Archives: technology transfer

The Hollywood Reporter recently did a story, entitled, “China’s Looming Entertainment Problem: Not Enough Lawyers,” discussing, among other things, intellectual property in China. Our own Beijing-based China entertainment lawyer, Mathew Alderson, was interviewed for that story and The Hollywood Reporter has kindly agreed to allow us to run a post based on the original interview.

 

Hollywood Reporter:  We’d like to first give a general overview of the state of entertainment and IP law in China.

Alderson:  There is no separate body of entertainment law as such, but it helps to understand how China generally views foreign investment. China limits the industries in which it accepts foreign investment or foreign business operations.  Foreign involvement in Chinese industries is categorized as “encouraged,” “permitted,” “restricted” or “prohibited”. Industries move between, or appear within, the various categories from time to time depending on the changing requirements of the Chinese authorities and the economy they oversee. An awareness of these categories not only assists foreigners to avoid illegal or unwise investments, it allows us also to understand the level of regulation to be expected in a particular industry as well as the business entity prescribed for that industry. Foreign involvement in the entertainment business in general, and the business of operating cinemas in particular, is “restricted” in China. It follows that there are substantial barriers to entry into the cinema business and the China film production business. These businesses are heavily regulated. Foreigners cannot operate in these areas independently of Chinese partners, so a co-production is required to make a film and a joint venture is required to set up a movie theatre.

As far as intellectual property is concerned, at first glance China’s legislative framework is world-class. This is largely because such a framework is a requirement of China’s WTO membership. The trouble is that this framework has been grafted onto a society with little frame of reference for its underlying concepts and the level of protection of intellectual property rights in China is often less than satisfactory despite the generally good quality of the laws themselves. I give some examples of current problems below.

In China, authority to adjudicate infringement and damages is vested in the courts and administrative agencies. So you have a situation in which the Chinese Patent Office, for instance, can make its own infringement determinations, award damages and issue injunctions without the need for a complaint filed in court.

One of the big issues at present is that foreign technology transfer is sometimes a pre-condition for market access. Trademark piracy remains a persistent and serious problem. Local businesses routinely register enterprise names that use famous US trademarks in misleading ways, often in conjunction with goods or services for which the US brand is famous. What we Westerners would see as Bad faith filings and trademark “squatting” are commonplace. And, as everyone is aware, DVD and online piracy are rampant. The Chinese government itself reckons that 15-20% of all products made in China are counterfeits accounting for around 8% of gross domestic product.

 

Hollywood Reporter:  Is this field developing fast enough to serve the booming Chinese film industry (expected to eclipse North America as the world’s largest film market in 5-10 years, as I’m sure you’re aware — the impressive growth numbers abound)?

Alderson:  I think it is developing steadily, but whether it serves any particular industry is another question.

 

Hollywood Reporter:  Is it reasonable to assume that more legal disputes will arise in the film and entertainment sector as the stakes rise and the value of the business grows?

Alderson:  Yes. That is a straightforward outcome of the sort of growth we are seeing. More business means more disputes in any market.

 

Hollywood Reporter:  This piece covering the “Lost in Thailand” suit quotes a consultant who suggests many studios are ill-equipped to handle IP protection issues (“Practitioners in the film industry have relatively weak awareness of intellectual property rights protection and very few companies would equip themselves with a complete team of lawyers in a film project or seek professional legal advice in advance.”) Do you agree with that assessment?

Alderson:  That may be the case with certain purely Chinese studios but I do not think it applies to everyone else.

 

Hollywood Reporter:  What kind of legal issues/problems/complaints do you think Hollywood parties are most likely to encounter/make in China?

Alderson:  It is generally assumed that China’s quota on foreign films is the biggest challenge but the quota has no application to domestic Chinese films or to official co-productions because these are regarded as domestic films. The biggest challenges are getting films approved by the Chinese censors and then getting paid a full share of box office. Foreign films must be cleared by the censors before they can be considered for the quota. Censorship comes first. China’s lack of any age rating system provides it with a useful and additional justification for censorship decisions. Censorship is a key issue because during the first 30 years or so of the PRC, foreign films were entirely banned and the film medium was seen mostly as a means of achieving “social enlightenment”. The government remains determined to subordinate the growth of the film industry to outcomes such as social stability and morality.

 

Hollywood Reporter:  What legal and other protections could and should a Hollywood studio seek when doing business in China?

Alderson:  There is a tendency to assume that US law and jurisdiction should apply to all contracts in all circumstances.  US law and jurisdiction are of little value unless the Chinese party has assets in the US. Just getting this jurisdiction piece right can be a critical form of protection.

 

Hollywood Reporter:   Are legal protections likely to be weaker for foreign parties than local counterparts in Chinese courts?

Alderson:   These days, foreign companies seeking to enforce contracts can often obtain good results in Chinese courts if the contract was written with the Chinese courts in mind and if the other party is a private company of a similar size. Having said that, it certainly is more difficult when you are suing a State Owned Enterprise (SOE) or a Government Agency.

 

Hollywood Reporter: Given that foreign (Hollywood) investment into China’s film industry, and partnership with local players, is continually increasing in scale, is it realistic to hope that new IP protection regulations might soon be passed and enforced in China?

Alderson:  Yes. Improvements are occurring all the time.  But at this point, the problem is not so much the laws and regulations, but rather, their enforcement.

 

Richard Brubaker over at All Roads Lead to China just did an interesting post on the return of China Joint Ventures. The post is entitled “Who is up for another round of Joint Ventures,” and its thesis is that China is getting tougher on foreigners so foreigners are reconsidering the value of a Joint Venture in which they can take advantage of their joint venture partner’s local connections.  Yes, but….

Richard starts his post by relating a recent conversation he had with a friend in a large multinational about the “barriers that foreign (industrial) firms have been facing recently in realizing the ROI they had planned on for their investments in China.”  The conversation then went to the question of how companies would react to these barriers:

Which opened up what I felt was the most interesting questions… Would firms roll the clock back and start all over again? Would they open up their IP for access to the market? Or… would firms begin to exit?

Questions that have no answers, but unlike 3-4 years ago when China was the only market that was providing positive growth figures for many firms, there are now questions about China’s short/ medium term trajectory and other countries that are seeing positive growth in markets like Brazil.

Which is to say that China, even for all its promise, is  perhaps not as compelling as it once was depending on the industry, timing of the cycle, and whether or not the firms felt like they had heard that song before.

JV 2.0?  Is it right for all firms?

Things that make you go hmmm.

First off, Joint Ventures are not right for all firms. In fact, they are wrong for most firms.

But Richard definitely makes some good points. China is getting tougher on foreign businesses, both in the way government is treating them and in terms of competition.  But in determining how to go into China, there is absolutely no “one size fits all” solution and for most companies, there are a whole host of options short of jumping into bed with someone you do not know well.

For those who are not familiar with the inherent risks of China joint ventures, I urge you to read at least some of the following:

To grossly summarize all of the above posts/articles on China Joint Ventures, they are risky because you are not on an even playing field with your joint venture partner who may end up having a lot of incentive to kick you out of the joint venture just when the joint venture starts taking off.

Fortunately, there are all sorts of ways to dip one’s toe into China, without doing a Joint Venture.

Opening a Rep Office is one of those ways.  In the old days (say 5-7 years ago), Rep Offices were the traditional way to test the China market.  Forming a Rep Office was considerably cheaper and easier than forming a Wholly Owned Foreign Entity (WOFE) or a Joint Venture and yet by doing so, the foreign company could enter China on its own. The problem today with Rep Offices, however, is that the Chinese government has so limited their range of activities, that they now make sense for only a tiny subset of companies seeking to do business in  China.  For more on what it takes to set up a Representative Office in China and the pros and cons of doing so, check out the following:

But here’s the thing.  For many companies seeking to do business with China, neither a WFOE nor a Joint Venture, nor even a Rep Office makes sense.  For many companies seeking to do business with China, avoiding going into China at all can be the best option.  In fact, these days, in most instances when a company calls us wanting “to go into China,” our default position is to try to figure out how that company can achieve its China goals without going into China at all.  I am always saying that running a company in the United States is very difficult and time consuming and anyone planning to go into China must first realize that running a company is much more difficult and time consuming there, ignoring even the language and cultural difficulties.  Oh, and it is expensive as well.  Of course.
So if “going into China” via a WFOE, a Joint Venture, or a Rep Office does not make sense, what else is there?  Many companies have no real desire to go into China at all. Rather, their real desire is to make money from China by selling their product or service or technology to China. Looking at it that way, there are three common additional options:
  1. Selling your product into China via a distributer or distributers based in China.
  2. Selling your product into China simply by exporting it from your own country.
  3. Licensing or selling your brand name or your technology to a company in China.
Earlier this year, we did a post, entitled, Selling Your Product To China Through A Distributor. Just The Basics.  That post started out talking about how distributorships are a viable option for getting one’s product into China, without having to form any sort of China entity to do so:

I often get calls from companies that want to get their product into China or increase sales there. Many times, they are under the false impression that they have two choices: go it alone or form a joint venture with a Chinese company. Entering into a distributorship relationship with a Chinese company (or companies) is another option. From a strictly legal perspective, distribution relationships between foreign and Chinese companies are actually fairly straightforward and are far easier and generally less risky than joint venture deals and typically far less costly and time consuming than going it alone.

From a business perspective, taking most products into China (be they industrial or consumer), marketing it, selling it, and then delivering it, is a massive task for any foreign company. I hate to trot out a cliche, but China is a big and diverse country and it should be viewed as many markets, not just one. Yet with China’s wealth rapidly increasing, it is the rare company that is not at least desirous of adding China to its list of markets. China is becoming a consumer/buyer nation.

For more on China distributorship relationships, check out the following:

Licensing or Technology Transfer arrangements are other options for monetizing a product, name or technology in China and we have seen a number of companies succeed with those. In a licensing or technology transfer deal, the foreign company can sell rights to a Chinese company for a limited geographic area (maybe just China) and/or for a limited time.  Alternatively, the foreign company can just sell the rights to the Chinese company.  This sale of rights too can be limited geographically or even by product.  For instance, XYZ foreign company may make 20 different products but license or sell rights to use its name and product technology and product IP (such as patents) for only one product and limit that even further by limiting the geographical use to just China.  For more on China licensing agreements, check out the following:
Lastly, and certainly not least, is the option of simply export sell your product into China from your own country. We have clients who have done this particularly successfully with things like industrial equipment, where there is a real and perceived benefit to having the product made in the United States and selling from the US and shipping from the US works just fine because the price is so high (typically $100,000 and up) for the product that shipping costs are not that big a factor.  For more on this straight selling and exporting method, check out the following.

So what is the best way to do business with China?  It depends….

What do you think?

We have been drafting an increasing number of contracts for foreign companies licensing their concept or technology for use in China. In the old days, this type of licensing was primarily in the industrial sector. These days, most of our work has been on licensing agreements in the services sector in China. Much of this licensing is for operations in China that are prohibited from direct participation by foreign companies, such as in publishing, media, telecom, insurance and finance. Most of these foreign companies are choosing to license, rather than to participate in a China Joint Venture.  This post describes the negotiating tactics I so often see from the Chinese side and sets forth how foreign companies can counter those tactics.

The Chinese government is internally conflicted on how to treat this new form of licensing. In industrial sector licensing, the Chinese government is eager for the technology transfer to occur. The same is not true in the service sector. On the one hand, the Chinese government formally welcomes the transfer of Western expertise in the service sector. On the other hand, the Chinese government fears that U.S. participation in China’s service sector will result in unacceptable control of the Chinese system. As always, the Chinese government is uncomfortable with the introduction of Western intellectual concepts into China.

This ambivalence is mirrored by many of the potential licensees that we deal with in the service sector. Industrial licensees bargain hard, but the bargaining is similar to any commercial negotiation. In the service sector, we are finding that the Chinese side works to strike a much harder deal. This often surprises our clients, since they expect the service side to be softer than the industrial.

As part of this process, in service sector licensing contracts we are starting to see the Chinese side dust off negotiating tactics that were common in the 80’s and 90’s when the Chinese were negotiating their famously dysfunctional joint venture agreements.  In negotiating service sector licensing agreements with Chinese companies, we are seeing the following tactics from the Chinese side:

  • The most common tactic is for the Chinese company to seek to wear the foreign side down with endless issues. This tactic actually has two variants. In the first variant, the Chinese side raises a series of issues. As these issues are resolved, the Chinese side then raises a series of unrelated new issues. The list of issues is endless and the process never stops. The second variant is for the Chinese side to make a several unreasonable demands and then refuse to address the concerns of the foreign company on the other side. As in the first variant, the discussions proceed with no attempt at all by the Chinese side even to pretend to address the concerns of the other side. All of this is designed to simply wear down the foreign side in the hopes that the other side will simply concede. When the other side concedes, the Chinese side then inserts provisions in the agreement that are beneficial to the Chinese side, under the assumption that the foreign side is simply too tired to object. The success of this strategy rests on the negotiators on the foreign side being busy people with a lot to do, while the negotiators on the Chinese side are functionaries who have no other job but to involve themselves in the endless negotiation.
  • My favorite tactic is the artificial deadline. It is my favorite because it is such an obvious manipulation of the foreign side and yet it seems to work extremely well. The tactic works like this. At the very beginning of the negotiating process, the Chinese side sets a fixed date for executing the contract. It then sets up a public signing ceremony on that date, at which high-level officers from both sides will participate amidst much pomp and circumstance. The date is set far enough in advance to ensure that parties negotiating in good faith can reach agreement on the contract. The Chinese side then ensures that no agreement is reached. This results in panic on the foreign side, since failure to get an agreement that the bosses will sign is seen as a loss of face. The Chinese side then uses this concern to extract concessions from the already exhausted foreign side negotiator.  This tactic also has two variants. The first variant is the crude approach. The Chinese side simply refuses to concede on key points under the quite reasonable assumption that the foreign side will crumble when faced with the fixed signing deadline. The second variant is much more subtle. In this variant, the Chinese side initially concedes on key points, while still holding its ground on numerous minor points, consistent with the “wear them down” tactic. Then, just a day or two before the signing ceremony, the Chinese side announces that the contract must be revised on one or more key issues in a way that entirely benefits the Chinese side. The Chinese side usually justifies this by refering to the demand of a “government regulator” or an outside source such as a bank or insurance company. The claim is “we don’t want to go back on our word, but these other folks have forced us to do this.” Again, the plan is that the combination of the pressure of the impending signing ceremony and the general fatigue of the negotiators will result in a crucial concession favoring the Chinese side.
  • The final technique is to come back to the key issues after the lawyers have left the room. Again, though this is an obvious technique, it seems to work very well with service businesses. This tactic involves the Chinese side signing a contract, conceding on the key issues. By virtue of the contract having been signed, the key negotiators, China advisors and most importantly the lawyers, are off working on other projects. The Chinese side then waits a reasonable time and works to get the project started. Once the project is started, the foreign side is then invested in the project. Since service projects involve people, rather than machines or product, this means certain key persons on the foreign side are now fully committed to the project. Once this happens, the Chinese side then comes to the committed parties on the foreign side and announces that certain key provisions of the contract must be changed. The Chinese side usually claims this change is mandated by law, government regulators or banks and insurance companies. The only people left at this point are the “committed parties” with a strong incentive to allow for the change so the project can proceed. Often, these people do not even fully understand the implications of the change the Chinese side is now demanding. The foreign side then presents the change to busy upper level management as a minor technical revision and it gets signed. Everyone remembers how the initial negotiation was so troublesome and nobody wants to bring in “legal” to start the process over again.

Though crude and obvious, the three tactics work wonderfully well and so Chinese companies do not hesitate to employ them regularly (pretty much always).  There is one simple antidote for each tactic:

  1. If the Chinese side uses the “wear ’em down technique,” the foreign side should refuse to participate. The foreign side should firmly state its position and not bend unless and until the Chinese side agrees or at least moves closer to the foreign side’s position.
  2. Never agree to a fixed signing date. Make it clear that the signing ceremony will be scheduled only after the contract has completed final negotiations. If that takes forever, then it takes forever. Never allow the Chinese side to use a deadline as a tool. This seems like obvious advice, but we see the rule constantly violated. Chinese companies love signing ceremonies and foreigners fall into the trap because they do not want to cause offense at the start. The Chinese have contempt for a sucker, so refusing to go along on this obvious technique will not cause offense: it will instead earn the respect of the Chinese side.
  3. Make it clear to that there will be no changes to the contract after signing and any attempt by the Chinese side to change the contract will be treated as a material breach, leading to termination and a lawsuit for damages. Chinese companies are well known for using the signing of a contract as the start of a new negotiating process, not the termination. If the foreign party is willing to accept this approach, then a clear procedure must be instituted on the foreign side that brings back in the legal and China advisory team. The neutral players on the foreign side must make the decisions. The decisions should not be made by the foreign side players who have already become committed to the project.

Negotiating a good licensing agreement with Chinese companies is difficult and time consuming, but not so much if you know how to handle Chinese negotiating tactics.  There is no reason to make the situation worse by falling for the simple negotiation tactics discussed above.