The RAND Modified Hypothetical Negotiation

During promulgation of the H.264 and 802.11 standards, Motorola submitted numerous Letters of Assurance to the ITU and IEEE standards setting organizations (“SSOs”) stating that it would grant licenses to its SEPs under RAND terms. Although both the ITU and IEEE impose RAND license assurances, the terms as to what constitute a RAND license are left up to the SEP holder and the
implementer to negotiate.

In October 2010, Motorola offered to license its SEPs for the H.264 and 802.11 standards to Microsoft at a rate of 2.25% of the end product price. Without responding to Motorola's license offers, Microsoft in November 2010 brought the present action for breach of contract. Microsoft contends that Motorola's license offers for its H.264 and 802.11 SEPs were unreasonable, and that Motorola breached its contractual obligations to the ITU and IEEE to grant licenses under RAND terms.

Procedural History

On Feb. 27, 2012, Judge Robart ruled on Microsoft's motion for partial summary judgment, finding that Motorola entered into binding contractual agreements to license its SEPs on RAND terms through its Letters of Assurance to the ITU and IEEE. Judge Robart also found that Microsoft, which was also a member of the ITU and IEEE, was a third-party beneficiary of Motorola's agreements to license its H.264 and 802.11 SEPs on RAND terms.

On June 6, 2012, Judge Robart addressed additional summary judgment motions filed by both parties. Judge Robart reaffirmed his previous finding that Motorola was contractually obligated to grant RAND licenses for its H.264 and 802.11 SEPs but held that although this obligation did not require Motorola's initial license offers to be made on RAND terms, it did require the initial offers to be made in good faith. Judge Robart also held that Microsoft did not repudiate or revoke its right to a RAND license by failing to negotiate with Motorola prior to bringing suit. Finally, as a necessary step prior to any jury determination of the fact issues surrounding whether Motorola's license offers were made in good faith, Judge Robart determined that a true RAND royalty rate was needed for comparison purposes. Judge Robart held a six-day bench trial on this issue in November 2012.

In the April 25, 2013 findings of fact and conclusions of law, Judge Robart concluded that the RAND royalty rate for Motorola's H.264 SEPs is 0.555 cents per unit. He also concluded that the range of RAND royalty rates for Motorola's H.264 SEPs is 0.555 to 16.389 cents per unit for Microsoft Windows and Xbox products, and that the RAND royalty rate for all other Microsoft products using H.264 is 0.555 cents per unit. Judge Robart also concluded that the RAND royalty rate for Motorola's 802.11 SEPs is 3.471 cents per unit, that the range of RAND royalty rates for Motorola's 802.11 SEPs is 0.8 to 19.5 cents per unit for Microsoft Xbox products, and that the RAND royalty rate for all other Microsoft products using 802.11 is 0.8 cents per unit.

Framework for Analysis

The court's approach for determining a RAND royalty rate begins with the application of a modified version of the Georgia-Pacific factors ' the 15 factors traditionally analyzed in determining reasonable royalty damages under 35 U.S.C. ' 284 ' to analyze a hypothetical negotiation between Motorola and Microsoft. See Georgia-Pacific Corp. v. United States Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970). Judge Robart provided two reasons why the Georgia-Pacific factors must be modified. First, because of its commitment to the ITU and IEEE, Motorola is required to license its SEPs on RAND terms. This is unlike a patent owner in the traditional hypothetical negotiation who is not obligated by such a commitment and can exercise its monopoly power by refusing to license. Second, Microsoft, as an implementer of the H.264 and 802.11 standards, would negotiate a license to Motorola's SEPs with the consideration that it likely will need to license a number of other SEPs in order to implement the H.264 and 802.11 standards. Judge Robart's modified Georgia-Pacific analysis also attempted to mitigate both the risk of patent hold-up that RAND commitments are intended to avoid and the risk of royalty stacking by considering aggregate royalties that would apply if other SEP holders sought royalties from the implementer.

In the RAND modified hypothetical negotiation, the court customized the considerations under most of the Georgia-Pacific factors, finding two factors to be inapplicable and one factor to have essentially no impact. Factor 4, which examines the licensor's policies and programs for maintaining a monopoly in the patents in suit, and Factor 5, which considers the commercial relationship of the licensor and licensee (i.e., Are they competitors in the same field?), were deemed inapplicable because in the RAND context the licensor has already committed to forego a monopoly on its patents and to license its patents on RAND terms. Factor 7, which examines the duration of the patent and term of the license, has little, if any, impact because in the RAND context the term of the license is the duration of the patent.

The court tailored the analysis under two factors to be specifically guided by negotiated royalties and customary practices in licensing of patents subject to RAND obligations. The court found that the royalties that are relevant to a hypothetical negotiation for SEPs under Factor 1, which examines established royalties for the patents in suit, are those that are negotiated under a RAND obligation or comparable negotiation. Similarly, for Factor 12, which examines the portion of the profit or selling price that is customary in allowing for the use of the invention, the court found that it must look at what is customary in the business of licensing patents subject to RAND obligations.

The court's analysis under Factor 9, which looks at the advantages of the patented technology over any old modes or devices for working out similar results, focused on alternatives that, prior to adoption and implementation of the standard, could have been written into the standard instead of the patented technology.

The court also customized the considerations under several factors for the RAND context by concentrating the inquiry on the fact that the value of the patented technology is separate from the value of its incorporation into the standard. This is because the standard itself has significant value separate from any specific technology that is incorporated into it, and the RAND commitment exists so that SEP holders cannot demand more than they contribute. The overarching considerations for the court involved looking at the importance of the SEPs to the standard and also looking at the importance of the standard and the SEPs to the implementer and the implementer's products.

The court applied this focus to Factor 6, which examines sales involving the patented invention and its effect on convoyed sales for the licensee and derivative sales for the licensor; Factor 8, which examines profitability and commercial success of a product made under the patents in suit; Factor 10, which considers the nature and benefits of the patented invention; Factor 11, which considers the extent to which and related value of the use of the invention by the infringer; and Factor 13, which examines the portion of the profit credited to the invention apart from non-patented elements or improvements added by the infringer.

The court also found that in the RAND hypothetical negotiation under Factor 15 (i.e., What amount would the parties have agreed upon at the time the infringement began?), the parties would consider the RAND commitment and its purpose of avoiding patent hold-up and royalty stacking when negotiating a RAND royalty.

Within this framework, the court analyzed Motorola's SEPs to ascertain their importance to the H.264 and 802.11 standards and their importance to Microsoft's products prior to determining a RAND royalty rate and range. The court found Motorola's SEPs to be of varying importance to the associated standard and that Motorola's SEPs were of minor importance to Microsoft's products. In deciding the royalty rate and range, the court refused to find any agreement entered into as a result of pending litigation indicative of a RAND license and instead concluded that the MPEG LA H.264 and Via Licensing 802.11 patent pools were indicative of RAND rates for those respective standards. The court also considered the royalty rate that third-party Marvell pays to ARM for intellectual property needed to make 802.11-compliant Wi-Fi chips and an evaluation of Motorola's SEPs from InteCap (a consulting firm) as indicators of a RAND rate for 802.11 SEPs.

Considering these comparables, the court found that the 2.25% royalty rate sought by Motorola for its SEPs did not fall within the range of RAND royalties. The court found that the RAND royalty rate for Motorola's H.264 SEPs is 0.555 cents per unit with a range of 0.555 to 16.389 cents per unit for Microsoft's Windows and Xbox products, and the RAND royalty rate for Motorola's 802.11 SEPs is 3.471 cents per unit with a range of 0.8 to 19.5 cents per unit for Microsoft's Xbox products. Whether Motorola's license offers to Microsoft were made in good faith and whether Motorola breached its obligation to license its SEPs under RAND terms remain questions for the jury in the trial scheduled to begin at the end of August.

Conclusion

In its Findings of Fact and Conclusions of Law, the court presented a thorough analysis supporting the RAND license rates and ranges it found using a modified hypothetical negotiation. The framework provided by the court will be helpful for companies participating in SSOs, parties negotiating RAND licenses, and other district courts addressing issues related to SEPs. If and when appealed, the court's detailed analysis and findings will be helpful in guiding the Federal Circuit's review of the methodology used to determine the RAND royalty rates and will allow the Federal Circuit to pinpoint any issues with the district court's detailed analysis.

Mark A. Chapman is a partner and Rose Cordero Prey is an associate in the New York office of Kenyon & Kenyon LLP. Chapman's practice focuses on representing high-technology clients in patent infringement litigation, but also includes opinions, licensing and transactions. Cordero Prey's practice focuses on patent litigation and licensing in the mechanical and electrical arts.

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On April 25, 2013, Judge James L. Robart of the Western District of Washington publicly issued his Findings of Fact and Conclusions of Law from the November 2012 bench trial in Microsoft Corp. v. Motorola, Inc., et al., Case No. 2:10-cv-01823-JLR (W.D. Wash.). Judge Robart's 207-page opinion describes in great detail the methodology he used and the evidence he considered to determine a reasonable and non-discriminatory (“RAND”) royalty for Microsoft's use of certain Motorola standard essential patents (“SEPs”) related to video compression and wireless networking. To determine the RAND royalty, Judge Robart applied the traditional Georgia-Pacific factors, but modified the hypothetical negotiation to assume that it was conducted under a RAND obligation. For both sets of SEPs, Judge Robart determined both a royalty rate as well as a range of royalty rates that would satisfy the RAND obligation. These determinations will serve as a baseline for the jury in the upcoming August trial over whether Motorola's license offers to Microsoft ' which were considerably higher than the court's RAND license rates ' were made in good faith and not a breach of Motorola's contractual obligation to license its SEPs under RAND terms.

Background

The Motorola patents at issue relate to the H.264 video encoding standard developed by the International Telecommunications Union (“ITU”) and the 802.11 wireless networking standard that was developed by the IEEE Standards Association (“IEEE”). These standards are both widely used in consumer products, including Microsoft's Xbox 360 and Windows software for personal computers and smartphones.

During promulgation of the H.264 and 802.11 standards, Motorola submitted numerous Letters of Assurance to the ITU and IEEE standards setting organizations (“SSOs”) stating that it would grant licenses to its SEPs under RAND terms. Although both the ITU and IEEE impose RAND license assurances, the terms as to what constitute a RAND license are left up to the SEP holder and the
implementer to negotiate.

In October 2010, Motorola offered to license its SEPs for the H.264 and 802.11 standards to Microsoft at a rate of 2.25% of the end product price. Without responding to Motorola's license offers, Microsoft in November 2010 brought the present action for breach of contract. Microsoft contends that Motorola's license offers for its H.264 and 802.11 SEPs were unreasonable, and that Motorola breached its contractual obligations to the ITU and IEEE to grant licenses under RAND terms.

Procedural History

On Feb. 27, 2012, Judge Robart ruled on Microsoft's motion for partial summary judgment, finding that Motorola entered into binding contractual agreements to license its SEPs on RAND terms through its Letters of Assurance to the ITU and IEEE. Judge Robart also found that Microsoft, which was also a member of the ITU and IEEE, was a third-party beneficiary of Motorola's agreements to license its H.264 and 802.11 SEPs on RAND terms.

On June 6, 2012, Judge Robart addressed additional summary judgment motions filed by both parties. Judge Robart reaffirmed his previous finding that Motorola was contractually obligated to grant RAND licenses for its H.264 and 802.11 SEPs but held that although this obligation did not require Motorola's initial license offers to be made on RAND terms, it did require the initial offers to be made in good faith. Judge Robart also held that Microsoft did not repudiate or revoke its right to a RAND license by failing to negotiate with Motorola prior to bringing suit. Finally, as a necessary step prior to any jury determination of the fact issues surrounding whether Motorola's license offers were made in good faith, Judge Robart determined that a true RAND royalty rate was needed for comparison purposes. Judge Robart held a six-day bench trial on this issue in November 2012.

In the April 25, 2013 findings of fact and conclusions of law, Judge Robart concluded that the RAND royalty rate for Motorola's H.264 SEPs is 0.555 cents per unit. He also concluded that the range of RAND royalty rates for Motorola's H.264 SEPs is 0.555 to 16.389 cents per unit for Microsoft Windows and Xbox products, and that the RAND royalty rate for all other Microsoft products using H.264 is 0.555 cents per unit. Judge Robart also concluded that the RAND royalty rate for Motorola's 802.11 SEPs is 3.471 cents per unit, that the range of RAND royalty rates for Motorola's 802.11 SEPs is 0.8 to 19.5 cents per unit for Microsoft Xbox products, and that the RAND royalty rate for all other Microsoft products using 802.11 is 0.8 cents per unit.

Framework for Analysis

The court's approach for determining a RAND royalty rate begins with the application of a modified version of the Georgia-Pacific factors ' the 15 factors traditionally analyzed in determining reasonable royalty damages under 35 U.S.C. ' 284 ' to analyze a hypothetical negotiation between Motorola and Microsoft. See Georgia-Pacific Corp. v. United States Plywood Corp. , 318 F. Supp. 1116 (S.D.N.Y. 1970). Judge Robart provided two reasons why the Georgia-Pacific factors must be modified. First, because of its commitment to the ITU and IEEE, Motorola is required to license its SEPs on RAND terms. This is unlike a patent owner in the traditional hypothetical negotiation who is not obligated by such a commitment and can exercise its monopoly power by refusing to license. Second, Microsoft, as an implementer of the H.264 and 802.11 standards, would negotiate a license to Motorola's SEPs with the consideration that it likely will need to license a number of other SEPs in order to implement the H.264 and 802.11 standards. Judge Robart's modified Georgia-Pacific analysis also attempted to mitigate both the risk of patent hold-up that RAND commitments are intended to avoid and the risk of royalty stacking by considering aggregate royalties that would apply if other SEP holders sought royalties from the implementer.

In the RAND modified hypothetical negotiation, the court customized the considerations under most of the Georgia-Pacific factors, finding two factors to be inapplicable and one factor to have essentially no impact. Factor 4, which examines the licensor's policies and programs for maintaining a monopoly in the patents in suit, and Factor 5, which considers the commercial relationship of the licensor and licensee (i.e., Are they competitors in the same field?), were deemed inapplicable because in the RAND context the licensor has already committed to forego a monopoly on its patents and to license its patents on RAND terms. Factor 7, which examines the duration of the patent and term of the license, has little, if any, impact because in the RAND context the term of the license is the duration of the patent.

The court tailored the analysis under two factors to be specifically guided by negotiated royalties and customary practices in licensing of patents subject to RAND obligations. The court found that the royalties that are relevant to a hypothetical negotiation for SEPs under Factor 1, which examines established royalties for the patents in suit, are those that are negotiated under a RAND obligation or comparable negotiation. Similarly, for Factor 12, which examines the portion of the profit or selling price that is customary in allowing for the use of the invention, the court found that it must look at what is customary in the business of licensing patents subject to RAND obligations.

The court's analysis under Factor 9, which looks at the advantages of the patented technology over any old modes or devices for working out similar results, focused on alternatives that, prior to adoption and implementation of the standard, could have been written into the standard instead of the patented technology.

The court also customized the considerations under several factors for the RAND context by concentrating the inquiry on the fact that the value of the patented technology is separate from the value of its incorporation into the standard. This is because the standard itself has significant value separate from any specific technology that is incorporated into it, and the RAND commitment exists so that SEP holders cannot demand more than they contribute. The overarching considerations for the court involved looking at the importance of the SEPs to the standard and also looking at the importance of the standard and the SEPs to the implementer and the implementer's products.

The court applied this focus to Factor 6, which examines sales involving the patented invention and its effect on convoyed sales for the licensee and derivative sales for the licensor; Factor 8, which examines profitability and commercial success of a product made under the patents in suit; Factor 10, which considers the nature and benefits of the patented invention; Factor 11, which considers the extent to which and related value of the use of the invention by the infringer; and Factor 13, which examines the portion of the profit credited to the invention apart from non-patented elements or improvements added by the infringer.

The court also found that in the RAND hypothetical negotiation under Factor 15 (i.e., What amount would the parties have agreed upon at the time the infringement began?), the parties would consider the RAND commitment and its purpose of avoiding patent hold-up and royalty stacking when negotiating a RAND royalty.

Within this framework, the court analyzed Motorola's SEPs to ascertain their importance to the H.264 and 802.11 standards and their importance to Microsoft's products prior to determining a RAND royalty rate and range. The court found Motorola's SEPs to be of varying importance to the associated standard and that Motorola's SEPs were of minor importance to Microsoft's products. In deciding the royalty rate and range, the court refused to find any agreement entered into as a result of pending litigation indicative of a RAND license and instead concluded that the MPEG LA H.264 and Via Licensing 802.11 patent pools were indicative of RAND rates for those respective standards. The court also considered the royalty rate that third-party Marvell pays to ARM for intellectual property needed to make 802.11-compliant Wi-Fi chips and an evaluation of Motorola's SEPs from InteCap (a consulting firm) as indicators of a RAND rate for 802.11 SEPs.

Considering these comparables, the court found that the 2.25% royalty rate sought by Motorola for its SEPs did not fall within the range of RAND royalties. The court found that the RAND royalty rate for Motorola's H.264 SEPs is 0.555 cents per unit with a range of 0.555 to 16.389 cents per unit for Microsoft's Windows and Xbox products, and the RAND royalty rate for Motorola's 802.11 SEPs is 3.471 cents per unit with a range of 0.8 to 19.5 cents per unit for Microsoft's Xbox products. Whether Motorola's license offers to Microsoft were made in good faith and whether Motorola breached its obligation to license its SEPs under RAND terms remain questions for the jury in the trial scheduled to begin at the end of August.

Conclusion

In its Findings of Fact and Conclusions of Law, the court presented a thorough analysis supporting the RAND license rates and ranges it found using a modified hypothetical negotiation. The framework provided by the court will be helpful for companies participating in SSOs, parties negotiating RAND licenses, and other district courts addressing issues related to SEPs. If and when appealed, the court's detailed analysis and findings will be helpful in guiding the Federal Circuit's review of the methodology used to determine the RAND royalty rates and will allow the Federal Circuit to pinpoint any issues with the district court's detailed analysis.

Mark A. Chapman is a partner and Rose Cordero Prey is an associate in the New York office of Kenyon & Kenyon LLP. Chapman's practice focuses on representing high-technology clients in patent infringement litigation, but also includes opinions, licensing and transactions. Cordero Prey's practice focuses on patent litigation and licensing in the mechanical and electrical arts.

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