Recent Developments in PRC Foreign Investment, Cross-border Tech Transfer, and Trade Secrets Laws – Implications for Foreign IP Owners

Interestingly, the United States Trade Representative's Office just released its 2019 Special 301 Report (301 Report) on April 26.  The Report pointed to major shortfalls in China's IPR regime with regard to foreign investment:  "…investment and regulatory approvals, market access, government procurement, and the receipt of certain preferences or benefits may be conditioned on a firm's ability to demonstrate that IP is developed in or transferred to China, or is owned by or licensed to a Chinese party."  The Report also notes that: "[t]he United States urges that, in formulating policies to promote innovation, trading partners, including China, refrain from coercive technology transfer and local content policies, and take account of the importance of voluntary and mutually-agreed commercial partnerships."

Looking at the FIL through the lens of the 301 Report, it makes clear that FIL Article 22 was specifically drafted with the 301 Reports trade complaints in mind:

The state protects the intellectual property of foreign investors and foreign-invested enterprises, and protects the lawful rights and interests of intellectual property rights holders and neighboring rights holders; and pursues legal liability for infringement of intellectual property rights in strict accordance with the law.

The state encourages technical cooperation in the course of foreign investment based on the principle of free will and business rules. The conditions of technical cooperation shall be determined by the parties to the investment through consultations conducted on the basis of equality in accordance with the principle of fairness. Administrative authorities and their working personnel may not use administrative means to compel technology transfer.

Until the FIL's implementing regulations (which should arrive before year's end) are issued, precisely what the benefits of Article 22 will be for foreign IPR owners who are keen to invest in China remain uncertain.  The repeal of the existing foreign investment regime and explicit prohibition on coerced tech transfers indicates China's willingness to level the playing field, but those efforts could falter if the implementing regulations fail to adequately address IPR-related complaints of the type called out in the 301 Report.

Where the foreign investment requires an administrative permission from PRC governmental authorities, the revision to APL Article 31 adds a clear mandate: "An administrative authority or its working personnel may not set the transfer of technology as a condition for securing an administrative permission, or, in the course of according such an administrative permission, directly or indirectly require a technology transfer."  The same law was revised to punish such acts (Article 72(6)).  Both of those revisions were effective as of April 23.

TIE Regs and EJV Regs

In conjunction with the FIL's promulgation, the amended TIE Regs and EJV Regs appear to ameliorate many aspects of cross-border tech transfer and IP licensing roadblocks that have long frustrated foreign IPR owners seeking to expand into, or participate/benefit from, the massive market opportunities offered by China.

TIE Regs

Before March 18, the TIE Regs forbade foreign IPR owners from using any of the following provisions in their tech import (into China) transfer/license agreements:

(1)  requiring the licensee to accept attached conditions that are not indispensable to the import of the technology, including the purchase of technology, raw materials, products, equipment or services that are not essential;

(2)  requiring the licensee to pay royalties or to undertake relevant obligations for the technology when the valid term of the patent has already expired or the patent has been declared to be invalid;

(3)  restricting the licensee from making improvements to the technology provided by the licensor or restricting the licensee from using the improved technology;

(4)  restricting the licensee from acquiring from other sources technology similar to, or in competition with, the technology provided by the licensor;

(5)  unreasonably restricting the channels or sources from which the licensee purchases raw materials, parts and components, products or equipment;

(6)  unreasonably restricting the quantity, type or sale price of the products manufactured by the licensee; or

(7)  unreasonably restricting the export channels of the products manufactured by the licensee with the imported technology (Article 29).

With the revisions to the TIE Regs, these restrictions are eliminated, though competition/antitrust concerns may still come into play depending on the circumstances.  Commercial realities will also play a role (i.e., just because a licensor can now try to include such provisions, it doesn't mean a licensee will be willing to accept them).  Moreover, the PRC Contract Law (中华人民共和国合同法) (as interpreted by the Supreme People's Court) applies many of the same restrictions but was not revised accordingly.  This is likely to limit the benefits of the TIE Regs revisions where PRC law governs the contract (though foreign tech owners can generally specify foreign law in contracts with PRC entities).

On a more optimistic note, the following onerous mandates on the licensor were also removed from the TIE Regs:

• Licensors are liable where a licensee's use of the imported tech as agreed in the contract infringes a third party's lawful rights and interests.
• During the term of a tech import contract, the results of any improvements to the tech are to belong to the party that made the improvement.

The liability provision had served as a de facto non-infringement warranty that was unavoidable for the licensor.  Given that a patent license is essentially a covenant from the patentee not to sue, not an affirmative guarantee that the licensee can practice the invention without infringing another's rights, the liability provision had been widely criticized, particularly where relevant provisions of the PRC Contract Law permitted (and still permit) the parties to allocate liability by agreement, thereby making it possible for licensors to avoid such infringement liability.

The improvements provision also made no sense from a licensor's perspective.  The licensee only had an opportunity to develop improvements because the licensor granted access and a license to use the technology.  Giving to the licensee ownership of its improvements denied the tech owner the ability to maintain complete ownership over the licensed technology, which can have undesirable knock-on effects (e.g., where the technology is also licensed to other parties who have a most-favored-nations clause that could then require the licensor to provide that benefit to its existing MFN licensees, depending on what the MFN clause provided).

EJV Regs

In the context of importing tech to China to license to, or use as investment in, an equity JV, the TIE Regs work in conjunction with the EJV Regs.  The relevant revision to the EJV Regs is the removal of Items (3) and (4) from the second paragraph of Article 43, which provided:

A technology transfer agreement must comport with the following provisions: (1) the technology use fees are to be fair and reasonable; (2) unless otherwise agreed upon by both parties, the technology exporter may not restrict the regions, quantities or prices of the technology importer's exports of the resulting products; (3) the technology transfer agreement's term generally shall not exceed 10 years; (4) after the technology transfer agreement's expiration, the technology importer has the right to continue using the technology in question; (5) the terms for mutual exchange of improvements in the technology between the parties to the technology transfer agreement is to be reciprocal; (6) the technology importer has the right to purchase needed machinery, equipment, parts and raw materials from sources that it considers suitable, in its own discretion; (7) shall not have any unreasonable restrictive clauses prohibited by Chinese laws or regulations.

Prior to this revision, foreign technology owners that wanted to license the tech to or set up a JV with a Chinese entity had to limit the agreement's term to 10 years, after which the JV had the right to continue to use the licensed technology without need for a further license.  But even with the removal of Items (3) and (4), perhaps there is less cause to cheer than would be expected; Items (5) and (7) still serve to place substantial limits on the licensor's freedom to contract by requiring mutual exchange of improvements to the licensed tech, and importing an unpredictable reasonableness threshold on restrictive clauses (i.e., what is reasonable to the foreign tech owner might not be to a Chinese court evaluating such clauses' enforceability).  Further, JV owners still need to comply with other PRC laws and regulations, including the PRC Contract Law and its prohibitions on certain provisions being included in tech transfer agreements.  Perhaps we will see a different approach, one providing full/near-full freedom to contract, when the FIL implementing regulations are issued (which will supersede the EJV Regs).

Trade Secret Protection

In addition to tech transfer issues, the FIL also requires PRC government authorities to maintain trade secrets as confidential (Article 23) and provides for punishments for unauthorized and unlawful disclosures (Article 39).

Article 23

Administrative authorities and their working personnel shall keep confidential, in accordance with the law, the trade secrets of foreign investors and foreign-invested enterprises to which they are privy in the course of performing their duties, and may not disclose or illegally provide the same to third parties.

Article 39

If a member of the working personnel of an administrative authority abuses his/her authority, is derelict in his/her duties, practices favoritism, commits another irregularity or discloses or illegally provides trade secrets to which he/she was privy in the course of performing his/her duties to a third party in the course of foreign investment promotion, protection or administration work, he/she shall be disciplined in accordance with the law. If a criminal offense is constituted, his/her criminal liability shall be pursued in accordance with the law.

The FIL is not the only law prescribing how administrative authorities should act with respect to trade secrets.  The  April 23 revisions to the APL also address this, providing in Article 5 that, without the applicant's consent, administrative authorities and their personnel, including participating experts involved in evaluation, shall not disclose applicant-provided trade secrets, undisclosed information, or confidential commercial information (unless otherwise provided by law or involving national security or important societal rights and interests).  The revisions also provide for punishment for such disclosures (Article 72(5)).

Further, the  April 23 NPC Decision to amend the AUCL represents a "beefing up" of trade secrets protection, which has long been a poorly-protected IP right, taking trade secret protection to a level commensurate with patent and trademark protection.  The principal changes can be summarized as follows:

• Expansion of acts that constitute trade secret misappropriation |
  • In addition to misappropriation by theft, bribery, fraud, coercion, or other improper means, electronic intrusion/hacking is now specifically named;
  • Disclosure or use of, or permitting others to use, trade secrets [through the foregoing acts, or] in violation of confidentiality obligations (not limited to where an agreement exists);
  • Abetting, luring, and assisting others to violate confidentiality obligations, or the trade secret owner's relevant requirements to preserve confidentiality, and obtain, disclose, use or permit others to use the rights owner's trade secrets.
• Expansion of scope of trade secret definition |
  • Any kinds of commercial information could qualify as a trade secret if proper measures are taken to protect confidentiality, not merely technical or business information.
• Expansion of scope of potential defendants |
  • Previous limitations of protection to "business operators" now also includes natural persons, legal persons, and organizations without legal personality.
• Increase in the monetary punishments for misappropriation |
  • Statutory damages increased from Rmb3 million to Rmb5 million (about US$750,000);
  • Punitive damages for malicious misappropriation of up to 5x actual damages suffered by the trade secret owner or illicit gains of the defendant are now available.
• Shifting of burden of proof of misappropriation away from the trade secret owner |
  • In the past, and before the burden of proof would shift to the defendant, trade secret owners were required to establish: (a) a defendant's access or exposure to the information; and (b) that the information used was substantially the same as the trade secret.
  • Now, the owner merely needs to provide preliminary/prima facie evidence of confidentiality measures having been taken and reasonably demonstrate that the trade secret has been misappropriated. The burden then shifts to the defendant to prove that the asserted trade secret is not one protected by the provisions of the AUCL.
  • The burden also shifts to the defendant (to disprove that misappropriation exists) if the owner provides preliminary evidence reasonably demonstrating that the trade secret has been misappropriated, and provides evidence of one of the following: |
    • evidence demonstrating that the defendant had means or opportunity to obtain the trade secret, and that the information used is substantially identical to the trade secret;
    • evidence demonstrating that the defendant has disclosed or used the trade secret, or there is a risk of such disclosure or use; or
    • other evidence demonstrating that the defendant misappropriated the trade secret.

How these changes will play out in practice remains to be seen. Still, revisions this extensive to a trade secret regime that has been around (and poorly enforced) since 1993 cannot but help to improve the situation for foreign trade secret owners seeking to protect and enforce their rights in China.

Certain Drafting Considerations

More important and far-reaching than most commercial or tax considerations for structuring a China cross-border IP/technology license (a tech import subject to the TIE Regs), drafting any contract's governing law and dispute resolution provisions is critical.

• Governing Law

It is common for foreign IP owners licensing their rights (including trade secrets) to a party in China to seek to adopt their home jurisdiction's law to govern the license contract.  It is what the owner is most familiar with, and many jurisdictions outside of China have robust bodies of law that are very protective of technology and trade secret owners, and encourage licensing activities.  And, of course, China's reputation as a "difficult" jurisdiction for foreign IP owners does not help.

On the other hand, the licensee is in China (where the implementation of the contract will occur).  Given that, it is not surprising that licensees will often insist on PRC law governing the contract.  Such insistence is only likely to become more emphatic with the changes to PRC law that appear to be protective of foreign IP owners.

A compromise position would be to adopt a neutral jurisdiction's law.  Hong Kong, though part of China, maintains its own separate legal system, a system based on common law principles familiar to IP owners from many western countries, and is often an agreeable compromise.  Singapore's legal system is also common law-based and a popular choice in the region.

• Dispute Resolution

Foreign IP owners often favor resolving disputes in the courts of their home jurisdiction.  Where the licensee in China does not have substantial assets in the foreign IP owner's jurisdiction, combined with the fact that very few countries have reciprocal enforcement of court judgments with China, however, it is likely that a foreign court judgment will be all but unenforceable in China.

A favorite alternative to foreign court adjudication of cross-border contract disputes is international arbitration, as arbitral decisions issued in member countries are (at least ostensibly) enforceable in China under the New York Convention, making arbitration outside China a viable option.  But IP disputes, particularly those involving the threatened or actual disclosure of trade secret information, will quite likely require swift action in the licensee's jurisdiction (i.e., China).  An injunction from a foreign court or arbitrator will not generally be enforceable in China, as China's laws and regulations don't permit Chinese courts to issue interim injunctions in aid of foreign arbitrations administered by institutions outside of China (though they do permit preliminary and interlocutory injunctions, including prior to the commencement of litigation in a Chinese court or an arbitration before a Chinese arbitral institution).

The one exception thus far is Hong Kong.  The PRC government and Hong Kong SAR government recently signed an arrangement on April 2 whereby parties can apply to PRC courts for interim measures in aid of arbitral proceedings administered by arbitral institutions in Hong Kong.  This should boost Hong Kong as a leading choice for dispute resolution of cross-border IP licensing contract disputes (where the foreign licensor refuses to entertain resolution of disputes in mainland China).

• Interplay of Governing Law and Dispute Resolution

The challenge in selecting governing law and dispute resolution provisions is how those terms interact and, practically, how their enforcement might (or might not) be carried out.  Below are the options and notes outlining main issues/related concerns:

In a cross-border license agreement with a PRC-based licensee, there would be little point in adopting Hong Kong governing law and the IP owners' home courts for venue, nor would it be sensible to adopt HK law but arbitrate outside of HK/PRC, and those options are therefore not discussed above.

Adopting PRC governing law could be a prudent choice for a cross-border IP license agreement but requires the licensor to pay special attention to various aspects of PRC contract law and practice that survive the revisions to the TIE Regs.

TIE Regs Revisions May Ultimately Have Little Impact

With the changes to the TIE Regs, foreign IP owners are now free to include various pro-licensor provisions that were previously prohibited.  But that freedom has limits.  If the parties adopt PRC governing law for the license agreement (often a preferred option, depending on the overall circumstances between the parties), the PRC Contract Law as interpreted by the Supreme People's Court still includes many of the same licensor-unfriendly provisions that were just excised from the TIE Regs.

The parties could try to avoid those limitations by adopting law other than PRC law (such as Hong Kong law) to govern.  The challenge is that acting against breaches or otherwise to enforce the agreement's terms against a PRC licensee (at least one without significant assets outside of mainland China) eventually will require the assistance and involvement of PRC courts.  If the provisions of the agreement would otherwise violate the PRC Contract Law or other mandatory PRC laws and regulations, or the catch-all category "public policy", such violation could serve as a basis for the PRC court to deny enforcement of an arbitral award or refuse to issue interim measures, thereby frustrating much of the purpose in adopting foreign governing law to begin with.

Conclusion

The recent issuance of the new FIL and revisions to several laws to (1) prohibit forced tech transfers, (2) level the playing field for tech imports to China, and (3) provide an improved legal framework and tools for trade secret protection, bode well for increased protection of foreign IP being transferred/licensed into China, whether as part of foreign investment or in a cross-border licensing arrangement.  Just how much of an increase in protection the new regime offers is likely to be affected greatly by the various forthcoming implementing regulations, and these issues will need to be revisited in respect of any drafts of those documents and their final promulgated versions.