The European Commission claims that companies taking licenses for patents that are deemed essential to an open standard need more information about aggregate royalties to facilitate license negotiations with patent owners. It makes this claim in its recent proposal for a new Regulation on standard-essential patents (SEPs). The evidence does not support its claim.
SEPs deliver technical functionalities for cellular telephony, computers, smart televisions and connected automobiles, among other applications. The Commission believes SEP licensing will become more problematic in the future, particularly for small- and medium-sized businesses. But empirical data do not support this view and indeed point in the opposite direction.
The draft EU regulation introduces a mechanism for the Commission to set the aggregate, or total, royalty that should be paid to license all SEPs for a given standard. The EC believes that by providing information about the aggregate royalty, the regulation “is going to solve one of the key issues in SEP licensing negotiations.” This claim is not supported by the Commission’s own commissioned study.
FRAND licensing gap narrows
Based on Darts-ip data, the study finds that cases related to fair, reasonable and non-discriminatory (FRAND) licensing terms and conditions in the EU have also reduced since 2014 and that the gap between what is offered and what is found agreeable as a FRAND licensing negotiation or FRAND licensing fees has “winnowed” (narrowed).
We do not find any support for the Commission’s claim that uncertainty about the aggregate royalty is a “key issue” in SEP licensing. Nor do we find support for the Commission’s claim that providing information about the aggregate royalty would facilitate the execution of SEP license agreements.
For example, there was some litigation in Europe on elements of a FRAND licensing negotiation (including aspects on FRAND licensing fees) following the 2015 European Court of Justice (CJEU) decision in Huawei v ZTE regarding FRAND licensing. But the recent study prepared for the European Commission finds that “SEP licensing negotiations resulting in litigation are not representative of SEP licensing negotiations more generally.” The study further concludes that diverging views of a licensor and potential licensee regarding the number of SEPs to be included in a license “are very rarely the main factor in driving litigation.”
Transparency is not the issue
This suggests that transparency during a licensing negotiation regarding SEPs is not an issue, as one would expect following the licensing framework affirmed by the CJEU in Huawei v ZTE. Of course, each case is to be assessed on a case-by-case basis, but the data strongly suggest that the ensuing number of SEP-related court cases is relatively limited in number.
The EC should amend its impact assessment to determine whether a lack of information about the aggregate royalty is really a key issue in SEP licensing negotiations such that a regulation providing a new framework for SEPs is really needed.
The EC’s concern about the aggregate royalty is misplaced. SEP licensing negotiations typically do not involve discussions about the aggregate royalty. While the total expected royalty payments is likely to influence a licensee’s willingness to pay for a license, sufficient information is already available to estimate what the total royalty cost is likely to be. Moreover, experience suggests that providing information about the aggregate royalty will not avoid disputes over SEP licensing.
Take Avanci’s 2G/3G/4G patent pool. In 2017, Avanci announced that it would license cellular SEPs to automobile manufacturers at a rate of $15 per vehicle. At that time, the Avanci pool included patents from 12 SEP holders, including among others, Ericsson, Qualcomm, and InterDigital. Today the pool includes more than 55 licensors and covers the vast majority of cellular SEPs. Avanci’s royalty rate, and thus the cost (i.e., the aggregate royalty) to implement 2G, 3G, and 4G standards in connected cars, is transparent. Yet, despite this transparency, some standard users have continued to resist entering a license agreement.
The public nature of Avanci’s rates and the advance notice Avanci has given for rate changes suggests that these disputes are not due to a lack of information about the aggregate royalty but instead are about the calculation of that rate or whether the rate is FRAND. For this reason, transparency about the aggregate royalty is unlikely to reduce SEP licensing disputes.
Royal stacking not hindering standards adoption
In addition, the EC claims that setting an aggregate royalty “may also help to overcome problems of royalty stacking.” Royalty stacking, in the context of standards, refers to the total stack of royalty payments implementers must pay SEP holders to access the standard. Royalty stacking is only a problem if the stack is so high that it undermines implementation, and therefore the success, of a standard. But the idea that royalty stacking occurs in practice, particularly in the context of cellular standards, has been repeatedly rejected. As the EC itself acknowledges, “wide implementation of the standard is of interest to the SEP owners.” That is, SEP holders have a clear business interest in ensuring that royalties are not so high as to undermine the widespread adoption of the standard.
The smartphone industry provides a good example. Despite handset manufacturers’ repeated claims of a royalty stacking problem, cellular standards have been widely adopted. The European cellular market grew to more than 5 billion subscribers (GSMA data) in less than 30 years following its launch in July 1991. Unsurprisingly, U.S. courts now prohibit references to royalty stacking in jury trials unless a party can support the claims with empirical evidence. Yet, the Commission seems to believe that theoretical concerns about royalty stacking justify the introduction of a burdensome new administrative procedure for determining an aggregate royalty.
Top-down approach widely rejected
The only way in which information about the aggregate royalty could be useful is if the Commission intends to use the regulation to introduce a “top-down” approach for the determination of FRAND royalties for SEP portfolios. In the top-down approach, an aggregate royalty is determined for all the SEPs for a particular standard and then apportioned among SEP holders—usually in proportion to their total number of SEPs.
While this top-down approach has been discussed in some academic papers and used by some courts, most courts around the globe have rejected it, finding it too speculative to provide a reliable estimate of FRAND terms and conditions. In the Unwired Planet decision, Judge Birss gave a clear preference to the comparable license agreement approach: “In my judgment the statements set out above have little value in arriving at a benchmark rate today for a number of reasons. The claims are obviously self-serving. The statements about aggregate royalties in particular are statements about other people’s money on the footing that the person making the statement says at the same time that the cake is quite small but they are entitled to a large piece of it” (para 269 of Judge Birss’ decision in UP v Huawei). In the United States, the only two decisions that used the top-down approach were In re Innovatio, one of the first FRAND determinations (now more than 10 years old) and TCL v. Ericsson, a decision that was ultimately vacated by a different judge.
Comparable licenses best basis for FRAND royalty determination
Courts have consistently recognised that, when available, comparable licenses provide the most reliable methodology for determining a FRAND royalty for a licensed portfolio (see, for example, Ericsson v. D-Link, Unwired Planet v. Huawei, and Sisvel v. Haier). The Commission provides no support for a departure from this principle, or the conclusion that the introduction of a “top-down” approach would produce better outcomes.
While the EC appears to believe that the absence of information about the aggregate royalty is a major problem in SEP licensing negotiations, its own regulatory impact assessment provides no support for such a conclusion. If anything, experience shows that providing such information will not avoid SEP licensing disputes.
Combined with the other issues highlighted in our blog series and Live blog we believe the Commission should voluntarily withdraw its proposal and go back to the drawing board—or the Council and Parliament should reject it and force the Commission to rethink it.
This is the fourth in a series of articles analysing the Commission’s proposed SEPs regulation. You can see all the previous posts here.