Standard essential patents have received a lot of attention in recent years – from industry participants such as Apple, Ericsson, Huawei, Motorola, Nokia and Samsung, who have been engaged in costly and heated global litigation related to the enforcement of such patents; to economists, who have devoted considerable attention to articulating the proper economic approach to valuing such patents; to regulators, who through speeches, publications, and enforcement actions have sought to identify what are (and what are not) appropriate ways for industry participants to litigate and resolve their disputes over the value of such patents. Thus far, the consensus regulatory view is that arbitration – or a similar type of neutral adjudication – is the form of dispute resolution most likely to lead to fair and appropriate outcomes, and a wave of recent arbitrations has put that regulatory theory to the test. The question now being asked is whether arbitration is the solution that regulators hoped it would be – is litigation over standard essential patents a thing of the past?
As some recent lawsuits show, the answer to that question is “no” – we still see litigation over standard essential patents from time to time – but the existence of a handful of lawsuits does not mean that the regulatory push toward arbitration has been a failure. To the contrary, what it shows is that arbitration is not a panacea. However, as discussed below, in the right circumstances it can be a useful and efficient means for parties to resolve disputes over the value of standard essential patents.
To understand this issue, it helps to have some background on standard essential patents and how they differ from ordinary patents that cover technologies that, while useful, are not incorporated into an industry standard. Broadly speaking, a standard essential patent – or “SEP,” as it is often short-handed – is a patent that an entity must practice, or infringe, if it wants to manufacture a product that is compliant with a given industry standard. When it comes to today’s most popular consumer electronic products, industry standards abound – DVD, Bluetooth, Blu-Ray, HDMI, MPEG, Micro-SD, and NFC are but a few examples of industry standards that are commonly found in today’s products. In recent years, it is the standards relating to wireless communication technology, such as 4G/LTE and Wi-Fi, and the patents that are claimed to be essential to practicing those standards, that have attracted the attention of regulators around the globe.
Understanding SEP Licensing
To understand why SEP licensing has become a hot topic for antitrust authorities, it is helpful to have an understanding of how patent licensing works in the case of ordinary, non-essential
patents and why the licensing of standard essential patents is different and raises special concerns. So, here’s a quick primer:
In a prototypical license negotiation involving a non-essential patent, (i) the inventor is awarded a patent that defines a new and useful invention and that grants the inventor a limited monopoly, (ii) the inventor has the right to practice or to license his patented technology, as he chooses, (iii) if he chooses to license the patent, he can demand the price he wants as a royalty, and (iv) prospective licensees will either pay that amount and use the invention or, if the royalty demand is too high, will not pay and instead will use an alternative technology. Because, in the case of a non-essential patent, the licensee has the option of walking away from the deal and using an alternative technology (designing around the patent), economic theory posits that the agreed-upon royalty is based upon the underlying value of the patented technology.
In the case of a patent that is essential to practicing an important and accepted industry standard, such as 4G/LTE, however, the same result does not necessarily follow. The reason is because, in the case of a patent that is essential to a ubiquitous industry standard, if the prospective licensee wants to sell standard-compliant devices, it must use the patented technology; it has no practical alternative. In economic parlance, the licensee is “locked in,” even if, before the standard was established, there existed other, alternative technologies of equal or nearly equal value and utility.
This “lock in” has significant consequences when it comes to licensing the standard essential patent. It means that in an unconstrained (or insufficiently constrained) market, the SEP holder will have considerable negotiating leverage – since the device manufacturer has no alternative (other than to cease manufacturing standard-compliant products), it will rationally agree to pay more for a license to an SEP than the technology itself is actually worth. That, in turn, has the potential to harm consumers and innovation.
These concerns are particularly acute if, when it is unsatisfied with the state or progress of negotiations, the SEP holder – no matter how trivial its contribution to the standard may have been – is able to threaten the prospective licensee with injunctive relief that would bar the implementer from selling its standard-compliant products. In such cases, the ability to credibly threaten an injunction increases the SEP holder’s bargaining power and, in turn, increases the likelihood that the licensee will agree to pay a royalty significantly greater than the value of the underlying technology. When one realizes that this risk exists, not just for one SEP, but for all of the hundreds, or even thousands, of patents that are essential to practicing a given standard, it is easy to understand why parties are interested in addressing this issue.
The first step in mitigating the risk of opportunistic behavior by patentees was taken by the standard setting organizations (SSOs) themselves. Specifically, many SSOs have adopted policies requiring their members to commit to license their SEPs on fair, reasonable, and non-discriminatory (FRAND) terms and conditions. For better or worse, however, few, if any, SSOs have defined what FRAND terms and conditions are or how they can be determined in a given license negotiation. That lack of clarity has led to a number of disputes between SEP holders and prospective licensees about what the appropriate level of royalty should be, with some SEP holders opting to pursue patent litigation, and to seek injunctive relief, as a means of encouraging allegedly recalcitrant licensees to agree to terms.
Advocating for Arbitration
Given the high profile nature of these litigations, which have involved some of the world’s leading high-tech companies (including Apple and Samsung, among others), it is perhaps unsurprising that the interest of regulators was piqued. In some instances through enforcement actions, and in others through policy statements and speeches, antitrust authorities have made clear how they believe companies should resolve disputes over the proper level of royalties for SEPs. For example, as part of the resolution of an investigation relating to the enforcement of SEPs, the United States Federal Trade Commission (“FTC”) required Motorola to offer binding arbitration as a means of resolving royalty disputes related to SEPs, before seeking injunctive relief for infringement of such patents.  Similarly, the European Commission’s Directorate-General of Competition has indicated, in connection with a recent investigation of Samsung, that arbitration is a vehicle for resolving concerns regarding the enforcement and licensing of SEPs. And the United States Department of Justice likewise has expressly encouraged SSOs to devise arbitration procedures by which their members can resolve FRAND disputes. The regulators’ thinking in this regard appears to be that arbitration is a “win-win” for the parties. The would-be licensor gets a contractual commitment from the would-be licensee to pay royalties, but the level of royalties can be determined objectively, by neutral parties, without any risk that the threat or issuance of an injunction will compel the licensee to accept a royalty that is greater than FRAND.
In the wake of these regulatory directives, a number of parties have chosen to arbitrate their royalty disputes. While confidentiality rules and orders make it impossible to identify all of the licensors and licensees that have agreed to arbitrate, public reports indicate that companies such as Huawei, InterDigital, LG Electronics, Nokia and Samsung Electronics have chosen arbitration as the vehicle for resolving certain of their SEP licensing disputes. But to what end? Has the regulatory push towards arbitration been worthwhile, and should companies continue to pursue arbitration in lieu of litigation in the courts?
The answer, in my experience, is that arbitration can be a very effective means of resolving a given dispute. But the circumstances must be right. To the extent regulators have suggested that arbitration is always the best path forward, that overstates its utility, and as the recently-filed litigations referenced above show, parties do not always believe that arbitration is viable option.
The Limits of Arbitration
In the prototypical arbitration, the parties have a contract; a dispute related to that contract has arisen; and the parties have agreed to resolve that dispute through arbitration. Arbitrating SEP disputes can be complicated because the parties typically do not yet have a contract (a license agreement). That is what they are negotiating, and there are a multitude of issues that must be worked out between them, ranging from the scope of patents covered (e.g., which standards are to be licensed) and which products will be covered, to how long the license will last and what law will govern its interpretation, to name but a few. Further complicating matters, all of those issues impact the ultimate question of how much the manufacturer should pay for a license to the patent holder’s SEPs.
For parties to be pushed into arbitration in these circumstances makes little sense. Fundamentally, issues such as the scope or duration of a license are business terms that are subject to negotiation. For example, there is no “right” length of a given license – for a variety of reasons, a party may prefer a short term agreement or one that lasts in perpetuity, or something in between – and it is unclear how arbitrators should or would decide which party’s business judgment about the duration of the license, or any other such issue, should prevail. Indeed, where two parties are at an impasse over multiple, essential terms of a license, it is hard to imagine them coming to agreement on a comprehensive agreement to arbitrate. To the extent regulatory policy is designed to push parties into arbitration in these circumstances, such policy would appear ill conceived.
Where SEP Arbitration is Useful
In contrast, in cases in which the parties have reached agreement on all essential terms of a license except the price (royalty), arbitration may indeed be an effective means of resolving the dispute  – one that makes sense for both parties and also furthers the regulatory goal of having a neutral royalty determination untainted by the threat or risk of an injunction. To be sure, by agreeing to arbitration, the would-be licensor gives up whatever leverage it can create by taking the would-be licensee to court, including the risk that an injunction may be entered, but in exchange, the licensor, among other things, secures a contractual commitment from the licensee that the latter will pay royalties pursuant to an award that is enforceable anywhere under the New York Convention. Particularly for a licensor that has patents in a number of jurisdictions, that is far more efficient than pursuing litigation in each of those jurisdictions with all of the attendant rights of appeal. As for the licensee, if it agrees to arbitration, it commits to pay the award entered by the arbitral tribunal and gives up its right to require the licensor to prove, in each jurisdiction that it has patents, that each of its patents is valid and infringed. In exchange, the licensee avoids any risk of a court entering an injunction and avoids the costs and risk associated with having to litigate in multiple fora. It is presumably for these reasons that many companies – licensors and licensees alike  – have concluded that arbitration is in their best interests in certain cases.
So what does this mean for regulatory policy as it relates to SEP licensing? It means that any such policy should recognize there is nuance here. Ultimately, the policy goal is to facilitate resolution of SEP disputes such that the level of royalties is set consistent with FRAND licensing principles and is not distorted by the threat or risk of an injunction. In some cases, such as those where the primary or only sticking point is the amount of royalty, arbitration may further that goal. But in cases in which the parties’ disagreement is more fundamental and relates to more than just the level of royalty, it is difficult to see how pushing the parties toward arbitration is likely to lead to the successful resolution of their dispute.
In other words, there is no one-size-fits-all solution to SEP disputes, but arbitration is certainly an effective solution to certain SEP disputes that furthers regulatory policy goals.
1. See In re Motorola Mobility LLC, Docket No. C-441, Decision & Order (Jul. 23, 2013).
2. See “Antitrust: Commission accepts legally binding commitments by Samsung Electronics on standard essential patent injunctions,” European Commission (Apr. 29, 2014) (available at http://europa.eu/rapid/press-release_IP-14-490_en.htm).
3. Even in such cases, there are a number of issues that must be addressed, such as choice of law, in order for the arbitration to be successful. The details of how a given arbitration should be structured will depend on the facts and circumstances of each individual case.
4. For ease of discussion, this article assumes that a party is either a licensor or a license, but in reality, many parties are both (i.e., they own patents and also manufacture standard-compliant products and thus require licenses).
Kevin Hardy is a partner at Williams & Connolly LLP in Washington, DC, and has been counsel in a number of cases involving standard essential patents, including Nokia Corp. v. Samsung Elec. Co., Ltd. (arbitration), Huawei Tech. Co., Ltd. v. Samsung Elec. Co., Ltd. (N.D. Cal.), and International Trade Commission Investigation No. 337-TA-868. This article represents the personal views of the author; it is not a reflection of any client viewpoint.
Filed Under: Industry regulations