Last week, Judge Gilstrap ruled that Ericsson’s end-product-based “offers to HTC–$2.50 or 1% with a $1 floor and a $4 cap per 4G device–were fair, reasonable and non-discriminatory.” Judge Gilstrap found that the comparable licenses presented by Ericsson to be “the best market-based evidence” of the value of Ericsson’s standard essential patents (SEPs) and that “the market evidence, in the form of comparable licenses, has failed to embrace HTC’s preferred SSPPU [smallest salable patent-practicing unit] methodology.” He noted that there was no evidence that industry licenses are negotiated based on the cost of a baseband chip (the alleged smallest saleable patent practicing unit or SSPPU) and evidence showed that the value of SEPs can exceed the value of the chip, which price does not include the cost if that intellectual property. This SEP cases is one of the closest to capturing what actually happens in the licensing market with FRAND-committed SEPS, rather than generating new litigation-based theories on valuing SEPs (e.g., top-down analysis). This decision also is at odds in many respects with the decision by Judge Selna in the TCL v. Ericsson case that currently is on appeal at the Federal Circuit (see our Jan. 3, 2018 post summarizing that decision).
The European Telecommunications Standards Institute (ETSI) enacts cellular standards, including 2G, 3G and 4G standards. ETSI has intellectual property rights (IPR) policies concerning patents that are essential to the standard–i.e., it is not technically possible to practice the standard without infringing the patent. If a participant in ETSI owns a patent they believe may be essential to the standard, then they are required to identify the patent and indicate whether it is willing to license the patent on fair, reasonable and non-discriminatory (FRAND) terms. Such a declaration has been deemed to create a contract between the patent owner and ETSI where those who implement the standard are third-party beneficiaries of that contract.
HTC is a Taiwanese company that designs, makes and sells mobile devices implementing 2G, 3G and 4G standards. HTC is a member of ETSI and submitted declarations that it owns and is willing to license SEPs on 2G, 3G and 4G standards.
Ericsson is Swedish company that makes and sells base stations, software and services implementing those standards. Ericsson is a member of ETSI and filed declarations that it would license its 2G, 3G and 4G SEPs on FRAND terms under ETSI’s IPR Policy.
Ericsson and HTC entered cross-license agreements on their SEPs in 2003, 2008 and 2014. The last license expired in 2016 and the parties reached an impasse in negotiating a renewed license. In December 2016, Ericsson offered a license at a rate of $2.50 per 4G device; HTC rejected that offer and counter-offered $0.10 per 4G device. Later, while the instant case was pending, Ericsson offered a license at 1% the net price of HTC’s end product device with a $1 floor and a $4 cap. Both of those offers remain open.
On April 6 2017, HTC filed this suit against Ericsson alleging that Ericsson breached its commitment to license its SEPs on FRAND terms. Ericsson counterclaimed for a declaration that Ericsson did comply with its FRAND commitment. A jury trial was held on HTC’s claim and the jury determined that HTC had not shown by a preponderance of the evidence that Ericsson had breached its FRAND commitment. Judge Gilstrap then considered Ericsson’s claim seeking a declaration that it complied with its FRAND commitment.
Both HTC and Ericsson agreed to be bound by Judge Gilstrap’s adjudication of the FRAND issue. Judge Gilstrap ruled there remained a justiciable case and controversy between the parties, as required to have subject matter jurisdiction to enter this declaratory judgment, because the parties continued to dispute whether Ericsson complied with its FRAND commitment notwithstanding the jury verdict that HTC had not proven breach.
Further, Judge Gilstrap found that there was substantial overlap between the factual issues tried before the jury on HTC’s breach of FRAND claim and Ericsson’s declaratory judgment request here that it did not breach its FRAND commitment. Judge Gilstrap found that substantial evidence supported the jury’s verdict and, even absent that verdict, his independent review of the evidence would lead him to conclude that Ericsson complied with its FRAND commitment.
ETSI IPR Policy
The ETSI IPR policy is governed by French law where, as a contractual matter, HTC as an implenter of the ETSI standards is a third-party beneficiary of Ericsson’s FRAND contract with ETSI and is entitled to enforce that contract. Further, Judge Gilstrap previously ruled that ETSI’s IPR policy does not require licensing based on the smallest saleable patent-practicing unit (SSPPU), but depends on the facts of a particular case with no prescribed methodology:
[A]s a matter of French law, the FRAND commitment embodied in the ETSI IPR policy does not require a FRAND license to be based on the SSPPU. Rather, whether a license meets the requirements of FRAND will depend on the particular facts of the case, as there is no prescribed methodology for calculating a FRAND license.
Further, Judge Gilstrap ruled that, under French law, an SEP-owner satisfies its FRAND commitment by “either (1) offer a FRAND license, or (2) negotiate in good faith towards a FRAND license.” The jury determined that neither HTC nor Ericsson had negotiated in good faith towards a FRAND license. But Ericsson still would have complied with its FRAND commitment if it had “offer[ed] a FRAND license,” which Judge Gilstrap will determine here.
Smallest Saleable Patent Practicing Unit (SSPPU)
HTC’s assertion that Ericsson breached its FRAND-commitment primarily was premised on whether “Ericsson should have based its royalty calculation on the smallest saleable patent practicing unit, or SSPPU, contained in a cellular device, which HTC submitted was the baseband processor.” HTC argued that licensing based on the SSPPU (i.e., baseband chip) was required to apportion out features that were not related to the cellular connection, and proposed that Ericsson receive a few cents per device based on the profit margin for the chips:
HTC argued that, due to the proliferation of features in modern smartphones that are not related to cellular connectivity and as a matter of economics, the royalty should be based on the baseband processor in order to apportion out the value of features not related to the cellular connection.
At trial, HTC asserted that a portion of the profit margin of a baseband processor was the cash flow available for payment of license fees, and that, as a result, the aggregate royalty for all essential patent holders should be between $0.19 and $1.22 per 4G device. Based on HTC’s calculations of Ericsson’s share of patents compared to the industry, HTC claimed that under its SSPPU approach, Ericsson’s royalty should be between $0.01 and $0.08 per 4G device.
In response, Ericsson argued that the profit margin on a component of a device, such as the baseband chip, may not represent the value of the intellectual property embodied in that device, “especially in a situation like the one presented here where the component supplier does not pay royalties for that intellectual property.”
Judge Gilstrap found that “the market-based evidence offered by Ericsson at trial shows that customers value cellular technology more highly than HTC suggests”, including “evidence that consumers are willing to pay more than $100 to add cellular functionality to regular Wi-Fi enabled tablets”:
The market-based evidence of the value of cellular belies HTC’s suggestion that the entire value of the cellular technology [based on profits on the baseband chip component] is between $0.19 and $1.22 and demonstrates the reasonableness of Ericsson’s proposed royalty rates of $2.50 or 1% with a $1 floor and a $4 cap per 4G device.
Judge Gilstrap further stated that it was disputed whether the baseband chip was the SSPPU, because several SEPs patent claims required components other than the baseband chip–e.g., “antennas, RF switches, baseband filters, low-noise amplifies, and duplexers”–and patent claims were directed to the entire “mobile terminal” or “user equipment”, not just the baseband chip.
Finally, Judge Gilstrap considered evidence of the actual industry practice of licensing at the end product level, not baseband chip component level, stating:
The Court views the rates contained in licenses as highly probative, given the sophistication of the market and the amount of resources and time that the industry devotes to negotiations. Ericsson established, and HTC’s own experts conceded, that there are no examples in the industry of licenses that have been negotiated based on the profit margin, or even the cost, of a baseband processor. HTC’s license expert … was unable to identify a single industry license based on the profit margin of a chip.
Based on the foregoing, Judge Gilstrap ruled that there was sufficient and credible evidence for the jury to reject HTC’s SSPPU approach:
Specifically, Ericsson presented credible evidence (i) that the profit margin, or even the cost, of the baseband processor is not reflective of the value conferred by Ericsson’s cellular essential patents, (ii) that Ericsson’s patents are not limited in claim scope to a baseband processor, and as a result, even if one were to indulge HTC’s approach, the baseband processor is not the proper SSPPU, and (iii) that the market evidence, in the form of comparable licenses, has failed to embrace HTC’s preferred SSPPU methdology.
Judge Gilstrap found that “the comparable licenses provide the best market-based evidence of the value of Ericsson’s SEPs and that Ericsson’s reliance on comparable licenses is a reliable method of establishing” rates “consistent with its FRAND commitment. Ericsson presented evidence of its SEP licenses with Apple, BLU, Coolpad, Doro, Fujitsu, Huawei, Kyocera, LG, Panasonic, Samsung, Sharp, Sony and ZTE. Judge Gilstrap found that Ericsson’s other licenses have “running royalty terms that are either similar or substantially similar to the rates Ericsson offered to HTC.” There also was evidence of HTC’s SEP licenses with Apple, Nokia and NTT DoCoMo. Ericsson argued that its offers to HTC “were consistent with the vast majority” of all of those licenses.
HTC argued that Ericsson’s offers were discriminatory based on licenses or license offers to Apple, Samsung, Huawei, LG, TCL and ZTE. Ericsson argued that those licenses did not show discrimination because (1) many were with large manufacturers with large up-front royalties “which are particularly different than running royalty rate agreements” and (2) several companies “had a different geographical scope of sales, and therefore not similarly situated to HTC.”
Judge Gilstrap found that many of the comparable licenses had non-royalty terms that provided value, but were difficult to value as a one-way royalty:
Many comparable licenses included terms, such as cross-license provisions and lump sum payments, that required economic analysis to translate into an effective, one-way royalty rate. For example, nearly all of Ericsson’s licenses are structured as cross-licenses, under which Ericsson obtains license to implement its licensee’s patents in its own cellular infrastructure products. The cross-license represents, in many cases, significant value to Ericsson, the amount of which depends on the strength of the patents for which Ericsson receives a cross-license. In contrast, HTC’s essential 4G patents are entitled to little cross-licensing value, because HTC granted a royalty free license to Ericsson before trial.
Based on the foregoing, Judge Gilstrap found that “the only reasonable inference that can be drawn from the verdict is that the jury necessarily rejected HTC’s arguments that Ericsson’s offers resulted in discrimination against HTC.”
Judge Gilstrap therefore found that “based on the whole of Ericsson’s submitted comparable licenses, both of Ericsson’s offers to HTC–$2.50 or 1% with a $1 floor and a $4 cap per 4G device–were fair, reasonable, and non-discriminatory.” Accordingly, he declared that “Ericsson complied with its FRAND assurance to HTC, as set forth in its IPR licensing declarations to ETSI and the ETSI IPR policy.”