Intellectual Property Licensing in China
The Chinese legal issues associated with the licensing of all kinds of intellectual property rights, with a particular focus on the licensing of intellectual property by foreign entities. The introduction of new rules based on antitrust theories, and an adjustment of royalty remittance rules should be focused on.
In China, there are generally no restrictions on the establishment of a business entity, such as a wholly foreign owned enterprise (WFOE) by a foreign licensor or a JV involving a foreign licensor. However, an exception is if the industry of the licensor is under the restricted or prohibited list, which is updated and issued by the PRC National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOFCOM) from time to time.
Furthermore, while there are no restrictions against a foreign licensor entering into a license agreement without establishing a subsidiary or branch office in China, a foreign licensor intending to establish a business entity or JV in China will first need to file with the local MOFCOM office for approval and subsequently register with the local Administration for Industry and Commerce (AIC).
Kinds of licenses
Licence arrangements in China include trademark licensing, patent licensing, copyright licensing, intellectual property licensing agreements for all types of IP, and technology/know-how licensing.
Trademark licensing is regulated by the Trademark Law and the Measures for Putting on Record of Trademark License Contracts. A trademark registrant may authorize other parties to use its registered trademark by signing a trademark license agreement, and the goods that bear the registered trademark must indicate the name of the licensee and the origin of the goods. Although currently not mandatory, the license agreement should be registered with the Trademark Office within 3 months of signing the agreement. The right to sub-license a trademark or service mark does not exist statutorily, and must be granted contractually with the authorisation or the consent of the licensee.
Patent licensing is regulated by the Patent Law. Every type of patent including invention, utility model and design can be licensed by signing a license agreement. According to the Patent Law, the licensee has no right to authorize any entity or individual, other than that referred to in the agreement, to use the patent. The licensor should register the license agreement with the Intellectual Property Office.
Copyright licensing is regulated by the Copyright Law and its Implementation Regulations. The copyright owner can license others to exercise its property rights, including the right of reproduction, right of distribution, right of lease, right of exhibition, right of performance, right of translation and the right of compilation. Personal rights such as the right of publication, right of authorship, right of alternation, and right of integrity of the work cannot be licensed. It is recommended that the copyright assignment/license contracts be registered with the Copyright Protection Center, as this will amount to prima facie evidence available for use against infringements.
Law affecting international licensing
There is no legislation in China directly governing the creation of an international licensing relationship. However, applied laws, regulations and rules are applicable to the relationship, including the PRC Law against Unfair Competition which prohibits any activities that may substantially restrict competition in the Chinese market. Further, the parties involved in the international licensing relationship need to comply with tax and foreign exchange provisions, as well as filing relevant records with the authorities in accordance with IP regulations.
While there are no specific pre-contractual disclosure requirements for licensors, a trademark licensing, patent licensing, or copyright licensing should be registered with the relevant authority for recordals in accordance with the Trademark Law, Patent Law and the Regulation on Implementation of Copyright Law, respectively.
Although there are no obligations imposed on an international licensing relationship, the Law against Unfair Competition stipulates there must be good faith or fair dealings, and the contract law stipulates the obligation to act reasonably in the exercise of rights or requiring good cause for termination or non-renewal.
The Law against Unfair Competition requires business operators to act in good faith, and prohibits specific acts of unfair competition, such as counterfeit, commercial bribe, misleading ads, trade secret infringement, dumping, and agreements encompassing unreasonable conditions.
According to the Contract Law, parties shall observe the principle of honesty and good faith in exercising their rights and performing their obligations. The parties to a contract may terminate the contract under any of the following circumstances: 1) the purpose of the contract has been rendered impossible due to an event of force majeure; 2) prior to the expiration of the period of performance, the other party expressly states or indicates through its conduct, that it will not perform its main obligation; 3) the other party delayed performance of its main obligations after such performance has been demand, and fails to perform within a reasonable period; and 4) the other party delays performance of its obligations, or breaches the contract in some other manner, rendering it impossible to achieve the purpose of the contract.
It is noted that licences and franchises are quite different under Chinese law. In accordance with the Regulations on the Administration of Commercial Franchises, a commercial franchise usually exhibits the following 3 characteristics:
1) The franchisee is authorized through a licence agreement to use the franchisor’s business resources, including trademarks, patents, know-how etc.;
2) The franchisee undertakes business operations under the uniform business model;
3) The franchisee pays franchising fees to the franchisor.
When an arrangement satisfies the pre-requisites above, the franchise regulations are applicable.
Intellectual property issues
The licensee can be prohibited from contesting the validity of a foreign licensor’s intellectual property rights or registrations under the agreement, as there are no laws preventing such acts. However, it must be done so without unfair competition or bad faith in accordance with the PRC Law against Unfair Competition or Contact Law.
According to contract law principles, a licence agreement on the registration of a patent is terminated on the expiry or invalidity of that right for which the licence is granted, as the purpose of the agreement has been rendered impossible. While the licensee may stop paying royalties immediately, the royalties already paid to the licensor will not be returned in accordance with legal practice.
However, the licence agreement for the trademark continues to remain in effect despite any expiry or invalidity, as the value of an unregistered mark is recognised under the Trademark Law and the Law against Unfair Competition. According to Trademark Law, an applicant shall not register by unfair means a mark that is already in use (but not registered) by another party. Further, an unregistered mark is protected by the Law against Unfair Competition, including the packaging or decoration peculiar to it. Therefore, operators shall not use without authorization, the names, packaging or decoration peculiar to well-known goods or use names, packaging or decoration similar to those of well-known goods so as to confuse buyers to mistake them for the well-known goods of others.
A registration in the jurisdiction of origin is necessary only when a priority claim is filed in China. Evidence of use is not necessary prior to the registration of a trademark, but it may be relied upon when the Trademark Office does not recognize the distinctiveness of the mark, or if the right of registration is being challenged by a third party.
The Trademark Law, Patent Law and the regulations specify the requirement of a written licence agreement, which is to be filed with the authority for recordals. However, the recordals do not affect the validity of a patent license, which means the license agreement remains valid despite it not fulfilling its filing requirements. However, a license without recordals cannot be used against a third party in good faith. Additionally, a security interest, such as a pledge based on an exclusive right to use a trademark or the property rights in a patent or copyright, should be registered with the authorities.
In China, although a foreign owner or licensor of intellectual property may institute proceedings against a third party for infringement without joining the licensee as a party to the proceedings, it is common practice for the licensor, and the licensee as an interested party, to join together against the infringement.
However, a licensee cannot institute proceedings against an infringer of the licensed intellectual property without the consent of the owner or licensor. The licensee can be contractually prohibited from doing so. Any rights which are not granted by the licensor to the licensee cannot be enforced by the licensee.
Protection of trade secrets and know-how
In China, trade secrets are protected under the Law against Unfair Competition. Accordingly, it defines trade secrets as technical information and operational information not known to the public, is capable of bringing economic benefits to the owners of the rights, has practical applicability, and which the owners of the rights have taken measures to keep secret. Furthermore, there is no specific legislation referring to know-how but it is protected under the Law against Unfair Competition and Contract Law as a type of trade secret. It is difficult to enforce rights in trade secret and know-how in China courts without a written agreement, therefore it is recommended to establish absolute confidentiality and create non-disclosure agreements before embarking on commercial negotiations or sensitive information sharing.
An operator shall not adopt any of the following means to infringe on trade secrets of others: 1) obtaining trade secrets from the owner of the right by stealing, promising of gain, resorting to coercion or other illegitimate means; 2) disclosing, using or allowing others to use the business secrets of the owner of the right obtained by the means mentioned in 1); and 3) disclosing, using or allowing others to use the business secrets that it has obtained by breaking an engagement or disregarding the requirements of the owner of the right to preserve the business secrets. Further, according to the specific provisions of Contract Law, both parties under a technology contract shall abide by their respective confidentiality obligations.
The law in China provides that a licensor is allowed to restrict disclosure or use of trade secrets and know-how by the licensee or third parties during the term of the licence agreement and after a reasonable term of the agreement, which is usually no more than two years in practice. The improvement to which the licensee may have contributed should be specified in the licence agreement.
Software cannot be protected as a patent, as pure software is classified as “methods for mental activities for which no patent right can be granted under the Patent Law. Similarly, business processes or methods cannot be patented. However, “perpetual” software licenses are valid and recognised. The protection term of the copyright differs depending on its creator: 50 years and the author’s life if the author is an entity; and 50 years after author’s death if the author is a natural person. However, “perpetual” means “within the protection term” as it is not in accordance with the Copyright Law and Regulations on Protection of Computer Software.
There are generally no specific legal requirements to be complied with prior to granting software licenses.
In accordance with the Regulations on Protection of Computer Software, the licence agreement should contain provisions expressing who will own the improvements and modifications to the software. The licensee has no right to improve and modify the license software if such right is not granted by the licensor under the license agreement. If the licensee is granted the right to improve and modify the licensed software, but the ownership of the copyright in improvements and modifications to the licensed software is not referred to in the license agreement, the licensee owns the copyright.
In legal practice, a software licensee may not obtain bug fixes, upgrades and new releases from the licensor in the absence of a contractual provision to that effect. This is because bug fixes, upgrades and new releases are based on the original software.
China courts have not recognized that software is not inherently error-free in determining the liability of licensors and their performance of the licensed software. As per the principle of trial, the judges would issue a decision based on the specific terms of the software license agreement. Further, it is currently controversial in China if software, as an intellectual product, should be covered by the products referred to in the Product Quality Law.
China courts have not restricted the enforceability or applicability of public licenses for open source software. There has been no legal developments in China relating to the use of open source software yet.
Royalties and taxes
There is no specific legislation in China governing the payments of royalties, as this is an issue referred to in the license agreement between the parties.
According to the transfer-pricing legislation in China, the transfer pricing rules apply to international licensing arrangements if the licensor and licensee are related parties. The relevant transfer pricing authorities adhere to the arm’s-length principle which states that enterprises involved in related-party transactions and tax authorities evaluating related-party transactions shall adopt reasonable transfer pricing methods on an arm’s-length basis, in accordance with the Implementation Measures for Special Tax Adjustments (Provisional). Chinese entities paying royalties to overseas entities pay the withhold tax (rate: 10%) in accordance with the Enterprise Income Tax Law.
In China, remittance of over US$50,000 overseas needs to be registered with the tax office. The currency can be remitted only when the payer provides a tax payment certificate issued by the tax office for the bank as required by the foreign exchange administration rules.
A foreign licensor will only be taxed on income obtained within China. A foreign licensor that has set up institutions or establishments in China shall pay enterprise tax on the income earned by its institutions or establishments from inside China as well as income generated from outside China which is relevant to the said institutions or establishments. Where a foreign licensor has not set up any institutions or establishments in China, or it has done so but the income it earns is not relevant to the said institutions or establishments, it shall pay tax on the portion of its income generated from within China.
There are no provisions of law or judicial interpretation in China governing the currency in a court judgment. Different courts may have different practice. While some courts render judgments in RMB only, others render some judgments in foreign currency by stating “foreign currency should be exchanged to RMB when the debtor pays it in China”. The exchange rate authorized by the central bank is calculated as the middle price issued by China Foreign Exchange Transaction Center, in accordance with instructions from the Supreme Court.
Competition law issues
In accordance with the PRC Anti-monopoly Law, companies are prohibited from concluding agreements that have an object or an effect of preventing or restricting competition. Competitors cannot enter into agreements:
• On prices, including sales prices, discounts, profit margins, payment terms, times of price changes, etc.;
• On sharing of the market geographically or by customer category, product/service categories, or otherwise;
• That keep other competitors out of the market by refusing to deliver to the competitor, or to jointly exert pressure on customers or suppliers to make them refrain from trading with the party concerned; or
• To deliver to only one or several specific customers.
Furthermore, an agreement implying binding resale prices, minimum prices, or prohibition of resale will be prohibited.
There are no specific legal restrictions in respect of the duration of license agreements, exclusivity, internet sales prohibitions, non-competition restrictions, and grant-back provisions. However, the parties need to carefully draft their articles of agreement to ensure they abide with rules referred to above.
Furthermore, the China’s State Administration of Industry and Commerce of the PRC (SAIC) recently issued the Provisions on the Prohibition of the Abuse of Intellectual Property Rights to Eliminate or Restrain Competition, effective as of 1 August 2015. The Provisions prohibit business operators from entering into horizontal and vertical monopoly agreements when exercising their intellectual property, require operators with market dominance to license their intellectual property under the “essential facility” doctrine, and prohibits patent pool members from undertaking certain activities.
In prohibiting against monopoly agreements, provisions providing for special safe-harbor permit a horizontal agreement, if either the aggregate market share of the operators concerned is no more than 20 percent; or at least four substitutable technologies with reasonable costs in the same relevant market are available. Additionally, it permit a vertical agreement, if either the respective market share of each operator concerned is no more than 30 percent; or at least two substitutable technologies with reasonable costs in the respective upstream or downstream relevant market are available.
In providing for the abuse of dominance, the dominant operators cannot refuse to license others to reasonably use their intellectual property, if such intellectual property has constituted an “essential facility” which include the following factors:
• The intellectual property has no reasonable replacement and is essential for other operators to compete in the relevant market;
• Refusal to license could have an adverse impact on competition and innovation and could impair consumers’ welfare and the public interest;
• Licensing such IPR would not cause unreasonable damage to the licensor.
In providing for the prohibitions related to patent pools, the Regulations prohibit the dominant patent pools members from the following abusive behaviors: restricting patent pools members from licensing their patents to parties outside the patent pools, imposing an exclusive cross-license of improvements, restricting patent pools members or licensees from developing competing technologies, and forbidding licensees from challenging patents’ validity.
Indemnification, disclaimers of liability and damages
In China, indemnification provisions are commonly used and generally enforceable. Insurance coverage for the protection of a foreign licensor is available in support of an indemnification provision.
According to the principle of contractual freedom, parties can contractually agree to waive or limit certain types of damages. Disclaimers of liability are generally enforceable if they do not violate society public interests, but such provisions cannot unreasonably allocate the rights/interests and risks between the parties, restrict or deprive one party’s rights/interests, or add one party’s risks.
China’s laws do not impose any conditions on, or otherwise limit, the right to terminate; the right not to renew an international licensing relationship; or require the payment of an indemnity or any other form of compensation upon termination or non-renewal. Instead, these issues are included in the agreement. The application of commercial agency laws does not extend to governing licensing relationships.
In the event of termination or expiration of a licence agreement, the sub-licence will also expire and terminate. This is so even in the absence of any contractual provision addressing this issue, as the sub-license existence is based on an effective license. Therefore, the licensee will lose the right to sub-license.
According to Enterprise Bankruptcy Law, after the court accepts the licensee’s application for bankruptcy, the administrator designated by the court has the right to determine the license agreement to be continually performed or immediately terminated. The licensor may continue to perform the agreement if the administrator determines so, but the licensor can require the administrator to provide a guarantee. Once the licensor’s bankruptcy is declared, the licensor, as a debtor, can wait for compensation as per the bankruptcy rules.
The licensee cannot grant any sub-license without authorization or consent of the licensor, as mentioned above. Also, the licensor can structure its international license agreement to terminate it prior to the filing of the bankruptcy application with the court and remove the licensee’s rights.
Governing law and dispute resolution
The PRC Contract Law and Civil Procedures Law provides an international licensing arrangement can be governed by the laws of another jurisdiction chosen by the parties. Parties can contractually agree to arbitration for dispute resolution instead of resorting to the courts of China. The arbitration proceedings may be conducted in another country, as one of the parties may be located in a foreign country.
China joined the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards in 1986. Therefore, China may enforce an arbitral award from another jurisdiction in accordance with the New York Convention and its reciprocity principle, or any bilateral treaties signed by China and other countries. However, China will only enforce an arbitral award made by another party to the Convention.
China may determine if a court judgment from another jurisdiction is enforceable. This is done so based on the parties’ application or another country’s request according to any bilateral treaties signed by China and the other country, or in accordance with the reciprocity principle.
Similar to injunctive relief, China has a special system called “advanced execution”. In accordance with the Civil Procedures Law, if the execution of a judgment becomes difficult or damage has been caused to the parties because of the acts of one party or for other reasons, the court may, at the application of the other party, order it to conduct or not to conduct certain acts, the party can apply to the court for advance execution under urgent circumstances only. The court will order advance execution if:
• The relationship of rights and obligations between the parties is clear and definite, and denial of advanced execution would seriously affect the livelihood or production operations of the applicant and;
• The other party against whom the application for advanced execution is made is capable of fulfilling its obligations.
The court may require the applicant to provide security so that if the applicant loses the lawsuit, it shall compensate the other party for any loss of property incurred from the advanced execution. It may not be waived contractually. The parties may waive their entitlement to claim specific categories of damages in an arbitration clause. The parties’ wishes are more sufficiently considered and respected in an arbitration (than in a court suit).
ABOUT THE AUTHOR: Yu Du
Yu Du is a Partner in the MMLC Group.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.