FRAND: Can Kindergarten Teach Us Something?

May 19, 2012

For the last decade, there has been a lot of high profile litigation over the royalties that should be paid for IP essential to implement an industry standard.   Lawsuits have been in every technology area, in different courts, in different countries.  But even after a decade, there is no formula for royalties to be paid for a patent essential to implement all or part of an industry standard.  There is only the vague acronym “FRAND” (sometimes called “RAND”) that is argued back and forth as the “guiding principle” for payment and terms involving industry standards.

How should price be decided?  How should terms be decided?   How can this discussion be informed by the last decade’s NPE litigation, such as the cases on damages and patent injunctions?  What about the increasing convergence of technologies and functions in more complex devices?  The economic bust since 2008?

This post will first briefly touch on some background, and then compare just a couple of the benchmarks argued in this complex mix. I will ask the readership to consider how a group of kids might resolve a similar problem with a ball on a playground. (I am assuming well-behaved children, not “Lord of the Flies”).   While kindergarten kids can’t answer the standard-setting FRAND issue, cooperative behavior on the playground might offer a lesson for us all…

Background to be Considered: Standard-setting is when an industry group decides on a specification or design for a function of a product.  Typically, the design is for the function or form of some type of a “connector” or “interface” to allow for compatibility of different products from different sources.  In some industries compatibility requires more extensive or “deeper” product penetration than in other industries.

Examples of compatibility standards are the configuration of an electrical outlet and “plug” that goes in the outlet. In the U.S. we have the rectangular prongs with the round peg configuration; different countries in other parts of the world use different configurations. But each country uses the same configuration within that country — consumers want products that plug into the wall in any outlet.  By having uniformity in how electrical devices are connected to the power supply in a building through electrical cords and outlets, more products can be made more cheaply, distributed more widely, and more easily used by more people (imagine if these things were not compatible).

Most standards for interfaces do not implicate significant advances in the technology or the device itself — the “landmark” invention is in the design of the LED or the method for its use in a light bulb, or the design of the lamp, or the composition of the chemical in the vessel.  Instead, most standards generally involve the choice — or the refinement — of one of several options for an interface.

When a group of competitors, their suppliers, and vendors, get together to decide they will only make one product or type of product and not another, this is generally a crime, a felony, under the Sherman Antitrust Act, 15 U.S.C. Section 1 or Section 2.  It is no different from a group of competitors, their suppliers and vendors, fixing prices for a product.  However, there are statutory and case law exceptions for standard-setting on the theory that fair, open standards allow different companies to make interoperable products, which promotes competition — increasing supply and reducing price for consumers.

Nearly all standards groups have adopted intellectual property policies to guide their members in avoiding foul play.  A standards process that suffers years of delay while intellectual property lawsuits are fought out among its members probably would not deliver the benefits that justify the antitrust exception.  The rules most groups use are not intended to resolve infringement issues, but to help avoid the market disruption and costs to members and consumers that result from litigation, which undermine the antitrust exception for standards.

General Overview of FRAND or RAND: Fair Reasonable and Non-Discriminatory Royalty or Reasonable and Non-Discriminatory Royalty — At a high and very general level, can loosely be called the compensation (including terms) an intellectual property owner may be permitted or entitled to ask for under a standards’ groups rules.  As a general proposition, antitrust laws will often permit this compensation where, 1) the owner made clear prior to selection of the standard that it would require compensation if its IP were infringed in implementation of the standard — and, 2) the compensation is based on the value of the IP for the function used, without being inflated by selection of the standard by the group.  Indeed, if there were a blanket rule against compensation, an argument might be made that this prevents new market entrants or smaller players from putting their technology into a standard, or participating in standards at all; since they would lose their R&D investments or the opportunity to realize any gain on those investments.

Nonetheless, participants must remember a group’s rules are not law, and are not a substitute for compliance with antitrust laws or principles.  The United States Supreme Court has explicitly held compliance with a standards group’s rules is not a defense to an antitrust violation.  The FRAND commitment may under certain circumstances be mandated by antitrust concerns, whether or not in the group’s rules.  The measure of FRAND may be limited by antitrust and competition laws, just as the patent or other IP laws permit the owner to ask for compensation in the first instance.

What is Reasonable in FRAND? 35 U.S.C. 284 says the minimum compensation a patent owner should receive for infringement of his or her patent in a lawsuit is a “reasonable royalty”.  Some people argue that “reasonable” in FRAND mirrors section 284.  However, “reasonable royalty” in a lawsuit is generally based on a “hypothetical negotiation” between a “willing licensor” and “willing licensee”.  Section 284 damages are not typically based on a group of competitors giving a monopoly to the patent owner:  Some “translation” is required to put Section 284’s “reasonable royalty” into the standards context.  Indeed, once an IP owner has agreed to permit use of his patent in a standard, there is an argument over whether or not there is a limitation on remedies, or an infringement claim at all, or only other contract or relationship based claims?

Moreover, Lucent v. GatewayUniloc v Microsoft, as well as eBay v. MercExchange, are now embedded in Section 284’s “reasonable royalty” definition:  1) compensation must be limited to the contribution the technology makes to the overall product (apportionment); 2) license fees must be put into a context where both the technology licensed and the economics of the license are compared on an “apples to apples” basis;  3) neither arbitrary benchmarks (e.g., 25% rule), nor the entire market value of the product, may ordinarily be used in computing the royalty; and 4) the threat of market disruption by injunction should not be part of the analysis.

Over time, circumstances change, and this may change FRAND.  Consider how the convergence of functions into devices, such as internet based televisions, or netbooks, or others, has made any one function a smaller part of the overall combined device?  Consider whether the economic conditions of the last four years has impacted on margins?  Consider in the last few years, not just Federal Circuit law limiting remedies, but also other cases limiting claim scope (e.g., recent cases on means plus function in software claims).  All of these factors may have impacted the value of any one patent (or patent family) in the apportionment of value of implementation of an interface.

Another place in U.S. law where “reasonable” appears is also relevant here:  That is, the limitation read into Section 1 of the Sherman Act by the United States Supreme Court in Standard Oil Co. of New Jersey v. United States221 U.S. 1 (1911), which held Section 1 only prohibited “unreasonable restraints” on trade.  In the context of antitrust law, there is an argument the group’s decision cannot create an unreasonable restraint on trade — hurdles to entry into, or disruption of supply or prices in, a market.   Consider as well the problems of Section 2’s prohibition against a group of competitors giving one of them a monopoly?  Consider also the concept in many European and Asian competition laws against “abuse of dominant position”, such as abusive pricing?

An agreement on a product function or feature by competitors risks harm to competition since it necessarily is intended to eliminate competing functions (or incompatible products).  There is a concern that adoption of common product features by group decision will increase the risk of price-fixing along with the implementation of those features.

Standards groups typically do not get involved in financial terms of a license to avoid allegations they caused a boycott of the “losing technology”, or price-fixing for essential IP rights, or even price-fixing for products that comply with the standard.  Some standards groups do have guidelines about certain terms, such as the scope of a grant back, but typically terms and price are left to participants to work out among themselves.

This is where notice or disclosure in advance of the work on and adoption of the standard ties back into the process: The theory is that if participants disclose IP they own that they contend will be infringed by a standard, then regardless of how a court might rule on infringement or validity or remedies or surviving claims or any other issue, the participants can work out deals to allow for implementation of the standard without disruption or delay for patent and other lawsuits.  If standards could not be implemented, or could be disrupted by litigation, years of delay would slow standardization — potentially countering all of its pro-competitive benefits, and making the exercise itself an unreasonable restraint on trade.  There is an argument that a license, express or implied, or some other type of promissory estoppel or other limitation on remedies, must come into play at the point of inclusion of the IP into the standard:  Generally, a license, however, is only a right not to be sued for infringement, it is not a right to use the IP without compensation; nor does a limitation against injunction or exclusion from a market imply “free-riding” is permitted.

The bottom line is a patent owner cannot charge whatever it wants, or ask for any terms it likes, when it would not otherwise be in a position to do so but for the group making its technology a standard.  This is especially true when the erosion of patent value is considered as well as the convergence of functions in a tough market.  Yet the users of the standard are not permitted generally to ignore or by-pass the patent owner’s right to compensation.

Kindergarten Rules?: Is the FRAND analysis as complex as some of the technology involved?  At some level, might well-behaved kindergarten children be able demonstrate it for you?  If each kid has a ball, but before they leave school, the kids have to agree that only one of them will bring a ball to the park to play a game after school, is it fair for the kid with the ball to ask for money or terms when everyone shows up later at the park for the game?  Should the kid tell everyone his intentions before they vote at school on whose ball to use later at the park?   If more than one kid has a ball that is “good enough” for the game, even if not as good as the ball picked, wouldn’t most kids who are surprised at the park yell, “no fair”?  Even if no one else had a ball, the kids could have played a different game or done something else after school.

But while it is easy to say you need to disclose, it is harder to figure out how much compensation is fair to ask for from each player.

Back to kindergarten:  If the kid with the ball gets to ask each player in the game for compensation, can he ask everyone for the same reimbursement?  A penny a game?  A dollar a day?  Can he ask the kid who plays once a week to pay the same as the kid who plays three times a day?  Can he ask different kids who play the same number of games to pay different prices? One a dollar another two dollars?  Can he ask for compensation or reimbursement that ends up being multiple times what his ball is worth — many times what he would have sold his ball for before it was picked for the game?  Can he demand payment not just for use of his ball but all his other toys?  If you were supervising a group of kindergarten children in this exercise, how would you moderate the issue?   Would you let the kid with the ball kick people out of the park if they argued with him, or simply resolve what he is entitled to receive from each kid since he has already said every one could play with his ball?  If you asked the kids, what would they say?

Kids don’t have to deal with all the complexities of a research company or manufacturing operation or patent holding company in a tough world — deal with R&D expenses, operating costs or profit margins — kids just want to play in the park.  Yet, what if you looked at the standards issue in the same way?

For example, can the kid with the ball ask for the right to be allowed to play in other games on the same or equivalent terms when someone else’s ball is used later?  Sounds fair?  Can the kid announce at the park to everyone that they must give him the right to use every other toy, bike or ball owned by every other kid any time?  Ask a kid if this sounds fair or unfair?  Again, do you kick kids out of the park who don’t agree or resolve the payment dispute among them and let the game go on?

Kindergarten vs. Antitrust: If the kid is leveraging or exploiting the fact that without permission to use the ball, another kid can’t play in the game or can play but is required to pay whatever compensation is demanded, is this an abuse of the power from the vote?  This is especially problematic if  the ball picked was not the only option for the group, regardless of whether it is the “best ball”.  The leverage results not from the ball itself, but from the group decision.  Should the kid be allowed to do this?  What do you think?  What do you believe an antitrust or competition enforcement official would think in the context of a standards group in a competitive market?  Is this a dispute over compensation or whether kids can play at all?  Ask a kid?

There are multiple theories on these issues in standard-setting, which arise out of the complex thinking of lawyers, business people, and engineers. Whenever smart and highly educated people each come up with different theories on how to implement a goal, you will get different solutions and strong feelings about those solutions.  Companies might feel they can take different positions in different circumstances.  Kids in a simpler situation might come up with simpler solutions.

What is the Answer to FRAND?

So how do we answer the question of FRAND?  How would you moderate the kids’ behavior with the ball?  How would the kids view “fair” and “no fair”?  Maybe we isolate business interests from how we would like to think kids would treat each other to cooperate in a game with a ball at the park after school?   Maybe we get some of our kids or grandkids or nieces or nephews to work it out…assuming they are well-behaved…Are the answers to the FRAND question as complex as the “grown-ups” have made them out to be?

Filed under: antitrust,contract,contract clause,damages and remedies,Department of Justice,EU enforcement,Europe,Federal Circuit,good faith negotiations,hypothetical negotiation,hypothetical negotiations,license,licensing strategy,litigation planning,reasonable royalty,software claims,standard-setting,strategy,Uncategorized

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Dave Healey

Dave Healey

Dave's Bio

I am a principal in the Houston office of Fish & Richardson, a leading global intellectual property law firm. I have been practicing law for twenty-five years, specializing in patent lawsuits. During that time, I have watched IP become more important than ever as a business asset. And I’ve gained some perspective on the best way to protect and exploit IP assets. I hope my ideas offer a unique perspective, and help you create your own practical solutions.

The ideas and opinions on this blog are my own as of the time of posting, have not been vetted with the firm or its clients, and do not represent the positions of the firm, its other lawyers, or any of its clients. None of these posts is intended as legal advice and if you need a lawyer, you should hire one. If you make a comment on the post, the comment will become public and beyond your control to change or remove it.

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