NDRC’s Qualcomm Decision Sends Mixed Messages

by Dorsey & Whitney LLP
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Chinese New Year celebrations culminated in a big way for foreign multinationals in China with the news at the end of February that the head of the National Development and Reform Commission’s (“NDRC's”) Antitrust Bureau had been removed. Xu Kunlin had made his name by initiating numerous investigations against sectors involving multinationals such as auto parts and bearings, cars, and contact lenses. Former Director Xu (who is still director of the NDRC’s Price Department) was widely regarded as a fine leader, and his Antitrust Bureau hit monopolies with hefty penalties of RMB 7.9 Billion (US$1.29 Billion) from 2014 through February 10, the date the Qualcomm decision was announced as discussed below. He has been replaced by Zhang Handong (former deputy director of the Healthcare Reform Office under the State Council), whom we presume will take time to settle into his new position. Based on his familiarity with the medical sector, we would caution clients in that sector to continue to pay close attention to antitrust compliance.

The full content of the long-awaited result of the Qualcomm decision was published in early March (following the February 10 announcement of the result). In only three prior cases has the NDRC published the full content of an antitrust decision. Qualcomm was ordered to cease its infringing activities and was assessed a fine of RMB 6.1 billion (US$975 million), which represented about 8% of its 2013 revenue in China. The NDRC found Qualcomm guilty of abuse of market dominance and implementing monopolistic activities that eliminate and restrict competition. The following activities were deemed illegal: (1) charging unfairly excessive patent royalties, (2) tying patents that are not standard-essential patents in the telecom industry without a legitimate reason, and (3) imposing unreasonable conditions in the sale of baseband chips. During the investigation Qualcomm cooperated with the authorities and raised a series of rectification measures including the following: (1) calculating patent royalties on the basis of 65% of net wholesale price of the device sold in China, (2) when Qualcomm licences its patent to Chinese licensees it will provide a list of patents and not charge royalties over patents that have already expired, (3) Qualcomm will no longer require that Chinese licensees provide a compulsory (and royalty-free) cross-licence for Qualcomm customers, (4) where wireless standard-essential patents are concerned, Qualcomm will not tie in non-standard-essential patents without a legitimate reason, and (5) unreasonable conditions will not be included in the licence agreements when selling baseband chips, such as conditions prohibiting licensees from challenging the terms in the licence agreement.

The Chinese press celebrated the decision as a victory for China. But Qualcomm was not forced to change its business model by the NDRC, so the decision could have been far worse for Qualcomm, reflected in a rise in the stock price of Qualcomm by 4.69% on the second day after the decision was announced. Qualcomm's core business model is to impose royalties on the net selling price of the entire device rather than the chips or other components, so it need now only change the calculation of the royalty base rather than the business model itself, leading some commentators to claim that the decision was a victory for Qualcomm.

Although the media claims victory for both sides, many problems seem to have been forgotten. For example, why was a formal investigation only initiated at the end of 2013 when publicly-available information indicates that the first complaint was made as early as 2008 by Texas Instruments? Further, under the Chinese Anti-Monopoly Law a guilty decision requires that illegal gains be confiscated, but this case resulted only in the imposition of a fine. The NDRC required such a confiscation in the LCD maker case. So if the NDRC agreed that 65% (mentioned above in Qualcomm’s rectification plan) was the correct calculation base, then Qualcomm should at least have been asked to return the portion of royalties calculated on the other 35% (which could amount to billions of dollars). In addition, the law provides that a fine should be charged on the basis of the revenue of the previous year, i.e. 2014, and not 2013, which was used in the decision. Some even questioned the jurisdiction of the NDRC in the first place because, judging from the decision, most of the illegal activities listed were not price-related, indicating that it would have been more appropriate for SAIC to launch the investigation. On the other hand, Qualcomm dropped its request for a hearing at the last minute, and paid up the fine in only three days. All of the above clues lead us to believe that the decision was the result of a compromise between the investigator and the investigated, in the context of which the investigator somehow lost sight of the fact that it was deviating from the national law. But we have seen this before. For example, in the Liquor Case involving Chinese spirits (Moutai and Wuliangye), the NDRC limited its investigation to provincial level, only in Guizhou and Sichuan.

The moral of the story seems to be to make sure that you proactively engage the authorities up front. It may be best to do so before any investigation is even contemplated. Regardless of the timing, it appears that open engagement during an investigation should lead to a much better result.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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