Tuesday 8 August 2023

How to derive and apply aggregate royalty rates for SEP FRAND determinations

Among numerous legal, economic and commercial concerns about the European Commission’s proposed legislation for Standard Essential Patent (SEP) licensing, its plans for aggregate rate setting and mandatory Fair, Reasonable and Non-Discriminatory (FRAND) rate determinations in various technology standards raises all kinds of issues and alarms.

Following publication of the proposed legislation and impact assessment on April 27, the Commission has been seeking online feedback submissions by August 10, 2023.

In a previous posting here and in my initial feedback submission the Commission 14th June, I have argued against the Commission’s apparent intention to abandon the established approach of using comparable licensing agreements directly as benchmarks in FRAND rate determinations, and instead apportion rates among SEP owners based on their respective shares of total SEPs using the top-down approach.[1] For example, I was critical about use of patent counting methods. My new feedback submission to the Commission focuses on aggregate royalty rate setting.

Any aggregate royalty rates set must be precisely defined, derived and applied. Aggregate rate setting for standards, as proposed by the Commission, will enable proposed rates to be depicted and manipulated in ways which are anticompetitive, unfair and will under-value patented standard-essential technologies. According to the proposed legislation, “‘aggregate royalty’ means the maximum amount of royalty for all patents essential to a standard.”[2] The Commission also indicates “uncertainty about the SEP royalty burden” and that “Stakeholders consider that the FRAND licensing concept could benefit greatly from some clarification, notably with regard to the determination of an aggregate royalty burden.”[3]

Aggregate royalty rates proposed to or set by the EUIPO could be in quantification of the total payment burden to be paid or of the rate to be used in determining individual FRAND royalty rates with the top-down approach.[4] The latter should be a higher figure than the former to allow for SEPs that remain unlicensed and for which there is no payment.

Either of these aggregate royalty rate percentages might be derived somehow from among various different formulations of aggregate rates reported. However, these reported rates vary enormously, for example, global rates from more than 35% to less than 5% of a smartphone’s selling price. The maximum aggregate rate burden implementers will have to pay and the correct Aggregate Royalty Rate for Apportionment (ARRFA) in a top-down approach FRAND determination will fall well within those two extremes.

An alternative approach in aggregate rate setting is to estimate value in standards with use of techniques including hedonic pricing or conjoint consumer preference analysis, and then apportion value somehow between SEP licensors and implementers.

If aggregate rates are to be set at all—as they are for patent pools in their rate cards, but in the opinion of many is unnecessary and dysfunctional in bilateral licensing[5]—such rates must be derived in the applicable context. Collective action—such as in patent pools—where some major licensors are typically also major licensees will tend to set rates that are lower than would be agreed bilaterally. Another crucial difference is that patent pool aggregate rates are the rates licensees actually pay.

In FRAND determinations for bilateral licensing there is always a shortfall between the ARRFA and what is actually paid because the SEPs in any given standard are never fully licensed. The aggregate rates from which bilateral licensing rates are derived are never fully paid due to notional royalty allocations to patents that remain unlicensed. Any aggregate royalty setting must recognize this difference if such rates are to be used to determine FRAND rates using the top-down approach.

To mitigate shortcomings in rate setting, some guiding principles must be established on what the “SEP royalty burden” and ARRFA should include and exclude, as well as how and by whom such rates should be derived and applied. The interests of both SEP owners and implementers must be safeguarded while reflecting industry realities with the many factors that shape varied financial and other terms in established licenses. Application of economic theory must have full and proper regard for what royalty figures reported in the industry represent and how licensing actually gets done.

My full submission to the Commission can also be downloaded from WiseHarbor.

[1] Feedback on draft EU legislation by Keith Mallinson, WiseHarbor; June 14, 2023

[2] Article 2 (10).

[3] Proposed regulation (page 8) and Impact Assessment (2.3.2)

[4] “A SEP holder or an implementer may request the competence centre for a non-binding expert opinion on a global aggregate royalty.” Article 18

[5] Various court decisions including Unwired Planet v. Huawei and  InterDigital v. Lenovo have avoided or explicitly rejected aggregate rate setting, while others including Optis v Apple, also in the UK, have also primarily used comparable licensing benchmarks in their FRAND determinations.

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