United States: F/RAND – The Economic Incentives And A Discussion Of Microsoft V. Motorola

Last Updated: September 12 2013
Article by Jennifer Vanderhart

The importance of technical standards has grown tremendously over the past two decades with the increase in the communications and information technology industries for which standards are critical. Formal national and international standard setting organization (SSO) have, in many cases, been replaced or supplanted by informal SSOs or industry consortia, but, whether established formally or informally, the benefits of standardization are readily apparent. It certainly would be inefficient if, for instance, various electrical appliances all had differently shaped plugs or if mobile phones made by various manufacturers could not call one another.

Most standards, and in particular those covering modern communications and information technology, embody patented intellectual property (IP), and SSOs require that the owner of the patented technology commit to licensing patents on fair, reasonable and non-discriminatory (F/ RAND) terms.1,2 F/RAND does not mean that a patent owner gives up the rights to patented IP. However, if the IP is established as a standard essential patent (SEP), then, as the name implies, a third party that wishes to produce a product that embodies the standard will be required to commit to a license for the SEP. The rationale behind the F/RAND requirements is twofold in that it is meant to ensure that essential technology that has been embodied in a standard is available to the industry while, at the same time, providing that the holders of the IP are fairly and adequately compensated.

The definition of F/RAND is not clearly defined and is hotly debated, but the intent is generally understood. The patent owner should be willing to negotiate in good faith. The owner should not refuse to license or offer a license so high as to essentially be refusing to license. Fair and reasonable are generally accepted as the same concept, with the use of "fair" being more common in the European Union. The U.S. Federal Trade Commission ("FTC") has stated that "Courts should apply the hypothetical negotiation framework to determine reasonable royalty damages for a patent subject to a RAND commitment. Courts should cap the royalty at the incremental value of the patented technology over alternatives available at the time the standard was defined."3 While the FTC has summarized the generally accepted belief that the ceiling of the royalty should be no higher than what the patent owner would have earned prior to the IP being incorporated into a standard in order to avoid the holdup problem (discussed further below), it also is generally accepted that a non-discriminatory royalty typically does not mean that every licensee must be given the same rate.

Because participation in an SSO is voluntary, IP owners must be allowed to seek adequate compensation if they are to remain involved in the standard setting process and are willing to contribute their valuable IP to the SSO. The policies of the majority of the SSOs do not specify particular licenses or royalty amounts in order to ensure the availability of the technology to the broadest possible audience. While this ensures the flexibility of licensing under F/RAND, it introduces a degree of indefinitiveness to the licensing process. Different parties will have varying ideas as to what constitutes a F/RAND royalty, and this often gives rise to substantial litigation.

Economists have called for SSOs to reform their intellectual property policies in a way that would reduce the burden on the courts.4 Proposals include putting into place steps that must be taken by the parties involved in the dispute prior to the patent owner commencing formal litigation or seeking an injunction or exclusion order. Possibilities include arbitration and alternative dispute resolution within the SSO and, depending on the particulars of a specific situation, might include defining the royalty base or stipulating other factors. In this way, an arbitrator or panel would more quickly be able to assess whether a proposed royalty is F/RAND, reducing the time and cost involved from that normally needed to resolve a patent dispute in the courts.

If a patent is not part of a standard, the usual process of licensing would be known as an arms-length transaction, in which two unrelated, well-informed parties acting independently from one another come to an agreement on the royalty to be paid. A licensor will not agree to a royalty amount that is more than the incremental benefit that an entity will receive from obtaining the license, and a licensee will not agree to an amount that is more than the cost of providing the license plus any additional amount an entity gives up (such as lost sales) in providing a license. Typically, a licensee can look to the next best option available and compare the cost and value of that next best option with that of the license being negotiated. In the case of a standard, however, there may not be a next best option, and one concern is that the owner of a patent that covers technology embodied in a standard might engage in what is known as holdup behavior, in which the owner approaches a firm practicing the standard with an unreasonable demand. Because the firm likely would not have another alternative, it would be forced to pay or exit the industry or sue.

MICROSOFT V. MOTOROLA

On April 25, 2013, Judge James L. Robart issued his opinion in Microsoft v. Motorola.5 The case was a breach of contract matter in which Microsoft alleged that Motorola breached its F/RAND obligations by making unreasonable offers to license two of its SEPs. Both SEPs were portfolios of patents covering Wi-Fi and video compression technology. Motorola contended that it was entitled to a royalty rate of 2.25 percent of the net selling price of Microsoft's Windows and Xbox products for both its SEP portfolios. On a $200 Xbox, this would result in a payment of $4.50. Microsoft claimed (Motorola disputes this claim) that this would result in annual royalty payments that would exceed $4 billion per year. Microsoft argued that it should have to pay only pennies per product, or approximately $0.5 million per year.

Judge Robart ultimately favored Motorola's methodology of a simulated hypothetical bilateral negotiation under the RAND obligations over Microsoft's proposal, which required an analysis of the incremental value of the patented technology as compared with the alternatives that existed at the time and could have been written into the standard when it was adopted. However, the judge's opinion on the amount of the royalty rates resulted in Microsoft paying just over $1 million per year, which has been noted as being about $560,000 above what Microsoft proposed and about $4 billion below what Motorola wanted.

Although the final amount of the decision was of interest given the chasm that existed between the opinions that had been proffered by the parties the more important element was the way the judge reached that decision in his 207-page findings of fact and conclusions of law. The court created a hypothetical negotiation between the parties by applying a modified Georgia-Pacific analysis. Judge Robart considered each of the relevant 15 Georgia-Pacific factors and provided a detailed discussion of each one as the court believed it should be interpreted in the context of the RAND obligations.

The Georgia-Pacific factors are well-established in patent law, and any damages analysis that calculates a reasonable royalty will address each factor, even if only to note that it doesn't apply. However a typical hypothetical negotiation assumes that the date of the negotiation occurs just before the first infringement, recognizes that there usually are alternatives to the patented technology and allows for an impact on the royalty rate depending on the relationship between the parties (i.e., if they are competitors or not). In addition, if the patentee has a policy of not negating licenses for the IP at issue, that also can be a factor in the determination of the royalty. Georgia-Pacific factors 4 and 5, thus, were determined by the court not to apply to a hypothetical negotiation under F/RAND obligations.

Judge Robart then went through the remaining Georgia-Pacific factors, addressing each in turn.6 I will not go through a detailed discussion of each here; however, certain findings were of particular interest. The court opined that the royalties received by patent pools could serve as indicators of a rate that is "consistent with the RAND commitment." In addition, the court opined that alternatives that could have been written into the technology instead of the SEPs-in-suit should be considered. Also relevant would be the customary practices of businesses licensing RAND-committed patents as opposed to those licensing patents that were not obligated under any RAND commitments. As to Georgia-Pacific factor 13, the portion of the realizable profit that should be credited to the invention, Judge Robart addressed the holdup concerns discussed above, noting that "As with many of the other factors, in the RAND context, it is critical to consider the contribution of the patented technology apart from the value of the patent as the result of its incorporation into the standard, the latter of which would properly reward the SEP owner for the value of the standard itself."

The ultimate influence of the methodology employed by Judge Robart is not yet certain, but his decision almost certainly will influence litigation regarding RAND rates and obligations. In the case of Microsoft v. Motorola, the ultimate decision favored Motorola. However, the importance of the Microsoft SEPs was shown to be less valuable than other patents essential to the standards, especially for Motorola's purposes. Other decisions, using the same methodology, might lead to a decision favoring the plaintiff. It remains to be seen whether a better road map will result in less litigation or less costly litigation of RAND royalty commitments.

Footnotes

1. The acronyms F/RAND and RAND both are used, and there does not appear to be any difference in meaning between the two terms.

2. It often is the case that a standard will embody technology covered by numerous patents owned by many different parties. One way to address this situation is to establish a patent pool. A pool normally will allow a licensor to use the pooled patents upon payment of a license fee and will allocate to each member of the pool a portion of the licensing fees. This has the effect of likely increasing market entry by avoiding the need for each licensor to negotiate multiple licenses (although it may raise competitive concerns).

3. "The Evolving IP Marketplace: Aligning Patent Notice and Remedies with Competition," Federal Trade Commission Report, March 2011.

4. Kai-Uwe Kahn, Fiona Scott Morton and Howard Shelanski, "Standard Setting Organizations Can Help Solve the Standard Essential Patents Licensing Problem," Competition Policy International Antitrust Chronicle, March 2013.

5. Microsoft Corporation v. Motorola Mobility Inc., 10cv1823, U.S. District Court for the Western District of Washington (Seattle), filed April 25, 2013.

6. The court did not directly address Georgia-Pacific factors 2, 3 or 14, although it did consider certain elements relevant to those factors.

The views expressed herein are those of the author and do not necessarily represent the views of FTI Consulting, Inc. or its other professionals. (c)FTI Consulting, Inc., 2013. All rights reserved.

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