IP considerations for high-tech companies entering the China market
Whatever your motivation for entering the China market, as a technology-oriented company it is important to define your objectives up front, devise your corporate vehicle for doing business in China, and carefully police the use of your inbound intellectual property while ensuring that future IP developed in China is properly protected. While China offers unparalleled opportunities, there are also numerous pitfalls for the uninitiated. While the scope of this brief note cannot capture all the considerations of starting up in China, it will offer some ideas on how to structure your company to effectively use your existing IP while maximizing the value of future IP developed in China.
While there are several types of business entities that foreigners can establish in China, two types predominate- the Wholly Foreign Owned Enterprise (WFOE), a limited liability entity with 100% foreign ownership and control, and the Joint Venture, a limited liability entity with a local company as partner. The former type is most common (about three-fourths of the foreign-owned manufacturing sector) and allows foreign currency conversion to facilitate repatriation of profits to a foreign owner or owners. However, note that profit repatriation is NOT built-in to the WFOE laws- it must be explicitly included in the Articles of Association of the China WFOE.
Most technology companies have considerable intellectual property that will be used by the China WFOE- not only patents, trademarks, and copyrights but also trade secrets and know-how. While the latter two categories of intellectual property are often overlooked, it is important to note that China broadly recognizes trade secrets which can include client lists, prices, production techniques and other “intangibles” that otherwise bring economic benefit to a company under China Anti-Unfair Competition Law.
However, many companies are somewhat reluctant to directly transfer this IP information to the China WFOE, both for enforcement reasons and for tax consideration reasons. In these cases, it may be beneficial to set up an intermediary holding company in a jurisdiction such as Hong Kong or Singapore to hold the IP. For example, the foreign company owns the Hong Kong holding company which, in turn, holds the WFOE in China, providing an extra layer of “insulation” from the China enterprise. The foreign company can loan or sell the IP rights to the Hong Kong holding company which then receives licensing fees from the WFOE. The Hong Kong holding company pays little to no tax on these fees (depending on the structure of the transaction); in turn, the payment of these fees to the parent foreign company is the repayment of the loan or sale of the IP and would therefore not be subject to the profits tax of most foreign jurisdictions.
Hong Kong holding companies offer further benefits to their foreign owners. The banking system in Hong Kong is excellent and does not restrict foreign currency remittances. Further, selling a WFOE China enterprise can be complex under the laws of China. Therefore, when it comes time to sell, the Hong Kong holding company can be sold in lieu of the China WFOE making recouping the investment in China a more real probability.
During the course of operation of the China WFOE, there will likely be improvements to existing intellectual property and development of new intellectual property by the local Chinese engineers and scientists employed by the WFOE or by a China commissioned party through contract. The following issues may surprise the foreign investors:
1. Territory limitation for registered IP rights
Although Hong Kong, Macau and Taiwan belong to China, according to the policy of One Country Two Systems and other arrangements, the registered IP rights (i.e. patent right and trademark right) cannot automatically extend to the foregoing regions. The IP rights must undergo a re-registration procedure so as to obtain the protection in the corresponding jurisdiction(s).
2. Ownership of the patent right
Unless otherwise agreed upon, the China WFOE or China commissioned party who makes the invention-creation shall be deemed as the owner of the patent right. If the investor or a third party wishes to be the owner, it must be specified by a contact.
3. Security examination
Except for a design application, if the first filing of an invention or utility model application which is made in Mainland China is in another country, the application must be subject to a security examination conducted by the State Intellectual Property Office (SIPO). Failure to do so will result in the loss of patent rights in China.
4. Exploitation of a jointly-owned patent
If a patent is jointly owned by several parties, for example, the investor and WFOE, the co-owners should clearly stipulate the manners of exploitation and distribution of the profit. Otherwise, each of the co-owners may individually exploit, or grant a non-exclusive license to others to exploit the patent, wherein the royalty shall be distributed by all the co-owners.
5. Awards and compensation for the inventors
An employee-inventor must be compensated for his/her invention, even if it is made in the ordinary course of the employee’s duties. In the absence of an agreement to the contrary, the employer is obligated to pay the employee-inventor a one-time payment of at least 3000 RMB is required for an issued invention patent or RMB 1000 for an issued utility model or design patent. Additionally, there are payments of at least: (1) 2% of all profits derived from exploiting an invention or utility model patent or 0.2% for design patents, and (2) 10% of all licensing royalties for third-party licenses.
Therefore, it is imperative to properly structure employment contracts to provide for inventor incentive awards to avoid the above default provisions. Further, employment contracts should clarify that the China WFOE is the owner of any invention made during the course of employment and a specified time thereafter (at most one year). Other important provisions regarding non-disclosure of confidential information and protection provided to trade secrets should be included.
Ella Cheong (Hong Kong & Beijing), with offices in Beijing and Hong Kong, is an intellectual property firm uniquely positioned to advise clients on the above issues with attorneys specializing in PRC law, Hong Kong law, and the laws of various foreign jurisdictions including the U.S.
Margaret Burke is a U.S. Patent Attorney at Ella Cheong (Hong Kong & Beijing). Margaret has served at the United States Patent & Trademark Office as both a Chemical Patent Examiner and as an Electrical Patent Examiner. She also has extensive experience working in-house as a Patent Attorney and as Intellectual Property Counsel in private technological institutions such as AT&T Bell Laboratories, Ciena Corporation and Seneca Networks. Margaret also has international experience as a patent attorney for six years at a Tokyo IP law firm, Taiyo, Nakajima, & Kato. Margaret can be contacted at firstname.lastname@example.org.
WuBin Yan is a Director at Ella Cheong (Hong Kong & Beijing). Wubin has had over 10 years' of experience in intellectual property matters. During her years of intellectual property practice, she was involved in all aspects of intellectual property, in patents, trademarks, copyright, domain name disputes and unfair competition in China. This includes patent and trademark prosecution, opposition, re-examination, invalidation, appeal, license, infringement, as well as raid actions. Her clients included multinational corporations with famous brands in the food & beverage, apparel, cosmetics, and pharmaceutical industries. WuBin can be contacted at email@example.com.