Under U.S. pressure, China recently adopted a new Foreign Investment Law 中华人民共和国外商投资法 (“FIL”) that had been under discussion for several years. Many believe this law will lead to foreign invested enterprises being treated the same as domestic Chinese private businesses. Unfortunately (and not surprisingly), the existing system that limits foreign participation in China’s economy will be retained.
The actual effect of China’s new Foreign Investment Law will be to eliminate the few remaining policies that benefit foreign investors as compared to domestic Chinese businesses. This means foreign investors will no longer be treated better than Chinese nationals; they will instead be treated the same or worse. Just to be perfectly clear, the new law does not confer benefits on foreign investors; it merely represents the final step in a decade long process of China eliminating incentives to foreign investors that were formerly used to encourage foreign investment in China. In that sense, the intent and impact of the new law seems to have been fundamentally misunderstood by most who have commented on the law and I will be doing a series of posts on what this new law really means for foreign investors.
Though the new Foreign Investment Law constitutes a revolution in the way China deals with foreign investment, most interest in the West has been on a single completely irrelevant provision that deals with forced technology transfer. The focus has been on Article 22 below:
Article 22: The State protects the intellectual property rights of foreign investors and foreign-invested enterprises according to law, protects the lawful rights and interests of intellectual property right holders and relevant right holders, and encourages technological cooperation based on the principle of voluntariness and business rules.
The conditions for technological cooperation in the course of foreign investment are to be negotiated by the various parties to the investment, and administrative organs and their employees must not force the transfer of technology through administrative measures.
Does this provision resolve the current dispute between the United States and China regarding forced transfer of technology? Absolutely not. This provision merely states what has been the law in China for many years. In the 90s, it was common to condition approval of Sino-Foreign joint ventures with the requirement that the foreign entity in the proposed joint venture transfer its technology to the joint venture entity as part of the foreign investment. Under that system, foreign investors were given substantial incentives to invest in China, including reduced land and rent costs, reduced utilities costs, freedom from various forms of taxation and tariffs, and reduced employee salary and social benefit obligations. In exchange for these substantial benefits, it was commercially reasonable for the Chinese side to require the foreign company engage in technology transfer. It was not exactly a forced transfer; it was more like an even commercial trade.
After China entered the WTO, these incentives were gradually withdrawn. In addition, the need to operate as a joint venture in China mostly disappeared and most investors chose to operate as WFOEs. In this new environment, foreign investors had fewer commercial reasons for transferring their intellectual property as part of their investments in China. The foreign investors cash and equipment was enough, and that is the way most savvy foreign companies structured their China investments.
For these reasons, Article 22 of the new Foreign Investment Law merely states what has been and still is the current law: the intellectual property of foreign invested companies will be protected on the same basis as any private Chinese company. This is what Chinese law already provides. Since Chinese government officials do not now have any role in approving foreign investment projects, the officials have no ability to force technology transfer as a condition of approval. So (once again) Article 22 simply sets forth existing law. Article 22 does not add anything positive or negative.
I can though confirm from the hundreds of China deals on which I and my law firm have worked that forced technology transfer continuously occurs in China. Moreover, unlike the 90s, where the transfer was compensated for by numerous benefits given to the foreign companies, the current form of forced transfer is a one way street where all the benefits go to China and the foreign owner of technology receives little to nothing in return. But these forced technology transfers arise from how business is conducted in China, not from the operation of formal legal rules.
A description of how forced technology transfers work in China today shows why Article 22 is not relevant. Here is an example. Take a German company that has developed a hand held medical testing device. The device is perfect for use in Chinese hospitals and clinics. The German company hires a salesperson and offers to sell the device at a good price to Chinese hospitals.
The hospitals tell this salesperson how they really like her company’s medical device but they cannot buy it because China’s national and local health administrations have ordered them to limit their purchases to products manufactured in China. They tell her that if they try to pay for this device in Euros or dollars, the local bank will not allow them to convert their RMB to either. Moreover, the local government requires them to obtain a formal RMB tax receipt, a document you cannot provide.
So the German company proposes trying to solve the payment problem by using a Chinese distributor for its medical device, figuring the Chinese hospitals can pay their distributor in RMB and their Chinese distributor can in turn issue a tax receipt. The hospital replies that still will not work. If we make use of a device not manufactured in China, our health administrators will not approve.
This sort of situation described above goes to the core of forced technology transfer. The problem is not forced technology transfer per se. The problem is forced manufacturing in China. In a normal commercial world, the German company would not consider manufacturing offshore in a difficult place like China. In a normal world, having to manufacture in the home country of the buyer is not even considered an issue.
The normal international commercial practice for the foreign buyer to simply purchase directly from the German company. If more servicing is required, or if payment in local currency has advantages, the foreign buyer purchases the product from a local distributor. But manufacturing remains in the seller’s home country or in whatever country the seller normally operates.
It is a unique feature of China that the buyers will not accept this normal commercial practice because oftentimes they simply cannot. It is a unique feature of China that buyers will tell you that you need to have your product made in China for them to be able to buy it. And then, once the manufacturing of the product is moved to China, it is almost inevitable that the technology will be appropriated (i.e. stolen).
This is why China’s new foreign investment law is not relevant on the issue of forced technology transfer. This new law applies only after the foreign owner of technology has decided to invest in China to manufacture its products in China so as to meet the demands of its Chinese buyers. That is, the price to entering the Chinese market for these medical devices is accepting forced manufacturing in China.
China’s new foreign investment law applies only after the foreign owner of technology has decided to pay this price. It is true that many foreign manufacturers of very sophisticated products are able to hold the line and refuse to pay this price. But for many others, there is no alternative. Either ignore the Chinese market or pay the price of entry. But once the price has been paid and manufacturing has been moved to China, it becomes very difficult or even impossible to protect the technology from infringement. So once the price has been paid, the game is over for the foreign investor. For an example of one way these technology thefts often go down, check out The Huawei Indictments are the New Normal. China’s new Foreign Investment Law is deliberately and entirely silent on anything having to do with forced foreign manufacturing. Indeed, to the extent the new Foreign Investment Law makes China’s foreign investment process easier and more certain, it actually facilitates forced technology transfers.
Forced manufacture in China is an issue created by Chinese government policy. This being the case, ending it requires the Chinese government, and Chinese regulatory agencies and Chinese banks reverse their policy forcing Chinese companies to limit their purchases to products manufactured in China. But this sort of change goes directly against the overall policy of the Chinese government to make China the new technology factory of the world. China cannot become the technology factory of the world if it purchases products made in foreign countries. This is why nothing has changed and why nothing will change. This is also why I can unequivocally state that none of the China manufacturing lawyers at my firm nor any of our China IP lawyers have seen any hint of a change in the way our own clients are treated in China.
Which then leads back to my fundamental conclusion: Article 22 of China’s new Foreign Investment Law is not relevant to the issue of forced technology transfer. On that front absolutely nothing has changed and nobody should expect it to either.