Friday, February 24, 2017

Samsung is now taking the second Apple v. Samsung patent case to the Supreme Court

The first Apple v. Samsung case went all the way up to the Supreme Court and has meanwhile gone all the way back to the Northern District of California to take a new look at the question of design patent damages. But the steps to the Supreme Court are like a revolving door for this huge commercial dispute: a new petition for writ of certiorari (request for Supreme Court review) is already in the making! This time around it's about the second California Apple v. Samsung case (the one that went to trial in 2014, resulting in a $119 million verdict).

Donald Chisum, the author of "Chisum on Patents," described the Federal Circuit majority's decision to overrule (in Apple's favor) a unanimous panel decision (which had been favorable to Samsung's interests) as what may turn out to be the appeals court's "most controversial decision ever." The patent law community at large was very, very surprised (to say the least). Here's another example (on Law360).

After months of not hearing or reading anything about the case except for an Apple motion in California that essentially said "let's get it over with," I looked up the Supreme Court docket in light of a deadline approaching these days and, indeed, under no. 16A823, the top U.S. court has received and granted an application for an extension of time. Samsung now has until March 29, 2017 to file its petition.

Right after the Federal Circuit decision had come down, I already outlined my thoughts on the prospects for another Apple v. Samsung Supreme Court appeal and discussed what kinds of issues might be raised in that event. In a little more than a month, we'll know what issue(s) Samsung's attorneys have decided to bring up.

I'm pretty sure that Professor Chisum's quote will appear in the petition. It's a silver bullet in this situation, where the name of the game for Samsung is to persuade the justices that a second Supreme Court review is warranted in connection with the same dispute (though it's technically a different case involving different patents and different issues). Merits are going to be less than secondary at this stage. Certworthiness in terms of one or more key legal issues and public interest (that's where amici curiae, "friends of the court," can be very helpful) is all that matters now.

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Monday, February 20, 2017

The case against the EU "state aid" case against Apple: 13 billion euros out of thin air

When Apple is party to a litigation, the numbers involved tend to be huge. Sometimes the numbers are just the nature of the beast and there is underlying merit. But not always. Apple itself and, far more frequently, its legal rivals sometimes blow things out of proportion and/or make assertions one doesn't really have to agree with. Case in point: it's been almost three years since I described an Apple damages claim over five software patents as "an objective insanity," and when that case went to trial, a damages claim of well over $2 billion got contracted to an award of roughly 5% that number which (along with a temporary decision by an appeals court to dismiss the entire case) suggests that my criticism wasn't baseless.

The EU "state aid" case against Apple (technically against Ireland, but for all practical intents and purposes against Cupertino) is also an objective insanity. I've read the 130-page decision by the European Commission more than once, and the closer I looked at it and the more I thought about it, the less sense it made to me. I don't think a court that respects itself and its laws can possibly conclude that Ireland granted "state aid" amounting to roughly 13 billion euros to Apple.

Shortly before Christmas, and right before the Commission published its decision, the Irish government provided a summary of its legal arguments against the ruling. Since last summer, senior Apple executives have occasionally voiced their disagreement with Brussels in interviews that were unusual and possibly even unprecedented for a company whose official communications are normally consistent with its approach to product design: minimalistic elegance. For example, Apple's CFO told a German newspaper that the Commission should be ashamed of what it's doing here (which he described as a disgrace for all European citizens).

Ireland's pleas in law and main arguments against the Commission decision were published two weeks ago in the Official Journal of the European Union. Since my post last week on how hypocritical it is of Commissioner Vestager to back the 5% tax rate that applies to the Madeira scheme while alleging that Ireland granted "state aid" to Apple, I've been waiting for Apple's own arguments to be published, and here they are: 14 partly-overlapping pleas.

I'll probably talk about some of those points on other occasions. In this post here I'll just outline why I think this is not a "state aid" case and, actually, not even a "case" by any stretch of the imagination. It's what happens when unelected officials who are not accountable to the people develop an "idée fixe."

Allocation among subsidiaries in different countries has nothing to do with tax avoidance

In its late-August press release, the Commission claimed that Apple's "effective tax rate decreased further to only 0.005% in 2014." That claim portrays Apple as a tax evader that doesn't contribute back to society and fails to pass even the most basic plausibility test because no one, not even a hypothetical merger of a dozen Apple-like companies, could be Ireland's biggest taxpayer that way. The European Commission is all too often a fake news organization--or "very fake news" as President Trump likes to say--and even proud of it (its current president said that you just have to lie when things get serious).

Apple's "effective tax rate" is not what its international subsidiaries pay in one jurisdiction or another. It's what Apple ultimately pays on a global basis, which obviously includes U.S. repatriation taxes. Sooner or later (and it might be sooner rather than later since President Trump hopes to reach an agreement with major U.S. companies on repatriation of overseas funds), Apple would have to bring money back to the U.S. because it can't make dividend payments directly from its Ireland-based operations to its shareholders. At that point, U.S. tax laws would apply, and it goes without saying the tax rate is then not going to be 0.005% or anything like that. Right now it would be more like 35%.

Neither Apple nor Ireland are responsible for a certain asynchronicity of U.S. and European rules governing the taxation of globally-operating corporate groups: while European tax systems (and also the tax systems in many other parts of the world based on what I read) tend to just consolidate a corporation's worldwide income and tax profits in the year in which they were made (no matter where they were made), the U.S. "global deferred" approach focused on when any money gets repatriated.

Until Apple repatriates the money owned by any of its Irish organizations, particularly of Apple Sales International (ASI), it can obviously invest that money. For example, it could make acquisitions. When large U.S. companies with lots of money in the bank in Europe buy European companies (such as Microsoft's deals with Skype and Nokia), they can just use the money they already have in Europe rather than send money over from the U.S. to the selling European shareholders or corporate entities. Then the acquisition targets become subsidiaries of European subsidiaries, and if those deals generate profits, those profits, too, must stay in Europe or will be subjected--as they will be sooner or later--to the U.S. repatriation tax.

In its decision, the Commission does recognize that under Irish tax law a company can be registered in Ireland without being subject to Irish taxes. The Commission describes those companies as "stateless," which again sounds like "never paying taxes anywhere, anytime" and is not the way it is: if a company is registered in Ireland but practically operates outside of Ireland and is managed in the U.S., its profits will be subject to U.S. taxes, just that the point in time when this occurs depends on repatriation.

The EU Commission doesn't say that such companies cannot legally exist. It's all about allocation: it's about how much is taxed in Ireland (and, in that case, taxed immediately) versus how much can be kept in Ireland for a while but will ultimately be subject to U.S. repatriation tax. And that leads us to the second point, which is an incredible legal deficiency of the Commission decision.

There is no basis whatsoever for the "arm's length principle" in EU or Irish statutory or case law

Apple's first plea and Ireland's second and third pleas mention the "arm's length principle" and other pleas involve it indirectly.

When I founded my first limited-liability company in Germany 25 years ago, my tax adviser explained this concept to me. In Germany, it's called "dealings as between third-party strangers," meaning that the business terms of a transaction between myself and a company I own, or between a company and its subsidiaries, have to be reasonable in the sense that one would also, potentially, give that kind of deal to a stranger. If my company bought a laptop for 2,000 euros and sold it to me three days later for 1,000 euros, it would obviously not be the deal it would give anyone else because it just wouldn't make economic sense. However, if my company sold me a laptop today that it bought a year ago, then the commercial value of such a used laptop--and considering that technology has advanced in the interim--may even be less than 1,000 euros.

It's a principle that works very well--though it obviously does keep tax authorities and courts busy--in many jurisdictions. But on 130 pages the European Commission failed to provide a single citation to Irish statutory law or case law that makes it applicable to Apple's inter-company charges in Ireland. The Irish government says it doesn't accept it. Apparently some expert report was provided, too.

Now, theoretically EU rules could require Ireland to apply the principle since EU law can trump national law. But EU law trumps national laws only if a field of law is subject to the acquis communautaire, which is the notion of EU law absorbing more and more parts of national law. However, this ever-expanding nature of EU law (part of the now-failed vision of an "ever closer union") is subject to rules. There must be a democratic process by EU standards. The EU is so undemocratic that one of its past commissioners quipped the EU would have to deny the EU membership in the EU because of its democratic deficit, but even the compromised kind of democracy that the EU has in place is at least partially democratic, with a weak parliament where too many MEPs are directly on the payrolls of corporations and lobby groups and which doesn't have the right of initiative as Nigel Farage recently explained again. So, even the semi-democracy that is called the EU at least has a process in place for what makes something subject to EU law, and that process does involve the European Parliament. The Commission cannot singlehandedly expand the scope of EU law.

There is no EU statute that makes the arm's length principle an EU-wide rule. It's up to the member states to have it or not. The only statute the Commission cites to is the general "state aid" clause, which is not about taxes. There is no EU case law that says the arm's length principle must be applied in all 28 member states. The closest thing that the Commission cites to is a case relating to Belgian tax law, and Belgium, like Germany, simply has the arm's length principle in place in its domestic tax law.

At the fundamentally-flawed heart of the Commission's 130-page decision there is a non-binding recommendation by the non-EU Organization for Economic Co-operation and Development (OECD) concerning the arm's length principle. The OECD is not a legislative body. It's well-respected in some places and contexts, but so are the International Committee of the Red Cross and the World Economic Forum.

Dozens of pages in the Commission decision talk about how to apply some OECD recommendations to the taxes Apple should have paid in Ireland in the opinion of the EU Commission. Dozens of pages to cite to something that is, in legal terminology, persuasive authority at best. It's the kind of thing one would additionally point to in order to show that there is some sort of political support for a law, but it's not a law all by itself.

What adds insult to injury is that the relevant OECD recommendations were issued in 2010, while the Irish tax authority's decisions at issue in the Apple case are from 1992 and 2007. Even if the OECD guidelines predated the relevant decisions, they wouldn't be or make law, but even less so retroactively...

I can't imagine that the Luxembourg-based EU court will content itself with persuasive authority and, on that basis, tell Ireland what its tax laws have to be, when tax sovereignty at the national level is (for better or worse) a cornerstone of EU rules.

Intellectual property

Apple's third plea in law accuses the Eurpoean Commission of "failing to recognize that [the relevant Apple subsidiaries'] profit-driving activities, in particular the development and commercialization of intellectual property ('Apple IP'), were controlled and managed in the United States."

I've been in this industry for decades and I've been on the distribution side as well as on the product development side (that's where my focus is at this point again), and I've been a mediator between both sides, advising IP owners, IP licensees, scouting for products and negotiating agreements. I'm speaking from three decades of experience when telling you that distribution and marketing are generally (there can be exceptions under rare circumstances that merely prove the rule) much less profitable, especially in the long run, than innovation itself.

If Apple commercialized some of its IP in part through entities registered in Ireland but not subject to Irish tax because value creation entirely or essentially occurred in the United States, it's obvious that Europe can't collect taxes on U.S. innovation anymore than it would be acceptable the other way round. As a product scout and dealmaker 99% of my business was about U.S. innovations being commercialized in Europe; now I'm soon going to launch an iPhone app that is very U.S.-focused in its first release (we'll provide content for international markets a little bit later) and I believe I should be taxed in Europe, the place of product development in that case.

The 13-billion euro amount is just a starting point and even the EU Commission recognizes the number could actually be a lot lower

The Commission decision contains three alternative lines of reasoning and it took me a while to figure out how those theories relate to the recovery claims in the decision.

Paragraph 447 of the Commission ruling says that "all profits from the business activities of [Apple Sales International] and [Apple Operations Europe] should, as a starting point, be allocated to their respective Irish branches for the period 12 June 2003 to 27 September 2014 for the purposes of calculating ASI's and AOE's corporation tax liability under the ordinary rules of taxation of corporate profit in Ireland." This approach is like a parody of Occam's razor. They basically look at the profits of those entities--of which ASI is the one that matters for the most part--and apply Ireland's 12.5% standard corporate tax for domestic companies. That's how they arrive at roughly €13 billion, based on the numbers summarized in paragraph 97 (one table for ASI and one for AOE; taxes would then apply to the "profit before tax" column).

But that's just a starting point since paragraph 448 admits that some deductions might still apply. All of us have received communications from tax authorities and they always tell you, down to the cent, how much you are supposed to pay. Here, the Commission doesn't even go through that exercise, yet elevates itself to the Supreme European Tax Authority without lawmakers ever having formally decided that it should play that role.

Then there is a secondary line of reasoning in paragraph 355. Looking at other distribution companies (different companies, different products, but anyway), the Commission determined that 3% is an industry-standard kind of return for distributors. Now, if you compare the "Profit before tax" and "ASI turnover" columns in Table 1 (paragraph 97), ASI's profitability on sales was between about 10% in 2003 and almost 50% in 2011, with only ranges being provided in the redacted version for 2012-2014, which still show a profitability on sales of more than 50% in 2012 and roughly 40% in the following years. So, if the Irish 12.5% tax rates was to be applied to 3% of ASI's turnover, the Commission's recovery amount would go down to a fraction of 12.5% of what the "Profit before tax" column says. With respect to the years when most of the relevant profits were generated (i.e., recent years), the recovery amount would then be less than a tenth (!) of the Commission's primary line of reasoning. Yeah, the €13 billion figure would be more like one billion on that basis. I'll probably take a closer look at it again.

There is also a third line of reasoning in the Commission decision and it just compares the decisions the Irish tax authority took with respect to Apple's business in 1992 and 2007 to decisions made with respect to other companies. Apparently, Apple's lawyers didn't even get any information on those other decisions, making it impossible for them to defend their client. There's nothing in the decision that even specifies what alternative recovery amount the Commission would deem appropriate on the basis of its third line of reasoning. Basically, the Commission just says "we've looked at other decisions and concluded that Apple got some kind of preferential treatment and you all have to take our word for it."

Brussels bogus. I tend to put "state aid" in quotes when writing about this case. It would look too awkward, though it would be justifiable, to also put the word "case" in quotes.

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Tuesday, February 14, 2017

Hypocritical EU competition chief Vestager going after Apple while backing Madeira tax avoidance scheme

This morning I heard an interesting radio report on the European Commission's long-standing, practically unconditional support of one of Europe's worst tax avoidance schemes. In light of the Ireland-Apple "state aid" case, it would be bad enough if this merely involved the European Commission as an institution. Large organizations rarely manage to be consistent. But this is a lot worse: the very same commissioner who wants Apple to pay approximately 13 billion euros in additional taxes, Danish socialist-populist Margrethe Vestager, has given her blessings to the extension of the infamous Madeira tax avoidance scheme until 2027. The aforementioned radio report quotes her spokesman, Ricardo Cardoso, as saying that "the free trade zone is a job engine for the Madeira region and the Commission is presently not aware of any indication that the related structure is not compliant with [EU state aid] rules." That statement is absolutely ridiculous and I'll debunk it further below.

While my primary focus is and remains on patent policy issues, particularly reasonable patent remedies (mostly, but not exclusively, in connection with standard-essential patents), I do take an interest in other issues of concern to my industry, especially competition policy. There was a time when working on EU affairs was an exciting opportunity for me, but I've always viewed the EU's attempts to promote innovation as pathetic, sometimes self-contradictory (with respect to open source, for example), and in some cases downright laughable. What has me concerned now is that the EU has gone from merely failing to have a positive impact on European innovation to causing serious damage, such as by creating legal uncertainty that threatens to dissuade more and more companies from investing here.

There is no way that what Mrs. Vestager is doing against Apple and other U.S. companies (I also disagree with parts of the positions taken by the Commission in the Google investigation) is going to make Europe's own economy any more innovative or competitive. But that may not be the objective. It could be that this is just about anti-American, anti-corporate populism, and it may be driven at least in part by a desire to demonstrate strength while the EU is dealing with enormous centrifugal forces especially in this election year in several key countries.

When the EU Commission handed down its decision against Apple, it stated explicitly that Ireland's 12.5% corporate tax rate is not at issue. Instead, the Commission has made up a "state aid" case when, in reality, the whole issue, for the most part, comes down to Irish tax law not recognizing the arm's-length principle (I support that principle but on 130 pages the Commission's Directorate-General for Competition wasn't able to show that Ireland recognizes it) and the practical effects of different international tax regimes ("global deferred" system in the U.S. versus immediate taxation of global income in Europe).

Instead of blaming Apple for simply playing by the rules, I'm against Ireland's 12.5% rate because it's an abuse of the EU Single Market: it's not the result of fair tax competition but simply arbitrage at the expense of other countries whose taxpayers have to pay for the infrastructure in 99% of the Single Market. If the Commission proposed a change of Single Market rules so as to eliminate this distortion of fair tax competition, I would totally support it. But instead of focusing on the gap between Ireland's abusive 12.5% rate and a more normal corporate tax rate in the 30% range, the Commission is desperately and unconvincingly arguing that Apple unfairly paid less than 12.5%. In other words, instead of tackling two thirds of the problem (the difference betweeen roughly 30% and 12.5%), the Commission is crying foul over whatever may or may not have happened in the bottom third (i.e., whatever the difference may be between 12.5% and what Apple paid).

The EU may very well be the only club in the world that does not have rules in place to get rid of a member if need be. Any sports club, any automotive club, any stamp collectors or pigeon breeders' club can do it. If a member somehow abused the rules, a majority of members could vote to exclude the misbehaving one--and most of the time it will be enough to just threaten with it. But the EU has a bad design that has gotten worse over the years due to grossly incompetent and unbelievably irresponsible "leaders" pursuing the idea of an ever-closer union. Since Brexit, the tide has turned, except that some people in Brussels don't want to face that fact yet.

Ireland's 12.5% corporate tax rate is still high if you compare it to the tax rates that apply to the so-called International Business Centre of Madeira (IBCM) on the namesake, remote Atlantic island belonging to Portugal. According to its own representations, it offers a reduced corporate tax rate of 5% (five percent!), and this official question by a far-left Member of the European Parliament refers to tax rates "vary[ing] between 1[%] and 5%".

The investigative reporters at Bayerischer Rundfunk ("Bavarian Broadcasting") just don't buy the European Commission's claim that the Madeira tax haven is just part of a regional development initiative designed to attract foreign investment on that remote Portuguese island. Instead, it plays a role in tax minimization schemes employeed by such individuals as

  • former FIFA secretary-general Jerome Valcke,

  • someone who was close to Muammar Gaddafi,

  • soccer player Javier Mascherano (who was convicted of tax evasion in Spain),

  • another famous soccer player, Xabi Alonso, who is being investigated by Spanish authorities, and

  • a German rock band, Böhse Onkelz, that assigned all of its trademark rights to a Madeira-based entity.

Furthermore, companies such as Chevron, its Italian competitor eni, Pepsi and Russian aluminum maker Rusal have set up legal entities there.

Approximately 1,600 legal entities benefit from the rockbottom tax rates of this special deal between Madeira and the European Commission. If this were a regional development program, the objective would have to be to create employment. But the EU is lying about the true purpose. All those Madeira-based low-tax entities combined have created only 2,721 jobs according to official statistics (year 2014), which would be a pretty meager number in and of itself but even overstates the actual effect on jobs since a closer look reveals that many individuals formally hold jobs in several such companies at the time, with each job being counted once even if one person holds, as they found in one case, 300 jobs. If this fact is properly taken into account, the whole Madeira scheme has not had any noteworthy effect on employment.

Time and time again, over the course of 30 years and in one or more cases under Ms. Vestager's auspices, the EU Commission has approved the extension of Madeira's tax regime and has declared it as a category "of aid compatible with the internal market"--now even until 2027.

The Commission's decision against Apple is weak; the Commission's inconsistency is also on display in connection with the Monte dei Paschi di Siena bank bailout; but the Commission's handling of the Madeira scheme, as compared to the fabricated "state aid" allegations in the case relating to Apple's Irish taxes, is more than inconsistent. It's hypocritical beyond belief.

Bavarian Broadcasting quotes a German Member of the European Parliament, Markus Ferber, whose regional party is part of Merkel's government coalition, as saying that the EU can only enjoy credibility vis-à-vis Panama, Singapore or the Bahamas (or Switzerland) if it has its own house in order. Therefore, Mr. Ferber finds it incomprehensible that the European Commission has been tolerating the Madeira scheme so far, despite being alerted to the problem that it constitutes. I agree with Mr. Ferber up to this point, but he forgot to mention the Ireland-Apple case and the praise he heaped a few months ago on Ms. Vestager.

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Friday, February 10, 2017

Apple may have paid Qualcomm approx. $40 per iPhone, accounted for third of Qualcomm's revenues

At the end of my previous post on Qualcomm's business model I wrote I would follow up with an analysis of the economic magnitude of the various antitrust investigations and civil complaints concerning Qualcomm's two mutually-reinforcing business areas, baseband processor chipsets and wireless standard-essential patent licensing. While it will probably take a while before a publicly-accessible court filing by either Qualcomm or Apple makes reference to a particular damages claim or royalty rate, some information is already available and I'll take the liberty of connecting some dots. If you consider some of it speculative, that's fine, but someone has to do the job of trying to infer and deduce information even in the early stages of a dispute.

Many media reports on Apple's recent complaint (see PatentlyApple's report, which includes the document) portrayed it as a $1 billion case. However, $1 billion is just the only somewhat precise number that the complaint states but relates to merely a subset of the issue. Paragraph 4 is clear about that:

"Apple, which has been overcharged billions of dollars on Qualcomm's illegal scheme, brings this action to recover its damages, enjoin Qualcomm from further violations of the law, and request declaratory relief. Among Apple's damages are nearly $1 billion that Qualcomm owes to Apple under an agreement between the two companies." (emphases added)

So without much effort or speculation, we know it's about "billions of dollars." But how many billions? Apple's prayers for relief don't say. After the court has determined a fair, reasonable and non-discriminator (FRAND) royalty rate for certain Qualcomm patents, Apple may be more specific.

"Billions of dollars" can mean anything from $2 billion to ten times that amount or more. If we were talking about substantially more than $20 billion, the complaint would almost certainly say "tens of billions." But in the aggregate of damages recovered for the allegedly excessive charges of the past and lower payments being made in the future, that dispute may indeed be about tens of billions of dollars.

The $1 billion part of the overall claim is just about one year's "rebate" (a term that, according to the complaint, Apple uses though Qualcomm rejects it) paid by Qualcomm to Apple. Paragraph 100 provides the following clarification:

"The rebates reduced, but by no means eliminated, Apple's overpayment of royalties to Qualcomm. Taken together, these rebates reduced the effective royalty burden on Apple to around [REDACTED] per iPhone and iPad through 2016. This represents an amount that is still significantly larger than the royalty Apple pays for [REDACTED]—licenses that collectively represent a far greater percentage of the patents declared as essential to the cellular standard."

The second sentence is consistent with other factual representations made by Apple in its complaint, such as the second sentence of paragraph 79:

"In 2016, this was an order of magnitude greater than the royalties that Apple pays to any other patent holder, and indeed is more than Apple pays to all other cellular patent holders combined."

Paragraph 80 focuses on four other licensors (presumably including such companies as Nokia and Ericsson):

"By way of illustration, in 2016, Apple's four largest direct licenses for cellular-related SEPs, excluding Qualcomm, were with [REDACTED], each of which has made claims similar to Qualcomm about the strength and value of their respective portfolios of 3G and 4G cellular SEPs. Together, these four licensors represent [REDACTED] of all 4G cellular SEP declarations, significantly above the 23.5% self-declared by Qualcomm [...]"

The second sentence of paragraph 81 suggests the problem is exacerbating:

"Moreover, Qualcomm currently is demanding Apple pay [REDACTED] that amount starting January 1, 2017."

If we knew how much Apple pays licensors like Nokia and Ericsson, we'd now be able to estimate what Qualcomm has received. I would guess that the four largest cellular patent holders except Qualcomm collectively get something on the order of $10 per iPhone, but this guess could also be very wrong (in whatever direction).

What the complaint makes clear is that Apple has to pay Qualcomm for the baseband processor chipset (except that it's now using Intel chips in part) and for a patent license. Paragraph 83 is a very important one: its first sentence states that "a baseband processor chipset sells for around $10 to $20." It's a reasonable assumption that Qualcomm as the market leader is at the higher end of the range, while anyone still trying to somehow compete with Qualcomm will have to sell products at a much lower price.

The last sentence of paragraph 83 compares Qualcomm's patent royalty demands to the price at which it sells its baseband processors. In the image below, I've added some possibilities for what is hidden under the blackout rectangle (click on the image to enlarge; this post continues below the image):

Note that the numbers are not meant literally: they are just meant to show the width of different kinds of numbers (or the word "half") in the same font. For example, 100% has the same width as 199%, but not the same as 200% ("2" is wider than "1").

A triple-digit percentage with a "1" (all other numbers are wider) in the beginning looks like the most probable scenario. Let's now assume 100% because it's the lowest (i.e., most conservative) percentage that would match the width of the redacted area. The other examples in the above image just aren't wide enough, and it's really very hard to imagine anything else there than a percentage.

So, if Qualcomm sold its baseband processors at approx. $20 per unit and collected or demanded royalties from Apple amounting to more or less the same amount, that would correspond to $40 per iPhone (or cellular iPad). Since 2015, annual iPhone sales have been north of 200 million units. If one multiplied that number with the $40 hypothesis, that would be a total (even before adding cellular iPads) of $8 billion a year, or roughly a third of Qualcomm's revenues.

This is now the right moment for a first plausibility check. Is it possible that Apple alone accounts for approximately a third of Qualcomm's revenues? I believe it is. Qualcomm reports revenues for its two divisions, the chipset division and the patent licensing division. Chipset sales are more than twice as big as patent licensing revenues (see the table on page 10 of Qualcomm's last annual report), but presumably the chipset price doesn't vary nearly as much from customer to customer as patent royalties, given that Qualcomm seeks a percentage of the sales price of a device. The average sales price of the iPhone was $695 last quarter and not much lower in the previous quarters. That's a whole lot more than for other companies in the industry (and part of the reason why Apple is by far and away the most profitable device maker). Apple is also selling the highest number of units (it has surpassed Samsung again, and Samsung's average sales price is substantially lower).

Another plausibility check is based on what is publicly known about Qualcomm's commitments and representations to China's National Development and Reform Commission (NDRC). In this press release (PDF), Qualcomm refers to "royalties of 5% for 3G devices (including multimode 3G/4G devices) and 3.5% for 4G devices (including 3-mode LTE-TDD devices) that do not implement CDMA or WCDMA, in each case using a royalty base of 65% of the net selling price of the device." Multiplying 5% with 65% of the average iPhone sales price is also roughly a $20 per-unit amount.

By the way, while Qualcomm's press release portrays those percentages as having been approved and/or mandated by the NDRC, footnote 10 of this third-party document says:

"The [NDRC] Decision does not define what would constitute a lawful royalty base or royalty rate. It thus stops short of imposing on Qualcomm a 'compulsory license' with any specific rates or terms."

I don't know what exactly the purpose of those percentages is then, but here we just need them for a plausibility check.

What I have no doubt about is that Apple v. Qualcomm is way bigger than Apple v. Samsung, and if Apple succeeds in getting its terms improved, or if further headway is made on the antitrust front, I wouldn't be surprised to see Samsung and others seek refunds and price reductions... actually, in that scenario I'd be surprised if it didn't happen.

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Wednesday, February 8, 2017

Federal Circuit sends Apple v. Samsung design patent damages back to where things started

Apple and Samsung have now been embroiled in litigation for almost 70 months--the dispute's sixth anniversary is just about two months away. Many issues have been resolved over the years (at least to the extent that the parties stopped pursuing certain claims), but unless there is a surprise settlement, it could take several more years for the part relating to design patent damages to reach the point of a final ruling where all appeals have been exhausted.

Yesterday, the United States Court of Appeals for the Federal Circuit remanded (PDF) the matter to the United States District Court for the Northern District of California. A week before I had written that I was "fairly optimistic" about that direction.

The Federal Circuit stresses in the remand opinion that it technically hasn't agreed with either party's proposed course of action. Apple wanted the appeals court to determine that the record didn't support Samsung's theory regarding the appropriate article of manufacture. Samsung wanted a remand for the purpose of a retrial. The Federal Circuit just wants the district court to "parse the record" and determine whether any further proceedings are needed, which could be the retrial Samsung is seeking but could also be the kind of finding of evidentiary failure that Apple is hoping for.

Since the Federal Circuit initially affirmed the original ruling by the district court, Samsung has had to surmount three hurdles, at any one of which it could have faced final defeat but didn't:

  1. The first hurdle was Samsung's cert petition. Getting the Supreme Court to hear a case is statistically a long shot, but I was very optimistic about that one from the beginning. The statistical odds are long against a cert petition if one looks at the totality of all petitions, even including pro se litigants. In this case, the importance of the matter was easy to figure out and the Supreme Court hadn't looked at a design patent case in well over a century.

  2. At the outset of the Supreme Court proceedings it still wasn't a given that the original Federal Circuit opinion (according to which there was no room for any other interpretation than considering an entire phone the article of manufacture with respect to which Samsung owed Apple a disgorgement of infringer's profit) would be overturned. The tipping point was probably when the Department of Justice filed an amicus curiae brief that formally supported neither party, still backed Samsung's key point about the Federal Circuit having made a mistake. Apple subsequently stopped short of defending the original Federal Circuit opinion. But even with the parties and the DoJ agreeing on a particular question of law, the Supreme Court could still have reached a different conclusion. The Supreme Court could still have said that the law is what it is and any policy concerns would have to be directed to Congress. It didn't say that, but it didn't pronounce a new rule either.

  3. After the court of third instance remanded the case to the court of second instance, Apple already had a better chance of prevailing on its "unsupported by the record" argument. But it makes sense for the appeals court to say that this kind of discussion belongs into the trial court. There must be millions of documents in the record and the devil could be in the detail, with the case potentially hinging on whether some testimony in connection with some passage from an expert report is or is not sufficient to support a particular "article of manufacture" theory.

Some of the experts who participated in a media briefing conference call last month (organized and moderated by Carl Cecere, an appellate attorney who filed amicus curiae briefs in support of Samsung's position for non-governmental organizations) talked about how likely it was that the case would be decided on the basis of the record not supporting Samsung's article-of-manufacture argument, and while they agreed that one would actually have to see the whole record (which isn't possible), it didn't seem to be the most likely way in which the case would be resolved. What also came up on that call was the question of who has the burden of proof for the "article of manufacture": plaintiff or defendant? The parties disagree on that one. I consider yesterday's Federal Circuit decision the most efficient way forward for this dispute with only one exception: I think it would have been (even) better if the appeals court could have given guidance to the district court with respect to the burden of proof. It didn't have to, and it might have been a bit unusual to do so, but it would have helped because otherwise the burden of proof alone could give rise to another sequence of appeals...

The district court will, unless the case is decided on the basis of the alleged evidentiary failure, have to pronounce a rule for identifying the relevant article of manufacture. As I wrote last month, I believe the Federal Circuit would have been in a great position to do it, and that panel in particular. But it's understandable that the Federal Circuit wouldn't want to pronounce a rule that may not even be relevant in the further proceedings here (though it may be forced to do just that in connection with some other case, such as Nordock v. Systems).

In my opinion, rule-setting benefits greatly from a multi-judge panel, or (even better) a full-court review. Judge Lucy Koh, who would be a Ninth Circuit judge by now or even a nominee for the Supreme Court if not for the outcome of the presidential election, will have to do it all alone. Over the years of this Apple v. Samsung litigation, she has proven that she can manage a complex, high-stakes case very well. In connection with the standard for injunctive relief, I felt sorry for her because she had to deal with a constantly-moving target--even worse than that, a target that would almost always adjust its position in such a way that she got overruled. No matter what rule for the "article of manufacture" she pronounces, one party will believe to have been prejudiced by her decision and appeal, and then this could even go back all the way to the Supreme Court. On the aforementioned conference call, Carl Cecere asked Rothwell Figg's Derek Dahlgren whether there was "a decent change it'll boomerang right back to the Supreme Court as to the design, whatever the test they fashion?" Mr. Dahlgren replied:

"I think that it's possible. I would suspect that if there were issues in the implementation of the test after [unintelligible] on remand, for example, if that was necessary, that then depending on the outcome, if it was something that the Supreme Court disagreed with, I think that you look at the massive damage adjustment that that will receive in this case and I think that just the [unintelligible] of it certainly lent itself to getting scrutiny from the Supreme Court.

So if there's something that happens after, like some sort of [unintelligible] test, they kind of present the same type of [unintelligible], something that says 'This isn't right, this is out of balance,' then I think there's a pretty reasonable chance that the Supreme Court may want to take this issue on."

In that hypothetical scenario, the case might go all the way back to the district court for yet another trial...

So much for the worst-case time frame. What about the stakes?

For the parties, it's still about enough money and to some degree also a reputational concern that it makes sense for them to keep going. The worst case for Samsung would have been that Apple's judgment gets affirmed and that the industry at large, with Samsung being (besides Apple) the main target of patent assertions by non-practicing entities, would have had to deal with the consequences. That very worst case has been avoided thanks to the Supreme Court opinion. Samsung still faces some remaining uncertainty as to whether it will have the burden of proof for the "article of manufacture" and, if so, what the district court's findings related to the record are going to be. For Apple, it's now a nothing-to-lose-something-big-to-gain situation. Apple itself would have been a target of extortionate design patent assertions if the original Federal Circuit opinion had been affirmed, but that's not going to happen and future defendants like Apple will present tons of evidence regarding the article of manufacture. Apple can still try to get the most out of this litigation. I understand that desire but I would consider it unfortunate because no matter on what basis Apple would get an outsized design patent damages award, it would encourage more litigation of that kind and could lead courts and (to the extent they hear about it) juries to award excessive amounts.

Judge Koh is a hard-working judge. No doubt she will soon provide a roadmap.

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Thursday, February 2, 2017

Qualcomm's two mutually-reinforcing monopolies: SEP thicket, baseband processor chipsets

In late December, the Korea Fair Trade Commission held Qualcomm in violation of antitrust laws, and after a reader pointed me to what appears to be Qualcomm's unofficial translation of the decision, I promised "further discussion here at a later stage." Then, a couple of weeks later, the United States Federal Trade Commission sought injunctions against Qualcomm (a complaint was filed in the Northern District of California). A little later, Apple brought its own lawsuit against Qualcomm (see PatentlyApple's post, which contains the complaint, according to paragraph 4 of which Apple claims to have been "overcharged billions of dollars on Qualcomm's illegal scheme" and now "seeks to recover its damages").

It appears that Samsung played a more active role in Korea, as the KFTC decision lists an expert who participated in the investigation on Samsung's behalf (Professor Sang-Seung Yi of the School of Economics of Seoul National University) but not one for Apple. In the U.S., Apple has now been more proactive as it filed its own complaint against Qualcomm, though I wouldn't be surprised to see a similar one by Samsung.

While we're on the subject of Apple and Samsung, or #appsung, just a quick update. If you don't care about design patents, please just click here.

I've been watching the dispute between those two companies for almost six years and most of the time I agreed with whomever was the defendant. Since Samsung dropped its own standard-essential patent (SEP) assertions against Apple, the main concern has been about Apple's assertions of design patents and non-standard-essential utility (technical) patents against Samsung. In December, Samsung prevailed in the Supreme Court, though the ultimate outcome of that dispute remains to be seen. Apple filed a statement in late December asking the Federal Circuit to uphold the original judgment, while Samsung ideally wants a new trial or, at a minimum, new appellate proceedings (briefings and oral argument).

I wouldn't want Apple to win affirmance of the original judgment against Samsung. Even though the Supreme Court ruling should enable future defendants to avoid a total disgorgement of infringer's profits over a design patent infringement and Apple's argument is now all about Samsung having allegedly failed to present evidence regarding the "article of manufacture" question, the signal would be that draconian damage awards are still available, and that would have chilling effects and encourage extortion. I'm fairly optimistic that Samsung will get a remand to the district court simply because there will have to be a damages retrial anyway (with the same design patents at issue again), so the Federal Circuit may very well consider it more efficient to just have the design patent damages question addressed there.

An industry issue

For now, there is every indication that Apple and Samsung, despite Apple's still-disappointing design patent damages claims and Samsung's once-disconcerting royalty demands and injunction requests over SEPs, agree on the huge Qualcomm issue--and so many others agree with them, including Intel and the Brussels-based Fair Standards Alliance, whose members include (among others) Google and several automotive and other Internet-of-things companies. Antitrust enforcers in multiple jurisdictions agree as well, but they don't always act forcefully enough to bring about change.

Over time the different Qualcomm proceedings will make plenty of news and bring interesting facts to light. I'll write about this from time to time, depending on how interesting the revelations are. For now, while one can already find a number of interesting tidbits in the various complaints and decisions (also including the Chinese NDRC's Qualcomm order), let's focus on the biggest issue:

Qualcomm has a patent-based monopoly as well as monopoly power (one might argue it's not a monopoly in a strict sense but "merely" market superdominance) in the baseband processor chipset market, and beyond appearing to abuse such monopoly power to extract supra-FRAND royalties and anticompetitive concessions, Qualcomm is (based on what certain regulatory agencies have held) leveraging each monopoly to reinforce the other.

This is a vicious circle for the mobile industry, and I hate to even think about all the money that I have indirectly paid to Qualcomm as I've bought roughly half a dozen Samsung Galaxy phones and almost as many iPhones over the years. Qualcomm deserves to get fair compensation for its contributions to innovation, but the vicious circle I just mentioned must be broken, lest it turn into a spiral with Qualcomm potentially gaining control over additional smartphone components. Monopolies are always a problem, but monopolies that spawn additional ones are a worst-case scenario for competition and innovation.

SEPs are monopolies by definition--but the problem is even bigger here

Courts and regulatory agencies in different jurisdictions (including the U.S. FTC and the KFTC) have recognized that even a single patent, if it is truly standard-essential (meaning you can't implement the standard without licensing or infringing the patent), confers monopoly power on its holder. A very few outlier opinions that denied this on the basis of more than one patent holder owning SEPs to a specific standard were plain ridiculous as a patent is not a right to do something but a license to sue someone, so even if you own one patent or have a license to one patent, it won't serve as a defense in case you infringe someone else's patent.

One SEP can be powerful (as a Motorola expert once said, "it only takes one bullet to kill"), but if your only concern as an implementer of a standard was a single patent, you would at least have the chance to evaluate the patent, identify prior art to get it invalidated if necessary, and analyze whether the patent actually is essential to any implementation of the relevant standard.

Not so with an entire patent thicket. In 2010, told Samsung that it owned an entire "thicket of patents" around the iPhone. Depending on your definition of a patent thicket, it did, but the portfolio Apple was referring to back then is dwarfed by those thousands of Qualcomm patents declared (by Qualcomm itself, which means court would still have to verify) essential to wireless standards.

Baseband processor chipsets: Qualcomm's competition is somewhere between a heavily-endangered and an extinct species

What regulators have found is that Qualcomm's position in the market for baseband processor chipsets--the basic component that handles the low-level (i.e., basic) communication of the device with the base stations of mobile network operators--is extremely dominant. Without a baseband processor chipset, it's impossible to make a phone call, but even the dumbest dumbphone has one, which shows that it takes Samsung a whole lot more to build a Galaxy smartphone and Apple a whole lot more to build an iPhone.

It's obviously not impossible from an engineering point of view to build chipsets that implement different cellular standards. The market is huge. So why is there a lack of competition? After reading multiple decisions and complaints, I believe it's because of the way Qualcomm has made it next to impossible for others to compete in certain market segments. If a company like Intel struggles to stay in this business at all, despite its ability to develop and manufacture even the most complex chips, the answer must be non-technical.

Qualcomm holds patents related to different wireless standards and makes chips implementing different standards, but its position in the baseband processor market is particularly strong with respect to CDMA (code division multiple access), a standard that the existing network infrastructure of Verizon and Sprint, a large chunk of the market in the U.S., supports. It's a 2G (GSM-level) standard, but backwards compatibility is still key. This gives Qualcomm particular leverage--and an incentive to prevent CDMA from being replaced by competing standards that might work over the same existing network infrastructure.

No license, no chips--no chips, no affordable license

One of the antics that the FTC and apparently also other regulators don't want to put up with anymore is that Qualcomm has a "no license, no chips" policy: unless you take a patent license from them, you won't get to buy their chips. This is a huge issue given that the principle of patent exhaustion says a maker of a product can't allege infringement of its patents by any direct or indirect ("downstream") customer. Basically, Qualcomm wants to get paid for patents that have already been exhausted. (According to what I read in a complaint, Qualcomm also wants to get paid for patents that have expired...)

The even bigger problem is that Qualcomm allegedly charges far higher license fees if a company doesn't exclusively use its chips. Apparently, the way it works is that Qualcomm charges fairly high fees but pays some of the money back (Apple's complaint describes this as "rebates" in spite of Qualcomm apparently rejecting the term) in exchange for exclusivity commitments and other concessions that may be similarly anticompetitive.

But the biggest issue in my view is this: Qualcomm refuses to grant licenses to other baseband processor chipset makers. How could such conduct not be discriminatory, i.e., the opposite of FRAND (fair, reasonable and non-discriminatory)? Qualcomm is not the only SEP holder to refuse to license chipset makers. Ericsson even explained publicly why it likes that strategy. The Qualcomm cases in different parts of the world may be the most splendid opportunity in a long time to have that practice be declared anticompetitive and non-FRAND. By the way, as I already discussed here almost five years ago, Qualcomm once changed its corporate structure just in an effort to avoid patent exhaustion.

A cornerstone of Qualcomm's strategy is that it has positioned itself as the primary clearing house for cellular patents. It requires its licensees to enter into a covenant not to sue Qualcomm's customers. Apple benefitted from this in the early stages of its dispute with Samsung (patent exhaustion), but patent pools with FRAND licensing terms are a much better vehicle to achieve this than a private, allegedly predatory enterprise that has simply leveraged monopoly power to elevate itself to this.

For device makers, this means that if you don't buy from Qualcomm, you're exposed to patent infringement claims that Qualcomm may bring against you; but if you do buy from them (which includes that you need to take a license), you'll be protected from infringement assertions by a long list of cellular SEP holders.

SEPs should be licensed on FRAND terms, and chipset makers should compete on the technical and economic merits. Regulators, customers, the sole remaining competitor (Intel) and industry associations are now trying to get Qualcomm to offer licenses on FRAND terms to everyone, including its competitors and its competitors' customers.

This blog has been pro-FRAND since the year I started it (2010). While I'm not as prolific a writer nowadays as I used to be, I'll try to follow the various Qualcomm cases. In light of Apple's latest financials (with record iPhone sales), I also intend to talk about the economic dimension of this issue based on the information available to me, i.e., regulatory decisions, publicly-accessible complaints, and SEC filings.

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