Tech transfer in China: common mistakes and how to avoid them

Your company’s China deal went bad. The technology which you licensed or transferred to your Chinese partner appears to have been stolen and now your prized products are being sold all over the world, under Chinese brands. This is a nightmare that every foreign business executive, IP or otherwise, tries to avoid. Foreign technology companies operating in China face a whole new set of challenges compared to those they face in domestic markets. This article summarises some common mistakes that foreign technology companies have made in China with regard to their IP assets, and provides strategies to avoid or remedy these.

Secure IP rights before entering market

It is easier said than done to secure IP rights before you enter the market. It may surprise many readers to learn that quite a few multinational companies fail to properly lock down their IP assets in China before entering the Chinese market; IP executives are then shocked to discover that their companies’ trademarks and domain names were registered years ago by Chinese domestic entities. Well-known examples include 高通 (Qualcomm), 伟哥 (Viagra), 乔丹 (Jordan) and 卡斯特 (Castel). In some cases, patents belonging to foreign technology companies have been copied, translated and granted as utility models in China without the rights holders’ knowledge. Remedying such abuses is expensive, time consuming and, in many instances, unsuccessful. To avoid this situation, IP executives should secure their IP rights well in advance. To be fair, it is not always straightforward for companies to predict whether or when they will enter the Chinese market and unlikely that they will know if they will have the budget to take such action years in advance.

However, securing IP assets in China is part and parcel of the job of a competent IP executive or IP counsel. It is crucial for such personnel to understand Chinese IP laws and regulations, as well as international IP treaties and how these are implemented in China. To be safe, the regular English language brand, its Chinese transliteration, phonetic counterparts and even popular misrepresentations should all be registered. This calls for local expertise and deeper understanding of Chinese consumer markets and cultural traditions. Rights holders need to be aware of the different Chinese markets or regional variations – Hong Kong and Taiwan are different from mainland China, and markets in Guangdong province are different from those in Shanghai, Beijing or the northeast region. Be mindful of trade secret regulations and compensation requirements for employees’ inventions. Chinese patent law requires first filing in China for inventions made in China. While these are basic measures, they can help companies to avoid million or billion-dollar blunders.

Besides the cost, the perception that China is weak when it comes to IP enforcement may also be a reason that IP executives fail to apply for or register rights in China. This is extremely short sighted. While it is true that Chinese IP laws, regulations and enforcement might not be on the same level as those in more developed countries, if a rights holder fails to avail itself of the Chinese rules and regulations, then its arguments against the unfair treatment of foreign IP assets are less persuasive.

Understand China industrial and innovation policies

According to statistics released by the Ministry of Science and Technology, China has spent Rmb41.41 billion in 2015 on technology imports, among which Chinese domestic enterprises spent Rmb20.4 billion (49.3%) and foreign-invested enterprises spent Rmb17.8 billion (43.1%). The amount spent on technology imports has remained relatively stable since 2011 after substantially increasing from the amount spent in the early 2000s. At the same time, R&D spending has increased significantly to about Rmb1 trillion, with the ratio of technology import expenses to R&D expenses falling. This substantial increase in R&D can be attributed to both market forces and government support for certain strategic industries.

Generally, China tends to structure five-year national economic plans – this is because the Chinese economy is more heavily regulated by the government at both national and local levels than many foreign markets. Knowing the five-year plan will give IP executives the proper background for understanding the environment in which their IP assets are operating.

The most recent Five-Year Plan for 2016 to 2020 identified several strategic and new technologies for which the government has pledged support. This is crucial for analysing the motivation, goals or strategies of Chinese partners or consumers.

More importantly, the “Made in China 2025 Plan” promulgated by the State Council in 2015 called for major breakthroughs by Chinese companies in replacing foreign competitors’ products, which are usually high end and concentrated on intellectual property. A competent IP executive or business manager should be familiar with this plan and especially any parts that might relate to its own products and services. In addition, “Made in China 2025” also set certain targets for different industries with regard to localisation.

Detailed IP landscape analysis should be carried out in order to assess the strengths and weaknesses of Chinese competitors and strategic decisions should be made to improve foreign companies’ IP portfolio in China. IP counselling that is merely reactive is no good. In addition, foreign companies should have in place an Asia-Pacific IP strategy, as well as a global IP strategy to meet the coming IP challenges likely to emerge from Chinese competitors in China and the Asia-Pacific region and on a global scale.

Figure 1. Tech transfer and R&D in China

Know your Chinese partners and customers

Again this is more easily said than done. Routine IP due diligence and audits are important but insufficient alone. Beyond regular IP validation, ownership audits and competitor IP landscape analyses, special attention should be paid to ownership of Chinese competitors. This is related to the national economic plan and “Made in China 2025”. A state-owned Chinese company is more likely to have a mandate to implement national and local economic plans. The executives and boards of directors of such companies have more than business and economic considerations when engaging in IP transactions with foreign rights holders. Even privately owned companies operating in the Chinese market will find that taking advantage of those plans puts them in a better position when negotiating with foreign rights holders.

A deep analysis and understanding of the ownership of Chinese companies can be difficult. Some state-owned companies try to make it appear that they are privately owned, while privately owned companies sometimes try to behave as if they are state owned. There are local government-owned companies that want to behave like national government-owned companies. In addition, individuals whose names appear as shareholders, directors or executives may not actually be the real stakeholders. IP executives and business managers need to go beyond a superficial understanding of Chinese partners and customers – those unfamiliar with Chinese markets are especially vulnerable to unintended consequences when it comes to making IP deals.

It is also important to understand what your Chinese partners bring to the table. Two crucial considerations are land and finance. For manufacturing companies, Chinese partners usually bring land and buildings to the joint venture. Although few IP executives are experts in real estate, especially Chinese real estate, it is crucial to understand the value of the assets at stake.

Because Chinese land is not privately owned, your Chinese partners will have only a user’s right for a certain period of time. Foreign companies need to understand these limits. In addition, you need to understand your Chinese partner’s funding source. Does it rely heavily on state bank loans? Will IP assets be pledged as a guarantee for the loans? For example, government grants may be tied to certain IP goals, the sales of certain products and meeting local government employment or social services goals.

Business executives anxious to show progress in Chinese deals may willingly ignore or accidently overlook such IP risks. However, a competent and far-sighted IP executive needs to face these head on and argue for a better deal.

Another important aspect to maintaining control of your valuable IP assets is the business organisation. If possible, the IP assets should be owned directly by the offshore foreign companies. If it is necessary and profitable to transfer the IP ownership to Chinese joint ventures or wholly foreign-owned enterprises incorporated in China, the structure of the latter is preferable. However, no matter the circumstances, there must be competent executives, preferably IP executives, keeping control of these IP assets in China. Such control may take many forms (eg, restricted access to data, sites and trade secrets, aggressively pursuing former employees engaging in unfair competition and proactively registering or capturing IP assets in the same area as the Chinese partners or competitors).

Figure 2. Ministry of Commerce statistics show that the majority of the foreign invested enterprises in 2015 have been in the form of wholly foreign-owned enterprises (75%)

Divide and conquer

Chinese companies play this game well. When an important technological product enters the Chinese market, a Chinese company is likely to conduct back-to-back negotiations with multiple leading companies around the world, usually competitors. The Chinese company may intentionally leak certain aspects of its negotiation with one foreign company in order to leverage negotiations with another.

Like the prisoner’s dilemma in game theory, these foreign competitors all wish to have a monopoly over the Chinese market and thus tend not to share information with one another. The result is that the Chinese negotiator tends to obtain the best bargains from multiple foreign companies, including access to valuable IP assets. This usually occurs when one or a few dominant Chinese firms are negotiating with a number of multinational technology companies in an industry with a lot of government regulations.

Even if the foreign companies appear to prevail in preserving their IP assets initially, remember that these dominant Chinese state-owned firms have significant influence when it comes to changing government policies. Initial victories can easily evaporate down the road. Those IP executives and business managers celebrating those initial big deals should have done a better job in pursing long-term goals for their viability in Chinese and global markets. Yet it is hard to argue that IP executives and business managers should focus exclusively on long-term goals for their viability in Chinese and global markets – such people have short-term goals, which are not always the same as those of their employers.

The good news is that smart IP executives in foreign companies can also play this game. If possible, try to negotiate with different Chinese companies – including competitors and those from different regions. Leverage their rivalry to your advantage. In addition, even among state-owned companies, there are differences between companies owned by the national government and those owned by local government. Understanding national and local government plans and the differences between them may also provide a good way to achieve the business goals of foreign companies without sacrificing too much with regard to IP ownership or control.

Further, it may be possible to find and engage with a partner to promote government IP policies which favour the preservation or fair treatment of foreign IP ownership or control. Such partners may be Chinese privately owned companies, influential industry associations or even certain Chinese state-owned companies. However, remember – things change fast in China. Tread prudently and intelligently. Staying away from the huge Chinese market is certainly unwise. Making calculated IP moves will help to speed up technology innovation in China and globally.

Scrutinise details of China-related IP agreements

IP agreements are complex, China-related IP agreements especially so. Do not use templates or boiler plate agreements and merely insert “China” into them. China has detailed contract laws, technology import regulations, catalogues on permitted technologies to import and registration requirements. In addition, there are specific laws and regulations related to foreign invested enterprises, taxation and foreign exchange control. For example, a wholly foreign-owned enterprise is the recipient of foreign technology and can be used to keep control of your intellectual property. If your Chinese partner promises rosy sales prospects, you may demand a high up-front fee for the technology transfer.

The Regulations on Technology Import and Export Administration require the technology assignor or licensor to declare that it is the lawful holder or authorised assignor or licensor of the technology and that the technology is “complete, error-free, valid, and capable of accomplishing contracted technical objectives”.

The Supreme People’s Court issued a judicial interpretation to the lower level courts in 2004 regarding trials of technology contract disputes (Fashi [2004] No 20). This provided detailed rules on scope and types of technology contract, the definition of ‘work made for hire’, restrictions on technology transfer contracts terms and also what amounts to a breach of a contract and liabilities. Clauses in a technology contract which prohibit the receiver from challenging the validity of the IP rights of the technology at issue are deemed invalid under this judicial interpretation.

Compliance with Chinese laws and regulations is the first step. The relationship between the regulations, Chinese contract law, foreign trade law, the Anti-monopoly Law and the new General Principles of the Civil Law are complicated. There are different views on whether the general freedom of contract principle or more specific regulations apply. Further inquiry and research should also be made on how courts treat technology transfer disputes, how often violation of these laws are actually enforced and what is the attitude or policy of the national or local government to specific types of technology.

There have been no reported cases where the Regulations on Technology Import and Export Administration have been applied. However, this does not mean that no such disputes have taken place. Even if certain provisions of the technology transfer contract are declared invalid due to failure to comply with administration registration requirements, the contract may still be performed (see Kang Li Yuan Corp v Qili Pharmaceutical Co, Ltd Technology Transfer Contract Dispute (Supreme People’s Court, 2011, Mintizi No 307)). Due to these uncertainties, a savvy contract drafter should make the technology recipient or licensee pay upfront whenever possible.

IP executives should work closely with business managers, including the highest executives taking charge of the China project, to understand the strategic goals of any China deal. A competent IP executive should be willing to challenge any arrangement which might cause the company to lose control of its intellectual property. This is not easy and may well be beyond the remit of an IP counsel. On the one hand, your Chinese partners need to know your technology to make the products for sale in China and elsewhere. On the other hand, you do not want to lose control of that technology as a result of sharing it with Chinese partners. A skilful IP business manager needs to balance these conflicting goals to achieve balance and leverage.

Do not underestimate start-ups, small players and former employees

IP executives should also pay attention to start-ups and small players in the Chinese market. They can transform rapidly into big competitors if they obtain access to venture capital or government connections. Special attention should also be paid to former employees. Employment contracts should include non-compete and confidentiality clauses; trade secrets should be documented and security measures should be taken regarding these. These efforts will pay off when administrative or judicial enforcement is required.

A large number of trade secret and unfair competition cases in China are related to current or former employees. In addition, criminal prosecution is possible for trade secret violations. IP executives need to maintain a good working relationship with local police and prosecutors so that once criminal prosecution is justified, your company’s case will be receive the proper attention.

Monopolists, beware

One tool that the Chinese legal system has adopted from the Western legal system is anti-monopoly law. This can prove useful in regulating monopolising companies in China. Foreign rights holders are usually market leaders in their fields, which make them more likely to be the targets of Chinese anti-monopoly law enforcement. The nearly $1 billion dollar fines imposed by the Chinese government on Qualcomm for unfair practices in IP licensing certainly raised alarm among IP executives and business managers working on Chinese IP deals.

To avoid sharing such a fate, it is vital that executives understand Chinese anti-monopoly laws and regulations, as well as the three government enforcement agencies. The Ministry of Commerce has an Anti-monopoly Bureau (also known as the State Council Anti-monopoly Committee Standing Office), which is mainly responsible for reviewing operator concentrations. The National Development and Reform Commission has a Price Supervision and Inspection and Anti-monopoly Bureau, which oversees unfair pricing. The State Administration of Industry and Commerce has an Anti-monopoly and Anti-unfair Competition Enforcement Bureau and provincial sub-bureaux, which are mainly responsible for abuse of market dominant position and consumer protection.

As Chinese companies becoming strong competitors or even market leaders, foreign companies should consider using Chinese anti-monopoly law and foreign antitrust laws to protect their lawful IP interests, both in China and globally.

Participate in dialogues and institution building

To more proactively protect foreign IP owners’ rights in China, leaders need to actively participate in dialogues with Chinese IP stakeholders in both the public and private sectors. Trying to set the agenda or at least participate in the process will help them to better articulate different perspectives on formulating IP laws and policies in China. Using business associations and quality brand owner committees to advocate for policy change and concerns has proved an effective way to influence government decision making without having grievances attributed to any particular party.

One improvement in government policy apparent over the last few years is that various government agencies – especially those responsible for IP laws and policies – are more willing to seek public input from around the world. Foreign rights holders should actively participate in such dialogues, at least through bar associations or business associations, if they are unwilling to put their private company’s opinion on the record. These efforts at changing Chinese IP policies have already met with various degrees of success.

In addition, various new IP institutions have been established in China on a pilot basis, including specialised IP courts. Foreign rights holders need to actively participate in building these institutions from the start. For example, the IP case precedent project should be supported and encouraged to improve consistency in judicial decision making in IP enforcement. Further, foreign rights holders should pay attention to patent and trade secret administrative enforcement. Whether such approaches should be encouraged should be a topic for consideration by IP executives and business managers.

Wise companies learn from the mistakes of others. IP decision makers who are willing to learn and take long-term views will do more to protect IP assets for their company. Unfortunately, such IP executives and business managers are rare. Be one of them or keep them happy if you find one.

Anyone tackling Chinese IP matters in high-tech companies should learn from inventors, who always find novel solutions to problems big or small, and adapt to different environments through constant learning and change. The Chinese market is no exception to innovation. In fact, success in solving Chinese IP problems may be the key for your companies’ prosperity at home and globally.