China IP Challenges for Automotive Suppliers

I did an interview the other day with a very international site dedicated to the auto industry. The topic was China IP Challenges for Automotive Suppliers, but it dealt mostly with automotive high-tech, which in most respects is no different from high tech generally. I urge you to go here to listen to the entire interview as the below is just a hastily put together transcript of it and it does not include all of it.

For anyone who has been living in a cave, the auto industry has changed, is changing, and is very much on the cusp of more change, much of this stemming from cutting edge and rapidly advancing technologies. Or to borrow from a mega-famous car ad, this is not your father’s auto industry.

And with these technological advances comes massive IP needing protection. Our China lawyers have mostly represented American (and a smattering of European) auto tech companies that have been approached by Chinese companies interested in our client’s intellectual property. Just as is true of the United States, some of China’s largest tech companies are interested in developing and commercializing automobile technologies (autonomous driving, artificial intelligence, internet of things, connectivity, battery charging, etc.) and they are searching the world to find such technologies. These massive Chinese companies (and some not so massive ones as well) are reaching out in droves to foreign companies to try to supplement their automobile technologies. Our job as their China IP attorneys is to help them protect their IP. My interview discusses some of the IP issues these foreign tech companies face and some of the things they can and should do to protect their IP. I urge you to give it a listen because it includes a few things not covered below (including church bells going off in Madrid — that’s a long story). Anyway, please enjoy.

Ron: Welcome to the Global Business Professor Audio Interview Series. I’m Ron Hesse, and today I’m interviewing Dan Harris. Dan is an international lawyer who helps Western companies navigate Asia’s laws. Dan is founder of Harris Bricken, an international law firm with lawyers in Los Angeles, Portland, San Francisco, Seattle, Beijing, and Barcelona. Today’s topic is IP challenges for automotive suppliers in China. How are you, Dan?
Dan: I’m good and I’m looking forward to talking with you today, Ron.

Ron: Excellent. Well let’s get started! Let me start with this, Dan: what are the big issues you are seeing with China and the automotive world?
Dan: The auto industry is changing, and fast, and a large part of the rapid changes are happening with technology. What I am seeing is many Chinese companies want access to auto technology being developed outside China. Ten years ago, we were talking about things like transmission mechanics and technology, but today, we’re seeing this in all sorts of cutting edge technologies: driverless cars, battery-charging sensors, always-on cameras, artificial intelligence, composite materials technology, adaptive headlights, Internet of things, connectivity. It’s just endless, and so many of these technologies have direct applications to the auto industry.

Ron: Dan, what sort of companies want these technologies, and from whom?
Dan: A lot of companies in China want these technologies, but it is mostly just the big and powerful Chinese and auto tech companies that have the wherewithal to seriously go out and try to get access to these new technologies. On the foreign side, the side outside China, all sorts of companies are being contacted for their technology, ranging from one-product start-ups to mid-size companies. With some of these companies — in fact most of them — their technology has been developed specifically for the auto industry, but many of these companies are pure technology companies. What so many of these foreign companies have in common is that they have no experience dealing with China.

Ron: What sort of deals do the Chinese companies usually propose, and what should the foreign companies do in response?
Dan: What’s so funny here is that the Chinese companies oftentimes do not propose anything at all. They simply tell the foreign companies about the massive opportunities in China and ask to be able to test out the foreign company’s technology. Fortunately, at least some of these foreign companies reach out to lawyers experienced in dealing with China for help on what they should be doing at this point before they turn over any of their technology to China.

Ron: And what should they be doing at this point?
Dan: Not handing over their technology right away, that’s for sure. At this stage, we usually advocate our clients do two things right away. One, register whatever IP they have in China. This IP typically consists of patents and trademarks and sometimes even copyrights. And we explain how US Trademarks and Patents do not provide protections in China and how it is necessary to register these in China to protect them in China from Chinese companies. Then we explain how they need an NDA agreement for China (a Non-Disclosure Agreement) that is very different from the NDA agreements they use in the United States or in Europe—so different, in fact, that their home NDAs almost never provide any protection in China. And in fact, sometimes, these NDAs that are American or Western European style are actually worse than having nothing at all. [See Why Your NDA is WORSE Than Nothing for China]

What these companies almost always need is a China-centric NNN agreement, an agreement that prevents the Chinese company from competing, from disclosing, and from circumventing the American or the European company. And this agreement should be in Chinese, and it should be drafted for China. Once the American or European company has done its IP filings and has an NNN in place that’s been signed by the Chinese company they are thinking of showing their technology to, they are then in a much better position to provide their technology to the Chinese auto or technology company. And really, I probably should have been a little bit more specific earlier, it’s not just auto companies in China looking for this technology. Many of China’s biggest technology companies are looking for this also — companies like Alibaba and Tencent, etc., are looking for technology for the auto industry as well.

Ron: Are the IP registrations in place and a signed NNN agreement enough to make it safe to turn over the IP?
Dan: Well, it depends how you define the word safe. How’s that for a lawyer answer for you? It definitely makes it safer and in  most cases, it’s about all you can do at this point. But the reality is, the more companies to which any company turns over its IP and the more Chinese companies to which any company turns over its IP, the greater the risk of losing the IP. So we always advocate that our clients first make sure the company to which our client is looking to turn over its IP is a legitimate company. And we usually determine that after some level of due diligence on that company. And you’re probably thinking well, what do you mean by a legitimate company? Well, what we see a lot of times with China is that there are companies that are not really companies, and those are basically just scammers, and that’s actually fairly rare in the technology field because it’s a pretty sophisticated field. But what we also see are companies that want to get into the high technology automotive field and they’re not licensed to be in that field yet. So not kidding, we’ve had situations where a big Chinese sock (as in, what you put on your feet) a big Chinese sock company came to one of our clients wanting high-end auto technology and we looked up this Chinese company and they weren’t licensed to do anything even close to what they wanted to look at. And we explained to our client how in China, unlike in the United States or in Europe, if you’re licensed to make socks in China, you really cannot do anything other than make socks unless you go through what can sometimes be a difficult procedure to get licensed to do something else. So although this company might be a very legitimate sock manufacturer, the odds of it ever really going anywhere with high-end automotive technology is pretty slim. And so it’s not a company you want to turn over your technology to, unless you’re paid a lot of money in advance. And so that’s one of the other things that we also do.

And most importantly, and this goes back to one of the reasons we do due diligence on the potential Chinese partner, is we want there to be at least some chance of a deal happening before the technology is revealed. So for instance, if the Chinese company wants to buy the technology for $1 million, and our client would never sell it for less than $10 million, then it might as well just walk away without ever revealing its technology. And I would estimate that probably 25% of the time, a few forthright conversations with the Chinese company will tease out that there will never be a deal and our client walks away without a deal but it also walks without having put its technology at risk of being lost to China. Although, now that I say that, I have to laugh a little because even without sending your technology over to China, there’s always a risk of losing it to China because Chinese companies can maybe buy it on the market and/or reverse engineer it or whatever, but that’s still no reason to easily turn over your technology to everybody. And what usually happens once the parties start talking is that the Chinese company wants to form some sort of joint venture with our client. And in that joint venture deal, our client would put its technology into the joint venture entity that will be formed in China, and the Chinese company will tell our client, “and then if the joint venture entity does well, you’re going to do really well.” And our client starts thinking, “wow, this is great, I’m going to have a company in China and that company’s going to sell my technology to 1.4 billion Chinese consumers.” Well, as lawyers, we don’t like it because once IP or technology goes into a joint venture, it virtually never comes back and it is the rare foreign company that takes home profits from a China joint venture.

Ron: Those are interesting points, Dan. What sort of deals do you prefer?
Dan: Again I’m gonna give you a lawyer’s answer and say that it depends, but usually something more along the lines of straight licensing deals are safer for our clients—something where our client keeps all its IP in its name and retains ownership over all its intellectual property, and simply licenses it out to the Chinese company for $10 million a year, or failing that, for $2 per widget into which its technology goes. And it’s a lot easier to pull the plug on that sort of deal and keep your technology than it is on a joint venture deal. Now, do Chinese companies go for these licensing deals? Yes, they do, but usually only after our clients have held out long enough to convince the Chinese company that this is the only way it will get any access to the IP or the technology. Unfortunately, there are many American and European companies that don’t hold out, and that makes it tough for everybody else, and a lot of times those American and European companies end up calling law firms like us four or five years down the road when they’ve not made a penny off the joint venture and they’re now trying to get their intellectual property back out. And a lot of times, they’ll call us after the Chinese joint venture has gone out using the foreign company’s technology to compete with the foreign company internationally.

Ron: Dan, how do you ensure your clients will get paid the $10 million on a licensing deal? Because I’ve heard getting money from Chinese companies can be difficult.
Dan: You’ve heard right, and there are many reasons for this, ranging from government capital controls — the Chinese government does not like hard currency leaving China without its approval — to Chinese companies simply wanting to get technology by paying as little as possible for it. There are though all sorts of solutions that can increase the likelihood of foreign companies getting paid, with the best solution being to require some or all payments be made before some or all of the technology is revealed. Of course, the best situation is where our client gets the $10 million first and then reveals the technology. Chinese companies rarely go for that, so then the second best situation is one where the Chinese company pays, let’s say, $5 million, and then our client reveals half of the technology, and then the Chinese company pays another $5 million, and then our clients reveals the rest of the technology. Now, that’s an over-simplification — we’ve done deals where there have been ten stages — but what’s always so interesting about these multi-stage licensing deals is how the Chinese side will often try to circumvent those deals. So for instance,  it’s not uncommon for the Chinese side, after making three payments and getting three levels of the technology, to then say, “look, we can’t make this fourth payment because the Chinese government is not gonna let us do it for another six months, but we need you to send the technology to us now” and we have to sometimes fight hard with our own clients to get them not to send over the technology. Because a lot of times, they’ll tell us, “well, you know, if we just send the technology, it won’t matter because there’s nothing the Chinese company can do with our technology until they hit level 7, and this is just going to get them, you know, a little bit closer to that, but it’s not going to get them all the way there.” And we tell them, “look, I don’t think you really understand how a lot of these Chinese companies operate. They will be happy to get to maybe to level 4 or level 5 using your technology and not paying for all of it, and then they’ll hire their own people in China to get from level 5 to let’s say level 7 or level 8.” And a lot of times American companies will say, “well, if they get to level 8, it’s not that big a deal because it’s really not that great a technology until they get to level 10.” And we tell them, “look, it may not be that great a technology in the United States, but in Pakistan, or in Ethiopia or Nigeria, it might be a pretty valuable technology, and maybe those are the companies this Chinese company wants to sell to, so you’ve got to really get away from an American/Western European way of thinking when you’re doing these deals.

Ron: Very interesting. Thank you for your great insight, Dan. And that concludes today’s audio interview. Everyone, have a wonderful day!