Qualcomm agrees $975 million fine and behavioural remedies under Chinese antitrust laws- Anti-trust law update

A case study: how the record breaking antitrust penalty against Qualcomm transforms the landscape of SEPs licensing in China

Dechert LLP

China March 26 2015

The PRC National Development and Reform Commission (NDRC) finally concluded its antitrust investigations against Qualcomm and issued an administrative sanction on February 10, 2015, putting an end to the 16-month investigation. The anti-monopoly enforcement agency held that Qualcomm had abused its dominant market position and restricted competition, and that its monopolistic conduct had violated the PRC Anti-monopoly Law (AML). A written decision was published on March 2, 2015.

As a result of the violation, a record-breaking administrative penalty of RMB6.0988 billion (~US$975 million) was imposed by the NDRC, which turned out to be the largest fine for antitrust violations ever imposed by the Chinese government and an amount equal to five times the total amount of fines levied by the NDRC in 2014.

A. Background of China’s antitrust laws

The AML can be implemented through public and private enforcement. Private parties may elect to assert antitrust litigation against another party for violation of the AML, or lodge a complaint with the proper antimonopoly enforcement agency.

There are three main antimonopoly enforcement agencies: the NDRC, which focuses on price-fixing investigations; the Ministry of Commerce (MOFCOM), which oversees proposed merger-related transactions for potential antitrust violations; and the State Administration for Industry and Commerce (SAIC), which handles all other types of antitrust investigations.

In August 2013, the NDRC declared that it would focus its efforts on antitrust investigations in the telecommunications industry. Subsequently, in November 2013, it commenced a formal antitrust investigation against Qualcomm to determine whether its licensing scheme was in breach of China’s antitrust laws, particularly the AML.

Contrary to previous speculations that the investigation was instituted by the government or some domestic players, Xu Kunlin, the head of the agency’s antitrust division, revealed that the investigation against Qualcomm stemmed from complaints filed by two undisclosed U.S. companies (however, as discussed below, the decision and the remedial plan ended up focusing on penalizing Qualcomm’s monopolistic conduct against Chinese phone makers).

B. Licensing model of Qualcomm

The monopolistic activities being investigated by NDRC were Qualcomm’s licensing of Standard Essential Patents (SEPs) on 3G and 4G technologies and its sales of baseband chipsets to mobile device makers in China.

Qualcomm is the largest manufacturer of cellular baseband chipsets in the world. In Q1 of 2014, it had a 66% share of the global market for cellular baseband processors.

Qualcomm is also the industry leader in the research and development of cutting-edge telecommunications technologies and holder of extensive patent portfolios on various generations of telecommunications standards. For example, it has over 1,400 SEPs on 3G CMDA and 4G LTE technologies. Qualcomm capitalizes on the R&D of these technologies by licensing its patent portfolios to competing chip makers as well as to all major mobile device manufacturers. Specifically, it has devised different licensing programs to chip makers and phone manufacturers across the world. It also reserves the right to seek royalties from smartphone manufacturers that purchase and implement chipsets from its competitors, making a phone manufacturer susceptible to its licensing demands regardless of whether they are a customer of Qualcomm or not. As of 2015, Qualcomm is reported to have over 250 licensees worldwide.

Qualcomm has long been criticized for leveraging its extensive SEP portfolios to charge higher-than-normal royalty rates. For example, for smartphone manufacturers, the royalty rate is generally 3-5% of the wholesale price of the entire handset (in addition to the cost of the chipsets). In addition, its licenses are provided on a “black-box” basis, meaning that its licenses are granted in a bundle and licensees have no information on the patents they license from Qualcomm.

In the past, the above licensing practice has faced multiple antitrust investigations by authorities in Europe, the United States and South Korea. In particular, following NDRC’s decision, South Korea’s Fair Trade Commission is considering launching a new probe against Qualcomm for abuse of its dominant position. The agency already fined Qualcomm ~US$235 million after a three-year investigation back in 2009, with the ruling still under appeal.

C. Relevant provisions under AML

Under the AML, a business operator with a dominant market position is deemed to have abused such position if it: sells the relevant product market in the relevant territory at unreasonably high prices, refuses to trade with a party without legitimate reasons, bundles the sales of such product with other products and/or imposes unreasonable conditions for trading, etc.

Whether a business operator has a dominant market position with respect to a relevant product market in the relevant territory shall be determined according to the following factors:

• The market share of a business operator in the relevant market, and the competitive situation of the relevant market.
• The capacity of a business operator to control the sales markets.
• The financial and technical condition of the business operator.
• The degree of dependence of other business operators upon the business operator in transactions.
• The degree of difficulty faced by other business operators seeking to enter the relevant market.
• Other factors related to the determination of a dominant market position of the said business operator.

The AML further provides that a prima facie case of a dominant market position may be made when a business operator accounts for 50% of the market share (by revenue) in the relevant market.

If a business is found to have abused its dominant market position, the applicable antimonopoly enforcement authority may order the operator to cease the objectionable activities, confiscate its illegal gains, and levy a fine between 1-10% of the turnover of the business from the previous year.

D. Summary of the penalty decision

According to the penalty decision, NDRC’s factual findings are based on the following evidence: a report studying the value of Qualcomm’s key SEPs, Qualcomm’s license agreements, Qualcomm’s baseband chipset supply agreements, Qualcomm’s answers to questions posed by NDRC, and depositions taken by the NDRC. A summary of the holdings is as follows:

1. Qualcomm has market dominance in the business of licensing telecommunications SEPs.

The NDRC found that the CDMA, WCDMA and LTE standards are the main telecommunications standards currently implemented, and that each of those standards covers different generations and are not replaceable.

Accordingly, each SEP covering those standards is unique, irreplaceable and essential to use the technology. Since there is no design around or alternatives, failure to obtain a license on a single SEP may prevent a mobile device maker from producing devices that fully comply with the relevant standard. Therefore, each telecommunications SEP would constitute a separate relevant product market on its own. Each SEP forms a relevant product market, and the holder of such SEP owns 100% market share in that market. A number of SEPs that cover the same standard form an SEP portfolio. As the patent owner, Qualcomm controls 100% of the market in an SEP portfolio.

The NDRC found that:

• The licensing conditions of the SEPs are unilaterally decided by Qualcomm.
• Mobile device manufacturers are highly dependent on the SEPs.
• It is difficult for other players to enter the market (and/or provide alternatives) once those telecommunications standards are adopted and implemented.

Accordingly, the NDRC concluded that Qualcomm has a dominant market position in the relevant market (i.e., the licensing of portfolios in CDMA, WCDMA and LTE) under the AML.

2. Qualcomm has abused its dominant market position in the licensing of SEPs.

The NDRC held that the following licensing practices by Qualcomm constituted an abuse of its dominant market position, given that the royalties demanded by Qualcomm were unreasonably high based on the following findings:

• The license agreements appear to be perpetual, while the royalty rates are not adjustable, regardless of changes of patents in the portfolios.
• While some patents would inevitably expire over time, as the list of patents included in the license is not disclosed, the licensees are unable to assess the changes in fair market value of the license at a given time.
• Qualcomm demanded that licensees (i) provide cross-licenses on certain non-SEPs in the relevant markets without consideration or offers to offset on the royalties charged, and (ii) agree not to assert patent infringement actions against Qualcomm or its other licensees.1 

On a separate note, the NDRC found that Qualcomm had also abused its dominant market position by bundling SEPs with non-SEPs. As a result, Chinese companies were forced to take out licenses of non-SEPs that were not desired.

3. Qualcomm has market dominance in the supply of baseband chipsets.

The NDRC separately found that Qualcomm has a dominant market position on baseband chipsets in three different relevant product markets (i.e., CDMA, WCDMA and LTE baseband chipsets) and determined that the relevant territory to be the global market. Specifically, it held that:

• Citing a report by Strategy Analytics, Qualcomm’s market revenue in the global market for each of the relevant product is over 50%.
• There is no other major competitor with a comparable market share comparable to Qualcomm's.
• Because of the outstanding attributes and quality of Qualcomm’s baseband chipsets, they are highly sought after, and mobile device manufacturers have become highly dependent on Qualcomm’s products, especially in the market of high end smartphones.
• It is difficult for other players to enter the market based on the sophistication of the technologies.

While Qualcomm argued that they do not have over 50% of market share based on quantities, NDRC explicitly rejected this argument and clarified that the 50% market share shall be calculated based on revenue generated instead of the units sold.

4. Qualcomm has abused its dominant market position in the supply of baseband chipsets.

NDRC held that Qualcomm had imposed unreasonable conditions on sales of baseband chips. It refused to supply chipsets to Chinese companies unless they agreed to accept no-challenge clauses in the license agreement, e.g.:

• Qualcomm requires its licensees to sign a license agreement that inherently violates AML (as discussed above) as a pre-requisite for supplying chipsets.
• The licensees are also required to make assurances not to challenge or invalidate Qualcomm’s patents.

5. Penalty decision.

As a result of the antitrust violations, the NDRC ordered Qualcomm to:

• Clearly set out the patents to be licensed in the portfolios and cease attempts to license expired patents.
• Stop demanding its licensees to cross-license their non-SEPs.
• Stop demanding its licensees to cross-license its SEPs without fair value.
• Not to base the royalty rates on the full wholesale price of the mobile device.
• Cease bundling SEPs with non-SEPs when licensing telecommunications SEPs to mobile device manufacturers within China.
• With respect to sales of its baseband chipsets, cease demanding a buyer to take out a license that is by itself in violation of the AML or including no-challenge clauses as a prerequisite to supplying the products.

In addition, a penalty of US$975 million, which was based on 8% of Qualcomm’s reported sales revenue of US$12.3 billion in China in 2013, was imposed against Qualcomm. In its press release, Qualcomm announced that it will not contest the decision and will pay the fine on a timely basis as required by the NDRC.

E. Rectification plans

In response to the decision, Qualcomm has voluntarily committed to a “rectification plan” in China to remedy the antitrust violations (see below for a comparison of the changes to be made under the plan). The pre-negotiated plan had been reviewed and accepted by the NDRC prior to the announcement of the antitrust violations and was incorporated into its decision.

Click here to view the table.

Under the plan, all Chinese licensees are no longer bound by their existing license agreements and may elect to adopt the new terms for mobile devices that are sold “for use in China.”

In comparison, in exchange for MOFCOM’s approval in April 2014 of its acquisition of Nokia's smartphone business, Microsoft promised to comply with certain principles, which include:

• Licensing its SEPs under the FRAND rate.
• Not seeking injunctions against Chinese smartphone manufacturers when enforcing the SEPs.
• Not compelling licensees to grant any reciprocal cross licenses, except for licenses of SEPs on the same industry standard.

F. Significance and implications

1. All licensors of SEPs have a dominant market position.

Other than the record-setting penalty, one of the most significant implications of the Qualcomm decision is that it was the first instance in which an antimonopoly enforcement agency in China such as the NDRC has stated and recognized that holders of SEPs have a dominant market position, and that licensing of technologies (particularly SEPs) may constitute monopolistic conduct. In other words, the NDRC concluded that because of the nature of SEPs, a holder or exclusive licensee would be deemed to have market dominance per se and run a risk of antitrust violations in China if its licensing scheme does not comply with the AML. Further, unlike antitrust breaches in other cases where dominant market position is determined by market shares, each licensor of an SEP has the power to impose unreasonable and unfair licensing terms, regardless of the number of SEPs and the percentage of SEPs it owns within a standard. Therefore, based on NDRC’s stance in the penalty decision, we do not believe that a licensor with few SEPs is more likely to avoid antitrust violations based on that ground.

2. Administrative v. judicial enforcement.

Private parties may elect to pursue antitrust violations in the judiciary system (as in the case of Huawei v. InterDigital, Shenzhen Intermediate People’s Court (2013), Guangdong High People’s Court (2013)) or file an administrative complaint with an antimonopoly enforcement agency such as the NDRC, or both.2

These two procedures have different implications. Judicial proceedings involving antitrust violations single out licensing practices with individual licensees, while administrative proceedings may have a more profound effect on the patentees in terms of both financial damage and equitable remedies. For example, NDRC fined Qualcomm US$975 million, based on 8% of the patentee’s sales revenue, while the Shenzhen court merely awarded Huawei US$3.51 million to cover the attorney fees. In addition, the rectification plan committed by the licensor will be binding on all of its prospective licenses (and may also amend existing licenses, allowing existing licensees to renegotiate their licensing terms). However, while a court may have this capability, complainants should not rely on antimonopoly enforcement agencies to set or provide a basis for calculating a FRAND rate for the license.

3. Optimized licensing practices.

It can be derived from the Qualcomm decision (and the other administrative antitrust decisions) that there are recommended do’s and don’ts that licensors should keep in mind during negotiation of SEP licenses that cover Chinese patents, e.g.:

Do’s:

• Offer a patent list in the license negotiations.
• Offer non-discriminatory and reasonable royalty rates, consistent with any FRAND rate applied.
• Resort to arbitration to resolve disputes regarding royalty rates.

Don’ts:

• Mix licenses of SEPs and non-SEPs.
• Bundle patents that cover different standards in a portfolio.
• Attempt to license patents that are expired.
• Apply no-challenge clauses as a pre-requisite to license SEPs or supply products.
• Request any reciprocal cross licenses for no consideration.
• Condition SEP licenses on grants of reciprocal cross licenses (but it may be acceptable if the cross licenses are related to the same standard).
• Seek injunctive relief when enforcing the SEPs.
• Restrict licensees' on its use of the licensed SEPs.

4. Permissible licensing practices.

While permissible licensing practices should be determined on an ad hoc basis, under Qualcomm’s rectification plan, it can be observed that the NDRC does not object to the following licensing practices, at least in the case of Qualcomm:

• Charge licensee-buyers separately on the basis of the costs of the baseband chips plus royalty rates on the applicable technologies.
• Calculate royalties based on a portion of the wholesale price of the finished products, even though the subject matter of the license only relates to a key component of such product (assuming and provided that the finished product actually performs the patented subject matter).

While it was neither addressed nor apparently considered in the NDRC’s Qualcomm decision, there is a possibility that the rectified licensing scheme may run afoul of the patent exhaustion doctrine under PRC Patent Law, which provides that an affirmative defense to infringement may be available if a party uses, offers to sell, sell or imports a product after the sale of a patented product or a product obtained directly by a patented process by the patentee.

In any event, since the rectification plan is customized for the licensing practice of Qualcomm, it may have limited probative value for other licensors. Specifically, the decision does not provide any basis or guidance on reasonable royalty rates in the industry. Furthermore, not only does the decision fail to refer to FRAND rates, but the reduced royalty rates in the rectification plan are discriminatively lower than the standard royalty rate Qualcomm charges in other jurisdictions.

5. Scope of the decision.

While it is not specified in the penalty decision, the scope of NDRC’s decision (and the rectification plan) would also be territorial in nature, adopting language that focused on (i) licensing of Chinese SEPs (ii) to Chinese smartphone manufacturers (iii) for use in China in various instances. It remains unclear whether Qualcomm will adhere to the terms of the rectification plan in its worldwide licenses to Chinese manufacturers, or separate the Chinese license from the global license as a result of the decision. However, based on the FRAND principle, it is foreseeable that Qualcomm will face requests from its licensees to extend the (lower) license rates under the rectification plan to licenses involving other jurisdiction.

6. Draft regulations on licensing of SEPs.

It wasn’t until recently that Chinese law makers have begun drafting laws and regulatory guidelines to address antitrust issues in the abuse of IP rights. Specifically, to raise awareness of this issue and provide guiding references on the licensing of SEPs, the SAIC has released draft regulations on Prohibition of Abuse of Intellectual Property Rights to Eliminate and Restrict Competitions in June 2014 for public comments. The relevant draft provisions include:

• Recognition that certain conduct related to the licensing of IP may be deemed monopolistic in nature, especially if the IP is essential to the business activity, e.g., the IP is essential for other player to enter the market and there is no design-around available.
• Licensors with a dominant market position may not refuse to grant licenses for others to use any essential IP under reasonable terms.
• Bundling of IP or products of different nature is not permitted.
• Licenses by licensors with dominant market positions may not contain the following conditions: request for grant-back licenses; inclusion of no-challenge clauses; charging royalties on expired patents; restriction of licensees from dealing with third parties; and any other unreasonable conditions.  

While the draft regulations have not been finalized and promulgated, they may provide some further insights on the licensing of SEPs.

G. The questions unanswered

We have singled out two main questions regarding the licensing of SEPs not addressed in the Qualcommdecision:

1. Compliance of AML in license of non-Chinese SEPs / to non-Chinese phone makers.

While the NDRC claimed to have collected evidence from both Chinese and foreign smartphone makers in the investigation, its findings appear to be mostly based on Qualcomm’s monopolistic licensing practices against Chinese companies and licensees. In response, the rectification plan covers licensing terms that are almost exclusively applicable to Chinese licensees and their devices sold for use in China. It is quite obvious that a main driving force behind NDRC’s sanctions was to protect the interest of Chinese manufacturers. Therefore, the question is whether the NDRC or another antimonopoly enforcement agency will apply the same level of enthusiasm in protecting the interest of foreign licensees against holders of Chinese SEP, even if a significant number of their mobile devices are sold to Chinese consumers.

In other words, what are the risks of antitrust violations by SEP holders when they are negotiating licenses to non-Chinese companies for use in China, or to Chinese multinational companies for global licenses not limited to China? Should the licensor be overly concerned to ensure that the licensing terms comply with the AML?

We believe that the answer would depend on (i) the origin of the licensee, (ii) the market share of the licensee in China and (iii) the amount of the licensor’s revenue from royalties it derives in China. Depending on the “nexus” of its licensing activities with China, it may be preferable for the licensee to seek an opinion on compliance with AML, or even to grant a Chinese license separate from its global license to avoid any potential sanction by the NDRC.

Click here to view the table.

For example, under the above table, for licensing of an SEP to Xiaomi, which is currently the top smartphone maker in China by unit sold and is predominantly a local brand, the “nexus” is high and the licensor should ensure that its licensing scheme is in compliance with AML. For licenses with China-based multinational smartphone makers such as Huawei and ZTE, due to their strong government ties, the licensee should also carefully consider the AML, regardless of the territory of the license, especially when cross licenses of IP from those companies are sought. The same may apply to a license with Samsung or Apple, whose products are highly popular in China. While it may not be a priority for the NDRC to protect their interests, a resourceful foreign licensee may also take advantage of the Qualcomm decision and threaten to file complaint with the NDRC, incurring risks of antitrust investigations against the licensor.

2. Whether licensor must comply with FRAND standard in licensing of SEP.

Even though FRAND rates have been mentioned and adopted in other administrative and court decisions regarding the license of SEPs (e.g., Huawei v. InterDigital, InterDigital and Microsoft antitrust probes) as well as the draft regulations, it was not applied by the NDRC in the Qualcomm decisions. Specifically, contrary to Huawei v. InterDigital, no discussion that the royalty rate must be under the FRAND term was made by the NDRC.

If the FRAND rate is not the sole standard, another question that was not answered in Qualcomm is the existence of a proper and objective basis for computing reasonable royalty rates for the licensing of SEPs. To the contrary, the reduced royalty rate to be charged by Qualcomm under its rectification plan is lower in China than in other territories, making the licensing terms more favorable to Chinese phone makers and thereby creating inconsistencies and departing from the FRAND term. In any event, based on the proceedings in investigations by the NDRC, it may ultimately be up to the licensor to prove that the license rate adopted or committed by it is not unreasonable in light of all of the circumstances.

As the Qualcomm decision did not address the above issues, they remain unanswered for now, and licensors will need to evaluate their own risks and proceed to implement their own licensing programs in China with considerable caution.

To view all formatting for this article (eg, tables, footnotes), please access the original here.

Dechert LLP - Lewis Ho and Monique Lee