DRAFT RULES ON SERVICE INVENTIONS
November-December 2012 China Bulletin

In November, the State Intellectual Property Office (SIPO) released the Draft Service Invention Regulations for a comment period, which ended on December 3rd.  The draft regulations have attracted considerable attention and comment because of their potential to impose an unreasonable cost burden on R&D in China.  The burden arises less from compensation awarded to inventors than from the notice, accounting and administrative burdens the draft regulations would impose on companies that employ inventors, and related exposure to penalties and liabilities.

Current provisions on service inventions (basically meaning inventions created in the course of employment or using the resources of the employer) are set out in Article 16 of the Patent Law, Article 326 of the Contract Law and Article 77 of the Implementing Regulations of the Patent law, which mandate compensation and set default standards that apply if the parties have not provided for compensation by contract.  The current provisions also give the inventor a first right of first refusal if the technology is transferred, but leave many questions about implementation unanswered.

The new draft regulations adopt the same approach, but increase inventor compensation:

Article 21 provides for an award to the inventor of 200% of the average monthly salary for patent rights, taking all employees into account, and 100% of such salary  for most other intellectual property rights.

Article 22 provides for compensation for exploiting intellectual property rights (e.g., by licensing) of 5% of profits or .5% of revenue for patent rights,  and 3% of profits or .3% of revenue for most other intellectual property rights.  It also requires payment to the inventor of 20% of net income from assigning or licensing the rights.

Although these provisions will increase the costs of payment to inventors, the challenge for employers may lie more in administrative burdens and legal uncertainties.  For example, in addition to accounting and other procedures required to calculate the compensation packages noted above, time and cost will be incurred to comply with the following proposed provisions:

Article 14 mandates that the employer must decide within six months whether to apply for any intellectual property rights,

Article 15 allows the inventor to request information about any application during the application process,

Article 16 requires the employer to inform the inventor one month in advance if it stops or withdraws an application, and states that the inventor can negotiate for the rights to the invention,

Article 18 requires the employer to grant an award to the inventor when it is granted an intellectual property right and pay the inventor remuneration when it assigns or licenses the invention,

Article 20 requires the employer to report “economic benefits earned” from exploiting the invention to the inventor”, and

Article 29 affirms the inventor’s right of first refusal when the intellectual property rights to the invention are assigned.

Software is also treated as an invention.

Article 26 provides that the inventor continues to be entitled to awards and compensation after leaving his/her position with the employer, and the rights are heritable, passing on the inventor’s heirs.

The above provisions create at least two very substantial burdens for the employer.

First, it will have to institute procedures to track when an invention occurs, when it is exploited and the continued location of the employee and his/her heirs during and after employment in order to comply with notice and payment obligations under these draft regulations.  In certain cases, this procedure could extend over generations.

Second, it will have to put in place procedures to assign a value to the invention meeting the requirements of this regulation, a value which may be difficult to define and determine.  The invention could, for example, be used as one part of a product or procedure or the inventor could be one of several contributors (situations noted in Article 23 of the draft regulations), the expected value of the invention may not be realized or, on the other hand, it may greatly exceed an original estimation, and the value may not lie in exploiting the invention immediately but in withholding it from the market for the time being or keeping it as a resource in inventory.  Doing so if the regulations become law may well invite challenges from the inventor as to why the invention is not exploited and what its true value is.

Article 22 permits an employer to pay an inventor a lump sum in lieu of ongoing payments based on profits or revenue from exploiting intellectual property rights, eliminating the most burdensome of the requirements.  However, the long-term value of the rights must still be calculated because Article 22 requires a lump sum payment to be determined with reference to a ”reasonable multiple” of statutory ongoing percentage payments.

Article 19 states that the parties may vary statutory compensation provisions by contract.  However, what this articles gives in its first paragraph, it takes away in the second by stating that any agreement or rule eliminating or limiting the rights to which the inventor is entitled are invalid.  Since a key reason for an employer to enter into an agreement is to limit an inventor’s rights to compensation, any contract providing for less than the statutory minimum is at risk of being deemed to limit rights and therefore to be invalid, even if commercially reasonable.  This provision is an invitation to lawsuits by inventors, particularly if an invention generates more income than anticipated when the agreement was made.

Further, inventors are also entitled to compensation for inventions protected as know-how, such as trade secrets.  Article 14 deems inventions by default to be know-how if the employer fails to respond to an employee’s notice of invention.  Treating know-how as a service invention will invite disputes since an inventor’s view of his/her contribution to and the value of know-how may be quite different than his/her employer’s, the industry’s or even his/her colleagues and predecessors.  The claimed know-how may also be difficult to separate from other know-how and assets that the employer uses to generate revenue.

The draft regulations also give substantial powers to local intellectual property offices to inspect contracts and other employer documents related to non-compliance, and impose penalties of as much as RMB 50,000 under certain circumstances.  Worse than the penalties, however, the documents inspected may include confidential, proprietary information of the employer that would otherwise be secure from examination.  Local intellectual property offices are required to keep the information confidential, but there is at least a possibility of abuse in practice from local officials, due to guanxi or outright corruption, passing on business secrets the employer’s competitors  contacts.

The draft regulations provide some welcome clarifications, but, as they stand, may not deal adequately with the costs and benefits of the business of commercializing inventions.  For example, under these regulations, inventors would share in the profits and revenues from their inventions almost like equity investors in their employer.  But what about loses?  Commercializing inventions is often a high risk business with losses as likely as profits and no certainty as to how an individual project will turn out.

Employers typically wish to fix their costs, including minimizing the risk of law suits if they are successful, in order to focus on managing the risk of investing, developing and selling new products and services.  The added risks and administrative burdens that these regulations would impose are likely to drive up costs and/or drive R&D overseas.

Questions? Contact Allan Marson at china.desk@ishimarulaw.com for a complimentary response.