Article 24 of the Administrative Regulations of the People's Republic of China on Technology Import and Export (hereinafter the “Regulations”) provides that “a technology supplier in a technology import contract shall ensure that he is the legitimate owner of the technology supplied or that he has the right to assign or license such technology.” It is generally understood that this provision imposes an obligation on the transferor to warrant against defects. Consequently, transferors are often concerned about whether or not such provision has mandatory legal force; in other words, whether or not parties to a contract may opt out of the provision by agreement. Transferors are also concerned about how to mitigate or even eliminate its impact. With these questions in mind, the author offers analysis and commentary below:
The Regulations were formulated in 2001 and took effect the following year. So far, however, there has not been any precedent to which this provision of Article 24 has been applied; nor have there been any relevant judicial interpretations issued. Further, there is no specific stipulation on whether or not the provision is mandatory under both Chinese law and international treaties to which China is signatory.
The author believes that to determine whether Article 24 provides a general or compulsory obligation, we must analyze the legal nature of the Regulations. In other words, we must determine whether a technology import/export contract should be classified as a “general contract” or a “special contract”. A “general contract” does not have major implications for the public or the national interest, and the parties may reach agreement in accordance with the general principles of the Contract Law and the General Rules of Civil Law. On the other hand, since a “special contract” involves to a certain extent the interest of the general public or the nation, the parties’ specific obligations are regulated and controlled via compulsory provisions of law.
If the technology import and export contract contemplated in the Regulations is identified as a “general contract”, the parties thereto are entitled to opt out of Article 24 by agreement in accordance with the Contract Law.
According to Article 2 of the Regulations , technology import/export contracts must be categorized as technology contracts under the Contract Law and must be classified under subcategories including technology license agreements, technology transfer contracts, technology research and development contracts, technical consulting contracts and technical service contracts. According to Article 353 of the Contract Law , the parties may through separate agreement specify the sharing of liability in the event that the use of technology infringes the lawful interests of a third party. It is obvious that if a technology import/export contract is considered a “general contract”, the parties are permitted to include terms on the establishment and waiver of a technology supplier’s obligation to warrant against defects and the extent to which such obligation must be performed under the Contract Law.
This concept is the same as the judicial practice in other countries that adopt a civil law system. For instance, German case law deals with a “license agreement” as a general contract, to which specific principles in connection with leasing and rental under the German Civil Code apply . Under this circumstance, if the parties to a license agreement fail to agree on the licensor’s obligation to warrant against defects in rights, the licensor is still required to warrant that the rights contemplated therein are valid and effective; if not, the licensee is entitled to terminate or withdraw the agreement and file a claim.
If a technology import/export contract touches upon the public or national interest, it must be regarded as a “special contract”, and the parties cannot opt out of Article 24 by mutual agreement.
For a long time, differing opinions regarding whether or not technology import and export contracts concerns the public/national interest have surfaced. At the time the Regulations were formulated back in 2000, in most cases it was foreign advanced technology that was imported into China. Consequently the Chinese party, generally a licensee (or a transferee), was in a relatively weak contractual position. To protect the interest of the Chinese party, it was commonly accepted that the provision of Article 24 was compulsory at that time. Great changes have taken place in China over the past few years, and the Chinese economy has undergone a tremendous transformation as more and more Chinese technology is exported to foreign countries. Consequently, an increasing number of people now believe that the parties to a technology import/export contract may agree to the sharing of obligation.
Although it’s better to interpret and manipulate the provision of Article 24 in a flexible fashion based on actual circumstances in different historical periods, considering the prevailing understanding of this provision in current judicial practice, it is advisable to regard Article 24 as a compulsory provision for licensors from a risk mitigation perspective. Accordingly, when drafting a technology import/export contract, one should avoid exempting a transferor from warranty against defects, so as to guard against the possibility that the agreement will be found invalid or the parties will be subjected to administrative liability as a result of the contractual violation of a mandatory provision of law.
If the application of Article 24 cannot be directly avoided by agreement, is it feasible for a transferor to circumvent the provision by way of indirect licensing (transfer)? Let’s discuss this possibility using the following two scenarios.
1. A contract signed for a transaction between A Co. and the transferee’s legal representative located in a foreign country is subject to the laws of that foreign country.
Since evasion of the law is not permitted under Chinese law , a contract shall not be subject to foreign law if any act thereunder is intended to bypass Chinese compulsory or prohibitive provisions of law. Under this circumstance, A Co. cannot avoid the application of Article 24, and the legal risks are still present.
Regardless of the circumstance in which a contract is found invalid due to acts circumventing the law, whether or not A Co. must undertake the warranty obligation also depends on applicable foreign law. If the laws of the foreign country do not specify legal warranty obligations on a transferor, A Co. may be exempted from such obligations by way of negotiation and consultation with the other party. Accordingly, whether or not indirect licensing (transfer) can avoid a transferor’s legal obligation to warrant against defects remains uncertain.
2. A Co. licenses to its Chinese subsidiary before sublicensing the same in the name of such subsidiary.
A contract between A Co. and its subsidiary must not circumvent the provision of Article 24; accordingly A Co. must its obligation to warrant against defects to the subsidiary under the law. The sublicense agreement signed by A Co’s subsidiary and B Co. is a domestic technology license that does not touch upon technology import/export. Under the provisions of Article 353 of the Contract Law, the parties thereto may specify the sharing of liability through separate agreement in the event that the exploitation of such technology impairs a third party’s rights and interests. Consequently, one cannot circumvent Article 24’s legal force against a transferor by way of indirect licensing (transfer).
The foregoing analysis suggests that the provision stipulating a transferor’s obligation to warrant against defects under Article 24 of the Regulations cannot be completely avoided by way of either agreement or indirect licensing (transfer). Nevertheless, the Regulations do not prohibit or impose restrictions on the parties against agreeing on methods for a transferor to perform its obligation to warrant against defects or the extent thereof. For this reason, we believe that the parties may specify in a contract how a transferor must perform its obligation to warrant against defects, as well as the extent to which this obligation must be performed.
Based on the foregoing analysis, we recommend that a technology transferor mitigate the impact of Article 24 by agreeing with the other party on contractual terms as set forth below:
1. Provide Limitation of Liability in the Contract
- Clearly Limit the Condition of Warrant against Defects
- Where a licensee exploits a licensor’s technology strictly in accordance with an agreement, but is determined by effective law or judgment to have infringed a third party’s rights, the licenser shall bear proportional and limited liability in accordance with the contract signed between the parties;
- Where a licensee knows or ought to know that the licensed technology has defects or is at risk of infringing a third party’s rights when he/she signs a contract, the licenser shall not be liable for damages arising therefrom;
- In the event that a third party’s rights are infringed for a reason that is attributable to the licensee (such as exploitation beyond the scope of the license or unauthorized modification of technology), the licensor shall not be liable for damages arising therefrom.
- Specify the proportion of liability that each party must bear if third party damages arise;
- Specify the limitation of liability that a licensor is subject to for any damages arising out of the performance of the contract or any claims arising therefrom in any circumstance.
2. Choice of Governing Law and Forum for Dispute Resolution
The parties may circumvent the application of Article 24 by choosing an appropriate governing law and/or forum for dispute resolution:
- Provide that the law of a foreign country that is selected as the governing law (a law that does not impose statutory liability on a licensor to warrant against defects), and that in the event of a dispute the parties must seek resolution by arbitration with an arbitral authority in a foreign country;
- Provide that Chinese law shall be the governing law, but in case of a dispute the parties shall seek resolution by arbitration with an arbitral authority in a foreign country.