China: Coping Mechanisms for Trade Secret Infringement in Outbound Investment

Last Updated: 6 August 2012
Article by Chen Changhui and Jiang Zhipei

For decades, more and more Chinese overseas students and experienced employees in foreign enterprises have been flocking to domestic enterprises. In some cases, these employees have successfully developed products, that had been monopolized by enterprises in western countries in the name of trade secrets. Thus, Chinese enterprises are highly vulnerable to allegations by transnational enterprises of trade secret infringement. For Chinese enterprises, how to avoid falling into the pitfall of trade secret infringement and relevant legal risks, is the more immediate issue.

A trade secret falls within the protective scope of intellectual property ("IP") laws. It refers to technical or business information which is not generally known to the public, but which has utility and can bring economic benefits to the right holder; the right holder must also have taken security measures to keep the information secret. A trade secret is characterized by its ambiguous protective boundaries, e.g., even a clearly specified formula or blueprint is always a mix of trade secret and technology within the public domain. Consequently, trade secret disputes often feature complex facts, cumbersome procedures and difficult reasoning process. Thus, judges have to exercise their discretion when making court decisions.

In addition, such cases are often heard by local courts, and a plaintiff can exert extensive influence on the communities where the courts are located. The judges and juries might be partial to the plaintiff especially when deciding trade secret disputes with ambiguous protective boundaries. Under such situations, the non-local enterprises can be at a disadvantage when defending themselves against infringement allegations. An enterprise subject to trade secret allegations thus has to bear legal risk of losing lawsuit as well as publicizing their trade secrets in the court proceedings and in some cases even facing criminal liabilities.

Therefore, how to avoid and deal with trade secret disputes is a pressing issue for domestic Chinese enterprises dealing with outbound investment. Based on global experiences, domestically and abroad, this article suggests domestic enterprises take the following measures to lower the occurrence of trade secret infringements and enhance the enterprises' ability to resolve trade secret disputes.

  1. Strengthening Risk Management and Actively Avoiding Infringement

    Domestic enterprises must strengthen risk management in order to avoid trade secret infringement in outbound investments.

    Firstly, a domestic enterprise should sign a non-infringement agreement with a newly-recruited employee who formerly worked for a competing enterprise. In case a trade secret dispute occurs, the non-infringement agreement is compelling evidence demonstrating the enterprise did not intentionally commit the infringement. Besides, such agreement impels the employee to follow his or her duties of confidentiality, and to use technical experience and customer resources in a prudent manner. This will greatly reduce the employee's legal risk of trade secret infringement.

    Secondly, when using technical experience and customer resources brought with an employee, the domestic enterprise must ask: are these resources trade secrets of the competing enterprise? Have these resources been disclosed by the competing enterprise, or can they be obtained by reverse engineering? Only when the domestic enterprise has verified that its use of experiences and resources are legitimate can it use them when entering into a national market where a competing enterprise resides.

    In addition, the domestic enterprise should avoid disclosing trade secrets that an employee obtains from the former competing enterprise. Once convicted of trade secret infringement, the domestic enterprise may assume heavy compensation liability. As well, if information in a published paper or patent goes against non-infringement defenses, such documents might become a target and strong evidence for the claimant in a trade secret dispute.
  2. Classifying Technological Achievements and Applying for Patent Timely

    According to the exploitation difficulty in technology research & development ("R&D"), the possibility of getting a patent license and the licensing scope, the security ability of an enterprise and the enterprise's business expectations on different protection methods, a technological achievement can be protected in different ways: 1) applying for patent protection; 2) serving as trade secret; and 3) a mixed protection of patent and trade secret. In certain cases, the domestic enterprise should file for patent applications as soon as possible: 1) It is not convenient to protect the technological achievement as trade secret; or 2) even though a technological achievement can be treated as trade secret, the competing enterprise has adopted such technology and treated it as trade secret in advance; and relevant competitors will not increase rapidly in number if the technology is disclosed. In this way, the domestic enterprise could prevent competitors from stealing technological achievements, as well as lowering the risk of trade secret disputes.
  3. Retaining R&D Files to Prove Independent Development

    Many domestic enterprises have strict file retaining system to prove independent development. But quite a few enterprises are not well aware of the importance of retaining technology files and recording the R&D process clearly and accurately. Under this circumstance, if an enterprise is accused of trade secret infringement, it may have no convincing files to prove its acts are legitimate. Since any inaccurate recordings may become evidence against the domestic enterprise, companies should retain complete R&D files to prove their "innocence", and this is critical in dealing with trade secret disputes.
  4. Using Judicial Proceedings Wisely and Avoiding Local Protectionism

    Local protectionism has been a long-standing problem for transnational enterprises when doing business in China. But no laws, judges or juries can be fully independent of politics and society in any countries or regions. In outbound investment, domestic enterprises need to keep pace with the legal practices under common law system, especially the litigation system. They must know that "local protectionism" is also a common phenomenon in western countries. Local protectionism may be demonstrated as established rules in laws and regulations, or disguised in the form of a jury system with democratic appearance. Judicial proceedings are much more complex in common law system: During the litigation, the plaintiff and defendant always compete over proceedings (e.g., whether/how to introduce the jury to the proceedings; whether/how to introduce the expert, etc.) till either party wins the game. Therefore, unless the facts are beyond dispute, domestic enterprises will exercise judicial proceedings wisely. In order to avoid local protectionism, domestic enterprises must prevent the jury and the experts that are against them from participating in the proceedings.
  5. Fortifying Team Work and Hiring Qualified Law Firms

    Experiences show that a powerful intellectual property ("IP") management team will ensure the sound development of an enterprise. Many domestic enterprises have established IP management teams, which play an important role in managing an enterprise's IP strategy and resolving IP disputes. An outstanding IP advisor in chief should have: 1) engineering and law backgrounds; 2) work experience with law firms and experiences of enterprise IP management; 3) international perspective and accurate judgment; and 4) the ability to provide accurate and timely information to the enterprise decision-maker.

    Trade secret cases are usually characterized by ambiguous protective boundaries and complex technical features, therefore. Thus it is difficult to rule out subjective factors in related trials. Since overseas trade secret litigation often include cumbersome proceedings, rich litigation experience of the lawyers are required in a trade secret dispute in western countries, especially in the U.S. Since many cases can be settled through negotiation, lawyers with superior negotiation and coordination skills are heavily needed. Experienced lawyers and law firms with extensive influential power are critically important in a trade secret dispute.
  6. Submitting Files Deliberately and Avoiding Leakage of Technology

    In order to win in a fiercely competitive market, the plaintiff always puts forward a trade secret infringement lawsuit against his/her competitor in order to suppress competition and obtain relevant trade secrets from his/her competitor. To cope with the trade secret lawsuit, the defendant needs to submit R&D files, either actively or passively, to support his/her non-infringement defenses. If the defendant lacks a proper sense of confidentiality, he/she may make a full disclosure of relevant documents, and this may cause massive leakage of trade secrets.

    Therefore, domestic enterprises must carefully consider whether and what to submit to the court. To be specific, after weighing the pros and cons (e.g., probative force of the related files; whether other evidences provide sufficient credibility; impact on market and reputation, etc.), a domestic enterprise can make full use of related proceedings, and submit the R&D files in as limited a form as possible. Even when the files have been submitted, the domestic enterprise shall try to narrow down the scope of R&D files the judges disclose to other parties by making full use of proceeding rules.
  7. Counting All Factors and Optimizing Dispute Resolution

    Since, the defendant may be subject to criminal sanctions and lose his/her reputation in a trade secret lawsuit, the defendant cannot afford to lose such a lawsuit. A reconciliation agreement in favor of the plaintiff is a common way for dispute resolution, but is not the only way to solve disputes. Should the domestic enterprise have a great chance to win the lawsuit and prepare for a drawn-out lawsuit, the enterprise will stick to the lawsuit in that a winning lawsuit could actually raise brand awareness and improve product reputation in domestic and foreign markets. If the enterprise chooses to reconcile with the other party, it must count all factors to set down deliberated litigation strategy and effective counter measures. The counter measures serve as bargaining chips off the table, such as exercising influence on the plaintiff through media reports; filing a counterclaim; threatening to cancel or delay the procurement agreements and cooperation projects with the plaintiff; gaining support from the counter party's partners, etc..
  8. Regulating the Participants and Signing a Confidentiality Agreement

    Apart from internal employees and law firms, accounting firms, technical experts and mediators are likely to participate in trade secret dispute resolution. Domestic enterprises should have a high awareness of confidentiality, and they need to sign confidential agreements with the above-mentioned participants to avoid mistakenly disclosing trade secrets, lawsuit strategy and the bottom line of the negotiation.
  9. Managing Public Relations Crises and Reducing Negative Influences

    Once an enterprise has been named a "suspect" of trade secret infringement, the domestic enterprise needs to carry out every possible crisis management measures to reduce the negative impacts and create a favorable external environment. Firstly, the enterprise shall strictly control the release of lawsuit information. The improper release of information may lower the enterprise's stock price, impair the litigation or negotiation process, and introduce other disputes. Secondly, to reinforce the negotiation process, the domestic enterprise should avoid arguing with the plaintiff and give the plaintiff chances to issue statements in public. As well, cooperating with related media is an effective way to eliminate false public information and reduce negative impacts on the enterprise's image.

Although avoiding and dealing with overseas trade secret disputes will be quite difficult, Chinese enterprises, with proper measures, can, like transnational giants, become a force in outbound investment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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