China: China’s MOFCOM Conditionally Clears Microsoft/Nokia And Merck/AZ

Last Updated: 23 May 2014
Article by Peter Wang and Yizhe Zhang

China's Ministry of Commerce has issued two new conditional approval decisions relating to Microsoft's acquisition of Nokia, and Merck's acquisition of AZ Electronics. These decisions show that MOFCOM will pay close attention to the intellectual property rights owned by the parties to the transaction and will impose remedies where it feel that, in its view, such rights can be misused, especially if to the detriment of Chinese licensees.

Microsoft/Nokia

On April 8, MOFCOM approved Microsoft's acquisition of Nokia's mobile handset business. MOFCOM's review focused on three product markets:  smartphones, mobile operating systems, and the licensing of standard-essential and non-essential patents for smartphones. Geographically, MOFCOM focused on potential impact on the China market.

MOFCOM found that the Microsoft mobile operating system and the Nokia smartphone business had minor market positions and were unlikely to impact competition post-closing.

However, MOFCOM concluded that, post-acquisition, Microsoft would have the capability to restrict competition in the upstream patent license market for smartphones, particularly with respect to Microsoft's package license for Android phones, known as the Android program license. MOFCOM stated that Microsoft's patents covered by the Android program license include technology that is "essential" for the production and manufacture of Android phones, which make up more than 80% of the Chinese smartphone market, including many standard-essential patents as well as 26 families of non-essential patents. MOFCOM found that Microsoft has the motivation to increase competitors' costs by raising its patent royalty rates, now that it was acquiring another competing smartphone manufacturer, the existing Nokia mobile handset business. By contrast, MOFCOM stated that the majority of Chinese smartphone manufacturers lack the "strength" to engage in effective cross-licensing; that patent licensing is a key barrier to entry for smartphone manufacturing; and that any increase in royalty fees would endanger the ability of Chinese smartphone manufacturers to compete, thereby reducing competition and injuring consumers.

MOFCOM also found that, post-acquisition, Nokia (i.e., the seller of the existing Nokia mobile handset business and related patents) will have the incentive and ability to increase its own patent licensing royalty rates for smartphone-related patents. (Note that, unlike other jurisdictions, MOFCOM also considered likely effects on post-closing behavior by the seller, rather than looking only at the likely post-closing conduct of the acquiring entity, Microsoft.)  MOFCOM noted that Nokia has "thousands" of standard-essential patents relevant to telecommunications and was a "leader" in that area "in terms of patent quantity and quality," and that its patents are needed by smartphone manufacturers to conduct production activities. As a result, MOFCOM found that "Nokia has controlling power over the smart phone market."  Moreover, MOFCOM posited that, because Nokia is exiting the downstream device and service market through the transaction, it will have reduced motivation to maintain lower patent royalty fees for the mobile industry. MOFCOM again stated that Chinese potential licensees lack countervailing bargaining power; that such patents are the key barrier to entry in the smartphone business, and that any increase in royalty fees would affect competition in the China market.

As a result, MOFCOM imposed conditions on both Microsoft and Nokia:

  1. With regard to its standard-essential patents ("SEPs"), Microsoft is required (subject to the requirement of reciprocity by any potential licensee):
    1. to honor its FRAND commitments for SEPs;
    2. not to seek injunctions or exclusion orders based on its SEPs against smartphones made in China;
    3. not to require reciprocal licensing from licensees unless the licensee holds SEPs for the same industry; and
    4. to transfer its SEPs only to third parties that agree to abide by these conditions.
  2. For its non-essential patents, Microsoft is required:
    1. to continue to provide nonexclusive licenses to smartphone manufacturers within China;
    2. to license such patents (a) for fees not exceeding those it charged prior to the concentration or contained in current license agreements, and (b) on the same (in substance) non-price terms and conditions as prior to the concentration; and
    3. for 5 years, not to transfer these patents to any third party, and thereafter to transfer them only to third parties that agree to abide by these conditions.

The conditions on Microsoft generally are imposed for 8 years with some exceptions.

3. Nokia is required (generally subject to reciprocity):

  1. to continue to honor its existing FRAND commitments for SEPs;
  2. to confirm its support for the principle that, subject to reciprocity, injunctions should not be enforced based on SEPs to prevent implementation of a standard subject to FRAND undertakings unless the prospective licensee is unwilling to enter into or comply with a FRAND license;
  3. not to require licensees also to license Nokia's patents not subject to FRAND undertakings;
  4. to transfer its SEPs to a new owner only subject to existing FRAND undertakings and its MOFCOM commitments; and
  5. not to depart from its current generally offered FRAND per unit running royalty rates for its current portfolios of cellular communication SEPs.

The conditions on Nokia are subject to a reporting duty for 5 years, but do not appear to have a specific time limit on the conditions themselves.

Merck/AZ

On April 30, MOFCOM approved the acquisition of AZ Electronic Materials S.A. ("AZ") by Merck KGaA ("Merck"). MOFCOM's review focused on two products that are components in the manufacture of flat panel displays (FPDs):  liquid crystal and photoresist. The decision indicates that MOFCOM engaged outside economists to assist with its review.

MOFCOM found that, because both liquid crystal and photoresist are raw materials used for FPD manufacturing, they are "complementary" and constitute "adjacent" markets. Merck and AZ have significant market shares in the two markets -- Merck has 60% share worldwide and 70% share in China in liquid crystal, while AZ has 35% worldwide and 50% in China in photoresist. MOFCOM found that, after the concentration, Merck would become the largest supplier of both liquid crystal and photoresist, while other competitors are able to supply only one product alone and with limited capacity.

As a result, MOFCOM found that the transaction would have the effect of eliminating or restricting competition in both markets, because Merck would have the capacity to engage in tied or bundled sales and cross subsidies to harm competition, and barriers to entry (including IP/patents) are high.

To resolve those concerns, MOFCOM required Merck and AZ to commit:

(a) not to engage in tie-in sales that would force Chinese customers to purchase both Merck and AZ's products at the same time including not to give cross subsidies between Merck's liquid crystal and AZ's photoresist; and

(b) to license Merck liquid crystal patents on non-exclusive, commercially reasonable and non-discriminatory terms. 

These terms were imposed for a period of 3 years.

Key points

MOFCOM view of adjacent/complementary markets. In Merck/AZ, MOFCOM viewed different raw materials used for FPD manufacturing as adjacent markets, even though there is no demonstrated relationship between the two other than that they are separate inputs required for FPD, and indicated concerns with cross-market bundling or tying. 

Non-overlap products. In Merck/AZ, MOFCOM imposed remedies even though the parties have no overlaps in the relevant markets, and although AZ's worldwide photoresist share is only 30% (although its China share is 50%). 

IP barriers to entry and licensing. With very little discussion, MOFCOM concluded in Merck/AZ that, "in the liquid crystal market, Merck has over 3500 patents, and some patents constitute substantial barriers."  Combined with an estimated 2-3 years for downstream customers to test and certify the technology of alternative photoresist suppliers, MOFCOM found significant barriers to entry. Similarly, in Microsoft/Nokia, MOFCOM found that both companies possess significant numbers of standard-essential and non-essential patents constituting barriers to entry into smartphone manufacturing. The Merck decision even requires the parties to ''notify MOFCOM in advance'' if they license any technology to Chinese licensees, presumably so that MOFCOM can oversee the license terms.

Timing. The Microsoft/Nokia case was cleared with conditions on the last day of Phase III. It is not clear from the decision when the Parties began to offer remedy proposals.

The Merck/AZ case was formally accepted by MOFCOM at the end of January. The Parties proposed the final set of remedies on April 25, and the decision was issued on April 30, i.e., in the middle of Phase II. That case, like the earlier Thermo Fisher case, shows that, if MOFCOM has clear and focused concerns, and parties are prepared to make specific remedy proposals to address those concerns up front, then even cases raising concerns and, in MOFCOM's view, requiring conditions can be cleared relatively quickly. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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