Appeals court seems poised to reverse landmark Qualcomm antitrust ruling

"What would be anticompetitive about that?" one judged asked.

An attorney for the Federal Trade Commission faced a skeptical reception from three appellate judges Thursday as he fought to defend a landmark ruling that Qualcomm's aggressive modem chip licensing tactics violated antitrust law.

"Isn't that maybe being overly capitalistic but not necessarily anticompetitive?" Judge Consuelo Callahan asked at one point during the argument before the 9th Circuit Court of Appeals in California. Callahan, a George W. Bush appointee, was hearing the case alongside another Bush appointee, Stephen Murphy, and Clinton pick Johnnie Rawlinson.

Last May, a federal trial court judge ruled that Qualcomm had violated antitrust law with its "no license, no chips" policy. Under this policy, no one was allowed to buy chips from Qualcomm unless they first agreed to pay royalties for Qualcomm's patents.

The FTC argued—and Judge Lucy Koh agreed—that Qualcomm had ruthlessly used its monopoly over certain types of modem chips to force customers to pay unfairly high royalties for its patents. Those excessive royalties acted as a de facto tax on its competitors' products, since handset makers had to pay Qualcomm whether or not they bought Qualcomm's chips.

Judges and lawyers in the case repeatedly referred back to an antitrust case from the 1990s that pitted Microsoft against Caldera, which had been selling a competing version of DOS. In that case, Microsoft charged PC makers a licensing fee for every computer it sold, whether or not the machine shipped with Microsoft software. Caldera convinced the judge that this was anticompetitive, since the licensing fee acted as an anticompetitive tax on Microsoft competitors like Caldera.

FTC lawyer Brian Fletcher argued that the same analysis applied to Qualcomm's licensing practices. In this case, the tax on competitors is described as patent royalties, making the situation superficially different from Microsoft's licensing strategy. But the FTC argued that the practical effect is the same: Qualcomm's patent licensing fees effectively include a "surcharge" on competitors' chips that they couldn't have gotten without a chip monopoly. Qualcomm then uses excess profits from patent licensing to pay rebates to its own customers, effectively giving its own chips an unfair advantage in the market.

“I’m having a hard time keeping up”

The judges seemed skeptical of Fletcher's case—if they understood it at all.

"Things are going so fast I'm having a hard time keeping up with all this," said Judge Murphy. "The district court found in terms of surcharging that the surcharge reflected the monopolistic or illegal value of what did you say?"

"It's the monopoly position that Qualcomm has in the chip market," Fletcher explained. "Patent negotiations, ordinarily, the way that they work is the patent holder says, 'You're infringing my patents, you need to take a license.' The other side says, 'I don't think so.' They reach a determination of an appropriate license rate against the backdrop of ordinary patent remedies."

The key question, Fletcher said, is "are these patent royalties in fact being driven by the chip monopoly and not by the value of the patents?"

"So what would be wrong with that?" Rawlinson shot back. "Doesn't the Supreme Court say that patent holders have the right to price their patents? What would be anticompetitive about that?"

Fletcher drew the judges' attention to the Caldera case, which he argued involved a similar business practice.

"Why did the OEMs say it's unfair?" Callahan asked (by "OEMs," she meant smartphone makers). "Because they have to buy a license? They have to buy a license anyway."

When Qualcomm lawyer Tom Goldstein came back to the podium for a rebuttal, one judge—Rawlinson—did seem to have absorbed Fletcher's argument.

When Goldstein argued that even the FTC didn't claim Qualcomm wasn't imposing a tax on competitors' chips, Rawlinson objected. "They're saying in essence that's the same thing you're doing. You're calling it something else. But when the cover is pulled off, it really is just a naked tax" on competitors, she said.

A divided government

It's an inherently complicated case that has been made even more complicated by a schism within the executive branch. The Federal Trade Commission originally filed its lawsuit against Qualcomm in the final days of the Obama administration.

Republicans tend to favor less aggressive antitrust enforcement, so ordinarily, the inauguration of a new Republican president would have meant a new Republican majority that could quickly settle pending cases they didn't think were worth pursuing. But the new FTC chairman, Joseph Simons, recused himself from the case because his former law firm had counted Qualcomm as a client.

That led to a 2-2 deadlock, with the commission's two Democrats wanting to continue pursuing the case and the two Republicans preferring to drop it. In this situation, the FTC goes with the default option, which is for FTC staff to continue pursuing the case. But it does so without a clear strategic direction from the commissioners.

The Department of Justice shares jurisdiction over antitrust enforcement with the FTC, and ordinarily the two agencies coordinate to avoid stepping on each other's toes. But in a highly unusual move, Trump's Justice Department intervened in the case on Qualcomm's side. That led to the spectacle of two government lawyers squaring off on opposite sides of a legal argument.

The Justice Department argues that Judge Koh's decision, which ordered Qualcomm to decouple patent licenses from chip sales and stop engaging in other anticompetitive conduct, is a threat to US national security. Communications chips are widely seen as important for national security, and Qualcomm is America's leading modem chipmaker. Qualcomm's major rivals are mostly in Asia—including the South Korean Samsung and the Chinese Huawei.

But judges seemed skeptical of the Justice Department's national security arguments, calling them vague and unsubstantiated. They noted that the Justice Department had not offered any specific numbers or market analysis showing how much Judge Koh's ruling would damage Qualcomm's standing in the market. And the FTC's Fletcher pointed out that one reason Qualcomm is the only major modem chip maker in the US is that Qualcomm's anticompetitive tactics helped push another American company, Intel, out of the market.

The case is far from over. Judge Koh's ruling last May was a preliminary injunction ordering Qualcomm to change its business practices while the case moved to trial. The appeals court could reverse that injunction but let the case go to trial, which could eventually lead to a similar order years in the future. Or the appeals court could go further and overturn some or all of Judge Koh's legal analysis, handing Qualcomm an immediate win in the case.

Theoretically, the judges could also uphold Judge Koh's ruling and leave the injunction in place. But the tenor of the judges' questions on Thursday made me think this isn't very likely.