Tuesday, October 23, 2012

Judge 'skeptical' of FRAND position Google's Motorola will present at Microsoft trial

Against Microsoft's objections, wholly-owned Google subsidiary Motorola Mobility will be allowed to defend its well-known 2.25% royalty demand at a FRAND rate-setting trial in the Western District of Washington starting November 13, but the federal judge presiding over this litigation, Judge James L. Robart, has already declared himself "skeptical of Motorola's position" that it can base its royalty demand on the selling price of the relevant end products rather than the portion of this market value that is attributable to the relevant standards, IEEE 802.11 (WiFi, or WLAN) and H.264 (video codec).

The order, which denies both parties' Daubert motions seeking to exclude each other's FRAND royalty reports, was entered yesterday and entered the public electronic record today.

The expert reports themselves are sealed, and only versions of the Daubert pleadings are available. On September 8 I blogged about the Daubert motions and the responsive briefs. Three days later I commented on the parties' reply briefs. While not directly related to the Daubert motions, a Ninth Circuit ruling that came down later that month in Microsoft's favor is also worth mentioning.

Meanwhile Microsoft and Googlorola have also filed a variety of other motions to exclude evidence or argument, raising partly overlapping issues. I wrote about this a week ago and said the following at the end of that post:

I have no idea how Judge Robart is going to adjudicate the parties' Daubert motions and other motions in limine. Since the November 13 trial will be a bench trial, he doesn't have to worry about juror confusion. If there's something he doesn't buy, he can throw it out now or he can let a party present such an argument anyway even if it's unlikely to succeed. The EMVR [Entire Market Value Rule] issue is a key one that could be addressed ahead of the trial, and it appears ripe for a decision.

Judge Robart's approach to the Daubert order was clearly the permissive one: he didn't want to exclude testimony at this stage if any criticism, no matter how well-founded, goes to the weight and credibility of the testimony (which is a matter of, among other things, cross-examination at trial) as opposed to its admissibility. As a result, the bar was very high -- too high for the parties' Daubert motions.

Motorola will have to respond at trial to Microsoft's FRAND royalty theory based on the idea of multilateral ex ante (pre-standardization) negotiations. Judge Robart notes that the ex ante approach to standards patent royalty negotiations "has been endorsed by numerous publications and the Federal Trade Commission". Judge Robart does agree that hold-up and royalty-stacking are valid concerns and that "Microsoft's proposed framework reasonably relies upon and logically addresses widely acknowledged and published concerns of hold-up and stacking found in licensing standard essential patents". Also, "[t]he fact that multilateral license agreements for standard essential patents, including the H.264 patents, do indeed occur in practice adds to the reliability of Microsoft's proposed framework". Nevertheless, the order acknowledges that there may be some difference between an ex ante negotiation and "Motorola's ex post promise that it license its standard essential patents on [F]RAND terms". But there's no reason why Microsoft couldn't present its theories.

Microsoft objected to Motorola's report on three grounds. It argued that Motorola's testimony is unreliable because it starts with the usual 2.25% royalty demand it previously made in connection with cellular standards, which are something else than IEEE 802.11 and H.264. Microsoft also alleges Motorola's expert's failure to properly account for he value of Motorola's patents essential to those standards. The order doesn't say that Microsoft's criticism is necessarily wrong, but Judge Robart declined to hold Motorola's testimony inadmissible.

A third Microsoft argument, however, almost succeeded. Microsoft argued that the Entire Market Value Rule (EMVR), a theory commonly used in connection with patent damages, requires the apportionment that Motorola refused to do by basing its royalty demands on the price of the relevant end product. The order recalls that "the court has already expressed skepticism that an appropriate [F]RAND royalty rate for Motorola's standard essential patents should be based on the end product price of Microsoft's products" and agrees with Microsoft that "Motorola's standard essential patents only relate to the 802.11 and H.264 capabilities, which in turn only constitute a portion of Microsoft's end products". It even goes as far as to say that "[i]t would thus seem illogical to turn around and base a [F]RAND royalty on the end product price".

But the outcome-determinative consideration in this regard was that Microsoft sought exclusion of this testimony for violation of the EMVR, and Judge Robart's understanding of the EMVR is that a royalty rate can be based on the end product even without a showing that the patented features create the basis for customer demand. Judge Robart particularly relies on the Federal Circuit's Lucent Technologies, Inc. v. Gateway, Inc. opinion, in which this appeals court found that "the base used in a running royalty calculation can always be the value of the entire commercial embodiment, as long as the magnitude of the rate is within an acceptable range (as determined by the evidence)". Since Microsoft argued that use of the wrong royalty base is, in and of itself, a violation of the EMVR, Judge Robart denied its Daubert motion despite the skepticism I mentioned before.

The EMVR has previously been criticized as not being hard and fast enough to prevent overcompensation of patent holders, and this Daubert decision suggests to me that there really is a need for stricter rules at least in connection with standard-essential patents. The idea of the royalty base and the royalty rate just being two variables and that a combination of them can be acceptable no matter what the royalty base is doesn't convince me. I think this applies only to negotiations in which parties can agree on a rate without a legal dispute. But once there's a controversy, there's a need for clear-cut rules that make the determination of an appropriate royalty rate reasonably likely. Considering royalty base and royalty rate just two variables that can be combined in all sorts of ways is a recipe for confusion.

By expressing skepticism of Motorola's position, Judge Robart has made clear that there's a problem. If I were Google (Motorola), I wouldn't be thrilled by the prospect of going into a trial with a theory that the presiding judge, who in this case will decide without a jury (it's a bench trial), views skeptically. But there will be other FRAND cases in the future, and some of them will involve juries. If companies are allowed to argue at a trial that a seemingly low percentage of a grossly-inflated royalty base is acceptable, some juries may buy it. There's actually a high risk that many juries will set excessive royalty rates on that basis.

In this Seattle action, the rate-setting exercise itself won't involve a jury. But again, the question is what framework should be applied in the future. What if someone starts suing Boeing over WiFi patents and seeks an allegedly modest percentage? Wouldn't it be preferable then to limit the royalty discussion to the WiFi component of the airplane as opposed to discussing percentages?

Judge Robart has already made very important contributions to FRAND case law. I think there's a very good chance, especially in light of the skepticism he expressed, that his FRAND rate-setting order after the bench trial is also going to help provide clarity, and if it is upheld by an appeals court just like his antisuit (or, more precisely, anti-enforcement) injunction was affirmed, then it may be much harder for future litigants to ignore the EMVR, in the FRAND rate-setting context, in the way Motorola proposes to.

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