Saturday, March 31, 2012

These two charts show that Motorola's royalty demands for standard-essential patents are way out of line

Late on Friday (March 30, 2012), Microsoft and Motorola Mobility each brought a motion for partial summary judgment on certain issues relevant to their dispute in the Western District of Washington that is centered around Motorola's FRAND licensing obligations. Two days before, Microsoft had filed a motion for a temporary restraining order and preliminary injunction against the enforcement of a German patent injunction that the Mannheim Regional Court might hand down on April 17.

Microsoft's summary judgment motion asks Judge James L. Robart to find Motorola in breach of contractual commitments. Motorola's motion requests a finding that Microsoft "has repudiated any benefits it may have had as a beneficiary of Motorola’s promises", which would involve a determination that Motorola did not breach any contractual obligation or promise and a denial of the existence of any such FRAND obligation going forward.

I copied two diagrams over from the PDF version of Microsoft's motion. Here's the first one (click to enlarge):

This relates to the H.264 video codec standard. On the left side of that chart, Microsoft highlights that it pays to the MPEG LA pool (which contains 2,339 patents on H.264, contributed by 29 different companies) an annual royalty that is capped at $6.5 million. If the cap didn't exist, the amount would be $60 million. By sharp contrast, Motorola holds only 50 such patents but has made a royalty demand that would, even in the most conservative (!) estimate, amount to $4 billion. It's conservative because, as Microsoft's motion explains, Motorola wants 2.25% of the price of the relevant end product (i.e., an entire computer running Windows), and the underlying assumption here is a very low average per-PC price of $500.

Even on that basis, it would take little more than three years to arrive at an aggregate royalty amount -- just for H.264 and with respect to Windows -- in excess of the $12.5 billion Google offered for Motorola, or actually less than three years if one counts both standards (also including 802.11) and all of the products with respect to which Motorola is asserting allegedly essential patents.

The motion also says that "Motorola sought royalties from Microsoft that were several times greater than the total royalty revenue that Motorola receives from all of its other licensees combined". It's not hard to see that something is fundamentally wrong with Motorola's demand.

I have heard and seen Motorola argue -- in open court as well as in written pleadings -- that the whole purpose of the MPEG LA was allegedly just to bring down licensing costs for some large players and to maximize adoption. Furthermore, Motorola claims that its patents are exceptionally valuable. Even if one assumed, just for the sake of the argument, that Motorola had a point here, the discrepancy between Motorola's demand and the pool rates is so huge that it cannot be explained away on that basis.

The other chart I wanted to show you relates to IEEE 802.11, more commonly known as WiFi or WLAN (again, click on the image to enlarge):

On the left side, you see a cartoony image of the Xbox 360. The $199 price tag is again very conservative: it's the price of the least expensive Xbox. The little yellowish circle indicates the Marvell chip implementing the 802.11 standard, magnified to the right of the Xbox and shown with a $3-$4 price tag. That chip comes with a lot of patent rights. On the right side, you then see that Motorola's royalty demand, even if based on the cheapest Xbox, would exceed the price of the component it actually relates to. The motion notes that "when judged in terms of a potentially legally-plausible royalty base, Motorola wanted a royalty of more than 100%". This highlights the "royalty base" problem (the base against which a royalty percentage is applied) I discussed in bullet point no. 2 of this recent post on an Apple letter to a standard-setting organization.

The motion goes on to say that "[a]pplied to sales of higher-end Xboxes (those with additional components like larger hard drives or the Kinect sensor), Motorola's offer even more plainly would capture value entirely unrelated to Motorola's marginal contribution to the 802.11 standard, because the royalty demand on such units is more than twice the price of the entire 802.11 chip--i.e., Motorola was demanding an effective royalty rate of more than 200%".

The royalty base issue is, unsurprisingly, also relevant to Motorola's demands with respect to H.264: "Likewise, even for a low-end $500 computer, Motorola demanded a royalty of $11.25, which is a substantial portion of the average price of Windows--of which support for H.264 video decoding is only a tiny part."

Microsoft's motion points out that dozens of other companies hold patents that have been declared essential to the standards in question, and "[i]f each of the others demanded similar royalties, the total royalty would exceed 50% of the end-product price and 3000% of the relevant component value".

In light of all of this, Microsoft's motion refers to Motorola's position -- literally dozens of times -- as "blatantly unreasonable". The repetitive use of that word is due to the fact that, as a recent court order revealed, "counsel for Motorola agreed [at a hearing] that blatantly unreasonable offers would violate its RAND obligations under the policies". That way, Motorola's own lawyer conceded the breach-of-contract theory at the heart of Microsoft's partial summary judgment motion.

The legal threshold for a summary judgment motion is that its legal theories must succeed even if all of the disputed facts are viewed in the light most favorable to the other party. The court will hold a FRAND mini-trial to have a jury evaluate the disputed facts, but it allowed certain summary judgment motions (as well as Microsoft's aforementioned preliminary injunction motion) in order to adjudicate whatever can be decided without a jury. Motorola will certainly try to create factual disputes, in addition to raising legal issus such as over applicable law and its interpretation. But there appears to be so much of a discrepancy between Motorola's royalty demands and anything that could be viewed as a remotely reasonable rate that a breach-of-contract finding is fairly possible even prior to the involvement of a jury. For example, Microsoft's extrapolation that the total royalty for the relevant standarsd would exceed "50% of the end-product price and 3000% of the relevant component value" is by a huge factor above anything that can be considered a reasonable total licensing cost for standard-essential patents. For example, if one assumed five times the cost of the "relevant component value" stated by Microsoft, the total royalty percentage would go down from 3000% (for all patent holders) to 600% -- and it would still be nowhere near a FRAND rate.

Motorola's argument is largely based on its own practice and the course of events in the Motorola-Microsoft relationship. Motorola claims to have consistently commenced its patent licensing negotiations with its standard 2.25% demand and blames Microsoft for having gone to court in response to it, as opposed to trying to bring the rate down through negotiation. However, Motorola's relevant letters (one on H.264 dated October 29, 2010, and one on IEEE 802.11 dated October 21, 2010) both ended with the following paragraph:

"Motorola will leave this offer open for 20 days. Please confirm whether Microsoft accepts the offer."

At the time, the companies were already embroiled in litigation since Microsoft had sued Motorola on October 1, 2010, for patent infringement. In that situation, Microsoft apparently assumed that Motorola was going to sue after the end of the 20 days, or even sooner if Microsoft had rejected those terms: "Motorola apparently believed it could paper over its RAND obligations by delivering a blatantly unreasonable, sham offer to Microsoft, waiting for the 20 days Motorola prescribed, and suing on its standard-essential patents." In a recent order, Judge Robart already made clear that there's nothing wrong with taking a dispute over FRAND licensing terms to court.

Microsoft's motion plausibly portrays Motorola's strategy in the following way:

"Rather than seeking genuinely to fulfill its contractual duties, Motorola's obvious strategy was just the opposite--to make an offer that Microsoft was sure to refuse so that Motorola then would be free (in its view) to sue on its standard-essential patents to gain leverage in other disputes with Microsoft."

The motion claims that this was confirmed by the testimony of two Motorola IP executives, a smoking gun kind of claim that I can't verify because any quotes from those depositions have been redacted in the public version of the motion. But even without access to that information, it's quite obvious that Motorola didn't expect its 2.25% demand (to be applied against an unreasonable royalty base) to be met within that 20-day period.

Microsoft describes Motorola's strategy as one of "leveraging the 'bullets' of its standard-essential patents to wrest either crippling royalties, or licenses to Microsoft patents (including non-standard-essential patents), from Microsoft". Motorola, of course, claims that its royalty demand was a reasonable basis for starting negotiations, and denies that it ever made a demand for a license to non-standard-essential patents. It tirelessly points out that it is willing, in formal terms, to grant a license on a cash-only basis.In practical terms, the fact that Motorola is aggressively pursuing injunctive relief based on standard-essential patents (also in some litigations based on non-standard-essential patents, such as the push notification patent that is being enforced against Apple and asserted against Microsoft, but that's a separate issue) while making exorbitant demands certainly shows that Motorola wants maximum leverage for any negotiations, and it would never have to explicitly demand a license to non-standard-essential patents from those other players: it could simply continue to insist on its out-of-this-world royalty rates until someone starts to offer a broader settlement. At this stage, there's no indication that Apple or Microsoft will blink.

If Motorola was truly just interested in a cash-only royalty, I can't see why its lawyers weren't receptive to Microsoft's offer of a $300 million bond to secure any damages resulting from a potentially delayed enforcement of an injunction Motorola might win in Germany. The longer this dispute takes, the more the plot thickens. It's a tough fight for the parties involved in it, but for the industry at large it's actually a good thing that disputes such as this one will result in court rulings that will, certainly not in all but probably in some cases, enhance legal certainty with respect to FRAND licensing commitments related to standard-essential patents.

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