GC Agenda China: March 2015

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GC Agenda China: March 2015

by Brad Herrold, Consultant and Practical Law China

NDRC Issues New Foreign Investment Catalogue

On 13 March 2015, the National Development and Reform Commission of China (NDRC) (中华人民共和国国家发展和改革委员会(国家发改委)) and the Ministry of Commerce (MOFCOM) (中华人民共和国商务部) jointly released the sixth version of the Catalogue of Industries for Guiding Foreign Investment 2015 (Catalogue), which will take effect on 10 April 2015. Foreign invested businesses in China must apply for government approvals to do business. Which approvals they need, what restrictions apply and whether preferential treatment will be available all depend on how the sector they wish to invest in is classified in the Catalogue. For an overview of the foreign investment regime (updated to reflect the new Catalogue), see Practice note, Foreign direct investment law: China: Overview: Foreign Investment Catalogue.

Relationship with draft foreign investment law

China's Draft Foreign Investment Law 2015 was recently circulated for public comment. If the draft law is enacted in its current form, the Catalogue will be replaced by a schedule of industry sectors in which foreign investment is either prohibited, or permitted subject to restrictions (negative list). The negative list will contain much more specific conditions to foreign investment than the Catalogue. Until then, the Catalogue will remain one of the most closely watched indicators of China’s macro-economic policies toward foreign investment.

What has changed?

Reduction in the number of restricted sectors and minimum domestic equity participation requirements.
Opening new sectors to foreign investment:
- insurance brokerage;
- real estate development; and
- R&D for genetically modified organisms.
Reducing restrictions in some sectors:
- manufacturing (in particular the manufacture of transportation equipment);
- e-commerce platforms; and
- some other service sectors.

Limited changes for value-added telecoms

Investors will need to wait a while longer for the value-added telecoms services (“VATS”), which includes the internet sector, to open up to foreigners beyond just the e-commerce space (which had already been opened to foreign investment within the China (Shanghai) Pilot Free Trade Zone (Shanghai FTZ) (中国(上海)自由贸易试验区); see Practice note, E-commerce in China: E-commerce and the Shanghai FTZ for details). “We all continue to look for signs [of further opening up],” noted Robert Lewis of Zhong Lun Law Firm, who pointed out that any announcement of a changed policy towards foreign investment in VATS would need to come first from the Ministry of Industry and Information Technology (MIIT) (工业和信息化部).

Consolidation, not breakthrough

Many of the adjustments merely clarify prior versions of the catalogue or reflect industry-specific rules or policies already in force. Several changes expected based on a November 2014 draft of the Catalogue - most of which fall within the purview of the Ministry of Culture - were rolled back, either due to lobbying by domestic competitors or to the conservative leanings of the regulator (or both). It is also likely that China, which is currently negotiating major trade deals with the US and Europe, is delaying opening up sensitive, high technology sectors as part of its broader negotiating strategy.

No specific action is required for GC who operate in industries that have not been reclassified. The GC most immediately affected by the changes will be those whose companies have held off from investing directly in China due to the existing restrictions and those whose China operations can now be restructured to grant the foreign company more control. In particular, GC that had the foresight to include a clause in their joint venture contracts allowing them to buy out their Chinese partner if the law changes to permit greater foreign ownership may find that now is a good time to open discussions about exercising those rights.

For detailed information on the new Catalogue, including a sector-by-sector analysis of the changes, see Legal update, China releases new foreign investment catalogue.

State Council Adopts Implementing Regulations for Government Procurement Law

The Implementing Regulations of the Government Procurement Law of the People’s Republic of China 2015 (procurement regulations) took effect 1 March 2015. The Government Procurement Law of the People’s Republic of China 2014 (procurement law) governs most purchases of goods, projects and services by Chinese government organs. The procurement regulations aim to address widespread government corruption by improving transparency and fairness in the government procurement process.

A more open procurement process

New transparency provisions include soliciting public comment on purchases for the public benefit, recording illegal conduct in an online search platform, fleshing out the query and complaints mechanism established under the procurement law, and requiring public disclosure of various aspects of the procurement process on media outlets designated by China’s finance departments.

Fairer procurement decisions

The procurement regulations seek to enhance fairness by requiring the use of government bidding and contracting form documents, public tenders (except under certain prescribed circumstances) and specified bid evaluation methods and procedures; prohibiting those in charge of government procurement from soliciting or accepting gifts, kickbacks or other property or services; obligating the various participants in the procurement process to monitor and report on one another; giving local finance departments increased investigation and disciplinary powers; and listing specific consequences for improper procurement award decisions.

Poor practices to attract increased scrutiny

The new regime means that all government procurement activity will be subject to increased scrutiny. GC for organisations that do significant business with SOEs or other government agencies in China should be aware that their points of contact are more likely to be examined by government and in some cases the general public. These GC should therefore ensure that their sales and marketing activities can withstand the increased scrutiny and transparency of the new government regime.

CBRC and MIIT Impose Network Security Standards on Banking Sector

On 29 December 2014, the China Banking Regulatory Commission (CBRC) and the MIIT jointly issued the Guidelines for Promoting the Application of Secure and Controllable Information Technology in the Banking Industry (2014-2015) (银行业应用安全可控信息技术推进指南), together with the Catalogue for Classifying Banking Industry Information Technology Assets and Secure and Controllable Targets 2014 (银行业信息技术资产分类目录和安全可控指标) (together, the new standards). The new standards follow two guiding opinions issued by the MIIT, CBRC and other agencies in September 2014 calling on the banking and IT sectors to strengthen network security through the use of “secure and controllable” IT and the implementation of network security review standards. The new standards specify a broad range of categories for IT products and services and define what constitutes secure and controllable IT within each category.

“Secure and controllable” technology: a blueprint for discrimination?

The new standards have caused a great deal of consternation among foreign IT companies as they appear designed to benefit domestic competitors by reducing foreign access to China’s banking IT sector. Worse may be in store. “The banking sector appears to be at the vanguard of the Chinese government’s network security campaign”, says Paul McKenzie of Morrison Foerster, noting that it is widely assumed that the new rules in the banking sector are a precursor to a broad rollout of similar network security standards in other industries. The new standards require, among other things:

Mandatory submission of source code to the CBRC.
“Indigenous” ownership of intellectual property rights to embedded software.
Certification of trusted computing modules under China’s TCM standard, as opposed to the international TPM standard.

Suppliers face a difficult choice

Foreign chambers of commerce are lobbying the Chinese government to reconsider the new standards in the light of the potential discriminatory effect of the new standards on foreign suppliers. In the meantime, GC for companies selling software or hardware products to banks should prepare to educate boards and product teams on the new standards. Ultimately, businesses may need to decide whether their products can be made to comply with the new standards - or whether the costs of continuing to sell them in China are too great.

NPC expands scope and increases sanctions under amended Work Safety Law

The amended Law of the People’s Republic of China on Work Safety 2014 (Work Safety Law) took effect on 1 December 2014. The Work Safety Law applies to all entities engaged in production and business operations in China and signals the Chinese government’s increased attention to hazardous workplaces. “The recent changes in the law, in particular the heavier fines, have been prompted by a public outcry over a spate of recently publicised cases of worker deaths caused by unsafe working conditions” says Jonathan Isaacs of Baker McKenzie. “The government needs to show that they are taking this issue seriously”.

Any business with 100 or more employees, and any business engaged in mining, construction, road transportation, metals smelting, or the production, sales or storage of hazardous substances, must create a distinct administrative body (or designate a full-time employee) to supervise workplace safety, and is prohibited from retaliating against such personnel for acts related to their supervisory role. Businesses must provide training on safe production rules, policies and procedures to dispatched personnel and student interns as well as employees, and maintain accurate records of all training activities. The administrative body or designated employee, management personnel and investors must ensure that the business’s work safety programme is properly funded. The Work Safety Law also calls for the State Council (中华人民共和国国务院) to draft measures related to the use, supervision and control of such funds. Finally, the Work Safety Law imposes significantly larger fines and penalties against businesses and their management personnel for workplace safety violations.

Unsafe workplaces a greater business risk

Taken together the new rules make unsafe and borderline workplaces into a substantially greater business risk for employers. GC for affected businesses should take the new law as a cue to review their existing workplace safety arrangements in China. The review should include ensuring that safety training is rigorous, mandatory and adequately funded. Qualifying companies should also designate their workplace safety committees or supervisors as soon as practicable.

Intermediate Courts Clarify Jurisdiction of Arbitration Forums

A series of recent decisions by the courts in Shanghai and Shenzhen has held that the Shanghai International Arbitration Center (SHIAC) and the Shenzhen Court of International Arbitration (SCIA) have exclusive jurisdiction over disputes involving legacy contracts (that is, contracts concluded prior to 2012 that contain arbitration clauses specifying Shanghai CIETAC and Shenzhen CIETAC (or CIETAC South China), respectively. SHIAC and the SCIA were originally established as sub-commissions of the China International Economic and Trade Arbitration Commission based in Beijing (CIETAC Beijing), but in 2012 they broke away from CIETAC Beijing, changed their names and adopted new rules of arbitration and arbitration panels (without otherwise changing their legal status). CIETAC Beijing responded by asserting its jurisdiction over any related dispute in 2012 and establishing new sub-commissions in Shanghai and in Shenzhen in 2014. For more information, see Legal update, Jurisdiction over CIETAC Shanghai and Shenzhen clauses: the latest developments.

It may seem that this confirms once and for all that the SHIAC and the SCIA have jurisdiction over a legacy contract dispute in which the relevant arbitration clause specifies them under either their former or current names. However, it is still not clear how courts will interpret arbitration clauses which refer disputes to the Shanghai and Shenzhen CIETAC sub-commissions in contracts that:

Post-date the 2012 split.
Post-date the 2014 establishment of the new CIETAC sub-commissions.

Getting the name right

The underlying risk, as Timothy Blakely at Morrison & Foerster notes, is that local courts in China “would refuse to enforce an award obtained from an arbitration institution later deemed to have lacked jurisdiction”. To mitigate this risk, GC should make sure that new contracts are unambiguous about which dispute resolution forum has jurisdiction, which includes using its correct, current name in English and Chinese. If important contracts signed after the split refer to SHIAC or the SCIA by their former CIETAC names, consider entering into a variation to clarify which institution was intended. For sample wording, see Standard clause, Arbitration (SHIAC and SCIA): China.

NDRC Imposes Record Fine on Qualcomm for Abuse of Market Dominance

On 10 February, 2015, the NDRC concluded a high-profile investigation of Qualcomm and announced a record fine. At issue was Qualcomm’s alleged abuse of its dominant position in several specific markets in violation of the Anti-monopoly Law of the People’s Republic of China 2007 (AML). Specifically, section (1) of article 17 of the AML prohibits the sale of commodities at an unfairly high price and section (5) prescribes the unreasonable tie-in sale of commodities or the addition of other unreasonable trading conditions. The NDRC examined Qualcomm’s market share for licenses of various standard essential patents (SEP) using wireless communications technology and sales of CDMA, WCDMA and LTE baseband chips, and concluded that Qualcomm held a dominant position in each market. It further determined that Qualcomm abused its dominant position in these markets by charging unfairly high royalty fees, tying the sale of SEPs with the sale of non-SEPs, and imposing unreasonable conditions on the sale of baseband chips. In cases involving abuse of market dominance, the AML permits fines of between one and 10 percent of the turnover for the preceding year. Qualcomm was fined less than 10 percent of its China-based turnover due to its willingness to cooperate in the investigation and agreement to a rectification plan. The decision may represent potential overreach by the NDRC as it combines price-related abuses of dominance, which are its mandate, with non-price-related abuses of dominance, which fall under the jurisdiction of the State Administration for Industry and Commerce (SAIC) (中华人民共和国国家工商行政管理总局). For more information on the legal regime on IP monopolies and SEP, see Article, China GC Agenda: June 2014.

Identifying risky licenses

GC for companies with patent-heavy portfolios should, if they have not done so already, assess their risk by examining the inventory of SEP that they license into China for sensitive terms such as those criticised in the Qualcomm decision. GC without a background in interpreting the anti-monopoly law in the technology sector may wish to seek specialist input due to the highly technical nature of the issues involved. Where problematic licences are identified and to the extent that it makes commercial sense to do so, GC can consider discontinuing some terms on renewal or varying the contracts.

For more information on the Qualcomm decision, see Legal update, China imposes record antitrust fine on Qualcomm.

SPC Revises Judicial Interpretation of Patent Disputes

The Decision of the Supreme People's Court on Revising the Several Provisions of the Supreme People’s Court on the Application of Law in the Hearing of Cases of Patent Disputes 2015 took effect on 1 February 2015. The new decision modifies the Several Provisions of the Supreme People's Court on the Application of Law in the Hearing of Cases of Patent Disputes 2001 (2001 Patent Interpretation) to conform to the revised Patent Law of the People’s Republic of China 2008 (2008 Patent Law) and expands jurisdiction over design patent disputes to include the place where the products are “offered for sale”. Under the 2008 Patent Law, the scope of protection of an invention patent or utility model patent is subject to its claims of rights, which under the 2001 Patent Interpretation was determined by the essential technical features recorded in the claims of rights, including the features equivalent to such technical features. The new decision expands this “doctrine of equivalents” to include all technical features recorded in the claims of rights, and adds a time element to such determination, (that is, the time when the alleged infringement occurred). The new decision also adopts the 2008 Patent Law’s cascade mechanism for determining damages and permits a plaintiff to exclude from the statutory cap on damages those expenses reasonably incurred in stopping an infringement. Finally, in an infringement suit involving a utility model or design patent, while a patent evaluation report may not be necessary for a case to be accepted by a court, the court now has discretion to suspend the proceeding or impose “adverse consequences” if it requests submission of the report and the plaintiff refuses without justification.

Patent evaluation reports increasingly important

The new decision “mainly serves to codify current judicial practice” says Chris Smith of Baker McKenzie, who sees the main impact as “the greater importance of patent evaluation reports going forward”. GC should ensure that they are ready to provide an adequate patent evaluation report for important utility models or design patents. Otherwise, although the decision is long overdue, it does not raise new issues.

GC Agenda China: March 2015 | Practical Law