[David J. Kappos] The *Real* Innovation Economy—Myth Number 2: FRAND is Broken
Below is the second of nine serialized essays examining current debates over technology, standards and standard-essential patents (SEPs) aimed at educating readers about an area of law and economics that is increasingly in the news. This essay has been adapted from a speech Mr. Kappos, former director of the U.S. Patent and Trademark Office and U.S. Undersecretary of Commerce, delivered in Taiwan in March at the International Symposium on Standards, SEPs and Competition Laws.
David J. Kappos,
former director of the USPTO
[email protected]
Myth number two claims that FRAND is broken. One of the better legal acronyms, FRAND stands for “Fair, Reasonable, and Non-Discriminatory,” and is a licensing obligation to which SSOs commonly require that members agree in order to participate in the standard-setting process.
“Fair” means pro-competitive (not in violation of competition laws such as tying or bundling); “Reasonable” refers to a reasonable royalty and “Non-discriminatory” means that each licensee is treated similarly.
The myth contends that: (1) FRAND licensing is not working because SEPs set royalties too high; (2) the creation of SSOs has decreased the effectiveness of FRAND regimes; and (3) in order to “fix” FRAND, public disclosure of license terms in private agreements between commercial parties should be required.
The truth is that FRAND is a powerful tool by which SSOs discourage holdup. FRAND maintains balanced royalty rates that appropriately address the monetary interests of both innovators and implementers. Mythtellers have attacked SEP owners by citing litigation in which courts have determined royalty rates that are lower than the SEP owners’ original offer.
However, these voices fail to acknowledge that the courts have invoked the SEP-holder’s commitment to FRAND licensing in order to calculate an appropriate rate. FRAND thus obviates the need for overbearing regulatory intervention, which would disrupt the efficiency of the market. FRAND commitments are treated by courts as enforceable contracts with implementers as third-party beneficiaries.
The knowledge of this practice alone serves to regulate patent holders’ behavior in licensing negotiations. In this way, FRAND has worked exactly as intended. It has both guided the vast majority of SEPs to operate in a manner that avoids holdup and also provided courts with an efficient and effective mechanism to correct errant SEP actions.
For example, in Huawei Technologies v. ZTE Corporation, the Court of Justice of the European Union (“ECJ”) established a strict but balanced practical framework to govern SEP disputes concerning FRAND licenses. The ECJ’s framework neither favors nor eliminates automatic injunctions. Instead, the Huawei ruling requires both the SEP owner and the alleged infringer to behave in an objectively reasonable fashion.
ECJ
Next, the SEP owner must provide a written offer for a license on FRAND terms. The alleged infringer must then respond in good faith and in a timely fashion, either accepting the SEP owner’s offer or promptly submitting a written FRAND-compliant counteroffer.
Finally, if the SEP owner rejects a counteroffer, the alleged infringer must provide security for the payment of royalties and accounts of usage of the SEP in question.
Recently, a Düsseldorf court applied the ECJ’s Huawei framework in a German case, Sisvel v. Haier. The court validated that Sisvel, the SEP owner, adequately informed Haier of its alleged infringement and offered a FRAND-compliant license before rejecting Haier’s counteroffer in good faith. Completing the Huawei analysis, the court granted an injunction because Haier failed to provide accounting information for their use of the SEP and security for the payment of royalties within one month of the rejection of their counteroffer.
As is demonstrated by the German court’s application, the ECJ’s equitable framework does not let either party “off the hook,” nor does it assume that either party is automatically a “bad guy.” It also wisely avoids sending a message to innovators that their patents will not be rendered ironically worthless by nature of being declared essential to a standard.
Returning to the claims of the mythtellers who contend that FRAND is broken, the myth holds that public disclosure of patent license terms would increase market competitiveness. The truth is that, by proper and prudent design, FRAND does not require that all licensees receive identical terms, only that they be treated in the same manner.
It would be no injustice that a person pays full price for one computer while a business buying fifty computers receives a bulk discount. Fairness is found in the fact that the person, if she wanted to buy fifty computers, would be entitled to the same discount.
FRAND “fairness” works the same way: license terms can, should and do vary based on the nature of the parties involved and their business relationship. This flexibility is crucial in business dealings.
Commercial transactions have operated in the shadow of information asymmetry for all of time. Requiring disclosure of license terms would expose both innovators and implementers to the competitive abuses that occur whenever opponents have access to one another’s pricing information and other sensitive terms. Fair arm’s-length negotiations require that business agreements remain confidential. Policymakers should be tremendously wary when asked to break sound, longstanding business principles.
The truth is that the current system is highly effective at balancing the interests of each stakeholder because SSOs compete against each other for important constituents and for the development of commercially successful standards. This leads to an incentive for SSOs to adopt FRAND regimes that discourage opportunistic behavior and maximize value for all constituents—licensors and licensees alike. For example, a patent owner that attempts to extort implementers would likely find their next round of technology shunned by the technical working group, and potentially even other SSOs.
Furthermore, parties on both sides of the negotiation have significant long-term incentives to reach a reasonable license agreement rather than relying on ex post facto damages. Licensing agreements are multidimensional instruments. They create long-term relationships and establish the rights, remedies and incentives necessary to support long-term innovation pipelines. To become a reality, a new idea requires financing, product development, design, testing, manufacturing, marketing and sales, among other functions. Versatile capability networks are required to bring inventions from conception to commercialization. The contracts and relationships that establish crucial innovation networks provide employees with skilled jobs, organizations with valuable human capital and business partners with specialized services such as research, engineering, manufacturing, marketing, and distribution.
Accordingly, no damage award can replace the range of benefits provided by multifaceted licensing relationships. Monetary remedies are no substitute for an experienced network of trusted partners offering advanced business capabilities that can be leveraged over time to support further innovation.
[David J. Kappos] The *Real* Innovation Economy—Myth Number 2: FRAND is Broken
