Speaking in a personal capacity - the views expressed are not necessarily those of the firm or any client. © 2007 Cleary Gottlieb Steen & Hamilton LLP. All rights reserved. EC competition law and IP licensing in a standard-setting context Are hold-up, royalty stacking and patent ambush serious concerns and, if so, what are possible responses? Maurits Dolmans, Cleary Gottlieb Steen & Hamilton LLP ABA Section of Antitrust Law, IP Committee Brown Bag on Standards and IP Brussels, June 22, 2007

2 Why is antitrust law concerned about standardisation?  Standardisation, if properly executed, generally leads to economic efficiency and substantial consumer benefits –Compatibility and interoperability – particularly important for IT, telecom and other network industries –Rationalisation of production, economies of scale, network effects for introduction of new technologies, unified platforms for the development of new products, R&D efficiencies, etc. –Increased competition and lower prices in the markets for the standardised products and components  But, the creation of important formal standards eliminates technology competition and creates entry barriers upstream –All competition between alternative technological formats or substitutable technologies may be excluded –Could give patentee a de facto monopoly, or at least create market power that the patentee did not have before –No power/monopoly where different standards effectively compete

3 Antitrust enforcers are well aware of the need for safeguards  Standards “lock out” alternatives “Thus, ex post, the owner of a patented technology necessary to implement the standard may have the power to extract higher royalties or other licensing terms that reflect the absence of competitive alternatives. Consumers of the products using the standard would be harmed if those higher royalties were passed on in the form of higher prices.” DOJ and FTC, Antitrust Enforcement and Intellectual Property Rights, April 2007  Elimination of alternatives by a group of competing firms is accepted by antitrust law because of substantial efficiencies relative to harm, provided conditions are met –To ensure benefits outweigh risk of harm, SSOs typically impose constraints on members: 1.Obligatory ex ante disclosure of essential patents 2.Optional commitment to license on royalty-free or fair, reasonable, and non-discriminatory (FRAND) terms

4 FRAND licensing under Article 81 EC  Industry standards often restrict (a) inter-technology competition, and (b) access to the market for products that do not comply with the standard.  Conditions for exemption in Article 81(3) EC must be met –Objective of standardization must be legitimate (e.g. efficiency, interoperability) –Must not include any indispensable restrictions –Must allow a fair share of benefits to consumers (non-FRAND terms allow patent holders to appropriate the benefits of standardisation) –No elimination of competition in substantial part of the products. “To avoid elimination of competition in the relevant market(s), access to the standard must be possible for third parties on fair, reasonable and non-discriminatory terms.” Horiz. Coop. Guidelines, para 174. –Legal duty to license on non-discriminatory and reasonable terms where patent pool, joint venture or other group of companies agree on substantial restriction of competition, such as a standard. Salora-IGR Stereo Television (1981); British Interactive Broadcasting (1999).

5 FRAND licensing under Article 82 EC  Particularly where a standard was adopted in reliance on FRAND commitments, and several viable alternative technologies were available ex ante, a dominant position in the licensing of an IP holder’s essential patents may be a direct result of its FRAND promise. –Horizontal, vertical and dynamic constraints may exist, but do not always exist for all IP owners, and can be avoided by violations of FRAND (eg, by excluding downstream competition)  Article 82 obligations are substantially similar to the contractual obligations under FRAND commitments. –prohibits unfair, exploitative, licensing terms, such as excessive royalties, where market forces do not constrain power (where the standard is a barrier to entry of alternative technologies) –prohibits restrictions or foreclosure of competition through exclusionary licensing practices (e.g. exclusivity provisions, raising rivals’ costs, margin squeeze). –the non-discrimination obligation applies in particular where discrimination would favour the dominant company’s own downstream operations or shield the licensor from competition in innovation and technology licensing.

6 EC Guidelines recognize importance of FRAND obligations  FRAND T&Cs for ex post licensing required by 81(3) and 82 EC: –“…an industry standard [can lead] to a situation in which there is little competition in terms of the technological format. Once the main players in the market adopt a certain format, network effects may make it very difficult for alternative formats to survive. […] in order for the agreement to comply with Article 81(3), it must be ensured that the agreement does not unduly restrict competition and does not unduly restrict future innovation. EC 2003 Technology Transfer Guidelines, para 152 –It will normally be required that the technologies which support such a standard be licensed to third parties on fair, reasonable and non- discriminatory terms.” id. para 164 –“Where the pool has a dominant position on the market, royalties and other licensing terms should be fair and non-discriminatory and licences should be non-exclusive.” id, para 226

7 Particular antitrust concern: patent ambush, holdup, royalty stacking, and exclusion  Opportunity of monopoly rent is incentive for patent ambush. This is not hypothetical: –December 2005 Sun/ETSI case –FTC opinion and order in the Rambus matter (February 2007) –These are not the only cases… JVT case and others –Increasing concerns of patent stacking, patent trolls, and ex post opportunism  Opportunity of monopoly rent is incentive to exclude downstream competition: –another (complementary) way to reap monopoly rent, –also reduces innovation and efficiency downstream –also creates leverage over future standardsetting (threat of supply interruption)  Ex ante auction is a possible solution in certain cases to avoid these concerns –DOJ/FTC: rule of reason applies to multilateral ex ante royalty negotiations and SSO requirements to disclose model licensing terms (April 2007) –EC Commission letter to ETSI June 2006

8 Problem: ex ante auction is not a panacea – often not practical  Ideally, competition takes place before standard is set, and before users are “locked in”  Problem: Complex standard have many IPRs - maybe 1,000+ –Upfront choice may have to be made about general direction –But process takes years and specifications are further developed during standardization –Features are added during standardization –Unknown applications mature into issued patents; this takes time –Not possible to do one “auction” – A series of many auctions would be needed, and there is the risk that initial choices “locks in” the general direction, and foreclose later choices –SSOs are still worried about price fixing concerns (even with rule of reason) –This creates risks of ex post hold-up (not hypothetical) –So a policy promoting ex ante auction is not enough. A FRAND license obligation is also required to avoid abuse of lock-in  FRAND obligations are vital; it is important to know what they mean

9 Meaning of “FR” in FRAND  “FRAND” reflects Article 82(a) and 82(c) EC verbatim  1992 EC Communication on IPRs and Standardization: “imposing unfair selling prices (rates including royalties for the use of standards) or other unfair trading conditions”  Economic principle underlying FRAND is well understood: essential patent holders should not exploit the added power gained as a result of being included in the standard –“reasonable royalty” … approximates the outcome of an auction-like process appropriately designed to take lawful advantage of the state of competition existing ex ante... among available IP options.‘” (FTC remedy decision in Rambus, at 17 (quoting Swanson & Baumol) –Regional Court of Dusseldorf in Siemens v. Amoi (13 February 2007) examined reasonableness of licensing terms against what could have been achieved in negotiations “under the conditions of an open market” –Thus, RAND royalty = π(v 1 -v 2 )+c where: –π = probability the patent is valid –v 1 = value added per product using the patent –v 2 = value added per product using the next best alternative –c = cost of licensing –(inter-technology competition would drive price of next best solution to zero)

10 Meaning of “FR” in FRAND  In practice ex ante “valuation” not easy to apply  Benchmarks to determine whether a royalty is “reasonable” (Rambus): –The existence and viability of technical alternatives ex ante to determine value. Royalties should not exceed incremental value compared to next-best alternative; –Other relevant benchmarks (See case law under 82 EC.): –Royalties charged by other companies for essential patents of comparable number and value; –Royalties charged by the licensor in similar but competitive markets.  Also: need to avoid Cournot problem (royalty stacking harming consumers and licensors) well understood in the industry. –Requires cooperation (pool, or compliance with mutual FRAND promise)  No refusal to license to impose excessive royalty or exclusionary terms –No injunctive relief unless material and irreparable breach of contract (e.g., license will not/cannot pay royalty objectively determined to be FRAND)

11 Meaning of “ND” in FRAND (cont’d)  Licensors must avoid exclusion through discrimination: –against and between other technology providers (e.g., by requesting unremunerated grant-backs, discriminating against IP-rich licensees and diminishing innovation incentives and technology competition) –against and between rival firms in downstream markets (e.g., by refusing to provide reciprocal licences to rival manufacturers of standardised components or products) –against and between licensees in downstream markets (e.g., by offering royalty rebates and incentives, particularly when such discrimination is linked to exclusive or preferential supplies - resulting in “primary line” antitrust injury)  Patent holders cannot impose non-FRAND royalty levels or terms by threat of injunction against licensee that is willing to accept FRAND conditions (see e.g. Miller 2006; Shapiro 2006)  Contractual FRAND obligations and Article 81 and 82 requirements have similar or identical legal effects

12 FRAND is meaningful and enforceable  Policy objectives: Essential IP must be available (no refusal to license, to constructive refusal to license (excessive pricing), and all implementers must have access (no discrimination, no exclusion). –This was fully understood in the industry since the 1990s (ETSI IPR Policy, EC statements, verbatim use of 82 EC terms, etc)  If there is disagreement about FRAND, who decides? If IP owner can enjoin use even if licensee is willing and able to pay FRAND, this is a de facto refusal to license.  A court, authority or arbitrator should be able to decide what FRAND means. –Reference: “FR”: ex ante fee tempered by 82 EC, and “ND” non-discrimination (no exclusion) –"non-discriminatory" is relatively easily applied (there is a standard of comparison) and once other companies have begun licensing, there is a standard of comparison for "fair and reasonable" too  Certain IP owners argue for de facto immunity from both contractual obligations and competition/antitrust law, plainly inconsistent with EC and US and SSO policies –“Good faith” negotiations does not resolve holdup, is not enforceable in practice, in certain jurisdictions is not in law enforceable

13 Conclusion: What is FRAND Promise? –A license or promise to license: –No refusal or termination of a license, no injunctive relief, no suit for treble damages, if defendant is willing and able to pay, but disagrees on T&Cs –No constructive refusal to license (e.g., excessive fees, delays, etc.) –Fair and reasonable – equitable, balancing all interests (proportionality) –Taking into account also interest in development and roll-out of the standard (avoiding multiple monopoly rents), implementers, users, innovation, etc. –No monopoly rent, moderate, allowing IP owner innovation incentive, but not allowing IP owner to appropriate entire value of standard. –Non-discriminatory – equal treatment of all customers, including the IPR- owner’s own downstream business, so as to enable level playing field. –No restriction of downstream competition on the merits (no price-squeeze, no T&Cs that have the object or effect of restricting downstream competition, no differential treatment based on whether licensee purchases the licensor's downstream product) –No restriction of upstream technology competition (no free NAP/pass-thru) –These duties apply under 81 and 82 EC anyway –82(a) = “not excessive, and 82(c) = not exclusionary” –81(3) prohibits exclusion of competition, and requires fair share for consumers