Authored by E. Robert Yoches and Kelly Lu
I. INTRODUCTION
Almost all standard-setting organizations (SSOs) require participating members with patents essential to practicing a standard (standard-essential patents or SEPs) to license those patents on terms that are reasonable and nondiscriminatory (RAND, sometimes called FRAND, where the “F” stands for “fair.”) This prevents such patent owners from using the SEPs to exact unreasonable terms or excessive royalties from those adopting the standard.
Requiring RAND rates is easy. The hard task is determining the amount. For years, authors have debated the issue, and in 2013, two courts undertook the task. Although they reached slightly different results, both courts found very low royalty rates. Their reasoning is important for any company facing requests to license SEPs.
II. Microsoft Corp. v. Motorola, Inc.
Microsoft argued that Motorola breached agreements with SSOs to license its SEPs for two standards, an H.264 and an 802.11 standard, on Rand terms by insisting on a 2.25% royalty on the sale price of the end product (e.g., Xbox, PC, telephones). The court held that Motorola’s initial offer needed to be RAND, It started its analysis with the following principles for RAND rates:
(1) The rate should further the SSO’s goal of wide adoption of the standard;
(2) The rate should not allow a patent owner to extract large royalties simply because the patent is an SEP;
(3) The rate should consider royalty stacking (one product being subject to many patent licenses);
(4) The rate should reward creators of valuable technology; and
(5) The reward should be for the value of the technology independent of its status as a SEP.
To find a RAND rate for each standard, the court applied the fifteen Georgia-Pacific factors, which courts use to determine a reasonable royalty for patent infringement. Those factors help determine a royalty that a reasonable licensor and licensee, in the position of the plaintiff and defendant, would agree to in a hypothetical negotiation. The court added that the parties in would have known Microsoft needed licenses from other SEP owners as well.
For the H.264 standard, the court found Motorola was not a pioneer in that technology, contributed to only one part of the standard, and had no patents key to the standard. The court also rejected most of the license agreements the parties offered because they were not sufficiently comparable, except for one relating to a patent pool of SEPs for the H.264 standard. A pool licenses patents from its participants, who share in the royalties according to some agreed formula. Although Motorola helped form the pool, it never joined because it sold patent that it would have contributed.
The pool’s royalty rates of the pool were, in the court’s eyes, lower than two parties would have negotiated on their own because licensees get additional benefits from joining pools. An internal Microsoft memo suggested Microsoft received a three-to-one benefit from such pools (additional benefits of twice the royalties), so the court tripled the H.264 pool’s royalty rate for this case. According to the pool’s rules for distributing royalties. Motorola SEPs would have generated 0.185 cents per unit. After tripling, the court found the lower bound for RAND royalty rates to be 0.555 cents per unit for Motorola’s H.264 SEP portfolio.
The court also found that the founders of the pool wanted to cap royalties at $1.50 per unit. Motorola’s share of this, had it been a member, would have been 5.463 cents per unit, which became and upper bound of 16.389 cents per unit after tripling.
For the 802.11 SEP patents, the court looked at a Via licensing pool. Using methodology similar to its analysis of the H.264 SEP pool, the court calculated Motorola would have received 2.038 cents per unit had it belonged to the Via pool, which jumped to 6.114 cents after tripling.
The court also considered the 3 to 4 cents-per-chip royalty that a chip manufacturer paid another company for intellectual property that implements 802.11 functionality. Yet another company determined a 0.1% royalty rate for some Motorola SEPs, which would have yielded between 20 and 40 cents per Microsoft product. The court found this 25 times too high because Motorola’s SEPs were not so valuable, and adjusted the rate to be between 0.8 and 1.6 cents per unit. The average of all three rates was 3.471 cents per unit. The proper RAND royalty range for Motorola’s 802.11 SEP portfolio was 0.8 to 6.114 cents per unit.
Motorola’s offer would have yielded nearly $4 billion per year. After the court’s decision, the RAND royalty was about $560,000 per year. In a later decision, the court held Motorola had breached its obligation to the SSO by not offering a RAND royalty, and Motorola had to pay damages to Microsoft for the breach.
III. In re Innovatio IP Ventures, LLC Patent Litigation
Innovatio sued several commercial enterprises (coffee shops, hotels, etc.) for infringement because they provided internet access to their customers. In response, manufacturers of the networking equipment sued Innovatio for declaratory judgment of noninfringement. The parties agreed it would be helpful for the court to determine the RAND rate for the patents, which the parties agreed were SEPs for the 802.11 standard.
The court reviewed the Microsoft court’s methodology for determining RAND rates, which the court summarized as having three steps: (1) consider the importance of the patent portfolio to the standard; (2) consider the importance of the patent portfolio to the accused products; and (3) examine licenses for comparable patents.
The Innovatio court explained it was determining patent infringement damages, while the Microsoft court was simply setting a range of royalties to see whether Motorola’s offers were within the range. Another difference was that the licensee in Microsoft could question whether a particular patent was essential, whereas in Innovatio, the court made such a determination.
The Innovatio court focused on the royalty base to determine damages. The plaintiff wanted the base to be a percentage of the selling price of the end products after discounting that price by a factor representing the percentage of the end product directed towards WiFi, the subject of the standard. The manufacturers asked instead that the royalty base use the price of the chip reduced by the amount unrelated to the patented features. The court chose the chip price for determining the royalty base because Innovatio could not “credibly apportion” the value of the patented features from the end product.”
Unlike the Microsoft court, the Innovatio court found all Innovatio’s patents had moderate to high importance. Like that court, however, the Innovatio court rejected the most of the licenses the parties proffered as comparable. It also rejected the Via license pool rate because the pool included marginally important patents. Although this may not have been a problem for the Motorola patents, the Innovatio court found the Innovatio patents had moderate to high importance.
The court then calculated the average chip price and per-chip average profit, and multiplied that profit by a ratio representing the number of Innovatio SEPs (19) to the total number of relevant SEPs (300), which was the top 10% of 3000 SEPs for the standard. The court explained that this approach also allowed it to adjust the ratio to account for the value of certain patents.
Because the parties to the hypothetical negotiation 1997 would have expected chip prices to drop over time, the court calculated an average chip price and an average profit margin of 12.1%. This resulted in a per-chip profit of $1.80.
Citing an article opining that the top 10% of patents account for 84% of the value of electronic patents, the court multiplied the $1.80 profit times 84%, since it found the Innovatio patents to be in the top 10%, and the result was $1.51 per chip. After multiplying $1.51 by the 19/300 ratio of the Innovatio SEPs to the total, the court found the RAND rate for Innovatio’s SEPs to be 9.56 cents per product. Although this was higher than the rate from Motorola, the court noted that the Innovatio patents were more important to the technology than Motorola’s. Since the average chip price was $14.85, the effective royalty rate for the Innovatio patents was 0.64%
IV. CONCLUSION
An important lesson is how low courts found RAND rates to be, even for strong patents, as in Innovatio. Armed with this knowledge, licensees should be able to take strong negotiating position when facing demands from SEP owners.
Lecture
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