Last month I wrote a post entitled How to Avoid Inadvertently Gifting your IP, explaining how Western companies often “gift” their intellectual property to their foreign manufacturers by not initially making clear by contract who will own the intellectual property that will be developed jointly by the foreign manufacturer and the Western company.
Since Western companies seem so eager to give away their intellectual property to their foreign competitors, I thought I would continue my series on this topic by describing my favorite method for making such a gift, what I call the joint venture scam. This technique started in China way back in the early 80’s and after over thirty years of hard work, Chinese state owned companies have now mastered the technique.
I can illustrate the early form of this system by describing a project on which I worked back in the late 80’s. A U.S. company developed an advanced and expensive aquaculture technique ideally suited for species and conditions along China’s coast. The original plan was to sell six of these systems to a state owned fish grower in Shandong province.
The Chinese company agreed to purchase the systems at a bargain price. After all the terms were agreed upon, I drafted the contracts and joined the U.S. company in Shandong to finalize and execute the contract. The day before the signing ceremony, the local government officials in charge of the project let us know that the price for the six as yet untested systems was just too high. They then explained how they had instructed the Chinese company not to execute the contracts and proposed the following as an alternative:
- Form a 51/49 joint venture company, with the U.S. company owning the majority interest. See China Joint Ventures — The Information the Chinese Government Does Not Want You to Know as to why owning a majority interest in a Chinese Joint Venture does NOT mean that you control it.
- The U.S. side would contribute one aquaculture system as its capital contribution. The Chinese side would contribute the space for the system in the local bay, together with all other infrastructure required for six systems.
- The JV entity would commit to purchase five additional systems after the first system was up and running.
I told my client this was a bad deal and I did everything I could to try to get them to try to force the Chinese side to stick with the straight sale deal. The client nonetheless chose to move forward with the JV.
The U.S. company delivered and installed the first system and the Chinese side claimed the system was no good. The JV then refused to purchase the five additional systems. The JV then went bankrupt and disappeared. Undaunted, the U.S. company then explored selling its aquaculture systems to an unrelated Chinese company in southern Zhejiang. However, when the U.S. company went on its first visit to the Zhejiang company, it found ten copies of its original system up and running. The only thing the Zhejiang company wanted from the U.S. company was consulting advice on how to fine tune its ten systems. The U.S. company was permanently closed out of the China market and had to feel the sting of seeing clones of its systems being used up and down the China coast.
This is the classic technique for using a Chinese joint venture to “assimilate” foreign intellectual property. The technique though has been refined somewhat since the 80’s. The current standard technique works as follows:
- Foreign company offers to sell complex and expensive technology on a standard technology licensing basis.
- After much discussion, the Chinese side indicates the price is too high for untested technology. The Chinese side then offers to establish a joint venture company in which the foreign company will own some percentage.
- The foreign side contributes one unit of its technical system in exchange for its ownership interest. The Chinese side contributes the rest. The contribution means the JV now owns the technology for China. The JV agrees to purchase a number of units at full price after the first unit is up and running properly.
- The foreign company then delivers and fully trains the Chinese side on how to operate the foreign company’s technology.
- The JV never purchases any additional units, claiming the foreign company’s technology does not work properly. The foreign company eventually discovers its technology has been cloned and is being actively utilized by an unrelated (usually state owned) company in China. Since the JV owns the technology, this unauthorized use is an infringement of the JV’s intellectual property. The JV must therefor sue to defend its rights. But, since the JV is controlled by the Chinese side its management will refuse to take any legal action.
- The JV then disappears. Normally, the Chinese side simply buys out the foreign side at a substantial discount.
This system in various forms is still actively used in China. A variant of this system was used to extract the high speed rail technology from foreign companies and to extract jet fighter technology from the Russians. Since foreign companies continue to participate in these ventures and since the intention of the Chinese side is so transparent, it seems the foreign companies fully intend to offer their IP to the Chinese side as a gift: a gift Chinese companies are happy to accept.