One of the most relevant and challenging issues in the intellectual property valuation and damages world today relates to determining fair, reasonable, and non-discriminatory (FRAND) licensing terms for standard essential patents (SEPs). The issue is currently of particular interest to, and being addressed by, SEP owners, standards implementers, patent pools/platforms, courts, government organizations, lawyers, economists, accountants, damages experts, valuation professionals, academics, and others. From our knowledge and experience, FRAND licensing terms are determined for a variety of purposes, including:
Because different stakeholders in different jurisdictions are attempting to calculate FRAND licensing terms in different contexts, there is a great deal of information that currently exists regarding potentially appropriate methodologies. Herein, we attempt to distill all of this information to help stakeholders consider at least some of the various options available.
The following is a list of the most frequently used methodologies that may be appropriate for determining FRAND licensing terms for SEPs:
Often, these methodologies are considered as part of the hypothetical negotiation framework used for determining a reasonable royalty for patent infringement litigation matters as articulated in Georgia-Pacific v. United States Plywood Corp.
This list of methodologies has been culled from a variety of sources, including traditional valuation approaches; approaches accepted, and/or utilized, by judges and juries; and/or economic rationale. While this list considers many sources and perspectives, it is not a comprehensive list of all possible methodologies. In other words, there may be other methods that can be reliably used to determine FRAND licensing terms for SEPs. Importantly, each of the identified methods may or may not be applicable to any specific determination of FRAND licensing terms. Instead, the methods from the list that may be applicable to a particular context will be based on the facts and circumstances relevant to any particular FRAND royalty rate determination, potentially including available information, the relevant technical standard, and the purpose of the exercise. Furthermore, depending on the particular facts and circumstances, certain methods may be more or less reliable than others.
Our goal here is to simply identify and define, at a high level, the various methods that may be relevant to determining FRAND licensing terms. Each method has its own unique data requirements, as well as theoretical and implementation challenges, that we do not necessarily address or at least do not address at the level of detail required for a reliable implementation.
For the purposes of the methodology descriptions below, the term “Subject SEP” will refer to the specific SEPs for which the analysis is being performed.
The Subject SEP Transaction Method refers to a Market Approach for which one or more past arm’s-length transactions, including the Subject SEP, are used as a basis for determining FRAND licensing terms. A Market Approach refers to a variety of methods for the determination of values or licensing terms based on the prices or licensing terms paid for assets considered to be comparable to the Subject SEP.
As an example, if the Subject SEP were licensed to an unrelated party for 2% of the net sales of the products incorporating the patented technology, then 2% of the net sales may be a starting point for determining a FRAND royalty rate for the Subject SEP. However, given the facts and circumstances associated with the comparable transaction, the 2% royalty rate may need to be adjusted to be consistent with a FRAND commitment.
In more challenging implementations of the Subject SEP Transaction Method than that described above, the Subject SEP is only one patent within a portfolio of patents that are licensed. In this context, the royalty rate found in the comparable transaction would need to be apportioned or "unpacked" to determine the FRAND royalty rate specifically relevant to the Subject SEP. This particular set of facts and circumstances is consistent with the method used, at least in part, by Ericsson’s damages expert in the Ericsson v. D-Link, et al.patent infringement matter in which a RAND royalty rate was determined for Ericsson patents that were essential to the 802.11(n) (i.e., Wi-Fi) standard. The implementation of this method in the Ericsson v. D-Link, et al. matter survived scrutiny by the defendants at both the District Court and Federal Circuit.
Another set of facts and circumstances that may make determining a FRAND running royalty rate (e.g., percent of revenue or dollar per unit) for the Subject SEP challenging is when the comparable past transaction has lump sum payment licensing terms such as upfront, milestone, or earn-out payments. In this scenario, the lump sum payments may need to be converted to running royalty terms.
The Comparable Asset Transaction Method is a Market Approach that is virtually identical to the Subject SEP Transaction Method. However, instead of relying on one or more past arm’s-length transactions that included the Subject SEP, the relevant transactions include other patents that are considered comparable to the Subject SEP. This method may be challenging to implement due to the potential difficulty in supporting the contention that the Subject SEP and the potentially comparable assets are, in fact, comparable. As one example, because patents are inherently unique, it is sometimes challenging to support a contention of comparability between different assets. Despite this and potentially other challenges, the Comparable Asset Transaction Method has been used successfully in various contexts.
The Publicized Rates Method is a Market Approach for which publicized offered rates for the licensing of comparable SEP portfolios are used as a basis to determine a FRAND royalty rate. This method is a variant of the Comparable Asset Transaction Method in the sense that it relies on royalty rates for what can be argued to be comparable assets. The aspect of this method that differentiates it from the Comparable Asset Transaction Method is that the Publicized Rates Method specifically relies on royalty rates that have been offered to potential licensees instead of royalty rates that have actually been agreed to between unrelated parties in an actual transaction.
All else being equal, publicized offered rates for patents considered to be comparable to the Subject SEP may overestimate a FRAND royalty rate because rates offered by licensors are typically a starting point for negotiations with potential licensees and the royalty rate ultimately agreed to is typically lower than the initial offered rate. This is a feature of virtually all negotiations between unrelated parties and is not particularly unique to patents or SEPs in particular. Despite this issue, if the publicized offered rates relate to patents that are encumbered by a FRAND commitment, they may still arguably be consistent with FRAND because FRAND commitments often require licensors to start negotiations with offers that are believed to be FRAND. Even if the publicized rates are considered higher than FRAND, it may be possible to make adjustments to the offered rates to account for this issue.
The Patent Pool Method is a Market Approach for which licensing terms for SEP pools/platforms that contain comparable assets are used as a basis to determine FRAND licensing terms for the Subject SEP. Generally, a patent pool aggregates SEPs relevant to a particular standard and offers a license in a single licensing package to implementers of the standard. Patent pools generally distribute royalties on a per-patent basis, meaning that each SEP receives equal compensation without regard to the technology or its incremental contribution to the standard. That notwithstanding, the Patent Pool Method can serve as an indicator of a royalty rate that is FRAND, depending on the characteristics of the patent pool, including: when the pool was developed; the number of SEPs included in the pool; the technologies covered by the SEPs and their contribution to the technical standard; and the number of licensees to the pool, among others. This method was implemented by Judge James Robart in the Microsoft v. Motorola SEP contract dispute litigation matter in the Western District of Washington.
The Top-Down Method is performed by estimating an aggregate royalty burden for all of the SEPs related to a particular standard and then apportioning that aggregate royalty burden to the Subject SEP. This method typically requires the implementation of a valuation method to first determine an appropriate aggregate royalty burden that is consistent with FRAND and also the ability to estimate the total number of patents that are essential to the relevant standard. Implementation of this method has often been performed assuming that all SEPs related to a particular standard are equally valuable because it is challenging to accurately quantify differences in value among what are typically large amounts of patents. This method was relied upon in both the TCL v. Ericsson and the Unwired Planet litigation matters.
A somewhat unique implementation of the Top-Down Method was performed by Judge James Holderman in the Northern District of Illinois in the In re Innovatio litigation matter relating to damages for patents essential to the Wi-Fi standard. Judge Holderman’s implementation used the profit of a chip-set as the aggregate royalty burden and, unlike in the TCL v. Ericsson and Unwired Planet matters, did not assume that all SEPs were equally valuable.
The Incremental Economic Value Method (IEVM) is an Income Approach that uses an estimate of the incremental economic benefits obtained by the licensee resulting from the use of the Subject SEP as a basis for determining FRAND licensing terms. This method often focuses on estimating the incremental income earned by the licensee from use of the Subject SEP through factors such as:
Importantly, an appropriate implementation of the IEVM must be sure to focus solely on the incremental economic benefits associated with the Subject SEP and must exclude any economic benefits that are attributable to the relevant standard itself and realized from the Subject SEP’s inclusion in the standard. The IEVM is sometimes implemented as part of a Top-Down Method for which the IEVM is used to determine an aggregate royalty burden for all or a group of SEPs that are a part of a particular standard. In other implementations, the IEVM can be used to directly measure the value of the Subject SEP.
The Non-Infringing Alternatives Method refers to a Cost Approach for determining FRAND licensing terms. A Cost Approach refers to a variety of methods for the determination of values or licensing terms based on the costs that would be incurred by the buyer/licensee of the Subject SEP to design around the Subject SEP such that the resulting technology would:
The implementation of this method is challenging because it requires the identification of the acceptable, non-infringing alternatives, which may not exist.
For many purposes, a best practice is to consider, test, and implement as many methods as possible based on those that would be appropriate considering the facts and circumstances of the particular effort, including the purpose/context, jurisdiction, available information, and other relevant factors. To the extent multiple methods are reliably implemented, the FRAND conclusion may be articulated as a range, or judgement may be used to conclude on a single set of licensing terms.