Antitrust Aspects of “Unfairly High Patent Pricing” for Licensing Transactions in China

This guest blog has been written by Prof. HAO Yuan of  Tsinghua University School of Law.

 China is facing a pressing need to build its innovation-driven economy. To facilitate key features of an innovative economy Chinese anti-monopoly authorities, along with their worldwide peers, face a daunting challenge of transition from a static regime to a more dynamic one.  Several recent judicial and administrative disputes, including Huawei v. IDC, Shenzhen Intermediate People’s Court, Shen Zhong Fa Zhi Min Chu Zi No. 857 (2011); Huawei v. IDC, Guangdong High People’s Court, Yue Gao Fa Min San Zhong Zi No. 306 (2013); and the NDRC’s administrative investigation against Qualcomm, Administrative Penalty Decision [2015] No. 1, point out the need to better understand the IP and antitrust intersection, particularly with regard to controversial issues such as  “unfairly high patent pricing (不合理专利高价)”.   This blog summarizes my recent paper (available on SSRN) which addresses this important issue (upcoming 2020 in GRUR International (Journal of European and International IP Law)).

Chinese Anti-Monopoly Law (“AML”), in contrast to US law but not facially dissimilar to EU competition law, pays substantial attention to a dominant market player’s unilateral “exploitative” conduct. Specifically, section 17(1) of the AML (2008) forbids a dominant undertaking from “abusing its market position” by selling at “unfairly high prices”. However, neither the Law nor later enacted Judicial Interpretations clearly define “unfairly high price” in the anti-monopoly sense. Correspondingly, courts and enforcement agencies have significant discretion in characterizing a market price as “unfairly high”, thereby potentially exposing an undertaking to harsh penalties.

Despite perhaps a legitimate institutional intention, this ex post legal risk of being found “unfairly high” could seriously curtail business entities’ ex ante incentive to innovate in China. Meanwhile, lacking adequate legal and economic guidance, this institutional discretion would likely result in significant error costs. Such costs are likely to be even more severe in the context of patent-intensive industries, particularly those in China’s burgeoning high-tech sector.

Section 55 of the AML arguably provides an IP “safety harbor”, providing that a proper exercise of IPR shall be immune from the AML scrutiny, while “an abuse of IPR, excluding or restricting on competition” shall not. As pointed out elsewhere on this website, this provision remains essentially unchanged in a recently proposed revisions to the AML.

Despite this statutory framework, recent cases indicate that the IPR immunity approach has been largely ignored in practice. In the 2011 Huawei v. IDC action, both courts found IDC’s patent pricing to be “unfairly high” primarily on three grounds: one, the licensing royalties IDC offered to Huawei were “apparently higher” than “comparable licenses”, i.e. those royalties IDC charged other companies previously (though whether these licenses were truly comparable with licenses made to Apple, Samsung and others was worthy of serious discussion); two, “IDC’s act of charging unfairly high licensing fee to Huawei, will force Huawei to either quit the competition in the relevant end product market, or accept the unfair pricing conditions, which will render Huawei to increased costs and decreased profits in the relevant end product market, directly restricting its capability to compete”; and three, IDC required Huawei to give global patent grant-backs on a royalty-free basis, an arguable violation of both the Antimonopoly Law and the then-existing Administration of Technology Import/Export Regulations,. Similarly in the Decision against Qualcomm, the NDRC also disregarded Section 55 immunity, finding that Qualcomm’s licensing conditions were “unfairly high” due to these three factors: charging a flat fee for an ever-changing patent portfolio without proving the replenished patents are of equal value to expired ones; coercion for free grant-backs; and using the entire end product as royalty base. So far, Huawei v. IDC and Qualcomm have been the only two completed Chinese cases that entailed an extensive “unfairly high patent pricing” analysis.  Other currently ongoing cases include Iwncomm v. Apple (Beijing IP Court), Huawei v. Panoptics (Shenzhen Intermediate People’s Court), Xiaomi v. Sisvel (Beijing IP Court), and the anti-monopoly investigation by SAMR (China’s AML administrative enforcement authority) against Ericsson’s 3G/4G SEP licensing practices, etc..

It is true that both IDC and Qualcomm involved SEPs and  arguably an extra layer of FRAND commitment needs consideration, which may require additional law and policy analysis. For example, the courts might have looked to how to interpret FRAND in Chinese legal framework – is it a specific commitment to a SSO, or a general “principle (原则)” imposable by loosely grounded policy arguments? Will this FRAND interpretation affect an SEP holder’s anti-monopoly obligations in China?  And if so, how? Nevertheless, to a large extent these cases still reflected a practical departure from the statutory IPR immunity framework approach under Chinese law. Such an aggressive approach has also been reflected in Section 14 of the Anti-Monopoly Guidelines for IP Abuse (Draft for Comment 2017) as published by the Anti-Monopoly Commission of State Council. (Editors note: see the comments of the American Bar Association, as well as earlier drafts by enforcement agencies here). According to this rule-of-reason framework, “Business entities that enjoy dominant market positions may abuse their dominance by licensing intellectual property at unfairly high prices, excluding or restricting competition; while assessing whether such high pricing constitutes abuse of dominant market position, the following factors may be considered: (i) calculation method of license royalty, as well as the IP’s contribution to the value of goods; (ii) the business entity’s undertaking with regard to the IP licensing; (iii) the license history or comparable license standards; (iv) license conditions that may have led to unfairly high pricing, including territorial or product scope restrictions; and (v) whether a portfolio licensing includes expired or invalid IP”.

This laundry-list framework is not administrable. How these factors play out in a specific case, whether and how they would interact with each other, how much weight should be attached to each and every one of them, how to incorporate the pro-efficiency features into consideration … all these important practical questions remain unanswered. Facing such vague rules, patentees and other relevant market players would find it very hard to ascertain legal compliance. Vague rules combined with the high stakes often entailed in antitrust cases may lead to rent seeking and bad precedents, further upsetting a prior well-functioning market system, and harming market players’ confidence to  continuously invest in innovation.

One critical reason for this stark departure between the Law and enforcement may be the lack of an administrable test to differentiate “proper exercise” of patent right from “abuse”. Ambiguity lies in at least two aspects. First, due to the very mechanisms of patent regime in fostering innovation, even a proper exercise of right would necessarily restrict certain market competitions. Thus, it seems that an over-general standard of whether “to eliminate or restrict competition” cannot work as the ultimate test to differentiate abuse from legitimate exercise. Second, despite extensive use of “patent abuse” in the past decades worldwide, the exact contour of this concept remains elusive. Resorting solely to the various definitions and constructions in comparative law of sister jurisdictions, helpful as it is, would not solve these ambiguities adequately.

Mark Cohen, the editor of this blog, has also noted that one little-referenced basis for resolving the distinction between “proper exercise” and “abuse” is in fact found in Article 40 of the TRIPS Agreement, which creates a similarly vague dichotomy in permitting WTO members to provide remedies for abusive licensing practices.  Article 40 authorizes member states to address “licensing practices or conditions that may in particular cases constitute an abuse of intellectual property rights having an adverse effect on competition in the relevant market.”   Article 40 also permits member states to control mandatory grant backs of the type address in Huawei v. IDC.  The ambiguities in China’s AML and TIER may in no small part be due to the ambiguities within Article 40 itself, which may have been an important resource for the drafting of Article 55 of the AML.  Furthermore, as Prof. Cohen has separately noted, the legislative history of  Article 55 suggests that it was intended to provide greater assurance that enforcement of IP rights would not by themselves violate the AML, see Harris et al, Antimonopoly Law and Practice in China (2011), at 55. Prof. Cohen’s latter point was well proved in the little referenced, but authoritative, Statute Interpretation and Legislative Reasoning of the Anti-Monopoly Law (hereinafter “Statute Interpretation”) (published by the Legislative Work Commission of the NPC), which noted that, “To restrict competition by the exercise of IP right, is permitted by law after its balance of distinctive interests; in other words, certain restrictions must be imposed on competition to further technological innovation and improve competitive capability. Thus, monopoly status resulting from IP right as well as the restriction on competition because of the exercise of IP right, are legal acts based upon the legal authorization. Other jurisdictions generally treat the legal exercise of IP right as an exception to the application of antitrust laws” ; but on the other hand,  “[I]f an IP right holder abuses its right by exceeding the scope of exclusive right, in acquiring or strengthening a monopoly position, such act will not be protected, and if it excludes or restricts competition, the AML shall govern here.”

Though not a binding document in itself,  the Statute Interpretation can work as a useful guidance, since it embodied important legislative intents and reasoning at the time, particularly when no other legislative reports are accessible to the public. Therefore, to assess “unfairly high patent pricing”, a crucial question is whether the alleged excessive pricing act falls within the scope authorized by patent law. If the answer is positive, then even if this “excessive” pricing would restrict certain competition in the relevant market, such static efficiency loss is a necessary cost we deliberately pay for sustainable innovation, i.e. section 55 immunity applies. If and only if on the other hand, the alleged pricing has been proved to exceed the legally authorized scope of such patent, section 55 immunity will then be stripped and the high pricing act will be examined under section 17(1) of the AML. In other words, to be stripped of the IP clause immunity and subject to “unfairly high patent pricing” scrutiny under the AML lens, the alleged pricing must be not only excessive enough to exclude competition, but also in a way that departed from what patent law has originally contemplated.

Economic insights into the patent law jurisprudence of various jurisdictions, including China, US and EU, reveal that despite some rather subtle differences, all patent regimes promote innovation essentially through the instigation of dynamic competition. Specifically, the patent regime (1) bridges an innovator’s technological R&D to market demand: the better aligned a new technology is to consumer needs, the more valuable this “shell” of exclusive right would be in the marketplace, resulting in higher profit an innovator can harvest by excluding her imitating competitors (“competition by imitation” or “CBI”).  In addition, the patent regime enables innovators to signal potential “innocent” imitators utilizing mechanisms such as disclosure requirements, thereby reducing the amount of duplicative investment in innovation. See Edmund W. Kitch, The Nature and Function of the Patent System, Journal of Law and Economics, Vol. 20, No. 2 at 278; (2) with some caveats addressed in my full paper, by restricting CBI with reasonably tailored claims of the patent right coupled with disclosure requirements, the patent regime simultaneously induces social resources into “inventing around” activities, i.e. to provide better/cheaper substituting technologies, thereby encouraging competition by substitution (“CBS”).    In certain circumstances, the fruits of such CBS  may also be protectable with a new property (patent) right. For example, if a competitor’s “inventing around” technology is found sufficiently “inventive” or “non-obvious”, it would likely be entitled to a patent in itself.  See Robert P. Merges, Intellectual Property Rights and Bargaining Breakdown: The Case of Blocking Patents, 62 Tenn. L. Rev. 75 (1994); and (3) feeling the pressure of CBS, the earlier patentee/innovator would likely be incentivized to keep on her next run of “inventing around”, striving to stay a winner in the marketplace. In this way, a virtuous circle of dynamic competition could come into force.

On the other hand, a brief comb-through of the economic foundations and jurisprudential development of antitrust law suggests that this regime promotes innovation essentially through efforts to maintain an (optimally) heterogeneous competition ecosystem. Based on an understanding of both innovation-facilitating mechanisms, two insights are worthy of note here. First, a mutual ground shared by both patent and antitrust regimes in their disparate routes to innovation is the common facilitation of dynamic competition. And correspondingly, Chinese anti-monopoly law should respect the very patent mechanism, i.e. the instigation of dynamic competition, which pivots on the CBS precisely through efforts including a restriction upon CBI. Therefore, to put it in practical terms, if an alleged act at the intersection with anti-monopoly law, such as an accusation of “excessive” pricing, merely caused a restriction on CBI   as indicated in supra-competitive profits, AML must refrain from intervening. In other words, AML should not lightly disturb a well-functioning circle of dynamic competition, simply because under its lens CBI  or static efficiency seems restricted in a link, and local optimum seems not achieved – as a result, a supra-competitive profit enjoyed by a patentee should be found legal per se if static efficiency loss is the only proven harm. More importantly, the focus should be instead on whether the questioned act would not only restrict competition, but also in a way that departed from what the patent regime has contemplated, i.e. the restriction is to dynamic competition or CBS itself. As an example of the latter scenario, consider a joint agreement between two patentees owning substituting technologies or a patent pool consisting of competing technologies, with the patentees or pool members consenting to suppression of one technology in promotion of another (others).

Coming back to the context of patent pricing, is it possible for a high pricing to restrict dynamic competition, thereby constituting an abuse under the anti-monopoly lens? Maybe yes in theory. Arguably in exceptional circumstances, certain pricing may be so excessively structured to actually constitute a refusal to subsequent or follow-on innovators, or at least a significant “margin squeeze” for them, and such refusal or squeeze in theory may lead to foreclosure of the CBS itself or competition in downstream markets, thus frustrating the circle of dynamic competition.. A little more discussion on the interaction of patent and market competition may help here. In a nutshell, from the perspective of a patent law student, there often exist three tiers of market competition. Tier I is vanilla CBI, referring to those competing technologies with mere replication or insubstantial changes, the only advantage of which are their lower prices (mostly by saving duplicating R&D costs). Of course, CBI can be efficient and legal in those circumstances where patentee grants a license, but in most other cases, CBI is legitimately excludable under patent law and antitrust shall never interfere. Tier II, competition by improvement, is really a higher level of CBI, in that competing technologies here involve substantial improvements on the patented technology, though still falling into the scope of earlier claims. Note a caveat here – patent law is clever enough to give certain leeway to those competitors with own substantial improvement, for example by granting a new patent right if the improvement has been found to be “inventive” or “non-obvious”, so that these competitors would have stronger bargaining power to negotiate with the original patentee and harvest higher profits from the pair of sequential innovation. This power and resulting profit would further incentivize competitors to do follow-on improvements. This is actually the scenario of blocking patents. Generally speaking, the second tier only applies to those industries that are characterized with cumulative innovation. Despite the substantial improvements, Tier II is still legitimately excludable under patent law and antitrust shall not interfere. Tier III is CBS, referring to those technologies that are capable of truly substituting the earlier patented technology to fulfill consumer needs in the market. By their very name, in most circumstances Tier III is comprised of “inventing around” technologies that do not fall into the protected scope of earlier patent, thus there exists no serious risk of being excluded by the earlier patentee unilaterally. The theoretical worry can happen however, at the rare circumstance of tier II and III intersection: occasionally an infringing improvement could be so radical that it would truly substitute the commercialized earlier patent as a break-through technology.   A real-world example here is the long deadlock between the famous Marconi diode patent and the Lee De Forest triode patent during the early development years of radio technology. This kind of radical improvement, even though literally infringing on the pioneer patent, is precisely the type of “creative destruction” Schumpeter emphasized many years ago that fuels innovation in a most powerful way – an innovator’s descendants can actually become the instruments of his destruction, yet the society benefits in the long run.

Following this train of thought, if we temporarily leave the “unfairly high patent pricing” context and turn  to some of the classical NIE (New Institutional Economics) scholarly works in a more general sense, including the conventional hypothesis of patent “anti-commons” (Heller and Eisenberg 1998), worry of over-broad pioneer patents’ suppressing effect on follow-on innovation (Merges and Nelson 1990), and recent conjecture of patent hold-up and royalty stacking in the SEP context (Shapiro and Lemley 2007), arguably they all may be considered as embodying (more or less) such theoretical worries of patent foreclosure on dynamic competition.

Inspiring as these theories were, they, need to be tested in practice.  Curiously, decades of empirical research in various industries have showed little success in proving these theoretical worries happening in the real marketplace, at least on a macroscopic level. A specific concurrent example for this striking disintegration between theory and empirical results is the robust innovation and significant consumer benefits (as indicated in quality-adjusted prices) in the SEP intensive wireless communication industry, in the shadow of persistent “patent hold up and royalty stacking” predictions. See Alexander Galetovic, Stephen Haber & Ross Levine, An Empirical Examination of Patent Holdup, Journal of Competition Law & Economics 11(3) (Aug. 2015); Jonathan Barnett, Antitrust Overreach: Undoing Cooperative Standardization in the Digital Economy, 25 Mich. Telecomm. & Tech. L. Rev. 163 (2019). There might be different explanations to this empirical difference. I give a rough quantitative analysis in my paper why the seemingly plausible theoretical worry of dynamic competition foreclosure is unlikely to happen in practice.  In addition, I argue that perhaps precisely because CBS  has always been a critical link pivoted by patent regime in its instigation of dynamic competition, throughout ages patent law has developed an implicit yet critical awareness to safeguard CBS from being foreclosed per se. This implicit awareness has been built into a wide variety of rules and principles of patent jurisprudence prevalent in many jurisdictions, such as the eligibility doctrine, inventiveness/non-obviousness and disclosure/enablement requirements in the granting phase, all-element rule and reverse doctrine of equivalents in infringement assessment phase, as well as in deeper principles underlying and threading these specific rules together. A good example for the latter is the proportionality principle well illustrated by Prof. Merges in his Justifying Intellectual Property (Chap. 6, 2011).  Surely these built-in mechanisms are not ironclad, but they may have worked in a more successful way than we give faith to, and the AML  should not overlook it.

Based on the above, I further propose that a patentee’s unilateral pricing act should be generally found legal per se in China; or at the very least, presumed legal under section 55 of the AML unless an agency/plaintiff can prove otherwise – that the alleged pricing constitutes an “abuse” in that it would disrupt dynamic competition. Specifically, a patentee’s unilateral pricing act should be immune from the “unfairly high pricing” scrutiny under Section 17(a) of the AML, unless an anti-monopoly plaintiff or enforcement agency can overcome all three following hurdles with concrete evidence, in addition to a persuading economic analysis: (i) the patentee enjoys a real dominant market position; (ii) such pricing constitutes a de facto refusal to deal, and (iii) the refusal would likely foreclose the very type of competition patent law has aimed to promote, i.e. dynamic competition. More specifically, the harm to dynamic competition can be proven in either one of the following two dimensions: i. In the same market of patented technology, a monopolist patentee’s constructive refusal to license would render radical all follow-on substitutes impossible to be developed (restriction on competition by substitution); or ii. In the circumstances of a vertically integrated monopolist patentee, the constructive refusal to license would foreclose the competition or subsequent innovation in downstream markets in which the patentee also competes.

True this burden seems high, but it is justified by three cumulative resources, (i) the above economic insights into the intersection of patent and antitrust; (ii) the prevalent non-interventionist attitude toward “excessive patent pricing” in sister jurisdictions; and (iii) the inevitable limitations of antitrust law, manifested in the error costs due to lack of proper information and economic analysis methodologies on dynamic efficiency. See Frank H. Easterbrook, The Limits of Antitrust, 63 Tex. L. Rev. 1 (1984).

Despite existence of formal empowerments in some countries/regions, almost all jurisdictions with well-developed antitrust jurisprudence have exercised a very cautious attitude in condemning a market price as “unfairly high” in practice. Section 17(1) of the AML does not have a counterpart in conventional US antitrust jurisprudence, and despite the existence of a theoretical counterpart in EU (Art. 102(a) TFEU), it has been rarely invoked. When it comes to patent pricing, the EC has been taking a virtually non-interventionist approach. This non-interventionist approach may have originated from the Commission’s awareness that many general objections against exploitative excessive pricing actions, such as the danger of undermining investment incentives of new entrants as well as dominant firms, difficulty in assessing “excessiveness”, risk of improper price regulation, and undue space for political rent seeking etc., are particularly true in the context of patent-intensive innovative industries.

Antitrust is costly. As Judge Easterbrook pointed out many years ago, in reality judges and enforcement officials are always equipped with imperfect information about actual effects of the accused practice, and such costs of information and their corresponding actions are the limits of antitrust. Part of these costs comes from the judicial ignorance and inhospitality against business practices. Very often, if a poor defendant in an antitrust case cannot convince the judge that his practices promote competition, he is doomed. Unfortunately, “the gale of creative destruction produces victims before it produces economic theories and proof of what is beneficial.” Consequently, this unfortunate judicial inhospitality and ignorance would inevitably generate substantial positive costs in practice.

During the transition from  a planned regime to market economy, China needs to overcome all kinds of obstacles, ranging from formal restraints in laws and institutional infrastructure, to lingering outdated theories and prejudice that die hard and can still be quite powerful impeding the progress. On an institutional level for example, varied degrees of inertia may unavoidably exist on anti-monopoly agencies’ enforcement philosophy, especially when it comes to high pricing acts that seem to harm consumer interest (albeit short-term) on its face, and which had long been the subject of pervasive regulation through local pricing bureaus, even prior to the existence of the antimonopoly law.  In view of this potential institutional inertia, the likelihood of inhospitality a monopolist patentee, domestic or international, encounters in “unfairly high pricing” cases could be substantial.

Antitrust has two major analysis modes: per se rule and the rule of reason. If equipped with thorough information of market practices and perfect analysis methodologies, rule of reason is the route to precision and ultimate truth. Unfortunately, as discussed above, that is not the case in reality. One may contend that during the several decades after Judge Easterbrook’s seminal writing, rapid development of economic theories have provided more substantial guidance in many areas, but I am still reluctant to say that the improvement has been so significant to render his insight obsolete, particularly in context of dynamic efficiency and IP related issues. As such, an ambitious rule-of-reason framework as embodied in Section 14 of the Anti-monopoly Guidelines for IP Abuse, would inevitably generate significant error costs despite its good-willed intention.

Admittedly, our presumed legal per se framework is not cost-free. It may be conceivable that in exceptional circumstances, a monopolist patentee’s excessive pricing would disturb dynamic efficiency yet escape the law because the plaintiff simply cannot meet the high burden. On a systematic level however, I believe this possible negative error would be at least offset by the significant positive error costs avoided. A per se rule has always been used to condemn (or excuse) whole categories of practices, even though some of them are actually beneficial (or evil), and one cannot have the savings of decision by a particular rule without accepting its cost of errors.  When we choose which analysis mode to go, what really matters is the overall probability. In summary, we presume patent pricing to be legal per se, because both economic insights and comparative law already showed us that the happening chance of a real exclusionary excessive patent pricing would be extremely low (roughly estimated to be 1/100,000 – 1/100M in the paper), and partially confirmed by empirical studies so far. The exact reasons can be further explored, but the bottom line is clear – it seems that in a vast majority of circumstances, again the market mechanism coupled with strong patent protection has been functioning adequately well to facilitate innovation. Facing this extremely low probability of real foreclosure on dynamic competition, it would be unwise in every individual case to incur enormous administrative and error costs only to search a mere possibility. In a brief conclusion, if either way we are destined to make mistakes, we naturally choose the side with less cost.

In contrast to private law, anti-monopoly law is a much stronger form of interference with the market by government. Perhaps too many people today have omitted this (not only in China) – a blunt instrument as it is, antitrust law acquires legitimacy only in a minority of cases where market failure really happens, rather than a mere theoretical possibility. “The history of Chinese economic reform has clearly told us, whenever a market-oriented policy became dominant and market mechanisms were more frequently used to allocate resources, the quality and speed of Chinese economic development was better.”  Wu Jinglian, The Economic Development of China (The Great Encyclopedia Press 2018), at p. 3 (translation is my own). On the contrary, every time Chinese economic policy was influenced by the theories of planned economy, “both macroeconomic risks and microeconomic interests were affected deleteriously… … Therefore, to resolve the many problems we are confronted with during the economic reform process of China, the only answer is to insist and deepen our reform centering upon the confidence on market economy and rule of law, and further use the market mechanism to allocate resources; it should never be the pursuit of more state interferences.” Id. When stepping into the deep water of reform today, China should learn its historical lesson and be especially cautious with those legal instruments that potentially interfere with price mechanisms, the core feature of a market economy.

The author wishes to thank Hon. David Kappos, Prof. Robert Merges, Chief Judge Randall R. Rader (retired), and Prof. Mark Cohen for their editorial suggestions.  The opinions expressed herein are the author’s own.

 

 

Draft Civil Code Technology Contract Law Available for Comment

The NPC has released a draft of the contract chapter of the draft civil code for public comment. According to the NPC Observer, this is the first draft of the entire Civil Code with the final round scheduled for consideration as early as March 2020.  Comments are being accepted by the NPC through January 26, 2020.  According to the NPC Observer the contracts section of the draft had previously been separately published in December 2018.  This blog considers the differences between the contract law provisions and the current draft, as well as the relationship of the draft entire civil code with other legislative changes involving technology contracts.

Chapter 20 of the contract chapter deals with technology contracts. Based on a quick read, several provisions are directed to long-standing concerns, such as ownership of service invention compensation, ownership of improvements (grant backs), indemnities from infringement, and the relationship of contract regulation to China’s Antimonopoly Law and the recently amended Technology Import Export Regulations (TIER).

Some Key Substantive Provisions

Articles 847 and 848 deleted from the prior draft the part  (Arts. 622, 633) that addressed mandatory service invention (employee inventor) compensation, which proposed that “[a] legal person or an unincorporated organization shall extract a certain percentage [emphasis supplied] from the proceeds obtained from the use and transfer of the service technical achievements and award or reward individuals who have completed the service technical achievements.” The draft law thereby appears to carry forward the ambiguity and debate regarding what amount of compensation is required, if any, in addition to salary and other benefits.  This had also been a focus of previous bilateral discussions.

第八百四十七条 职务技术成果的使用权、转让权属于法人或者非法人组织的,法人或者非法人组织可以就该项职务技术成果订立技术合同。法人或者非法人组织订立技术合同转让职务技术成果时,职务技术成果的完成人享有以同等条件优先受让的权利。职务技术成果是执行法人或者非法人组织的工作任务,或者主要是利用法人或者非法人组织的物质技术条件所完成的技术成果。

第八百四十八条 非职务技术成果的使用权、转让权属于完成技术成果的个人,完成技术成果的个人可以就该项非职务技术成果订立技术合同。

Article 847 Where the right to use or transfer a service technical achievement belongs to a legal person or an unincorporated organization, the legal person or unincorporated organization may conclude a technical contract for the service technical achievement. When a legal person or an unincorporated organization concludes a technology contract to transfer service technology achievements, the person who completed the service technology achievements has the right to receive priority transfer on equal terms. The service technical results are the technical results of performing the work tasks of a legal person or an unincorporated organization or mainly using the material and technical conditions of a legal person or an unincorporated organization.

Article 848 The right to use or transfer a non-service technical achievement belongs to the individual who completed the technology achievement, and the individual who completed the technology achievement may conclude a technology contract for the non-service technological achievement.

Articles 849 and 875 addresses ownership of improvements, providing further detail on the implications of the removal of Article 27 in the recently revised Administration of Technology Import Export Regulations (TIER). This provision also supports freedom of contract, by providing that the improving party owns the improvements unless the parties stipulate otherwise.  Article

第八百七十五条 当事人可以按照互利的原则,在合同中约定实施专利、使用技术秘密后续改进的技术成果的分享办法;没有约定或者约定不明确,依照本法第五百一十条的规定仍不能确定的,一方后续改进的技术成果,其他各方无权分享。

Article 875 The parties may agree in the contract in accordance with the principle of mutual benefit and determine how to share the technical results of implementing patents and using technological secrets for subsequent improvements; if there is no agreement or the agreement is not clear, and it is still uncertain according to the provisions of Article 510 of this Law 【regarding  supplemental contractual language】 then the technical results of subsequent improvement by one party shall not be shared by the other parties.

Article 874 also supports freedom of contract by providing for a default but negotiable indemnity against third party infringements or torts.   This language is consistent with the revised Art. 24 of the TIER

第八百七十四条 受让人或者被许可人按照约定实施专利、使用技术秘密侵害他人合法权益的,由让与人或者许可人承担责任,但是当事人另有约定的除外。

Article 874 Where the assignee or the licensee implements a patent or uses proprietary technology to infringe upon the legal rights and interests of others, the assignor or the licensor shall be held liable unless the parties agree otherwise.

Relationship with Other Laws

As indicated, the draft law must also be read in conjunction with the revised TIER and other laws and regulations.  As a higher level, more recent legislation, the Civil Code language would generally be more authoritative than the TIER in the event of any conflict.  Among the provisions that reference other laws and regulations is Article 877 which provides that these other laws and regulations shall normally govern.  Moreover, Article 877 does not expressly restrict the Civil Code from “gap-filling” these other laws and regulations.  It may thereby perpetuate the possibility of government intervention through its vague language such as “mutual benefit”, “monopolize technology”,  “hindering technological development”, ‘infringing technological achievements”, etc.

第八百七十七条 法律、行政法规对技术进出口合同或者专利、专利申请合同另有规定的,依照其规定。

Article 877 If there are laws and administrative regulations on technology import and export contracts or contracts for patents or patent applications, such provisions shall be followed.

The draft law also contains vague references to competition and antimonopoly law.  Article 850 contains identical language to Article 329 of the Contract Law, and Article 864 is nearly identical to Article 343 of the Contract Law:

第八百五十条 非法垄断技术、妨碍技术进步或者侵害他人技术成果的技术合同无效。

Article 850 A technology contract that illegally monopolizes technology, hinders technological progress, or infringes on the technological achievements of others is invalid.

第八百六十四条 技术转让合同和技术许可合同可以约定实施专利或者使用技术秘密的范围,但是不得限制技术竞争和技术发展。

Article 864 A technology transfer contract and a technology license contract may stipulate the scope of patent implementation or use of technology secrets, but they shall not restrict technology competition and technology development.

As with the prior Contract Law and TIER, the law does not clarify the difference between a covenant not to sue or a settlement of an infringement lawsuit on the one hand, and a patent license agreement.  Lawyers drafting such settlement agreements may wish to ensure that default provisions of the Civil Law, such as those regarding indemnities and ownership of improvements do not come into play.

These provisions also further underscore the importance of thorough monitoring of changes on technology transfer, including the TIER, particularly as operational implementation by the courts and administrative agencies, through cases, judicial interpretations, and rule making,  may now be more significant than legislative changes.

In addition to these revisions to China’s contract law in the proposed Civil Code, an Export Control Law has also been released for public comment by the NPC.  The draft law sets up a general export control system and specifically regulates both technologies and services (Art. 2).  Comments are also due January 26, 2020.

Happy New Year to all!

Note: all translations are based on machine translations with minor editing and are not intended to be authoritative.  Please provide any corrections or suggestions on these translations or any additional commentary to the author.  This blog was revised on March 23, 2020 with the assistance of Dr. Xu Xiaofan.

Foreign Investment Law Implementing Regs Open For Public Comment: Administrative and Punitive Enforcement Ascends Again

The Ministry of Justice had published a draft of the Foreign Investment Law Implementing Regulations for public comment.  Chinalawtranslate has prepared an English translation of the proposed regulations and of the law itself.   The due date for submitting comments is December 1.  The US-China Business Council has graciously already made its comments available in English and Chinese to the public.  The Foreign Investment Law was one of several laws enacted earlier in 2019 that appear to be responsive to US concerns and pressure.

The primary provisions addressing IP are Articles 24 and 25, which state:

Article 24: The state is to establish a punitive compensation system for violations of intellectual property rights, promote the establishment of rapid collaborative protection mechanisms for intellectual property rights, complete diversified dispute resolution mechanisms for intellectual property rights disputes and mechanisms for assistance in protecting intellectual property rights, to increase the force of protections for foreign investors’ and foreign-invested enterprises’ intellectual property rights.

The intellectual property rights of foreign investors and foreign-invested enterprises shall be equally protected in the drafting of standards in accordance with law, and where foreign investors’ or foreign-invested enterprises’ patents are involved, it shall be handled in accordance with the relevant management provisions of state standards involving patents.

Article 25: Administrative organs and their staffs must not use the performance of administrative management duties such as handling registration, approvals or filings for investment projects, and administrative permits, as well as implementing oversight inspections, administrative punishments, or administrative compulsion, to compel or covertly compel foreign investors or foreign-invested enterprises to transfer technology.

(chinalawtranslate translation).

The language in the first paragraph of Article 24 appears to track trade war pressures, including demands for punitive compensation.   As I have argued repeatedly, a better focus might be on deterrent civil damages, and/or the basic structure set forth in the WTO of having adequate and effective civil remedies with criminal remedies as an adjunct for willful, commercial-scale harm.  In this scheme, there is little place for administrative remedies, as was noted in DS362 (the IP enforcement case at the WTO).  The WTO panel, in that case, noted that “neither party [the US nor China] to the dispute argues that administrative enforcement may fulfil the obligations on criminal procedures and remedies set out in Article 61 of the TRIPS Agreement. Therefore, the Panel does not consider this issue.”  There have also been numerous academic studies on the challenges of creating a sui generis administrative IP enforcement system in China.  The language in Article 24 is also highly repetitive of the November 21, 2018 special Memorandum of Understanding/campaign mechanisms involving 38 government agencies to address six types of faithless IP conduct, about which I previously blogged.

What is notably absent from these commitments is an obligation to increase transparency, which is especially concerning due to an apparent slowdown in the publication of foreign IP-related court cases since the trade war began.   I will be blogging more about this soon, but here is what the decline in published US cases looks like based on IPHouse data, with a flatlining since January 1, 2018:

iphouse

See also my slides from the recent Berkeley transnational IP litigation conference available here.

The language regarding standards in the second paragraph repeats long-standing concerns about foreigners being excluded from standards-setting processes, as was addressed in the 2015 JCCT.  It does not set forth commitments about fairness or equal treatment which have been raised before in industrial policy drafting (as was addressed in the 26th JCCT on semiconductor policy), antitrust investigations, patent prosecution or litigation (for which there is a wealth of empirical data).

Article 25 also appears trade responsive.  It would be useful at this time to determine the current magnitude of forced technology transfer in foreign direct investment, and to determine how it subsists and whether it has measurably decreased since the trade war began, including whether legitimate licensing transactions have stepped in to provide increased revenue for technology licensors as a result of these and other reforms, including revision of the Administration of Technology Import/Export Regulations.

 

 

 

Upcoming Events – Early November

On the calendar:

Philadelphia friends: I will be at U Penn on November 12, speaking from 4:30 – 6:30 with Zhou Hanhua (CASS) and Samm Sacks, (New America) on technology issues in US-China relations.

Other events:

On Wednesday November 6, I will be speaking with Philip Rogers on supply chain disruption and strategies at the sourcing summit  in San Francisco (6:15-7:00 PM) with Greg Fisher of the Berkeley Sourcing Group.  The topic is supply chain disruption and counter-strategies.

On November 13, I will be speaking at the IP Dealmakers Forum in New York City with Jamie Simpson, Chief Counsel, House Judiciary Subcommittee on Courts, IP, and the Internet and  Malathi Nayak, Reporter, Bloomberg Law (moderator).  The topic is “Patent Policy Update: US and Beyond”.

Looking forward to catchup and engaging with my panels and the audience!

Licensing IP In a Changing Trade Environment

 

This first part of my two-part article, Licensing IP in a Changing Trade Environment first appeared in Intellectual Asset Management  (IAM) issue 97, published by Globe Business Media Group – IP Division. To view the issue in full, please go to IAM Media

The second part of the article on how a changing geopolitical climate is affecting IP licensing is expected in IAM issue 98.

The 600 Billion Dollar China IP Echo Chamber

“Most people use statistics the way a drunkard uses a lamp post, more for support than illumination.”  Mark Twain

What are the losses due to “IP Theft” from China? On a recent trip to Washington, DC, I heard the range of $300 billion to $600 billion repeated from various sources without any critical gloss. These numbers have taken on a greater legitimacy than they likely deserve, in terms of capturing the scope of US concerns, the magnitude of the loss and shaping the Trump administration’s unilateral retaliation.

The 2017 and 2013 reports from the Commission on the Theft of American Intellectual Property (the “Commission”) appear to be the origin of much of this data.  The data was also referred to in the Section 301 Report (p. 8) and in a subsequent White House report “How China’s Economic Aggression Threatens the Technologies and Intellectual Property of the United States and the World” (June 2018).

In 2017, the Commission found that “Chinese theft of American IP currently costs between $225 billion and $600 billion annually.” The Commission pulled together different sources of data, including sales of counterfeit and pirated goods ($29 billion), and that “the value of software pirated in 2015 alone exceeded $52 billion worldwide.” The Commission further noted that there was “a paucity of reliable data on the economic costs of patent infringement” and that American companies were most likely the leading victims of this “IP Theft.”  It estimated losses of at least 0.1% of the $18 trillion U.S. GDP.

The largest single loss contributor to the Commission’s estimate was based on data provided by create.org and later repeated by the White House, that trade secret theft cost between 1% and 3% of US GDP, and totaled between $180 billion and $540 billion.  One critic (Stephen S. Roach) of these loss figures recently noted that “the figures rest on flimsy evidence derived from dubious ‘proxy modeling’ that attempts to value stolen trade secrets via nefarious activities such as narcotics trafficking, corruption, occupational fraud, and illicit financial flows. The Chinese piece of this alleged theft comes from US Customs and Border Patrol data, which reported $1.35 billion in seizures of total counterfeit and pirated goods back in 2015.”  One area of overlapping concern I have with Mr. Roach is the use of Customs seizure data to justify allocating as much of 87% of global “IP Theft” to China. Seizures by US Customs of Chinese originating counterfeit and pirated goods are as high as 87% of global totals. However, this does not mean that China is the source of 87% of the world’s production of these goods, nor does it address trade secret infringement or patent infringement origination. See The 2017 Commission Report at p. 3.  Misunderstanding about the utility of Customs data contributes greatly to the weaknesses of many IP infringement loss estimates.

The 2013 Commission Report noted that “it is safe to say that dollar losses from IP theft are hundreds of billions per year, which is at least in the range of total exports to Asia in 2012 (valued at $320 billion).” This report pulled together several sources, including OECD data that estimated global trade in counterfeit and pirated goods as $200 billion in 2005 (p. 25).  All the studies to date, including this 2013 Report, have recognized the difficulties inherent in doing accurate loss estimations, although many have also not distanced themselves from sources, such as the OECD 2005 data which had not stood the test of time.

Remarkably, the loss data itself has been relatively consistent over approximately two decades despite different methodologies and varying definitions of what constitutes “IP Theft”. During my tenure at the US Embassy (2004-2008), the typical guestimate was $200 billion to $250 billion per year.  These guestimates enjoyed wide currency in Washington.  For example, Congressional Reports, such as H.R. 110-617 “Prioritizing Resources and Organization for Intellectual Property Act of 2008” stated: “[I]ncreasing intellectual property theft in the United States and globally threatens the future economic prosperity of our nation. Conservative estimates indicate that the United States economy loses between $200 and $250 billion per year, and has lost 750,000 jobs, due to intellectual property theft.”  This data was typically based on counterfeit and pirated goods “compris[ing] six to nine percent of all world trade, the bulk of which violates the intellectual property rights of United States businesses and entrepreneurs.”  (Id.). Six to nine percent, however, easily gets rounded up to 10 percent, as Congressman Donnelly from Indiana noted at about the same time:

“It is estimated that these [counterfeit] products comprise almost 10 percent of world trade, that they are costing American companies nearly $250 billion in revenue and an estimated 750,000 jobs.”

The number was also widely adopted by IP advocates. The U.S. Chamber of Commerce in its report What Are Counterfeiting and Piracy Costing the U.S. Economy, (2004) circulated the 200- 250 billion dollar number, as did a National Geographic film. In fact, I used the $250 billion dollar figure when I was IP Attache in Beijing (2004-2008) to urge additional support for my elevation in diplomatic rank, as it seemed rather odd that I had been tasked with a problem costing nearly 750,000 jobs and I had no staff of my own. An article in Ars Technica (2008) noted that this earlier $250 billion/750,000 job number may have its origins in a Forbes magazine article from 1993. There are also references to loss calculations of 200 billion dollars per year appear from as early as 2002 in Congressional reports.   To the extent that these calculations rely upon a base estimate of “approximately” 10 percentage points of world trade being in counterfeit or pirated goods, this data point harkens back to an OECD estimate of world trade in counterfeit goods at 5% in 1998. That number was however revised downward to 1.95% in 2007, at an estimated value of $250 billion. The OECD data seems to be the origin of the $250 billion IP Theft loss figures current at that time.

Other USG studies have shown a more cautious approach. A 2010 Government Accountability Office (“GAO”) study analyzed the economic effects of counterfeit and pirated goods and found that “it was not feasible to develop our own estimates [of the total value of counterfeit or pirated goods] or attempt to quantify the economic impact of counterfeiting and piracy on the U.S. economy.” Noting the lack of data as a primary challenge to quantifying the economic impacts of counterfeiting intellectual property and goods, the GAO concluded that “neither governments nor industry were able to provide solid assessments of their respective situations.”

The U.S. International Trade Commission in a well-researched report,  China: Effects of Intellectual Property Infringement and Indigenous Innovation Policies on the U.S. Economy, (2010) calculated that the theft of U.S. IP from China alone was equivalent in value to $48.2 billion in lost sales, royalties, and license fees. This estimate falls within a broad $14.2-billion to $90.5 billion range.  The breadth of this range is explained by the fact that many firms were unable to calculate their losses. Of the $48.2 billion in total reported losses, approximately $36.6 billion (75.9%) was attributable to lost sales, while the remaining $11.6 billion was attributable to a combination of lost royalty and license payments as well as other unspecified loss.

The current concerns around “IP Theft” as identified in the Section 301 Report include licensing of technology, an issue that is not covered by US Customs seizure data. Any calculation of losses due to IP Theft from non-payment of royalties should include estimates of lost royalties or license fees. Most of the current calculations do not include such data. Nonetheless, as I have noted elsewhere, accurately calculating lost royalties can be especially difficult as many licensors use tax haven jurisdictions to manage patent portfolios. There may be implied licenses in product purchases form OEM suppliers, and there can be valuation challenges. However, China’s relatively small role as a purchaser of US technology and its dominant role as an exporter of high tech or information technology products does suggest that it is a significantly under-licensed (infringing) economy. For example, China has leaped from exporting only 2% of the world’s information technology products in 1996, to 33% in 2015. Yet China has purchased very little technology directly from the US over the years, and its technology payments are a very small share of total trade. There is likely a huge shortfall in unpaid royalties from Chinese manufacturers.

Many discussions around IP theft have also declined to take into account cybercrime and other security threats. According to an often cited 2013 report by the International Data Corporation (IDC), direct costs to enterprises from dealing with malware from counterfeit software were estimated to hit $114 billion in 2013 and “potential losses from data breaches” might have reached nearly $350 billion.” However, data breaches are not necessarily a form of IP infringement, as they can be undertaken for other purposes, including simply injuring the computer system of a competitor through a denial of service attack.

Apart from differences in methodology, there are different definitions of “IP Theft” that should be affecting total loss calculations. The FBI currently  defines “Intellectual property theft” as “robbing people or companies of their ideas, inventions, and creative expressions—known as ‘intellectual property’—which can include everything from trade secrets and proprietary products and parts to movies, music, and software.” This definition notably would exclude any non-willful infringement, i.e., where there is no “robbing” as well as trademarks – which are not specifically enumerated.

In its 2013 Report, the Commission offered some examples of “IP Theft”, which also excluded trademark protection, and failed to discuss patent protection: “IP theft varies widely in both type and method. It ranges from more commonly known forms, such as software and music piracy, to more elaborate types, such as the use of economic espionage tactics to steal complex industrial trade secrets. Each type of IPR violation harms an economy in unique ways and brings with it a discrete set of challenges that make both deterrence and enforcement difficult.”

These approaches to “IP Theft” are different from the meanings advanced for the same term in the last decade. Victoria Espinel, who has had a long and distinguished career in IP and international IP issues, testified in Congress in 2005 when she was with USTR and spoke of “IP Theft”  in terms of the fight against ‘fakes’, declining to mention patents for inventions or trade secrets.   This was consistent with the focus at that time on criminal copyright and trademark focus of US government advocacy in China, including the bringing of a WTO case (DS362):

“Our companies report billions of dollars in lost revenue, irreparable harm to their brands and future sales, all of which ultimately affects U.S. workers who design and produce legitimate products forced to compete against Chinese fakes. We want and look forward to working closely with you and your staff in combating the theft of American IP in China.”

“IP Theft” of the prior decade certainly appears under-inclusive in not focusing on patent or trade secret infringement.  It also fails to reflect that most IP infringement is addressed by civil remedies, where questions of willfulness are secondary to the harm being caused. Criminal remedies, while important, are relatively rare in most legal systems. This approach is consistent with the TRIPS obligation to treat IP as a “private right.” Moreover, the TRIPS Agreement itself does not require member states to criminalize patent infringement or trade secret infringement.  Finally, there may be grey areas including market access barriers, investment restrictions, government procurement restrictions, informal government supported forced technology transfer, or aggressive use of antitrust laws that many would argue need to be included in the definition of “IP Theft”.  Many of these would also be very difficult to quantify.

“IP Theft” is also slightly over-inclusive, as there are also certain forms of bad-faith behavior that may be sanctioned by the state and permissible under international IP rules. For example, rights holders in China face a significant burden of bad faith patent and trademark applications that entail costs of challenging and invalidating these rights, while US-based rights holders often complain about non-practicing entities and patent trolls.

Individuals who might suspect an exaggerated “IP Theft” loss estimate might be surprised to know that there are data points that have typically been omitted from these calculations. For example, US Customs data typically does not include the value of goods excluded from the US market under Section 337 exclusion orders. I am unaware of any methodology that attempted to extrapolate from US damage awards in US courts against Chinese infringers. USTR in its 301 report, was also unable to calculate the value of “forced technology transfers” in joint ventures or technology transfers. Certain rights, such as plant varieties and plant patents are typically not included in loss figures, nor are losses due to design infringements. Consequential damages (attorneys fees/court costs/losses to brand value/harm to public health or safety) are also often not included in the above calculations.

There are also factors that could reduce the loss figures that have often not been used.  Assumptions about the US being the overwhelming victim of “IP Theft” are hard to substantiate. I suspect that different countries and industries bear different costs in different markets. European companies, for example, likely suffer most from trademark and design infringements of luxury goods.  In the United States, over 50% of US patent applications originate with foreigners; logically this may mean that a substantial portion of the injury suffered by US companies overseas due to patent infringement may be attributable to innovations that occurred outside of the United States.

Calculating how much “IP Theft” originates from China also ignores whatever the “baseline” is for infringement in the US.  Historically, for example, the greatest value of software piracy losses were in the United States, According to BSA data for 2017, China’s piracy losses were 6.8 billion, while the US was 8.6 billion. In addition to other deficiencies, US Customs data is based largely on the pro-active behavior of US rightsholders and thereby considerable selection bias. As one example, if “IP Theft” priorities were based on Custom data, apparel, watches and footwear would be the major area of US trade concern with China, as there were the three categories of goods most seized by US Customs in 2017.

“IP Theft” losses also do not necessarily reflect losses due to unredeemed WTO commitments, nor are they based solely on violation of WTO disciplines.  The TRIPS Agreement, for example, does not require members to criminalize willful trade secret theft – which is likely a major contributor to the current calculations. Moreover, if the calculations were one that adhered to WTO procedures, then the various methodologies would also need to look to WTO jurisprudence in terms of calculating damages when a WTO member fails to implement a WTO decision involving IP. A good reference point might be the “Irish Music” (DS160), which the US lost, and where the US was required to pay 1.2 million euros per year as an arbitral award in the early 2000’s. Another reference is the Antigua/gambling dispute, where the island of Antigua was permitted to retaliate against US IP interests in the value of 21 million dollars per year, considerably less than a claim by Antigua of 3.44 billion dollars.

Tying tariffs to losses due to IP theft has other challenges.   While it may help address a sense of national outrage, the unilateral imposition of tariffs on Chinese imports is unlikely to benefit any US victim of IP theft, nor do the tariffs themselves appear to be geared to a particular loss threshold. Instead, the tariffs are loosely based on loss estimates but appear primarily oriented to forcing China to change its behaviors.

A cynical reader looking at the data might conclude that large loss numbers are self-serving and make compelling rhetoric in the echo chamber of Washington, DC. Someone looking over the history of the data might, however, view their weaknesses as due to such factors as difficulties in collecting data, the growth of the Chinese economy and changes in infringement practices, and changing technologies including the growth of the Internet as a vehicle for content and goods delivery. The current focus on “technology” in the scope of IP Theft might be viewed as a belated recognition of how the Chinese economy has become more technology-oriented in the past decade.

In my view the statistics do serve as more than a “support” of the type referred to by Mark Twain, above. They also help to “illuminate” a deeply felt and sustained injury that is otherwise hard to calculate.

Note: The author (Mark Cohen) has contributed to many of the reports noted above, typically in a private capacity.

Corrections to the above are welcomed.

THE TIER IS REVISED…

After nearly twenty years of advocacy, China has finally revoked certain offensive provisions of the Administration of Technology Import/Export Regulations (“TIER”), effective March 18, 2019.   The decision was made by State Council decision no. 709, paragraph 38 of March 2, 2019,  which provides as follows:

三十八、删去《中华人民共和国技术进出口管理条例》第二十四条第三款、第二十七条、第二十九条。

第四十一条改为第三十九条,修改为:国务院外经贸主管部门应当自收到本条例第三十八条规定的文件之日起3个工作日内,对技术出口合同进行登记,颁发技术出口合同登记证。

A rough translation is:

38. Delete Article 24, Section 3, Article 27 and Article 29 of the Regulations of the People’s Republic of China on the Administration of Import and Export of Technology.

Article 41 shall be changed to Article 39 and revised as follows: “The competent foreign economic and trade department of the State Council shall, within 3 working days from the date of receipt of the documents stipulated by this Article 38  register a technology export contract and issue a technology export contract registration certificate.

The relevant provisions being modified of the TIER, as translated on the WIPO website, are as follows:

24 (3): Where the receiving party to a technology import contract infringes another person’s lawful rights and interests by using the technology supplied by the supplying party, the supplying party shall bear the liability therefore.

27: Within the term of validity of a contract for technology import, an achievement made in improving the technology concerned belongs to the party making the improvement.

Article 29 A technology import contract shall not contain any of the following restrictive clauses:

(1) requiring the receiving party to accept any additional condition unnecessary for the technology import, including buying any unnecessary technology, raw material, product, equipment or service;

(2) requiring the receiving party to pay exploitation fee for a technology when the term of validity of the patent right in which has expired or the patent right of which has been invalidated, or to undertake other relevant obligations;

(3) restricting the receiving party from improving the technology supplied by the supplying party, or restricting the receiving party from using the improved technology;

(4) restricting the receiving party from obtaining technology similar to that supplied by the supplying party from other sources or from obtaining a competing technology;

(5) unduly restricting the receiving party from purchasing raw material, parts and components, products or equipment from other channels or sources;

(6) unduly restricting the quantity, variety, or sales price of the products the receiving party produces; or

(7) unduly restricting the receiving party from utilizing the channel for exporting products manufactured using the imported technology.

This is one of 49 separate legislative provisions being modified by notice 709 of the State Council.

The TIER was itself part of ongoing WTO disputes (DS542, and DS549).  In addition, it was called out by USTR in its 301 Report on China’s forced technology transfer regime .  A panel had recently been composed in the US case against China (DS542).  The State Council has now addressed the most onerous provisions of the TIER by removing those provisions that had most obviously violated China’s National Treatment obligations under TRIPS Article 3, including footnote 3, which addresses discrimination in “the availability, acquisition, scope, maintenance and enforcement of intellectual property rights as well as those matters affecting the use of intellectual property rights.”

The legislation is immediately effective.  However, it does not address contracts that had previously been negotiated under the prior TIER.  Article 84 of China’s Law on Legislation does provide for the possibility of retroactive effect where the new legislation is made in order to better protect the rights of citizens, legal persons and other organizations, and may apply in this circumstance.  It will be up to the courts and/or the State Council to issue necessary interpretative guidance.

Interestingly, China did not take a “phased” or “limited” approach to revoking these terms, such as providing for limiting the application of mandatory provisions to protect smaller businesses or creating a default provision that could be waived in writing.  The Chinese government, to its credit, thus intended to rely solely upon the market and any other general provisions of the Contract Law.  China also did not seek to clarify the relationship between the TIER and China’s Contract Law or Antimonopoly Law, which had overlapping provisions with the TIER, and which should now apply more clearly and equally to foreign and domestic licensors.  However, the TIER provision regarding non-profit oriented technical cooperation, including government to government science and technology cooperation also continues to be in effect.  Specifically, article 2 of the TIER states that the legislation governs “technical cooperation” including “technical services and transfer of technology by other means.” (Art. 2).

It will be interesting to determine if the changes in the TIER have any impact on the manner in which technology is transferred by foreign companies to China, including use of affiliated/subsidiary companies of foreign companies in China to import foreign technology to avoid application of the TIER to technology imports.  The majority of US licensing transactions to China had been through such intermediated/affiliated entities.  After the affiliated licensee takes over the licensing activity of the licensor, any subsequent sub-license was believed to be governed by China’s Contract Law.

The amendment also comes shortly after China passed a new Foreign Investment Law on March 15, 2019, which also purports to address the forced technology transfer problem identified in the Section 301 report.  These legislative efforts thus appear to be part of a package intended to address US concerns.

Blog post by Mark Cohen.  Thanks to Jill Ge of Clifford Chance, Shanghai for pointing out this legislative development to me.  Thanks as well to the many lawyers, companies, officials, judges, and business people over the years who have advocated for revising the TIER and to the State Council for finally undertaking these revisions.