Ninth Circuit Overturns FTC-Requested Injunction Against Refusal to License Standard Essential Patents
In a decision that is potentially important for licensors as well as licensees of standard essential patents (SEPs), a panel of the Ninth Circuit has vacated an injunction that the U.S. District Court for the Northern District of California entered in response to the Federal Trade Commission’s (FTC) challenge to the patent licensing practices of Qualcomm Incorporated (Qualcomm).1 The FTC alleged that Qualcomm used its licensing practices for its SEPs on technology for code division multiple access (CDMA) and premium long-term evolution (Premium LTE) cellular telephone technology (3G and 4G) to maintain its monopoly power in chips manufacturing. Qualcomm both develops technology used in 3G and 4G cell phones and manufactures the chips used in such phones. The appeals court held that the following practices of Qualcomm were neither agreements in restraint of trade nor monopolistic practices violating Sections 1 and 2 of the Sherman Act:
- Licensing its patents only to cell phone manufacturers (OEM) and not to competing chip manufacturers;
- Setting royalty rates for its patents as a percentage of the price of the finished cell phone rather than as a percentage of the chip prices;
- Refusing to sell chips to OEMs who have not licensed Qualcomm’s technology (No License, No Chips);
- Charging high royalties for its technology, even if that price exceeds the fair value of the licenses; and
- Conditioning substantial discounts on its chip prices on the purchasing OEM’s agreement to buy exclusively Qualcomm chips.
It is unknown whether the FTC will appeal further.
Some of Qualcomm’s patents are incorporated in the 3G and 4G technical standards adopted by the standard settings organizations (SSOs) that established the 3G and 4G technical standards. As a condition for incorporating these Qualcomm SEPs into the standards, the SSOs required Qualcomm to agree to license those SEPs to competitors and other customers on fair, reasonable, and non-discriminatory terms (the so-called FRAND commitment).
The appeals court acknowledged that Qualcomm enjoys monopoly power in the sale of the chips in question, with CDMA market shares of over 90 percent between 2006 and 2016 and Premium LTE shares of at least 70 percent. Around 2015, however, competitors found new ways to compete, and Qualcomm’s CDMA share declined to 79 percent in 2017–2018 and its Premium LTE share to 64 percent.
Although competing chip manufacturers necessarily practice some of Qualcomm’s patented technology, Qualcomm only licenses its CDMA and Premium LTE technology to the OEMs, not to chip manufacturers. Qualcomm offers its chip competitors agreements in which Qualcomm promises not to assert its patents against the competitor in return for the competitor’s promise not to sell chips to OEMs who do not license Qualcomm’s SEP technology. These agreements allow Qualcomm’s chip competitors to practice its technology royalty-free.
Qualcomm also employs a No License, No Chips policy that refuses chip sales to OEMs who have not licensed its SEP technology. Both the refusal to license chip makers and the No License, No Chips policy allow Qualcomm to obtain higher royalty payments from OEMs and avoiding arguments that Qualcomm exhausted its patents in the sale or manufacture of the chips.
In 2011 and 2013, Qualcomm signed contracts with Apple Inc. (Apple) that provided substantial incentive payments (i.e., pricing discounts) if Apple sourced its iPhone modem chips exclusively from Qualcomm. In 2014, however, Apple terminated these contracts and purchased the modem chips for its 2016 model from Intel.
The district court held that Qualcomm’s conduct had violated Section 2 of the Sherman Act by monopolizing the markets for CDMA and Premium LTE chips and that its exclusive purchasing agreements violated Section 1 of the Sherman Act by unreasonably restraining trade in those markets. It also held that the refusal to license rival chip makers both breached its FRAND commitments and constituted predatory conduct violating Section 2. Further, it’s No License, No Chips policy was held to be an anticompetitive practice. Finally, its “unreasonably high royalty rates” in conjunction with its No License, No Chips policy were considered “an artificial and anticompetitive surcharge on its rivals’ chip sales.”
As a remedy, the district court entered a worldwide injunction prohibiting the foregoing practices and requiring Qualcomm to re-negotiate all of its sales contracts that had resulted from the implementation of these policies. Qualcomm appealed the injunction, and the appeals court stayed the injunction. In a highly unusual move, the Antitrust Division of the United States Department of Justice filed amicus briefs supporting the stay and later supporting a reversal.
The appeals court declined to opine on whether Qualcomm’s insistence on licensing only OEM manufacturers and not rival chip manufacturers violated its FRAND commitments. However, whether or not such refusal gave rise to a contract or patent law claim, the court held that it did not violate the antitrust laws. The antitrust laws, the court noted, generally impose no duty on a trader to deal with a competitor. The limited exception under Aspen Skiing Co. v. Aspen Highlands Skiing Corp.,2 applies only where (i) a monopolist has unilaterally terminated a voluntary and profitable course of dealing with a competitor, (ii) the only conceivable rationale for the refusal to deal is to sacrifice short-term profits to obtain higher profits in the long run from the exclusion of competition, and (iii) the refusal to deal involves products the defendant already sells to others in an existing market. In Verizon Communications, Inc. v. Trinko,3 the Supreme Court described this exception as “at or near the outer boundary of §2 liability.”
Here, according to the appeals court, Qualcomm did not terminate a voluntary course of dealing with competing chip producers because it never granted licenses to rival chip manufacturers. Instead, it entered into royalty-bearing licenses with OEMs. Nor did its practice involve sacrificing short term profits to obtain larger monopoly profits in the long run. As the district court found, the practice of licensing OEMs maximized both its short term and its long term profits. Moreover, its practice was adopted as a response to developments in the doctrine of patent exhaustion, not to sacrifice short term profits for long term gains. Finally, Qualcomm was not singling out a specific chip competitor for anticompetitive treatment. The appeals court specifically distinguished Qualcomm’s refusal to license rival chip makers from cases involving an SEP holder’s deception of an SSO regarding such a commitment that leads to the SSO’s adoption of the holder’s technology as part of the SSO’s standards. Here, neither district court nor appeals court found evidence of deception or charging discriminatorily higher royalty rates to competing customers.
The appeals court also held that the district court’s theory that Qualcomm’s “unreasonably high” royalty rates constituted an anticompetitive surcharge on its rivals’ chips was incorrect. First, the district court’s determination that the royalties were unreasonably high because they were based on handset prices was misplaced. In addition to misapplying patent damage rules to interpret the antitrust laws, the district court erroneously assumed that royalties are anticompetitive under the antitrust laws when they are higher than the patent’s current intrinsic value and higher than the royalties other companies charge on similar patents. The antitrust laws, however, do not limit the price a monopolist may charge. Moreover, whether the amount of the royalties was reasonable or not, they did not constitute an “artificial surcharge” on rivals’ chips because Qualcomm charged the same royalties whether the OEM used Qualcomm chips or a competitor’s chips.
In addition, Qualcomm’s royalties were for patents that the OEMs actually used (regardless of the brand of chips purchased) and that therefore had value to the OEMs. Furthermore, the appeals court held the FTC’s theory that Qualcomm used its high licensing royalties to enable it to cut its chip prices and squeeze out chip competitors was precluded by the Supreme Court’s rejection of “margin squeeze” theories of liability in Pacific Bell Telephone Co. v. Linkline Communications, Inc.4 In Linkline, the Supreme Court had rejected monopoly claims of margin squeeze asserted against AT&T by its competitors who procured access to AT&T’s telephone lines in order to compete with AT&T in retail sales of internet service. Absent evidence that AT&T was guilty of selling below cost at the retail level, the Supreme Court held that AT&T had no antitrust duty to deal with its competitors on the wholesale level and could only be liable for monopolization at the retail level if there was evidence that its retail pricing was below cost. The FTC’s case against Qualcomm not only failed to show pricing below cost but was premised on the theory that Qualcomm receives monopoly profits on modem chips.
Qualcomm’s No License, No Chips policy, the appeals court held, imposed no anticompetitive harm on rival chip producers, since Qualcomm received the same royalty rates for its SEP technology, regardless of whose chips an OEM purchased. By definition, the court reasoned, such equal royalty rates for the technology do not distort competition among chip manufacturers. The court distinguished this case from a hypothetical case in which Qualcomm would not license its technology unless the OEM purchased Qualcomm’s chips. Under the No Chips, No License policy, OEM would either have to use Qualcomm’s chips or pay for both Qualcomm’s and a competitor’s chips. But unlike such a policy, the No License, No Chips policy is neutral as to the brand of chips purchased.
The appeals court concluded that Qualcomm’s contracts affording Apple pricing discounts if they bought exclusively Qualcomm chips did not foreclose a substantial share of the market since a competitive chip producer won a substantial portion of the Apple business the year after the challenged agreement was signed. Although exclusive dealing agreements can have anticompetitive effects, they are not per se unlawful. Instead, they are unlawful only when they foreclose competition in a substantial share of the markets. Pricing discounts conditioned on exclusivity in short term contracts seldom have significant adverse competitive effects.
Although licensors of SEPs may find solace in the appeal court’s decision that Qualcomm’s licensing practices were not antitrust violations, licensees may take heart from the fact that the court left open the question of whether the same practices could generate liabilities under contract law for a breach of Qualcomm’s FRAND commitments to license all users of its technology on fair, reasonable, and non-discriminatory terms.