Defining FRAND Royalties and FRAND Terms and Conditionsis.jrc.ec.europa.eu/pages/ISG/EURIPIDIS/documents/MauritsDolmans.pdf · Huawei/ZTE (2015?) 12 . Samsung . Commitments – FRAND

© 2013 Cleary Gottlieb Steen & Hamilton LLP. All rights reserved. Throughout this presentation, “Cleary Gottlieb” and the “firm” refer to Cleary Gottlieb Steen & Hamilton LLP and its affiliated entities in certain jurisdictions, and the term “offices” includes offices of those affiliated entities.

Maurits Dolmans Institute for Prospective Technological Studies, SEP Workshop Seville, Oct 27, 2014

Defining FRAND Royalties and FRAND Terms and Conditions

T&C What is a FRAND royalty - patent pools as comparators? What base (phone or chip) - the difference between

– MSFT case (2012 judgment) – goal is to restore competitive market – FRAND in SSO context – goal is to find ex ante incremental value – Excessive pricing – goals is to avoid exploitation (abuse only if price is

substantially above value) - Can “pre-willingness” damages be supra-FRAND?

Overview

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What is the economically efficient level of royalties overall (in view of creating innovation, spreading technology)?

Should the societal benefits of standards be reflected in permissible royalty rates? How?

Should FRAND royalties be based on end products (interest of innovators) or on product components (interest of implementers)?

Are there upper or lower bounds for FRAND licensing terms (2, 5, 10%)? Should royalty fixing also consider the other royalties (i.e. the royalties

for patents that are not standard essential) to be paid by the licensee or should the fee only be related to what the standard essential patents had contributed?

Should royalties consider an ex ante benchmark? Could more transparent and more harmonized rules on patent

'essentiality' and FRAND licensing terms mitigate the risk of conflicts? How?

Questions

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1. Principles, Relevance of Competition Law and Recent EC Cases (Motorola, Samsung)

Principle: industry-wide successful standards must be available to everyone to implement

- Horiz. Guidelines, para 268: “If a company is either completely prevented from obtaining access to the result of the standard, or is only granted access on prohibitive or discriminatory terms, there is a risk of an anti-competitive effect

- SEP holders, esp. PAEs, should not use injunctions to hold up “willing licensees”

- Various ways to achieve this availability to willing licensees:

– Contract law, patent law (equity principles), competition law: Standard setting (restriction of inter-technology competition) only allowed if no abuse under 102 TFEU, and if conditions of “rule or reason” / 101(3) TFEU are met, including:

– Necessity (no less restrictive alternative)

– Fair share to consumers – that means FRAND licensing

– No elimination of all competition – this means no injunctions that could foreclose competitors

Standard-setting and FRAND

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Para. 269: “a participant holding IPR essential for implementing the standard, could, in the specific context of standard-setting, also acquire control over the use of a standard. When the standard constitutes a barrier to entry, the company could thereby control the product or service market to which the standard relates. This in turn could allow companies to behave in anti-competitive ways, for example by ‘holding-up’ users after the adoption of the standard either by refusing to license the necessary IPR or by extracting excess rents by way of excessive royalty fees thereby preventing effective access to the standard”

Para. 285: “In order to ensure effective access to the standard, the IPR policy would need to require participants wishing to have their IPR included in the standard to provide an irrevocable commitment in writing to offer to license their essential IPR to all third parties on fair, reasonable and non-discriminatory terms ”

Para. 286: “IPR policy would need to require good faith disclosure, by participants, of their IPR that might be essential for the implementation of the standard under development. This would enable the industry to make an informed choice of technology and thereby assist in achieving the goal of effective access to the standard.”

Para. 287: “FRAND commitments can prevent IPR holders from making the implementation of a standard difficult by refusing to license or by requesting unfair or unreasonable fees (in other words excessive fees) after the industry has been locked-in to the standard or by charging discriminatory royalty fees. ”

FRAND promises and disclosure in Guidelines on Horizontal Agreements

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EC adopted decision against Motorola for seeking and (briefly) enforcing injunction against Apple based on FRAND encumbered SEP

- seeking and enforcement of an injunction against Apple … amounts to an abuse… [since] clear indication that Apple was not unwilling to enter into a licence agreement on FRAND terms and conditions” (Motorola, para. 280)

- Apple reserved right to challenge validity and infringement of the licensed SEPs

Motorola v Apple (2014) -- background

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EC contradicted German court, which granted injunction because Apple was not a “willing licensee” based on Orange Book case law

Litigations took place against background of broader patent war in the mobile industry waged by Apple, Microsoft, and others against Android

- Steve Jobs: “I'm willing to go thermonuclear war on this”

Motorola and Samsung: Apple’s huge portfolio = countervailing power - Ability to punish or retaliate

EC ignored this (had to…, since otherwise precedent would fall apart) - “countervailing buyer power is the buyer's ability (or credible threat) to switch to

competing suppliers” (para. 243) – But there are other sources of power, like ability to punish or retaliate

- “the Commission’s assessment of whether Motorola enjoys a dominant position is based on the economic strength Motorola enjoys as the holder of the Cudak GPRS SEP vis-à-vis the market as a whole, and not on the basis of its negotiating position vis-à-vis one or more customers such as Apple” (para. 241).

– In past cases, EC resolved this by defining separate relevant product market for different customer categories. See Guidelines on Market Definition, para 43

- “In cross-licensing negotiations between Motorola and Apple, Motorola … has consistently evaluated the strength of Apple's patent portfolio to be below the strength of Motorola’s own portfolio. As a result, and regardless of whether Apple agrees with such an assessment, Apple's large patent portfolio comprising both SEPs and non-SEPs does not exercise a constraint.” (para 252-3)

– In reality, Apple did the same, and litigated aggressively, and got injunctions

1. When Are SEP Owners Dominant?

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“seeking and enforcement of an injunction against Apple … amounts to an abuse… [since] … Apple was not unwilling to enter into a licence agreement on FRAND terms and conditions” (Motorola, para. 280)

– “and” means both are required in the circumstances of this case where Apple was unwilling between 2007 and at least until 2d Orange Book offer in 2011

– Commission makes a point of mentioning the (< one-day) “enforcement”

If the Samsung or similar process is being followed, and the user has agreed to submit rate setting and T&Cs to court review, then “seeking” may already be an abuse.

– But to say that “seeking” alone is an abuse when use is “unwilling”, or it is unclear whether user is “willing” is wrong under ITT Promedia, and impractical.

– ITT Promedia: a company cannot be prevented from going to court to ask a judge whether the other side is “unwilling” and whether an injunction is justified, unless that litigation itself is vexatious – i.e., when it is clear than user is “willing”

So, is there a “safe harbour for patentees? – Press release / Q&As leave open what happens if a user does not submit. – Patentee must be able to use if the user refuses to submit (as ZTE did in Huawei).

2. What exactly is the abuse –seeking injunctions?

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The Ostrich-head-in-the-sand prize for para 420: – “This risk of reverse hold-up by Apple, however, does not arise in this case.” – Para 441 “Apple's alleged unwillingness between 2007 and 2010 is irrelevant for

the purposes of this Decision as this cannot justify Motorola's continued seeking and enforcement of an injunction against Apple in Germany on the basis of the Cudak GPRS SEP after 4 October 2011, the date of the Second Orange Book Offer.”

– So: unwilling users can redeem themselves, even after years of obstruction, even after injunction is granted

See also fn 349: “Motorola’s allegation that internal Apple e-mail correspondence suggests that, when making its Orange Book Offers, Apple may also have been hoping to delay the litigation, cannot alter the fact that, as of its Second Orange Book Offer, Apple was willing to enter into a licensing agreement with full judicial review and determination of the proposed FRAND royalties with retroactive effect by a court “.

– Does that mean there is no incentive to take early license? Some incentive left: – Para. 399: “The Second Orange Book Offer added that "LICENSOR reserves the

right to assert higher damages for these acts in addition to this one-time royalty payment." The decision does not object to that. See also para. 404-405.

3. What is “willingness”? – no attention to Apple’s shenanigans…(focal point in Huawei v ZTE)

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FRAND principles now followed in various jurisdictions: -EC – Rambus, IPCom, Samsung, Motorola – Huawei v ZTE

– D -- Orange Book; NL – Samsung v Apple; UK – Nokia v IPCom -US – Rambus, Broadcom v Qualcomm, Bosch, MSFT v Motorola

(Robart), Apple v Motorola (Posner), Innovatio (Holderman), Ericsson v D-Link (Davis), Wi-LAN v Alcatel Lucent (Davis), CSIRO v Cisco (Davis), Realtek v LSI (Whyte), GPNE v Apple (Koh), Golden Bridge v Apple (Grewal)

-China – InterDigital, Qualcomm? Exceptions include: -Licensee breach of contract -Licensee who cannot pay -Licensee who refuses per-standard reciprocity -Licensee who brings SEP-based litigation against SEP holder

(defensive suspension)

Convergence EU, US, PRC: No holdup based on SEPs

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Motorola establishes the precedent (although facts didn’t fit theory): - No injunction against a user who is willing to take a license on FRAND terms - Request to license can be made at any time, even years after litigation starts - A licensee is “willing” if it offers FRAND fee and/or agrees to have FRAND

royalty set by court or arbitral tribunal - A licensee may be “willing” even if challenging validity, infringement, essentiality

Samsung Commitment Decision explains one way how this can be done - Offer to give/take FRAND license, followed by period of negotiation, and if that

fails, royalty and any disputed term are set by court of arbitral tribunal Judgments in US already set FRAND rates (Motorola, Innovatio) - And arbitration proceedings are pending

Huawei v ZTE (preliminary ruling) - Advocate General opinion expected November 20, 2014

4. How to implement? Samsung (2014) and Huawei/ZTE (2015?)

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Samsung Commitments – FRAND setting process

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Lengthy negotiation period

No obligation to pay into escrow

No release if user challenges validity and infringement

Can FRAND rate be set probabilistically?

If so, how does it fit with ability to challenge validity and infringement?

Can patent owner require global license?

Basic principle: Offer resolution process to set FRAND terms

Final Commitments; Commission decision of April 29, 2014

http://ec.europa.eu/competition/antitrust/cases/dec_docs/39939/39939_1502_3.pdf

http://ec.europa.eu/competition/antitrust/cases/dec_docs/39939/39939_1501_3.pdf

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2. What is a FRAND royalty?

1. Revealed preference of vagueness? -Used to be the case when telecom operators dominated ETSI, who did

not compete cross-border – Now everyone is unhappy

2. Joe Farrell economic analysis suggests: collective interest to charge outsiders and set off claims between insiders -Requires Symmetry of patent ownership and business size ?

3. Participation constraint / trade-off – clarifying rules chases members away, who then are not constrained and can hold up members (Rambus!) -But those who leave SSO lose influence and knowledge, - lose value in getting technology accepted / advance knowledge

4. Gridlock in ETSI: desire to maintain holdup and holdout opportunity…

Why is FRAND so vague? Why don’t SSOs clarify?

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What is FRAND royalty? Article 102 TFEU

• Price must bear reasonable relationship to “value” (102, Swedish Ports) • “Value” = rate that the IPR owner could have obtained in ex ante inter-

technology auction (Shapiro/Baumol Principle). Two aspects: • 1. “incremental value” rule

– Value of innovation of technology A = (i) profit that licensee gains if it uses A instead of next best alternative B + (ii) price of B

• (i) = opportunity cost of “not using A and instead using B” • (ii) Price of next best alternative B is probably competed down to zero: this

benefit accrues to the consumer

• 2. Ex ante rule: incremental value to be calculated before lock-in – When there still is inter-technology competition

• Check that IP owner did not take anti-competitive action to diminish ex ante inter-technology competition, e.g. by buying patents in all alternatives

– Ex post valuation inappropriate since it would allow patentee to appropriate not just value of the innovation but also value of licensee’s investments in innovation and implementation

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Assume essential patent for product - Royalty = licensee’s opportunity cost of not using the patent =

net value of the market created by the patent - In case of an essential patent, this is the entire monopoly value. Is that “fair

and reasonable”? This is like the Dictator game (proposal to share, take it or leave it) or

Ultimatum game (proposal to share, responder can veto) - Rational SPNE = proposer gets greater of (a) proposer’s opportunity cost of

licensing, and (b) 99%; licensee gets 1%. - If both parties (or neither party) have alternative or if this is a repeat game

(equal power): in that case, rational SPNE is 50/50 sharing Is this the actual outcome of negotiations in real life? Experimental outcomes suggest that in practical reality, the patentee in

negotiations should not demand the licensee’s entire incremental value - In many cultures, or if responder and proposer know each other, or in repeat games,

proposer offers 50/50 to avoid reputation of greed and unfairness. - In one-shot game, proposer often offers 30%, and responder refuses offers <20%

1. Game theory insight: FRAND = Sharing incremental value between patentee/licensee

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FRAND: Parties do not generally expect licensors to appropriate the entire incremental value

30-50%

One-shot game SPNE

One-shot game

Experimental

outcome

Num

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Number of coins offered to responder

Experimental outcome indicates what this audience regards as fair and reasonable That also gives indication what licensors and licensees expect from each other when negotiating The rationally optimal outcome for a one-shot game is NOT the normal outcome

These outcomes appear even where players are not constrained by a promise to license on fair and reasonable terms

Privileged and confidential

http://naturalcureinsomnia.com/img/Bell-Curve.gif



2. Ex ante rule consistent with 2004 Microsoft Decision

• EC: Dominant firm deserves revenues attributable to its invention, but not “strategic value” (revenues deriving from ex post ability to exclude rivals from neighboring market). Microsoft 2004, para. 1008:

• “terms imposed by Microsoft [must] be reasonable and non-discriminatory… in particular: …

(ii) … remuneration should not reflect the “strategic value” stemming from Microsoft’s market power…;

(iii) …restrictions should not create disincentives to compete with Microsoft, or unnecessarily restrain the ability of the beneficiaries to innovate;

(iv) … implementing the specifications will …constitute a significant investment, which … vendors will not incur if they have no assurance that the terms under which they can make use of the disclosed specifications will remain reasonably stable.”

• Confirmed on appeal in Case T-167/08 Microsoft v Commission • Conclusion: Hold-up not allowed; ex ante value is correct criterion

Ex ante valuation: consistent with Horizontal Guidelines

• In context of a standardization agreement, but of general relevance • 289: “it may be possible to compare the licensing fees charged by

the company in question for the relevant patents in a competitive environment before the industry has been locked into the standard (ex ante) with those charged after the industry has been locked in (ex post). This assumes that the comparison can be made in a consistent and reliable manner “

• Calculation after lock-in allows patent-owner to appropriate not only the value of his innovation, but also the value of the defendant’s innovation and value of his investments in bringing product to market, and his reward for taking risk. – Overcompensation – The very knowledge that such hold-up may happen discourages

investment

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Also consistent with US law FTC Report on The Evolving IP Marketplace

• “the incremental value of the patented invention over the next-best alternative establishes the maximum amount that a willing licensee would pay in a hypothetical negotiation.

• A reasonable royalty damages award that is based on high switching costs, rather than the ex ante value of the patented technology compared to alternatives, overcompensates the patentee. It improperly reflects the economic value of investments by the infringer...

• set the hypothetical negotiation at an early stage of product development, when the infringer is making design decisions.

• for a patent subject to a RAND commitment [, c]ourts should cap the royalty at the incremental value of the patented technology over alternatives available at the time the standard was defined.”

• But: not easy to establish....

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Incremental value rule hard to implement

• Posner J in Apple v Motorola: – “[t]he proper methodology of computing a FRAND royalty starts with

what the cost to the licensee would have been of obtaining, just before the patented invention was declared essential to compliance with the industry standard, a license for the function performed by the patent. That cost would be a measure of the value of the patent qua patent. ... The purpose of the FRAND requirements ... is to confine the patentee’s royalty demand to the value conferred by the patent itself as distinct from the additional value — the hold-up value — conferred by the patent’s being designated as standard-essential.”

• But see Robart J in Microsoft v Motorola: – “Calculating incremental value for multipatent standards ‘gets very

complicated, because when you take one patent out of a standard and put another one in you may make other changes, the performance of the tandard is multidimensional, different people value different aspects”

This works if there were substitute technologies before technology was chosen, and data were available on price and relative quality

• as complainants argued in Rambus

If direct data are unavailable: make a “consistent” comparison with prices of similar products (United Brands, SACEM, Rambus)

• Price charged by Licensor in non-standardized competitive markets • Price charged by Licensor to its own downstream business (be careful to

adjust for intra-enterprise profit allocation ...) • Price charged by other licensors for similar technology (Bodson) or for

complementary essential patents for the same standard • Price charged by Licensor or other patentees in competitive markets with

inter-standard competition (unless the IP owner took anti-competitive action to diminish ex ante inter-technology competition, or owns patents in all alternatives)

3. Practice: Use actual information or proxies (ex ante)

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If no internal proof of infringer’s estimate of projected excess profit 15 factors in total to determine what a “willing licensor and willing

licensee” would have agreed. Key criteria (affecting esp. royalty rate) • Incremental value to licensee • What parties said ex ante what they might have paid / charged • What patentee charged others or what licensee paid others • What third parties pay or charge

GP provides adjustment factors (affecting esp. royalty base), such as • T&Cs of license: exclusive? customer/territorial limit? field of use? • Life of patent and duration of license • Established policy not to grant licenses [lost profit a better factor, then] • Horizontal or vertical relationship [if the latter, interests are aligned] • Incremental profits in neighbouring markets? • established profitability • Importance of invention for downstream product (entire market?)

Use the Georgia-Pacific factors, applied ex ante


Georgia-Pacific Corp. v United States Plywood Corp – 318 F. Supp. 1116 (S.D.N.Y. 1970), mod. and aff’d, 446 F.2d 295 (2d Cir. 1971), cert. den, 404 U.S. 870 (1971)

Attempts to set royalty rate to be multiplied by revenues from infringing sales (hypothetical negotiations between willing licensor/licensee)

1. royalties received by the patent owner for licensing the patent in suit, in FRAND circumstances [what patentee charged others]

2. rates paid by the licensee for the use of other patents comparable to the patent in suit , in FRAND circumstances [assessed strictly]

3. nature and scope of the license, as exclusive or non-exclusive, or as restricted or non-restricted in terms of territory or with respect to whom the manufactured product may be sold [adjustment factor for rate or royalty base]

4. licensor’s established policy of not licensing others [irrelevant for FRAND]

5. commercial relationship between the licensor and the licensee, such as whether they are competitors in the same territory in the same line of business, or whether they are inventor and promoter [irrelevant for FRAND]

Georgia-Pacific factors (2)


6. effect of selling the patented specialty in promoting sales of other products of the licensee; existing value of the invention to the licensor as a generator of sales of its non-patented items [adjustment factor, to be adjusted to ex ante]

7. duration of the patent and the term of the license [affects royalty base]

8. established profitability of the product made under the patent; its commercial success; and its current popularity [to be adjusted to ex ante]

9. utility and advantages of the patent property over the old modes or devices, if any, that had been used for working out similar results [incremental value]

10.nature of the patented invention; the character of the commercial embodiment of it as owned and produced by the licensor; and the benefits to those who have used the invention [incremental value, to be adjusted to ex ante]

11.extent to which the infringer has made use of the invention, and any evidence probative of the value of that use [incl. ex post findings of incremental value, to be adjusted to ex ante]

Georgia-Pacific (3)


12.portion of the profit or of the selling price that may be customary in the particular business or in comparable businesses to allow for the use of the invention or analogous inventions [what 3d parties charge/pay; Goldscheider’s 25% of gross profit? IBM’s 5% of revenues? Nokia’s “single digit” rule?]

13.portion of the realizable profit that should be credited to the invention as distinguished from non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer

14.opinion testimony of qualified experts [subject to Daubert standard]

15.amount that a licensor (such as patent owner) and a licensee (such as infringer) would have agreed upon (at the time the infringement began) if both had been reasonably and voluntarily trying to reach an agreement

Georgia-Pacific (4)


Posner J: “how many additional factors may be lurking somewhere?” Can “a judge or a jury really balance 15 or more factors and come up with anything resembling an objective assessment?”

When relying on comparators: Consistency = key (same product; same T&Cs?) - ECJ in United Brands; Fed Cir in ResQNet v Lansa : need to adjust comparisons - Expert testimony must be �”not only relevant, but reliable” (Daubert);

Important to adjust to ex ante only, since the outcome is usually higher than real-world negotiated royalties (even more so since ex post calculation)

- Assumes patent is valid and infringed (while in real-world licensing negotiation, patents often discounted to reflect risk of invalidity and finding of non-infringement)

- Fed. Circuit reluctant to consider ex post events to reduce damages (e.g. infringer’s low profit margins on infringing product/process not considered,) Hanson v Alpine Valley Ski Area, Inc., 718 F.2d 1075,1081 (Fed. Cir. 1983))

- For example: 15% royalty when patent had been licensed for 1% ! Deere & Co. v International Harvester Co., 710 F.2d 1551, 1554-58 (Fed. Cir. 1983)

Georgia-Pacific -- Comments


We now have an example: Robart J. in Microsoft v Motorola (25/4/2013) • Microsoft sued Motorola over ActiveSync (de facto standard) patents,

seeking US ITC exclusion order • Motorola responded asking 2.25% royalty for 802.11 (WLAN) and

H.264 (video) standards – Standard rate Motorola had asked since 1990s (ex ante)

• Microsoft filed breach of contract claim in its home court (Washington) saying Motorola’s request violated RAND promise

• Motorola sought injunction against Microsoft in Germany • Robart J decided RAND commitments are enforceable contracts and

users can enforce them contracts as a third-party beneficiary, and issued order prohibiting Motorola from enforcing German injunction (!)

• And proceeded to set RAND rate, using Georgia-Pacific factors (1-3, 6, 8-15) applied on an ex ante basis

– And that was then used to determine that MML was in breach (!)

• See also Holderman J in Innovatio (percentage of chip price) 29

Robart’s RAND Royalty Rate

• Initial offer need not be RAND so long as a RAND terms issue eventually • Criterion : willing licensor and licensee (Georgia-Pacific)

– Applied ex ante, "before [licensor] gets the extra boost in value by the standard becoming final and everyone has to practice the patent "

– Adjusted for: • (1) importance of the SEPs to the standard and • (2) importance of these SEPs to the overall product • (3) “unresolved disagreements” on infringement and validity

– Using comparators from industry contracts as proxies / guidance • Including patent pool royalties (not comparable) • But ignored a history of 20 years of MML licensing (!)

• Result: very low royalty rate (total abt $1,5 million): • H.264: $ 0.0555 to $ 0.16389 per unit (fixed at 0.555) • 802.11: $ 0.08 to $ 0.195 per unit (fixed at 3.471) • but at least recognized that 3G/4G patents were very valuable…

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Robart J.’s judgment is now subject to appeal - Robart J. ignored patent war context and MSFT refusal to license ActiveSync - Court set rate for individual patents, rejected Motorola licenses as comparators -

they were portfolio settlements including valuable telecom patents • Judgment ignores how portfolio licenses are negotiated in the market

-Motorola patent "only constitutes a sliver of the overall technology“ • But that does NOT mean it was not important or valuable ex ante

- If all 92 patentees charged 2.25%, that leads to royalty stacking? • But that assumes all other patents are equally valuable.

- Court used patent pool as a comparator • Ignored that pools generally have lower rates, because licensees and

practicing licensors want standard to succeed so they can make profits downstream • although pool dominated by NPEs may set rate too high – see Cournot problem

Reviewing Robart’s RAND Royalty Rate


Use portfolios licenses as proxies - Adjust for size, strength, product scope, territorial range, life left, etc - Adjustments can be done based on “sampling” / “proud list” approach –

patents are probablistic – E.g.: Vringo v ZTE [2013] EWHC 1591 (Pat), Birss J: if both sides

accept, have portfolio-wide royalty set before patent validity/infringement found, “the cheapest and most cost effective way, of resolving the whole global case overall, would be if a single court were to do what was done in Microsoft v Motorola. …if both sides were willing to be bound by the outcome, there is no reason why the English court could not do it. … it would at a stroke resolve the case in a time and cost efficient manner because then there would be no patent trials at all.” (para 54)

Samsung suggests parties may agree to such a “pragmatic” approach If arbitrator allows a lowering of the royalty for a portfolio licence after a finding

of invalidity or non-infringement for one or more individual patents, then it should also allow licensor to request an increase if a patent is found validity and infringed (reflecting the elimination of risk/uncertainty after such finding).

Valuing Portfolios

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Cournot complements problem: each patentee sets rate without regard for rate set by other owners of complementary patents, leading to supra-monopoly royalty stack, and inefficient outcome. Everyone loses. Royalty cap avoids this.

Robart J: “court must determine a reasonably royalty rate for … SEPs based on the principles underlying the RAND commitment, one of which is the concern of royalty stacking.” (Motorola) - Patentee can avoid that by showing “evidence that it considered royalty stacking issues

when it established its royalty rates.” (Ericsson v D-Link, Davis J) - License can try to show roylaty cap was agreed ex ante (was argued in WCDMA case)

Simply multiplying number of patents and requested royalty rate is not enough - May underestimate royalty stack, e.g. when ignoring royalties for non-SEPs - May overestimate royalty stack, e.g., when SEP ex ante more valuable than other SEPs - But two stage process and reversal of burden of proof may solve this:

– 1. licensee shows royalty leads to prohibitive stack if all SEP owners charge the same – 2. patentee rebuts by showing that its patents were more valuable ex ante – 3. licensee may show that patentee royalty + actual royalties paid to others + royalties

realistically expected leads to prohibitive stack – 4. patentee may show that third-party royalties are too high

4. Royalty Stacking and Royalty Caps

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Goldscheider’s 25% Cap -- Uniloc v Microsoft

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Goldscheider‘s rule - based on experience from 1959 in negotiating/litigating

Often misused as end point, while it should only be starting point for negotiations

- Key: what allocation of risk between licensee and licensor? Licensee often takes major R&D, bring-to-market, marketing and production risk, esp. where high fixed costs

- Adjusted upwards if IP owner bears more of the overall risk than usual

- Adjusted downwards if IP owner bears less of the overall risk than usual

- If multiple patents apply, 25% rule applies to entire stack

“a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation” and “fails to tie a reasonable royalty base to the facts of the case at issue.“ (Uniloc US v. Microsoft (2011)

- Query whether systematic research in specific industry segments could nonetheless reveal a similar cap…?

salesnet expectedprofits expected25 salesnet on rateroyalty ×= %

Privileged and confidential

Patentee can obtain royalty on entire market value of infringing product incorporating the infringing part/feedstock, not merely the value of the infringing component itself

Interest for patentee to go after the most downstream manufacturer to increase net sales base

Applies in situations where the component is key for a downstream product. requires showing that (Cornell v. HP ):

- the infringing components must be the basis for customer demand for the entire machine including the parts beyond the claimed invention (Cornell v HP);

- the individual infringing and non-infringing components must be sold together so that they constitute a functional unit or are parts of a complete machine or single assembly of parts, (Paper Converting Machine v. Magna-Graphics); and must be analogous to a single functioning unit, (Kalman v. Berlyn).

It is not enough that the infringing and non-infringing parts are sold together for mere business advantage. See Rite-Hite, 56 F.3d at 1549-50.”

Proof that component is essential is not proof that it is basis for customer demand!

5. What Royalty Base? “Entire Market Value” or the “Smallest Saleable Patent Practicing Component”?


Cornell Univ. v. Hewlett-Packard (2009): patented invention = small component of HP’s products (patented invention > processor > CPU > CPU brick > cell board > server)

- royalty base reduced to include only HP’s earnings attributed to the infringing technology (= smallest salable patent-practicing unit i.e. processors):

“The logical and readily available alternative was the smallest salable infringing unit with close relation to the claimed invention-namely the processor itself.”

- Using estimated revenues permissible when no market for infringing product : “Reliance on hypothetical sales or estimated revenues is entirely permissible in connection with a reasonable royalty analysis.”

Lucent v Gateway (2009): - no proof that infringing feature was “the basis – or even a substantial basis – of the consumer demand for Outlook” - using “entire market value” acceptable where infringing component or feature is not sold separately, so long as royalty is adjusted downwards

Entire Market Value – limiting case law


IP Innovation v RedHat (2010): sound economic basis needed

“In invoking the �entire market value rule,� Mr. Gemini included 100% of Red Hat�’s and Novell�’s total revenues from sales of subscriptions to the accused operating systems in his proposed royalty base. Mr. Gemini�’s methodology however does not show a sound economic connection between the claimed invention and this broad proffered royalty base. The claimed invention is but one relatively small component of the accused operating systems.”

Uniloc v. Microsoft (2011): CAFC reaffirms limitation of entire market value, but using a

low royalty rate is no excuse for using the “entire market value” for minor features:

“Uniloc argues that the entire market value of the products may appropriately be admitted if the royalty rate is low enough, relying on the following statement in Lucent Technologies. […] The Supreme Court and this court’s precedents do not allow consideration of the entire market value of accused products for minor patent improvements simply by asserting a low enough royalty rate.”

See also FTC Report 2011

Entire Market Value – limiting case law


“P]roof that consumers would not want a laptop computer without such features is not tantamount to proof that any one of those features alone drives the market for laptop computers. … says nothing as to whether the presence of that functionality is what motivates consumers to buy a laptop computer in the first place. It is this latter and higher degree of proof that must exist to support an entire market value rule theory.” LaserDynamics v Quanta (Fed. Cir. 2012)

“[t]he law requires patentees to apportion the royalty down to a reasonable estimate of the value of its claimed technology, or else establish that its patented technology drove demand for the entire product.” VirnetX, Inc. v. Cisco (Fed. Cir. Sept. 16, 2014)

Does not mean that royalty going forward must be expressed as a percentage of the smallest component. What matters is technology value, not royalty base - Davis J (CSIRO v Cisco): “It is simply illogical to attempt to value the contributions of

the [CSIRO patent] based on wireless chip prices that were artificially deflated because of pervasive infringement. Basing a royalty solely on chip price is like valuing a copyrighted book based only on the costs of the binding, paper, and ink needed to actually produce the physical product. While such a calculation captures the cost of the physical product, it provides no indication of its actual value.”

Don’t confuse damage calculation based on Smallest Saleable Patent Practicing Component with royalty formula

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3. FRAND Terms and Conditions

Illegal tying –vs- permissible portfolio license

Illegal forced countertrade –vs- reasonable cross-license

Illegal no-challenge clauses –vs- permissible settlements and avoiding delays

Field of use restrictions (generally permissible)

What are the rules for FRAND-covered non-SEPs (“FREPs”), essential portfolios

2 – What T&Cs for compulsory licensing?

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No tying of essential IPR and non-essential IPRs allowed But : “portfolio licensing can be efficient in some cases” (EC Speaking Points

at ETSI IPR #16 on 9/9/2013 and EC Speaking Points at ITU on 12/9/2013) – Allows bundling on “per-standard” basis. – Allows voluntary full-portfolio licensing

See also - Article 9 commitments in Samsung: licensing framework for bundle of

“Samsung Electronics’ Mobile SEPs” - Google FTC Consent Order, provides procedure to determine terms for

bundle of “patents that are Essential to the Covered Standards” Criticism: Tying should be allowed for all essential IPRs needed per product”. - Efficient and practical solution: a willing licensee needs all of them anyway

and should accept bundle (subject to right to challenge validity, infringement). - Otherwise, patent holder might be forced to litigate SEP for every single

standard in the product, which would be costly and inefficient in practice.

Illegal tying vs legal portfolio licensing

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Motorola Decision, para 456: “SEP holders are in principle entitled to request reciprocity in line with the rules of SSOs.”

– Motorola requested reciprocity in the Second Orange Book Offer – EC (rightly) did not list that as an element of the abuse

Samsung Commitment, para. 79 and 89: – “Samsung cannot condition the licensing of its Mobile SEPs on the

crosslicensing of a potential licensee’s non-SEPs or SEPs not covered by the reciprocity rules of SSOs.” . – Interpreted as per-standard reciprocity – should have been per-product ?

– Also, defensive suspension: Samsung may seek and enforce injunction if (1) Potential Licensee files claim for injunctive relief in the EEA against Samsung or a customer of Samsung for Mobile Device/components for infringement of any Potential Licensee’s Mobile SEPs, and (2) Samsung offers to be bound by Licensing Framework

– Samsung should have been allowed to defend itself in the EEA against injunctions elsewhere, considering that this was a worldwide war

Implied: cross-license must be FRAND (license cannot demand free cross-license)

Illegal forced countertrade vs legal cross-license?

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Motorola, Samsung: no-challenge and “termination” clauses not allowed – But how to avoid perpetual litigation after a license is signed? – EC: “a reasonable time frame for resolution is of the essence”. – Ban on termination clauses should be allowed in legitimate settlement:

– Technology Transfer guidelines para 235 - 236: “Settlement agreements in the context of technology disputes are, as in many other areas of commercial disputes, in principle a legitimate way to find a mutually acceptable compromise to a bona fide legal disagreement. …

– Para. 242-243: “In the context of a settlement agreement, non-challenge clauses are generally considered to fall outside Article 101(1) of the Treaty. It is inherent in such agreements that the parties agree not to challenge ex post the intellectual property rights which were the centre of the dispute. … a non-challenge clause may infringe Article 101(1) where an intellectual property right was granted following the provision of incorrect or misleading information. Scrutiny of such clauses may also be necessary if the licensor .. induces, financially or otherwise, the licensee to agree not to challenge the validity of the technology rights or if the technology rights are a necessary input for the licensee's production”

Solution: “sampling” / “proud list” approach (See portfolio valuation slide)

Illegal no-challenge clauses vs permissible settlements and avoiding delays

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EC emphasizes the SEP and standards context, Motorola and Samsung give no explicit guidance about FRAND-covered non-

SEPs like ActiveSync or FAT, or enforcement of unavoidable portfolio enforcement

On the other hand, – (278) “…The exercise of an exclusive right by its owner may, however, in

exceptional circumstances and absent any objective justification involve abusive conduct. The list of exceptional circumstances is not exhaustive.“

– Note also the nod to the “legitimate expectations” argument in para 294, which may apply to refusal to license non-SEPs subject to a FRAND promise

– Decision and the press release emphasize that Orange Book applies more broadly to non-SEPs and is not inconsistent with the EC decision,

– Microsoft continues to apply (that case concerned non-SEPs) – And cutting off licenses to essential portfolios can be abuse (Commercial

Solvents, etc) – FRAND licensing also required for technology pools (see TT Guidelines)

What rules for non-SEPs?

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4. Conclusions

What is a FRAND promise?

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A license or promise to license: - No refusal or termination of a license, no injunctive relief, no suit for treble damages, if

defendant is willing and able to pay, but disagrees on T&Cs. Exception: Defensive suspension, material (actual or anticipatory) breach

- No constructive refusal to license (e.g., excessive fees, delays, etc.) Fair and reasonable – equitable, balancing all interests (proportionality) - Same criterion as 102(a) EC: “not excessive” = share benefits of standards with licensees and

consumers (required by 101(3) anyway) - rate that the IPR owner could have obtained in ex ante inter-technology competition, unless

the IP owner took anti-competitive action to diminish ex ante inter-technology competition - No monopoly rent, moderate, allowing IP owner innovation incentive, but not allowing IP owner

to appropriate entire value of standard. Avoid Cournot stack Non-discriminatory – equal treatment of all customers, including the IPR-owner’s own

downstream business. - Same criterion as 102 EC(b) and 102(c) and 101(3)(b): “not exclusionary, not discriminatory” - No restriction of downstream competition on the merits (no price-squeeze, no T&Cs that have

the object or effect of restricting downstream competition, etc) - E.g., no differential treatment based on whether licensee purchases the licensor's downstream

product - No restriction of upstream technology competition (no free NAP/pass-thru)

Standardization can generate efficiencies and promote innovation and competitiveness, and is shielded from Article 101 TFEU, provided that certain conditions are met, including access to the standard on FRAND terms. - “in order for a standard-setting agreement to fall outside Article 101(1) TFEU, the

SSOs IPR policy should ensure that each entity which contributes technology to a standard must limit their freedom to exercise their "ownership" of a piece of that standard by committing to license the relevant technology to anyone wishing to use the standard on FRAND terms.”

– Case No COMP/M.6381 - Google/ Motorola Mobility, para. 57. - “Where participation in standard-setting is unrestricted and the procedure for adopting

the standard in question is transparent, standardisation agreements which contain no obligation to comply with the standard and provide access to the standard on fair, reasonable and non-discriminatory terms will normally not restrict competition within the meaning of Article 101(1).”).

– Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements, OJ C 11, 14.1.2010, para. 280

Risk of SSO violation Art 101 if no proper arrangements

Implications for SSO IPR Policies

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IPR Policy must (interpret FRAND to): Ban injunctions against willing licensee unless exceptions met - including defensive suspension and reasonable reciprocity

Ban no-challenge clauses except in legitimate settlements Ban tying SEPs to non-SEPS -But allow portfolio licensing if agreed voluntarily

Ban forced cross-licensing -Except that licensee cannot refuse to cross-license its SEPs reading

on same standard (or same product) on FRAND terms -Cross-license allowed if voluntary and on FRAND terms

Need to provide rules for FRAND calculation? -For time being process is enough

Will SSOs agree? - If not, risk of enforcement in court or EC

Implications for SSOs

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Patent Related Concerns Should Be Resolved Holistically

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SEPs

De facto Standards

Trolls

Large Portfolios

Privateers

The next problem: Trolls and Privateers (1)

• There are growing opportunities for trolls and privateers, because of the increasing complexity of products, and growth of patents

• No need to define what a troll is. – It’s not who they are, but what they do.

• The essence of “troll” behaviour is – Creating expectations (FRAND promise, license promise), or allowing

expectations of patent-free environment/non-assertion to arise, awaiting lock-in, and then exploiting lock-in by “hold-up” – often using injunction

– They then extract high royalties (tying/block booking), cross-license, or other terms the cost of which is greater than the innovative value of the IP (ex ante), and instead reflects switching costs and opportunity costs of not taking a license

• Privateers engage in similar conduct – But in cooperation with, or to benefit, a practicing entity – Portfolio disaggregation creates Cournot complements problem

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• “hold-up” is a growing problem, and is increasing also in EU • “Hold-up” is not limited to SEPs. It also occurs with commercially

essential patents, and even unavoidable patent portfolios. • And even practicing entities can engage in “hold-up” conduct.

– Practicing entities may have to worry about counterclaims. – But the smaller their practicing business is, the less vulnerable they

are. NPEs are invulnerable to counterclaims • Strategic use of privateers creates even greater danger:

– Patent disaggregation leading to royalty stacking (multiple monopoly rents); raising rivals’ costs (Mosaid)

– Avoiding cross-license dynamics (Spinco) – Evading FRAND promises (Rockstar)

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• Deny injunctions against willing licensees (eBay principles) unless • 1) plaintiff suffers irreparable injury; • 2) remedies available at law (such as damage award) inadequate to

compensate for the injury; • 3) a remedy in equity is warranted in light of the balance of hardships between

plaintiff and defendant; and • 4) the public interest would not be disserved by a permanent injunction.

• No valid reason to treat SEPs and other FRAND-covered Patents differently: same theory of harm ( “legitimate expectations”, see Motorola, para 294)

• No valid reason to differentiate between NPEs and practicing entities, except that NPEs are more easily found dominant (no countervailing power)

• Ensure that the EPC does not become a troll tool (potential for misuse of bifurcation + preliminary injunction): apply eBay principles

• Apply Article 102(a) in cases of clearly excessive demands; • Apply Article 101 to privateers • Apply national or EU merger control to avoid creation of asymmetries that

allow buyer to leverage acquired patents


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Defining FRAND Royalties and FRAND Terms and Conditionsis.jrc.ec.europa.eu/pages/ISG/EURIPIDIS/documents/MauritsDolmans.pdf · Huawei/ZTE (2015?) 12 . Samsung . Commitments – FRAND

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