European Commission is recklessly replacing established and effective FRAND valuation and licensing practices with dubious top-down rate setting

I have already made various public comments on a draft Proposal for Regulation of the European Parliament and of the Council establishing a framework for transparent licensing of standard essential patents, including the associated draft Impact Assessment report that were leaked ahead of their public launch on 27 April 2023. These comments were first published in IAM (paywalled) and then republished in IP Finance. 

Among numerous legal and other issues in these proposals, I am focusing my feedback to the European Commission, in a new consultation running 27th April 2023 to 9th August  2023, on the anticipated methodologies for setting aggregate and individual SEP royalty charges by the new competence centre at an expanded EUIPO.

My analysis is summarised below and my full submission including detailed analysis and support can be downloaded here.

The proposed regulation largely ignores and seemingly abandons comparable license valuation of patent portfolios—that predominates in licensing negotiations and court decisions—and implicitly replaces this with the dubious top-down approach[1] that is antithetical to patent law and is repeatedly rejected by the courts worldwide. Comparable licenses provide fair, reasonable, non-discriminatory and effective royalty benchmarks in bilateral and multilateral SEP valuation and license charging. The standing of these—typically global—benchmarks is underpinned by billions of dollars of licensing income over decades in numerous licenses including many licensors and licensees.

If a prospective licensor can demonstrate that it has infringed and valid patents it is entitled to a license. If these are standard-essential patents it is obliged to offer and is entitled to receive FRAND royalties. Where charges and other terms have been established in existing licenses, some of these can often be comparable benchmarks for licensing other implementers.

The proposed legislation makes only one passing mention of comparable licenses when describing difficulties including transparency and complexity in making FRAND determinations. The impact assessment only includes references to comparable licenses to acknowledge that they are used and to indicate that some are dissatisfied with the extent of disclosure of existing licensing terms and licenses. Neither document finds that the established royalty charges in existing licenses are excessive or inapplicable FRAND licensing benchmarks.

Elsewhere in licensing negotiations and in litigation, comparable licenses are generally considered to provide the very best benchmarks in determining royalty charges.

Regulated royalties are unwarranted

Setting aggregate rates and apportioning them among patent owners, centrally by the EUIPO—even on a non-binding basis—will unnecessarily distort the free market processes in standards development and FRAND patent licensing compensation that has been effective in enabling the world’s fastest growing and largest ever technology ecosystem serving more than five billion people and 16 billion connections with cellular worldwide. Parties in licensing disputes will feel obliged in the proposed mandatory conciliation process to give significant weight to the EUIPO’s determinations, as will the courts. However; there is no basis whatsoever, let alone supporting evidence, to infer there is market failure or harm to be fixed, or that established benchmarks for royalty charges need to be replaced.

Despite the existence of well-established licensing benchmarks, there is significant dispute about how else to value SEP portfolios and determine royalty charges for these. According to the impact assessment, “Although an impressive amount of scholarship has analysed or interpreted the FRAND concept, this scholarship is characterized by persistent differences of opinion on key aspects of the FRAND concept such as royalty evaluation methods and obligations to license certain parts of the relevant industry.”

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[1] The Commission is explicit in its intention to determine aggregate royalties for some technology standards. As the impact assessment indicates from the results of its literature analysis: “An aggregate royalty for a standard is the royalty due for all SEPs on the standard. It is the starting point in a top-down determination of the royalty to be paid for a given portfolio.” The Commission’s desire that the essentiality of all patents in standard, or a representative random sample of them, are checked, rather than only small numbers of them per patent owner, stealthily implies that it wants patent counts to be used as measures of patent strength— as required in the top-down approach—even though this widely contested apportionment method is not explicitly identified or advocated in the proposed legislation. The proposed legislation requires that “The checks will be conducted based on methodology that ensures a fair and statistically valid selection capable of producing sufficiently accurate results about the percentage of truly essential patents among each SEP holder's registered SEPs.” The impact assessment also hopes that “if the register will be perceived by SEP holders as a means of indicating portfolio strength (and e.g. used in negotiations to determine the share of aggregate royalty applicable to them), they may increase the number of registered patents.”

DG GROW seeks to replace established FRAND valuation and licensing practices with top-down rate setting

In case you missed it or were unable to access my paywalled article in IAM on 5th April 2023, here it is with my analysis of the draft Proposal for Regulation of the European Parliament and of the Council establishing a framework for transparent licensing of standard essential patents, including an associated Impact Assessment report (IA) that were leaked ahead of their anticipated public launch on 26 April.

DG GROW is proposing various ill-conceived interventions — processes that have not yet even been designed or properly budgeted, let alone tested. These will upset a standards development and patent licensing system that has been effective in enabling the world’s fastest growing and largest ever technology ecosystem serving more than five billion people and 16 billion connections with cellular worldwide.

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I have feared but anticipated in my publications that the EC might try to build some kind of Ministry of Patent Counting with the purported aim of helping SEP implementers including SMEs in particular in Fair Reasonable and Non-Discriminatory (FRAND) licensing. DG GROW now proposes to do that in spades by building a large “competence centre” bureaucracy at the European Union Intellectual Property Office (EUIPO). No, this is not the non-EU European Patent Office (EPO) that 63% of respondents to a DG GROW survey last year stated they preferred conduct the checks. This EU organisation has no expertise in patents, let alone in SEPs. It was selected because “the body needs to be aligned with the EU’s overarching political values and current policy priorities (e.g. support for SMEs)”,“accountable to the EU Public and European Parliament”, and “subject of a review by the CJEU".

The new centre will become a white elephant, even if it can acquire the required competences and get away with making the industry, and ultimately consumers, pick up the tab.

A recipe for hold-out and short-changing SEP owners

DG GROW’s unconscionable mission, which will undermine SEP licensing and enforcement (eg in Germany), is without legal or evidential support. The status quo purportedly exposes European companies to more litigation than “foreign producers that might fly under the radar", however patent infringement and exposure to enforcement occurs in both the location of manufacture and of sales. Unlicensed products manufactured outside Europe are more susceptible to being excluded through customs seizures as well as injunctions in Europe than are unlicensed European manufacturers. The Impact Assessment presents much anecdotal rather than quantitative evidence that European implementers are systematically and significantly disadvantaged. Rather than racing to the bottom by crushing European royalties and enforcement to level-down with foreigners’ alleged infringing sales, all suppliers in and to Europe should be held to the same high standards of patent protection.

If the reforms proposed in the leaked draft are accepted, this will do more economic harm to licensors, including EU’s leading innovators Ericsson and Nokia — that are highly dependent on SEP income to fund R&D — than it will to speculatively benefit implementers including SMEs who are purportedly those most in need of these changes. DG GROW also complains of “insufficient transparency on SEP ownership and essentiality; lack of information about FRAND royalties; and a dispute settlement system not adapted for FRAND determination”.

And yet, for most European implementers, including SMEs in particular, there is only limited exposure to unexpected SEP licensing or litigation costs because virtually all phones are manufactured outside of the EU and most SEP patents are exhausted in, for example, IoT modules that are also overwhelmingly manufactured elsewhere. The significant exception is cars.

Avanci has very successfully created a solution that is licensing all European manufactures at the modest cost of up to $15 (before the increase to $20) for the vast majority of patents declared essential to 2G, 3G and 4G, while its upcoming 5G program is in the works.

A centre of insufficient competence for DG GROW

DG GROW is unsatisfied with ETSI’s IPR database of declared essential patents. Its declaration process exists only to ensure technology standards are not blocked by unavailable IPRs. Essentiality of declared patents is not checked, let alone updated to reflect whether declared patents end up staying or becoming essential through patent prosecution and to finalisation of standards. ETSI also refuses to participate in commercial matters, such as setting royalty rates — even in aggregate, let alone for individual licensors and licensees — because its members do not want to compromise ETSI’s technically-focused functions, because ETSI does not have that competence and because it would be a violation of competition law.

Consequently, DG GROW apparently wants to expand administrative scope by edict through the EUIPO with new competences including:

• Registration of SEPs and access to the electronic database established by the competence centre. It seems this will largely duplicate what the ETSI IPR database does for patents declared essential to cellular standards, while also providing updates on patent status.
• Essentiality checks, including peer evaluation. The proposed process is fraught with all kinds of issues that will lend to manipulation, favouritism, bias and also subject checks or patents to subsequent challenges. SEP owners have shunned a system like this in Japan.
• Aggregate royalty determinations. Despite many claiming expertise, there is no consensus on methodology, let alone on applicable figures. The Unwired Planet Decision assumed patent value proportionality only to imply — not set — aggregate figures in cross-checking comparable license valuations due to the uncertainties. Even defining aggregate is debateable: is this total a theoretical maximum that nobody would ever pay, a typical or average figure actually paid after caps and discounts, or something in between?
• FRAND determinations. DG GROW is incredibly abandoning the industry’s prevailing comparable licenses valuation method. Its proposed top-down approach is unsubstantiated and has floundered in the courts. The recent InterDigital v Lenovo Judgment in the UK “f[ound] no value in InterDigital’s Top-Down cross-check in any of its guises”, despite huge amounts of expert work. The entirety of the TCL v. Ericsson FRAND Decision including its shaky top-down valuation was unanimously vacated on appeal. The IA acknowledges “persistent differences of opinion on key aspects of the FRAND concept such as royalty evaluation methods”. The EUIPO’s experts will have to build trust in their top-down competence from the ground up.

DG GROW advocates exemptions from royalty payments for low sales volumes in FRAND licensing. This is appropriate and already common practice in many bilateral and pool licenses. However, while DG GROW calls this “royalty-free licensing”, its ambiguous use of this term, while also referencing examples of Bluetooth and USB standards, dangerously implies reciprocity that prevents counter-parties from generating any royalties. This undermines the business model neutrality in an open and competitive market DG GROW should be preserving.

Disregarding facts

It’s staggering that DG GROW disregards plain facts and maths. No wonder it’s being accused of being so one-sided. While it professes to cherish transparency and balance, and claims to conduct literature analysis, it has not cited any of my articles among the hundreds cited in its IA. This is despite mine being widely cited elsewhere for my seminal research on key SEP issues including aggregate royalties and inaccuracies in patent sampling and essentiality checking. On the latter, in 2021, I identified a mathematical howler in a 2016 report for the EC by CRA that is cited eight times in the IA. CRA hugely understates — by a factor of much more than 10 — the estimated sample size of only 30 it claims provides “quite a good precision”. Neither a rebuttal to my claim, nor erratum has ever been produced. Sample size and time spent per patent are the two biggest cost drivers in essentiality checking.

And, as highlighted by FOSS Patents, DG GROW is also wrong to assert that “false positive and false negative random errors tend to cancel each other out” because more of the former creates systemic bias.

Nevertheless, my findings that accurate samples of several thousand are required have got through. The IA anticipates the need to check 10,000 to 99,500 patents at a cost of €4,000 or €5,000 each for a total of €40-498 million, plus claim chart, office IT, administration and depreciation costs. Ouch!

This empire-building framework defies common sense and smacks of agency capture by Big Tech and Auto lobbyists seeking to minimise licensing charges. It disregards the proven efficacy of standard-essential technology development, established licensing FRAND practices, economic realities and the interests of innovators. Bureaucratised and centralised essentiality checking, patent counting and rate setting will be burdensome and costly. Internal processes and external challenges to what these deliver will only exacerbate existing patent hold-out and further delay licensing payments.

The technology standards ecosystem has evolved and flourished in a free market. European SEP licensing is overwhelmingly a European net export worth billions of Euros per year including major earners Ericsson and Nokia. Its reckless to jeopardise that and saddle the European industry with the additional costs of these proposals. These set a terrible example that will encourage jurisdictions seeking to benefit from erosion of SEP value. Rather than having most of EU’s estimated 1,500 experts in the field check others’ patents at an estimate cost of €500 per hour, it would be more fruitful for them to spend their time innovating and patenting themselves.

Essentiality checks might foster SEP licensing, but they won’t stop over-declarations from inflating patent counts and making them unreliable measures

 Essentiality checks could help implementers determine with whom they need patent licenses.  However, essentiality checking does a poor job in adjusting for over-declaration in patent counts and will encourage even more spurious declarations.

We await a new policy framework from the European Commission (EC) with its Impact Statement regarding the Fair Reasonable and Non-Discriminatory (FRAND) licensing of Standard Essential Patents (SEPs). The EC is considering instigating checks on patents disclosed—to Standard Setting Organization (SSO) Intellectual Property Rights (IPR) databases as being possibly standard essential— to establish whether they are actually essential to the implementation of standards such as 5G. Objectives for essentiality checking are to:

1.      enable prospective licensees to determine with whom they need to be licensed

2.      correct for over-declaration and only count patents deemed essential; and

3.      use such figures in FRAND royalty determinations.

If clutches of selected patents are independently and reliably checked to establish that prospective licensors each have at least one patent that would likely be found essential by a court, these results might be used by several or many prospective licensees to determine with whom they need to be licensed.[1] But such checks would be of limited and questionable additional use to existent court determinations. Checks have already been made on some patents for all major licensors and many others in numerous SEP litigation cases over many years. Greater legal certainty is provided in court decisions where many patents have been found standard essential, infringed and not invalid.

My full paper on this topic, which can be downloaded here, focuses on the wider use of essentiality checks and sampling in patent counting. With too many patents to check them all properly, it is hoped that thorough checking of random samples of declared patents will—by extrapolation—also enable accurate SEP counts to be derived. However, essentiality checks do not fix and can only moderate exaggerations in patent counts due to over-declaration. For example, false positive essentiality determinations will exceed correct positive essentiality determinations where true essentiality rates are less than 10% unless at least 90% of determinations are correct.[2] Inadequate checking could imbue many with a false sense of security about precision while encouraging even more over-declaration by others which would further misleadingly inflate their measured patent counts and essentiality rates.

My empirical analysis also shows that declared essential patents are too numerous, and bias in checking and random errors in sampling are too great to provide even the modest precision expected and that should be required for patent counts to determine FRAND royalties without very thorough and highly accurate checks on thousands of patents per standard.

Even ignoring residual bias after improved but imperfect checking, sample sizes of thousands of patents would be required to provide even only modest levels of precision in essential patent counts (e.g. a ±15% margin of error on the estimated patent count at the 95% confidence level) on patent portfolios and entire landscapes where essentiality rates are low (e.g. 10%) due to over-declarations.

The dangers in not recognizing the sources and extent of bias and other errors and in not designing studies with sufficient scale and precision (e.g. for a court setting a royalty rate) is that far from increasing transparency, information provided will be imprecise, distorted and unreliable. Ignoring analytical errors, and mistakenly implying or pretending otherwise is even worse.

This new paper, also available on SSRN, is a follow-on to my previous research on essentiality checking and patent counting in 2011, 2017 and 2021.

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[1] This ignores validity and actual infringement in any specific product, which also determine whether licensing is required under patent law and FRAND conditions. These are also important issues.

[2] The essentiality rate is the number of essential patents divided by the number of declared essential patents. An estimated or found essentiality rate will differ from the true essentiality rate due to inaccuracies.