China: Increasing compensation for wilful Infringement by five times - will infringers be deterred?

In this blog we look at a recent decision of China's Supreme People's Court where it awarded the highest amount of compensation in the history of trade secret infringement cases and subsequently set out guidance for compensation in future cases, which will be a powerful deterrent to infringers.

Summary

On 3 March, 2021, China’s Supreme People’s Court (“SPC”) promulgated the "Judicial Interpretation on the Application of Punitive Damages in the Trial of Civil Cases of Infringement of Intellectual Property Rights" (“Interpretation") to give guidance on the application of punitive damages in civil cases of intellectual property (IP) rights. Just before this, in a case known as the "Vanillin trade secret case”, the SPC awarded the highest amount of compensation in the history of trade secret infringement cases, increasing the amount of compensation from 3 million in the first instance to 156 million in the final judgment.
 
It is worth noting that in this case the right owner lodged the lawsuit in 2018 with a claim of the compensation for the economic loss it suffered from 2011 to 2017.  Due to the restriction of the filing date and the claims made, the court did not award punitive damages.  However, in its judgment, the court clearly clarified that the circumstances of the infringement constituted the conditions for the application of punitive damages, and said that for the continuing infringement of the technical secrets after 2018, the right holder may seek more relief.
 
This blog focuses on the court's considerations when determining the amount of compensation in the Vanillin trade secret case, and the relevant provisions of the "Interpretation" to provide readers more practical guidance on the application of punitive damages.

 Brief introduction of the Vanillin trade secret case

Jiaxing Zhonghua Chemical Co., Ltd. ("Zhonghua Chemical") is one of the world's largest vanillin manufacturers, with annual sales of 2 billion RMB.  More than 90% of its products are for export, accounting for 60% of the global vanillin market share.   It took many years for Zhonghua Chemical and Shanghai Xinchen New Technology Co., Ltd. ("right holders") to jointly develop their vanillin processing technology, including design drawings of a number of equipment and instruments, flowcharts, etc. for the manufacture of vanillin by the glyoxylic acid method, which was protected as a technical secret.  Wanglong Group Co., Ltd. ("infringers") allegedly lured Fu, an employee of Zhonghua Chemical, to steal a number of design drawings and flowcharts, and then hired a number of former employees of Zhonghua Chemical to start vanillin manufacturing.  The infringer began to produce vanillin in 2011 and soon accounted for 10% of the global market.  The global market shares of the rights holders also quickly dropped to 50%.
 
In 2018, the right holder filed a lawsuit against the infringer's infringement of trade secrets, requesting compensation for the infringement between 2011 and 2017.  The court of the first instance determined that the infringers infringe the right holdes' trade secrets, and granted the right holders a compensation of 3 million RMB, and reasonable rights protection costs of 500,000 RMB, totaling 3.5 million RMB. Both siders appealed. At the appeal, the SPC further expanded the identification of infringement factors, and ordered the infringer to compensate the right holder for economic losses of 156 million RMB and reasonable rights maintenance costs of 3 million RMB, totaling 159 million RMB.

 Relevant factors in determining the amount of compensation in the Vanillin case

 The SPC considered the following eight factors relevant in determining the amount of compensation in this case:

 1. The infringer used severe methods to illegally obtain the technical secrets

The infringer was originally a chemical enterprise specialising in the production of food additives and knew of the right holder’s competitive advantage and position in the chemical additive industry, especially in vanillin manufacture.  The infringer used cash and equity interest to lure the right holder’s employee Fu, who had access to know the technical secrets involved, to steal the design drawings and flowcharts of the right holder.  The infringer then immediately started vanillin manufacturing and hired more and more employees who used to work at the right holders' factory.  Some of the design drawings used in customisng the vanillin manufacturing equipment are exactly the same as the drawings of the right holders, including the signs made by the right holders on the drawing.  The SPC concluded that the method of illegally obtaining the technical secrets involved in the case is too severe.

 2. The number of technical secrets illegally obtained and used by the infringers is considerable

According to the evidence, the technical secrets claimed by the right holder include 287 equipment design drawings and 25 flowcharts. The infringer illegally obtained 185 drawings and 15 flowcharts, accounting for 64.10% of the whole technical secrets, and included the most critical parts of the same.

 3. The infringers knew that such behaviour constitutes an infringement of the technical secrets and continue to use them to manufacture large quantities of vanillin, showing malicious intent

The infringers not only schemed the theft of technical secrets, but later lured more employees to leave the right holders to join the infringers' company, and help build up the vanillin production line.  After the right holders realised that their technical secrets might be infringed, they sued before the court with the infringers listed as the third party in that case, but they did not stop the infringement.  After the court of the first instance made a provisional injunction decision, ordering them to stop infringing the technical secrets immediately, the infringers continued to manufacture vanillin.  These facts not only show the subjective fault of the infringers, but also their contempt for judicial authority.

4. The technical secrets involved have high commercial value

The technical secret involved in the case is the new process of manufacturing vanillin by the glyoxylic acid method independently developed by the right holders, creatively using a chemical oxidation method, which has outstanding advantages over the traditional "catalytic oxidation method" and is an innovative technology.  After the completion of the research and development of the technical secrets involved, the annual output value of the right holders increased sharply.  After the infringers' actions they successfully made low-cost production of vanillin archived and quickly accounted for 10% of the global market share, capturing huge commercial profits.  Based on this, the SPC concluded that the technical secrets involved in the case are the key factors for the vanillin manufacture and create huge profits for both the right holders and the infringers.

 5. The infringers are companies primarily engaged in infringing activities

This case involves several joint infringers, some of whom were either set up for carrying out infringing activities or the main business of the infringement. The infringers' factory was built for manufacturing vanillin only and therefore the infringers constituted the companies primarily committing the IP infringement.

 6. The infringement of the technical secrets had a serious impact on the global market

Before the infringers committed the infringement of the technical secrets involved, 90% of the global vanillin market was dominated by the two major companies and the price of vanillin remained at a relatively stable level.  After the infringers start manufacturing vanillin in June 2011, the price of vanillin and 10% of the global market share has been affected, which is huge loss to the right holder.

 7. The infringers refused to submit evidence and acted dishonestly by concealing evidence of infringement

During the trial of this case, the court asked the infringers to submit evidence such as the sales volume of the infringing product and the drawings related to the vanillin equipment, but they did not provide any evidence to either court. They claimed that the relevant technology was developed and created by themselves, but were unable to provide any supporting evidence.  Considering that the vanillin production line involved a large number of non-standardised equipment, it is impossible to build up the manufacturing line within a short period without drawings of the relevant equipment.  The court concluded that the infringers had obstructed the collection of evidence and had acted dishonestly in litigation.

 8. The infringers refused to implement the preliminary injunction ordered by the original trial court

After the court of the first instance made a preliminary injunction decision ordering the infringers to stop the infringement of the technical secrets involved, the infringers neither appealed nor stopped the infringements.   At the appeal they also admitted that the alleged infringement continued. The SPC found that this not only proves that this action was deliberate, but also constitutes a serious infringement and contempt of court.

Guidance from the SPC on the application of punitive compensation under the Interpretation

The SPC's considerations in the Vanillin trade secret case in determining the compensation for infringement are reflected in the "Interpretation" that it subsequently issued.  According to the Interpretation, the scope of application of punitive damages is that the infringer has a willful intention to infringe the IP rights enjoyed by the right holder and the circumstances are serious.  It provides two lists of circumstances that “willful intention” and “serious circumstances” could be established, which are based on the SPC's experience from precedents, namely:
 
1. Wilful intention includes the following situations:
 
(1) The defendant continues to commit the infringing acts after being notified or warned by the claimant or the interested party;
(2) The defendant or legal representative or manager thereof is the legal representative, manager or real controller of the claimant or interested party;
(3) The defendant and the claimant or the interested parties have relationships in terms of labour, service, cooperation, licensing, distribution, agency, representative, etc., and have access to the infringed IP rights;
(4) The defendant has business with the claimant or interested parties or has negotiated for reaching a contract, etc., and has access to the infringed IP rights;
(5) The defendant committed acts of pirating, or counterfeiting registered trade marks; and
(6) Other circumstances that can be determined as intent.
 
2. Serious circumstance includes the following situations:
 
(1) After being punished in an administrative penalty or a court decision for infringement, committing the same or similar infringement again;
(2) Committing the infringement of IP rights as its primary business;
(3) Forging, destroying, or concealing evidence of infringement;
(4) Refusal to abide by the preservation ruling;
(5) Infringement gains or the right holder’s losses being huge;
(6) Infringements likely to endanger national security, public interests or personal health; and
(7) Other circumstances that can be determined as serious.

Comment and practical consequences

In reality, it is usually very difficult to obtain evidence in trade secret infringement cases.  Once the infringement of trade secrets can be established, it should not be difficult to prove wilful intention.  In the Vanillin trade secrete case, the joint infringers at least fall into the situations in (1) and (3) above, and therefore the requirement of wilful intention should have been satisfied.  In general, sending a proper cease and desist letter would also be helpful to prove the wilful intention if the infringer does not respond nor stop infringing acts.  This helps reduce the right holder’s burden of proving the wilful intention.
 
In addition, in the Vanillin trade secrete case, the right holders filed an infringement lawsuit in 2010 targeting a different entity but listed the infringer as the third party.  Although the right holders dropped the case due to lack of sufficient evidence, the court has also taken that dropped case into consideration and how the infringers ignored the preliminary injunction order.  The court concluded that the infringers did not stop infringement after the right holder had already targeted them in the infringement lawsuit and also continued manufacturing after the preliminary injunction order, showing their serious wilful intention. Consequently, previous infringement lawsuits might also be helpful in proving the wilful intention of the infringer.  
 
With regard to the serious circumstance, the situations of no. (2) and (3) as listed above are also worth noting.  In terms of committing the infringement of IP rights as its primary business, once the right holder provides prima facie evidence showing that an infringer is primarily engaged in infringement business, the burden shifts to the infringer to prove it is not, by showing it also runs other business which is legal.  As to the circumstance of "forging, destroying, or concealing evidence of infringement”, now the infringers will have to restrain themselves from acting dishonestly in infringement litigations so as to avoid punitive damages up to five times.
 
According to an article published by the judge from SPC’s Intellectual Property Tribunal about another recent judgment in which five times of the damage has been granted as punitive compensation, "five times the amount of punitive damages can be applied if the elements of ‘direct intent, committing infringement as a primary business, large scale of infringement, long duration, substantial loss or profit, and hindrance of proof" are met.”   In the Vanillin trade secrete case, the infringers have obvious direct intention as the technical secret was stolen from the right holders; several infringers were committing infringement as their primary business since establishment; the scale of technical secrets involved is large - 185 design drawings and 15 flowcharts were involved, accounting for 64.10% of the whole technical secrets of the right holder; the infringement lasts for more than 10 years and it causes the right holder to lose 10% of the global market share.  In addition, the infringers ignored the preliminary injunction order after the first instance and admitted that manufacturing of vanillin continued.  All these facts fully meet the conditions for granting a punitive compensation of five times damages.  If the right holders lodge another infringement lawsuit against the infringers for the infringing acts after 2018, we believe that they may expect a punitive compensation with five times damages. 
 
Undoubtedly, the promulgation of the "Interpretation" is not only to encourage the right holders to actively defend their rights but also to promote good faith litigation for all.  Whether it is a large amount of damages or a punitive compensation with five times damages, it will no doubt be a powerful deterrent to infringers, especially to those who have committed infringements for a long time and repeatedly.  For the wilful infringers, more and more lawsuits with punitive compensation granted will make them feel like they are skating over thin ice.  For the rights holders, who have long suffered from infringements, it is a good time to taking a more active role to fight back.
 
 With thanks to Di PAN, Intern, co-author of this blog.