The second judicial determination of F/RAND rates

by Nicole Daniel

On 27 September 2013 the second judicial determination – after Judge Robart’s ruling in Microsoft v Motorola – on F/RAND royalty rates was handed down by Judge Holderman.

Innovatio IP Ventures LLC owns several patents essential to the 802.11 standard, i.e. Wi-Fi, and had originally filed a lawsuit against several respondents like coffee shops, restaurants and hotels using wireless internet access internally or offering it to customers. This was followed by a suits seeking declaratory judgment against a number of manufacturers of electronic devices, like Motorola, Hewlett-Packard and NetGear. These respondents allege that no infringement took place and that Innovatio’s patents were invalid. Innovatio in turn claimed that the plaintiff’s devices infringed its SEPs.

The parties waived their right to a jury determination of damages and agreed with the court to assess potential damages first before determining the validity of the SEPs and alleged infringements.

The 89-page opinion by Judge Holderman sets out a fact-specific and evidence-based approach to determine the royalty rate for RANDs:

  1. The Framework

At first Judge Holderman reviewed Judge Robart’s method which is based on the simulation of a hypothetical negotiation between the owner of a SEP and a potential licensee at the time when the infringement started. Judge Holderman identified the relevant Georgia Pacific factors, modified them and described a three-step process where a judge has to evaluate

(i)    the importance of the patent portfolio to the standard,

(ii)   the importance of the patent portfolio as a whole to the products of the alleged infringer and

(iii)  other licencing agreements which are potentially comparable.

Then the court modified this methodology to fit the specific facts of the case at hand. Firstly, in contrast to Microsoft v. Motorola, where a RAND range for further consideration by a jury was set, the court defined a single F/RAND rate for calculating the damages. Secondly, the F/RAND rate was not adjusted to take account of the pre-litigation uncertainty regarding the essentiality of the patent in question, since it was already determined in a separate proceeding that the patents in question were standard-essential. Thirdly, the court decided to use the Wi-Fi chip as the basis for calculating the royalty and not the end products. Accordingly, it was not necessary to determine the importance of Innovatio’s patent portfolio to the alleged infringers’ products.

Judge Holderman also considered some of the issues commonly surrounding the determination of F/RAND royalty rates, namely hold-up, royalty stacking and reverse hold-up.

He concluded that “patent hold-up is a substantial problem that RAND is designed to prevent” and that the RAND rate must “reflect only the value of the underlying technology and not the hold-up value of standardization”. The ease with which a patent can be adopted into a standard is part of its intrinsic value and this should be taken into account when determining a royalty rate.

Judge Holderman also wrote that courts should ensure that “the asserted patents are not overvalued compared to the technological contribution they make to the standard. Furthermore, the overall royalty rates for SEPs included in the standard do not prevent its widespread application. Using numeric proportionality to assess F/RAND rates was rejected.

The court did not give special consideration to reverse hold-up “beyond what it receives in a typical patent case”.

The date for the hypothetical negotiation was set to 1997, i.e. the date of adoption of the 802.11 standard.

  1. The calculation methodology

The parties disagreed on the methodology to determine the royalty rate. Innovatio argued that the RAND royalty should be calculated based upon

(i)    the average selling price of the products manufactured by the accused infringers discounted by the “Wi-Fi Feature Factor” accounting for the value of the product attributed to the Wi-Fi functionality Fi and

(ii)   a 6% licensing rate based upon allegedly comparable licenses.

The manufacturers on the other hand argued that the appropriate base is the weighted average selling price of Wi-Fi chips, which provide the 802.11 functionality to the products in question. They further argued for using a top down approach equal to

(i)    the weighted average selling price of Wi-Fi chips,

(ii)   multiplied by the industry average profitability of Wi-Fi chipmakers and further

(iii)  multiplied by one of the ratios proposed, depending on the court’s determination of the technological importance of the patents.

The court rejected Innovatio’s calculation method and went for the top down approach. However, it adjusted the formula from the weighted average chip price to the average price of a Wi-Fi chip over the life of Innovatio’s patents. The court further found Innovatio’s analysis, especially as the “Wi-Fi Factor”, to be unreliable, “speculative and subjective”.

  1. The courts’ application of the top down approach

The court applied the top down as follows:

(i)    It identified the average price of a Wi-Fi chip from 1997 to 2013, the average profit margin and the total number of patents essential to the 802.11 standard.

(ii)   Then it assessed the value of Innovatio’s portfolio to the standard in relation to the other SEPs. They “are likely among to top 10% of all patents essential to the 802.11 standard” since “84% of the value in electronics patents is found in the top 10% of electronics patents”.

(iii)  It then multiplied the average chip price by the profit margin to identify the average profit. The average profit was then multiplied by the value attributable by the top 10% of the 802.11 SEP. The result was then divided by the number of essential patents included in the top 10%. The resulting pro-patent share was then multiplied by the number of patents included in Innovatio’s portfolio.

The result was 9.56 cents per Wi-Fi chip. According to the court this royalty rate is within Judge Robart’s range for a RAND rate and the difference to the rate set for Motorola’s patents was justified due to the moderate to moderately-high importance to the standard of Innovatio’s patents. Motorola’s patents only provided for minimal value to the standard.