On 10 February 2015, China fined Qualcomm CNY6.08 billion (approx. USD975m or EUR870m) for abusive patent licensing practices and imposed several remedies on the company.
The decision, the most severe ever taken in China, confirms that China is determined to tackle complex anticompetitive activities. The case provides insight into the authorities’ procedures and interpretation of the law, and highlights the importance for companies of defending themselves in antitrust probes in China.
THE NDRC AND THE QUALCOMM INVESTIGATION – OVERVIEW
The National Development and Reform Commission (NDRC) is the Chinese competition authority charged with investigating price-related conduct that is anticompetitive, such as cartels, “resale price maintenance” (RPM), and abuses of dominance. Since 2013, it has a track record of imposing heavy fines against cartels and RPM infringements committed by both Chinese and multinational companies. In 2014, it imposed total fines of almost USD300M. However, the Qualcomm case is a significant milestone in the ramp-up of Chinese competition law enforcement: not only with the imposition of the highest fine to date in China – or for that matter in many other countries in the world – but also with the imposition of intrusive “behavioural” remedies, similar to those its sister agency, the Anti-Monopoly Bureau of the Ministry of Commerce (MOFCOM), in charge of approving transactions under the PRC merger control regime, has been imposing for the last six years.
The NDRC investigated Qualcomm’s standard-essential patents (SEPs) for certain telecommunication standards and its licensing practices on the basis of complaints filed, apparently as early as 2009, by both Chinese customers and it would appear U.S. companies, though the company names have not been publicly disclosed. The NDRC formally started its investigation in November 2013 when several dozen NDRC officials raided Qualcomm’s offices in China. There followed multiple rounds of submissions, intense hearings and negotiations between Qualcomm representatives, NDRC officials, as well as many other interested parties. The investigation was widely covered by the local media, and has fuelled heated diplomatic debate at the highest level between China and the U.S. The investigation concluded with the decision of 10 February 2015 (yet to be published), and lasted less than 18 months, a much shorter timeframe than usual for similarly complex matters in other jurisdictions, although longer than previous NDRC investigations undertaken in 2013 and 2014.
WHY QUALCOMM? WHO’S NEXT?
Qualcomm is a U.S. leading chip maker and holds a significant number of SEPs.
Since the outbreak of the financial crisis in 2008 and with the realisation that their export and investment-led engines of growth were vulnerable and could stall, China’s leadership has placed a priority on upgrading its industrial infrastructure and boosting domestic consumption. Many recent antitrust investigations have focused on the consumer goods, health product, automobile, insurance, and high-tech sectors and this trend is expected to continue.
Furthermore, in recent years, China has become the biggest telecommunications market in the world. The smartphone industry is one of the most dynamic industries in China, creating millions of jobs. The size of the Chinese mobile device market is worth billions of RMB. It is therefore not surprising that the royalties paid to Qualcomm for its device chips and its licensing practices have become the focus of the NDRC’s attention. There have been precedents in the same sector in China: in 2014, MOFCOM imposed stringent remedies in the Microsoft/Nokia transaction, both on the buyer and more surprisingly on the seller, Nokia, as the holder of various SEPs and non-SEPs in the mobile telecommunication sector. Previously, in 2012, MOFCOM had imposed remedies in relation to the acquisition of Motorola by Google requiring Google to license the Android platform on a free and open basis.
QUALCOMM’S DOMINANCE
The NDRC found that Qualcomm holds a dominant position in several markets, namely the license of SEPs for the CDMA, WCDMA and LTE wireless communication standards, as well as the supply of baseband chips.
The NDRC public statement issued on 10 February 2015 does not detail how the relevant markets were defined. In particular, it is not yet clear whether the NDRC considered all the SEPs held by Qualcomm as one single market, or distinguished separate markets comprising the SEPs for each specific standard, or whether it considered that each SEP constitutes a separate market in itself. The latter definition was adopted by the European Commission in its merger review of the acquisition of Motorola Mobility by Google, on the basis that each SEP is necessary to comply with a standard and thus cannot be designed around. Neither did the NDRC elaborate on the market for the supply of baseband chips. However it is likely that it considered China to be the “relevant” geographic market, in line with its usual practice.
There is also no indication in the NDRC public statement on the market shares held by Qualcomm, the competitive constraints it faces, or on how the NDRC established dominance.
We are hopeful that the decision, which the NDRC should soon publish, will contain more insight into the authority’s reasoning as to how the markets were defined and how dominance was assessed.
ABUSIVE CONDUCT – A TRADITIONAL READING?
Qualcomm was found to have abused its dominant position in three ways: excessive pricing, unfair terms, and bundling. These forms of conduct are all prohibited by the Anti-Monopoly Law (AML) and the NDRC-written Price Law of 2010, but until now they have not been rigorously enforced by competition authorities in China; the reading of the full decision should shed some light on the interpretation of these provisions.
Excessive pricing
The NDRC found that Qualcomm charged unreasonable royalties on Chinese mobile device manufacturers. This finding is actually split into several claims. First, Qualcomm refused to provide customers with a list of all patents included in its comprehensive licensing package, resulting in customers being charged for patents that had already expired. Second, Qualcomm imposed unfair cross-licensing conditions: it forced customers to grant Qualcomm free licenses for their own patents whilst refusing to lower the royalties it imposed in consideration of the value of the patents licensed to it. Third, the royalty rate was set at a high level and applied to the net wholesale price of the mobile devices concerned.
These claims, taken together, resulted in Qualcomm imposing excessive royalties in violation of the AML. It should be noted in this respect that, unlike other jurisdictions, China does not shy away from finding violations of competition law for excessive pricing. Article 17 of the AML provides that dominant companies shall not sell products “at an unfairly high price” – a concept that must be interpreted in the context of China’s economic governance. Similarly, China’s Price Law (also enforced by the NDRC) provides that excessive profits shall be prohibited. It is therefore unsurprising that the NDRC feels empowered to regulate the royalties charged by Qualcomm.
Bundling
The NDRC also found that Qualcomm forced customers to accept the licensing of Qualcomm’s non-essential patents (for which Qualcomm possibly holds no dominant position) in order to obtain a license for its SEPs. This mandatory licensing package constitutes bundling within the meaning of the AML.
Unfair terms of sale
Finally the NDRC found that Qualcomm imposed unreasonable conditions on the sale of baseband chips because Chinese customers were forced to accept a non-challenge clause prohibiting them from challenging the validity of Qualcomm’s patents. This may sound less serious than the other two claims and hardly justification for such a high fine; but it is worth remembering that a non-challenge provision is often considered to be anticompetitive. For example, the European Commission in its investigation of Motorola’s enforcement of its SEPs considered that it was a disadvantageous licensing term likely to produce anticompetitive effects.
THE FINE: AN ENFORCEMENT MILESTONE OR A ONE-OFF EVENT?
The CNY6.08bn fine is the most severe ever imposed by the NDRC or any other Chinese competition authority under the AML, and is also one of the largest fines ever imposed by any antitrust authority in the world against a single company. It puts the NDRC on a par with other competition authorities around the world, such as the European Commission, for having a reputation for taking strong action against anticompetitive conduct by dominant companies.
Under the AML, Chinese antitrust authorities can impose a fine of up to 10% of the annual revenues of companies found to be in breach of competition law. There have been arguments in the past on whether the fines imposed should apply to global or Chinese revenues. The argument now appears to have been settled: only revenues generated in China should be considered. In the Qualcomm case, the NDRC stated expressly that the fine amounts to 8% of Qualcomm’s 2013 revenues generated in China. Considering that China is Qualcomm’s largest market and represents about half its global revenues, and in light of previous cases (e.g. the infant milk formula proceedings, where fines of up to 6% of Chinese revenues were imposed), the fine imposed in the Qualcomm case is not insignificant.
It is widely expected that fines will continue to increase in China and reach the 10% level provided for by the AML; in fact, the NDRC has made no secret of its intention to increase the sanctions imposed when cracking down on anticompetitive behaviours in China.
However, it is understood that the level of the fine was not – in itself – the most important aspect of the NDRC proceeding, as it has been the case for example for Microsoft in the EU, when the company was heavily sanctioned for abusing its dominant position in 2007 and was also forced to concede substantial remedies. Fines are not the only deterrent factor used by authorities and the NDRC seems to have mainly focused on identifying and imposing adequate remedies.
THE “BEHAVIOURAL” REMEDIES IMPOSED: A GROUND-BREAKING PRECEDENT?
Remedies have traditionally been used in China to intervene in companies’ business and instil changes in the way they operate in China. MOFCOM has championed this practice when conditionally approving some transactions and imposing intrusive remedies – such as forcing companies to remain separated post-closing, to maintain their pricing system and to refrain from investing in a given market in the future. The Qualcomm decision is, from that perspective, no exception. However, the remedies imposed on Qualcomm are likely to set a ground-breaking precedent.
The first set of remedies is relatively traditional: Qualcomm agreed not to bundle SEPs with non-essential patents; not to impose non-challenge clauses or other unfair clauses in licensing agreements with Chinese customers; to refrain from imposing royalty-free grant-back clauses on Chinese licensees on their own patents; and not to charge royalties for expired patents.
However, in addition to these remedies and the fine imposed, Qualcomm also agreed to calculate the royalty rates on the basis of 65% instead of 100% of the wholesale price of handsets sold for use in China.
The NDRC believes these remedies will boost Chinese mobile device manufacturers by ensuring more favourable terms in licenses entered into with Qualcomm. At the same time, they do not appear to affect fundamentally Qualcomm’s business model and its way of calculating royalties.
It is, however, discouraging to note that the Chinese authorities continue to use antitrust investigations to regulate prices. In many NDRC-led investigations, the authority obtains agreement from the infringers that they will decrease their price by a certain percentage, instead of letting the market decide what the right price should be. It is also likely that the Qualcomm decision will create a negative precedent and affect negotiations between licensees and any other SEP holder, undermining the whole purpose of investing in SEPs. The remedy may have additional spill-over effects, including possibly inspiring other antitrust authorities, such as the Korean Fair Trade Commission which just announced a new proceedings against Qualcomm. Finally, it is yet to be seen how the NDRC will monitor the remedies imposed on Qualcomm. Drawing on our own experience with Chinese competition authorities, both as attorney and monitoring trustee, the authority is likely to take an active role in supervising Qualcomm’s compliance with the decision. A hands-on approach, together with continued pressure from interested parties, may mean that Qualcomm is not yet done with the authority.
DEFENDING ONESELF IN PRC ANTITRUST PROCEEDINGS
Companies at times hesitate to defend themselves to the full in China, but the Qualcomm case demonstrates that the PRC authorities consider the interests of various parties in their antitrust investigations, including non-Chinese defendants. It also demonstrates that companies can leverage their position to negotiate reasonable remedies. Much depends on the approach companies adopt in their dealings with the Chinese authorities: the quality of the arguments, the evidence submitted and the negotiating stance all play their role. Finally, the Qualcomm case also confirms that companies can be creative in how they design the remedies that they propose to the Chinese antitrust authorities.
CONCLUSION
The decision issued by the NDRC on 10 February 2015 will have long-lasting effects not only on Qualcomm and the Chinese mobile device industry, but also on the enforcement of antitrust rules in China. The NDRC imposed a significant fine on a foreign company, in a very complex area at the interplay between competition and intellectual property law. Other competition authorities around the world have hesitated to take similarly strong positions in recent comparable cases. But the decision also shows that companies can fully defend their commercial interests in China, which is encouraging.
