IP Regime in China
IP Monetization in China
Foreign investors can contribute their IP as registered capital into a Foreign-invested Enterprise in China. This is an important channel of IP monetization, but the rules used to be unclear. Will the new Foreign Investment Law (enacted on January 1, 2020) bring new opportunities?
What is “In-Kind Investment”?
A patent (or IP in general), like other intangible assets, may have an assessed monetary value. Accordingly, while a shareholder brings cash to a NewCo as its paid-in capital, another shareholder may transfer a patent to the NewCo to fulfill its capital contribution.
For example, a foreign investor can contribute its technology (rather than cash) to invest and own a pre-agreed shareholding percentage in a company. If planned well, this IP monetization arrangement can help to expedite R&D payback cycle, reduce investment risk, and enhance flexibility in financing a new venture.
In many countries, shareholders may contribute capital to their companies in cash or, as explained above, in kind. The in-kind contribution may include land use rights, tangible properties, or intangible properties, such as intellectual property. While a shareholder brings cash to a new corporation (newco) as its paid-in capital, another shareholder may transfer a patent to the newco to fulfill its capital contribution.
This flexibility may facilitate innovation by monetizing patents, knowledge, and proprietary technologies during the incorporation process of an entity. For example, a foreign investor can contribute its technology (rather than cash) to invest and own a pre-agreed shareholding percentage in a company. If planned well, this IP monetization arrangement can help to expedite the R&D payback cycle, reduce investment risk, and enhance flexibility in financing a new venture.
China has recognized this practice in principle for decades.[i] However, the implementation has long been criticized as lacking coherence and predictability, particularly in the following aspects:
As this regime is evolving, the legislative and policy changes in recent years have eliminated some uncertainties and increased the feasibility of the model.
In principle, Chinese laws recognize the IP in-kind capital contribution, but the implementation becomes complicated in practice. The best way to understand recent developments is to view the regime by the categories of different IP rights, which is explained in detail in Innovation’s Crouching Tiger. The remaining hitches in the process of making an in-kind contribution are also outlined in ICT.
Brand New Foreign Investment Law
A very well-received development was promulgated on January 1, 2020. China’s new foreign investment law, dubbed the “Foreign Investment Law”, is intended to replace the prior FIE regulations. Would the new law eliminate the uncertainties of foreign investors when seeking to make in-kind investments by contributing their IPs to a Chinese company?
Two important observations hint the answers.
1. China’s company law First, the Foreign Investment Law is silent about in-kind investment. Because the previous FIE regulations were repealed and the new law is silent on this point, the “Company Law of the PRC” kicks in to fill in this vacancy. The company law was recently revised. Now it gives much more consideration to all the ways in which IP can be of value to businesses, in addition to more deeply contemplating and expressing the subtle nuances among various kinds of IP. This law also governs “in-kind investments” with a single body of law, leaving no ambiguity for substantive interpretation at either the local or national level.
Theoretically speaking, the limitations and uncertainties in the definition, ceilings, and classification concerning IP in-kind investment within the legal text are gone. Foreign investors now have clear rules to follow when monetizing their IP through in-kind investment in China.
Practically speaking, it remains to be seen how local authorities, the gatekeepers in most FIE approval applications, will implement the new law. While substantive rules are the same when it comes to IP in-kind investment, the establishment of FIEs are still following a different procedural track. However, there should be no reason to cast doubt here. As the new law was just enacted in January this year, the market is supposed to see more successful cases soon after the applications go through the approval pipelines.
2. The US-China trade war The second and probably most important observation comes from the US-China Trade War. The ongoing US-China trade negotiations will serve as a driving force behind the changes in China’s IP regime in the foreseeable future.
The demand from the US may tilt the scale toward a more level playing field. For example, the first round of settlement agreements signed in January 2020 contain an umbrella clause which dictates that “each party shall ensure fair and equitable market access to persons of the other party that rely upon intellectual property protection”. Foreign parties’ IP contributions in FIEs as a way to monetize IP in China appear to fall into this general principle.
The New World Investment Norm
In sum, the Foreign Investment Law is expected to resolve the long-standing challenges of IP monetization by foreign investors through in-kind investment in new, Chinese ventures. Local approval practices may still need some time to smooth over initial troubleshooting in implementation, but at least foreign investors seeking to monetize their IP in China can now spare themselves a hard time in reconciling conflicting rules – as these rules have been removed. This regulatory development will also greatly enhance the utilization of IP in cross-border collaborative projects.
In an era when globalization stalls and confidence in currencies is decreasing, in-kind investment is becoming a feasible option for innovative business ventures in China.
(Dr. Jili Chung, founder of SpringIP Group, is currently working in Greater China and is dedicated to fostering enterprises’ innovation through AI and big data. Carlo Geremia, a cross-border transaction expert residing in Shanghai and Italy, is also a contributor to this article.)
[i] See Article 27 of Company Law (capital contributed by intellectual properties as long as they are assessible monetarily and legally transferrable). http://www.npc.gov.cn/wxzl/gongbao/2014-03/21/content_1867695.htm.
Article 12 of Patent Law. http://www.cnipa.gov.cn/zcfg/zcfgflfg/flfgzl/fl_zl/1063508.htm.
Article 342 of Contract Law (Patent Use Right is transferrable). Last visited 2019.7.29. http://www.npc.gov.cn/wxzl/wxzl/2000-12/06/content_4732.htm.