In this first of a two-part study, the China IPR SME Helpdesk explores research and development (R&D) in relation to developing your R&D strategy, structuring of intellectual property (IP) ownership and licensing of IP. They point out that legal practices described here should be considered in the context of specific business models and specific methods of technology development.

Develop your strategy

When addressing intellectual property rights (IPR) issues related to R&D, people often quickly jump to questions of IPR ownership, licensing and enforcement. All of these issues are important, however, it is very helpful to examine the following questions before discussing legal structures with your counsel:

Where is your market in your current business model?

If you focus on the market in China, your Chinese business partners might want to ask a lot more from you, including sharing the ownership of IPR, in exchange for helping you develop the product and the market.

Who will be the inventors?

If the primary inventors are non-Chinese citizens, you will have much more leverage in deciding how to control the IPR. If, however, the Chinese team is expected to make key contributions IPR ownership will be a more sensitive issue when negotiating the terms of your agreement. To retain control you will need to include a sufficient amount of rewards and incentives for them as individuals in the case that ownership of the innovation is not granted to them.

Additionally, you will need to consider the legal status of the Chinese inventors. If the inventor is an employee of another party, for example a researcher at a local university, the inventor may be under contractual duty to assign his/her IP rights to that employer. Ignoring the inventor’s existing legal duties can cause serious problems.

Is the technology going to be useful for other areas?

Very often small- and medium-sized enterprises (SMEs) introduce a promising technology to develop applications or products to suit the Chinese market. People often focus on the IPR related to the particular applications or products that are being developed. However, the underlying technology may be useful for other sectors. Control over the IPR for the underlying technology, and the outcome of R&D, often have much greater stakes.

Are you willing to give away your IPR in exchange for equity?

Are you willing to give away your IPR in exchange for shares, stock options or other equity interests in their enterprises in China? The answers to this question may help you open up some doors to creative solutions in China.

What if your business fails in China?

Intellectual property rights may be the only asset you are left with in the case of your business venture failing in China. For example, if your current business venture is closed down, can you securely use the IP you have developed somewhere else, or in other fields, or with other partners? Thinking about the worst-case scenario will give you some insight into your fall-back options.

Who owns the IP?

Intellectual property ownership is less of an issue if you simply set up your own entity in China to conduct all R&D activities. You can choose to file patent applications under the name of the Chinese entity, or its affiliates outside China.

Placing the IPR under an overseas entity may provide greater flexibility to suit the future needs of your business operations and financing. However, companies increasingly apply for IPR under their Chinese entities in order to qualify for the incentive plans offered by local governments in China.

If you rely on your business partner to some extent, IPR ownership may be more complicated. Some common choices can be seen below:

• Sole ownership of all the IPR by the European SME.
• Sole ownership of all the IPR by the Chinese business partners.
• Co-ownership, shared between the European SME and the Chinese business partner. Terms of the co-ownership can be largely defined by contracts.

The ownership issue can be sensitive between foreign SMEs and Chinese business partners. Excessive fighting over ownerships will produce risks for future business cooperation. It is therefore advisable to keep revisiting the business models you have in place, and to always sign mutually-agreed contracts on ownership, licensing and other legal tools to support your shared business interests, so that ownership is clearly defined from the start.

For example, if you realise that the software tool you have developed can be used for another business model, to which your Chinese business partner has no relation, you may need to carefully craft the agreement in a way that will allow you the freedom to use the technology in other fields. Failure to do this will likely lead to disputes in the future.

Secure your licenses

An IP licence is a contract to permit where, when, and how your IP can be used by another party, for free, for royalties, or in exchange for other services. In most R&D contracts, licensing is a key aspect. The greater leverage the business partner in China has in terms of knowledge about the market and execution ability, the more consideration is likely to be given to licensing options.

In practice, licensing is probably one of the most important legal tools that SMEs often overlook. Part of the reason is that SMEs are not always confident about the effectiveness and enforceability of the contracts they enter into with Chinese partners. For example, people may be afraid of unfair court rulings and difficulties with the enforcement of judgments.

While such considerations may be justified in some cases, SMEs should not overlook the importance of using contracts, as the lack of an agreement in writing will inevitably lead to disaster. Licensing options for IP should be well thought out prior to negotiations.

In China common types of licences, such as exclusive and non-exclusive licences, are permitted. The laws and regulations are designed to give a large amount of autonomy for the parties to decide what to do with their IP licences. Parties can negotiate and reach a mutual agreement on the following key terms:

• Territory of the licence: Does the licence cover China or is it applicable worldwide? Is it better to have a licence that covers a certain specified geographical area in China?
• Duration of the licence: When does the licence expire? How should it be renewed? Can the licence be terminated under certain clearly-defined circumstances?
• Licensed IP: Are you only going to license your patents? What about copyrights and trademarks? How about less familiar types of IP such as graphic user interfaces, sensitive client information or special skills? Some innovations may not be fully protected by the patent, trademark or copyright laws, but you may use the contract to protect yourself.
• Licensed products covered by the licence: You need to clearly define what types of products/services are covered by the licence.
• Royalties: You can choose a lump-sum payment, running royalties or even operate royalty free for a certain period of time and then start charging. Issues like tax and auditing should be addressed as well.
• Limitations of the licence: Do you have to give warranty or indemnify everything requested by your Chinese partner? Think of ways to limit your exposure to liabilities.
• Other key terms: Every licence is different; do not imagine that one template can fit all your needs. Work with your counsel, think about your business interests and come up with mutual agreements with your business partners.

Important note: In the context of joint IP development, keep in mind that Chinese laws do not allow foreign companies to retain ownership of improvements that are made by Chinese parties, unless the Chinese parties are being remunerated in some way for these inventions. This remuneration could be in the form of cash, shared profits, equity interest, or other types of property rights.

Chinese laws also require the foreign company providing the technologies to authorise the quality and usefulness of the technologies, and to bear the liabilities if the technologies turn out to have infringed others’ legal rights. Therefore, through discussions, European SMEs and their Chinese business partners should decide on fair and workable solutions before proceeding with a deal.

Take-away messages

• Your first step should be to review your business strategy, and ask yourself the following questions: who are you doing the deal with, what is the potential of your technologies under the R&D, what are the worst case scenarios?
• IP ownership and IP licensing are probably the most important considerations in structuring your R&D agreement. In particular, the licensing options may offer you a great deal of flexibility to fulfil the business interest for both sides and avoid potential conflicts between parties.

In part two of this study we will describe the steps required for building valuable IP portfolios and feature a business case study.

The China IPR SME Helpdesk is a European Commission funded project that provides free, practical, business advice relating to China IPR to European SMEs. To learn about any aspect of intellectual property rights in China, visit our online portal at www.china-iprhelpdesk.eu. For free expert advice on China IPR for your business, e-mail your questions to:  question@china-iprhelpdesk.eu. You will receive a reply from one of the Helpdesk experts within seven working days. The China IPR SME Helpdesk is jointly implemented by DEVELOPMENT Solutions and the European Union Chamber of Commerce in China.