Federal Court Criticizes Qualcomm Licensing Methods for SEP Patents, Finds Antitrust Violations

Tuesday, May 28, 2019

On May 21, 2019, the U.S. District Court for the Northern District of California entered a decision in a Federal Trade Commission action alleging that Qualcomm’s approach to wireless Standard Essential Patent licensing violated antitrust laws.  FTC v. Qualcomm, Inc., Case No. 17-CV-00220-LHK (N.D. Cal. May 21, 2019). In a 233-page opinion, District Judge Lucy H. Koh ruled that Qualcomm acted with “anticompetitive malice” in its licensing tactics. The Court entered an injunction requiring Qualcomm to renegotiate its current license agreements and prohibiting future anticompetitive licensing practices.

 

Background:

The FTC filed suit against Qualcomm in 2017 alleging that its licensing practices violated the FTC Act, which prohibits “[u]nfair methods of competition in or affecting commerce.” 15 U.S.C. § 45(a). Before its final opinion issued May 21st, the court  ruled on summary judgment that Qualcomm had committed to license its modem chip patents on fair, reasonable, and nondiscriminatory terms (“FRAND”) to other chip manufacturers, including Qualcomm competitors. The subsequently held a ten-day trial in January, 2019, and released its findings this week.

 

Rulings:

The district court ruled that Qualcomm violated the FTC Act by engaging in conduct that violated the Sherman Act. The court found that Qualcomm had market power in the markets for CDMA modem chips and premium LTE modem chips. Among other things, Qualcomm sold its chips at prices that were much higher that comparable communications chips. In addition, the court found that from 2014 to 2016, Qualcomm held at least a 96% share of the worldwide CDMA modem chip market. In the Premium LTE chip market, Qualcomm held an 89% share in 2014 and an 85% share of the market in 2015.

The Court found that Qualcomm engaged in a number of anticompetitive licensing practices. First, it refused to sell modem chips, or even to provide sample chips, unless the purchaser signed a patent license agreement. The agreement had terms which prevented a sale of the chips to exhaust Qualcomm’s patent rights. “Specifically, Qualcomm threatens to withhold OEMs’ chip supply until OEMs sign patent license agreements on Qualcomm’s preferred terms. In some cases, Qualcomm has even cut off OEMs’ chip supply, although the threat of cutting off chip supply has been more than sufficient to coerce OEMs into signing Qualcomm’s patent license agreements and avoiding the devastating loss of chip supply.” Slip op. at 44.

Second, the court found that Qualcomm acted in a manner to create a monopoly by threatening to cut off OEM access to Qualcomm chips. Since the OEMs lacked a viable secondary source of modem chips, the prospect of losing access to Qualcomm chips put tremendous pressure on OEMs to accept terms dictated by Qualcomm. The court summarized by finding that “Qualcomm has engaged in extensive anticompetitive conduct against OEMs. In practices that are unique within Qualcomm and unique in the industry, Qualcomm refuses to sell its modem chips exhaustively and to sell modem chips to an OEM until the OEM signs a separate patent license agreement. To enforce those licensing practices, Qualcomm has cut off OEMs’ chip supply, threatened OEMs’ chip supply, withheld sample chips, delayed software and threatened to require the return of software, withheld technical support, and refused to share patent claim charts or patent lists.” Slip op. at 113.

Third, the court found that Qualcomm engaged in anticompetitive conduct by refusing to extend licenses to rival modem chip manufacturers, including Intel and Broadcom. The refusals delayed the introduction of competing modem chips and, in some cases, prevented the introduction of competing chips in the marketplace. The court concluded that “Qualcomm’s refusal to license has prevented rivals’ entry, impeded rivals’ ability to sell modem chips externally or at all, promoted rivals’ exit, and delayed rivals’ entry. Qualcomm’s refusal to license rivals has further limited OEMs’ chip supply options, which has enabled Qualcomm’s anticompetitive conduct toward OEMs, sustained Qualcomm’s unreasonably high royalty rates, and required OEMs to spend more money on royalty payments to Qualcomm rather than on new technology and product development for consumers.” The court noted that Qualcomm originally licensed other chip manufacturers under its own understanding that its FRAND obligations required it to do so. “Qualcomm stopped licensing rival modem chip suppliers not because Qualcomm’s view of FRAND changed, but rather because Qualcomm determined that it was far more lucrative to license only OEMs.” Slip op. at 128.

In addition, the court found that Qualcomm acted in an anticompetitive manner by entering into agreements that effectively created exclusive supply arrangement with OEMs. In some cases, this included substantial rebates, funded by high royalty rates, that were subject to clawbacks in the event that an OEM purchased modem chips from another source.

The court concluded that “Qualcomm leverages its monopoly chip supply and engages in a host of anticompetitive practices to avoid exhaustion and ensure that OEMs acquiesce to Qualcomm’s license demands. For example, Qualcomm cuts off chip supply, threatens to cut off chip supply, threatens to withhold engineering support, and delays and threatens to take back software, among other tactics—all to coerce an OEM into signing a Qualcomm license agreement before purchasing modem chips, unlike any other component supplier in the industry.” Slip op. at 164-65.

Finally, the court ruled that Qualcomm’s royalty rates, based on the value of the smartphone handset, rather that the modem chips, was unwarranted. First, the approach ignored other valuable features in the smartphone. Second, it violated the Federal Circuit’s law requiring apportionment of value between patented and non-patent features of a product. Under that law, “[a] patentee is only entitled to a reasonable royalty attributable to the infringing features.” Power Integrations, Inc. v. Fairchild Semiconductor Int’l, Inc., 904 F.3d 965, 977 (Fed. Cir. 2018). Third, the royalty did not reflect the value that Qualcomm’s patents contributed to the standard. “Qualcomm has sustained by far the highest royalty rates of any cellular patent holder despite its declining SEP share with successive standards and the expiration of its patents.” Slip op. at 175.

The court concluded that “Here, Qualcomm’s interrelated practices create insurmountable and artificial barriers for Qualcomm’s rivals, and thus do not further competition on the merits. Qualcomm’s practices all reduce rivals’ sales. Qualcomm’s chip incentive funds for OEMs lower the effective price of Qualcomm’s modem chips, result in exclusivity, and restrict the OEM customer base available to Qualcomm’s rivals. . . .  The surcharge on rivals’ modem chips imposed by Qualcomm’s unreasonably high royalty rates increases the cost of rivals’ chips, which reduces demand for rivals’ chips and reduces rivals’ margins. By attacking all facets of rivals’ businesses and preventing competition on the merits, these practices “harm the competitive process and thereby harm consumers.” Slip op at 194-95.

The court found that Qualcomm was aware of its anticompetitive practices. “Qualcomm’s own documents show that Qualcomm knew its licensing practices could lead to antitrust liability, knew its licensing practices violate FRAND, and knew its licensing practices harm competition, yet continued anyway—even in the face of government investigations in Japan, Korea, Taiwan, China, the European Union, and the United States.” Slip op. at 208.

The court then granted the FTC’s request for a permanent injunction against future anticompetitive actions by Qualcomm.  The court noted that Qualcomm’s activities are continuing and threaten to affect the market for 5G compliant modem chips. It entered an injunction stating that “Qualcomm must not condition the supply of modem chips on a customer’s patent license status and Qualcomm must negotiate or renegotiate license terms with customers in good faith under conditions free from the threat of lack of access to or discriminatory provision of modem chip supply or associated technical support or access to software.” In addition, the court ordered that “Qualcomm must make exhaustive SEP licenses available to modem-chip suppliers on fair, reasonable, and non-discriminatory (“FRAND”) terms and to submit, as necessary, to arbitral or judicial dispute resolution to determine such terms.” In addition, the court ordered that Qualcomm “may not enter express or de facto exclusive dealing agreements for the supply of modem chips.” Finally, the Court ordered Qualcomm to submit compliance reports to the FTC for the next seven years.

 

Practical Significance:

The impact of this decision is much broader than Qualcomm’s licensing practices.  Over the last 10 years, Qualcomm’s over-priced SEP licensing model has given rise to an entire SEP-licensing industry in which SEP owners charge adopters of public telecommunications standards exorbitant licensing rates divorced from (1) the owners’ FRAND obligations, (2) the footprint of their respective patents with respect to the at-issue chipsets, and (3) their relative patent share as compared to the many other SEP owners for a given standard.

In many cases, SEP owners demand high royalties without identifying the relevant patents or providing claim charts.  And, the SEP owners typically make their licensing demands only at the retail end of the supply chain – where the least is known about the low-level modem technology to which the patents are directed.  This misalignment between the SEP owner-licensors (chip level) and the demanded licensees (OEM/retail level) makes it difficult, if not impossible, for the would-be licensee to determine for itself which patents are relevant, and which are not.  The SEP owners naturally assert that all of their patents are relevant, driving the demanded royalty rate higher.

These improper licensing practices transcend the wireless SEP licensing industry.

The FTC decision is important because it addresses many of these issues – providing important guidance for the other SEP owners and potential licensees.

The opinion requires truly FRAND licensing with a clear opportunity for dispute resolution.  It obligates SEP owners to respect and undertake apportionment, i.e., an obligation to demand a royalty that is limited to the innovation claimed in the at-issue patents.  The decision requires SEP owners to offer licenses upstream in the supply chain at the point where (1) the technology first enters the supply chain, and (2) the price is more closely tethered to the chipset which practices the patents.  This will provide more alignment of knowledge and pricing vis-à-vis the patented invention, ultimately leading to more fair and reasonable license fees.

The FTC decision does not, however, address the royalty stacking problem that often arises from the fact that tens of thousands of SEPs owned by many different companies.  Over 70,000 patents are self-declared “standard essential” for the 4G/LTE standard alone.  While the FTC decision squarely addresses the licensing negotiation between a licensor and licensee, such as Qualcomm and its customers, the decision provides little guidance for the typical licensee who receives licensing demands from many different SEP owners.  Collectively, the license fees demanded from the active SEP owners often dwarf the price and value of the underlying wireless chipset.  The FTC decision may mitigate the royalty stacking problem on a per-license basis, but the problem remains as a collective and disproportionately high burden in addition to the cost of the chipset itself.