The U.S.-China Business Council recently released its China Business Environment Survey. Of those U.S. companies surveyed, 95% indicated they are either somewhat or very concerned about IPR enforcement in China. Despite that concern, over half indicated that they had seen some improvements in IPR protection in the past year. While other areas of intellectual property rights have historically garnered more attention, U.S. companies are increasingly concerned about trade secrets protection in China. The rising level of concern over trade secrets reflects longstanding concerns about companies’ ability to use the Chinese legal system to protect and enforce trade secrets. Further, with the enactment of the third amendment to the Chinese Patent Law and the related Implementing Regulations, inventor remuneration in China is no longer a negligible issue for multinational companies (MNCs) who have R&D activities in China. Developing and implementing an inventor remuneration policy is on the agenda of most MNCs in China. This article discusses best practices to prevent trade secret theft and prompt the inventor remuneration policy in China.

 

While China has a comprehensive set of laws, regulations, and judicial interpretations designed to protect the rights of trade secret owners, the enforcement of trade secrets has not been straightforward. This is primarily because China does not have U.S.-style discovery in litigation and the evidentiary burden for a plaintiff to bring a claim of trade secret misappropriation in Chinese courts is high. Notwithstanding the difficulties, there have been numerous cases of successful enforcement, both civil and criminal. Experience shows that it is possible to protect and enforce trade secrets in China, but the devil is in the details.

To prevail in a trade secret misappropriation action in China, a trade secret owner must prove that: (1) the asserted trade secret is not publicly known; (2) the asserted trade secret has economic benefits and practical utility; (3) the trade secret owner has taken measures to protect the confidential nature of the asserted trade secret; and (4) a wrongdoer or third party has misappropriated the asserted trade secret. Chinese courts prefer evidence in its original form. In practice, documentary evidence is almost the only form of evidence that carries significant weight in Chinese courts.

Although trade secrets can be protected by means similar to those used in the U.S., such as a confidentiality agreement, the mere existence of a confidentiality agreement may not be sufficient. In addition to a confidentiality agreement, it is advisable to have recipients of confidential information sign an acknowledgement before they receive that confidential information.

Because one of the key elements for a protectable trade secret is that the trade secret owner has taken measures to keep the trade secret confidential, it is important to establish and enforce a company-wide confidentiality policy.

 

If a company has trade secrets of any value, it is essential to establish a trade secret audit program and implement a robust policy to maintain the confidentiality of its trade secrets. The necessary steps of any effective confidentiality policy should include at least the following:  

l  identifying what information the company deems confidential and how its employees should handle that information;

l  clearly spelling out the consequences of any unauthorized or improper use or disclosure of confidential information; and

l  clearly stating that improper use or disclosure constitutes grounds for termination or even criminal prosecution.

 

The following are the recommended practices on enforcing company confidentiality policies and protecting the company’s trade secrets.

Have all key personnel who have knowledge of trade secrets sign confidentiality agreements. In addition, the company should have a formal policy regarding the ownership of any intellectual property created by the employee during his or her employment, such as assigning all IP rights including trade secrets to the company.

l  Conduct regular training on the company’s confidentiality policy.

l  Verify that all employees have received a copy of the confidentiality policy in their employee handbook and have signed a statement acknowledging that they have read, understood and will comply with the policy as a condition of their employment.

l  Keep confidential information in restricted areas and in clearly marked binders and storage media. Those items should be marked as Classified, Restricted, Confidential, Do Not Disclose, Do Not Copy Property of [company name], or some other reasonably appropriate method particular to the company’s business.

l  Implement the following measures: (i) restrict access to confidential information and disclose it only on a need-toknow basis; (ii) adopt a locking system on the confidential information, such as a check-in and check-out system; (iii) put passwords on confidential information.

l  Impose confidentiality requirements on visitors to the company’s factories and premises.

l  To the extent possible, have all employees sign a written acknowledgement before receiving any company information. If not, a subsequent written acknowledgement must be obtained. For a consultant, subcontractor, or any other third party, obtain a written acknowledgement in advance.

l  Conduct exit interviews of departing employees to ensure that they are not taking any information that the company would not want to disclose to a competitor with them to their new jobs. This also serves to remind all key employees that their obligation not to disclose trade secrets extends beyond their employment with the company. Also have departing employees provide written acknowledgment that they had access to certain confidential information and attach a list of that information. It is advisable to have departing employees return all electronic storage devices, such as USB drives, when employment terminates.

l  Since one of the most common avenues for loss of trade secret is disclosure through electronic means, electronic access for departing employees should be either blocked immediately before termination or closely monitored in accordance with company computer policies. It is also advisable for the company to have computer policies in place that permit monitoring of electronic transmissions (such as regular imaging of an employee’s CPU) in a way that would alert the company if confidential files were being transmitted outside the company without the company’s consent.

l  To the extent possible, keep the key computers storing confidential information off any network.

l  To the extent possible, limit unauthorized downloading and installation of software that is not work-related.

l  To the extent possible, but without invading personal privacy, monitor employee web surfing and email communication both in and out of the company computers.

l  Ask contractors and employees to enter into non-competition agreements with your business after they leave.

l  Obtain reference and background checks on all managers, key employees and persons who will have regular access to any confidential information.

l  Build and maintain good relationships with the local police and Chinese government agencies, such as the State Administration for Industry and Commerce.

Although these measures may not completely protect trade secrets from unwanted disclosure, they may substantially reduce the risk of misappropriation. Moreover, these are necessary steps to prove that the trade secret owner has taken adequate measures to protect the confidentiality of the trade secret, which is essential in any enforcement action against misappropriation in China.

When it comes to trade secrets, prevention is the best cure. But don’t be shy of taking enforcement action in China if misappropriation has occurred. Chinese courts are improving. MNCs can now get meaningful remedies from Chinese courts.

While the inventor remuneration law has been on the books for years in China, it did not become a serious concern for MNCs until the enactment of the third amended Patent Law in 2009 (Patent Law) and its Implementing Regulations in 2010 (Implementing Regulations).

Under Article 16 of the Patent Law, an entity that is granted a patent right must reward the inventor of a service invention and pay reasonable remuneration to the inventor if the invention is exploited.

The language of Article 16 was not changed in the third amendment to the Patent Law, but the third amended Implementing Regulations have broadened the range of entities that must pay a reward and remuneration. Previously only state-owned enterprises had such an obligation; the requirement now stretches to any entity that is granted patent rights in China. Therefore, MNCs that have R&D activities in China, including equity joint ventures, cooperative joint ventures, and wholly owned foreign entities, must now consider this requirement when designing their R&D schemes in China.

Under the Patent Law and the Implementing Regulations, all types of patents (i.e., invention patents, utility model patents and design patents) are subject to the reward and remuneration requirement. The plain language of the Law provides that all inventors of a service invention are eligible for reward and remuneration, and there seems to be no limitation on the nationality of the inventors. However, as the Patent Law and the Implementing Regulations are national laws without extraterritorial effect, a foreign entity that has no business operations in China is not obligated to reward and remunerate the inventors in its own country based on PRC law, even though the foreign entity is granted a patent right in China. In addition, as the legislative intent is to stimulate innovation and encourage more service inventions in China, the reward and remuneration requirement applies to a service invention that is completed in China. Therefore, anyone who contributes to a patented invention that is made or completed in China is eligible for the PRC inventor reward and remuneration.

The Implementing Regulations provide that the entity that is granted a patent right may establish a policy formulated in accordance with the laws or enter into an agreement with the inventor of a service invention specifying the amount and manner of the payment. In the absence of such a policy or agreement, the entity must reward the inventor as follows: (i) within 3 months of the grant of the patent, at least 3,000 yuan for an invention patent and at least 1,000 yuan for a utility model or design patent; (ii) upon exploitation of a patent, at least 2% of after-tax profit for an invention or a utility model patent and at least 0.2% of after-tax profit for a design patent; and (iii) upon licensing of a patent, at least 10% of after-tax income from the patent license.

Although the Implementing Regulations allow an employee to waive the default rules through a remuneration policy “formulated in accordance with the laws” or by a contract, there is no guidance on what laws the remuneration policy must follow. Indeed, there are several Laws and regulations governing the inventor remuneration policy, including the Labor Law, the Labor Contract Law, the Patent Law, and the Contract Law, and their respective implementing regulations. Therefore, for a policy to be legally enacted, both its formation and its content must comply with the above Laws and regulations, in particular, any mandatory requirements in those Laws and regulations.

Since the Implementing Regulations were issued, a question commonly raised by MNCs is which entities must pay the reward and remuneration in a commissioned research arrangement. The commissioning party enters into an agreement with a contract research organization (CRO) to carry out a research project. The parties stipulate that the commissioning party will own all inventions arising from the research project. Consequently, the commissioning party will become the patent owner of the invention after an invention obtains patent protection. Although the Patent Law mandates that the patent owner, who will be the commissioning party in the above scenario, is obligated to make the payment, the commissioning party does not have an employment relationship with the inventor employees at the CRO. In addition, an MNC may file a patent application for an invention made in China in the name of its parent company.

Determining the payment obligation for the reward and remuneration under this patent-filing scheme is also challenging. In the above scenario, the question of which party is obligated to pay the reward and remuneration to the inventor employees remains open. Should the employment relationship or the labor contract be the condition precedent to the entity’s obligation to pay? Will the relevant parties have joint and several liabilities for the payment if the employee inventors do not receive payment? These questions are important for MNCs that have R&D activities in China. Although most practitioners are inclined to hold the view that the entity that has the employment relationship with an inventor employee is the party obligated to pay the reward and remuneration, there is no clear guidance in the legislation.

Similar to the requirement under the patent legislation, there is a requirement to reward and remunerate under the Contract Law. Article 326 of the Contract Law requires the owner of a service invention to set aside a portion of benefits derived from the use or transfer of the service invention to reward or compensate the inventor employees. However, the reward and remuneration requirements under the Contract Law and the Patent Law are not consistent. The Contract Law allows the owner of a service invention to pay either a reward or remuneration to inventor employees, but under the Patent Law the owner’s obligation to pay applies to both reward and remuneration. According to the principles of “new laws take precedence over old laws” and “special laws take precedence over general laws,” which apply in interpreting Chinese legislation, the reward and remuneration requirement under the Patent Law is likely to take precedence over that of the Contract Law. Nevertheless, legislative clarification is needed to address the inconsistency between the Laws.

Article 326 of the Contract Law also grants an inventor employee the right of first refusal to take a service invention on equal terms when the service invention is transferred to a third party. Although patents are regularly assigned, it appears that an MNC rarely considers the inventor employee’s right of first refusal when transferring a patent to a third party. This is probably because most MNCs are not aware of the inventor employee’s “priority” right under the Contract Law. A relevant issue is how an inventor employee’s right of first refusal will impact a patent transfer if the inventor employee asserts this right after the patent has been transferred. Will the transfer agreement be cancelled? How should the inventor employee be compensated if the patent owner fails to inform him or her of the patent transfer when assigning the patent to a third party? China is now focused on an intellectual property-led industrial strategy. The reward and remuneration requirement is thought to be part of China’s plan to become a leader in innovation. However, as discussed above, the practical application of the reward and remuneration requirement is vague. It calls for further legislation or judicial interpretation to clarify the ambiguities associated with this requirement.

At the time of this writing, Chinese courts have seen few lawsuits brought by inventors seeking remuneration, but no inventor remuneration lawsuit has been observed since the Implementing Regulations were issued. In addition, there has not been any significant award in China so far, although the UK, Japan, and Germany have all seen large inventor remuneration awards. It is, however, entirely possible that a Chinese court would reach a different conclusion in the future and take a different legal approach to inventors’ rights.

Given these uncertainties, below are some measures MNCs can take to minimize the risks in connection with the reward and remuneration requirement in China:

(1) Comply with the procedural requirements of the Labor Law and the Labor Contract Law when creating a remuneration policy.

(2) Consider making several milestone payments as opposed to a one-off payment.

(3) Build some discretion into the remuneration policy to deal with extraordinary inventions.

(4) Obtain a written acknowledgement from each employee certifying that the employee: (i) is aware of the inventor remuneration policy; (ii) agrees that the inventor remuneration policy is reasonable and fair; (iii) waives all future claims for reward and remuneration after the company fulfills the reward and remuneration obligations, and (iv) has waived the pre-emptive or first refusal right under Article 326 of the Contract Law.

(5) In a commissioned research project, expressly state that the CRO has the sole responsibility to compensate, reward, and remunerate eligible parties for any inventions made under the commissioned research.

(6) In a patent assignment agreement, expressly state that the assignor has the sole responsibility to compensate, reward, and remunerate its inventor employees.

The inventor remuneration policy should not be viewed just as a compliance issue. It is a way to encourage innovation and build loyalty. Therefore, a proper policy can go a long way in benefiting the company in the long run.