Zhan Hao Song Ying Sharif Hendry November 9 2017 NDRC hints at SEP pricing guidance to enhance Anti-monopoly Law compliance AnJie Broad Law Firm | Competition & Antitrust - China Zhan Hao, Song Ying, Sharif Hendry Competition & Antitrust IntroductionBackgroundNDRC's proposalsLegal developmentsIntroductionAt the recent China Competition Policy Forum, which was held in Shanghai on August 31 2017, a top-level Price Supervision and Anti-monopoly Bureau official commented on the potential enactment by the National Development and Reform Commission (NDRC) of regulations on standard-essential patent (SEP) licensing practices. This proposal follows the announcement of forthcoming draft IP rights-related antitrust guidelines, which are expected to provide an analytical framework and recommended approaches to SEP-related issues in China. The proposed SEP guidelines will provide a more fixed approach to price-setting mechanisms for SEP licences as they apply to products used or sold in China,(1) which are not covered by the forthcoming IP rights guidelines.To this end, the NDRC's proposal does not aim to interfere with the rights of SEP holders to price and negotiate appropriate licences. Rather, it aims to:provide further practical guidance to ensure greater consistency with the Anti-monopoly Law; anddevelop a consistent approach to the enforcement of IP rights-related anti-competitive conduct as it relates to SEP holders' pricing practices.(2)BackgroundThese developments are based on the mobile telecoms standards that have largely been developed in tandem with standard-setting organisations (SSOs). SSO participants comprise all players in the telecoms industry – from manufacturers and sellers of mobile telecoms and wireless equipment to network service providers and application and solution researchers and developers. According to the European Telecommunications Standards Institute (ETSI) – one of the primary members of the Third Generation Partnership Project, which is responsible for promulgating mobile telecoms standards – ETSI members with potential SEPs (ie, patents that cover aspects of a technical standard relating to mobile phone communication) must be prepared to grant irrevocable licences to those SEPs on fair, reasonable and non-discriminatory (FRAND) terms and conditions. This will allow for a unified and collaborative approach to proliferating technical standards, while also recognising and appropriately rewarding licensors for developing methods and processes that can be incorporated into these standards.In concluding such a licence, the negotiating parties generally enjoy the freedom to conduct negotiations according to their own specific circumstances, provided that the negotiations are conducted in good faith and in pursuit of a licence with FRAND terms and conditions. Given the complexity of the licensing issues typically at stake and a mutual desire to avoid costly and protracted litigation, the parties are generally considered to be best positioned to reach the most appropriate commercial arrangement.NDRC's proposals The NDRC's recent proposals implicitly recognise a growing need for greater guidance for parties when pricing SEPs in China. Greater clarity on the price-setting mechanisms that should inform the course of negotiating SEP licences and whether their related terms are formulated on a FRAND basis could help to avoid protracted negotiations and costly injunction claims. This is especially important for large manufacturers, such as Huawei and ZTE, and other major wireless telecoms companies which operate in a fiercely contested global environment with short product cycles and cannot afford unnecessary interruptions and impediments.According to the slides presented at the China Competition Policy Forum, the factors to be considered by patent holders when deciding concrete licensing fees include:the number of patents and the proportion of patents with regard to a specific standard;the geographic scope covered by the patents;the value that the patent portfolio contributes to a product;the patent expiry dates and any expired patents;the proportion of patents in China;the average selling prices of the relevant product in the Chinese market; andthe average margins of the manufacturers of the end products.(3)In addition, there is a recognised concern over 'royalty stacking', which occurs where a single product may infringe on a multitude of patents, thereby bearing multiple royalty burdens that deplete profits. While not revelatory, this indicates what the NDRC's focus will be when considering further guidelines.Legal developmentsIn the interim, for those negotiating SEP licences in China and elsewhere, some value may be drawn from Unwired Planet v Huawei.(4) One of the most significant aspects of this case is the diligent calculation set out by the judge in determining the FRAND royalty rates to apply to the parties and their methodologies. While the case is still undergoing a fairly wide-ranging appeal, the appeal issues are mainly concerned with the impact of competition law on FRAND issues.(5) While common methodologies for valuing SEP's in terms of their relevance and quality are inevitably drawn from the various technical factors, in Unwired Planet the judge offered two methods for calculating the relevant royalties:an analysis of comparable licences elsewhere; anda top-down analysis based on the total aggregate royalty applicable to the relevant standards and SEPs.(6)This comparative methodology relies on identifying licensing agreements that are comparable with the FRAND licence agreement under contention.In Unwired Planet, reference was made to the prior licensing agreement under which Unwired Planet had acquired a portion of Ericsson's SEPs. Since these included some of the SEPs under dispute by Huawei, a relatively simple apportionment calculation was possible. While this method may not be so easily applied by parties in cases with no directly comparable licence, the case supports the argument that comparative methodology is one of the most appropriate means for valuing SEP licences. The top-down methodology involves aggregating the total royalty payable for use of all SEPs required to incorporate a particular standard (eg, 4G), as a percentage of a product's price (eg, a smartphone). This value can then be filtered by various means – including by determining the number of patents and their relevance to the standard – in order to determine what proportion of that royalty rate should apply to the SEP portfolio in question.Hence the values derived from such price-setting mechanisms provide a necessary basis for establishing the relative strength of an SEP portfolio. However, they are a prelude to what is essentially a commercial arrangement, as they do not accurately reflect the market dynamics between the parties and cannot be considered in isolation as such. The true FRAND royalty rate and its associated terms in any negotiation will also incorporate commercial considerations relating not only to the parties' relative positions, but their positions in relation to other third parties and the market at large. These may involve terms that relate to scope, forms of payment, sales exposure and expected sales, among other factors, which may be unique to those parties. Consideration of these issues and the compromises that they involve are reflective of a unique set of circumstances specific to the negotiating parties and are not necessarily open for comparison. These issues emphasise the applicable limits of the SEP price-setting mechanisms under contemplation by the NRDC. They also underpin one of the key findings in Unwired Planet, which is that only one set of licence terms can be FRAND in a given set of circumstances.These points serve to highlight that in postulating guidelines for valuing SEPs, the NDRC does not intend to impinge on commercial negotiations, but rather set out a more concrete framework in this regard. This will be valuable for the industry, as it will provide a fixed approach to Anti-monopoly Law compliance and the enforcement of anti-competitive conduct relating to SEP pricing. Unwired Planet goes further, as it not only applies FRAND royalty calculation methodologies towards determining an appropriate rate, but also sets out some further FRAND commitments that may have a legal bearing on negotiating stances – in particular, that there is only one set of FRAND licence terms in any SEP negotiation. While in the prior case of Vringo v ZTE(7) the same judge considered a set of competing FRAND licensing offers, or a range thereof, to all be FRAND, in Unwired Planet that interpretation was narrowed, thereby solving the problem of which set of competing claims to accept for the purposes of an injunction. It may also further compel licensing parties to work towards a negotiated outcome, rather than maintaining a position that they presume to be within an acceptable FRAND range. This would then free them up to carry on their core business without further distraction.For further information on this topic please contact Hao Zhan, Ying Song or Sharif Hendry at AnJie Law Firm by telephone (+86 10 8567 5988) or email ([email protected], [email protected] or [email protected]). The AnJie Law Firm website can be accessed at www.anjielaw.com.Endnotes(1) Further details are available here.(2) Further details are available here.(3) Further details are available here.(4)  EWHC 711 (Pat).(5) Further details are available here.(6) Further details are available here.(7)  EWHC 1591 (Pat) and  EWHC 214 (Pat).