Playing the Ratings Game

2.11.16

We generally take it for granted that our various technological devices can work well together. That interoperability, however, requires the often contentious negotiation of patent licenses on so-called “reasonable and nondiscriminatory (RAND)” terms.

For evidence, one need look no further than a recent decision by the U.S. Court of Appeals for the Ninth Circuit regarding the proper rate Microsoft must pay another tech company to use its ubiquitous patented technology. The case, Microsoft Corp. v. Motorola Inc., provides valuable guidance on how such RAND rates should be set.

SSOs and SEPs

Standard-setting organizations (SSOs) set technical specifications ensuring that a variety of products from different manufacturers operate compatibly. Because SSO standards often incorporate patented technology, all manufacturers that implement a standard must obtain a license to use those standard-essential patents (SEPs).

Once a standard becomes widely adopted, SEP holders have substantial leverage over product developers who need their SEP technologies. To mitigate the risk of SEP holders exploiting this leverage, many SSOs require SEP holders to agree to license their patents on RAND terms. SEP holders can’t refuse a license to a manufacturer that commits to paying the RAND rate.

Breaches of contract

Motorola held two SEP portfolios, which it offered to license to Microsoft at a rate of 2.25% of the selling price of the end products that would use the patented technology. Microsoft responded by filing a breach of contract lawsuit against Motorola, contending that the company had breached its RAND commitment.

Motorola then sought an injunction stopping Microsoft from using some of its SEPs. Microsoft subsequently amended its complaint to allege that seeking the injunction constituted a breach of contract because an obligation to offer RAND licenses to all seekers prohibited Motorola from seeking injunctions for violations of patents subject to that obligation.

The trial court determined that Motorola’s RAND commitment created an enforceable contract that standard users such as Microsoft could enforce. It also found that a jury needed to know the appropriate RAND rate before it could determine whether Motorola had breached its commitment. After hearing testimony, the court settled on RAND rates that were significantly lower than those demanded by Motorola.

When the case went to a jury, Microsoft was allowed to introduce the RAND rates. The jury awarded Microsoft $14.5 million, and Motorola appealed.

The great rate debate

On appeal, Motorola contested the trial court’s RAND rate analysis. The lower court had adopted a framework intended to approximate the royalty rates that the parties would have agreed to in a hypothetical negotiation.

Motorola’s primary challenge to the court’s analysis focused on the court’s interpretation of the Georgia-Pacific factors. (These are 15 factors that courts use to determine a royalty rate the parties might have agreed to in a hypothetical negotiation.) The 15th factor directs courts to set the hypothetical negotiation at “the time the infringement began.”

The appeals court agreed that the trial court had, to an extent, taken into account the present-day value to Microsoft of Motorola’s patents. It pointed out, though, that the Federal Circuit has “never described the Georgia-Pacific factors as a talisman for royalty rate calculations.” In fact, the Federal Circuit has actually cited the trial court’s opinion on appeal to support the proposition that many Georgia-Pacific factors are contrary to RAND principles.

Microsoft argued that Motorola’s breach was ongoing because Motorola had maintained its 2.25% rate demand throughout the case. In light of this, the appeals court concluded that it was reasonable for the trial court to include the present-day value of the SEPs as a factor in calculating the RAND rate for use in a breach of contract proceeding.

The appeals court also endorsed the trial court’s reliance on two patent pools (collections of two or more SEP owners that package and license their SEPs collectively) as relevant indicators of the RAND rate, rather than Motorola’s historical licenses. It found that the pools were sufficiently similar to RAND agreements, while the historical licenses either encompassed much more than the SEPs at issue or were entered under threat of litigation.

Failure of the factors

The appeals court’s decision upheld the trial court’s analysis. Now both the Ninth and Federal Circuits have rejected strict adherence to the Georgia-Pacific factors in a RAND context. So if you find yourself in a similar legal conflict, expect a court to take a more flexible approach based on the circumstances.