SEP and FRAND 2016: FRAND and SEPs in the United States

Although the subject of much recent attention, fair, reasonable and non discriminatory (FRAND) licensing requirements are far from new in the United States. As early as 1942, a federal district court required mandatory licensing on “reasonable and non-discriminatory terms”, and in 1945 the Supreme Court approved the remedy of compulsory licences on “standard royalties” and “without discrimination”. Indeed, a 1970 statistical analysis by Richard Posner counted 60 court-imposed remedies requiring FRAND licensing between 1940 and 1969. Typically, these remedies were imposed to address abuses of patent rights that created an anti-competitive effect. For many courts, requiring FRAND licensing to remedy patent abuse was little different from centuries-old antitrust remedies granting access on fair terms to facilities deemed to be essential to compete with a monopolist.

The contemporary concept of FRAND has arisen not because of judicial decrees, but because of rules adopted by standard-setting organisations (SSOs) regarding the adoption of patented technology into standards. Although not a new phenomenon (in 1959 a policy of the American Engineering Standards Committee, now known as the American National Standard Institute, discouraged adoption of patented technology into standards unless licences were widely available on “reasonable terms”), the widespread adoption of FRAND policies by SSOs and the proliferation of standards have focused global attention on the question of what, precisely, are FRAND licensing terms.

To understand the contours of FRAND licensing requirements, it is helpful to begin with the objectives of the rule. The proliferation of SSO FRAND rules generally arose to address the potential abuse of the market power that a patentee may acquire as a result of the adoption of its patent into a mandatory standard. FRAND requirements are imposed to address the now widely recognised problem of what is known as ‘patent hold-up’. Simply put, once a patented technology has been adopted into a mandatory portion of an industry standard, the patent becomes a standard-essential patent (SEP) and the patent owner achieves market power that would not exist but for the adoption of the patented technology into the standard. Because those employing the standard in their products must now use the patented technology to the exclusion of reasonable functional substitutes, the patent owner can engage in ‘hold-up’ by exploiting the market power arising from a patent becoming a SEP, either by charging exorbitant and monopolistic royalties or by refusing to license at all.

This report:

• explores the contours of FRAND licensing in the US courts and the administrative agencies; and
• attempts to synthesise what FRAND means and how FRAND licence terms are determined.

‘Fair and reasonable’

Although FRAND licensing requirements have become pervasive in SSO rules, SSOs have generally avoided suggesting how FRAND terms should be determined and whether specific licence terms satisfy the FRAND requirement. Notable exceptions include:

• the VMEbus International Trade Association, which requires patentee disclosure of maximum royalty rates and most restrictive additional licence terms; and
• the Institute of Electrical and Electronics Engineers (IEEE), whose recent policies attempt to place parameters around ‘reasonable’ licence rates, including excluding any value to the SEP as a result of standard adoption and a recommendation that rates should consider the value of the patent to the smallest saleable compliant implementation that practises the SEP claim.

The latter IEEE recommendation is controversial and many have rejected the idea that rates must be based on – for example – the value of a patent to an integrated circuit, rather than the value of the technology to a product in the form used by a consumer. As noted below, although the IEEE suggestion may be sensible in certain extreme circumstances, the US Court of Appeals for the Federal Circuit recently rejected a general rule that FRAND requires licensing at the chip level.

As Deputy Assistant Attorney General Renata Hesse noted several years ago, determining FRAND terms is “challenging and complex”. The task for licensors and licensees alike is made all the more difficult by the paucity of guidance from SSOs, the courts, the legislature and governmental agencies about precisely what constitutes FRAND terms. Indeed, one of the goals set out in multiple speeches from representatives of the Federal Trade Commission and the Department of Justice Antitrust Division (which shy away from rate setting) is for SSOs to provide more guidance about what FRAND means and how it is determined.

Nevertheless, since 2013 several US district and appellate courts have started to establish a methodology to determine FRAND royalty rates. Because FRAND commitments are generally considered to be contracts between the SSO and patent owner (with parties that practise the standard being third-party beneficiaries of those contracts), the judicial task is to determine what the parties intended by the FRAND commitment. Consequently, the courts begin by examining the goals that FRAND licensing seeks to accomplish.

In general, two leading district court cases (Microsoft v Motorola Inc (WD Wash April 25 2003) and In re Innovatio IP Ventures LLC Patent Litigation (ND Ill October 3 2013)) and three court of appeal cases (Microsoft v Motorola (Ninth Circuit, July 30 2015), Ericsson v D-Link Systems (Fed Cir December 4 2014)) and Commonwealth Scientific and Industrial Research Organization v Cisco Systems (Fed Cir December 3 2015) – have summarised the FRAND goals as follows:

• widespread adoption of the relevant standard;
• an appropriate return to the patent holder to encourage participation in and contribution to standard-setting activities;
• avoidance of the excessive royalties that arise from adding together the royalty on all SEPs which a standard may include;
• recognition of the value to the standard of the patent at issue and appropriate apportionment of the value of the patented technology to the device accused of infringement; and
• avoidance of the attribution of value to a patent that arises from the inclusion of the patent in the standard.

To set FRAND rates in light of those goals, the courts have largely relied on the traditional method of determining reasonable royalty damages in patent infringement litigation: constructing a hypothetical licence negotiation between the plaintiff and defendant as willing licensor and licensee and analysing how that negotiation would address the 15 Georgia-Pacific factors, which were first identified in 1970.

In the FRAND context, courts have recognised that some of the 15 factors will be irrelevant or misleading (eg, commercial success of the accused product and the advantages of the new patented product over old models), while other factors typically not among the 15 must also be addressed (eg, eliminating the value attributable to the patent from its adoption into the standard and focusing on the value of the patent to the standard). While providing these goals and analytic tools, the courts have rejected rigid tests and recognised the “need for flexibility in determining a royalty rate for a RAND-encumbered patent”.

Thus, in the United States, FRAND rates are determined consistent with the goals noted above by examining, among other things:

• the rates in licences for the patents at issue and licences for similar technologies and patents (provided that such licences are not too contextually dissimilar and are subject to FRAND constraints);
• rates for patent pools or joint licensing programmes that may have been organised around the standards;
• the total universe of SEPs for the standard at issue;
• the objective value of the patents to the standard;
• the quality of the technology and any alternatives;
• the significance of the technology to the infringer’s business; and
• whether the patents cover mandatory core features of the standard.

These principles were clarified and reaffirmed by the US Court of Appeals for the Federal Circuit in December 2015. Three issues addressed by the court in this case are significant to the FRAND SEP analysis. First, the court held that the requirement to exclude from the royalty calculation any value derived by the patent from standardisation applies not only to the FRAND commitment, but also to any SEP because of rules set out in the Patent Act for determining a reasonable royalty.

Second, the court noted that the requirement of apportioning to the patents at issue the value they bring to the accused device does not mandate basing royalties on the value of the smallest saleable patent-practising unit (SSPPU). For example, if evidence indicates that the market or the parties focus on a flat rate per unit royalty rather than a percentage royalty, it may be wholly inappropriate to consider the SSPPU.

Third, echoing the flexibility mandated by the Ninth Circuit in Microsoft, the court stated that “damages models are fact-dependent”. Thus while many of the factors noted above will be relevant to a FRAND rate analysis, they will not be considered in the abstract unless evidence before the court makes the factor relevant. In sum, a fair and reasonable royalty rate to both patent owner and licensee takes into account multiple factors relevant to the particular circumstances to meet the five primary goals identified above.

Fair and reasonable licensing issues other than rates are also subject to limited guidance from the courts and agencies. Generally, grant-back provisions are considered acceptable but, consistent with the views of worldwide agencies, royalty-free grant-backs may be deemed problematic because they can have the effect of inhibiting innovation if an inventor is deprived of the fair value of its patent.

Perhaps the most significant FRAND issue to attract agency comment has been the question – addressed in other jurisdictions including the European Union, China and South Korea – of when, if ever, a patent owner may seek an injunction to prevent infringement of an SEP. More so than any other FRAND issue, there appears to be worldwide consensus that a FRAND promise precludes seeking an injunction unless the infringer has refused to or cannot accept a FRAND licence. Although providing greater detail than US agencies have, the European Court of Justice opinion in Huawei v ZTE, which detailed the conditions under which an injunction may be appropriate, appears to be consistent with US rules.

Finally, it also appears settled that an SEP owner may demand reciprocity from a licensee as a condition to offering a FRAND licence. Indeed, many SSOs incorporate this condition into the required FRAND commitment. There seems to be agreement that there is nothing “fair or reasonable” to the patent owner to require that it extend a FRAND licence if the licensee refuses to reciprocate with its own patents.

‘Non-discriminatory’

While guidance about ‘fair and reasonable’ is far from abundant, guidance regarding what ‘non-discriminatory’ means is even more scarce. Once again, non-discriminatory rules should reflect the purpose of the requirement – that is:

• widespread adoption of the standard;
• ease of entry into markets for products incorporating the standard; and
• licence terms that do not disadvantage the ability of a prospective licensee to compete.

With these goals in mind, discrimination principles are likely to coalesce around the following points.

First, it appears clear that non-discriminatory terms for all do not require identical terms for all. It is reasonable, lawful and commercially acceptable to treat differently (within limits) licensees that are not similarly situated. This includes proportional ‘better deals’ for those which provide benefits to the licensor in forms other than cash royalties (eg, early adopters, high-volume producers, market leaders that drive technological adoption and those that provide valuable grant-backs or contribute valuable intellectual property to pool or joint licensing programmes).

Second – although more controversial – is the question of whether non-discrimination requires licensing all those that desire a licence, regardless of their place in the distribution chain of a product. For example, must an owner of a FRAND-encumbered patent license a chip manufacturer directly or can it insist that a licence is available only to end-product manufacturers? Obviously, where in the distribution chain a technology is licensed has a significant impact on the reasonable royalty that may be charged (eg, on a $20 chip or a $650 smartphone incorporating the chip). Further, given that licensing a chip may exhaust patent rights in the end product, licensing at various distribution levels may make it difficult – if not impossible – for a patent owner to keep track of what end product actually is licensed.

The question of whether it is discriminatory to refuse to license a chip manufacturer is distinctly different from that of whether an SEP owner may refuse to exclude such a licence and yet seek to enforce its patent against the chip fabricator. Provided that no enforcement effort is made against the chip, the better argument is that a refusal to license a chip maker is not discriminatory when the patent owner agrees to license the chip indirectly by offering a licence to the manufacturer of the product incorporating the chip. No discrimination occurs and there is nothing ‘fair or reasonable’ about requiring a patentee to license at the distribution level when the patent may have the least value and disallowing an effort to capture the value of the technology in the end product (because of exhaustion of rights). Indeed, recent refusals to participate in IEEE activities because of the IEEE policy focusing on the value of the patent to a chip suggest that the FRAND goal of encouraging widespread participation in SSO activities may be harmed by interpreting FRAND to require licensing at the chip level.

A third issue concerns whether a patentee must agree to license only part of a licensee’s worldwide production. For example, a worldwide manufacturer may seek a FRAND licence in a jurisdiction which readily enforces patent rights while refusing to take a licence in jurisdictions that may be more lax. Again, although controversial, there seems nothing ‘fair or reasonable’ in requiring a patentee to accept remuneration for its patented technology in some places, while the licensee uses the technology in other places without permission. Not requiring such a partial licence seems all the more compelling when a licensor would discriminate against those that are licensed in the jurisdiction in which the prospective licensee refuses to enter into a FRAND licence. Further, interpreting the non-discrimination provision as requiring such a result advances no legitimate goal. A recent decision in Germany to this effect is persuasive.

This is not to say that the same patented technology is necessarily worth the same ‘fair and reasonable’ value in all places. Indeed, the factors noted above in determining a fair and reasonable rate suggest that an agreement between licensee and licensor to reflect the different value of different products in different jurisdictions may be appropriate.

Conclusion

Given the proliferation of standards and their significance, FRAND licensing is critical to prevent patent hold-up. However, it must not get lost in the debate that a FRAND licence must be reasonable to both licensor and licensee. FRAND policies must be adopted and applied without adversely affecting the goal of encouraging widespread participation in standard setting and liberal contribution of the best available technologies. The United States is well on the way to defining precisely what FRAND licensing means with these and other goals in mind.

Garrard R Beeney
Partner
[email protected]

Garrard Beeney is co-head of Sullivan & Cromwell’s IP and technology group and a member of the firm’s managing partners committee. Mr Beeney has been inducted as a fellow of the American College of Trial Lawyers. He is counsel in the two major patent cases to be argued before the US Supreme Court in 2016. He has litigated IP cases throughout the United States in both federal and state courts and also represents clients before US and EU competition law authorities. Mr Beeney graduated from University of Pennsylvania Law School and has a BA from Swarthmore College.