Reasonable Royalty Base: The Never-Ending Dilemma in Licensing of SEPs

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January 18, 2021

[This post has been authored by Pranay Dixit and Daanish Dube, students at Jindal Global Law School.]

Introduction

Since the 1990s, the Internet of Things (“IoT”) has been largely facilitated by the evolution of Standard Essential Patents (“SEPs” ). SEPs can be defined as patents that are essential to the implementation of a particular industry standard. Such ‘industry standards’ are developed and established by voluntarily formed associations called “Standard Setting Organizations” (“SSOs”). In addition, they develop policies that govern the disclosure and licensing obligations with respect to such SEPs. There are two kinds of parties involved in SSOs – the innovators and the implementers. These innovators are the parties that own and license SEPs whereas the implementers are the ones who obtain licenses to such SEPs, to further implement the technology. While both parties are united by a commonality of interests, there are certain issues where the innovators and implementers tend to differ. One such issue is the debate surrounding the appropriate royalty base. The European Commission stated that SEPs should be licensed as per terms that are “….fair, reasonable and non-discriminatory (FRAND).”[i] The innovators believe that such royalties should be calculated on the basis of a percentage of the entire market value of the end product (“EMVR”) whereas the implementers assert that reasonable royalties should ideally be determined as a percentage of the Smallest Saleable Patent Practicing Unit (“SSPPU”).

A Jurisprudential Overview

Microsoft v. Motorola was the first decision given by the Federal Circuit Court on this issue. The ratio of the case was a result of the derivation of the seminal principles laid down in the Georgia Pacific case. He based his analysis on two factors – firstly, the determination of reasonable royalties was to be made on the basis of the time prior to the patented technology being incorporated into the standard.[ii] Secondly, the contribution made by the patented technology was to be assessed and further, the contribution made by those capabilities to the implementer’s products.[iii] Subsequently, the decision In Re: Innovatio Ventures LLC further contributed to this debate where Judge Holderman had held that the importance of the patent portfolio must be assessed on the basis of the proportion of all SEPs that are a part of the portfolio as well as the technical contribution of the portfolio to the standard, as a whole.[iv] In addition, one should assess the relevance of the entire patent portfolio to the alleged infringer’s products along with the licenses for comparable patents.[v] Both of these decisions involved the determination of reasonable royalties on the basis of SSPPU. However, Ericsson v. D-Link was the first decision where it was held that reasonable royalties should be assessed as a percentage of the EMVR.[vi] The Court reasoned that the patent damages in cases of infringement of a SEP would involve the determination of such damages where the entire market value of a machine is ‘properly and legally attributable to the patented feature’.[vii] In CSIRO v. CISCO, the Court had held that there are more effective methods to assess the value of a patent and it is not necessary to apply the SSPPU principle.[viii] However, the value of the patent attributable to its standard must be excluded, irrespective of whether the same has been subjected to RAND commitments.[ix]

IEEE’s Policy Amendments

In 2015, the Institute of Electronic and Electrical Engineers (“IEEE”) amended its policy that was in contradiction to the development of law at that time.[x] The amendment sought to ensure that the royalty rate was to be determined as a percentage value of the SSPPU.[xi] It was largely perceived that the said amendment was designed to benefit the implementers. However, it was also subjected to a significant amount of criticism by the innovators – who thought that this severely undermined the importance of their patented technologies.

In 2015, the Department of Justice (“DoJ”) had released a Business Review Letter (“BRL”) that was interpreted to mean that SSPPU ought to be considered while deciding the reasonable royalty base.[xii] This BRL drew both criticism as well as applause from the innovators and implementers respectively. After the Federal Circuit Court’s decision in FTC v. Qualcomm, the DoJ released a clarification stating that the 2015 BRL was interpreted in an incorrect manner, thereby opposing the established jurisprudence till 2015.[xiii] The DOJ highlighted the Ninth Circuit Court’s ruling where the latter had observed that –

“No court has held that the SSPPU concept is a per se rule for “reasonable royalty” calculations; instead, the concept is used as a tool in jury cases to minimize potential jury confusion when the jury is weighing complex expert testimony about patent damages”.[xiv]

However, this statement is fundamentally flawed considering SSPPU has been a relevant factor to determine the royalty base for SEPs since well before the 2015 BRL by the DOJ.

Possible Implications

It is very essential to understand the value of the contribution by a patented technology in isolation along with assessing the contribution of the technology in question to the implementer’s products. The breaking point of determining the royalty base then arrives on whether the presence of such technology is driving the demand for the implementer’s product in question. Consider the example of a 5G chip in a smartphone. Obviously, the SSPPU or the chip is not the only factor that influences the demand for an end product. While it might be essential to a certain aspect of the functionality of the end product, it would be incorrect to conclude that the same is driving the demand for a product. The camera, interface or the design of the handset would be the factors that could drive the market demand. It would thus be unreasonable to consider EMVR as the royalty base. However, royalties based on SSPPU would also be unfair towards the innovators. This is primarily because the 5G chip or technology significantly contributes to the functionality of the smartphone, even if it is not the major factor driving its demand in the market. Therefore, it becomes rather imperative that a middle ground while considering both EMVR and SSPPU would seem like a more appropriate way around this question to keep both parties satisfied.

Recent developments pertaining to SEPs in the automotive sector

There has been a shift in the utilisation of standardized technologies with companies facing severe struggles due to widespread digitalisation of the products and services. The Mannheim Regional Court, this year, decided a case this year granting an absolute injunction in favour of Nokia that makes sure that there would be no sale of cars produced by Daimler that incorporated the patent EP2981103.[xv] This patent enables telecommunication capabilities in automobiles. One of the reasons why the case reached an injunction stage was due to Daimler’s reluctance to pay the royalties based on a percentage price of the automobiles. This practice of demanding royalties based on EMVR has rather become a custom for the patent holders. The rapid development of technologies pertaining to 5G and the WiFi standards mean that there is an ever-increasing need to incorporate these patented technologies. The primary reason for their inclusion is that they would facilitate interoperability across different ranges of products. Furthermore, the inclusion of SEPs in the case of the autonomous vehicles would lead to a significant improvement in their overall functionality.[xvi] However, would this justify patent holders demanding royalties as a percentage of the EMVR? The answer to that question can be found in the same jurisprudence developed by the Federal Circuit Courts discussed above. Since a vehicle is a combination of different patented technologies that collectively contribute to its overall functionality, demanding a reasonable royalty based on EMV would be far-fetched.

Conclusion

Considering that there is an inherent difference between the innovators demanding EMVR and implementers demanding SSPPU as the base for royalty calculation, there can never be a straightjacket formula to ascertain the reasonable royalty base. A patented technology that is essential to a standard might be significantly contributing to the market demand of a product or it might be one of the components in the end product. In the former, EMVR ought to be preferred, however, in the latter, it would be rather fair to adopt SSPPU as the royalty base. The determination of a reasonable royalty base must also account for the situation of royalty stacking.[xvii] This situation is likely to occur when multiple innovators opt for EMVR as the appropriate royalty base. Thus, the determination of the reasonable royalty base will be driven by the nature of the technology, its contribution to the implementer’s products and the degree of interoperability prevailing at that particular time.

[i] http://aei.pitt.edu/1222/1/1222.pdf.

[ii] [2012] Daily Journal D.A.R. 13, 619

[iii] Microsoft (n 1).

[iv] [2013] U.S. Dist. LEXIS 144061.

[v] Innovatio (n 3).

[vi] [2014] U.S. App. LEXIS 22778.

[vii] Ericsson (n 5).

[viii] http://www.cafc.uscourts.gov/sites/default/files/opinions-orders/15-1066.Opinion.12-1-2015.1.PDF.

[ix] Id.

[x] https://patentlyo.com/patent/2015/02/amends-patent-policy.html.

[xi] https://patentlyo.com/patent/2015/02/amends-patent-policy.html.

[xii] https://www.justice.gov/atr/page/file/1315291/download.