Patent privateering - a comment on the FOSS Patents campaign

In my previous post, I questioned the stance taken by FOSS Patents blogger Florian Mueller on what he calls "patent privateering". It seems like a veritable FOSS Patents campaign has been launched against this phenomenon, with crowd-sourced name-and-shaming and all. 

I feel that this campaign is - at best - unhelpful, since its basis is rather lacking in analysis and it carries an unwarranted presumption of sinister causes on behalf of SEP holders. 
In short, FOSS Patents goes after an effect rather than a cause.

More questioning of the campaign has recently come from Richard Lloyd of IPR newspaper Intellectual Asset Management (IAM): "the notion behind the FOSS Patents initiative - that privateering is bad and should be stamped out – is just plain wrong".

However, in a more recent FOSS Patents post, Mr. Mueller does ask the relevant question "...why companies with such vast resources and enormous sophistication (in-house and externally, in legal and in technical respects) need help from little guys with a controversial business model to do license deals with the very same licensees with which they've already done deals before and do deals with all the time."

But the question was rhetorically put, i.e. still presuming sinister motives. It shouldn't be rhetorical though. It's an excellent question. At least if you really want to try to understand the problem. My answer, as I indicated last year and more recently last week, is that patent holdout is an important driving factor behind SEP sales. So to the extent we need a campaign, patent holdout should be the target. To cite IAM's Richard Lloyd again: "In short, it doesn’t look like the privateer who is being unreasonable and abusive, it is the companies who will not sit down and talk turkey. Maybe this is what we really want to be shining a light on. Anyone want to help IAM put together a list?"

In what looks like an attempt to isolate a particular group of "good guys" from "evil-doers", Mr. Mueller goes on to ask the question "...why a number of major right holders generally don't sell patents to PAEs. For example, I'm not aware of Qualcomm doing this... Or IBM. ... Or even Microsoft".

Again rhetorical, and again it needn't be. This one is particularly easy to explain. To begin with, in a cellular SEP context we can forget about IBM and Microsoft since neither is a significant SEP holder. So let's look at Qualcomm. It's the only significant SEP holder that sells chipsets and not end-user products. And not just any old chipsets, but the most popular ones on the market. So for Qualcomm, SEP-licensing is more straightforward than for other SEP-holders since there's already an established and keen business interest on the part of its potential licensees. Indeed, Qualcomm hardly ever initiates SEP infringement lawsuits, and yet it has the industry's highest SEP license royalty revenue. Clearly, Qualcomm has so far been subject to far less patent holdout than other significant SEP-holders, and therefore hasn't felt the need to engage in SEP selling for "patent privateering".

So, while perhaps contrary to Mr. Mueller's intention, his Qualcomm example is the perfect corollary to my own conclusion: SEP selling is largely a rational response to patent holdout. 

Patent privateering - cause and effect

In a recent FOSS Patents blog post, there was a discussion on "patent privateering" in relation to SEPs. The definition used in the post was "the act of large companies feeding trolls with patents in order to maximize their patent monetization income and/or drive up their competitors' total cost of defense". Whether this definition is appropriate or not could be debated, but the blog post is nevertheless interesting as one reaction to what seems to be a relatively new form of behaviour in the industry.

However, there's a key statement in the post: "Many privateering deals involve SEPs and are part of a scheme to circumvent FRAND licensing obligations", that is worth quite some scrutiny.

Regarding FRAND licensing obligations, my experience is that:

1) A growing number of SDOs and competition jurisprudence ensure that FRAND licensing obligations transfer with the SEPs to the new owners. Therefore, SEP-holders typically contractually bind the buyer to abide by FRAND terms for the purchased SEPs. Sellers may also impose royalty caps versus third parties on the buyer. 

2) The post inherently assumes that when an SEP holder sells off SEPs, the seller's FRAND rate is unchanged. It doesn't explore whether there may be legitimate reasons for maintaining the same rate or whether sellers reduce their FRAND rates by a "corresponding" amount after sale. Sellers can contractually agree with the buyer to do so, as well as permit buyers to disclose that information to potential licensees. Then the transfer won't affect the cumulative FRAND rate for OEMs.

But the most troubling aspect of the FOSS post is that it carries a presumption of sinister motives being present; "part of a scheme to circumvent...obligations". No attempt is made to explore what might be legitimate motives for selling SEPs.

My experience from real-world licensing is overwhelmingly that companies do have legitimate motives for their business decisions, so to simply and sweepingly assume the opposite strikes me as a rather extreme position to take.

In fact, as I've already mentioned in an earlier post, there is indeed a major legitimate cause of SEP selling. It's called patent hold-out.

Several of today's phone OEMs with large product sales are relatively new to the business and as regards to SEP licensing tend to behave differently from their equivalents in the past. Instead of trying to negotiate necessary SEP-portfolio licenses in good faith, there's a tendency to proclaim virtually any license offer as being "non-FRAND". Then simply wait for the patent holder to try to obtain FRAND value on its global SEP-portfolio through expensive and inefficient patent-by-patent, country-by-country litigation - a process that may never lead to FRAND value recoupment. This behaviour is known as "patent hold-out" and is becoming widely recognized by courts and agencies worldwide as being a major problem. For a discussion on the mechanism, reasons and effects of patent hold-out, I refer interested readers to my earlier post on the subject.

As a result of all this, several holders of significant global SEP-portfolios have in recent times increasingly become unable to obtain FRAND value from their portfolios in traditional ways, i.e. through bi-lateral patent licensing. These SEP-portfolio owners don't have the corporate culture or relevant experience to extensively enforce their patents through courts and so have turned to NPEs, who are much more experienced with patent litigation, in order to recoup value from their patents.

If we really want to mitigate "privateering" going forward, we should voice our support for appropriate changes to mitigate its actual causes. We should find ways to facilitate fair and efficient adjudication of FRAND license terms of global SEP-portfolios, and adopt clear rules that allow injunctive relief against those who refuse such an adjudication. And of course, regulators, courts and agencies should continue to acknowledge, highlight and enforce against the growing patent hold-out problem.

With such measures effectively implemented, I'm convinced that SEP transfers seen as "privateering" will decrease and SEP licensing efficiency will increase.

Apple and Ericsson - a first look

On January 12, 2015, Apple filed a complaint in the US District Court for the Northern District of California asking for a declaratory judgment that i) seven Ericsson US patents are not essential to 4G nor infringed by Apple or alternatively, if found essential and infringed, ii) the court sets reasonable royalties using a royalty base of "at most, the component that substantially embodies the alleged invention". It also asked the court to prevent Ericsson from seeking injunctive relief or exclusion orders based on the patents-in-suit.

Shortly after, Ericsson filed a complaint in the US District Court for the Eastern District of Texas asking for a declaratory judgement that i) Ericsson's global license offers have "complied with its FRAND commitment" and ii) Ericsson has "complied with its contractual obligations under its FRAND commitment".

There's been more filings in this dispute since, and of course there could be more to come. But in this post I'll specifically examine certain aspects of this first filing by Apple. There are some parts that I find interesting and related to what I have touched upon in previous posts. Also in relation to both of these first filings, I'll revisit the issue of SEP portfolio license valuation.

The first point in Apple's complaint concerns the "royalty base". Basically, a "royalty base" is the value of "something" that a royalty rate percentage is multiplied by, to arrive at a payable royalty for a licensed product. In its complaint, Apple argues that "the law requires" that the royalty base be selected as "(at most) the smallest salable unit", and explains that such a unit would correspond to "(at most) the baseband processor chip" inside its products. Apple further implies that the "current technological and legal environment" is one where this particular Apple opinion prevails, and that Ericsson has refused to "adapt" to it.

Let's first look at the law. The fundamental basis for US patent damages can be found in 35 USC 284, "...the court shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer..." (emphasis added). Clearly, there are no limitations of the type advanced by Apple to be found there.

So how about the "smallest salable unit"? Well, the phrase is actually part of the Entire Market Value Rule (EMVR) concept in US patent damages law. But Apple has embraced it in a completely out-of-context manner. The concept, as clarified only recently by the US Federal Circuit in Ericsson vs. D-Link in 2013, is only an "evidentiary principle" to be used to specifically assist a US layman jury to arrive at a reasonable royalty when there is a risk of it being misled (biased) by a higher end-product value. Moreover, in the very same breath the Federal Circuit made it crystal clear that i) licenses are "generally negotiated without consideration of the EMVR" and ii) the "substantive legal rule" is that the “ultimate reasonable royalty”– e.g. the result of multiplying a royalty rate and a royalty base–”must be based on the value that the patented invention adds to the end product” (emphasis added).

And if that's not enough, also the market has rejected Apple's position. It's an indisputable fact that the end-product selling price has been used as a royalty base in cellular SEP licensing for more than 20 years. That is, since more than a decade before Apple even got into the mobile phone business. During all those years, several hundreds, if not thousands, of cellular SEP license agreements were signed using precisely that royalty base.

If those hundreds of licenses would have been so clearly wrong, how could the world's legal systems - including the US legal system - have let such practices flourish for decades? Not to mention the tremendous global growth in the mobile phone business during those 20 years, from virtually zero to 7 billion mobile subscriptions and 2.5 billion devices sold annually today? All that, based on something that's basically against the law? I'm afraid I find that quite hard to believe.

Clearly, Apple's opinions about what "the law requires" and the "current legal environment" on the subject of royalty base do seem quite odd to say the least.

Moving now to the question about injunctive relief. Here Apple asked the court for "a ruling that Ericsson cannot seek injunctive relief or exclusion orders against Apple" based on any of the patents-in-suit found to be infringed and essential.

As I've mentioned before, there's no legal support whatsoever for banning the seeking of injunctive relief for infringement of SEPs. In fact, the US Federal Circuit in Apple vs. Motorola in 2014 could not have been clearer on this point: "To the extent that the district court applied a per se rule that injunctions are unavailable for SEPs, it erred." Indeed, "an injunction may be justified where an infringer unilaterally refuses a FRAND royalty or unreasonably delays negotiations to the same effect." Clearly, an SEP holder does have the right to seek an injunction and it's up to the court to decide on a case by case basis whether an injunction is warranted, based on e.g. whether the infringer is deemed to have engaged in patent hold-out. An actual hold-out situation can be very damaging to the SEP holder and especially to other willing and existing licensees, as I discussed in a specific post on that subject. This is presumably why the US Federal Circuit believes that an injunction may be appropriate in such cases.

So, like the royalty base issue, Apple's request about injunctions also seems out of touch with US law.

The last aspect I'll examine here is that of SEP portfolio license valuation, looking at both Apple's and Ericsson's filings.

Apple seems to view the entire issue from a patent-by-patent aspect, and asked the court for declaratory judgements on seven particular Ericsson patents in terms of essentiality and infringement, and assuming those are fulfilled, value.

Ericsson on the other hand appears to treat the issue as a SEP portfolio licensing effort, and asked the court to determine whether its terms for its entire worldwide alleged SEP portfolio as a whole - i.e. not just seven US patents - are to be considered FRAND.

So essentially we have two approaches pitted against each other; i) patent-by-patent license value adjudication and ii) global patent portfolio license value adjudication.

The patent-by-patent approach requested by Apple may be suitable when the matter at hand is a license to a limited explicit set of patents granted in the US. But that's really not the case here at all. The majority of Apple's sales are outside the US, and it sells tremendous volumes on every continent. And an SEP-holder like Ericsson surely has granted SEPs on every continent too. In addition, major standards-contributors tend to obtain new SEPs over time, adding to their portfolios. For at least these reasons, the license scope of the Apple-Ericsson negotiation preceding these court filings must have concerned a global SEP portfolio license. Anything else would have been highly inefficient if not irrational for companies such as these.

As I elaborated in an earlier post, when it comes to a license to a large global SEP portfolio, a  patent-by-patent, country-by-country approach to adjudication can never be a complete solution, and when pursued by an infringer it may in practice amount to a patent hold-out situation. Patent hold-out can in turn lead to the unreasonable result that the SEP-holder cannot efficiently enforce its SEP portfolio simply because it's so large.

Looking now at the "one-stop shopping" approach requested by Ericsson. It does have an obvious attraction point; it directly focuses on the very topic of the actual negotiation between the parties - the value of a license to a global SEP portfolio. And in cases where significant databases of existing license agreements to the very same global SEP portfolio are available as references, this approach should have the potential to be both efficient and fair. In particular if the vast majority of those existing license agreements have been negotiated in good-faith without litigation, something we know is generally true for SEP portfolio licensing. So if Ericsson's public statements about having "more than 100 patent-licensing agreements in place" are to be believed, this case should surely qualify for this approach.

In recent times the "one-stop-shopping" approach has indeed gained support from courts and agencies worldwide. In Microsoft vs Motorola in the US District Court for the Western District of Washington, although some dubious calculation methodology was used as I've mentioned earlier, the court did in fact determine a global FRAND rate to Motorola's SEP portfolio. And the “Request for a FRAND Determination” process endorsed by the US Federal Trade Commission in the consent degree of Motorola vs Google also expressly concerned a global SEP portfolio license. Even the Chinese National Development and Reform Commission (NDRC) in 2014 imposed a similar process on InterDigital for a global SEP portfolio license.

Concluding this review of the initial filings of Apple and Ericsson, I find the argumentation coming from Apple surprisingly unconvincing so far. Its arguments about royalty base and injunctions seem to be at odds not only with US law - including recent US Federal Circuit opinion - but also with decades of regular SEP-portfolio licensing. So for Apple's sake, one would hope that it comes up with some better argumentation as the case continues. Furthermore, the global license value adjudication sought by Ericsson seems to be rather more appropriate for the case at hand - a global SEP portfolio license - as compared to the patent-by-patent approach initiated by Apple.