Qualcomm loses the battle, but not yet the war as appeal looms

Key aspects of a federal court decision that Qualcomm’s patent-licensing practices violate the law rest on controversial antitrust and patent precedents, opening obvious avenues of appeal for the chipmaker.

US District Judge Lucy Koh released her decision late Tuesday, siding with the Federal Trade Commission, which had sued Qualcomm for antitrust violations. In her decision, Koh said Qualcomm’s practice of refusing to sell chips unless phonemakers agreed to patent licenses favorable to Qualcomm violated the law and was one of several ways the chipmaker kept potential rivals such as Intel and Mediatek from gaining a foothold in the market.

"In combination, Qualcomm’s licensing practices have strangled competition in the CDMA and premium LTE modem chip markets for years, and harmed rivals, [device makers], and end consumers in the process,” Koh said. “Qualcomm's conduct 'unfairly tends to destroy competition itself.'”

The fate of Qualcomm’s current business model may ultimately be determined by three judges on the US Court of Appeals for the Ninth Circuit, and whether they agree with Koh’s application of a controversial Supreme Court decision from the 1980s that held a company can be required to do business with a rival if it controls an 'essential facility' that competitors need to be able to compete.

In a statement Wednesday, Qualcomm said it “strongly disagrees with the judge’s conclusions,” and would seek a stay of the injunction requiring it to renegotiate its patent licenses.

Koh’s decision was issued at 11:25 pm San Francisco time on Tuesday. By market close Wednesday, Qualcomm’s stock had dropped 10.86 percent.

Speaking at an event* in California today, Bruce Hoffman, who heads the FTC’s Bureau of Competition, said the case was a “straightforward raising rivals’ costs theory.”

"This is not a case saying that antitrust requires some specific rate for licensing intellectual property. This is not a case in which we say the ‘fair, reasonable and non-discriminatory’ commitment that some standard-setting organizations require of participants dictates some particular price for that, or that we are in the business of setting royalty rates,” Hoffman said. “This is a raising rivals' cost theory. It’s not a theory about what Frand means in some objective sense or about rate regulation by the FTC.”

Trial evidence

Much of Koh’s decision rests on two pivotal pieces of evidence from the one-month trial earlier this year.

One was the admission of Qualcomm’s co-founder, Irwin Jacobs, on the witness stand Jan. 15 that Qualcomm hadn’t just threatened to cut off, but had actually stopped the supply of modem chips to a phone maker, LG Electronics, in 2004. Previously in the trial, Qualcomm executives had refused to say they had gone beyond threats to actually block the supply of chips to a phone maker.

But perhaps even more damning in Koh’s eyes was a taped meeting between a group of Qualcomm executives and the US Internal Revenue Service in 2012, when the Qualcomm officials told the IRS the company stopped licensing its standard-essential patents to rival chipmakers, and was only licensing to smartphone makers based on the price of a full smartphone. Doing so, Qualcomm executives told the IRS, was “humongously more lucrative.”

Qualcomm told the IRS that it was able to grow its royalties from 30 cents per unit when it was licensing based on the value of its chips in 1999, to a $20 royalty payment per chip Qualcomm could get when it demanded a 5 percent royalty rate on a $400 smartphone, Koh noted.

Over and over in the course of the order, the judge returned to the statements that Qualcomm executives made to the IRS, finding that their statements to the taxman were more credible than their testimony in her San Jose courtroom. She said the testimony of Qualcomm CEO Steve Mollenkopf and James Thompson, its chief technology officer, both “lacked credibility.”

“Thus, when the IRS asked whether Qualcomm’s decision to stop licensing its SEPs to rivals was a ‘business decision,’ [Qualcomm executive] Marv Blecker agreed: ‘Oh it’s more than that, it’s more than that. That’s an understatement,’ ” Koh wrote in the order. “Blecker told the IRS that to license rivals would have ‘the potential of threatening our entire revenue stream at the handset level.’ ”

That evidence helped seal Koh’s conclusion that Qualcomm had violated the Sherman Act by sacrificing short-term profits in favor of anticompetitive behavior that would allow it to make much bigger profits.

“Qualcomm’s contemporaneous documents and recorded statements to the IRS indicate that Qualcomm’s refusal to license rivals is characterized by a ‘willingness to sacrifice short-term benefits’—like profitable licenses from modem chip rivals—'in order to obtain higher profits in the long run from the exclusion of competition’ to QCT, Qualcomm’s modem chip business,” Koh wrote.

A second key moment in the trial was Jacobs’ testimony. Qualcomm had called the venerated co-founder to describe Qualcomm’s innovative development of wireless CDMA technology in the 1980s. But that exposed Jacobs to an aggressive cross-examination by FTC lawyer Dan Matheson.

"Anybody who says Qualcomm has never cut off a chip shipment is wrong, according to what you just said. Isn't that right?" the FTC lawyer asked Jacobs.

Jacobs ultimately acknowledged during that cross examination that a cut-off of supply to LG did happen. “We did not ship to them the chips that were specified here, the 500 and then 6,000 chips as far as I know at this time,” he testified.

Throughout the trial, Qualcomm lawyers had said the company never actually cut off the supply of chips, but the FTC's antitrust allegations focus on the years 2006-16, and focus on CDMA chips, not the older WCDMA chips Qualcomm was selling to LG in 2004.

Jacobs’ bombshell admission prompted Koh to conclude that by cutting off chip supplies, Qualcomm had made it impossible for phone-makers to use arbitration or litigation to decide royalty disputes. The inability to sue or seek arbitration was crucial to allowing Qualcomm to collect royalty rates on its SEPs that weren't fair and reasonable, she concluded.

“Because Qualcomm threatened to cut off and actually did cut off OEMs’ chip supply and threatened to revoke technical support and software from OEMs, arbitration — even if technically available — was not a realistic path for an OEM. Accordingly, Qualcomm’s monopoly chip power leads to unreasonably high royalty rates by eliminating the prospect of FRAND litigation or arbitration,” Koh wrote in yesterday's order.

While Koh said Qualcomm’s royalty rates — which are about 5 percent — are too high, she didn’t specifically say what a more appropriate rate would be. In her decision, though, she quoted the FTC’s patent valuation expert, Michael Lasinski, who said the rate should be closer to 0.58 percent.

Apple, Intel and the Department of Justice declined to comment on the ruling.

Legal conclusions

Qualcomm immediately said it plans to appeal Koh’s decision to the US Court of Appeals for the Ninth Circuit.

At least two legal conclusions in Koh’s ruling are likely avenues for challenge. The judge ruled that Qualcomm has a legal duty to license its patents to rivals. To reach that conclusion, Koh cited a controversial 1985 Supreme Court decision, Aspen Skiing v. Aspen Highlands Skiing. The high court held that a company can be required to do business with a rival if it is deemed to control an 'essential facility' without access to which it is impossible for competitors to compete. That holding, which the court itself said was "at or near the outer boundary of" US antitrust laws, has never been applied to refusals to license intellectual property.

The Supreme Court sought to pull back on Aspen Skiing some in its 2004 decision in Verizon v. Trinko. In that case, the high court said there is “no duty to aid competitors,” calling Aspen Skiing a “‘limited exception’ to the rule that there is no duty to deal under the antitrust laws.’”

In her decision, Koh laid out why, in her view, Qualcomm’s situation was closer to Aspen Skiing than Trinko. She noted that Qualcomm had previously licensed to its rivals, but stopped doing so even though it was profitable because of “anticompetitive malice.”

Another aspect of Koh’s decision likely to be raised on appeal involves a ruling by the US’s top patent court related to “smallest salable unit.” In several cases over the past 10 years, the US Court of Appeals for the Federal Circuit has ruled on how patent damages should be calculated in cases that involve a device with several components or that involve standards. Koh cited two of those decisions to find that Qualcomm isn’t entitled to a royalty based on the price of a handset and should instead calculate royalties based on smaller components within the device.

Each of the cases in which the Federal Circuit has applied the "smallest salable unit" rule involve damages calculations during jury trials. Koh’s ruling didn’t address a 2016 decision, which addressed the use of the smallest salable unit rule in the context of standard-essential patents and said applying it in every case was “untenable”. No court has ever before ruled that a company must base its patent licenses on the smallest salable unit.

In her decision, Koh criticized Nokia and Ericsson for “imitating” Qualcomm’s practice of licensing at the device level rather than the component level. Nokia, in particular, came in for admonishment. Koh noted that Nokia told the European Commission in 2006 that Qualcomm had an “unequivocal” commitment to license to rival chipmakers, but then Nokia’s head of standards, Dirk Weiler, seemed to walk that back.

“Despite opining about how the entire industry licenses modem chip SEPs, Weiler conveniently claimed complete ignorance about the specific licenses and licensing discussions of Weiler’s employer, Nokia,” Koh wrote. “Thus, Weiler was unable to answer any questions about whether Nokia had licensed its SEPs to modem chip suppliers.”

Koh said she found Weiler’s testimony “not credible.”

Still, despite the harsh words, nothing in Koh’s decision at this point is likely to negatively impact other large patent holders like Nokia, Ericsson and Interdigital. Koh found Qualcomm’s commitments to two standards bodies — the Alliance for Telecommunications Industry Solutions and the Telecommunications Industry Association — require the chipmaker to license to rivals. But her decision didn’t address the biggest standards group, European Telecommunications Standards Institute, or ETSI.

Koh also gave short-shrift to the US Department of Justice, which submitted a statement this month urging her to hold a hearing before imposing a remedy. The DOJ’s request relied heavily on the Microsoft case, Koh said, in which the requested remedy was a divestiture and the parties had several factual disputes.

“The United States identifies no such disagreements or circumstances in this case. Therefore, the Court declines to hold an evidentiary hearing on the question of remedy,” Koh said.

While Koh’s ruling isn't the last word in the US, it may have important implications abroad. On Wednesday, the Seoul High Court heard its last day of testimony in Qualcomm’s appeal of a competition case brought by the Korea Fair Trade Commission. The KFTC imposed a record 1.03 trillion won ($866 million) fine and required the chipmaker to alter its licensing practices.

Many of the same individuals who testified before Koh have also appeared before the Seoul High Court, which is expected to issue a decision before the end of the year. Qualcomm and the KFTC are expected to give closing statements in the case in August, and Koh’s ruling is certain to garner a mention.