By Lawrence Hoffman
Sooner or later, whether your products are in the field of driverless vehicles, data security, telecommunications, or medical technology, to mention a few that come immediately to mind, you are going to be confronted with a technical standard. It may be a voluntary standard or it may have been adopted as part of a regulation and will effectively have the force of law. As a practical matter, you will have to comply with it, even if it’s voluntary, to compete in the market place.
Standards are generally the work of standards development organizations (SDOs) comprised of individuals from the industries to which the standards will apply and others to whom the subject matter is of concern. Often, such stakeholders will have patents in the field, which means that it may be necessary to practice the subject matter of these patents to comply with a standard. Such patents have come to be known as “standard essential patents” (SEPs).
The owners of SEPs must commit to licensing them to anyone seeking to comply with the standard since selective refusal to grant licenses or otherwise unfair terms are likely to have anti-competitive effects. SDOs therefore will not incorporate the subject matter of a patent in a standard unless the owner agrees to license the patent on fair, reasonable and non-discriminatory (FRAND) terms. Though the commitment to do so is voluntary, it will generally be enforced by courts.
When SEPs are involved in patent infringement litigation, FRAND issues will arise in the context of past and future damage computations. However, there has also been litigation involving alleged antitrust law violations arising out of alleged predatory and discriminatory licensing. Trade regulation agencies in various countries are investigating some of these licensing activities as well, particularly in the telecommunications field.
In the remainder of Part I of this article, we will discuss issues related to judicial interpretation of the FRAND commitment in determining appropriate royalty rates. In Part II, we will discuss in detail the appellate decisions in the U.S. and in Europe governing setting of FRAND royalties. We will also provide an update on U.S. lower court cases involving SEPs and on a recent post on our Website concerning antitrust litigation brought by Apple against Nokia and several Patent Assertion Entities (PAEs) to which Nokia assigned patents when it exited the handset business. Finally, we will discuss other antitrust litigation relating to SEPs and investigations in China, South Korea and elsewhere into the licensing practices of the owners of SEPs.
Negotiating Royalty Rates:
In a typical scenario, patent litigation begins with a letter from a lawyer asserting that the recipient is infringing someone’s patent(s). The letter may be courteous or nasty, depending on how well-brought up the lawyer was, the corporate culture of his or her firm, and that of the patent owner. Ideally, at least one allegedly infringed claim will be identified and “read on” the accused product.
Depending on the situation, the letter may include an invitation to negotiate a license, for example, if the patent owner is a patent assertion entity (PAE), or if the patent is an SEP. Perhaps there will even be a suggestion of a royalty rate or a proposed paid-up license, and perhaps even a proposed standard license.
What happens next may depend on whether the recipient (and its lawyer) think the patent may be do infringed. If so, the next question is likely to how easily the design can be changed to avoid infringement and the effect the change will have on performance pricing, market elasticity (how much royalty can you pass on to your customers) as well as other factors. The relative cost of litigation versus taking a license will also be considered.
Some critics say there is a more common scenario, especially when the accused infringer is one of the technomonsters and the patent owner is a small or medium size competitor. Such villains are said to practice “efficient infringement”, i.e., they regard the cost and burdens of patent litigation to be so burdensome for the little guys that they will rarely be sued. Even when they are sued and are found to have infringed the patent(s), they are said to believe that injunctions are so rarely granted that they can steal the technology they want with impunity. I am not aware of any comprehensive study which suggests how often this actually occurs.
Now this article is not about the science (or more properly, the art) of license negotiation. Fortunately, this is a well-traveled road with reasonably good signposts along the way to facilitate good faith negotiation.
Damages if you Litigate and Lose:
Under U.S. law, §284 of the Patent Act says, “…the court shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer…” Calculation of compensatory damages is typically keyed to lost profits.
Broadly similar laws exist elsewhere, with “statutory damages” within fixed ranges also available in some places. Usually, actual damages can be increased when a court finds there was willful infringement.
But things get more complicated when damages have to be based on reasonable royalty. Practices in the parties’ industry may provide guidance, but sometimes a jury the court may have to figure out what a willing licensor would pay a willing licensee if they were negotiating in a non-contentious situation. In 1970, in the case of Georgia-Pacific Corp. v. U.S. Plywood Corp., the U.S. District Court for the Southern District of New York proposed a 15 factor test to help determine reasonably royalty. The factors are:
- Royalties the patentee receives for licensing the patent in suit to others;
- Rates licensee actually pays for use of other patents comparable to the patent in suit;
- Whether the existing licenses are non-exclusive or exclusive, whether they are territorially restricted, or restricted as to permitted customers;
- The licensor’s policy and marketing program as to licensing others to use the invention and special conditions under which licenses are granted;
- Commercial relationship between licensor and licensee, such as, whether they are competitors or inventor and promoter;
- Effect of selling the patented specialty in promoting sales of other products of the licensee; the existing value of the invention to the licensor as a generator of sales of his non-patented items; and the extent of such derivative or convoyed sales;
- Duration of patent and term of license;
- Established profitability of the products made under the patent, its commercial success and its current popularity;
- Utility and advantages of patent property over old modes and devices
- The nature of the patented invention; the character of the commercial embodiment of it as owned and produced by the licensor; and the benefit of those who have used the invention;
- The extent to which the infringer has made use of the invention and the value of such use;
- The portion of profit or selling price customarily allowed for the use of the invention;
- The portion of realizable profit attributable to the invention as distinguished from non- patented elements, significant features / improvements added by the infringer, the manufacturing process or business risks;
- Opinion testimony of qualified experts;
- Outcome from hypothetical arm’s length negotiation at the time of infringement began
These factors have been widely adopted and are presented to juries, either in whole, or in part, as things to be considered in determining a reasonable royalty. Trial judges also consider these factors when faced with a motion to set aside a jury verdict, or when reasonable royalty is determined by a bench trial. They are supposed to be used as additive or subtractive factors in relation to expert testimony or other evidence. The parties’ experts weave their interpretation of them into their reports and testimony, and the lawyers weave their client’s desired outcome into their closing arguments in relation to them in their closing arguments and briefs/
Quite clearly, though, they do not amount to a formula and their influence on the court’s or the jury’s determination will depend greatly on Factor 14. Further, they have often been criticized as resulting in overcompensation. Nevertheless, while they are fodder for second guessing by appellate judges, there isn’t anything better on the horizon. In short, reliable predictions as to reasonable royalty requires lots of luck; and a very good crystal ball.
SEPs – The Ultimate Nightmare:
Now, to the really scary one. A typical standard normally does not cover a single product, but rather a universe of products. Nor is there usually just one SEP involved in a typical standard. For example, say there are five SEPs (an atypically small number which I use only for simplicity in my discussion) that are incorporated in a particular standard. Some products may be covered by all the patents while others may be covered by only some or even one patent. Also, the standard will often be adopted in many countries and there may not be patents in all the countries. Even where there are patents, the scope of the claims may differ so significantly from country to country that, in some instances, one or more of the patents are not even SEPs at all. How in the world can you determine FRAND royalties given all those possibilities?
The concept of FRAND royalties goes back many years, but its first judicial application to SEPs seems to have been in Microsoft Corporation v. Motorola Inc, a case that began in 2010 and was first the subject of a substantive judicial decision in 2013. Since then, there have been several lower court decisions that needed to deal with FRAND royalties for SEPs, but only three appellate decisions. These are the CAFC decisions in Commonwealth v. Cisco Systems, Inc. (decided December 3, 2015) , in Ericsson, Inc. v. D-Link Systems, Inc. (July 30, 2015) and the Ninth Circuit decision in Microsoft Corporation v. Motorola Inc (decided July 30, 2015).
Because there are issues that are unique to computation of FRAND royalties that don’t exist in other situations, the state of the law is best described as still evolving. Indeed, the two appellate decisions are arguably in conflict, as we will discuss in Part II.
Before we do that, however, let’s look at the issues that the courts have had to address which include:
- Whether there has been patent hold-up and royalty stacking;
- Who has the burden of proof on these issues, e.g., is proof of actual hold-up or royalty stacking necessary;
- Whether courts should apply the incremental value rule;
- What constitutes a “comparable license”; and
- Whether the appropriate royalty base is limited to the “smallest salable patent practicing unit,” and if so, how that should determined.
The calculation of a royalty depends on both a “royalty base” and a ”rate” applied to that base. The first four of the issues noted above relate to royalty rate.
The term “patent hold-up” refers to a situation in which the owner of a SEP holder tries to leverage incorporation in a standard to obtain a higher royalty than it could have obtained if the patent was not an SEP.
“Royalty stacking” refers to what royalties are being paid to owners of other SEPs and the cumulative significance of such payments on the reasonableness of the royalty being sought for the patent in suit.
Trial judges have addressed the risk of royalty stacking in two ways. Several have considered the aggregate royalties that would apply if other SEP holders made similar royalty demands of the implementer, without requiring the implementers to show what royalties they were currently paying. Others have refused to take royalty stacking into consideration absent evidence of the actual amount of royalties the defendants currently pay for the patents.
When the question of “hold up” has arisen, it is treated as a consideration according to the evidence presented.
The “Incremental Value” approach involves consideration of the incremental value of the patented technology over the next-best alternative as a basis for establishing what a willing licensee would pay in a hypothetical negotiation. The U.S. Federal Trade Commission favors this approach, but it has not gained much traction to date in the courts.
Consideration of “comparable licenses” is first a question of how to define “comparable”. If a patent is important (or not particularly important) in relation to the standard, a license of a comparably important (or not important) patent would be relevant. Licenses in non SEP patent pools are sometimes also used as guidelines where the degree of importance of the patent in suit relative to the standard is comparable to the importance of the pooled patents in their context.
The final issue relates to determination of the appropriate royalty base. Under prevailing Federal Circuit law, the royalty base in any royalty calculation (FRAND or otherwise) should be the “smallest salable patent practicing unit” because calculating a royalty on the entire product carries a considerable risk that the patentee will be compensated for non-infringing components of the product. However, as we will see in Part II, in some cases, trial courts have not followed this approach.
To summarize, some general principles have emerged. For example, FRAND royalties must provide the patent holder with reasonable compensation but based on the economic value of the patented technology itself, without regard to additional value resulting from incorporation of the technology into the standard. Also, courts will look at comparable licenses in the industry, just as they do when SEPs are not involved.
About the author: Larry Hoffman has a B.S. in Electrical Engineering and Comp. Sci. from Massachusetts. Institute of Technology and a J.D. from the George Washington University School of Law. He has been a lawyer since 1965 specializing in IP law and product liability defense. He is registered to practice before the U.S. PTO, the U.S. Court of Appeals for the Federal Circuit and the state and federal courts in New York, Maryland, and the District of Columbia. His work has included preparation and prosecution of patents in countries throughout the world, and counseling on IP and product safety matters. He has been involved in the trial of close to 100 lawsuits of various kinds. You can reach him at Lawrence@ipatent.co.il.