The Ninth Circuit yesterday (July 30, 2015) issued one of the most significant appellate opinions regarding standard essential patents (SEPs) subject to commitments to license on fair, reasonable and non-discriminatory (FRAND, or simply RAND) terms. In Microsoft Corp. v. Motorola, Inc. (Case No. 14-35393), the Court upheld determinations by U.S. District Court Judge James Robart (W.D. Wash.) as to (i) when a member of a Standard Setting Organization (SSO) is obligated to license that member’s SEP on FRAND terms, (ii) what the proper methodology is for calculating a FRAND royalty rate, and (iii) what remedies are available for breach of an obligation to license a SEP on FRAND terms. The affirmance represents a major victory for Microsoft and other SEP licensees, and provides significant guidance regarding future FRAND disputes.
The Microsoft v. Motorola case involves a breach of contract action, filed by Microsoft after it concluded that Motorola’s proposed licensing terms under the Motorola IEEE 802.11 and ITU-T H.264 SEP patent portfolios (respectively covering wireless local area network standards and video compression standards) were excessive and violated the FRAND obligations for SEPs, which obligations Motorola assumed as a member of the IEEE and ITU-T. Motorola initially sent Microsoft two letters offering to license its SEPs for 2.25% of the price of the end product incorporating each standard. (The end products included Microsoft’s xBox game consoles and PCs running Microsoft Windows.) Microsoft claimed that Motorola’s license offer—which amounted to over $4 billion per year—was in breach of Motorola’s obligation to license its SEPs on FRAND terms. Shortly thereafter, Motorola initiated patent infringement proceedings in U.S. District Court, the International Trade Commission, and Germany seeking injunctions to exclude Microsoft’s allegedly infringing products incorporating certain of those SEPs.
Microsoft prevailed at the district court, where Judge Robart conducted an initial bench trial on FRAND. After modifying several factors in the Georgia-Pacific analysis for determining reasonable royalty patent damages to account for the special circumstances surrounding FRAND-encumbered SEPs, Judge Robart calculated a FRAND royalty rate well below 2.25% per unit, resulting in a royalty amount of only $1.8 million per year. Microsoft’s breach of contract claim was then tried to a jury, and Judge Robart’s FRAND royalty calculations and underlying findings of fact were introduced as evidence at the jury trial. Microsoft argued to the jury that Motorola’s initial licensing offer, as well as Motorola’s conduct in seeking injunctions after Microsoft filed suit, were breaches of the implied covenant of good faith and fair dealing imposed on SEP owners. The jury returned a verdict in favor of Microsoft, and awarded $14.52 million dollars in damages. (The damages represented costs incurred by Microsoft in defending against the injunction actions, and moving Microsoft’s European distribution center out of Germany to avoid any injunctive consequences.)
Motorola appealed, challenging the methodology Judge Robart used to reach his FRAND calculation, the sufficiency of the evidence for the jury’s finding, and the procedural mechanisms Judge Robart used to decide the FRAND and breach of contract issues.
The Court’s analysis opened by discussing the benefits and risks of the standardization process. The Court noted the “opportunity for companies to engage in anti-competitive behavior” following formal adoption of the standard by “demanding more for a license than the patented technology, had it not been adopted by the SSO, would be worth.” That risk is known as patent hold-up. “To mitigate the risk that a SEP holder will extract more than the fair value of its patented technology, many SSOs require SEP holders to agree to license their patents on ‘reasonable and nondiscriminatory’ or ‘RAND’ terms.” The purpose of that FRAND commitment is to prevent a SEP owner from attempting to use its SEPs to exclude competitors from the market or to obtain more favorable licensing terms than it could have obtained absent the patent’s inclusion in the standard.
Moving to Microsoft’s claim that Motorola’s breach of its FRAND commitment constituted a breach of contract, the Ninth Circuit first concluded it, as opposed to the Federal Circuit, had appellate jurisdiction to resolve the issues related to the FRAND rate, notwithstanding that the underlying dispute arose in the context of licensing and evaluation of the value of patents. Critical to the Ninth Circuit’s conclusion were the facts that (i) Motorola had taken an earlier interlocutory appeal to the Ninth Circuit, and (ii) Motorola had tried to appeal the district court’s FRAND calculations and jury verdict to the Federal Circuit, and the Federal Circuit had transferred the appeal back to the Ninth Circuit. The Ninth Circuit also ruled that Motorola had consented to Judge Robart’s bench trial to calculate the underlying FRAND royalty rate for submission to the jury in the breach of contract action, while being careful not to rule “whether, absent consent, a jury should have made the RAND determination.”
On questions of substantive law, the Ninth Circuit found that Judge Robart’s FRAND analysis in the bench trial was consistent with Federal Circuit law on patent damages. The Court first affirmed Judge Robart’s approach to framing a hypothetical negotiation, and particularly the “factors an SEP owner and implementer would consider in an actual negotiation directed at licensing a patent subject to RAND commitments,” such as “the objective value each contributed to each standard, given the quality of the technology and the available alternatives as well as the importance of those technologies to Microsoft’s business.”
Specifically, the Court rejected Motorola’s argument that Judge Robart misapplied the Georgia-Pacific royalty factors when he modified, and outright discarded, a number of factors that he determined were inapplicable to a FRAND commitment. For example, the Court stated that “factor fifteen” setting the hypothetical negotiation at —“the time the infringement began” —requires modification in the FRAND context, and that Georgia-Pacific offered flexibility in application of its factors. The Court also noted that what date the infringement began was an unclear point in this breach-of-contract action—as opposed to a patent infringement action—making it impracticable to consider only evidence that pinpointed the value of Motorola’s patents to Microsoft at a particular moment in time.
In another significant part of the opinion, the Court fully endorsed Judge Robart’s reliance on patent pools rather than Motorola’s historical license agreements, as more relevant indicators of the FRAND rate. The Court noted that patent pools were similar enough to FRAND agreements and “mirrored the objectives of FRAND agreements, namely including advanced technology to create valuable standards, while at the same time ensuring widespread adoption” of the standards. Motorola’s past licenses, in contrast, were not probative because they either encompassed much more than the SEPs at issue here (which made it impossible “to isolate, or apportion the value” attributable to the SEPs), or they were formed under threat of litigation, which is inconsistent with the underlying purpose of FRAND commitments. The Court noted that it “holds only that licenses should be considered when comparable; it does not in any respect impugn the district court’s reasoning as to why the proffered licenses were not comparable.”
Turning to the jury verdict, the Court found that Judge Robart’s denial of Motorola’s motion for judgment as a matter of law at the close of Microsoft’s case-in-chief (and again at the conclusion of the trial) was proper. According to the Court, the jury had sufficient evidence to find that Motorola breached its duty of good faith and fair dealing with respect to its FRAND obligations. In reaching this finding, the Court noted the danger of and need to prevent patent hold-up by a SEP owner who refuses to license technology essential to practicing a standard unless the licensee pays exorbitant royalty rates. The Court also held that a jury could have found that Motorola sought to leverage the “crippling consequences” of the injunction it attempted to obtain against Microsoft in order “to capture more than the value of its patents.” The Court observed that Motorola pursued injunctive relief even after it knew its suit against Microsoft could establish FRAND rates, meaning Motorola should have known that it could not show the irreparable harm necessary for injunctive relief.
Finally, in affirming the award of damages for Microsoft’s attorneys’ fees to defend against Motorola’s pursuit of an injunction, the Court concluded that Motorola’s Noerr-Pennington/First Amendment defense was inapplicable to suits for breach of contract because a FRAND commitment amounts to a voluntary waiver of the right to seek injunctive relief in certain circumstances. The Court also emphasized that awarding attorneys’ fees under the circumstances would decrease the risk of patent hold-up by encouraging SEP owners to negotiate FRAND licenses rather than seek injunctions.
Some portions of the Ninth Circuit’s decision, such as jurisdiction and the right to a jury trial, are unique to the underlying factual circumstances of this particular dispute. But there are several key takeaways that SEP owners and potential licensees should be mindful of in future FRAND disputes:
As a final and fundamental matter, the Ninth Circuit in Microsoft v. Motorola ultimately affirms a FRAND calculation methodology that should be viewed as pro-SEP licensee. The Court’s tendency can be seen in its repeated mention of the risk of patent hold-up for SEPs and suggestion that FRAND royalties based on end product calculations are inappropriate, absent proof that both the SEP and the standard itself relate to the functionality of the end product. Of course, what an ultimate FRAND royalty equates to in a particular case will be heavily dependent upon the facts of the case, including the comparability of prior licenses and the relative technological importance of particular patents to the functionality of the underlying standard.
For more information about the implications of the Ninth Circuit’s opinion or other FRAND licensing issues, please contact the authors or your Orrick relationship partner.