for the wonks:
9th Circ. Microsoft FRAND Ruling Ignores Ericsson
Law360, New York (September 1, 2015, 10:21 AM ET) --
J. Gregory Sidak %>
J. Gregory Sidak
On July 30, 2015, the Ninth Circuit affirmed the 2013 Microsoft Corp. v. Motorola Inc. decision of Judge James Robart of the U.S. District Court for the Western District of Washington — the first decision in which a U.S. court determined a fair, reasonable and nondiscriminatory royalty for the use of a standard-essential patent.[1] Despite the considerable discussion that this appellate opinion has already generated, commentators so far have overlooked the decision’s larger implication: the Ninth Circuit has managed to create a circuit split with the far more experienced Federal Circuit concerning the principles for determining a FRAND royalty that the latter court articulated in its December 2014 opinion in Ericsson Inc. v. D-Link Systems Inc.[2]
Curiously, the Ninth Circuit cited Ericsson v. D-Link when defending the modified Georgia-Pacific framework that Judge Robart created to calculate FRAND royalties for SEPs — and to that extent the Ninth Circuit implied that Ericsson v. D-Link supports the outcome in Microsoft v. Motorola. But that implication is false. The Ninth Circuit ignored the fundamental principles that Ericsson v. D-Link underscored, including the requirement that the implementer of an SEP substantiate any theoretical conjectures it makes about patent holdup or royalty stacking with actual empirical evidence that is relevant to dispute at hand.
The Ninth Circuit, sitting en banc, could repair the circuit split that the panel in Microsoft v. Motorola created. If the Ninth Circuit declines to do so, one would be hard-pressed to identify any other patent case that more deserves the grant of a writ of certiorari than Microsoft v. Motorola, for the FRAND royalty issues in the case implicate the welfare of hundreds of millions of U.S. consumers, as well as billions of additional users of cellphones and mobile devices in other countries.
Are Theoretical Conjectures Relevant to Calculating a FRAND Royalty?
When determining the adequate compensation for the use of SEPs, one must first analyze the importance of properly determining fRAND royalties. Regulators across the globe have recognized the benefits that standardization generates for consumers and the economy.[3] Standards promote “efficient resource allocation and production by facilitating interoperability among complementary products,”[4] and, as a result of those efficiencies, standards stimulate economies of scale and increased innovation.[5] However, with each succession of a new standard, heavy private investment is necessary to introduce new improvements in connectivity, security, and performance that consumers demand.[6] The Ninth Circuit said that, “[w]hen we connect to WiFi in a coffee shop, ... we owe thanks to standard-setting organizations.”[7] But the Ninth Circuit forgot to thank the innovators whose significant investment in research enabled the development of Wi-Fi technology.
Standard-setting organizations — which develop and promulgate industry standards — have recognized the need to fairly compensate companies that have invested in research and development and contribute their innovative technologies to standards. SSOs typically require their participants to clarify whether they are willing to license their technologies implemented in industry standards on FRAND terms. The purpose of a FRAND commitment is to ensure that implementers have access to the patented standard-essential technology and that SEP holders are adequately compensated for their contributions to the standard — not, as the Ninth Circuit contends, to avoid patent holdup and royalty stacking.[8]
After the patent holder has agreed to license its SEPs on FRAND terms, a licensor and a licensee negotiate the exact licensing terms for the use of the SEP portfolio. When, infrequently, the parties cannot agree on the exact licensing terms and conditions, the parties may ask a court or arbitral tribunal to determine a FRAND royalty for the use of the SEPs. Courts, regulators and competition authorities have faced this challenge, yet they have not adopted a generally accepted methodology to calculate a FRAND royalty.[9] Nonetheless, the respective decisions of Chief Judge Leonard Davis and the Federal Circuit in Ericsson v. D-Link recognize important economic principles that can assist future juries, judges and arbitrators in calculating a FRAND royalty for SEPs.
The two decisions in Ericsson v. D-Link confirm that royalties upon which parties willingly agree in real-world transactions reveal what market participants consider to be a FRAND royalty for those SEPs.[10] By accepting the methodology that Ericsson’s damages expert applied, the Federal Circuit confirmed the long-established economic principle that comparable licenses — that is, licenses signed in circumstances that are sufficiently comparable to the hypothetical license at issue in suit — reliably inform the value of a licensed technology. Analyzing comparable licenses is an accurate and reliable methodology for calculating a FRAND royalty. Conversely, methodologies that rely on heuristics or indirect information about the value of the patent portfolio, such as extrapolations from patent pools or the “Top-Down Approach,” risk determining an erroneous FRAND royalty.
Both Chief Judge Davis and the Federal Circuit confirmed that royalties specified in comparable licenses enable the adjudicator to apportion the damages award to include only the incremental value of the licensed patents.[11] They correctly observed that a rational licensee would not agree to pay a royalty that exceeds the incremental value of the licensed technology. Moreover, SEP licenses are typically negotiated by sophisticated parties who know that the SEP holder is obligated to license its SEPs on FRAND terms and conditions and that an implementer can enforce that obligation in court. Consequently, it is improbable that the royalties upon which the parties have agreed in those licenses include so-called patent-holdup value.
Chief Judge Davis and the Federal Circuit also reiterated that unsubstantiated conjectures, such as patent holdup and royalty stacking, should not influence the determination of a FRAND royalty.[12] This approach is economically sound. The patent-holdup and royalty-stacking conjectures were first presented in 2007, and since then, scholars in economics and in law have exposed the flawed logic of the two conjectures. Supporters of the two conjectures fail to account for developments in the law that have significantly reduced, if not completely prevented, patent holdup and royalty stacking from occurring in practice since academics first published their conjectures.
Furthermore, as of 2015 — eight years since these theories were first presented — empirical evidence has contradicted the grim predictions made by the proponents of the patent-holdup and royalty-stacking conjectures. Even Professor Mark Lemley, one of the major advocates of the holdup conjecture, has recognized that legal developments in patent law have led to a situation in which “we probably have the balance we need,” such that courts and legislators should take “some time to digest [past court decisions] and take some time to look around where we are.”[13]
Consequently, by 2015, it is demonstrably unsound economic analysis to rely upon the patent-holdup or royalty-stacking conjectures in cases in which the alleged infringer has failed to substantiate those conjectures with empirical evidence. The finder of fact should attempt to account for the theorized risks of patent holdup and royalty stacking only when empirical evidence shows that those risks exist in a particular case.
Following the Federal Circuit’s decision in Ericsson v. D-Link, other courts and administrative bodies, both in the United States and in other jurisdictions, have refused to rely on theoretical allegations of opportunistic behavior. For example, in April 2015, Administrative Law Judge Theodore Essex found that unsubstantiated claims about the risk of patent holdup were insufficient to avoid an exclusion order from the U.S. International Trade Commission.[14] Judge Essex examined the specific facts of the case and found that, in the case at issue, reverse holdup — the scenario in which an implementer uses SEPs without compensation, in an attempt to force the SEP holder to accept a lower royalty — was more likely than patent holdup to have occurred.[15]
The Court of Justice of the European Union adopted a similar approach in July 2015 in Huawei Technologies Co. v. ZTE Corp.[16] Although the CJEU only briefly mentioned the risk of patent holdup and reverse holdup, it reiterated the need to reconcile allegations of an abusive injunction with “the specific legal and factual circumstances in the case.”[17] Similarly, in March 2015, the High Court of Delhi, in ordering an injunction against an infringer of a FRAND-committed patent,[18] did not rely on abstract allegations of excessive prices or holdup. Rather, the High Court of Delhi examined the parties’ conduct during the negotiation process, and declined to consider theoretical allegations of excessive royalty demands by SEP holders that lacked any empirical substantiation.[19] Curiously, the Ninth Circuit’s decision in Microsoft v. Motorola does not comport with the trend of courts disregarding allegations of patent holdup and royalty stacking without empirical evidence of those theoretical phenomena.
Although the Ninth Circuit’s reasoning in Microsoft v. Motorola regarding the patent-holdup and royalty-stacking conjectures may appear on the surface to be “empirical,” it is nothing of the sort. The expert witnesses’ testimony from the trial transcript of the district court proceedings confirms that the district court and the Ninth Circuit accepted theoretical allegations of opportunistic behavior by the SEP holder without any genuine empirical evidence. For example, Microsoft’s leading expert witness, Professor Kevin Murphy of the University of Chicago, invoked the theory of holdup, but on cross-examination could not identify a single real-world instance of holdup, admitting that the existence of holdup “is an open question.”[20]
Other Principles That Guide the Determination of a FRAND Royalty
Besides recognizing the need to substantiate allegations about patent holdup and royalty stacking with empirical evidence, the Federal Circuit recognized two other principles that should guide the determination of a FRAND royalty.
First, the Federal Circuit recognized that the parties may use the price of the final product as a royalty base for the calculation of a royalty compensation for SEPs. The Federal Circuit observed that, in real-world licenses for SEPs, parties routinely use the value of the downstream product as the royalty base and confirmed that that practice is legitimate and consistent with the FRAND commitment. The Federal Circuit emphasized that the SEP holder’s decision not to use the price of a chip as the royalty base does not diminish the probative value of actual royalties specified in comparable licenses.[21] The Federal Circuit acknowledged that the practice of using the downstream product as the royalty base might not comport with the requirements of the entire market value rule. However, it emphasized that the EMVR is an evidentiary principle developed for a jury trial — in which jurors are, according to the court, “less equipped” than a judge in a bench trial to apportion patent damages adequately when presented with a large royalty base.[22] Consequently, through its reliance on the EMVR, the Federal Circuit does not aim to direct the parties’ behavior outside the courtroom. The Federal Circuit emphasized that a jury can determine FRAND compensation on the basis of royalties observed in comparable licenses, even if those licenses use the value of the downstream product as the royalty base, because those royalties reveal what the licensor and the licensee consider to be fair compensation for the use of the licensed technology.
Finally, the Federal Circuit said that a FRAND royalty should not include any value that the patented technology provides by virtue of its inclusion in the standard.[23] This language would have benefited from greater specificity, but economic analysis can aid its proper interpretation. The Federal Circuit’s decision should not be interpreted to mean that one should exclude from a FRAND royalty any and all of the standard’s value. When an invention covered by the SEPs in suit increases the value of the standard, only a FRAND royalty that includes a part of that contributed value will fully compensate the SEP holder for the incremental value of its invention. The most accurate and probative methodology to determine the value that an SEP contributes to the standard is to evaluate royalties paid in comparable licenses. Because comparable licenses implicitly disaggregate the value of the licensed technology from the value attributable to the noninfringing components of the standard, comparable licenses most accurately reflect the market-disciplined price for a patented technology.
—By J. Gregory Sidak, Criterion Economics LLC
Gregory Sidak is founder and chairman of Criterion Economics in Washington, D.C. He formerly was a staff member of the president’s Council of Economic Advisers and was deputy general counsel of the Federal Communications Commission.
