China IP Challenges for Automotive Suppliers

I did an interview the other day with, on China IP Challenges for Automotive Suppliers, dealing mostly with automotive high-tech, which in most respects is no different from high tech generally. The below is a transcript of that interview.

For anyone who has been living in a cave, the auto industry has changed, is changing, and is very much on the cusp of more change, much of this stemming from cutting edge and rapidly advancing technologies. Or to borrow from a mega-famous car ad, this is not your father’s auto industry.

And with these technological advances comes IP needing protection. Our China lawyers represent many American and European auto tech companies that have been approached by Chinese companies interested in our client’s intellectual property. Just as is true of the United States, some of China’s largest tech companies are interested in developing and commercializing automobile technologies, such autonomous driving, artificial intelligence, internet of things, connectivity, battery charging. These Chinese companies are looking to foreign companies to supplement their technologies. My interview discusses some of the IP issues  foreign tech companies face and what they should be doing to protect their IP. I urge you to give it a listen because it includes a few things not covered below (including church bells going off in the background in Madrid — that’s a long story).


Ron: Welcome to the Global Business Professor Audio Interview Series. I’m Ron Hesse, and today I’m interviewing Dan Harris, an international lawyer who helps Western companies navigate international transactions. Dan is a founder of Harris Sliwoski, an international law firm with lawyers in Los Angeles, Portland, San Francisco, Seattle, Beijing, and Madrid. Today’s topic is IP challenges for automotive suppliers in China. How are you, Dan?
Dan: I’m good and I’m looking forward to talking with you today, Ron.

Ron: Let me start with this, Dan: what are the big issues you are seeing with China and the automotive world?
Dan: The auto industry is changing and a large part of the changes are with technology. What I am seeing is many Chinese companies want access to auto technology being developed outside China. Ten years ago, we were talking about things like transmission mechanics and technology, but today, we’re seeing this with cutting edge technologies like driverless cars, battery-charging sensors, always-on cameras, artificial intelligence, composite materials technology, adaptive headlights, Internet of things, connectivity. It’s just endless, and so many of these technologies have direct applications to the auto industry.

Ron: Dan, what sort of companies want these technologies, and from whom?
Dan: Many Chinese companies want these technologies, but it is mostly the big and powerful Chinese companies that have the wherewithal to get access to these new technologies. Outside China, all sorts of companies are being contacted for their technology, ranging from one-product start-ups to mid-size companies. With most of these companies, their technology has been developed specifically for the auto industry, but many of these companies are pure technology companies. What so many of these foreign companies have in common is that they have no experience dealing with China.

Ron: What sort of deals do the Chinese companies usually propose, and what should the foreign companies do in response?
Dan: What’s funny here is that the Chinese companies oftentimes do not propose anything at all. They simply tell the foreign companies about the massive opportunities in China and ask to be able to test out the foreign company’s technology. Fortunately, most of these foreign companies reach out for help from =lawyers experienced in dealing with China before they turn any of their technology over to China.

Ron: And what should they be doing at this point?
Dan: At this stage, we usually advocate our clients do two things. One, register whatever IP they have in China. This IP typically consists of patents and trademarks and sometimes copyrights. We explain how US Trademarks and Patents do not provide protections in China and how they need to register their IP in China for their IP to be protected in China from Chinese companies. Then we explain how they need an NNN agreement for China that is very different from the NDA agreements they use in the United States or in Europe. A China-centric NNN agreement prevents the Chinese company from competing, from disclosing, and from circumventing the American or the European company. This agreement should be in Chinese, and drafted specifically for China. Once the American or European company has done its IP filings and has a signed NNN Agreement in place, they are much better positioned to provide their technology to the Chinese auto or technology company.

Ron: Are the IP registrations in place and a signed NNN agreement enough to make it safe to turn over the IP?
Dan: It depends how you define the word safe. How’s that for a lawyer answer? Having these things in place definitely makes it safer and in most cases, it’s about all you can do at this point. The more companies to which a company provides its IP, the greater the risk of losing the IP. So we always advocate doing at least some due diligence on the company to which the IP will be provided.

When my law firm conducts due diligence on a potential Chinese partner, we want to see that the Chinese company has at least some chance of completing the deal and if it doesn’t we do not want to see our client give them a view of their technology. So for instance, if the Chinese company wants to buy our client’s technology for $1 million, and our client would never sell it for less than $10 million, our client might as well just walk away without ever revealing its technology. And I would estimate that more than 25% of the time, a combination of due diligence and a few forthright conversations with the Chinese company teases out that there will never be a deal and our client walks away without a deal but it also walks without having put its technology at risk of being lost to China. What often happens once the parties start talking is that the Chinese company wants to form a joint venture with our client with our client putting its technology into the joint venture entity that will be formed in China. The Chinese company will tell our client, “and then if the joint venture entity does well, you’re going to do really well.” And our client starts thinking, “wow, this is great, I’m going to have a company in China and that company’s going to sell my technology to 1.4 billion Chinese consumers.” Well, as lawyers, we don’t like it because once IP or technology goes into a joint venture, it virtually never comes back, and it is the rare foreign company that takes home profits from a China joint venture.

Ron: Those are interesting points, Dan. What sort of deals do you prefer?
Dan: I’m again going to give you a lawyer’s answer and say that it depends. Something more along the lines of a straight technology licensing deal will be safer for our clients—something where our client keeps all its IP in its name and retains ownership over all its intellectual property and simply licenses it out to the Chinese company. It’s a lot easier to pull the plug on that sort of deal and keep your technology than it is on a joint venture deal. Chinese companies will go for these licensing deals, but usually only after our clients have held out long enough to convince the Chinese company that this is the only way it will get any access to the IP or the technology. Unfortunately, there are many American and European companies that don’t hold out, and that makes it tough for everybody else, and often those American and European companies end up calling law firms like mine four or five years down the road when they’ve not made a penny off their China joint venture and they’re now trying to get their intellectual property back out. And a lot of times, they’ll call us after the Chinese joint venture has gone out using the foreign company’s technology to compete with the foreign company internationally.

Ron: Dan, how do you ensure your clients will get paid on these licensing deals with Chinese companies? I’ve heard that getting money from Chinese companies can be difficult.
Dan: You’ve heard right, and there are many reasons for this, ranging from Chinese government capital controls to Chinese companies simply wanting to get technology by paying as little as possible for it. There are though all sorts of solutions that can increase the likelihood of foreign companies getting paid, with the best solution usually being to require some or all payments be made before some or all of the technology is revealed. Of course, the best situation is where our client gets $10 million first and then reveals the technology. Chinese companies rarely go for that. The second best situation is one where the Chinese company pays, let’s say, $5 million, and then our client reveals half of the technology, and then the Chinese company pays another $5 million, and then our clients reveals the rest of the technology. Now, that’s an over-simplification — we’ve done deals where there have been ten stages — but what’s always so interesting about these multi-stage licensing deals is how the Chinese side will often try to circumvent these deals. So for instance, it’s not uncommon for the Chinese side, after making three payments and getting three levels of the technology, to then say, “look, we can’t make this fourth payment because the Chinese government is not going to let us do it for another six months, but we need you to send the technology to us now” and we have to sometimes fight hard with our own clients to get them not to send over the technology. Because a lot of times, they’ll tell us, “well, you know, if we just send the technology, it won’t matter because there’s nothing the Chinese company can do with our technology until they hit level 7, and this is just going to get them a little bit closer to that, but it’s not going to get them all the way there.” And we tell them, “look, I don’t think you really understand how most Chinese companies operate. They will be happy to get to maybe a level 4 or 5 using your technology and not paying for all of it, and then they’ll hire their own people in China to get from level 5 to let’s say level 7 or level 8.” And a lot of times American companies will say, “well, if they get to level 8, it’s not that big a deal because it’s really not that great a technology until they get to level 10.” And we tell them, “it may not be that great a technology in the United States, but in Pakistan or Ethiopia it might be a pretty valuable technology, and maybe those are the companies this Chinese company wants to sell to, so you’ve got to get away from an American/Western European way of thinking when you’re doing these deals.

Ron: Very interesting. Thank you for your great insight, Dan. Everyone, have a wonderful day!