Intellectual property (IP) laws in foreign jurisdictions are increasingly relevant to U.S. companies as the consumer market becomes more globalized and web-based. China is currently the leading e-commerce market in the world, with sales totaling $426.26 billion in 2014. Additionally, Chinese e-commerce sales are expected to increase by another 42.1 percent to $672.01 billion in 2015. Predictions based on China's current growth rates suggest that it will become a $123 trillion market by 2040.
The Chinese Congress has worked to strengthen patent rights through a series of reforms over the past two decades to encourage further economic growth and trade. One of the most recent of these reforms is the proposed Fourth Amendment to the Chinese patent law. This amendment will impact U.S. companies' choice between maintaining inventions as trade secrets or applying for patent protection. This article will: (1) highlight some of the trade-offs and strategic considerations in creating international IP portfolios and (2) analyze the extent to which the proposed Fourth Amendment might impact such IP strategies for U.S. companies.
Patents vs. Trade Secrets
One of the major influences in a company's IP strategy is the target markets' applicable IP laws. For instance, U.S. companies that market products in countries with weaker patent protection might not opt to file for a patent in such jurisdictions. This is because any patent filings would disclose the ideas to competitors and eviscerate any claims to trade secret protection.1 In other words, businesses must weigh the pros and cons of the two forms of protection and choose one over the other in formulating their IP strategies.
Trade secrets can protect non-patentable subject matter such as negative knowledge (i.e., what methods do not work) or inventions that do not pass patent law's novelty threshold (e.g., commercially successful food recipes, customer lists, and financial data). Trade secrets might additionally be used to protect patentable subject matter where the benefits of a trade secret outweigh that of a patent. One such benefit is that trade secrets do not require any initial filing fees or expensive prosecution. Hence, they are sometimes favored by fledgling businesses with little start-up capital. Additionally, trade secret protection can last indefinitely: The Coca Cola formula would have entered the public domain in 1897 if the formula were patented upon invention. Finally as previously explained, trade secrets are favored by businesses that market their products in jurisdictions with weaker patent protections.
In contrast, patents potentially offer much stronger protection than trade secrets during their terms and may provide more strategic options in business negotiations. First, patents are generally favored in heavily regulated industries (e.g., pharmaceuticals) where the public disclosures of the inventions are mandatory and therefore trade secrets would be difficult, if not impossible, to maintain. Second, patents might be preferable because trade secrets can limit the information flow needed for business transactions. For example, companies that frequently collaborate with or outsource to third parties might prefer patents over trade secrets due to the difficulty of keeping their inventions secret. Patents also are a better choice for a company that is anticipating investments and acquisitions because the needed information to carry out the transaction conflicts with the trade secret's requirement for secrecy.2
Third, patents can be an advantageous bargaining chip in various forms of business partnering and competitive scenarios. They have more "vulture value" than trade secrets to investors (i.e., the patents can be sold off even if the business fails) and hence result in higher investment evaluations. Patents can also be used as a potential deterrent against patent infringement suits. For example, defensive termination provisions are clauses in patent licensing agreements that automatically void the license upon the other party's filing of an infringement suit.
Fourth, patents might offer more certainty in litigation because U.S. private trade secret suits are based on state law and hence can vary in results from state to state. Finally and most importantly, patents offer the right to exclude. A company protecting its products with trade secrets cannot prevent its competitors from inventing the technology on their own, or even from patenting it.
China has gradually reformed its patent system over the last two decades in an ongoing effort to harmonize its IP policy with other major trade countries. In 2001, China became a member of the World Trade Organization's Trade-Related Aspects of Intellectual Property Rights (TRIPS) Agreement, which includes a minimum set of standards for IP rights in member countries. Under the TRIPS Agreement, patents must be granted for "inventions" in all "fields of technology" and must be enforceable for at least 20 years.3
China also made a series of amendments to its Patent Law in 1992, 2000, and 2009 in order to strengthen patent rights. Finally, China established IP courts in Beijing, Shanghai, and Guangzhou in 2014. Importantly, the judges in these specialized courts often consult with technical advisers on complex scientific issues and refer to foreign patent cases in writing their opinions. Most Chinese patent infringement cases reach judgment (called a "first instance") within six to 12 months and cost approximately a tenth of U.S. litigation expenses.
Patent validity is challenged exclusively through invalidation proceedings before the Chinese Patent Reexamination Board of the State Intellectual Property Office (SIPO) and takes much longer to be adjudicated than the infringement cases in the Chinese IP courts. For at least this reason, invalidity challenges occur in fewer than 15 percent of Chinese patent cases. This is significantly fewer than the percentage of such challenges in the United States, where a patent can be challenged both in court and through the U.S. Patent and Trademark Office (USPTO).
However, many U.S. businesses still believe that the current Chinese patent system remains inadequate despite the effort that China has made in its patent reforms. Patent damages remain small, in part due to the limitations on damages discovery. In fact, the USPTO found that the median amount in civil IP actions brought by foreigners from 2006-2009 was $7,500,4 indicating that companies with significant markets in China might still opt to protect their products with trade secrets instead of patents in order to avoid disclosing their inventions to competitors.
The Fourth Amendment, published for comment in April 2015, would alleviate many of these current business concerns. Some of the amendment's proposed changes include: (1) giving Chinese courts the power to compel accused infringers to provide evidence during damages discovery; (2) imposing joint liability upon Chinese e-commerce sites and Internet service providers (ISPs); and (3) providing for a voluntary licensing framework for patentees upon their registration with the SIPO. These proposed changes significantly increase and strengthen the available enforcement options for patent holders.
The expanded damages discovery process under the proposed reform will likely lead to greater damages awards, increasing the incentive for companies to obtain and enforce their patents in China. Under the Fourth Amendment, patent holders can also bring suit against e-commerce sites and ISPs carrying allegedly infringing products on their servers for additional recovery. The threat of joint infringement liability would also likely facilitate e-commerce sites' responses to take-down requests for suspicious goods. Finally, the clarified licensing guidelines would likely make it easier for the patent holder to license patents by streamlining the process.
These proposed changes not only make the Chinese legal system much friendlier toward patent holders, but also potentially increase the value of patents to companies that are doing business in China. Therefore, the gradual improvement in the Chinese patent system not only confers additional protection for existing patents, but might also influence the initial decision of filing for patent protection over maintaining a trade secret.
Whether the changing Chinese IP landscape will significantly impact the number of patent filings in the United States remains to be seen. However, the transition to a globalized web-based economy and China's rising prominence in the e-commerce space mean that Chinese IP reforms will certainly influence U.S. businesses' IP strategies at home.
1. Information disclosed in a patent application cannot be a trade secret. Tewari De-Ox Sys. v. Mountain States/Rosen, L.L.C., 637 F.3d 604, 612 (5th Cir. 2011).
2. Additionally, early stage investors usually do not sign non-disclosure agreements.
3. Agreement on Trade-Related Aspects of Intellectual Property Rights art. 27, 33, April 15, 1994, Marrakesh Agreement Establishing the World Trade Organization, Annex 1C, The Legal Texts: The Results of the Uruguay Round of Multilateral Trade Negotiations 320 (1999), 1869 U.N.T.S. 299, 33 I.L.M. 1197 (1994).
4. Patent Enforcement in China: Summary of Industry Views, USPTO, http://www.uspto.gov/ip/global/Summary_Chart_of_Issues_and_Recommendations_FINAL.pdf.
Reprinted with permission from the January 4, 2016 edition of New York Law Journal © 2016 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited.
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