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Essential Patents and FRAND judicial fragmentation

Essential Patents and FRAND judicial fragmentation

1. Introduction

In our current world of technological progress, standard essential patents have become part of our life.

Without even realizing it we are surrounded by standards. Most of our daily life is controlled by technological devices: all smartphones or tablets that we use today include one or more standards. To give an idea of this phenomenon Biddle, Brad and Woods shows that there are “251 technical interoperability standards implemented in a modern laptop computer and estimates that the total number of standards relevant to such a device is much higher”[1].

A patent that regulates any portion of a standard’s technology is referred to as a standard essential patent (SEP). The stakes around standardization are becoming increasingly important due to the development of the Internet of Things. The technology must operate together in each component in order to function. This implies that devices typically have to meet standards, in other words protocols through which machines interact with each other. For instance, standardization in cellular communications enables an iPhone to interact with a Samsung Galaxy.

Despite the fact that these norms are critical to the modern world, they present challenging issues with patent licensing[2]. When standards include patented techniques (hence making the patent a standard essential patent), holders of SEPs may be able to exercise disproportionate bargaining power over standards implementers. This may lead to patent “hold-up“, whereby the holder of an SEP requires a disproportionate royalty for their SEPs or threatens to prevent others from implementing the standard[3].

In order to counter the danger of patent hold-up, Standard Setting Organizations (SSOs) have developed Intellectual Property Rights (IPR) policies requiring standard essential patents holders, in exchange of the possibility of incorporating their technology into a standard, to agree to license their patents under “fair, reasonable and non-discriminatory” terms, in other words under FRAND’s terms.

Although there have been many developments in this area in recent years, the legal and regulatory framework applicable to essential patents remains highly uncertain in Europe as in the rest of the world. Industry players are increasingly aware of these challenges, as highlighted by the rapidly growing activity of IP Europe organizations, which defend the interests of essential patent holders (including Nokia, Orange and Airbus)[4], and the Fair Standards Alliance, which defend the interests of essential patent users (including Apple, Volkswagen, Google and Freebox)[5].

Many questions remain unanswered: how the judiciary determines who can implement the commitments? What kind of relief parties can seek? How to calculate FRAND royalties? Which courts will decide on these different problems?

Common law and civil law jurisdictions provide different answers for these questions. This is not a surprise given the substantial differences that exist between these two systems. However, what is most surprising is that divergent interpretations exist also within the same judicial system.

In the first part of our research we will analyze the divergent approaches between Common Law and Civil Law judicial system regarding the interpretation of FRAND’s commitment. Given the broadness of the subject we will focus on the essential and contentious issue surrounding the calculation of FRAND royalty (2). In the second part we will show that the outcomes in the interpretation of FRAND commitment vary not only across national jurisdictions worldwide but also within the same judicial system. The recent decisions released by Judge Gilstrap (U.S. District Court for the Eastern District of Texas) and Judge Koh (U.S. District Court for the Northern District of California) perfectly explain this phenomenon. Two judges within the same country analyze similar facts and reach a completely opposite result (3). Then in the last part we will give our conclusions (4).

2. Conflicting approaches regarding the calculation of FRAND royalties between Civil Law and Common Law countries

Despite the increased attention that standard essential patents have received in recent years, many questions are yet to be answered regarding the practical implementation of FRAND’s theoretical framework. One of the most challenging controversy regarding FRAND commitment concerns the pertinent methodology for calculating FRAND rate. In this part we will analyze the big divide between Common Law and Civil Law countries regarding this issue.

  • Civil law approach: towards the recognition of FRAND’s rate as a range.

Following the European approach FRAND’s rate is not represented by an exact amount but rather a range:

German courts, in particular, would rather derive the value of the SEP at issue based, e.g., on established licensing practices and existing agreements, than actively determine it. In any case, these courts do not generally perceive royalty determinations as the derivative of simulated negotiations[6].

Following this reasoning the Düsseldorf District Court in the case St Lawrence Communication v. Vodafone, affirmed that the need to provide explanations about the methodology used to calculate the royalty, as required under Huawei v. ZTE, should not be interpreted too strictly[7].

Civil law jurisdictions are not willing to define royalty rates and focus more on the parties’ conduct during negotiations to determine whether such behavior complies with FRAND commitment[8]. In particular, the judicial body verify: “whether an SEP proprietor made a specific, written offer for a royalty rate, whether the supposed infringer’s counteroffer occurred in a timely way, or whether an implementer who refused a licensing offer from a patent holder proved that he would be ready to enter into an appropriate licensing contract (e.g. by paying accruing royalties to escrow), etc”[9].

This methodology is subject to many critics. In particular, some authors condemn the “vagueness” of FRAND. Thus, there is a strong demand to substitute this methodology with a more pragmatic approach. For instance, Lerner and Tirole (2014, 2015) suggest the introduction of royalty thresholds before the setting of a standard.

Although the implementation of FRAND does not lead to a unique royalty rate it presents important advantages. Such flexibility permits the existence of a broad range of licenses which reflects nowadays market dynamic and variety. In this sense “the said approach recognizes that the idea of FRAND as a range also accommodates different interpretations regarding its economic function, allowing the parties to determine and substantiate the respectively proposed rates based on objective criteria”[10]

  • Common law approach: towards the creation of evidentiary rules

Clearly, the dispute and legal uncertainty surrounding FRAND stems from the fact that FRAND’s principles do not provide the courts with adequate instructions to determine royalty rates. Therefore, the U.S. judiciary have created extra methodologies and rules of evidence to determine FRAND rates[11].

“Regarding the royalty base, the choice between the price of the end product and the price of a smaller component lies at the heart of an ongoing controversy in the US”[12]In particular, methodologies such as the Entire Market Value Rule (“EMVR”), the Smallest Saleable Patent Practicing Unit (“SSPPU”), Top-Down Method and the Comparable Licenses Rule have been used in FRAND disputes. Following the opinion of authors such as Justus A. Baron, Chryssoula Pentheroudakis and Nikolaus Thumm “The application of such restrictive evidentiary rules in the context of FRAND litigation is used to limit the number of accepted criteria for the determination of a FRAND rate, thereby significantly shrinking the FRAND range and – with it – the scope for disagreement on a rate”[13].

  • The Entire Market Value Rule

The EMVR arose in early days. Yet in 1884, In Garretson v. Clark case, the judge held that:

“The patentee […] must in every case give evidence tending to separate or apportion the defendant’s profits and the patentee’s damages between the patented feature and the unpatented features, and such evidence must be reliable and tangible, and not conjectural or speculative; or the [sic] must show, by equally reliable and satisfactory evidence, that the profits and damages are to be calculated on the whole machine, for the reason that the entire value of the whole machine, as a marketable article, is properly and legally attributable to the patented feature[14].

Thus, by applying this rule the rate is based on the value of entire product and not just the specific component containing the essential patent.

  • The Smallest Saleable Patent Practicing Unit Rule

US Courts established that calculation of FRAND’s rate can be based on the price of the “smallest saleable infringing unit” or the “smallest saleable patent practicing unit” (SSPPU)[15]. In other words, using this methodology, the determination of FRAND royalties is based on the smallest unit that embodies the patent claim.

The concept of the SSPPU was suggested for the first time in the case of Cornell University v. Hewlett- Packard Co. (2009). In this context, the patentee tried to use the value of the servers as the calculation base for its essential patent. To mitigate the threat of patent holdup the Court rejected such attempt, stating that SSPPU rule should be used for calculation of damages. After that case, using SSPPU as the royalty calculation base is widely accepted in standard essential patent cases. For example, in Microsoft Corp. v. Motorola (2012) which was related to the WiFi and H.264 standards, the court determined the royalty based on the price of the WiFi chip. Also in this particular context the judges held that the price of the end product (i.e. Xbox) should not be used as the royalty calculation base because this will cause royalty stacking.

Quoting the recent case Ericsson v D- Link, Pentheroudakis and Baron state “recent jurisprudence defines the purpose of the SSPPU as a means of avoiding prejudicing a jury with large royalty base figures that result from the sales of the downstream product containing the SSPPU component”[16].

  • The Comparable licenses method

Experts have consistently relied on Comparable licenses to calculate FRAND rate. The reason is well explained in the LaserDynamics v. Quanta Computer case, where the judge held that this methodology is “highly probative as to what constitutes a reasonable royalty for those patent rights because such actual licenses most clearly reflect the economic value of the patented technology in the marketplace[17].”

The Federal Circuit defined comparable licenses to be licenses that are “sufficiently comparable to the hypothetical licenses at issue in suit”[18]. However, it is not satisfying alleging “a loose or vague comparability between different technologies or licenses”[19]. Comparable licenses can thus be allowed as a rule only if there is the possibility “to associate the royalty rates used in [the] prior licenses to the particular hypothetical negotiation at issue in the case[20].”

In Ericsson v. D-Link case Judge Davis relied on comparable licenses to calculate the FRAND rate that D-Link owed Ericsson. Similarly, in Realtek v. LSI[21], Judge Whyte considered other licenses for patents comparable to the two FRAND-encumbered 802.11 patents at issue. In this decision we also find some useful criteria that may be help in the determination of license comparability: 1) the patents included in the license agreement, 2) the date of the license, 3) any limitations on the use of the licensed technology, 4) the inclusion of other consideration in the agreement, 5) whether the license was part of a settlement of litigation or arbitration, 6) whether the royalty was a lump sum or a running royalty rate, 7) opinion testimony of qualified experts[22].

  • Top-Down Approach

The Top-Down Method is achieved by estimating the aggregate standard essential patent royalty applicable to a standard and then allocating an appropriate portion of the total to the Subject SEP. The UK courts that used top-down approach in FRAND cases based their aggregate rates on public statements made by standard essential patent holders and other market participants[23]. Similarly Judge Selna pointed out public statements and press releases to endorse the aggregate royalties found[24]. In addition, she specified that “implementation of this method has often been performed assuming that all SEPs related to a particular standard are equally valuable because it is challenging to accurately quantify differences in value among what are typically large amounts of patents”.

A singular application of the Top-Down approach was showed in In re Innovatio case where Judge James Holderman, unlike Judge Selna in the TCL v. Ericsson decision, did not take into consideration that all Wi-Fi SEPs were equally valuable.

Consideration

In this part we have outlined one of the major divergences in the interpretation of FRAND’s commitment between common law and civil law countries; explainable considering that we are talking about two completely different systems. However surprisingly FRAND commitment received a different interpretation also within the same judicial system.

In the previous part we have described some of the methodologies for FRAND’s royalty rate calculation. It should be noted that those methodologies were never applied coherently. Similar issues were solved very differently also within the same judicial system. In the next part of our research we will study in detail this divergent approach, focusing on US case law, and in particular on the recent decisions of Judge Koh, of the U.S. District Court for the Northern District of California and Judge Gilstrap, of the U.S. District Court for the Eastern District of Texas.

3. FRAND commitment in the US: different take on the same issue within the same judicial system

One disputed question is whether the non-discrimination aspect of FRAND commitment requires a standard essential patent owner to treat each potential licensee in the distribution chain in the same way. Texas court in HTC v. Ericsson case[25] and California court in FTC v. Qualcomm case[26] had a different opinion regarding this matter. This divergence is particularly interesting considering that we are talking about the same judicial system.

  • HTC v. Ericsson case

On May 23, 2019, Judge Gilstrap in the case of HTC v. Ericsson, confirmed that Ericsson’s offer to HTC fulfilled its obligation to license its essential patents on fair, reasonable and non-discriminatory terms. The judgment, which is in contrast with the opinion given by Judge Koh in FTC v. Qualcomm case, dismiss the royalty concept of SSPPU in favor of a market-based strategy.

In order to understand the major issues arising in this context it is important to provide some details about the background of the dispute. Ericsson, as a member of ETSI, agreed to license its 2G, 3G and 4G SEPs portfolio on FRAND terms under ETSI’s IPR Policy and offered a license to HTC at a rate of $2.50 per 4G device, or 1% of the net device price with a $1 floor and $4 cap[27]. HTC considered this rate too high and in breach of Ericsson FRAND commitment. In particular he argued that “Ericsson should have based its royalty calculation on the smallest saleable patent practicing unit, or SSPPU, contained in a cellular device, which HTC submitted was the baseband processor”. However, in Ericsson’s view this calculation methodology undervalued considerably its technology, given that its patents were worth much more.

Judge Gilstrap confirmed the view of the jury that Ericsson’s offers did not breach Ericsson’s agreement to license on FRAND terms and conditions.

First the court held that the ETSI FRAND commitment doesn’t oblige a company to license its essential patent in consideration of the cost of SSPU:

 “As a matter of French law, the FRAND commitment embodied in the ETSI IPR policy does not require a FRAND license to be based on the SSPPU.  Rather, whether a license meets the requirements of FRAND will depend on the particular facts of the case, as there is no prescribed methodology for calculating a FRAND license”.

This opinion is in line with the Ericsson v D-Link precedent in which we read that “courts must consider the facts of record when instructing the jury and should avoid rote reference to any particular damages formula.”

In particular the Judge stressed the fact that the value of Ericsson’s 4G portfolio is considerably more than a royalty rate on the profit margin or cost of the baseband processor in HTC’s devices (HTC’s “SSPPU”)[28]. The court argued that “Ericsson established, and HTC’s own experts conceded, that there are no examples in the industry of licenses that have been negotiated based on the profit margin, or even the cost, of a baseband processor” and that evidence endorsed the fact that “the profit margin, or even the cost, of the baseband processor is not reflective of the value conferred by Ericsson cellular essential patents.” In addition, Gilstrap held that Ericsson’s “comparable licenses provide the best market-based evidence of the value of Ericsson’s SEPs and that Ericsson’s reliance on comparable licenses is a reliable method of establishing fair and reasonable royalty rates that is consistent with its FRAND commitment.”  The terms of several of Ericsson’s licenses with other companies, such as  Sony, Apple, BLU, Doro, Fujitsu, Kyocera, Huawei, Coolpad, Kyocera, LG, Samsung, Sharp, ZTE and Panasonic were “similar or substantially similar” to Ericsson’s offers to HTC, thus dismissing the assertion that Ericsson’s offers to HTC were discriminatory.

  • FTC v. Qualcomm case

Judge Koh applied a different reasoning in a very similar case. In the case FTC v Qualcomm the court stated that Qualcomm was contractually obliged to license its SEPs to all implementers of the standard on FRAND terms.

Qualcomm is an American multinational that designs and markets semiconductor devices, known as modem chips, which are used for cellphones. Qualcomm also owns SEPs to cellular standards, including the 3G and 4G/LTE standards established by the Telecommunications Industry Association (TIA) and the Telecommunications Industry Solutions Alliance (ATIS)[29].

According to Judge Koh, the IPR policies of the two SSOs included “non-discrimination provisions that prohibit Qualcomm from distinguishing between types of applicants”[30]. Hence it doesn’t matter the place of the applicant in the production distribution chain: a  standard essential patent holder has an obligation to license to all of them.

The reasoning of the judge in understanding the meaning of FRAND commitment in this specific case was inspired by a Ninth Circuit precedent. Hence, in the case Microsoft v Motorola the Court of Appeals for the Ninth Circuit affirmed that the FRAND commitment read in line with the pertinent IPR policy (which terms are similar to the ones of the case analyzed) creates “an obligation to license to all comers”. In particular, it “required members who hold IP rights in standard-essential patents to agree to license those patents to all comers on terms that are ‘reasonable and non-discriminatory”[31].

4. Conclusion

As stated by Peter GeorgPicht “FRAND determination is a tricky business”. The vagueness of FRAND commitments, together with the increased importance of standard essential patents to the modem economy, have generated a variety of legal questions that received a different answer in common law and civil law countries but also within the same judicial system.

As already stressed the divergent approaches regarding FRAND commitment between US and EU are not surprising given that exist substantial differences between these two legal systems related to the legal structure, classification, fundamental concepts, terminology, etc. In other words, “the various approaches and divergent outcomes of FRAND disputes across national jurisdictions worldwide are due not so much to fundamental disparities on what constitutes FRAND as to differences in litigation profiles, competition dynamics and political priorities”.

However, what is surprising is that also within the same judicial system courts assess what seems to be a similar set of facts and reach a completely opposite result. The decisions released by Judge Gilstrap and Judge Koh explain perfectly this phenomenon. Regardless of whether the Judge Gilstrap approach or the Judge Koh approach is more convincing, the inconsistency between the courts’ reasoning have a significant impact on the incentives to innovate, implement and participate in Standard Setting-Organizations, creating uncertainties for both licensors and licensees.

Courts and legal scholars should get a better awareness of these consequences. It is only through an intense dialogue between judges that we can hope for a more coherent and predictable framework for the application of FRAND licenses in the future.

 

[1] Biddle, Brad and White, Andrew and Woods, Sean “How Many Standards in a Laptop? (And Other Empirical Questions)” (September 10, 2010). Available at SSRN: https://ssrn.com/abstract=1619440or http://dx.doi.org/10.2139/ssrn.1619440

[2] Jeffrey I. D. Lewis, “WHAT IS “FRAND” ALL ABOUT? THE LICENSING OF PATENTS ESSENTIAL TO AN ACCEPTED STANDARD”, 6 November 2014, available at: https://cardozo.yu.edu/what-“frand”-all-about-licensing-patents-essential-accepted-standard

[3] Sullivan & Cromwell LLP “District Court Holds That FRAND Commitment Requires Patent Owner to “License All Comers,” Including Chip Makers”, November 8, 2018 available at: https://www.sullcrom.com/files/upload/SC-Publication-District-Court-Holds-FRAND-Requires-Qualcomm-to-License-Competing-Chip-Makers.pdf

[4] www.iptalks.eu

[5] www.fair-standards.org/about-us.

[6] Chryssoula Pentheroudakis, Justus A. Baron (2017) “Licensing Terms of Standard Essential Patents. A Comprehensive Analysis of Cases”. JRC Science for Policy Report. EUR 28302 EN; doi:10.2791/32230

[7] Düsseldorf District Court, Decision of 31 March 2016, 4a O 73/14 – St. Lawrence Communication v Vodafone.

[8] Pentheroudakis, Baron (supra n. 16)

[9] Ibidem

[10]Baron, Justus and Pentheroudakis, Chryssoula and Thumm, Nikolaus, “FRAND Licensing in Theory and in Practice: Proposal for a Common Framework”(September 15, 2016). Antitrust Chronicle, Volume 3, Number 1, Summer 2016. Available at SSRN: https://ssrn.com/abstract=2839476

[11] Ibidem

[12] Pentheroudakis, Baron (supra n. 16)

[13] Baron, Justus and Pentheroudakis, Chryssoula and Thumm, Nikolaus (supra n.19)

[14] Garretson v Clark, 111 U.S. 120 (1884).

[15] Cornell University v Hewlett-Packard, 609 F. Supp. 2d 279 at 287-88 (N.D.N.Y. 2009); LaserDynamics, Inc. v Quanta Computer Inc., 694 F. 3d 51 at 67 (Fed. Cir. 2012); In re Innovatio IP Ventures, LLC , 921 F. Supp. 2d 903 (N.D. Ill. 2013).

[16] Pentheroudakis, Baron (n. 16)

[17]LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51, 79 (Fed. Cir. 2012).

[18] VirnetX, Inc. v. Cisco Sys., Inc., 767 F.3d 1308, 1330 (Fed. Cir. 2014) (quoting Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1325 (Fed. Cir. 2009)).

[19] Id. (quoting LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51, 79 (Fed. Cir. 2012))

[20] Apple Inc. v Motorola Inc., 757 F.3d 1286 (Fed. Cir. Apr. 25, 2014).

[21] Realtek Semiconductor Corp. v LSI Corp., 946 F. Supp. 2d 998, United States District Court, N.D. California (2013).

[22] Pentheroudakis, Baron (n. 16)

[23] See, Contreras, Jorge L., TCL v. Ericsson: The First Major U.S. Top-Down FRAND Royalty Decision (December 27, 2017). Patently-O, Dec. 27, 2017; Jorge L. Contreras, Aggregated Royalties for Top-Down FRAND Determinations: Revisiting ‘Joint Negotiation’, 62 ANTITRUST BULLETIN 690 (2017); Norman Siebrasse & Thomas F. Cotter, Judicially Determined FRAND Royalties in THE CAMBRIDGE HANDBOOK OF TECHNICAL STANDARDIZATION LAW: COMPETITION, ANTITRUST, AND PATENTS (Jorge L. Contreras, ed., 2017).

[24] TCL Communications v. Ericsson, Memorandum of Findings of Fact and Conclusions of Law (C.D. Cal., Dec. 21, 2017, SACV 14-341 JVS(DFMx) and CV 15-2370 JVS (DFMx)) at 19-26

[25] HTC Corp. v. Telefonaktiebolaget LM Ericsson, 18-cv-00243, Dkt. No. 376 (E.D. Tex. Jan. 7, 2019).

[26] FTC v. Qualcomm Incorp., 17-cv-00220, Dkt. No. 792, at 19 (N.D. Cal. Nov. 6, 2018).

[27] McKool Smith, Client Alert: Ericsson Offers FRAND – District Court Endorses Comparable Licenses, Rejects SSPPU Royalty Rate, November 2019, available at: https://www.mckoolsmith.com/newsroom-publications-243

[28] Ibidem

[29] Sullivan & Cromwell LLP (supra n.3)

[30] FTC v. Qualcomm Incorp., 17-cv-00220, Dkt. No. 792, at 19 (N.D. Cal. Nov. 6, 2018).

[31] Microsoft Corp. v. Motorola, Inc., 696 F.3d 872 (9th Cir. 2012); Microsoft Corp. v. Motorola, Inc., 795 F.3d 1024 (9th Cir. 2015).

Arianna Valeriani

Laureata in Giurisprudenza presso l'Université Paris I Panthéon-Sorbonne, con specializzazione in diritto pubblico, con il massimo dei voti. Dopo aver integrato la sua formazione, come Visiting Student, presso l'Università di Cambridge e l'Università della California Los Angeles (UCLA), continua i suoi studi presso l'Université Paris I Panthéon-Sorbonne, conseguendo un Master di primo livello in Diritto Internazionale. Particolarmente interessata all'applicazione del diritto nell'era digitale, si candida ed è ammessa  all'edizione 2018-2019 del LL.M in Law of Internet Technology, presso l'Università Commerciale Luigi Bocconi di Milano. La sua formazione le permette di avere una conoscenza livello madrelingua della lingua francese e inglese, oltre ad una buona padronanza della lingua spagnola.

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