Continuing our series on doing business in China, this instalment discusses the challenges and risks involved in the transfer of technologies from foreign companies to Chinese parties. The transfer of technologies may involve various forms. For example, patent and/or know how assignments, patent and/or know how licences and technology service agreements – all of which are likely to involve significant and sensitive issues around the use and access to proprietary confidential information.

This article highlights risks inherent in one particular type of technology transfer, i.e. the licensing of technologies from foreign companies to Chinese parties, and offers suggestions to consider in order to minimise the impact caused by those risks.

Risks

Broadly speaking, a typical technology licensing deal between foreign and Chinese parties covers technology licensing into and out of China. In such a case, the licence arrangement would include (i) a foreign party importing and transferring the primary background technologies, e.g. the licensor's patents and know-how, though a licensing mechanism to a Chinese party and (ii) the Chinese party exporting and transferring foreground technologies through a grant-back licence to the licensor, e.g. patents and know-how created by the Chinese party deriving directly from improvements and further developments made to the foreign party's licensed background technologies.

Under this scenario, we outline below certain applicable Chinese rules that foreign companies should be aware of:

Filing requirements

In China, the import or export of technologies triggers certain filing requirements. Applicable rules generally require technology transfer contracts importing or exporting permitted technologies (compared to restricted technologies whose transfer must be pre-approved by the relevant Chinese authorities) to be filed with China's Ministry of Commerce within 60 days of the effective date of the relevant contract. For sensitive technologies such as weapons manufacturing, imports and exports could be prohibited or restricted.

If a technology licensing agreement is not filed when required, this may adversely affect procedures relating to foreign exchange, taxation and customs, e.g. hindering or preventing the Chinese party from paying royalty payments in foreign currencies to the foreign party outside China.

Restrictions on making improvements are invalid

Chinese law prevents a foreign licensor from prohibiting or restricting the Chinese licensee from making further improvements to the licensed technologies, as such limitations may be deemed to be illegally monopolising technology and/or stalling future innovation. Any such contractual restrictions would likely be held invalid and unenforceable in China.

Ownership of improvements

The default position is that the original ownership of improvements made by a Chinese licensee will be owned by the Chinese licensee. The parties can contractually agree that the Chinese licensee shall assign its original ownership to the foreign licensor, but the contract must include fair and reasonable consideration for the assignment of the improvements.

Consideration for technology grant-back licences

Similar to the point made in relation to an assignment of any improvements, a commonly adopted grant-back licence clause, to enable foreign licensors to use improved technologies made by the Chinese licensee, cannot be royalty-free and must be accompanied by separate consideration and compensation. As such, terms and conditions of a mutual exchange of improved technologies which require a party to offer its improved technologies to the other without compensation, or transferring of rights to others on a non-reciprocal basis, or sharing such improved technologies without consideration, may be construed as invalid and unenforceable.

Licensor (or transferor) disclaiming liabilities

Chinese law prohibits a foreign licensor from disclaiming liabilities in connection with the licensed technologies. If the licensee infringes third party rights while using the licensed technologies, the licensor shall assume all liabilities in connection with such infringement.

Issues to consider

Below we set out some measures to counter the risks of licensing technologies to Chinese parties:

On ownership of improvements

Foreign companies have to think carefully about what technologies they should bring to China and licence to Chinese parties. It is important to consider the form of technology transfer and consult an experienced local consultant who can explore effective ways to structure the terms of the licence agreement in order to most suitably address the development, ownership, and use of improvements.

On consideration for technology grant-back licences

Unfortunately, Chinese law does not define what constitutes adequate consideration in this context. Ultimately it will come down to negotiations between the parties in order to structure a fair and reasonable deal. Again, obtaining local advice is fundamentally important.

One approach to consider is an option to license improvements with a right of first refusal with due consideration. In this case the licensor should require the licensee to provide regular reports/disclosure on its R&D and potential improvements based on the licensed technologies and know-how. The licensor may then decide on a case-by-case basis whether it wishes to receive a licence and how much it is prepared to pay for it.

On licensor (or transferor) disclaiming liabilities

One arrangement is for the parties to apportion their respective liabilities in the event that third-party claims lead to losses, based on an agreed percentage, or an agreed cap on liability of the licensor for any IP infringement.

Further, the parties could include a "knowledge" clause stating that if the licensee knows or ought to have known that the licensed products or technologies infringe or would likely infringe third party rights at the time of signing the licence agreement, and yet still proceeds to sign the agreement, the licensor is exempted of any relevant liabilities.

Another general approach is to increase the upfront licence fee to cover the risk of infringement or losses caused by the Chinese licensees, to the extent commercially feasible.

Finally, one may also insert a clause exempting the licensor from any related liabilities if third party infringement occurs due to the licensee's negligence or intentional wrongdoing.

General issues to consider

  • The most effective method of protecting the foreign party's confidential information is not to licence or transfer ultra-sensitive information and know-how (if possible). However, in reality this may be difficult to achieve as the vast majority of Chinese parties seek cooperation with their foreign counterparts for the specific purpose of obtaining valuable foreign technologies and know-how.
  • It is imperative to register the foreign parties' patents and other intellectual property rights before importing related technologies to the Chinese market.
  • Foreign licensors should also include a robust non-disclosure clause in the technology transfer and licence agreement to restrict the licensee's disclosure of sensitive information to a strictly need-to-know basis, as well as limit the licensee's right to sublicense; and
  • Foreign companies must also be mindful that reverse engineering or the acquisition of

Technology by taking apart and studying an existing product on the market is legal in China. Consequently, a well-devised technology licence agreement should include measures to restrict or prohibit the Chinese party from engaging in reverse engineering.

Conclusion

Increasing numbers of foreign businesses are engaging in business relationships with Chinese parties to share advanced technologies through technology licensing arrangements, in the context of the current push by the Chinese government to replace the "Made in China" model to a "Made by China" model. This article explored and highlighted some of the Chinese rules on technology transfer via technology licensing which pose challenges to foreign parties. It also set out some suggestions aiming to minimise the adverse impact caused, based on our recent experiences advising clients on these issues.