“No License, No Problem” – Is Qualcomm’s Ninth Circuit Antitrust Victory a Patent Exhaustion Defeat?

Guest post by University of Utah College of Law Professor Jorge L. Contreras

The Ninth Circuit’s recent decision in FTC v. Qualcomm (9th Cir., Aug. 11, 2020) is generally viewed as a resounding victory for Qualcomm.  In a strongly worded opinion, the Ninth Circuit reversed the entirety of the district court’s holding, which found that Qualcomm violated Sections 1 and 2 of the Sherman Act.  The Ninth Circuit exonerated Qualcomm with respect to each of its allegedly anticompetitive practices, concluding that these practices merely reflected the flexing of Qualcomm’s “economic muscle” with admirable “vigor, imagination, devotion, and ingenuity” (slip op. at 55).

Among Qualcomm’s challenged practices was its refusal to license rival chip makers under patents that are essential to one or more wireless telecommunications standards (standards-essential patents or SEPs).  While the District Court found that this refusal violated Qualcomm’s antitrust duty to deal under Aspen Skiing Co. v. Aspen Highlands Skiing Corp., 472 U.S. 585 (1985), the Ninth Circuit disagreed.  It reasoned that Qualcomm did not violate any duty to deal because it uniformly refused to grant patent licenses to chip makers and did not “single[] out any specific chip supplier for anticompetitive treatment” (slip op. at 35).

In praising Qualcomm’s egalitarian approach toward rival chip makers, the Ninth Circuit points out that instead of granting licenses to these rivals, Qualcomm merely “declines to enforce its patents” against them “even though they practice Qualcomm’s patents” (id). As such, the Ninth Circuit quips that Qualcomm’s “policy toward rival chipmakers could be characterized as ‘no license, no problem’” (id., emphasis added).  Yet, as I discuss below, this approach could actually be a very big problem, not only for Qualcomm, but for all patent licensors seeking to extract revenue from the most lucrative point in the supply chain.

The Patent Exhaustion Doctrine and Chip Sales

As the Supreme Court explained in Quanta Computer, Inc. v. LG Elecs., Inc., 553 U.S. 617, 625 (2008), “The longstanding  doctrine of patent exhaustion provides that the initial authorized sale of a patented item terminates all patent rights to that item.”  That is, once the patent holder or its authorized licensee sells a product covered by a patent, that patent can no longer be asserted against a downstream buyer or user of the product. The patent is “exhausted” with respect to that particular product.

In Quanta, LG licensed three patents to Intel.  Intel manufactured chips allegedly covered by the patents, then sold the chips to Quanta for incorporation into Quanta’s PCs. LG then attempted to assert the patents against Quanta.  The court held that so long as the Intel chips “substantially embodied the patent[s]”, they were exhausted upon Intel’s sale of the chips to Quanta (553 U.S. at 633).  LG had no right to assert the patents against Intel’s customer Quanta.

Level Discrimination and SEPs

To grossly oversimplify, the supply chain for standardized wireless telecommunications functionality can be divided into three relevant tiers: (1) standards developers, (2) chip manufacturers, and (3) end user device (e.g., smartphone) manufacturers.  Standards developers like Qualcomm cooperate within standards-development bodies to create telecommunications standards like 4G LTE. Chip manufacturers then implement these standards in chipsets, which they sell to device manufacturers for incorporation into smartphones and other consumer devices.

What happens, however, when a standards developer like Qualcomm holds patents (SEPs) that cover a standard like LTE?  In theory, both the chips embodying the standard and the smartphones incorporating those chips infringe its SEPs.  Thus the SEP holder could choose to license those SEPs at either Tier 2 (chip manufacturers) or Tier 3 (device manufacturers). How to choose?

If a SEP holder licenses a chip manufacturer, then its SEPs covering a particular chip will be exhausted as soon as the manufacturer sell that chip to a device manufacturer, just as LG’s patents were exhausted in Quanta.  This means that if the SEP holder licenses a Tier 2 chip manufacturer, it cannot separately license, or collect royalties from, Tier 3 smartphone manufacturers for the same SEPs.  Qualcomm was keenly aware of the risk of patent exhaustion, which is why it refused to grant “exhaustive” licenses to chip makers like Intel. 411 F.Supp.3d at 748, 761.

If SEP royalties were standardized on a per-unit basis (e.g. $0.50 per product embodying the standard), then it would not matter whether the SEP holder licensed its SEPs at Tier 2 or Tier 3.  In either case it would receive the same payment.  However, due to longstanding industry practice, that is not how SEP royalties are calculated. Instead, they are usually based on some percentage (say 2.5%) of the price of the product embodying the standard.  So for a 4G LTE wireless radio chipset priced at $30, the royalty would be $0.75.  But for a $600 iPhone incorporating that chipset, the royalty would be $15.  For this reason, SEP holders strongly prefer to license their SEPs to end device makers (Tier 3).  As explained by one Ericsson licensing executive, “we choose to license the patents as late in value chain as possible …. One big advantage with this strategy is also that it is likely that the royalty income will be higher since we calculate the royalty on a more expensive product.” Or, as more succinctly expressed by a Qualcomm attorney at trial, licensing SEPs to device makers is “humongously” more lucrative than licensing  them to chip makers. 411 F.Supp.3d at 754, 758, 796.  The practice by which a SEP holder licenses its SEPs at only one tier of the supply chain is sometimes called “level discrimination.” (Courts and commentators disagree whether level discrimination is permitted under the nondiscrimination prong of a FRAND commitment – see this article for a discussion).

Pseudo-Licensing Deals with Chip Makers

If a SEP holder licenses its SEPs at Tier 3, what happens to the Tier 2 chip manufacturer? Does the chip that embodies the standard infringe the SEPs?  Yes, probably. Patent exhaustion only works downstream, not upstream.  That is, a smartphone manufacturer can’t infringe a SEP if it purchases a chipset from a licensed chip maker.  But a chip manufacturer can infringe a SEP even if its customer (the smartphone maker) has a license to use it.  Without a license, the Tier 2 chip maker is exposed to infringement claims by the SEP holder.

So what’s a chip maker to do?  Should it manufacture and sell chipsets that embody a standard even though it knows that it is infringing a host of SEPs?  Wouldn’t this infringement be willful, subjecting the chip maker to a risk of treble damages (see Sec. 5.2.1(1) of this chapter for a discussion of willful infringement of SEPs)?  It seems like an untenable situation for a chip maker.

To address this situation, Qualcomm appears to have developed various strategies.  In the 1990s, it granted chip makers purportedly “non-exhaustive licenses” that permitted them to manufacture chipsets covered by Qualcomm’s SEPs (in exchange for a royalty), but which explicitly excluded any license rights for the purchasers of those chipsets (9th Cir., slip op. at 14 n.7).  In Quanta, the Supreme Court rejected such a “non-exhaustive” arrangement between LG and Intel, holding that LG’s patent rights were exhausted upon Intel’s sale of covered chips to Quanta.  After this, Qualcomm amended its practices and began to enter into “CDMA ASIC Agreements” with chip makers. Under these agreements, “Qualcomm promises not to assert its patents in exchange for the company promising not to sell its chips to unlicensed [smartphone manufacturers]” (9th Cir., slip op. at 14, emphasis added).  According to the Ninth Circuit, these agreements “allow Qualcomm’s competitors to practice Qualcomm’s SEPs royalty-free” (id.).  Or, as the court pithily observed, Qualcomm’s “policy toward rival chipmakers could be characterized as ‘no license, no problem’” (id. at 35).

The Ninth Circuit found that because Qualcomm applied its “no license, no problem” policy uniformly toward all rival chip makers, it did not violate the antitrust laws.  But did Qualcomm, instead, open the door to a finding that its patents are exhausted at the chip maker level?

Do SEP Makers Inadvertently Grant Exhaustive Licenses to Chip Makers?

As observed by the Ninth Circuit, Qualcomm “promises not to assert” its SEPs against chip makers.  Its CDMA ASIC Agreements allow chip makers “to practice Qualcomm’s SEPs royalty-free”.  Ericsson, which employs a similar form of level discrimination, has referred to the result as “indirect licensing” of chip manufacturers (see Ericsson v. D-Link, 2013 U.S. Dist. LEXIS 110585, *80 (E.D. Tx. 2013)).

In assessing whether a patent has been licensed, courts have generally looked beyond the language used by the parties.  As the Supreme Court reasoned in De Forest Radio Telephone Co. v. United States, 273 U.S. 236, 241 (1927), “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”.

A number of lower court cases have equated a license to a ‘covenant not to sue’.  As the Federal Circuit held in Ortho Pharmaceutical Corp. v. Genetics Institute, Inc., 52 F.3d 1026, 1031 (Fed. Cir. 1995), “A license may amount to no more than a covenant by the patentee not to sue the licensee for making, using or selling the patented invention.”

Given this precedent, SEP holders’ practice of tacitly permitting chip manufacturers to operate under their patents, whether by promising not to assert or “indirectly” licensing, looks suspiciously like licensing.  And, if SEP holders are granting chip manufacturers licenses to make and sell chips under their SEPs, then those SEPs should, by rights, be exhausted upon the sale of those chips to smartphone and other device manufacturers.  And this exhaustion should thereby prevent SEP holders from seeking to license and collect royalties from Tier 3 device manufacturers who incorporate those chips into their smartphones and other products.

This result should come as no surprise to anyone, least of all Qualcomm.  According to the District Court, a Qualcomm executive admitted to the IRS in 2012 that “if Qualcomm licensed a rival [chip manufacturer] … ‘[W]hen [the rival] sell[s] that chip to somebody who’s going to put the chip in a cell phone, okay, the licensee’s sale of that chip will exhaust our rights and then we won’t be able to collect a royalty on a cell phone that’s based on the price of the cellphone’” (411 F.Supp.3d at 796).  When Huawei apparently asserted that Qualcomm’s SEPs were exhausted after selling chips to Huawei, Qualcomm allegedly “threatened to cut off [Huawei’s] chip supply” (id. at 712).

These statements and actions indicate that Qualcomm was well-aware of the threat of patent exhaustion, and actually took measures to avoid the appearance of exhaustion (e.g., by converting its chip maker license agreements into CDMA ASIC Agreements).  Yet in trying to rebut the antitrust allegations made against it, and to overturn the District Court’s antitrust holdings, Qualcomm seems to have persuaded the Ninth Circuit that it effectively grants licenses to rival chip manufacturers. And, in doing so, Qualcomm may have armed its next smartphone licensee with a potent exhaustion defense to any claim of infringement.  Ultimately, “no license, no problem” may cause big problems for Qualcomm and other SEP holders that seek to license only at the most lucrative level of the supply chain.

38 thoughts on ““No License, No Problem” – Is Qualcomm’s Ninth Circuit Antitrust Victory a Patent Exhaustion Defeat?

  1. 9

    “Given this precedent, SEP holders’ practice of tacitly permitting chip manufacturers to operate under their patents, whether by promising not to assert or “indirectly” licensing, looks suspiciously like licensing. And, if SEP holders are granting chip manufacturers licenses to make and sell chips under their SEPs, then those SEPs should, by rights, be exhausted upon the sale of those chips to smartphone and other device manufacturers. And this exhaustion should thereby prevent SEP holders from seeking to license and collect royalties from Tier 3 device manufacturers who incorporate those chips into their smartphones and other products.”

    There are some interesting twists of logic in this point. My understanding is the covenant not to sue only applies if the chip maker sells to licensed device manufacturers. If the chip maker sells to an unlicensed device manufacturer, then those sales are not subject to the covenant, and so there is no “exhaustion.”

    On the other hand, if a device manufacturer is licensed by Qualcomm, then the chip maker’s sales to that device manufacturer are subject to the covenant. But the device manufacturer has already contracted to pay Qualcomm for use of Qualcomm’s patents. Is the device manufacturer going to ask for a refund? If that happens, then it would seem the device manufacturer is going back on the bargain it reached with Qualcomm–no payment, no license. If no license, then no covenant to the chip maker. Same result – no exhaustion.

    A different way to look at what Qualcomm is doing is that Qualcomm decided it would get its “reward” for the use of its inventions from the smartphone and device manufacturers. The “covenant” Qualcomm gives to the chip makers simply ensures that the licensed smartphone and device manufacturers will not have their supply chains disrupted by Qualcomm suing their suppliers for infringement.

    Another way to look at what Qualcomm is doing is that Qualcomm can get only one full “reward” for use of its inventions, and the reward is the license fees paid by the smartphone/device manufacturers. In a hypothetical lawsuit by Qualcomm against a chip maker, any sales to licensed smartphone/device manufacturers would not be included in the damages calculation. The “covenant” simply confirms what would already happen anyway.

    Still another way to look at this – under the old (but still controlling) precedent in Carey v. United States, 326 F.2d 975 (Ct. Cl. 1964):

    “It must be held that all of the titanium purchased by defendant under its contracts with the producers, obligating it to purchase all the titanium which they could not sell on the open market, was produced under defendant’s exclusive license to produce, use, and sell. Such a license is not restricted to production by the licensee personally or use by him personally or sales by him personally. It permits him to employ others to assist him in the production, and in the use and in the sale of the invention. Nor need he take any personal part in the production. A licensee having the right to produce, use and sell might be interested only in using the article or in selling it; in order to use it or sell it, the article must be produced; to have it produced, his license permits him to engage others to do all the work connected with the production of the article for him. Production of the article for the use of the licensee is production under the license.”

    Under that case law, the chip makers’ manufacture and sales to licensed smartphone/device manufacturers could be treated as being licensed under the smartphone/device manufacturers’ licenses, and so no covenant by Qualcomm would be necessary.

    1. 9.1

      One way to look at the Supreme Court’s recent “exhaustion” cases (Quanta, Impression Products v. Lexmark) is that the Supreme Court views patent owners as getting a “monopoly,” and so expanding patent exhaustion has the effect of minimizing the “monopoly rents” society has to pay.

      Prof. Contreras’ post seems to suggest a similar result here. Under an expansive view of exhaustion, Qualcomm’s “reward” for use of its inventions is 1/20th of what it has obtained by licensing the smartphone/device manufacturers.

  2. 8

    The focus here in regards to license/pseudo-license/license by any other name has to do with hardware.

    There is — of course — a corollary with software that is perhaps even more invasive and intrusive.

    Think: shrinkwrap and its variations.

    Even (especially) if people do not want to admit of the existence of the Kondratiev fifth wave, such is the reality that we have.

    1. 7.2

      From the article:

      “More specifically, the tech companies say that the rule is based on vague factors that lead to “speculative, unpredictable, and unfair outcomes.”

      Oh, boo hoo. You mean like widespread PTAB / CAFC / SCOTUS 101 jurisIMprudence?

      The Big Tech hypocrisy just never ends.

  3. 6

    Off-topic, but while I would be delighted if Dir. Iancu is correct in his supposition that “there is an appetite on Capitol Hill to potentially do somethingon §101,” I would be interested to know what makes him think that. I would, naively, suppose that Congress does not have much time and attention of late for anything other than the budget, the economy, the pandemic, and the election.

    I also had to laugh at the contention that “[t]he USPTO… and court could see eye-to-eye on Section 101 if they followed the agency’s 2019 guidance on patent subject matter eligibility… .” Well, yes, if the courts were to take their lead from the USPTO, then there would be little disagreement between the courts and the USPTO. Somehow, however, it seems like it should be the USPTO taking its lead from the courts, rather than the other way around—just as a basic rule-of-law matter. “It is emphatically the province and duty of the judicial department to say what the law is,” as Marbury v. Madison, 5 U.S. 137, 177 (1803) explained.

    1. 6.1

      Greg “I Use My Real Name” DeLassus is a joke.

      Not in his view of the role of the court in interpreting what the law is, but in his PAINFULLY polly-annaism in pretending that the courts have not
      F
      A
      I
      L
      E
      D
      to do so in ANY manner (on 101) that has not yielded the current Gordian Knot.

      1. 6.1.1

        +1 for anon.

    2. 6.2

      “while I would be delighted if Dir. Iancu is correct in his supposition that “there is an appetite on Capitol Hill to potentially do somethingon §101,” I would be interested to know what makes him think that.”

      I think it is extremely naive to believe that Iancu thinks something based on what he says.

      Also, re: soup cans: I don’t know if he’s accurate describing protestors, but the idea seems plausible to me because the soup can as weapon is literally taught in public schools. It’s a last ditch technique in an active shooter scenario: teacher passes out cans, and if the shooter comes in the classroom door, pelt him all at once.

      1. 6.2.1

        To my—admittedly old-fashioned—way of thinking, there is a wide gulf between “this is theoretically plausible” and “it is appropriate for the president of the United States to speculate about this in public without any discernible evidence and during a time of national emergency.”

    3. 6.3

      Not since Chevron. The Court should be deferring to the Agency expertise.

      1. 6.3.1

        Yeah , hmm, not likely.

        I do not think that Chevron applies in this situation (it does not apply universally)

      2. 6.3.2

        The Court should be deferring to the Agency expertise.

        Is it your understanding that the CAFC should be extremely reluctant to reverse the PTAB when—in an ex parte appeal by a patent applicant—they affirm the examiner? The USPTO has just as much “expertise” in that circumstance as when they promulgate examiner training materials.

  4. 5

    OT: So who needs justice . . . when you’ve got the CAFC with their trusty Rule 36s:

    link to cafc.uscourts.gov

    Is today’s 6 a new record?

    “All adjudicatory panels must explain their reasoning . . . ‘cept us, of course.”

    — CAFC

    1. 5.1

      No, six Rule 36s is nothing like a record. The CAFC routinely releases great boluses of Rule 36s all at once, unusually near the start of each month, and then again right after the month’s oral hearings session.

  5. 4

    OT but important because of his huge number of long-pending patent claims that will not expire until 17 years after they finally issue: Hyatt v. U.S. Patent & Trademark Office, E.D. Va., No. 1:18-cv-00546, 8/19/20. The judge dismissed this mandamus suit by Gilbert Hyatt charging the USPTO with deliberately not processing, examining, or issuing his patents.
    Hyatt had reportedly filed nearly 400 patent applications before June 1995 that are some of the longest-pending at the USPTO, and added hundreds of later claims. It was alleged by the PTO that the applications feature “some of the largest claim sets the PTO has ever encountered” with specifications that “run many hundreds of pages,” and Hyatt has amended them to add even more “significant complexity.” The USPTO also said it formed a special 12-examiner unit dedicated to processing Hyatt’s applications. The complexity of Hyatt’s applications was partly responsible for the office’s slow review, the court said in dismissing the case.

      1. 4.1.1

        As I read through this, I was drawn to a contrast between gamesmanship portrayed and gamesmanship asserted.

        The adage of, “One must come to the table of equity with clean hands” seems to be the overpowering message here.

        The scary take-away (below the surface), is that the Office can delay/deny/diminish – at its whim IF there is some nominative “yeah we are examining — wink, wink.”

        Even if one does not agree with Hyatt, this cannot be a comforting message.

  6. 3

    OT but important, reportedly yesterday a group of companies sued the PTO Director under the APA for PTAB IPR initiation refusals [PTAB IPR work avoidance] allegedly based entirely on a W.D.TX judge’s proposed trial dates, [This is in addition to the previously noted recent mandamus petition by a party there on the same issue. [Also, inconsistent with some comments in prior blogs and lawsuits that the PTAB is motivated to INcrease its IPR workload.]

    1. 3.1

      Thanks Paul. Do you know where it was filed? Perhaps a case #?

      1. 3.1.1

        Case 5:20-cv-06128 Filed 08/31/20 N.D.CA (San Jose division)

        1. 3.1.1.1

          Thanks Paul.

            1. 3.1.1.1.1.1

              Bias much? (and not in a good way)

              From the link:

              Andrei Iancu, an IP litigator and former chairman of a firm that primarily represents patent trolls, has been persistent and creative in his efforts to prove that it’s bad idea to put the fox in charge of the henhouse. The Director of the United States Patent & Trademark Office is one of the three most dangerous men in the U.S. from a patent policy perspective. The other two are Senator Chris Coons (D-Del.) and Antitrust Assistant Attorney General Makan Delrahim, with whom Mr. Iancu teamed up to abandon a very balanced U.S. policy position on the enforce…

              The Efficient Infringer mouthpieces hard at work…

              1. 3.1.1.1.1.1.1

                anon, maybe it wasn’t clear, but I only provided the link as an easier way to obtain a copy of the complaint, for those who don’t already have PACER (or CourtListener, small plug there), or do but want to be spared the inconvenience of running a search.

                It wasn’t my goal to publicize the accompanying commentary, that just comes along for the ride. You can take it or leave it (the commentary) obviously.

                1. My apologies sir, if the ‘hardworking’ jibe implicated you, as it was meant for the people in the article.

                  Thank you for this link (and the one above).

    2. 3.2

      Rah rah rah — those awful people saying that IPR is ‘bad’ simply cannot be correct per the edict of head cheerleader Paul.

  7. 2

    …that might be the equivalent of a drunken sailor’s version of patent profanity.

  8. 1

    Thanks for the analysis.
    Since this FTC v. Qualcomm case has been characterized as “FTC v. DOJ,” and is economically significant, one wonders if the odds of cert grant on antitrust law, patent exhaustion law (as above), and other possible issues here, are considerably higher than normal?

    1. 1.1

      Would not this being MORE messy than normal dictate away from cert grant?

    2. 1.2

      Especially if cert is successfully presented to the Supremes as a case of Qualcomm semantically subverting their decision in Quanta Computer, Inc. v. LG Elecs., Inc., 553 U.S. 617, 625 (2008). [A decision recent enough for some of the present Justices to have been on.]

    3. 1.3

      I think much more likely… so long as the FTC majority which brought this case is still intact. This is clearly a new issue raised by new technology that has wide-reaching effects, and the FTC-DOJ split (as well as the number of companies which support FTC’s position) seem to make it highly likely that this makes it up.

      1. 1.3.1

        Agreed, but what makes this a “new issue” [for extracting patent royalties] as compared to the many prior situations of patents on parts supplied to plural-part consumer product mfg./sellers? [E.g., computer chips or other parts supplied to car manufacturers.] Is it the “standards” requirement here, and/or the inability of the parts purchasers to obtain normal UCC patent infringement protection?

        1. 1.3.1.1

          I think that the Ninth Circuit bypassed the district court’s explicit factual findings regarding anticompetitive effects, which were pretty thorough – Judge Koh’s opinion has quite a lot of information in it. So it’s really just a question about whether failing to comply with requirements of a standard setting organization which have an explicit duty to deal can be a violation of Section 2. And I think the latter is different from Aspen Skiing, likely to arise again in the future, and has very major economic impacts. If the FTC files a cert petition (which is a big if), I think it is highly likely that cert gets granted.

          1. 1.3.1.1.1

            I think that I see a very heavy ‘pro-Koh’ shade here, while most people that I have talked to think that Koh was very much out of her mind and purely driven by a desired ends (her decision was pretty thoroughly bad).

            Plus, there is a definite pendulum swing back to wanting US competitiveness (even at such bodies as the FTC).

            I won’t be as adamant about this, this being outside of my own personal balliwick, but I am definitely seeing way too much ‘Koh-shading’ here.

    4. 1.4

      First we’ll see if the FTC files for en banc review by the 9th Circuit. That will be interesting, and cert could definitely follow.

      The big question right now is whether the FTC will appeal at all. Chairman Simons just announced that his 2-year recusal from the case has expired (I think that his firm represented QC before he joined the FTC), so the vote could be 2-3 for the appeal.

      Personally, I hope the fun continues all the way to SCOTUS.

      1. 1.4.1

        …yes, because we all have seen their proclivity for inserting clarity and reason into matters attached to patent law…

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