New “in-kind investment” rules for monetizing IP 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 a new opportunity? 

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.

Sounds perfect!?  However, an article “Would you marry me? — with an IP ring in China”（https://www.linkedin.com/pulse/would-you-marry-me-ip-ring-china-dr-jili-/） reveals the truth -- a foreign investor proposing such “IP ring” to “marry” its Chinese counterparts should plan carefully. When such a foreign investor forms a foreign-investment enterprise (“FIE”) with its Chinese partners by contributing its IP as register capital, it is facing the following three uncertainties:

1.What kinds of IP are qualified for capital contribution? Patents, trademarks, and copyrights appear to be straightforward. But what about trade secrets (proprietary information), proprietary technologies, licensing rights, rights to apply for IP, etc.? 

2.What is the statutory percentage ceiling for such in-kind capital contribution? To what extent the transaction parties may use their discretion to decide the percentage?

3.As FIE approval and registration procedures vary locally, how to manage such variation when collaborating with a Chinese party? 

Long Story Short

These uncertainties were created with a background.  These relevant FIE rules were not enacted in one time. They were enacted in a lengthy time span of the legislative history in China back in 1980s.  The awareness of IP’s value and subtle but crucial differences among various kinds of IPs were not consistent among the legislators at different times.  While the legislators were gaining more knowledge and experience in dealing with IP regulatory issues in investments, the accumulated regulations have become cumbersome and hard to reconcile.

As a result, the FIEs rules are inevitably less straightforward, difficult to reconcile, and subject to interpretation by the local authorities.  The book Innovation’s Crouching Tiger（https://www.amazon.com/Innovations-Crouching-Tiger-Introduction-Monetization-ebook/dp/B07PZ8TXS9/ref=sr_1_1?keywords=jili+chung&qid=1585488279&sr=8-1） analyzes such risks and countermeasures in great details.

Brand-New Foreign Investment Law

A very welcome development is the promulgation of the new Foreign Investment Law on January 1, 2020 (the “Foreign Investment Law”).  The law is meant to replace the preceding FIE regulations. Would the new law eliminate the uncertainties for foreign investors seeking to make in-kind investment by contributing their IPs in a Chinese company? 

Two important observations hint the answers:

The China Company Law has a role

First, the new Foreign Investment Law is silent about in-kind investment.  Because the previous FIEs regulations are repelled and the new law is silent on this point, the China Company Law kicks in to fill in this vacancy.  The China Company Law was revised recently.  As such it better contemplates IP’s value to a business and subtle differences among different kinds of IP.  In addition, it governs “in-kind investment” with a single body of law, leaving no ambiguity to reconcile among competing regulations.

Theoretically speaking, therefore, now the limitations and uncertainties in definition, ceilings or classification concerning IP in-kind investment are gone. Foreign investors have more clear rules to follow in monetizing their IP in China through in-kind investment.

Practically speaking, it remains to be seen how local authorities (the gate keeper in most FIE approval applications) will implement the new law.  However, there should be no reason to cast a 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.

US-China Trade War also plays a part

The second and probably more important observation comes from the US-China Trade War.  As discussed in the article “How the Trade War is Fostering IP Monetization in China”, the ongoing US-China trade negotiations will serve as a driving force behind the change of China’s IP regime in the foreseeable future.  The demand from US may tilt the scale toward a more level playing field.  For example, the first-round settlement agreement signed in January 2020 contains an umbrella clause that requires “each party shall ensure fair and equitable market access to persons of the other party that rely upon intellectual property protection”.  Foreign parties’ contribution of their IP in FIEs as a way to monetize their IP in China appear to fall into this general principle.

The New World Investment Norm

In sum, the new Foreign Investment Law is expected to resolve the long-standing challenges to IP monetization by foreign investors through in-kind investment in Chinese new ventures. Local approval practice may still need some time to grind in.  But at least foreign investors seeking to monetize their IP in China can now spare hard time reconciling apparently conflict rules as these rules have been removed.

This regulatory development will also greatly enhance utilization of IPs in cross-border collaborative projects.  In an era when globalization stalls and confidence in currencies decreases, in-kind investment is becoming a feasible option for innovative business ventures in China.  

(Dr. Jili Chung is currently working in Greater China, founding SpringIP Group, dedicated to foster enterprises’ innovation through AI and Big Data tools.  Carlo Geremia, a cross-border transaction expert residing in Shanghai and Italy has also contributed to this article.)