<<November 5, 2023>> This post discusses my views regarding how parties can agree on FRAND license terms. I welcome your feedback on this post. Please send your thoughts to info@justechlaw.com
For years standards essential patent (SEP) holders and standards implementers have argued about how to determine a fair, reasonable, and non-discriminatory (FRAND) royalty rate. SEP holders typically believe their SEPs are very valuable, and implementers typically believe that the SEPs are not essential, not infringed, not valid, are unenforceable, and of little value.
There are some differences when negotiating a patent license where the patent is a SEP subject to a FRAND license commitment. First, the implementer may market its products and services as conformant with the standard. In that case, if claims of the patent are truly essential, the SEP holder has an easier time proving infringement so long as the patent claim is valid and enforceable. Another difference stems from the fact that the patent owner has agreed to license the patent claims in its SEP on FRAND terms whereas no such commitment is made with respect to non-SEPs. While the definition of FRAND is hotly debated as mentioned above, most would agree that a FRAND commitment means the SEP owner cannot refuse to license one party but grant a license to that party’s competitor. For example, if I have a good business deal with Amazon to sell my products but I don’t have any business dealings with Microsoft, I probably can’t license Amazon and then refuse to license Microsoft. A SEP owner’s leverage in negotiations may be weakened by its FRAND commitment in comparison to its patents that are not subject to a FRAND commitment.
These differences, however, fade away when large portfolios that include both SEPs and non-SEPs at are issue. I refer to these portfolios as mixed portfolios. Valuing mixed portfolios is no different than valuing any other patent portfolio except that if the portfolio contains patent claims that are truly essential to a standard then at least those patent claims must be licensed to practice the standard.
With very large portfolios a reasonable assumption by both licensor and licensee is that at least some of the patents will contain claims that will be found infringed, valid and enforceable, and at least some patents will contain claims that are found not infringed, invalid, or unenforceable. For large mixed portfolios it is not practical or efficient to litigate every patent (or even the most likely candidates) due to the number of patents but also the issues involved in determining infringement, validity and enforceability. Even after accepting the possibility that not all of the patents in the portfolio are going to be infringed, valid, and enforceable, a licensor may still value its portfolio too high. Similarly, even after accepting that some of the patents are going to be infringed, valid, and enforceable, a licensee may still value the portfolio too low.
So what is a FRAND rate? At its core, it is the highest rate that a licensee can pay and still ensure that it has a profitable business opportunity. There is no one FRAND rate or formulation that will be appropriate for all. Different businesses and different products have different cost structures, distribution models, roadmaps, etc., Even when different licensees have similar businesses and products, factors such as cost, distribution models, etc. are not the same for each licensee.
As a result, different licensees may want to structure their licenses very differently meaning that the royalty base could be different, i.e., per product, per product price, per revenue generated, etc. A lower royalty rate may be charged on net sales prices or net revenues whereas a higher rate could be charged on profits. Basing the royalty rate on profits would be ideal because both parties could ensure that the royalty extracted does not render the business unprofitable.
The trade-off, however, is that most licensees are loath to disclose their costs and inefficiencies, especially indirect ones, to any third party, even under strict confidentiality obligations. Indeed, some licensees are not willing to risk a royalty audit by a licensor. In those cases, the parties may agree on fixed fees paid at some regular interval to simplify the agreement and eliminate the need for an audit.
The various royalty structure options are just a drop in the bucket as far as determining a FRAND rate. Other factors also apply especially with large mixed portfolios. For example, the licensee may get preferential treatment as an early adopter. Early adoption actually has value to the licensor because it may encourage other market entrants, i.e. future licensees, and eliminate the costs of litigation. By contrast, a party that insists on litigating every reasonable patent claim in many jurisdictions around the world should not get the same preferential rate as the early adopter. FRAND does not mean everyone gets the exact same terms.
Licensees with high volumes may be granted discounts. Licensees who agree to minimum royalties may likewise negotiate lower rates. Licensees may also agree to license or transfer certain rights to the licensor or support the licensor’s business in other ways. Those licenses too may receive better rates than licensees who don’t offer similar value to the licensor.
In addition, there are many other terms and conditions in a patent license, including SEP licenses. For example, the license could be sublicensable, transferable, or irrevocable. Any of these terms could increase the royalty. The scope of the license may extend to suppliers or downstream combinations of the licensee’s products with other products and services in the licensee’s chain of distribution. Such scope could also increase the royalty. Some parties may also insist on certain representations and warranties, indemnities, or limitations on liability. These terms could also impact the royalty. Practically every term in a patent license agreement confers value on one party or the other and as those terms are negotiated and agreed upon, they can impact the royalty rates or fees ultimately agreed upon by the parties. I can hardly think of a patent license where these terms were not part of the negotiations.
So how do parties arrive at a FRAND rate? They need to take into account all of these factors. Irrespective of how valuable the licensor believes its patents may be, that licensor has to be willing to license its portfolio to a licensee in a way that the licensee’s business is sustainable and so that it can make a reasonable profit over a realistic time period. A licensee must equally consider how much profit it can shed and still maintain its business and achieve a reasonable level of profit. That profit may be affected by license fees the licensee actually is required to pay other licensors.
Each patent portfolio license agreement is like completing a jigsaw puzzle. But there are many puzzles to choose from. Some puzzles will be missing pieces for some licensors and licensees. They have to find the puzzles they can complete. It is seldom easy, and it often takes time and multiple tries, but it feels great when the puzzle has been completed.
