As I mentioned earlier, the Federal Circuit today vacated and remanded Judge Davis's damages judgment in Commonwealth Scientific and Industrial Research Organization (CSIRO) v. Cisco Systems, Inc, opinion available here. Chief Judge Prost wrote the opinion, joined by Judges Dyk and Hughes. Bottom lines: (1) use of the smallest salable patent-practicing unit is not necessary where the evidence shows that the parties proposed a different base in real-world negotiations; (2) damages for the infringement of an SEP should not reflect the additional value resulting from standardization. As discussed below, I agree with the first but not second of these propositions.
As stated in the opinion, the patent in suit "discloses techniques directed to solving issues from wireless signals reflecting off objects and interfering with each other, commonly referred to as the 'multipath problem'" (p.3). The patent was essential to the IEEE's 802.11 standard, as ratified in 1999, and CSIRO duly submitted a letter pledging to license the patent on RAND terms. The "patent is also essential to various later iterations of 802.11 (802.11g, n, and ac)," but "despite the IEEE’s repeated requests . . . CSIRO refused to encumber the ’069 patent with a RAND commitment for these revisions" (pp. 3-4).
In the 1990s, an Australian company called Radiata was formed to sell wireless chips in the U.S. CSIRO and Radiata thereafter entered into a technology license agreement (TLA) for the '069 patent. In 2001, Cisco acquired Radiata, and the TLA was amended twice. Cisco paid royalties under the TLA until 2007, when it "ceased using Radiata-based chips in its products" (pp. 4-5). Meanwhile, CSIRO developed a form license offer (the "Rate Card") which it offered to prospective licensees beginning in 2004 (p.5). CSIRO offered Cisco a license based on the Rate Card rates, which Cisco declined, though
the district court found that in subsequent discussions in 2005, Dan Lang, Cisco’s Vice President of Intellectual Property, informally suggested to CSIRO that a $0.90 per unit rate may be more appropriate. . . . This rate was not much lower than what Cisco was already paying CSIRO under the TLA, though over time the TLA rates declined dramatically due to rapidly decreasing chip prices. Despite both parties’ apparent willingness to negotiate a license, CSIRO and Cisco failed to agree on terms (pp. 5-6).
CSIRO filed suit against Cisco in 2011. Cisco did not contest validity or infringement, and a bench trial on damages was held before Judge Leonard Davis in the E.D. Texas in 2014.
At trial, CSIRO's expert testified that
the benefits of 802.11 products that practice the ’069 patent over 802.11 products that do not practice the ’069 patent “are primarily attributable to the technology of the ’069 Patent.” Id. at *5. “Based on this claim, CSIRO contend[ed] that the difference in profit Cisco captured between accused 802.11a and 802.11g products and unaccused 802.11b products largely represents the value attributable to the ’069 Patent” (p.6).
The court rejected this damages model "for, among other reasons, performing 'arbitrary' final apportionment and having broad profit premium ranges" (p.7). The court also rejected Cisco's model, which was based on the TLA, finding
that the TLA was not comparable to the license Cisco and CSIRO would negotiate in a hypothetical negotiation. Significantly, the district court determined that “the primary problem with Cisco’s damages model is the fact that it bases royalties on chip prices.” Commonwealth Sci., 2014 WL 3805817, at *11. According to the district court, “[t]he benefit of the patent lies in the idea, not in the small amount of silicon that happens to be where that idea is physically implemented.” Id. The district court reasoned that “[b]asing a royalty solely on chip price is like valuing a copyrighted book based only on the costs of the binding, paper, and ink needed to actually produce the physical product. While such a calculation captures the cost of the physical product, it provides no indication of its actual value.” Id. (p.7)
The court then proceeded to conduct its own analysis
based on CSIRO’s 2004 Rate Card offer and the informal rate suggestion made in October 2005 by Cisco’s Mr. Lang. The district court noted that both data points were near the hypothetical negotiation dates of May 2002 for Linksys-branded products and October 2003 for Cisco products. “Based on these data points,” the district court found, “a range of $0.90 to $1.90 is a reasonable starting point for negotiations between the parties in 2002 and 2003” (pp. 7-8).
The court then considered the Georgia-Pacific factors, concluding that because some of these factors suggested an increase while others suggested a decrease there would be "no overall adjustment" to the $0.90 to $1.90 range (except for certain Linksys-branded products that had a lower profit margin and for which the royalty range was calculated to be $0.65 to $1.38).
On appeal, Cisco argues that
(1) the district court erred in not beginning its damages analysis with the wireless chip, which it found to be the smallest salable patent-practicing unit; [and] (2) the district court did not adjust the Georgia-Pacific factors to account for the asserted patent being essential to the 802.11 standard. Cisco also argues that the district court clearly erred in not crediting the TLA evidence (p.9).
On the first issue, the court reiterates its holding in Ericsson, Inc. v. D-Link Sys., Inc., 773 F.3d 1201 (Fed. Cir. 2014), that the "smallest salable patent-practicing unit" is an outgrowth of the apportionment principle:
Recognizing that each case presents unique facts, we have developed certain principles to aid courts in determining when an expert’s apportionment model is reliable. For example, the smallest salable patent-practicing unit principle provides that, where a damages model apportions from a royalty base, the model should use the smallest salable patent-practicing unit as the base (p.12).
Fundamentally, the smallest salable patent-practicing unit principle states that a damages model cannot reliably apportion from a royalty base without that base being the smallest salable patent-practicing unit. That principle is inapplicable here, however, as the district court did not apportion from a royalty base at all. Instead, the district court began with the parties’ negotiations. At trial, the district court heard evidence that, around the time of the hypothetical negotiations, the parties themselves had brief discussions regarding Cisco taking a license to the ’069 patent. According to the district court’s factual finding—which is supported by the testimony at trial—Cisco informally suggested $0.90 per unit as a possible royalty for the ’069 patent. The district court used this rate as a lower bound on a reasonable royalty. For the upper bound, the district court looked to the $1.90 per unit rate requested by CSIRO in its public Rate Card license offer. Because the parties’ discussions centered on a license rate for the ’069 patent, this starting point for the district court’s analysis already built in apportionment. Put differently, the parties negotiated over the value of the asserted patent, “and no more.” Ericsson, 773 F.3d at 1226. The district court still may need to adjust the negotiated royalty rates to account for other factors (see infra Section II.B), but the district court did not err in valuing the asserted patent with reference to end product licensing negotiations . . . .
The rule Cisco advances—which would require all damages models to begin with the smallest salable patent-practicing unit—is untenable. It conflicts with our prior approvals of a methodology that values the asserted patent based on comparable licenses (pp.13-14).
So far, so good, but I think the court stumbles in its second holding, namely that "the district court legally erred under Ericsson because it failed to account for any extra value accruing to the ’069 patent from the fact that it is essential to the 802.11 standard" (p.15). In other words, according to Chief Judge Prost, the court should have reduced the damages award to eliminate any portion that is attributable to the fact that the technology was part of a standard. In support of this proposition, the court cites its opinion in Ericsson, which states:
When dealing with SEPs, there are two special apportionment issues that arise. First, the patented feature must be apportioned from all of the unpatented features reflected in the standard. Second, the patentee’s royalty must be premised on the value of the patented feature, not any value added by the standard’s adoption of the patented technology. These steps are necessary to ensure that the royalty award is based on the incremental value that the patented invention adds to the product, not any value added by the standardization of that technology. . . .
[T]he royalty for SEPs should reflect the approximate value of that technological contribution, not the value of its widespread adoption due to standardization (p.16).
Significantly, the court rejects CSIRO's argument that these statements from Ericsson apply only to RAND-encumbered SEPs, appearing to hold that they apply to all SEPs. In particular:
. . . a reasonable royalty calculation under § 284 attempts to measure the value of the patented invention. Id. at 1232. This value—the value of the technology—is distinct from any value that artificially accrues to the patent due to the standard’s adoption. Id. Without this rule, patentees would receive all of the benefit created by standardization—benefit that would otherwise flow to consumers and businesses practicing the standard. We therefore reaffirm that reasonable royalties for SEPs generally—and not only those subject to a RAND commitment—must not include any value flowing to the patent from the standard’s adoption (p.17).
Applying this understanding to the facts of the case:
This error impacted the district court’s analysis on all three factors that it weighed in favor of CSIRO. With respect to factor 8—“[t]he established profitability of the product made under the patent; its commercial success; and its current popularity,” Georgia-Pacific, 318 F. Supp. at 1120—the district court found that “[a]t the time of the hypothetical negotiations, the market for wireless products was growing rapidly, indicating increased commercial success.” Commonwealth Sci., 2014 WL 3805817, at *13. As to factors 9 and 10—which relate to the advantages of the patented invention—the district court concluded that “[a]lternative technologies in the wireless industry, such as PBCC, MBCK, and PPM, failed to achieve commercial success.” Id. However, the district court never considered the standard’s role in causing commercial success. Ericsson calls out factors 8, 9, and 10 as all being irrelevant or misleading in cases involving SEPs. Ericsson, 773 F.3d at 1231. We therefore conclude that the district court erred in failing to account for standardization when it evaluated the Georgia-Pacific factors.
Additionally, the district court failed to account for the possibility that the $0.90 and $1.90 per unit rates that it used as a starting point may themselves be impacted by standardization (pp. 18-19).
With all due respect, for the reasons Norman Siebrasse and I explain in our paper The Value of the Standard, I think that Judge Davis got this second issue right and that the Federal Circuit got it wrong. As we argue in the paper, the principle that a royalty should not reflect the value of the standard can mean three distinct things: that the award should not be based on the patent's holdup value; that the award should be proportionate to the value of the technology in comparison with other patented technologies also embodied in the standard; and that the award should not reflect any added value resulting from network effects. We argue that the first two interpretations are sound but that the last one is not. Indeed, in both SEP and non-SEP cases, the award often will reflect the value of widespread use to the extent the damages take the form of a "running royalty" consisting of an ex ante rate multiplied by an ex post base. In this sense, the patent owner benefits from widespread ex post use (or loses out if the use isn't as great as expected), and that's the way it should be if we want an award that is roughly commensurate with the value of the technology. A technology adopted into a standard necessarily is more valuable to users than one that isn't.
Finally, the court holds that the district court erred in rejecting the TLA as a possible comparator (pp. 20-22), and remands for a recalculation.