Catching up With The Literature on Forced Tech Transfer…

FTT
(from the OECD report, discussed below)

While President Trump has extended the truce on the trade war, academic and business debate around the nature of “forced technology transfer” (FTT) practices in China and appropriate business and legal strategies continues.

A  study last year by Dan Prud’homme and his team, discussed earlier in this blog, was one important empirical effort looking at the nature and consequences of FTT.  Their FTT Strategy & Risk Forecasting Matrix was intended to guide foreign firms to anticipate risks associated with FTT policies and serve as a starting point for understanding how to further quantify or mitigate these risks.  In January 2019, the OECD also released a study on International Technology Transfer policies which cites to the Prud’homme study and further describes FTT, as well as the various international agreements and practices that may constrain it.  Consistent with the approaches of the US and EU in the currently pending WTO case, the study highlights the importance of joint ventures for transfer of technology in China (para. 90), pointing to equity restrictions as one reason for such licensing arrangements.   Because of the high volume of multinational and governments in tech transfer, the OECD reports also underscores the importance of transparency in the tech transfer process to “distinguish[] voluntary  technology transfer from its more constraining variants.” [para. 92].  Predictably, the report also cites to the same provisions cited by the United States and Europe in the pending WTO case against China regarding its FTT polices [para 65].

A timely and business-oriented to FTT was presented by the IP consulting firm Rouse in a highly useful webinar of February 27, 2019, available here.  The speakers, Tim Smith and Chris Bailey, noted that due to the current trade dispute with the US, Chinese prospective JV and business partners are currently “falling over themselves” not to require tech transfer as a condition to a deal.   The speakers also noted that there had been a resurgence of joint ventures in tech-driven deals with China.  In addition, smaller companies have found that it has become more expensive to develop market share in China making a JV more attractive.  Even if a JV is not mandatory, the access to local capital and expertise can be a rationale for forming a JV.  The additional capital may also lead to higher valuations if an IPO exit is contemplated for the joint enterprise.

The speakers noted that Chinese companies are also increasingly more concerned about less traditional factors of a tech transfer such as whether they can scale up quickly using the technology, how they will handle IP infringements in China, and whether the technology can offer an immediate competitive advantage.

Amongst the newly emerging business structures, the speakers also noted that there have also been  an increasing number of offshore joint ventures formed outside of China that then reinvest China.  The Chinese party may also try to take a stake in a foreign party, and then license the technology into China. The Chinese party thereby may become a financial or strategic investor in the foreign partner.  Contrary to the common understanding, the Rouse speakers also underscored that state-owned enterprises are not as “untouchable” in IP or licensing disputes with foreign partners as private companies.  In some cases they may be better targets for litigation, as they may be more concerned about reputational risks from IP law suits than privately-owned companies.

The presenters also noted that there are deals where China is licensing out have become more common, particularly in new technologies such as AI, VR/AR, electric vehicles and battery technologies.  Western businesses are increasingly looking to Chinese businesses for these innovations.

As is evident from the above, the presenters’ viewed the current WTO dispute around the TIER and other concerns over FTT to be “yesterday’s issue” for practitioners and business people.  They also point to the data from recent surveys showing that a minority of US and European Companies have been asked to transfer technologies by their business partners, often as a condition of obtaining market access. However, they also note that companies have long utilized work arounds to the TIER, which has been on the books since 2002.

The Rouse webinar is particularly instructive in documenting the sophistication of Chinese licensees and future licensors.  Of course, the subsistence of a discriminatory provision as “yesterday’s issue” is also not justification for its continued existence.  If anything, it underscores how much of an unncessary, if not counterproductive,  impediment China’s Administration of Technology Import/Export Regulations (TIER) has become.  From a WTO perspective, even if the TIER is often irrelevant to current transactions, the key issue  in WTO jurisprudence is likely to be whether “expectations of the competitive relationship” offer less favorable treatment to a foreign licensor than a domestic Chinese licensor.   Further, the presence of “additional regulatory hurdles”, such as the necessity of using a domestic subsidiary or an offshore joint venture to sub-license a technology due to discriminatory provisions that exist for a foreign licensor,  does not afford a useful justification for a discriminatory provision.  Indeed such additional regulatory hurdles may constitute de jure discriminatory treatment, as was documented in the case the United States brought against the EU regarding its regime for Geographical Indications (See Para. 7.314, WTO Panel Report)  Due to the increasingly sophisticated experience of Chinese companies, including their willingness to contribute capital or participate in complex multinational licensing structures, the webinar ultimately proved to me that the TIER itself has also largely outlived its usefulness in protecting “vulnerable” Chinese licensees.

An important legislative development that also deals with FTT is China’s revised Foreign Investment Law.  The European Union Chamber of Commerce has released its comments on the draft law here. The comments were due February 24, 2019.  This draft law addresses some foreign concerns about FTT involving foreign investments in China.  The EU’s comments on the FTT provision are as follows:

“Article 22 explicitly prohibits administrative organs and their staff from using administrative means to force the transfer of technology, which echoes the language used in other high-profile policies that have been released in recent years, most notably State Council Document No. 19 (2018). However, this leaves open the possibility for any non-administrative body to use any other means to compel technology transfers. Instead, the Foreign Investment Law should simply prohibit forced technology transfer by any means.”

I personally believe that the language of the draft law, by itself, is insufficient. Other observers, such as Rouse in its webinar, have noted that other incentives to FTT remain, including restrictions arising from national security, foreign investment restrictions, Made in China 2025 incentives, data localization requirements, etc.  Moreover, the draft law does not present a clear pathway to present legal challenges to local authorities, and to minimize any possible retribution when a foreign company complains about extortionary practice.  Prior history shows that foreigners are also highly reluctant to bring law suits against the same local governments that may be involved in regulating their investments. One partial solution is for China’s new national appellate IP court to consider taking jurisdiction over these FTT disputes. The Chinese government might also consider other measures such as creating an ombudsman for foreign investors, fast track administrative reconsideration of investment reviews, improvements to trade secret protection and employee mobility rules, and other measures that constrain the ability of local governments or individuals to directly or indirectly encourage a foreign investor to relinquish its technology, whether through legal or illegal means.  As another example, if the Chinese government seriously wants to address the problem of FTT, the theft of trade secrets that is undertaken in “support” of national or local government technology policies might be subject to enhanced penalties.  Moreover, such cases should be adjudicated by courts other than ones located in the jurisdiction where the misappropriation occurred.

Update from February 28, 2019: A second draft of the Foreign Investment Law has been released and made available in English by the NPC observer.  It is available here.

 

 

 

 

 

 

Some Good and Bad News in Recent Reports on China’s IP Environment

“The good news is China interested in IP, and the bad news is that China is interested in IP.” This proposition is proved by some of the recent reports on China’s IP environment  particularly the 2016 China Business Environment Member Survey by  the US-China Business Council, European Business in China Position Paper 2016/2017  prepared by the European Union Chamber of Commerce in China and the Global Innovation Index 2016, (GII) which was prepared by Cornell University, INSEAD and WIPO.   

The Good News

As for the goods news: for US China Business Council Members, intellectual property enforcement has slipped overall to the eight-ranked slot for USCBC members doing business in China. The top challenge is competition with Chinese companies in China.  IP enforcement has, in fact, slid from the number two slot (2014), the number four slot (2015) to number eight.  Still, IP concerns remain highly important for the tech sector, which lists IP in the number four slot, but also includes many “quasi-IP” issues in its top 10: innovation policies (number 2), government procurement ( 5 ), antitrust (7 ), standards (8) and cybersecurity (9).

The GII also singles out China’s improvements in IP.  For the first time this year, China became a “top 25” innovative economy in the GII. It is the first middle income country to do so.  China’s rise is attributable to a number of factors, several of them IP related: the country has a particularly high number of R&D-intensive firms among the top  global corporate R&D spenders.  China has had top scores in indicators such as patent applications by origin, utility model patents, high-tech exports, global R&D companies and  research talent in business enterprise (see chart, below).  While some of these indicators are of questionable value (such as numbers of utility model patents), the GII report recognizes many of the steps China has taken towards improving its innovation and IP environment. 

The Bad News

There are several important issues that the EU Chamber suggests China needs to address: procedural reform in the courts and improvements in administrative enforcement; addressing the problems of counterfeiting for OEM production in China and what constitutes infringement domestically; improving trade secret protections when workers leave an employee;  insuring the availability of provisional measures addressing higher barriers to obtaining High and new Technology Entity Status through removal of a global exclusive licensing approval option; and greater coordination and clarification of standards in IP-related antitrust investigations (amongst others).

One area of bad news shared by both the Chamber and the GII:  The GII scored intellectual property payments according to a formula as a percentage of total trade.  China came out below its overall rank at 72nd place, while it ranked number 1 in high tech exports (p. 199).  While the GII did not draw any specific correlation between the two, this is further support to me that China is a “remarkably underlicensed economy.”   

One reason for this disproportionality between licensing payments and high tech exports is the discriminatory provisions in China’s Technology Import/Export Regulations.  These regulations require that a foreigner indemnify a Chinese licensee against third party infringements and that the licensee own all improvements to the technology, while a Chinese domestic licensor can freely negotiate other terms.  As the EU Chamber notes, these regulations they “not only interfere with the needs of Chinese and foreign companies for effective technology trade mechanisms but also contradict the provisions of the Contract Law on technology transfer contract.” 

These concerns are not only directed to foreigners extracting IP ‘rents’ from China.  The ability to negotiate contractual terms is critical to developing flexible international networks for innovation through negotiated sharing of risks and benefits.  The GII recognizes the increasing importance of such international collaboration to China and  that “the Chinese innovation system is now densely connected to sources of expertise everywhere.” (p. 93).  The report also notes that Chinese companies had “the 7th largest foreign footprint of all countries with 178 R&D centers set up or acquired outside China by year end 2015.” (p. 125).    These unbalanced provisions can also affect bilateral science and technology cooperation by requiring that a Chinese party owns any improvements to technology that is licensed to it, or is indemnified against infringements by reason of use of this technology.  A recent report by the Government Accountability Office regarding clean energy cooperation between the US and China noted that “The U.S. Patent and Trademark Office has identified a potential discrepancy between Chinese law and the bilateral U.S.-China Science and Technology Agreement upon which the IP Annex to the CERC Protocol is based, according to U.S. Patent and Trademark Office officials. These officials stated that the potential discrepancy is related to ownership of any improvements made to IP licensed between U.S. and Chinese entities….” ( p. 2).

It is time for China to create a more level playing field in technological collaboration for foreigners licensing to China by removing these discriminatory provisions that treat foreign and domestic licensors differently. 

graphchinainnovationSource: GII.

Slouching Towards Innovation – A Survey of the Surveys on China’s IP Environment

Here is a summary of the business surveys on IP protection in China, drawn from the European Chamber of Commerce in China, Business Confidence Survey 2015 (June, 2015), the US China Business Councils’ 2015 USCBC China Business Environment Member Survey (Sept. 2015), the American Chamber of Commerce 2016 Business Climate Survey (“Amcham China” Report, Jan. 2016), and Amcham Shanghai’s 2016 China Business Report (“Amcham Shanghai” Report, Jan. 2016), and others.

IP Issues a Core Concern

While IP issues are less dominant than in recent years, businesses report that IP is still critical to them. When Amcham China respondents in all sectors addressed what they considered their competitive advantage versus Chinese domestic entities, three of their top four perceived advantages were IP-related: Brands (74%), Technology & IP (63%), and Development and Innovation (59%). USCBC respondents listed IP concerns in a number four priority slot, having dropped from number 2 in 2014. However IP issues have averaged as a number 4.5 priority over the past ten years, so the drop is not that significant. According to Amcham Shanghai’s survey, 49% of respondents believed that lack of IPR protection and enforcement constrains their investment in innovation and R&D in China.

Still different IP concerns vary in their impact on different businesses. For example, tech companies in the USCBC survey noted the following IP-related issues in their top 10 challenges: Innovation policies (number 2), IPR enforcement (number 5), cybersecurity (number 6), government procurement policies (number 7), standards and conformity assessment (number 8) and antitrust/antimonopoly law (number 10).

IPR Enforcement is Improving

On the brighter side, 91% of respondents of the Amcham survey indicated that IPR enforcement had improved over the past five years, a view that was generally shared by USCBC respondents (38% reported some improvement over the past year).

USCBC’s survey addressed the most viable options for IP enforcement: administrative enforcement had a slight edge in terms of viability in some or most cases (78%), followed by civil cases (70%) and criminal courts (57%).

The data also suggests that trade secrets will be of continuing concern. Amcham China respondents were least satisfied with trade secrets legislation and enforcement (45/40%).  Amcham China respondents were most satisfied with patent legislation and patent enforcement (66%/54%), followed by trademarks (62%/51%) and copyrights (57%/48%). USCBC respondents similarly rated trade secrets as their top area of concern (32%) followed by trademarks (28%), patents (22%), and copyright (9%).

Of particular importance for trade secret protection are challenges noted in responses to surveys in attracting and retaining talent.   According to the Amcham survey, among the principal challenges in attracting the right talent were competition from local businesses (45%), and competition from other foreign businesses (34%). Data security and cybersecurity were also identified as concerns by many surveys.

China’s Efforts to Innovate Leads to More Foreign R&D in China

Innovating in China has clearly become a priority for the foreign business community. The EU Chamber notes that China R&D centers are increasingly achieving global levels of innovation, although a large percentage (42%) are primarily focused on product localization. According to USCBC, about 43% of large member companies had established an R&D center.

European companies viewed innovation as one of five most critical drivers needed to move the Chinese economy up the value chain. The USCBC report notes that more than 9 out of 10 US companies believe that innovation in China will be critical to their company’s future in China, with 40% of the companies reporting that that half their profits came from products designed, developed or tailored to local requirements (an increase from 32% last year). Companies prioritizing investment in R&D, according to the Amcham Shanghai survey, were in hardware, software and services (81%), automotive (65%), industrial manufacturing (55%) and health care (35%).

Continuing Concerns about Technology Transfer

USCBC reported that 59% of respondents expressed concern about transferring technology to China. Twenty three percent of USCBC respondents advised that their company had been asked to transfer technology to China and that central or local governments had requested the technology transfer 60% percent of the time. Concerns about technology transfer included maintaining protection of the proprietary information during certification/ approval (83%), protection of IP (75%), enforcing license agreements (51%) and the government dictating or influencing licensing negotiations (32%). Nonetheless, according to USCBC, technology transfer concerns fell out of the top twenty this year, to number 23 out of 30. However the USCBC noted that the companies impacted by this issue felt it “very acutely”.

Innovation Policies Not All Positive

Thirty two percent of technology and other R&D Intensive industries that responded to the Amcham China survey indicated that China’s increasing capability for innovation presented an important opportunity for their business. However, as the preceding data suggests, not all of China’s innovation and IP policies have been perceived to be positive by foreign industry. Fifty-five percent of USCBC tech companies stated that China’s innovation promotion policies had a significant negative impact on sales to date, or had a significant negative impact on sales or operation. Also of note was that 75% of USCBC respondents indicated that they limited the products that they introduced into China because of IPR concerns. In addition, 37% of USCBC respondents indicated that China’s level of IPR enforcement limited R&D activities in China, as well as limited products co-manufactured or licensed in China. The Amcham China survey also noted that 83% of technology R&D intensive companies feel less welcome than before.

Aggressive Antimonopoly Enforcement of Concern to Foreign Companies

Eighty percent of USCBC respondents were concerned about antimonopoly law enforcement in China. Among the key substantive issues were: (a) lack of transparency in AML cases (55%), excessive focus on foreign companies (50%), lack of clarity on key criteria and definitions (49%), lack of due process (29%), and inability to have legal counsel (26%).

Rule of Law: Another Overarching Concern

One common thread amongst antimonopoly and IP concerns was rule of law. The EU Chamber Report contains the most information on desires of foreign companies for the Chinese government to improve the rule of law, with 39% of European businesses rating the Chinese government’s efforts in 2015 as “below expectations”, and rule of law perceived as the main driver of future economic growth by 78% of respondents. For Amcham China, 57% of respondents believed that inconsistent regulatory interpretation and unclear laws were their top business challenge in China. Legal reforms were identified as the top reform priority by Amcham Shanghai members.  USCBC respondents rated uneven enforcement of Chinese laws, as their number nine challenge, however companies reported that the problems are persistent and worsened in the last year.

Putting China in Context: Not All That Patents Is Innovative

There are other reports that have been released have recently been released that also place China in a comparative perspective. The Information Technology & Innovation Forum, for example, recently issued a report Contributors and Detractors: Ranking Countries’ Impact on Global Innovation, which ranked 56 nations on how much they contribute or detract from global innovation. China ranked 44, and was classified as an “innovation mercantilist” that “significantly balkanize[s] both global production and consumption markets” and has “generally weaker protection” for intellectual property than the global norm. However, China does perform better than “innovation follower” countries in contributing to the global innovation ecosystem, largely due to investments in STEM fields and high numbers of graduates in those areas. China ranked twenty eight out of fifty six in terms of contributions, and was among the top five detractors from global innovation, according to this report (behind Thailand but ahead of India, Argentina and Russia).

Thomson Reuters in its China’s IQ (Innovation Quotient) Report (December 2015) analyzed China patent filings. The IQ Report noted that citations of Chinese patents had increased. In data processing patents, China had forward citation data of 1.17 This was much less than the United States (6.72), but comparable to Japan (1.82), and Europe (1.31), and better than South Korea (.78). Interestingly, another Thomson Reuters report on the top 100 innovators (2015), declined to include a single Chinese company. Huawei did appear as a top innovator in 2014. Its antitrust adversary, InterDigital, was considered a top innovator in 2015.

Policy Outcomes

The USCBC’s Board of Directors recently outlined its priorities for the year, which included: strengthening IP enforcement, including deterrent civil and criminal remedies; improving enforcement against online infringements; strengthening trade secret protections; harmonize patent examination practices; reforming China’s system of innovation incentives (HNTE incentives/service inventions). Other USCBC recommendations in transparency, antimonopoly law, and ecommerce also have IP-related implications.

Summary

There may be a number of reasons for the repetition in these reports, including a common core of concerns, a focus on issues in the media and bilateral relations, and common membership among the organizations. The location and membership of each organization can still result in different perceptions. Moreover, certain rights, such as copyrights, tend to be of core concern to fewer industries some of which, such as the entertainment sector, may be less extensively invested in China. As such, the surveys reflect concerns and priorities, and may not necessarily represent researched approaches to resolving specific problems of concern to all American industries. The surveys may also not align well with China’s own surveys such as on software piracy, where China has offered a counter-survey that counts other incidences of piracy, or on satisfaction with China’s IP system. As for satisfaction at least, it is all subjective. In some cases, the survey data likely aligns well with other factual or empirical data, such as licensing revenues, damages in antimonopoly law cases, IP enforcement activity, etc.

Here’s what this survey of the surveys suggests to me:

  1. China’s IP laws are generally good and its enforcement is improving but still problematic.
  2. China has become deeply interested in patents and innovation, which will present important strategic opportunities over time.
  3. There remains a low level of confidence in trade secret protection in China, which can be a significant impediment to China’s innovative ecosystem.
  4. China’s innovation environment has become increasingly complex and nationalistic, leaving many foreign tech companies with a sense that they are less welcome.
  5. Reforms in the legal system and antitrust enforcement are a high priority.

The US Chamber will be issuing its latest International IP Index February 10 in Washington, DC. Let’s see how China stacks up there…

Any corrections or comments? Something I have missed? Please write us!