Saturday, May 26, 2012

Google's Motorola wants Apple to pay $347 million for past use of two wireless patents in the U.S.

This week, Judge Richard Posner ruled on Apple's and Motorola's Daubert (exclusion of damages theories ahead of trial) motions against each other. The case will go to trial in Chicago next month.

In January I already wrote about Judge Posner's reputation. He's the most-cited U.S. legal scholar of the 20th century. What makes his Daubert ruling particularly interesting is that legal economics are his favorite subject. I have uploaded the order to Scribd. It entered the public record only a couple of days ago.

Judge Posner threw out several theories presented by the parties' experts. A couple of Apple theories failed because Apple's damages expert asked Apple engineers about the cost of engineering around Motorola's patents, and Judge Posner said that if someone was looking for alternatives on Motorola's behalf, he certainly wouldn't ask an employee of a company that has an interest in overstating the cost. In one of these contexts, Judge Posner wrote up the following fictitious dialog to show what reaction someone hired by Motorola would get if he did this:

"So again imagine this imaginary conversation between Napper [Apple's damages expert on the relevant patent] and Motorola, which I'll pretend hired Napper to advise on how at lowest cost to duplicate the patent’s functionality without infringement:

Motorola: 'What will it cost us to invent around, for that will place a ceiling on the royalty we'll pay Apple?'

Napper: 'Brace yourself: $35 million greenbacks.'

Motorola: 'That sounds high; where did you get the figure?'

Napper: 'I asked an engineer who works for Apple."

Motorola: "Dummkopf! You're fired.'"

As you can see, this order is not only enlightening but also entertaining. But here I'll focus on what I'm particularly interested in: FRAND. That part comes up at the end in a section on Motorola's damages claims (and Apple's counterargument) regarding the '559 and '898 patents. Those are standard-essential wireless patents. One covers a preamble sequence, the other a countdown. There are actually numerous viable alternatives (in fact, an infinite number of viable alternatives) for what either patent does, but the problem with standard-essential patents is that an industry standard prescribes a particular way (out of many ways) to solve a problem, so even if those patents were narrow before they made their way into the standard, they can't be worked around.

In his analysis, Judge Posner presumes that these two patents must be licensed on FRAND terms. He also denied a Motorola motion to strike all FRAND references in Apple's damages theory: Apple argues that the most Motorola could have received as a royalty is a FRAND rate. Judge Posner agrees with Apple that "Motorola's obligation to license its standards-essential patents on FRAND terms--the content of those terms to be determined in the bench trial immediately upon the liability trials--is highly relevant to the royalty it would have been able to extract from Apple had they successfully negotiated a reasonable royalty ex ante".

While Apple's FRAND theory survived, a Motorola theory that resulted in a damages claim of $347 million as an estimate of a "reasonable" royalty (or alternatively $468 million based on Motorola's allegedly lost profits "plus a reasonable royalty on sales not subject to a lost‐profits analysis") was tossed because the reasoning was based on "a counterfactual world in which there is no Apple product on the market because Apple doesn't have a license to use Motorola's cellular patents", an "alternative‐universe approach" that Posner dismisses as "science fiction".

Courts should always reject theories according to which the economic value of a FRAND-pledged standard-essential patent is the gatekeeper value of access to the market. Any FRAND rate must be based on the value of the technology someone contributed to a standard as opposed to the value of standardization itself, which at least in this industry involves cartels that leverage collective market power.

Judge Posner didn't take a position on Motorola's 2.25% royalty demand per se since he wants to discuss it at the FRAND stage of the trial. He simply mentioned it because even if one applied that royalty, as a worst-case scenario, Apple would have paid less, given that the 2.25% royalty relates to far more patents than just the two at issue here.

At first sight, one may think that Motorola's $347-$468 million damages theory is not inconsistent with what some other right holders demand in their litigations. For example, Apple just recently said it is seeking billions of dollars from Samsung. But one can't compare any of those numbers without also looking at the facts. Here, the fact is not only that Motorola has a FRAND licensing obligation but also that those two patents are only two out of a large number of standard-essential wireless patents (for example, roughly 8,000 patents from almost 900 patent families were, by their holders, declared essential to the 3GPP/3GPP2 standards). There are situations in which two patents represent enormous value. Even a single patent can be very valuable. But here it's easy to extrapolate those numbers considering how many patents it takes to implement the 3G standard (and even more to implement standards 3G is backward-compatible with).

Of course, Motorola could argue that those two patents have a value that's far above the value of the average patent essential to the same standard. That's what Motorola did. Motorola's damages expert apparently recognized the fact that Apple had to implement those two patents only in order to make the iPhone work on AT&T's network, but wouldn't have needed them for Verizon in a technical sense. Motorola's damages theory is based in part on the fact that Apple's contract with AT T was exclusive and Apple couldn't have switched later. Judge Posner, however, points out that Apple might have negotiated a modification or could have broken the contract, with AT T's damages then representing the relevant cost. Motorola should at least have analyzed those alternatives.

As for Apple's benefit from partnering with AT&T, the order finds that Motorola's expert simply argued that it was substantial but cannot be quantified.

In this context, she makes an argument that a $100 million amount doesn't matter to Apple anyway, and Judge Posner dismisses that approach as "nonsense":

"She began her testimony at the Daubert hearing by explaining that $347 million, while a seemingly large number, is nothing to Apple--a company that made some $30 billion in revenue from the products that Motorola contends infringe the Motorola patents. The implication is that even if Apple could have saved, say, $100 million by launching on Verizon, what's the difference to Apple of having to pay $347 million versus $247 million? Either figure is less than 1 percent of Apple's total profits during the damages period. Obviously a damages estimate cannot be based on such reasoning. For imagine her being hired by Apple for advice on how to minimize its liability to Motorola, and her advising Apple that although her highest estimate of the cost of avoiding infringement is $347 million, that’s probably too high by a couple of hundred million dollars, but that she hasn’t bothered to consider avoidance measures that would cost less than $347 million because one hundred million dollars or so is chicken feed to Apple and so it wouldn’t want to pay an additional fee to her to search the alternatives. That is nonsense."

There's a related issue to consider here which didn't play a role in Judge Posner's analysis (it wouldn't have been relevant at this stage) but which is important to me from a FRAND point of view. Even if Apple had partnered with Verizon instead of AT T and if Verizon's network doesn't use the features those two patents read on, Apple would always have had to assume that its customers might need that functionality if they travel outside the United States. It's risky not to implement all mandatory parts of a wireless standard in a device. Apart from potential incompatibilities with existing or future cellular networks in foreign countries, it can also result in a loss of a device maker's entitlement to a FRAND license -- or at least a debate over whether a FRAND license was effectively repudiated. FRAND pledges and FRAND license agreements relating to standard-essential patents are usually designed to benefit only those who implement a standard in full. Under antitrust law, a materially compliant implementation might also be entitled to a FRAND license, regardless of what a contract or a FRAND pledge say. But there would be some degree of legal uncertainty. There must be a limit somewhere: it would certainly be unreasonable for any standard-essential patent to be available on FRAND terms for just any purpose, no matter how little it has to do with implementing the standard the patent is essential to.

From a damages point of view, the argument that full compliance is required may seem to help Motorola rather than Apple -- but not if a court determines that the special circumstances of standard-essentiality and a FRAND licensing obligation require a completely different analysis than the one for non-standard-essential patents. In this particular litigation, the FRAND issues have not been evaluated yet, but the case is on a tight schedule and the Daubert decision had to be made now. That's why Judge Posner's Daubert order considered the existence of FRAND obligations only as an assumption in certain (but not in all) contexts. In my opinion, all FRAND issues should always be adjudicated first if there's a reasonably strong prima facie case for FRAND. FRAND should set the framework for everything else, including damages claims and Daubert motions. But I know that others have a preference for dealing with everything at the same trial.

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