1. FRAND Licensing of IP Rights and Standard Setting Trevor Soames ABA Brown Bag Series “EC Competition Law and IP Licensing in a Standard-Setting Context” 22 June 2007 Brussels

2. 2 Importance of Standardisation  Technology-driven world: industry standardization, device interoperability and product compatibility critical to promoting innovation and competition  Standards typically created by standard-setting organizations (SSOs) composed of participants from a given industry  SSOs gained importance in technology-driven sectors  More and more products have to work together  Particular importance in IT/communications – network interoperability

3. 3 Standardisation and Competition policy  IP laws grant exclusive rights to encourage innovation and risky investments  IP rights should not be viewed as protecting owners from competition but as encouraging firms to engage in competition  There is a role for antitrust enforcers in standard- setting but given potential importance of this area to dynamic efficiency, innovation and long-term consumer welfare, it is a role that should be played with great caution (DAAG Masoudi)

4. 4 Standardisation under FRAND Regime  Under traditional standards development procedures IPR owners:  Disclose patents they consider may be essential for standard  Typically provide assurance or commitment that, if IPRs essential to standard, they are prepared to enter licence on fair, reasonable and non-discriminatory (FRAND) terms, with or without monetary compensation  This is an important commitment as IPRs grant the right to exclude, i.e. not to provide a licence at all – FRAND modifies that  Licensing terms - typically negotiated on a bilateral basis outside the SSOs

5. 5 Standardisation under FRAND Regime in Practice  Voluntary ex ante disclosure and negotiation on bilateral basis entirely consistent with current FRAND regime. Potential licensees not prevented from asking potential licensors about planned licensing terms and conditions  Not merely a theoretical possibility: –frequently done in practice –potential licensors have every incentive to sign early deals – i.e. before standard is adopted to gain support for their technology from SSO members  In the unusual case where potential licensor refuses to provide this information, potential licensees can choose to take refusal into consideration when voting for adoption of given standard for which there are alternative technology solutions

6. 6 Issue – Contested Theory of Ex Post hold up  The contested theory of ex post standardisation hold up has a number of controversial and unsubstantiated variants (which have been rebutted in a number of papers, see reading list) : –If SSO members select standard and only then discover that standard infringes IPR, patent owner is said to be in a position to “hold up” the standard: patent owner may be able to demand a higher royalty than if the negotiation had been conducted before the standard was set –This can inject inefficiency into the process in at least three ways:  Uncertainty  Delay  Under some conditions, an allegedly uneconomical royalty  Proposals to deal with perceived concerns: –Upfront disclosure of potentially essential patents (which some even consider may in and of itself dispel any risk of hold-up) –FRAND commitments –Ex ante licensing

7. 7 Controversy  Some argue that –standard setting in the modern economy is crucial (true) –and that there are serious problems that require intervention by antitrust/competition law and agencies (untrue)  In particular, claims that FRAND does not work and needs fixing

8. 8 Attempts to Extend Scope of FRAND Principle and Competition Law in Absence of Non- disclosure Issues  Controversial theories: –Standardisation creates lock-in and market power –Patent value greatly increases when essential for standard –Power to demand excessive royalties unless restrained by Art 81 (allegedly requiring FRAND duty) and Art 82 (to constrain prices and applying only to certain companies but not to others similarly placed)  Claims that FRAND means many things: –Based on faulty premises: what the law should be, not what it is  True motivation: –War of the business models –Efforts to skew FRAND and competition law to favour licensees and unwind lawful, negotiated prior agreements: buyer’s remorse

9. 9 Different Business Models and Incentives  Firms participating in SSOs with different business models have different incentives when it comes to IP licensing:  Innovators (upstream) – Licensing revenues represent return on investment in innovation and are life blood of these companies  Manufacturers/Implementers (downstream) – Want to pay lower royalties to reduce costs  Vertically-integrated firms (upstream and downstream) – Low royalties or even a zero royalty may be acceptable. Alternatively, may want to raise rivals’ costs  Buyers of equipment – Also tend to believe that lower royalties would benefit them by reducing price of equipment

10. 10 What FRAND Really Means (1)  Patent holder agrees to make licences available for those patents covered by FRAND commitment: gives up right to outright refuse to licence and instead keep patented technology for own sole use  Patent holder agrees it is prepared to make licences available under “[fair and] reasonable... terms and conditions” including : –financial terms (e.g. up-front fees and/or running royalties) and –other non-financial “terms and conditions” (e.g. cross-licences)  Patent holder agrees to make licences available to all interested parties: gives up right (often exercised) to grant exclusive licences or “pick and choose” who to license  Patent holder agrees to make licences available on terms and conditions that are “non-discriminatory”

11. 11 What FRAND Really Means (2)  FRAND means licensor is prepared to negotiate in good faith to determine licensing terms provided that counterparty also demonstrates good faith  “It takes two to make a licence agreement”: all a patent owner can do is make genuine bona fide licensing offer  Terms and conditions of any licence subject to FRAND result from normal commercial negotiations between licensor and licensee  FRAND does not mandate specific royalty level: what is FRAND to one may not be FRAND to another  Important elements of consideration other than royalties

12. 12 Myth 1: Standardisation = Market Power (1)  Claim: incorporation of proprietary technology into standards creates market power beyond “power” conferred by patent itself  Reality: it may in certain circumstances create market power  Standardization only grants additional market power when patented technology can be easily designed around. If no alternative (peerless technology), ability of essential patent holder legitimately to seek significant royalties exists ex ante adoption of standard  Necessary condition for creation of market power: technologically comparable alternatives at time of standardisation: –If such alternatives are available, SSO endorsement of proprietary technology may result in reduction in short term competition. –But if no economic or technical substitutes, then standard selection process will have no effect on ex post market power, as technology already had its importance ex ante

13. 13 Myth 1: Standardisation = Market Power (2)  Availability of alternative technologies necessary but not sufficient for standardisation to create market power  Holders of essential IP face significant competitive constraints even after IP included in standard: –Horizontal constraints: prices commanded by complementary patents within standard and by competing standards within same field –Vertical constraints: patent holders without any downstream operations constrained by elasticity of consumer demand for product:  Vertically integrated licensor has stronger bargaining position because it has alternative of capturing profits through own product sales  Vertically integrated firms have incentives to raise rival downstream firms’ prices through licensing terms (e.g. GSM club), whilst remaining open to cross licensing agreements with other integrated companies –Dynamic constraints: formal standard setting process is a repeat game and essential IP holder committing abuses could be punished in negotiations leading to subsequent standards or iterations

14. 14 Myth 2: FRAND Means Waiver of Injunctive Relief (1)  Claim: by giving FRAND commitment, IP holder is contractually prevented from or has implicitly waived right to seek injunctive relief against infringer  Reality: waiver of rights cannot be presumed, must be explicit  FRAND commitment not a licence but enforceable obligation to negotiate in good faith  Owners of intangible IP need to be able to rely on the legal system to protect their interests to a greater degree than the owners of tangible (physical) property  Risk of expensive serial litigation: ability to obtain injunction may be only practical leverage that patent holder has to force infringer to the bargaining table  Absent that ability, patent holder's only recourse may be to repeatedly litigate and collect damages on a recurring basis, to the extent that infringer's products continue to infringe patent

15. 15 Myth 2: FRAND Means Waiver of Injunctive Relief (2)  Suggestion that so long as suitable mechanisms put into place to ensure that patent holder will be able to collect the reasonable royalties ultimately due, patent holder does not need an injunction to protect its legitimate commercial interests ignores: –Critical role in many patent licence negotiations of cross-licences, which courts generally cannot award or compel an infringer to grant –Role that availability of injunctive relief may play in inducing companies to enter into cross-licences –No single “tribunal” capable of resolving such disputes –Judicial resolution (especially of multi-jurisdictional disputes over infringement, validity, and damages) takes a significant amount of time –Delay in payment benefits infringer and harms patent holder –Interestingly, some leading proponents of this approach do not seem to consider that a FRAND declaration and undertaking amount to a waiver of right to seek injunctive relief (cf Nokia v Vitelcom, Spain)

16. 16 Myth 3: FRAND as a Requirement for Compliance with Articles 81 and 82 EC  Claim: standardisation agreements necessarily infringe Article 81(1); FRAND licensing is a condition for exemption under Article 81(3); a refusal to license on FRAND terms is caught by Article 81  Reality: –“The existence of a restriction of competition in standardisation agreements depends upon the extent to which the parties remain free to develop alternative standards or products that do not comply with the agreed standard. Standardisation agreements may restrict competition where they prevent the parties from either developing alternative standards or commercialising products that do not comply with the standard.” Com. Guidelines on Horiz. Coop., §167 –Refusal to license on FRAND terms is unilateral action and outside scope of Article 81  Claim: FRAND and Article 82 impose similar if not identical obligations, and breach of the former by a dominant company necessarily implies infringement of latter  Reality: –If FRAND commitment mirrors obligations to which a dominant firm is in any event subject under Article 82, there is no need to have recourse to it –If, on the other hand, FRAND commitment goes beyond the requirements imposed by Article 82, it has no role to play in the application of this provision

17. 17 Myth 4: FRAND Means Numerical Proportionality (1)  Claim: reasonable royalties are those determined through numerical proportionality: –proportion of all essential patents contributed to standard owned by patentee –multiplied by an arbitrarily set royalty cap  Reality: –FRAND does not require a patent holder to license its essential patents according to a particular methodology (particularly one dictated by a potential licensee) –ETSI explicitly rejected proposal by Nokia, Ericsson, Motorola (MCOI) to redefine FRAND by incorporating numerical proportionality

18. 18 Myth 4: FRAND means numerical proportionality (2) Numerical proportionality is untenable:  Relies on patent counting: assumes that all patents are of equal value  Ignores patent value, economic circumstances or market conditions  Unsupported by economic or legal theory  Contradicts principles of efficiency and fairness  Would deprive a patent owner of ability to be rewarded for its innovative contributions  Would stifle innovation, distort resource allocation  Unworkable in practice  Would tend to benefit vertically-integrated IP holders who care little about royalties  Fundamentally at odds with positions actually practised by industry players, including the proponents of such methodologies (cf Nokia v Vitelcom, Spain)

19. 19 Myth 5: Royalty Stacking  Claim: Royalty stacking - Cumulative royalty rates paid by users may be too high when standard involves multiple essential patents held by multiple firms  Reality: Most of the literature claiming the existence of royalty stacking is theoretical in nature or based on inaccurate case studies: –Little empirical evidence of royalty stacking in general and in 3G industry in particular –Geradin, Layne-Farrar and Padilla (2006) have demonstrated that theory of royalty stacking is not robust

20. 20 Myth 6: Hold-up in 3G  Much talk of problems in 3G telecoms industry. But no evidence of hold up: –Need to compare royalty and non-royalty terms charged by owners of technologies selected to WCDMA standard before and after adoption of standard and time at which equipment manufacturers and operators had committed significant standard-specific investments –Need to show that licensing terms ex post were materially worse for users than those applied ex ante

21. 21 FRAND Works  FRAND regime has allowed successful development of innovative technologies (e.g., mobile telephony, Internet, WIFI, DSL, etc.) fostered competition  Abuses of FRAND are rare: –very little case-law –involve intentional failures to disclose patents (patent ambush), not licensing terms  Criticisms made against the FRAND regime fail to convince and efforts to move away from FRAND or to reinterpret notion are essentially motivated by consumer welfare reducing desire to reduce prices paid for patented technology

22. 22 True purpose of the attack on the FRAND regime  As criticisms of FRAND regime are unsubstantiated, less well intentioned explanations must be considered: –Buyers’ remorse: disgruntled licensees seeking to fabricate competition cases to try and reopen previously agreed and negotiated arrangements, to reduce costs –A range of industry players would find it attractive to shift whatever bargaining power they can away from the IP holders to the more numerous (and often larger) standard implementers –This is nothing less than a general assault on the vitality of an innovation producing patent system