The SEP and the hypothetical negotiation

When trying to assess reasonable royalty damages for patent infringement, US courts often apply the concept of a "hypothetical negotiation between a willing licensor and willing licensee on the eve of the infringement", where a "next best non-infringing alternative" is available to the willing licensee. This principle can be traced back to the the US Supreme Court's Georgia-Pacific vs. United States Plywood Corp decision from 1970.

The hypothetical negotiation construct has faced some criticism over the years for not always being that realistic. But since it's being used after all, it would still be interesting to see how it applies to the special subset of patents known as wireless Standards Essential Patents (SEP).

Let's first make the following assumptions, relating to the wireless SEP context:

a) In the hypothetical negotiation scenario, a willing licensee intends to sell standards-compliant products and only for this reason enters into a negotiation with an SEP-holder for an SEP license just before the sale of such products would start.

b) A Standards Setting Organization (SSO) selects each solution, whether patented or not and whether big or small, to be incorporated into the standard based only on the best technical merit among all competing proposals on the table for that particular problem.

Regarding b), note that an SSO's mandate is to be "ideal" in this respect, which is therefore a reasonable approximation of reality, although perhaps potentially less so for the IEEE for unique reasons discussed in an earlier post. 

When it comes to how standards and SEPs come about it's also important to realize that standard and SEPs are developed together. Virtually all SEPs include solutions to specific problems that were encountered during the SSO effort to develop a standard, given the specific requirements placed on the standard. In other words, the vast majority of SEPs are filed during the SSO work and not prior to it.

So let's begin by putting the "eve of the infringement" into a time-perspective. The willing licensee intends to sell standards-compliant products, and such can only be created after the relevant standard version has been frozen. Also, due to normal patent prosecution timelines, the SEP-holder's patent will typically only have been granted some time after freezing of the standard version. The earliest possible "eve of the infringement" will thus be the latter of the standards version freeze date and the patent grant date.

Now let's examine the "next best non-infringing alternative" available at the hypothetical negotiation at that time-point. Consider the following: 

1) The next-best alternative solution to the one represented by the SEP-holder's patent was not selected by the SSO to be a standardized solution for the specific problem at hand. And since SSO problems tend to be highly specific, the next best alternative solution is almost certainly not standards-compliant and hence would then not constitute a "non-infringing alternative" at the time of the hypothetical negotiation.

2) The SSO could not have selected the second-best solution instead of the solution represented by the SEP-holder's patent because it selects the solution with the best technical merit. Therefore - given the alternatives that were actually at the table at the time of selection - the solution represented by the SEP-holder's patent was "destined" to be selected.

3) It's not relevant to look at the hypothetical situation where the solution represented by the SEP-holder's patent was never on the SSO's table at all, and therefore the actually second-best solution became a hypothetical best alternative for the SSO. If the solution represented by the SEP-holder's patent would not have been on the SSO's selection table, then it would almost certainly never even have come into existence, and hence a choice between the two would not be available at the hypothetical negotiation. 

Based on the above, we can see that - besides the alternative of not entering into the business at all - there would most likely be no "next best non-infringing alternative" at a hypothetical negotiation taking place on the "eve of the infringement". So the hypothetical negotiation construct is typically non-applicable for SEPs. 

This is largely due to the "winner-takes-it-all" aspect that operates on the individual problem/solution level of wireless standardization, while not on the standard as a whole; wireless SSO work is  competitive on the micro-level but collaborative on the macro-level. Arguably, it's precisely this combination that promotes successful and future-proof global standards. 

But it's perhaps not only the hypothetical negotiation and SEPs that are incompatible. Theoretical ideas about patent valuation in general also tend to be suitable for one or a few patents, but could be impractical for portfolios of patents. 

However, the vast majority of SEP valuation exercises actually take place outside the courtroom. And the wireless cellular industry has established a workable, portfolio-based SEP valuation metric that's generally considered fair. License values of different individual portfolios of truly essential and valid SEPs typically adhere to a proportionality principle, while consideration is given to maintaining a reasonable aggregate license value, i.e. the license value of all the SEP-portfolios in accumulation for the standard and product in question.

Fair Standards Alliance and the licensing point

A grouping that calls itself Fair Standards Alliance (FSA) appears to want to give FRAND a "clearer meaning in order for standards to promote innovation, economic growth, competition, and consumer choice."

FSA has published a position paper outlining some principles to this effect. Several of them seem reasonable and generally in line with the law, competition authority investigation outcomes and established SEP FRAND licensing practices. Others are more dubious, such as an unhealthy emphasis on a chipset royalty base. 

However, a key message from FSA relates to the so-called "licensing point" that I've written about earlier and defined as "the entity among several entities in a product value-chain that obtains a patent license for making or selling products". FSA essentially conveys the message that:

a) an SEP license should be available at any licensing point, and

b) the same royalty should apply regardless of licensing point. 

Now, while a) and b) certainly don't sound unreasonable per se, the irony in this message from FSA should not be missed. It's well-known that there are only a few upstream entities harbouring an expressed desire to become a wireless SEP licensing point in the first place. And this wish typically comes along with the caveat that the SEP royalty must be discounted by something like 99%.

Looking past the irony though, FSA's wish to move the wireless SEP licensing point upstream is worth discussing, including some practical considerations. 

I have previously described how the issue of so-called "grant-back" tends to prevent the licensing point for at least mobile phones from moving upstream, as long as there are SEP-holding mobile phone and/or infrastructure OEMs around. I won't elaborate on that issue further here as it's a bit intricate, so interested readers may check the earlier post for details.

Furthermore, FSA's promotion of an upstream licensing point relies on an implicit assumption. Namely that the SEP-portfolio license value to the end-product is the same regardless of end-product-type. But as I also touched upon in the earlier post, that's not necessarily true. For mobile phones, the cellular SEP-portfolio FRAND license value is well-established by markets and courts. But in principle, there could exist other types of end-products for which this license value could be lower than for mobile phones. This could e.g. be due to significant aspects of the standard, along with their patented features, being less valuable to those end-products.

Take a refrigerator for example, an end-product actually mentioned in the FSA position paper. Many advanced patented innovations for cellular standards relate to ways of being able to communicate effectively in presence of challenging and dynamic radio conditions or with limited available power.  But the fridge isn't going anywhere in particular and it's connected to the power grid day and night. So for the fridge, the value of the cellular standard in itself - and hence of a license to all its associated SEP portfolios - may perhaps be considered lower than for a mobile phone.

In such a case, one could argue that it ought to be possible for SEP-holders to "promote" the standard in question towards such a product-segment by offering a discounted royalty from that of mobile phones. Provided of course that such an offer would still be considered FRAND. As long as it's a sufficiently differentiated end-product category and the same discounted offer would be provided to all providers of such end-products, this would most likely be the case. 

But if the chipset vendor would be the SEP licensing point, such a promotion might become challenging, since chipset vendors typically don't know what end-products their chipsets will end up in. While this could in principle be solved by advanced logistics management and proper contractual follow-up, it may still turn out to be difficult in practice.

On the other hand, the chipset vendor is not the only potential upstream SEP licensing point. For example, module vendors or solution providers within the vehicular or telemetry industries could also be licensing points. In such a scenario, traceability may become less of an issue since there would be stronger end-product control. 

Summarizing all of this, there's actually nothing per se that prevents the SEP licensing point from moving upstream from the end-product OEM. There are certainly practical obstacles that can be identified as I've expressed here and previously, but at the end of the day they're probably not insurmountable. 

Therefore, the biggest reason for the cellular SEP licensing point staying at the end-product OEM level may well be the refusal by upstream entities to accept the FRAND royalty levels established by markets and courts.

For mobile phones, established royalty levels consider the value brought to the end-product and end-user. Thus the royalty can ultimately be seen as a cost distribution issue between the end-product OEM and the end-user. By contrast, upstream intermediate products such as chipsets do not take into account this end-product SEP value at all, which is clearly reflected in their prices. But if - as seemingly desired by FSA - the cellular SEP licensing point is to generally move upstream, relevant FRAND royalty levels would certainly have to be made visible upstream too.

Injunctive relief - is a re-assessment of Ebay on the way?

In its Ebay vs. MercExchange ruling of 2006 ("Ebay"), the US Supreme Court basically concluded that injunctive relief shouldn't be automatically granted for patent infringement. Monetary damages was ruled to always constitute adequate compensation unless the patent holder could demonstrate that a rigorous four-factor test was fulfilled on all points. As a practical consequence of Ebay, it became more complicated for a patent holder to obtain injunctive relief or exclusion orders against infringing products in US courts after 2006.

While the gist of Ebay may perhaps have been to minimize NPEs' possibilities of obtaining unreasonable compensation, it may well have been blunt enough to negatively affect also true innovators as well as true competitors.

In wireless SEP FRAND licensing for example, the reverse patent hold-up behaviour seen among infringers in recent times may at least partly have been fueled by Ebay. And for non-SEPs, we can look at Apple. Since launching its iPhone in 2007, the Ebay ruling arguably hasn't made Apple's struggle to protect its patented smartphone-related inventions any easier.

However, a potential re-assessment of injunctive relief in US patent cases may now be on its way, incidentally in relation to an Apple case. On September 17, 2015, the US Federal Circuit overturned a district court's denial of injunctive relief in Apple vs. Samsung.  The original request was for a feature-based injunction against multi-function products, to which mobile phones arguably belong, and the overturn could actually be seen as a slight softening of Ebay. The main point of discussion related to the first Ebay factor concerning "irreparable harm" and establishing a "causal nexus" between the patented feature and consumers' decision to purchase the multi-function product in question. 

Interestingly, on December 16, 2015, the Federal Circuit denied Samsung's request for an en banc revisit of the issue, and issued a revised opinion along with the order. This seems to indicate that the Federal Circuit's stance is becoming solidified. On the "causal nexus" requirement, it says:

"In short, the record establishes that the features claimed in [the patents] were important to product sales and that customers sought these features in the phones they purchased. While this evidence of irreparable harm is not as strong as proof that customers buy the infringing products only because of these particular features, it is still evidence of causal nexus for lost sales and thus irreparable harm. Apple loses sales because Samsung products contain Apple’s patented features.The district court therefore erred as a matter of law when it required Apple to show that the infringing features were the reason why consumers purchased the accused products. Apple does not need to establish that these features are the reason customers bought Samsung phones instead of Apple phones–it is enough that Apple has shown that these features were related to infringement and were important to customers when they were examining their phone choices." (emphasis in original),

and in the conclusion part of the opinion one can almost sense some underlying "frustration" with Ebay: 

"If an injunction were not to issue in this case, such a decision would virtually foreclose the possibility of injunctive relief in any multifaceted, multi-function technology.".

The Federal Circuit's stance seems quite reasonable to me. If a company invents a feature for a multi-function product that's attractive to consumers and implements that feature in its own multi-function products, shouldn't it have the legal right to, for a limited time-period, prevent others from implementing that very feature in their directly competing multi-function products? I don't really see such a right as being too far-fetched, given the definition of what a patent really is.

If Samsung wants to avoid an injunction, it now looks like a Supreme Court petition would be needed. This story will surely be interesting to follow.

Federal Circuit dismisses SSPPU "rule"

Readers of this blog will know that I've frequently questioned the idea that there's a "rule" mandating that royalty or damages for infringing multi-component products be calculated using a "Smallest Salable Patent-Practicing Unit" (SSPPU) as a value-base. The idea of this "rule" has attracted quite some powerful followers and in February 2015 it was even codified into the new IEEE patent policy (!).

Well, on December 3, 2015, in an appeal decision in the CSIRO vs. Cisco case, the US Federal Circuit made it crystal clear that no such "rule" exists.

The decision includes other interesting opinions too, but I'll limit this post to royalty-base aspects. 

This statement from the decision sums things up quite nicely:

"The rule Cisco advances — which would require all damages models to begin with the smallest salable patent-practicing unit — is untenable. It conflicts with our prior approvals of a methodology that values the asserted patent based on comparable licenses. ...Such a model begins with rates from comparable licenses and then “account[s]for differences in the technologies and economic circumstances of the contracting parties.” Finjan, 626 F.3d at 1211. Where the licenses employed are sufficiently comparable, this method is typically reliable because the parties are constrained by the market’s actual valuation of the patent."

In other words, an SSPPU royalty-base "rule" would e.g. conflict with the use of comparable licenses as evidence of damages value. Given the importance placed on comparable license evidence in US law, an SSPPU royalty-base "rule" can therefore not exist.

Besides the square dismissal of the imaginary SSPPU "rule", the Federal Circuit also noted that:

"The choice of royalty base — which is often the focus of the apportionment analysis—is irrelevant to the district court’s analysis. The particular rates relied on by the district court were contemplated as cents per end unit sold by Cisco, but they could equally have represented cents per wireless chip without affecting the damages calculation.",

and:

"Because the parties’ discussions centered on a license rate for the ’069 patent, this starting point for
the district court’s analysis already built in apportionment. Put differently, the parties negotiated over the value of the asserted patent, “and no more."".

It's good to also see this point being made. People - oddly - seem to forget that payments for legitimate use of others' IPR are not made in "percent", but in real money, i.e. Dollars, Euros, Yuan etc. So what's ultimately relevant is the value - in real money - that a patent portfolio brings to the end-product. In this sense, a too strong focus on a specific model parameter such as a royalty-base is arguably irrational.

Hopefully, this Federal Circuit decision can bring any ongoing debate about SEP FRAND license value in line with actual law. 

IEEE after the patent policy update

A number of technology-contributing IEEE members have now refused to be bound by the IEEE's new patent policy adopted in February 2015. The question is, what does that mean for the IEEE as a Standards Setting Organization (SSO)?

In my experience, the strength of the international competitive-collaborative style of telecommunications standardization - largely pioneered by ETSI - lies in the fact that individual technical contributions compete purely on technical merit. This means that the type of competence needed for the effort can be highly specialized; basically some of the very best research engineers in the field, from all over the world, get together to create these complex standards. This ensures cutting-edge, future proof, global standards.

This in turn is possible when the SSO's patent policy has been generally agreed by all members on a high level, and patent policy issues can therefore effectively be "removed" from the daily standardization work itself. Those specialist engineers can focus all their efforts on inventing new clever solutions and arguing about the technical pros and cons of each other's proposals. And importantly, they can spend zero time thinking about patent policy.

But in the IEEE today we have a fragmented situation where a subset of its members have publicly stated that they will not adhere to the IEEE's new patent policy. Here some readers may of course wonder why those members aren't then simply "thrown out" of the IEEE's SSO work? But actually, in order to make the work of an SSO - not only the IEEE - as inclusive as possible, contributors are allowed to declare on a case by case basis which patent policy their patented contribution would be licensed under, which in fact does not have to be the policy adopted by the SSO. It's just that the norm has typically been that all members have agreed with the SSO's policy. But in the IEEE we now have an anomaly. The existence of these "disagreeing members" creates some distinct challenges to the IEEE's standardization effort going forward, at least within 802.11 ("WiFi") standardization.

Prior to the new policy's acceptance in Feb 2015, disagreeing members had submitted - and the IEEE had accepted - certain so-called Letters of Assurance (LoA) endorsing the old IEEE policy for certain 802.11 standards. LoAs are documents describing under which conditions the submitter agrees to license its potential SEPs for a specified standard, i.e. essentially whether the existing IEEE patent policy is agreeable to the submitter or if another policy will be used instead. Now, with the assumption that accepted adherence to a given IEEE patent policy cannot be changed retroactively, SEPs relating to the IEEE standard(s) specified in those pre-Feb-2015 LoAs will therefore be subject to two different patent policies - the old and new IEEE patent policy - depending on who owns the SEP in question.

Some of those standards are already finalized, and in those cases the impact will largely be limited to the licensing and dispute resolution spheres. However, some standards are still being worked on, meaning that there can be an impact within the SSO work itself. There could be an increased risk of proposals not being selected purely on technical merit, but potentially also based on whether the submitter supports the new or old IEEE patent policy. Thankfully, standardization/research engineers' natural behaviour is to focus on technical merit, but one still can't rule out that their management could convince them to behave differently. 

Furthermore, regarding potential SEPs for IEEE standards not specified in those pre-Feb-2015 LoAs, new LoAs would have to be submitted. But a disagreeing member submitting a new LoA would - by definition - tick the box stating its disagreement with the (new) IEEE policy. So at least if the disagreeing member's proposed solution would technically outsmart all other proposals, there's a potential issue to resolve. Assuming that technical merit continues to be the yardstick, that proposal should be selected for inclusion into the IEEE standard in question. But in this case the IEEE would instead have to examine the LoA and decide whether it would be acceptable or not. This would generally have to be done on a case-by-case basis. And if the LoA would not be acceptable to the IEEE's members, the technical proposal itself can't be accepted. Or in other words, the admittedly best technical solution would have to be actively de-selected from the standard (!). 

There has been some speculation as to whether Qualcomm - one of the disagreeing members - could benefit from its recent acquisition of Cambridge Silicone Radio (CSR) in the sense that CSR had made a "broader than usual" pre-Feb-2015 blanket LoA covering all IEEE 802.11 (WiFi) standards. Qualcomm could then allegedly utilize the CSR LoA to license also its future SEPs according to the old IEEE policy at least for all future versions of WiFi. If so, it would at least save Qualcomm from having to make those new "potentially difficult" LoAs for IEEE 802.11. While that could reduce the probability of its proposals being rejected due to origin, the risk will still be there given that Qualcomm, after all, doesn't adhere to the new IEEE policy. 

Clearly, scenarios as described above threaten to remove the "pure technical bliss" of the classic international competitive-collaborative standardization effort within the IEEE. There may now have to be more patent engineers and patent attorneys involved in the SSO work processes. The efficiency of the IEEE as an SSO will likely suffer, and alarmingly, the IEEE's future standards run the risk of not containing the best technology out there. Even worse, the best technology may have been made available to the IEEE, who then actively rejected it. If such fears materialize, some companies might very well leave the IEEE and instead support - or perhaps even create - other competing standards through other means.

The new IEEE patent policy's apparent disconnect with the law is problematic. Only last week in its CSIRO vs Cisco appeal decision, the US Federal Circuit squarely rejected one of the key principles of the new policy, namely the mandatory chipset royalty base. In the same breath, the Federal Circuit re-emphasized the importance of evidence in the form of comparable licenses, also in stark contrast to the new policy. We also know that the new policy's rule on injunctive relief in practice also differs from Federal Circuit opinion. 

The IEEE, and ultimately the general public, would surely benefit the most if the IEEE stays strong and relevant, capable of efficiently creating top-notch standards going forward. So perhaps it's time for a pragmatic and open discussion among IEEE members with the aim to consolidate the different viewpoints in the light of the law. Another update of the policy may very well be needed to put the IEEE's standardization work back on track again.

FOSS patents and the royalty base

In a recent FOSS patents post, blogger Florian Mueller continues to advocate that the SEP license royalty base for cellular mobile devices should be changed from the end-product to the "smallest saleable unit", i.e. the chipset. In the post, quite some disappointment is expressed regarding Judge Robart's "failure" to mandate a chipset royalty base in Microsoft vs. Motorola. 

As I mentioned in a previous post, the royalty base is a parameter in a specific royalty calculation model. What matters in the end is the absolute payable royalty, and that it considers the value that the patent portfolio in question brings to the end-product. I believe that judges adjudicating patent cases are generally well aware of this.

But there's a statement in the FOSS patents post that specifically caught my attention: "Apple's position is that the difference between the price of an iPhone and that of a cheap "feature" phone (colloquially also called "dumbphone") is unrelated to wireless communications standards. I support Apple on that one"

I'm not sure I'd support that statement. The difference in price between a "dumbphone" and a "smartphone" most certainly appears to be related to wireless communication standards. 

Imagine a "smartphone" that only includes 2G wireless communication standards. Such a "smartphone" would hardly command a high price on the market, if indeed it could be sold at all. But simply add 3G/4G to it and suddenly it becomes a very attractive product. Clearly, the 3G/4G wireless communications standards bring tremendous value to a "smartphone" device. 

But while we're at it, why not compare Apples to Apples?

I'll simply quote myself from an earlier post: We can look at the illustrating example of the iPod Touch vs. the iPhone. These products are very much alike, with the difference largely being that one has cellular connectivity and the other one doesn't. The products have similar specs and both carry the "brand magic" of the OEM, Apple. Yet today's price difference between the two is around $250. 

Surely that's a more interesting price difference.

CJEU ruling follow-up - other scenarios

In my previous post I commented on the Court of Justice of the European Union's (CJEU) opinion on when an injunction request by an SEP-holder would be non-abusive. The ruling is largely in line with those of other competition authorities, encouraging diligent and timely bi-lateral negotiations, including a path to timely third party adjudication.

The ruling describes a certain presumed scenario or "flow-chart" under which an injunction request from an SEP holder would not be considered abusive. However, there are in fact real-world situations that clearly fall outside the scope of the CJEU's flow-chart but for which injunction requests would also be perfectly appropriate. In this post I'll describe two examples of such.

One surprisingly common real scenario is the "no response" situation. Some infringing OEMs may simply choose not to respond at all to formal letters from an SEP-holder offering an SEP FRAND license and an invitation to a license discussion. SEP-holders may very well send multiple such letters - even hand-delivered by international courier - over a period of months or even years, without ever hearing a word back from the alleged infringer through any communication channel whatsoever.

Clearly, such behaviour clashes with the general principles of good faith, diligence and timeliness emphasized in the CJEU ruling, while preventing the SEP-holder from - no matter how much it wishes to do so - providing detailed infringement information to the OEM, i.e. the first step of the CJEU's flow-chart scenario. In such a situation, an injunction request by the SEP-holder can surely not be considered abusive.

Another scenario occasionally encountered nowadays is the "no NDA" situation. While patents and wireless standards are documents available in the public domain, patent claim interpretations are typically not, as they ultimately constitute the legal opinions of either party. For at least this reason, the established practice in the field since at least two decades is for the parties to sign a Non-Disclosure Agreement (NDA) before details of the infringement are presented to the alleged infringer and discussed between the parties. Such NDAs are normally fully reciprocal, time-limited and non-binding with respect to concluding any other agreement than the NDA itself. Hence the signing of such must be seen as virtually harmless to either party.

Nevertheless, some infringing OEMs argue that an NDA can not be a prerequisite for negotiating an SEP license and therefore simply refuse to sign one. This again prevents even the first step of the CJEU's flow-chart from being reached. So again we have a reduction of licensing efficiency through non-compliance with established practices in the field, delaying tactics, and lack of good faith. Accordingly, an injunction request can not be seen as abusive in this case either. 

These kinds of behaviours are often part of an overall reverse patent hold-up / patent hold-out strategy with a clear objective; to avoid or severely delay (to minimize past damages) obtaining necessary licenses for SEP portfolios. In fact, some OEMs even consciously exclude SEP license costs - and sometimes other IPR license costs - from their business cases from day one. All this points to a disregard for the substantial creative efforts and intellectual property rights of others which arguably - and somewhat ironically - provide the very foundation of these OEMs' business. Such infringing OEMs are clearly "unwilling licensees", and courts and competition authorities worldwide have repeatedly confirmed that injunction requests are perfectly appropriate in such instances. But actually, they shouldn't have to keep reminding market participants about that. It should be patently obvious.