China: Antitrust Litigation

2013 has been a significant year for the PRC Anti-Monopoly Law (AML). As the National Development and Reform Commission (NDRC) is actively enforcing the AML through voluminous investigations, the courts have issued several thorough and intriguing judgments with respect to anti-monopoly disputes. Industrial giants such as Huawei and Tencent are involved in these lawsuits. Notably, monopolisation was for the first time found against influential multinational corporations. We will review some of the important cases below and comment accordingly.

Qihoo v Tencent

Competitors Qihoo and Tencent have been embroiled in a long-term battle. In November 2010, in response to Qihoo’s accusations of privacy invasion, Tencent publicly released a letter forbidding its users from using 360 software (a computer management software launched by Qihoo), and requested it be uninstalled from their computers. The dispute quickly escalated into a lawsuit brought on 31 March 2011, where Qihoo alleged before the Guangdong High People’s Court that Tencent had been abusing its dominant market position by forcing its users to choose between QQ and 360, and by tying QQ Apps Manager with Instant Messenger.

Surprisingly, the court of first instance made ‘no finding of monopolisation’. Qihoo has since appealed to the Supreme People’s Court, and the first hearing opened on 26 November 2013. The media has extensively covered the lawsuit since the first day. In response to wide public attention, the Supreme Court even permitted a live broadcast for the first trial. In this section, we will review only the first instance judgment.

In AML cases involving ‘abuse of market dominance’, the Court should go through a three-step analysis to reach a decision:

• identifying the relevant market;
• assessing whether the defendant holds a dominant market position in the relevant market; and
• assessing whether the defendant has abused its dominant market position.

The debate in this case centres on the first two steps.

Definition of ‘relevant market’

The definition of ‘relevant market’ has proven problematic in AML disputes. Although both the AML and the anti-monopoly committee of the state council’s Guide on the Definition of the Relevant Market have provided helpful guidance, the delineation of the relevant market in any specific case is fact-intensive and remains contestable in almost every AML case.

In light of the large amount of evidence provided by both parties, the Guangdong High People’s Court conducted the most sophisticated analysis on the scope of the relevant product market of all judgments to date. Instead of starting from a broad definition, the Court first identified three types of ‘core’ services that form a narrow product market. They include multifunctional IM services such as QQ or MSN, cross-platform IM services such as Fetion, and cross-network IM services such as Skype. It then went on to consider whether four other groups of services that were suggested to be substitutable for the IM services provided by the parties should also be placed in the same market. As part of its analysis, the Court conducted the small but significant and non-transitory increase in price (SSNIP) test, and considered both the supply and demand-side substitutability of the respective group of services.

The Court concluded that if the providers were to charge a price on their IM services, a consumer could switch easily, immediately, and without cost from IM services to voice/video calls, social networking websites and micro-blogging websites, all of which share similar functions. Therefore the latter should also be considered part of a broader market of IM services. As for traditional telecoms services and e-mails, these services do not serve the same functions as IM services, and thus are not substitutable. The Court also considered the increasingly intensive competition between gateway platforms and the low entry barrier of the relevant market, deciding to reject Qihoo’s much narrower market definition that IM service by itself forms a distinctive product market.

As for the relevant geographic market, the Court gave due consideration to both Chinese and global markets. But resting on the finding that internet service is globally accessible and users are not limited by territorial boundaries, the Court was convinced that the competition among IM service providers happens across borders. Therefore the relevant geographic market should be defined as the global market.

During the Court’s analysis of the relevant product market, it is worth noting that the Court has adopted a ‘ruling-out’ approach rather than starting with a broader definition of the relevant market. This approach allows the Court to consider each suggested service’s supply-side and demand-side substitutability separately without being tangled in a mess. The discussion also reveals that the Court heavily relies on expert evidence and survey results from the China Internet Network Information Center (CNNIC). This suggests that economic evidence is increasing in importance, albeit no independent economic studies were conducted to collect information directly from market participants.

The dominant market position

With respect to ‘dominant market position’, articles 17 and 18 of the AML require a number of factors to be considered, including market share, the ability to control price, quantity, or other terms of trade, and the ability to block other market entrants. Article 19 of the AML also stipulates that a business operator may be presumed to have a dominant market position if its market share accounts for one-half or more of the relevant market.

To establish a presumption of market dominance, Qihoo presented survey reports provided by iResearch Consulting Group to demonstrate that Tencent had over 50 per cent of the market share. However, this evidence was denied once the Court concluded that Qihoo’s definition of the relevant market was constructed too narrowly. Instead of continuing to determine Tencent’s market share in the Court-defined relevant market, the Court went on to conclude that even if the Court accepted Qihoo’s definition, Tencent still held no dominant market position because it had no ability to control the price, quantity, or other terms of trade, and had no ability to block or affect other market entrants.

The Court’s conclusion on market dominance focused on the fact that the IM services market was fully competitive and erratic. Business operators like Apple, China Unicom and China Mobile have all launched their own IM services. Since no one is willing to pay for IM services and all competing IM services are free of charge, users can immediately switch to another service cost-free if they find the latter more favourable. The so-called ‘user lock-in’ effect is an overstatement given that users often employ multiple IM services simultaneously with overlapping social networks. Overall, Tencent has no power over pricing or other trade terms and has no ability to block other business operators.

The Court’s finding of no market dominance is somehow surprising. As the largest IM service provider, Tencent has over 1 billion registered users and 700 million active users. It is hard to imagine that such a market share leads to no finding of dominant market position. The Court seems to suggest that in a special industry like internet services, the existence of fierce competition and low entry barriers may defeat the presumption of market dominance. However, no quantitative, qualitative or even common sense economic study was conducted to actually prove the existence of full market competition, except for the Court’s own inference.

Abuse of a dominant market position

Once the defendant Tencent was found to hold no dominant position in the relevant market, it became unnecessary for the Court to consider abuse of a dominant market position. But in an effort to lay out clear guidelines for market behaviour, said the Court, it continued to consider the legality of Tencent’s acts against
Qihoo.

Article 17 of the AML prohibits exclusive dealing – a business operator with a dominant market position may not without justifiable cause restrict its trading parties to exclusively conducting deals with the business operator or with parties designated by the business operator. By forcing its users to choose between QQ and 360, Tencent was essentially precluding third parties from dealing with Qihoo. It cannot claim justification under self-defence because its acts have implicated all internet users other than Qihoo. This may constitute refusal to deal under the AML, if Tencent was found to hold a dominant market position.

With respect to tying arrangements, the Court decided users were given options whether to install or update other QQ software or not. Since no signs of restricting or eliminating competition were found, Tencent did not violate article 17.

Rainbow Medical v Johnson & Johnson

In August 2013, less than half a year after the issuance of the Tencent judgment, came the appellate decision of Rainbow Medical v Johnson & Johnson, with a surprising result in favour of the plaintiff, Rainbow Medical. The court of second instance overruled the lower court decision and ordered compensation in the amount of 530,000 renminbi to Rainbow Medical. This was the first successful case for plaintiffs in the history of AML enforcement in China. The court’s analysis regarding retail price maintenance (RPM) provisions was also profoundly insightful.

This suit was brought in 2010 against Johnson & Johnson before the Shanghai No. 1 Intermediate People’s Court. Rainbow Medical alleged that Johnson & Johnson had violated article 14 of the AML, which prohibits price fixing in vertical agreements by setting a minimum retail price in distribution agreements. The court of first instance decided in favour of Johnson & Johnson on the ground that Rainbow Medical failed to satisfy its burden of proof. During the appeal in the Shanghai High People’s Court, the Court addressed several important issues left unresolved by the first instance judgment, and provided important guidance on the legality of RPM provisions between business operators at different levels of a supply chain.

Rule-of-reason analysis

Unlike horizontal agreements concluded between competitors of the same level, RMP provisions are usually concluded between business operators at different levels of the supply chain, and are referred to as vertical monopoly agreements. There have been debates over whether vertical monopoly agreements should be considered illegal per se, or analysed by rule of reason under the AML. The Court in the present case clarified this question. It explained that article 13 of the AML defined ‘monopoly agreements’ as ‘agreements, decisions or other concerted behaviours that may eliminate or restrict competition’. This definition should also apply to article 14 of the AML that deals with vertical agreements, in order to retain consistency throughout the statute. Thus, only vertical agreements that have the effect of ‘eliminating or restricting market competition’ may be held to violate the AML. This illustrates that the ‘rule of reason’ analysis should be applied in vertical price fixing.

Burden shifting

The Court also affirmed that burden shifting (ie, the defendant bears the burden to prove that the agreement at issue does not have the effect of eliminating or restricting market competition) only applies in civil suits when laws and regulations expressly provide so. Article 7 of the Provisions of the Supreme People’s Court Regarding Law Application in Adjudicating Anti-Monopoly Law Civil Dispute allows burden shifting only in antitrust cases involving horizontal agreements, but not vertical agreements. Therefore, the plaintiff Rainbow Medical still bears the burden to prove that the vertical agreement at issue had the effect of eliminating or restricting market competition.

Legality of RPM provisions

The main issue in this case involves whether the RPM provisions have the effect of eliminating or restricting market competition. Both parties presented expert opinions on the economic harms and benefits of the RPM provisions. The Court conceded that a number of factors should be considered and laid out a four-prong test for its analysis:

• whether the relevant market is a fully competitive market;
• whether Johnson & Johnson has a strong position in the relevant market (though not necessarily reaching a level of market dominance);
• whether the purpose of the RPM provisions is to avoid price competition in the relevant market; and
• whether the anti-competitive effect of the RPM provisions far outweighs its pro-competitive effect.

The Court defined the relevant market as ‘the market for medical suture products in the territory of China’ by using the substitutability analysis from both the supply and demand sides. As for the SSNIP test, the Court decided that it was not a required test in cases where the scope of the relevant market could be determined by the substitutability analysis. Based upon the evidence, the Court found that a high entry barrier and little price competition existed in the relevant market due to the fact that decision-makers, namely the doctors, were insensitive to price changes and had instead developed strong brand reliance. The fact that Johnson & Johnson had maintained prices for over 15 years further proved that point. Although the Court denied the creditability of Rainbow Medical’s accounting report on Johnson & Johnson’s market share, it still found that Johnson & Johnson held a strong market position by inferring from its market influence and control over the distributors. Lastly, the Court found that the RPM provisions were put in place with the purpose of precluding price competition, which resulted in the elimination of intra-brand price competition and the avoidance of inter-brand price competition.

Futhermore, the Court’s four-prong analysis reflects a very deep and thorough deliberation of each contestable prong. Since RPM may be both pro- and anti-competitive, courts always face problems in determining whether the disputed RPM is intended to restrict or promote competition. Factors such as degree of competition and entry barriers in the relevant market are indispensable for consideration. The framework laid out in Johnson will lend great help to subsequent decisions involving vertical monopoly agreements.

Damages

Having found article 14 was violated, the Court next determined whether Johnson & Johnson should be liable for all losses suffered by Rainbow Medical resulted from the RPM provisions. The Court decided that the ‘but-for’ test which is often used to determine contractual damages should not be used to calculate damages in an AML case. Instead, the amount of damages should be based on the loss to consumers resulting from the agreement’s negative effect on market competition. In particular, in a vertical price-fixing case, courts should use the normal profit of a participant in the relevant market, rather than the profit of the plaintiff, to calculate the damages, because the plaintiff may have already enjoyed the monopoly profit from the price-fixing agreement. In the end, the Court adjusted Rainbow Medical’s annual sales and gross profit accordingly, and reached a finale amount of compensation.

Huawei v InterDigital

Huawei v InterDigital is also a high-profile case that attracted wide attention from legal professionals as well as the general public. Due to the involvement of trade secrets, no judgment has been released to the public to date. But two judges from the first instance, Mr Zhu Jianjun and Mr Chen Wenquan, published articles commenting on several important issues involved in the case that could help us understand the process.

The plaintiff Huawei, known as a major global supplier of telecommunication equipment, brought a suit against InterDigital Inc (IDC) and its subsidiaries before the Shenzhen Intermediate People’s court, alleging that IDC had abused its dominant market position by engaging in excessively high pricing and tying arrangements in standard-essential patent (SEP) licensing. Before this suit, Huawei and IDC had engaged in multiple negotiations with respect to the licensing fee of IDC’s patents involved in this case, but failed to reach an agreement. In July 2011, IDC sued Huawei before the US Delaware District Court and the International Trade Commission (ITC) alleging patent infringement. This finally led to Huawei’s counter-attack in the Chinese courts.

Like Qihoo v Tencent, this case also involves issues such as the definition of the relevant market, findings of market dominance, and abuse of dominant market position. But before we dive into the court’s analysis, it is important to understand two concepts: SEPs, and fair, reasonable, non-discriminatory (FRAND) commitment. SEPs refer to patents that are essential for the implementation of technical standards of relevant products. Implementers of SEPs must first obtain licences from patentees before legitimately engaging in production. To ensure that process, SEP owners are committed to grant licences to the implementers under fair, reasonable, and non-discriminatory terms, or the FRAND commitment, when incorporating their patents into standards. In the field of wireless communication, IDC holds a large amount of essential patents under the 2G, 3G and 4G standards that must be used by Huawei during its production of telecommunication devices.

Relevant market

The judges’ article stated that the definition of the relevant market mainly depends upon the substitutability of the commodity or service market. As mentioned above, a technical standard is mandatory. Once a patented technology is incorporated into a technical standard, manufacturers of the products will have to use the patented technology to ensure that their products comply with technical standards. No substitutable technology can be found to circumvent the SEPs. Based upon that theory, the Court concluded that due to the SEP’s uniqueness and non-substitutability, as well as the territoriality principle of intellectual property rights, every licensing market of each SEP constitutes an independent relevant product market, and each country of the relevant product market constitutes an independent relevant geographical market.

Market dominance

According to the judges, the uniqueness and non-substitutability of SEPs implied that IDC is the only supplier of its SEPs in the relevant market. Therefore it is reasonable to conclude that IDC holds a full market share in every licensing market of each essential patent under 3G standards, and has the ability to block or affect the entry of other business operators into the relevant markets. The judges further argued that since IDC does not engage in any substantive manufacturing activity, Huawei is unable to constrain IDC by way of cross-licensing. Thus, the Court concluded that IDC has the ability to control the price, quantity, and other trade terms of SEP licences during negotiations.

Abuse of market dominance

In cases involving SEP licences, courts around the world have found considerable difficulty in determining what fair, reasonable and non-discriminatory terms actually mean.

In the present case, the Court took a ‘comparative’ approach by laying out terms and conditions of several different licence agreements entered between IDC and its licensees. In the end, it picked one licence – the licence between IDC and Apple, as the criteria for determining whether any of IDC’s licence offers satisfy the FRAND requirement. For other IDC licences, such as the licence to Samsung, the Court simply dismissed its relevance to the FRAND determination with apparently no reason. Judge Zhu, in another article, mentioned that licensing fees for SEP should reflect and be limited to their value to the technology, and patent holders are not entitled to extra benefits when their patents become industry standards. He also believes that the injunction suit filed by IDC before the US court and ITC was meant to force Huawei to accept the stringent licensing terms offered during negotiations.

Besides its excessive and discriminatory pricing, the Court also found that IDC engaged in tying arrangements by packaging its essential and non-essential patents. This also constitutes abuse of a dominant market position, said the Court. Based on the above findings, the Court ordered IDC to immediately stop its monopolistic acts and compensate Huawei for its loss in the amount of 20 million renminbi.

Conclusion

These three cases represent the Chinese courts’ great change of attitude towards AML enforcement, at least against multinational corporations. Before 2013, only a handful of decisions had been made since the AML’s implementation, and no monopolisation was ever found. But starting from this year, the process of enforcing the AML has accelerated. Courts began to conduct extensive analysis of monopolistic behaviour and tried to set non-binding but clear precedents for subsequent disputes. More decisions in this area will be issued by the end of 2014. Although problems remain with regards to how the courts might adequately address both parties’ arguments and evidence, year one of China’s AML enforcement is still worth celebrating.