China: Maximising owner potential

IP licensing and exploitation are on the rise in China. In the past it was predominantly foreign owners that attempted to license patents or trademarks to China. However, in recent years the trend has been leaning more towards the transfer of Chinese intellectual property to foreign licensees. As IP procurement and protection are paramount to China’s continued growth and development, significant emphasis has been placed on ensuring the integrity of all intellectual property entering and leaving the country.

While previously the focus may have been on enforcement and obtaining patents and trademarks, the trend has quickly moved to maintaining the legality and practicality of licensing agreements.

A trademark owner has total autonomy to license its Chinese registered trademark to another party through a licensing agreement. The Chinese Supreme Court has clarified the definition of an ‘acceptable trademark licensing agreement’, listing three potential categories:

• an exclusive licence, under which the rights holder grants a licence to a single licensee:
  • to use the registered trademark for an agreed period, within an agreed territory and in an agreed manner; and
  • barring itself from using the registered trademark;
• a sole licence, under which the rights holder grants a licence to a single licensee:
  • to use the registered trademark for an agreed period, within an agreed territory and in an agreed manner; and
  • allowing it to use that registered trademark, but barring it from licensing the mark to another party; and
• a non-exclusive licence, under which the rights holder grants a licence to another party:
  • to use the registered trademark for an agreed period, within an agreed territory and in an agreed manner; and
  • allowing it to use and grant licences to additional parties to use the registered trademark.

Although the trademark licensing options appear numerous at first, there are factors to consider before entering into a licensing agreement.

While most agreements are entered into with the best of intentions, unfortunately they sometimes go in a direction that no one intended. With regard to enforcing a licensing agreement, depending on which agreement is ultimately chosen, parties have different rights and obligations when it comes to litigation and combating potential infringement:

• Parties that enter into an exclusive licensing agreement have the option of filing suit before the relevant court for breach of the agreement or infringement issues.
• If the trademark is structured as a sole licensing agreement and a breach or infringement arises, either party may file suit. Coming from a more nuanced position, Chinese law allows the licensee to file suit either in concert with the rights holder or independently if the rights holder does not or is unwilling to take action in defence of the mark.
• The final option allows a licensee operating under a non-exclusive licence to act independently and file suit against a potential infringer only if the licensee is expressly authorised to do so by the rights holder.

Often when infringement is discovered by a party to a licensing agreement, the first step is to make note of the infringement and acquire evidence of the illegal activity. Evidence preservation is essential to bring a successful case before the courts in China and little can be done without properly obtained evidence.

In cases in which evidence is likely to be moved or destroyed before proper preservation can take place, Chinese law allows the petitioner to request a court order to prevent the evidence from being tampered with. The court will grant this only in limited exigent circumstances, but the licensor must consider the above three rules when applying for evidence preservation.

Further, with regard to recording the licensing agreement at the trademark office, Chinese law mandates that the licensor record the agreement within three months of execution of the final agreement.

The general reasoning behind the recordal is to allow the trademark office to regulate content and work to standardise agreements in future. This is also important for a number of practical business reasons (eg, banks require proof of recordal to allow for royalties to be paid to the licensor). If the licensor does not record the agreement at the trademark office, the agreement will still be valid.

However, the scope of the overall licence may be somewhat limited. One of the potential fall-outs from not recording is that a good-faith third party may not be bound to the agreement’s terms, whereas the licensee and licensor are. This makes enforcement against a good-faith third party impossible.

With regard to the agreement itself, there are a number of legal concerns that parties must consider before executing it. The agreement must comply with stringent contract law requirements.

While Chinese law lists a number of circumstances in which a contract and/or licensing agreement will be declared invalid, the courts tend to focus on whether the following conditions are present at the time of signature:

• The contract is against the general public interest, which is specifically defined and often construed very broadly if one party ultimately objects to the validity of the contract.
• The licence ultimately harms the country’s interest or was entered into by fraud, deceit or coercion. It is imperative that all parties to a licensing agreement agree on contractual terms and there is a meeting of the minds regarding the purpose of the whole agreement.
• The contract covers any illegal purposes, even if it is legal in form and intent. A licensor should consider any potential technology that may be prohibited or restricted from import or export to or from China. China General Customs lists a large number of prohibited or restricted goods. It is essential to consider this list before entering into a licensing agreement. Although a trademark may have been registered in China, the product covered may have import or export restrictions.
• The parties entered into the agreement under malicious collaboration with intent to harm the interests of China, a collective group or a third party. While there is limited ancillary support regarding what harm to a third party entails, it should be considered for business purposes. A licensing agreement could yield positive business returns, yet it also risks harming a competitor. If the agreement was structured with the intention of harming a third party, an argument could be made that the agreement is invalid, per se. This option is rarely exercised, but it is imperative to consider it when entering into an agreement.
• The contract does not accord with Chinese contract law. Any deviation from this or violation of regulatory or legal requirements could lead to the entire agreement being held invalid.

A number of requirements must be met to make the overall licence valid in accordance with Chinese law. The agreement must be in writing and signed by the contracting parties, and must also clearly define:

• the duration of the licence;
• the scope of use; and
• certain requirements that allow the licensor to monitor and supervise the production and ultimate quality of goods using the licensed mark.

These three requirements are frequently not included in licensing agreements and issues arise from their omission.

Of particular concern are the provisions pertaining to the scope of use and supervision of the quality of goods produced using the licensed trademark. It is common for a licensor in China to exceed the scope of use and act independently for its own business purposes. Such instances may involve sub-licensing the goods to a third party without authorisation or producing goods that are not included in the licensing agreement.

Further, it is imperative for a licensor to supervise the overall quality of the goods produced. Instances have occurred in which an authorised licensee has produced inferior-quality goods for export that bear the licensor’s trademark which have entered foreign markets. As a result, the licensor’s brand was adversely affected and there were significant quality control issues for the licensor to deal with.

While Chinese contract law and the law governing license agreements are based on some of the same principles, both are nuanced in their application. Chinese contract law implements a broad brush stroke to encapsulate all commercial activity in China, while laws governing licence agreements tend to be more granular in application. It is essential to draft your agreement in accordance with the relevant contract laws and then extend the necessary overtures to meet the stringent licensing protocol.

Trademark licensing in China continues to increase in scope and frequency. As markets grow, so do the number of licensing agreements. While China may have abundant potential on a number of levels, certain considerations must be examined to ensure legal enforcement and brand integrity. Consulting counsel on any licensing agreement and taking into account local law and practice are important first steps.

While thinking creatively can yield impressive results in business, it is prudent for a brand owner to obey the rules when licensing its trademark in China.

Aaron D Hurvitz
Of foreign counsel
[email protected]

Aaron D Hurvitz joined Kangxin Partners PC in 2009 as of foreign counsel and is responsible for advising Kangxin’s foreign clients on IP law in China. Mr Hurvitz frequently lectures around the world, focusing on anti-counterfeiting and IP enforcement, and advises on doing business, licensing technology and commercialising intellectual property in China.