China: Intellectual Property Issues of Biomedical Outsourcing in the PRC

Last Updated: 3 November 2012
Article by Qu Miao

As a result of the development of the biomedical industry and the Contract Research Organization (CRO) and Contract Manufacturing Organization (CMO) business models, China has become one of the most important outsourcing destination countries, acquiring considerable market share of the global outsourcing market. This paper aims to provide an overview of the intellectual property issues as related to biomedical outsourcing in the Chinese context.

I. Types of outsourcing and their respective legal relationships

In practice, there are many different types of possible relationships between pharmaceutical enterprises and CROs, for example: the revenue and risk sharing model, technology sharing model, cooperative management and development model, general research & development (R&D) model and technology service model. However, regardless of the type of commercial relationships or commercial terms the parties enter into, the legal status of the relationships will normally fall into one or more types of specific legal relationships. Therefore, how to define the specific legal relationship of an outsourcing model will affect the application of law, as well as the interpretation and execution of the contracts.

Under the PRC Contract Law i, the legal relationship between a pharmaceutical enterprise and a CRO usually falls within one of the following types: commissioned development, cooperative development, technical consultancy and technical services, and technology transfer. The biggest difference between commissioned development and cooperative development is the participation of R&D activities. In a commissioned development model, the commissioning party usually pays for all research and development expenses, as well as remuneration, and provides technical materials and original data, while the commissioned party completes the research and development. In a cooperative development model, the parties make their respective investments (including investments of technology), as well as collaborate in R&D activities according to the terms of the contract.

The legal relationships between pharmaceutical enterprises and CMOs normally fall under processing contracts (for relatively straightforward CMOs). Occasionally, the relationship may also be classified as technical consultancy and services or as commodity purchasing.

II. Intellectual Property issues pertinent to the outsourcing relationship

A. Ownership of Intellectual Property rights

Cooperating parties must make clear and detailed agreements during the negotiation process regarding ownership of intellectual property rights to avoid potential disputes.

First, the parties must clearly define the content, scope and boundaries of their respective intellectual property rights before executing any contracts. This may seem like a simple task, however, due to the unique nature of intangible assets and the frequency of information exchange, it is no small feat in practice. This imposes a higher daily management requirement on the party delivering the information and data.

Next, the parties need to explicitly agree on the ownership of any technical achievements as well as their respective rights regarding those results. If there is no express agreement in the contract, ownership of the technical achievements will be determined by the law under the following principles:

a. Commissioned development contracts

Under the Chinese legal framework, the ownership of any technical achievement arising from a commissioned development contract depends on the method by which the parties choose to protect the achievement. With respect to an invention created in a commissioned development, without an express agreement otherwise, the right to apply for a patent belongs to the research party, but the commissioning party may use the patent for free. In the event the research party transfers the right of patent application, the commissioning party shall have priority over transfer under the same conditions. However, if the technical achievements are technical secrets, then both parties have equal rights to use and license such secrets as under a general license, similar to that under co-ownership.

b. Cooperative development contracts

For any technical achievements developed under the cooperative development model, the right to apply for a patent will be owned by the parties jointly. If one party chooses to assign its application right, the other party enjoys priority to be assigned the right under the same conditions. If one party is unwilling to pay the application costs and waives its right to jointly apply for a patent, then the other party may apply for the patent independently; nonetheless, the waiving party may still be entitled to use the patent for free. It should be noted that if one party does not agree to apply for a patent, e.g. is unwilling to disclose the technology results, the other party will be unable to apply as well.

c. Technical consultancy and service contracts

Under the technical consultancy and service model, any technical achievements, accomplished by the CRO utilizing the technical materials and development facilities supplied by the pharmaceutical enterprise, shall belong to the CRO. However, any new developments, accomplished by the pharmaceutical enterprise using the results generated by the CRO, shall belong to the pharmaceutical enterprise.

Furthermore, if the parties do not set forth confidentiality obligations towards each other in the contract in respect of the technical materials and data provided by pharmaceutical enterprises as well as consultancy reports and opinions provided by CROs, and under the condition that exposure of such material will not cause due damage to the legitimate rights and interests of the parties, the parties shall be entitled to refer to, publish, and supply such information to the third parties.

It is therefore vital to set explicit terms regarding the ownership of any technical achievements as well as the rights enjoyed by the parties with respect to the achievements.

B. Identifying third-party rights

In addition to clearly defining the ownership of IP rights of both parties, the existence of third-party rights should also be evaluated to ensure the allocation of IP is valid and enforceable. Potential third parties include employees or research sub-contractors of CROs or third-party institutes assisting CROs.

CRO research is usually done by R&D fellows, who may be employees of CRO, employees of third-party institutes commissioned by a CRO, such as universities, hospitals and inspection institutes, or independent contractors who signed contracts with the CRO. In such cases, in order to ensure the allocation of IP rights between parties are enforceable, one should firstly ensure that the CRO is legally entitled to dispose of such technical achievements.

a. Statutory rights of CRO employees

CROs must explicitly stipulate in the employment contracts with its employees that all the inventions and technical achievements created by the employees belong to the CRO. However, CROs should also be aware that the employees, as developers of a technical achievement, enjoy a series of statutory rights:

  1. Under the Patent Law, an inventor or designer has the right to identify himself as the inventor or designer in the relevant patent documents; pharmaceutical enterprises particularly need to pay attention to this aspect when preparing filing documents and filing patent applications after obtaining the relevant technical achievements developed by CROs.
  2. Under the Contract Law, an individual who accomplishes a technical achievement is entitled to identify himself as the developer in the documentation related thereto, and to receive recognition and awards, as well as remuneration from his employer.
  3. Under the Contract Law, the individual who accomplishes the technical achievement shall have priority of assignment rights to the technical achievement under the same conditions.

Furthermore, CRO's should also be aware of the rights of third-party entities such as former employers of its employees referred to in section 2.2.3 of this article.

b. CRO's cooperative units and their staff

If the CRO further commissions third-party institutes or cooperates with them to jointly complete part of the research project, the CRO would also become a commissioning party or a cooperating party in the cooperative development relationship. The CRO itself should also make it clear regarding the ownership and/or limitations of the relevant IP rights in the contracts entered between the CRO and any third-party institutes.

In the case that the CRO fails to acquire sole ownership with complete, unlimited, and unimpeded rights by explicit provisions in the contract, due to either lack of awareness of the IP involved or contract management issues, the CRO would not be entitled to assign the IP rights of such technical achievements to the commissioning pharmaceutical enterprise. Even if the parties set forth in the cooperation contract explicit provisions regarding the assignment and disposal of such rights by the CRO, the CRO would still not be able to dispose the relevant property and rights as such provisions would be deemed invalid.

Furthermore, the CRO must also pay attention to any agreements entered into between the third-party institutes and their own employees or independent contractors. This is to ensure that the third-party institutes can legitimately dispose of any technical achievements without infringing others' rights and interests.

Thus it is possible that the pharmaceutical enterprisemay not be guaranteed all the rights provided for in the contract despite the must scrupulous contract negotiation and execution with the CRO due to unforeseeable issues which have occurred on the CRO side.

c. Independent contractors to CROs

Similarly, the CRO must also pay attention to the allocation of rights of any technical achievements and explicitly provide for such in its contracts with independent contractors. Such independent contractors also enjoy certain statutory inventor rights under the Patent law and the Contract law.

d. Former employers or commissioners of the employees of CROs or its independent contractors

The CRO must be aware of the rights of the former employers of its employees or contractors who worked on a similar subject matter previously.

  1. Under the PRC law, any technical achievements developed by a former employee within one year after leaving the employment on a topic related to those the employee had been engaging in his previous employment shall be deemed as work-related technical achievements. Such rights of use and assignment belong to his former employer.
  2. Under the PRC law, where a technical achievement is accomplished by an individual through performing his duties with his former employer, but using mainly the materials and development facilities provided by the CRO, the rights and interests shall be determined pursuant to the agreement between the former employer and the CRO. If an agreement cannot be reached, the rights and interests shall be shared by both parties on the basis of their contributions to the technical achievement.
  3. The former employer is entitled, pursuant to signed contracts, to forbid former employees, who have left their positions, from pursuing similar professions or trades in competition with the former employer after the termination of employment, and to bind former employees with confidentiality obligations.
  4. If independent contractors have worked for other institutes, the CRO must be aware of and seek to prevent contractors from using achievements the contractors have accomplished for the former employer as deliverables. The possession of certain technical achievements which actually belong to others will put the CRO at risk of infringement.

C. Protection and management of Intellectual Property

a. Choosing a method to protect technical achievements

Laws vary across jurisdictions, and this is a key factor for pharmaceutical enterprises to consider when determining the method by which to seek protection for IPR achieved through international outsourcing. For instance, with respect to patentable technical achievements, the PRC laws provide greater flexibility in terms of choosing the method of protection, that is, pharmaceutical enterprises can choose to protect technical achievements via trade secrets, and can amend them into patent applications at any time. In comparison, under the US laws, such alteration must be made within a certain time limit.

Furthermore, pharmaceutical enterprises should also ensure that the method with which they choose to protect technical achievements complies with the legal rules and practice in the relevant countries and jurisdictions. For instance, the standards of patentability of substantive examination of patent applications are different across different countries. Taking technical achievements regarding medical methods as an example, it is very difficult to obtain such patent grants in the PRC, whereas it is possible to do so in the US and other countries.

b. Preventing leaks of confidential information by CROs

Another challenging problem that pharmaceutical enterprises face is the leakage of information and the loss or publication of technical achievements by CROs. Provided that the CRO itself does not intentionally infringe or breach any contracts, leaks of confidential information are generally caused by third parties, such as loss of technical achievements by intentional or negligent conduct of employees, turnover, as well as willful theft by a third person.

Pharmaceutical enterprises should adopt preventative measures to prevent such leaks. In selecting CROs, pharmaceutical enterprises should consider factors such as internal management, sufficiency of employee IP awareness, adequacy of legal documents, and sufficiency of measures taken to safeguard sensitive information. Furthermore, pharmaceutical enterprises should be familiar with local laws, so as to be able to make prompt decisions in case of emergency.

It should also be noted that pharmaceutical enterprises and CROs should explicitly agree in contracts on items such as what legal measures may be taken in case of dispute, the governing law, and the bearer of any legal costs. It is particularly important with respect to technical achievements developed in partnership due to the uncertainty of allocation of rights, to agree beforehand on the right of first decision in case of emergency, to minimize delay.

Finally, given the fact that confidential leaks may involve CROs (their employees, or willful third parties), there may be more legal remedies available to the CRO as compared with the commissioning pharmaceutical enterprise. As such, even if the pharmaceutical enterprise is accorded the right of first decision, it's ideal to include explicit provisions regarding obligations to assist in the protection of IP, so as to allow for more potential remedies under local law.

c. Constructing patent applications with a global vision

In the process of cross-border outsourcing, not only do pharmaceutical enterprises need to consider how to maximize the outsourcing relationship's advantages, they need to be aware of the risks of cross-border outsourcing. Risks include mandatory regulations imposed on CROs and the applicable regulations and practices in the jurisdiction.

(i) Avoid choosing the PRC as the country of initial application for patents

PRC Patent Law expressly states that any entity seeking to apply for a patent with respect to an invention or utility model accomplished in the PRC shall first report the matter to the administrative department for patents under the State Council for a confidentiality examination. Therefore, even if pharmaceutical enterprises as commissioning parties wish to apply for patents for the technical achievements produced through outsourcing in their home country or jurisdictions other than the PRC for the initial application, they still need to abide by the confidentiality examination regulations under PRC law.

(ii) Genetic resource related research and development

Research and development making use of genetic resources should be in conformity with PRC law. PRC Patent Law expressly states that no patent right shall be granted for any invention-creation which is produced using genetic resources acquired or utilized in violation of any law or administrative regulations. Accordingly, the applicant must indicate the direct and original sources of the genetic resources used in application documents when applying for a patent.

(iii) Statements of patent application

A common mistake American pharmaceutical enterprises make is naming the patent inventor as "Assignor" when they apply for patents in the US. They also request that patent inventors directly sign a transfer agreement to obtain the right to patent application. Although this is common practice in the US, this practice violates PRC law. These actions may result in an invalid transfer and may even constitute a mistaken statement in the patent application process and ultimately affect the validity of patent. That is because according to PRC law, if a technical achievement is a service technical achievement, the employer is the legal owner of said technical achievement as opposed to the inventor. As such, the inventor has no right to sign such a transfer agreement with the American company.

(iv) Tax Consequences

Taxes are often another important factor considered in developing patenting strategies for technologies developed though outsourcing. Because of the general policy of encouraging inventions and creations, patent application may implicate preferential tax treatment by certain governments. Determining the most effective patent application strategy, especially when technical achievements are produced in different countries and jurisdictions, usually requires a comprehensive analysis and implementation scheme supported by a team of professionals.

III. Other legal issues pertinent to outsourcing relationships

A. Technological monopolies

The PRC has not published any specialized guidelines directed at antitrust issues arising from technology transactions. However the Contract Law provides several prohibitions. The following restraints may be deemed to monopolize a technology market, rendering such contracts invalid: (1) Restricting one party from making further research based on the technology subject to the contract, or restricting one party from using such improved technology, or providing disparate terms of exchange for any improved technologies between the parties, such as requiring one party to gratuitously provide the other party with the improved technology, or to unilaterally transfer the improved technology to the other party, or requiring sole or joint ownership of IP rights of the improved technology without consideration; (2) Restricting one party from obtaining, from other sources, technologies similar to or competitive with that of the technology provider; (3) Impeding one party's reasonable exploitation of the technology subject to contract pursuant to the market demands, such as unreasonably restricting the quantity, varieties, price, sales channel or export market of products or services based on the technology subject to contract; (4) Requiring the technology accepter to accept unnecessary conditions relevant to exploiting the technology, including purchasing unnecessary technologies, raw materials, products, equipment, services and accepting unnecessary persons, etc.; (5) Unreasonably restricting the technology accepter's channels or sources of raw materials, parts and components, products or equipment, etc.; and (6) Prohibiting the technology accepter from making objections regarding the validity of the IP rights of the technology subject to contract, or imposing conditions to any objections made.

Although these prohibitions are more relevant to technology transactions and licensing agreements, they may be involved in CRO outsourcing relationships, especially the first restraint.

B. Technology import/export control

The PRC controls the import and export of technology. Specifically speaking, technologies are categorized as free export technologies, restricted export technologies and prohibited export technologies. Pharmaceutical enterprises should be aware of these regulations prior to working with CROs in order to avoid to violating any regulations.

In addition, even in the case of free export technologies, contracts must be submitted for registration formalities with the commercial department or local ministry of foreign trade and economic cooperation. Even though a contract will not be invalidated due to failure to comply with registration formalities it may affect a party's ability to collect payment or obtain tax benefits.

IV. Conclusion

China is an attractive market with a unique legal system. However, companies that choose China as an outsourcing destination should obtain information about local relevant laws at an early stage to establish the right legal relationships, protect property rights, and reduce the risk of future conflicts and delays.

Footnotes

i The PRC Contract Law was adopted at the Second Session of the Ninth National People's Congress on March 15, 1999, and became effective as of October 1, 1999.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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