Many technology transfer licenses in China fail. Though it may be true that not all Chinese companies plan from the very start to violate the terms of their licensing agreements, you must not ignore that many do. A fascinating thing though is that when Chinese companies plan to breach their licensing agreement with a foreign party, they almost always cannot help but reveal this from the outset.
A Chinese company that intends to violate a licensing agreement and run off with the foreign company’s IP will usually have a very clear plan. What the China lawyers in my office call the Standard Plan works as follows. First, the Chinese company will negotiate in a way that guarantees a weak license that cannot be enforced against them by the foreign party. The tricks used to do this are quite standardized. Second, the Chinese company will ensure that it does not make any (or else it makes very few) payments until after it has already received the technology. If the Chinese company makes any payment at all, it will make a minimal number of payments, usually late and in violation of the agreement and then once it has received enough of the technology it seeks, it will cease making any payments entirely.
When our China attorneys encounter a Chinese company clearly working on the Standard Plan, we warn our clients. However, it is also typical for our clients to nonetheless want to forge on ahead. The client will usually explain how their situation is unique and that means the Chinese could not possibly be planning to breach.
These explanations are often based on common misunderstandings about how China works, or on what so many call China Myths. Here are three of the many such myths I have heard from clients in just the past six months:
1. Myth One: The Chinese company will not breach our technology licensing agreement because it needs us. The usual argument is that the technology is complex and the application know-how is critical and the important/critical information will not be disclosed until the Chinese company has made its last payment. The problem with this argument is that even though it may be factually true that the Chinese company cannot successfully implement the technology without the final data and continuing support from the foreign licensor, what really matters is that the Chinese company believes otherwise.
Far too often the Chinese company is convinced that once it gets some relatively small percentage of the technology from the foreign licensor, it no longer needs the foreign licensor. First, Chinese companies commonly believe with respect to the technology itself that the whole package is not important; the only thing truly important is the magic formula. Based on this the Chinese company will seek to extract the magic formula as soon as possible in the transfer process and with as few payments as possible, and once it has done that, they see no reason to continue the relationship with their foreign licensor. The Chinese company believes (often with good reason) that once it knows some key portion of the technology it can just hire key engineers to assist them in the implementation phase for considerably less than it would cost them to continue making their licensing payments. And get this: many times the Chinese company will bring in your former employees and consultants and former employees and consultants from your competitors to do this work.
2. Myth Two: The Chinese company is acting this way because it is inexperienced or incompetent, not because it plans to breach. This myth is based on Western arrogance and it is the rare Chinese company that does not know how to exploit it. Our China legal team sees this myth in a number of settings, including the following:
- The Chinese company submits its response to a carefully crafted technology licensing agreement 2-3 days before the deadline for executing it. The document comes back from the Chinese company with substantial revisions to the agreement terms, but with no redlining and no explanation.
- Immediately after executing the technology transfer or the technology agreement, the Chinese side insists on assigning the agreement to a newly formed subsidiary that has no assets.
- When the Chinese company’s payment is due, it reports that the bank has imposed restrictions that either make its payment impossible or that require substantially revising the agreement. And no surprise, the revisions the Chinese company contends must be done to free up payment are the exact revisions it sought but was denied during the technology license negotiations. The Chinese company will then press for the foreign company to continue transferring technical information while this payment issue gets resolved.
When we describe the above tactics as standard tools of the Standard Plan, used almost by rote by Chinese companies planning to breach their license agreement our clients will sometimes counter by arguing that these are not indicators of an intent to breach, but rather just mistakes that reveal the Chinese company’s lack of international experience and general incompetence.
This argument is based on a myth and it is seldom correct. First, Chinese companies are not incompetent. They know what they are doing just as much as Western companies and on international technology licensing agreements, probably better. If you can read Chinese, you can go to any bookstore in just about any Chinese airport and find books (yes plural) that explain exactly how to take advantage of Western companies on technology licensing deals. Second, Chinese companies are not inexperienced in the procedures that apply in international technology transfer agreements. Tech transfer has been a core of Chinese business since 1981. Chinese companies, together with their lawyers, bankers and government/private consultants know exactly how the system works. What is true is that Chinese companies know exactly what to do to get Western companies to let down their guard and give them what they want. In this way, Chinese companies that intend to breach are masters at fooling foreigners into thinking (wrongly) that they are inexperienced and incompetent. Our Chinese lawyer friends readily (and laughingly) admit all of this to us.
3. Myth Three: The Chinese company will not breach this technology transfer agreement because it takes a long view of business and it will not want to sour relations for the future. This myth is based on a general view that due to their long history, the Chinese take a long term view toward business relations. This is often explained by some vague reference to a Confucian ethic that still underlies Chinese culture, even in the PRC, a communist country.
This is just a cultural stereotype not based on recent Chinese history. I am not going to discuss Chinese culture or Chinese history in this post, but I am going to tell you what I have seen over the decades in which I have been providing legal representation on Chinese transactions (coupled with what the other China lawyers have seen in their practices as well) and that is that Chinese companies — if anything — tend to take the long view far less often than the Western companies (mostly North American, Latin American, European, and Australian) I represent. In fact, many of the Chinese business people I know and with whom I speak (in Chinese) are very skeptical about the future and tend to evince a “get it while I can” attitude about business, particularly when dealing with foreign companies, who tend to come and go and have little power or even relevance. Benefit now is real, calculation for the future is for suckers. See Is There A Chinese Mindset, And So What If There Is?
These are three commonly held myths by foreign companies that do technology transfer deals with Chinese companies. They are not true; they do not reflect reality. If you are negotiating with a Chinese company based on any of these myths, you will likely fail. Don’t do it.