China’s regulation of technology transfer has been a central point of tension during US-China trade negotiations, now developing into a geopolitical issue. We look at what this means for foreign investors.

The tension of technology transfer in China

While China related inbound and outbound M&A activities have been a rollercoaster ride for a long time, one thing has remained constant: technology is at the heart of most deals. Previously, China needed new technology in order to modernise, which resulted in a one way flow of technology transfer, from foreign investors to Chinese business partners.

At the same time, technology has become a highly strategic asset, and the security of uninterrupted supply leaves questions relating to national security. For this reason, governments globally have stepped in with restrictions limiting companies' freedoms to trade technological assets as they wish.

China puts early restrictions on technology transfer in various forms, such as the Regulation on the Administration of the Import and Export of Technologies ("TIER"). These import rules may seem to benefit a Chinese transferee, however, a closer review shows they restrict the transferee agreeing with a foreign partner on the terms of their transaction. This may also affect situations where the parties have legitimate reasons to agree on certain limitations.

Regulatory development: more open than ever?

The US government back in 2018, when escalating trade disputes with China, recognised the complaints of foreign investors relating to “forced” technology transfer (“FTT”) and related restrictions. They held the view that the rules restricted foreign investment into China. Furthermore, TIER began to lose strategic importance over the years and limited inbound transactions to China. China responded by reducing restrictions and introducing the new Foreign Investment Law and its supporting regulations ("FIL") which included:

  • outlawing FTT in the law,
  • offering greater protection to IPR and trade secrets, and
  • removing controversial restrictions e.g. mandatory indemnification, mandatory allocation and prohibited terms.

While China continues to work on optimising the business environment, strengthening international exchanges and cooperation on technology transactions[1], regulations on certain categories of technologies are also being strengthened. Examples include:

  • Amendments to the Catalogue of Technologies Prohibited and Restricted from Export (“Catalogue”) released in 2020, tightened control over high-tech industries, e.g. automatic driving, AI, data analysis-based personalized recommendation pushes

  • China’s new Export Control Law, effective from 1 December 2020, included “technical materials and other data related to the Controlled Items” within the “Controlled Items” definition. Therefore, disclosures of controlled technologies and data to third parties are treated as exports subject to approval procedures. Additionally, exporters are restricted from trading with foreign importers or end users subjected to the Controlled List.
What else should foreign investors know when entering a technology transfer contract in China?

Certain restrictions on technology transfer remain intact. Foreign investors should assess if concerned technologies are classified as technologies restricted from importing and exporting to and from China under TIER and corresponding catalogues. Furthermore, technologies must fulfil other matters relating to the Ministry of Commerce of the Peoples Republic of China (MOFCOM) filing/licensing, foreign exchange, banking services, taxation and customs administration, etc.

When entering a technology transfer contract in China, the January 2021 Chinese Civil Code sets out specific requirements including:

  • mandatory terms,
  • void contracts,
  • technology competition; and
  • warranty and more.

With increasing foreign technology transfer projects taking place in China, foreign entities are advised to be aware of these requirements under Chinese laws and regulations. Foreign investors are advised to stay updated with regulatory development and adopt measures to protect their legitimate rights and interests in good time. Furthermore, this will ensure a smooth process of technology transfer when dealing with receiving parties.

[1] https://www.twobirds.com/en/news/articles/2020/china/technology-transactions-in-china-doing-deals-in-a-complex-legal-environment