7 FTC V. Qualcomm: The Balance Between Patents And Antitrust
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FTC V. Qualcomm: The Balance Between Patents And Antitrust

Authored by Derek F. Dahlgren and Spencer J. Johnson for Law360

August 22, 2017

In January of this year, the Federal Trade Commission brought suit against Qualcomm Inc. in the Northern District of California. The FTC is alleging that Qualcomm used its position as a dominant supplier of certain cellphone components, and its patent portfolio covering standards used in cellphones, together in a manner that constituted unfair methods of competition.

Qualcomm moved to dismiss the suit in April, noting that a strong dissent was issued to the FTC vote to file the complaint, and arguing that the FTC had failed to properly allege facts sufficient to support the claims in its complaint. In May, the FTC opposed the motion, and amicus curiae briefs were filed by four parties in support of the FTC, including by Samsung Electronics Co. Ltd. and Intel Corp. Qualcomm’s motion was denied by Judge Lucy Koh on June 26, 2017, and the discovery phase of the case is currently ongoing.

As acknowledged in Judge Koh’s order denying Qualcomm’s motion to dismiss, this case is fundamentally quite complicated, touching on such concepts as standard-essential patents, and requiring a certain level of knowledge of cellular communication standards, the cellphone components that allow cellular communication, and the markets for those components, for cellphone manufacture, and of cellular service providers in the United States. At the risk of almost certainly oversimplifying the technical and legal issues underlying this case, a brief summary of these topics (as based on the FTC’s allegations) are presented below.

At its core, this case is based on issues related to cellular communication technology. Different cellular networks operate on different standards, such as LTE, UMTS, GSM or CDMA. Industry members such as Qualcomm and many others are involved in developing these standards, and as a result of work during or prior to the development of the standards, many patents are issued which are implicated when in compliance with the standard. Because having too many patents in too many different hands covering the standards could render them de facto unusable as a result of the hold-out problem, the involved parties such as Qualcomm commit to standards organizations to disclose the patents they own essential to the standard and to license them to applicants on fair, reasonable and nondiscriminatory terms.

Cellular networks support one or more of these standards. Some standards are used by different service providers. For example, Sprint and Verizon use CDMA, while AT&T uses UMTS. Other standards are used across these providers’ networks, such as LTE. In order for mobile devices to operate with the network, the device must contain a modem or “baseband processor” which complies with the network’s supported standards.

Finally getting to the core of the FTC’s case, Qualcomm was both heavily involved with the development of some of these standards and is also a major manufacturer of the processors complying with certain of those standards. For example, Qualcomm is the dominant supplier of both CDMA processors and premium LTE processors, having exceeded 80 percent of sales for both processor types worldwide. Similarly, Qualcomm held a share of essential patents for the 2G-CDMA, 3G-CDMA, 3G-UMTS, and LTE standards.

As an owner of SEPs, Qualcomm receives license fees from manufacturers for the use of those standards, but it must also license to the manufacturers under FRAND terms. Although it is not the goal of this article to get deeply into the merits of this case, one arm of the FTC’s allegations is based on Qualcomm’s policy of not selling their processors to those who have not also bought a license to their patents. This leads to manufacturers paying larger fees to Qualcomm than to other standard-essential patent holders based on the proportion of essential patents held for the relevant standards. This is allegedly because manufacturers are unable to negotiate a lower rate with Qualcomm because of its dominance in the supply of CDMA and premium LTE processors. The FTC alleged that manufacturers would fear that if they did not accept Qualcomm’s proposed license, which is essentially the same across manufacturers, they would run the risk of being unable to obtain CDMA or premium LTE processors, and thus be foreclosed from selling cell phones which would operate on those networks. In other words, any negotiations with Qualcomm would not truly be under FRAND terms.

Qualcomm’s position held outside of the court has largely been to defend its practices rather than to deny the accusations, while also stating that the FTC’s case was unnecessary, would harm innovation, and would undermine U.S. intellectual property rights around the world. Statements by Qualcomm executives have included that “Qualcomm has been the leader in innovation and invention in the mobile industry for more than 30 years,” and that its technological contributions and business practices had led to high levels of innovation and competition in the mobile technology industry. However, the FTC’s own description of the case in their complaint is that Qualcomm has engaged in conduct that “reduces competitors’ ability and incentive to innovate.” Further, in the context of the motion to dismiss, Judge Koh’s order amounts to agreeing that Qualcomm’s behavior, as alleged by the FTC, would amount to anti-competitive behavior if true.

Outside of the legal merits of the case, both sides claim that a result in favor of the other harms innovation. This situation is not unusual in patent cases, especially in situations such as this, where anti-competitive behavior is alleged.

To break down this conflict requires an analysis of the various interests at a more basic level. As enshrined in the Constitution, Congress is given the power to grant limited monopolies to inventors in order to “promote the Progress of Science and useful Arts.” This power is, of course, manifested in the patent system, where inventors are incentivized to innovate and disclose their inventions in return for allowing them to exclude others from using the disclosed invention for a limited time.

The scope of this exclusion is limited in many ways other than time, such as by the exhaustion doctrine, which limits a patent owner’s exclusionary rights and control after it has sold an embodiment of its patented invention. These limits are exemplified in the U.S. Supreme Court’s recent decision in Impression Products Inc. v. Lexmark International Inc., which held that attempted post-sale restrictions by a patent owner were not allowed, and that neither geographical or other types of license-based limitations could work around that. In that case, allowing purchasers of products, whose sales were authorized by a patent holder, to do what they wished with the product afterwards was considered to be more valuable than allowing the patent owner to control the product after the sale. Other limitations on the exclusionary rights include classic concepts of equity, where questions related to public interest are allowed to influence an outcome.

In the case of standards, the balance has been struck in the current standard-setting ecosystem that the owners of SEPs are still able to benefit greatly from their patents by receiving licensing fees from a broader base of licensors, and in exchange the owners are obligated to license the patents to anyone. As such, those participants whose patents have become part of a standard must negotiate fairly with those seeking licenses. By having all industry participants playing by these same rules, distribution of the high development costs of new technology standards are incentivized, and technology progresses in a clear and demonstrable way (as anyone who has used cellular data over the last 10 years can attest).

By having a patent be declared essential to a new standard, the royalty base for which that patent can earn licensing fees becomes greatly expanded. The trade-off is being subject to FRAND rules when licensing the patent. As such, standards organizations and industry groups have attempted to strike a balance between rewarding individual patent holders for their contributions while preventing hold-out problems that would render a standard unusable. In an ideal form then, an interested manufacturer could use the standard by paying reasonable fees to the patent holders, and the owner of each patent essential to a standard would then be compensated proportionately to the value of their contributions.

Although Qualcomm’s position is that a decision that its licensing practices are anti-competitive would harm innovation (that is, would lessen their reward for being innovators), its practices use its power as a manufacturer to influence the market in a way that could truly have a widespread impact on innovation. For example, the license that Qualcomm uses is a flat 5 percent royalty based on the final product price. This alone results in greater licensing revenue than the sum of several companies, despite Qualcomm’s share of patents essential to LTE standards being roughly equal to several other companies such as Nokia, Ericsson and Samsung. By taking a greater-than-proportionate share of licensing fees, this arguably disincentivizes other companies from making investments toward innovations that would end up incorporated into new standards.

While these disproportionately high license revenues skew the market in Qualcomm’s favor, other terms such as requiring cross-licensing of the other company’s patents may further disincentivize investment. Qualcomm’s cross-licensing requirements are alleged to not result in any adjustment of the royalty rate which it demands. This does little to recognize the contributions of other companies. Notably, in a study of LTE SEPs, Qualcomm was found to have 13 percent of the “highly novel” essential patents, compared to other leading companies at 19 percent or 12 percent. Thus, Qualcomm may be a major contributor to the technology behind the standard, but certainly is not the sole responsible party. In other words, these standards would not be able to be developed from Qualcomm’s contributions alone.

However, Qualcomm’s licensing practices do not seem to recognize these other contributions. Its licensing practices instead devalue the innovation of the other major contributing companies by not offsetting the demanded royalties against that company’s relative contribution. In essence, a company with a high level of contribution is treated the same as a company that might not have contributed to the development of the standard at all. Where the FRAND rules were intended to prevent the hold-out problem, Qualcomm’s practices instead encourage the free-rider problem when other innovators are essentially given nothing for their efforts by Qualcomm.

Qualcomm’s own statement that they have been “the leader in innovation and invention” in the mobile industry may have inadvertently revealed a core issue underlying how both sides can claim progress toward “innovation” as being on their side. Qualcomm is a major player, and its market position gives it enough power to dictate terms to others in the mobile technology industry. It is not, however, the only player, and its contributions alone would not have enabled mobile technology to develop to the point that it has today. By virtue of having the power to dictate terms, Qualcomm may have used that power without concern as to how its actions affect investment and innovation by others, putting the entire standard-setting ecosystem at risk.

Trade commissions in Korea, Japan, China, Taiwan and now the United States have investigated or are investigating Qualcomm. The wide interest into looking into Qualcomm’s actions belies the statements by Qualcomm executives that the field of mobile technology has such high levels of innovation and competition that it is “difficult to understand why the FTC decided to act in this case.” The FTC’s decision to act now stands supported by the survival of the case through the motion to dismiss. While the FTC’s allegations still must be adequately supported and ultimately proven, Judge Koh saw enough in the complaint to support the FTC’s claims should the FTC be successful in proving its allegations. In the process, Judge Koh may have helped to preserve the balance of innovation incentives underlying the standards system.

This article was originally published in Law360's Expert Analysis section on August 22, 2017. To read the article on Law360's site, please visit: https://www.law360.com/articles/956396/ftc-v-qualcomm-the-balance-between-patents-and-antitrust.