Was the U.S. National Institutes of Health conflicted during the COVID-19 pandemic period?

Jon Cohen at Science has an interesting and informative article titled, “Accusers’ bad math: NIH researchers didn’t pocket $710 million inroyalties during pandemic,” published on June 5.  The article addresses allegations that government scientists made $710 million in royalties on COVID-19-related technologies.  Those allegations raise an interesting conflict of interest issue. 

The article is definitely worth a read to provide some clarity to the controversy.  The article does note that government researchers did receive around almost $37 million in royalties during a three-year period that were mostly related to COVID-19-related technologies.  The article also states that there is a significant limit on the amount of royalties an NIH researcher can receive a year: $150,000.  I guess the math adds up to around a maximum of $450,000 over a three period for an individual researcher.  How long will they receive those royalties?  Do we have an issue with this or is this type of system which provides an incentive for government researchers to try to invent useful and valuable inventions for the public a very good thing?  Does the yearly limit effectively eliminate the conflict of interest issue? 

Big Win for Qualcomm in the Ninth Circuit

 In a big win for Qualcomm, the Ninth Circuit Court of Appeals (Judge Callahan writing the opinion), in FTC v. Qualcomm, __ F.3d __ (9^th Cir. August 11, 2020), found that Qualcomm had not violated competition law based on licensing practices, including refusal to deal and FRAND practices.  Notably, the Ninth Circuit overturned the District Court’s “permanent, worldwide injunction prohibiting Qualcomm’s core business practices.”  The District Court made five major findings:

1) Qualcomm's “no license, no chips” policy amounts to “anticompetitive conduct against OEMs” and an “anticompetitive practice[ ] in patent license negotiations”; (2) Qualcomm's refusal to license rival chipmakers violates both its FRAND commitments and an antitrust duty to deal under § 2 of the Sherman Act; (3) Qualcomm's “exclusive deals” with Apple “foreclosed a ‘substantial share’ of the modem chip market” in violation of both Sherman Act provisions; (4) Qualcomm's royalty rates are “unreasonably high” because they are improperly based on its market share and handset price instead of the value of its patents; and (5) Qualcomm's royalties, in conjunction with its “no license, no chips” policy, “impose an artificial and anticompetitive surcharge” on its rivals’ sales, “increas[ing] the effective price of rivals’ modem chips” and resulting in anticompetitive exclusivity.

One important problem with the District Court’s analysis, according to the Ninth Circuit, was the District Court’s failure “to distinguish between Qualcomm’s licensing practices (which primarily impacted OEMs) and its practices relating to modem chip sales (the relevant antitrust market).”  The Ninth Circuit rejected the District Court’s reliance on the Aspen exception to the general concept that refusals to deal are not antitrust violations and quoted a prior case: “’Competitors are not required to engage in a lovefest.’”  The Ninth Circuit also found that Qualcomm’s conduct in breaching its SSO agreements did not arise to an antitrust violation.  Notably, the Ninth Circuit stated:

Finally, we note the persuasive policy arguments of several academics and practitioners with significant experience in SSOs, FRAND, and antitrust enforcement, who have expressed caution about using the antitrust laws to remedy what are essentially contractual disputes between private parties engaged in the pursuit of technological innovation. The Honorable Paul R. Michel, retired Chief Judge of the Court of Appeals for the Federal Circuit, argues that it would be a mistake to use “the hammer of antitrust law ... to resolve FRAND disputes when more precise scalpels of contract and patent law are effective.” Amicus Curiae Br. of The Honorable Paul R. Michel (Ret.) at 23. Judge Michel notes that “[w]hile antitrust policy has its place as a policy lever to enhance market competition, the rules of contract and patent law are better equipped to handle commercial disputes between the world's most sophisticated companies about FRAND agreements.” Id. at 24. Echoing this sentiment, a former FTC Commissioner, Joshua Wright, argues that “the antitrust laws are not well suited to govern contract disputes between private parties in light of remedies available under contract or patent law,” and that “imposing antitrust remedies in pure contract disputes can have harmful effects in terms of dampening incentives to participate in standard-setting bodies and to commercialize innovation.” Wright, supra note 1, at 808–09.

The Ninth Circuit rejected the District Court’s determination that Qualcomm engaged in anticompetitive conduct by charging “unreasonably high royalty rates” among other things.  The Ninth Circuit stated:

We hold that the district court's “anticompetitive surcharge” theory fails to state a cogent theory of anticompetitive harm. Instead, it is premised on a misunderstanding of Federal Circuit law pertaining to the calculation of patent damages, it incorrectly conflates antitrust liability and patent law liability, and it improperly considers “anticompetitive harms to OEMs” that fall outside the relevant antitrust markets. Furthermore, even if we were to accept the district court's conclusion that Qualcomm's royalty rates are unreasonable, we conclude that the district court's surcharging theory still fails as a matter of law and logic.

On the Federal Circuit’s damages law, the Ninth Circuit states:

Even if we accept that the modem chip in a cellphone is the cellphone's SSPPU, the district court's analysis is still fundamentally flawed. No court has held that the SSPPU concept is a per se rule for “reasonable royalty” calculations; instead, the concept is used as a tool in jury cases to minimize potential jury confusion when the jury is weighing complex expert testimony about patent damages. See Ericsson, 773 F.3d at 1226(explaining that the SSPPU concept is a flexible evidentiary tool, not an unyielding substantive element of patent damages law); VirnetX, Inc. v. Cisco Sys., Inc., 767 F.3d 1308, 1327–28 (Fed. Cir. 2014) (same); LaserDynamics, 694 F.3d at 68 (same). As this case involved a bench trial, the potential for jury confusion was absent.

Moreover, the Federal Circuit rejected the premise of the district court's determination: that the SSPPU concept is required when calculating patent damages. See Commonwealth Sci. & Indus. Research Org. v. Cisco Sys., Inc., 809 F.3d 1295, 1303 (Fed. Cir. 2015) (“The rule Cisco advances—which would require all damages models to begin with the [SSPPU]—is untenable [and] conflicts with our prior approvals of a methodology that values the asserted patent based on comparable licenses.”) (citations omitted). The Federal Circuit has also observed that “ ‘[s]ophisticated parties routinely enter into license agreements that base the value of the patented inventions as a percentage of the commercial products’ sales price,’ and thus ‘[t]here is nothing inherently wrong with using the market value of the entire product.’ ” Exmark Mfg. Co. Inc. v. Briggs & Stratton Power Prods. Grp., LLC, 879 F.3d 1332, 1349 (Fed. Cir. 2018) (some alterations in original) (quoting Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1339 (Fed. Cir. 2009)). These statements of law and current practice run counter to the district court's conclusion that patent royalties cannot be based on total handset price and that doing so exposes a firm to potential antitrust liability.

On Qualcomm’s “no license, no chips” policy, the Ninth Circuit stated:

This is not to say that Qualcomm's “no license, no chips” policy is not “unique in the industry” (it is), or that the policy is not designed to maximize Qualcomm's profits (Qualcomm has admitted as much). But profit-seeking behavior alone is insufficient to establish antitrust liability. As the Supreme Court stated in Trinko, the opportunity to charge monopoly prices “is an important element of the free-market system” and “is what attracts ‘business acumen’ in the first place; it induces risk taking that produces innovation and economic growth.” Trinko, 540 U.S. at 407, 124 S.Ct. 872. The record suggests that this case is more like Am. Express, where a company's novel business practice at first appeared to be anticompetitive, but in fact was disruptive in a manner that was beneficial to consumers in the long run because it forced rival credit card companies to adapt and innovate. 138 S. Ct. at 2290. Similarly here, companies like Nokia and Ericsson are now “[f]ollowing Qualcomm's lead” with respect to OEM-level licensing, and beginning in 2015 rival chipmakers began to successfully compete against Qualcomm in the modem chip markets. We decline to ascribe antitrust liability in these dynamic and rapidly changing technology markets without clearer proof of anticompetitive effect.

On the alleged anticompetitive nature of Qualcomm’s dealings with Apple, the Ninth Circuit stated:

Even if we were to agree with the district court that the Apple agreements were exclusive dealing contracts that substantially foreclosed competition in the relevant antitrust markets, it is undisputed that these agreements do not pose any current or future threat of anticompetitive harm. Despite the “clawback provisions,” Apple itself terminated the agreements in 2015—two years before the FTC filed its action. Thus, while we agree with the district court that these were structured more like exclusive dealing contracts than volume discount contracts, they do not warrant the issuance of an injunction.

Finally, the Ninth Circuit nicely sums up its reasoning and approach:

Anticompetitive behavior is illegal under federal antitrust law. Hypercompetitive behavior is not. Qualcomm has exercised market dominance in the 3G and 4G cellular modem chip markets for many years, and its business practices have played a powerful and disruptive role in those markets, as well as in the broader cellular services and technology markets. The company has asserted its economic muscle “with vigor, imagination, devotion, and ingenuity.” Topco Assocs., 405 U.S. at 610, 92 S.Ct. 1126. It has also “acted with sharp elbows—as businesses often do.” Tension Envelope Corp. v. JBM Envelope Co., 876 F.3d 1112, 1122 (8th Cir. 2017). Our job is not to condone or punish Qualcomm for its success, but rather to assess whether the FTC has met its burden under the rule of reason to show that Qualcomm's practices have crossed the line to “conduct which unfairly tends to destroy competition itself.” Spectrum Sports, 506 U.S. at 458, 113 S.Ct. 884. We conclude that the FTC has not met its burden.

First, Qualcomm's practice of licensing its SEPs exclusively at the OEM level does not amount to anticompetitive conduct in violation of § 2, as Qualcomm is under no antitrust duty to license rival chip suppliers. To the extent Qualcomm has breached any of its FRAND commitments, a conclusion we need not and do not reach, the remedy for such a breach lies in contract and patent law. Second, Qualcomm's patent-licensing royalties and “no license, no chips” policy do not impose an anticompetitive surcharge on rivals’ modem chip sales. Instead, these aspects of Qualcomm's business model are “chip-supplier neutral” and do not undermine competition in the relevant antitrust markets. Third, Qualcomm's 2011 and 2013 agreements with Apple have not had the actual or practical effect of substantially foreclosing competition in the CDMA modem chip market. Furthermore, because these agreements were terminated years ago by Apple itself, there is nothing to be enjoined.

Large differences in FRAND rates and royalty payments are legitimate and pro-competitive

Cellular technology companies with substantial device businesses — including Huawei and Samsung today, and Nokia until it sold its handset business in 2014 — generate no more than modest net licensing revenues, despite the significant Standard-Essential Patent (SEP) portfolio sizes they have declared. Crucially, they must also cross license their manufactures against infringement of other companies’ patents.  Companies without significant device businesses, including Qualcomm and InterDigital, have no such overriding need to barter their intellectual property. Instead, their businesses are focused on licensing cellular and smartphone patents for cash, upon which their technology developments crucially depend.

SEP licensors do the costly technology developments that make new generations of standards including 3G, 4G and 5G openly available to all OEMs: however, since 2011, if not earlier, none of the former has received, in licensing revenues, even as much as an average of $4.50 per phone or a few percent of global wholesale handset sales revenues, for example, totalling $398 billion in 2018. Aggregate royalties paid to all licensors have averaged less than five percent. In contrast, Apple has taken up to 43 percent revenue share with its iPhone sales and other smartphone leaders Samsung and Huawei are also currently in double digits.

Leaders' technology licensing and OEMs' total handset sales revenues in cellular

FRAND rates and net payments in cash

Some licensors legitimately generate rather more licensing income than others. Net royalty rates charged, and cash payments received, by the same licensor may vary substantially from licensee to licensee without violating Fair Reasonable and Non-Discriminatory (FRAND) licensing obligations.

The question of what levels of royalty rates should be deemed FRAND for licensing SEPs in cellular technologies has loomed large in commentary on the recent US Federal Trade Commission (FTC) v. Qualcomm antitrust trial in the Northern District of California. Witness Huawei claimed 80% to 90% of its SEP royalty payments are made to Qualcomm. Apple previously claimed Qualcomm charged it at least five times more in payments than all other cellular patent licensors combined. That was until Apple unilaterally withheld all such payments a couple of years ago. Notwithstanding the April 2019 settlement of all litigation between Qualcomm and Apple and with resumption of licensing payments to Qualcomm, including a one-off payment of between $4.5 billion to $4.7 Billion, the court’s decision in the above case is imminent.

It should be expected that some companies net much higher licensing rates and generate much more licensing income than most others. It should not be considered untoward or a violation of FRAND or antitrust requirements. FRAND rates negotiated bilaterally or multilaterally, let alone licensing payments made after netting off parties’ charges, may vary substantially from case to case due to different business models, patent holdings cross-licensed, payment timing and disparate trade flows of products licensed, manufactured and sold among SEP licensees. Substantial differences in net rates and payments can therefore be quite legitimate due to various quid pro quos, as well as differences in patent portfolio sizes and strengths.

Major OEMs would rather limit rates to minimize out-payments than maximize royalties received

Companies with predominantly downstream business models as device OEMs, that implement numerous SEP technologies, tend to benefit from generally low royalty rates, even if they have substantial patent holdings themselves. Many device OEMs have, accordingly, tended to advocate licensing regimes that cram down royalty charges by capping aggregate royalty rates. As I have explained in my publications for more than a decade, SEP owners with large device businesses prefer to limit rates, even though that limits them to generating only modest licensing fees, because low rates also minimise their royalty out-payments on those devices.

Market leaders in cellular handsets, including Nokia 12 years ago, Apple, Huawei and Samsung today, invariably have much larger market shares in featurephone or smartphone sales than they have shares of SEPs reading on the cellular standards. They are therefore far more financially exposed as licensees than they stand to gain as licensors — particularly in negotiating licensing agreements with other SEP owners that have no downstream device business in need of licensing. Even though some of the above companies are also major patent owners, their royalty incomes were or are modest in comparison to licensors without downstream operations producing or selling devices.

Patent pools

Patent pools provide notable evidence of this downstream effect with their rates tending to be much lower than bilaterally negotiated rates. Patent pools are typically dominated by leading implementers of the applicable standard and that may also own many SEPs reading on that standard. For example, MPEG LA lists Apple, HP, Panasonic, Samsung, Sharp, Sony, Toshiba and ZTE among its many licensors for the very popular AVC/H.264 video standard employed in smartphones and TVs. Its maximum rate is around $0.20 per unit sold including smartphones, PCs and TVs.

Royalty-free joint licensing, very similar to pooling in many ways but without the need to check patent essentiality or collect and distribute royalties, is an extreme case of this downstream effect. The Bluetooth Special Interest Group allows its members royalty-free implementation of this popular standard so long as they also commit to license their patents on that basis.

Some joint licensing arrangements, also very similar to pools, are not dominated by the applicable standard’s implementers. Major SEP licensors in Avanci are companies that do not manufacture automotive products including Ericsson, InterDigital, Nokia and Qualcomm. It was telling, and quite self-serving, that the Huawei speaker at the recent TILEC recent conference on patent pools asserted that Avanci’s cellular-SEP licensing charges [of $3 to $15 per car] are too high.

Patent pool benchmarks were, at first, presented by TCL in its FRAND licensing rate litigation versus Ericsson in the Central District of California. But the dynamics of patent pools were totally inapplicable to this dispute about bilateral rates. Patent pool licensing rates were never even considered by the Court because these, following my expert rebuttal report, did not even make it into direct testimony at trial.

Proportional allocations

SEP owners with major downstream operations commonly also contrive for apportionment so that, for example, owners of only few SEPs can command no more than very low rates. This action was, among other reasons, to counter some OEMs with small patent portfolios punching way above their weight in cross-licensing negotiations with large SEP holders who were also seeking freedom to operate with low patent infringement risk as major device OEMs. For example, Nokia had a $50 billion handset business in its heyday approaching and including 2008. The threat of litigation from small patent holders against such a large amount of trade made it impossible to achieve anywhere near Qualcomm’s rates when Nokia sought to license them for use of Nokia’s SEP technology. In contrast, Qualcomm exited the handset business many years earlier around the turn of the millennium.

If it ain’t broke don’t price fix it

Antitrust authorities, including the FTC, should not be price setters. Instead of adjusting established royalty rates—underpinned by hundreds of licenses and billions of dollars in payments over many years—applicable questions for these organizations are: is the market competitive, efficient and maximizing consumer welfare? Copious evidence shows that it is: with relentless market entry and disruption to incumbents, ever-improving quality and declining prices. The unintended consequences of price regulation would harmfully disincentivise new-technology investments in standard-essential technologies that could be exploited by the entire ecosystem of suppliers and consumers at very low incremental costs in comparison to product and service prices.

FRAND rates and payments differ with variations in other licensing terms and trading volumes 

FRAND licensing must accommodate a wide variety of factors. Rates and payments can vary substantially among different pairs of licensors and licensees – even for the same patent portfolios — because other contractual terms and trade flows for licensing vary so much (i.e. how many handsets manufactured and at what prices sold by each party). But that does not mean that anything goes. The words fair, reasonable and non-discriminatory still have meaning— it is just that the detail with various offsets and other factors is devilish and can account for major differences in apparent royalty rates and actual payments – particularly between licensors that are predominantly that, and those that are largely major implementors and patent licensees as device OEMs.

A very similar article to the above was first published for the cellular industry in RCR Wireless. The full version of my above analysis is available here.

The Importance of an Accurate Assessment of Patent Valuation and Potential Market

A recent article in the Saint Louis Post Dispatch by Christopher Yasiejeko describes a patent-related dispute between two academic institutions.  Two major research universities, University of Wisconsin (through its technology licensing arm, Wisconsin Alumni Research Foundation (WARF)) and University of Washington, Saint Louis (WUSTL) are engaged in litigation concerning royalty payments over a jointly invented patented invention that was licensed to Abbott Laboratories.  The inventors included a researcher from Wisconsin and one from WUSTL. 

One of the issues with university developed technology is who will cover the patent prosecution costs.  Here, WARF apparently agreed to cover the costs for a higher royalty rate.  The dispute concerns apparent representations made by WARF concerning the value of the patent—allegedly representations were made that the value was not very high by WARF.  WUSTL appears to assert that WARF made representations to others that the patent was actually quite valuable and eventually important to the pharmaceutical, Zemplar, which according to the article “generated $409 million in sales in 2011.”  This appears to be a case where fraud in the inducement in entering the contract is relevant.  However, it seems strange that WUSTL was unable to arrive at their own valuation or understand the potential market for the invention—perhaps they did not have the resources at the time invested in technology transfer.  WARF was likely well financed at that time and certainly experienced.

[Hat Tip to Technology Transfer Central]

Under-reporting of IP licence royalties: is it a problem worth tackling?

IP Finance has received word from InvotexIP of the findings of its 14th Royalty Compliance Report in which, it reports, licensors who fail to audit their intellectual property income may be losing significant revenue. The study shows that a staggering 87% of audited licensees underpay royalties. The errors are substantial: 

• 57% of licensees under-report sales
• 31% misinterpret the licensing agreement
• 27% under-report due to disallowed deductions

The report also offers data on the frequency rate of common under-reporting errors, findings by error type and under-reported royalties as a percent of reported royalties.

This blogger is not surprised. Noting that 57, 31 and 27 add up to rather more than 100%, he has no doubt that some licensees under-report in more than one way -- and he is sure that there are other bases upon which under-reporting is made. Rigorous auditing by licensors is often resented both by licensees who find it invasive and embarrassing and by licensors who find it expensive and inconvenient. However,the cost of taking measures to ensure accurate reporting of sales volumes, income and so on should be measured against the cost of not taking them.

FRAND in India: how much will your royalties cost you?

"FRAND in India: The Delhi High Court's emerging jurisprudence on royalties for standard-essential patents" by J. Gregory Sidak (Criterion Economics), has just been published online by the Journal of Intellectual Property Law & Practice (2015) doi: 10.1093/jiplp/jpv096. The abstract of this article reads as follows:

Indian jurisprudence on fair, reasonable, and non-discriminatory (FRAND) licensing practices for standard-essential patents (SEPs) is at a relatively nascent stage. Unlike US and EU courts, which have dealt with cases concerning calculating a FRAND royalty for a considerable time, Indian courts and the Indian antitrust authority—the Competition Commission of India (CCI)—have only just begun to decide such cases.

In its initial orders in the first two antitrust complaints concerning SEPs, the CCI seemed to favour using the smallest saleable patent-practising component (SSPPC) as the royalty base to determine a FRAND royalty. However, in the short time since the CCI's orders, the Delhi High Court has rendered contrary decisions in two SEP infringement suits. The Delhi High Court's decisions use the value of the downstream product as a royalty base and rely on comparable licences to determine a FRAND royalty. The Delhi High Court's decisions are not only consistent with sound economic principles, but also indicate that the court is responding to the judicial and industry trends in the rest of the world.

Because the CCI is still investigating the antitrust complaints with respect to the same SEPs, the CCI could benefit from considering the legal and economic arguments in the Delhi High Court's decisions. It would be counterproductive for the emerging FRAND jurisprudence in India if the judiciary and the competition authority take opposing views toward the rights of SEP holders and SEP implementers.

This is an Open Access article, distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/4.0/), which means that you can read the article in full, without payment, here.  The licence permits unrestricted reuse, distribution, and reproduction in any medium, provided the original work is properly cited.

Should You Hire An Auditor To Ensure You Are Obtaining All of Your Royalties? Invotex Thinks You Should Hire It and Here is Why.

Invotex is an accounting, financial and economic consulting firm that provides expert services in litigation, forensic and valuation support; intellectual property services; insurance services; and restructuring and investigation services.  As part of its suite of intellectual property services, Invotex offers royalty audits and compliance services.  And, as Professor Crouch at the excellent Patently O Blog recently noted, Invotex has released its 13^th Annual Invotex Royalty Compliance Report.  The report's headline states, in part, “89% of Audited Licensees Underreport and Underpay Royalties.”  According to Invotex, there has been a trend up in underreporting and underpaying royalties since it started creating reports in 2007.  The audits included in the report appear to be of companies that Invotex was hired to audit.  It is unclear, however, how many companies were audited by Invotex for this report; although the press release notes that “hundreds of agreements” have been audited by Invotex and Invotex has recovered “$150 million in underpaid royalties.”  Invotex states that:

Underreported Royalties as a Percent of Reported Royalties
In our examinations, we found that in a high percentage of cases, licensees owed the licensor more than two times the amount paid in royalties. As a percentage of reported royalties, we found that of all licensees:

·         25% underreport the royalties they owe by more than 100% of the total amount reported

·         7% underreport the royalties they owe by 50 to 99% of the total amount reported

·         8% underreport the royalties they owe by 25 to 49%

·         11% underreport the royalties they owe by 11 - 24%

·         11% underreport the royalties they owe by 6 to 10%

·         27% underreport royalties they owe by 1 to 5%

·         11% accurately report royalties owed

Invotex also helpfully reports the reasons for underreporting.  Notably, the report states that, “56% underreport sales; [and] questionable license interpretation accounts for 44% of the total misreported dollar amount.”  Apparently, Invotex has, perhaps unsurprisingly, found that licensees will interpret certain terms such as “the definition of the product to how to calculate the sale” in ways that result in lower royalty amounts.  This interpretation issue can be the result of poor drafting and Invotex notes that, “outright fraud is a rare occurrence.”   The report states other sources of underreported royalty amounts including: Royalties from Disallowed Deductions; Math Errors; Royalty Rate Errors; Unreported Sublicenses; Transfer Prices; and Unreported Benchmarks and Milestones.  Invotex also reports that it audited a major pharmaceutical company on behalf of a research university and found that, “Based on our audit, an underpayment of more than 75% of what had originally been reported to the client was uncovered and paid to our client. This underpayment was based on the overestimation of discounts, the use of transfer prices instead of third party pricing and the misclassification of sublicensee revenue.”

In a recent article in Corporate Counsel, Invotex’s Deborah R. Stewart and Judy A. Byrd offer advice for how to maximize the opportunity to receive 100% of the royalties you are entitled.  Ms. Stewart and Ms. Byrd provide a sage “Takeaway”:

The role of in-house counsel is changing. Many corporate counsel are now evaluated not only on effectiveness and efficiency, but increasingly, on how they contribute to the company’s financial bottom line. Capturing the full value of your corporate royalties will increase your firm’s revenue. The solution may be easier than you realize.

Best practice dictates a systematic license compliance program that includes royalty audits. Audits typically generate positive results for the licensor and can turn your “cost center” into a revenue-generating resource.

IP licensing is one of the most significant and fastest-growing sources of an organization’s earnings, yet it remains one of the most poorly managed and underutilized assets. Managing a successful licensee compliance program is like managing everything else. It takes time and interest to keep it on track.

Are the experiences of readers of this blog similar in discovering underreporting of royalties? 

Royalties in publishing agreements: when expectation leads to litigation

In Morse v Eaglemoss Publications Ltd [2013] EWHC 1507 (Ch), a Chancery Division (England and Wales) decision of Mrs Justice Proudman last month, the judge who kickstarted the whole Meltwater controversy in the UK over internet browsing and copyright infringement (see various blog posts here and here) found herself once again dealing with a copyright-flavoured issue, this time involving royalties.

In short, Morse was claiming royalties from Eaglemoss, basing his claim on publishing agreements which concerned a series of illustrated wildlife publications for the Reader's Digest magazine. In effect, the agreements let Eaglemoss make use of Morse's published work, Wildlife in Britain, by packaging a series for licensed publication and mail order sale by Reader's Digest.

Morse's first contention was that there had been a binding contract even before the agreements had been entered into; this was rejected, even though the parties had been co-operating on the basis of trust and informality. Morse however had better luck with the publishing agreements themselves: on their correct construction there was a licence between the parties which entitled Morse to a proportion of the royalties in the strict sense -- but not to any elements of the fixed payments from the Reader's Digest to Eaglemoss. According to Proudman J, Eaglemoss was, on the true construction of the licence, entitled to deduct the  cost of paying third party owners of copyright in the pictures from these royalty payments, even though Morse was entitled to an account of the sums expended on them. Finally, the pleas of Morse that the agreements should be rectified for unilateral mistake or that Eaglemoss owed him fiduciary duties and should have disclosed that it would be receiving the fixed payments from Reader's Digest were also dismissed.

This is one of those curiously old-fashioned cases in which the judge actually had to decide the case on the facts before her, rather than engaging in detailed analyses of the legal principles involved.  If any moral can be extracted from this action, it is contained in the fact that, wherever money is expected by one party from another, it is best to concretise that expectation in clear and unassailable terms from the outset -- however embarrassing it may seem at the time.  Understandings and expectations based on trust and mutual respect are all very well, but in the long run they so often lead to tears.

Asian Subsidiaries Royalty Rising

The London Financial Times has an interesting story today about rises in the royalty rates that Asian subsidiaries are expected to pay to their parent companies. Apparently a number of investment funds have been gaining exposure in Asian markets by buying shares in a locally listed subsidiary of a multinational company, such as Unilever or Nestlé. The investors are concerned by the recent rises in the rates of royalties paid by these local subsidiaries for the use of "shared services" such as research and development, marketing, branding etc. This author's experience with several such agreements suggests that rates between 5% and 8% are generally paid to recognise not just the goodwill in the company name but also, for industries in which innovation plays a key role, the use of patents and know-how. Thus Unilever's rise to a royalty rate 8% of sales from 3.5% does not seem unreasonable in this context. On the other hand, it is not surprising that that investors in Unliver's Indonesian subsidiary - who have happily collected dividends - are not happy. Uniliver justifies its rise by stating that the rise is about cost recovery and that the royalties are apparently subject to the same level of tax both at home as abroad.

One issue not pointed out in the article is that the rise in royalties paid to a UK company seems to coincide with the introduction of the UK's patent box regime under which revenue attributed to patented products is taxed at a lower rate. It is almost certain that a substantial proportion of the royalties from the Indonesian (and other foreign subsidiaries) will be based on patented products and thus the royalties will be taxed at an effective rate of 10% rather than the usual rate of 23% of coloration tax. This probably makes it rather interesting for a company like Unilever to repatriate as much as its revenue from overseas subsidiaries in the form of royalties on patented products. There is clearly tension here between the interests of investors in separately quoted companies that are interested in getting a maximum level of profits from the local companies and the interests of the parent company in repatriating its profits in a tax-efficient manner Such locally quoted subsidiaries have traditionally enjoyed a premium on their share price because they are regarded as being well-governed. It's clear also in many cases that they have benefited from an undervaluation of the use of the groups intellectual property. The Swiss company Holcim has only paid 1.5% to date - which is substantially under market value despite Holcim's technological innovation and the rise to 5% will still put it at the lower end of the going rates for royalties.

The article concludes that the authorities in the local regions should wake up to what is happening and ask whether the trend is welcome. From their point of view the grand is probably not welcome as it will reduce taxable profits locally. However, the rates being talked about are well in line for going rates negotiated at an arms length basis for the use of technology - and this point is not make in the arcticle.

Judge decides royalties -- and rules on the cost of drafting an IP licence

A news flash from Anti Copying in Design -- ACID -- reports that one of its members, Temple Island Collection, scored an early victory against New English Teas in the first of a two-part intellectual property case heard in the Patents County Court, England and Wales, which readers can find at [2011] EWPC  21. ACID says:

"Having settled the original dispute about the infringement of its iconic "Red Bus" image a dispute arose about the exact scope of settlement. ...

The first [issue for Judge Birss QC to settle] was the Royalties due under the settlement. New English had agreed to pay 5% of the trade sale price of all past and pending sales of the first image. Later, New English attempted to reduce the royalty on "multi-packs" by 66% on the basis that of the three items in the multipack only one featured the first image. Temple disagreed, saying that it was clear that the parties had in mind a 5% payment on the sale price of the product sold which included the image. Judge Birss QC agreed with Temple, the parties had not invented some complicated mechanism to decide the royalty and Temple's reflected the parties' intentions when viewed objectively.

The second issue was the amount of costs payable (by New English) for drafting a licence agreement, the rival figures being £500 and £2000. Judge Birss QC accepted Temple's submission that the time taken to draft the licence was not the only factor but that other factors, such as expertise and the value of the document to the parties, were relevant and awarded £1500.

The third issue was as to whether or not the settlement required New English to enter into a formal licence, and whether that licence should include an 'open book' accounting term. This depended upon Judge Birss QC analysing correspondence between the two parties' representatives, and he ruled there was no requirement to enter into a formal licence. The Judge however indicated that he would have included an open book term had he found a licence was required.

New English have had to pay over £14,000 to Temple Island for royalties and the licence agreement as well as a previous unpaid amount in costs ..."

It's good to see a trial judge getting stuck into the financial details so decisively, particularly in what was effectively a case management conference. This blogger can't recall a previous occasion in which a judge had to consider the cost of drafting a licence, either.  Can readers, particularly those from other jurisdictions, comment the cost of drafting on the facts of this case?

India: a follow-up

Just when you thought it couldn’t get more confusing … Following on from the previous post on the Microsoft shrink-wrap case, I came across a Advance Ruling given to GeoQuest Systems BV (a Dutch company) by the Indian authorities in August.

Remember that the Delhi Tax Appeal Tribunal pretty much held that all software payments are royalties, and withholding tax needs to be deducted from payments, even if for shrink-wrap boxed software? Well, the GeoQuest Advance Ruling concludes that a payment for the licensing of special purpose software does not constitute a royalty – so no withholding tax on payments made from India.

The customer was granted an exclusive, but non-transferable, right to use the software and the associated proprietary information. but no rights to modify the source code, make copies or transfer the software to any other person. The software had to be returned at the end of the licence period.

The Advance Ruling confirmed that:

• unless the right to directly exploit copyright in the software (by copying it, amending it or similar) is granted to the payer, the payment should not be considered a royalty under Indian domestic law; and


• a payment for the use of a product that has an embedded copyright is not the same thing as a payment for the use of the copyright.

Now, see, these points make sense. The Advance Ruling makes it clear that income from a supply of software constitutes business profits rather than a royalty, so that no withholding tax should apply. Now, could they just explain this to the Tax Appeal Tribunal?

International: Malta announces tax exemption for patent royalties

The Maltese Government approved a number of changes to their tax laws on 16th April 2010 – of particular interest on IP is the news that, with immediate effect, royalty and similar income derived from qualifying patents in respect of inventions will be exempt from Malta income tax (subject to conditions still to be announced, including a cap on the maximum amount that may be exempted – and the EU may well have some comments on the matter).

Malta has been reasonably tax-efficient for IP income, but this will put the country on a par with Ireland for patents, depending on the level of the cap. Under EU pressure, Ireland extended its exemption on patent royalty income to include royalties received in respect of non-Irish patents granted after 1 January 2008. A similar cut-off date for the Maltese exemption would seem to be likely, if only to appease the EU.

Royalties for decades to come

“Plans for Michael Jackson burial remain elusive day after funeral” reported the Guardian today, after the memorial services for the king of pop held yesterday. There is no question though that his music will keep him living on: Billboard reported that last week, Michael Jackson had a record eight albums out of the top 10 on the Top Pop Catalog Albums chart, and that this week, the entire top 10 is “all-Jackson, all the time. He alone has albums at Nos. 1-6 and Nos. 8-10 while a Jackson 5 title ("The Ultimate Collection") resides at No. 7.”

Jackson was also the most popular artist on Nokia's Comes With Music service last week: seven of the top ten downloaded songs were by Jackson, with the popularity rate going up from 21st most popular the week before.

This of course has also an effect on the royalty income streams which will now benefit the (debt-laden) estate. Melbourne’s The Age reports on the king’s most valuable assets:

Jackson's most valuable asset is his 50 per cent share in the Sony-ATV Music Publishing catalogue, which people with knowledge of the partnership value at between $US1.5 billion and $US2 billion. The partnership has about $US600 million in debt, one person said. In what is recognised as the shrewdest business move of his career, the singer bought the catalogue in 1985 for $US47.5 million. In the early 2000s, he borrowed $US300 million against it. That makes the value of Jackson's share, accounting for the debt, worth between $US150 million and $US400 million.

The so-called "Beatles catalogue" is famed for music written by John Lennon and Paul McCartney. It administers nearly all of the Beatles' greatest hits. Sony-ATV also oversees the publishing of performers as varied as Elvis Presley, Eminem and Bjork and is reportedly the fourth-largest music publisher in the world.

The catalogue generated between $US13 million and $US20 million for Jackson annually, said people close to the singer.

A second catalogue, Mijac Music Publishing, includes Jackson's music as a solo artist as well as songs by other acts, including Sly & The Family Stone, Curtis Mayfield and Ray Charles. People close to Jackson estimated its worth at $US100 million, but it is difficult to place a current value on it because of the tremendous sales of Jackson's music since he died.

It is reported that the superstar used to over-record for every album he produced throughout his remarkable career – so fans can live in hope that there will be many more records, books and movies coming out. Long live the king.

ECJ hearing on royalty payment reference

There was a hearing today before the Court of Justice of the European Communities in Case C-533/07, Falco Privatstiftung and Thomas Rabitsch v Gisela Weller-Lindhorst, a reference for a preliminary ruling lodged just over a year ago by the Oberster Gerichtshof (Austria). The questions referred are as follows:

"1. Is a contract under which the owner of an incorporeal right grants the other contracting party the right to use that right (a licence agreement) a contract regarding 'the provision of services' within the meaning of Article 5(1)(b) of Council Regulation (EC) No 44/2001 of 22 December 2000 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (the Brussels I Regulation, OJ 2001 L 12, p. 1.)?

2. If Question 1 is answered in the affirmative:

2.1. Is the service provided at each place in a Member State where use of the right is allowed under the contract and also actually occurs?

2.2. Or is the service provided where the licensor is domiciled or, as the case may be, at the place of the licensor's central administration?

2.3. If Question 2.1 or Question 2.2 is answered in the affirmative, does the court which thereby has jurisdiction also have the power to rule on royalties which result from use of the right in another Member State or in a third country?

3. If Question 1 or Questions 2.1 and 2.2 are answered in the negative: Is jurisdiction as regards payment of royalties under Article 5(1)(a) and (c) of the Brussels I Regulation still to be determined in accordance with the principles which result from the case-law of the Court of Justice on Article 5(1) of the Convention of 27 September 1968 on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters (the Brussels Convention)?"

Does any reader know what this dispute is actually about? It's rare for cases involving IP licences to reach the upper echelons of European jurisprudence unless they concern market division, abuse of dominant position or some other competition-related issue. But this case looks as though it's about something to do with a licensor suing for his royalties and finding that jurisdictional/enforcement problems are barring his path. Any information, particularly from this blog's Austrian readers, would be welcome.

What's wrong with hi-tech royalties?

According to the Antitrust Hotch Potch weblog Dutch scholar and Howrey partner Damien Geradin (right) has presented a paper, "What's wrong with royalties in high technology industries" at the George Mason University School of Law and Microsoft Corporation’s second annual conference on The Law and Economics of Innovation: "Patents and the Commercialization of Innovation" last month in Arlington, Virginia. According to the abstract,

"Over the past few years, there has been an unprecedented degree of interest among competition authorities, scholars, Standard-Setting Organizations (hereafter, SSOs) and trade associations with respect to the level of royalties that are charged by holders of intellectual property rights (IPRs). For instance, in the past two years, the US Department of Justice (DoJ) granted business letter clearance to two SSOs - VITA and IEEE - to implement new IPR policies designed to control the IPR costs. In April 2007, the DoJ and the Federal Trade Commission (FTC) jointly released a report on Antitrust Enforcement and Intellectual Property Rights. But the interest is not limited to the United States. The European Commission is currently investigating the compatibility of certain licensing regimes and conduct within SSOs against EC competition law. Reflecting the debate at the policy level, scholars have produced a large body of legal and economic literature on IPR and standardization issues, including patent hold-up (where the patent holder exploits ill-gotten market power in excessive licensing fees) and royalty stacking (where multiple patents must be licensed and thus the royalty rates stack up to excessive amounts).

Against this background, this paper addresses the issue of whether something has gone wrong with royalties in high technology industries. This paper seeks to answer this question first by looking at a number of concrete scenarios where firms holding IPRs seek to obtain a return on their patent portfolios by licensing them. As will be seen, the behaviour of these firms essentially depends on whether they are vertically-integrated or non vertically-integrated. Vertically-integrated firms engage in research and development activities, patenting at least some of their inventions, and also manufacturing products based on their own innovations and the innovations produced by others. Non vertically-integrated firms, in contrast specialize in one or the other layers of production. Pure upstream firms conduct research and development activities and patent their innovations, but they do not engage in manufacturing. Downstream firms specialize in manufacturing, but do not engage in R&D".

Link to SSRN here [thank you Kristof Neefs of Laga, Belgium, for this item].

Customs duties on royalties and licence fees

The December 2007 issue of Global Intellectual Property Asset Management Report, (published by WorldTrade Executive), carries a brief article by Ben Goodger and Stefanie Slapke (both of Rouse & Co. International), "Are New Customs Duties on Royalties and License Fees Relating to Imported Goods on the Way? The authors write:

"Recent World Customs Organization (WCO) deliberations are likely to lead to major changes in the way trade mark royalties and licence fees relating to imported goods are currently being dealt with by Customs offices around the world. The changes look set to have a serious financial impact on both brand owners and licensees.

Although precise details of the changes are not yet available, IP owners should be aware, at least in general terms, of what is being proposed.

Background

How trademark royalties and license fees should be dealt with by Customs authorities has been the subject of ongoing debate within the WCO for some time. The issue is both complex and contentious.

Two years ago, a sub-committee of the WCO Technical Committee on Customs Valuation was established to examine the various national authorities’ current practice. We understand that at a recent meeting, this sub-committee decided that certain royalty payments that are not currently regarded as part of the dutiable value of imported goods should in future be included in the dutiable value.

Many of the WCO’s earlier conclusions on this subject have already been taken up by the European Commission’s Valuation Committee in its Commentary No. 11, issued earlier this year, which deals specifically with royalties and licence fees paid to a third party. It is likely that the Commission will also take up the proposed further changes.

Proposed Changes

The outcome of the most recent WCO Customs Valuation sub-committee deliberations is expected to be documented in April 2008. Although the precise content of the changes being proposed will not be known until April, it is clear that many trade mark royalties and licence fees that relate to imported goods and are not currently included in the dutiable value for Customs purposes will begin to be so included".

The authors then add that brand owners and trade mark licensees are well advised to keep a close watch on things. They expect the latest changes to be adopted promptly by Customs authorities, at least in Europe and suggest that, if European authorities are seen to be raising significant amounts of revenue from the imposition of additional duties, other countries will probably be quick to follow.