Why a Transparent Patent System Is the Right Choice for Chinese Companies

Background

In the application of United States patent law, there exists a long-standing point of misunderstanding: the widespread belief that the best IP policy a company can adopt with respect to intellectual property is a closed one — one that therefore prohibits the company's engineers, technical personnel, and other related professionals from researching or even reading the patents of competitors.

The main arguments in support of such a policy are the following three: (1) reducing the risk of being found liable for willful infringement; (2) reducing the burden of submitting Information Disclosure Statements (IDS) to the patent office; and (3) reducing the burden of obtaining infringement/non-infringement opinions on known patents from licensed patent attorneys.

In this article, we will advance an argument that, since the United States Court of Appeals for the Federal Circuit (CAFC) rendered its decision in In re Seagate (2007), the artificially closed "ostrich policy" is no longer a reasonable course of action — and is in fact a harmful one. Such an approach is particularly harmful to Chinese high-technology enterprises. By contrast, an open patent policy grounded in transparency offers numerous advantages and benefits, and is therefore the superior choice. This is especially true for Chinese companies entering the U.S. market.

In what follows, we support the above argument not only with legal realities but also with practical experience.

Why Do Some American Companies Adopt a "Closed IP Policy"?

Traditionally, it is true that some American companies have deliberately adopted a closed IP policy. The essential premise of such a policy is to discourage — and even prohibit — technical personnel from searching for and reading competitors' patents.

In common understanding, there are three distinct motivations for adopting a closed IP policy.

The first is to attempt to avoid "enhanced damages" resulting from a finding of willful infringement (enhanced damages may be awarded up to three times the normal damages award).

The second is to reduce the burden of submitting Information Disclosure Statements (IDS) to the patent office. IDS (information disclosure statements) is a distinctive requirement of U.S. patent law. A patent applicant must disclose to the patent office all prior art documents of which the applicant is aware that are "materially related" to the patent application. Deliberate concealment constitutes inequitable conduct and may result in the invalidation of the relevant patent. The third is to reduce the burden of obtaining infringement/non-infringement opinions on known patents from licensed patent attorneys. This rationale is in fact related to the first, and is still primarily motivated by concerns about being found liable for willful infringement.

With regard to willful infringement, a defendant that has adopted a closed IP policy does indeed thereby establish a fairly effective "clean room" defense (though not an absolutely effective one — see below). With respect to the IDS and infringement/non-infringement opinion burdens, a closed policy naturally reduces the number of third-party patents encountered, and correspondingly lightens the IDS burden as well.

What Are the Costs and Drawbacks of a Closed IP Policy?

However, adopting a closed policy comes at a price. Even before the In re Seagate decision in 2007, the consequences and negative effects of adopting a closed policy were already widely recognized in the industry. In fact, many American companies have never adopted a closed policy; and among those that did, the approach was generally tailored to circumstances and applied with discretion, rather than as a one-size-fits-all rule.

After In re Seagate, these already-existing costs grew greater — some changed in a fundamental way — and, owing to this important case, certain new costs emerged. At the same time, nearly all of the benefits that had previously been recognized were effectively eliminated. This article first discusses the general costs and drawbacks of a closed IP policy, and then addresses the changes brought about by In re Seagate.

First, although a closed IP policy has the effect of reducing the likelihood of a finding of willful infringement, it simultaneously increases the likelihood of ordinary infringement. This is because a closed policy, in shutting out knowledge of third-party patents, also severely undermines or eliminates entirely the company's capacity to design around potential infringement. Typically, if a third party's patent is publicly disclosed, an attentive company may undertake careful legal and technical study in order to design around it. A closed policy, however, leaves the company blind — often incurring a greater risk of infringement in exchange for the passive defense of "we didn't do it intentionally" if infringement is ultimately found. In most cases, this is a poor trade.

Only under the following extreme circumstances might such a risk exchange be worthwhile: (a) a competitor's patent rights are foundational in nature and extremely broad in scope; and (b) the company's capacity for design-around is very limited.

In most cases, however, circumstances are not so extreme. Many patent rights are neither foundational nor broad, and legal and technical avenues for circumvention exist. For example: (a) designing around may lead to new technological breakthroughs and innovations; (b) the result of designing around is almost as effective as the patented product; (c) designing around, though somewhat of an unavoidable compromise, nevertheless effectively circumvents the third party's patent; (d) designing around, even if ultimately adjudicated to be infringing, has a reasonable basis that at least affords the designer a defensible ground for believing at the time that there was no infringement (after In re Seagate, the likelihood of this scenario has increased substantially — see the discussion later in this article).

A closed policy, however, forecloses all of the above opportunities.

Second, a closed policy also simultaneously weakens a company's ability to identify weaknesses in a competitor's patents in order to challenge their validity. In the United States, although the drafting requirements for patents are relatively demanding, the standard for examining whether a patent is valid is also very high. Many patents — statistically as many as one-third — appear valid on the surface but cannot withstand subsequent challenge, and are often declared invalid under rigorous scrutiny. The more carefully and thoroughly a patent is examined, the greater the likelihood of its being overturned. But a closed policy amounts to closing the eyes of scrutiny, allowing third-party patents to operate unchallenged.

Third, a closed policy also weakens a company's capacity for technological innovation. This is in fact self-evident, since a closed policy strips technical R&D personnel of the impetus to draw upon existing technology and knowledge.

Fourth, under certain conditions, a closed policy will not only fail to reduce the risk of a finding of willful infringement — it will actually increase it. For example, under current U.S. case law, if a defendant in a patent infringement action has never previously formulated a reasonable non-infringement position, and only advances a non-infringement theory during litigation, such a theory may not be credited as evidence of the absence of willful infringement. Such a ruling is highly unfavorable to the party accused of willful infringement.

In this scenario, adopting a closed policy will clearly increase — rather than decrease — the risk of a finding of willful infringement. If an open, transparent policy is adopted instead, whereby third-party patents are studied in the light from the outset and non-infringement opinions and analyses are developed accordingly, this problem simply does not arise. Such opinions and analyses, when developed, may later be presented as effective evidence of the absence of willful infringement in future litigation.

What Has Changed Since In re Seagate?

In 2007, the U.S. Court of Appeals for the Federal Circuit substantially changed the standard for determining willful infringement in its decision in In re Seagate. The basic effect of In re Seagate is that, since that decision, the likelihood of being found liable for willful infringement is considerably lower than before. In practice, since In re Seagate, the proportion of patent infringement cases in which willful infringement is pleaded as a claim has become quite small (whereas previously, plaintiffs tended to include it regardless of their prospects). In other words, after In re Seagate, most plaintiffs are no longer willing to pursue a willful infringement claim, because unless the evidence is overwhelmingly clear, doing so is a waste of time and money.

Perhaps more importantly, the case's impact is not equal as between defendants that adopt a closed IP policy and those that adopt an open IP policy. Specifically, although In re Seagate across the board has made a finding of willful infringement more difficult to obtain, this effect is felt more strongly by defendants that have adopted an open IP policy, while the effect on defendants that have adopted a closed policy is comparatively modest.

Accordingly, after In re Seagate, the costs of adopting a closed policy described above not only remain but have become even more pronounced. Certain entirely new costs have also arisen as a result.

In In re Seagate, the Federal Circuit elevated the standard for finding willful infringement from the previous standard — analogous to a negligence standard — to a standard of "reckless disregard." Prior to that decision, the standard for willful infringement was determined according to the nine factors enumerated in Read v. Portec. Those factors still apply, but the standard has now been elevated to "objectively reckless conduct."

The principal hallmark of "objectively reckless conduct" is an objectively measured finding that there existed a highly elevated probability of harming another. In In re Seagate, the court held that to prove willful infringement, the patent holder must present "clear and convincing" evidence that the infringer disregarded an objectively high probability that its conduct constituted infringement, and proceeded to infringe in that state. The subjective mental state of the actor is not determinative. The patent holder must, through evidence adduced in litigation, establish an objectively defined and measurable "risk of harm," and the infringer must have known of — or, even without actual knowledge, should have known of — that risk.

By elevating the standard for willful infringement, the court substantially increased the difficulty of establishing it. In re Seagate explicitly abrogated the prior, lower standard and replaced it with a higher one.

The Several Effects of In re Seagate

In re Seagate effectively eliminated the greatest concern underlying reluctance to adopt an open IP policy — namely, the risk of being found liable for willful infringement. Before that decision, the most important rationale for a closed policy was that it provided, to some degree, a defense against a finding of willful infringement. In re Seagate effectively removed that rationale. Under the old willful infringement standard, merely becoming aware of a patent's existence could trigger a risk of a willful infringement finding. For that reason, gaining knowledge of third-party patents became a hazardous act and a dangerous state of affairs, and many companies were therefore reluctant to conduct any investigation or research into third-party patents — even at times when it was known that such research would help the company avoid infringement. Now, because the standard has been elevated to "objectively reckless" conduct, the likelihood of being found liable for willful infringement has been greatly reduced. Indeed, even before In re Seagate, whether adopting a closed policy was advisable was already highly questionable. After In re Seagate, the conclusion has become clear. With its principal benefit eliminated, a closed policy can no longer be easily justified.

Second, after In re Seagate, an open IP system can readily be used as evidence to rebut a claim of willful infringement. One of the characteristics of an open IP system is that it permits a company to conduct competent patent clearance searches. If a clearance search identifies a potentially infringed patent, the company can take timely and appropriate steps to avoid infringement. Should an infringement dispute arise in the future, a properly structured open IP system will provide evidence demonstrating that the company honestly reached the conclusion that its products did not infringe, or that the company redesigned its products in response to the patent and honestly believed that the new design did not infringe. Such evidence may not guarantee a finding that the company's products did not in fact infringe, but it will substantially help to guard against a finding of willful infringement.

Third, in addition to directly reducing the risk of willful infringement, an open IP system also helps to identify the focal points of potential infringement disputes at an early stage and to design around them, thereby avoiding actual litigation. Given the enormous cost of litigation — whether one wins or loses — this is an extraordinarily valuable strategy. The idea is that an open IP system casts light on the issues that company decision-makers need to focus on, providing the company with sufficient time and attention to take appropriate measures to avoid being sued.

Fourth, In re Seagate also has a positive effect on the extent of enhanced damages — a point that is frequently overlooked. People tend to automatically assume that once willful infringement is found, damages will necessarily be trebled. This is not in fact the case. Treble damages represent the maximum ceiling permitted under the patent statute. The actual extent to which damages are enhanced is determined by the court based on the specific circumstances, and is often related to the strength of the evidence and the degree of willfulness. After In re Seagate, even if a defendant is found liable for willful infringement, it may still present evidence demonstrating that it made considerable efforts to avoid infringement, and thereby persuade the court not to apply the maximum treble damages award.

Fifth, after In re Seagate, opinions of outside counsel and defenses grounded in outside counsel's non-infringement opinions may become more valuable. In particular, a defense grounded in outside counsel's non-infringement opinion, if not manifestly unreasonable, will enable a defendant to demonstrate that it took appropriate measures to avoid infringement and therefore did not act willfully. Moreover, after In re Seagate, there is no longer any concern that, by voluntarily producing early non-litigation counsel's legal opinion as a defense against willful infringement, the attorney-client privilege protecting communications with and work product of litigation counsel during the litigation will be deemed waived. With that concern removed, defendants no longer risk exposing their entire litigation defense strategy to the opposing party. For this reason, companies are further encouraged to regularly seek opinions from outside counsel and to rely upon those opinions in future litigation to demonstrate the absence of willful infringement. (However, a caveat is needed here: communications and work product between the company and the outside counsel who provided the opinion prior to litigation may still be subject to disclosure — and thus lose their attorney-client privilege protection — if the defendant voluntarily relies on that opinion as a defense. See further discussion below.)

Sixth, at the same time, In re Seagate did not hold that obtaining a non-infringement opinion from outside counsel is a necessary condition for avoiding a finding of willful infringement. If other evidence can establish the absence of objectively reckless conduct, a defendant's failure to obtain a prior non-infringement opinion from outside counsel neither prejudices the defendant nor in itself gives rise to a finding of recklessness. For this reason, adopting an open IP system does not give rise to an excessively high demand for outside counsel opinions. Companies are not compelled to seek an outside counsel opinion for every third-party patent they become aware of. Any such demand arises from the company's actual needs and is determined by the company itself, without any procedural or artificial requirement.

How Should the IDS Burden Be Addressed?

Adopting an open IP system will lead to an increase in the Information Disclosure Statement (IDS) burden. In re Seagate itself does not help to alleviate this burden, and therefore any company adopting an open IP system will feel its effects in this regard. This may remain the principal remaining obstacle to the adoption of an open IP system.

However, this burden will chiefly inconvenience those companies and firms that continue to rely on older-style IP management systems. Advanced management systems can minimize this problem. For example, Lehigh Law Firm has developed a system known as New IP, which — in addition to providing intelligent management of intellectual property assets through a technology classification system (taxonomy) — provides a greatly improved and largely automated IDS filing system, capable of effectively meeting IDS requirements without incurring excessive costs. (Further details are provided below.)

Why Is It Even More Urgent for Chinese Companies to Adopt a Transparent, Open IP System?

For Chinese companies that have already entered or are about to enter the North American market, the necessity and benefits of adopting an open IP system are especially pronounced. In addition to the broadly applicable reasons set forth above, an open system offers many unique advantages for Chinese companies.

First, many Chinese companies lag behind American companies in technological R&D, and the large number of existing patents held by foreign competitors has two very different effects on Chinese companies. The first effect is that of an obstacle — namely, the legal protection conferred upon the patent holder by the patent. The second effect is that of a benefit — that is, the vast repository of knowledge and technical information formed by the public disclosure of those patents.

When a patent applicant is granted a patent, the applicant is required to confer a benefit upon the public — namely, public disclosure of the patent's contents — in exchange for the privilege granted by the government: patent protection. This bargain is the foundation of the entire patent system. Naturally, the public has the right to enjoy the benefits arising from the publicly disclosed content of patents, for that is an inherent purpose of the patent system. But a closed IP policy voluntarily surrenders this right, with the result that a system that should be balanced loses its balance and becomes a system that benefits only patent holders — allowing patent holders to gain an undue advantage in the "patent bargain," because their inventions are on the one hand protected by patents and on the other hand function in practical effect as undisclosed "trade secrets" (a disclosure that an adversary dares not read is, in practical terms, no disclosure at all). This outcome is neither reasonable nor natural.

Second, due to the particular circumstances of Chinese companies, the inequitable imbalance caused by a closed policy is especially severe. There are at least five reasons for this particularity.

If an American company holds a U.S. patent but does not have a corresponding Chinese patent, the American company enjoys no patent protection in China. Provided that the product is manufactured, sold, and used exclusively within China, a Chinese company has the right to make full use of such an American patent, including by reproducing the patented technology. A closed policy essentially deprives Chinese companies of this enormously valuable right, effectively granting American companies that have not filed for Chinese patents the practical benefit of Chinese patent protection.

For Chinese companies seeking to enter the U.S. market, making full use of publicly disclosed technology — learning from the prior art (not for the purpose of copying, but for the purpose of learning and surpassing it) — is a critical step. A closed policy essentially deprives Chinese companies of this opportunity, prolonging their current disadvantage into an extended one.

For Chinese companies, there is a cumulative historical imbalance in their starting position within the U.S. patent system. Chinese companies hold very few U.S. patents, but as a "counterbalance," there exists an enormous repository of publicly disclosed patents from which they can learn and benefit. This is a historical imbalance that makes it all the more important for Chinese companies to adopt a smart strategy to optimally exploit this situation — drawing nourishment from this public repository of technical knowledge — rather than bearing only the pressure of third-party patent rights and voluntarily surrendering the benefit that the other side has conceded in the "patent bargain."

Because Chinese companies are unfamiliar with both the U.S. market and the U.S. patent system, it is necessary to make use of every available opportunity to learn this system and ultimately to master and effectively operate within it. Although Chinese companies often have considerable reservations about the U.S. patent system, one fact must be acknowledged: the U.S. patent system remains the most fair and reasonable in the world, and genuinely affords foreign companies the opportunity to compete fairly in the United States. The success stories of European, Japanese, and Korean companies in the United States fully attest to this. Yet adopting a closed policy deprives Chinese companies of the proactive learning opportunity. After all, occasionally being hauled to the defendant's table in a courtroom to learn a lesson is hardly an ideal educational arrangement.

Perhaps more importantly, the greatest threat currently facing Chinese companies attempting to enter the U.S. market is not enhanced damages from a finding of willful infringement, but rather receiving an injunction order prohibiting importation into the United States. Such injunctions may result from a ruling of a U.S. federal court, or from a ruling of the U.S. International Trade Commission (ITC) under Section 337. The consequences of an injunction may be far more serious than those of a willful infringement finding. The latter entails damages; the former constitutes an outright prohibition on a product's entry into the U.S. market — and may well implicate numerous similar products. In this regard, directly confronting competitors' patents and making every effort to avoid infringement is far preferable to entering the United States blindly only to find oneself caught in a minefield of patents. A closed policy, by its very design, tends to lead to precisely these serious consequences. An open IP system is therefore the only truly correct choice.

Are There Special Exceptions That Still Call for a Closed IP Policy?

Although we firmly believe that an open IP system is the right choice, we also note with care that there are certain special circumstances that may warrant treatment as exceptions.

One such circumstance arises when all of the following conditions are simultaneously satisfied: (1) with respect to a particular product, the company has made a strategic decision to enter the United States at all costs, with no option to withdraw; (2) before conducting any formal infringement investigation, the company already knows that the field is covered by foundational patents and intuitively understands that any commercially viable product of the same type is unlikely to design around those foundational patents; and (3) the company is confident that its engineering and R&D personnel can develop a satisfactory product without studying or learning from the blocking patents.

If all of the above conditions are satisfied, then adopting a so-called "clean room" policy with respect to that product may have some justification (though it remains debatable). The essential rationale for such a policy is that, although the product so designed is likely to be infringing, the company may avoid a finding of willful infringement.

However — perhaps somewhat surprisingly — In re Seagate has made the "clean room" defense less effective than it once was. Although Seagate elevated the standard for willful infringement to "objectively reckless conduct," it simultaneously held that the evidence used to prove "reckless conduct" need not be grounded in the infringer's subjective mental state but is instead assessed by an objective standard. If the evidence presented to the court paints an objectively "reckless" picture, then regardless of the infringer's subjective mental state, a finding of willful infringement may still be made. In such a scenario, even a "clean room" defense may be ineffective.

What Are the Implications for Attorney-Client Privilege?

Attorney-client privilege is frequently misunderstood, particularly by Chinese companies. Several matters require careful distinction.

First, the attorney-client privilege that applies in willful infringement cases may be treated very differently depending on whether the attorney is acting as a counseling attorney — providing opinions and handling patent matters in the ordinary course — or as litigation counsel in a lawsuit. Before Seagate, if a defendant voluntarily produced a prior counseling attorney's non-infringement opinion as a defense against willful infringement, the court would hold that the defendant had thereby waived all related attorney-client privilege. For this reason, defendant companies that were accused of infringement were often reluctant to use counsel's opinions as a defense. After Seagate, however, absent an exception for clear misconduct, the privilege protecting litigation counsel's work and communications during the litigation will no longer be deemed waived merely because the defendant produces a prior counseling attorney's opinion as a defense — particularly where the counseling attorney and the litigation attorney are different attorneys at different firms.

Because Seagate expressly removed this concern, the effect is to further encourage companies to regularly obtain and use the opinions of legal counsel, and to engage separate law firms for non-litigation matters and for litigation matters.

However, it must be noted that if a defendant voluntarily produces a prior counseling attorney's non-infringement opinion as a defense against willful infringement, the counseling attorney's own communications and work product (as distinct from those of the litigation attorney) will nonetheless be deemed waived as a result. On this point it must be perfectly clear: the law is consistent and there has been no change whatsoever, because a defendant cannot "have its cake and eat it too."

Second, it should be noted that attorney-client privilege applies to the communications themselves between client and attorney, and does not provide absolute protection for the contents contained within those communications. For example, if