Intellectual Property

Within a two-minute walk from my apartment in Shenzhen, there is ample evidence that intellectual property, particularly American, is not very well-protected in China. Nighttimes, three different vendors set up their folding tables on the main street with pirate DVDs by the carton-full, including many of the latest Hollywood releases. Cost: RMB5 each, or 73 cents each.

A little further west at the main intersection, a huge new superstore is under construction. The four-story-high signs proclaim it’s Shenzhen’s new “Official NBA Store”. But, when I emailed a friend who is one of the top executives at the NBA headquarters in New York, intending to congratulate them on their expansion in China, he emailed back to say that the NBA has no such project underway in Shenzhen. In other words, some other group is going to try to hijack the NBA logo (and most likely, when the store opens, NBA merchandise as well) and pass itself off as the genuine article, presumably making a killing along the way in basketball-crazy China.

So far so ordinary, right? Everyone knows that China is a paradise for counterfeiters and IP thieves, right?

Well, as is often the case in China, things are not quite as malign as they appear from the outside, in the minds of Western critics. Slowly but surely, China is taking the right steps to build a legal framework through which intellectual property – including foreign IP — can be protected in court. *

This is very good news for all of us in the private equity and investment banking industries in China. Improved enforcement will help bring China into closer accord with the rest of the developed world in terms of IP protection. In many successful companies, intangible assets, including IP, are the most valuable item on the balance sheet. So, protecting IP is commensurate with protecting the value of a business, and so the financial interest of investors.

There’s another key reason: some of the best private Chinese companies are developing their own successful brands in the Chinese domestic market. These Chinese brand-leaders are among the best opportunities for private equity investment, not just in China, but anywhere in the world. They face the same threats in China as foreign companies whose IP is being stolen. As the IP legal system develops, China’s own emerging brands will find it easier to defend their position in the domestic market, and shut down competitors who are ripping them off.

One telling data point: perhaps the fastest-growing area of Chinese law – measured by billable hours among well-qualified lawyers – is in intellectual property. That’s because it’s getting much easier for companies to prevail in court against those who appropriate their logos, trademarks, designs, patents and other intellectual property.

The court system is more and more responsive to such claims of IP theft. So, with increasing regularity, Western companies are taking action in Chinese courts. This is, without question, a positive development, and one that points the way toward a future where IP protection is more strenuously and uniformly enforced across China.

The legal system is still evolving. At the moment, damage awards for the victor in an IP infringement case are not very high, often no more than RMB500,000 ($73,000), which is not going to be enough to discourage many of the larger-sized businesses in China that are producing and selling products that obviously rip off other companies’ IP. But, there’s often more at stake here than just the damage award. Litigation in China, as elsewhere, is costly. The victor in an IP case, in addition to the damages, will often also be awarded legal costs, meaning they can reclaim their entire legal fees from the company they’ve just defeated in cost.

This is the real sting in the tail. Legal fees can easily reach amounts 10-20 times higher than the maximum damages. So, the victor can ultimately collect tens of millions of renminbi from the loser. In addition, of course, the losers have to swallow their own legal fees, which can be no less sizable. That sort of cumulative penalty (damages+own costs+victor’s costs) is enough to inflict a lot of pain on a company that is prospering by stealing someone else’s IP. Now, sure, collecting on a large monetary judgment in China can be a challenge. But, if the losing Chinese company is large enough, it’s hard for them to escape paying. They can’t just close up shop, and start again under another name.

As China’s economy continues to grow robustly, more companies (including those whose success is predicated on stealing others’ IP) reach a size where they are too large and too well-established to escape the effects of such a punitive judgment. Result: some of the worst and largest IP offenders will be the first to suffer, made to bear heavy costs, or forced out of business.

Now, of course, it’s likely going to be a very long time before the pirate DVD street vendors are put out of business. It’s not often discussed, but other countries, including the US, have similar sorts of opportunistic businessmen. I’ve been to areas of Los Angeles – usually not the nicest ones – and found guys on the street selling pirate DVDs of the latest Hollywood movies owned by studios that are headquartered less than 10 miles away. If the US can’t shut these operators down, it’s unrealistic to ask China to.

But, the legal remedies now available – and I expect them to get even more extensive and water-tight over time –allow companies in China to act against the biggest IP thieves who do the most financial damage. This will benefit both foreign and the domestic Chinese companies now investing heavily to build their own brands and unique IP. A category of private equity investors in China will be winners also – those that back the companies now developing the brands that will one day dominate China.

 

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