The Pendulum Swings Back: Optis v Apple Court of Appeal FRAND judgment – Rapid Reaction

Yesterday the Court of Appeal handed down its eagerly anticipated decision in Optis’ long running SEP licensing dispute with Apple.  The outcome was a comprehensive defeat for Apple, with the Court of Appeal awarding Optis a FRAND royalty of $0.15 per device – an order of magnitude higher than the figure Marcus Smith J found at first instance.  This equates to a lump sum of $502m, plus interest, over the term of the licence.   

This decision will be welcomed by patent owners, most of whom have considered both the first instance decision in Optis v Apple and the first instance and appeal judgments in InterDigital v Lenovo as determining very low per unit royalty rates.  It is likely to have a major impact on global FRAND litigation strategy, as recently the English Court has proved very popular with SEP implementers who have brought cases before the English Courts, hoping similarly low rates. It may prove alarming for those implementers who have current actions in the UK in reliance on the reputation for low rates, and have committed to pay what the court decides. 

Introduction

This decision relates to an appeal of Marcus Smith J’s judgment, handed down in June 2023, in which he decided that Apple should pay an annual lump sum of $5.13m per year for 11 years, totalling $56.43 million.  He reached this figure using a valuation method of his own creation, comprehensively rejecting the evidence of both sides’ experts.

The decision was appealed by Optis on 25 grounds, primarily arguing that that the royalty determined at first instance was far too low.  Optis’ primary case on appeal was that the valuation should be on the basis of the Optis licence with Google, as it considered this was the closest comparable.  Apple, meanwhile, supported the first instance decision (albeit suggesting that there should be some modifications to the approach taken by the judge).

The Court of Appeal’s judgment was split into two parts, with Birss LJ dealing with the royalty payment aspects of the dispute and Arnold LJ dealing with the dispute on the non-financial licence terms and the interplay with a parallel judgment given by the Eastern District of Texas which had awarded Optis $300m in damages.

How we got here

In the first part of the judgment, Birss LJ gave a detailed summary of the first instance decision.  Both parties pursued valuation cases based on comparables, but disagreed on which licences were the most comparable.  Optis pursued an ad valorem (i.e. percentage royalty rate) based approach to its comparables (either because the comparables expressed a running royalty on an ad valorem basis or they were lump sum licences which could be unpacked so as to imply ad valorem rates).  Apple argued that it would be more appropriate to unpack its comparables on an implied per unit basis, given its high average selling price (or ASP).

In addition to running cases based on comparables, the parties each ran two alternative methods for deriving a FRAND rate.  Optis proposed: 

1. scaling from the royalty awarded in Unwired Planet v Huawei.  Optis argued that this produced an ad valorem FRAND royalty of 0.30%.  This was rejected by Marcus Smith J, and there was no appeal on this finding by Optis; and
2. a top down cross check.  Optis advanced an aggregate royalty for the stack of 15% which, based on PA Consulting data, produced an ad valorem royalty range for Optis’ portfolio of 0.16% to 0.23%.

Meanwhile, Apple advanced the following alternative cases:

1. an approach based on using its FRAND ‘Framework’, which is a methodology based on two starting premises: (i) the baseband chip is the smallest saleable patent practicing unit (“SSPPU”); and (ii) the total royalty stack should be no more than the profits on the baseband chip; and
2. an approach based on the profits available using a “basic handset” that did not incorporate all of the features found in Apple’s devices.

Grounds of Appeal

Of Optis’ many grounds of appeal, the first four related to its primary case, that “the judge made fundamental mistakes by rejecting the evidence before him and then by adopting his own approach, which was itself fatally flawed”. These were summarised as:

• Optis Ground 1 – The judge took the wrong approach overall;
• Optis Ground 2 – The judge wrongly rejected the conventional comparables approach;
• Optis Ground 3 – The judge erred on hold out and how he dealt with the Apple Comparables; and
• Optis Ground 4 – By rejecting, wholesale, both parties’ economic expert evidence, the judge’s approach was procedurally unfair, unsupported and inconsistent with the common ground between the parties.

Optis had a fallback position that “if this court thought that the judge was entitled to adopt his own approach albeit there are flaws in it, then this court could correct those flaws and produce a result that way”. This was made out in grounds 5 – 9, which could be summarised as:

• Optis Ground 5 – The judgment should not have included licences which were not relied on;
• Optis Ground 6 – The treatment of the Apple / Qualcomm licence was incorrect;
• Optis Ground 7 – The judge used the wrong average in his calculation;
• Optis Ground 8 – The judge failed to take into account sales volumes; and
• Optis Ground 9 – The judge was wrong in his approach to apportionment of the lump sum for past and future sales.

Optis Ground 10 related to past sales going back beyond the limitation period, but Birss LJ explained that this point did not arise given it was determined at the appeal level in the recent Lenovo decision.

Optis Grounds 11 – 20 concerned the non-royalty terms of the licence, while Grounds 21 and 22 related to the terms of the final order generally and Grounds 23 and 24 concerned the terms of the licence and the final order relating to foreign proceedings.  Of these, Optis dropped Grounds 15, 16 and 18 – 20 prior to the hearing.  

Optis Ground 25 was characterised by Birss LJ as being an argument of procedural unfairness due to the changes Marcus Smith J made to his draft judgment after issues were identified by the parties.  Essentially, Optis argued that the necessary changes should have resulted in a material difference to the overall royalty figure, but that the judge made “further unrelated, un-asked for amendments to his methodology and reasoning so that the final figure licence was similar to the figure in the draft judgment, even though the latter was based on acknowledged errors”.   

Apple’s Grounds were not covered in any real detail in the Court of Appeal’s judgment other than a note that Grounds 1 and 2 related to the financial case, while the remainder related to the non-financial terms. 

The Court of Appeal’s decision

The Court overturned several aspects of the approach taken at first instance.  This included:

• taking insufficient account of the time value of money and the fact that different parties had different sales volumes in a cross licence (rather than assuming equal sales in both directions); 
• the fact that the first instance analysis gave very large range of value for the implied royalty stack (the number of multiples was redacted), which Birss LJ contrasted to the smaller range of values for the ad valorem rates of the comparables that Marcus Smith J considered to be too large to be reliable;
• The first instance court’s approach to unpacking in a way that it considered to disincentivise hold out.  Birss LJ was clear that the court’s role is to assess and draw conclusions about what actually happened, not to interpret facts in a way that supports a particular objective.  Any attempts to disincentivise hold out should come in the later stages when packing up. 
• Rejecting the first instance court’s “novel” concept of legitimate and illegitimate hold up / hold out. 

The Valuation Case

Birss LJ started by noting that Marcus Smith J was wrong to reject the evidence of both parties’ economic experts, stating that “while it is clear that the judge did feel he had not been assisted as much as he ought to have been, that was not the reason for rejecting their evidence wholesale as he did (nor in my judgment could it have been)”. Birss LJ also considered it to be unfair that the evidence was rejected on the basis that the experts had strayed outside of their expertise and had not exercised independent judgement, when this point had not been put to them at trial.  Birss LJ considered this to be “unfair and unjustified”.  Birss LJ concluded that “The experts sought to use their skill to give the judge the tools necessary to decide the case”. 

While Birss LJ also found that the trial judge had been wrong to criticise the experts for not being independent by adopting their instructions to use a comparables approach, he reaffirmed that the comparables approach “is an appropriate approach in law. As accountancy experts they might well need to be instructed as to which licences they should consider. They were unlikely to be able to comment on comparability of individual licences as I have defined it, but they could and did comment on the quality of the data which can be gleaned from the licences – in other words they commented on reliability and were entitled to do so”. 

Birss LJ also felt the criticism of Mr Bezant, Optis’ expert, for his unpacking using ad valorem rates was “completely unfounded”, summarising that the judge’s criticism “misunderstands the purpose of unpacking and the distinction between a lump sum and per unit rate”.  Similarly, the judge rejected criticism of Apple’s expert, Ms Gutteridge, which was based on the judge’s use of an extract from cross-examination which went to a different point. 

Birss LJ summarised the correct approach to the comparables exercise by saying: “Before leaving this topic I will say a bit more about starting from the SEP holder’s own licences. I maintain that this is the place to start but that is all it is”. However, he did express a view that the licences of the putative licensee could still be of assistance, although the exercise “also involves a further dimension which is why, although they may well be useful in the end, they are not the best place to start. Their comparability (not reliability) also depends on the relationship between the patent portfolio being licensed and the SEP holder’s portfolio. Not only does one need a view about stack shares, the issue of portfolio quality arises. It is not enough to render them comparable to say that the SEP holder’s portfolio is average. The other licensed portfolios also have to examined”. 

Finally, Birss LJ was critical of the judge’s rejections of the parties’ comparables cases on the basis of issues he considered to be insurmountable, noting that “when the judge came to work through his own method he had to grapple with all [of the same issues] one way or another”.  Consequently, Birss LJ allowed the appeal on Optis Ground 4. 

Having found that the trial judge was wrong to reject the parties’ expert evidence, Birss LJ then turned to assessing the trial judge’s approach.  Birss LJ started by clarifying that each side had abandoned parts of its case, with Apple not seeking to advance a case based on the smallest saleable patent-practising unit (SSPPU) or profits available, while Optis no longer pursued (i) its primary case at first instance, based on scaling the Unwired Planet decision; (ii) a case that Apple should pay an ad valorem royalty; and (iii) an argument that any of its licences, other than Google, were comparable. In addition, Optis made two concessions in relation to patent data (both the source and the approach to the recent Ericsson licence).  Birss LJ noted that these concessions “greatly simplified” the valuation exercise. 

Running through Marcus Smith J’s valuation method, Birss LJ accepted that “putting available licences on a common scale for the purpose of evaluating them is entirely logical”. However, Birss LJ concluded that there was a “major flaw” in the judge’s approach to common scale as the ‘lump sum’ method he used “disguises the true relationship between them [the Optis / Google licence and the Apple licences]”. 

Birss LJ considered there were other issues too.  While he did not agree with the trial judge’s approach to either the BlackBerry or Qualcomm licences, he ultimately concluded it did not matter, as neither party relied on them at appeal.

However, Birss LJ considered that “the real problem with the judge’s method is the next step, which was to take a simple average of the entries in the table. That had no precedent or basis in the evidence before him nor can it be justified in principle. In terms of the evidence, neither accountancy expert took this approach”.  While Optis had argued that, if averaging was to be done, a weighted average should be used, Birss LJ was “not satisfied a weighted average is any more justifiable than the simple average. Both forms of averaging share the same weakness in giving weight to all licences in the table as comparables, albeit that weight is different”. 

While Apple suggested ways to fix these issues, Birss LJ was not persuaded.  He concluded that “the right approach was to adopt a comparables based approach (ground 2) in the sense of being one based on identifying the best comparable or comparables, excluding others and working from there. Moreover there was no justification for setting aside the common ground of the experts to adopt some kind of unpacking to evaluate licences in per unit terms. I have also rejected the use of lump sums and averaging which means ground 7 (averaging) and ground 8 (failure to take into account sales volumes) succeed. Ground 9 (apportioning the lump sum for past and future) does not arise nor does ground 5 about the inclusion of licences not relied on”. 

Birss LJ then moved to consider Optis Ground 3, and whether Apple’s licences were tainted by hold out. He held that “the distinction drawn [between legitimate and illegitimate hold up / hold out] is unhelpful and led the judge into error” and noted that “both hold up and hold out are behaviours by one party, mischiefs, which the other party is to be protected from and this underpins the FRAND system itself”.  Birss LJ explained that the ideal licence that the court was seeking to determine would not include any hold up or hold out, while real parties will negotiate hard and there may be a degree of hold up or hold out.  Summarising the issue, Birss LJ concluded that “focussing on the Apple Comparables in particular, drawing the distinction between legitimate and illegitimate hold out led the judge to simply place all of Apple’s behaviour on the “legitimate” side of the line (e.g. [417](iii)) and in turn led him to his erroneous approach of including (almost) all the licences and taking an average”. 

This in turn led to an issue as Birss LJ noted that “when it can do so, Apple’s significant negotiating strength leads some parties to agree lower rates than would be agreed between a willing licensor/willing licensee. There is a degree of hold out involved”.  As a result, Birss LJ held that the first instance judge had been “wrong to place weight on the values derived from the Apple licences as a whole. There is hold out involved, particularly as an explanation for the spread of values of these licences whenever they are put on a common scale by stack share”.

Given these conclusions, Birss LJ considered whether a retrial should be ordered.  He noted that Optis had not sought an order for a retrial in its appellants’ notice and made clear in oral submissions that no retrial was necessary.  Apple, meanwhile, contended that a retrial would be necessary if the court went further than correcting perceived errors in Marcus Smith J’s approach.  This was on the basis that Apple’s cross-examination would have been different had Optis run its primary case at appeal at first instance.  Birss LJ found Apple’s submissions to be unconvincing in this regard.  In any case, Birss LJ considered that “in my judgment given the various concessions identified above and the conclusions reached so far, it is not necessary to remit this case for a retrial. Against the background I have described this court is in a position to reach a just conclusion on the FRAND rate starting from the position of identifying the potential comparables in issue and analysing them by putting them on a common scale of some kind by reference to the stack share under licence in each case, as determined by the Innography data. Expressed in this way, this is the core of the judge’s approach below and to that extent it is not now criticised by either party (although Optis contends there is only one comparable – Google). The difference now is to adopt this approach using the DPU data produced by the experts, which the judge wrongly rejected” and concluded that “the exercise is not as complicated as it might seem. It will involve a broad axe – as it always would have done if the judgment had approached this matter the right way – but that arises in any event”.

Turning to the calculation itself, Birss LJ acknowledged that “one of the key things the judge was trying to do was to reach a result which took into account licences both from Optis and to Apple. I believe the judge’s instincts here were correct”. It was the trial judge’s methodology for reaching the rate that Birss LJ considered to be flawed.  Considering the evidence of the experts, Birss LJ did not seek to criticise either expert but appeared to favour Mr Bezant’s approach, focusing more on his approach than that of Ms Gutteridge, Apple’s expert. 

Considering this evidence in the round, Birss LJ made several conclusions:

1. the highest four rates implied based on Apple’s licences are those derived from the Ericsson, InterDigital, Nokia and Sisvel licenses;
2. a device per unit rate for Optis lower than those implied by these four Apple licences would be too low.  That is the case for Marcus Smith J’s rate, which was in the order of $0.01 to 0.02 per device.  Birss LJ concluded that “there is no justification I can see for a DPU rate that low when those four companies are able to license Apple at an appreciably higher rate”;
3. The Optis / Google licence showed that the rate derived from the Apple licences alone would be too low.  However, the converse was also true: the implied per unit rates of the four highest Apple licences suggested that using the Google licence alone would result in a rate that was too high.  This was further confirmed using a top down cross check, which indicated the lowest rate derived by Mr Bezant from Google ($0.27) would indicate an overall stack of 15% for a handset using Google’s ASP, which was a figure already rejected as being too high by Marcus Smith J;

Birss LJ concluded that, in working out where to go from here, there are two considerations: (i) to the extent that there are a range of FRAND terms, Optis was entitled to a rate at the top of the range; and (ii) the evidence did not justify fine distinctions. Consequently, Birss LJ considered that “realistic options are a DPU of $0.20, $0.15 or $0.10”.  Using a top down cross check, he considered that $0.10 was “clearly too low”, while $0.20 was “still too much”. He therefore landed on a rate of $0.15, stating that “I reach that conclusion based on using Google and also Ericsson/InterDigital/Nokia/Sisvel as the best comparables, recognising that they are not similarly situated and that there would appear to be degrees of hold up and hold out involved” and that a top down cross check would indicate an aggregate royalty burden of 8.4%. 

Converted into a lump sum, Birss LJ held the figure would be $502m, plus interest. 

Finally, Birss LJ concluded that he did not need to consider Optis Ground 25 in light of his other findings. 

Non-Financial Terms

While many of the findings in relation to the non-financial terms in this case are driven by the facts of the case, there are a number of points of more general interest.  The first relates to the first instance judge’s approach to settling the non-financial terms of the licence, in a process Arnold LJ described as being “on any view, both extraordinary and undesirable”.  In essence, the parties had engaged in seeking to agree the non-financial licence terms and “by the end of this process the parties had prepared a composite draft licence in which many of the terms were agreed. In relation to the terms which remained in dispute, the composite draft set out the rival texts”.

However, rather than determining the points in dispute, Marcus Smith J provided the parties with “a draft short-form licence of his own devising (referred to as the “Court-Determined Licence”) which bore little resemblance to the composite draft, did not include most of the terms agreed between the parties and did include certain terms which neither party had requested and had not been the subject of argument”.

Arnold LJ summarised Optis’ grounds of appeal as follows: “Optis contends that the judge’s approach to determining the non-royalty terms of the licence involved a misunderstanding of the court’s role in declaring FRAND licence terms (ground 11), resulted in licence terms that did not constitute a commercial licence (ground 12), involved procedural unfairness (ground 13), wrongly gave Apple benefits for free (ground 14) and erred in principle with respect to the interest stop date (ground 17)”.

While Apple argued that the judge had not made an appealable error in relation to Grounds 11-13, it adopted the pragmatic approach at the appeal hearing that it would not resist the court setting aside Marcus Smith J’s short form licence and returning to the composite draft. 

Of the remaining grounds relating solely to the non-financial terms: 

1. it was not necessary to determine Ground 14, other than a discrete point in relation to the US proceedings, which Arnold LJ dealt with together with Grounds 22-24; and
2. Arnold LJ followed the position on interest (Ground 17) taken in the InterDigital v Lenovo appeal, namely that interest should be awarded on the basis that it ensures that the passage of time between when a royalty was due to be paid, and actually is paid, is cost neutral.

For Grounds 22-24 (and the remaining aspects of 14) Arnold LJ explained that they were highly fact-specific and related to the interplay between the parallel action in the Eastern District of Texas, where Optis had obtained an award of $300m in damages from Apple in respect of a reasonable royalty as a result of patent infringement. Setting out the history of the two proceedings, Arnold LJ explained that “on 21 September 2021 Apple gave an undertaking to the EDTX to pay the judgment within 30 days after it becomes final and unappealable”.  While it was common ground that there should be no double recovery, the dispute centred around the status of this payment and whether or not the patents that were the subject to the judgment of the Eastern District of Texas fell within the scope of the court-determined FRAND licence. 

In the consequentials judgment following the FRAND trial, Marcus Smith J held that there should be no carve out for the patents subject to the Eastern District of Texas finding and that these fell within the scope of the court-determined FRAND licence. As a result, the judge considered that Optis should not seek to enforce the verdict of the Eastern District of Texas and should repay the balance of any payment made by Apple over and above the award by the English Court.  In addition, paragraph 6(2) of the judge’s order (which is reproduced at paragraph 221 of the Judgment) set out restrictions on the parties that Optis characterised as akin to an anti-suit injunction. 

Arnold LJ noted that “I did not understand Apple during the course of argument before this Court to criticise Optis for bringing proceedings simultaneously in two jurisdictions, but if any criticism was intended I would reject it. Apple’s formal position at that time was that it did not need a licence under the Optis portfolio because Optis had not proved in court or demonstrated to Apple’s satisfaction that any of the patents in the Optis portfolio anywhere in the world was both valid and essential (and therefore infringed by Apple in the absence of a licence). Optis’ commencement of proceedings in two significant markets was an appropriate response to this”.  Consequently, Arnold LJ considered that, if there was any blame for the situation that had arisen, it should fall squarely with Apple, given its conduct up until it gave an undertaking to the English Court to take a licence on the terms it determined to be FRAND. 

Turning to the Grounds, Ground 22 argued that paragraph 6(2) of the final order was procedurally unfair because it was not sought by either party, nor was it the subject of argument between the parties.  Arnold LJ concluded that, “given that Optis have had a full opportunity to argue the merits of paragraph 6(2) on this appeal, however, the procedural unfairness has now been rectified”.

Ground 23, meanwhile, was “that the judge should not have imposed licence terms interfering with foreign proceedings, in particular the EDTX proceedings and more particularly the judgment therein, since this was (i) not FRAND and (ii) contrary to comity”, while Ground 24 was “that the judge should not have imposed terms of his order interfering with foreign proceedings, in particular the EDTX proceedings and more particularly the judgment therein, since this was (i) not FRAND and (ii) contrary to comity”.   

Arnold LJ recognised that both grounds raised the same issue, and concluded that there was the potential for inconsistency between the Court of Appeal’s judgment and the outcome of the action before the Eastern District of Texas if the Court of Appeal of the Federal Circuit, who are due to hear the appeal of the decision of the Eastern District of Texas, either overturn the decision and award Optis nothing, or award Optis more than the FRAND royalty determined by the Court. 

In particular, Arnold LJ considered that Marcus Smith J’s approach raised concerns of comity, stating that “I disagree with the judge’s view in [76] that no question of comity arises. On the contrary, for the English courts to make an order requiring a regularly-obtained US judgment to be vacated seems to me manifestly to give rise to an issue of comity. I shall return to this point below”. 

While Optis proposed three possible solutions to these issues, Arnold LJ accepted that “in principle, the right answer would be for the English courts’ valuation to be adjusted to take account of the EDTX judgment, but as discussed above the valuation methodologies adopted by the parties make that impractical. In those circumstances, the least-worst solution to the problem which Apple has caused is for the US final judgment to be treated as a floor for the royalties payable by Apple under the licence determined by the English courts in the manner proposed by Optis”.

Key Take Aways

This decision is likely to result in significant discussion, not least because it adds to the growing body of English case law relating to SEP disputes.  It provides possibly the clearest guidance to date on how the English Court should approach FRAND actions, which should help to reduce the time to judgment and overall cost of these cases. 

In addition, there are some key patterns that are now emerging:

1. The English Court of Appeal has increased the FRAND royalty in both of the recent appeals they have heard.  While it was generally accepted in the industry that the uplifted rate determined in InterDigital v Lenovo is low for InterDigital’s portfolio, Arnold LJ’s clear statements that the royalty in that case should be considered to be an estimate should be seen as just that.  As a result, it would be wrong to label the English Courts as being ‘implementer friendly’ (as has often been the case in recent years).   
2. The focus of analysis in a FRAND action should be on the best comparables.  In addition, the Court of Appeal has again signalled that a ‘broad axe’ approach (i.e. taking a reasonable approximation) is most appropriate when determining the FRAND rate and that injecting false accuracy into the calculations should be avoided.  These factors should help focus and simplify the evidence needed in future cases and drive down the cost of litigation. 
3. There is often substantial common ground between the economic experts, with Birss LJ noting that “Although the parties were far apart on what the answer to the financial question was it is relevant to see that there was substantial common ground about aspects of the approach to answering that question”.  This comes off the back of cases such as InterDigital v Oppo, where the judge gave directions for joint expert meetings and hot-tubbed the economic experts to identify the common ground and non-material differences.  It seems likely that, in future cases, the Court will look to encourage the parties to find such common ground to reduce the cost, complexity and Court time of these disputes.
4. The English Court will work with the findings of other courts.  While the approach adopted in this case could be argued to be a fudge to avoid comity issues, it demonstrates that the Court is very alive to these issues.  Given the global nature of FRAND disputes, this is important as it is only likely to become a bigger issue in future. 
5. Non-monetary terms should be agreed, if possible, with limited intrusion by the Court. This reflects the job of the Court in a FRAND assessment: to conduct a hypothetical negotiation.
6. The top down cross check is back – Birss LJ acknowledged that “I believe that approach can be useful provided it is kept in its place”.  It also formed the basis for confirming what Birss LJ considered to be the correct FRAND rate.  This is in stark contrast with Mellor J’s approach in InterDigital v Lenovo and, combined with Birss LJ’s guidance on the use of a ‘broad axe’ approach, indicates that the Court expects a rather different approach to be followed in future FRAND cases. 
7. While most recent judgments have focused on implied per unit rates rather than ad valorem rates, Birss LJ did not accept Marcus Smith J’s criticism of them: “In my judgment either [ad valorem or per unit] to a rate is manifestly capable of being FRAND, particularly when, as here, it is common ground that the FRAND licence will in fact involve a lump sum payment so that either ad valorem or DPU is just a tool on the way to producing that lump sum”.