Stern on FRAND

Richard Stern has published a paper in Issue 9 of the European Intellectual Property Review (2015), pp. 549-57, titled "What are Reasonable and Non-discriminatory Terms for licensing a Standard-essential Patent?"  Here is the abstract:

The Federal Circuit's recent Ericsson decision, and the IEEE's new, expanded policy of prescribing added specificity for the patent licensing assurances it requires before agreeing to embody patented technology into an IEEE standard, provide different ways to address the plague of litigation over what terms and conditions are reasonable and non-discriminatory in the licensing of patents essential to implementing a standard.  The Federal Circuit's after-the-fact patch-up of contract failure in the Ericsson case and the IEEE's pre-contract clarification efforts in its new policy have their limitations, however, and difficult problems still remain.  

Mr. Stern makes some interesting arguments, some of which I agree with, some not. 

First, On the issue of holdup, he takes issue with the Federal Circuit's statement in Ericsson that "Absent evidence that Ericsson used its SEPs to demand higher royalties from standard-compliant companies, we see no error in . . . refusal to instruct the jury on patent hold-up," arguing that the test should be whether "the rate is too high relative to what a license on comparables of analogous technology in the industry sells for?  In other words, hold-up is not properly judged only on the basis of the patentee's historical acts, but rather on the basis of the general practice in the industry.  The patentee's acts, such as raising rates after adoption of the standard, may be relevant as sufficient proof of hold-up, but proof of such acts is not necessary." (p.551 n.14).  In my view, the economic concept of holdup involves the extraction of a royalty that is based on the user's sunk costs and related switching costs, not the extraction of a royalty that is higher than industry standards (though I would accept that departure from "general practice in the industry" could be evidence of holdup properly defined).  See my recent paper with Norman Siebrasse, here.  (For my blog post on Ericsson, see here.)

Second, Mr. Stern takes issue with respect to the Ericsson court's handling of the question of royalty stacking.  (The court affirmed the district court's decision not to instruct the jury on royalty stacking, on the ground that the defendants "failed to provide evidence of patent hold-up and royalty stacking sufficient to warrant a jury instruction. . . .")  Mr. Stern argues that it is "quite unrealistic" to "expect[ ] evidentiary proof (which costs money) on a point where common sense tells us it is unlikely to be needed," and that "[i]t is virtually impossible for it not to occur."  (p.552)  Rather, he argues, there should be "at least . . . a rebuttable presumption that rouyalty stacking occurs at some SEP level, say 50 or 100 SEPS . . . . That would shift the burden to the patent holder to produce evidence of no stacking . . . ." (id.)  Nevertheless, he writes, "it is by no means clear what should be done about stacking.  How do you conclude that Ericsson has to bear all the financial impact of the stacking, if there is any, rather than those SEP patentees who came earlier to the table to collect royalties?"  (id.).

My own view, as I have expressed it before, is that stacking is a serious theoretical issue, and that an ideal system of patent damages would try to avoid it by ensuring that royalties are reasonably proportional to the patent's contribution to the value of the standard (see again the paper with Norman Siebrasse, above).  Put another way, if a royalty for a relatively minor aspect of the standard would (if multiplied by all of the other patents in the standard, including the more important ones) exceed the profit earned from sales of standard-compliant devices, something has gone wrong.  In other words, concerns about royalty stacking can act as a sort of "sanity check" against awarding a royalty that is disproportionately high in comparison with the value produced by the patent in suit.  Beyond that, I agree with Mr. Stern that there isn't much courts can do to about royalty stacking, given the constraints under which they operate.

Third, Mr. Stern makes an interesting argument regarding the U.S. rule that the royalty base should be the smallest salable patent-practicing unit.  The principal rationale for the rule is that a jury won't necessarily be able to correctly apportion the value of the patented invention if it hears testimony about the defendant's entire sales revenue, but Mr. Stern provides another possible reason, namely that "there is inherently a greater risk of error."  As an example, suppose that the correct royaltyis 5 cents, which is 5% of a $1 chip or 0.02% of the $500 price of the end product.  Mr. Stern argues that either a jury or judge could easily award 0.01% or 0.1% of $500, such that "the cash value of the error is multiplied greatly by starting out with an inflated royalty base" (p.544 n.26).  I'll have to think about that some more.

Fourth, Mr. Stern argues that a patent pool would be a better solution to the problem of valuing SEPs, because it would take all or most of the relevant stakeholder interests into account such that the royalty stacking problem would probably evaporate" (p.555).  Professor Siebrasse and I make some similar observations about pools in our paper (noted above); for another take on pools and SEPs, see Jorge Contreras, Fixing FRAND:  A Pseudo-Pool Approach to Standards-Based Patent Licensing, 79 Antitrust Law Journal 47 (2013).

Another interesting paper in this issue of EIPR is by Nicholas Fox, Bas Berghuis, Ina vom Feld, and Laura Orlando, titled Accounting for Differences:  Damages and Profits in European Patent Infringement.  I'll be blogging about this one in the near future.