Yesterday the Federal Circuit issued its long-awaited Ericsson v. D-Link decision that reviewed the Judge Davis jury verdict award for RAND-obligated 802.11 standard essential patents (see our Aug. 7, 2013 post).   The Federal Circuit eschews any per se rules for RAND-obligated patents–e.g., no set modified Georgia-Pacific analysis–and instructs the court to fashion damages instructions to the specific circumstances and evidence presented in a particular case.  The Federal Circuit summarized its decision as follows, and remanded the case for further consideration consistent with its decision:

In sum, we hold that, in all cases, a district court must instruct the jury only on factors that are relevant to the specific case at issue.  There is no Georgia-Pacific-like list of factors that district courts can parrot for every case involving RAND-encumbered patents.  The court should instruct the jury on the actual RAND commitment at issue and must be cautious not to instruct the jury on any factors that are not relevant to the record developed at trial.  We further hold that district courts must make clear to the jury that any royalty award must be based on the incremental value of the invention, not the value of the standard as a whole or any increased value the patented feature gains from its inclusion in the standard.  We also conclude that, if an accused infringer wants an instruction on patent hold-up and royalty stacking, it must provide evidence on the record of patent hold-up and royalty stacking in relation to both the RAND commitment at issue and the specific technology referenced therein.

Note that the court’s reference to “the incremental value of the invention” refers to apportioning the value of the invention to the accused product from other non-patented features and was not referring to the different  concept of the incremental value of the invention over a non-infringing alternative, which was not raised in this case.

This is a significant decision worth reading given its impact on  patent damages generally–e.g., clarifying the entire market value rule and applicability of Georgia-Pacific factors–as well as the specific impact in litigating royalties for RAND-encumbered patents.  A summary of the decision is provided below with generous excerpts from the decision itself given the importance thereof.

This is generally a patent friendly ruling that may increase the value of standard essential patents given the court’s rejection of some bright line rules that had been propounded that may have generally lowered the value of such patents — e.g., arguments to apply a one-size fits all RAND analysis to the smallest salable patent practicing unit based on public policy concerns beyond the actual circumstances of the case and RAND commitment that the patent owner made to the standard setting body.

Background

Ericsson sued D-Link and others in E.D. Texas for infringing patents alleged to be essential to the IEEE 802.11(n) WiFi standard.  The case ultimately was tried to a jury that found three patents infringed and awarded $10 million in damages, which was roughly 15 cents per infringing device.  Judge Davis sustained the jury verdict, from which this appeal followed.

Technical Standards Background.  The Federal Circuit explained the general background for industry technical standards based on an example user in a coffee shop being able to plug her laptop into the wall using a standard plug shape with standard voltage and being able to connect to the Internet through the coffee shop’s wireless network using standard protocols for wireless signal frequency, message formats, etc.  The standards are needed to ensure compatibility given the many different devices and device manufacturers.  Thus standard development organizations (“SDOs”) publish technical standards to ensure compatibility if the standard is adopted by “a critical mass of device developers.”  The standard at issue here is the Institute of Electrical and Electronics Engineers, Inc. (“IEEE”) 802.11(n) “Wi-Fi” wireless standard.

Developing the standard is a collaborative process of many different entities that may include technology covered by different patents.  The Federal Circuit defines such “standard essential patents” as follows:

Because the standard requires that devices utilize specific technology, compliant devices necessarily infringe certain claims in patents that cover technology incorporated into the standard.  These patents are called “standard essential patents” (“SEPs”). [citing IEEE Amicus Br. 13-14]

The Federal Circuit also described two  ”potential concerns” of patent hold-up and royalty stacking that the RAND-obligation seeks to address, stating:

SEPs pose two potential problems that could inhibit widespread adoption of the standard: patent hold-up and royalty stacking.  Patent hold-up exists when the holder of a SEP demands excessive royalties after companies are locked into using a standard.  Royalty stacking can arise when a standard implicates numerous patents, perhaps hundreds, if not thousands.  If companies are forced to pay royalties to all SEP holders, the royalties will “stack” on top of each other and may become excessive in the aggregate.  To help alleviate these potential concerns, SDOs often seek assurances from patent owners before publishing the standard.  IEEE, for example, asks SEP owners to pledge that they will grant licenses to an unrestricted number of applicants on “reasonable, and non-discriminatory” (“RAND”) terms. [emphasis added; citing IEEE Amicus Br. at 16-18].

In this case, patent owner Ericsson submitted letters of assurance to the IEEE that promised to offer licenses for all of its 802.11(n) SEPs on reasonable and non-discriminatory terms (“RAND”).  Specifically, Ericsson pledged to “grant a license under reasonable rates to an unrestricted number of applicants on a worldwide basis with reasonable terms and conditions that are demonstrably free of unfair discrimination.”  The parties agreed that Ericsson was bound by this commitment for the three asserted SEPs.

The ’568 Patent.  The asserted ’568 Patent is directed to having a data packet header field that identifies what type of data is in the data packet–e.g., voice, video or data.  This allows packets to be prioritized for when to transmit them over limited bandwidth, such as giving a higher priority to real-time voice or video data that suffer from transmission delay more than other types of data, such as downloading a file.  This patent was alleged to cover the 802.11(n) traffic identifier (“TID”) field used in a data packet header to indicate the priority level of the data in the packet.

The ’215 Patent.  The asserted ’215 Patent concerns a particular way of sending an “Automatic Repeat Request” (“ARQ”) to indicate what packets were not received so that the sending device will resend them.  In the ’215 Patent, a new “type identifier field” (“TIF”) is provided to indicate what format the ARQ field is in–e.g., is the ARQ simply the identification number of a missing packet or is it special coded bit-sequence denoting several missed packets.  This patent was asserted to cover the 802.11(n) “Multi-TID subfield” of the packet header that indicates what type of feedback response is in the “BlockAck” field of the header.

The ’625 Patent.  The asserted ’625 Patent concerns a way for the transmitting device to tell the receiving device that it does not need to wait for specific packets it may have missed during a data reception window (which would cause the receiving device to reject all other incoming packets), but to keep moving forward its data reception window to accept all transmitted packets.  This is helpful for certain types of data, such as real-time voice or video data, where it may be better to keep the conversation going rather than get stalled waiting for missed packets.  In contrast, for other types of data it may be important to receive all sent packets, such as in downloading a file so that you ultimately receive an exact copy of that file.  This patent was asserted against the 802.11(n) requirement that all packets should be received without using a reception window.

Accused Products.  The accused products include laptop computers and routers (“the end products”) that used 802.11(n)-compliant wireless chips made by Intel.

District Court Proceedings.  In 2010, Ericsson brought suit in E.D. Texas asserting nine patents alleged to be essential to 802.11(n).  Intel, who supplied the WiFi chip for the products, intervened.  At trial, Ericsson asserted five patents.  The jury found that the three patents above were infringed and awarded $10 million in past damages–about 15 cents per infringing device.  Judge Davis then had a bench trial on some RAND issues and ruled on JMOL motions that ultimately sustained the jury verdict (see our Aug. 7, 2013 post).

Federal Circuit Decision

Judge O’Malley authored the opinion, joined by Judge Taranto (except for a non-RAND issue) and Judge Hughes.

Infringement/Validity.  The Federal Circuit first went through challenges that the patents were not infringed or were invalid.  The Federal Circuit ruled substantial evidence supported the jury finding that the ’568 and ’215 Patents were infringed, but reversed the finding of infringement of the ’625 patent.  This included an interesting issue for the ’568 Patent concerning the Fantasy Sports line of cases dealing with whether there is infringement by a device simply because it is capable of performing a function even if there is little evidence that the claimed function is actually used, stating:

In sum, when the asserted claims recite capability, our case law supports finding infringement by a “reasonably capable” accused device on a case-by-case basis particularly where, as here, there is evidence that the accused device is actually used in an infringing manner and can be so used without significant alterations.

This may be a common issue for standard essential patents, because standards often have optional features that end products ultimately may not use, but must have the capability if they are to be deemed standard compliant–e.g., must be compliant to put the WiFi logo on the box.

The Federal Circuit also ruled that substantial evidence supported the jury’s verdict that the ’625 Patent was not invalid, which appears to be the only invalidity challenge on appeal.

Entire Market Value Rule (“EMVR”).  With respect to damages, the Federal Circuit first considered D-Link’s challenge to Ericsson’s damages expert relying on licenses tied to the entire value of the licensed product, rather than the smallest salable patent practicing unit within the licensed product, where Ericsson did not dispute that the patent claims are practiced entirely within the Wi-Fi chips that are components within the end products.  The Federal Circuit described the EMVR as having two separate parts: (1) a “substantive legal rule” that the “ultimate reasonable royalty”–i.e., combination royalty rate and royalty base–”must be based on the incremental value that the patented invention adds to the end products”; and (2) an “evidentiary principle”  applied to the choice of the royalty base that is intended “to help our jury system reliably implement” the substantive legal rule of apportionment.  The Federal Circuit explained this latter evidentiary principle as follows:

The principle, as applicable specifically to the choice of a royalty base, is that, where a multi-component product is at issue and the patented feature is not the item which imbues the combination of the other features with value, care must be taken to avoid misleading the jury by placing undue emphasis on the value of the entire product.  It is not that an appropriately apportioned royalty award could never be fashioned by starting with the entire market value of a multi-component product–by, for instance, dramatically reducing the royalty rate to be applied in those cases–it is that reliance on the entire market value might mislead the jury, who may be less equipped to understand the extent to which the royalty rate would need to do the work in such instances.  Thus, where the entire value of a machine as a marketable article is “properly and legally attributable to the patented feature,” the damages owed to the patentee may be calculated by reference to that value.  Where it is not, however, courts must insist on a more realistic starting point for the royalty calculations by juries–often, the smallest salable unit and, at times, even less.

The Federal Circuit ruled there was no error in allowing expert testimony on the challenged licenses at issue here.  Following its rationale in VirnetX (see our Sep. 17, 2014 post) that concerned comparable licenses in general, the Federal Circuit ruled that any concerns about the licenses proffered here go to the weight, and not admissibility, of those licenses:

This court has recognized that licenses may be presented to the jury to help the jury decide an appropriate royalty award.  Prior licenses, however, are almost never perfectly analogous to the infringement action.  For example, allegedly comparable licenses may cover more patents than are at issue in the action, including cross-licensing terms, cover foreign intellectual property rights, or, as here, be calculated as some percentage of the value of a multi-component product.  Testimony relying on licenses must account for such distinguishing facts when invoking them to value the patented invention.  Recognizing that constraint, however, the fact that a license is not perfectly analogous generally goes to the weight of the evidence, not its admissibility.  In each case, district courts must assess the extent to which the proffered testimony, evidence, and arguments would skew unfairly the jury’s ability to apportion the damages to account only for the value attributable to the infringing features.

The Federal Circuit also noted the practical issue that licenses generally are negotiated without considering the EMVR (e.g., smallest salable patent practicing unit), so too strict a rule on admissibility could preclude reliance on any actual real-world licenses, often deemed the best indication of what are reasonable licensing terms:

As the testimony at trial established, licenses are generally negotiated without consideration of the EMVR, and this was specifically true with respect to the Ericsson licenses relating to the technology at issue.  Makring real world, relevant licenses inadmissible on the grounds D-Link urges would often make it impossible for a patentee to resort to license-based evidence.  Such evidence is relevant and reliable, however, where the damages testimony regarding those license takes into account the very types of apportionment principles contemplated by Garretson [v. Clark, 111 U.S. 120, 121 (1884)).  In short, where expert testimony explains to the jury the need to discount reliance on a given license to account only for the value attributed to the licensed technology, as it did here, the mere fact that licenses predicated on the value of a multi-component product are referenced in that analysis--and the district court exercises its discretion not to exclude the evidence--is not reversible error.

The Federal Circuit, however, did counsel district courts to give cautionary instructions if requested and explain the importance of apportionment:

We do conclude, however, that, when licenses based on the value of a multi-component product are admitted, or even referenced in expert testimony, the court should give a cautionary instruction regarding the limited purposes for which such testimony is proffered if the accused infringer requests the instruction.  The court should also ensure that the instructions fully explain the need to apportion the ultimate royalty award to the incremental value of the patented feature from the overall product.

The Federal Circuit noted that simply relying on Georgia-Pacific factors--e.g., factors 9 and 13 that allude to apportionment--is not enough, but a separate instruction should be used in future cases.

The Federal Circuit also ruled that D-Link had waived its challenge to Ericsson's counsel having referred to the total cost of the laptop when discussing the royalty rate.  D-Link had only objected to the licenses (not the counsel statement), referred to its end product value itself during cross-examination and did not raise the issue in post-trial motions.

The Federal Circuit's ruling here on the entire market value rule should provide significant guidance on the "smallest salable patent practicing unit" debate for patents in general, as well as for standard essential patents.  Recall that in other SEP litigations involving the 802.11 WiFi standard, a dispute has been whether the royalty base should be the end product or the WiFi chip component within that end product.  For example, in Innovatio, Judge Holderman used the WiFi chip as the royalty base given a failure of proof by the patent holder to apportion value of the invention to the end product.  InCSIRO, Judge Davis used the end product as the royalty base because limiting the base to the cost of the WiFi chip would not capture the value of the patented technology.

The Federal Circuit's emphasis on the Rule 403 jury prejudice "evidentiary principle" also may provide guidance on application of the entire market value rule.  For example, both the Innovatio andCSIRO cases were bench trials in which Rule 403 prejudice concerns are less prevalent and, thus, might tend to allow more flexibility in referring to the end product as the royalty base, rather than the smallest salable patent practicing unit.  Further, the Rule 403 evidentiary principle is not an issue in actual, arms-length licensing negotiations between sophisticated market participants.  So actual negotiated licenses for RAND-encumbered patents may properly refer to the end product as the royalty base even though that might be precluded under a Rule 403 evidentiary basis in litigating the RAND rate before a jury on those same patents.  Such a disconnect between reasonable real-world practices and packaging a case for the jury may be problematic where the jury is asked to consider whether a RAND commitment was breached based on the license terms offered in actual negotiations (where the Rule 403 evidentiary principle is not applied) and the litigated RAND rate (where the Rule 403 evidentiary principle may be applied).

No Per Se RAND-Specific Modified Georgia-Pacific Analysis.  The Federal Circuit considered the issue of an appropriate RAND royalty rate "an issue of first impression", stating knowledge of only three other district court decisions on the issue: Judge Robart's Microsoft v. Motorola decision (on appeal to the Ninth Circuit), Judge Holderman's Innovatio decision (settled) and Judge Whyte'sRealtek v. LSI jury decision (on appeal to the Ninth Circuit).  If you follow our blog, you know there is also a Judge Davis bench trial decision in CSIRO v. Cisco (see our July 28, 2014 post).

At the outset, the Federal Circuit cautioned about over-reliance on all factors enumerated in Georgia-Pacific, even when not all factors are relevant:

Although we have never described the Georgia-Pacific factors as a talisman for royalty rate calculations, district courts regularly turn to this 15-factor list when fashioning their jury instructions.  Indeed, courts often parrot all 15 factors to the jury, even if some of those factors clearly are not relevant to the case at hand.  And, often, damages experts resort to the factors to justify urging an increase or a decrease in a royalty calculation, with little explanation as to why they do so, and little reference to the facts of record.

The Federal Circuit explained that many Georgia-Pacific factors are not applicable to RAND-encumbered patents, stating:

For example, factor 4 is "[t]he licensor’s established policy and marketing program to maintain his patent monopoly by not licensing others to use the invention or by granting licenses under special conditions designed to preserve that monopoly.”  Because of Ericsson’s RAND commitment, however, it cannot have that kind of policy for maintaining a patent monopoly.  Likewise, factor 5–”[t]he commercial relationship between the licensor and licensee”–is irrelevant because Ericsson must offer licenses at a non-discriminatory rate.

Several other Georgia-Pacific factors would at least need to be adjusted for RAND-encumbered patents–indeed, for SEP patents generally.  For example, factor 8accounts for an invention’s “current popularity,” which is likely inflated because a standard requires the use of the technology.  Factor 9–”utility and advantages of the patented invention over the old modes or devices”–is also skewed for SEPs because the technology is used because it is essential, not necessarily because it is an improvement over the prior art.  Factor 10, moreover, considers the commercial embodiment of the licensor, which is also irrelevant as the standard requires the use of the technology. [emphasis added]

Thus the district court erred by giving the jury instructions on Georgia-Pacific factors that were not relevant, “including, at least, factors 4, 5, 8, 9 and 10.”  The Federal Circuit noted that referencing irrelevant factors alone may not be reversible error, but remand in this case will be necessary anyway given other errors.  Further, the Federal Circuit explained that the specific jury instructions should be tailored to the specific facts and circumstances of the case, finding it “unwise” to have a single modified Georgia-Pacific rule specific to all RAND-encumbered patents:

To be clear, we do not hold that there is a modified version of the Georgia-Pacificfactors that should be used for all RAND-encumbered patents.  Indeed, to the extent D-Link argues that the trial court was required to give instructions that mirrored the analysis in Innovatio or Microsoft, we specifically reject that argument.  We believe it is unwise to create a new set of Georgia-Pacific-like factors for all cases involving RAND-encumbered patents.  Although we recognize the desire for bright line rules and the need for district courts to start somewhere, courts must consider the facts of record when instructing the jury and should avoid rote reference to any particular damages formula.

The Federal Circuit’s ruling here, thus, gives significance guidance in all cases on use of theGeorgia-Pacific factors in general and the need to tailor jury instructions to the specific circumstances and evidence presented.  And it plainly rejects rote application of a modified Georgia-Pacific analysis to SEPs.  Rather, as with other patents, determining a RAND royalty rate will depend on the specific evidence presented in that particular case.

Consider Actual RAND Commitment.  Consistent with the focus on the actual facts and circumstances presented by the particular case, the Federal Circuit explained that the district court erred by generally instructing the jury to consider Ericsson’s RAND obligations, rather than instructing the jury about what those specific RAND obligations were, stating:

Trial court’s should also consider the patentee’s actual RAND commitment in crafting the jury instructions. … The district court should have turned to the actual RAND commitment at issue to determine how to instruct the jury.  In this case, Ericsson promised that it would “grant a license under reasonable rates to an unrestricted number of applicants on a worldwide basis with reasonable terms and conditions that are demonstrably free of unfair discrimination.”  Rather than instruct the jury to consider “Ericsson’s obligation to license its technology on RAND terms,” the trial court should have instructed the jury about Ericsson’s actual RAND promises.  ”RAND terms” vary from case to case.  A RAND commitment limits the market value to (what the patent owner can reasonably charge for use of) the patented technology.  The court therefore must inform the jury what commitments have been made and of its obligation (not just option) to take those commitments into account when determining a royalty award. [emphasis in original]

The Federal Circuit’s decision here thus brings the focus more on what the patent owner actually committed to do, rather than on some general public policy of what a RAND commitment should be.

Apportionment.  The Federal Circuit considered two special apportionment issues for SEPs:

First, the patented feature must be apportioned from all of the unpatented features reflected in the standard.  Second, the patentee’s royalty must be premised on the value of the patented feature, not any value added by the standard’s adoption of the patented technology.  These steps are necessary to ensure that the royalty award is based on the incremental value that the patented invention adds to the product, not any value added by the standardization of that technology. [emphasis in original]

The Federal Circuit noted that this may not be a precise science and “the jury should be told of its obligation to approximate the value added by the patented invention and that a degree of uncertainty in setting that value is permissible.”  Also worth noting is that the Federal Circuit’s reference to “the incremental value that the patented invention adds to the product” should not be confused with the “incremental value” the patented invention has over non-infringing alternatives, which is a totally different issue not discussed in this opinion.

The Federal Circuit noted that, in this case, the patented functionality of the two infringed patents were directed to only a small portion of the 802.11(n) standard and that some 802.11(n)-compliant end products do not use that functionality.  This is similar to computing damages for patents that cover only a small part of a device, and the jury should be instructed accordingly:

Just as we apportion damages for a patent that covers a small part of a device, we must also apportion damages for SEPs that cover only a small part of a standard.  In other words, a royalty award for a SEP must be apportioned to the value of the patented invention (or at least to the approximate value thereof), not the value of the standard as a whole.  A jury must be instructed accordingly.  … [I]f a patentee can show that his invention makes up “the entire value of the” standard, an apportionment instruction probably would not be appropriate.

***

Because SEP holders should only be compensated for the added benefit of their inventions, the jury must be told to differentiate the added benefit from any value the innovation gains because it has become standard essential.

The Federal Circuit used the Realtek court’s jury instruction as illustrative of this point, where the jury was instructed it “should not consider LSI’s advantage resulting from the standard’s adoption, if any.  However, you may consider any advantage resulting from the technology’s superiority.”

The Federal Circuit’s ruling here leaves some ambiguity in how to apply it.  The general purpose in apportioning the value of the patent to the standard appears to be a check that patented technology making only a nominal contribution to the standard does not improperly capture the value of the entire standard simply because the technology is in the standard.  But, of course, the ultimate issue to a licensee is the value of the patented technology to the licensed product, which product may not use or need all functionality provided by the standard.  For example, encryption of the WiFi signal may be important to some products that may be used in public places to protect the transmitted information, but may not be important to other products that use their own encryption scheme.  That was the case  in the Microsoft v. Motorola case that led Judge Robart to attribute little value to encryption patents for the Xbox products that did their own encryption for transmissions from the Xbox all the way through the WiFi connection and Internet to a remote server.  Judge Robart also had weighed the value of those patents to the standard itself, but it was not clear how that actually was applied in the case and the more controlling determination appeared to be the value to the licensed product, as is typically the case for all patents.  So it is not clear how a jury is to apply apportioning the value of the patent to the standard itself–in conjunction with apportioning the value of the patent to the accused product–beyond a rough check  that value is not being attributed to the mere fact that the patented technology is in the standard.

Need Evidence of Patent Hold-Up/Royalty Stacking.  The Federal Circuit agreed with the district court’s decision not to instruct the jury on patent hold-up or royalty stacking because there was no evidence of either.  Absent such evidence, an instruction would not be “necessary nor appropriate”:

In deciding whether to instruct the jury on patent hold-up and royalty stacking, again, we emphasize that the district court must consider the evidence on the record before it.  The district court need not instruct the jury on hold-up or stacking unless the accused infringer presents actual evidence of hold-up or stacking.  Certainly something more than a general argument that these phenomena are possibilities is necessary.  Indeed, “a court should not instruct on a proposition of law about which there is no competent evidence.”  Depending on the record, reference to such potential dangers may be neither necessary nor appropriate.

The Federal Circuit ruled there was no evidence of patent hold-up here, such as a showing that the patent holder started seeking higher royalty rates after the 802.11(n) standard was adopted.  Further, there was no evidence of royalty-stacking here, where D-Link did not present any evidence of other licenses it had taken under 802.11 patents: “The mere fact that thousands of patents are declared to be essential to a standard does not mean that a standard-compliant company will necessarily have to pay a royalty to each SEP holder.”

On this latter point, its worth noting that patent owners typically do not declare patents “to be essential to a standard”; rather, they typically submit letters of assurances or declarations that they will license the patent on RAND or other terms if the patent ends up being essential to the standard.  This is a practical issue, such as letters of assurance often are submitted before the standard is finalized so one may not know what the adopted standard will cover or there may be disagreements or uncertainty as to what a particular patent actually may cover (some patents alleged to be essential to a standard often are found not to be in litigation).

Hypothetical Negotiation Date.  The Federal Circuit noted that it was not addressing the date of the hypothetical negotiation–i.e., whether it should be at the time the standard was adopted or the time of infringement–because D-Link did not request such a jury instruction.  This goes to the issue whether non-infringing alternatives may include alternatives available at the time that the standard was adopted, as was considered by Judge Robart in Microsoft v. Motorola and Judge Holderman inInnovatio (modified to consider only alternatives that the SDO actually considered).

Reversed and Remanded.  Given the various errors identified above, the Federal Circuit vacated the RAND determination and remanded the case back to the district court for further proceedings consistent with the decision.