With the rise of IoT and, in particular, the increased importance of vehicle connectivity, the last few years have seen an increase in arguments that the licence point and royalty basis for telecoms Standard Essential Patents ("SEP") should be at the component level.
However, in the last fortnight there have been two judgments , one from the US and one from Europe, that deal with this topic: FTC v Qualcomm  and Nokia v Daimler . These judgments give guidance on how Courts in both the US and Europe will approach this question and, while some of the details are different, both are framed as claims of breach of antitrust law. In this article we discuss the findings of these judgments and consider to what extent they close the door to arguments that the SEP license point and royalty basis are beyond the discretion of the patent owner. With more cases to come, it remains to be seen whether other courts will follow the same path.
The development of chipset level arguments
In the 1980s, 1990s and early 2000s, when the 2G and first 3G standards were being developed, the companies involved in standardisation were generally the ones who also produced the mobile handsets. As a result, the companies that had large SEP portfolios were also the ones who were implementing the SEPs. Licensing of SEPs, therefore, tended to be cross licenses made between these manufacturers, which may have involved a balancing payment.
The smartphone revolution saw new phone manufacturers bringing products to market. These companies had different business models to the established players, often buying in components rather than developing and manufacturing their own. Also, as these companies had no historic involvement in standardisation, they did not (at least initially) have significant SEP portfolios. Therefore, these new entrants had little or nothing to offer in the way of a cross license to offset against the effective royalty rate, meaning any SEP license would be a one way license with a higher cash payment. In an effort to reduce these payments, the new entrants made two arguments:
- SEPs are practiced in the chipsets that they buy in, not the end user product that they produce. Therefore SEP owners should license at the level of the chipset manufacturer, rather than the smartphone manufacturer; and
- In light of 1), any royalty should be calculated based on the sale price of a chipset, rather than the sale price of a smartphone. In support of this, the implementers relied on the US evidentiary doctrine of the smallest saleable patent practicing unit ("SSPPU")
The arguments were supported by the US cases of LaserDynamic v Quanta  and In re Innovatio  , in which courts used components or chips as the royalty basis to determine damages for patent infringement. In the later case of CSIRO v Cisco , the Federal Circuit clarified that SSPPU had not become a mandatory feature of US damages law, and calculated royalties based on an apportionment of the end product. The courts of Texas followed suit in a dispute between Ericsson and HTC: having heard evidence from some of the originators of the ETSI IPR policy, Karl Heinz Rosenbrock and Bertram Huber, the court held that royalties for Ericsson's patent portfolio should not be calculated by reference to the chipset price, but instead by the price of the finished smartphone.
Component level licensing arguments have been adopted by automotive OEMs who are now implementing cellular connectivity in their vehicles. These OEMs, like the implementer smartphone manufacturers, generally do not produce the connectivity components themselves – they buy them in from Tier 1 suppliers in modular form, which they then incorporate into a vehicle. Automotive OEMs have traditionally required of their supply chain that all parts are supplied free from any IP claims (meaning the supplier handles any licensing), with the supplier indemnifying the OEM against any claim for IP infringement.
In a departure from this tradition, the Avanci licensing platform, a SEP patent platform specifically focused on automotive use cases, has successfully signed up a number of OEMs to take a license. Other OEMs have resisted this approach. One of these OEMs is Daimler AG, the parent company of the Mercedes Benz brand, and the heart of its SEP dispute with Nokia relates to these component level licensing arguments.
US Court of Appeals applies the brakes
The Qualcomm judgment from the United States Court of Appeals for the Ninth Circuit is not specific to automotive licensing, but is relevant. The case is an appeal against a decision of the US District Court for the Northern District of California. In May 2019, at the instigation of the Federal Trade Commission, the District Court had issued an injunction against a number of Qualcomm's general SEP licensing practices. These predominantly relate to licenses with smartphone manufacturers.
In the first instance decision the District Court held that Qualcomm violated US Federal antitrust laws by (a) refusing to directly license rival chip manufacturers, rather than OEMs; (b) imposing an "anticompetitive surcharge" on sales by rival chip manufacturers and with its "no license, no chip" policy; and (c) entering into an exclusive dealing agreement with Apple in 2011 and 2013. At the time, a number of commentators were of the opinion that the District Court had gone too far, and at the appeal hearing it seemed clear that Qualcomm put forward the better argument. As a result the United States Court of Appeals for the Ninth Circuit's recent decision, overturning all of the District Court's findings, is perhaps unsurprising.
"No license, no chip" – an extension of the license point argument?
The court accepted that, while Qualcomm's "no license, no chip" policy was novel, it was driven by the US doctrine of patent exhaustion, and Qualcomm's unique position as both a component supplier and also the proprietor of a major SEP portfolio.
The Court noted that, if Qualcomm offered licences at the chip level, this would result in the partial exhaustion of its rights. OEMs would be less likely to take a license to Qualcomm's patents. It would leave Qualcomm with more limited options to recover value for its IP – either it would need to build the value of its IP into the price it charged for chips, or it would need to try and split its portfolio into a chipset level portfolio and an end user product portfolio.
Although splitting a portfolio into patents implemented in at the chipset level and patents implemented in the end user product may at first glance seem like a viable solution, it has difficulties. Few patents are actually implemented in the chip – even if the functionality is ultimately enabled by the chipsets, primary acts of infringement of an SEP cannot take place until the chip is incorporated into an end user product (such as a phone handset). While there may be arguments of indirect infringement by the chip, this complicates the matter further as a licence to the chip supplier may then license the indirect infringement but exhaust the patent meaning the patentee cannot seek a license fee for the act of direct infringement. The court of appeal also accepted that this "would require the company [Qualcomm] to engage in "multi-level licensing", leading to inefficiencies and less profit" .
Notwithstanding these findings, the appellate court then considered whether Qualcomm's "no license, no chip" policy could be objectionable on antitrust grounds. For the following reasons, they did not:
(i) although the court accepted that licensing at the OEM level is more lucrative for SEP owners, it did not consider maximising returns to be an abuse of competition law. Additionally, the court, relying on Amicus Curiae submissions by both Nokia and Dolby, accepted that OEM level licensing was consistent with current industry practice;
(ii) Qualcomm's policy was "chip supplier neutral", as it applied equally to all – an OEM would pay for the same license fee to Qualcomm regardless of where it sourced its chips. As a result, there was no "anticompetitive treatment";
(iii) the fact that Intel and MediaTek had been able to successfully break into the market in the last five years undermined the Federal Trade Commission's argument that OEM level licensing does not encourage competition. Indeed, the Court held that the presence of these other players, and the fact that Apple was able to terminate its supply agreement with Qualcomm in 2016 to source its chips from elsewhere, demonstrated that the "no license, no chip" policy was not excluding others from the market.
The appellate court noted that, if Qualcomm's policy had been the other way round, such that it required OEM's to buy its chips before it granted a license, then the story may have been different. However, that was not the case and the court considered that the policy only ensured that OEMs have a license to implement Qualcomm's patents, regardless of from whom they buy their chips.
License point – a European perspective
In the Daimler judgment, the Landgericht Mannheim found that, as a matter of principle, it is up to a patentee to choose the point in the supply chain at which it will enforce its property rights and that there is nothing in antitrust law that restricts this.
Reflecting the judgment in Qualcomm, the court held that art.102(c) TFEU was intended to ensure that there was no distortion of competition between trade partners. The court clarified that this did not mean that treating different trade partners differently was unjustified. However, it considered that all interests needed to be weighted up and that the question that needed to be determined is whether there is evidence of unequal treatment which hinders competition. In this case, the court held that there was no risk that Daimler could have been at a competitive disadvantage on the basis of Nokia actions compared to other automotive OEMs. As a result, Nokia's decision to seek a licence at the OEM level would not be anti-competitive.
SSPPU not a proxy for license base
In the Qualcomm judgment, the appellate court rejected the district court's ruling that that Qualcomm's royalties could, of themselves, amount to a breach of antitrust laws, due to being: (1) unreasonably high for reason that they are based on handset price, rather than the "fair value of Qualcomm's patents"; and (2) anticompetitive as they increase the OEM's costs, which in turn are passed onto consumers and/or result in less investment in other handset features.
In relation to the question of whether it was legitimate to use the handset price as a royalty base, the appellate court rejected the district court's finding that value should be based on the doctrine of SSPPU, stating:
"No court had held that the SSPPU concept is a per se rule for "reasonable royalty" calculation; 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".
The appellate court held that the District Judge had been wrong to conclude that SSPPU was required when calculating patent damages and that calculating royalties on the basis of total handset price would expose the patentee to potential liability under antitrust law.
To further support their finding, the appellate court considered who would be impacted if Qualcomm's rates had caused anticompetitive harm. It concluded that the harm would have been to the OEMs, who were Qualcomm's customers, rather than competitors. As a result, Qualcomm's actions could have no direct impact on competition, taking the matter outside of the scope of antitrust law.
On the question of the reasonableness of Qualcomm's rates, the court overturned the District Judge's finding that Qualcomm's royalty amounted to an 'anticompetitive surcharge'. The district court had relied on a single case in support of this point: Caldera v Microsoft . In this case, Microsoft was held to have imposed an artificial surcharge due to requiring OEMs to pay a license fee on all devices, even those that did not contain a Microsoft operating system. The finding was that this practice essentially amounted to a tax on rivals' software, as any machine that came loaded with a non-Microsoft OS would pay two software royalties, rather than one for machines with a Microsoft operating system. The Court of Appeal concluded that Qualcomm's licensing practices were "qualitatively different from the per-unit operating-system royalties at issue in Caldera" – an OEM taking a license from Qualcomm needs that license to avoid infringing Qualcomm's patents, regardless of whose chip the OEM is using. Also, unlike in Caldera, the OEM is not paying twice for something it is not using.
Licence base must give fair compensation
While the Landgericht Mannheim in Daimler reached the same conclusion as the Court of Appeals in Qualcomm, the reasoning is rather different. The starting position was to note that, in SEP cases in Europe involving mobile phones, the royalty basis is the mobile phone sales price, and specifically not the purchase price of components.
With this in mind, the Landgericht considered the question of whether Daimler had a valid objection to an injunction on the basis of Art. 102 TFEU – i.e. it asked whether Nokia had abused a dominant position. In line with the finding in Unwired Planet, the chamber considered that Nokia, as the owner of SEPs, did hold a dominant position. As it was seeking an injunction, this could lead to a finding of abuse, as the injunction would have effect of preventing standard compliant products from being placed on the market in the EU.
However, this assessment would be made in light of the Huawei v ZTE steps. The second part of the assessment was whether Daimler was willing to take a licence on FRAND terms. Daimler's position had consistently been that it was its suppliers that should take the licence and that the royalty rate should be calculated on the basis of the purchase price of the connectivity module. In assessing willingness, the Court expressly endorsed the approach taken by Birss J in Unwired Planet, by considering whether Daimler had expressed a genuine willingness to take a licence on whatever terms were considered to be FRAND. In making this assessment, the Court considered Daimler's conduct in negotiations, including the counteroffers it made.
The Court held that Daimler was unwilling to take a license on FRAND terms. The reasons included:
(i) Daimler's conduct after Nokia developed a licensing model under which Tier 1 suppliers might become a party to the licence was to withdraw from negotiations. Daimler justified its actions on the basis that it considered its continued involvement to be unnecessary, as the Tier 1 suppliers could conclude discussions. However, the Court held that this conduct was incompatible with a demonstration of genuine willingness to take a license on FRAND terms.
(ii) Although Daimler offered to submit to third party determination, the offers were made well after the start of the proceedings and reserved certain matters until later proceedings. The Court noted that this later point could arguably be viewed as further evidence of hold out, with a hope that the patents in suit would expire before resolution of the matter, with the result that the injunction risk would drop away.
(iii) Daimler's counteroffers were based on the price of the connective modules supplied to it by the Tier 1 suppliers. These counteroffers were held not to be FRAND for the reason that they were based on a top down approach using the average sale price of a connective module, which the Court did not consider to reflect the benefit of the technology in the end product. As a result, the Court considered that the failure to provide a FRAND offer to be further evidence of unwillingness.
(iv) The Avanci pool, which licenses at the OEM level, has been accepted by a number of automotive OEMs. The Court considered this to be indicative of Avanci's approach being normal industry practice. The Court found that Daimler's failure to provide a FRAND counter-offer confirming their unwillingness.
Some commentators argue that the approach at (iii) which is currently being taken by the German courts incorrectly rolls together two of the Huawei v ZTE steps, namely step 2 (the expression of willingness) and step 4 (whether a FRAND counteroffer has been made). They argue that this therefore incorrectly sidesteps step 3: the assessment of the SEP owner's offer. Others argue that this criticism misunderstands the court's analysis: in assessing willingness it is reasonable to consider a party's conduct in negotiations. The question of whether any counteroffers have been made and, if so, whether they are FRAND must be relevant to this assessment. That should not be the only factor used to make the assessment but, in this case, it was not.
In assessing Daimler's counteroffer, the Court focused on the importance of the patentee being able to "participate in the economic benefit of the technology in the saleable end product at the last stage of the value chain
", noting that the right conferred under Art 64(1) EPC extends to use of the patented invention. Therefore, where the end user product works the invention and derives the benefit from it (as is the case with cellular connectivity), the Court considered that licensing at the OEM level was consistent with the EC Commission's 2017 guidelines on the approach to SEPs
. While the Court clarified that these findings did not mean that the SEP owner needed to licence exclusively at the OEM level, a counteroffer by a supplier using as a licence base the sale price of a connective module would fail to give an SEP owner the necessary economic benefit.
In the action, Daimler also advanced a case that the connective modules it was supplied were saleable "terminals" and therefore the correct basis for calculating royalties – i.e. an argument based on the SSPPU. The Court disagreed. It held that these components are only 'used' when incorporated into the finished vehicle and that the components themselves do not realise the patented inventions.
As a result of the finding of unwillingness, the Court did not specifically consider the question of whether Nokia's offer was FRAND. However, it observed that there was no suggestion that Avanci's public offering does not reflect the benefit of connectivity in the end user product. It also noted that major OEMs and competitors of Daimler had entered into license agreements with Avanci, suggesting it was an accepted model for SEP licensing in the industry. The Court noted that there was no suggestion that licenses that Avanci has agreed came about under excessive pressure – essentially the Court considered them to be arm's length transactions, which have generally been considered to be the best proxy for a FRAND license. The implication, therefore, is that the Court felt that there were reasons that support Nokia's offer as being FRAND.
Where does this leave us?
This is unlikely to be the end of the matter. Daimler has appealed the Mannheim decision and Automotive OEMs, including Tesla, Ford, Honda and Daimler have urged the FTC to petition the Ninth Circuit to rehear the case before the full panel. More Nokia Daimler cases are to come, before different German courts. And the Continental v Avanci case in the United States may dig into these arguments further.
The level of bond in the Daimler case, set by the Landgericht Mannheim at EUR 7 Billion, remains a cause for concern. Whilst companies of the size of Nokia can afford to put up a bond set at this level, this suggests that in Germany a first instance injunction against a large unwilling licensee is now out of reach for most patent owners, who will need to wait for an appeal level decision. Patent owners will hope that other German courts do not follow this aspect of the decision, as the speed and low cost of bringing an action in Germany have traditionally been two factors that have been perceived as benefits. With the recent Supreme Court decision in Unwired Planet and Conversant providing more certainty over the English Court's approach to SEP disputes, and a promise of quicker timetables, high bonds in Germany may cause patent owners to look to the UK as a preferred venue.