A Definitely UnFRANDly Situation

22.03.2017

By Lawrence Hoffman

J.D.; B.S.E.E. and Comp. Sc.; U.S. Patent Attorney

The smartphone wars are clearly still on full boil assuring continued full employment for patent lawyers. Apple and Samsung have been engaged world-wide in patent infringement litigation against each other. Sometimes, Apple wins and sometimes Samsung wins. For example, as reported in our November Happenings post, the U.S. Supreme Court just vacated a 400 million dollar damage award to Apple in a design patent case.

The newest flare up is between Finland’s Nokia Oy and Apple Inc. Involved is a mix of antitrust and patent licensing issues, and alleged conspiracies between Nokia and several Patent Assertion Entities to extort “exorbitant” royalties from Apple by refusing to license “standard essential patents” (SEPs) on fair, reasonable, and non-discriminatory (FRAND) terms.

Background:

After several years of world-wide litigation, in 2011, Apple and Nokia settled their ongoing disputes by entering into a cross-licensing agreement. Reportedly, the terms included a payment by Apple of more than €800 million and future royalties of €8 per iPhone for the duration of the agreement. According to a statement issued by Apple in connection with the settlement, “Apple and Nokia have agreed to drop all of our current lawsuits and enter into a license covering some of each other’s patents, but not the majority of the innovations that make the iPhone unique. “

Nokia, once the world’s largest supplier of cellular phones, was blindsided by Apple’s introduction of the iPhone in 2007 and never recovered.  By the time of the settlement with Apple in 2011, Nokia’s business model had evolved, and licensing its technology had become an important aspect of Nokia’s business. At that point, it stated that it had entered into license agreements with what it called a “growing number” of other companies.

In 2013, when Nokia sold its handset business to Microsoft Corp., it retained its patents to the technology it had developed during its high-flying years and continued to license these patents to others in the cellular communication industry. Bloomberg Technology reports that in the Third Quarter of 2016, licensing fees accounted for about 40 percent of Nokia’s total adjusted operating profit. Nokia attempted to negotiate licenses to Apple for some of its patents not covered by the 2011 agreement, but the parties could not reach an agreement as to royalty rates.

Transfer of Nokia’s Patents:

At about the time Nokia exited the handset market, it also transferred part of its patent portfolio to several PAEs.  In 2011, Nokia formed a company, Core Wireless (“Core”), to which it assigned part of its patent portfolio. Later, Core was transferred to Conversant Intellectual Property Management Inc., (”Conversant”). Apple asserts that than 2000 patents, of which about 1,200 were declared SEPs owned by Core when it was transferred to Conversant.

Also in 2013, Nokia entered into an agreement with Acacia Research Corporation (“Acacia”)  under which it sold another group of its patents related to communications network technology. U.S. patent 8,055,820 was one of those transferred to Acacia in this transaction.

Acacia and Conversant are Patent Assertion Entities (PAEs), i.e., entities whose business model is to purchase unused or underused patents, to license the patents to others, and in some instances, to share the resulting revenue with the previous owners. The PAE community has developed a bad reputation because of the allegedly predatory nature of some of its business practices. For this reason, PAEs are frequently referred to as “patent trolls”. We will have more to say about this below.

In 2014, Acacia subsidiary Cellular Communications Equipment LLC (CCE), to which the ‘820 patent had been assigned by Acacia, filed an infringement action against Apple in patent troll heaven (sometimes called the U.S. District Court for the Eastern District of Texas). Last September, a jury awarded CCE $22.1 million for infringement of the ‘820 patent.

Apple filed a post-trial motion to set aside the verdict or for a new trial. The motion is still pending, so judgment hasn’t been entered, but it seems likely that there will be an appeal, irrespective of the outcome of the motion.

Also in 2014, Core Wireless, which was now part of Conversant, sued Apple for infringement of two SEPs, and on 15 December 2016, a Northern District of California jury awarded Core at total of $7.3 million for infringement of the patents. Post-trial motions will likely be filed by one or both parties shortly. Again, an appeal is likely, regardless of the outcome of any motions.

SEPs and FRAND Licensing Terms:

As suggested above, the new battles are largely about the licensing of SEPs on FRAND terms. Standards result from the work of standards developing organizations (SDOs) comprised of individuals from the industries to which the standards will apply and others to whom the subject matter is of concern. There are international, regional, and national SDOs. The major international SDOs are the International Electrotechnical Commission (IEC), the International Organization for Standardization (ISO) and the World Trade Organization.

An example of a regional SDO is Underwriters’ Laboratories (UL), accredited as a standards developer in the U.S. and Canada. European examples include the European Committee for Standardization (CEN), the European Committee for Electrotechnical Standardization (CENELEC) and the European Telecommunications Standards Institute (ETSI), all officially recognized as European standards bodies by the European Union. Another example is the Pacific Area Standards Congress (PASC) including national SDOs from 25 Pacific Rim Countries.

Compliance with standards is typically voluntary, in some cases, standards are given legislative or administrative recognition and compliance becomes mandatory.

SEPs are patents that must be practiced to comply with the standard. This creates issues for the owners of the SEPs and for those seeking to comply with the standard. For example, if the owner of an SEP selectively refuses to grant licenses or if the terms are selective onerous, or otherwise unfair, anticompetitive effects are likely. SDOs therefore require the owner of a patent being considered for incorporation in a standard to agree to license the patent on fair, reasonable and non-discriminatory (FRAND) terms. The commitment is voluntary, but if made, it will generally be enforced by courts. If the owner refuses, the subject matter will not become part of the standard.

Implementation of the FRAND concept can be highly complex. The biggest problem is that there can be no universally applicable formula for determining a FRAND royalty. Even universally accepted definitions of the FRAND components do not exist.

Moreover, antitrust issues related to SEPs have be studied extensively over the past 10 years and the U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC) have issued policy statements, orders and consent decrees on SEPs. In addition, the Justice Department has several Business Review Letters on the SEP-related antitrust issues.

Further, in October 2016, the DOJ and FTC jointly issued proposed updates to the Antitrust Guidelines for the Licensing of Intellectual Property. Interestingly, however, these say nothing about SEPs. This omission has met with mixed reaction but the relationship between antitrust issues and SEPs is a major current patent law issue.

A comprehensive study of FRAND issues will be posted on our Website the near future.

Current Bloodshed:

The parties have not been sitting patiently waiting for rulings on Apple’s post trial motions in the ‘820 and the Core Wireless litigations. Apple launched a preemptive strike on 20 December by suing Acacia and Conversant in the U.S. District Court for the Northern District of California for violation of U.S. antitrust laws, alleging that they each colluded with Nokia to extract and extort exorbitant revenues unfairly from Apple.

Nokia Strikes Back:

The day after Apple filed its antitrust action, Nokia itself filed infringement lawsuits against Apple in Germany, and two in the Eastern District of Texas alleging infringement of 32 patents covering displays, user interfaces, software, antennas, chipsets and video coding. And it didn’t stop there.

According to Nokia, as of 22 December, it had initiated additional patent infringement actions so that it then had actions  pending in 11 countries altogether involving 40 patents covering display, user interface, software, antenna, chipsets and video coding technologies. Also pending is a complaint filed by Nokia with the U.S. International Trade Commission asking that an investigation be initiated against Apple pursuant to Section 337 of the U.S. Tariff Act based on eight of its patents.

Apple Strikes Back Too:

Curiously Nokia was not originally named as a defendant in the antitrust action complaint. Despite this, Apple attempted to obtain a summons to be served against several Nokia-related companies. The Court refused to issue the summons, so Apple amended the complaint to add the Nokia companies as defendants, which it probably should have done originally.

The Texas Cases:

The plaintiffs in the two Texas cases are Nokia and Alcatel-Lucent USA (“A-L”), which is described as an affiliate of Nokia, and which is the record owner of the patents in the two cases. The Complaints appear to conform to normal practices for asserting patent infringement.

In the first case, (16-cv-01440) the Complaint asserts that Apple infringes eight patents directed to video coding “compliant with the H.264 Advanced Video Coding standard promulgated by the International Telecommunication Union” and that several of Apple’s products support the H.264 standard and infringe the claims of the patents. The complaint further asserts that:

Apple has steadfastly refused to agree to license Nokia’s H.264 patents on reasonable terms. Dozens of companies have licensed Nokia’s patents for use in their products that support the H.264 standard at Nokia’s established royalty rates. Apple, however, refuses to pay Nokia’s established royalty rates.

The Complaint in the second Texas case (16-cv-01441) asserts infringement by Apple products of ten other patents. Among these, is a patent for translating natural language inquiries into database queries, which claimed to be infringed by Apple’s Siri digital assistant. These patents are not asserted to be standard compliant.

The ITC Case:

Section 337(a) of the Tariff Act addresses unfair practices in import trade, including under Subparagraph 1(B), “importation into the United States, the sale for importation, or the sale within the United States after importation by the owner, importer, or consignee, of articles that—(i) infringe a valid and enforceable United States patent”. Paragraph (2), however, specifies that Subparagraph 1(B) applies “only if an industry in the United States, relating to the articles protected by the patent…exists or is in the process of being established.

Paragraph (3) provides that “…an industry in the United States shall be considered to exist if there is in the United States, with respect to the articles protected by the patent…— (A) significant investment in plant and equipment; (B) significant employment of labor or capital; or (C) substantial investment in its exploitation, including engineering, research and development, or licensing.

If the alleged infringement and the validity and enforceability of the patent or patents, and existence of an industry in the U.S. are demonstrated, the ITC has the power to ban importation of the infringing products.

The patents alleged by Nokia to be infringed are the same ones asserted in the Texas infringement cases. Nokia asserts that the requirements of Paragraph (2) are met by non-exclusive licenses to Microsoft and Samsung and with specific allegations of domestic investments by each of them.

Apple’s Antitrust Case:

In its complaint, Apple alleges that Acacia and Conversant:

have respectively colluded with Nokia…to obtain from Nokia thousands of patents as part of a plan to extract and extort exorbitant revenues unfairly and anti-competitively from Apple and other innovative suppliers of cell phones, and ultimately from the consumers of those products.

Apple further alleges that “Nokia has also coordinated with” at least three other named PAEs in the same manner as with Acacia and Conversant. Interestingly, is there no allegation of collusion between Acacia and Conversant or between any of the other named PAEs.

The underlying basis for the antitrust law violations asserted in the complaint is referred to as “diffusion” of Nokia’s patents. Apple asserts that spreading Nokia’s patents among multiple PAEs “dramatically enhanced the market power associated with those patents and that  “Nokia, in turn, has shared in the fruits that increased power brings by obtaining an ongoing share of the exorbitant royalties that Acacia, Conversant, and other PAEs receive”.

Apple emphasizes that the conduct of the defendants:

[I]s all the more pernicious because it unfairly and anti-competitively evades binding commitments that Nokia made to license declared standard essential patents (“SEPs”) on fair, reasonable, and non-discriminatory (“FRAND”) terms. Nokia positioned itself to claim that its patents cover technologies included in telecommunications standards by repeatedly assuring standard-setting organizations that it would license its patents fairly. Yet Acacia and Conversant are now conspiring with Nokia in a scheme to diffuse and abuse such patents and, as the PAEs and Nokia fully intended, monetize those false promises by extracting exorbitant non-FRAND royalties in ways Nokia could not.

Not surprisingly, Nokia and Apple view the situation differently. “Since agreeing to a license covering some patents from the Nokia Technologies portfolio in 2011, Apple has declined subsequent offers made by Nokia to license other of its patented inventions which are used by many of Apple’s products”, Nokia said in a statement, adding that the royalty rates it had offered were the same as those paid by Apple’s competitors.

“We’ve always been willing to pay a fair price to secure the rights of patents covering technology in our products,” said Apple. “Unfortunately, Nokia has refused to license their patents on a fair basis and is now using the tactics of a patent troll to attempt to extort money from Apple by applying a royalty rate to Apple’s own inventions they had nothing to do with.”

Will Apple’s suit survive a preliminary motion to dismiss for failure to state a claim? Let’s look at each Count of the complaint separately. Count I alleges breach of contract to license patents on FRAND terms. That’s not an antitrust issue and would survive. Whether Apple can prove its case remains to be seen.

Counts II, III, and IV allege violations of Section 1 of the Sherman Act (concerning contract in restraint of trade), Section 7 of the Clayton Act (directed to unlawful acquisition of assets), and Section 2 of the Sherman Act (directed to monopolization or attempted monopolization).

Patents can definitely be used in ways that violate the antitrust laws, but as stated by the Supreme Court, for example, in Radio Mfg. Co. v. Hazeltine Research, 339 U.S. 827, 834 (1949), acquiring patents is not an antitrust violation. Thus, acquisition by Acacia or Conversant of Nokia’s patents per se is not likely to be enough to sustain this Count. Disregarding for a moment the FRAND commitment, all that Nokia has done is transfer the patents to the PAEs in an effort to maximize the income it derives from licensing the patents. That’s exactly what is involved in every acquisition by a PAE.

But do the facts alleged amount to an unreasonable restraint of trade? Disregarding nefarious implications and characterizations, the facts are these:

  • Nokia stopped using its patented technology in 2013 but retained its patent portfolio with the intent of monetizing this asset through licensing.
  • The same year, it transferred some of these to several PAEs, two of which are being sued here.
  • At least some of the patents involved are SEPs.
  • No agreements between the PAEs are alleged.
  • The PAEs are vigorously doing what they were created to do, namely maximize revenue by working hard to license the patents or if necessary, to prosecute actions for patent infringement.
  • According to the agreements, the PAEs are to share the resulting licensing fees or damage awards with Nokia.

To this observer, the facts as stated can reasonably be interpreted as not demonstrating  a restraint of trade, much less an unreasonable one. There is no discrimination being alleged; high royalties are allegedly being demanded from everyone in the industry. Nor is it being alleged that the royalties demanded are low enough to provide an incentive to pay rather than litigate. In fact, just the opposite is the case. Apple alleges that the royalties being demanded are “exorbitant”.

Of course, any license fee paid by a manufacturer will be reflected in the ultimate retail price of the goods but there is nothing wrong with that. In any event, if royalty rates for non-SEPs is high, the PAE can be said to have done its job well.

What really seems to have Apple’s nose out of joint is that Nokia’s transfer of its patents to multiple PAEs effectively nullified Apple’s bullying advantage. Apple’s antitrust action seems to be the first attempt by anyone to assert this diffusion theory in litigation.

Will the California court punt here, or will it let Apple see if it can prove its case? One important point to be considered is the very significant evolution of the relationship between patent and antitrust law. Many practices of patent owners, especially licensing practices, that were formerly treated as per se illegal are now subject to the rule of reason, i.e., is the resulting restraint reasonable. In short, the patent and antitrust laws are playing much more nicely together than in the past. That may not bode well for Apple’s case.

Sticking one’s neck out is an invitation to get it guillotined, but this observer thinks that if, as likely, the legal sufficiency of the complaint is challenged, Apple might well have allege more than it has (i.e., amend its complaint) for the antitrust claims to survive.

Admittedly, there is an elephant in the room we have largely ignored, namely the PAE phenomenon itself. The practices and business models of PAEs are a major current topic of interest. Unquestionably, some PAEs behave in ways that justify the derogatory characterization as “patent trolls”, such as sending unfounded infringement charges to large numbers of small companies demanding that they take licenses for small fees, or face ruinously expensive patent litigation. Of course, biggies like Apple are also juicy targets for the PAEs.

On the other hand, many IP stakeholders regard PAEs as making a valuable contribution by monetizing patents that would otherwise be infringed with impunity. Those who view PAEs positively might feel that Apple is the bad guy because it refuses to take licenses on reasonable terms. In fact, the tech giants, of which Apple is certainly one, have been described as “efficient infringers” because, as a matter of economics, they prefer to ignore the patents of others and risk the rare infringement judgment obtained by those with the resources and will to bring suit.

In this context, PAEs can be regarded as leveling the playing field. Apple’s position is that it is always willing to pay reasonable royalties, but what is reasonable obviously depends on one’s viewpoint.

The PAE industry has been under intense scrutiny for several years. In October, the U.S. FTC issued a long-awaited study on Patent Assertion Activity. According to an FTC press release, FTC Chairwoman Edith Ramirez characterized the study as “a big step forward in enhancing our understanding of PAEs and provides an empirical foundation for ongoing policy discussions.” She added, “The recommendations we are proposing are designed to balance the needs of patent holders with the goal of reducing nuisance litigation.”

The study identified several different PAE business models. One of these, typically employed by what the study referred to as Litigation PAEs, is characterized by aggressive filing of infringement lawsuits before securing licenses. It further noted that Litigation PAEs accounted for 96 percent of all patent infringement lawsuits, but generated only about 20 percent of all reported PAE revenues. The study found that 93 percent of the patent licensing agreements held by Litigation PAEs resulted from litigation.

True to popular belief, the study found that the royalties typically yielded by Litigation PAE licenses were less than the lower bounds of early stage litigation costs. This data, the study says “is consistent with nuisance litigation, in which defendant companies decide to settle based on the cost of litigation rather than the likelihood of their infringement.” The study further pointed out that “nuisance infringement litigation, however, can tax judicial resources and divert attention away from productive business behavior.”

With the foregoing in mind, the FTC study proposes reforms to:

  • Address the imbalances between the cost of litigation discovery for PAE plaintiffs and defendants;
  • provide the courts and defendants with more information about the plaintiffs that have filed infringement lawsuits;
  • streamline multiple cases brought against defendants on the same theories of infringement; and
  • provide sufficient notice of these infringement theories as courts continue to develop heightened pleading requirements for patent cases.

Notably, the study does not discuss or make any recommendations related specifically to anticompetitive effects of PAE business practices. Nevertheless the issue is on the table, as evidenced by Apple’s law suit, and by transfers of large numbers of patents from Nokia, and other companies such as Ericsson and British Telecom, and litigation relating to the transferred patents.

These issues, particularly as they concern SEPs and FRAND licensing are considered in a forthcoming article on our Website.

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