Huaxing company represented by Xu Xinming lawyers team won against RSF companyin arbitration with respect of technology transfer contract dispute

Abstract: On April 1, 2012, Guizhou Huaxing Aviation Technology Co., Ltd. (hereinafter referred to as “Huaxing”) and Beijing RSF Technology Co., Ltd. (hereinafter referred to as “RSF”) entered into the "Brake Shoe Production Line Equipment Transfer Contract" (hereinafter referred to as "Production Line Equipment Transfer Contract”) and “Technology Transfer (Patent Implementation License) Contract” (hereinafter referred to as “Technology Transfer Contract”) respectively. According to the contracts, RSF shall transfer the brake shoe production line equipment and production process to Huaxing and provide secret formula raw materials for Huaxing. Accordingly, Huaxing shall pay RSF 15 million yuan for production line equipment and a maximum of 9.8 million yuan as royalties for use of the patented technology involved in this case (hereinafter referred to as “involved patented technology”). The dispute resolution provided in the Production Line Equipment Transfer Contract is by litigation, while the dispute resolution provided in the Technology Transfer Contract is by arbitration in Beijing Arbitration Commission. The contract takes effect in accordance with the law. During the performance of the contract, disputes occurred between the two parties. By means of litigation, RSF forced Huaxing to pay for the production line equipment, while immediately after Huaxing had paid for the production line equipment, RSF filed an arbitration application with Beijing Arbitration Commission and claimed that (a) Huaxing shall pay RSF 2.16 million yuan as royalties and 5 million yuan for breach of contract; and (b) Huaxing shall immediately stop using the involved patented technologypatented technology involved in the case. Huaxing entrusted Xu Xinming lawyers’ team to represent the case and made counterclaims in arbitration that (a) the Technology Transfer Contract shall continue to be performed; and (b) RSF shall pay 2.5 million yuan for breach of contract. Beijing Arbitration Commission held a hearing on the above-mentioned case on January 15, 2020, and made a ruling on May 22, 2020 that (a) the Technology Transfer Contract shall continue to be performed and Huaxing can continue to use RSF's patented technology without time limit; (b) Huaxing shall pay royalties equal to 1.3568 million yuan at one time and no longer need to pay any royalties  in the future; and (c) Huaxing shall pay 800,000 yuan to RSF for breach of contract, and RSF shall pay 400,000 yuan to Huaxing.

1. The background of the cooperation between RSF and Huaxing

On January 19, 2009, the Transport Bureau of the Ministry of Railways of China issued a notice stating that the high friction brake shoes which are produced by using the technology introduced from German BK company have passed the technical review organized by the ministry on January 18, 2008 and can be installed.

On October 31, 2008, RSF applied to the National Intellectual Property Administration for the patent of high friction brake shoes and manufacturing method of it, and acquired the patent for invention in October 2010.

In addition, the production of the aforementioned brake shoes requires a special formula. This formula was originally provided by the German BK company.

RSF took the initiative to introduce the advantages and huge market value of the aforementioned brake shoes to Huaxing, and invited Huaxing to visit the brake shoe production line. After that, RSF delivered its old brake shoe production line equipment directly to Huaxing in September 2011 and March 2012 in twice and urged Huaxing to purchase it.

2. RSF and Huaxing signed "Production Line Equipment Transfer Contract" and "Technology Transfer Contract". RSF transferred a set of old brake shoe production line equipment to Huaxing, and allowed Huaxing to use its patented technology

Under RSF's enthusiastic offer, Huaxing began to negotiate with RSF on the introduction of brake shoe production line equipment. In the process, RSF promised to license Huaxing to use its patented technology and technical secrets and provide Huaxing with 10 % secret formula raw materials to ensure that the brake shoe products produced by Huaxing can pass the CRCC certification and can bring 1 million pieces of sales to Huaxing annually. In view of this, Huaxing finally agreed to purchase RSF's second-hand brake shoe production line equipment at a high price of 15 million yuan. On April 1, 2012, RSF and Huaxing signed the "Technology Transfer Contract" and "Production Line Equipment Transfer Contract".

During the trial operation of the brake shoe production line equipment purchased by Huaxing, RSF immediately purchased new brake shoe production line equipment with upgraded performance.

The "Production Line Equipment Transfer Contract" provides that RSF shall transfer brake shoe production line equipment to Huaxing and provide the involved patented technology and 10% secret formula raw materials. The procurement of secret formula raw materials adopts the method of centralized procurement and transfer. RSF shall gather all manufacturers using brake shoe technology to negotiate prices with the raw material suppliers according to the raw material procurement standards. After the price is determined, RSF will purchase and transfer the secret formula raw materials to various manufacturers. RSF shall provide Huaxing with technical support for the brake shoe production line equipment for a long time. Regarding the royalties, the contract provides that within five years after Huaxing starts the mass production (with an annual output of more than 500,000 pieces) and begins to sell the products, for the first three years before the end of each quarter, Huaxing shall pay RSF royalties equal to 3% of sales revenue for the quarter, royalties for the next two years is adjusted to 2% of sales revenue. Regarding the payment method and the time of payment, the contract provides that within 10 days after RSF delivers the brake shoe production line equipment to Huaxing, Huaxing shall pay 3 million yuan and within 10 days after RSF assists Huaxing to obtain the Ministry of Railways production license qualification and certification, Huaxing shall pay another 3 million yuan. After the second payment, the balance will be paid to RSF in twice within a year and the payment of each time shall be 50% of the balance.

The "Technology Transfer Contract" provides that RSF shall authorize Huaxing to implement its product and manufacturing method patents and the technical secrets related to the implementation of the patents by means of simple license. Regarding the royalties, the contract provides that the total amount of the royalties is 9.8 million yuan, of which 300,000 yuan is the technology secret use fee which Huaxing shall pay within 30 days after signing the contract and the remaining part is the technology royalty fee which shall be paid by Huaxing within five years after the start of mass production and sales, specifically, at the end of each quarter for the first three years, Huaxing will pay RSF a royalties of 3% of the sales revenue for the quarter, and the payment ratio for the next two years will be reduced to 2%.

The above-mentioned contract shall be effective from the date of signing. RSF has delivered production line equipment to Huaxing.

On September 21, 2012, RSF and Huaxing held a special meeting on high friction brake shoe project. The chairman of RSF, chairman, deputy general manager and other department heads of Huaxing attended the meeting. At the meeting, RSF solemnly promised: it will be responsible for selling all brake shoe products produced by Huaxing; Huaxing will not pay for the production line equipment transferred by RSF Company for the time being. The two parties involved reached the "Minutes of the Meeting".

3. The two parties had a dispute over the payment of the production line equipment, and RSF forced Huaxing to pay the equipment and "liquidated damages" by means of lawsuit

On July 23, 2013, Huaxing paid 6 million yuan to RSF. Since RSF did not actually sell the brake shoes of Huaxing, Huaxing had not obtained any income through production yet, therefore it was unable to pay RSF. In addition, both parties have made it clear in the "Meeting Minutes" that Huaxing does not need to pay RSF temporarily. Therefore, before achieving mass production, Huaxing is unable and does not need to pay the balance to RSF.

However, in 2018, RSF filed a lawsuit in a court in Beijing, demanding Huaxing to pay the balance of the equipment which is 8,435,000 yuan and the liquidated damages according to the standard of 0.03% of the unpaid balance per day from July 24, 2014 to July 23, 2018. Huaxing entrusted a law firm in Shanxi to attend the lawsuit. Regrettably, both the court of first instance and the court of second instance in Beijing fully supported RSF's claims, and rejected Huaxing's defence that based on the "Meeting Minutes", Huaxing does not need to pay for RSF's production line equipment.

4. RSF submitted an arbitration application to the Beijing Arbitration Commission, requesting Huaxing to pay 2.16 million yuan for royalties and 5 million yuan for liquidated damages, and immediately stop using the patented technology involved.

On August 22, 2019, RSF filed an arbitration application with Beijing Arbitration Commission in accordance with the arbitration clause in the "Technology Transfer Contract", claiming that Huaxing shall immediately stop using the involved patented technology and pay the royalties and the liquidated damages.

If RSF's request for Huaxing to stop using the involved patented technology is supported, then the 15 million yuan invested by Huaxing for the purchase of production line equipment and the "liquidated damages" of several million yuan will be lost, Huaxing will fall into extreme difficulty. So far, Huaxing has been forced to a cliff, and there is no way to go back. Huaxing attached great importance to this case, and its chairman and general manager went to Beijing to visit professional intellectual property lawyers. After several interviews with different lawyers, Huaxing finally decided to entrust Xu Xinming, the chief lawyer of China Intellectual Property Lawyers, to represent the case.

After studying the case, Xu Xinming believes that: ① The terms of the "Production Line Transfer Contract" and the "Technology Transfer Contract" are mutually infiltrated and interrelated, and neither of the contracts can exist and be performed independently. As far as the purpose of the contract is concerned, the "Production Line Equipment Transfer Contract" is particularly dependent on the "Technology Transfer Contract". Without a technology license, the production line equipment will be reduced to a pile of scrap iron. ② There shall be no time limit for technology implementation in the "Technology Transfer Contract", so Huaxing can implement the related technologies without time limit. ③The term for RSF company to receive royalties is 5 years, and it has expired. ④RSF’s failure to provide 10% secret formula raw material to Huaxing in accordance with the contract constitutes breach of contract and shall be liable for breach of contract.

Based on the above analysis, Xu Xinming decided to represent Huaxing in the arbitration and filed a counterclaim for arbitration.

5. The arbitration tribunal held hearings on the case

The parties to the arbitration each selected an arbitrator, the chief arbitrator was appointed by the chairman of Beijing Arbitration Commission, and the three arbitrators formed an arbitration tribunal to hear the case. Xu Xinming's team of attorneys represented Huaxing to submit pleading, arbitration counterclaim and evidence materials to the arbitration tribunal. The arbitration tribunal held a hearing on this case on January 15, 2020. Xu Xinming and his paralegal Hu Jun represented Huaxing to appear in court. RSF also appointed four attorneys to appear in court.

5.1 The cause of action and claims of RSF

RSF believes that it licensed Huaxing to use the patents involved in this case patented technology by way of simple licenses, and the license period is from April 1, 2012 to March 31, 2017. After the contract came into effect, RSF provided relevant technical materials to Huaxing in accordance with the agreement, and transferred the technical secrets related to the implementation of the patented technology. After Huaxing implemented the patented technology, the high friction brake shoes produced by Huaxing complied with the relevant standard provided in the contract and passed the Ministry of Railways certification. RSF has fulfilled all its obligations under the contract. The DQ Railway Company’s project negotiation and procurement invitation letter showed that the project required a total of 900,000 high friction brake shoes, and Huaxing won the bid for the project. Based on the price of the brake shoe which is 80 yuan per block, Huaxing could obtain about 72 million yuan of brake shoe sales income through this project. The conditions for Huaxing to pay royalties have been fulfilled, and RSF shall pay 2.16 million yuan (72 million yuan✖3%=2.16 million yuan) for royalties as agreed, but Huaxing has not paid royalties so far. Huaxing’s failure to pay royalties as agreed constituted breach of contract, and it shall pay RSF liquidated damages of 5 million yuan in accordance with the contract. Accordingly, RSF claimed that:

1. Huaxing shall pay royalties equal to 2.16 million yuan;

2. Huaxing shall pay liquidated damages of 5 million yuan;

3. Huaxing shall stop using the patented technology immediately

5.2 The cause of action and claims of Huaxing

Huaxing holds that:

(1) There is a special background where Huaxing and RSF signed "Production Line Equipment Transfer Contract" and "Technology Transfer Contract".

RSF introduced the brake shoe's advantages and huge market value to Huaxing, and invited Huaxing to visit the brake shoe production line. After that, RSF delivered its old brake shoe production line equipment directly to Huaxing in twice in September 2011 and March 2012, asked Huaxing to purchase and advanced the carriage occurred therefore itself. RSF promised to license Huaxing to use its patented technology and technical secrets and provided Huaxing with 10% secret formula raw materials. It further ensured that the brake shoes produced by Huaxing can pass CRCC certification and bring Huaxing sales of 1 million pieces each year. Based on this background, Huaxing decided to enter into the contracts with RSF.

(2) The "Production Line Equipment Transfer Contract" and the "Technology Transfer Contract" are interdependent, and the terms of the contracts are interpenetrative and complement each other.

For example, Article 6 of the "Technology Transfer Contract" provides: "In order to ensure that Party A (Huaxing) effectively implements this patent, Party B (RSF) will transfer to Party A the technical secrets related to the implementation of this patent: ... 2. Requirements for the implementation of technical secrets: the prescribed equipment, tooling, raw materials, etc. are in place.... “The "prescribed equipment" here refers to the brake shoe production line equipment agreed in the "Technology Transfer Contract".

Another example, the first and second paragraphs of Article 11 of the "Production Line Equipment Transfer Contract" provides: "Technical support: party B provides party A with technical support for the brake shoe production line equipment for a long time. In order to ensure sales, reduce transportation costs and meet customer needs, party A shall use the model of segmented sales, all manufacturers jointly negotiate to determine the domestic supply area. Within five years after party A starts mass production (with an annual output of more than 500,000 pieces) and begins to sell, before the end of each quarter for the first three years, party A will pay to party B royalties of 3% of sales revenue this quarter, and the royalties for the next two years will be adjusted to 2% of sales revenue."

Article 9 of the "Technology Transfer Contract" provides: "Party A shall pay to Party B the royalties for the implementation of the patent and the method of payment shall be:

1. The total royalties is 9.8 million yuan, of which the fee for using of technical secrets is 300,000 yuan and the royalties for using of the patented technology is 9.5 million yuan.

2. The royalties shall be paid by Party A to Party B. The specific payment methods and time are as follows: (1) Within 30 days after signing the contract, 300,000 yuan shall be paid; (2) Within five years after Party B begins mass production and begins to sell, at the end of each quarter for the first three years, Party B will Pay 3% of the sales revenue of this quarter for royalties; the payment ratio will be reduced to 2% in the next two years. "

The two parties have introduced royalty clauses in the "Production Line Equipment Transfer Contract", which fully demonstrates that technology transfer is a prerequisite for the transfer of production line equipment, and technology transfer clauses are an important part of the "Production Line Equipment Transfer Contract". Without the technology license, the second-hand equipment purchased from RSF will become a pile of scrap iron. Accordingly, without the "Technology Transfer Contract", the "Production Line Equipment Transfer Contract" cannot be established, let alone the purpose of the contract. As the saying goes, with the skin gone, what can the hair adhere to?

(3) RSF failed to fully perform its obligations in accordance with the "Technology Transfer Contract" and "Production Line Equipment Transfer Contract", and its behavior constituted breach of contract.

RSF refused to provide Huaxing with 10% secret formula raw materials, which violated Article 6 of the "Technology Transfer Contract" and should be liable for breach of contract.

The second paragraph of Article 6 of the "Technology Transfer Contract" provides: "Requirements for the implementation of technical secrets: the required equipment, tooling, raw materials, etc. are in place."

Article 3 of the "Production Line Equipment Transfer Contract" provides: "...10% of the secret formula raw materials shall be provided by Party B to Party A."

According to the above agreement, RSF is obliged to provide Huaxing with 10% secret formula raw materials. In 2018, Huaxing won the bid for DQ's first batch of material procurement projects (high friction synthetic brake shoe, HGM-D type), and the number of winning bids was 900,000. In order to complete the production task, Huaxing purchased 10% secret formula raw materials from RSF. However, RSF only provided 30 tons (only 125,357 pieces of synthetic brake shoes can be produced) of the 10% secret formula raw materials, and then refused to provide further. RSF's behavior violated Article 6 of the "Technology Transfer Contract" and should be liable for breach of contract.

The second paragraph of Article 16 of the "Technology Transfer Contract" provides: "Party B (RSF) shall pay 2.5 million yuan for breach of contract in violation of Article 6 of this contract."

Accordingly, RSF should pay liquidated damages equal to 2.5 million yuan to Huaxing.

(4) The "Technology Transfer Contract" is valid without time limit, and RSF does not have the right to terminate the contract. In addition, the term for RSF to acquire royalties has expired.

Article 3 of the "Technology Transfer Contract" provides that Party B permits Party A to use this patent in the following scope, method and time period: ... 3. Implementation period: long-term. Accordingly, the "Technology Transfer Contract" is valid for a long time.

According to Article 11 of the "Production Line Equipment Transfer Contract", when Huaxing produces and sells more than 500,000 products within one year, it will begin to pay RSF royalties. In fact, Huaxing passed CRCC on April 24, 2013, and at the time of certification, it had the annual production capacity of 1 million products. According to the "Minutes of the Meeting", RSF Company is obligated to sell all brake shoe products produced by Huaxing, that is, RSF is obliged to provide Huaxing with orders.

In summary, from April 24, 2013 when Huaxing had mass production capacity, the five-year period during which RSF Company has the right to acquire royalties would start to calculate and expired on April 23, 2018.

As RSF failed to provide orders to Huaxing and failed to provide sufficient 10% secret formula raw materials in accordance with the contract when Huaxing obtained orders through its own efforts, its behavior has constituted serious breach of contract. Since RSF breached the contract first, Huaxing is entitled to the defense of first-performance. Therefore, even if Huaxing did not pay the royalties in time, RSF did not have the right to terminate the contract.

6. The main issue in this case: the term of "Technology Transfer Contract"

The main dispute between the parties in this case focused on the term of the "Technology Transfer Contract", that is, whether the term of the contract is five years claimed by RSF or no fixed term claimed by Huaxing. If the 5-year term claimed by RSF is supported by the arbitration tribunal, then the production line equipment that Huaxing purchased at a high price will have to stop production. If Huaxing wishes to continue to produce brake shoes, it has to ask RSF for license to use its patented technology again and the cost must be huge.

The term of "Technology Transfer Contract" is in question because the contract itself has contradictions. The cover of the contract clearly states: "Term of contract: April 1, 2012 to March 31, 2017", while article 3 of the contract provides: Party B permits Party A to use this patent in accordance with the following scope of implementation, implementation method and implementation period:

1. Implementation method: the production shall be according to the patent and supporting technical materials provided by Party B. 2. Scope of implementation: implement in Guizhou Huaxing Aviation Technology Co., Ltd. 3. "Implementation period: non-fixed term".

Obviously, the term of the contract stated on the cover of the contract is inconsistent with the implementation period provided in Article 3 of the contract. So which one should prevail?

RSF claims that the contract period should be five years. The main reason is: RSF has sent a "Notice Letter on Termination of Cooperation Agreement" to Huaxing on August 15, 2018 stating that the term of the contract in this case is 5 years. The contract expired on March 31, 2017, and the two parties have not renewed the contract so far, which further illustrates that with respect to the term of contract, the true intention of the two parties at the time of signing the contract was five years.

Huaxing believes that:

(1) The third item of Article 3 of the "Technology Transfer Contract" clearly provides that "the implementation period: long-term". Although the term of contract stated on the cover of the contract is from April 1, 2012 to March 31, 2017, if the term of contract stated on the cover is inconsistent with the contract terms, the contract terms shall prevail.

(2) Both parties sign the "Production Line Equipment Transfer Contract" and the "Technology Transfer Contract" at the same time. Therefore, the interpretation of the term of the "Technology Transfer Contract" should be the same as the "Production Line Equipment Transfer Contract".

Article 2 of the "Production Line Equipment Transfer Contract" provides that "the transfer period: April 1, 2012 to March 31, 2017." As we all know, the result of the production line equipment transfer is that the property right of the production line equipment belongs to Huaxing permanently.

Article 3 of the "Production Line Equipment Transfer Contract" provides that "...All the technical data of the brake shoe transferred by Party B to Party A shall be transferred by Party B to Party A, and the transfer of the above-mentioned materials shall be completed before the expiration of the transfer period...."

According to the above agreement, the five-year transfer period provided in Article 2 refers to the transfer period of technical materials.

In the same way, the 5-year term of validity stated on the cover of the "Technology Transfer Contract" refers to the transfer period of technical materials, not the period of technology implementation.

(3) If the term of the "Technology Transfer Contract" is determined to be five years, it will cause Huaxing to fail to achieve the purpose of the contract.

The purpose of Huaxing's purchase of the brake shoe production line equipment is to use the brake shoe production line and use brake shoe production technology to produce qualified brake shoes and sell them. The brake shoe production technology consists of the patents and technical secrets involved. If the term of the "Technology Transfer Contract" is determined to be five years and RSF does not grant a license for use of the patented technology, Huaxing will not be able to continue to implement the patented technologies and the brake shoe production line equipment that Huaxing has spent a lot of money to buy will be reduced to a pile of scrap iron.

(4) On the one hand, RSF forced Huaxing to pay off the production line equipment transfer price and "liquidated damages" through litigation in accordance with the "Production Line Equipment Transfer Contract", on the other hand, it intends to terminate the performance of the "Technology Transfer Contract". Its behavior violated the principle of fairness and good faith and shall not be allowed by law.

In summary, there is no time limit for technology implementation in the "Technology Transfer Contract", and Huaxing can use related technologies without time limit.

7. Arbitration results

(1) The five-year term for royalties is from November 13, 2014 to November 12, 2019

According to the contract, "five years" shall be calculated from "Party A starts mass production and sale of the products", but not from the signing of this contract. The two parties have no objection to this point, and the dispute between the two parties lies in the starting time.

The arbitration tribunal held that because the "Technology Transfer Contract" did not directly provide the definition of "batch", RSF recognized that the 20,000 pieces sold by Huaxing on November 13, 2014 were sold in batches, and the quantity was reasonable to be defined as “batches”. Accordingly, November 13, 2014 can be regarded as the starting time for calculating the “five-year” royalties, that is, the five-year term for the royalties is from November 13, 2014 to November 12th, 2019.

In summary, time for RSF to request payment of technology royalties expires on November 12, 2019. After that, RSF has no right to request Huaxing to pay technology royalties.

(2) There shall be no time limit for the implementation of the technology license

The arbitration tribunal held that the "Production Line Equipment Transfer Contract" should not be considered in isolation from the "Technology Transfer Contract". According to the "Production Line Equipment Transfer Contract", the purpose of Huaxing's payment of 15 million yuan is not only to purchase RSF's production line equipment, but also to obtain RSF's involved patents and technical secrets. If the implementation period of the patent is determined only based on the period stated on the cover of the contract, it is obviously contrary to the relationship between the "Technology Transfer Contract" and the "Production Line Equipment Transfer Contract" and the original intent of the contract, thus violating the principle of contract fairness.

To sum up, the arbitration tribunal determined that there shall be no time limit for Huaxing to implement the patented techonology involved in the case.

(3) Both parties have breached the contract and each bears responsibility for breach of contract, but RSF has no right to terminate the "Technology Transfer Contract".

The arbitration tribunal held that RSF’s failure to provide 10 % raw materials and Huaxing’s failure to pay royalties in accordance with the contract both constituted a breach of contract and should be liable for breach of contract. However, RSF has no right to terminate the Technology Transfer Contract.

The arbitration tribunal finally determined that Huaxing shall pay RSF royalties equal to 1.3568 million yuan and liquidated damages of 800,000 yuan to RSF in accordance with the contract, and RSF should pay Huaxing liquidated damages of 400,000 yuan.

In summary, Huaxing can continue to use RSF's involved patented technology without paying any fee.