Standard-essential patent holders and implementers may face uncertainty regarding licensing practices following a May 23 Texas court ruling. In the ruling, a Texas federal judge reached a conclusion different from a recent California court decision—FTC v. Qualcomm—on the question of whether an SEP holder must base its royalty rates on the “smallest salable patent-practicing unit” in order to comply with a fair, reasonable and non-discriminatory royalty commitment.

IN DEPTH

On May 23, a Texas federal judge entered a declaratory judgment that Ericsson, a standard-essential patent (SEP) holder, did not breach its obligation to offer HTC, an end-device manufacturer, a license to its SEPs on fair, reasonable and non-discriminatory (FRAND) terms. The decision follows a jury verdict finding that Ericsson did not breach its FRAND commitment. The judge rejected HTC’s argument that Ericsson must base the royalty rate for its SEPs on the value of baseband chips within smartphones rather than on the phones themselves. This ruling stands in tension with the recent decision in FTC v. Qualcomm, where a California court concluded that it was unreasonable for Qualcomm to base the royalty rates for its SEPs on the price of an entire phone rather than on the baseband chip. The contrasting rulings, thus, may create uncertainty regarding licensing practices among SEP holders and implementers until further clarification is provided from courts of appeal.

Ericsson owns patents declared essential to the 2G, 3G and 4G wireless communication standards. Ericsson made a commitment to several standard setting organizations, including the European Telecommunications Standards Institute (ETSI), to license those SEPs on FRAND terms. HTC makes smartphones that implement Ericsson’s SEPs and brought suit against Ericsson in April 2017, alleging that Ericsson overcharges for its SEPs. HTC argued that Ericsson’s royalty rates are unreasonable on a number of grounds, including because they are based on the value of the smartphones HTC produces rather than on the baseband chips that incorporate Ericsson’s SEPs within the phones. In response, Ericsson brought a counterclaim seeking a declaratory judgment that it complied with its FRAND obligation.

Last year, Ericsson moved for a ruling that its FRAND commitment to ETSI does not require it to base its royalty rates on the “smallest salable patent-practicing unit” (SSPPU)—the baseband chip. The court held earlier this year that, as a matter of French law, ETSI’s Intellectual Property Rights policy neither requires nor precludes SEP holders from using the SSPPU as a royalty base. Instead, what constitutes a FRAND offer depends on the particular facts of the case. The parties then proceeded to trial and the jury found that Ericsson did not breach its FRAND commitment.

Following the jury verdict, the court entered a declaratory judgment that, based on the facts of the case, Ericsson complied with its FRAND obligation despite not using the SSPPU as its royalty base. The court rejected HTC’s assertion that Ericsson must base its royalty rates on the value of the baseband chip instead of the smartphone itself. Baseband chips enable phones to communicate with each other across cellular networks but serve no other function. HTC argued that basing the royalty rate on the entire phone is unreasonable because modern smartphones have many features unrelated to cellular connectivity that do not utilize Ericsson’s SEPs. Thus, HTC argued that Ericsson’s proposed royalty rate does not reflect the limited value baseband chips add to smartphones.

The court rejected HTC’s SSPPU argument on several grounds. First, the court cited evidence that customers value cellular connectivity more than HTC suggested. Given that Ericsson was negotiating with the end-device manufacturer and not the component supplier, it was appropriate to consider the overall value Ericsson’s technology added to the end device rather than limit the value to the component only. Second, the court found that the baseband chip is not the SSPPU. Ericsson presented expert testimony that its SEPs also cover additional components, such as antennas and RF switches. Thus, the court determined that Ericsson’s SEPs would not be infringed by a baseband chip alone. Finally, the court noted that HTC was unable to identify even a single example of a license to a smartphone OEM based on the baseband chip.

The court also found that other comparable licenses provide evidence that Ericsson’s royalty rates are consistent with its FRAND obligation. The court cited evidence that Ericsson’s SEP licenses with other smartphone OEMs all have royalty rates that are similar to the rates Ericsson offered to HTC. Given these other comparable licenses, the court concluded that Ericsson’s offers to HTC were FRAND.

The court’s declaratory judgment in HTC v. Ericsson stands in contrast with a California court’s decision earlier this month in FTC v. Qualcomm. In that ruling, the court concluded that Qualcomm violated the Federal Trade Commission Act by maintaining its monopoly power as a baseband chip supplier through a number of exclusionary practices. One of the Qualcomm court’s findings was that Qualcomm’s royalty rates for its SEPs, with respect to baseband chips, are unreasonably high.

In particular, the Qualcomm court found that it is unreasonable for Qualcomm to charge royalty rates to chipset suppliers on the price of an entire phone. The court cited an internal Qualcomm document acknowledging that “user experience,” rather than the baseband chip, drives the modern smartphone’s value. The Qualcomm court also was persuaded by several OEMs’ testimonies that OEMs add significant value to their phones unrelated to the baseband chip and that smartphones “are now essentially computers.” Thus, in the court’s view, Qualcomm’s royalty rates based on the end device are disproportionate to the value of its SEPs and the chips that implement them. The court also cited Federal Circuit precedent holding that a patent royalty should be based on the SSPPU, and then concluded that Qualcomm’s imposition of a royalty based on the entire phone is inconsistent with that precedent.

The HTC and Qualcomm decisions demonstrate that the law is unsettled as to whether an SEP holder must base its royalty rates on the SSPPU in order to comply with a FRAND commitment. In the smartphone context, some may argue that basing SEP royalty rates on the value of the entire phone exaggerates the value of those SEPs—especially as modern cell phones have become more sophisticated. The Qualcomm court accepted this argument, but the HTC court found that Ericsson’s practice of basing its royalty rates on the entire phone is consistent with industry practice. Going forward, district courts may issue more divided opinions on this issue. In the interim, it is important for SEP holders to look to industry practice, comparable licenses and ordinary course documents when assessing their strategy for SEP licensing negotiations.