Standard Essential Patent Licensing Practices Do Not Violate Antitrust Laws
The US Court of Appeals for the Ninth Circuit vacated a district court decision that found Qualcomm’s patent licensing practices violate antitrust laws and reversed a permanent, worldwide injunction against several of Qualcomm’s business practices. Fed. Trade Comm’n v. Qualcomm Inc., Case No. 19-16122 (9th Cir. Aug. 11, 2020) (C.J. Callahan).
Qualcomm sells modem chips that are incorporated into cellular handsets (i.e., smartphones) made by companies such as Samsung, Huawai, Apple and others. Qualcomm also holds a number of standard essential patents (SEPs) implemented by modem chips that are essential to cellular communication standards. A core part of Qualcomm’s business model is that it only licenses its SEPs to smartphone makers, i.e., its original equipment manufacturer (OEM) customers, not to rival modem chip suppliers—even though its rivals’ chips practice Qualcomm’s SEPs. Doing this allows Qualcomm to maximize its profits by charging royalty rates based on the value of the end-product smartphones rather than just the modem chip. In addition, Qualcomm will not supply modem chips to OEM customers unless they first pay to license Qualcomm’s SEPs (“no license, no chips”). OEMs must pay this licensing fee to Qualcomm even if they source chips from another supplier.
In January 2017, the FTC filed suit against Qualcomm in the Northern District of California, alleging that Qualcomm’s licensing practices violate the antitrust laws and unfairly protect its monopoly power as a modem chip supplier. Following a two-week bench trial, the district court issued a lengthy opinion ruling in favor of the FTC and ordering extensive injunctive relief requiring Qualcomm to change its business practices. The court made a number of findings, including: (1) Qualcomm’s refusal to license its SEPs to rival chipmakers violates both its FRAND commitments to standard-setting organizations (SSOs) and an antitrust duty to deal; (2) Qualcomm’s royalty rates for its SEPs are unreasonably high because they are based on the value of end products and (3) Qualcomm’s royalties, in conjunction with its “no license, no chips” policy, imposes an anticompetitive “surcharge” on the price of its rivals’ chips. Qualcomm appealed.
The Ninth Circuit reversed the district court’s decision in its entirety and vacated the injunctive relief which had been ordered, finding that Qualcomm’s licensing practices amount to “hypercompetitive,” not anticompetitive, behavior. The Court recognized that Qualcomm’s licensing practices are designed to maximize its profits, but concluded that they do not unfairly distort competition within the modem chip markets. According to the Court, the district court improperly extended the reach of the antitrust laws in issuing its injunction.
The Ninth Circuit addressed and rejected each of the district court’s findings. First, the Court concluded that Qualcomm does not have an antitrust “duty to deal” with its rival chipmakers. The Court emphasized that the Supreme Court has recognized only a narrow exception to the general rule that a business need not deal with its competitors, and concluded that the exception was not met here. The Court also concluded that whether Qualcomm breached a FRAND commitment to license its SEPs to rivals was irrelevant for antitrust purposes. The Court explained that breaches of FRAND commitments are issues of contract and patent law, not antitrust law. Similarly, the Court concluded that whether Qualcomm’s royalty rates are “unreasonably high” is a question of patent law, not antitrust law. In any event, the Court noted, basing royalty rates on the end product rather than a component is consistent with current industry practice. Finally, the Court concluded that the district court’s “surcharge” theory failed to state a cogent theory of anticompetitive harm. The Court noted that Qualcomm requires OEMs to license its SEPs regardless of whether they choose to buy chips from Qualcomm or a competitor, and so the licensing requirement does not distort competition. The Court also rejected the FTC’s argument that the royalties Qualcomm collects on competitors’ sales allow it to charge ultralow prices on its own modem chips and push out rivals by squeezing their profit margins. According to the Court, the FTC offered no evidence that Qualcomm engages in predatory pricing.
The Ninth Circuit’s reversal is a win not only for Qualcomm but for other holders of SEPs in several ways:
First, the decision supports the view that SEP holders who, like Qualcomm, also sell components implementing their SEPs have no antitrust obligation to license those SEPs to competing component suppliers. From an antitrust standpoint, SEP holders may choose to license their patents only to OEMs and not to competitors.
Second, the decision supports the view that breaches of FRAND commitments to SSOs are not generally antitrust issues and should be addressed through contract and patent law. This position, supported by the Department of Justice’s Antitrust Division, will make it more difficult for parties sued by SEP holders for infringement to bring antitrust counterclaims arguing that SEP holders have not complied with their FRAND obligations.
Third, the decision takes the position that the “reasonableness” of royalty rates charged by SEP holders is not an antitrust issue. The antitrust laws do not prohibit SEP holders from basing their royalty rates on the value of end products rather than components.
Finally, the decision holds that an SEP holder may refuse to supply components implementing its SEPs to a customer unless the customer first takes a license.
On the whole, the decision gives SEP holders greater leeway to maximize the value of their patents without running afoul of the antitrust laws. However, SEP holders and implementers should be mindful not to rely too heavily on the decision until the Federal Trade Commission (FTC) announces whether or not it will seek rehearing of the panel’s decision with the full Ninth Circuit or file a petition for certiorari with the Supreme Court. The FTC’s Commissioners have changed significantly since the agency decided to sue Qualcomm in January 2017, transitioning from a Democratic-led to a Republican-led Commission. At least one Republican Commissioner, Christine Wilson, publicly urged the Ninth Circuit to reconsider the district court’s sweeping decision. While the change in leadership may indicate the FTC will no longer pursue its litigation against Qualcomm, SEP holders and implementers should proceed with caution until the agency announces whether it will seek recourse.