Licensors Do Not Commit Patent Misuse by Basing a Royalty on the Net Sales of a Product that Includes Patented and Unpatented Components

Authored by Mindy L. Ehrenfried, D. Brian Kacedon, and John C. Paul

When entering into a license agreement, a licensor should carefully consider whether its proposed royalty base could subject it to a claim of patent misuse. Although a recent decision by the Federal Circuit limited the scope of patent misuse based on license agreements, a licensee may have a credible claim of misuse if they can demonstrate that the agreement required licensing both patented and unpatented components together or used sales of such products as a royalty base. In Samsung Elec. Co v. Panasonic Corp., No C10-03098 (N.D. Cal. Aug. 25, 2011), the United States District Court of the Northern District of California addressed a patent misuse claim in the context of a patent pooling agreement, where the claim was based on an alleged improper royalty base.

Background

In 1999, Panasonic Corporation of North America, SanDisk Corporation, and Toshiba Corporation (collectively, "the SD Group") began to develop a next-generation flash-memory card. Less than a year later, the SD Group published the specification describing Secure Digital Memory Card technology, also known as an "SD Card." Since its introduction in 2000, no other memory-card technology has eclipsed the SD Card, which now accounts for over 80 percent of global sales of flash-memory cards for use in products like mobile phones and digital cameras.

After publishing the specification, the SD Group formed SD-3C, LLC. Companies seeking to manufacture SD Cards could purchase a license to a pool of patents from SD-3C, allowing them to practice essential SD card technology. Samsung Electronics Co., Ltd. entered into an SD Memory Card License Agreement with SD-3C on September 24, 2003. In 2006, Samsung and SD-3C discussed an amendment to the 2003 license, but ultimately Samsung refused to sign it. In 2010, Samsung filed suit against Panasonic and SD-3C in the United States District Court for the Northern District of California, alleging antitrust violations and patent misuse, which prompted Defendants to file a motion to dismiss those claims.

The Samsung Decision

Samsung asserted that Defendants committed patent misuse by requiring that royalties be paid based on the net sales price of the entire SD Card even though the SD Card includes both patented and unpatented components. In support of its theory, Samsung relied on the Supreme Court's decision in Zenith Radio Corp. v. Hazeltine Research, Inc., 395 U.S. 100 (1969), which held that it was patent misuse to require a licensee to pay a royalty on all sales of products regardless of whether the products were covered by the licensed patents.

The Court rejected Samsung's theory, however, and found that Defendants had not committed patent misuse by basing its royalties on the net sales price of the entire SD Card. In reaching its decision, the court relied on the Federal Circuit's holding in Princo Corp. v. ITC, 616 F.3d 1318 (Fed. Cir. 2010), which limited patent misuse to license agreements that (1) extend the life of the patent beyond the statutory term, or (2) require "tying" by including conditions that the licensee must also license unpatented components along with the patented components. Samsung's theory, the court found, fit neither of the Princo categories.

Moreover, the court found Zenith Radio Corp. inapposite. Unlike the patentee in Zenith, which required royalties to be paid on unpatented products, in this case, each SD Card indisputably practiced the licensed technology. The fact that those cards also include unpatented components does not take them outside the scope of the patents. Indeed, the court stated it was a widely accepted practice to base royalty payments on a percentage of total sales, where the final product includes, but is not limited to, the licensed technology.

Strategy and Conclusion

License agreements can base royalties on a percentage of net sales of a patented product without committing patent-misuse when those products practice the patented technology, even if they contain unlicensed components. A license agreement using sales of both patented and unpatented products as the royalty base may raise misuse issues under Zenith Radio.

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