China’s Ministry of Commerce (MOFCOM) cleared Microsoft’s €5.4 billion acquisition of Nokia’s Devices & Services Business with conditions on 8 April 2014. It is the second conditional clearance in 2014, and deals with the thorny question of the licensing of standard essential patents (SEPs), and non-SEPs in the IT sector.
Microsoft, a US company engaged in the development, production, licensing, support and sale of computer software and consumer electronic products, sought to acquire the Devices & Services Business of Nokia, a Finnish company with global operations in communications and IT. The Devices & Services Business of Nokia essentially encompasses its mobile phone business and smart devices business.
Although cleared without remedies in both the EU and US (footnote 1), the transaction was subject to seven months-long scrutiny in China due to the perceived negative impact on the licensing of certain patents related to the smartphone market. MOFCOM concluded that the proposed transaction risked eliminating and restricting competition in the smartphone market in China.
The transaction was notified to MOFCOM on 13 September 2013 and declared complete on 10 October 2013, indicating a pre-acceptance period of approximately 4 weeks. MOFCOM started a Phase II review on 8 November 2013, which it extended on 8 February 2014. MOFCOM completed its review and adopted a conditional clearance decision on 8 April 2014.
MOFCOM found that the parties had vertical relationships in several markets. Its review focused on three product categories: (1) smartphones, (2) operating systems (OS) for smart mobile devices, and (3) patent licensing related to smart mobile devices. MOFCOM concluded that smartphones constituted a single product market because they can be distinguished from traditional feature mobile phones based on functionalities and price, and from tablets given the telephone function.
In relation to OS for smart mobile devices, MOFCOM determined that since an OS such as Android and iOS could be installed and operated on both smartphones and tablets, OS for smart mobile devices should constitute a distinct product market. This was also confirmed by market surveys.
With respect to patent licensing in the smart mobile devices arena, MOFCOM considered (i) licensing of SEPs related to communications technology, and (ii) Microsoft’s technology licensing with respect to Android phones (Microsoft Android Project Licensing). With regard to communications SEP licensing, MOFCOM viewed the licensing of all communications SEPs as a single market because further segmentation would not affect its conclusions. As for Microsoft Android Project Licensing, most of the patents concerned are non-SEPs. MOFCOM concluded that a group of patents that address the same functionality could constitute a separate product market. It focused on 26 groups of non-SEPs in relation to smart mobile devices over which third parties raised competition concerns. In addition, MOFCOM considered Microsoft Android Project Licensing as a whole given that bundled licensing is common practice in the industry.
Regarding the relevant geographic market, MOFCOM acknowledged that the relevant product markets had certain global characteristics. However, it focused its review on the China market because smartphones sold in China are mainly manufactured in China, targeted at Chinese customers, equipped with OS and applications in Chinese and are developed for Chinese customers.
MOFCOM then considered the impact of the transaction on the relevant markets, and found that the transaction may eliminate or restrict competition in China’s smartphone market for the following reasons.
I. Microsoft may eliminate or restrict competition in China’s smartphone market by leveraging its position as the holder of patents related to the Android OS
MOFCOM concluded that Microsoft’s Android Project Licensing may raise competition concerns. MOFCOM’s market survey showed that Android phones accounted for more than 80% of the mobile smartphone market in China, and that smartphone manufacturers in China relied heavily on the Android OS. The technologies used in Android phones include Microsoft’s SEPs and non-SEPs, which are bundled as Microsoft Android Project Licensing for licensing purposes. The relevant SEPs and non-SEPs relate to essential technical components that address important functionalities of the Android OS and Android phones. MOFCOM was concerned that, post-transaction, Microsoft may adversely affect competition in the downstream smartphone market because: (1) by entering the smartphone manufacturing market, Microsoft would reduce its reliance on other smartphone manufacturers and thereby incentivise Microsoft to raise rivals’ costs by increasing licensing fees; (2) 90% of Chinese smartphone manufacturers are unable to enter into cross-licensing arrangements to constrain Microsoft’s bargaining power given limited technological strength; and (3) patent licensing is a major barrier to market entry.
II. The transaction may result in abuse of patent rights by Nokia
Post-transaction, Nokia, as the owner of thousands of communications SEPs, may be incentivised to abuse its SEPs. According to MOFCOM, since Nokia is essentially exiting the downstream device and service market, it will no longer require cross-licensing arrangements for its handset business. Further, potential licensees will not be able to rely on cross-licensing to counterbalance Nokia’s advantageous bargaining position. In addition, like Microsoft Android Project Licensing, licensing of communications SEPs is a major entry barrier for handset manufacturers in China.
To address the identified competition concerns, MOFCOM imposed the following behavioural remedies on each of Microsoft and Nokia.
Conditions imposed on Microsoft:
1. With regard to smartphone-related SEPs held by Microsoft, Microsoft must:
- continue to license such SEPs under fair, reasonable, and non-discriminatory (FRAND) terms as per its commitments to the relevant Standard Setting Organisations (SSOs);
- not seek injunctions or exclusion orders against smartphones that read on the SEPs and are produced by manufacturers in China;
- not require a licensee to license its patents back to Microsoft, although this condition does not apply to SEPs that a licensee holds in the same sector (i.e. smartphones); and
- transfer any SEPs to new patent holders only if such new patent holders agree to comply with the above conditions.
These conditions are indefinite unless MOFCOM agrees to modify or terminate them.
2. With regard to the non-SEPs held by Microsoft, Microsoft must:
- continue to offer non-exclusive licenses to smartphone manufacturers in China for its non-SEPs under the current Android Project Licensing and EAS, RDP and exFAT projects (including any newer versions of these projects launched in the future);
- maintain essentially the same price and non-price terms in its licensing agreements as those imposed before the transaction;
- not transfer any non-SEPs to new patent holders within five years of MOFCOM’s decision (ie before 8 April 2019) and, after expiry of the five-year term, transfer any non-SEPs to new patent holders only if such new patent holders agree to comply with all the applicable licensing commitments made by Microsoft prior to the commitments under this decision; and
- not seek injunctions against potential licensees unless such licensees are considered not to have negotiated with Microsoft in good faith.
Except for the condition on non-transfer (whose duration is five years), the aforementioned conditions are effective for eight years, ie from the date of the decision until 8 April 2022.
Conditions imposed on Nokia:
- Nokia must continue to license its SEPs under the terms of its commitments to relevant SSOs, under FRAND terms;
- Nokia must not seek injunctions in relation to SEPs and thereby prevent implementation of relevant standards with FRAND commitments attached. This condition does not apply to situations where the relevant licensor has offered licensing terms consistent with FRAND principles, while the potential licensee fails to agree to such FRAND terms in good faith and comply with them;
- Nokia must not license its SEPs on condition that the licensee also takes a license for Nokia patents not subject to FRAND obligations; and
- Nokia must not transfer its SEPs to new patent holders unless such patent holders agree to comply with Nokia’s FRAND obligations under the terms of its commitments to relevant SSOs.
MOFCOM made it clear in a subsequent press conference that the conditions imposed on Nokia are effective indefinitely (footnote 2).
The decision shows MOFCOM’s increasing confidence in dealing with complex antitrust questions involving Intellectual Property Rights (IPRs), and its willingness to adopt decisions that may diverge from decisions taken in other major jurisdictions.
On the face of the decision, MOFCOM did not provide any quantitative or econometric analysis (although the agency may have actually conducted such analysis) to determine the likelihood and/or profitability of the parties’ potential leveraging of their respective market position in the patent licensing market. However, MOFCOM did develop a relatively comprehensive evaluation. Unlike its previous IPR-related decisions where it merely referred to the concepts of ‘FRAND’ and ‘SEP’, MOFCOM provided details on its approach to licensing issues related to SEPs (and key non-SEPs) for the first time and outlined the obligations to which it considers an owner of FRAND-encumbered SEPs is subject.
The case also highlights the impact of complaints in the merger review process, and the government’s focus on indigenous innovation.
MOFCOM’s position on licensing SEPs and non-SEPs
First, MOFCOM appears to presume that SEP owners possess significant market power. However, unlike the extreme position taken by the Guangdong High Court in its Huawei v. InterDigital judgment, it did not conclude that the licensing of each individual SEP constitutes a separate market in which the SEP owner effectively has a 100 per cent market share (footnote 3).
Second, MOFCOM may limit the scope of SEP FRAND commitments. It is important to note that the conditions on SEP FRAND commitments only apply to potential licensees that are willing to make a reciprocal commitment.
Third, MOFCOM will intervene in cases where it is concerned about how companies, post-transaction, may assert the SEPs they retain. In this case, it was concerned, for example, that post-transaction Nokia might have the incentive to harm competition and the welfare of downstream Chinese customers by acting like a patent assertion entity (PAE), ie, enforcing and monetizing (but not using) its portfolio of SEPs(footnote 4). MOFCOM recognised that, normally, smartphone manufacturers may exert effective competitive constraints on each other via cross-licensing their respective manufacturing-related patents. However, this was not the case where, as here, Nokia no longer has a hardware business/manufacturing capabilities and hence no longer requires a license to patents owned by its potential licensees for manufacturing purposes. It would therefore be able to enforce its SEPs much more aggressively.
The remedies imposed on Nokia also highlight that where the seller of a hardware business retains ownership rights to relevant SEPs it may be subject to long-term post-transaction commitments.
Fourth, MOFCOM may look into the licensing of non-SEPs especially if the non-SEPs concerned are technologically or commercially indispensible. This blurs the boundary between at least some non-SEPs and SEPs. For technology companies with large patent portfolios, the decision indicates that MOFCOM will not only scrutinise SEPs and FRAND commitments related thereto, it may also scrutinise certain non-SEPs during its review. It also shows MOFCOM’s willingness to impose conditions related to the licensing of non-SEPs – which may include restrictions on the right to transfer non-SEPs.
Importance of third-party complaints
Although it is a known that MOFCOM consults widely during its review process, its scope and impact remains unclear to the public. The Microsoft/Nokia decision is the first time that MOFCOM seemingly highlighted the specific concerns raised by third-parties in its decision. As MOFCOM notes in its decision, it considered 26 groups of non-SEPs in relation to smart mobile devices held by Microsoft because they were ‘questioned by third-parties’.
Third-parties reportedly raised concerns at a very early stage in the review process. In November and December 2012, about one month after MOFCOM commenced its Phase II review, several leading Chinese technology companies reportedly submitted opinions and complaints to the MIIT as well as MOFCOM to flag concerns over the potential impact of the transaction on patent licensing (footnote 5). The decision also pointed to the fact that Chinese smartphone manufacturers rely heavily on the Android OS and have thin profit margins.
The decision illustrates the importance of third-party opinions in China’s merger review process. The third-parties consulted by MOFCOM include other government authorities and departments, trade associations, competitors, customers and suppliers. The decision is a reminder of the importance of taking into account the potential reaction of different stakeholders and preparing, in advance, a strategy to deal with potential complaints from third-parties.
The increasing focus on IPR-related issues in China
The Microsoft/Nokia decision highlights the uptick in IPR-related issues being addressed under China’s Anti-monopoly Law (AML). In October 2013, the Guangdong Higher People’s Court delivered two landmark judgments in Huawei v. InterDigital, with one of them setting the first FRAND royalty rate in China (footnote 6). In addition, two global wireless communications giants, Qualcomm and InterDigital, are reportedly under investigation by the National Development and Reform Commission (NDRC). Separately, in September 2013, the State Administration of Industry and Commerce (SAIC) reportedly published a seventh iteration of ‘Rules of the Administration for Industry and Commerce on the Prohibition of Abuses of Intellectual Property Rights for the Purposes of Eliminating or Restricting Competition’.
The increasing levels of intervention in IPR-related cases and legislative authority reflect the increasing importance that the government attaches to its indigenous innovation policy. For several years, the government has been encouraging domestic technology companies to develop their own technology and products, and is concerned about them being hindered by technology barriers erected by foreign firms. Quite apart from this policy, the AML instructs MOFCOM to consider, inter alia, a transaction’s impact on technological development during its review. The Microsoft/Nokia decision indicates that transactions involving technology-rich products may be subject to close scrutiny, if the transaction risks impacting indigenous innovation.
Divergence with decisions taken elsewhere
Unlike its EU and US counterparts, MOFCOM identified competition concerns and imposed far-reaching remedies to address them. In relation to market definition, MOFCOM focused on the market for patent licensing related to smart mobile devices whereas the European Commission (the Commission), for example, did not consider this as a relevant market. And, MOFCOM did not take into account the markets for apps for smart mobile devices as well as mail server software and services (footnote 7).
In addition, the Commission concluded that there were limited horizontal overlaps between the parties’ activities, and that ‘the overlap of the two companies’ activities [in the field of smart mobile devices] is minimal and several strong rivals, such as Samsung and Apple will continue to compete with the merged entity’. The Commission also considered a number of vertical relationships between the parties. Unlike MOFCOM, the Commission ruled out competition concerns. It found that Microsoft would have no ability or incentive to engage in conduct that forecloses competition. And such conduct, even if implemented, would not have a significant foreclosure effect on the merged entity’s competitors. It also found that concerns regarding Nokia’s potential conduct with respect to its SEPs and non-SEPs portfolio for smart mobile devices following the transaction fall outside the scope of the Commission’s assessment under the EU Merger Regulation, because ‘Nokia is the seller [and not an undertaking concerned,] whereas [its] investigation relates to the merged entity’. Even if such conduct fell within the scope of the Commission’s assessment under the EUMR, that conduct is not merger-specific and Nokia would have no ability or incentive to engage in conduct that forecloses competition. Further, if Nokia’s incentives to enforce its patents were to change post-transaction, the effects of any such change would be limited. However, the Commission will closely monitor Nokia’s licensing practices post-merger under the conduct-related competition rules.
This is not the first time that MOFCOM’s decision has diverged from decisions in the EU and/or US on the same deal in the IT sector (footnote 8). This latest decision reflects MOFCOM’s confidence in adopting diverging decisions and is a reminder that companies must carefully consider and address any China-specific concerns comprehensively to secure approval.