IP in China: a risky business

09 Nov 2005 | News
When Google hired Kai-fu Lee from Microsoft to set up the internet company's new R&D centre in Beijing in July, it set off a legal battle that highlights how much is at stake in the rush to cash in on the country's booming economy and vast scientific labour force.

China's booming economy has opportunities, and perils, for investors.

When Google hired Kai-fu Lee from Microsoft to set up the internet company's new R&D centre in Beijing in July, it set off a legal battle that highlights how much is at stake in the rush to cash in on the country's booming economy and vast scientific labour force.

Microsoft says Lee, who has worked for the company on language recognition and search technology, is in breach of his non-compete agreement. And even though he had not worked on its China business in recent years, Taiwan-born Lee was responsible for setting up Microsoft's Chinese research operation in the 1990s.

Foreign investment in R&D in China

According to Chinese figures there are now over 700 recognised R&D centres set up by foreign companies in China, compared with only a handful a few years ago. China is also rapidly increasing its own investment in R&D in both the public and private sector.

The growth in foreign R&D in China is impressive, even if some of the R&D centres claimed by the Chinese government are actually ordinary establishments claiming to be engaged in R&D to take advantage of tax incentives.

Much of the R&D carried out in China tends to be focused on development, especially the adaptation of products to the Chinese market. Still, it is clear that a broad range of R&D is being carried out by foreign companies, and that many leading multinationals have established one or more R&D centres in China.

Probably the best-known foreign company investing in research in China is Microsoft, which has a major centre in Beijing employing 170 researchers. IBM was one on the pioneers, founding its research centre in Beijing in 1995. And relative newcomer Google also established its own centre there this year.

Several of the biggest names in the telecoms sector have R&D centres in China. Nokia this year opened a 3G research centre in Chengdu, its sixth in China, while Ericsson has announced that will establish a new centre in Nanjing, which will focus on TD-SCDMA services (a Chinese variant of 3G) and follows centres already existing in several other cities.

The pharmaceutical sector is increasingly becoming interested in China as a location for R&D and conducting clinical trials, and in late 2004 Roche established an R&D centre near Shanghai. The main justification for all this investment is the potential savings on R&D costs, especially human resources, as it is possible to employ a well-qualified researcher in China for a fraction of the cost in the West.

Microsoft might regret the departure of Lee, but it can probably count itself lucky in one respect – at least it had recourse to the US court system (Lee was employed at the software company’s Seattle base). The case is still ongoing. In contrast, China is generally considered to be a country where foreign companies can expect to be victims of infringements of their IP almost as a matter of course.

Chinese IP law has advanced enormously, albeit sometimes reluctantly, in the past 20 years. Today it is comparable with that of most advanced economies, and in itself is not likely to deter companies from investment in IP. The country is also a signatory to all the major international agreements and conventions, and the government takes IP seriously.

But the reality on the ground is a complete contrast. Companies carrying out R&D in China face a multitude of threats ranging from straightforward theft of designs to poaching of staff or attempts by competitors to invalidate patent applications. Companies will have to take account of all of these in devising a strategy of security and legal measures to protect their IP.

Many of the strategies to protect R&D in China are the same as apply anywhere in the world, although given the climate of endemic IP violations, they may need to be applied even more rigorous than elsewhere. Foreign companies can take steps to protect themselves by taking preventive action.

Be safe, go it alone

One of the first steps will to ensure that any local R&D partner is reliable. Exhaustive due diligence is essential, to ensure that the background of any partner is fully understood. But many now prefer to go it alone. One of the lessons learned by international companies in China is that is often better to do without a local partner if possible – in fact, IP violations by local partners are one of the greatest dangers to foreign investors.

Most large foreign companies are now perfectly capable of running their own business in China, and do not need the advantages that a Chinese partner might once have offered. Still, even if there is no local partner, and R&D is carried out by a subsidiary of the foreign company, the same need for security measures to protect IP applies to any staff employed in China.

There are a number of legal areas that need to be considered when engaging in R&D in China, according to Horace Lam, an IP specialist with law firm Lovells in Beijing. Ownership of the results of research must be handled carefully in any agreement for R&D, even when the entity carrying out the work is a wholly owned subsidiary of the foreign company.

One potential danger is that under Chinese law a party commissioned to carry out R&D has the right to apply for and own the patent for any resulting technology – unless the parties have made a prior arrangement. Lam also points out that ownership of the results of R&D should be clarified in contracts to ensure that they can be transferred out of China if required.

Under Chinese patent law, it is possible to apply for invention, design or utility model patents. While invention patents give protection for 20 years, the other two last only 10 years. The advantage of design and utility model patents is that they do not require substantive examination, and are granted relatively quickly, making them suitable for technologies that are likely to have a short economic life. Invention patents require substantive examination, and may take several years to be granted.

File quickly

China's patent application system is based on the first to file principle, not first to invent, so any attempt by a competitor to make a pre-emptive application must be prevented. It has become common for Chinese companies to seek to pre-empt patent applications by foreign companies by filing their own.

According to Kalley Chen, partner with King & Wood PRC Lawyers in Beijing, a new type of infringement that has appeared: Chinese companies are filing utility model patents based on the descriptions of invention patents already granted, thus enabling them to circumvent the original patent. She suggests filing for both invention and utility model patents at the same time to prevent this problem from arising.

Potential loss of trade secrets is another area of concern in R&D. There is no specific trade secret law in China, but the subject is treated under law dealing with unfair competition. Employees have a statutory duty to keep their employer’s trade secrets and know-how confidential. Where non-employees are involved, a contractual agreement is required to protect trade secrets. It is also possible to require employees and contractors to sign non-compete agreements, preventing them from taking proprietary information to competitors when they change jobs.

Know the system

When a problem arises, foreign companies will need to enforce their legal rights. According to Lam, the key to successful IP enforcement in China is to understand the system and the problem, and then formulate a strategy. But weak enforcement of the law by Chinese authorities and lack of serious deterrents are the focus of more or less continuous criticism from foreign companies and governments.

Under Chinese IP law remedies for infringements can be sought through administrative enforcement action or civil lawsuits. In the case of administrative action, enforcement may be carried out in the form of raids to seize infringing products, with fines imposed. This type of enforcement is relatively easy to carry out, but often provides no real deterrent, as the fines are often so low that the infringers simply absorb them into their costs.

Civil lawsuits can also be brought, and allow for the possibility of claiming damages. Criminal prosecutions are possible if the scale of infringement is sufficiently large, although such actions are relatively rare. Still, the deterrent effect is greater, since infringers may end up with a prison sentence. Given the increasing internationalisation of China's R&D, if a company is lucky, or has prepared its ground well, it may also be able to seek remedies in jurisdictions outside China.

Local difficulties

R&D in China is here to stay, and protection of IP will continue to be a major concern. China is under strong pressure to improve its record on IP protection, with both the EU and the US pressing the Chinese government to strengthen the legal system and its enforcement. But no matter how much the central government may be willing to improve things, enforcement by local authorities is widely seen as the real problem.

The local administrative or judicial authorities responsible for enforcement are often beholden to government officials who may have an interest in protecting the infringer – either because the infringer is actually controlled by the government or because local officials see their main role as protecting employment in their district.

And there are also signs that Chinese companies are more willing to exploit the IP system to their advantage. There is a growing list of examples of Chinese companies, often combining together, to seek to invalidate patents already granted.

The most famous example of this is the decision of the State Intellectual Property Office last year to invalidate Pfizer's patent for Viagra after a challenge by a number of Chinese pharmaceutical companies, a decision since challenged in the courts by Pfizer. In a similar case, GlaxoSmithKline gave up its patent for Avandia, a drug for treating diabetes, after it was challenged by four Chinese pharmaceutical companies.

The future

It is often said that better IP protection in China will come when there is a constituency in China that stands to benefit from it. As Chinese companies increasingly see their own products being knocked off, so the argument goes, they will realise the need for stronger protection – as is happening in, for example, India.

The Chinese government has been encouraging research institutions to ensure that the results of their work are exploited through patent registrations, and there has been an increase in patent applications by Chinese entities, not only in China but also internationally. This may be a sign that in the importance of IP in scientific, R&D development and overall economic growth is being recognised.

Whether that will immediately translate into better protection for everyone engaging in R&D in China may be another matter. For the moment, foreign companies will have to continue focusing on their own efforts protect their intellectual property.

Never miss an update from Science|Business:   Newsletter sign-up