Open Innovation in China—- How to Sign Technology Transfer Contracts with Foreign businesses, from the View of Foreign Businesses

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(Author: Kawamoto Keiji; Source: DeBund Law Offices)

(Translated from the Chinese version by Wang Feng)

With social, scientific and technological advances over the past years, the scope of basic technology used for new product development has been wider and wider, with technical requirements for development of such basic technology becoming increasingly higher, which has made it very difficult for a business to launch new products by relying solely on research and development (“R&D”) of basic technology on its own. Open innovation (meaning introduction of ideas created by others to push forward scientific and technological innovation or performance of innovation tasks with others to share innovation risks and achievements) has been playing an increasingly more important role in today’s world. China is known as the world factory and an important globally recognized goods and services market. In the future, it is expected that an increasing number of R&D projects will be based in China. Against this changing environment, Chinese businesses must actively adopt open innovation, enhance collaboration with other companies and organizations and push forward R&D of new products.

Technology contracts are important legal tools for open innovation. Technology contracts include patent or proprietary technology transfer agreements, R&D cooperation agreements, etc. When promoting open technology, Chinese businesses should not limit itself to collaborating with only domestic businesses. Collaboration in R&D with foreign businesses will become increasingly more important. When cooperating with foreign businesses, we frequently refer to the “special” national conditions of China. Chinese businesses should not use China’s “special” national conditions as an excuse to evade the issues, but should explain to foreign businesses the general context of the Chinese society for better understanding. Only in this way, can mutual trust between domestic and foreign businesses or organizations be established in the early stages of their cooperation. Time is a key element in the R&D phase of an open innovation project. Any mistrust between partners of a project should be addressed and resolved in the shortest time, otherwise the success of the project would be seriously jeopardized.

When forming technology transfer contracts with Chinese businesses, foreign businesses often have difficulty in understanding China’s legal systems and policies, transaction rules, payment terms, etc. Such issues will be discussed in the following passages by using a patent and technology licensing agreement as an example. This article should help Chinese businesses foresee the doubts and confusions of foreign businesses and learn to persuasively explain the terms and conditions they intend to propose to foreign businesses.

1. Terms of payment for technology transfer agreements

Payments for general commodities are usually made in full at the time of delivery. However, upon execution of a technology transfer agreement, a technology transaction has to go through a number of processes involving handover of technical materials, research, development, commercialization, production and sales. Payments for international technology transfer agreements are generally made by installments based on transferee’s performance. For example, payment of an initial fee upon execution of the agreement, payment of fees during development phase (milestone payments) and payment of license fees or royalties during production and sales phase.

Many Chinese businesses have difficulties in understanding why payments should be made to their transferor before or during the R&D phase since they have yet to make any profit (until the sales phase) and that they have to support R&D expenses.

On the other hand, foreign businesses believe that technologies are the result of their long-term investments and continuous research and development, thus receiving payments in the form of an initial fee upon conclusion of a patent license technology transfer agreement is within their right and naturally so.

Time is a key element in determining the outcome of a technology transfer transaction. A deep understanding of China’s national conditions and general context will help foreign businesses reach an agreement with domestic businesses on transaction prices as early as possible. Chinese businesses should also actively discuss with foreign businesses their ideas and points of view. It should be made known that they have a large customer base in China, and that after putting products on sale they will be able to pay considerable royalties to foreign businesses (transferors). In addition, Chinese businesses should try to understand foreign businesses’ concerns or at least to keep an open mind in this regard.

2. Performance of long-term contracts

A patent is valid for 20 years, therefore, a technology transfer agreement is also a long-term contract. China is a unique country known for its vast territory, large population and social diversity. Chinese companies differ greatly from one to another, some of which respect long-term contracts, while others would not. For these reasons, many foreign businesses worry that they will encounter Chinese business who will not respect their signed contracts and thus, their rights and interests will not be protected. This is an issue that foreign businesses usually wish to address in priority.

The Chinese government has greater regulatory power and control than most other foreign governments, and is able to change policies in an efficient manner. Achievements have been made by the Chinese government in strengthening intellectual property protection measures, amending SIPO related policies, clarifying issues with respect to the court’s jurisdiction over intellectual property cases, and further enforcing policies on the governance of China in accordance with laws. Chinese businesses need to have their foreign partners keep abreast of latest social development trends across China, and acquaint them with the prospects and tendencies of the Chinese society during the period of their long-term contracts. In any contractual negotiations, the starting point would be to reassure the other party’s worries and concerns. For the purpose of seamless and successful negotiations, Chinese businesses should take every chance to let their foreign counter parties know about the potential of China’s future development.

3. Legal systems in connection with licensing agreements

1) Applicable legal system in China

The existing Contract Law of the PRC defines technology transfer agreement as a general contract and provides specific provisions on transferor’s warranties and obligations. In addition, relevant legal interpretations (Interpretation of the Supreme People’s Court concerning Some Issues on Application of Law for the Trial of Cases on Disputes over Technology Contracts published by the Supreme Court in 2004) specify circumstances under which a contract becomes invalid because of illegal technology monopolies. The Foreign Trade Law of the PRC and the Regulations of the PRC on Administration of Import and Export of Technologies also specify the transferor’s and the transferee’s obligations in cases of technology transferred from foreign businesses. Once the basic conditions are established, the parties to a transaction should register the contract with the relevant authorities. When making payments to foreign businesses, Chinese businesses are required to submit Chinese versions (translations of original English versions) of the technology transfer agreement and have the contract registered with relevant authorities. Since few foreign businesses have employees fluent in Chinese and international technology transfer agreements are not usually drafted in Chinese, providing translations of original documents could be a heavy burden on foreign businesses.

2) Points of view held by foreign businesses and solutions

Contract laws of major technology exporters such as USA, Japan, etc. exist under the “freedom-of-contract” principle. Few countries have specific rules regarding technology transfer agreements within the framework of general contracts. As a result, many foreign businesses are perplexed about the applicable legal system and policies in China as well as the requirements for registration of Chinese versions of the technology transfer agreement with government authorities. Such policies and requirement exist partly for protection of Chinese transferees’ interests. When dealing with unacceptable terms or conditions proposed by foreign businesses during negotiations, rather than insisting that such terms or conditions are unacceptable because of legal restrictions in China, the Chinese business should note that commercialization and sale of related technology in China is the only way to maximize interests for both parties. Chinese businesses should explain specific reasons why such terms or conditions are unacceptable and offer counter-proposals and solutions so foreign businesses may understand and accept their points of view. Proposing corresponding solutions with regards to transferor’s obligations in accordance with Chinese Law is an act of protecting legal rights and interests of Chinese businesses themselves.

3) Anti-monopoly law

In China, illegal technology monopolies and unfair business practices are substantially treated according to the Contract Law and other applicable laws, while in technology export countries, such actions are mainly treated under anti-monopoly laws. Applicable foreign and domestic anti-monopoly guidelines and case laws arising therefrom are important basis for drafting the technology transfer agreements. Recently, based upon the Anti-Monopoly Law of the PRC, the Chinese government enacted corresponding rules and regulations (Provisions of the State Administration for Industry and Commerce on Prohibiting the Abuse of Intellectual Property Rights to Preclude or Restrict Competition released on 7th April 2015), however, its actual application is still to be seen. Over the past few years, the Chinese government strengthened investigation into monopolies, some of which involved multinationals and drew widespread attention. Patent license agreement is a common way to exert patent rights. How patent license agreements will be defined by the Chinese anti-monopoly law in the future is unclear, which worries most foreign businesses. Nonetheless, the recently published regulation (Provisions of the State Administration for Industry and Commerce on Prohibiting the Abuse of Intellectual Property Rights to Preclude or Restrict Competition) indicates that clauses relating to technology transfer agreements are basically within the framework of the Contract Law of the PRC and the Foreign Trade Law of the PRC. Chinese businesses should explain this to their foreign partners.

4. Conclusion

Time is a key element in determining the success of a R&D project of a new product. Technology contracts are important legal tools for open innovation. Whether Chinese businesses and their foreign partners are able to agree on subject matters of technology contracts for their transactions in a timely manner relies on whether they can establish mutual trust in the early stage of their negotiation on such contracts. When negotiating with foreign businesses on technology contracts, Chinese businesses should try to relieve their doubts and worries by taking into account notes and suggestions contained herein and to actively take on the responsibility of explanation so as to establish a mutual understanding as soon as possible.