Thursday, July 30, 2015

Ninth Circuit Opinion in Microsoft v. Motorola: Analysis

As I mentioned earlier, today the Ninth Circuit affirmed Judge Robart's judgment in Microsoft v. Motorola (opinion here).  Bottom line:  the court's decision is consistent with the emerging consensus, both in the U.S. and abroad (as reflected in the CJEU's decision in Huawei two weeks ago), that a patent owner who has made a RAND (a/k/a FRAND) commitment is (generally speaking) precluded from seeking injunctive relief against a willing licensee, and that RAND royalties should not reflect holdup value.  Here are some highlights:

1.  The court begins by noting that "[s]tandardization provides enormous value to both consumers and manufacturers," "increases competition by lowering barriers to entry and adds value to manufacturers' products by encouraging production by other manufactures of devices compatible with them" (p.8).  At the same time, however:
. . . once a standard becomes widely adopted, SEP holders obtain substantial leverage over new product developers, who have little choice but to incorporate SEP technologies into their products. Using that standard development leverage, the SEP holders are in a position to demand more for a license than the patented technology, had it not been adopted by the SSO, would be worth. The tactic of withholding a license unless and until a manufacturer agrees to pay an unduly high royalty rate for an SEP is referred to as “hold-up.” Ericsson, Inc. v. D-Link Sys., Inc., 773 F.3d 1201, 1209 (Fed. Cir. 2014). “Royalty stacking” refers to the risk that many holders of SEPs will engage in this behavior, resulting in excessive royalty payments such that (1) the cumulative royalties paid for patents incorporated into a standard exceed the value of the feature implementing the standard, and (2) the aggregate royalties obtained for the various features of a product exceed the value of the product itself. Id.; see also Mark A. Lemley & Carl Shapiro, Patent Holdup and Royalty Stacking, 85 Tex. L. Rev. 1991, 2010–13 (2007); Amicus Br. of Public Knowledge at 11–20. 
To mitigate the risk that a SEP holder will extract more than the fair value of its patented technology, many SSOs require SEP holders to agree to license their patents on “reasonable and nondiscriminatory” or “RAND” terms. . . . Under these agreements, an SEP holder cannot refuse a license to a manufacturer who commits to paying the RAND rate (9-10). 
Elsewhere, the court states that "Motorola’s actions [seeking injunctive relief] were intended to induce hold-up, i.e., to pressure Microsoft into accepting a higher RAND rate than was objectively merited, and thereby to frustrate the purpose of the contract" (p.41);  that "The evidence that the rates Motorola sought were significantly higher than the RAND rate found by the court suggested that Motorola sought to capture more than the value of its patents by inducing holdup, and that it filed infringement actions to facilitate that strategy by preventing Microsoft from using its patents—and therefore from implementing the 802.11 and H.264 standards—until it obtained a license at a rate significantly higher than the RAND rate" (pp. 41-42); that "The very purpose of the RAND agreement is to promote adoption of a standard by decreasing the risk of hold-up" (citing Mark A. Lemley, Ten Things to Do About Patent Holdup of Standards (And One Not To), 48 B.C. L. Rev. 149 (2001)) (p.53); and that "The fact that Motorola’s patents were of minor import to the H.264 standard, for example, was evidence from which the jury could infer that demanding a 2.25% royalty rate was not a good-faith effort to realize the value of the technology, but rather an attempt to capitalize on the value of the standard itself—that is, to obtain the hold-up value" (p.56).  

I think the view of holdup expressed above is generally correct, though as Norman Siebrasse and I argue in a paper we have been working on over the past few weeks, standardization can result in three distinct economic effects, namely (1) the patent owner can use the threat of an injunction to extract a royalty that reflects the defendant's sunk costs and the high cost of switching to another technology; (2) the patent owner can extract a royalty that is disproportionate (in comparison with other SEPs) to the individual patent's contribution to the value of the standard; and (3) the patent owner can demand a royalty that reflects value resulting from the standard's widespread use due to network effects.  We argue that a FRAND royalty should not reflect the first two effects, but in our view it may reflect (3).  To date, however, in their discussions of holdup courts have not clearly distinguished among the three effects, and this opinion is no exception.

2.  The court affirms the judgment that Motorola was contractually obligated, by reason of the RAND commitments it made to IEEE and ITU, not to seek injunctive relief, and that doing so breached Motorola's duty of good faith and fair dealing (see pp. 7, 14, 40, 54).  I am not a contracts law expert, and the courts' conclusions on these matters may well be correct under the governing contract law.  I would note, however, that in some other countries RAND commitments may not be interpreted in the same manner, though liability may arise under antitrust law (as discussed by the CJEU in Huawei) or the abuse of right doctrine (see here), both of which are less likely to work in the U.S.   For discussion of differing views on the contract issue, see my paper here at pp.4-8, 37-38.    

3.  Much of the opinion is taken up with procedural matters which the court resolves in favor of Microsoft:  specifically, that the Ninth Circuit (not the Federal Circuit) has jurisdiction over this appeal under the law-of-the-case doctrine (pp. 16-23); that Motorola consented to have Judge Robart determine the RAND rate and range at a bench trial prior to submitting to a jury the question of whether Motorola breached its contractual obligations (pp. 24-28); and that Judge Robart did not clearly err in admitting (in the jury trial) portions of his findings of fact from the bench trial and testimony concerning the FTC's investigation of Google/Motorola's licensing practices (pp. 55-63).

4.  Now to the meat of the opinion:  did the district court correctly determine the RAND rate?  Yes, according to the Ninth Circuit.  First, the district court applied a "hypothetical agreement"  framework that was generally consistent with both "the Federal Circuit's patent law methodology," which "can serve as guidance in contract cases on questions of patent valuation," and with Motorola's own recommended approach (p.29):
Applying that approach, the district court sought to approximate the royalty rates upon which the parties would have agreed by setting up a hypothetical negotiation between the parties. In doing so, the court carefully thought through the “factors an SEP owner and implementer would consider” in an actual negotiation directed at licensing a patent subject to RAND commitments. The court then discussed each of Motorola’s fifteen H.264 patents and eleven 802.11patents, considering the objective value each contributed to each standard, given the quality of the technology and the available alternatives as well as the importance of those technologies to Microsoft’s business. Finally, the court performed a meticulous analysis of the testimony of eighteen witnesses, including executives, economists, and technology experts, to sort out which evidence to rely upon in determining the RAND royalty rate. Generally, the court credited Motorola’s experts; where it did not, it provided reasoned explanations for not doing so. . . .
Motorola’s central RAND-rate merits contention is that Judge Robart’s analysis failed to meet Georgia-Pacific’s factor fifteen criterion, as interpreted and applied by the Federal Circuit, and so constituted error. Several portions of the court’s findings of fact and conclusions of law do indicate that the court did to an extent take into account the present day value to Microsoft of Motorola’s patents. For example, the court noted that a third-party valuation of Motorola’s 802.11 SEPs was only somewhat probative because, at the time of the valuation, “Motorola’s 802.11 SEP portfolio” was much larger than the portfolio “as it exists today.”
This partial present-day focus did not, however, render the district court’s RAND-rate determination invalid. First, the Federal Circuit has “never described the Georgia-Pacific factors as a talisman for royalty rate calculations.” Ericsson, 773 F.3d at 1230.  . . . 
. . . An element of Microsoft’s claim is that Motorola maintained its demand of a 2.25% royalty rate throughout the proceedings, and also pressed its injunction suits even after Motorola was on notice that its actions were in tension with its RAND obligations. Given Microsoft’s argument that Motorola’s breach was ongoing, the district court could reasonably have concluded that it was appropriate to include the present-day value of Motorola’s SEPs as a factor in calculating the RAND rate-and-range for use in the breach-of-contract proceeding. 
Second, Motorola never specifies the past date the district court should have used. In pointing to “the time the infringement began, ” Georgia-Pacific, and subsequent cases applying its framework, referred to the date of the manufacturer’s first unlicensed use of the patented technology. 318 F. Supp. at 1120; see also Lucent Techs., 580 F.3d at 1324. But, as Motorola acknowledges, the “infringement” at issue in this case is Motorola’s breach of contract, not Microsoft’s use of Motorola’s patents. Motorola mentions both “the date Motorola sent the [offer] letters” and “the time right before Microsoft’s first [patent] infringement began” as possible hypothetical negotiation dates the court could have used, without specifying which is correct.
Motorola did not mention either date in putting forth its version of the hypothetical negotiation analysis in its posttrial brief. To assume the correct date would have been the date the breach of contract began is of no help, as the alleged breach of contract was not tied to any specific date. The jury could have found a breach of contract based on Motorola’s offer letters, its seeking a number of injunctions, or its overall course of conduct (pp. 29-32).
This is interesting, and probably right, but note that it doesn't take a position on the question of whether, in a  patent infringement case involving FRAND-encumbered SEPs, the date of the hypothetical negotiation should be a date just before the infringement began (as in a standard Georgia-Pacific analysis) or just before the standard was adopted.  The latter is probably the economically correct view in the SEP context, and it seems more consistent with Judge Robart's own view as expressed in paragraph 106 of his opinion (". . . the parties to a hypothetical negotiation under a RAND commitment would consider alternatives that could have been written into the standard instead of the patented technology. The focus is on the period before the standard was adopted and implemented (i.e., ex ante)"), as well as statements by Judge Holderman in Innovatio and Judge Posner in Apple v. Motorola).  Once the standard is adopted, the holdup problem may arise, whether or not the defendant has yet begun infringing.

5.  The court also approves of Judge Robart's consideration of the rates charged by the VIA Licensing 802.11 pool and the MPEG LA H.264 pool, noting that to account for differences between pool rates and negotiated rates "the court multiplied the pool rates by three" (p.35).  Though I have expressed some disagreement with the specifics of Judge Holderman's analysis related to the pool rates , I agree that such rates can be relevant and that, if anything, Judge Holderman's use of them may have been more favorable than necessary to Motorola (see here at pp. 47-50).  In addition, the court finds no clear error in Judge Robart's conclusion that the licenses Motorola suggested as comparable were in fact not comparable, because they were "too contextually dissimilar" (pp. 36-38).    

6.  The court finds that the jury had substantial evidence from which to conclude that Motorola sought injunctive relief for the purpose of "inducing holdup" (p.41), that this was indicative of bad faith (pp. 40-43), and that the Noerr-Pennington doctrine does not preclude liability for seeking an injunction under these circumstances (pp. 44-47) (though the court expresses agreement "with the Federal Circuit that a RAND commitment does not always preclude an injunctive action," for example where the defendant refuses a FRAND offer (p.47 n.19)).

7.  Finally, the court concludes that Motorola Microsoft was entitled to recover as damages for the breach the attorneys' fees it expended to defend itself against the actions for injunctive relief (pp. 47-54).

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