Methodologies For Calculating FRAND Damages: Part 2

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Law360, New York (October 9, 2014, 10:18 AM ET) --

Anne Layne-Farrar

In the first installment of this series, we discussed the primary concerns underlying FRAND licensing rate and damages assessments, namely patent hold-up and royalty stacking. We concluded part 1 by observing that a FRAND rate assessment focused on the value to the standard and products embodying the standard to which the standard-essential patent portfolio at issue has contributed will necessarily avoid hold-up and royalty stacking.

In part 2, we turn to the methodologies proposed to and relied on by courts for linking FRAND royalties and damages to the SEP portfolio value contributed to the standard and to products embodying that standard. We first consider the court rulings to date, organizing our discussion by the methodologies adopted by the courts, which include the “hypothetical negotiation” approach and the other 14 Georgia-Pacific factors, so-called “ex ante” benchmarks, the “incremental value” rule, and comparable licenses. With these various methods in mind, we conclude with our commentary.

Competing Methodologies for FRAND Determinations

Court Rulings to Date

Hypothetical Negotiations and the Georgia-Pacific Factors

Thus far, courts have favored modified versions of the Georgia-Pacific factors to recreate a hypothetical negotiation between the parties as the best starting point for FRAND assessments. The rulings to date include those by Judge James Robart in Microsoft Corp. v. Motorola Mobility LLC, Judge James Holderman in Innovatio IP Ventures LLC, and Judge Leonard Davis in CSIRO v. Cisco Systems Inc.[1] In addition, several juries (e.g., in Realtek v LSI and Ericsson v. D-Link) have made FRAND royalty rate or damages determinations based on instructions to apply a modified version of the Georgia-Pacific factors.

As patent attorneys are aware, in Georgia-Pacific the District Court for the Southern District of New York compiled a nonexhaustive list of 15 factors relevant to a reasonable royalty calculation in the context of damages in a patent infringement suit, the last of which was a “hypothetical negotiation.” Judge Holderman explained the approach as follows:


Given the courts’ familiarity with Georgia-Pacific factors in traditional patent infringement cases, their extension to FRAND determination is not surprising.[3]

As for when that hypothetical negotiation should be set, the courts have generally held that the exercise must reconstruct the negotiation that would have taken place between the parties prior to the date on which the patented invention was adopted as a part of the industry standard.[4] In Innovatio, the parties agreed that the appropriate date for the hypothetical negotiation was “around the time of the initial adoption of the 802.11 standard, and therefore approximately the time when the manufacturers began selling 802.11 compliant products.” As a consequence, the negotiating parties would have negotiated a single license covering all subsequently obtained 802.11 SEPs.[5]

The hypothetical negotiation is just one of 15 Georgia-Pacific factors — what of the other 14? And what, exactly, does it mean to modify those factors to account for FRAND commitments? On April 19, 2013, U.S. District Judge James Robart became the first U.S. judge to opine on these questions.

In Microsoft v. Motorola, Judge Robart determined a FRAND royalty rate and range for standard-essential patents in a contract dispute between Microsoft and Motorola over SEP portfolios relevant to two industry standards, Wi-Fi and H.264 (for video coding).[6] Judge Robart modified the traditional Georgia-Pacific factors so that they might better reflect the obligations embodied in a FRAND commitment:


Shortly after Judge Robart issued his opinion, Judge Holderman (on Oct. 3, 2013) adopted the hypothetical negotiation approach in In re Innovatio IP Ventures LLC Patent Litig., although with revisions to match the different circumstances of the Innovatio case.[7] The jury in Innovatio found that three of Ericsson’s 802.11n (Wi-Fi) SEPs were infringed and awarded lump sum damages, which the court then translated into a per-unit FRAND rate for ongoing future royalty payments. According to Judge Holderman, “[a]s a practical matter,” Judge Robart’s analysis proceeded in three steps, “which provide a framework for any court attempting to determine a FRAND licensing rate for a given patent portfolio.”[8]

First, a court should consider the importance of the patent portfolio to the standard, considering both the proportion of all patents essential to the standard that are in the portfolio, and also the technical contribution of the patent portfolio as a whole to the standard.

Second, a court should consider the importance of the patent portfolio as a whole to the alleged infringer's accused products.

Third, a court should examine other licenses for comparable patents to determine a FRAND rate to license the patent portfolio, using its conclusions about the importance of the portfolio to the standard and to the alleged infringer’s products to determine whether a given license or set of licenses is comparable.[9]

Judge Holderman made two important modifications to Judge Robart’s approach. First, Judge Holderman refused to adjust the license rate for SEPs whose essentiality was questionable prior to the court’s adjudication. He acknowledged that such adjustment “may seem reasonable” given that “[t]he hypothetical negotiation tries ... to recreate the ex ante licensing negotiation scenario and to describe the resulting agreement.”[10] Yet, he explained that, at the time a court is evaluating damages in a patent infringement suit, it has determined whether the patent is valid and infringed, “foreclosing the hypothetical negotiator from benefiting from any uncertainty as to future court rulings.” Thus, “it would be inappropriate to adjust the FRAND rate based upon pre-litigation uncertainty.”[11]

Second, Judge Holderman found that his determination that the appropriate royalty base is the Wi-Fi chip “effectively merge[d]” steps one and two of Judge Robart’s methodology, explaining that “[b]ecause the purpose of a Wi-Fi chip is, by definition, to provide 802.11 functionality, determining the importance of Innovatio’s patents to the 802.11 standard also determines the importance of those patents to the Wi-Fi chip.”[12]

In CSIRO v. Cisco, Judge Davis used the Georgia-Pacific factors stating that “the RAND commitment will be considered where appropriate throughout the analysis.”[13] Judge Davis concluded that the evidence before the court indicated that a “reasonable royalty based on hypothetical negotiations between CSIRO and Cisco would have resulted in a flat rate assessed per infringing end product unit sold with an increasing discount based on total volume of products sold.”[14]

Several juries have also determined FRAND royalty rates or damages based on instructions to apply a modified-version of the Georgia-Pacific test. In Realtek v LSI, the jury awarded percentage royalties per Wi-Fi chip for the two SEPs at issue.[15] In Ericsson v. D-Link, the jury awarded lump sum damages to compensate Ericsson for the defendants’ past infringement based on jury instructions that modified the Georgia-Pacific factors to include Ericsson’s obligation to license its patents on FRAND terms.[16] That court refused to determine a FRAND rate, however, stating that the “Defendants cannot ask the Court to determine a FRAND rate but refuse to be bound by it.”[17]

“Ex Ante” Benchmarking

In contrast to the judges and juries discussed so far, Judge Richard Posner refused to apply the Georgia-Pacific factors (modified or not) in Apple v. Motorola, noting the ambiguity in the factors (e.g., “how many additional factors may be lurking somewhere?”) and questioning whether “a judge or a jury [could] really balance 15 or more factors and come up with anything resembling an objective assessment?”[18] Ultimately, Judge Posner decided that he could refuse to apply the factors without reaching these issues on the grounds that Apple failed to present admissible evidence that the Georgia–Pacific factors supported its damages claim.[19]

According to Judge Posner, “[t]he proper methodology of computing a FRAND royalty starts with what the cost to the licensee would have been of obtaining, just before the patented invention was declared essential to compliance with the industry standard, a license for the function performed by the patent. That cost would be a measure of the value of the patent qua patent. ... The purpose of the FRAND requirements ... is to confine the patentee’s royalty demand to the value conferred by the patent itself as distinct from the additional value — the hold-up value — conferred by the patent’s being designated as standard-essential.”[20]

The Incremental Value Rule

Somewhat akin to an ex ante benchmark, some have recommended a method first put forward in the literature by economists extending a price theory for traditional physical products known as the incremental value rule, which holds that courts should recognize that the incremental value of the patented technology over the next-best alternative establishes the maximum amount that a willing licensee would pay in a hypothetical negotiation, and thus should not award reasonable royalty damages higher than this amount.

In Microsoft v. Motorola, Judge Robart rejected in part an “incremental value” approach on the grounds that it lacks “real-world applicability” given that “explicit multilateral ex ante negotiations cannot be conducted under the auspices of many SSOs,” and is impractical with respect to implementation by courts:


Judge Robart went on to say that “[n]evertheless, a reasonable royalty rate for an SEP committed to a FRAND obligation must value the patented technology itself, which necessarily requires considering the importance and contribution of the patent to the standard. If alternatives available to the patented technology would have provided the same or similar technical contribution to the standard, the actual value provided by the patented technology is its incremental contribution. Thus, comparison of the patented technology to the alternatives that the SSO could have written into the standard is a consideration in determining a FRAND royalty.”[22]

Ultimately, Judge Robart concluded that the incremental value approach is “realized, in part” through Factor 9 of Georgia-Pacific, which considers the utility and advantages of the patent property over the old modes or devices, if any, that had been used for working out similar results.[23]

In Innovatio, Judge Holderman rejected the manufacturers’ “bottom up” approach for calculating a FRAND royalty, which shared a number of commonalities with the incremental value rule. (The bottom-up approach suggests determining the costs of implementing reasonable alternatives to the patents at issue that could have been adopted into the standard, and dividing that cost by the total number of infringing units to determine the maximum per unit royalty.) Holderman noted that the approach is based on the theory that a hypothetical licensee would not pay more for patents than the amount necessary to adopt an alternative.[24]

The court found that there were no alternatives to Innovatio’s patents that would provide all of the functionality with respect to the 802.11 standard, and pointed to Judge Robart’s rejection of an incremental value approach. Instead, Judge Holderman adopted a “top down” approach, which starts with the average price of a WiFi chip and then calculates the average profit that a chipmaker earns on the sale of each chip, as a means of isolating the portion of the income from the sale of the chip available to the chipmaker to pay royalties on intellectual property. The available profit on a chip was then multiplied by a fraction calculated as a number of the SEPs at issue, divided by the total number of SEP in the standard.[25]

Comparable Licenses

The final approach seen in rulings thus far focuses on just two of the Georgia-Pacific factors, factors 1 and 2 on comparable licenses. In determining a FRAND royalty rate or damages, courts have generally considered royalties received by the patentee for the licensing of the patent-in-suit in other circumstances comparable to FRAND-licensing circumstances.

In Microsoft, Judge Robart expanded the set of potential comparable licenses beyond prior agreements for the patents-in-suit and similar agreements the defendant had entered into: he added patent pool rates to the list. Although the court agreed “as a general matter that patent pools tend to produce lower rates than those that could be achieved through bilateral negotiation,” Judge Robart nevertheless found that rates offered by patent pools (the MPEG LA H.264 pool and the Via Licensing 802.11 pool) “served as good indicators of a FRAND royalty rate” for Motorola’s SEPs.[26] The basic foundation for Judge Robart’s view is the fact that modern patent pools are largely bundles of SEPs related to particular standards, and as such, Judge Robart reasoned that they offer comparable value for strictly complementary patents.


In contrast, in Innovatio, Judge Holderman found that the Via Licensing 802.11 pool was “not an appropriate comparable license,” distinguishing Judge Robart’s decision on the grounds that Judge Robart determined that Motorola’s 802.11 patents were not important to the 802.11 standard, whereas Innovatio’s patent portfolio is of “moderate to moderate-high importance to the 802.11 standard.”[27]

Judge Holderman identified numerous additional problems with using the Via pool rate as a comparable, including the fact that the pool has not been successful (the pool had only five licensors, 35 patents, and 11 licensees); does not include high value patents; does not distinguish between patents in the pool on the basis of technical merit, but rather gives the exact same royalty to all patents in the pool; and does not consider the importance of the patents to the implementer’s products. Judge Holderman further noted that, because the Via patent pool does not allocate royalties among SEP holders based on relative merit, patent holders with valuable patents will not contribute their technology to the pool, but will instead seek to license those patents bilaterally. “As a result, the pool rates may be considerably depressed.”[28]

Judge Holderman did not make any general statements on whether non-RAND licenses can ever be useful in determining a FRAND rate. He did conclude, however, that because the evidence in the record was “insufficient for the court to determine the relative merit of the patented technology in each of those licenses compared with the technology in Innovatio’s patents, the court rejects the use of non-RAND licenses and finds that they are “unreliable indicators in this case of the appropriate FRAND rate.”[29]

Judge Holderman also rejected Innovatio’s other proposed comparable licenses on various grounds, including that the rates: were “adopted under the duress of litigation”; were determined only as part of a package deal involving a larger patent; were based on large patent portfolios, such that the rate would not be appropriate for an agreement including a significantly smaller number of patents; were based on different standards; or failed to provide any indication of how valuable the patents were compared to other patents in the portfolio.[30]

In SK Hynix Inc. v. Rambus Inc., a case in which the court set a FRAND rate as a sanction against Rambus for spoliation, Judge Ronald Whyte followed Judge Robart, concluding that “a monetary sanction that takes into account the royalty rates negotiated and paid by SK Hynix’s primary competitors is ... [an] appropriate and straightforward way to mitigate the prejudice to SK Hynix caused by Rambus’s spoliation.”[31] Thus, the court based its FRAND rate determination on other Rambus licenses, based on the effective, not stated, rates.

In Golden Bridge Techn. v. Apple Inc., Magistrate Judge Paul Grewal excluded Golden Bridge’s expert’s FRAND royalty calculation based in large part on portfolio licenses Apple signed with Ericsson and Nokia. Magistrate Judge Grewel’s rationale was that, “under established Federal Circuit law, an expert may not rely on broad licenses that cover technologies far beyond the patents-in-suit without accounting for the differences in his calculations,” which the expert failed to do.[32]

The court pointed to several significant flaws in the expert’s report, including improperly and sub silencio allocating the entire value of Apple’s portfolio license with Ericsson and Nokia “to a tiny subset of a subset of a subset of a subset of the patents and standards in those portfolios” and failing to allocate any value to the nonlicense terms of the Ericsson and Nokia agreements. According to the court, the expert’s assumption that the “entire dollar value of the Apple-Ericsson and Apple-Nokia agreements stemmed entirely from the actually essential (not just declared essential) WCMDA patents (not those related to other active standards) relating to terminal devices is an implausible assumption to begin with. ... Each of the other errors identified by Apple then compound this basic error.”[33]

Commentary

While the discussion above ranges across five methods, the courts have not been as scattered in their approaches as might at first appear. Importantly, three of the five approaches fit well with each other. Namely, the hypothetical negotiation is frequently informed by the other 14 Georgia-Pacific factors and comparable licenses, as Factors 1 and 2, have been the bread and butter of reasonable royalty determinations outside of FRAND contexts for many decades.

Judge Posner certainly raises valid complaints regarding the 15 Georgia-Pacific factors — they are a bit vague, it would be dangerous to let them form some sort of mandatory checklist as each factor will not always apply in every case, and they can be abused by unscrupulous damages experts who place the various factors on an arbitrary scale for weighing against one another.

That being said, the factors also cover a number of legitimate elements that any fact-based, data-driven assessment of royalties (in or out of FRAND contexts) should take into consideration (even if it is to determine that a particular factor does not apply in the instant case). For example, the nature and scope of the license (Factor 3) is typically important to valuation: Broader rights (more relevant jurisdictions covered or more standards included, for instance) provide more value to the licensee and hence can command higher rates. And other licenses covering the SEPs at issue (Factor 1) can provide market-based data points for how parties actually operating in the industry value the patents-in-suit.

In our view, modifying the factors to reflect FRAND commitments — including comparable licenses and working everything into a hypothetical negotiation framework — is a reasonable approach. Plus, the courts are largely familiar with it, having over 40 years of Georgia-Pacific experience in traditional patent infringement suits. Nevertheless, this overall approach is one whose application should continue to be policed by judges in their role as gatekeepers. Merely invoking the name “Georgia Pacific” is not enough for a pass: the factors should be used with available data, the comparability of licenses should be defended, and all calculations should be explained.

Moreover, it is not clear how Judge Posner’s suggestion that ex ante values should determine FRAND rates could be implemented without such expedients as comparable licenses and some reference to the likely factors underlying how the parties would negotiate. That is, when no ex ante licenses for the SEPs at issue exist (which would themselves fall into the comparable license category), how exactly would courts go about determining the ex ante value of SEPs?

Standards-development organization working group documents (where technology choices are hashed out) may be able to shed light on any tradeoffs involved in an ex ante competition over technologies to include in a standard, but using those technical debates to set an actual license rate will be difficult at best. Most likely, courts will need to rely on comparable licenses from other time periods, consider the value contributed by the SEPs to the standard and products compliant with it, and put all of that evidence into context via a hypothetical negotiation framework.

The above endorsement of comparable licenses has intentionally left open the question of patent pools, as these deserve a discussion of their own. Given the difficulty of finding arm’s-length, market-based benchmarks for FRAND rates and terms, it seems profligate to dismiss patent pools out of hand. However, Judge Holderman’s discussion of the pitfalls that the use of patent pools can entail is important. Specifically, patent pools covering SEPs for a standard may be either “too high” (exceeding a FRAND range) or “too low” (falling below a FRAND range). If the pool was formed, say, by vertically integrated firms most interested in downstream profits and in holding royalty expenses for those products to a minimum, then there is a risk that the pool rates those firms set will fall below a FRAND range. If, on the other hand, the pool was formed by firms with marginal SEPs — technically essential but of low value contributed to the standard — then there is a risk that the pool rates will exceed a FRAND range.

Looking at the commercial success of the pool, from both the licensor and licensee side, can guard against the use of such pools as benchmarks. So, before a pool’s rates and terms are used as FRAND benchmarks, the following questions should be asked: (1) Has the pool signed up a significant number of SEP contributors and do those entities represent the key technology holders? If so, this gives comfort that the pool’s rates and terms are sufficiently high to fairly and reasonably compensate the SEP holders. (2) Has the pool signed up a significant number of licensors and do these entities represent key standard implementers? If so, this gives comfort that the pool’s rates and terms are sufficiently low to be fair and reasonable from implementers’ perspectives. If the answer to either question is no, then that pool should not be used, or if it is due to a dearth of other useful benchmarks, then it should be used with great caution and with full disclosure that it is an upper or lower bound on FRAND (as the case may be).

Finally, as for the incremental value rule approach, the underlying theory is a sound one, rooted in decades of pricing theory for physical goods. The problems arise, though, when that theory is applied to intangible intellectual property, particularly in the context of cooperative interoperability standard setting. First are the many practical difficulties in measuring what incremental value really is — as Judge Robart observed, two flaws in the approach are “its lack of real-world applicability” and “its impracticability with respect to implementation by courts.” On a more general level, however, technology selection within standard setting often involves multidimension tradeoffs. In other words, the technologies cannot be rank ordered best to worst; different parties can have vastly different rankings. That makes any discussion of alternatives not only messy, but subjective.[34]

Taken as a whole, then, it strikes us that the courts are off to a reasonably good start in terms of establishing solid methods and approaches for determining FRAND rates and damages. The devil is in the detail, though, and some of the specific rate calculations have ignored the guidelines set within the decision itself while others are built on shaky assumptions, as we will discuss further in our third and final installment, which focuses on choosing an appropriate base for FRAND determinations.

—By Anne Layne-Farrar, Charles River Associates, and Koren W. Wong-Ervin, Federal Trade Commission Office of International Affairs

Anne Layne-Farrar, Ph.D., is a vice president in the antitrust and competition economics practice of Charles River Associates. Koren W. Wong-Ervin is Counsel for Intellectual Property and International Antitrust in the Office of International Affairs at the Federal Trade Commission.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, the Federal Trade Commission, its commissioners, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] In CSIRO v. Cisco, although Judge Davis stated that specific adjustments to the overall Georgia-Pacific framework were unnecessary given the small percentage of total products at issue attributable to patents subject to a FRAND commitment, he went on to state that he would consider the RAND commitment throughout the analysis.

[2] In re Innovatio IP Ventures LLC Patent Litig., 2013 WL 5593609 at *5 (N.D. Ill. Oct. 3, 2013).

[3] This approach was suggested in the literature prior to the first ruling by Judge Robart in Microsoft v. Motorola. See Anne Layne-Farrar, Jorge Padilla, and Richard Schmalensee, “Pricing Patents For Licensing In Standard Setting Organizations: Making Sense Of FRAND Commitments,” 74 Antitrust Law Journal No. 3 (2007).

[4] See, e.g., Microsoft Corp. v. Motorola Inc., 904 F.Supp.2d 1109, 1121 (W.D.Wash. Oct. 22, 2012).

[5] Innovatio.

[6] (W.D. Wash. April 19, 2013). The case involved a claim that Motorola breached its FRAND contract obligation and the court determined that, without a clear understanding of what FRAND means, it would be difficult or impossible to determine whether Motorola breached its obligation to license its patents on FRAND terms.

[7] Innovatio.

[8] Id., though note that Motorola has appealed Judge Robart’s decision (http://cdn.ca9.uscourts.gov/datastore/opinions/2012/10/04/12-35352.pdf).

[9] Innovatio.

[10] Id. 

[11] Id.

[12] Id.

[13] (E.D.Tex. July 23, 2014).

[14] Id.

[15] Jury Instructions, Realtek v. LSI, Case No. 5:12-cv-03451 Instruction Nos. 12-15 (Feb. 23, 2014), available at http://www.essentialpatentblog.com/wp-content/uploads/sites/234/2014/02/2014.02.23-298-Jury-Instructions.pdf; Jury Verdict Form, Realtek v LSI, Case No. 5:12-cv-03451 (N.D. Cal. Feb. 26, 2014), available at http://www.essentialpatentblog.com/wp-content/uploads/sites/234/2014/02/2014.02.27-324-Verdict.pdf. Following the jury award, Judge Whyte entered final judgment in favor of Realtek in the amount of $3.8 million in contractual damages consistent with the jury’s special verdict. The court also granted Realtek’s request for a declaratory judgment that, to be in compliance with its FRAND commitment, LSI must offer Realtek licenses consistent with the jury’s award. Case No. 5:12-cv-03451 (N.D. Cal. June 16, 2014), available at http://assets.law360news.com/0548000/548585/Order%202.pdf.
[16] Ericsson Inc. v. D-Link Sys, Inc., (E.D.Tex. Aug. 2013); see also Final Jury Verdict, Ericsson Inc. v. D-Link Sys., Inc., Case No. 6:10-cv-00473 (E.D. Tex June 13, 2013), available at http://www.essentialpatentblog.com/wp-content/uploads/sites/234/2013/06/Ericsson-v-D-Link-Jury-Verdict.pdf.

[17] Ericsson, 2013 WL 4046225 at *22.

[18] Apple Inc. v. Motorola Inc., 869 F.Supp.2d 901, 911 (N.D. Ill. 2012).

[19] Unlike in Microsoft v. Motorola and Innovatio, where the courts were making rate determinations, Judge Posner was called upon to rule on a damages claim for alleged past infringement. As such, a lump sum payment could be determined, without needing to be specific on any percentage or per-unit rate. Judge Posner’s ruling has been appealed (http://cafc.uscourts.gov/images/stories/opinions-orders/12-1548.Opinion.4-23-2014.1.PDF) and a number of industry players filed amicus briefs, including the FTC (http://www.essentialpatentblog.com/wp-content/uploads/sites/234/2013/01/12.12.14-Doc.-104-FTC-Amicus-Brief-Supporting-Neither-Party.pdf), Qualcomm (http://www.essentialpatentblog.com/wp-content/uploads/sites/234/2013/12/2013.11.12-61-Qualcomms-Brief-of-Amicus-Curiae.pdf) and Ericsson (http://www.essentialpatentblog.com/wp-content/uploads/sites/234/2013/12/2013.12.03-65-Amicus-Brief-of-Ericsson-in-Support-for-Motorola.pdf), and others (see the discussion at http://www.essentialpatentblog.com/2013/01/various-amici-weigh-in-on-sep-related-issues-in-apple-motorola-federal-circuit-appeal/).

[20] Apple, 869 F.Supp.2d at 913.

[21] Microsoft.

[22] Id.

[23] Id.

[24] Innovatio.

[25] Id.

[26] Microsoft.

[27] Innovatio.

[28] Id.

[29] Id.

[30] Id. 

[31] Id.

[32] Order RE: Apple’s Second Motion to Exclude Karl Schulze and Motions in Limine, Case No. 5:12-cv-04882, at 3 (June 1, 2014), available at http://www.essentialpatentblog.com/wp-content/uploads/sites/234/2014/06/2014.06.01-494-Order-Re-Apple%E2%80%99s-Second-Motion-to-Exclude.pdf (internal citation omitted).

[33] Id.

[34] See Anne Layne-Farrar and Gerard Llobet, “Moving Beyond Simple Examples: Assessing the Incremental Value Rule within Standards,” International Journal of Industrial Organization, Vol. 37, 2014.

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