To Get a Seat at the Table, China Must Play By the Same Rules

China has done an amazing job of going from worst to first in patent enforcement in less than five years.  I have frequently spelled out the numerous advantages to litigating patents in China, including win rates (including for foreigners), virtually guaranteed injunctions (combined with the large manufacturing market in China), short time to trial, low cost of litigation, validity challenges infrequently successful, and just general support of innovation.  While the Chinese government has stated its strong support for IP and punishing infringers, many major Chinese companies have not received the memo.

In my experience over the last year, talking to all but the most sophisticated Chinese tech companies before litigation is often useless (you still need to do it, but don't expect a successful or even reasonable negotiation).  I have had Chinese companies tell me that they don't have to pay a license to a foreign company because they are Chinese.  I have also had folks laugh when we gave them the amount of prior licenses from other licensees.  I have even had Chinese lawyers call our clients (and me) derogatory names, thinking that I did not understand Mandarin.  None of this is helpful for China as it attempts to reach the next stage of its path toward technological and economic dominance.

Make no mistake, litigation in China is the great equalizer.  The statements I have heard that Chinese companies cannot lose in litigation are about 3-5 years stale.  It is just no longer true. Patent litigation by foreign companies against Chinese companies is very successful with good patents and strong lawyers (along with reasonable strategy and some patience).  But while foreign companies are realizing the power and excellence (and danger of being a defendant) of the new patent enforcement system in China, ironically, many Chinese companies are not.  As a result, it is very likely that Chinese companies will have to be sued before any deal is struck.

This is not good for anyone.  If a party has a strong patent and a good infringement read, a deal should be made without the cost of litigation.  In China, the penalty for infringement is generally greater once litigation is started as China has in some ways already endorsed the idea of a "Panduit kicker" which increases a royalty to compensate the plaintiff for the trouble of obtaining a royalty through litigation mentioned in Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1152 (6th Cir. 1978) but rejected in Marhurkar v. C.R. Bard, 79 F.3d 1572 (Fed. Cir. 1996).
Further, most patent owners will provide a discount for early settlement.  In fact, many patent owners will also apply a "China discount" because profit margins in China are often lower than in the US or Europe.  But once litigation begins, all bets are off the table.

In addition to exposing accused infringers to greater damages and settlement values, this lack of willingness to deal fairly by Chinese companies is also bad for China.  China has done an amazing job of creating the best patent enforcement system in the world in a short time.  One of the reasons it has done so is so that foreign companies will feel empowered to invest capital and know-how locally.  Only through this investment and sharing can Chinese companies quickly develop important technologies such as semiconductors.  If domestic companies continue the "but you can't sue us because we are Chinese" mantra, regardless of whether they ultimately lose in court, most foreign businesses will just assume nothing has changed in China. 

Further, China needs a robust licensing market to take its place at the top of the world in technology.  This means that everyone plays by the same rules.  Parties already have to play by the same rules in court, but they should also do so in negotiations outside of litigation.  Ultimately, China cannot insist on having a seat at the table if it will not play by the existing rules.  One of these rules is paying for a license when needed.  It just makes no sense for China to think it can take the positives of integrating into the high-tech international market without also accepting the negatives of paying for licenses.  

This will take care of itself in time through court cases, but for now it is a bit frustrating.  It is, though, a natural consequence of the quick growth of the patent system in China.  By definition, no Chinese attorney (that has not worked abroad) has more than a few years experience in high-stakes patent licensing and litigation because until about three years ago, the market did not exist.  Therefore, even some of the top Chinese companies have in-house counsel and executives that have no idea how to value ip and negotiate a license. 

Again, this is a natural growing pain and will take care of itself as more and more large-scale litigations make their way through court.  But for now, foreign companies should be prepared to be frustrated in pre-litigation negotiations for the most part.  I hope with some big cases over the next year, this will change.  After all, a big loss by a Chinese company will be a short-term loss for "China, Inc." but will pave the way for long-term growth and success for China and its economy.  I suspect the government realizes this, because unlike the West that thinks quarter-by-quarter, China plays the long game and plans well.  That's why they are where they are.