This article is the first in a series on a rapidly-evolving area of patent law: determining the “reasonable and non-discriminatory” (RAND) royalty rate for licensing a standard-essential U.S. patent. RAND royalties arise when technology promulgated by a standards-setting organization (SSO), such as the Institute of Electrical and Electronics Engineers Standards Association (IEEE-SA), is accused of infringing a patent claim contended to be “essential” to practicing the standard. In Europe, they are known as fair, reasonable, and non-discriminatory (FRAND) terms, but are considered synonymous with RAND. Who is impacted by this developing area of patent law? Anyone at a company whose products incorporate standardized technology.

Technology standards proliferated rapidly over the last 20 years. For example, the IEEE 802.11 standards family for wireless local area networks, commonly branded as “Wi-Fi,” is easily the most prevalent and commercially successful technological specification. Wi-Fi enabled devices are found worldwide in computers, tablets, phones, printers, and most recently, in appliances and other devices in the home, such as thermostats, alarm systems, and even refrigerators. The emerging interconnectivity of such objects is called the Internet of Things (IoT) or Internet of Everything (IoE). Unfortunately, the marketplace dominance and ubiquity of standards-based products make them attractive targets for patent litigation, especially to non-practicing entities (NPEs), otherwise commonly known as “patent trolls.”

Standards are created by interested participants from industry and academia, who contribute ideas in committees that consider alternative proposals and ultimately select those that will ratified into the standard. During the standard-setting process, participants may propose approaches or features that are covered by a pending patent application or issued patent. Generally, SSOs require the proposer to irrevocably agree to license the patented technology on F/RAND terms if incorporated in the standard, or the patent holder can irrevocably agree that it will not enforce its patent rights against implementers and users of the standard. This agreement, called a Letter of Assurance by IEEE-SA (or an IPR Licensing Declaration by ETSI) is meant to bind the patent holder and its successors-in-interest to its promise to license the patent on F/RAND terms. The details of the promised F/RAND terms, however, are rarely, if ever determined ex ante (prior to) the ratification of the standard, to avoid anti-trust concerns. Therefore, F/RAND terms are typically determined ex post (after) ratification, and usually after a standard has enjoyed widespread adoption and commensurate commercial success. The result of widespread adoption is that technology users essentially become “locked-in” to the particular technology that has been adopted into the standard. Thus, an ex post determination of F/RAND license terms raises several practical concerns; the two primary concerns being the effects of “patent holdup” and “royalty stacking.”  

Holdup occurs when an accused infringer pays substantially more to license the patent than the actual economic contribution conferred by the patented technology, usually under threat of litigation or an injunction. Holdup is a significant problem in the standard-setting context, because after a standard has been adopted, it might be impossible or impractical to implement the standard with an alternative technology (i.e. being “locked-in” to the standard). If the cost of switching to replace the accused standardized technology is sufficiently high, the royalty demanded will likely reflect this cost, rather than the actual intrinsic value of the invention.  

Royalty stacking refers to the aggregate royalty burden that must be paid by the manufacturer of a single product that potentially infringes many patents. The royalty stack can become prohibitively large in products that incorporate one or more standards, because even a single standard might implicate several thousand purportedly standard-essential patents. If the royalty stack approaches (or exceeds) the manufacturer’s profit for the accused product, it is no longer cost-effective to make, which would suggest the royalties being demanded exceed the intrinsic value of the invention.

Thus, it is important that the F/RAND royalty for a standard-essential patent capture only the incremental value of the covered invention and not contain a premium based on holdup value. Moreover, the F/RAND royalty cannot be calculated in a vacuum, but must account for the existing royalty stack, and therefore reflects the relative contributions of other patents.

Until recently, holdup and royalty stacking were largely theoretical, as no judge or jury in the United States had set the F/RAND royalty for a patent. That changed in Microsoft Corp. v. Motorola, Inc., on April 25, 2013, when Judge Robart set the F/RAND royalty rate for Motorola’s IEEE 802.11 standard-essential patents at 3.471 cents per unit, after a bench trial that included testimony from technical and economic experts. Judge Robart broke new legal ground in reaching this result, in which the court modified traditional Georgia-Pacific factors used for years in patent cases to determine reasonable royalties.

A few months later, Judge Holderman, presiding over In re Innovatio IP Ventures, LLC Patent Litigation, set the F/RAND rate at 9.56 cents per unit for a portfolio of 17 patents that he found were standard-essential for IEEE 802.11, after two bench trials. The first bench trial concerned which of the hundreds of asserted patent claims were standard-essential, the first such proceeding in the country.

Part 2 of this series will examine the methodologies adopted by the Microsoft and Innovatio courts to determine RAND royalties and how it may impact you and your business.