In a reversal that came as no surprise to many observers, on Tuesday, August 11, 2020, a unanimous panel of the U.S. Court of Appeals for the Ninth Circuit reversed the decision by the U.S. District Court for the Northern District of California in FTC v. Qualcomm and vacated the district court's worldwide, permanent injunction prohibiting several of Qualcomm Incorporated's ("Qualcomm") licensing practices with respect to standard-essential patents ("SEPs") covering cellular technology. In reversing the district court's decision, the Ninth Circuit held that Qualcomm had no antitrust duty to license its SEPs to rival chip suppliers and that the FTC failed to establish anticompetitive effects to the cellular chip market arising from Qualcomm's patent licensing practices.
This was a controversial and closely watched case by both antitrust and intellectual property practitioners, academics and enforcement agencies. The FTC brought the suit in 2017 on a 2-1 partisan vote over the strong and unusual objection of Commissioner Ohlhausen. As described below, Qualcomm used its monopoly power in aggressive and strategic ways, but as the Ninth Circuit concluded, within its rights as the owner of valuable intellectual property.
Qualcomm's Business Model: "No License, No Chips"
Qualcomm is a cellular technology company that holds patents to technological innovations relating to modern cellular technology, including third-generation ("3G") CDMA and fourth-generation ("4G") LTE cellular standards practiced in most modern smartphone devices.
Qualcomm licenses these patents to original equipment manufacturers ("OEMs"), such as mobile phone manufacturers/suppliers, whose devices practice CDMA and premium LTE technologies. In addition to its patent licensing business, Qualcomm also manufactures and sells cellular modem chips, the hardware that enables devices to communicate using these technology standards, to OEMs.
Qualcomm's patent portfolio includes standard-essential patents ("SEPs") for CDMA and premium LTE technologies found in all modern smartphone devices. SEPs are patents on technologies that international standard-setting organizations ("SSOs") choose to adopt as the technological standards practiced by each new generation of cellular technology; SEPs are therefore necessary to practice a particular standard. In order to ensure that SEPs are available to all industry participants, SSOs require SEP holders who participate in the standards setting process to commit to license their SEPs on fair, reasonable, and nondiscriminatory ("FRAND") terms. This commitment is generally set forth in agreements between the SSO and its members.
Qualcomm licenses its patents exclusively to OEMs; it does not license its patents to rival chip suppliers. These patents can include SEPs, non-cellular SEPs, and non-SEPs. Qualcomm enforces a "no license, no chips" policy, under which it refuses to sell its chips to OEMs that do not also take the licenses to practice its SEPs. Qualcomm sets the royalty rates for its CDMA and LTE patent portfolios as a percentage of the end-product sales price.
The reason Qualcomm does not license its SEPs to competing chip suppliers is to avoid "patent exhaustion," whereby OEMs could purchase chips from Qualcomm's rival chip manufacturers without paying for the licenses themselves. However, because those competing chip suppliers must practice Qualcomm's SEPs in their own chips by necessity, Qualcomm grants these competing chip suppliers a covenant not to sue, effectively allowing these chip suppliers a royalty-free license enabling them to practice the SEPs. In exchange, these competing chip suppliers must report their supply agreements with OEMs to Qualcomm. Qualcomm then charges OEMs a per-unit licensing royalty for the use of chips manufactured by Qualcomm's rivals that utilize Qualcomm's SEPs. As a result, OEMs pay royalties to Qualcomm for the SEPs regardless of which company they choose to source their chips from.
District Court Opinion
In January 2017, the FTC sued Qualcomm for equitable relief in the Northern District of California, alleging that Qualcomm's patent licensing practices excluded competitors and harmed competition in the modem chip markets in violation of the Federal Trade Commission Act and Sections 1 and 2 of the Sherman Act. In May 2019, the district court issued its opinion finding that Qualcomm violated federal antitrust laws by (1) refusing to license its SEPs to its direct competitors in the modern chips markets; (2) imposing an anticompetitive surcharge on rival chip manufacturers' chip sales through its patent licensing and "no license, no chips" policies to OEMs; and (3) entering into exclusive dealing arrangements with Apple in 2011 and 2013.
The Ninth Circuit's Opinion
In a unanimous opinion, the three-judge panel reversed the district court's decision and held that the FTC failed to satisfy its initial burden under the rule of reason framework to prove that the challenged restraint had a substantial effect that harmed consumers in the relevant market for CDMA and premium LTE chips. Accordingly, the Court vacated the worldwide permanent injunction relating to Qualcomm's patent licensing practices.
Refusal to License to Rival Chip Manufacturers Is Not an Antitrust Violation
The Ninth Circuit held that the exception provided by Aspen Skiing creating an antitrust duty to deal with competitors did not apply because Qualcomm's switch to licensing exclusively to OEMs did not meet any of the three required elements of the exception. The Aspen Skiing exception requires (i) the unilateral termination of a "voluntary and profitable course of dealing," (ii) the only conceivable rationale or purpose of which is to "sacrifice short-term benefits in order to obtain higher profits in the long run from the exclusion of competition," and (iii) the refusal to deal involves products that the defendant already sells in the existing market to other similarly situated customers. In contrast, the Court noted that Qualcomm ceased its prior practice following developments in patent laws that made it more difficult to provide "non-exhaustive licenses," that licensing exclusively to OEMs was profitable in both the short and long run, and that unlike in Aspen Skiing, the district court found no evidence that Qualcomm singles out any specific chip manufacturer for anticompetitive treatment in its SEP-licensing. The Court also found the district court's application of the Aspen Skiing exception in this case ignored the Supreme Court's subsequent warning in Trinko that the Aspen Skiing exception should be applied only in rare circumstances. Indeed, the FTC itself conceded the district court's error in that regard.
No Antitrust Violation for Breach of SSO Commitments
The Ninth Circuit held that the FTC failed to establish a Sherman Act violation arising from Qualcomm's breach of its contractual SSO obligations absent evidence that the breach impaired the opportunities of its rivals in the CDMA and LTE chip markets. The Court concluded that any alleged harm from Qualcomm's breach of SSO commitments was borne by OEMs, not rival chip manufacturers. Because Qualcomm's royalties were "chip-supplier neutral," the royalty rates are based on the portfolio chosen by the OEM customer regardless of where the OEM sources its chips. With regard to the CDMA and LTE chip markets, the Court pointedly noted that the FTC "identifies no such harm to competition," as Qualcomm's rival chip suppliers are permitted to practice Qualcomm's SEPs royalty-free. The Court also found unpersuasive the FTC's reliance on Broadcom v. Qualcomm given the lack of allegations relating to Qualcomm's deception during the standards setting process and discriminatory charging for royalties dispositive to that decision. Finally, the Court noted that "[a]bsent a showing of harm to competition, antitrust is not an appropriate regime for resolving contractual disputes."
"No License, No Chips" Policy is Permissible
The FTC argued that by setting "unreasonably high" royalty rates, Qualcomm controlled its rival chip manufacturers' prices by increasing the "all-in" price of its rivals' chips to include the nominal chip price and Qualcomm's royalty surcharge. The Ninth Circuit held that at worst, the "no license, no chips" policy might raise the price and harm Qualcomm's customers, not its rivals in the relevant market. Furthermore, the Court emphasized that the Sherman Act does not prohibit Qualcomm from either licensing SEPs independent from chip sales and collecting royalties or limiting their chip customer base to licensed OEMs; Qualcomm's policy would only raise potential antitrust concerns if it were exclusionary conduct in the form of "no chips, no license" in which Qualcomm refused to license its SEPs to OEMs unless they first agreed to purchase Qualcomm's chips. However, unlike that situation, under Qualcomm's "no license, no chips" policy, it makes no difference to Qualcomm whether the OEM purchases the Qualcomm chip or a rival's chip. The Court likened "no license, no chips" to the novel business practice in American Express that "at first appeared to be anticompetitive, but in fact was disruptive in a manner that was beneficial to customers in the long run."
Exclusive Dealing Arrangements with Apple Were Not Anticompetitive
While recognizing the merit in the district court's conclusion that Qualcomm's agreements with Apple in 2011 and 2013 were structured similar to exclusive dealing contracts, the Court held that the agreements did not have the actual or practical effect of substantially foreclosing competition in the CDMA modem chip market. Notably, the Court was persuaded by the record that no specific competitor or potential competitor was affected by either of the agreements, as there were no viable competitors to Qualcomm prior to 2014.
The Ninth Circuit's reversal of the district court's decision reinforces the long-standing principle that plaintiffs seeking to allege antitrust violations must meet their burden of showing anticompetitive harm to the relevant market. Here, the FTC failed to show that Qualcomm's practice of licensing exclusively to OEMs (and not rival chip manufacturers) amounted to a violation of the Sherman Act, as Qualcomm has no antitrust duty to license its rival chip manufacturers. To the extent that Qualcomm breached any of its SSO commitments by charging non-FRAND royalty rates, the Court emphatically noted that the remedy for such a breach lies in contract and patent law, not antitrust. Furthermore, the Court held that Qualcomm's "no license, no chips" policy was not an antitrust violation absent any showing of harm in the relevant markets. The Ninth Circuit's reversal of the district court decision serves as a reminder that plaintiffs bringing antitrust claims still bear the initial burden under the rule of reason framework to show anticompetitive harm to the relevant market. The last word on the "no license, no chips" approach may still be to come as this case is, of course, subject to appeal to the Supreme Court and a cert petition may well be filed. In any event, this is a big, if not unexpected win for Qualcomm.
Originally published by Mintz, August 2020
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.