Some secrets are hard to keep. While most investors in. China would seek to keep lists of customers and sup-pliers away from. their competitors, it is unclear whether such lists can be copy-righted under Chinese later. There is also uncertainty as to what. action could he taken if somebody were to pass such a list to a rival firm.
This is a tough problem for companies to tackle anywhere in the tiff orld, and is that much worse in China where investors have been struggling to protect technology and know-howr. While China has enacted a Large body of law protecting copyrights, patents and trademarks, legal protection of non-registered business secrets remains i.n its infancy.
Protection if in-house co.rnputer soft-ware – although. it is in theory covered by copyright law ?is another difficult area. There are value judgements to be made if, for instance, a computer pro-gramme has been copied by a competitor clever en,ougla to introduce genuine although minor code line modifications to deflect accusations of piracy.
Traditionally, the pattern. has been .for Chinese -companies to steal technology and business secrets from Western firms. But this – may now be changing. Competition between toreign-mvested ventures makes them all potential consumers of each other's business secrets.
Selling company secrets
A recent case reported in the Soul/.l tlima Vlornin,. Post involved the alleged leak-age of business secrets between two toreign-invested retailers operating in Guangdong province. The newspaper reported that a former employee of Trustmart, a subsidiary of Taiwanese-owned .Grace TI-1Pm Group, had been arrested in Nos-ember after admitting receiving 't n100,(10t) for leaking sensitive computer software data. The files were said to have been sold through an intermediary- to Makro, a Dutch retailer with stores in the cities of Guangzhou, Shantou and Beijing.
Trustmart -opened its huge Guangzhou supermarket in September 1.997. At first things seemed to be going well and. I'h'tO00 customers joined theshop's membership scheme in the first month of operation. But -then sales slumped unexpectedly. The reason, Trustmart now believes, is that Makro was able to use leaked sales information to undercut prices.
Mr Henk van Houten., Makro's China manager, had previously defined his company's China strategy as achieving a high turnover on goods priced at between five and 30 per cent less than in other outlets. "Our image is to be the cheapest in the market," he said. Part of this is achieved through economies on service extras such as plastic bags. Staffing levels are also kept to a mini-mum, with Nlakro's giant Beijing store, for instance, employing just 350 in a store with a shopping area of 10,000 sq metres.
Sharing the same partner
Computer systems are a key to competitiveness in. the hypermarket business, explains Mr Vincent Fan, head of Asian. private equity investments at Citibank, which has a 10 per cent stake in Trustmart. "Inventory management is crucial in high turnover businesses," he says. "You need to know which stocks are moving, and how quickly, as well as the spending patterns and behaviour of your customers."
Van ' Houten admits that sensitive information from Trustmart was passed to Makro employees but denies that the information was actually used, claiming instead that it was passed on to the investigating authorities as soon as the case came to light. "There has been. a problem. with this issue and people in our company were involved in a way that vs as not correct," he said, pointing out that a number of Makro employees including a general. manager in Guangdong had since left the company.
Mr Winston. Wang, chairman of Grace rl HVs Group, which has invested about US.$500m in China to date, says that he is preparing to sue Makro for damages. "Our business has started to pick up again but I'm afraid long-term damage has been done to our company," he adds.
Business secrets disputes between foreign-invested ventures remain. relatively rare; of greater concern is that secrets willhe leaked through the Chinese partners in joint ventures. -1-he problem. is potentially acute in the service sector, where restrictions on foreign investment mean that pioneering joint ventures by international competitors have to he made with a single dominant Chinese firm.
In the express courier sector, for example, DHL, UPS and TNT and, until recently; Federal Express, have all teamed up with Sinotrans, the powerful and well-connected Chinese transport company.
DHL, which has offices in. 21 Chinese cities and has an estimated 25 per cent market share, places value on the trust which has been built up with Sinotrans over 11 years of partnership. "Whilst we acknowledge that Sinotrans' relationship with some of our competitors would appear unusual by Western standards, we are fully confident that their professionalism ensures that there are no breaches of confidentiality," says Mr Andy Tseng, area general manager for DHL Greater China.
But Federal Express, which is DHL's closest international competitor in the China market with a 15 per cent market share, according to industry analysts, was reportedly unhappy with its relationship with Sinotrans. A few years ago it sv itched its affiliation to EAS 'Transport — a transport firm with links to the People's Liberation Army.
While Federal. Express regional counsel Andrew da Roza says that he is not aware of a history of confidentiality breaches in China, he confirms that firm. does use confidentiality clauses in its employment contracts with local workers, the nature of which are themselves "confidential to the parties". However, he adds that most of its staff are recruited through employment agencies and it does not contract directly with employees.
Including confidentiality clauses in. employment contracts is one of the most widely-used means of protecting business secrets in China. But the concept of an obligation on. employees not to disclose commercial information is new. There is, for example, no outline confidentiality clause mentioned anywhere in the Ministry of Foreign r- rade and Economic Co-operation's standard model investment contract.
While investors are free to negotiate their own commercial contracts, the absence of a solid endorsement of a contractual clause in Chinese commercial law can make enforcement in. the courts of such contracts difficult. "While it is quite a new idea in China that there is anything wrong vs ith passing on business information., the Chinese authorities are waking up to the idea," believes. Mr Clifford. Borg-larks, a I-long Kong based consultant with law firm Baker & McKenzie. One sign of this, he believes, is the listing of the infringement of business secrets as a crime for the first time (along with. copyright infringement and computer-related crime) in China's new criminal law statute which came out at the beginning of last year.
"Awareness is, growing, particularly among larger state-owned enterprises, that there is such a thing as a trade secret," adds Borg-Marks. To an extent, this grow ing awareness stems from. the need to control corruption resulting from the incomplete separation of goyernment and business in newly corpora-Used Chinese-owned entities.
A former official in the foreign loans department of a central government ministry was recently given. a suspended death. sentence for passing information to an associate. He -wasbrokering information to foreign companies bidding for contracts relating to governinent loans. The Bi'ijiiu Pie,-ui itnrs Doily reported last December that the pair had received a commission of LS$765,t)00 from the Australian-owned Olex Cable in relation to a deal for laying fibre-optic cable in north-western China. While such cases are by no means unknown in developed countries, a legalistic and systemic approach -to tackling such problems is clearly preferable to ad hoc anti-corruption campaigns of variable effectiveness.
A sticky area
The Anti-Unfair Competition 1_,aw issued in Iate 1993 was one of the first Chinese laws to explicitly forbid. the infringement of business secrets. Business secrets were defined here as technological and_ business information not known to the public and capable of producing economic benefits to civ, ners who must have taken security measures to keep it in strict confidence.
Much-needed elaboration on Chinese lair regarding business secrets was added by the l995 'Rules on Banning Infringement of Business Secrets'. The rules define what information can be protected by business secrets regulation. Procedures for Administrations of Industry and Commerce (AlCs) investigating business secrets infringements are outlined, as well as the penalties to whichinfringers may be liable (see 'page 31).
"The big question is still whether the employee/employer relationship implies a duty to maintain confidentiality," believes Mr Joseph Simone of the Hong Kong office of law firm Johnson Stokes & Master. "In China it does not make sense to play with fire and it is best to make sure by requiring each employee to sign something."
Working for competitors
While the laving down of procedures for bureaucratic involvement in the protection of business secrets represents a promising advance of the Chinese legal system, in practice most foreign investors will probably. continue to rely on. the courts. "The administrative authorities might regard a case involving business secrets as a little bit too sticky," adds Simone.
Borg-Marks points out that getting evidence is still going to be a big problem whichever course of action is chosen. He believes that there may some resistance on the part of alleged infringers to co-operating with AIC investigations. "The alleged infringer would have to divulge fairly sensitive material to the A1C. I would hate to show this sort of material to anybody," he says. The very fact that the SAIC felt it necessary to explicitly prohibit investigating AICs from divulging the information that they gather in the course of investigation shows that problems of trust remain in this area.
As always when drafting contracts, it pays to look at the practicalities of enforcement. This is a particularly sensitive issue in the drafting of so-called 'non-compete' segments of confidentiality clauses which obligate employees to
maintain confidentiality after leaving the company. With the high turnover in skilled and managerial posts currently being experienced by many joint ventures, non-compete provisions may be of equal importance to preventing disclosure during the employment term.
"It's normal for labour con-tracts to stipulate the continuance of confidentiality for a number of years after the employee has left the company. But in China you could never reasonably ask for more than three to five years. Anything beyond that xvould probably be unenforceable," says Borg-Marks.
Mr Zhou Chuanjie, who now
practices with. American lawn firm Shearman and Sterling, was previously involved in the evolution of Chinese patent and trademark law during the 1980s. He notes that "there has been some good news recently in. China in relation to the protection of technology in non compete clauses". He points out that the State Science and Technology Commission's opinion on 'Strengthening Administration of Technical Secrets in the Course of Movement of Scientific and Technical Personnel' promulgated in July 1997 backs up the legitimacy of non-compete clauses of up to three years.
Intrigued by these new provisions, he approached contacts within the Ministry of Labour to get their views on the validity of such contracts. They were aware of the regulations and confirmed that such clauses would be acceptable. They did., however, add a proviso that they would only apply to employees working in an equivalent position in a competing company. "But it's highly unlikely that an engineer would go to work as a receptionist for a rival," says Zhou.
Contracts however are no substitute for common sense management practices. "Physical management is also very important," stresses Baker & McKenzie's Borg-Marks. "Certainly you should keep valuable blueprints under lock and key and not leave them lying around. Documents should be marked confidential with a big red chop. You should also control very carefully who can take what out of the technical. library." Baker & McKenzie has responded to a flurry of enquiries recently by running a series of in-house seminars on best practice in the protection of business secrets.
Centralising crucial knowledge and processes is not only good management practice in itself but is also a requirement for a company to justify in any subsequent court cases that this knowledge constituted a commercially valuable secret in the first place. In cases where it may not be possible to centralise commercial secrets, it is sometimes better to diffuse information throughout the company. In this way it would be unlikely that any single disaffected employee would be able to divulge the entire company's secrets.
An. indirect way of safeguarding business secrets is to encourage a feeling of loyalty to the cc>Inpanr. High. staff turnover,, particularly in skilled and managerial. positions, is increasingly a major source of business secrets leakage. Borg-Marks reports that there have been several cases brought by Western firms against former Hong 'Kong Chinese employees who have left the company and gone on to use confidential information to set up their own competing concerns.
While no single strategy has proved. itself in ensuring retention of key staff, some advisors advocate a policy of linking employment with the company to confiscatable assets such as housing. Shenzhen local regulations on the protection of business secrets have even tried to extend the principle of confiscatable assets into the period after an employee has left the 'company, through the continued conditional payment of confidentiality fees to ex-employees.
A crisis of cloning
Borg-Marks notes that there has been a recent spate of problems caused by the Chinese partners of joint ventures filing design patents on confidential drawings and information licensed in technology transfer agreements. Apart from the laborious process of contesting these patents, there is also an unrecoVerable aspect of the Chinese party's action in that the information becomes public knowledge when. it is tiled with the patent office. ?here have been some pretty awful. messes in these cases,?he says.
Tektronix, a US-based manufacturer of electronic equipment, has recently had to deal with an unusual case of cloning in China. The firm, which has a co-operative joint venture manufacturing analogue -oscilloscopes and oscilloscope probes in Yangzhong, Jiangsu province, discovered that an enterprise under the Zhejiang }electronic Industry Bureau was advertising a copy of the Ic'ktronI' 2261 oscilloscope as the original model of the 2261. 1 lu Zhejiang firm was effectively implying .that Tektronix had copied the
The State Administration of Industry and Commerce 'Rules on Banning Infringement of Business Secrets', promulgated on November 23, 1995 is the most detailed Chinese legislation covering the protection of business secrets. 'These pro-visions are likely to form the basis of new business secrets law expected in 1998.
Article Two The definition of business secrets is given as 'technological information and business information which is not known to the public but can produce economic benefits to its owners. [It] should be practical information which the owners have taken security measures to keep in strict confidence'.
Article Three Obtaining, or allowing others to obtain, business secrets by theft, bribery or intimidation is prohibited in a clause which makes it clear that infringers may include employees, contractors, sub-contractors and other third parties.
Article Four States that cases of infringement of business secrets are to handled by Administrations of Industry and Commerce (AICs) above the county level.
Article Five States that owners of business secrets who suspect that infringement has taken place should present the relevant secrets and preliminary evidence of their infringement to the local AIC, which will investigate the suspected firms or individuals. The AIC would have to establish that the information possessed by the suspected infringer is similar or identical to the owner's business secret and that this party had a means to obtain it. The defendant would have to prove either that it generated the information independently or obtained the information by legal means.
Article Six States that the AIC can confiscate drawings, software etc. containing the infringed business secrets and order the infringer to stop marketing the products made through using the infringed business secrets.
Article Seven Permits AICs to fine infringers of business secrets amounts between YnlO,000 and Yn200,000 and order them to destroy or return to the owners of business secrets goods made using these secrets.
Article Nine Upholds the right of owners of business secrets to bring lawsuits as compensation against losses.
Article Ten Specifically forbids officials investigating claims of the infringing of business secrets, of themselves disclosing those business secrets.design of the 2261 from them.
If this were not enough, the venture has also had to simultaneously fend off the threat of cloning from its own joint venture partner. "They [the Chinese parent of the joint venture] are always enquiring how to manufacture the products, trying to find. out where the parts come from and whether they can make copies and sell them on the market," says Mr Tommy Tong. China country manager for Tektronix. The company has also chosen to be robust in resisting the temptation to benefit from leaked business secrets. " At one point our office received multiple phone calls from people saying that they had an inside line that could lead us to win a tender," recalls Tong.
Fears over the potential leakage of business secrets have influenced Tektronix's localisation of production, particularly for high-technology products. Instead of looking for a joint venture partner in China to manufacture high-technology components, it has decided. to protect its technology in a wholly-owned venture based in Beijing.
New dangers may be on the horizon for international companies as the pro-gramme of mergers and restructuring among Chinese state-owned enterprises gathers pace. International competitors with separate joint venture partners could find themselves suddenly part of the same enterprise grouping if their Chinese partners were to merge.
In the medium term there may also be the possibility that a rival international firm could buy into the shares of the Chinese parent to the joint venture. "Restructuring will increase the likelihood of disclosure of business secrets to other international companies," sags Shearman and Sterling's Zhou. Borg-Marks believes that it may. pay to "wear prophylactics against this kind of thing", in the form of requiring consent for mergers or alternatively acquiring an option to terminate a relationship should a merger actually occur.