On April 25, 2013, Judge James Robart in the Western District of Washington issued an unprecedented 207-page decision that marks the first time a federal judge has tried to define what constitutes a fair, reasonable, and nondiscriminatory (FRAND) royalty rate for standard-essential patents (SEPs). The decision provides a rigorous factual and legal analysis for determining a FRAND rate by modifying the factors traditionally used to determine reasonable royalty calculations in patent infringement suits and adapting that framework for the circumstances presented by patents that are essential to industry standards. If upheld, the decision is likely to have substantial implications for patent holders participating in standards as well as manufacturers who take essential patent licenses to make their products, and potentially on the prices that consumers pay for those products.

Factual Background/Case History

To facilitate interoperability among various electronic devices (e.g., computers, tablets, smartphones, televisions, cameras, appliances, etc.), companies like Microsoft and Motorola participate in standard-setting organizations that allow industries to agree on common technological protocols so that those products complying with the standards will work together. To make it easier for companies to follow these standards, the standard-setting organizations seek commitments from the owners of SEPs to license their patents to standard-users on FRAND terms. Motorola owns patents that are essential to two such standards (the H.264 video coding standard developed at the International Telecommunications Union and the 802.11 “Wi-Fi” standard developed at the IEEE Standards Association) that are used in thousands of consumer electronics products, including Microsoft’s Xbox gaming console, computers running the Windows operating system, and Microsoft’s line of smartphones. As part of the standards process, Motorola has committed to license these SEPs on FRAND terms.

In November 2010, Microsoft sued Motorola for breach of contract (as a third-party beneficiary of Motorola’s agreements with the standard-setting organizations), claiming that Motorola has an obligation to license SEPs to Microsoft at a FRAND rate and that Motorola breached its FRAND obligations by making unreasonable demands to license Motorola’s essential patents. Microsoft alleges that Motorola demanded a royalty of 2.25% on the retail price of Microsoft’s products incorporating those SEPs, which would have translated into royalty payments worth billions of dollars to Motorola. The case is captioned Microsoft Corp. v. Motorola Mobility, Inc., et al., Case No. C10-1823JLR (W.D. Wash).

The parties hotly disputed what FRAND means. Judge Robart had previously advised the parties that without a clear understanding of what FRAND means, it would be difficult or impossible to determine whether Motorola breached its underlying obligation to license its patents on FRAND terms. Thus, the court held a bench trial from November 13-20 to determine a FRAND licensing rate and a FRAND royalty range for Motorola’s patents. The decision released on April 25 is the judge’s “Findings of Fact and Conclusions of Law” following that November 2012 mini-trial to define FRAND in this context. A jury trial is scheduled in August 2013 to determine whether or not Motorola breached its FRAND obligations by seeking the 2.25% royalty rate from Microsoft.

The April 25, 2013 Decision

Judge Robart’s legal analysis starts with the existing framework for assessing FRAND terms set out in Georgia-Pacific Corp. v. United States Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970), and uses a modified version of that fifteen-factor analysis to recreate a hypothetical negotiation between the parties. Judge Robart modifies the Georgia-Pacific analysis by focusing on the importance of the SEPs to the standard and the importance of the standard and the SEPs to the product at issue. After establishing an analytical framework for assessing FRAND terms, the Court focuses on the two standards at issue, Motorola’s contributions to those standards, and Microsoft’s standard-using products. Finally, the Court weighs that information in the context of licensing transaction comparables suggested by the parties, including licensing rates for patent pools that license SEPs to pool members and third-party licensees independent of the standard-setting organizations.

Judge Robart is keenly sensitive to the problem of “royalty stacking,” which is the aggregation of royalty demands by multiple SEP holders. Judge Robart notes that there are at least 92 entities that own 802.11 SEPs, and if each of these entities sought royalties similar to Motorola’s demand, “the aggregate royalty to implement the 802.11 [Wi-Fi] Standard, which is only one feature of the Xbox product, would exceed the total product price.” See April 25, 2013 Decision at ¶ 456. To address this concern, Judge Robart takes a novel approach and concludes that the negotiation of a FRAND royalty must look beyond the licensor and licensee and to the broader context of the industry, the royalties payable to 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 patents to the standard and to the implementer’s products.” Id. at ¶ 112.

This point feeds into the key insight in Judge Robart’s valuation methodology — that a fair royalty must consider the relative value of SEPs in terms of the actual value that the licensed technology adds to the overall standard and to the products that implement that technology. Id. at ¶ 104. Judge Robart uses this basic principle to guide his detailed analysis of the relative contributions made by Motorola’s technology to the standards and the products at issue. He found Motorola’s patents contributed little to the industry standards and thus were entitled to low royalty rates.

Judge Robart agreed with Microsoft’s suggestion that patent pools can serve as useful indicators of a royalty rate that falls within the range of royalties consistent with the FRAND commitment. Id. at ¶ 508. However, Judge Robart also noted potential policy concerns with undervaluing patents by following pool rates because holders of valuable SEPs might be hesitant to participate in standard setting activities and/or develop their own proprietary standards. While stopping short of pronouncing that a pool rate itself constitutes a FRAND rate for an SEP holder who is not a member of the pool, Robart used pool rates as the basis of his royalty calculation. Ultimately, he held that Motorola is entitled to royalties of .55 cents per unit for Microsoft’s use of the video-coding SEPs and 3.5 cents per unit for the Wi-Fi SEPs — less than 1% of the royalty Motorola originally sought.

Patent holders and manufacturers will continue to monitor this case closely through the next trial phase in August and through any appellate process, as it has the potential to significantly impact multiple industries participating in the standards process and patent licensing outside of pools.