“Man bites dog” was surely a potential headline when it came to light in February that Netac Technology Co., a Shenzhen-based company, had become the first Chinese enterprise to sue a U.S. corporation for patent infringement–and was doing so in Texarkana, Texas.

“You hear a lot of ‘people in glass houses shouldn’t throw stones’ comments about this case,” says John Nathan, co-chair of Paul, Weiss, Rifkind, Wharton & Garrison’s patent litigation group.

Netac claims that New Jersey-based PNY Technologies has infringed its patent for USB flash-memory drives. Also known as “flash drives,” these devices generate sales of $2 billion annually in the U.S.

Netac is seeking “significant” but unspecified damages and an injunction suspending sales of PNY’s drives.

The case oozes irony. Although China is a signatory to the World Intellectual Property Organization’s (WIPO) IP treaties, the international community has been critical of the Chinese government’s lack of commitment to enforcement. What galls many is the prospect of a Chinese company using the American legal system for its benefit at a time when the U.S. government estimates Chinese infringement of foreigners’ IP rights costs rights holders more than $60 billion annually. International Data Corporation (IDC), a U.S. technology research firm, estimates that 90 percent of the software used in China in 2004 was unlicensed.

But others see Netac v. PNY as a turning point in the evolution of Chinese attitudes toward IP protection.

“This is what happens when a Third World economy begins generating technology instead of copying it,” says Stephen Judlowe, partner at Morgan, Lewis & Bockius who represents Netac.

On The Offensive

With 350 employees and sales approaching $70 million, Netac holds more than 200 Chinese patents and 50 international patents. The company claims to have invented the first flash drive in 1999 after investing $7.3 million in research and development. Three years later it obtained a Chinese patent on the device.

Almost immediately Netac launched a legal campaign to protect its patent. In September 2002 the company sued its competitors, Beijing Huaqi Information Digital Technology Co. Ltd. (Huaqi), and Beijing Acer Information Co. Ltd. (Acer), in the Intermediate People’s Court of Shenzhen. Netac claimed the defendants had infringed the core technology of its most popular product, OnlyDisc.

While the case was pending, Netac leveraged its invention into licensing deals with IBM Corp., Dell Inc., Samsung Corp. and Toshiba Corp., all of which seemed confident that Netac would prevail.

They were right. Early in the litigation Acer settled for an undisclosed sum and agreed to stop producing the offending drives. Huaqi took the case to trial. That turned out to be a mistake.

In June 2004 the court ruled in Netac’s favor, awarding $125,000 in damages and prohibiting Huaqi from selling the infringing product. Huaqi has appealed and is asking the Chinese patent office to reexamine the patent.

Undaunted by the uncertainty of an appeal, however, Netac decided to take on bigger fish by filing in August 2004 an almost identical suit in China against Sony Electronics. The case, which is still at an early stage, was barely warm when Netac announced it was investigating claims against Hewlett-Packard Co., SanDisk Corp. and Apple Computer Inc., which uses flash memory in its iPod Shuffle and Nano players.

As it turned out, 2004 was also the year in which Netac received its first U.S. patent. Given Netac’s history, it should have surprised no one that it would defend its American rights as staunchly as it had stood behind its Chinese patent.

Recent activity in Chinese courts suggests that Chinese plaintiffs will soon be regular parties in U.S. courts.

Foreign Defendants

Only 1.3 percent of civil IP cases in China featured foreign parties in 2003. By 2004, the proportion had tripled.

With the dramatic rise in the number of Chinese patents granted annually, the involvement of foreign parties in IP disputes is likely to grow. The Chinese patent office handled about 1 million patent applications between 1985 and 2000, then doubled that number over the next four years.

“The shoe is definitely moving to the other foot in the sense that foreign companies used to complaining about Chinese abuse of their IP rights are now finding the same accusations leveled against them by Chinese companies,” says Leo Seewald, a partner in King & Wood, China’s largest domestic law firm.

Most famously, Chinese regulators voided Pfizer’s Viagra patent in July 2004 after Chinese companies complained the patent didn’t meet the “novelty” requirement. And in April 2005 Donjin Xianda Technology Co. Ltd., a networking company, sued Intel for violating the WTO’s TRIPS treaty by binding its software and hardware products, effectively preventing Intel’s customers from using third-party hardware.

But it hasn’t all been a one-way street.

In the past two years, Starbucks and Dell have both won IP cases in Chinese courts. 3M Co. recently won a $30,800 infringement judgment in a Shanghai court against a Chinese firm. And in February the Beijing Municipal First Intermediate People’s Court agreed to hear Pfizer’s petition attacking the revocation of the Viagra patent.

Accelerated Progress

The most important development, however, may have occurred in late February when China’s National Working Group for IPR Protection, headed by Vice Premier Wu Yi, unveiled the details of its 2006 IP action plan. The plan attempts to bolster China’s IP laws and enforcement practices (See Sidebar).

Although the Group didn’t release a concrete implementation schedule, many observers see the mere existence of a plan as an important step forward.

“The action plan has been endorsed by the very highest officials and things can change very fast in accordance with that plan,” says Jane Clark, who leads Gowling Lafleur Henderson’s China initiative.

By all accounts, the process has already started. In April, Lenovo Group Ltd., China’s largest PC maker, and three of its competitors complied with a government mandate that hardware manufacturers install genuine operating software on PCs before the machines leave factories.

Nick Groombridge, co-chair of Weil Gotshal & Manges’ patent litigation group, says this is only the beginning.

“What we’re going to see is an evolution of IP rights in China on a time scale that’s greatly accelerated,” he says.

If that’s true, even the grousers will see the long-term advantages of Netac’s foray into Texarkana.



China’s New Plan

China’s National Working Group for IPR Protection released details of its 2006 IP action plan in February. Highlights of the plan include:

-Making it easier to send people to jail for IP infringements;

-Overhauling the rules governing disputes between trademark owners and business name owners;

-Boosting cooperation between IP administrative officials and China’s criminal law enforcement agencies; and

-Translating China’s patent examination guidelines into English.