Everything old is new again for Sino-foreign JVs

Despite China's entry into the WTO and the opening of its markets that attended China's entry, foreign investment in several sectors such as e-commerce, aviation and transportation remain restricted. In China, 'restricted' equated to 'must be done in conjunction with a locally-owned partner'. The local partner in such situations is often a state-owned enterprise (SOE), which may have objectives, attitudes and practices very different from that of a typical foreign investor.

Is this the same old Sino-foreign joint venture?

In the past, the foreign investor in a joint venture would typically contribute cash or equipment and provide the joint venture company with management expertise, a trademark licence, and sales access to foreign markets. Back then, the foreign markets were the target markets, and China was merely a workshop.

But the world has changed. In today's joint ventures, the target market is most often China. Few foreign investors are able to grow fast enough organically or even through M&As to establish a China-wide platform for distributing their products or services, and most lack the sales force or the marketing experience needed. As a result, the new joint venture requires a knowledge of local market contacts and conditions, and foreign investors believe they can best get these from their Chinese partners. This in turn, may alter the traditional allocation of management responsibilities in the joint venture.

Chinese parties today are more sophisticated, and their needs have changed. They often have all the capital they require and do not need the foreign currency that motivated many joint ventures in the 1990s. With growing experience in the global marketplace and disillusionment of Western practices as a consequence of the global downturn, Chinese companies today see less value in foreign management service contracts. If the Chinese joint venture partner doesn't need capital, access to foreign markets, or management expertise, then what does it want from the foreign party? It wants technology. This is today's holy grail for the Chinese partner and at the same time, these technology assets are often the crown jewels of the foreign co-venturer. The potential for dissimilar interests is high, so to smoothly establish a Sino-foreign joint venture in the current environment, a foreign investor should consider the following:

Recommendations

Confidentiality and non-competition obligations

The joint venture contract and the technology licence should define the technology that is being provided as broadly and comprehensively as possible, and should impose a clear and strongly-worded obligation to preserve the confidentiality of such technology. Because such an obligation will typically apply only to the parties and their affiliates, it may be appropriate to impose an additional obligation on the parties to cause the joint venture company to limit disclosure to employees on a need-to-know basis. On this employee obligation, as a pre-condition to any disclosure, the contract should require that the disclosing party obtain from the employee a binding agreement not to disclose the technology that would survive for a reasonable period notwithstanding any termination of employment.

In addition, the parties will customarily agree not to compete with the joint venture company, but as with the confidentiality obligations, it might be prudent to impose on the parties an obligation to secure a non-competition obligation from key employees of the joint venture and the employees of the opposing party. Such obligation should be drafted in a manner that complies with the applicable law (PRC Employment Contract Law (中华人民共和国劳动合同法) ), catches the investing parties, their affiliates and controlling shareholders, contains all terms required by national law and local regulations, and survives any termination or expiration of the employment contract.

Historically it has been common for such obligations to be imposed only on the Chinese party or, if mutual, remains one-sided in form and application. With the changes in circumstances described above, coupled with the increased sophistication and confidence of PRC companies, the drafters of such contracts may find it necessary to ensure that the contracts are more balanced.

Protection of technology

Given that access to Western technology is becoming the principal contribution that a foreign investor makes, the protection of intellectual property rights is critical. Though China has significantly enhanced the ability of foreign parties to protect their intellectual property rights in recent years, many challenges remain. The list below offers suggested actions that a foreign investor may want to take before licensing its technology:

Registrations: China is a first-to-file jurisdiction for trademarks (including Chinese names) and domain names, so a foreign investor should at least begin the process of registering any trade marks and domain names that are associated with the technology that will be provided to the joint venture. Trade marks should be registered with the Trademark Office under the State Administration for Industry and Commerce, and domain names with the China Internet Network Information Center under the Ministry of Industry and Information Technology. The investor may also want to put know-how into a readable form prior to providing it to the joint venture to facilitate protection under the PRC Copyright Law (中华人民共和国著作权法 (修正)) .

Improvements: It is customary for a licensor of technology to want to obtain rights to any improvements to that technology. The PRC Contract Law, however, specifies that a technology contract may not include any provision for a “technology monopoly or that restricts technology development” (Article 239 of the PRC Contract Law (中华人民共和国合同法) and according to an interpretation of the PRC Supreme Court, certain provisions common elsewhere will be considered illegal. Therefore to ensure its rights to the improvements, the foreign investor may want to provide in the technology licence contract that any improvement developed solely by the joint venture company will be owned by that entity, but the foreign investor will have the right to purchase or obtain an exclusive licence to such improvement.

Employees: The relatively high turnover of employees in China may result in a loss of technology, particularly know-how. It is critical that a foreign investor ensures that the employees who will have access to the know-how will be subject to enforceable confidentiality and non-competition obligations, as well as employee invention assignment agreements.

The foreign investor may also want to obligate the joint venture company to conduct in-house training of select categories of employees to ensure they understand and appreciate the concept of intellectual property rights. In the employment contracts of such employees, it may be prudent to include an obligation to repay the cost of any training he or she has received while employed by the joint venture in case of termination of the employment and to develop incentive plans that encourage employees to remain. Lastly, the employee handbook of the joint venture company should address how trade secrets should be handled.

Other: Any proprietary technology provided to the joint venture in electronic format should be password-protected and the foreign investor should consider appropriate use of encryption technologies. In this connection, team members responsible for planning the joint venture's operations would do well to consider the operational requirements and physical layout to evaluate whether physical and IT structures can be arranged to limit access. These strategies can be powerful as a means of preventing the leakage of intellectual property, but they do require a strong understanding of the competing needs of engineers, production, IT, HR and other working groups in order to develop protocols that are workable.

Daniel F Roules and Dongying (Doris) Chen, Squire Sanders & Dempsey, Shanghai