The Federal Trade Commission and Department of Justice Diverge on Qualcomm SEP Licensing

The Federal Trade Commission (FTC) and the Department of Justice (DOJ) recently appeared to be in opposition as a decision was pending (and subsequently delivered) in the FTC’s antitrust lawsuit against Qualcomm relating to licensing practices for its modem chip standard essential patents (SEPs) used in cellphones. DOJ filed a Statement of Interest indicating that any remedy should not interfere with the defendant’s innovation incentives going forward, and the FTC immediately opposed the DOJ position. What does this apparent opposition say about the future direction of enforcement policy on licensing SEPs? A further look into the facts of the Qualcomm case suggests that these opposing views may be at least partly due to case-specific facts and circumstances. Thus, this current opposition may not necessarily signal conflicting positions on future cases.

Apple also brought, and recently settled, an antitrust lawsuit against Qualcomm. The central issue in both the FTC and Apple lawsuits was Qualcomm’s practice of requiring iPhone assemblers not only to pay for Qualcomm’s modem chipsets but also to license its patented chip technology at an allegedly exorbitant royalty rate applied as a percentage of end use phone prices (“no license no chips”). The FTC litigation additionally challenged Qualcomm’s refusal to license to its chip competitors. The court in the FTC lawsuit found for the FTC, holding that Qualcomm must not condition the supply of modem chips on a customer’s patent license status (rejecting “no license no chips”), and that Qualcomm must, counter to its long-time business model, make SEP licenses available to competitor modem-chip suppliers on a fair, reasonable, and non-discriminatory (FRAND) basis.

DOJ argues in its Statement of Interest that the remedy in this case (which could potentially force Qualcomm to renegotiate all of its existing licensing agreements and significantly reshape the industry licensing structure) needs to be very carefully tailored so that it does “not interfere with the defendant’s innovation incentives going forward.” Further, the DOJ Statement of Interest states that “the remedy should work as little injury as possible to other public policies” and suggests that an overly broad remedy “could reduce competition and innovation in markets for 5G technology and downstream applications that rely on that technology.” FTC staff immediately opposed DOJ’s position, stating that it generally “disagree[ed] with a number of contentions in the Statement.”

DOJ’s pro-patent holder intervention could simply be a reflection of AAG Makan Delrahim’s stated position that antitrust enforcement had gone too far in accommodating the concerns of implementers at the expense of the patent owners of SEPs. However, there are several factors that are somewhat unique to the Qualcomm case that may also be driving the DOJ position.

First, Qualcomm is not a typical innovator/implementer. In a more typical case, the patent holder either has no implementer position or has both a significant number of SEPs relevant to the end use product and also manufactures the end-use product. Thus, the potential licensing concern is one either of “hold up” or of exclusion/raising rivals’ costs, since the patent holder may want to raise the costs of its end-product rivals by charging them high patent royalty rates. By contrast, Qualcomm holds SEPs relative to a component (modem chips) of the end-use product and also manufactures those chips, but does not compete in the end-use market. Thus, Qualcomm has little or no incentive to raise the costs of smartphone manufacturers and every incentive to maximize sales to smartphone manufacturers. This being the case, Qualcomm appears to be using its strong position in modem chips (where it has a high market share and allegedly makes advanced chips preferred by smartphone manufacturers) to get smartphone manufacturers, as a prerequisite to receiving those superior chips, to license based on a percentage of smartphone prices. There is nothing inherently confiscatory about such a strategy—as long as the royalty when applied to the royalty base is in line with the true value of the patents in the end-use product. DOJ’s position appears to recognize Qualcomm’s lack of implementer status and its economic interest in maximizing phone sales, which may explain part of its divergence from the FTC position.

Second, it is not clear that Qualcomm’s refusal to license its chip competitors necessarily puts these competitors at a competitive disadvantage. Qualcomm’s refusal to license its chip competitors does not mean that these chip suppliers were unable to supply their own standard-compliant chips to handset manufacturers due to fear of infringement The license was already “paid” by the handset manufacturer (for example, Apple) by means of the handset-based royalty paid to Qualcomm. It is only in the unlikely case that standard-compliant chips sold by Qualcomm’s competitors did not infringe Qualcomm SEP technology that there is an arguable issue that Qualcomm’s competitors are disadvantaged, since in that event Qualcomm would receive a handset-based royalty despite the use of non-infringing competitor chips.

Third, a FRAND royalty rate based on a component price is not clearly theoretically superior to one based on the end-use product price. The value paid for the intellectual property would still be the same as long as a royalty rate is calibrated to the royalty base—i.e., a lower royalty rate is applied to a larger royalty base and a higher royalty rate is applied to a smaller royalty base. In addition, there could be transactions cost savings connected with collecting royalties at the end-user stage compared to the intermediate product stage, meaning that the choice of alternative can be more of a business decision rather than a competitive strategy. This view that royalty rates can efficiently be taken at any level of the production process, which is consistent with a contract view of FRAND licensing, may well have been another factor leading DOJ to view Qualcomm’s licensing policy more benignly than the FTC.

Finally, DOJ seems particularly concerned that the remedy phase in the FTC case comes at a time when the smartphone industry is currently transitioning to 5G. For these reasons, DOJ’s differences with the FTC may be more idiosyncratic to this case than they appear at first blush and may not indicate differences on cases going forward.

Principal Robert D. Stoner advises clients on matters involving standard essential patents, FRAND obligations, and patent damages. He is based in EI's San Francisco Bay Area office.