China: Intellectual Property In Joint Venture From A Chinese Perspective

Last Updated: 2 January 2001
Article by Shaojie Chi

Since the adoption of the open-door policy in 1978, China has absorbed huge amount of foreign investments. Billions of dollars have been poured into China market to set up as many as 350,000 foreign-invested enterprises in the country in the past 22 years. At the same time, China comes to realize from what has happened in the highly developed countries that advanced technology is essential to drive the country to modernization. Greater importance has been attached to the introduction of advanced technology from the industrialized nations. Under the policy of encouraging the acquisition of sophisticated or advanced foreign technology, foreign investors are allowed to contribute their technology to the joint ventures in China as part of their investments in these entities. With this practice, it seems to be necessary for foreign investor to be informed of the relevant intellectual property issues in the establishment and management of a joint venture or wholly owned subsidiary in China.

Technology In-Put In A JV

In China, foreign-involved joint ventures may have two basic forms, i.e. Sino-foreign equity joint venture and Sino-foreign contractual joint venture. In case of Sino-foreign contractual joint venture, a legal entity may also be organized in accordance with the contract concluded between the two parties. In the case, contractual joint venture with a legal establishment is quite similar by nature to the practice of the equity joint venture. Generally speaking, technology transfer may happen in either of the above-mentioned forms.

Under PRC Sino-Foreign Equity Joint Venture Law, a foreign venturer may invest its technology into the JV to be set up. This could be done in two different ways. One is by way of assignment, namely the foreign investor assigns its IPR, e.g. patent or trademark registered in China, etc., to the future JV and the assigned subject matter is valuated into a fixed amount of money which is used to calculate the percentage of the shares the foreign investor takes in the JV. An appraisal report made by an intangible assets appraisal firm registered in China helps fix the reasonable value of the assigned subject matter. The obligation of investing the technology in the JV shall not be fulfilled until the assignor and assignee, i.e. the JV, going through the assignment procedures with the IP authorities. After finishing the assignment formalities, the assigned subject matter becomes part of the invisible assets of the JV and is entered into the balance sheet under the item of Invisible Assets that shall be amortized in accordance with the accounting rules in China. Generally, the amortizing rate is fixed in conformity with the operation term of the JV. In terms of liquidation of the JV upon its termination, the remaining value, if any, of the assigned IPR will be included in the liquidation assets of the JV.

The other is by of way licensing, namely the foreign investor licenses its technology to the JV. In this way, what the foreign investor puts into the JV is the capitalized license to use the technology. The expected accumulated running royalties in the term of the license is calculated at a discounting rate into the present value of the capitalized license. Upon the agreement by the Chinese venturer, the value is regarded as the contribution the foreign venturer makes to the JV. An evaluation report by a Chinese appraisal firm may also help fix the value of the capitalized license. The value is entered into the JV’s balance sheet under the item of invisible assets that are to be amortized in accordance with the duration of the JV. Since the license term is generally the duration of the JV, there normally should not be remaining value of the capitalized license upon the termination and liquidation of the JV upon its expiration.

Under the Chinese law, the percentage of the invisible assets in the total assets of an incorporated entity shall generally not be more than 20%. However, with the policy of encouraging the coming into being of more technology-concentrated entities, the percentage is raised by a big margin if the entity is proved to be in the IT or high-tech industries.

It should be emphasized that in contributing technology to a JV in China, it is absolutely necessary for the parties to make it quite clear that what is put into the JV by the foreign investor is the ownership of the technology or only the right to use the technology. In China today, not many people know clearly how to differentiate the nature of the invisible subject matter to be put into the JV. Most of the people mistakenly think that the licensed technology is theirs after the payment of royalties.

An example shows that the above advise is not unnecessary. Foreign party A invests its know-how into a JV with the Chinese party B under a know-how license. Later, party A applies a Chinese patent for the licensed know-how (we are not sure whether this is a breach of contract), and the JV continues to use the technology that is under the protection of the relevant patent until the dispute happens. Party B initiates arbitration proceedings claiming for the termination and liquidation of the JV. One of its arbitral claims is to ask for the award to order party A to assign the relevant patent to JV for liquidation. The arbitration tribunal holds that the patent should be assigned to JV for liquidation. In this case, the arbitration tribunal may get confused with the capitalized license to use the know-how and the total value of the know-how itself within a specific territory.

When a foreign venturer intends to invest the right to use its technology into a joint venture, it must meet certain legal requirements, e.g. the technology is legitimately owned by the investor as proved by certain valid documents, such as patent certificate, notarized statement by the investor in case of know-how, etc.; the subject matter technology or intellectual property rights shall not be the subject matter of a pledge, mortgage or guarantee, etc.

When the account of the JV is set up, the capitalized technology in-put is entered into the book under the item of invisible assets at the value designated in an appraisal document or laid down in the JV contract, which shall be averagely amortized within the term of the JV.

Non-Disclosure And Non-Compete Agreement With Employees

It is important for the JV to sign an agreement with its employees obligating them not to disclose without authorization the secret information of the JV to any third party and not to compete with the employer. In practice, many JVs include a confidentiality clause in the labor contracts with the employees. Some of the JVs would like to sign a separate non-disclosure and non-compete agreement with the employees, in addition to a labor contract.

Under the 1993 PRC Anti-Unfair Competition Law, business operators are prohibited from misappropriating trade secrets of other business operators’. Though the subjects under the law are clearly defined as those who are engaged in commodity dealings and profit-making service, some reported cases showed that the law was applied on the labor-contract-breaching employees who left the ex-employers and disclosed the trade secrets of the ex-employers’ to the new employers. There is an argument that the employee is not a business operator and thus is not included in the subjects under the PRC Anti-Unfair Competition Law. In case an employee violates confidentiality obligation under the labor contract with his ex-employer, the latter may sue the former in accordance with the stipulations in PRC Labor Law (e.g. Article 102).

Since the disputes under labor contracts need to be submitted to a labor arbitration tribunal first, it is advisable to sign a separate non-disclosure and non-compete agreement with the employees. Such an agreement may be regarded as normal commercial contract between two equal subjects, and thus may be enforced directly by court. If the JV prefers to solve the dispute involving trade secrets by commercial arbitration, it can lay down in the agreement an arbitration clause designating a commercial arbitral body.

Formulating confidentiality rules by the JV is important too. Under Article 10 or PRC Anti-Unfair Competition Law, a piece of information is regarded only when it meets the four basic requirements as laid down in the article, i.e. secret, valuable, practical and protected. In trade secrets disputes, the alleged defendants always argue that the disputed subject matter is not suitably protected by effective measures adopted by the owner of the secret information. In judicial practice, confidentiality agreement, secrecy rules, etc. may be taken as the required effective protection measures.

When a JV finds out that its former employee is lured away by its competitor and discloses the JV’s trade secrets to the new employer, the JV may sue the competing new employer and the confidentiality-contract-breaching former employee. Or alternatively, the JV may lodge claims with the administrative authorities against the law-violating parties. Under the PRC Anti-Unfair Competition Law, the State Administration of Industry and Commerce and its local offices are empowered to handle disputes relates to trade secrets. The authorities have the power to make on-spot investigation, including seizure of the alleged infringing goods and freezing and reviewing of the books of the alleged infringing parties, etc., and make sanctions on the law-violating parties, including administrative fines and perhaps damages. A good few reports were made on the trade secrets disputes. Most of them were in the secret information owners’ favor.

Ownership Of Inventions

Under PRC Patent Law, inventions are divided into service inventions and non-service inventions. Generally, a service invention is termed as those made either by the employees in the course of executing the assignments by the employers or by utilizing the material or physical conditions of the employers’. Under the new Amendment to PRC Patent Law, which shall be applicable on July 1, 2001, notwithstanding the above definition of the so-called service inventions, if a contract between the employer and the employee exists with regard to the ownership of the inventions made by the employee, the contractual stipulations shall prevail. Thus, it is meaningful for the JV to define the nature of inventions made by the employees in the relevant labor contract or a separate contract. It is suggested that the scope of the invention that is taken as service invention and belongs to the JV be clearly defined, and the obligation by the employee to report to the JV immediately an invention is made be laid down in the labor contract or a separate contract. When an invention is patented in the name of the JV, it should be taken as an invisible asset owned by the JV, and upon the termination and liquidation of the JV, the remaining value of the patent is included into the liquidation assets of the JV. When a service invention is exploited by the JV itself or licensed by the JV to other entities, the inventor is entitled to a reward by the JV.

When an invention is made, is should be regarded as a piece of invisible asset of the JV’s. Be it patented or kept as know-how, it should be entered into the JV’s account under the item of invisible assets, which value is calculated based on the actual expenses for the development of the technology and amortized in accordance with the term of the remaining years of the JV.

In case of a joint research project under a contractual arrangement, the parties should clearly define that who will be the owner of the future creative result of the joint research. Short of such stipulations, the invention made under the joint research arrangement is a joint property of the two contractual parties who are entitled to apply patent for the invention as co-applicants. If either party intends to assign its right to apply a patent for the invention, the other party has a priority to sign an assignment. However, if either party renounces its right to be a co-applicant for a patent for the shared invention, the other party may apply patent on his own behalf, while the former has a right to exploit the invention free of charge. Nevertheless, if either party disagrees to apply patent for the inventive subject matter, the other party cannot apply patent for the invention, meaning that the subject matter may be exploited as know-how.

It should be pointed out that under the new Amendment to PRC Patent Law, which shall become enforceable on July 1, 2001, in case an invention is made under a joint research arrangement, it shall belong to the party or parties who made the invention, unless an existing contract stipulates otherwise. In view of this new regulation, it is important to make it very clear in a written form that how the parties shall share the result of the joint research.

It should be emphasized that in case of a shared inventive subject matter, either party is entitled to exploit it. However, if either of the parties is incapable of making use of the invention, say, lack of necessary fund or equipment for the exploitation of the invention, be it patented or not, it may enter into a cooperative relations with a third party for the exploitation of the subject technology. Though such an arrangement is non-exclusive, it could threat the market competitive position of the other party’s.

Setting Up Ip Team

MNC-involved JVs in China always have their own IP and licensing departments, or IP personnel in their legal departments. People working in these departments have good connections with local Chinese IP agents and lawyers. Whenever these JVs need legal service for IP matters, they can easily find competent local attorneys. For small-and-medium-sized JV enterprises, it is hard to afford to establish an independent IP or legal division. In such a case, it is suggested to have someone in the appropriate division of the business to be acquainted with basic IP knowledge. With the development of market mechanism and IP system in China, it is imperative for business community to bring up IP sense in the top management. Various seminars and symposiums are organized from time to time to educate business community on IP protection, which provides joint venture companies with opportunities to understand the importance of IP protection in China.

Giving basic IP education to its employees, especially those worked in R & D department, is also significant to JVs in China.

Understanding Ip Dispute Resolution Mechanism

It is not enough for the JVs to know how to protect its IPRs and how to avoid the infringement upon others’ IPRs. It is quite meaningful to understand the IP dispute-resolving mechanism in China.

Generally, the potential disputes may be categorized into two major groups, i.e. disputes between the two venturing parties, and disputes between the JV and a third party. Generally in practice, the JV contract signed between the two venturing parties bears an arbitration clause choosing China International Economic and Trade Arbitration Commission (CIETAC) as the arbitral body. CIETAC has a long history of nearly 50 years in the arbitration of international commercial disputes, including disputes between foreign investors and their Chinese counterparts. It is estimated that around 30% of the total cases handled by CIETAC relates to JV disputes, meaning that CIETAC is experienced in arbitrating JV disputes in China. CIETAC has a panel of more than 300 arbitrators, out of which about 20% are foreigners. It gives foreign parties sufficient freedom to choose arbitrators in whom the disputing parties are confident.

Normally, disputes between the venturing parties involve those in the management of the JV’s business, the issues relating to the contribution of the subscribed investments, etc. Not very often, IP issues become the causes of disputes. Sometimes, the parties may dispute with each other on licensing issues.

The other type of disputes involving IP matters may be happening between a JV and a third party that may be a Chinese entity or another Sino-foreign JV, etc. The dispute could be one arising out of the execution of a licensing contract between a JV and a third party, or could be one in relation to IP infringement. In former case, the disputes are often than not solved by arbitration. So far, there are around 150 arbitral bodies in China. Institutional arbitration becomes more popular in China, and more and more enterprises would like to submit disputes of various kinds to arbitration.

Nevertheless, when an infringement dispute happens between a Sino-foreign JV and another entity in China, it is always difficult for the disputing parties to enter into an arbitration agreement. Thus, nearly all of the infringement disputes are brought to court trial if the disputing parties cannot reach a settlement.

China adopts a two-instance trial system. However, while the appellant judgment becomes enforceable upon service, the loosing party does have a chance to make petition to the appeal court or its superior court for the review on the case, if it does think there is something wrong in the final second-instance judgment. If the petition is held, a ruling for retrial of the case may be made.

Notwithstanding the fact that MNC-involved JVs or foreign subsidiaries in China may have their own legal personnel, it is advisable and suggested that competent Chinese lawyers be retained for court proceedings.

Keeping the relevant IP issues in mind helps foreign investors to run a JV in China, and the continuous improvement of IP mechanism in the country provides foreign investors with more comfortable environment for doing business in China.

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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