China – How To Prepare Evidence In Trade Secret Disputes.

 

It is said that a trade secret is to a business is what blood is to a man. This is true for companies or individuals with trade secrets as their core competitive advantage in the market. However, trade secret misappropriation by people is very common due to high profits that can be used for little or no cost in R&D. The damages caused to the holder of the trade secret is irreversible once the trade secret is leaked because of the loss of exclusivity.

 

Due to the inherent challenges in collecting evidence for trade secret misappropriation, not many right holders are able to bring a court case, or if they do, win and be awarded with substantial damages. According to statistics published on China Judgement Online, from 2013 to 2017, there were only 610 trade secret misappropriation cases concluded, with a losing rate of 63.19%, 27.5% of claims partially upheld by the court and only 9.27% of cases were fully won by the trade secret holders.[1]
 

This data is in line with our experience where many clients asked for advice on trade secret protection, but few cases could be filed to court or brought to the police for investigation due to the difficulties in collecting evidence to meet statutory requirements. The main challenges include proving the confidential features and boundaries of the alleged trade secret, confidentiality, the amount of damages caused or illegal profit made in order to meet the statutory criminal threshold of RMB 500,000 (USD$77,654), the basis of the claim for damages, and evidence that the alleged infringer has used the trade secret.
 

In recent years, China has launched a series of legislative reforms on trade secret protection to protect and encourage innovation and to ensure a healthy competitive environment. Most notable changes in the laws are the lowered requirements on the burden of proof of the right holder, raising maximum statutory damages from RMB 300,000 (USD$46,593) to RMB 500,000 (USD$77,654), adding punitive damages into the law, lowering the threshold for criminal liability from RMB 500,000 (USD$77,654) to RMB 300,000 (USD$46,593), and a longer sentence for imprisonment. The Supreme People’s Court (SPC) also recently published two case judgements in which the highest damages was awarded to the plaintiff and severe punitive damages were imposed for trade secret infringement.

 

In this article, we will examine how a trade secret holder can fulfill the burden of proof for a trade secret misappropriation action under the current law. 

 

Burden of Proof

 

The first two questions for a right holder to ascertain in a trade secret misappropriation action are: 1) what is the trade secret in concern? and 2) Has there been infringement? 

 

According to Article 14 of Interpretation (II) of the Supreme People’s Court on Several Issues Concerning the Application of Law in the Trial of Civil Cases Involving Trade Secret Infringements (adopted on 23 December 2020 and issued on 29 December 2020) (the “SPC Interpretation”), the plaintiff has the burden to prove that:

 

1. they legally own the trade secret;

2. that the information allegedly misappropriated by the defendant is identical to or substantially similar to that of the trade secret; and

3. that the defendant obtained the trade secret through illegal means.
    

1. Proving the trade secret right

 

According to Article 9 of the Anti-Unfair Competition Law (effective 23 April 2019) (“AUCL”), trade secret is defined as commercial, technical or business information that is not known to the public and has commercial value for which the right holder has adopted corresponding confidentiality measures.

 

It is usually not difficult to categorize trade secrets as technical, business or commercial information that has commercial value. Unlike other IP rights such as trademarks, the confidential features and boundaries of a trade secret is usually vague and requires the right holder to carefully specify them so that it falls within the statutory definition. To protect their trade secrets, right holders usually adopt protective measures such as establishing confidentiality regulations in employee handbooks and signing non-disclosure agreements .

 

The most challenging element lies in proving confidentiality. Article 9 of the AUCL appears to impose the burden of proof on the plaintiff. Meanwhile, Article 14 of the SPC Interpretation states that evidence to prove a trade secret has met statutory conditions includes the carrier, specific content, commercial value and the specific confidentiality measures taken to protect the trade secret. It should be noted that the element “unknown to the public” is not included. This has caused disagreements in judicial practice as some judges believe that the plaintiff should bear the burden to prove the confidentiality of the trade secret, while other judges are of the opinion that the burden lies with the defendant to prove that the trade secret is not confidential.

 

Case examples

 

• In Wang vs Beijing East Petrol Chemical Co. Ltd.& Others [Beijing HPC (2011) Gao Min Zhong Zi No. 220], the defendant failed to prove when the alleged trade secret had been created, nor could he prove his technology was not known to the public. It was held not to be a trade secret.

•  In the case of Hangzhou JINDA Electric Technology Company vs Chen [Zhejiang HPC (2004) Zhe Min San Zhong Zi No. 156], Zhejiang Higher People’s Court held that the ultimate burden of proof was on the defendant to prove the alleged trade secret was known to the public.
   

Article 9 of the SPC Interpretation also specifies that if the relevant information is not generally known to and easily obtainable by the relevant personnel in the field, it shall be deemed as “unknown to the public”. With this definition, it may be more difficult for the plaintiff to prove that the “relevant information” is not generally known than to prove it is “not easily obtainable” by the relevant personnel.

 

Case example

 

• In the appeal of Chengdu JiaLing Electric Manufacturing Co.Ltd vs Chengdu Hope Electric Research Institute [SPC (2001) Min Zhong Zi No.11], the court held that the plaintiff’s use of the publicly known technology for its design and components constituted as a trade secret.
   

 In summary, it is necessary to prove that there is a trade secret before claiming that it is misappropriated. The right holder should be clear about the commercial value and scope of the trade secret and take proactive methods to prevent the trade secret from being revealed to the public. Given there are no precise standards for deciding whether a technical or commercial information is unknown to the public, the right holder should utilize any means to establish that the information misappropriated is confidential and therefore a trade secret.
 

2. Proving identical or substantially similar

 

With the right to the trade secret ascertained, the plaintiff should then prove that the information used by the defendant is identical or substantially similar to that of the trade secret.

 

For example, technical information is often used in a product to gain competitive advantage in the market. A notarized purchase and a comparative analysis of the technical characteristics between the infringing product and the original product are usually required for the plaintiff when collecting evidence. In many cases, the plaintiffs claimed that all the information they had rights for should be protected as trade secrets, but this was not accepted by the court because they failed to exclude the publicly known information and therefore overestimated the scope of protection offered. The plaintiff should bear in mind that only the technical characteristics of the innovative part are protected as trade secrets.

 

When making an analysis, the plaintiff shall compare each corresponding technical characteristic between the infringing and original product to confirm if they are the same or substantially similar. If the technology involved is complex, technical verification by a certified third-party agency is required.

 

Case example

 

In the appeal of Shanghai Jiaoda AngLi Holdings Ltd vs Shanghai GaoBoTe Biological Health Care Product Co. Ltd [Shanghai PC (2005) Hu Gao Min San (zhi) Zhong Zi No. 33], the court held that only where it was determined that the products of the two parties were identical or substantially similar, was there the necessity to compare the technologies used to produce the products.

 

3. Proving access to trade secrets by defendant

 

Trade secret misappropriation is incorporated into unfair competition law in China because the infringer has violated the principle of good faith by illegally obtaining or using the trade secret to make profit. The new AUCL has reduced the burden of proof on the plaintiff who only needs to provide prima facie evidence to show that trade secret has been infringed upon. The burden is then shifted to the defendant to prove that there was no infringement. 

 

Article 32 of the AUCL states that where the right holder provides prima facie evidence to demonstrate that the trade secrets are infringed upon and provides any of the following evidence, the alleged infringer shall prove the absence of such infringement:

 

1. the alleged infringer has the means or opportunity to obtain the trade secret, and the information used is substantially similar;

2. the trade secret has been disclosed or used, or there is a risk of disclosure or use, by the alleged infringer; or

3. the trade secret is otherwise infringed upon by the alleged infringer.
    

The alleged infringer is usually an employee, former employee or licensee of the right holder. The plaintiff can rely on documents like employment contracts, non-disclosure agreements and licensing agreements to prove that there is misappropriation. For infringers without access to the trade secret but have misappropriated it, the plaintiff needs to prove that they obtained it through illegal means like stealing, coercion, or deception. Obtaining information through reverse engineering or research and development is not considered as infringement.

 

Case example

 

• In the appeal of Shenzhen Qinghua SiWeiEr Software Technology Co.Ltd vs Chen, Zhong & Others [Guangdong HPC (2004) Yue Gao Fa Min San Zhong Zi No. 284], the court held that there was trade secret infringement, as the defendants were both employed by the plaintiff and another company, and had access to the information on the trade secret.

 

II. Proving damages

 

The difficulty in estimating damages is also a key factor that deters many right holders from taking civil action or reporting a case to the police. However, the new AUCL provides guidelines for calculating damages, introduces punitive damages and increases the maximum statutory damages for compensation.

 

According to Article 17 of the AUCL, the amount of compensation for the damage caused to a business shall be determined in accordance with the actual loss suffered from the infringement. Where it is hard to ascertain actual loss, the compensation shall be determined in accordance with the profit made by the infringer from the infringement. For serious cases, the compensation may be determined in accordance from one up to five times the amount determined using the aforesaid method. The compensation shall also include reasonable expenses made by the business to prevent the infringement. Where a business operator violates Article 6 and Article 9 of the AUCL, and it is hard to ascertain the actual loss suffered by the rights holder or to ascertain the profit made by the infringer, the People’s Court shall, in accordance with the extent of the infringement, award compensation of an amount no less than RMB 5,000,000 (USD$776,542) to the rights holder.

 

The article provides general principles on compensation for trade secret misappropriation, but with the difficulty in providing evidence, obtaining the maximum amount of compensation is on a case-by-case basis.

 

1. Proving losses

 

The right holder is required to prove all the losses calculable for compensation. In practice, the court usually considers three types of losses:

 

1. Costs incurred for research and development of the trade secret. These include purchases of material, employees’ salaries and benefits, rent and loans.

2. Reasonable loss of profit incurred during the infringement. This includes the economic value that the trade secret has been bringing to the right holder, such as the increase of sales revenue and profit.

3. The third is the loss of competitive advantage due to the leak of the trade secret. Factors considered may include its economic value, market longevity and prospects in the market. However, these factors can be difficult to prove in practice.

 

2. Proving illegal profits by infringer

 

In practice, the loss incurred by the trade secret holder is usually very difficult to calculate, and the court would instead review evidence of illegal profits made by the alleged infringer from the misappropriation. The illegal profits are often calculated by multiplying the total sales revenue with the average profit rate. If the average profit rate cannot be ascertained, third party experts can be called to evaluate and provide a market average profit rate. As the evidence for the illegal profits is in the hands of the alleged infringer, the plaintiff must apply to the court for evidence preservation.

 

Case examples

 

• In the case of Xi’an Heavy Machinery Research Institute vs Pei & Zhongye Company [Xi’an IPC (2005) Xi Xing Er Chu Zi No. 93], the illegal profits could not be figured out by reviewing the two contracts and accounting books of the defendant. The court relied on the expert opinion of the China Heavy Machinery Industry Association to work out the average sales revenue of the product, which determined the amount of damages to be awarded.

 

3. Punitive damages

 

The new AUCL introduces punitive damages on trade secret misappropriation. To implement punitive damages, the Interpretation of the Supreme People's Court on the Application of Punitive damages in the Trial of Civil Cases of Infringement of Intellectual Property Rights (effective on 3 March 2021) further specifies what constitutes as malicious intention and what can be considered as “ serious infringement”.
 

Case examples

 

• On 24 November 2020, the SPC ruled in the case [SPC (2019) Zhi Min Zhong No.562] that Anhui Newman Fine Chemicals (“Anhui Newman”) was to pay RMB 30,000,000 (USD$465,925) as compensation, the first time the SPC awarded punitive damages for trade secret misappropriation.The SPC determined the punitive damages multiplier should be increased to a factor of 5 times because: (1) Since 2014, Anhui Newman did not stop creating the infringing products even under criminal proceedings; (2) the scale of production was large, with products exported to over 20 countries.

• On 19 February 2021, the SPC awarded the highest ever damages of RMB 159,000,000 (USD$24,694,042) for trade secret misappropriation [(2020) SPC Zhi Min Zhong N0. 1667], which highlights the SPC’s attitude on the crackdown of IP infringements.

 

III. Criminal thresholds and penalties

 

Along with taking civil action, right holders should also report to the police in order to further deter infringers. Proving the amount of damages caused or illegal profit made in order to meet the statutory criminal threshold of RMB 500,000 (USD$77,654) has been a key obstacle for right holders when collecting evidence. However, the Interpretation (III) of the Supreme People’s Court and the Supreme People’s Procuratorate of Several Issues Concerning the Specific Application of Law in the Handling of Criminal Cases Involving Infringements upon Intellectual Property Rights (effective 14 September 2020) has lowered the statutory threshold by reducing the amount to RMB 300,000 (USD$46,593).

The 11th Amendment to the PRC Criminal Law (effective on 1 March 2021) also makes significant changes to crimes associated with intellectual property, including increasing the imprisonment sentence from 3-7 years to 3-10 years for committing trade secret misappropriation.

 

IV. Conclusion
 

With comprehensive improvements in legislation and judicial interpretation, along with the increasing judicial practice in trade secret disputes, there is no doubt that there will be more cases brought to the courts in the coming years. Right holders will have confidence in the judicial system and seek remedy for their losses to bring justice to infringers in the market.
 

 

Sophia Hou, Principal, Rouse

shou@lushenglawyers.com

 

[1] http://www.cicn.com.cn/zggsb/2020-12/22/cms133861article.shtml