Searching for FRAND in FRAND valuations – Part 1/3

The year 2013 has been a watershed year for standard essential patent (“SEP”) owners and related fair, reasonable, and non-discriminatory (“FRAND”) valuations.  This year has seen a consensus build upon the unavailability of injunctive relief to FRAND-encumbered patent holders.  At least a few cases saw common ground built up on the methodology for calculating a fair, reasonable and non-discriminatory (FRAND) royalty rate and a royalty base.  This year also saw the takeover of Nokia’s devices and services business by Microsoft.  This in my view is a paradigm shift for the wireless handset industry.  For the background on SEPs, FRAND see my posts here and here.

The structure of this post series would be first to develop an empirical understanding of FRAND valuations from existing case law.  Till November, 2013 there have been only 3 cases where FRAND royalty rates have been provided – starting from InterDigital v. Huawei (February 2013, China), Microsoft v. Motorola (April 2013), to Innovatio IP Holdings (September 2013) where FRAND royalty rates have been judicially determined.

This post in the series will examine the case law (InterDigital and Microsoft), and discuss the application of the FRAND concepts.  The second post will examine the Innovatio decision and third post will apply the ideas learnt from the case law, and develop a suggested framework to determine a FRAND royalty rate that is fair to both the innovator and the implementer for 2G, 3G, and other technologies.  Long post follows:

Non-Availability of Injunctions in SEP licensing:  Because an SEP owner has agreed that it can be compensated in terms of money, there seems to be a global consensus that an injunction is not available except for egregious cases.  Starting from Judge Posner in Microsoft v. Motorola, unavailability of exclusionary measures (border control) has been discussed in Realtek v. LSI, Apple – Samsung (Japan), Innovatio, Apple – Samsung (Europe) and a large number of others.  Other decisions are from competition law authorities such as the United States International Trade Commission (ITC).  Various US agencies including the Antitrust Division at the Department of Justice, have at various times urged the ITC to take into consideration potential impact on competition and consumers before allowing an SEP holder to obtain an exclusionary order.

Traditionally, in patent law jurisdictions across the globe, a plaintiff in a patent infringement action, can seek an exclusion preventing a defendant from practising the invention(s) in the SEP(s).  Apart from injunctions, monetary damages were also available to the patentee in the form of reasonable royalties / lost profits.

Current case law rejects this traditional approach: For a patent to become part of a standard, the SEP owner has the option of committing to a FRAND arrangement for mass adoption of the standard.  Under this FRAND obligation, a defendant is seen as a third party beneficiary of the contract between a standard setting organization (SSO) and the patentee.  This case law correctly recognizes the problem that a patentee can use the threat of an injunction to extract unfairly high royalties and impede implementation of the standard.

Fair, Reasonable and Non-Discriminatory (FRAND): A conceptual overview

In simple terms, a FRAND commitment is an undertaking given by a patentee who believes that her patent has become or is likely to become a part of a technology standard, and that the patentee is willing to grant a license to any prospective licensee on fair terms on reciprocal basis.  Accordingly, a FRAND commitment is not a license but a covenant to agree in the future.

The reciprocity in the FRAND commitment is to ensure that parties license their individual SEPs to each other.  What follows from the definition is that the FRAND commitment furthers the goal of a SSO of increased adoption.

FAIR and REASONABLE: Per the authors understanding, the methodology used to determine a rate should be fair and reasonable.

NON-DISCRIMINATORY: This term has been interpreted by Courts to mean that similarly situated licensees receive similar terms.

Calculating a Fair and Reasonable Royalty: Lessons from case law:

1.  InterDigital v. Huawei: From InterDigital’s SEC filings, it is seen that a Chinese Court issued a first order defining the rates for FRAND encumbered SEPs held by InterDigital.  See SEC filing.

The SEC filing provides:

On February 4, 2013, the Shenzhen Intermediate People’s Court issued rulings in the two proceedings. With respect to the first complaint, the court decided that InterDigital had violated the Chinese Anti-Monopoly Law by (i) making proposals for royalties from Huawei that the court believed were excessive, (ii) tying the licensing of essential patents to the licensing of non-essential patents, (iii) requesting as part of its licensing proposals that Huawei provide a grant-back of certain patent rights to InterDigital and (iv) commencing a USITC action against Huawei while still in discussions with Huawei for a license. Based on these findings, the court ordered InterDigital to cease the alleged excessive pricing and alleged improper bundling of InterDigital’s Chinese essential and non-essential patents, and to pay Huawei approximately 3.2 million USD in damages related to attorneys fees and other charges, without disclosing a factual basis for its determination of damages. The court dismissed Huawei’s remaining allegations, including Huawei’s claim that InterDigital improperly sought a worldwide license and improperly sought to bundle the licensing of essential patents on multiple generations of technologies. With respect to the second complaint, the court determined that, despite the fact that the FRAND requirement originates from ETSI’s Intellectual Property Rights policy, which refers to French law, InterDigital’s license offers to Huawei should be evaluated under Chinese law. Under Chinese law, the court concluded that the offers did not comply with FRAND. The court further ruled that the royalties to be paid by Huawei for InterDigital’s 2G, 3G and 4G essential Chinese patents under Chinese law should not exceed 0.019% of the actual sales price of each Huawei product, without explanation as to how it arrived at this calculation. InterDigital intends to appeal both decisions.  (Emphasis added).

As InterDigital’s filing indicates, there is no reasoning given by the Chinese Courts.  However, it will be clear from the Microsoft and Innovatio cases that the reasoning followed by the Chinese Court would have been on similar lines as that of these cases.

2.  Microsoft v. Motorola: In April 2013, in the second case involving determination of FRAND royalties, Judge Robart, in Microsoft v. Motorola, W.D. Wash. Apr. 25, 2013 provided for the first time, a framework for calculating the value of SEPs on FRAND terms.

Motorola had initially offered to license to Microsoft, its SEP portfolio involving 802.11 and H.264 technologies at a 2.25% royalty rate on the price of Microsoft’s end products (Xbox 360, PC/Laptops, smartphone, etc.). Microsoft, counter sued under state law, alleging Motorola breached its FRAND obligations by making an unreasonable offer to license its SEPs, and Microsoft requested a judicial determination of a FRAND royalty rate.

The royalty rate demanded by Motorola (2.25%) translated to $3-$4.5 per device.  Judge Robart however, determined a FRAND range significantly lower than the demanded rate at $0.0555-$0.16 per device for the H.264 SEPs and $0.08-$0.195 per device for the 802.11 SEPs.

Judge Robart’s FRAND framework:

(i) Start with the Georgia Pacific factors for determining a reasonable royalty (Page 33);

(ii) Adjust the factors for determining a reasonable royalty through a hypothetical negotiation.  This hypothetical negotiation is at a time when a technology was adopted as a part of a standard or just before its adoption.

(iii) Further adjust to account for purpose of the FRAND commitment: In the context of SEPs is to induce the wider adoption of standards by guaranteeing patent holders receive reasonable royalties while also mitigating the risks of patent hold-up and royalty stacking. Hold up exists when a standard has been widely adopted, and the wide adoption allows a SEP holder to demand more than the value of the specific SEPs.  See P.21.  In addition, this adjustment is also important to ascribe value to key SEPs that are of relatively greater importance to a technology standard than others.

To determine the adjustments, Judge Robart determined: the total number of essential patents and essential patent holders related to the particular standard; the patent holder’s level of involvement in the standards setting process (e.g., timelines, research contributions); the quantifiable value of the essential patent’s contribution to the standard (e.g., efficiency gains, improvements over prior or alternative methods); and the existence or non-existence of alternative technologies including evidence of how the alternative could or cold not have been integrated into the standard.

These adjustments allows for:

(a) determination of the importance of an SEP portfolio to a technology standard; and

(b) determination of the importance of the SEP portfolio to an allegedly infringing accused product;

Judge Robart asked the parties to provide claim charts to pin-point the extent of practice of the SEPs in the infringing product. According to the opinion, these claim charts would help in deciding a breach of contract question.

Application of the Georgia Pacific Factors:

The Application of the Georgia-Pacific factors allows for determination of a comparable royalty rate or a comparable license.

The tables below summarize the application of various factors to the end royalty range determination for both 802.11 and H.264 SEPs.

Table 1: H.264 Licensing – FRAND ROYALTY RATE / RANGE