As a foreign company sourcing components in China, how can you avoid or reduce potential losses arising to disputes over patent infringement of one of your supplier's products or technologies?
On 14 October 2021, the largest iron producer in Japan, Nippon Steel, filed a patent infringement lawsuit with the Tokyo District Court against Toyota Motors ("Toyota") and Chinese steel company, Baosteel. Nippon Steel also applied for a court injunction to stop Toyota from manufacturing and selling any new energy vehicles (NEVs) that infringe upon Nippon Steel patents. Although Nippon Steel and Toyota have been business partners for years, as Nippon Steel is one of the corporation’s suppliers. Toyota was named as a co-defendant in the lawsuit because it had chosen to source some of its materials from Baosteel. Commercial considerations aside, product receivers can learn from this case about ways to avoid potential financial losses, or damage to reputation, arising from patent infringement disputes involving a supplier's products.
Today, complex technologies are embedded in many products. For instance, cars and mobile phones are made using components produced by many different manufacturers. This now means that the manufacturer of the end product may be named in infringement litigation as a co-defendant in the event of a patent infringement dispute stemming from a single component used in their product, resulting in unexpected losses.
So given this, how can foreign companies doing business in China avoid or minimise these kinds of losses when sourcing goods or components from suppliers? PRC law and judicial interpretations offer a few suggestions.
1. The legal defence
According to the Patent Law of the People's Republic of China (2020), if a patent infringing product is used, promised for sale or sold for the purpose of production and operation without the product receiver knowing that it was made and sold without the permission of the patentee, and the legal origin of the product can be proved, no liability for compensation shall be incurred.
According to Article 25 of the Interpretation of the Supreme People's Court on Several Issues Concerning the Application of Law in the Trial of Disputes on Infringement of Patent Rights (II), if the user of the infringing product being sued can further prove that it has paid reasonable consideration, it may not be prevented from using the infringing component, or from promising to sell or from selling the finished product.
The above-mentioned provisions of the law and the judicial interpretation are intended to protect bona fide users. Where a product provided by a supplier is involved in a patent infringement dispute, the product receiver is not liable for damages and is not required to stop using or to stop promising to sell or to sell the end product in question, provided that it can prove that its actions were bona fide - i.e., that it did not know and could not have known that the product in question was not licensed by the patentee – and that the product in question was obtained through the normal course of business, such as legitimate sales channels and usual sales and purchase contracts, and that it can provide evidence of conformity with trading practices, even if it is involved in a patent infringement action.
2. Suggestion One: Expressly stipulate in the contract that the supplier of the product or technology shall bear liability for any infringement, alleged or actual.
Even though clear legal provisions exist, as described above, being involved in a lawsuit for no apparent reason as a buyer who has obtained a product through a legal transaction can still lead to litigation and losses, although it can be defended under the aforementioned law.
The same applies to the process of technology transactions. This requires prior understanding between the receiver of the product or technology and the provider by means of an agreed exclusion and indemnity clause.
In the case of a contract for the sale of a product or for a technology transaction, although the provider may be reluctant to guarantee that the product or technology does not infringe on the intellectual property rights of any third party, the receiver should require that any compensation resulting from the alleged infringement of the product or technology be borne by the provider. Additionally, the receiver should require that the provider indemnify them for any losses resulting in such circumstances.
It is worth noting that the provider does not automatically bear liability for any alleged infringement of its technology, and that such a clause must be expressly agreed upon by both parties in the contract.
The amendment to the Regulations of the People's Republic of China on Import and Export of Technology in 2019 has deleted the passage reading that "where the assignee of a technology import contract uses the technology provided by the assignor in accordance with the contract but infringes the lawful rights and interests of the other parties, the assignor shall be held liable", further indicating the principle of contractual autonomy.
Thus, the receiver of the technology should make all efforts to ensure that it is explicitly agreed in the contract that liability for compensation due to alleged infringement of the technology is borne by its provider.
3. Suggestion Two: Request FTO report from product or technology provider
Under certain circumstances, the receiver of the product or technology may ask the provider to produce a Freedom To Operate (FTO) report to prove that the product or technology does not infringe, and to reduce the risk of alleged infringement during the course of transaction. FTO reports are time-sensitive, however, so attention should be paid to the date of the completion of the report and also to its scope, etc.
4. Suggestion Three: Request infringement analysis from product or technology provider
The receiver of the product or technology may have traded with one or several product or technology providers ("prior providers") for some time, and there may be new product or technology providers ("later providers") in future, who are able to provide a product or technology of the same quality for a lower price.
In this case, and prior to any transaction with the later provider, the receiver may request the later provider produce an infringement analysis of its product in relation to the earlier provider's associated patent, or request that the later provider provide the product so that the receiver can appoint a professional agency to conduct an infringement analysis at the later provider's expense. In doing so, the receiver should either have knowledge of the relevant patents of the prior provider, or ensure that the prior provider discloses to them the relevant patents corresponding to the product or technology in question.
It is worth noting that only the subjective element of good faith without intention to infringe or gross negligence - i.e. not knowing and not presumed to have known - can be upheld through recourse to an FTO report or non-infringement opinion issued by the provider. An agreement on liability and damages can reduce the negative impact and amount of damages incurred, but it does not completely eliminate the risk of being sued.
Observation
Economic globalisation has led to the extremely fast flow of goods. As the “Made in China” brand gradually builds a good reputation in world markets, more foreign companies are willing to accept products and technologies made by Chinese companies.
In this patent infringement dispute between Nippon Steel, Toyota and Baosteel, Toyota claimed that it was not aware of any patent infringement issues before signing its supply agreement with Baosteel, that it had verified with Baosteel whether the materials it was supplying were suspected of any patent infringement, and that it had obtained a written assurance of non-infringement.
However, as a company with global stature, the case inevitably had a negative impact on Toyota. The lesson best drawn from this is that when a company, especially one as well-known as Toyota, is receiver of a product or technology made in China, it must pay greater attention to pre-transaction due diligence, and also conduct more rigorous assessments.
