From current issue of Fortune Magazine

By Roger Parloff

March 7, 2006: 12:17 PM EST

(FORTUNE Magazine) - A U.S. business achieved a long-anticipated intellectual-property milestone last month: It became, as far as most legal experts can tell, the first company sued for patent infringement by a mainland Chinese plaintiff.

On Feb. 10, Shenzhen`s Netac Technology sued PNY Technologies of Parsippany, N.J., in federal court in Texarkana, Texas, alleging infringement of Netac`s U.S. patent relating to USB flash memory drives. While the case may strike Americans as a man-bites-dog story -- a Chinese firm accusing a U.S. one of violating Chinese IP -- many specialists see it as a harbinger.

``This is not a curiosity,`` says Netac attorney Stephen Judlowe of the New York office of Morgan Lewis & Bockius. ``I`d be very surprised if this is not the future you`re looking at.``

In a weird way some American IP experts are even welcoming the suit. ``It`s good news for people in the business of innovation,`` says Anthony C. Chen, an American IP lawyer in the Shanghai office of Jones Day.

That`s because IP experts have long predicted that only when Chinese companies begin protecting their own patents, copyrights, and trademarks will the notoriously unreliable Chinese courts and enforcement authorities become vigilant in protecting foreign companies` IP. In this sense, PNY might be seen as taking one for the team. (Attorneys and marketing people for PNY did not return numerous messages seeking comment.)

That Netac might be the first Chinese patent plaintiff on American soil is not surprising. In its home court in Shenzhen the litigious maker of OnlyDisk flash memory drives has already brought patent suits against domestic competitor Beijing Hua Qi, Taiwanese manufacturer Acer, and Japan`s Sony. (Hua Qi lost in June 2004 but has appealed; Acer settled; the Sony suit is in an early phase.)

Netac CEO Deng Guoshun has also rattled sabers in the Chinese press in recent years, warning the likes of SanDisk, Dell (Research), Hewlett-Packard (Research), and Apple (Research) (which uses flash memory in its iPod Shuffle and Nano) that Netac is investigating possible infringement by them as well. (In 2004, Netac ranked sixth in flash drive market share with 4.4%, according to Gartner Dataquest; the industry leaders were SanDisk, with 19.4%; M-Systems, 16.6%; and Lexar, 12%.)

Ironically, says IP attorney Chen, some American companies have been less vigilant about protecting their rights in China than they could -- and probably should -- have been. Under applicable treaties, U.S. companies have about 30 months from the time they file a patent application in the U.S. to seek corresponding patent protection under Chinese law.

But not foreseeing China`s swift industrial boom, many American companies missed their window of opportunity, says Chen, unwisely deciding that ``the Chinese market was not big enough or that China was not going to enforce anyone`s IP, so why bother?`` Though China has been accepting patent applications for over two decades, more than 60% of the 35,610 patents that U.S. companies had obtained there as of Dec. 31, 2004, were granted since Jan. 1, 2001. (Over the same period Chinese inventors were granted 2,579 U.S. patents, with 65% of those in the last four years.)

Chen says he knows of one major American IT company, which he declines to identify, which unsuccessfully tried to collect patent royalties from a Chinese company on U.S. telecom patents that it had never protected under Chinese law.

``You don`t have patents in China,`` the Chinese company responded, per Chen`s account. ``It`s not that we don`t respect your IP. You do not respect your IP.``

From the March 20, 2006 issue