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.

Portfolio licensing and patent hold-out

In the early days of the patent system, there was typically one company - one invention - one patent - one product - one jurisdiction. Today however, all these aspects have become de-coupled. Virtually any product can be covered by a number of patents in different jursidictions, originating from a number of inventions and owned by multiple companies.

For wireless Standards-Essential Patents (SEP) in particular, it's not about individual patents, it's all about portfolios of patents. Any standards-compliant product - your smartphone for example - will be covered by a number of patent portfolios, owned by different companies. By portfolio I mean one or more "patent families", where one patent family in turn consists of all patents worldwide originating from one invention. So one patent family consists of one or more patents in each of one or more jurisdictions, sometimes totalling dozens of patents. And remember, a patent portfolio can consist of many patent families, perhaps tens or even hundreds of them!

Of course, this is not strange in itself. First of all, as I described in a previous post on royalty stacking, a wireless standard is normally built through a multitude of inventions. An active contrubutor to a Standards Setting Organization (SSO) will typically contribute several inventions to the standard, quite possibly in different technology areas. Secondly, the world is highly globalized today, and virtually all manufactureres/sellers of standards-compliant devices (Original Equipment Manufacturers, "OEMs") sell their products in more than one country, and in most cases in a large number of countries. So obviously, innovators have the legal right to protect their IPR from being infringed in whichever countries support such protection.

But how about the licensing aspects of patent portfolios? Well, generally speaking patent portfolio licensing is more efficient than individual patent licensing, due to e.g. significant savings in transaction costs and time. So-called "patent pools" are often cited as examples of an extreme form of patent portfolio licensing that can bring greater efficiency to the market. Wireless SEP portfolio licensing (whether pool-based or not) also carries an additional aspect of efficiency. SEP holders normally generate new SEPs over time, and so license agreements are often designed to cover new additions of SEPs without the need of amendments or further transactions. Indeed, wireless SEP licensing has allowed the wireless device market to prosper tremendously in the last two decades. But in recent years, a worrying aspect of SEP portfolio licensing has emerged. It's connected to enforcement, and seriously threatens this efficiency. It's called "patent hold-out".

Since OEMs as well as SEP portfolios are typically global, it's perfectly natural and efficient for the SEP holder and OEM to agree on Fair, Reasonable and Non-Discriminatory (FRAND) licence terms for the entire global SEP portfolio. So there's a need to assess the value of a global SEP portfolio, in order to determine FRAND terms for it. While this is generally a reasonable requirement, there are also some important observations to make with this in mind, related to courts:

1) A given court has, at most, jurisdiction over it's own geographical territory (a region or a country), and can thus by definition only process a particular local sub-set of a given global SEP portfolio for infringement litigation.

2) Even a local sub-set of a global SEP portfolio may be very large, and consist of tens or even hundreds of patents. It's not always feasible for a given court to process even such a local sub-set in its entirety within a reasonable time.

3) Even with (hypothetically) super-high-capacity courts, the cost for an SEP holder to enforce an entire global SEP portfolio through litigation patent-by-patent would be extremely high.

Demonstrating the value of a global SEP portfolio in each jurisdiction to the fullest extent possible through patent-by-patent litigation is therefore difficult to do in practice. Only subsets of subsets of global portfolios, sometimes only a handful patents, can feasibly (from a time- and cost perspective) be processed per jurisdiction.

Because of this, an infringing OEM can adopt a "patent hold-out" strategy (also called "reverse patent hold-up") when confronted with an SEP portfolio licensing offer. The OEM can claim that the SEP-holder's offer - whatever it is - is non-FRAND, and then simply wait for the SEP holder to file infringment proceedings, knowing that proving the entire SEP portfolio's worth using that route can be very inefficient for the SEP-holder. So the strategy can allow a lot of time to pass, usually several years, during which virtually no royalty payments would have to be paid on a global basis. The OEM can continue and even increase its sales of infringing products, possibly even taking market share from licensed competitors (as I mentioned in a previous post on royalty stacking). Using the patent hold-out strategy, the absolutely worst thing that can happen from the OEM's viewpoint is that it will have to pay the royalties actually requested by the SEP holder in the first place, but many years later and even then possibly only sequentially per jurisdiction. It's true that in some jurisdictions, lawyers' and courts' fees may sum up to significant amounts over time, but in many cases the patent hold-out strategy is still very attractive for the infringing OEM, especially if sales revenue is large. As a result, the SEP holder may find itself effectively forced by the OEM to agree to a SEP license agreement on sub-FRAND terms.

But since wireless SEP licensing has always been about portfolio licensing, didn't patent hold-out happen in the past? Actually not. The emergence of patent hold-out is related to a tremendeus change to the mobile device marketplace in the recent decade or so. In the past, virtually all OEMs were also strong innovators, SSO contributors and SEP holders, and so there was a widespread acknowledgment of the actual value of R&D investment in standardization and hence SEP licenses. License negotiations for SEP portfolios were seen by all parties on the market as part of the normal business. Today, due to e.g. globalization and specialization, the situation is precisely the opposite - extremely few OEMs invest heavily enough in basic R&D to contribute to SSOs and become SEP-holders. Instead it has become possible for OEMs to use technology developed by others more or less off-the-shelf. This is generally a good market development, but unfortunately, it has also become an attractive proposition for many to ignore or avoid SEP licenses (and even other forms of IPR licenses) for such technologies to the greatest extent possible.  I've personally witnessed many cases of patent hold-out, and even received more or less explicit informal confessions from infringing OEMs on the clear benefits of the strategy.  It's certainly not just a theoretical concern.

The availablity and actual use of patent hold-out in the SEP portfolio licensing context constitute a devaluation of innovation. In effect this means - counter-intuitively - that it's more difficult to fairly enforce a large SEP portfolio than a small one. This is actually very serious and could be an important reason behind the trend of SEP divestments seen in recent years. Since it is difficult to realize the potential efficiency of portfolio licensing in practice due to patent hold-out, there can be a resulting tendency of portfolio break-up. Entities, including Non Practicing Entities (NPEs), procuring sub-portfolios for their own licensing programmes could thus ultimately be seen as a perfectly natural response to infringing OEMs engaging in patent hold-out against large SEP portfolios.

Some courts and agencies have finally begun to recognise and discuss patent hold-out as a serious problem. For example in its Samsung vs. Apple investigation July 5, 2013, the US International Trade Commission found that “Apple's position illustrates the potential problem of so called reverse patent holdup …..". And in relation to the Apple vs. Motorola US Court of Appeals for the Federal Circuit decision of April 25, 2014, Chief Judge Rader commented that hold out "is equally as likely and as disruptive as a hold up". Moreover, the Korean Fair Trade Commission in its decision on Feb 26, 2014 apparently also found that there had been patent hold-out in Apple vs. Samsung. These are clearly good calls, but considering the seriousness and widespread nature of patent hold-out, more courts and agencies worldwide need to become aware of it and disincentivize it as much as possible.

For sure, patent hold-out is real and is happening as we speak. But so far there's actually been more talk about something called "patent hold-up", which is the notion that an SEP holder is able to procure licenses on super-FRAND terms based on excessive power achieved by the SEP nature of the patent portfolio. However, the idea of an SEP holder as an armed robber (as in "patent hold-up") is hardly a fitting analogy if you think about it. To begin with, the FRAND regime exists precisely to combat such potential abuse of power. And at the end of the day only a state, i.e. a court or agency, can possess any "weaponry" and can decide whether to use it or not. In the context of SEP infringement where FRAND licensing commitments are in place, the court or agency will ultimately decide what form of relief would be appropriate.  From my experience of licensing in the wireless industry, patent hold-up is rather an allegation made by an infringing OEM while executing a patent hold-out strategy. This observation is in line with e.g. a recent finding by the US International Trade Commission in InterDigital vs. Nokia et. al., June 13, 2014: "While there may be a hypothetical risk of holdup, we have evidence that this is not a real threat in this case, or in this industry."

To counteract a patent hold-out situation by an infringing OEM, SEP holders would naturally be inclined to seek injunctive relief (or an exclusion order) for SEP infringment. Having frequently observed patent hold-out in real life, I believe that the availability of injunctive relief is crucial when an infringing OEM refuses an SEP portfolio FRAND license and engages in patent hold-out. A real threat of injunctive relief even only in a single jurisdiction weakens the attractiveness of the one-sided patent hold-out strategy for the OEM and instead allows the parties to conduct a balanced negotiation in good faith. Hence, in such a scenario injunctive relief - remarkably - works as a pro-competitive tool and helps maintain the value of innovation.

However, some voices in the industry appear to be against any kind of injunctive relief for SEP infringement, no matter what. For example, in 2011 Apple made the statement in a published letter to ETSI that "Seeking an injunction would be a violation of the party's commitment to FRAND licensing.". And in 2012, this stance appeared to be more or less endorsed by Microsoft. But taking such a position is clearly unfounded and unreasonable, as e.g. recently observed by the US Court of Appeals for the Federal Circuit decision in the aforementioned Apple vs. Motorola case of April 25, 2014: "To the extent that the district court applied a per se rule that injunctions are unavailable for SEPs, it erred.". It went on to say that "an injunction may be justified where an infringer unilaterally refuses a FRAND royalty or unreasonably delays negotiations to the same effect."

Granted, a perfectly reasonable question is of course: who decides whether an infringer is clearly engaging in patent hold-out? In response, there have been proposals put forward that address this question. For example, the parties could first be mandated to go through some form of binding arbitration or judicial process to ultimately determine FRAND terms for the portfolio. Such a scheme was used e.g. in the US Federal Trade Commission's Consent Order in the Google/Motorola case. This kind of process intends to strike some kind of balance between efficiency and rigorousness on a portfolio basis. The general idea is that if the infringing OEM refuses to be bound by the outcome of such process (or refuses the process per se), then seeking injunctive relief would be permissible. Unfortunately though, even creative proposals of controlled injunctive relief for SEP infringement are being challenged. The discussion about injunctive relief in SEP infringement cases is complex, but in absence of other ideas to combat patent hold-out, simply banning injunctive relief altogether would be totally unreasonable and would heavily tilt the playing field in favour of infringers and away from innovators.

On a policy level, it's really about whether we want to fairly credit innovation in a world where it's difficult to value global patent portfolios perfectly. How can we maintain efficiency in SEP portfolio licensing given that valuing a significant SEP portfolio through global litigation on a patent-by-patent basis is inefficient in practice? One could of course simply accept that the nature of global SEP portfolios means that one has to go through a very long and expensive process to arrive at a fair global FRAND SEP license. However, due to significant time and cost aspects, this disincentivizes innovation, promotes portfolio breakup and reduces the overall efficiency of SEP FRAND licensing. In my opinion, these negative aspects are overwhelming and bad for society as a whole. The question is; is it justified to find some solution for more efficient and fair SEP portfolio valuation other than forcing the SEP holder into global patent-by-patent litigation? I would say that it is. Consider that SEP portfolio licensing has historically worked very well indeed, and has struck a good balance between innovators and users that has led to an explosive growth in the wireless industry. This balance should be preserved rather than disrupted. Ideas such as the one used by the US Federal Trade Commission in the abovementioned case at least represent creative steps towards such preservation.
 
To summarize, in recent years it's become increasingly challenging for SEP holders to enforce their SEP portfolios to obtain FRAND royalties from infringers. By using a "patent hold-out" strategy, SEP infringers tend to avoid SEP portfolio license fees for years with limited risk, based on the notion that the SEP holder needs to demonstrate the value of the entire SEP portfolio to the fullest extent possible through litigation. The limited risk to the infringer is due to the limited feasibility for the SEP holder to timely and cost-efficiently litigate its entire global SEP portfolio. Ultimately all of this leads to devaluation of innovation and inefficient SEP licensing, since it - remarkably - makes it more difficult to fairly enforce a large SEP portfolio than a small one. This contributes to innovation disincentivization, patent portfolio fragmentation, NPE proliferation and ultimately decreased market efficiency. Furthermore, lobbying efforts against any kind of injunctive relief or exclusion orders for SEP infringement certainly do not help the situation at all. I believe there's a strong need for courts and agencies world-wide to acknowledge the problem of patent hold-out, and to disincentivize it in order to make SEP portfolio licensing more fair and efficient. Creative policy proposals need to be encouraged in the space of SEP portfolio licensing, which can strike a reasonable balance between the market participants and society as a whole. In the absence of any other potent balancing factor against clear and present patent hold-out in cases of SEP portfolio infringement, injunctive relief and exclusion orders continue to be necessary - and in fact pro-competitive - remedies.