China Technology Licensing: A Comprehensive Guide

Mastering Technology Licensing in China: A Comprehensive Guide

China’s massive market size presents a tantalizing opportunity for companies with innovative technology. However, navigating the legal and business complexities of operating directly in China can be daunting, especially as tensions between China and so much of the rest of the world continue to increase. Technology licensing can offer a compelling solution.

This post is designed for businesses of all sizes, from established companies to startups, who are interested in leveraging their technology to tap into the vast Chinese market without the burden of setting up a physical presence. But licensing technology to China has its unique legal and business challenges.  This post will equip you with the knowledge and strategies needed to overcome these challenges and profitably license your technology to China.

I have put this together now because in just the first 4.5 months of this year, my law firm has done more licensing agreements with Chinese companies as in any other year.

Glossary of Key Terms

This post utilizes some legal and business terms that may be unfamiliar to all readers. To ensure a smooth understanding, I’ve compiled a brief glossary to define these terms:

• Due Diligence: The process of investigating a potential business partner to identify and mitigate risks. In the context of technology licensing, Due diligence might involve verifying the Chinese company’s business license and financial standing.

• Export Control Laws: Regulations imposed by a government to restrict the transfer of certain technologies to other countries. These restrictions are often implemented for national security reasons or to control the proliferation of sensitive technologies. In the context of technology licensing in China, it’s important to ensure that your technology is not restricted by your own country’s export control laws.

• Joint Venture (JV): A business entity formed by two or more companies to undertake a specific project or for a defined period of time. Joint ventures can be a complex undertaking, and it’s important to be aware that technology transfer can occur unintentionally through a JV, even if a formal licensing agreement is not established.

• Licensing Agreement: A formal contract between two parties that outlines the terms and conditions under which one party (licensor) grants permission to another party (licensee) to use its intellectual property (IP) for a specified period and in a defined geographical area. There are different types of licensing agreements, such as exclusive licenses (the licensee is the only one allowed to use the IP) or non-exclusive licenses (the licensor can grant licenses to other parties as well).

• Royalties (Variable vs. Fixed): Payments made by the licensee to the licensor as compensation for the right to use the licensed technology. There are two main types of royalty structures:

  • Variable Royalties: These royalties are based on a performance metric, typically a percentage of the licensee’s sales of the product or service that incorporates the licensed technology. Variable royalties can be a good option if you expect strong sales growth in China.

  • Fixed Royalties: These are set fees paid per unit of time (e.g., annually) regardless of the licensee’s sales performance. Fixed royalties can offer predictability and guaranteed income, but they may not capture the full potential value of your technology if sales are particularly successful.

China Technology Licensing: The Historical Context and Market Trends

Over the past few decades, technology licensing in China has undergone significant transformations, mirroring the country’s rapid economic growth and integration into the global market. Initially, technology transfers were primarily driven by government initiatives aimed at acquiring foreign expertise to boost domestic industries, particularly in manufacturing and infrastructure.

Since China’s entry into the World Trade Organization in 2001, there has been a strategic shift towards developing high-tech industries, leading to a more structured and regulated approach to technology licensing. The evolution of China’s intellectual property laws and the establishment of specialized courts for handling IP disputes have also helped shape the current licensing landscape, encouraging more foreign companies to engage with Chinese entities.

In recent years, the Chinese market has shifted towards high-tech industries, fueled by the Chinese government’s push for innovation and self-reliance in core technologies. Initiatives like “Made in China 2025” and significant Chinese state investment in sectors such as semiconductors, artificial intelligence, and renewable energy technologies reflect this focus. Additionally, the global tech race, particularly in telecommunications and computing, has influenced China’s strategic positioning, with the government fostering a conducive environment for technology licensing as a means to quickly ascend the value chain in these competitive industries.

China’s Legal and Regulatory Framework for Technology Licensing

Before entering into a licensing agreement with a Chinese entity, it’s imperative to ensure that such an action is permissible under both your country’s laws and China’s Regulations on the Import and Export of Technology. This includes compliance with your own country’s export control laws, which regulate the transfer of technology to China.

China categorizes technology licensing into three distinct types: prohibited, restricted, and transferable. Prohibited technologies are completely barred from import or export, whereas restricted technologies may be imported or exported subject to government approval. Transferable technologies, while more freely tradable, still require that the licensing agreements be recorded with the appropriate Chinese governmental agency.

Due Diligence and Contractual Considerations When Licensing to China

Accurate identification of the Chinese counterparty to whom you will be licensing your technology is crucial. This typically involves verifying the potential licensee’s business license and registration details using online Chinese government databases. Comprehensive due diligence on your potential licensee is highly recommended to mitigate risks associated with under-reporting of production figures and other potential breaches.

Structuring Royalty Payments on China Licensing Deals

Given the challenges with verifying production figures due to the potential for under-reporting by Chinese companies, structuring royalty payments should usually be based on easily verifiable metrics. Instead of complex calculations, simpler, certain, and verifiable methods such as basing royalties on a percentage of the gross income reported in the licensee’s tax return are advisable. Even better, royalties can comprise a fixed annual payment supplemented by a variable component dependent on sales metrics.

Language, Law, and Enforcement of Your China Technology Licensing Agreement

Your licensing agreement usually should include a Chinese translation and stipulate that Chinese is the controlling language. In most instances, it should also be governed by Chinese law and enforceable in a Chinese court or through arbitration within China. This local legal compliance is not just about enforcement, but it also can be crucial for the registration of the agreement with Chinese authorities—a mandatory step for the payment of royalties since these transactions must be processed through a Chinese foreign exchange bank.

China Software Licensing Specifics

Software licensing in China has additional layers of complexity due to stringent registration requirements and the involvement of multiple governmental bodies responsible for registering foreign technology transfer contracts, a prerequisite for legally distributing software in China.

Registration and Compliance

Every technology licensing agreement in China must be registered, particularly those involving royalties. This registration not only facilitates the legal payment process, but it also is necessary for the agreement to take effect. Chinese banks play a crucial role in this process, and they generally require proof of registration before processing payments.

Key Clauses and Protections When Licensing Technology to China

In most instance, you need to be sure that your licensing agreement limits your Chinese licensee to just Mainland China. If your contract calls it China, it will include Hong Kong and Taiwan, and Macao. It should also emphasize strong confidentiality and IP protection terms to prevent misuse of the licensed technology.

It is usually essential that you hold registered ownership of the IP in China before licensing it, as Chinese law prioritizes registered rights over unregistered ones. This registration helps in defending against potential IP infringements and is critical in maintaining control over your technology. This is true of patents, trademarks, and copyrights.

When entering into technology licensing agreements in China, companies must take specific legal precautions to safeguard their interests. It is crucial to ensure that licensing agreements are comprehensive and explicitly define terms regarding IP rights, royalty calculations, and dispute resolution mechanisms. Common legal pitfalls include failing to register the licensing agreement with the appropriate Chinese authorities, which can lead to unenforceable agreements and difficulties in royalty remittances. Additionally, foreign licensors should be wary of indirect technology transfer through joint ventures or research partnerships that may not explicitly involve licensing but could result in IP leakage.

By adopting robust negotiation strategies, ensuring rigorous contractual protections, and adhering to the regulatory requirements, you can effectively manage the risks and leverage the opportunities of licensing your technology to China.