China: Agreement Between Right Holder And Infringers On How To Compensate For Repeated Infringement Can Serve As A Basis Of Determining Infringement Damage

Guangzhou Zhongshan Lerado Daily Article Co., Ltd v. Hubei Tongba Daily Article Co., Ltd (Civil Judgment (2013) Min Ti Zi Nos. 114-116, the Supreme People's Court, December 7, 2013)

The People's Courts upheld that right holders and infringers could enter into an agreement on infringement damage before or after the actual infringement, which fell into the principle of autonomy of private law. If such an agreement did not violate laws and regulations, courts should support the terms in that agreement. The Chinese Patent Law and the Chinese Tort Law did not prohibit a right holder and an infringer to enter into an agreement on tort liability and amount of compensation in advance.

Guangzhou Zhongshan Lerado Daily Article Co., LTD (hereinafter referred to as "Lerado") is the owner of the patents ZL02322197.6, ZL01355071.3 and ZL01242571.0 (hereinafter referred to as "the involved patents") relating to baby stroller.

Lerado filed a patent infringement suit against Hubei TongbaDaily Article Co., LTD (hereinafter referred to as "Tongba") in April, 2008. The two parties reached an agreement in a civil mediation held by the Hubei High Court where the pertinent part reads "Tongba promised never to infringe Lerado's patent again. If any further infringement occurs Tongba would voluntarily pay Lerado a damage of RMB 1,000,000 (or RMB 500,000 if the patent is directed to a design)."

In May, 2011, Lerado sued Tongba for its repeated infringement in May. In view of the prior mediation agreement, both the First Instance and the Second Instance courts held that this case falls under concurrence of breach of contract liability and infringement, and since Lerado expressly decided to sue for the infringement, therefore its claim to pay the damages based on the amount of liquidated damages agreed upon in the mediation agreement was dismissed.

Lerado was dissatisfied with the ruling and filed a retrial request with the Supreme People's Court (SPC). The SPC held that this case did not fall under concurrence of breach of contract liability and infringement. Tongba was liable for the infringement. The two parties' agreement, formed during the mediation, on the specific methods and amounts of compensation for Tongba's future infringement was to facilitate how Tonga could be held liable on repeated infringement. Accordingly, this case can adopt the methods and amounts of compensation agreed during the mediation between Lerado and Tongba.

Interpretation and Analysis

The distinctive point of this case is the prior liability agreement between Lerado and Tongba. Because of this agreement, both the First and the Second Instance courts held that this case fell under concurrence of breach of contract liability and infringement under Article 122 of the Contract Law, but the SPC denied this point outright.

I. The SPC interpreted as follows: under Article 122 of the Chinese Contract Law, the premise of concurrent liability was the existence of an underlying transaction contractual relationship between the two parties; and based on this relation, a party breached the contractual obligations and such breach led to an infringing of the other party's interest. Therefore, breaching under this article meant breaching the obligation agreed upon in the underlying transaction contract, and infringed the other party's interest at the same time.

In order to understand the SPC's interpretation, we need to understand the meaning of "the underlying transactional contractual relationship," which was not clarified in the SPC's judgment. This phrase does not seem to be a coined term in common practice and has no general meaning. An interpretation of "transaction contract" can be found in Baidu Baike as "an agreement entered into by two parties when buying and selling goods," which is a definition far different from the fact of this case. Accordingly, though the SPC ascertained that this case did not fell under concurrent liability and Tongba should assume the infringement liability, it would be better for the SPC to further clarify the reasons behind these grounds, especially to clarify why the premise of concurrent liability concurrence is based on an underlying transaction contractual relationship between the two parties, and what is the underlying transaction contractual relationship.

The author will try to answer why does this case not belongs to concurrent liability from the following aspects.

Under Article 122 of the Contract Law, concurrence of liability for breach of contract and liability of infringement refers to the circumstances where one party's breach of contract also constitutes as an infringement at the same time, a concurrence of the two liabilities. The breach is the cause of the infringement, the infringement is the outcome of the breach, therefore, the breach and the infringement should be the same legal action.

The mediation agreement between Lerado and Tongba seems to involve two civil legal actions, one being Tongba's "do-nothing" agreement on infringement, the other is the agreement on specific methods and amounts of compensation when actual infringement occurs. The "do-nothing" agreement cannot be substantively regarded as a civil legal act, since this agreement cannot generate a new civil legal relationship between Lerado and Tongba, because Tongba is legally obliged to not infringe. In other words, the mediation agreement is an agreement on the specific methods and amounts of compensation when infringement occurs. Breaching this agreement is apparently not the same legal action as the specific infringement, therefore, the breach and the infringement cannot constitute as a cause-and-effect relation. Therefore, the civil liability assumed by Tongba was not concurrent liability.

II. The SPC held that Tongba infringed and should compensate based on the amount of the liquidated damages agreed upon in the mediation agreement, which raises another legal issue worth discussion, i.e., is it legal and reasonable to adopt "liquidated damages" in a patent infringement lawsuit?

Article 65 of the Chinese Patent Law provides four methods to determine the amount of compensation of a patent infringement, i.e., actual losses incurred to the patentee, gains obtained by the infringer, multiple of the royalties, or statutory damages, and provides no catch-all provision on other determination methods. Despite this, civil law, as a law of regulating relation of private right and protecting private interest, is different from the public laws that require "all actions are prohibited unless permitted under the laws," such as criminal law and administrative law. The highlighted feature being that "all actions are permitted unless prohibited by the laws." Laws currently in effect such as The Patent Law and the Tort Law do not prohibit that a right holder and an infringer can, in advance, enter into an agreement on methods of tort liability and compensation amount. Moreover, according to the Tort Law, concerned parties can agree to compensation scopes under the principle of autonomy of will. Therefore, it is legal to apply "liquidated damages" in a lawsuit of patent infringement.

As a matter of fact, Article 34 of Certain Provisions of the Supreme People's Court on Issues Concerning the Application of Law in the Hearing of Patent Dispute Cases II (Draft for Public Opinions) provides "if a right holder and an infringer, in advance, enter into an agreement on compensation amount or manners of calculating compensation of patent infringement, and the holder claims damages in a lawsuit of patent infringement based on the amount of liquidated damages agreed upon, the People's Courts should support." If this provision is allowed in the future, application of "liquidated damages" in a patent infringement lawsuit can have legal basis.

It is also reasonable to apply "liquidated damages" in a lawsuit. In practice, compensation amounts are determined by the judge's discretion in most of IP infringement cases, since it is difficult to determine actual losses incurred to right holders and gains obtained by the infringer. Compensation amounts are always low, which significantly hinders the motivation of the right holders to protect their rights.

In another aspect, considering such low compensation amounts, defendants (infringers) tend to repeatedly infringe in pursue of economic interest. If right holders have an agreement on methods of compensation on repeated infringement with the defendants, such an agreement can effectively controlled the defendants' motivation to repeatedly infringe. During the court's mediation for defendant's first infringement, rights holders are advised to expressly draft the methods of compensation for defendant's repeated infringement as a necessary clause in the mediation agreement. If the defendants are unwilling to ratify such undertaking, the defendants are more likely to repeat the infringement. If the defendants agreed on such compensation clause for repeated infringement, the People's Courts shall support the compensation agreement.

Such compensation for repeated infringement agreed in advance is more or less intrinsically similar to liquidated damage in the contract law. However, such compensation does not equal to pure liquidated damage and has punitive damage nature. Therefore, it is acceptable to set the amount higher to a certain extent than actual losses incurred to right holders.

This case provides patentees a takeaway lesson that such compensation agreement agreed in advance can be used to request sufficient compensation in potential patent infringement, and to avoid excessively low compensation due to the high burden of proof or failure to provide sufficient evidence. For instance, in a patent licensing agreement, a patentee can require a licensee to ratify an undertaking on the compensation amounts in case of infringement in advance. In an ongoing patent infringement lawsuit, if the two parties enter into a settlement or mediation agreement, patentees can take this opportunity to require the infringers to ratify a undertaking on compensation amounts in case of repeated infringement in advance.

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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