Phase 1 and CAI: A Tale of Two Agreements

The European Union has recently released a draft text of its Comprehensive Agreement on Investment with China (CAI).  Compared to the other two major agreements signed by China since the beginning of 2020, the Phase 1 Trade Agreement (the Phase 1 Agreement) and the Regional Comprehensive Economic Partnership Agreement (RCEP), this is the least IP-focused.  The CAI is limited to bilateral investment and skirts IP  concerns. It could have done more.

 A report prepared by the Swiss National Center on Competence in Research in Trade Regulation  succinctly defined the differences between a Bilateral Investment Treaty (BIT) such as CAI and a broader trade agreement, by noting that “the role BITs can play in protecting the investors’ investments internationally against IPR piracy seems systemically limited. Investment law protects investors against undue interference by the state (and its various authorities) but not against violations by private parties.”  These broad considerations make sense in a traditional market economy, where investors may not face undue interference in their IP rates at the hands of the state.  They are less convincing in markets, such as China, where the state plays an active role. 

The distinction is also artificial for all BITs as IP is an asset that is often contributed to an investment.  In some instances, it can constitute the whole investment.  Licensing revenues are also considered service income and may be considered as a service industry investment.  The use of IP in an investment is also contemplated by the TRIPS agreement which requires national treatment in the “use” of IP rights overseas.  While IP issues may complicate negotiation of a BIT, excluding them can undercut the credibility of the BIT.  The United States Model BIT (2012) (Model BIT) recognizes IP rights as investments and is accordingly somewhat more comprehensive than the CAI. 

The CAI – along with many other BITs – grandfathers compulsory licensing, which restricts and can devalue IP rights.  It exempts compulsory licensing imposed by competition and public health authorities from its scope (Sec.  II.3.5(ii)).    While TRIPS standards regarding national treatment and most favored national treatment are also specifically grandfathered (Sec. II.7.5), a more balanced approach to BIT drafting would be to specifically identify IP-related investment risks. These risks might include: restrictions on licensing; excessive requirements for recordals of patent or trademark assignments; preferential taxes on locally created IP; subsidies and other preferences for IP creation given to local entities; discrimination against patenting in technological fields dominated by foreign investors; or other efforts that minimize the value of foreign innovations or discriminate against their use.    

Based on an initial read of this draft text, here are the CAI provisions that relate to IP and how they compare to the Model BIT and other legislative changes undertaken by China.

Section I fails to enumerate intellectual property as a covered “investment.”  The Model BIT recognizes IP as an “investment” (Art. 1, Definitions).

Section II.3 prohibits performance requirements in an investment that require the transfer of technology to the recipient country, or that a percentage of R&D is conducted in that country, or the use or favoring of a technology of the host country.  It also prohibits an advantage to an investment based on the use or favoring of a technology.  The United States has negotiated similar restrictions in the Phase 1 Agreement, Chapter 2.   The Chinese government had made similar commitments in its accession to the WTO, and has sought to address US concerns in the  Foreign investment Law , the Administrative Licensing Law, and other measures.  These concerns are also likely addressed in the context of the WTO disputes filed by the United States and the European Union regarding forced technology transfer.  The Model BIT also requires national treatment in technology transfer in terms of domestic performance requirements (Art. 1(h)). 

Section II.3bis.2.3 exempts national security entities from the scope of regulation. There is no reference to  security or competition regulations being exempted from the CAI.  The Model BIT exempts national security type regulation, as may be applied by the Committee on Foreign Investment in the United States (Art. 18).  It also excludes competition and other “laws of general application” from the scope of “investment authorizations” regulated by the BIT (fn. 6).  To the extent that national security laws are intended to protect the state, they should normally be exempted from national treatment obligations.  Competition laws present a different challenge which may depend upon whether they are indeed of general application, transparently and uniformly applied, and not intended to advance national economic security.

Section II.3.5 exempts compulsory licenses of competition authorities from the scope of the CAI.  A similar provision is found in the Model BIT (fn. 6, Art. 3(b)).

Section II.5 requires that the Parties protect the confidentiality of information in regulatory proceedings and that they do not impose unnecessary disclosure requirements.  Confidential business information is to be protected “in accordance with domestic law, including with respect to the protection of confidential business information or other information treated as confidential under the Party’s laws that is obtained during administrative proceeding.” 

As the above quote suggests,  each party should apply its own law.  If this is the correct interpretation, the CAI does nothing to further improve  protection of confidential information in a regulatory proceeding affecting foreign investments  Thankfully, China’s Administrative Licensing Law, Foreign Investment Law and the Phase 1 Trade Agreement  already have extensive provisions in this area. 

Section III.1.7 permits “covered enterprises” of the CAI to participate in the development of standards by the central government bodies, including “related standardization working groups and technical committees” on  a national treatment basis. The CAI also requires the Parties “to recommend that local and non-governmental standardizing bodies in its territory allow enterprises that are covered enterprises of the other Party to participate” in standardization activities.    A similar issue was addressed in the 26th JCCT  which provides that “China welcomes U.S.-invested firms in China to participate in the development of national recommendatory and social organization standards in China on a non-discriminatory basis.”  The CAI goes further than the JCCT commitment by requiring equal participation in national standards including, presumably including  mandatory standards (“GB” standards), and recommended standards (GB/T standards).   It does not go as far as the JCCT commitment by failing to address social organization standards.  Social organization standards tend to be more market-driven and ‘bottom-up.”  The CAI language might suggest that China is out of compliance with the 26th JCCT requirement since it does not mandate foreign participation in social organization standards setting.

 Section III.2.5 provides for a minimum of due process in competition investigations.  It requires the competition authority to “notify, in writing if so provided by domestic law, the addressee of its competition concerns or objections, including the facts and legal basis on which the proposed decision will be based. The address of the decision shall, prior to its adoption, be informed, to the extent provided for in the domestic law, of the evidence on which the decision will be based.  Prior to the adoption of the final written decision, the addressee of the decision shall have the right to submit written comments to the competition authority in relation to the competition authority’s competition concerns or objections. During such proceedings, the addressee of the decision shall have the right to a legal representative of its choice. The addressees shall have the right to appeal the final decisions of the competition authorities to a competent court of law.” 

The United States negotiated similar due process type requirements in the JCCT of 2014.  The summary of those negotiations provided that “the United States was able to address a significant concern for many foreign companies, which have expressed serious concern about insufficient predictability, fairness and transparency in the investigative processes of China’s Anti-Monopoly Law enforcement. The Chinese side agreed that, under normal circumstances, a foreign company in an Anti-Monopoly Law investigation would be permitted to have counsel present and to consult with them during proceedings. China also made several additional commitments, including to treat domestic and foreign companies equally and to provide increased transparency for investigated companies.” 

A weakness in both the CAI and the JCCT of 2014 is the failure to reference the TRIPS Agreement, which has long provided “guard rails” for IP-related competition investigations, including a substantive obligation on competition authorities to demonstrate an “adverse effect on competition” where there is an “abuse” of IP rights. In addition, TRIPS enforcement provisions require “fair and equitable proceedings”, based on “evidence” where the parties had an “opportunity to be heard”,  the right to “independent counsel”:  “judicial review”; no “overly burdensome requirements” for “personal appearances” ; and “safeguards against abuse”  (TRIPS Arts. 40-43, 49).  A more pro-IP approach would have been to recognize these commitments and elaborate on due process requirements in antitrust proceedings regardless of their IP-related elements.

Another  general “due process”  weakness in the CAI’s approach is its failure to deal with “commercial hostages”, including detention of foreigners by purported creditors or adverse parties in IP matters.   Entry and exist of temporary visitors for business purposes is addresses in Section II.6bis, with no mention of foreign detentions.

The final text of the CAI is not scheduled for completion for another two years.  In addition, the annexes to the CAI are not yet publicly available.  In the final text, there are likely to be numerous provisions which will have an indirect effect on the commercialization of IP rights, including  provisions requiring SOE’s to not discriminate in their purchase of goods or services (including  technology licensing?), the lifting of an investment ban for cloud services (subject to a 50% equity cap),  and not imposing new restrictions on investment in R&D in biological resources.

CAI, RCEP and the Phase 1 Trade Agreement all responded to different economic, trade demands and political urgencies.   The CAI has been understood as a sign by the Biden administration that the European Union will pursue its own trade relationship with China based on its own interests.  While the IP and forced technology transfer provisions of the Phase 1 Agreement helped establish new standards in China that are applicable to all countries, the non-IP provisions of the Phase 1 Agreement were not kind to Europeans and other allies in their preferential buying requirements.   Overall, the CAI may not undersell MFN treatment as much as the Phase 1 Agreement did.  On the other hand, the EU did not significantly advance IP protections in the CAI text, nor did it take an expansive view of the role of IP in BITs.  The bright side of this picture is that the CAI leaves space for  the United States and the European Union to further coordinate strategies on IP protection in China.  

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