Towards a Better Understanding of “Forced Technology Transfer” Policies in China and Their Strategic Implications

In August 2017, President Trump issued an executive order setting in motion an investigation of China’s trade policies including IP, technology transfer, and investment policies. The “Section 301” report on this investigation came out earlier this year. The Report itself uses the word “force” or “forced” 47 times and identifies a range of practices that result in “forced technology transfer.” However, there is a significant amount we still do not know regarding how these controversial Chinese policies actually work and the degree to which a technology owner’s behavior has in fact been compelled by state actors. A new paper by Dan Prud’homme, Max von Zedtwitz, Joachim Jan Thraen, and Martin Bader published in Technological Forecasting & Social Change explores this important issue.

The authors evaluate the ability of “forced technology transfer” (FTT) policies – which they define as policies meant to increase foreign-domestic technology transfer that simultaneously weaken appropriability of foreign innovations – to contribute to technology transfer. They draw on a survey of foreign firms, interviews with foreign firms, and case studies of Chinese firms.

The authors identify three categories of FTT policies that have significantly impacted foreign-Sino technology transfer in recent years:

(1) Policies which risk market loss (including market access preconditioned on meeting technology transfer requirements),

(2)  Policies that offer no choice regarding compliance (including unfair court rulings in IP civil litigation), and

(3) Policies that are based on legal obligations (including provisions in the technology import-export regulations; and certain policies related to the intersection of anti-trust and IP, and IP and technical standards).

Several other controversial policies were also identified, including disclosure of confidential business information through regulatory approvals, pharma patent issues, and certain tax schemes and subsidies.

The authors find that, with the exception of no-choice policies, foreign firms are allowed some flexibility to decide whether or not they want to comply with China’s FTT policies. Therefore, even though non-compliance with the policies is always met with consequences, the technology is not actually “forced” against a party’s will. After noting this limitation of the term, the authors explain that they retain the term “FTT policies” in their research for readability and because it is part of well-established lingo, but only use it to the extent that it meets their aforementioned definition.

Much of the research focuses on foreign-Sino transfer of frontier technology, i.e. the most advanced technology emerging from research and development which is generally not at the point of mass commercial adoption. According to the authors, not only the design of FTT policies per se helps determine if they exert substantial leverage over (i.e., force) frontier technology transfer, but the environment in which they are deployed is equally important. The authors find that FTT policies appear to exert the most leverage over frontier technology transfer when accompanied by seven conditions: (1) strong state support for industrial growth; (2) oligopoly competition; (3) other policies closely complementing FTT policies; (4) high technological uncertainty; (5) policy mode of operation offering basic appropriability and tailored to industrial  structure; (6) reform avoidance by the state, and (7) stringent policy compliance mechanisms.

Based on each of these conditions, the authors developed an FTT Strategy & Risk Forecasting Matrix with corresponding strategies the state may adopt to fully exploit, i.e. maximize the leverage of, FTT policies.

The authors’ analysis has several possible implications for technology transfer policymaking. In the authors’ view, Chinese FTT policies may enable domestic acquisition of frontier foreign technology if all seven conditions determining policy leverage are fully exploited by the state. However, if the state does not fully exploit all seven conditions, the FTT policies have less leverage. Moreover, if the state exploits none or only a few of the conditions, the FTT policies may result in a lose-lose game where foreign firms are discouraged from transferring valuable technology and domestic firms’ acquisition of new technology is made more difficult.

With this analysis, the authors provide evidence that can be used to appeal to the Chinese authorities to change some of their FTT policies: some of the policies are actually counterproductive in meeting their aims. The risks of loss of technology acquisition posed by Chinese policies is an important phenomenon which this blog has also identified, particularly as an unintended consequence of China’s Technology Import/Export Regulations (especially for start-ups and litigation-prone technologies, but also for technological collaboration) and which has been mentioned by the US Chamber of Commerce in its IP Index and its report on licensing.

The authors argue that in order to increase the chance that FTT policies will spur sustained transfer of frontier technology, Chinese regulators should not deprive foreign firms of  minimum level of appropriability. The policies should also allow foreign firms to benefit in at least minor ways from technology transfer arrangements.

The research also has important implications for technology strategy formulation and risk management. The authors’ FTT Strategy & Risk Forecasting Matrix can 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. The risks are of course compounded by potential trade secret theft, cyber intrusions, and less formal pressure points on foreign licensors to assign or transfer their technology in China. And these risks must be considered alongside major rising challenges to doing business in China, which Prud’homme and Zedtwitz have also discussed (in MIT Sloan Management Review), including: problematic areas of regulation in China and rising competition from Chinese rivals in terms of their recruiting and retaining top talent, more large-scale and strategic use of intellectual property, and ever faster time-to-market of products and services. Mitigating these many risks requires carefully integrated intellectual property, innovation, non-market, and human capital strategies, alongside yet other responses.

Edited of June 23, 2018:  An interview with Prof. Liu Chuntian of Renmin U. Law School on this same topic of forced technology transfer is found on page 2 of the People’s Daily (June 22, 2018, 2nd edition) (reporter Wang Yu)   A machine translation by Google is found here.  Liu focuses primarily on market access as a separate discpline from intellectual property under the WTO and as being essentially voluntary; he does not support formal and informal incentives in place (including the Technology Import/Export Regulations as noted in the article by Dan Prud’homme.

Edit of July 15, 2018: Here’s a link to Prof Prud’homme’s article outside of a paywall.  It may only be available for a short period of time.

IPR Abuse and Refusals to License

The US Chamber and American Chamber of Commerce (the “Chambers”) have recently made available its recent comments on the NDRC and SAIC drafts of the IP abuse guidelines to be promulgated by the Antimonopoly Commission of the State Council.  Here are the links: NDRC IP Abuse Guidelines Chinese; NDRC IP Abuse Guidelines English; SAIC IP Abuse Guidelines Chinese; SAIC P Abuse Guidelines English.  As there is no public database of comments received on most Chinese legislation, I will continue to try to make available comments by private entities here on this blog.

The NDRC and SAIC comments of the Chambers continue to focus on certain key areas of concern, including China’s endorsing of an essential facility doctrine without considering the pro-competitive aspects of licensing (or standards setting).  The Chambers have expressed concerns about “an approach that imposes restrictions on licensing because it is possible to imagine a license that creates more competition”, which (in my view) is essentially a state-management approach to licensing and intellectual property.    The Chambers also focus on burdens of proof – an increasingly important issue in IP cases generally, as well as extraterritorial authority based on “effect” on the Chinese market, without regard to substantiality or immediacy.  As I have noted elsewhere, concerns over extra-territorial issues have been of increasing concern bilaterally. 

The Chambers also support provisions to enable portfolio licensing, which may include expired patents and would otherwise need to be adjusted or renegotiated every time a patent expires or is found invalid.  The Chamber also takes issue with presumptions that cross-licenses and grant backs are anti-competitive.   The Chambers also address concerns about aggressive regulation of refusals to license patents, particularly those that are not encumbered by a F/RAND obligation (eg., Article 24, SAIC draft).

An important development on refusals to license in China has been noted by Benjamin Bai in a recent blog on a non-SEP refusal to license case now pending in China.  According to Benjamin:

Hitachi Metals At the time of writing, there is an ongoing litigation on whether a refusal to license non-essential patents constitutes IP abuse. Four Ningbo companies brought this case against Hitachi Metals in the Ningbo Intermediate Court. The dispute centers on neodymium-iron-boron magnets, which are widely used in the electric engineering, wind power, automotive, and high tech industries. About half of the global consumption of rare earth metals relates to this magnetic alloy, whose intellectual property rights are mostly held by Hitachi Metals. It owns more than 600 neodymium-iron-boron magnet patents globally but has only licensed selected patents to eight Chinese companies. Hitachi has refused to license to other Chinese companies.

 Hitachi’s refusal to license its patents to the plaintiffs is the basis for the suit. The accused abusive conduct includes refusal to license, bundling, etc. This is the first case in which plaintiffs have requested a Chinese court to license non-essential patents based on the notion of “essential facilities”. The plaintiffs argue that Hitachi’s patent portfolio on neodymium-iron-boron magnets should be considered as essential facilities for the industry because its patent portfolio cannot be substituted and avoided. The plaintiffs seek damages of RMB24 million (~USD3.4 million). A nine-hour hearing was held on December 18, 2015. The court has not yet issued any decision. This case will undoubtedly have a huge impact on the Chinese jurisprudence on refusal to license and IP abuse.

Benjamin concludes his blog by noting:

When it comes to non-essential patents, however, the rationale of Huawei v. InterDigital does not apply. Instead, the analytical framework laid out in Qihoo v. Tencent should be followed. According to the Chinese Supreme Court, market dominance refers to the position of an undertaking with the ability to control the price, quality of other transactional terms of products in the relevant market, or the ability to impede or affect the entry into the relevant market by other undertakings. The determination of market dominance is a multifaceted process. No single factor is necessarily outcome-determinative. A high market share in and of itself should not lead to a presumption of market dominance, especially where the high market share is due to high efficiency or better-quality products. Therefore, a high market share conferred by technology superiority might not lead to a finding of dominance.

Extension of essential facilities outside of the F/RAND context where a company may not have willingly abandoned certain rights in exchange for incorporation in a standard is problematic, as Benjamin notes. I believe there are also implications for China’s IP system.   Neither recent draft guidelines or court decisions to date recognize patents as a unique form of property which is based on a right to exclude offered in exchange for disclosure of an invention.   Aggressive antitrust enforcement could erode that incentive.  This can be of great concern in the non-SEP space, where a patentee may have a choice whether to disclose an invention or keep a proprietary method secret.  As disincentives to patenting continue to mount due to narrowing scopes of patentability, procedural changes making litigation more difficult and patents less stable, and/or increased antitrust enforcement, the technological “commons” created by patent disclosures, as well as the incentives that patents provide for investment and product development, may narrow. The dynamic efficiencies of the patent system, which frequently creates new technologies which is not even in current manufacture and “include[es] societal gains from innovation” (GAI comments on NDRC draft) could be placed at risk.

I also remain concerned about disproportionality between antitrust damages and a continuing low level of patent damages.  CIELA currently lists average patent damages in China at 419,366 RMB, based on a cohort of 511 cases where the plaintiff won its claim of patent infringement.  This is about 70,000 dollars, or about 1/10,0000 of the fine imposed on Qualcomm in its recent NDRC investigation.  Of course,  patent damages address harm to the rights holder and antitrust damages address harm to competition, making comparisons somewhat inexact.  A legal argument however is that, whatever the calculation of antitrust damages, China has an explicit international obligation to insure that patent infringement damages “constitute a deterrent to further infringements” (TRIPS Article 41).  WTO members may even impose criminal remedies for patent infringement where willful and on a commercial scale (Article 61).   The authorization for WTO members to address IP abuse under the TRIPS agreement is only to take “appropriate” measures (Art. 40).   In my view, overly aggressive antitrust enforcement in China when the IP system is fundamentally weak, is “inappropriate” for China, and could weaken market-based incentives to license and patent, as well as incentives for disclosure at a critical time in China’s quest to become an innovative economy.