Potential Impact of China’s Export Control Law in Acquisition of Technology Companies

Acquiring intellectual property from China has just become more complicated because of China’s Export Control Law. On October 17, 2020, the Standing Committee of China’s legislature, the National People’s Congress (NPC), passed the Export Control Law of the People’s Republic of China, which went into effect on December 1, 2020. The Export Control Law applies to, among other things, “dual-use items” and “goods, technologies, services and items relating to the maintenance of national security and national interests.” ([Official Chinese text]; [Unofficial English translation]). These provisions make it likely that cutting-edge technologies China has invested heavily in, such as artificial intelligence and semiconductors, will be subject to China’s export control policy.

It has been less than two months since the Export Control Law passed, but many have speculated how the law will affect U.S. businesses. One of those businesses could be whichever U.S. company ends up acquiring TikTok, if TikTok’s Chinese parent company ByteDance decides to sell. As we anxiously watch the story unfold, here is our analysis of what could be the potential hurdles to overcome.

TikTok

TikTok has a huge U.S. presence –including a former Disney executive as its CEO – and almost no presence in China at all, but here is why its intellectual property will likely be subject to the Export Control Law.

First, TikTok does not own any patents related to its technology, but its Chinese parent company, ByteDance, does. ByteDance, together with its subsidiaries Kingsoft and Smartisan, owns over 6,000 patents worldwide, including U.S. utility and design patents. (See, e.g., U.S. Pat. Nos. D867,382; 10,360,230.)

Second, TikTok’s intellectual property plays a huge role in its success and is therefore critical to any potential U.S. buyers. TikTok’s success rests on its powerful machine-learning algorithm. According to TikTok, the app recommends content by ranking videos based on a combination of unique factors. For example, the algorithm notices if a user finishes watching a longer video from beginning to end, thus showing particular interest from that user.

Third, because of an Executive Order issued earlier this year, ByteDance is under tremendous pressure to divest TikTok. Although the pressure has since gone down because of the legal challenges, the outcome of those challenges remains uncertain.

Therefore, TikTok is an interesting case worth noting with respect to whether the deals will continue despite the potential hurdles imposed by China’s Export Control Law.

Background on China’s Export Control Policy

Before the Export Control Law, China’s export control policy was scattered across two bodies of law – the Foreign Trade Law of the People’s Republic of China, adopted in 1994, and administrative regulations and rules with provisions on export control.

To provide unity and a coherent body of law, the Chinese government officially included the Export Control Law in its legislative plan in 2016.

The Export Control Law went through three rounds of legislative deliberations since its first draft in 2017. On June 16, 2017, the Ministry of Commerce released Export Control Law – Draft for Solicitation of Comments and solicited public comments. The Ministry of Justice then released Export Control Law (Draft) based on solicited opinions from 55 departments, including the Central Finance Office, the Development and Reform Commission, and the Legislative Affairs Bureau of the Central Military Commission. On December 28, 2019, the 15th meeting of the Standing Committee of the 13th National People’s Congress conducted the first review of the Export Control Law (Draft). On June 28, 2020, the 20th meeting of the Standing Committee of the 13th National People’s Congress reviewed the Export Control Law (Second Draft). Both deliberations put forward detailed amendments. (Id.)

Thus, the official release of the Export Control Law in October 2020 marks the beginning of a new phase in China’s export control legislation and we expect to see more related legislation in the coming months.

Highlights from the Export Control Law Relating to the TikTok Acquisition

The Export Control Law has five Chapters.

The General Provisions Chapter provides insight into what type of intellectual property might be regulated. For example, Article 2 defines “Controlled Items,” including “dual-use items” and “goods, technologies, services and items relating to the maintenance of national security and national interests.” In a related action, China’s Ministry of Commerce and Ministry of Science and Technology on August 28, 2020 amended China’s Catalogue of Technologies Prohibited or Restricted from Export (in Chinese) to impose new controls in technological areas including:

• biotechnology, pharmaceuticals, and medical equipment;
• 3D printing;
• construction, petroleum, and power equipment;
• machine tools;
• high speed wind tunnel design;
• aerospace bearings;
• unmanned aerial vehicles (UAVs);
• space–related remote sensing image acquisition, measurement instruments, and data transmission;
• vacuum technology;
• mapping; information processing technologies (e.g., personal interactive data algorithms, speech synthesis, artificial intelligence-based interactive interface, voice evaluation, and intelligent scoring); and
• cryptographic and cyber-related technologies.

TikTok’s data-mining algorithm will fall squarely under “information processing technologies,” and the algorithm’s broad application will likely make it a “dual-use item” and “goods, technologies, services and items relating to the maintenance of national security and national interests.”

The Control Policies Chapter sets the process for the Chinese exporters to obtain a license for exporting the Controlled Items. The agencies will consider the following factors when deciding whether to grant a permit, such as national security and national interests, type of export, sensitivity of the items, and end users and end use. It’s worth noting that if the exporter develops internal compliance policies, the relevant agencies “may grant facilitation measures such as a general license for the export of the related Controlled Items by such export operator.” Further, exporters need to submit documents certifying end users and end use of the controlled items, and the related certifying documents shall be issued by a national or local government agency in the place where such end-use or end-users are located.

So far, there have not been any reports that ByteDance has established an internal compliance system, and it’s not certain whether this means TikTok needs to submit user information to meet the certification requirements.

The Regulations Chapter provides supervision and investigation of non-compliance. The involved government departments and their employees shall be legally bound to keep any national secrets, trade secrets, personal privacy, and personal information that becomes known to them in the investigation confidential. The interesting question here is whether a company like TikTok would be forced to reveal any user information and, if so, whether this confidentiality provision will be sufficient to protect user privacy.

The Legal Liability Chapter provides penalties, liable parties, and rights to appeal for non-compliance. Most Articles apply to Chinese domestic companies, but Article 44 states that “An organization or individual outside of the territory of the People’s Republic of China that violates the provisions of this Law in relation to administration of export control, endangers the national security and national interests of the People’s Republic of China, [and] hinders the performance of non-proliferation and other international obligations, shall be subject to investigation and legal liability in accordance with the law.” This echoes Article 48 from the Supplemental Provisions Chapter, which states that “If any country or region abuses export control measures to endanger the national security and national interests of the People’s Republic of China, the People’s Republic of China may, based on the actual situation, take reciprocal measures against that country or region.” It remains to be seen what “reciprocal measures” are available if ByteDance is forced to divest TikTok’s technology.

Practical Impact on IP Acquisition

The Export Control Law creates several hurdles for IP acquisition by a U.S. company. First, U.S. companies must understand the key provisions of the Export Control Law and their practical implications and be vigilant of any related legislation, such as China’s Catalogue of Technologies Prohibited or Restricted from Export. Second, because of the license-application process created by the Export Control Law, IP acquisition will likely take longer, as applicants must await approval. Third, U.S. businesses might need to engage more with the Chinese government to establish proper communication channels regarding the license-approval process. Lastly, U.S. businesses need to be prepared to demonstrate end user or end application of the goods, technology, or services, which might be subject to U.S. privacy laws.

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