The arrest of an American Superconductor (NASDAQ: AMSC) employee in Austria who is accused of passing software secrets to Chinese wind giant Sinovel has resulted in the filing of criminal and civil complaints in China against Sinovel by AMSC.  

In criminal and civil complaints filed against Sinovel “and other parties,” U.S. wind turbine and electrical control system provider AMSC alleged the illegal use of its intellectual property and violation of contractual obligations.

“We have evidence that senior-level Sinovel employees engaged and paid an AMSC employee who illegally transferred some of our intellectual property,” AMSC President and CEO Dan McGahn said. “This individual appears to have turned over a portion of the upper layer, or binary code, of our PowerModule software and the source code we developed specifically for Sinovel’s 1.5-megawatt wind turbines.”

Using AMSC’s code, McGahn said, Sinovel upgraded its turbine control system with a new AMSC program developed to meet newly proposed Chinese grid standards. “We have compelling evidence that Sinovel has already utilized this stolen intellectual property to upgrade hundreds of its 1.5-megawatt wind turbines,” McGahn said, adding that the Chinese company “may also be looking to alter our source code to open the platform and allow the use of power electronics from other manufacturers, such as Guotong, a company founded by Sinovel.”

Sinovel licensed its 1.5-megawatt platform from Fuhrlander in 2005 and has since made thousands of the turbines. AMSC supplied the core electrical components with its proprietary (and heavily encrypted) power converter and control systems.

When suspicions were raised in mid-June, McGahn reported, AMSC began a criminal investigation in conjunction with law enforcement. “After compiling extensive evidence, we brought our issues to the attention of U.S. and Chinese authorities.”

The arrested employee worked in Austria, where AMSC subsidiary Windtec is based. He “is currently in jail awaiting trial on criminal charges that include economic espionage.”

McGahn said the investigation made clear that AMSC’s encryption was effective. “Outright theft was necessary,” he reported bluntly.

There have been significant indications that Sinovel, long China’s biggest wind turbine manufacturer, is struggling.

“The China wind market has slowed and it’s clear that Sinovel’s business is off,” McGahn said. “Their financial performance has weakened” and there are “clear signs of strain,” he went on, adding, “now Sinovel has compounded its troubles by stealing.”

AMSC, too, has been struggling since April when Sinovel, formerly AMSC’s biggest customer, refused a major shipment. “During the spring, we repeatedly attempted to reach a resolution with Sinovel on its contractual breaches,” McGahn said. Negotiations were fruitless, but they became pointless when AMSC discovered evidence of theft.

In its filings, AMSC is “asking for an order requiring Sinovel to meet its contractual obligations.” In addition, they are asking legal authorities in China to compel Sinovel to cease and desist from infringing its intellectual property and pay monetary damages and compensation for economic losses. “We are seeking full restitution,” McGahn said.

“AMSC is now operating its business based on the assumption that Sinovel will not be a customer,” McGahn said. “Customers pay their bills and customers respect intellectual property.”

On the other hand, McGahn quickly pointed out, AMSC’s actions do not represent a statement “on China wind or China in general,” he said, noting continued strong commitments to Chinese wind customers Dongfang, XJ Group, Shenyang Blower Works and JCNE. “It is an economic reality that we must do business in China, and I believe we can do it securely and profitably.” In fact, he added, the experience with Sinovel has left them “better prepared to succeed in China than ever before.”

In response to this setback, McGahn said, AMSC has trimmed 30 percent of its employees, streamlined management, cut its annual cost structure by $30 million since the start of the fiscal year and -- most importantly -- instituted “new, conservative financial controls, which include the requirement for letters of credit or bank guarantees before shipments to China.”

They have also “realigned the business” from a focus on power system and superconductor technologies to a focus on the wind and grid markets the technologies serve, creating a more customer-oriented business.

McGahn said the legal actions were filed in China because the turbines with the allegedly stolen software are “almost exclusively in China and it is a Chinese contract.” He described the lawsuits as pertaining to trademark and copyright infringements, not patent violations.

On the challenge of facing off against a Chinese company in the Chinese legal system, McGahn said AMSC had done “a lot of work on collecting the evidence” and “being cognizant of what we’re going to have to do in China.”

He noted the recent legal victory in China by telecom giant Cisco. “Cisco had a complaint about IP theft with a major Chinese telecommunications provider,” he said. “There was in my opinion less evidence than what we have, but Cisco was able to prevail and win a settlement with the company that had stolen their intellectual property. So there is precedent and our lawyers believe we have an extremely strong case.”

“Chinese companies really do value Western technology,” AMSC Communications Vice President Jason Fredette recently told Greentech Media in an eerie premonition of AMSC’s fate. By providing that technology, Fredette said, AMSC expected to be a part of China’s international pace-setting wind and transmission build-out. “The vast majority of AMSC’s revenues are coming directly from China.”

Not so much now.