May 7, 2013
LES Insights
Authored by D. Brian Kacedon, John C. Paul, and Kevin D. Rodkey
The mobile-phone patent wars have focused the legal community's attention on establishing a framework to use in determining the reasonable royalty rate for patents essential to industry standards ("Standard-Essential Patents" or "SEPs") and subject to a requirement to license the patents to others on reasonable-and-nondiscriminatory ("RAND") terms. The U.S. District Court for the Western District of Washington recently addressed how courts should determine RAND royalties in the context of litigation. The court determined RAND royalty rates for a pair of standard-essential patent portfolios owned by Motorola by constructing a hypothetical negotiation between Motorola and Microsoft.1 To do so, the court modified and applied the widely used Georgia Pacific factors, focusing on the patents' importance to both the standard and the accused products. By relying on those widely used factors, the Motorola decision itself may set the standard for other courts to use when setting RAND rates in standard-essential patent litigation.
In 2010, Motorola sent two licensing letters to Microsoft alleging infringement of two SEP portfolios, which relate to the H.264 video-compression standard and the 802.11 wireless standard. Motorola requested that Microsoft license the portfolios at a rate of 2.25% of the price of certain Microsoft products, including Windows computers and the Xbox. In response, Microsoft sued Motorola for breach of contract of Motorola's obligation to license two portfolios on RAND terms. Motorola had committed to two SSOs—the Institute of Electrical Electronics Engineers ("IEEE") and the International telecommunication Union ("ITU")—that promulgated and adopted the 802.11 wireless standard and the H.264 video-compression standard, respectively.
To determine the RAND royalty rate for each of Motorola's portfolios, the court modified the widely used Georgia Pacific factors to recreate a hypothetical RAND negotiation between the parties. Such a negotiation, the court held, should limit the patent holder to a reasonable royalty on the economic value of the patented technology itself, separate from any added value associated with incorporation into the standard.
The court first described several modifications of the Georgia Pacific factors to account for the negotiating positions of an SEP owner (the licensor) and a potential standard user (the licensee). The court focused on the importance of the patented invention to the licensor and to the licensee's sales, not any additional value created by the existence of the standard. In particular, the court's hypothetical negotiation focused on the contribution of the SEP patent to the technical capabilities of the standard and the relevant contribution to the technical capabilities of the licensee's products. The court observed that when looking at prior royalties received by the licensor, the royalties must have been negotiated under RAND or RAND-like circumstances, and that non-RAND patents should not form the basis for a RAND rate. The court also considered some factors inapplicable in the RAND context, such as an SEP owner's interest in preserving the patent monopoly by not licensing to others and the relationship between the licensor and the licensee, because the RAND commitment requires that the SEP owner license to anyone who implements the standard. The court stated that the parties would also determine the RAND rate based on the availability of alternatives, and whether the SEPs cover parts of a standard that are either optional or not practiced by the accused infringer's products.
After outlining the hypothetical RAND negotiation framework, the court described and applied a two-step analysis. First, the court looked to the importance of the SEP portfolio to the standard and the importance to the licensee's products. Second, the court determined a royalty rate for each SEP portfolio based on the licensee's products. The court applied this analysis separately to Motorola's H.264 portfolio and to its 802.11 portfolio.
The court first examined Motorola's H.264 portfolio, dividing it into six technological families and comparing each family to the H.264 standard and Microsoft's products. Although the court found that each of the patents was essential to the standard, it observed that the SEPs mostly relate to interlaced-video technology, which is not necessary to practice every part of the H.264 standard. Thus, the court concluded, the H.264 portfolio does not significantly contribute to the H.264 standard. The court next examined the importance of the H.264 SEPs to Microsoft's products, including the general value to Microsoft to offer H.264-compliant products, but not the value of any individual patent. The court observed that many Microsoft products do not support interlaced video and that many content providers do not use interlaced video. It concluded that interlaced video was becoming less prevalent in the marketplace and that little evidence suggested that Microsoft's users encounter interlaced video, but that support for interlaced video is important to Microsoft so that its products can seamlessly play any video encountered by its users. Therefore, the court determined that in a hypothetical negotiation, the parties would view the H.264 portfolio as having little contribution to the standard and Microsoft's products.
The court then turned to the specific products at issue, including the Windows operating system and the Xbox. The court found that video encoding plays only a small part in the Windows operating system. In particular, Windows users do not commonly encounter interlaced H.264 video content and mostH.264 decoding is not performed by the Windows operating system itself, which lacks the hardware components required by certain claims of the H.264portfolio. The court also determined that interlaced video could still be played by the Windows operating system using alternative technology, but it would be at a slower rate. As a result of this evidence, the court concluded that Motorola's H.264 portfolio provides only minor importance to the overall functionality of Microsoft's Windows product. Regarding the Xbox, the court observed that the primary use of the Xbox is to play single-player video games and that these games never contain H.264 video content. The court noted that the Xbox's web browser could decode interlaced video if encountered, but that interlaced video was rarely encountered. Accordingly, the court concluded, Motorola's H.264 SEPs provide only minor importance to the overall functionality of Microsoft's Windows operating system and Xbox products.
The court then analyzed Motorola's 802.11 portfolio, determining the importance of Motorola's patents to the standard and to Microsoft's Xbox product. Initially, the court observed that the 802.11 standard was covered by thousands of patents and that much of the standard was drawn from the public domain. As with the H.264 portfolio, the court grouped the asserted SEPs into technology areas and analyzed each technology area's contribution to the standard. Generally, the court found little or no evidence relating to the importance of the SEPs to the 802.11 standard. Because Motorola failed to present evidence of the importance to the 802.11 standard, the court concluded that the parties to a hypothetical negotiation would view the patents as contributing very little to the 802.11 standard. The court also determined that wireless functionality was not a core feature of the Xbox.
After assessing the importance of Motorola's H.264 and 802.11 portfolios to the respective standards and Microsoft's products, the court determined aRAND royalty rate for each portfolio. To establish the royalty rate, the court looked to comparable royalty rates and licensing agreements.
The court first examined, and rejected, five agreements that Motorola offered in support of a 2.25% royalty rate for each SEP portfolio. The court specifically rejected two licenses to VTech and RIM, and three licenses from Symbol Technologies, because the licenses were negotiated to settle broad litigation disputes outside of the RAND context and included non-standard-essential patents. The court also found that, although the VTech and RIM licenses included Motorola's H.264 and 802.11 portfolios, it was impossible to apportion royalty rates and find the contribution of each portfolio. The evidence, however, suggested that these portfolios contributed little to the final royalty rate. In particular, the court found, there was little evidence that either VTech or RIM would have licensed H.264 and 802.11 portfolios except as part of the much broader settlement agreement at issue. The court rejected the Symbol Technologies licenses because they were also negotiated in the context of litigation and because several of the patents expired before Motorola's dispute with Microsoft. As a result of these facts, the court concluded that Motorola's proposed comparable licenses were not indicative of a RAND royalty rate for either of Motorola's SEP portfolios asserted against Microsoft.
The court also addressed stacking concerns with Motorola's proposed royalty rate of 2.25%, observing that if each SEP-owning entity received a similar rate, then the 802.11 royalties alone would exceed the total product price. The court concluded that Motorola's proposed 2.25% rate cannot be a RAND royalty rate, especially in view of the Motorola portfolio's "minimal contribution to the 802.11 Standard." The court expressed similar concerns with Motorola's proposed H.264 rate, in part because that portfolio relates almost entirely to interlaced video, which is not a significant contribution to the H.264 standard or important to Microsoft's products.
The court then turned to the licenses that Microsoft suggested were comparable, which included the MPEG LA H.264 patent pool, the Via 802.11 patent pool, an 802.11 license between Marvell and ARM Holdings, and an 802.11 licensing-portfolio analysis of Motorola's 802.11 portfolio. The court first analyzed the MPEG LA H.264 patent pool, concluding that the pool reliably indicated RAND terms for Motorola's H.264 SEPs. In particular, Motorola characterized the MPEG LA H.264 rates as "reasonable" during negotiations of the pool royalties. The court expressed some concern with using patent pool rates as RAND rates. Specifically, the court noted, the pool rates were lower than rates that could be achieved through bilateral negotiations, but also concluded that patent pools, like RAND obligations, are designed to facilitate adoption of technology.
The court also stated that another problem with using patent pools as a RAND rate is that many patent pools distribute royalties through "patent counting"—thus considering the number of patents contributed to the pool rather than the importance of the patents to the standard or to the products atissue. The court noted that using pool rates as RAND rates could discourage SEP owners from participating in standard-setting activities. The court concluded, however, that although the patent-pool rates do not necessarily constitute RAND rates, they can reliably indicate a royalty rate or range consistent with RAND obligations.
The court then calculated a RAND rate for Motorola's H.264 portfolio by using the MPEG LA H.264 patent pool. To calculate this rate, the court determined the royalties that would have been paid to Motorola if the H.264 portfolio had been part of the MPEG LA H.264 pool. Under this structure, the court determined that Microsoft would pay Motorola 0.185 cents per unit sold. The court then increased this rate by the additional value of the other patents in the pool, which the court determined to be twice the per-unit rate. The court then concluded that the final RAND rate for Microsoft to use Motorola's H.264 portfolio is 0.555 cents per unit (0.185 + 2*0.185 = 0.555 cents). The court also found that there was no reason to increase this low rate any further because Motorola's H.264 portfolio "only constitutes a sliver" of the overall standard and because Motorola's portfolio is not very important to Microsoft's products.
Next the court determined a RAND rate for Motorola's 802.11 portfolio by analyzing the Via 802.11 patent pool, the Marvell-ARM license, and the InteCap analysis. Finding that each of these served as a reliable RAND indicator, the court then averaged the results of each analysis to arrive at the final 802.11 royalty. The court first analyzed the Via 802.11 pool, but acknowledged that it may not reflect a true RAND rate because it included only a small subset of the patents necessary to practice the 802.11 standard, relied on a patent counting to apportion royalties, and did not reflect the importance to the licensee's products, and because neither Microsoft nor Motorola were part of the pool. The court determined, however, that the Via 802.11 pool may indicate a conservative estimate of a RAND royalty. The court then calculated the proportional share of royalties that Motorola would have received if it had joined the Via 802.11 pool and found that Motorola would have received a royalty of 2.308 cents per unit sold by Microsoft. The court then adjusted this amount up by a factor of two to account for the increased value of Motorola's participation in the patent pool, arriving at a rate of 6.114 cents per unit sold. Because the court also determined that Microsoft's products do not practice more than half of Motorola's asserted SEPs, however, the court concluded that this rate was likely higher than an appropriate RAND rate.
The court next examined a royalty agreement between 802.11-chip maker Marvell and ARM Holdings. According to this agreement, Marvell pays ARM a 1% royalty on each wireless chip sold by Marvell, which sells for between $3 and $4 per chip. Thus the royalty rate is $0.03-0.04 per chip. The court also noted that this rate was a "high ceiling" because it also reflected additional intellectual property that ARM provides to Marvell. The court noted it would be appropriate to base the RAND rate on the wireless chip, rather than on the end product, because basing the rate on the end product could easily expand the royalty above the cost of the wireless chip that actually provides the 802.11 functionality. Based on this agreement, the royalty rate of $0.03-0.04 per chip also provided a reliable indicator of a RAND rate for Microsoft to use Motorola's 802.11 SEP portfolio.
Finally, the court examined a licensing valuation of Motorola's 802.11 portfolio by InteCap. The InteCap analysis assumed that Motorola's patents contributed 25% of the value to the 802.11 standard, and that the 802.11 royalty rate would be 0.1% of the selling price of end-user devices, or 0.5% of wireless chips. The court found that the InteCap analysis provided an appropriate indicator of a RAND royalty rate, but that it overvalued Motorola's 802.11 SEP portfolio. The court concluded that Motorola's portfolio contributes 1% of the value to the 802.11 standard, not 25%. Applying the InteCap analysis, the court calculated a royalty rate for Microsoft's Xbox products at 20 to 40 cents per unit, and reduced the rate by a factor of 25 to arrive at a royalty of 0.8 and 1.6 cents per unit.
To determine the final 802.11 RAND royalty rate, the court averaged the Via 802.11 pool rate, the Marvell-ARM rate, and the InteCap rate, and determined that the RAND rate for Motorola's 802.11 SEP portfolio is 3.471 cents per unit. The court concluded that this was a reasonable RAND rate because it falls within the range of the RIM-Marvell license and close to InteCap's valuation.
The Microsoft decision, although not binding on other courts, has the potential to become a very influential opinion because it uses the widely accepted Georgia Pacific factors and modifies them to apply to RAND royalties for SEPs. The decision provides guidance for SEP owners and suggests how to persuasively prove RAND royalty rates in litigation. For example, an SEP owner can increase the RAND rate by showing that the SEPs contribute significantly to a standard's technology or that the SEPs are important to the accused products. The decision also suggests that, when possible, licensors should consider the effect of apportioning royalties in licensing agreements that cover several patent portfolios, some of which contain SEPs—doing so increases the applicability of the agreement to a RAND royalty determination. On the other hand, practitioners of standards can argue for a lower RAND rate by showing that an asserted SEP portfolio doesnot significantly contribute to a standard or that the technology is not important to the accused products.
Although the Microsoft decision provides valuable guidance, it may be limited to SEP owners that are subject to RAND obligations. Stated otherwise, courts may not extend this analysis to SEPs asserted by entities who did not agree to license the patents on RAND terms. Therefore, although Microsoft establishes a viable RAND framework, it does not define the entire field of royalty rates for SEPs.
1 The Microsoft opinion can be found at http://www.finnegan.com/files/upload/LES_Insights_Column/2013/Microsoft_v_Motorola.pdf.
Copyright © Finnegan, Henderson, Farabow, Garrett & Dunner, LLP. This article is for informational purposes, is not intended to constitute legal advice, and may be considered advertising under applicable state laws. This article is only the opinion of the authors and is not attributable to Finnegan, Henderson, Farabow, Garrett & Dunner, LLP, or the firm's clients.
Copyright © Finnegan, Henderson, Farabow, Garrett & Dunner, LLP. This article is for informational purposes, is not intended to constitute legal advice, and may be considered advertising under applicable state laws. This article is only the opinion of the authors and is not attributable to Finnegan, Henderson, Farabow, Garrett & Dunner, LLP, or the firm’s clients.
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