What has to be paid for implementing standard essential patents?

The first attempt of a European court to determine a FRAND rate

In the Internet of Things (IoT) networking between products based on patented technical standards is required for example, for the transfer and processing of data. Under European competition law, the users of such standards generally have access to the underlying standard essential patents (so-called SEPs). However, this access is not usually granted for free, but only under royalty bearing licence agreements, which must be offered by SEP owners before the patent is enforced under fair, reasonable and non- discriminatory conditions, commonly known as “FRAND” terms. Recent case law, such as the European Court of Justice’s (ECJ) decision in the case Huawei vs. ZTE, defined a procedure which must be observed by SEP owners on the one hand and the implementers of the standard on the other hand when using or enforcing standard essential patents. The ECJ left open however the question of how a FRAND royalty actually has to be determined. Since the question concerning the calculation of the FRAND-compliant royalty rate will be at least as important to players in the IoT sector in the future as it already is to those in the smartphone sector, it is already worth having already a look into the recent case law dealing with FRAND rate determination in order to be prepared for upcoming discussions and disputes.

There have been a number of subsequent decisions taken by the Member States’ courts of lower instances. These, however, either rejected motions for injunctive relief because the SEP owner had failed to offer a FRAND licence before enforcing the SEPs, or they granted injunctive relief, if the implementer was not willing to enter into a FRAND license at all or applied delaying tactics. The German courts in particular avoided clearly expressing their opinions on the FRAND rate and its calculation. The German approach only seems to be clear regarding the opinion that FRAND is not only a specific rate, but a range. Moreover, German courts seem to be more open to the so-called “comparables approach” than to the so-called “top down approach” (the difference between these approaches will be explained in more detail below). Irrespective of that, it is still highly controversial whether or not an offer complies with FRAND terms and how the FRAND rate has to be calculated.

Therefore, the English High Court’s recent decision in Unwired Planet vs. Huawei ([2017] EWHC 711 (Pat)) received much attention, since it is the first decision in which a court in Europe provided a specific calculation of a FRAND rate. The decision was based on a dispute between the smartphone manufacturer Huawei and Unwired Planet, the owner of several patents regarded as essential to the standards relating to 2G/GSM, 3G/UMTS and 4G/LTE.

In order to determine whether the injunctive relief sought was to be granted or not, the High Court determined the FRAND rate for each of the three patent portfolios of Unwired Planet by developing a relatively complex calculation, which was based on the following general assumptions:

  • There shall be regionally dependent FRAND rates for so-called “Main Markets” for e.g. Germany, UK and US on the one hand, and so-called “Other Markets” as well as China on the other hand (reduction by 50%).
  • Just one specific rate shall be FRAND, rather than a range (as assumed to be FRAND by German courts).
  • The High Court made use of the “comparables approach” (Vergleichsmarktkonzept), which means comparing licence agreements already concluded by Unwired Planet or its predecessor with respect to the portfolios in question (similar to the basic approach of German courts).
  • With regard to the selection of these “comparables”, it shall be less important whether the licensee is a “similarly situated company“, but may be more relevant whether specific (subjective) circumstances influenced the terms of a licence contract. In this particular case, the High Court disregarded a recent licence contract concluded by Unwired Planet because it had apparently been entered into by Unwired Planet in a situation of financial distress.

Based on these assumptions, the High Court identified several “comparables”, i.e. allegedly comparable licence agreements, and developed a method of calculation which shall be summarized below (to give a clear overview of the calculation steps developed by the High Court, the following calculations are explained on the basis of the figures used to calculate the rate for handsets at 4G/LTE standard):

According to the High Court, the calculation starts with the identification of the average royalty rates which had been agreed upon for the portfolios. Based on the rates agreed on in previous predecessor’s contracts, the High Court identified an average licence rate of 0.80% for the 4G/LTE standard portfolios.

Comparable Licence Rate = 0.80%

Based on this, the High Court tried to determine the actually “reasonable” rate per patent. In a first step, this required a comparison of the number of patents in accordance with the “comparable” licence agreements with the total number of SEPs (on the basis of patent families). However, already the way of counting the total number of SEPs was highly controversial between the parties. Huawei counted 1812 SEPs, Unwired Planet counted a total number of merely 335 SEPs, and the High Court finally considered both methods for determining the number of SEPs as insufficient. Rather than that, it used a method for simplification (which seems to be difficult to justify on a legal basis) by dividing the number provided by Huawei in half and doubling the number provided by Unwired Planet, with a result of 906 to 710 SEPs, out of which the (approximate) mean value of 800 SEPs was identified.

SEPs in the 4G/LTE standard = ((1812/2) + (335*2)) / 2 = 800 (rounded up)

After that, the High Court compared this (hypothetical) number with the number of patents in the “comparables” portfolios as well as with the numbers of the portfolios of Unwired Planet. According to the considerations of the High Court, this resulted in a share of 0.70% for Unwired Planet in the total number of SEPs in the standard.

Share of Unwired Planet = 6/800 = 0.70%

Based on this number, the High Court tried to determine the ratio between the “comparables’” share of the total number of SEPs in the standard and the Share of Unwired Planet, which resulted in a relative value of 7.69%.

Value of the Unwired Planet’s Portfolio = Share of Unwired Planet / Share of Comparables = 7.69%

According to the High Court, this should then allow the calculation of the so-called “Benchmark FRAND Rate”, i.e. the very specific rate to which Unwired Planet should be generally entitled. For this purpose,
the High Court set the Comparable Licence Rate, i.e. the licence rate of the “comparables” in relation to the Value of Unwired Planet’s Portfolio.

Benchmark FRAND Rate = Comparable Licence Rate * Value of the Unwired Planet’s Portfolio = 0.80 * 7.69% = 0.62%

This Benchmark FRAND Rate was then multiplied by the percentage ratio of the actually validated SEPs in the Major Markets (5 in the 4G/LTE standard) against the total portfolio of the Unwired Planet portfolio (6 in the 4G/LTE standard), resulting in the final Rate for MM:

Rate for MM = Benchmark FRAND Rate * (SEP average MM / SEP Unwired Planet) = 0.062% * (5 / 6) = 0.062% * 0.83 = 0.051%

However these were not the High Court’s final considerations. Moreover, the court also asserted specific regional aspects as relevant regarding the determination of a worldwide FRAND rates. For this purpose, the High Court was of the opinion that the determined Benchmark FRAND Rate may only be used for so- called “Major Markets” (MM) with a strong patent coverage, i.e., particularly for Germany, France, the UK, the US, Japan, and India. However, in particular with regard to China the “comparables” clearly showed significantly lower rates than for the MM so that the High Court came to the conclusion that only 50% of the general Benchmark FRAND Rate shall apply for China (the so-called “China Benchmark”).

China Benchmark = Benchmark FRAND Rate * 50% = 0.031%

Finally, this China Benchmark rate was then multiplied by the percentage ratio of the actually validated SEPs in China (5 in the 4G/LTE standard) against the total portfolio of the Unwired Planet portfolio (6 in the 4G/LTE standard), resulting in the final “Rate for China”.

Rate for China = China Benchmark * (SEP China / SEP Unwired Planet) = 0.31% * (5 / 6) = 0.031% * 0.83 = 0.026%

According to the High Court, these reduced rates shall also apply to the so-called “other markets” (OM), which are identified as not being as important as the MM because of a lower number of patents validated respectively.

Rate for OM = Rate for China = 0.026%

Thus, according to the previously described calculation method, the High Court alleged the following royalty rates as FRAND for Unwired Planet’s SEP portfolios in dispute (2G/GSM, 3G/UMTS, 4G/LTE):

Major Markets China and Other Markets

Handsets

Infrastructure Handsets Infrastructure
2G/GSM 0.064% 0.064% 0.016% 0.032%
4G/LTE 0.052% 0.051% 0.026% 0.026%

In meantime, Huawei considered these rates as being too high and therefore lodged an appeal, without entering into a licence agreement with Unwired Planet. Hence, the High Court granted the injunctive relief, but stayed the enforcement until the decision of the Court of Appeal.

Therefore, it will be interesting to see how the Court of Appeal’s response will be regarding the determination of the FRAND rate and whether the High Court’s calculation method will actually be upheld. In any case, it can be assumed that German courts will not adopt this approach due to several reasons. In any case, companies who want to participate in the IoT business should be aware of the different approaches and the developments regarding the question of how to (allegedly) calculate FRAND rates in order to be prepared for an appropriate reaction.