Tech Transfer Prevention in China

IP Protection and Licensing are the Keys to Success

The threats of a trade war between the United States (US) and China have their foundation in disagreements over intellectual property (IP) and technology transfers. It is interesting that right after the Trump administration made their initial threats, the State Council passed the External Transfer of Intellectual Property Rights Measures (Measures) that went into effect on 29th March 2018. In this article Reinout van Malenstein, senior counsel at HFG Law and Intellectual Property (Shanghai) and vice chair of the European Chamber’s Intellectual Property Working Group, explains how these new Measures might complicate the transfer of IP and technology, and prevent the acquisition of a Chinese company.

It is good to know that China’s recently passed Measures are not entirely new. Since 2002, China has restricted technology imports and exports. These restrictions separate which technologies may be imported and exported into three areas: allowed, restricted and prohibited. Apart from that, the regulations have certain special provisions. For example, the foreign technology provider is liable for ensuring that the technology is not infringing the IP of anybody else.

However, these new Measures widen existing restrictions and impose a mandatory review by the Ministry of Commerce and the relevant authority when an IP transfer takes place. In addition, the Measures subject intellectual property to a security review in the case of a merger and acquisition by a foreign party in China. The Measures assess tech transfers and acquisitions on how this could possibly affect China’s national security and the country’s ‘interest’ as a whole. Further clarification on what constitutes the Chinese interest or is a national security concern has not yet been given and is desperately needed. At the moment, these Measures could allow China to potentially block the acquisition of Chinese companies by European companies on IP grounds.

This vagueness has resulted in European companies remaining uncertain on how China will respond to a European company’s IP. It is important to realise that Chinese wholly foreign-owned enterprises (WFOE) and joint ventures are both understood to be Chinese companies. As such, European companies that carry out research and development in China may not able to transfer intellectual property (including patents and software) and technology to their European parent company.

A response to US threats, or a long-term plan?

China and the US are currently in the middle of threatening a trade war, with tech transfers and IP violations being the initial reasons the US gave for threatening retaliatory action. The question of whether these new Measures were in response to President Trump’s demands or were already in the works has arisen. However, if one looks to the China Manufacturing 2025 initiative, it appears that this is part of a long-term strategy by the Chinese Government to acquire foreign IP and tech and these new Measures, that ensure certain acquired technology or IP stays in Chinese hands, are aligned with this long-term strategy. Therefore, in the future, European companies can assume that IP and tech transfers along with the foreign acquisition of a Chinese company could become more difficult.

Protecting IP and technology in China

Naturally, trade with China is a good thing. However, a long-term plan for European companies is needed to ensure that the European Union (EU) remains in a competitive position in tech and their innovative IP is not lost.

As part of a long-term plan to protect the EU’s IP, European businesses should register their IP in China and protect their trade secrets not only by using proper contracts (non-disclosure, non-use, non-circumvention agreements in accordance with Chinese law), but also by implementing physical and technological protection measures. The Chinese intellectual property rights (IPR) system actually works quite well, provided it is applied by the company in question.  A company’s IP is territorial, meaning that if a business files their IP in China the government’s protection only extends as far as the country’s borders. Since more than 80 per cent of all counterfeit and pirated articles seized at EU borders comes from China, it is important to register IP there even if a company is not active on the Chinese market. Only by registering their IPR in China can companies act against infringers and make the infringements stop by using local administrative and judicial forms of enforcement.

It is understandable that companies would want to sell their tech, trade secrets and IP to receive money. However, selling IP could help China obtain a monopoly on both tech and IP, which might harm the EU economy in the long term. Look to the current Dutch football team as an example. The Netherlands did not qualify for the 2018 World Cup after failing to qualify for the European Cup in 2016. The Dutch Premier League (Eredivisie), used to be competitive with the top European football teams. However, nowadays, great young Dutch players get bought by larger Italian, Spanish, German and English clubs resulting in the quality of Eredivisie going down and the Dutch clubs of Ajax, Feyenoord and PSV Eindhoven no longer being able to compete with the best in the sport. For the EU, the football example can be seen as a warning to not lose its competitiveness and innovation by selling the majority of its IP and tech. Instead, good remuneration can instead be obtained through licensing, as it allows the company to retain ownership over their IP.

China’s plan is clear, by buying intellectual property it wants to become a high-tech industry and innovative economy. There is nothing wrong with this plan, as it is in China’s best interest. However, with these new measures, the country has all the means to regulate what IP stays in China. Only with proper contracts and the correct IP strategy can European companies achieve a successful business outcome in China without losing their IP.

Reinout van Malenstein is a senior counsel at the Chinese law firm HFG in Shanghai where he advises companies on Chinese corporate law, contract law and IP law. Mr Van Malenstein is also the national vice chair of the Intellectual Property Working Group at the European Union Chamber of Commerce in China and is an external IP expert for the European Commission.