UPDATED March 28, 2012 at 12:15 am ET
In my last article, I posed the question whether the “Smart Phone Patent Wars” were giving IP rights – and more specifically, patents – a bad rap? My conclusion was an unfortunate “yes,” with the villains being a handful of companies that willingly contributed patented technologies to various standard setting organizations (SSOs), encouraged their use in a host of consumer electronics, and years later charge the very producers they encouraged to implement these standards with patent infringement. Now in this article – the second in a six-part series – I examine the so-called “Fair, Reasonable and Non-Discriminatory” (FRAND) licensing terms that SSOs require of their participants.
First, before discussing the meaning of FRAND licensing terms, we must understand the nature and importance of SSOs. These national or international organizations are typically private, non-profit organizations whose members include for-profit company participants seeking to establish one or more technical standards that will be incorporated into a product or technical system. Some of the more widely recognized SSOs include the Institute of Electrical and Electronics Engineers (IEEE), the Joint Electron Device Engineering Council (JEDEC) and the Telecommunications Industry Association (TIA). The technical standards adopted by these SSOs are voluntary (unless they are enacted into law by, for example, a state legislature), but influential. Why, however, have technical standards? Well, would you buy a smart phone if it could not connect to a mobile network so that you can communicate (by voice or text) to your peers, visit all your favorite websites on the Internet or download pictures, videos and the like? That is, standardization delivers consumer benefits, especially in product markets where the very value of the product is the fact that a great number of other consumers use the same or a compatible product.
Second, nearly all SSOs have rules requiring participants to not only disclose the patents they own that relate to a proposed standard, but to eventually grant licenses to industry participants on FRAND terms. These rules are intended to prevent an SSO participant from gaining exclusive control over a standard through the exclusionary power of a patent. Thus, the SSO disclosure rules ensure that SSO members make an informed decision when voting on a proposed standard that is (partially or wholly) patented. The disclosure rules, however, vary greatly among the SSOs. Admittedly, some can be downright confusing. The U.S. Court of Appeals for the Federal Circuit once observed in the noted Rambus v. Infineon case:
In this case there is a staggering lack of defining details in the [SSO] patent policy. When direct competitors participate in an open standards committee, their work necessitates a written patent policy with clear guidance on the committee’s intellectual property position. A policy that does not define clearly what, when, how, and to whom the members must disclose does not provide a firm basis for the disclosure duty necessary for a fraud verdict.
What is not confusing, however, is that FRAND obligations are indeed imposed on an SSO participant who owns one or more patents related to a standard that is eventually adopted. To be fair, not all of the smart phone patent wars have involved patents related to standards. Much of the litigation has involved, for example, non-standard user interface related features of one handset over another. This is “run of the mill” patent infringement litigation. What has caught the attention of both U.S. and European regulators, however, is where FRAND licensing efforts of standards-related (i.e., SSO-disclosed) patents have resulted in patent infringement litigation.
The question then becomes what exactly does FRAND mean!? From its most likely inception in 1991 by ETSI – a European SSO that creates standards for information and communications technologies – to today, no SSO (or even court case) precisely defines exactly what “fair, reasonable and non-discriminatory” licensing terms mean. (This may be a function of SSOs steering clear of dictating royalty rates and thus falling into antitrust price fixing territory.) The most-widely cited scholarly definition of FRAND with respect to royalty rates, and the one adopted by the FTC, is:
“[A] royalty should be deemed ‘reasonable’ when it approximates the outcome of an ex ante auction process where IP owners submit RAND commitments coupled with licensing terms and selection to the standard is based on both technological merit and licensing cost.”
This is not exactly a model of perfect clarity. There simply is no generally-accepted test to determine whether a particular license offer satisfies the reasonable aspect of an SSO participant’s FRAND commitment. How does this play out in practical terms?
As the smart phone patent wars were heating up, Google, Inc. announced that it had acquired Motorola Mobility Holdings, Inc. – a developer of smartphones and tablets with over 17,000 patents – for US$12.5B on August 15, 2011. As the acquisition awaited antitrust approval in the U.S. and Europe, Google sent a letter on February 8, 2012, to IEEE pledging to honor Motorola Mobility’s FRAND obligations should the deal be approved. The letter stated that Google was prepared to grant FRAND licenses “with a maximum per-unit royalty of 2.25% of the net selling price for the relevant end product.”
Then, on February 13, 2012, both the European Commission and the U.S. Department of Justice individually approved Google’s proposed acquisition of Motorola Mobility. However, Joaquín Almunia, the European Commission Vice President in charge of competition policy, warned:
“We have approved the acquisition of Motorola Mobility by Google because, upon careful examination, this transaction does not itself raise competition issues. Of course, the Commission will continue to keep a close eye on the behaviour of all market players in the sector, particularly the increasingly strategic use of patents.”
Similarly, the U.S. Department of Justice press release approving the acquisition stated:
“During the course of the division’s investigation, several of the principal competitors, including Google, Apple and Microsoft, made commitments concerning their [Standard-Essential Patent (SEP)] licensing policies. The division’s concerns about the potential anticompetitive use of SEPs was lessened by the clear commitments by Apple and Microsoft to license SEPs on fair, reasonable and non-discriminatory terms, as well as their commitments not to seek injunctions in disputes involving SEPs. Google’s commitments were more ambiguous and do not provide the same direct confirmation of its SEP licensing policies.”
This all came to a head when, on February 22, 2012, Microsoft Corporation filed a formal competition law complaint against Google with European Union antitrust regulators. Microsoft’s complaint was brought about because Google (i.e., Motorola Mobility) “has refused to make its patents available at anything remotely close to a reasonable price” and “attempting to block sales of Windows PCs, our Xbox game console and other products.” Well isn’t Google’s “maximum per-unit royalty of 2.25% of the net selling price for the relevant end product” in compliance with FRAND!? If you consider that often dozens (and sometimes, hundreds) of patents cover a single device, the answer is a resounding “no.” At 2.25% per patent, it would take only about four dozen patents before the entire selling price would be paid in royalties – an obviously absurd result.
Further, today’s complex products often incorporate dozens or even hundreds of standardized technologies, each potentially covered by patents. Long before these smart phone patent wars, an April 2007 joint FTC-DOJ report on innovation and competition recognized this overlapping patent rights (or “patent thicket”) problem:
“In many industries, the patent rights necessary to commercialize a product are frequently controlled by multiple rights holders. This fragmentation of rights can increase the costs of bringing products to market due to the transaction costs of negotiating multiple licenses, and greater cumulative royalty payments.”
Thus, imagine if the other owners of the dozens (or hundreds) of patents related to the smart phone or PC asked for a similarly “reasonable” royalty? That is, if many other patent holders follow Google’s lead and start demanding upwards of two percent of a retail product’s price in royalties, manufacturers could find themselves facing aggregate royalties that are many times the final selling price of their products. Needless to say, this would harm consumer electronics producers here and abroad, as well as U.S. consumers.
Lastly, even if Google’s ambiguous offer of “2.25% of the net selling price” were read to mean “at most 2.25% per unit regardless of the number of patents implicated,” its royalty demand to a single company like Apple or Microsoft would be far in excess of the US$12.5B that Google paid to acquire Motorola itself! Defining “reasonable” in FRAND may be difficult, but defining “unreasonable” is not so tough! Even if we were to apply a Justice Stewart pornography-like test to FRAND – “I know it when I see it“ – Google’s offer in this case is not that.
In sum, I have previously stated that the answer to this problem is two-fold. First, patent owners who attempt to renege on their SSO commitments should be held to such commitments via private lawsuits including patent misuse, estoppel, laches, breach of contract, and fraud claims. Second, regulators in all affected markets should take action to deter future renouncements of this type that have anticompetitive effects. I will discuss these solutions in future articles (as this is the second in a six-part series) exploring the smart phone patent wars, RAND patent licensing schemes, SSOs and their affects on the IP ecosystem. As always, please stay tuned!