China licensing Agreements

I am going to be speaking at USC this weekend and in poring over old PowerPoints (to create a new PowerPoint for my talk), I came across one with a fairly extensive China law bibliography of some of our most helpful posts.  This bibliography is definitely slanted towards the legal issues that confront foreign companies doing business in China.

Here it is:

CHINA CONTRACTS

CHINA LICENSING AGREEMENTS/CHINA DISTRIBUTOR AGREEMENTS/CUSTOMS

CHINA COMPANY FORMATION/CHINA WFOE FORMATION/CHINA JOINT VENTURES

NEGOTIATING WITH CHINA

CHINA —INTELLECTUAL PROPERTY

Twice in the last week, clients told me that their China sales had greatly increased in the last few months due to (not in spite of) China’s economic and other problems.  One of these companies sells a high end (but definitely not top of the line) home item.  The other sells industrial testing equipment. Both have been doing business with China for years.  Both are getting not only seeing increasing sales, but they both are getting all sorts of new (and real) offers to distribute their products.

Why?

I think it is because Chinese companies and consumers are starting to focus more on quality and value (defined as cost to quality/durability), as opposed to just price. I (and both of our clients) also think China’s new-found desire not to buy from Japan is also playing a major role.

Co-blogger Steve Dickinson recently wrote an article for Stratfor on how to negotiate with Chinese companies in which he talked of how our law firm’s China licensing practice has been growing at warp-speed:

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.

I would add that our writing of all types of China licensing agreements has increased and this too I attribute to an increased desire of China buyers for American goods and services.

Needless to say, I am not the only one seeing this impressive uptick for American companies.  China negotiation expert Andrew Hupert (and author of an excellent book on Chinese negotiations) asserts in his post entitled, How I Learned to Stop Worrying and Love the Rocky Landing that “the bargaining position for US negotiators in China hasn’t been this strong in years”:

1. USA is the calm, steady safe haven again.    Remember back to 2008 when all the globo-pundits were talking about the end of the American Generation? The Asian Age? The China Generation? The Bo Dynasty? They were predicting riots and unrest in US cities as chaos forced anyone of means to flee for his life. We may have our issues, but we’re still standing. China, however, has been a little quick to hit the panic button. At least our rich kids keep their passports.

2. The China middle-class market is no longer a lock-out that you can’t touch. In the post-crash days, it was briefly cool for well-heeled Mainlanders to buy local – but as China Inc. stumbles, confidence is down and investment has dried up. Even if the trend shifts from ostentatious super-lux brands to low-profile value buying, Western labels are still the first choice.

3. Brands, brands, brands. In China, the low cost model has crapped out, and the SOEs are drowning in their own inventory. Climbing the tech ladder is a long, slow slog. Chinese companies from automakers to oil companies want to build or buy name brands that they can take global. Western names and know-how are in demand again.

4. A new wish list for China business owners – export markets and international presence. What’s old is what’s new as Chinese look for Western expertise to keep their economy churning. It’s not capital or manufacturing technology this time – branding, international sales and process R&D are the deal points that count.

5. You’re (relatively) rich again.The local flippers are pulling up stakes. Chinese who made money in real estate or from cheap labor are cashing out and heading for the exits. Banks are cutting back and international investors are getting nervous. The China Miracle is looking a little risky for the first time in recent memory. American expanders have traction again for the first time in half a decade. But this time, don’t play the sucker game of driving prices to the bottom – pay a fair price but find ways to push quality up.

What are you seeing out there?  Ignoring how China continues to step up its weeding out of any foreigner or foreign company that is not in China completely legally, are happy times for American companies really here again?

The Globe and Mail did a story the other day, entitled, “Bombardier to share railway technology with Chinese.”  The story is on how Bombardier has granted a ten year license of its tram technology to “a subsidiary of China South Locomotive & Rolling Stock Corp. Ltd., the biggest player in the railway manufacturing sector.”  Under the deal, “Bombardier will supply documentation, training and other assistance in manufacturing and selling the streetcars to South China unit CSR Puzhen.”

The article raises IP concerns about such a deal:

This type of licensing-only agreement and other partnerships, however, raise concerns in some quarters that Bombardier is simply helping China develop its rail expertise so as to eventually become a major global rival in manufacturing trains and subway cars.

“I don’t think Bombardier is going to get much of a bump on this. Bombardier will regret it in 10 years when China starts mass producing their own versions,” said Malcolm Johnston, a transit advocate based in British Columbia.

Bombardier seeks to refute such worries by stating that “the key to these types of partnerships or joint ventures is to stay ahead of the innovation curve.”  The Facebook buzz, among people I greatly respect, is decidedly negative about Bombardier’s deal, and I note the following comments:

  • It’s the maglev technology transfer all over again.
  • Canadians
  • GE is the American version of Bombardier. They’ve been trading away entire industries.
  • If history is a good predictor of things to come, then I look forward to seeing their partner “innovate” upon the technology transferred and export “their” technology to markets around the world.

I eventually chimed in with the following and got the following responses:

Me: May turn out to be a brilliant move. Not kidding.

Response: How do you figure this will turn out any different from any other foreign company that has placed their technology in Chinese hands, Dan? The goals of the Chinese haven’t changed.  I don’t blame the Chinese for copying as much as I blame gullible foreigners for making it so easy.

Me:  You-all are making all sorts of conclusions. I will do a post on this, asserting that this sort of deal MAY be the wave of the future. Of course the goals of the Chinese haven’t changed and of course they do and will do whatever they can to steal technology. That isn’t the issue.

Response: I look forward to your post on this, Dan. From what I can tell “this sort of deal” looks like most of the others that have come before. It seems reasonable to expect a similar outcome.

Okay, here goes.

First off, let me say that I have represented hundreds of businesses in my legal career, ranging from one person operations all the way up to the largest company in the world (at the time) and, generally, I have found that nobody knows their business better than the people whose job it is to know the business. That alone makes me reluctant to criticize a company for a prospective move, especially when I no doubt lack many of the relevant facts.

The facts in the press are not enough to know whether Bombardier’s China technology licensing deal makes sense for Bombardier or not.  What if Bombardier is being paid $10 billion a year?  It’s a great deal, right?  What if Bombardier is licensing out an existing technology and it knows it is only a year or two away from a next generation technology that will put the existing one to shame?  What if this is an industry where the product is only one small aspect of a buyer’s decision, and Bombardier is rightly confident that no Chinese company will ever be able to compete on the more important aspects of installation of product, maintenance of product, and/or repair of product?  Or what if Bombardier knows that the product it is licensing is going to be surpassed by various competitors’ products within the next year or so and this deal is a profitable way to unload it? I do not know if any of these things are true, but isn’t it more likely that Bombardier knows what is best for Bombardier than my friends on Facebook? And anyway, what were Bombardier’s alternatives if it was going to make money in China?  I don’t know, do you?

This is not a comment about my friends on Facebook (who were participating in a relatively private discussion), but it has always bothered me how there are some China pundits out there who are always quick to criticize how certain companies are doing in China (usually noting how they are not moving fast enough), while ignoring all of the China factors that make doing what the pundit suggests so difficult.

I actually like what Bombardier is doing and it is something that we are seeing with increasing frequency among our SME clients. Licensing a technology to a Chinese company for a fee and then charging that Chinese company even more money to teach it about the technology oftentimes makes sense for SMEs without the capital or the desire to go into China on their own. I hate to equivocate like a lawyer, but the bottom line is that sometimes licensing makes sense and sometimes it doesn’t, and it is hard for us to judge from afar those companies that do it.

For more on licensing to China, check out the following:

  • China Intellectual Property (IP). I Hate Cats, in which we give the following advice to help assure payment from those to whom you license your IP:
    • Base your pricing on the assumption that you will not get full payment on your final payments.
    • Do whatever you can to make sure the Chinese company still needs you at the end of the deal so that the Chinese company has no choice but to keep paying you.
    • Put in some killer provisions in your contract that deal with a situation where the Chinese company stops paying at the end.

What do you think?

Santiago Cueto of the International Business Law Advisor Blog did a post, entitled, “6 Key Provisions You Should Include in Your International Licensing Agreements” [link no longer exists]. I borrow extensively from that post for this one, which is tailored more towards China. I list out Santiago’s tips in bold and then provide his explanation in normal font and then my comments in italics, I explain how they relate to any licensing agreement you might have with a Chinese entity. This post is formulated towards assisting a Western company looking to secure royalty payments by licensing its technology to a Chinese entity.

Again, please note, all of the below in normal font is directly from Santiago’s post. My comments are italicized.

Exclusive Property Rights.  Preliminarily, before you start negotiating a license agreement, make sure you have exclusive property rights. While the law often changes in this area, the best way to lock in your rights is to register for any or all of the following that apply to your situation:

Copyrights – original works of authorship fixed in any tangible expression form

Patents – inventions

Trademarks – words, names or symbols identifying goods made or sold, distinguishing them from others

The application process can be rigorous, and you may have to disclose your ideas publicly. So you may also want to further protect your intellectual property by relying on laws. Generally, these laws protect internally guarded ideas, formulas, codes or other information giving a business competitive advantage. A good example is source code to software.

All this is true for China, only more so. It borders on suicide to license your IP to a Chinese company without doing everything you can both outside of and within China to protect your IP through registrations or otherwise.

6 key provisions  I’ve selected 6 key provisions that should be included in your foreign license agreements:

1. Approval of licensed goods. When major US manufacturers license products to companies abroad, they often arrange periodic inspections of the manufacturing facilities to ensure the quality of the goods (and also to monitor whether the licensee is siphoning off products or engaging in illegal labor practices). This offers you some assurance of consistency and quality for your work.

2. Royalties and accounting. Payment of royalties from a foreign licensee can get tricky, especially when you consider issues like:

• currency conversion rates (probably best to always insist on payment in US currency)

• how the money will be paid (best to use wire transfers), and

• what taxes may be applied against your sales or royalties (before signing the license, inquire into national or local tariffs or taxes that may apply). Also, it’s wise to include an audit provision (which allows you to inspect the foreign licensee’s books).

Western companies often license their technology to Chinese companies based on the sales of the Chinese company’s product containing the licensed technology. In other words, the licensing agreement provides for the Western company to get $2 per widget sold. This sort of per product deal makes sense only if the Western company truly has the ability to audit sales. I have seen far too many instances where the Western company is not able to discern the sales of the Chinese company and then ends up getting paid way way less than it expected. I usually counsel my clients to get as much upfront as possible and to figure that amount may be all that is ever received.  

I find royalties/accounting to be the key issue in a good licensing agreement.

3. Jurisdiction. Sometimes referred to as personal jurisdiction, jurisdiction is the power of a court to bind the parties by its decision. Unless the company does substantial business in the states, the only way to get a foreign licensee into a US court is to include a provision in the license agreement that requires the licensee to consent to US jurisdiction.

Think long and hard about where you want to have your disputes against the Chinese company to whom you are licensing your technology. The problem with United States courts is that Chinese courts pay absolutely no mind to their judgments. In many situations, a Chinese court or Chinese or Hong Kong arbitral body will be your best choice. It really varies with the individual situation.  

4. Choice of law. Every country (and every state) has laws as to how contracts are interpreted. The licensee will want the disputes to be resolved under the laws of its country. Try to include in your agreement that disputes will be resolved under US law for copyright purposes and the laws of your state when it comes to contract issues.

I am more neutral than most on these provisions. I take the position that contract law is generally contract law and the contract law among countries is typically not all that dissimilar. Having said that, one should absolutely research any particular contract law issues peculiar to the individual licensing agreement so as to be able to choose the law that will be most favorable. 

5. Arbitration. In arbitration, instead of filing a lawsuit, the parties hire a neutral arbitrator to evaluate the dispute and make a determination. You’ll almost always benefit by agreeing to have disputes arbitrated and inserting this in your agreement. If possible, your agreement should award attorneys’ fees to the prevailing party in the arbitration.

Try to get the licensee to agree to arbitrate the matter in the United States. If the licensee does not agree, there are three popular spots for international arbitration:

• London (The London Court of International Arbitration)

• Paris (The International Court of Arbitration of the International Chamber of Commerce), and

• Stockholm (The Arbitration Institute of the Stockholm Chamber of Commerce).

Putting a more Pacific Rim focus on this, I note that I like Hong Kong (expensive but top of the line), Singapore (less expensive, but really good) and Vancouver, Canada (Not terribly expensive, yet still really good).  More importantly though, I also note that arbitration is oftentimes NOT the best way to go when dealing with China.  

6. Foreign registrations. If your works are protected by US intellectual property laws like copyright or design patent law, you should determine whether it’s worth your while to obtain foreign copyright or patent registration in the countries where your work is being manufactured or distributed (this will be the subject of a future post).You may be able to require that the licensee handle these administrative tasks.

As mentioned above, this step can be absolutely critical for China. There is one other step that is also absolutely critical (and for those who are counting, this is the eighth tip, with the preliminary tip being the first one — sorry but for good luck reasons, I had to get it to eight!) for China and that is registering the licensing agreement itself, which is required pursuant to Chinese law.  

For more on licensing technology to China, check out the following:

Fear The China Joint Venture And Front-Load Your China Licensing Agreements

China Intellectual Property (IP). I Hate Cats, in which we give the following advice to help assure payment from those to whom you license your IP:

  • Base your pricing on the assumption that you will not get full payment on your final payments.
  • Do whatever you can to make sure the Chinese company still needs you at the end of the deal so that the Chinese company has no choice but to keep paying you.
  • Put in some killer provisions in your contract that deal with a situation where the Chinese company stops paying at the end.

What are you seeing out there in the world of China technology licensing?

This is part 20 in a long existing (but of late somewhat dormant) and intermittent series of posts on China’s service sector. We wrote Part 1 back in January, 2006 and that post can be found here.

I was spurred on to write this post after a ultra-long conversation with co-blogger Steve where we updated each other on the matters on which we are working together. Like everyone else in China, Steve took last week off and this was our first opportunity to talk so much had piled up.

At the end of our conversation, we talked of how foreign service companies are doing so well in China, but of how there has been so little media on this. As Steve put it, the real market is still the “sale” of good technology to Chinese companies and to foreign companies doing business in China.

The bulk of our discussion centered on the following matters, stripped of anything that might identify the actual client or project:

1.  We talked of a client who has been contacted by the foreign manager of a foreign-run building needing repairs. The manager has become convinced that no Chinese company is capable of figuring out the plans for the building and then effectively repairing it in such a way as to maximize quality while minimizing disruption. The Chinese companies simply cannot do the engineering and the project management to the standards required. This same foreign engineering outfit is doing an engineering analysis of a foreign company’s facility to reduce energy consumption.

2.  We talked of another company that has been retained to do the annual internal audit on the stores in a foreign retail chain. This foreign company does not trust a Chinese company to do this audit because it is concerned with corruption. We have been told that corruption has two impacts in this sort of situation. The first is the obvious impact is the risk of bad information because of payoffs. The second is the less obvious impact that since payoffs are so common, the auditors who take the payoffs never actually learn how to do the work to high standards. 

Run of the mill Chinese companies are used to this system and simply accept it. The foreign owned and ultra high end Chinese companies are not able or are not willing to accept this. So there is a growing market for providing this kind of technical service to foreign owned companies in China. 

I have written of this previously in the area of technology, in a post, entitled, “That’s Hot: Made In China For China. By Foreigners.” In that post I talked of how my law firm was working on a large number of technology licensing contracts between U.S. companies and Chinese companies that were seeking to improve their quality to meet international standards. Similarly, in “China Law. Making Money Off The Misery Of Others,” in discussing the areas in which our China law work had actually increased due to the West’s bad economy, I mentioned technology licensing deals:

Licensing deals. This is a strange one, but both of us attribute this to the bad economy as well, or at least to the fact that China’s economy is doing so much better than the West. We both talked about how over the last year or so we have been seeing a marked increase in Western companies licensing their technology and/or name out to Chinese companies. Struggling companies are more likely to jump at this chance for extra revenue. 

And when I was asked the other day on a public radio interview to list out what I saw as the best opportunities for foreign business in or with China, all or nearly all of my list were in the service sector:  

I was asked where I saw the most opportunity for foreign businesses in China. My answer was education, healthcare, food, cleantech/greentech, and software. It is the same five industries I have been saying for years and the one that always seems to draw the most surprise is food.

I know food is a product, but when I am saying food, I am thinking more of the quality control and logistics and service that go into it as I am of it in its natural state.  

What are you seeing out there?

By Steve Dickinson

There has been much discussion lately about China’s domestic innovation/indigenous innovation policy. Foreign Affairs Magazine recently did an article on this entitled, “China’s Innovation Wall, setting forth the standard Western view, which is that this policy will be terrible for America. 

The standard view is wrong.

1. China’s currently conceived policy will certainly fail. If it were actually implemented, the requirement that all government purchases use Chinese technology would cripple the Chinese government. This is because Chinese domestic companies simply do not yet have sufficient technology. Moreover, if China were to eschew adopting the current international technological base, it could not “innovate” any new products. The program is therefore self-defeating.

2. The article repeats the common and outmoded complaint that China is trying to leapfrog the West by simply stealing Western technology. Of course, China will try to do this. That is what the U.S. did in the 19th century and it is what every technologically backward country does and will almost certainly continue to do. However, China is an export driven economy. To the extent China “steals” technology, the world system will shut China down.

3. The other standard complaint repeated in the article is that China is using its new innovation policy to force foreign companies to give their technology away at an unfair price. The appropriate response to this by foreign companies is to refuse to comply. 

China’s domestic innovation policy is part of a larger program initiated in 2006 designed to make China into a world power innovator in technology. The real issue in China is that this policy has been a dismal failure. There are few signs of any improvement in technological innovation in China. Chinese companies, government and educational institutions seldom innovate; they appropriate and adapt.

China remains nearly totally dependent on foreign technology. This bothers the leaders in Beijing, of course, and one response is for them to initiate ill designed policies like the domestic innovation initiative. This policy should be seen for what it is: a desperate attempt by China to force innovation through a top down directive.  

The fact is that China remains a very good market for foreign technology and this is not likely to change at any time in the near future. Over the last year, my law firm has doubled its legal work related to licensing Western technology to China and in none of those deals would it be fair to say that the Western company “gave away” its technology.

The bottom line is that for most company’s China’s domestic innovation policy can be safely ignored.

For more on China’s domestic innovation policy, check out the following:

China’s Latest Power Plays — More Unfair Trade, Now Grave Threats to Our Security,” where Leo Hindery gets all up in arms about it on the Huffington Post.

Indigenous Innovation: Determining “Our” Position,” where Scott Kennedy notes China’s “consistent pattern of … issuing unacceptable technology policies and then modifying them in the face of massive public criticism by foreign industry and government and quiet complaints from Chinese businesses with extensive foreign partnerships and pro-liberal Chinese experts.”

Report: China forcing foreign automakers to give up EV secrets?” where the Autoblog reports that the Chinese government may be forcing foreign automakers to reveal their electric vehicle technology secrets.

China’s Indigenous Innovation Policy and its effect on foreign intellectual property rights holders,” where China Law Insight analyzes the impact this policy might have on foreign company IP.

What do you think?