Opinion

Alison Frankel

Microsoft win in rate-setting case vs Motorola is call to litigation

By Alison Frankel
April 26, 2013

For the first time ever, a federal district judge has decided what constitutes a reasonable license rate for a portfolio of standard-essential patents. U.S. District Judge James Robart ruled late Thursday that Motorola is entitled to royalties of a half cent per unit for Microsoft’s use of standard-essential video compression patents and 3.5 cents per unit for Motorola’s wireless communication patents. According to Microsoft, those terms would require it to pay Motorola a grand total of about $1.8 million a year in royalties – a far cry indeed from the billions Motorola requested in a royalty demand to Microsoft in 2010. It’s still to be determined at a trial this summer whether Motorola breached its obligation to license its essential technology to Microsoft on reasonable terms. But make no mistake: Robart’s ruling on reasonable royalties is a dreadful outcome for Motorola and its parent, Google.

In fact, there’s a good argument that the framework Robart used to determine a fair royalty rate is bad news for all patent holders that depend on license fees for essential technology. Until the smart device wars, when Microsoft and Apple balked at Motorola’s licensing demands, product makers generally considered themselves to be at the mercy of companies that developed essential technology adopted by international standard-setting boards. Robart’s ruling, if it is eventually upheld by the 9th Circuit Court of Appeals, gives so-called implementers like Microsoft and Apple not only the methodology to whittle down patent holders’ licensing demands but also a recourse if negotiations stall. Implementers now know they can go to court and ask a judge to decide a fair royalty based on the relative value of essential patents to their final product. We’ve already seen courts and regulators blunt the threat of injunctions by holders of standard-essential patents. Robart’s decision shifts the balance of power even further away from patent holders.

To understand why, let’s run quickly through the findings in the 207-page opinion. The judge said early on that he agreed with Motorola’s lawyers at Ropes & Gray and The Summit Law Group that the best way to set a fair royalty rate would be to consider a hypothetical bilateral negotiation. He rejected Microsoft’s proposed “incremental value” approach, which would have based the value of essential patents on the cost of adopting alternative technology. But that was just about the only positive aspect of the ruling for Motorola.

Robart proceeded to analyze the relative significance of Motorola’s patents to the two standard-essential technologies at issue in the case, one involving video compression and the other wireless communication. Motorola’s role in both, Robart found, was minor. Of the thousands of contributions to each technology, Motorola was responsible for 16 patents related to the video compression standard and 24 to the standard wireless communications technology. The company presented “scant evidence” at a bench trial last November that its patents were at the core of either standard, Robart said.

Nor, he found, was Motorola’s IP at the core of any Microsoft products. Motorola’s video compression patents, the judge said, involve technology that’s increasingly irrelevant in the marketplace. (Even Google doesn’t use the Motorola tech on its Android platform or at YouTube.) And the 11 Motorola wireless communications patents incorporated in Microsoft products are only minimally important, according to the judge. Those factors would undermine the value of Motorola’s IP in a hypothetical negotiation, Robart said.

The judge said that a hypothetical negotiation would also have to take into account the issue of “patent stacking,” in which multiple holders of standard-essential patents all demand licensing fees from implementers. Patent stacking hurts consumers, Robart said, by driving up the cost of products. If every one of the 92 entities that contributed patents to the standard for wireless communications made the same licensing request of Microsoft that Motorola did, the aggregate royalty on Microsoft Xboxes would exceed the price of the devices – and wireless communication is only one feature of the Xbox. Particularly when any one patent holder’s contribution to a product is minimal – as Robart found Motorola’s to be in this case – “stacking concerns are heightened,” the judge said.

Robart acknowledged the rights of patent holders when he delved into the process of actually setting a royalty rate. Microsoft had urged him to look at fees charged by patent-licensing pools as a benchmark. Robart agreed that patent pool rates can be useful considerations, though they typically charge less than individual patent holders. But the judge said he had policy concerns with undervaluing patents. “If pool rates were held to be the most appropriate … royalty rates, (standard-essential patent) holders with valuable SEPs would be hesitant to participate in standard-setting activities and might instead try to develop proprietary standards,” Robart said. “Companies and SEP holders might not participate in the standard-setting process or contribute their patents to the standard if they believe that they will not receive full and fair value for their patents. As a result, the standards might fail to incorporate the best technology available.”

There’s no underestimating the significance of Robart’s ruling, but what you think of its long-term consequences depends on whether you side with implementers or IP developers. For the Microsofts and Apples of the world, Robart’s methodology is empowering. They have a new framework for negotiations with patent holders, and, as I mentioned, a friendly rate-setting model if those negotiations fail and they have to go to court. Judge Robart would probably argue that such an outcome is good for consumers: If product makers aren’t held hostage to patent holders, prices will be lower.

Or will they? Antitrust lawyer David Balto, a former Federal Trade Commission policy director who has represented Google (but not in this case), told me Friday that Robart’s ruling could lead technology developers to avoid sharing their intellectual property with standard-setting bodies. If they can’t charge adequate licensing fees to compensate them for the cost of developing standard-essential patents, he said, tech companies either won’t waste their time on such IP or will develop proprietary systems. “In the long term, this decision is disquieting,” Balto said.

Motorola hasn’t announced whether it intends to appeal Robart’s ruling, which will necessarily be a big part of the second phase of this case, a trial this summer to determine whether Motorola breached its obligation to license its standard-essential patents on reasonable terms. (Robart’s confusing inclusion of a range of reasonable royalties was probably in anticipation of a jury’s consideration of Motorola’s reasonableness in the upcoming trial.) Microsoft’s lawyers at Calfo Harrigan Leyh & Eakes and Sidley Austin are expected to ask for damages from Motorola based on Microsoft’s costs to ward off Motorola’s license demand, including the cost of moving an Xbox distribution center out of Germany, where Motorola had obtained an injunction against Microsoft.

It took years of trailblazing litigation to produce Robart’s monumental ruling. It’s going to take more years of interpretation to understand its full consequences.

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