Friday, June 21, 2013

German court unlikely to approve Google's 2.25% SEP royalty demand from Apple as FRAND rate

Last year Google proposed to Apple that the Mannheim Regional Court, instead of a U.S. court or arbitrator, determine a global FRAND royalty rate for Apple's alleged use of Motorola's wireless standard-essential patents. At today's Motorola Mobility v. Apple FRAND rate determination trial in this German court (the number one court in the world for smartphone-related patents), Google may just have realized that German judges, despite having a less robust body of patent royalty case law available than their U.S. counterparts, can easily identify a clearly unreasonable royalty demand and, which is not trivial but possible, set a FRAND rate reflective of the intrinsic value of standard-essential patents as opposed to hold-up value due to inclusion of patented techniques in an industry standard.

In April 2012 Motorola Mobility, about a month before finally obtaining antitrust clearance for its acquisition by Google (which closed in May 2012) finally elected, or more likely felt forced, to accept Apple's offer to take a license to Motorola's wireless SEPs in accordance with the German Orange-Book-Standard procedure for avoiding the grant or enforcement of injunctions over patents subject to compulsory licensing. This fact became known a few months later thanks to a U.S. court filing. Apple offered to take a royalty-bearing wireless SEP license, with respect to the German market, but did not specify a FRAND rate. Instead, the resulting agreement states that Motorola shall determine the rate using its "equitable discretion and according to the FRAND standard in industry". Under German law an equitable-discretion clause in favor of the beneficiary of a payment can be reviewed and adjusted by a court if the parties don't agree. And -- surprise, surprise -- Apple did not agree that Motorola's 2.25% royalty demand was fair, reasonable and non-discriminatory. (The royalty rate was not mentioned by the court today, but it has shown up in multiple publicly-accessible documents.)

Thus Motorola brought this Mannheim action in the summer of 2012, seeking declaratory judgment that its royalty demand was reasonable. Apple counterclaimed. Among other things, Apple has recently moved for declaration of unenforceability of several clauses of the license agreement. The European Commission issued a preliminary antitrust ruling ("Statement of Objections") last month according to which "[t]he Commission's preliminary view is that it is in the public interest that licensees should be able to challenge the validity, essentiality or infringement of SEPs" -- key defensive rights that Apple was forced to waive under the Orange-Book-Standard agreement, which came into being at the threat of sales bans against iPhones and 3G-capable iPads in Germany. Presumably Apple's counterclaim for declaration of unenforceability, which is limited to particular clauses and does not challenge the overall agreement, targets the clauses that contradict the Commission's preliminary position. Should the Mannheim court disagree with the European Commission on any of these issues, it will have to stay this German litigation pending further EU antitrust proceedings. This is required by Article 16 of EU Regulation 1/2003:

Uniform application of Community competition law

1. When national courts rule on agreements, decisions or practices under Article 81 [now Article 101; cartels] or Article 82 [now Article 102; abuse of dominant position] of the Treaty which are already the subject of a Commission decision, they cannot take decisions running counter to the decision adopted by the Commission. They must also avoid giving decisions which would conflict with a decision contemplated by the Commission in proceedings it has initiated. To that effect, the national court may assess whether it is necessary to stay its proceedings. [...]

Judge Voss ("Voß" in German), who presides over the panel hearing this case and many other smartphone patent cases, scheduled a decision for September 27, and when it comes down, Google is very unlikely to achieve its goal of a declaratory judgment blessing its 2.25% royalty demand. The court has some issues with it, and I don't think Google will be able to persuade the court of this rate. Apple insists on a declaratory judgment in its favor so it can, as one member of Apple's legal team told the court, subsequently sue Google for antitrust damages.

The reporting judge in charge of this case, Judge Lembach, outlined the court's inclination at a high level, restricted by a protective order that issued at the start of the trial. I thought Judge Lembach's introduction was perfect -- though not for Google's aspirations to overcharge Apple.

No numbers were discussed in public, and this process is not yet at the stage at which the court would set a particular rate. Before any rate-setting occurs (which would require another trial to hear experts etc.), the case may be stayed to wait for the EU to adjudge some of the antitrust issues involved. What was discussed in open court, however, is the fundamental approach, and it can be described as the German equivalent (taking into account certain differences between the two jurisdictions) of Judge Robart's approach in Microsoft v. Motorola, without the part relating to pool rates (which are more useful indicators in connection with H.264 and IEEE 802.11, the standards at issue in the Microsoft case, than the cellular standards at the center of the Google-Apple dispute in Germany).

As Judge Lembach explained, Google seeks to justify its royalty demand primarily by pointing to other patent license agreements Motorola concluded over the course of the last 20 years. It did not disclose the licensees' names to the court. Google claims that Motorola consistently received a consideration corresponding in value to its cash-only royalty demand from Apple. Judge Lembach noted that these individually-negotiated agreements have rather different terms, and the court declared itself unconvinced of Google having proven the reasonableness of its demand on this basis. Among other things, Judge Lembach said it "appeared rather optimistic [from Google's vantage point] to derive its license fee from those license agreements", considering that these agreements contain various "modifications and limitations". Judge Lembach also said that SEPs inherently come with a restriction of choice and are not subject to typical market dynamics, which I consider to be a valid and very important point. Apple's lead counsel in this action, Freshfields Bruckhaus Deringer's Dr. Frank-Erich Hufnagel, reinforced this later. He stressed his enthusiasm for patent law but said it just can't be denied that SEPs raise unique issues that must be taken into account.

The court advised Google that it's entitled to compensation for what its patents contributed to the state of the art, but not to the value of standard-setting itself.

Google's position has a major inconsistency (at least one). On the one hand, Google argues that Apple's reference to royalty stacking and any proposed calculations relative to the total number of patents declared essential to the standards in question is besides the point because it's all about the value of the patents in question. On the other hand, Google does not want the court to perform any valuation other than a derivation from other license agreements, while Apple advocated a representative-sample approach in order to make the valuation of a portfolio of this size more manageable. When counsel for Google (a Quinn Emanuel attorney) said that SEP licensing negotiations between industry players typically involve the exchange of infringement claim charts and an analysis of the technical value, essentiality and validity of the relevant SEPs (as opposed to arithmetics focusing on the total number of patents declared essential to a given standard), Judge Lembach noted that Google does not want such analysis to be performed in this litigation and that it wants "the court to derive the value of these patents [from other agreements] rather than determine it".

At this juncture of the public part of the proceedings the discussion was, relatively speaking, closest to Judge Robart's modified Georgia-Pacific approach. In Germany royalty determinations are not described as simulated negotiations. But Google's emphasis on "Motorola's and the industry's licensing practices" and its specific reference to the information exchanged and considered by negotiating parties moved the debate very close to the Georgia-Pacific factors.

The way I understood the Mannheim judges today, they're not inclined to engage in any simple arithmetic no matter which party proposes it. They're definitely underwhelmed by Google's derivation from disparate license agreements (as was Judge Robart in the Microsoft-Motorola case). And they also reject one of Apple's approaches based on a return-on-investment calculation (which Apple's counsel said was merely meant to be an analogy further confirming the economic soundness of its position). At this stage the Mannheim court has yet to determine the next steps and a complete methodology. It appears to me that the court will look for a pragmatic solution: reasonably focused to be manageable, but still based on an assessment of the subject of the license agreement in question.

The court doubts that Motorola can demand the same percentage of the sale of a modern-day smartphone (or tablet computer) as it may have obtained when phones were merely about placing calls and texting. While Apple's proposed royalty base (the price of a baseband chip) won't necessarily be adopted by the court, Google received the indication that it would probably have to adjust its royalty rate (possibly by means of a cap) to reflect the multifunctionality of today's wireless devices. This is somewhat similar to the position Judge Robart took on the royalty base issue in a Daubert ruling (he allowed Google to present a royalty demand at trial based on a percentage of the total price of the licensed products because theoretically this approach can also result in a correct absolute royalty amount).

Just to be clear: even though Apple cited to Judge Robart's ruling in its pleadings (and did so repeatedly at today's trial, where Motorola only referenced the dictum that its cellular SEP portfolio is stronger than its WiFi and video compression portfolio), the Mannheim court is not using the U.S. rate-setting opinion as a blueprint. The German judges are using common sense and their understanding of the relevant technologies. If Google tried common sense and adjusted its demands accordingly, its royalty demands would also get more traction in the various courts.

Here's another example of common sense running counter to Google's position that 2.25% is the "be all and end all" of SEP royalty negotiations: Judge Lembach said that the court believes the expiration of declared-essential patents suggests a decreasing royalty rate over time. Given that the standards in question are rather old, it's not likely that new SEPs reading on those standards will be granted. Should it happen anyway, Google could request an adjustment of a previously-determined rate. Theoretically Apple could also seek an adjustment under German contract law, but to the extent that expiration is foreseeable, the Mannheim court will probably want it to be reflected from the start in the form of a decreasing royalty rate. He indicated that the absence of such adjustments corresponding to expiration could in and of itself be a reason to find a royalty demand to be inconsistent with FRAND.

Other issues include that Google wants Apple to license all of its wireless SEPs (as opposed to, for example, only its 3G-essential patents), which might constitute tying.

Google now knows that the Mannheim court will proceed deliberately. This panel of judges is very much in favor of intellectual property, but it also hears competition cases all the time. At a different trial Judge Voss mentioned that he spent several years working on antitrust matters as a high-level clerk at the Federal Court of Justice. If and when this case reaches the stage of an actual FRAND determination, these judges will use their technical knowledge and their understanding of competitive dynamics in order to answer, possibly with the help of experts, the questions that must be addressed in order to separate the intrinsic value of the relevant SEPs from hold-up value. The numbers may very well be higher than what Judge Robart awarded Motorola with respect to different products and largely different standards. But FRAND means something. There were other contexts (in infringement proceedings) in which I didn't like the Mannheim stance on FRAND. Today I really liked what I heard.

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