This paper – which can be found here – argues that existing regulatory and judicial activity has unduly protected implementers (i.e. potential licensees) against SEP holders.

In particular, the authors: “stress that implementers owe a significant duty to negotiate FRAND licenses in good faith, which courts have largely overlooked and underenforced. We demonstrate that implementers’ good faith obligations are a critical component of basic FRAND architecture that is strictly necessary to the development of innovation-driven standards. (…) [FRAND enables] the standards development effort to yield commercial benefits that would not exist absent innovators’ voluntary participation. We show both theoretically and empirically that courts’ failure to appreciate these aspects of the FRAND bargain, combined with their over-reliance on liability rules, i.e., damages over injunctions, incentivizes the very patent holdout problem FRAND was intended to avoid. That outcome, in turn, has motivated innovators to reduce their participation in FRAND bargains, threatening to unravel a massive innovation-commercialization marketplace, and its innumerable positive externalities to all parties.”

The paper is structured as follows:

  • Section I begins with an explanation of how FRAND bargaining originally developed, and how it functions in the context of Standards Developing Organizations (“SDOs”) that establish the institutional framework within which these negotiations take place.

Standardization solves coordination problems more efficiently than a series of bilateral negotiations and enlarges the market on both sides by growing the addressable consumer base through interoperability and network effects. It also reduces marginal costs by reducing the number of options that each company must support and by decreasing the contracting and coordination costs that would accrue absent standardization. The desire to standardize innovations, however, gives rise to a series of challenges. Most notable are questions on how to identify and efficiently license the innovations that should form the standard – and how to navigate the conflicting interests  of SEP holders and SEP implementers.

Because implementers fear that innovation standardization may give rise to ex post injunctions and “patent holdup”, they are motivated to bargain ex ante with innovators to establish voluntary institutions that facilitate contractual solutions – such as FRAND. And because innovators’ latest discoveries are not yet published in patents or patent applications, implementers need to offer innovators some substantial consideration to motivate them to reveal those discoveries, which can then be incorporated into workable standards

The FRAND contract is thus meant to solve a host of coordination problems between potential bilateral monopolists seeking technology-driven standardization. Implementers agree to license any standard-essential patent on fair, reasonable, and non-discriminatory terms (“FRAND”), and to negotiate such terms in good faith. Innovators reciprocally agree to bring their latest discoveries to the marketplace, to notify the SDO of intellectual property rights (including patent applications) that would be infringed by the unlicensed use of such disclosed technologies, to offer FRAND licenses for any eventual SEPs in good faith, and to forego their categorical right to exclude willing licensees from the use of standard-essential innovations.

Importantly, the parties to the SDO know that they do not enjoy any monopoly position because the selection of any given standard does not guarantee that some rival standard will not emerge to deal with the same problem; all the parties are aware that any unilateral effort to degrade the standard for partisan advantage could result in the inability of the inferior standard to hold its own in the marketplace.

  • Section II looks at the question of whether injunction remedies should remain available to the innovator, since a FRAND commitment contains an obligation to licence the SEP (and hence an injunction to prevent the use of the SEP would implicitly run contrary to this obligation). In view of the particularly high transaction costs at play, and of the significant informational advantage the parties hold over the courts, a correct and socially efficient treatment of FRAND disputes should shift the parties’ incentives toward negotiated solutions through a recognition of strong property rights. To achieve that aim, the authors conclude that injunctions should be the presumptive remedy in infringement actions involving standard-essential patents. In turn, the defendant (i.e. the implementer) can rebut that presumption (or obviate the question of remedies altogether) by showing that its own negotiation conduct pre-injunction claim was in good faith.

The authors argue against damages as a remedy in this context because such an approach disregards the reciprocal benefits underlying voluntary FRAND agreements and encourages implementers to engage in inefficient opportunistic “hold out” from good faith discussions. In effect, the argument is that recourse to injunctions does not really create the risk of “hold up” that courts, regulators and academics so fear. To support this, the authors note empirical studies that have concluded that theoretical concerns regarding patent holdup and royalty stacking have not borne out in industries subject to innovation-driven standardization, such as mobile handsets, where the evidence points instead to the sharp lowering of prices, continuous innovation, low aggregate patent royalty payments, and increasing market penetration.

However, “courts have largely taken the opposite approach by defaulting to liability rules without due regard for property rights, even in the face of evidence of patent holdout by implementers, which is facilitated by misinterpreting and thus redefining FRAND as a wholly one-sided agreement that only serves implementers’ interests.

  • Section III tests the authors theoretical framework against recent court and administrative decisions. They purport to have found significant distortions and social inefficiencies arising from ex post one-sided revisionism of the FRAND contract “which evidences the unjustified preference for liability rules over property rights”. In particular, “in the face of high transaction costs, pure liability rules tend both to encourage “patent holdout” and to short-change innovators in ex post allocations of the cooperative surplus created by FRAND negotiations. Taken together, these two forces reduce the rate of return to innovation overall and to FRAND commitments in particular. Innovators are acutely responsive to such incentive changes in this context, and ex post devaluations of their returns from the FRAND game in a given round necessarily have feedback effects on their willingness to participate in that game in subsequent rounds. In practice, they might then refuse to license their innovations to the industry as a whole, preferring to develop them internally or form limited strategic innovation-development partnerships with only certain industry participants.”

They propose an alternative approach, according to which “implementers should be held to a reciprocal duty to negotiate a FRAND license in good faith, the breach of which should automatically trigger an injunction upon a finding that the patents at issue are valid and infringed, unless the innovator’s pre-suit offer is itself found not to have been in good faith”.

  • Section IV concludes with a broader discussion of the significance of these issues to the emergence of the “ideas economy,” in which it becomes more critical than ever to both reduce transaction costs around the patent right and to protect and reward innovation

While the last section falls outside the scope of my interests, the rest of the paper is an interesting analysis of FRAND and of the impact of prohibiting injunctions in this context. I also find it remarkable to see an American paper where the Huawei decision by the Court of Justice of the European Union is presented as a shining example of how to apply competition law to SEPs. As an European lawyer, I would like to just bask in this for a while. But I can’t, because the authors fail to address the various criticisms that  the Huawei decision has given rise to. These also serve as valid criticisms of the authors’ approach. Such an approach can introduce a significant element of uncertainty regarding how to identify conduct that infringes competition law; it is unclear what is the theory of harm under competition that supports such a “good faith approach”; and, ultimately, such an approach can introduce serious turbulence and legal risk into FRAND negotiations. I take no position here about the validity of such criticisms – I merely want to point out that the authors could have deal with them in order to reinforce their argument.

Having said this, it should be acknowledged that the authors at no point make an argument based on antitrust principles – they are merely trying to develop a system that optimises welfare. But failing to discuss the relevance of antitrust is, in itself, a striking absence, particularly when Huawei is used to support the argument.

Author Socials A weekly email with competition/antitrust updates. All opinions are mine

What do you think?

Note: Your email address will not be published