(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.