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Intellectual property theft is top risk for firms with operations in China

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Foreign companies expanding into China face a boundless and potentially costly risk--the theft of their intellectual property.

China is widely considered to be the most problematic country in the world with regard to violating intellectual property rights. Among U.S. trading partners, China was the No. 1 source of counterfeit products seized at U.S. borders, accounting for 81% of the total value of seized products, according to the U.S. Customs & Border Protection agency (see chart).

Intellectual property risks are among the top three operating issues currently facing multinational companies with operations in China, according to a survey by a committee of the Beijing-based China Assn. of Enterprises with Foreign Investment, a coalition of multinational companies that have invested more than $60 billion in China. About 10% of surveyed members estimated revenue losses due to intellectual property violations of more than 20%.

"In China, (intellectual property theft) is prevalent and troublesome," said Paul Clifford, a New York-based director of Marsh Inc. and Mercer Management Consulting who heads the companies' China client services practices.

As part of its 2001 entry into the World Trade Organization, the Chinese government revised its patent, copyright and trademark laws to comply with an agreement among WTO member countries known as the Trade-Related Aspects of Intellectual Property Rights, which requires WTO members to take certain steps to protect the intellectual property rights of foreign companies (see box).

Companies whose intellectual property rights are violated in China have several options. The most common and quickest approach is to try to stop infringement through administrative proceedings, but punishment for intellectual property violations usually is limited to confiscation of the counterfeit products or a monetary fine, experts say.

Foreign companies can also file civil lawsuits against infringers, but this process is more time-consuming than the administrative process and the damages awarded in civil proceedings generally do not adequately compensate for the infringement, lawyers say.

Although criminal prosecutions are still fairly limited in China, foreign entities are beginning to press for them in an effort to deter intellectual property theft. "That's what many brand owners are seeking these days...because that's really the only way to get serious impact on the problem," said Bill Thompson, managing director of Thompson Market Services (Shanghai) Ltd., an intellectual property investigation and enforcement firm.

The legal regime for intellectual property protection in China is generally viewed by lawyers as adequate, but enforcement of the laws is a challenge. "The availability of law is not the problem, it's the remedies," said Peter Bullock, a Hong Kong-based partner with law firm Pinsent Masons. "The problem is that enforcement is patchy and the penalties awarded as damages negligible." In one recent case, for example, a court awarded five brand owners about $2,500 each in damages for intellectual property infringement.

The Chinese government historically has not placed a high value on the protection of intellectual property rights, but this is starting to change amid intense international pressure to comply with the WTO's TRIPS provisions. Over the past year, various enforcement arms of the Chinese government have stepped-up enforcement of intellectual property rights, increasing convictions for infractions by 52% and seizures of goods by nearly 100%, although the value of these seizures was about $25 million, according to a report by the Washington-based International AntiCounterfeiting Coalition Inc.

In 2005, the value of copyrighted material alone that was pirated in China exceeded $23 billion, according to testimony by Chris Israel, U.S. coordinator for international intellectual property enforcement.

Despite the enforcement actions, intellectual property theft remains prevalent in China, mainly because government officials in different regions place different priorities on enforcement of intellectual property laws, observers say.

"The best (intellectual property) protection you're going to get is in the area between Beijing and Shanghai and when you go south or west, it gets murky," said Stan Abrams, a Shanghai-based partner and head of the intellectual property department of Lehman, Lee & Xu.

Regardless of the risk of infringement, the Chinese market provides tremendous potential in terms of a low-cost labor force and an enormous market, experts say.

"I don't see people running away from the Chinese market," said Joseph Simone, a partner with Baker & McKenzie in Hong Kong and a member of the IACC.

Rather than avoiding the Chinese market, companies should focus on risk management initiatives to curtail or prevent intellectual property theft, observers say (see story, page 19).

Unlike in the United States, companies in China have limited insurance options to guard against violations of intellectual property rights. The most common practice is to bundle intellectual property coverage with professional indemnity policies, which would respond if a Chinese company commits an inadvertent breach of intellectual property rights, said Aruno Rajaratnam, the Singapore-based managing director of Willis Group's Financial and Executive Risks Practice Asia.

Stand-alone insurance policies are available from Lloyd's of London syndicates, but the limits are less than £5 million ($9.67 million), and Ms. Rajaratnam estimates only five to 10 stand-alone intellectual property policies have been purchased in the region.

"In Asia, they find the insurance very expensive," Ms. Rajaratnam said.