China’s regulation of technology transfer has been one of the central points of tension during the US-China trade negotiations, and has now mushroomed into a geopolitical issue. We take a look at the background to it and what it means for foreign investors.
While China related inbound and outbound M&A activities have experienced a rollercoaster ride for a long time, one thing has remained constant over these years: technology has been at the heart of almost all deals. In the past, China simply needed new technology for its great project of modernizing the country, hence technology transfer was a one-way-street, from foreign investors to their various Chinese business partners. Now, things in China are sometimes so advanced that investors will need to bring their newest products to the market to convince customers. And increasingly, foreign investors investing into and cooperating with Chinese companies to have access to the newest technology in their sectors.
At the same time, technology in many fields has become highly strategic assets and the security of uninterrupted supply a question of national security. Take advanced computer chips as an example, or even more so the manufacturing equipment required to make them. For this reason, governments around the world have been stepping in with restrictions of companies' freedoms to trade their technology assets as they wish.
Early restrictions on technology transfer were put in place by China in various forms under de jure and de facto rules for foreign investment, particularly in the Regulation on the Administration of the Import and Export of Technologies ("TIER"). These included, for example, the so-called "forced" technology transfer ("FTT") requirements in some traditional industries (e.g. automotive) as a pre-condition to market access, and provisions from mandatory indemnification against risks of third party infringements of IP rights, mandatory allocation of the ownership of improvements of the transferred technology to the party making the improvements, up to the invalidation of certain clauses that protects the transferor against certain risks, which were also very questionable already under WTO rules since China’s accession to the WTO in 2001.
In a narrow sense, these technology import rules may be seen as a protection for the benefit of the Chinese transferee, but they really are restricting the transferee to agree with a foreign partner on the terms of their transaction which may entail very legitimate reasons why a party agrees on certain limitations on itself as part of the deal.
In any case, the US government when escalating the trade dispute with China in 2018 has taken up the complaints of foreign investors about FTT and related restrictions and endorsed the views that these rules are primarily to restrict foreign investment into China. Perhaps because the TIER have lost their strategic importance over the years and indeed started to limit inbound transactions to China, China decided to reduce the restrictions as part of the introduction of the new Foreign Investment Law ("FIL") and its implementing regulation - The Regulation for Implementing the Foreign Investment Law. The key features are:
While China is continuing its work to optimise the business environment and strengthen international exchanges and cooperation on technology transactions, regulations on certain categories of technologies are strengthened.
Certain restrictions on technology transfer remain intact through other existing sectoral laws and regulations. Foreign investors should first assess whether the concerned technologies would be classified as technologies prohibited or restricted from import to or export from China under the TIER, relevant administrative measures and corresponding catalogues.
When entering a technology transfer contract ("CTT") in China, the newly promulgated Chinese Civil Code, which will come into force on 1 January 2021 to replace, among others, the existing Contract Law, sets out specific requirements:
With the increasing number of foreign technology transfer projects taken place in China, foreign entities should be aware of those crucial requirements under the Chinese laws and regulations, and keep updated with the regulatory development, so as to make good use of welcoming changes and adopt measures to protect their legitimate rights and interests, as well as to smooth the process of technology transfer when dealing with the receiving parties.