Ninth Circuit Overturns District Court Judge Lucy Koh's Decision That Qualcomm's Licensing and Chip Sales Practices Are Antitrust Violations

The Federal Trade Commission has a history of taking positions and aggressively pursuing them, despite getting reversed (sometimes continually) by Circuit Courts (see "Reverse Payments in Generic Drug Settlements"), although occasionally finding an ally in the Supreme Court (see "Federal Trade Commission v. Actavis, Inc. (2013)"). Most recently, the FTC has waged a campaign against chipmakers involved in the cell phone industry, and their most spectacular victory was in convincing U.S. District Court Judge Lucy Koh (Northern District of California) to impose a worldwide injunction against Qualcomm. That victory was short-lived, however, with the Ninth Circuit ruling on Tuesday that Qualcomm's business practices, while aggressive did not rise to antitrust violations. (The result may have been telegraphed by the Court in granting a stay on the injunction, where it said that the "district court's order and injunction [was] either 'a trailblazing application of the antitrust laws' or 'an improper excursion beyond the outer limits of the Sherman Act.'")

As set forth in the opinion, Qualcomm has been successful in making chips used in code division multiple access ("CDMA") and premium long-term evolution ("LTE") cellular modern technology, which it sells to original equipment manufacturers (OEMs). In addition, the company licenses its cellular standard essential patents ("SEPs"), non-cellular SEPS, and non-SEPs to OEMs as well as rival chipmakers. These chips and their licensed technologies that "enable[] cellular devices to practice CDMA and premium LTE technologies and thereby communicate with each other across cellular networks"; in a footnote, the Court explains that the company has two separate divisions, its Technology Licensing arm responsible for licensing its patent portfolios and establishing licensing rates, and its CMDA Technology division that cells modem chips. These divisions distinguish Qualcomm from other companies in this space (including Nokia and Ericsson, for example) who license their SEP portfolios but don't also sell modem chips, and other chip makers (such as Samsung) who don't have SEP portfolios to license. The opinion also acknowledged that Qualcomm had "monopoly power" (90% market share) over the CMDA modem chip market between 2006-2016 and 70% market share over the LTE chip market, and accordingly charged "monopoly prices" on its chips.

According to the opinion, Qualcomm deals exclusively with OEMs, charging "a percentage of the end-product sales price," which the Court says is a "practice not unique to Qualcomm." Interestingly (perhaps as an example of the law of unintended consequences), the practice arose in response to the Supreme Court's decision on patent exhaustion in Quanta Comput., Inc. v. LG Elecs., Inc., 553 U.S. 617, 625 (2008). The rationale is that sales to suppliers of OEMs would exhaust all patent rights in the chips, and because such suppliers do not need licenses to Qualcomm's SEP and other standard portfolios the company would not be able to collect them from their OEM customers.

Qualcomm had not refused to license rival chipmakers, according to the opinion, offering them what amounts to a covenant not to sue provided that they do not sell their chips to unlicensed OEMs. Qualcomm has a "no license, no chops" policy to enforce these arrangements, refusing to sell the OEMs who do not license their SEP portfolios.

The opinion also notes that because Qualcomm is not itself an OEM, it is not in competition with OEMs; as stated in the opinion, "these OEMs are Qualcomm's customers" (emphasis in opinion), which changes how the antitrust laws are applied to Qualcomm's behavior.

As might be expected, Qualcomm's rivals complained about its business practices and the Federal Trade Commission sued, alleging violation of § 5(a) of the FTC Act, 15 U.S.C. § 45(a), and §§ 1 and 2 of the Sherman Act, 15 U.S.C. §§ 1, 2. The FTC contended that Qualcomm's business practices "unreasonably restraining trade in, and unlawfully monopolizing, the code division multiple access ("CDMA") and premium long-term evolution ("LTE") cellular modern chip markets." The District Court found that "Qualcomm's licensing practices are an unreasonable restraint of trade under § 1 of the Sherman Act and exclusionary conduct under § 2 of the Sherman Act." The District Court based its decision on "five mixed findings of fact and law" according to the opinion:

(1) Qualcomm's "no license, no chips" policy amounts to "anticompetitive conduct against OEMs" and an "anticompetitive practice[] in patent license negotiations"; (2) Qualcomm's refusal to license rival chipmakers violates both its FRAND commitments and an antitrust duty to deal under § 2 of the Sherman Act;12 (3) Qualcomm's "exclusive deals" with Apple "foreclosed a 'substantial share' of the modem chip market" in violation of both Sherman Act provisions; (4) Qualcomm's royalty rates are "unreasonably high" because they are improperly based on its market share and handset price instead of the value of its patents; and (5) Qualcomm's royalties, in conjunction with its "no license, no chips" policy, "impose an artificial and anticompetitive surcharge" on its rivals' sales, "increas[ing] the effective price of rivals' modem chips" and resulting in anticompetitive exclusivity.

Taken together, these practices "create insurmountable and artificial barriers for Qualcomm's rivals, and thus do not further competition on the merits" according to the District Court's opinion.

The Ninth Circuit vacated the District Court's judgment and reversed the permanent, worldwide injunction against Qualcomm, in a decision by Judge Callahan, joined by Circuit Court Judge Rawlinson and District Court Judge Murphy sitting by designation. The Court framed its decision on the difference between "anticompetitive behavior, which is illegal under federal antitrust law, and hypercompetitive behavior, which is not" (emphasis in opinion). After setting forth the legal predicate for antitrust violations (for example, that "[w]hereas § 1 of the Sherman Act targets concerted anticompetitive conduct, § 2 targets independent anticompetitive conduct," citing Am. Needle, Inc. v. Nat'l Football League, 560 U.S. 183 (2010) (emphasis in opinion)) the Court addressed the District Court's application of these principles to Qualcomm's business practices. Importantly in this regard, the Court stated that "novel business practices—especially in technology markets—should not be "conclusively presumed to be unreasonable and therefore illegal without elaborate inquiry as to the precise harm they have caused or the business excuse for their use," citing United States v. Microsoft Corp., 253 F.3d 34 (D.C. Cir. 2001) (emphasis in opinion), and Geoffrey A. Manne & Joshua D. Wright, Innovation and the Limits of Antitrust, 6 J. Comp. L. & Econ. 153, 167 (2010) ("Because innovation involves new products and business practices, courts['] and economists' initial understanding of these practices will skew initial likelihoods that innovation is anticompetitive and the proper subject of antitrust scrutiny"). The opinion credits the District Court with properly defining the relevant market ("the market for CDMA modem chips and the market for premium LTE modem chips") but faulted the Court for considering the impact of Qualcomm's business practices on the "much larger market of cellular services generally" which included OEMs, Qualcomm's customers rather than their competitors. Even if the District Court had properly identified "harms" to these parties, according to the opinion, these are not antitrust violations "because they do not involve restraints on trade or exclusionary conduct in 'the area of effective competition'" citing Ohio v. Am. Express Co., 138 S. Ct. 2274, 2284 (2018)). The proper relevant market, according to the opinion, was modem chip sales not Qualcomm's licensing practices with OEMs, a distinction lost on the District Court because that Court believed Qualcomm's business practices to be "interrelated." Rather than following the District Court's improper reasoning, the Ninth Circuit panel "reframe[d]" the issues to consider the effects of Qualcomm's business practices on the CMDA and LTE chip markets.

The opinion quickly dispensed with one basis for the District Court's decision, that Qualcomm owed an "antitrust duty" to license its patents to "its direct competitors in the modern chip markets" under a Supreme Court-defined exception set forth in Aspen Skiing Co. v. Aspen Highlands Skiing Corp., 472 U.S. 585 (1985). The opinion cites in this regard copious precedent to the effect than a business is under no obligation to "deal under the terms and conditions preferred by [a competitor's] rivals," quoting Pac. Bell Tel. Co. v. linkLine Commc'ns, Inc., 555 U.S. 438, 457 (2009), and can "freely []exercise his own independent discretion as to parties with whom he will deal," quoting United States v. Colgate & Co., 250 U.S. 300, 307 (1919). While recognizing the exception under the Aspen Skiing Co. case relied upon by the District Court, the panel held that this exception did not apply based on the absence of anticompetitive conduct here underlying the result in Aspen. The Ninth Circuit found clear error in the factual underpinnings of the District Court's opinion. The panel also recognized that Qualcomm's business strategy was a response to the effects on the application of the patent exhaustion doctrine occasioned by the Supreme Court's Quanta Computing decision rather than an effort to "sacrifice short-term benefits in order to obtain higher profits in the long run from the exclusion of competition" as in Aspen Skiing. And the consistency with which Qualcomm implemented its business practice, not singling out any particular competitor, was also a determinative factor for the panel in distinguishing Qualcomm's behavior from the anticompetitive behavior that resulted in the Aspen Skiing decision ("Qualcomm applies its OEM-level licensing policy equally with respect to all competitors in the modem chip markets and declines to enforce its patents against these rivals even though they practice Qualcomm's patents (royalty-free)").

The Court also rejected the FTC's "fallback" position that Qualcomm was guilty of antitrust violations under § 2 of the Sherman Act, because according to the Court the alleged anticompetitive activity was directed at Qualcomm's OEM customers rather than its competitors and was "chip-supplier neutral" because Qualcomm collects them from all OEMs that license its patents, not just "rivals' customers" (emphasis in opinion) and ignores Qualcomm's agreements wherein competitors are allowed to practice Qualcomm's patented SEPs "royalty-free" so long as they sell to licensed OEMs. Finally in this regard, the Court reminds the FTC that "to make out a § 2 violation, the anticompetitive harm identified must be to competition itself, not merely to competitors," citing Microsoft (emphasis in opinion) and the FTC had not shown any such harm.

The opinion also cites (and the panel apparently swayed by) the several amici writing in support of Qualcomm (or at least in support of reversing the District Court's decision), including retired Federal Circuit Chief Judge Paul R. Michel and former FTC Commissioner Joshua Wright.

Next the Court reaches what it termed "the district court's primary theory of anticompetitive harm: Qualcomm's imposition of an 'anticompetitive surcharge' on rival chip suppliers via its licensing ["unreasonably high"] royalty rates" that are anticompetitive because "they raise costs to OEMs, who pass the extra costs along to consumers and are forced to invest less in other handset features." The Circuit Court finds "no cogent theory of anticompetitive harm" that supports the District Court's conclusions. Indeed, the panel believes that the District Court's decision "is premised on a misunderstanding of Federal Circuit law pertaining to the calculation of patent damages, it incorrectly conflates antitrust liability and patent law liability, and it improperly considers 'anticompetitive harms to OEMs' that fall outside the relevant antitrust markets." The panel also thinks the decision also "fails as a matter of law and logic." The misunderstanding of Federal Circuit patent damages law perceived by the Ninth Circuit involves the "the patent rule of apportionment" and the smallest salable patent-practicing unit ("SSPPU"), its decision supported by LaserDynamics, Inc. v. Quanta Comput., Inc., 694 F.3d 51, 67 (Fed. Cir. 2012), and an unpublished, district court case for the proposition that "the modem chip . . . 'is the proper [SSPPU]' in a cellular handset," citing GPNE Corp. v. Apple, Inc., No. 12- CV-02885-LHK, 2014 WL 1494247, at *13 (N.D. Cal. Apr. 16, 2014) (somewhat amusingly commenting in a footnote that that case had been presided over by Judge Koh). The panel finds the District Court's analysis on this regard "fundamentally flawed" because "[n]o court has held that the SSPPU concept is a per se rule for 'reasonable royalty' calculations" but rather use it as a tool in jury cases for the benefit of the jury to avoid confusion. The panel also cite Commonwealth Sci. & Indus. Research Org. v. Cisco Sys., Inc., 809 F.3d 1295, 1303 (Fed. Cir. 2015), as evidence that the Federal Circuit itself has rejected this test as being required for assessing damages, and further that "'[t]here is nothing inherently wrong with using the market value of the entire product,'" citing Exmark Mfg. Co. Inc. v. Briggs & Stratton Power Prods. Grp., LLC, 879 F.3d 1332, 1349 (Fed. Cir. 2018). The panel also criticize the District Court and FTC for basing their characterization of the unreasonableness of Qualcomm's royalty structure on patent concepts (35 U.S.C. § 284) rather than antitrust principles. And finally on this point the panel returns to the fundamental error that the harm identified by both is to Qualcomm's customers not its competitors, which is not a sound basis for an antitrust violation.

The Ninth Circuit also found this misapplication of the harm with regard to Qualcomm's "no license, no chips" practice for the same reason -- it was directed to OEMs rather than rival chipmakers. The Court suggests the District Court's reasoning was completely backwards: it found Qualcomm to have engaged in anticompetitive business practices by making SEP licenses contingent on chip purposes under its "no license, no chips" policy. The panel states that anticompetitive behavior proscribed under the antitrust laws are the exact opposite: "[i]f Qualcomm were to refuse to license its SEPs to OEMs unless they first agreed to purchase Qualcomm's chips ("no chips, no license")." The panel explains:

This is because OEMs cannot sell their products without obtaining Qualcomm's SEP licenses, so a "no chips, no license" policy would essentially force OEMs to either purchase Qualcomm's chips or pay for both Qualcomm's and a competitor's chips (similar to the no-win situation faced by OEMs in [Caldera, Inc. v. Microsoft Corp., 87 F. Supp. 2d 1244 (D. Utah 1999)] (which the district court improperly relied upon).

The opinion closes by considering (and rejecting) the District Court's separate finding that Qualcomm violated both sections of the Sherman Act in signing an "exclusive supply" deal with Apple. While the Ninth Circuit panel found "[t]here is some merit in the district court's conclusion that the Apple agreements were structured more like exclusive dealing contracts than volume discount contracts." It did not find the requisite "actual or practical effect of substantially foreclosing competition in the CDMA modem chip market" required for this conduct to rise to an antitrust violation based on the facts regarding this deal adduced at trial (and indeed there was evidence to the contrary, inter alia, that Intel successfully competed with Qualcomm in supplying chips to Apple within one year of the objected-to Apple-Qualcomm supply agreement), and on this basis vacated the injunction imposed by the District Court.

The opinion concludes:

Anticompetitive behavior is illegal under federal antitrust law. Hypercompetitive behavior is not. Qualcomm has exercised market dominance in the 3G and 4G cellular modem chip markets for many years, and its business practices have played a powerful and disruptive role in those markets, as well as in the broader cellular services and technology markets. The company has asserted its economic muscle "with vigor, imagination, devotion, and ingenuity." [United States v. Topco Assocs., Inc., 405 U.S. 596, 610 (1972)]. It has also "acted with sharp elbows—as businesses often do." Tension Envelope Corp. v. JBM Envelope Co., 876 F.3d 1112, 1122 (8th Cir. 2017). Our job is not to condone or punish Qualcomm for its success, but rather to assess whether the FTC has met its burden under the rule of reason to show that Qualcomm's practices have crossed the line to "conduct which unfairly tends to destroy competition itself." [Spectrum Sports, Inc. v. McQuillan, 506 U.S. 447, 458 (1993)]. We conclude that the FTC has not met its burden.

No doubt Qualcomm is gratified by this decision. Experience and history show, however, that the FTC is persistent, and it is not unlikely that it will continue to press its case, either before the Supreme Court or though other agency action.