Client Alert

Who does this affect?

All firms with investments or business in China

What do you need to do?

Review your IP licensing arrangements in China and ensure a compliance strategy is in place to minimise the risk of class/representative actions and other litigation being taken against you under the Anti-Monopoly Law

Authors
Martyn Huckerby  (贺墨亭)
Partner

James Marshall  
Legal Adviser (Not Australian Qualified)

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Martyn Huckerby  (贺墨亭)
Partner
T +86 21 2308 7628

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Hong Kong
Hayden Flinn  (范凱敦)
Larry Kwok  (郭琳廣)

Beijing
John Shi  (史卫)

Sydney
Dave Poddar  

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Regulators in China have published merger control measures for financial institutions and commenced consultation on draft intellectual property guidelines, as well as draft judicial guidelines that include proposals to facilitate class actions and the award of “double damages” under the Anti-Monopoly Law (AML).

There have been some recent significant clarifications regarding the operation of China’s merger control regime. On 15 July 2009 China published Measures for Calculating the Turnover of Financial Sector Undertakings in Notification of Concentration (Measures), which will take effect 30 days after its publication. Separately, on 23 July 2009 the Ministry of Commerce (MOFCOM) published long-awaited amendments to the Provisions for Mergers With and Acquisitions of Domestic Enterprises by Foreign Investors (2006 M&A Rules) to ensure consistency between the 2006 M&A Rules and the AML, which we will cover in a different alert shortly.

Publication of the Measures follows a new consultation on draft Guidelines on IP-related Anti-Monopoly Law Enforcement (Guidelines). The Guidelines outline the approach that China’s competition authorities will adopt when reviewing the compliance of intellectual property (IP) arrangements with the AML. Most notably, the Guidelines provide for the possibility of a compulsory licensing requirement for IP holders.

Furthermore, and perhaps most significantly, the Supreme People's Court of China has recently commenced a consultation on Provisions on Several Issues Concerning Monopoly-Related Civil Cases (Draft Provisions). The Draft Provisions provide judicial guidance on:

• The filing of monopoly-related civil cases

• Rules of evidence, and

• Remedies, which may include damages of twice the loss suffered (so-called “double damages”) being awarded for breaches of the AML.

1. The Measures

The Measures specify how to calculate “turnover” for the purpose of applying the notification thresholds for mergers in the financial sector. The Measures were jointly issued by MOFCOM, the People’s Bank of China, the China Banking Regulatory Commission, the China Securities Regulatory Commission and the China Insurance Regulatory Commission.

Under the AML, pre-merger notification is compulsory where certain turnover thresholds are met (as set out in our previous alert). The Measures explain: (a) which undertakings are deemed as “financial sector undertakings” and therefore governed by the Measures; and (b) for those undertakings deemed to be financial sector undertakings, what turnover is taken into account to determine whether the merger control thresholds are met.

The Measures cover the following types of financial institutions, as well as the types of income that should be taken into account in calculating turnover for the purpose of applying the notification thresholds (insurance companies are dealt with separately below):

The turnover of these companies should be calculated on the basis of the following formula:

Turnover = (aggregate of turnover elements - business tax and associated charges) x 10%

In contrast, insurance companies’ turnover is deemed to arise solely from premium income under the Measures. The formulae for calculating insurance companies’ turnover are as follows:

• Turnover = (premium income - business tax and associated charges) x 10%, and

• Premium income = premium incomes under original insurance policies + reinsurance premium inpayments - reinsurance premium outpayments.

The approach set out in the Measures differs from that taken in the European Union and a number of practical issues are yet to be resolved. These include how the turnover of portfolio companies of financial institutions should be calculated and whether turnover should be attributed to the location of the relevant branch or to the countries where the firm’s clients are located.

2. The Guidelines

The Guidelines are intended to assist firms understand in what circumstances the competition regulators will regard them as having abused their IP rights in breach of the AML. The Guidelines apply to a broad range of “innovative property rights”, such as patent rights, copyright, technical secrets, and new types of plant and equipment. The Guidelines provide guidance in relation to both:

• Illegal agreements (i.e. horizontal and vertical cooperative behaviour), and

• Abuses of market power (i.e. generally (but not exclusively) unilateral behaviour by large market participants).

The Guidelines explain the general approach the regulators will take when applying the AML to IP arrangements. The Guidelines also cover the application of these general principles to particular types of IP arrangements including restrictive terms, refusals to licence IP, tying arrangements, creation of patent pools, adoption of technical standards, and the acquisition of IP rights.

The Guidelines provide for ‘safe harbours’, which limit the application of the AML to non-“core restrictive conduct”-IP licensing arrangements (subject to limited exemptions - see below). Arrangements between competitors will not be subject to prohibition under the AML, provided that the conduct is not “core restrictive”, and the aggregate market shares of the parties is 20% or less (in the case of horizontal arrangements), or 30% or less (in the case of vertical arrangements).

“Core restrictive conduct” is defined within the Guidelines, broadly following internationally accepted notions of so-called ‘hardcore’ cartel conduct, to include:

• Price fixing

• Restricting the output of commodities or the purchase of new technology

• Market sharing, and

• Engaging in group boycotts and/or squeezing competitors out of the market.

However, where parties can prove that their “core restrictive conduct” falls under any of a number of exemptions, no liability under the AML will arise. The exemptions are drafted relatively broadly, in line with the corresponding provisions of the AML, and include factors such as conduct for the purposes of improving technologies, upgrading product quality, enhancing operational efficiency, mitigating a serious decline in sales volume, or achieving public interests (such as protecting the environment). To gain the benefit of the exemption, the party seeking to rely on it must also establish that the conduct will not severely restrict competition and that consumers can share in the benefits (except in the case of agreements for the purpose of international trade, the so-called “export cartel” exemption).

Consultation on the Guidelines is at an early stage and therefore firms should monitor developments carefully.

3. The Draft Provisions

The Draft Provisions provide guidance in relation to the approach that will be taken by the Courts when handling cases under the AML. The Draft Provisions apply to individual actions, as well as joint, group or representative actions. The Draft Provisions confirm that the Courts may take an investigative role in gathering evidence, consistent with the civil law nature of China's legal system.

The Draft Provisions suggest a limitation period of two years, but also permit that action may be taken in relation to conduct that took place prior to the implementation of the AML, where the injury has continued after the implementation of the AML. If these provisions are retained, a firm considering making an acquisition of an existing business in China will need to carefully consider the target’s potential AML liability before proceeding with the acquisition.

The Draft Provisions single out technology agreements, which suggests that they will be an area of focus for the authorities. The Draft Provisions provide that a contract or clause that violates the AML’s mandatory provisions shall be declared invalid. However, a technology contract or clause which has the effect of illegally monopolising technologies, or preventing technology development shall be declared invalid, even if it does not violate the AML’s mandatory provisions.

Most significantly, the Draft Provisions provide that damages may be awarded up to twice the actual amount of loss suffered by a claimant. An informant that has provided significant evidence about the relevant conduct may have their liability limited to the actual damage caused (thereby encouraging whistleblowing).

Given the wide-ranging nature of the Draft Provisions and the heightened risk of litigious claims once they have been published in final form, firms should take steps now to ensure that they are complying with the AML.

4. Implications

Publication of the Measures is timely, given a recent uptick in M&A activity in China and MOFCOM reporting a critical mass of merger review cases under the AML. From commencement of the AML on 1 August 2008 to the end of June 2009, MOFCOM received 58 notifications, of which 46 reviews have been completed.

However, the draft Guidelines have potentially greater significance for firms operating in China. While the draft Guidelines contain a number of provisions that may reassure holders of a significant IP portfolio in China (such as statements encouraging technological innovation), there are also some risks for firms wishing to protect their IP. In particular, the draft Guidelines provide that the authorities may investigate refusals to licence IP in circumstances where an IP rights holder has already licensed the use of their IP to a third party. Firms should therefore be preparing a clear and objective policy outlining in what circumstances they will licence their technology to third parties.

Firms operating in China should also prepare themselves for a significant increase in litigation under the AML. Indeed, PRC courts have already begun hearing cases under the AML, including Li Fangping v. Beijing Netcom, Renren v. Baidu, and Beijing Shusheng v. Shanda Interactive.

With the Draft Provisions suggesting the possibility of class and representative actions, as well as the possibility of damages awards exceeding a claimant’s losses, there is likely to be an increasing incidence of court action being taken to seek remedies for breaches of the AML. Firms operating in China can mitigate the risk of such litigation by reviewing their compliance policy and training staff on the AML.

Disclaimer

The views set out in this publication are based on our experience as international counsel representing clients in their business activities in China. As is the case for all international law firms licensed in China, we are authorised to provide information concerning the effect of the Chinese legal environment. However we are not admitted to practice Chinese law and so are unable to issue opinions on matters of Chinese law.

This publication is only a general outline. It is not legal advice. You should seek professional advice before taking any action based on its contents.