Guest post by Profs. Yu and Contreras: The Uncertain Criminal Status of PAE Litigation in China

Guest post by Professor Jorge L. Contreras and Associate Professor Yang Yu of Shanghai University of International Business and Economics.  Professor Yu has graciously provided translations of core parts of the court’s judgment and Prosecutor’s protest.

On September 30, 2019, the Shanghai Pudong New Area People’s Court (court of first instance) ruled that an individual, Mr. Li Xingwen, was guilty of criminal extortion for asserting patents against a number of Chinese companies shortly before their initial public offerings (IPOs). The case was widely reported in the international press (see here, here and here) before the official release of this first-instance judgment, and gave rise to concern about the risks of asserting patents in China. The full text of the Shanghai court’s decision was finally released on September 30, 2019 and reveals several interesting details about the case. In particular, Mr. Li’s conduct giving rise to the judgment of extortion involved the falsification and backdating of a license agreement with a related company in order to extract additional royalties from a company with which Li had already settled.  However, most of Mr. Li’s other patent assertions, notwithstanding their strategic filing prior to the defendants’ IPOs, were viewed as legitimate.  Then, on October 18, 2019, the Shanghai Pudong New Area People’s Procuratorate lodged a protest with the Shanghai No.1 Intermediate People’s Court, arguing that the judgment against Mr. Li was too lenient.  Below, we summarize the facts of the case and the findings of the court of first instance, then assess the implications of the People’s Prosecutor’s protest.

The Patent Assertions

According to one news report, Mr. Li was a prolific inventor and patent agent. Beginning as a university student, he reportedly applied for over 1,000 patents, more than 600 of which had issued at the time of the case. These patents covered a diverse range of products including “a folding bicycle, a flushing water tank, a self-filtering aquarium, [and] an insecticidal device” (IAM, Oct. 1, 2018).  In addition to these, Mr. Li filed numerous patents covering aspects of electrical equipment. Working with his brother, Li established several holding companies to which he transferred some of these patents.

Beginning in 2015, Li’s companies sued four Chinese electronics firms for patent infringement in the Beijing, Xiamen and Shanghai courts. In several cases, the litigation was brought as the defendant companies were in the process of registering their securities in IPOs on the Shanghai or Shenzhen stock exchanges.  In all cases, the alleged infringers settled the cases brought by Mr. Li’s companies, committing to pay him a total of RMB 2.163 million (RMB 1.163 million of which had been paid at the time of his prosecution).

Some cases involved the assertion of two Chinese patents claiming methods for data transmission and image acquisition against Zhang Yue Technology Inc., a manufacturer of e-book readers. A series of cases were brought from March 2017 to  July 2017 by Mr. Li’s company Shanghai Ke Dou Electronic Technology Co. Ltd. (Ke Dou) in the Beijing Intellectual Property Court and Shanghai Intellectual Property Court.  Zhang Yue settled with Ke Dou on 15 July 2017, agreeing to pay a total of RMB 800,000.

Then, at the end of 2017, Li’s holding company Ke Dou entered into an agreement with another Li company called Shanghai Bu Dao Industrial Co., Ltd. (Bu Dao).  Under this agreement, Ke Dou purported to grant Bu Dao an exclusive license to a data transmission patent (Patent No. ZL201010523269.X “Method and system for initiating data transmission between devices through image acquisition”). What’s more, the Ke Dou – Bu Dao agreement was back-dated so that it appeared to pre-date the license that Ke Dou granted to Zhang Yue.

Armed with this exclusive license, Bu Dao sued Zhang Yue in the Beijing IP Court under the same patent. To exert even greater pressure, Bu Dao reported the lawsuit to the China Securities Regulatory Commission (CSRC), which had oversight over Zhang Yue’s pending IPO.  In an attempt to avoid interference with the IPO, Zhang Yue agreed to settle the lawsuit with Bu Dao for an additional RMB 800,000.

Arrest and Charges

After signing the second license agreement, Zhang Yue reported Mr. Li and his brother to the police (IAM, Jul. 23, 2018). The case was investigated by the securities crime unit of the Shanghai Public Securities Bureau.  Mr. Li and his brother were arrested in January 2018 and prosecutors charged them with extortion on August 24. As reported by IAM (Oct. 1, 2018) the Shanghai Public Security Bureau explained the charges as an effort to preserve order in China’s capital markets, and justified them on the basis that the purpose of Li’s litigation was not to protect his patented technology but simply to earn large sums of money. This behavior, one official noted, “is in line with the characteristics of extortion”.

The Court’s Decision

The Shanghai Pudong New Area People’s Court rendered its decision in Mr. Li’s case on September 30, 2019. It evaluated the conduct of Mr. Li and his brother with respect to four different defendants that had been sued for patent infringement, including Zhang Yue.  In three of the cases, Mr. Li’s lawsuits were timed to coincide with the defendant’s preparation for or execution of an IPO.  Unlike the Public Securities Bureau, however, the court did not consider this fact to be dispositive.  In order to prove the crime of extortion, the court explained that the accused must have illegally obtained payment by means of threats and intimidation.

The court then noted that the patents asserted by Mr. Li’s companies against the four defendants were either recognized as valid by the China National Intellectual Property Administration (CNIPA) or were, at worst, of uncertain validity. As a result, seeking and obtaining license fees for such patents was not illegal. It was not relevant that Mr. Li’s demands for royalties came at sensitive times when the defendant companies were preparing for stock listing or financing.  Moreover, the court did not find evidence that Mr. Li’s companies carried out “threats or blackmail” simply by demanding payment for its patents.  Rather, it was possible that the defendants decided to pay the requested amounts for legitimate business reasons.  Accordingly, extortion was not found in these instances.

However, with respect to the second demand made against Zhang Yue, Mr. Li and his brother colluded “in bad faith” to fabricate an exclusive license agreement between their companies Ke Dou and Bu Dao. Bu Dao then sought additional royalties from Zhang Yue after it had already paid Ke Dou for the same patent.  Moreover, when Mr. Li reported Zhang Yue’s infringement of the patents to the CSRC, he did so only to pressure Zhang Yue to pay Bu Dao for these patents.  This action constituted coercion, and Zhang Yue’s payment to Bu Dau was made out of fear of the effect that nonpayment might have on its pending stock offering.  As a result, the court found that the Lis’ behavior toward Zhang Yue constituted criminal extortion.

The convictions required the Lis to refund the payment improperly paid by Zhang Yue, as well as additional fines of RMB 50,000 and 20,000 for Mr. Li and his brother, respectively.  In addition, Mr. Li and his brother were sentenced to four years and six months, and two years, imprisonment, and the unspecified “tools” used to commit the extortion were confiscated.

The Prosecutor’s Challenge to the Judgment

On October 18, 2019, the Shanghai Pudong New Area People’s Procuratorate (the local prosecutorial authority) lodged a protest with the Shanghai No.1 Intermediate People’s Court, arguing that the judgments against Mr. Li and his brother were too lenient, in that no extortion judgment was imposed with respect to their patent demands against the companies other than Zhang Yue. In its protest, the Prosecutor has argued that having the right to bring a patent enforcement action under the civil patent law does not necessarily exonerate a patentee from a criminal judgment of extortion. That is, civil and criminal offenses must be judged independently, and in this case, whether or not the Li brothers had patents, their conduct amounted to extortion.  The Prosecutor also questions the legitimacy of Mr. Li’s  enforcement actions under the patent law, arguing that the patents were not clearly valid or enforceable, were based on minor modifications to prior art technology, and involved extremely low R&D costs – all of which make the basis for his patent claims dubious.  What’s more, the settlement payments made by the alleged infringers were not related to the number, content or value of the patents, but were instead paid unwillingly in order to avoid litigation that could scuttle their other financing and corporate transactions. The Prosecutor points to Mr. Li’s deliberate targeting of companies that were in the process of obtaining financing and failure to make substantial preparations for litigation as further evidence of his malicious intent.  For all of these reasons, the Prosecutor has petitioned the court to extent its extortion judgment to the Li brothers’ other patent assertions.

Conclusions

It not clear when the People’s Court will rule on the Prosecutor’s protest, or when (or whether) a written decision will be issued in response. However, the outcome of this protest could be important for all firms considering the initiation of patent infringement litigation in China. While one can assume that few legitimate patent holders will resort to the clearly deceptive tactics adopted by the Li brothers (e.g., creating backdated licensing agreements between related shell companies), the Prosecutor seeks to impose criminal penalties on behavior that is far more common in the business environment:  asserting patents without certainty regarding their validity, confronting an infringer prior to or in the midst of a financing transaction, or obtaining a settlement payment that is not directly related to the number or value of the asserted patents. In the U.S. and other Western countries, tactics like these have generally been accepted as permissible, so long as a patent has been validly issued by the relevant granting authority.  But if the Shanghai Pudong New Area People’s Procuratorate has its way, an entirely new level of intent-based scrutiny could be applied to patent litigation.

5 thoughts on “Guest post by Profs. Yu and Contreras: The Uncertain Criminal Status of PAE Litigation in China

  1. 3

    “Hot pot” for Chinese patent trolls? [Compare to infrequent U.S. sanctions as noted in the blog below on an attorney sanction.] [At least it’s apparently not an offense for which one has to buy one’s own bullet.]

  2. 2

    I agree with Pro Say’s “wow” reaction. Criminal penalties are a surprising development.

    This rather gives the lie, however, to those folks blathering about how innovation is all going to move to China because one can enforce patents over there but not over here. The willingness of the SIPO to grant certain patents is orders of magnitude less significant to a choice of where to do business than is the willingness of prosecutors to bring criminal charges against those who unsuccessfully attempt to enforce those patents.

    1. 2.1

      I think you missed a few (quite a few) facts there Greg in your haste to make an overgeneralized statement that attempts to diminish the fact that patent law is Sovereign-centric law…

    2. 2.2

      …BUT, wouldn’t it be interesting that like copyright (hint-hint-Big-Media), there was a movement in the US to add criminality to patent infringement….

  3. 1

    Wow. Just wow.

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