I will be chairing a panel on litigating and licensing patents in China on Tuesday, October 24 at LES 2017. Please come by, email me at email@example.com or text me at 713-498-6047 if you would like to meet!
The good news is that China’s entire civil litigation system has significantly improved, not just its patent enforcement system. Contracts are fairly and effectively enforced between foreign and Chinese parties. This means that if the contract is breached, a foreign company can get monetary damages and/or injunctive relief from a Chinese court so long as a foreign company: (1) executes a valid contract with a Chinese company, (2) that contract is sufficiently straightforward that a Chinese court can make a ruling of fact without significant investigation, and (3) the contract is not subject to China’s Technology Import Export Regulation (“TIER”), or the foreign company builds in a business advantage to incentivize the Chinese company not to escape the contract via TIER.
This brief memorandum addresses TIER and some ways to possibly deal with it, best practices for forming joint ventures with Chinese companies, and how to protect core and non-core IP in China.
II. China’s Technology Import Export Regulation (TIER)
A. TIER Restrictions
Licensing is the primary means by which technology flows into markets and it may also set the stage for joint additional advances. The challenge to parties negotiating a licensing agreement is to find terms that are mutually beneficial, so that agreement is in the interest of both sides. Especially in the context of high technology, and associated intellectual property, it is critical that the parties have great flexibility in arriving at mutually beneficial terms as the market and circumstances demand.
Unfortunately, China’s Technology Import Export Regulation imposes rigidities as they relate to certain key terms, making it more difficult for the parties to reach agreement. The Chinese government, via the Ministry of Commerce (MofCOM) has mandated certain conditions be a part of any license of technology into China, regardless of whether those terms are in the parties’ contract, or even if these terms are specifically contradicted by contract. TIER mandates that foreign licensors fully indemnify Chinese licensees, surrender ownership to any improvements, and not prohibit marketing rights of Chinese licensees.
The first potential problem with TIER pertains to indemnity terms, which govern which party should bear the burden if the licensee’s right to the licensed technology is challenged by a third party. Given the wide variety of circumstances, there is no single best approach to indemnity terms, which should be left to the parties to address in a mutually beneficial manner. TIER, however, inflexibly imposes all indemnity risks on the foreign licensor.
Interestingly, many open source licenses are incompatible with TIER because they mandate that no indemnity is provided. For example, most open source licenses do not provide any warranties of non-infringement or any provisions for indemnification and some licenses specifically disclaim any warranty or indemnification. This obviously contradicts TIER and requires a violation of either the open source license or TIER. As use of open source-licensed code grows in China, this will be an important issue. Although TIER does not have a strong record of enforcement, open source licenses do. Indeed, the penalties for violation of such license terms can be draconian, including enjoining distribution and use of the software, as well as damages and attorneys fees.
The second potential problem with TIER pertains to rights in technology improvements developed by the licensee. A licensor will often desire to have shared rights in improvements, in exchange for giving the licensee more favorable terms, such as by lowering any royalty payment. A licensor unable to share in improvements developed by the licensee risks being locked out by the new development, and so it may conclude that it cannot reach a deal with a Chinese partner due to the great uncertainty created by TIER. Absent the flexibility to negotiate shared access to improvements, a technology licensor may choose to avoid China completely, or to deal with an affiliated company that it can trust. Again, many open source licenses require any derivative works, including improvements, to be freely available to the public, so that the parties must violate either the open source license or TIER.
The third concern pertains to licensing parties’ allocation of marketing rights. The business-driven bargaining in a licensing transaction often involves allocating market rights between a licensor and a licensee. For example, a given technology transaction may give a Chinese company the exclusive marketing rights in China and a U.S. company the exclusive marketing rights in North America. However, TIER prohibits licensing agreements that “unreasonably restrict[s] the export channels” of the licensee. Under this TIER provision the licensing parties cannot freely negotiate allocation of market rights according to their business needs and proposed level of license fees. Absent the flexibility to allocate marketing rights, a foreign licensor and a Chinese licensee may have to forgo their licensing partnership despite interest by both.
B. Ways of Managing TIER Restrictions
There are very few cases in China in which TIER has been asserted by China or Chinese companies to void specific provisions of a contract. Although this is good news, it is still not all that comforting to foreign businesses forced to accept uncertainty in licensing technology into China. There are a few ways of managing the potential dangers of TIER.
First, it is clear that if a Chinese company voids important contract provisions using TIER, then that company will have significant problems ever working with a foreign company again. Foreign licensors, and foreign partners in general, will no longer trust such a Chinese entity to abide by its word. Such a consequence would be, therefore, bad for the Chinese entity as well as the foreign entity. Presumably, a Chinese company would only void the contract provisions via TIER in an instance where the value of doing so is very high – higher than the loss of future ability to work with foreign companies. Therefore, it may be possible to avoid such a case by providing business incentives (such as additional revenue, equity, or geographic share) to the Chinese partner in the event that the deal leads to great commercial success.
A foreign company may also be able to protect itself by simply writing the TIER restrictions into the contract and valuing them properly. Alternatively, the licensor could simply accept the risk of TIER and go along with the contract as if TIER were not a factor. There are also other means of possible protection (in addition to the general “best practices” mentioned in the next section. For example, instead of licensing to a company in China, it may be possible to license to a Chinese company outside the PRC. The foreign entity could provide a written contract provision prohibiting import of the technology into China, but with the unwritten understanding that the licensor will not object to such import so long as the licensee does not attempt to exploit TIER to change the contract. While this is not exactly fair for the Chinese company, neither is TIER, and it shifts the uncertainty from the licensee to the licensor. While not a perfect solution, it does reallocate the trust issue to the Chinese side.
Another option (at least for technology involving open source licensed technology) would be to contract to terms violating TIER, and then if anything goes wrong, seek to have the Free Software Foundation sue the Chinese company for violation of the open source license. This would be risky, and would require a very close relationship with the FSF and open source community. There are other possible creative solutions involving the foreign licensor using its own Chinese-owned subsidiary as the contracting party, or insisting that the licensee be a non-Chinese entity. The problem with all of these is that they have not been tested, because TIER itself has not been effectively tested. As with most business deals, it depends on the amount of risk that is tolerable to both sides.
III. Best Practices on Joint Ventures/Technology Licensing with Chinese Companies
While there is no guarantee that any contract will not be violated, there are many things that a foreign licensor can do to maximize its chances of making itself whole in the event that the contract is breached. Courts, judges, and arbitrators in China are getting more sophisticated each day. Also, such forums are generally quite fair and effective in enforcing foreign parties’ rights in China. However, the more complex the issue, the less clear the outcome and the slower the process. Therefore, several best practices should be followed in addition to general best practices regarding technology licensing outside of China.
B. Make the contract simple: define breach and liquidated damages
Although courts in China are more sophisticated than ever, they are burdened with a huge number of cases. They also are more reticent to give injunctive relief of large damages if they are not sure they are correct in their judgment. Therefore, make it easy for them: make the contract simple. Define specifically what constitutes a breach and what the penalty should be. Liquidated damages are a must. Make it so that all the aggrieved party has to show is: (1) there is a contract, (2) the contract was breached, and (3) the parties agreed at the outset what the penalty for such a breach would be. This should lead to a very fast and effective judgment.
C. Define “Confidential Information” (“CI”) clearly and put the onus on the licensee to show that information is not Confidential Information
Courts in the US get bogged down in determining what is CI under contracts. Chinese courts have the same problem. A solution to keeping up with what falls under CI is to make every bit of information provided to the Chinese partner fall under the definition. The contract should provide that all information is assumed to be CI, unless the Chinese party objects in writing within a specific period, say two weeks from receipt. There should be a provision for determining disputes quickly, including destruction of any material or information provided to the licensor that cannot be agreed as to confidential nature. Then, the licensor should provide a regular report to the licensee listing the information that it has sent the licensor and that it has received from the licensee as not constituting CI. Such a process would allow a judge of any dispute to quickly determine what was CI and provide quick redress.
D. Choices of venue and law and right to enforce judgment in China
Although the courts and arbitrators in China can now generally be trusted, if the licensee is particularly well connected, it may make sense to dictate that the choices of law and venue be in the licensor’s jurisdiction with the right to enforce any resulting judgment or adjudication in China.
E. Get a full list of officers, executives, and principals
The licensor should obtain a notarized list of officers, executives, and principals, with photos. The guards against the possibility that licensor’s CI and IP could end up in another company headed or run by the principals of the licensee. Depending on the size of the licensee and its reputation, it is very possible for the licensee to close down, move, and start up again under a new company name. Proving that this has happened will be much easier if the licensor has a list of those holding power at the original licensee. It is probably also worthwhile to get a list of lead engineers on the project.
F. Have in-document translations of each section
The contract may be in either English or Chinese, whichever the parties prefer. It is important to have in-document translations of each section. This allows for easier negotiation and for easier adjudication. One language should be controlling (likely the language corresponding to choice of venue). It may be helpful to get a notarized official translation of each section. This is not required, but for large deals is likely worth it.
G. Lay a trap
Foreign licensors of software may want to lay a trap by including in comments to the code or elsewhere specific information linking the code to the licensor. This way, in case the licensee ever tries to argue that the code is theirs, they will have a hard time explaining why links to the licensor are there.
IV. Top IP issues when forming a joint venture in China
A. Keep control
One key to protecting IP in any deal with a Chinese partner is to make sure that the foreign entity will control the joint venture. Since most foreign investors wish to maintain control over their Chinese joint venture entity, this issue is usually paramount. Often foreigner make the mistake of assuming that Chinese joint ventures are managed according to a Western model, under which the board of directors has controlling power over the company. Most foreign investors strive to obtain a 51% ownership interest in the equity joint venture, assuming this gives them the right to elect the entire board and thereby control the company. After winning the struggle for percentage ownership of the joint venture, foreign investors will frequently allow the Chinese side to appoint the equity joint venture’s two key management positions, the Legal Representative and the General Manager. But these “concessions” are all part of the Chinese side’s plan, and effectively render board control meaningless.
Control over a Chinese joint venture actually comes from the following:
The Chinese side to a joint venture will typically refuse to give the foreign party the above three measures of control. It will argue that it should control the joint venture for reasons of both efficiency and expertise. In many cases, it also will claim that it cannot bring its political connections, or guan xi, into play unless its own people fill the Legal Representative and General Manager slots. This argument is usually just a smoke screen for the Chinese side trying to secure the true levers of joint venture control.
If you want control over your China joint venture, you should follow the rules set forth above. Otherwise you might find yourself in a venture with no legal right to guide it.
B. Safeguard intellectual property the traditional way
Multinational companies still struggle to protect their intellectual property in China, and joint ventures are particularly vulnerable. Companies have traditionally had some success with more pragmatic, operational efforts, including the following:
C. Manage talent
Most leading multinationals learned from the first round of joint ventures in China that getting the right managers in place was critical. Many of these companies had simply dispatched available executives—often not top performers but rather average executives searching for new challenges. Most of these executives therefore had limited credibility with the corporate parent and were ill-prepared to manage demanding joint-venture partners. Today, experienced multinationals recognize that a successful joint venture requires credible, high-performing executives supported by strong local teams.
Yet with so many companies competing for the best local candidates, those men and women can afford to be choosy, and they understandably prefer leading companies that have a strong image and offer good prospects for career progression. So today, joint ventures must not only invest in their corporate brands but also partner with top universities to sponsor undergraduate and graduate students and to establish a training platform for current employees. CEIBS, a leading business school in China (and itself a joint venture), has more than 80 corporate sponsors, which provide funding and in return can recruit on campus and send their executives on advanced training courses.
Finally, companies must continue their commitment even after candidates are hired. In our observation, this means sending some of a multinational’s best people to the joint venture to create a strong team, compensating employees at or above relevant market rates, and fast-tracking the advancement of high performers—even breaking away from more tenure-based advancement systems.
D. Improved and New Intellectual Property
In the growth and development of a JV, new IP will come about, and these will be regarded as belonging to the Joint Venture. Therefore, it is also up to the JV to assign it or to apply for protection. If the foreign investor only holds a minority stake in the JV, then s/he may find themselves in a weak position regarding control over new IPRs. It is recommended to deal with these matters in the joint venture agreement before they become problems. *Note the prior discussion of TIER in this regard.
E. Investment Capital Contribution
The transfer of technology or IP of a foreign investor into a joint venture can serve as a contribution of capital. Depending on the investment sector of the JV, the transfer can make up a certain percentage of the JV. Although there are some exceptions, the maximum limit is usually 20%.
F. License/Royalty Fees
Licensing or royalty fees from the transfer of IP in a joint venture deserves close attention. In China, royalties are subject to income withholding tax and business tax. Also, in some sectors, the royalty rate may have a ceiling, such as the 0.3% royalty rate ceiling of sales revenue in the retail sector for the use of a trademark.
G. Getting the money out of China and paying taxes
Transferring money out of China has always been a challenge and is only getting harder. See, e.g., https://www.nytimes.com/2016/11/29/business/economy/china-tightens-controls-on-overseas-use-of-its-currency.html. Make sure to have a plan to transfer any revenue out of China, or keep it there, and know what taxes will be applied.
Great article from IP Watchdog providing insight into patent prosecution in China by my partner, Dr. Liaoteng Wang
From IP Watchdog: Challenges for Managing Chinese Patent Prosecution: Anything More Than Lost in Translation?
If you are an in-house counsel at a U.S. technology company, managing its global patent portfolio with a potentially significant exposure in China, you face some special challenges trying to effectively and efficiently manage the Chinese patent prosecution through your Chinese IP firms.
You might assume that these challenges would be caused by some undefinable “Chinese” element. You already knew how to manage U.S. prosecution, performed by the outside U.S. law firms, and in theory you can apply that learned expertise to managing the process in China. But this is not U.S.-style patent prosecution in another place. The working language will be Chinese in addition to English, the communications will generally be over long distances, 12 to 15 time zones away, and you will have to deal with significant differences in laws, practices, and cultures. This article provides a roadmap and tips for making this process productive and successful.
The Increasing Value of a Strong Chinese Patent Portfolio
At the outset, it’s worth noting that the value of a strong Chinese patent portfolio has been steadily increasing, and therefore trying to get a clear understanding of what’s involved in building IP in China can be very worthwhile. Companies trying to increase their presence in China should recognize this and budget for their IP work in ways that match their opportunities and aspirations.
Like the U.S., Chinese markets are extremely (and increasingly) competitive, requiring a very strong patent position in most sectors. But unlike the general decrease in value of patents in the U.S. over the past ten years (beginning with the weakening of injunctive relief in eBay Inc. v. MercExchange, LLC), patent owners in China still enjoy a robust regime of protection: injunctions are readily granted when a patent is held valid and infringed, and damages for patent infringement have been on the rise. Accordingly, Chinese patent prosecution is a good investment, likely to generate significant returns from markets where innovation is properly protected.
Lost in Translation
Patent applications originally drafted in English need to be translated into Chinese for Chinese patent prosecution. Because of the inherent danger of precise meanings lost in translation from one language to another, quality control for translation is very important.
As Learned Hand put it, “Words are chameleons, which reflect the color of their environment.” An English term can be translated into a number of different Chinese terms, depending on contexts and fields. Thus, even though the quality of machine translation has greatly improved, and professional translation vendors could be used at reduced rates as compared to those charged by patent law firms, to ensure high quality translation of patent application documents, there is no substitute for bilingual patent attorneys who are fluent in both English and Chinese and also understand the relevant technologies, thereby enabling them to properly contextualize claims and descriptions. To provide a simple example of the risks of machine translation, as of today, the powerful Google Translate still translates the English words “Chinese patent prosecution” into the Chinese words that actually mean “Chinese patent litigation.”
Because of the language barrier, this phenomenon of “lost in translation” repeats itself often during day-to-day management of Chinese patent prosecution. For example, one in-house counsel I know asked for a copy of translated claims of an issued Chinese patent, but instead received the translation of a set of different claims presented during prosecution. Another in-house counsel has told me that for most routine patent prosecution matters, the English of his Chinese patent attorneys is sufficient, because with experience they can just follow templates; but they are just not adequate when working on more complicated matters such as invalidation proceedings, or when conducting live discussions during conference calls.
Ideally, the “lost in translation” challenge can be overcome by working with top Chinese IP firms with patent attorneys who are fluent in both Chinese and English and fully familiar with both Chinese and U.S. patent laws. Moreover, the Chinese patent attorneys will be able to further improve the quality of translation if they have more background information about the inventions and the planned patent portfolios, because having a big picture helps to provide a fuller context for accurate translation.
Long Distance, Time Differences, Less Frequent Client Visits and Reduced Face Time
In addition to the language barrier, long distance and time zones can hinder smooth communications and management of the process. Attorneys at U.S. outside law firms generally are available to meet with clients upon request. Relationship partners take every opportunity to visit their clients, because face time, even in the age of social networking and virtual reality, is still important to build and maintain trust. Phone calls between outside counsel and clients in the U.S. occur spontaneously, or can be easily scheduled during normal business hours.
This is not so easy for Chinese outside law firms. Lacking a permanent post in the U.S., Chinese lawyers generally only occasionally visit their U.S. clients when coming here to attend a conference, resulting in comparatively limited face time and limited opportunities to strengthen the relationship. And due to time differences, U.S. clients typically can’t pick up the phone to call their lawyer in China, and arranged teleconferences typically occur at odd hours for participants from one side of the Pacific or the other.
Solutions to this problem can include U.S. clients’ setting up offices in China, Chinese law firms’ setting up offices in the U.S., improved videoconferencing quality, and more frequent visits between U.S. clients and Chinese law firms. Borrowing the tagline from the 2003 movie Lost in Translation, “Sometimes you have to go halfway around the world to come full circle.”
This is the more subtle part of the interactions between Chinese law firms and U.S. in-house counsel. It should be noted that the Chinese culture is constantly evolving, but differences can be stark. Some in-house counsel wish their Chinese outside law firms could be more proactive and think strategically from the client’s perspective. Other companies have noted inefficient legal advice and billing, where the Chinese law firms provided unsolicited analyses that the clients don’t need (or are not actually helpful).
Sometimes what’s acceptable in one culture may be frowned upon in the other. Without a sufficient understanding of the culture and background, and opportunities for fuller explanations where appropriate, some advice provided by Chinese law firms could even raise ethical concerns in the minds of the U.S. in-house counsel.
Cultural misunderstandings between U.S. clients and Chinese law firms can be reduced by giving each other the benefit of doubt, slowing down and providing fuller background when discussing sensitive matters, and making efforts to learn about each other’s culture. Obviously, using people who are already familiar with both the U.S. and Chinese cultures to help manage the process will make this easier.
Differences in Laws and Practices
Based on feedback from a number of U.S. companies, the differences in laws and practices between the U.S. and Chinese patent systems do not pose special problems for routine patent prosecution matters, because they are already well understood by the top Chinese IP firms. Moreover, the Chinese patent system has matured and is moving closer to EPO and JPO. By the time substantive prosecution starts in China, similar rejections have often been addressed in other jurisdictions, arguments are already mapped out, and what worked in Japan or Europe generally will work in China, too. That said, in the last few years, more and more rejections made by SIPO could no longer be overcome by simply using the same arguments that had worked before EPO and JPO.
To be clear, differences in laws and practices are important for U.S. clients to understand in order for them to build strong global patent portfolios — for example, the procedure for patent prosecution before SIPO is complex, and different from that before USPTO, and therefore it’s important to work with a top Chinese IP firm having personnel that know it like the back of their hands. It’s just that the top Chinese IP firms already understood the issues well and can help their U.S. clients in substantially the same way, without qualitative differences. Where the differences are well known, process management is relatively straightforward. However, new difficulties can arise when there are changes in Chinese laws and practices.
Rapidly Evolving Chinese IP Landscape
The Chinese patent system, like the Chinese economy and market, has come a long way in three short decades since the first Patent Law in 1984, the first Amendment of Patent Law in 1992, the second Amendment of Patent Law in 2000 (as a result of China’s expected entry into WTO in 2001), the third Amendment of Patent Law in 2008, to the currently contemplated fourth Amendment of Patent Law (with draft first published in 2015 for comment), and is still moving rapidly, creating opportunities for the prepared and traps for the unwary.
In addition to changes in patent laws, China has experienced rapid development of its court system. In November and December 2014, three specialized IP courts were established in Beijing, Shanghai, and Guangzhou, where IP case filings are most concentrated. Two years later, in January and February 2017, four new specialized IP tribunals, similar to the three specialized IP courts, were established in Nanjing, Suzhou, Chengdu, and Wuhan, technology and manufacturing centers where patent case filings are more concentrated. The establishment of a national appellate IP court, similar to the U.S. Court of Appeals for the Federal Circuit, is currently under consideration.
The source of all these changes is China’s expressed desire to become a strong intellectual property rights (IPR) country so as to promote the development of an innovation-driven economy. With this prevailing policy as a premise, the value of a strong Chinese patent portfolio will only increase in the foreseeable future, and efforts by companies to better manage their Chinese patent prosecution will be well rewarded.
Liaoteng Wang is the Managing Partner in the Silicon Valley office of Beijing East IP, a top Chinese IP firm headquartered in Beijing. Prior to embarking on his legal career, Liaoteng was an accomplished scientist, having received his B.S. degree from Beijing’s Tsinghua University and Ph.D. degree from UW-Madison, and published his scientific discovery in the world-renowned journal Nature. After receiving his J.D. degree from UW-Madison in 2005, Liaoteng interned for Judge Rader at the U.S. Court of Appeals for the Federal Circuit, practiced law at the Silicon Valley offices of top international law firms, and worked as an in-house general counsel for an Intel-backed startup and a top global technology company, before joining forces with his friends and alums at Beijing East IP in 2016 to provide premier IP legal services to clients worldwide.
A few quotes from me in today's IP Law360:
Dr. Lulin Gao: "US companies should feel comfortable filing patent litigation against Chinese companies in China"
On Monday, June 19 at IPBC Global in Ottawa, the Founding Commissioner of SIPO stated that US companies can feel comfortable filing patent cases against Chinese companies in China. This is a game-changer, and shows just how far China has come.
Full disclosure: Dr. Gao is the Founder and Chairman of my firm, Beijing East IP.
I invite you to take a look at my new article in IAM Magazine on "How to Win a Patent Case in China as a Plaintiff".
Below is a general outline of the content:
I just arrived in Ottawa for IPBC Global. Dr. Lulin Gao, our firm's Chairman and the father of the Chinese patent system, is also here along with my colleague Austin Chang. Dragon Wang, a VP and one of our top patent litigators arrives Friday night.
I would like to invite anyone interested in learning more about intellectual property, patents, and patent litigation in China to visit us. If anyone is also early (the conference officially starts on Sunday) please email (Erick.Robinson@BeijingEastIP.com) or call/text (+1 713 498 6047).
We will be in Ottawa through Wednesday, June 21. Please come by and let's chat!
Thank you to IAM and to my colleagues and clients for selecting me as a leading IP strategist for the third consecutive year!
A big Chinese "谢谢!" to everyone for selecting me to the IAM Strategy 300 – The World’s Leading IP Strategists for the third year in a row!
Each year, the World's Leading IP Strategists identifies the 300 most highly skilled individuals from around the world in the development and execution of strategies that maximize the value of patents, copyright, trademarks and other intellectual property rights. Published online by Intellectual Asset Management (IAM), the IP industry’s leading journal, this list of highly regarded IP practitioners is compiled after extensive research by teams in London, Washington DC and Hong Kong. The IAM research team annually speaks to a wide range of senior corporate IP managers in North America, Europe and Asia, as well as third-party IP service providers, in order to identify the men and women whose expertise in IP creation, development and monetization has attracted the greatest respect of their peers.
"Each year our IAM Strategy 300 publication grows in esteem and respect as the go-to source of reference for those seeking to identify the women and men who offer best-in-class expertise,” says Joff Wild, IAM editor. “The Intellectual Property industry grows in prominence as more and more of the world’s top companies rely on IP to grow their enterprises.” The IAM Strategy 300 is available in printed format and online at http://www.iam-media.com/Strategy300/
IAM (http://www.IAM-media.com) is produced in London by the IP Division of Globe Business Media Group and reports on intellectual property as a business asset. Its primary focus is on how intellectual property can be best managed and exploited to create corporate value. The publication's core readership comprises senior executives in IP-owning companies, corporate counsel, private practice lawyers and attorneys, licensing and technology transfer managers, and investors and analysts.
Email me and let me know what you think! Is this a useful medium? Or should I stick to writing? :-)
See my new article on why the @UnifiedPatents model will not work in China:
Excellent article on patent litigation in China, and it even includes several quotes from me:
Check out the full article here: https://www.law360.com/ip/articles/914779/china-becoming-more-attractive-for-foreign-patent-owners
Apple recently sued Qualcomm in the US and the UK, claiming Qualcomm had been significantly overcharging for the use of basic patents and generally abusing its position as a market leader. These lawsuits were filed quickly after the Federal Trade Commission, in one of its final acts under the Obama administration, announced that it would sue Qualcomm for violations of anti-competition law.
Today, Qualcomm filed its Answer and Counterclaims to Apple's California lawsuit, detailing the value of the technologies Qualcomm has invented, contributed, and shared with the industry through its licensing program, as well as Apple's failure to engage in good faith negotiations for a license to Qualcomm's 3G and 4G standard essential patents on fair, reasonable and non-discriminatory terms. The filing also claims that Apple:
My personal view on these lawsuits generally (keep in mind I am a former Qualcomm'er) is that essentially, Qualcomm could have chosen one of two paths: (1) ask for reasonable royalty rates and rarely litigate, or (2) ask for high royalty rates are litigate on a regular basis. Qualcomm chose option (1) a long time ago, and the fact that it has so rarely sued on its best-of-class patent portfolio shows both the quality of the portfolio as well as reasonableness of its licensing terms. If anyone wants more details, please email me, but today's post relates to Apple's attack on Qualcomm in China.
In China, Apple filed two lawsuits, both in Beijing. In the first, Apple is seeking 1 billion yuan (over $145 million USD), according to Reuters, claiming that Qualcomm violated China’s anti-monopoly law and harmed it by abusing the company’s market position as a dominant chip supplier. The second lawsuit focuses on patent deals, with Apple asking for the court to rule on the terms of a licensing agreement between the two companies.
On the surface, the Beijing filings seem to make sense for Apple. After all, Qualcomm receives over half of its revenue from China. Plus, in December 2013, the NDRC (National Development and Reform Commission) announced it was investigating Qualcomm for violating China’s 2008 AML (Anti-monopoly Law) and in February 2015 Qualcomm settled with the NDRC for a $975M fine, and for Chinese phones sold in China, a requirement to offer separate licenses for certain patents, with licensees paying 3.5% for devices using only its 4G technology and 5% for 3G-only devices or those that use both cellular technologies. Also, in addition to the rates being cut, so was the based to which those rates are applied. Instead of applying the percentage to the wholesale price of the handset, Qualcomm now applies it to 65% of the net selling price of a device, a lower figure than the wholesale price. So there were three decreases: (A) the rate, (B) the net selling price instead of the wholesale price, and (C) getting only 65% (of the wholesale price).
So attacking a company while it is down makes sense, right? But while Qualcomm emerged from the NDRC matter bloodied and battered, it did, in fact, emerge. Not only did it survive, but through the settlement with the NDRC, Qualcomm had received an official government blessing for its licensing protocol -- at least with Chinese phone-makers selling in China. The old saying, "What doesn't kill you makes you stronger" applies aptly to Qualcomm here. While the Chinese government via its Anti-Monopoly Agencies may not love Qualcomm, it made a deal with them.
Note, too, that Qualcomm is a necessary supplier to many Chinese companies, including the many smartphone makers. A supplier is not an an enemy. A competitor is -- especially a foreign competitor that has traditionally never been a friend of China. What? Apple? But Chinese people love Apple, right? Well, I am not sure that was ever true, and it seems even less true recently. And even if it is, it is not for the love of functionality, but rather the prestige of the iPhone as a "brand-identity status symbol" like Gucci or Louis Vuitton. This does not make Apple a friend of China. Not by a long shot, especially when Apple has a long history of not giving back to China.
Traditionally Apple has taken the vast majority of the revenue it has obtained in China and sent it back to the US via Ireland. If Apple were to leave China or be enjoined from selling iPhones here, tens of thousands of Chinese workers would be unemployed... for three weeks. Then they would move across the street or even to a different part of the same factory to build phones for Huawei, ZTE, Xiaomi, Oppo, Vivo, Meizu, or any of the other dozen or so Chinese smartphone makers. These Chinese companies would not only fully pay Chinese taxes, but also would reinvest in the country, its people, and the next generation of innovators. As for Apple, investing a billion dollars in a Chinese e-taxi company does not make up for years of lack of investment in China.
So Qualcomm is a supplier to some of China's most important companies and Apple is a direct competitor of these companies. Not good for Apple. Further, what Apple is essentially asking for through its Chinese lawsuits is to be treated by Qualcomm the same as Chinese phone-makers are now treated based on the NDRC settlement. Right now, Chinese phone-makers get around a 33% discount on the most important and expensive part of the phone: the chips. This allows the Chinese companies to have a huge advantage in their home market. This is especially true for Samsung because it, like the Chinese smartphone companies, uses the Android operating system. Since Samsung has the same OS, Chinese consumers are treating smartphones as fungible. Much like desktop computers in the late 1990s and early 2000s, no one cares about the brand of the phone/computer, only the specs like processor speed, memory, and connectivity. Because Samsung phones are very similar to other Android phones in China (except the Chinese phones usually do not explode), and are generally much more expensive even without the discount Chinese companies receive on Qualcomm chips, the Korean company is having a hard time in China.
Apple has the "bling" advantage as a luxury brand, and also has a distinctive OS. So the iPhone is not fungible. But it is still a competitor to many Chinese companies. Further, if Apple wins against Qualcomm in China, then it will have essentially the same advantage that the Chinese smartphone companies have. This would drive sales away from Chinese companies to a company with an established record of not investing meaningfully in China. That would be bad for the Chinese economy and its people.
Finally, even if Apple all of a sudden did want to become a fully-contributing friend of China, its basic business model prevents this. Apple is a hyper-secretive, closed, uber-proprietary company. Anyone who has visited the Apple campus or any Apple facility knows this. What most people do not know is that Apple does not even allow many companies to refer to it by name on their own campuses but rather by code words, either in conversations or in email. In short, Apple does not play nice with others and is as closed a company as exists in technology. This modus operandi has produced some amazing products such as the iPod, iPhone, and iPad. But there is simply no way to partner with Apple in any meaningful way technologically (other than as an add-on). And this is exactly what it means to be a friend of China. Long-term success in China requires not just investing money, but sharing technology with Chinese partners. For example, Intel's buy into Tsinghua Unigroup was ingenious. They became a Chinese company, developed instant "ears to the ground," and began the cross-pollination that China wants and needs as it continues to develop as an innovation and consumer nation. Investing in a taxi company just isn't the same.
So where does that leave Apple? It becomes a company attacking a licensing scheme recently blessed by the Chinese government. Also, Apple is asking for what China cannot, or at least should not, provide: the same advantage that its own companies have in terms of a discount on Qualcomm chips. All this by a company that directly competes with China's fastest growing companies and that has a record of not being a friend of China. This is not a good place to be.
Even if Qualcomm does not fire back with patent lawsuits or other actions in China, Apple is fighting a battle here it is likely not to. While I do not agree with the essence of the lawsuits in the US and UK, at least they make sense and have a reasonable chance of success, or at least a small chance of huge defeat. The rules are different in China, and American companies still seem to keep forgetting this.
China is like a broad river with a swift current. To do well here, a company need only stay somewhere safely within the banks and aim downstream. With such a strategy, quick and effortless success is virtually guaranteed. But for those that are so "creative" or "better than others" that they think they can move upstream or outside the banks of the river, defeat is equally assured. Apple has no upside here, and there are many bad things that could happen. They would be well-advised to stay in the middle of the river and head downstream.
Welcome to the China Patent Blog by Erick Robinson. Erick Robinson's China Patent Blog discusses China's patent system and China's surprisingly effective procedures for enforcing patents. China is leading the world in growth in many areas. Patents are among them. So come along with Erick Robinson while he provides a map to the complicated and mysterious world of patents and patent litigation in China. Erick Robinson is Chief Patent Counsel Asia Pacific at a leading international law firm.
Erick Robinson is an experienced American trial lawyer and U.S. patent attorney based in Beijing. He is Director of Patent Litigation at Beijing East IP, a top Chinese IP law firm, where he manages patent litigation, licensing, and prosecution throughout China. Check out my bio.
The ideas and opinions at ChinaPatentBlog.com are my own as of the time of posting, have not been vetted with my firm or its clients, and do not necessarily represent the positions of the firm, its lawyers, or any of its clients. None of these posts is intended as legal advice and if you need a lawyer, you should hire one. Nothing in this blog creates an attorney-client relationship. If you make a comment on the post, the comment will become public and beyond your control to change or remove it.