China IP protections

The below is part 2 of Hannibal El-Mohtar’s report on IP protections under China’s new Foreign Investment Law, which is set to come into being on January 1. For part 1 of this report, go here.

Depriving a foreign investor of their IPR in a way that violates TRIPs could give that investor an ISDS claim under a Chinese BIT

In practice, proper compulsory licenses will be excluded from expropriation claims under a BIT. This is typically provided for in a clause which disallows ISDS claims against losses resulting from compulsory licenses when their issuance is “consistent with the international obligations of Parties under the WTO Agreement [i.e. TRIPS].” As a result, in practice and in the context of investment treaty arbitrations for compulsory licenses, the issue of a treaty breach will often turn on whether or not the compulsory license was granted in accordance with the requirements of the TRIPS Agreement. In the case of China, the specific proviso mentioned in this paragraph (on compliance with the WTO Agreement) does not exist under its model BIT. The closest such clause is Article 13, which provides that a contracting party’s pre-existing legislation or international obligations which provide treatments more favourable than the BIT will not be affected by the BIT. Article 13 interacts, in this respect, with paragraph 3, Article 6, which clarifies that “measures adopted … for the purpose of general welfare, such as public health, safety and environment, do not constitute indirect expropriation.”[4] While less specific, these provisions are likely to have the same effect as the above described clauses, and ensure that TRIPs-compliant measures, like compulsory licensing for medical patents in the event of a healthcare emergency, do not expose the Chinese government to an ISDS claim.

It is another question, however, whether China can exclude liability under its BITs if an eventual compulsory license is found to be TRIPs non-compliant. The above described exclusion clauses are common in Indian IIAs (India is a TRIPs outlier, having issued several compulsory licenses in the past). India’s compulsory licenses were litigated through domestic courts and may be litigated under ISDS in the near future. In one case, Novartis AG, a Swiss pharmaceutical company, developed “Glivec”, an anti-cancer drug. After applying to have its patent registered in India (in what some described as an attempt to “evergreen” its anti-cancer drug patent), the Indian patent authorities rejected Novartis’ application. Novartis appealed and brought the case before the Indian Supreme Court, which rejected Novartis’ claim. It is conceivable that, having exhausted its options, Novartis could bring an IIA claim under the Switzerland-India BIT. This would set a precedent for ISDS, through ICSID, cannibalizing TRIPs dispute resolution, which is officially done through the World Trade Organization Dispute Settlement Understanding. While less likely, it is conceivable that a similar situation could arise if China decides to issue a compulsory license of its own over a foreign investor’s patent.

Both China’s FIL and BITs contain “Fork in the road” Clauses

China’s model BIT contains a “fork in the road” clause regarding ISDS, which allows investors to choose ISDS or domestic courts. This clause, Article 12.2 of the Model BIT, requires the potential claimant to either choose a local court, resort to ICSID, UNCITRAL, or other arbitration to resolve the dispute where the matter cannot be settled within six months. Where the claimant wishes to pursue international arbitration, China may require the investor to exhaust domestic administrative review procedures beforehand (final paragraph, Article 12.2). This clause has been “substantially watered down” in recent BITs like the one with Germany, whereby a claimant may withdraw their dispute from the Chinese court process and submit it directly to international arbitration.

Similarly, the FIL contains its own “fork in the road” clause. This clause, Article 26, gives foreign-funded enterprises or their investors the options of bringing disputes concerning administrative action to a “working mechanism” (投诉工作机制) for complaints, begin an administrative lawsuit, or pursue both options simultaneously. Article 32 of the Draft Regulations on Implementation of the FIL (the Draft Regulations) describes the role of this “working mechanism”, which is to “analyze and summarize the typical and general problems” facing foreign-invested enterprises or their investors, and to “promptly make suggestions to the people’s government at the [corresponding] level” to strengthen and improve the foreign investment environment.

Additional clarity on the FIL’s working mechanism may come from sub-national jurisdictions. For example, on September 18, 2019, the Shanghai Municipal People’s Government issued its interpretive opinions (the Shanghai Opinions) on the new foreign investment law (the first such sub-national opinions of this kind). In paragraph 23 of the Shanghai Opinions, the government tasks the Municipal Intellectual Property Office with improving the rapid rights protection mechanism of IP protections for foreign investors and enterprises, and it also, as set out in the FIL, establishes a complaint mechanism for foreign investors (Shanghai Opinions, para 26). Furthermore, Article 19 calls for the establishment for a “working mechanism” to optimize the rule of law to further protect the rights and interests of foreign businesses, with the responsible unit being the National Development and Reform Commission. While sub-state adoption is not a requirement for the FIL to have legal effect, it does signal that the jurisdiction is ready to welcome the reform by providing the investment industry with detailed provisions and additional legal certainty in this area.

China’s FIL and BIT “Fork in the road” Clauses May Prejudice Recourse to ISDS

Depending how these two “fork in the road” clauses interact, the length of time preceding an investor’s eventual recourse to ISDS may either be maintained or prolonged. Under Article 12.1 of the Model BIT, disputes must be “as far as possible” settled amicably through negotiation, and only after six months of failed negotiations can an investor begin other proceedings under Article 12.2. If the FIL’s working mechanism does not count as negotiation under Article 12.1, this may delay the required six months of tolling that precedes proceedings under Article 12.2. At the same time, an investor exercising their rights under the FIL’s Article 26 to immediately bring an administrative court action (rather than wait six months) would, under Article 12.3 of the Model BIT (“the choice of one of the four procedures … shall be final”), waive the investor’s right to bring an ISDS claim. Recall that under the final paragraph of Article 12.2, the state may require an investor to “exhaust [its] domestic administrative remedies procedures” prior to initiating international arbitration.

Because of the language in Article 12.2, the ways in which “negotiation” and “domestic administrative remedies” apply to the FIL working mechanism are extremely important. If the FIL working mechanism constitutes a domestic administrative remedy for the purposes of Article 12.2, its use by investors is mandatory should they wish to eventually pursue ISDS. This thereby delays an eventual ISDS claim. Note that investors who benefit from the BIT’s above described “watered down” “fork in the road” clause, such as German investors, will not face this issue. Moreover, if the working mechanism does not constitute “negotiation” under Article 12.2, an investor must first exhaust its remedies under the working mechanism and then negotiate for six months — all the while refraining from any administrative court action — before it can initiate an ISDS proceeding. If these two “fork in the road” clauses interact in this way, the FIL may ultimately prejudice an investor’s rights under a BIT to timely compensation. This is particularly sensitive where the asset at issue is an IPR.

Damages for Expropriation Under the FIL are Unclear, Whereas Compensation Under China’s BITs Follows the Hull Formula

In the FIL and the Draft Regulations, there is no provision for how to calculate compensation. Compensation is only described as “fair and reasonable … made in a timely manner” (应当及时给予公平、合理的补偿) in Article 20 of the FIL and Article 22 in the Draft Regulations.

Regarding compensation for expropriation under its Model BIT, China does not explicitly accept the “Hull Formula” but rather a variation thereof. The Hull Formula calls for “adequate, prompt, and effective” compensation. Instead, the Chinese provision, in the model treaty’s Article 6(4), calls for compensation “equivalent to the fair market value of the expropriated investments” made “without unreasonable delay”, and that is “effectively realizable and freely transferable.” Although different from the Hull Formula, this language is almost identical to the Australia-US Free Trade Agreement (AUSFTA), which concords with the Hull Formula’s line of cases, and as a result does not sever Article 6(4) from these cases.

Conclusion

China has improved its IPR regime by leaps and bounds. It has acceded to almost all IPR multilateral treaties, expanded its list of BIT partners, and agreed to open itself to ISDS claims by foreign investors.

Now, it intends to usher in a new era of FDI IPR protections with the new FIL. For rights holders under BITs, this will maintain and build on substantive BIT protections, but depending on how it interacts with BIT “fork in the road” clauses, it may prejudice ISDS timelines. For investors who do not benefit from a BIT, the FIL is expected to transform the protections they have over their IPR in China. In the case of patents, TRIPs will continue to play a role, either in determining whether an investor’s state can initiate a dispute with the WTO DSU, or whether an investor can initiate an ISDS claim under a BIT.

The details of the interplay between the FIL, China’s BITs, and TRIPs will become clearer in the future. Specifically, it is possible to see how a future successful ISDS claim might manifest itself by observing (1) future developments in ISDS IPR awards, (2) Chinese IPR and foreign investment legislation, and (3) influential Chinese IPR and FDI caselaw.