China FIL: Improvements to Rules on Technology Licensing by Foreign Licensors

For example, in the “Section 301 Report” published by the Office of the United States Trade Representative in March 2018, the U.S. claimed that “the Chinese government’s acts, policies and practices reportedly deprive U.S. companies of the ability to set market-based terms in licensing and other technology related negotiations with Chinese companies and undermine U.S. companies’ control over their technology in China. For example, the Regulations on Technology Import and Export Administration mandate particular terms for indemnities and ownership of technology improvements for imported technology, and other measures also impose nonmarket terms in licensing and technology contracts.”

As an effort to address such concerns, Article 22 of the Foreign Investment Law sets forth the following principles:

(1)  the Chinese State protects the intellectual property rights of foreign investors and foreign invested enterprises;

(2)  the Chinese State encourages technical cooperation carried out according to voluntary principles and business rules in the process of foreign investment;

(3)  the conditions for technical cooperation shall be negotiated and determined by all parties to the investment on equal basis pursuant to the principle of fairness;

(4)  administrative agencies and their staff members shall not use administrative means to force the transfer of technology.

Along with the promulgation of the Foreign Investment Law, certain provisions under the Regulations of the People’s Republic of China on the Administration of the Import and Export of Technologies (TIER) that were deemed to be unfair and discriminatory to foreign licensors were abolished. Foreign licensors are now in a better position to negotiate technology licenses with Chinese licensees.

1. What Old Rules Were Abolished, and What New Rules Apply?

Under the previous regime, technology licenses by foreign licensors to Chinese licensees had to follow the rules set forth in TIER. These rules do not apply to technology licensing and transfer occurring between two PRC domestic companies, which are governed by the PRC Contract Law (Contract Law) and the Interpretation of the Supreme People's Court on Certain Issues Concerning the Application of Law in Trying Cases Involving Technology Contract Disputes (SPC Interpretation).

Three provisions under the old TIER concerning restrictions on foreign licensors were abolished. Under the new regime, any technology license contract between a foreign licensor and a Chinese licensee governed by PRC law should follow the Contract Law and SPC Interpretation, in the same manner as a technology transfer between two Chinese domestic parties.

We set forth in the table below (i) the rules that were abolished under TIER, and (ii) the relevant rules addressing the same issues under the Contract Law and SPC Interpretation (differences with TIER requirements are highlighted in red).

(Click to open full PDF)

2.  Impacts on Cross-Border Technology Licensing

As summarized in the table above, key changes are made in the rules regarding (i) liability for infringement on third-party intellectual property rights, and (ii) ownership of technology improvements. Certain restrictive clauses (similar but somewhat different to those prohibited under TIER) are still prohibited from being included in cross-border technology license contracts under the rules set forth by the SPC Interpretation.

2.1 Liability for Infringement

In the past, this requirement has been used by Chinese licensors to require strict liability on the part of the foreign licensor in case of any infringement of the licensed technology on the intellectual property rights of a third party. This requirement is onerous and burdensome for foreign licensors (particularly small companies seeking to license technology) because many of them do not have the expertise or resources necessary to assess and bear the risk of third-party legal proceedings.

Now that the TIER requirement has been abolished and the Contract Law allows the parties to agree on the allocation of liability for infringement on third-party intellectual property rights, we suggest that foreign licensors consider the following points in negotiating with their Chinese counterparts:

• The licensor should require the licensee to promptly notify the licensor in writing in case of any third-party claim and to provide necessary assistance to the licensor in carrying out necessary defense.
• The licensor should distinguish (a) third-party claims on the basis of infringement by authorized use of the licensed technology on third-party rights from (b) those on the basis of infringement due to unauthorized or improper use of the licensed technology by the licensee.
• For claims (a) above, the licensor should require that the licensee makes no admission or prejudicial statement to a court without obtaining the licensor’s prior written consent. The licensor may only agree to indemnify the licensee where a final judgment rendered by a competent court of justice confirms the existence of such infringement.
• The licensor shall not indemnify the licensee for any losses caused by infringement due to unauthorized or improper use of the licensed technology by the licensee.
• Any intention of the licensee to settle with third party must be approved in writing by the licensor.
• The licensor may set a limit on the total amount of compensation and indemnification, to the extent permitted by the applicable law.

2.2 Ownership of Technology Improvements

This is another heated negotiation issue between foreign licensors and Chinese licensees. Under the old regime, this rule created confusion where the improved technology was inseparable with the licensed technology and was unfavorable to the foreign licensor where the improved technology was separable and therefore allowed the Chinese licensee to own such improved technology without shared ownership with the foreign licensor.

While the TIER requirement that the licensee shall own any technology improvement within the term of the technology license contract was abolished, any agreement on the ownership and use of technology improvements is subject to principle of mutual benefit and cannot be unequal.

We suggest that foreign licensors consider the following points in negotiating with their Chinese counterparts:

• Work with the technology team to distinguish between “change of technology” and “improvement of technology.” This task may not be easy but, if properly defined, may provide the foreign licensor with a good level of control over how the licensed technology may be used by the licensee. For example, any change to design, specification or working process due to market demand or other reasons must be consulted with and approved by the licensor. The licensor should require that the licensee shall assume full liability for all losses or damages that may result from such a change.
• The foreign licensor can negotiate for sole ownership on any technology that exists before any improved technology and any improved technology made by the licensor.
• The foreign licensor may require that any technology improvement made by the licensee be co-owned by the licensor and the licensee. As a back-up position, any separable technology improvement may be solely owned by the licensee while any inseparable technology improvement is still co-owned by the licensor and the licensee. The parties may agree that both the licensor and the licensee (including their respective affiliates) have the right to use any co-owned technology without consent from the other party.
• The parties may agree that the licensor and its designated parties are entitled to use any technology improvement owned by the licensee for a certain fee or in exchange for the licensee’s right to use any technology improvement solely owned by the licensor.

3.  Suggestions

While improvements have been made on rules governing technology licenses by foreign licensors to Chinese licensees, there are still restrictions on what conditions a foreign technology licensor may impose on a Chinese licensee. We therefore suggest that our foreign clients first consider the governing law of the technology license contract to be the law of the place of incorporation of the foreign licensor, assuming that law has fewer such restrictions on licensors.

For any existing technology license contract, if there are provisions that were included to comply with those now-abolished rules under TIER, the foreign licensor may review the contract to determine whether it has any contractual basis (e.g. a change-of-law clause) to re-negotiate such provisions.

For any new technology license contract, foreign investors can now negotiate for a better position in terms of liability for infringement and ownership of technology improvements. Our suggestions outlined above can serve as a starting point for foreign licensors to design negotiation strategies.