China's economic and industrial transformation is occurring so rapidly that foreign companies often fail to appreciate the risks of doing business in the country. This is particularly true in the sphere of intellectual property (IP), where companies now enjoy much greater protections but have simultaneously been tripped up by competition regulators' increased scrutiny of their patent and licensing practices.
China's ability to protect patents has grown after decades of non-existence and non-enforcement. In 10 years, the number of patent litigations filed has more than quadrupled, with close to 10,000 cases submitted last year.
The Chinese government's new specialised IP courts now provide companies with an enforcement mechanism comparable to, if not better than, those in Europe and the US. Litigation in China also offers many advantages to patent owners, including win rates above 75 per cent (and even higher for foreign patentees), injunction rates above 95 per cent, short time to trial, scant discovery and low costs (less than one-tenth of those incurred in the US). Most importantly, because so many supply chains pass through China, a single litigation can effectively impose a global ban on sales of a disputed product.
But not all patent owners should rejoice. Along with a strengthening of the patent system has come increased enforcement of China's 2008 Anti-Monopoly Law (AML). Over the past three years, China's National Development and Reform Commission (NDRC) has beefed up staffing levels and raised its price-related investigations fourfold.
In 2013, the NDRC imposed price-fixing fines of Rmb353m on six Korean and Taiwanese LCD panel manufacturers. Last year the NDRC began investigating InterDigital, a US wireless technology company, after complaints by Chinese companies. InterDigital subsequently reached settlement agreements with the Chinese complainants and, in an undertaking with the NDRC, said it would scale back the royalty rates it charges.
The NDRC also probed US technology giant Qualcomm on similar grounds and, earlier this year, imposed a record penalty of Rmb6.1bn. Qualcomm agreed to stop some of its "patent bundling" practices and lowered certain royalty rates by one-third.
AML penalties and fines in China can be extreme. But in the case of Qualcomm, perhaps the worst consequence of its run-in with the NDRC was the separate antitrust inquiries that followed in South Korea, the European Union and US.
There are a number of steps that companies can take to minimise the risks posed by regulatory investigations.
First, companies must have friends in China. In a country where everything is based on relationships, every company must have multiple levels of relationships with both government officials and influential Chinese industry leaders who have their ear to the ground. This is not to encourage any type of corruption, but rather facilitate a free flow of information. In China, trust and respect are paramount and cannot be developed overnight.
The challenge to Qualcomm might have been avoided or minimised if the US company had had better Chinese government contacts who could have advised it that problems were brewing and explained the need for action.
It is at this sort of early stage that having knowledge of the problem and the ability to communicate a defence is paramount. Once the investigation was announced publicly in February 2014, there was no path for the NDRC to impose either a minimal penalty or no penalty without losing face.
Had Qualcomm and NDRC instead been able to negotiate a mutually acceptable solution earlier — and with less publicity — the result may well have been a lesser penalty that did not trigger follow-up investigations in other jurisdictions.
Second, all foreign companies and their executives, lawyers and other agents must act with great respect in dealing with Chinese officials. US companies in particular have a well-deserved reputation for lacking deference and humility.
Had InterDigital and Qualcomm originally approached their situations with greater meekness, things might have evolved quite differently. Often it is the lawyers that get in the way, because when you are a hammer everything looks like a nail. The better road is one of calm and thoughtfulness rather than agitation and hostility.
Third, any company that licenses patents or technology in China should always have in its back pocket a specific minimum acceptable royalty rate. That way any dispute can be nipped in the bud with a public announcement that the company is lowering its licensing rate to an "even fairer level", with examples to support this claim. This is not ideal but far better than the alternative of having to face a formal AML investigation.