By Susan Ning, Kate Peng and Lingbo Wei King & Wood Mallesons’ Antitrust Group

NING, Susan (Xuanfeng)彭荷月After more than a year’s investigation into Qualcomm, the NDRC made an announcement of its investigation decision through press release on 10 February 2015.[1] About 20 days later, the NDRC published the full-text of the decision on its official website on 2 March 2015. The decision provided a comprehensive analysis on the definition of the relevant markets, Qualcomm’s dominant position and abusive conducts that are deemed violating the Chinese Anti-Monopoly Law (“AML”), which sent a warning to patent-heavy companies to review their business practices in China.

We hereby set out the points below to provide insight into the facts and factors that the NDRC considered in its decision making process.

1. What factors were considered in determining Qualcomms dominance

In the decision, the NDRC defined four relevant markets, i.e. (i) the license market of standard-essential patents (SEPs) for wireless communication technology, which is a collection of each independent license market constituted by each SEP held by Qualcomm[2], (ii) CDMA baseband chip market, (iii) WCDMA baseband chip market, and (iv) LTE baseband chip market. The NDRC found that Qualcomm had dominance in each of the above markets.

In determining Qualcomm’s dominant position in each of the relevant markets, the NDRC mainly focused on factors including market share, Qualcomm’s control over the relevant market, downstream customers’ reliance on Qualcomm’s technology/products and market entry barriers.

With respect to the license market for SEPs, the NDRC found that Qualcomm had 100% market share in the market, as it is the only holder of the SEPs. This approach is the same as what is adopted in the Huawei v. IDC case which was decided by Guangdong High People’s Court in October 2013.

With respect to the baseband chip markets, the NDRC found that Qualcomm ranked 1st in the baseband chip markets during the period from 2007 to 2013; in particular, Qualcomm had 93.1% in CDMA baseband chip market, 53.9% in WCDMA baseband chip market, 96% in LTE baseband chip market. Based on the above data, the NDRC reasoned that Qualcomm had some extent of control over the relevant markets considering its ability to maintain its leading position for such a long period of time. Especially, the NDRC determined that Qualcomm had dominant position in the WCDMA baseband chip market, despite that Qualcomm only had a 53.9% market share, which just exceed the 50% threshold for presumption of dominance [3], and that there were other important market players, i.e. MTK, Intel and Broadcom, holding market shares of 15.5%, 11.8% and 9.3% respectively. The NDRC reasoned that even though there were other players in the market, choices for downstream mobile device manufacturers were limited and Qualcomm’s chipsets had advantages over other products in respect of technology, function and brand.

The above decision may reasonably lead to a question about the different outcome of the Qihoo 360 v. Tencent case, where the Supreme People’s Court held that Tencent did not have dominant position even though its market share in the instant message (“IM”) service market exceeded 80% in the past few years, from 2009 to 2012 at the minimum.

It is too soon to say whether the NDRC took a different approach from the Supreme Court or it took the same approach but reach different outcome because the competition status of the baseband chip market differed from the IM service market. Noticeable, the Supreme Court’s decision heavily relies on the finding that the competition in the IM service market is dynamic in nature and the entry to the IM service market was active. These factors were not mentioned in the Qualcomm decision. It is yet to observe if the NDRC would come to the same conclusion if it deals with the internet industry. But from the present decision, companies that hold a leading position in the relevant markets should be cautious of the risk of being considered as dominant, especially if the other market players have relatively small market shares and the barriers to entry are high.

2. What licensing practices may risk violating the AML

Qualcomm was found to run afoul of Article 17(1) and 17(5) of the AML by engaging in three types of conducts, i.e. charging unfairly high royalties, tying SEPs with non-SEPs and imposing unfair conditions on the sale of baseband chips.

A. Unfairly High Royalties

The NDRC determined that Qualcomm charged unfairly high royalties based on the following three considerations: (i) Qualcomm refused to disclose its patent list and included expired patents in its patent portfolio licensed to Chinese licensees; (ii) Qualcomm requested that Chinese licensees grant back their patents free of charge, and refused to deduct the value of such patents from royalty fees or to pay for such patents in other ways; and (iii) Qualcomm charged relatively high royalty fees and unreasonably used the net sale price of the whole mobile devices which incorporated its technology as the base for its royalty fees.

The foregoing considerations were different from the factors listed in Article 11 of the NDRC’s Anti-Price Monopoly Provisions, which provides that in determining unfairly high price, the factors should be considered include (i) whether the sales price of a product is noticeably higher than the price of other undertaking; (ii) when costs are stable, whether the sales price was raised beyond a normal range; and (iii) whether the level of price increase is noticeable higher than the increase in cost.   The considerations also differ from the ones taken into by the Huawei vs. IDC court, in which case the court emphasized on the relatively low royalties that IDC charged other mobile device manufactures, like Apple and Samsung.

In addition, it is noticeable that unlike the Huawei v. IDC court[4], the NDRC did not set a specific royalty rate for Qualcomm’s SEP licensing. Rather, it handled this difficult issue by allowing Qualcomm to propose new rates and made them part of Qualcomm’s commitments.

The above decision of the NDRC on one hand indicates the flexibility and discretion enjoyed by the authority in determining excessive pricing depending on different cases, and on the other hand reflects the difficulty in determining a reasonable price level for a specific product/service. This to some extent increases the uncertainties for undertakings to comply with Article 17(1) of the AML. Nevertheless, as far as SEP holders are concerned, the Qualcomm decision provides important guidance on how their pricing policies and practices should fit into the Chinese antitrust regime.

a. Calculation basis of royalties

It is a common understanding in the antitrust community that the decision did not fundamentally challenge Qualcomm’s charging mode, which is to calculate royalties based on the net wholesale price of the entire mobile device. For many SEP holders, this is a great relief. According to the decision, what is forbidden is setting high royalty rate while using the net wholesale price of device as calculation basis at the same time. Following such order, Qualcomm committed to charge at 65% of such wholesale price.

At the same time, it is worth noting that on 9 February, i.e. the same day when the NDRC issued the decision, IEEE’s board of directors approved changes to its IPR Policy, which injected a new term called “smallest saleable compliant implementation. The revised IPR Policy encourages the determination of reasonable royalty rate of SEPs on the value that the SEPs contribute to the smallest saleable compliant implementation that practices such SEPs.   This new development deserves close attention from SEP holders.

b. Including expired patents in licensing package

The NDRC considered the company’s failure or refusal to provide patent list and inclusion of expired patents in the package as unreasonable. Qualcomm argued that new patens had been added to the package and therefore expired patents would not drag down the value of the license. However, from the NDRC’s decision, it can be seen that the burden would be on the undertakings to prove the value of newly added patents in order to justify the level of royalties. Otherwise adding new patents to the license package will not serve as a justification for including expired parents in the package while maintaining the royalties on the same level.

c. Patent grant-backs

The NDRC expressly pointed out that grant-back requirement is not per se illegal. The reason why Qualcomm’s grant-back requirement is problematic is that it requires licensees to license their non-SEPs back, to grant back their patents and to waive their right to enforce patents free of charge. Qualcomm argued that the grant-back requirement was designed to protect its business and to protect its customers from patent infringement. However, the NDRC rejected such argument and stated that it should not be an excuse for Qualcomm to deny the value of patents held by the licensees. The NDRC concerned that such practice would impose restriction on competition through suppressing licensees’ innovation impetus and granting Qualcomm illegitimate competitive advantages.

Accordingly the above decision, patent holders with a dominant market position should be cautious of including grant-back clause into license agreements, especially when the clause requires the licensee to provide free grant-back or the grant-back terms for the licensor and the licensee are unequal.

B. Tying

The NDRC found Qualcomm’s practice of tying its SEPs with non-SEPs as illegal. One of the major arguments raised by Qualcomm is that licensees may be subject to patent litigation if they only obtain license for SEPs, as it is very hard to distinguish SEPs from non-SEPs. However, the NDRC did not think this argument could justify tying the two. The NDRC found that SEPs and non-SEPs can be separately licensed and it is a common practice in the industry to specify SEPs in license agreements; even though licensing agreements for SEPs and non-SEPs separately may entail certain cost and may increase the complexity of negotiation, licensors should nonetheless provide such options to licensees. The NDRC’s concern is that forcing licensees to license non-SEPs from Qualcomm will deprive substitutable technologies of the opportunity to compete with Qualcomm’s non-SEPs, and thus would eliminate or restrict the competition in the relevant markets.

Clearly, the NDRC’s attitude to tying SEPs with non-SEPs is the same as that of the Huawei vs. IDC court. SEP holders should be mindful of the decision and should review their contracts relating to China license to avoid legal risks.

C. Imposition of Unfair Conditions

The NDRC found that Qualcomm availed itself of its dominant position in the baseband chip markets, threatening to refuse selling baseband chips to Chinese enterprises if they did not sign patent license agreements containing unreasonable terms, and prohibiting the licensees from challenging such license agreements. The NDRC concerned that such practice would restrict the right of the licensees to initiate legal actions against the unreasonable licensing terms, and that licensees who refused to accept Qualcomm’s unfair conditions would be excluded from downstream mobile device market, whereby competition in the said market would be eliminated or restricted.

3. Summary

In its more than 20-page decision, the NDRC revealed new approaches to define and regulate certain licensing practices. Patent-oriented companies (especially SEP holders) should keep abreast of this new development of antitrust enforcement in China and should adjust their licensing terms and policies accordingly, bearing in mind the potential hefty sanctions that could be levied according to the AML.

[1] See our article “Qualcomm Investigation Finally Closed: Some Changes in Business Model in Addition to an RMB 6.088 Billion Fine”.

[2] With respect to the definition of the license market, the NDRC took a similar position as the Huawei vs. IDC case, which was decided by Guangdong High People’s Court in October 2013. The NDRC reasoned that from demand-side substitutability, each SEP is indispensable for mobile device manufacturing and thus has no actual or potential alternatives; from supply-side substitutability, no other undertakings can provide actual or potential alternatives to a SEP; therefore, each SEP constitutes a single relevant product market.

[3] According to Article 19 of the AML, if an undertaking’s market share exceeds 50%, it can be presumed to have dominant position unless it is proved otherwise.

[4] The Huawei vs. IDC court set a royalty rate for IDC’s SEP at 0.019%.