A F/RAND-Centric Georgia Pacific Analysis

Arm’s length pricing of royalty pay-outs has been a complex transfer pricing issue around the world. In this article, the author discusses a recent ruling in Microsoft Corp. v. Motorola, Inc., et al., wherein a U.S. District Court outlined the factors that could be used in determining the royalty in the context of F/RAND (Fair, Reasonable And Non-Discriminatory) or RAND (Reasonable And Non-Discriminatory) standards.  The F/RAND or RAND is used to determine the commitment by participants in Standard Setting Organizations (SSOs) to license their standard essential patents (SEPs) on fair and reasonable terms. While this is a ruling in a non-transfer pricing context, the principles provide guidance on price setting for royalty arrangements in third party scenarios and relevant for transfer pricing purposes.

 

By Dr. Ramon S.J. Dwarkasing LLM - 10 June, 2013

 

The analytical Georgia-Pacific framework[1] has been serving as the leading guidance regarding ‘reasonable royalty’ calculations in the United States for decades. However,  RAND-specific policy considerations were added to this framework by Judge Robart in his judicial opinion on the Microsoft Corp. v. Motorola, Inc., et al. case.[2] The Court’s decision provides important guidance regarding the meaning of RAND and can be considered as an important analysis for those involved in standard setting activities, licensing standard essential patents and those involved in transfers of patents subject to an SSO commitment.

The Court adopted the Georgia-Pacific framework in the Microsoft Corp. v. Motorola, Inc., et al. case, but relied primarily on the following policy considerations to reach his valuation: (a) the risk of patent hold-ups; (b) accounting for royalty stacking; and (c) valuing the patent on its own merits and not in the context of the standard.

 

 The author will provide an analysis of this F/Rand –Centric Georgia-Pacific Analysis for Transfer Pricing Associated BV.

 

 

 

 

The term F/RAND means “fair, reasonable and non-discriminatory”. The term F/RAND is often used in Europe, and the term RAND is used in the  United States. The term refers to the commitment by participants in Standard Setting Organizations (“SSOs”) to license their standard essential patents (“SEPs”) on fair and reasonable terms.[3] SSOs are very important for economic developments as can be concluded from the acknowledgment of the US Department of Justice and the US Federal Trade Commission:

 

“Industry standards are widely acknowledged to be one of the engines of the modern economy. (..)They can increase innovation, efficiency, and consumer choice; foster public health and safety; and serve as a fundamental building block for international trade”.[4]

 

SSOs exist for a majority of industries, for instance the telecom, automotive and health industries. SSOs aim to develop a consensus-driven approach to interoperability. SSOs generally require their participants to both disclose the relevant patents they own or control as well as agree to license the same on “reasonable and non-discriminatory” (RAND) terms. If a patentee participant declines to provide the RAND commitment, the SSO will generally not adopt that technology, thereby helping to avoid a so-called “patent hold-up”. A “patent hold-up” is the ability of the holder of a standard essential patent to demand more than the value of its patented technology and to attempt to capture the value of the standard itself.

 

The Microsoft Corp. v. Motorola, Inc., et al.case provides guidance regarding the SSO participant’s affirmative obligation to negotiate in good faith.

 

 

A patentee’s participation in an SSO presents the danger of a “patent hold-up”. The threat of a hold-up increases as a standard becomes more widely implemented and firms make sunk cost investments that cannot be recovered if they are forced to forego implementation of the standard or the standard is changed. Hold-up can threaten the diffusion of valuable standards and undermine the standard-setting process. Hold-up by one SEP holder also harms other firms that hold SEPs relating to the same standard because it jeopardizes further adoption of the standard and limits the ability of those other holders to obtain appropriate royalties on their technologies.

 

 

High-tech products can comply with dozens or even hundreds of different standards. For example, a typical personal computer implements as many as 90 different formal standards and over 100 informal interoperability standards. In the context of standards having many SEPs and products that comply with multiple standards, the risk of the use of post-adoption leverage to exact excessive multiple royalties is compounded by the number of potential licensors and can result in cumulative royalty payments that can undermine the standards. The payment of excessive royalties to many different holders of SEPs is referred to as “royalty stacking”. The RAND commitment also addresses royalty stacking and the need to ensure that the aggregate royalties associated with a given standard are reasonable. In casu, Judge Robart stated that the anti-stacking principle constrains RAND because parties in a RAND negotiation would determine a reasonable royalty by considering how much in total license fees the implementer can pay (for all essential patents) before implementation of the standard becomes costs-prohibitive. In the Microsoft Corp. v. Motorola, Inc., et al. case Motorola’s request of 1,15% to 1,73% of the end-product price, the aggregate royalty to implement a specific standard, which is only one feature of the product, would in casu exceed the total product price.   

 

 

According to the Microsoft Corp. v. Motorola, Inc., et al. case, a RAND analysis should also consider the value of the patented technology itself, separate and apart from the value of the standard. Reasonable parties in search of a reasonable royalty rate under the RAND commitment would consider the fact that, to induce the creation of valuable standards, the RAND commitment must guarantee that holders of valuable intellectual property will receive reasonable royalties on that property.

If the RAND valuation considers the value of the standard itself, then the participant is improperly rewarded for the value of the standard, which would be contrary to the purpose behind the RAND commitment.

For instance, in the Microsoft Corp. v. Motorola, Inc., et al. case the Court notes that Motorola was not involved in the formative stages of a specific Standard. Instead, Motorola became involved after the draft of that specific Standard had been prepared, and Motorola’s contributions were limited to the sub-category of that Standard.

The sheer number of SEPs and the relatively humble contribution made by Motorola’s patents were significant factors in the Court’s royalty determination.

 

 

 

The Southern District of New York, in its frequently cited opinion in Georgia-Pacific, compiled the following list of fifteen factors relevant to a reasonable royalty calculation in the context of damages in a patent infringement suit. Though in the Microsoft Corp. v. Motorola, Inc., et al. case the Court adopted the Georgia-Pacific Framework, the Court made comments on some factors under the RAND context.

 

 

 

 

According to the Court in Microsoft Corp. v. Motorola, Inc., et al. this factor is inapplicable in the RAND context because the licensor has made a commitment to license on RAND terms and may no longer maintain a patent monopoly by not licensing to others. In fact, the RAND commitment requires the SEP owner to grant licenses on Rand terms to all implementers of the standard.

 

According to the Court in Microsoft Corp. v. Motorola, Inc., et al. this factor is inapplicable in the RAND context because having committed to license on RAND terms, the patentee no longer may discriminate against its competitors in terms of licensing agreements. Instead, the patent owner is obligated to license all implementers on reasonable terms.

 

 

Though Factor 6 is relevant to a reasonable royalty in the RAND analysis, it  is important to focus the analysis of this factor on the value of the patented technology apart from the value associated with incorporation of the patented technology into the standard.

 

According to the Court, Factor 7 is greatly simplified in the context of a dispute over a reasonable royalty for a RAND-committed patent because the term of the license would equate to the duration of the patent. Generally, this factor will have little influence on what constitutes a reasonable royalty under the RAND commitment.

 

Though Factor 8 is relevant to a reasonable royalty in the RAND analysis, it  is important to focus the analysis of this factor on the value of the patented technology apart from the value associated with incorporation of the patented technology into the standard.

 

 

 

 

 

According to the Court, licensing fees for non-RAND committed patents customary in a business industry cannot form the basis for comparison. Instead, factor 12 must look to customary practices of businesses licensing RAND-committed patents.

 

 

In the RAND context it is critical to consider the contribution of the patented technology apart from the value of the patent as the result of its incorporation into the standard, the latter of which would improperly reward the SEP owner for the value of the standard itself. Rewarding the SEP owner with any of the value of the standard itself would constitute hold-up value and be contrary to the purpose behind the RAND commitment.

 

 

 

7. Conclusion: A RAND-centric Georgia-Pacific Analysis

 

As stated above, the Court adopted a familiar analytical framework for performing the analysis but added RAND factors to it. According to the Court, the Georgia-Pacific framework is an established and familiar starting point for RAND analyses. The key considerations that the Court identified are:

 

 

In addition to identifying these key considerations, the Court adopted the Georgia-Pacific case as the analytical framework for performing RAND analyses.

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