[This post has been authored by Daanish Dube and Pranay Dixit, students at Jindal Global Law School.]

Factual Background

On 9th August 2020, the 9th Circuit Federal Court of the United States (the “Court”) gave a decision involving the Federal Trade Commission (“FTC”) and arguably, the world’s biggest tech giant – Qualcomm Inc. According to the factual matrix, Qualcomm entered into CDMA ASIC agreements (“Agreements”) with rival chipmakers. The terms of these Agreements specified that chipmakers are allowed to use Qualcomm’s cellular Standard Essential Patents pertaining to the CDMA and premium LTE standard (“SEPs”) on a royalty-free basis. In exchange, the former could only sell such chips involving Qualcomm’s SEPs to those Original Equipment Manufacturers (“OEMs”) that have licensed those respective SEPs from Qualcomm – a policy that has been termed by the Court as ‘No License, No Problem’. Qualcomm, however, enforces a policy of ‘No License, No Chips’ with respect to OEMs where it ‘refuses to sell modem chips to OEMs that do not acquire licenses to use Qualcomm’s SEPs’. In addition, Qualcomm is entitled to receive per-unit royalties from the OEMs for its patent portfolios, irrespective of the source from where they are procuring the chips. This arrangement was a result of the decision given by the Supreme Court of the United States reaffirming the patent exhaustion doctrine in the case of Quanta Computers v. LG Electronics Inc. The Supreme Court, in that case, had opined that –

“The authorized sale of an article that substantially embodies a patent exhausts the patent holder’s rights and prevents the patent holder from invoking patent law to control post sale use of the article”.[i]

Is the ‘No License, No Problem’ policy providing constructive Licenses to rival chipmakers?

When the policies mentioned above are examined together, it is observed that they are problematic when one considers the case of Quanta Computers where the concept of patent exhaustion was brought into practice. In fact, according to Qualcomm, it adopted its present policy in order to avoid the issue of patent exhaustion, i.e., the exhaustion by a licensor of his right to gain further royalties from any subsequent sales of the licensed technology. However, the Court overlooked a significant issue in Qualcomm’s business practices. In De Forest Radio Telephone Co. v. United States, the Supreme Court of the United States had stated,  

“No formal granting of a license is necessary in order to give it effect. Any language used by the owner of the patent, or any conduct on his part exhibited to another from which that other may properly infer that the owner consents to his use of the patent in making or using it, or selling it, upon which the other acts, constitutes a license”.[ii]

The Court recognized the current structure of Qualcomm where they are licensing their technology to rival chipmakers, as de-facto licensing. When one considers the ‘No License, No Problem’ policy through the lens of Contract law, it means that Qualcomm promises to not assert its patent in return for the Agreements being signed by the licensee. Thus, the arrangement in place results in granting a constructive license to the rival chipmakers.

Can it be argued that the CDMA ASIC Agreements are inconsistent with patent exhaustion doctrine laid down in Quanta Computers?

Considering that the present suit was filed involving alleged violations under the Sherman Antitrust Act of 1890 (the “Sherman Act”), the Court did not evaluate the inherent problem of the Agreements in light of the law laid down in Quanta Computers. Qualcomm’s rights in those SEPs would be exhausted the moment those chips were sold to OEMs considering that the Agreements are, constructively, licensing arrangements. Therefore, it can be very well argued that the OEMs are not required by the law to license the same SEPs (the rights in which have been exhausted now) from Qualcomm once they have paid the price for procuring the chipsets from rival chipmakers. Since Qualcomm has authorized the implementation of their SEPs into chipsets, the chipmakers do not have to concern themselves with whether the OEM has a license from Qualcomm or not. However, looking at the terms of the Agreements as well as the NLNC policy together, this seems to be a case in point where Qualcomm intends to ‘have their cake and eat it too’.

Whether Qualcomm’s pro-competitive justification is tenable considering the existing law on Patent Exhaustion?

Since the issues involved the application of antitrust laws in the present case, the FTC was alleging anti-competitive conduct under Section 1 and 2 of the Sherman Act. In response to the said allegations, Qualcomm justified their business practices on the ground that ‘multi-level licensing’ as an alternative would lead to inefficiencies and less profit. The present discussion only aims to analyse the legal tenability and logic involving the patent exhaustion doctrine with respect to Qualcomm’s pro-competitive justification in response to FTC’s contention.

Notably, Qualcomm’s pro-competitive justification does not hold its ground since multi-licensing is not possible in any case. As discussed above, Agreements are essentially constructive licenses because they promise to not assert their patents and allow rival chipmakers to practice their SEPs royalty-free. Since, the Agreements amount to an authorization from Qualcomm, the rights in all those SEPs that Qualcomm has contracted to not assert against the rival chipmakers will be exhausted upon the sale of those chipsets. Consequently, Qualcomm will be in no position to demand royalties from the OEMs due to patent exhaustion. This is the reason why Qualcomm chose to change its business practices. They were well aware of the fact that patent exhaustion would lead them into a reality where SEP licensing would not be as lucrative. While the Agreements do not amount to a ‘refusal to deal’, they create yet another problematic situation, given the law on patent exhaustion. This is because either the OEMs will choose to deal with Qualcomm to incorporate the CDMA or the premium LTE standard into their phones by licensing the SEPs or they obtain the chipsets from the chipmakers who are practising Qualcomm’s SEPs. In case of the latter, Qualcomm should not be able to seek royalties from the OEMs because their rights in the SEPs would become exhausted the moment those chips are sold. Therefore, Qualcomm’s pro-competitive justification is untenable considering the established law on patent exhaustion leading to their argument against a violation of section 1 and 2 of the Sherman Act to be untenable as well.

The Impact Of the Case

In this decision, the Court observed that –

“No court has held that the SSPPU concept is a per se rule for “reasonable royalty” calculations; instead, the concept is used as a tool in jury cases to minimize potential jury confusion when the jury is weighing complex expert testimony about patent damages”.[iii] 

However, SSPPU is not only a tool in cases decided by a jury but a factor in deciding the royalty rate base. This can be seen in various judgements like Microsoft v. Motorola,[iv] Ericsson v. D-Link[v] (“DoJ”) 2015 Business Review Letter (“BRL”) for the Institute of Electronic and Electrical Engineers (“IEEE”). In 2020, the DoJ cited this judgement stating that parties should not be discouraged from using the entire market value (“EMVR”) of the end product as the appropriate royalty base because it was “the most effective method of estimating an asserted patent’s value’. This is problematic because the Court, while deciding on the concept of Smallest Saleable Patent-Practicing Unit (“SSPPU”) and EMVR, did not consider the already set precedent of taking into consideration both the EMVR and SSPPU. The Court rather chose to digress from the same by heavily leaning towards EMVR as the royalty base. Consequently, the SEP holders would be inclined to demand a royalty based on EMVR, which would eventually lead to the problem of royalty stacking for the OEMs. In Microsoft v. Motorola, Judge Robart stated (later approved by the Court itself) that the innovators need to be more open to negotiations in order to avoid royalty stacking. If Qualcomm is paid a royalty on the basis of EMVR and not SSPPU, then the possibility of royalty stacking increases.[vi] The OEM will have to pay a royalty to other SEP holders too like ones for WiFi, Bluetooth, cameras, etc. If using EMVR becomes the rule, then a definite situation of royalty stacking would occur, adversely affecting OEMs and eventually, consumers.

This could be a potential landmark decision in the sphere of Antitrust law as well as Patent law. As for now, it has the potential to bring big changes, when it comes to its impact on SEP licensing, the reasonable royalty rate calculations and the patent exhaustion doctrine in the context of SEPs.

_______________________

[i][2008] U.S. LEXIS 4702.

[ii] [1927] 273 U.S. 236, 241.

[iii] Federal Trade Commission v. Qualcomm Incorporated  [2020] No. 19-16122 9th Circuit.

[iv] [2012] Daily Journal D.A.R. 13, 619

[v] [2014] U.S. App. LEXIS 22778.

[vi] Microsoft (n 4).