How European companies can protect their IP while transferring technology to China

European companies are increasingly wanting to engage in technology transfers with Chinese companies. However, there is a risk associated with long-term partnerships. The China IPR SME Helpdesk explains how European companies can devise solutions to minimise issues pertaining to intellectual property and how one can safeguard themselves when engaging China.

Many European companies are keen to come to China. While in the past, European companies came to China to take advantage of low-cost manufacturing for export, more recently, they have come to enter the Chinese domestic market, establish R&D, engage in cooperative development, take advantage of a skilled workforce, establish suppliers and develop long-term partnerships in China. In order to achieve this, they are often willing to ‘transfer’ key technologies and designs to Chinese subsidiaries of European firms, joint-venture (JV) partners or Chinese manufacturing and service companies. One of the challenges facing European companies that decide to come to China is how to devise a creative solution to minimise intellectual property (IP) risk associated with these technology transfers.

A technology transfer happens in a number of different ways. European companies most commonly transfer technology by licensing their patents, designs, software, trade secrets, and know-how. Technological ownership may be transferred, but this type of transfer is less common. A common misconception is that a technology transfer is limited to high technology transfers. However, many European companies, using contract manufacturing to manufacture low technology, consumer, or industrial products, for example, based on product design, must deal with many of the same risks to IP as their high technology counterparts.

Thinking of transferring technology? – The first step

Small and medium-sized enterprises (SMEs) that are new to China or are considering bringing new technology to China should first check the Catalogue for Prohibited and Restricted Technology Imports (the ‘Technology Import Catalogue’), published by the Ministry of Science and Technology (MOST) and the Foreign Investment Catalogue, jointly published by the Ministry of Commerce (MOFCOM) and the National Development and Reform Commission (NDRC).

Imports of technology to China are divided into “freely importable”, “restricted” and “prohibited” categories. Restricted and prohibited technologies are listed in the Technology Import Catalogue, with technologies not mentioned in the Technology Import Catalogue deemed freely importable. In most cases, technology is deemed freely importable, with only certain technologies related to economic policy development or national security, classified as restricted or prohibited. If a technology will later be exported, SMEs should check the corresponding Catalogue for Prohibited and Restricted Technology Exports (the ‘Technology Export Catalogue’) and whether there are any relevant regulations governing the item’s importation into the destination country.

Whenever technology is brought into China via foreign direct investment (FDI), such as with the establishment of a joint-venture or wholly foreign-owned enterprise (WFOE), it is important to consider the Foreign Investment Catalogue to determine what restrictions, if any, apply to the establishment of the Chinese entity. For example, foreign investment in design and manufacturing of civil aircraft equipment is limited to JVs. For technology transfers, in the form of an FDI, the permitted form of FDI will be critical when determining what contractual and non-contractual solutions one will need to protect SMEs’ IP. What can companies do to protect

What can companies do to protect themselves?

Picking the right partners

It is important to recognise that part of the motivation for a Chinese company to participate in a technology transfer is to obtain foreign technology and know-how. This fact is not a secret and SMEs should not treat it like one. Consequently, as a first step to protect IP in a technology transfer, it is important to make sure SMEs choose the right partners. Essentially, the ideal partner will be complementary, but not in a position to directly compete with European SMEs. In order to make an informed decision, SMEs need to take a closer look at how they conduct business as well as their potential Chinese partner.

Structure

Once European SMEs select the right partner, structuring the technology transfer is crucial to effectively protect IP assets. IP risk associated with a particular technology transfer will vary depending on whether SMEs are licensing, setting up a JV or setting up a WFOE. In all three of these situations, SMEs need to prevent their IP from being inadvertently leaked, intentionally misappropriated or misused by a related or unrelated Chinese party.

Contracts

In addition to structure, the other thing needed to successfully protect IP in technology transfers is to make sure the IP owner has all the relevant contracts in place and that they are airtight. It is recommended that companies use IP licensing with Chinese partners; in addition to establishing each party’s rights, the IP license ensures that the technology that was transferred was documented in case issues arise later on. This is especially necessary since Chinese companies also contribute technology and IP making it difficult to identify or differentiate.

Improvements: One of the most negotiated parts of a technology transfer agreement’s IP clause is the provision for improvement creation and the ownership of improvements made by Chinese enterprises. This is because improvements to transferred technology are often extremely valuable and form the basis of cooperation. As a result, the foreign party typically wants to own all improvements made to the technology by the Chinese party. However, there are a couple of important points under Chinese law, on improvements, SMEs need to know:

1. Commissioned IP belongs to the commissioned party unless the contract states the commissioning party
owns IP. Therefore, it is important the contract states clearly what IP is to be developed and who will own it.

2. Improvements are owned by the party that makes the improvements and cannot be automatically ‘granted-back’ to the other party without some form of compensation, or without reciprocation e.g., granting a license to the other party’s improvements. This means that the typical automatic ownership of improvements being owned by the foreign party will be unenforceable.

3. A Chinese party cannot be restricted from making improvements to a transferred technology and using these improvements. This means that a Chinese party can make improvements and any such restrictions will be unenforceable.

The implications of these three rules create many problems for European companies looking to transfer technology to China. Since the Chinese party is permitted under Chinese law to make and use improvements, European companies have to think twice about what technology they are willing to bring to China and allow the Chinese party to improve on. It is important to discuss the technology transfer with an experienced lawyer who can help IP owners come up with effective ways to structure contractual terms in order to address development, ownership, and use of improvements.

Confidentiality: It is important to include strong confidentiality provisions in the technology transfer
contract. European companies often go to great lengths to protect confidential information, trade secrets and know-how, including using key-card access, closed-circuit TV, virtual data rooms, and sophisticated document tracking measures. While these measures may be expensive and difficult to administer, they should be seriously considered if critical IP is transferred.

Reverse engineering: In addition to dealing with issues related to technological improvement, European companies must also think about reverse engineering. This is technology acquired through the process of taking apart and studying an existing product on the market. Reverse engineering is permitted under Chinese law and not considered a theft of trade secrets. As a result, well-drafted technology transfer contracts should include a provision limiting or prohibiting a Chinese party from engaging in reverse engineering.

Take away messages
• European SMEs who do not think carefully about how to guard against IP risk, when transferring
technology to China may unwillingly suffer a loss of competitiveness and market share.
• SMEs should refer to the Catalogue for Prohibited and Restricted Technology Imports (the Technology Import Catalogue) and the Foreign Investment Catalogue to make sure they will be allowed to bring technology into China.
• To protect IP in a technology transfer, it is important to make sure SMEs choose the right partners at the
outset. It is recommended that companies use IP licensing when dealing with Chinese partners.
• The IP risk associated with a particular technology transfer will vary depending on whether the SME is licensing, setting up a JV, or setting up a WFOE. However, in all three situations, the goal is the same
– to prevent IP from being inadvertently leaked, intentionally misappropriated or misused by a related or unrelated Chinese party.

The China IPR SME Helpdesk supports small and medium- sized enterprises (SMEs) from European Union (EU) member states to protect and enforce their Intellectual Property Rights (IPR) in or relating to China, Hong Kong, Macao and Taiwan, through the provision of free information and services. The Helpdesk provides jargon-free, first-line, confidential advice on intellectual property and related issues, along with training events, materials and online resources. Individual SMEs and SME intermediaries can submit their IPR queries via email (question@china-iprhelpdesk.eu) and gain access to a panel of experts, in order to receive free and confidential first-line advice within 3 working days.

The China IPR SME Helpdesk is co-funded by the European Union.

To learn more about the China IPR SME Helpdesk and any aspect of intellectual property rights in China, please visit our online portal at http://www.ipr-hub.eu/.