less than five percent of the operating profit or not less than 0.5 percent of the revenue earned from exploitation of the patent invention or new varieties of plant
Other intellectual property: Not less than three percent of the operating profit or not less than 0.3 percent of the revenue earned from exploitation of other intellectual property right5
The remuneration stipulated in the Implementing Rules is:
Invention and utility model: Not less than two percent of the profits after the taxation earned from exploitation of the invention or utility model
Design: Not less than 0.2 percent of the profits after the taxation earned from exploitation of the design6
Comparing these two valuation methods regarding remuneration, one can see two main differences: (1) the percentage and (2) the valuation basis. Currently, it is not clear why the Draft Rules adopts such percentage and valuation basis. It is likely that the entities affected by the Draft Rules will object to the new standards of remuneration.
One advantage of the Draft Rules over the Implementing Rules is that the Draft Rules cap the remuneration by providing that “[t]he accumulated amount of the remuneration above will not be more than 50% of the accumulated operating profit of exploiting the intellectual property right.”7 However, entities may still question such a cap provision. For example, consider a product that is covered by 10 patents. Under the Draft Rules, if each invention has one inventor who receives the maximum remuneration of 50 percent of operation profit, the amount of remuneration paid by the entity would be 500 percent of the operating profit. Even if only two patents with two separate inventors cover a product, a 50 percent remuneration rate may inhibit production of the product. Such questions were raised during the legislation process of the third amendment to Patent Law and the Implementing Rules, but the Implementing Rules did not provide an answer. However, the Draft Rules clarify the issue by providing, “When an entity is deciding the amount of the remuneration, factors shall be considered such as the economic contribution to the entire product or process made by each inventor-employee’s invention, and the contribution into each inventor-employee’s invention made by every inventor, etc.”8 By codifying this provision, entities can avoid the above situation by distributing all profits generated from the product covered by more than one invention to inventor-employees in an equitable fashion.
In addition, the Draft Rules provide not less than 20 percent of the net income of an assignment or license as remuneration to the inventor when an entity assigns or licenses an intellectual property right. Such remuneration standard may prove to be a heavy burden to the affected entities.
A Right of First Refusal
A right of first refusal provides that before an entity transfers an invention to a third party, the inventor-employee shall have a right to buy that invention on the same terms. Strictly speaking, a right of first refusal does not belong to reward and remuneration. However, since the right of first refusal is a right granted to an inventor-employee by the Draft Rules, it is relevant to the discussion. Entities, especially foreign entities, may object to codifying the right of first refusal into the Draft Rules since granting such right of first refusal to an employee is in contravention with typical inventor-employee’s labor contracts with their employers. Generally, most labor contracts will prevent an employee from engaging in a competing business against such employee’s employer. Given the potential conflict, it would seem that the legislative authority nevertheless provided for the right of first refusal to the inventor-employee because the legislative authority believes the inventor will understand the invention better than any other party and will find a better use of such invention. While this idea is fair in principle, the legislative authority needs to consider the actual business environment. The legislative authority should focus on balancing the interests between the inventor-employee and the relevant entity by limiting the right of first refusal to situations where such inventor-employee does not compete with the entity.
The Draft Rules were designed to further protect an inventor-employee’s rights by imposing restrictions and requirements on the employer entity. Such provisions may be welcomed given the historically weak bargaining position of employees in China. However, such restrictions and requirements risk reducing the competitiveness of impacted entities and may ultimately stifle innovation. As such, the legislative authority should look to balance the interests of two sides.
Protection of IP Rights in China
By Mark A. Aiello (email@example.com) and Chao Meng (firstname.lastname@example.org)
Chinese civilization has a long history of innovation and creativity. However, due to a variety of historical reasons, China began developing and reforming its intellectual property (IP) rights protection system at a comparatively late date. Today, as manufacturing is becoming more concentrated in China, so too has IP rights infringement. According to the U.S. government, U.S. companies lose more than $1 billion each year to piracy alone. Other forms of IP infringement, such as the illegal inclusion of U.S. proprietary technology in Chinese goods, are equally, if not more, damaging. Therefore, IP protection is pivotal to successfully doing business in China.
In order to best protect the IP rights of a U.S. company seeking to produce goods through a Chinese manufacturer by providing a protected design, the U.S. company needs to take actions even before the contracting stages. The client should first identify the types of IP rights that may be involved in the project because, like the United States, China classifies IP rights according to the type of IP. For example, utility patents may protect a product’s structures, functions, and/or manufacturing process; design patents protect a product’s appearance; trade secrets protect technical know-how; and copyrights protect written materials.
Following identification of the different IP rights potentially at risk, the U.S. company should further ascertain whether appropriate registrations of certain IP rights have been sought in China and, if not, whether it shall pursue such registrations. Companies must register their patents and trademarks for those rights to be enforceable. However, copyright registration is optional, although it may buttress a U.S. company’s claim that it held title to the copyright in the event of a dispute.
Specifically, in the case of trademarks, it is advisable to seek trademark registrations in advance, as China employs a first-to-file system, under which it is likely that the first company to file the trademark application would be entitled to protection even though it may not be the first company to develop or use the registered trademark. As for product designs, it is also advisable to consider seeking utility patent and/or design patent registrations because, although it is possible to enforce trade secrets in China under Article 10 of the Anti-Unfair Competition Law, it could be difficult to do so in practice. The better alternative would be to seek protection under the Patent Law.
Such preparation work will better position the U.S. company in the negotiation with the Chinese manufacturers and may also prevent disputes from arising in the first place.
It is critical that before sharing any confidential information with its partner in China, the U.S. company should enter into a confidentiality agreement obligating the Chinese party to keep such information confidential and restricting the Chinese party’s usage of this information. The confidentiality agreement may need to be revisited and revised from time to time in accordance with the progress of the project. For example, in the initial discussion, the confidentiality agreement may only cover some general information disclosed to the Chinese party for evaluation purposes. When both parties enter into a formal business relationship, a separate confidentiality agreement may be required to cover the detailed technical know-how to be shared with the Chinese party for the purpose of manufacturing.
In manufacturing activities, the most important IP agreement is probably a licensing agreement that clearly defines ownership of the various IP rights, scope of the license, and royalty scheme, among other items. The ownership prong should encompass both existing and newly developed IP. The scope of the license also should encompass the term, territory, and exclusivity of the license. Finally, in the royalty scheme, the U.S. company should consider first the royalty rate and second whether a minimum royalty payment is required.
The U.S. company also should bear in mind that in certain circumstances, other alternatives to licensing may be beneficial. For example, when creating a joint venture (JV), which remains a fairly popular way to manufacture goods in China, the U.S. company may consider injecting its existing IP rights into the JV. Although this may dilute the U.S. company’s control over the IP rights, it will minimize the U.S. company’s capital investment, although valuation of such contributed IP rights is complex and lengthy, and ultimately most foreign JV partners end up structuring a license agreement from the affiliate owner of the IP rights to the Chinese JV. In any circumstance, the U.S. company should be aware that in a JV scheme, the newly developed IP by the JV will likely belong to the JV itself such that the U.S. company may be restricted from using the newly developed IP. This is in addition to the normal risks of unauthorized disclosure or use of IP rights to commercialize such rights outside of the confines of the JV itself and to the sole financial benefit of the Chinese JV partner or some other affiliated company.
Furthermore, the U.S. company should be aware that it will have diminished control over the existing IP that it has contributed or licensed to the JV. Thus, the risk of misappropriation of such IP becomes more significant. Actually, so long as the U.S. company has little control over the manufacturing process, such a risk also exists in most other possible schemes to manufacture in China, which are discussed below.
The second scheme involves a supplier relationship (e.g., a “factory-in-factory” arrangement) between the U.S. company and Chinese company. This arrangement may provide the U.S. company with tight control over its technologies if the U.S. company chooses to run operations on its own. However, the downside is that such an arrangement requires heavy investment on behalf of the U.S. company. The third scheme involves setting up a licensing and royalty arrangement. Doing so may give the U.S. company the option to work with other Chinese vendors if a non-exclusive license is entered. On the other hand, the U.S. company should closely audit the relevant sales and productions to ensure its royalties. Finally, a U.S. company has the option to engage in contract manufacturing. From the IP point of view, however, this scheme could be the most risky because little stands in the way of misappropriating IP, especially if proper patent registrations are not sought in China.
In recent years, China has enacted IP laws and has attempted to abide by international regulations. However, poor enforcement and cultural differences often frustrate the efforts of U.S. companies to enforce their IP rights in China. Thus, it is crucial for the U.S. company to make IP protection a core objective of the entire business endeavor. Specifically, the U.S. company needs to closely monitor the market to ascertain any possible infringement of its IP rights or violation of the manufacturing arrangement. Alternative forms of protection, such as technical controls, should also be explored. No one method of protection in China is perfect, but by using custom tailored strategies, it is possible to minimize the risk of IP loss.