QCOM QUALCOMM Inc

By Brent Kendall and Asa Fitch 

SAN FRANCISCO -- A federal appeals court appeared receptive to Qualcomm Inc.'s appeal of a ruling that found it was illegally maintaining a monopoly in cellphone chips and extracting unreasonably high royalty rates for patents that are essential to the industry.

A three-judge panel of the Ninth U.S. Circuit Court of Appeals repeatedly questioned arguments by the Federal Trade Commission, which sued Qualcomm in 2017 for alleged antitrust violations.

Near the end of the hourlong hearing Thursday, Judge Consuelo Callahan suggested Qualcomm's practices had been "overly capitalistic but not necessarily anticompetitive." She also voiced skepticism of FTC arguments that Qualcomm's tactics had unlawfully raised costs incurred by its chip rivals.

Judges on the panel said that, even if the evidence showed that Qualcomm charged high royalty rates for its patents, that wasn't necessarily evidence that the company had stifled the competitive process.

"Anticompetitive behavior is illegal under the Sherman Act. Hypercompetitive behavior is not," said Judge Stephen J. Murphy, a visiting judge from Michigan. "This case asks us to draw the line between the two."

The case cuts to the heart of Qualcomm's business model and promises broad stakes for two areas of the law that are often in tension -- antitrust, which is designed to promote competition, and patent law, which gives intellectual-property owners the right to exclude competitors from using their inventions unless they pay licensing fees.

The litigation also comes with an unusual twist: Two different government agencies that enforce U.S. antitrust laws disagree on whether Qualcomm's conduct is unlawful and argued against one another Thursday.

San Diego-based Qualcomm designs and markets chips that facilitate cellphones' communications with cell towers. It owned about 43% of the global market for such chips, according to a Strategy Analytics report from last year's second quarter.

The company also has a licensing arm that collects royalties when others use a portfolio of more than 140,000 patents world-wide, many of which cover key telecommunications technologies. Licensing revenues are only a fraction of chip sales, but the division is a driver of Qualcomm's overall profits because its margins are much better.

The Federal Trade Commission sued Qualcomm in the final days of Democratic control under the Obama administration. It focused on a central Qualcomm business policy that FTC lawyers described as "no license, no chips."

The FTC said Qualcomm enjoyed monopolies in two types of modem chips and wouldn't sell those must-have chips to device makers unless those companies also paid to license a broader portfolio of Qualcomm's patents. That structure made it difficult for phone makers to challenge Qualcomm's royalty rates, and the arrangement also meant those manufacturers were paying Qualcomm royalties even if they used a competitor's chips in their phones, FTC lawyer Brian Fletcher told the panel.

Judges indicated they weren't convinced.

"Is that the standard, making it more difficult for competitors?" asked Judge Johnnie Rawlinson. "Because that's the nature of business, to make it more difficult for your competitors to operate."

"If you're making it hard for competitors because you have a better product or you sell it for less, no problem," Mr. Fletcher responded. "That's not this case."

Apple Inc. sued on similar grounds, but the iPhone maker and Qualcomm settled their differences in April last year, dropping all litigation and reaching a new chip-supply agreement.

U.S. District Judge Lucy Koh in San Jose, Calif., ruled against Qualcomm last May. She agreed the chip designer improperly leveraged its market dominance and ordered Qualcomm to change the way it does business. If her ruling holds, Qualcomm would be forced to renegotiate existing patent licenses without taking into account chip-supply deals, which could dramatically lower licensing revenues.

Even before Thursday's hearing, the Ninth Circuit already had stayed the effect of that ruling for now.

The court, both in its stay order and during the hearing, suggested Judge Koh was on shaky ground in at least part of her ruling, when she found that Qualcomm had obligations to license certain industry-essential patents to rivals.

Qualcomm says it acquired its market position through ingenuity and business acumen, and argues that its licensing practices make sense because every cellphone invariably uses its patented technologies.

Qualcomm's lawyer, Thomas Goldstein, said the company invested $60 billion in a vibrant industry, on the prospect that it would be able to collect royalties and realize financial success.

Mr. Goldstein didn't dispute that the company had monopoly power in communications chips, but argued it hadn't used that power to freeze out competitors. "What has gone wrong in the competitive process? The answer to that question is nothing," he said.

The company has gained a powerful ally in the past year: the Justice Department, which argued in defense of Qualcomm at Thursday's hearing.

The department has said Judge Koh made fundamental errors and imposed harsh penalties that could hurt innovation and impair a company that is critical to maintaining the U.S.'s technology advantage over global rivals.

Qualcomm is a leading U.S. purveyor of superfast fifth-generation cellular technology, and the U.S. sees the company's health as crucial to maintaining a 5G advantage over China, which is rapidly deploying the networks.

A decision is expected in the coming months.

Write to Brent Kendall at brent.kendall@wsj.com and Asa Fitch at asa.fitch@wsj.com

(END) Dow Jones Newswires

February 13, 2020 16:45 ET (21:45 GMT)

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