The line between anticompetitive behavior and hypercompetitive behavior

On Aug. 11, the 9th U.S. Circuit Court of Appeals handed a big victory to Qualcomm, Inc., reversing the district court's judgment that Qualcomm unreasonably restrained trade in, and unlawfully monopolized, certain modem chip markets, in violation of Sections 1 and 2 of the Sherman Act. In reversing the judgment, the 9th Circuit also vacated the lower court's permanent, nationwide injunction prohibiting several of Qualcomm's core business practices. Federal Trade Commission v. Qualcomm, Inc., 2020 DJDAR 8430.

To understand the legal reasoning behind the 9th Circuit's decision, it is important to first understand -- at least in general terms -- Qualcomm's business model and the modem chip market in modern cellular systems.

Background

To ensure that cellular products from different manufacturers are compatible with each other, international standard-setting organizations, or SSOs, choose certain technologies to include in the technical standards that are used or "practiced" (patent term) across each new generation of cellular technology. Qualcomm owns patents on some of those technologies. Because patent holders could prevent other industry participants from implementing those technical standards if the patent holders selectively refused to license their patents, SSOs require patent holders to commit to license their patents on fair, reasonable and nondiscriminatory terms before those patents are incorporated into the industry standards.

Cellular modem chips are the hardware that enable cellular devices to practice these patented technologies and thereby communicate with each other across cellular networks. Qualcomm manufactures and sells these chips, too.

Qualcomm does not license its patents to other chip manufacturers. Instead, Qualcomm licenses its patents to original equipment manufacturers, or OEMs, whose products (end products such as cellphones) practice one or more of Qualcomm's patented technologies. However, because rival chip manufacturers practice many of Qualcomm's patents (by necessity), Qualcomm enters into agreements with these rivals wherein Qualcomm promises not to assert its patents against them (effectively allowing its rivals to practice Qualcomm's patents royalty-free) in exchange for a promise by the rival manufacturers not to sell chips to OEMs that have not licensed Qualcomm's patents. This is known as Qualcomm's "no license, no chips" policy because OEMs cannot purchase a chip that practices Qualcomm's patents -- regardless of who manufactured the chip -- if the OEM does not have a license agreement with Qualcomm.

Qualcomm's competitors in the modem chip markets contend that Qualcomm's business practices, in particular its refusal to license them, have hampered or slowed their ability to develop and retain OEM customer bases, limited their growth, delayed or prevented their entry into the market, and in some cases forced them out of the market entirely.

In 2019, following a 10-day bench trial, the U.S. District Court for the Northern District of California concluded that Qualcomm's licensing practices constitute an unreasonable restraint of trade under Section 1 of the Sherman Act and exclusionary conduct under Section 2 in the modem chip markets. See Fed. Trade Comm. v. Qualcomm, Inc., 411 F. Supp. 3d 658 (N.D. Cal. 2019). The court found, among other things, that (i) Qualcomm's refusal to license rival chipmakers violated both an antitrust "duty to deal" and its SSO contractual obligations; (ii) Qualcomm's royalty (i.e., license) rates were unreasonably high; and (iii) Qualcomm's royalties, in conjunction with its "no license, no chips" policy, imposed an anticompetitive surcharge on its rivals' sales, thus increasing the effective price of rivals' modem chips.

The 9th Circuit Reverses

The 9th Circuit reversed the district court's judgment in its entirety.

First, the court held that neither the antitrust laws nor Qualcomm's SSO commitments required it to license its patents to rival chipmakers. With respect to the antitrust laws, the court explained that the Sherman Act generally "does not restrict the long recognized right of a trader or manufacturer ... to exercise his own independent discretion as to parties with whom he will deal." The U.S. Supreme Court has recognized only one limited exception to that rule, whereby the antitrust laws force parties to deal with competitors when three conditions are met: (i) the company unilaterally terminates a voluntary and profitable course of dealing; (ii) the only conceivable rationale or purpose 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. Here, the 9th Circuit held that the FTC failed to establish any of those three conditions. First, the FTC offered no evidence that Qualcomm formerly provided exhaustive licenses to chipmakers; thus, Qualcomm did not terminate a voluntary and profitable course of dealing. Second, Qualcomm licensed OEMs instead of rival chipmakers -- not to sacrifice short-term benefits for the prospect of higher profits down the road, but to obtain higher profits at all times. The record was clear that licensing OEMs instead of rival chipmakers is simply more profitable. Third, there was no evidence that Qualcomm singled out any specific chip supplier for anticompetitive treatment; its policy of licensing only OEMs applied across the board to every chipmaker.

With respect to Qualcomm allegedly violating its SSO commitments by not licensing rival chipmakers, the court declined to decide whether those contracts require Qualcomm to offer those licenses. Rather, the court reasoned, even if Qualcomm violated its contractual obligation, there was no evidence that such breach impaired competition, as necessary to impose antitrust -- as opposed to contractual -- liability. The court noted that Qualcomm permits its rivals to build chips that utilize Qualcomm's patented technology without paying Qualcomm any royalties. Moreover, the record showed that multiple additional chip manufacturers entered the modem chip market even while Qualcomm refused to license them, undermining the FTC's assertion that Qualcomm's refusal to license other manufacturers stifled competition in the relevant market. The court also expressed hesitance to use the antitrust laws to impose liability in what it deemed was more properly characterized as a dispute that arises under contract and patent law.

Second, the 9th Circuit rejected the district court's finding that Qualcomm's royalty rates were anticompetitive because they were "unreasonable." The court reasoned that the FTC's theory and the district court's holding that patent royalties must "precisely reflect a patent's current, intrinsic value and be in line with the rates other companies charge" -- a theory the court declined to adopt -- was a theory of patent law, not a basis to impose antitrust liability. Further, any harm based on purportedly unreasonable royalty rates was suffered, not by rival chipmakers, but by OEMs, which are Qualcomm's customers rather than competitors. Thus, the reasonableness of the rates did not affect competition in the relevant market.

The court also rejected the FTC's argument that Qualcomm's royalty rates imposed an anticompetitive surcharge on its rivals' sales because Qualcomm was able to charge "ultralow" prices on its own modem chips and thereby push out rivals by squeezing their profit margins. The court explained that the Supreme Court has already rejected this "margin squeeze" theory as a basis for antitrust liability and, in any event, the FTC did not offer any evidence that Qualcomm engaged in predatory (i.e., "ultralow") pricing. This was not surprising, given that it's the FTC's antitrust theory was based on Qualcomm charging monopoly (i.e., above-market) prices.

Third, the court held that Qualcomm's "no license, no chips" policy did not give rise to antitrust liability. The court explained that the district court had treated this policy as though Qualcomm was conditioning a license for its patented technology on an OEM buying Qualcomm's chips. The policy, however, is the reverse. An OEM can buy a chip from any manufacturer, but if the chip practices Qualcomm's patent -- regardless of who the manufacturer is -- then the OEM must first obtain a license. Thus, the policy is "chip neutral"; it does not prefer one chip manufacturer over another.

The 9th Circuit characterized its decision as "draw[ing] the line between anticompetitive behavior, which is illegal under federal antitrust law, and hypercompetitive behavior, which is not." In so doing, the court also helped delineate the contours between which types of conduct are properly policed by the antitrust laws, and which are more properly regulated under other regimes, such as contract and patent law. One thing is certain: The court's decision will have significant implications going forward for patent holders in the cellular technology arena.

The FTC has not yet said whether it will seek en banc review at the 9th Circuit or petition the Supreme Court for certiorari. 