Update: TSMC wins major victory over China's biggest chip maker

TSMC could be awarded up to $1 billion in damages after a U.S. jury ruled in its favor in a case against SMIC involving trade secret theft and breach of contract

Taiwan Semiconductor Manufacturing (TSMC) has won a major victory over China's biggest chip maker in a court case that could have wide ranging implications for the loser.

A jury at the Superior Court of California in Alameda County voted in favor of TSMC in the case against Semiconductor Manufacturing International (SMIC). TSMC had sued SMIC in a case involving theft of trade secrets, patent infringement and breach of contract over a prior settlement between the two companies.

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The next phase of the trial, to assess damages against SMIC, begins Thursday. The damages alone could be enough to force SMIC to seek a buy-out, according to Randy Abrams, research analyst at investment bank Credit Suisse.

TSMC could be awarded up to $1 billion in damages, and could also win an injunction preventing infringing chips from entering the U.S., Abrams wrote in a research note. Since SMIC ended the third quarter of this year with $500 million in cash and $1.1 billion in debt, a big financial penalty and an injunction would seriously crimp SMIC's ability to do business, he said.

"We regret the court's decision," SMIC said in a statement, noting the case is not yet over and vowing to continue in the best interests of the company and its shareholders, including a possible appeal of the verdict.

In a statement, TSMC said, "The unanimous verdict confirms that SMIC breached its commitment in a 2005 settlement agreement, and misappropriated TSMC’s trade secrets."

An injunction against SMIC could cut it off from customers that represent over half of its sales. In the third quarter, 59 percent of SMIC's sales were attributable to North American companies, according to presentation material from its third-quarter investors' conference. However, it is winning new customers fastest in Greater China, which includes China, Hong Kong and Taiwan. Around 37 percent of its sales were to companies in Greater China.

Analysts and legal experts say it's difficult to tell how a financial judgement by a U.S. court might be applied to a company with most of its operations in China. SMIC maintains a complex corporate setup. The company was incorporated in the Cayman Islands, which as a British Overseas Territory would likely honor a judgement by a U.S. court. The company maintains stock listings in the U.S. (New York Stock Exchange) and Hong Kong, which boasts a robust legal system.

The legal system in China is different, however, and does not always honor U.S. court judgements.

SMIC's billion-dollar factories are all in China and the company is viewed as a key part of China's plan to become a chip manufacturing powerhouse in the future. SMIC even works with several provincial governments in chip-related activities, including factory management.

"According to our understanding, the U.S. court's decision would only be effective in the U.S., but would not have the power to impact our Chinese customers," SMIC said. "SMIC's main clients are in China."

The judgement in the U.S. case was read on Tuesday. The case is part of a wide-ranging legal battle between TSMC, the world's largest contract chip maker, and rival SMIC. The two first went to court in December 2003, in a patent infringement and trade secrets theft case that was ultimately settled in 2005 with a $175 million payment to TSMC and a cross-licensing deal. But the relationship turned sour soon after and TSMC filed the current case just a year later.