Landmark Court Opinion Provides Guidance in Determining RAND Royalties for Standard-Essential Patents

by Orrick, Herrington & Sutcliffe LLP

On April 25, 2013, U.S. District Judge James Robart (W.D. Wash.) issued a much-anticipated opinion in a dispute between Microsoft Corporation (“Microsoft”) and Motorola, Inc., Motorola Mobility, Inc., and General Instrument Corporation (collectively, “Motorola”). The opinion calculated reasonable and non-discriminatory (“RAND”) royalty rates and ranges for certain Motorola standard-essential patents (“SEPs”) used by Microsoft. It is the first time a court has calculated RAND royalties in a dispute involving SEPs. Judge Robart’s decision provides guidance for future RAND disputes, especially in regards to valuing the patented technology, royalty stacking and selecting comparable licenses.

Executive Summary

The court developed a legal framework for resolving RAND disputes, and made several pronouncements regarding the value of SEPs where a RAND commitment exists. According to Judge Robart, in the RAND context, SEPs are valued:

  • Separately from the value associated with incorporation of the patented technology into the standard;
  • In light of the contribution of the patented technology to the capabilities of the standard, and the contribution of those relevant technical capabilities to the licensee and its products;
  • Considering the alternatives that could have been written into the standard instead of the patented technology;
  • Apart from license agreements that resolved disputes not involving standards-compliant products, or licenses entered into after pending or imminent litigation; and
  • Relative to the overall licensing landscape relating to the standard and the licensee’s products.

Background of Dispute

Motorola owns patents that it claims are essential to two standards at issue in this dispute: the H.264 Standard (video compression) and the 802.11 Standard (wireless communication). A SEP is a patent for a technical standard adopted by an industry standard-setting organization (“SSO”). In return for their patents being included in the technical standard, SSOs generally require members to promise to license any SEPs on RAND terms. The purpose of a RAND 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 (i.e., patent hold-up).   

In October 2010, Motorola sent Microsoft two letters offering to license its SEPs for 2.25 percent of the price of the end product incorporating each standard. In response, Microsoft sued Motorola for breach of contract, alleging that Motorola’s license offer—which Microsoft claimed amounted to over $4 billion per year—was in breach of Motorola’s obligation to license its SEPs on RAND terms.

In prior rulings in the case, Judge Robart held that: (1) Motorola’s RAND commitments created enforceable contracts between it and the SSOs; (2) as an implementer of those standards, Microsoft is a third-party beneficiary with enforceable contract rights; and (3) although Motorola’s initial license offers did not have to satisfy RAND, those license offers had to have been made in good faith. Accordingly, the purpose of the court’s recent opinion was to establish a RAND rate and range in order to enable a fact-finder in a later trial to determine whether Motorola’s offer letters to Microsoft breached its obligation to offer to license its SEPs in good faith.

Summary of Opinion

The court held that the proper framework for determining RAND royalties is a modified version of the 15 Georgia-Pacific1 patent damages factors to re-create a hypothetical negotiation between the parties. Specifically, the court concluded that many of the Georgia-Pacific factors needed to be revised in a RAND scenario in order to account for: (a) the importance of the SEPs to the standard; (b) the importance of the standard and the SEPs to the licensee’s products; (c) licenses for other RAND-committed patents; and (d) the number of other patents covering the standard/products (i.e., royalty-stacking).

The court then analyzed each standard and Motorola’s respective SEPs, and determined each patent’s relative importance to the standard and to Microsoft’s products. The court also reviewed the various license agreements and patent pools submitted by the parties as comparable benchmarks for the SEPs in dispute. After examining the evidence, the court set the following RAND royalty rates for Motorola’s SEPs:

  • Motorola’s H.264 SEP portfolio: 0.555 cents per unit, with a RAND royalty range of 0.555 cents per unit to 16.389 cents per unit.
  • Motorola’s 802.11 SEP portfolio: 3.471 cents per unit, with a RAND royalty range of 0.8 cents per unit to 19.5 cents per unit.

Microsoft has since announced that the product royalties resulting from Judge Robart’s decision are approximately $1.8 million per year, or less than one-twentieth of a percent of Motorola’s initial demands. 

Implications of the Opinion for Future RAND Disputes

Although Judge Robart’s opinion is fact specific in nature, its underlying methodology and application likely will serve as a roadmap for future RAND disputes. In addition to being the first U.S. decision to calculate RAND royalties, the 207-page opinion addresses several important policy issues concerning RAND disputes. As a result, it provides a legal framework and useful guidance for parties and courts to follow in determining RAND rates. 

Modifications to Georgia-Pacific Factors. Judge Robart concluded that three of the 15 Georgia-Pacific factors are inapplicable, and nine of the remaining factors need to be modified, to take into account a SEP owner’s RAND commitment. Although a detailed analysis of those modifications is beyond the scope of this alert, several important adjustments warrant mention:  

  • When considering royalties paid by other entities for the SEPs in dispute (factor 1) or customary licensing practices (factor 12), any benchmark licenses relied upon must have been negotiated under a RAND obligation or comparable negotiation. Thus, license agreements that resolved disputes not involving standards-compliant products, or licenses entered into after pending or imminent litigation, are not comparable benchmarks, even if those licenses are for the same patents as the SEPs in dispute.
  • When examining the importance of the patented invention to both the licensor’s and licensee’s sales and profits (factors 6 and 8), the character and benefits of the invention (factor 10), the extent to which the invention is used (factor 11), and the portion of realizable profit attributable to the patent (factor 13), one must consider the value of the patented technology apart from the value associated with incorporation of the patented technology into the standard. This was based on the court’s recognition that incorporation of a patented technology into a standard likely increases its value above that provided by the technology covered by the patent.  
  • When evaluating the importance of the patented invention (factors 6 and 8) and the monetary amounts the licensor and licensee would have agreed upon after good-faith negotiations (factor 15), one must consider: (a) the contribution of the patented technology to the capabilities of the standard; and (b) the contribution of those relevant technical capabilities to the licensee and its products. This also requires assessing the extent to which the patented technology, as opposed to non-patented technology in the standard or other differentiating features, drives product sales. Thus, one would expect downward pressure on RAND royalties in a hypothetical negotiation involving SEPs that provide little benefit to the standard relative to other technology contributions, or which provide little benefit to products implementing the standard relative to other product features.
  • When considering the utility and advantages of the patent over the old modes or devices that had been used for working out similar results (factor 9), one must consider alternatives that could have been written into the standard instead of the patented technology. Again, this suggests downward pressure on RAND royalties in situations where the SSO could have adopted alternative technologies to the SEPs in dispute. 

Royalty Stacking. A recurring concern throughout Judge Robart’s opinion is royalty stacking. In many technology standards (including the 802.11 and H.264 standards at issue in the dispute) dozens of SSO members own patents that they have declared essential to the standard.2 If each of those entities pursue similar royalties, the aggregate royalty could make up a large portion—or even exceed—the total product price and thus impede adoption of the standard. Thus, Judge Robart held that a proper methodology for determining RAND royalties must address the risk of royalty stacking by considering the overall licensing landscape relating to the standard and the licensee’s products. “[A] RAND negotiation would not occur in a vacuum. The parties would consider other SEP holders and the royalty rate that each of these patent holders might seek from the implementer based on the importance of these other [SEPs] to the standard and the implementer’s products.”  (Opinion at ¶ 112.)

Patent Pools. Finally, Judge Robart concluded that patent pools3 may serve as an important benchmark in calculating RAND royalties. While certain factors of patent pools led Judge Robart to decline adopting pools as the de facto royalty benchmark in RAND disputes, he nonetheless concluded some patent pools “closely align with all the purposes of the RAND commitment” (Opinion at ¶ 508), and, in such situations, can serve as indicators of RAND royalties. When relying on patent pools as benchmarks, however, Judge Robart adjusted the resulting royalty to account for the patent protection that resulted from cross-licenses obtained as part of the pool. 

For more information about the implications of Judge Robart’s opinion or other RAND licensing issues, please contact the authors or your Orrick relationship partner.

1. See Georgia-Pacific Corp. v. United States Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970).
2. For example, at least 92 entities own patents declared to be essential to the 802.11 standard, and at least 52 entities own patents declared essential to the H.264 standard.
3. Patent pools are devices, separate from SSOs, in which two or more SEP owners voluntarily license their patents to implementers in a single package and distribute the royalties between pool members.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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