Standards Essential Patent (SEP) matters are the giant squid of the intellectual property ocean.  Enormously powerful and capable of making or disrupting the commercial plans of some of the world’s largest companies, they prowl a zone so mired in technical complexity and commercial confidentiality that their mighty struggles are largely obscured from view, despite their potential to swing hundreds of millions – even billions – of dollars from one group of companies to another.  Under these circumstances, it is not so surprising that a universally respected commenter on IP matters openly wondered what all the fuss was about after delivering an impeccable summary of the most important decision in this area for several years.  At first sight, the lack of excitement is understandable – the decision just seems to be a lot of stuff about who should do what when and looks about as thrilling as the rules for filing a tax return.  Let us, in the manner of James Cameron descending into the Challenger Deep, see if we can shed a little light on the ecosystem of the sea bed and explain why this decision might matter.

Technical standards are widely considered to be a good thing – they allow complex and heavily interactive technical systems to develop with agreed specifications and operating processes, enabling proprietary differentiation while ensuring that an industry can develop rapidly with the involvement of many participants.  It is difficult to see how, for example, the mobile phone industry could have progressed without them.  However, the interaction between patents and standards has always attracted controversy, particularly in the area of software – for some patenting of aspects of a technical standard amounts to a tragedy of the commons, whereas for others it is necessary to ensure that there is not an economic advantage to freeriding on an adopted standard over doing the technical work needed to ensure that the standard will be effective.   It’s reasonable for different industries to take different views on this, as the commercial models in different industries differ so significantly.  Where SEPs are allowed to exist, the normal arrangement is for these to be licensable by any party on FRAND (Fair, Reasonable and Non-Discriminatory) terms.

How does the development of SEPs work in practice?  Taking the example of cellular telecommunications (3G, 4G, 5G… black-out must be a risk at some point), the main engine of development is a number of working groups including technical experts from a number of relevant companies.  These working groups identify problems that need to be solved, and meet regularly to review a large number of technical submissions directed to addressing these problems.  These submissions will (mainly) be made by representatives of one participating company, and if they contain any perceived new solution to a technical problem they will probably be filed as a patent application before submission to the standards body.  This is necessary – standards discussions will typically be considered public immediately and even if not, the disclosure will most likely be followed by intense technical debate at which any number of parties could move the idea forward, making ownership of any generalisation or development of the original disclosure highly unclear.  If the development is adopted in the standard, the patent application will go ahead and be prosecuted to grant – otherwise it is likely to wither.  In this way, large portfolios are built up – key players have hundreds of SEP patents for 4G, for example.

So far, so straightforward – Party 1 has a bundle of SEPs, Party 2 wants to operate under the standard, so Party 2 just licenses from Party 1 on FRAND terms – easy, surely?  Not really.  The main problem is that “what are FRAND terms?” is a significantly harder question to answer than “how long is a piece of string?” – this is appreciated by the courts, who have typically given little guidance as to what FRAND means in practice as what is “fair” and “reasonable” is so dependent on the overall position that applies for the commercialisation of that specific standard.  This leads to long negotiations between SEP owners and SEP licensees – while there should only be one class of outcome (licensing of the SEPs by the licensees on FRAND terms), the lack of clarity about the meaning of FRAND makes the specific financial outcome uncertain.  The position is still more complex if there are several significant licensors and many licensees – if a licensor offers a generous deal to one party, the need to be non-discriminatory may prevent a tougher line being taken elsewhere, and if a licensee caves early, they may take a huge cash hit while their competitors fight on, challenging patents and in some cases arguing that there has been an abuse of a dominant position in contravention of competition law.  Giant squid wrestling ensues, with tentacles everywhere.

This is the area addressed by Huawei Technologies vs. ZTE – specifically the question of what a patentee can and cannot do if they wish to obtain an injunction against a less than compliant potential licensee without risk of a competition law defence that a dominant position is being abused or, even worse, active involvement of the Commission and the prospect of the dreaded dawn raid.  There has been one key case on this point under German law – Orange Book Standard.  As can be seen in this useful summary from the Essential Patent Blog, the German Federal Supreme Court established that an abuse of dominant position defence existed in seeking an injunction if the defendant took certain specific actions – making an unconditional offer to enter into a license with the plaintiff at a particular royalty rate or a rate to be determined by the plaintiff and reviewed by the court, and then actually paying appropriate royalties into an escrow account – effectively, by the defendant acting as a shadow licensee.  There has been criticism of this defence as being too limited or too onerous from some quarters – rulings and press releases from the European Commission suggest that the Commission may consider a dominant position to be abused without this specific course of action from the defendant.  Its legitimacy has been questioned in other cases – for example, the Dutch courts in Philips vs. SK Kasetten, which considered the Orange Book defence as incompatible with patent law.

Huawei Technologies vs. ZTE is a request for a preliminary ruling from the Landgericht Düsseldorf for answers to a set of five questions.  The request arose from proceedings brought against ZTE by Huawei Technologies for infringement of certain LTE (4G) SEPs, with a selection of remedies, including injunctions, sought.  There had been negotiations between Huawei Technologies and ZTE but the German court found that they did not qualify ZTE to run an Orange Book defence.  The questions – and the answers given by the CJEU – are provided below:

(1)      “Does the proprietor of [an SEP] which informs a standardisation body that it is willing to grant any third party a licence on [FRAND] terms abuse its dominant market position if it brings an action for an injunction against a patent infringer even though the infringer has declared that it is willing to negotiate concerning such a licence?”  or  “Is an abuse of the dominant market position to be presumed only where the infringer has submitted to the proprietor of the [SEP] an acceptable, unconditional offer to conclude a licensing agreement which the patentee cannot refuse without unfairly impeding the infringer or breaching the prohibition of discrimination, and the infringer fulfils its contractual obligations for acts of use already performed in anticipation of the licence to be granted?”

(2)     “ If abuse of a dominant market position is already to be presumed as a consequence of the infringer’s willingness to negotiate:  Does Article 102 TFEU lay down particular qualitative and/or time requirements in relation to the willingness to negotiate? In particular, can willingness to negotiate be presumed where the patent infringer has merely stated (orally) in a general way that it is prepared to enter into negotiations, or must the infringer already have entered into negotiations by, for example, submitting specific conditions upon which it is prepared to conclude a licensing agreement?”

(3)     “ If the submission of an acceptable, unconditional offer to conclude a licensing agreement is a prerequisite for abuse of a dominant market position: Does Article 102 TFEU lay down particular qualitative and/or time requirements in relation to that offer? Must the offer contain all the provisions which are normally included in licensing agreements in the field of technology in question? In particular, may the offer be made subject to the condition that the [SEP] is actually used and/or is shown to be valid?”

(4)     “ If the fulfilment of the infringer’s obligations arising from the licence that is to be granted is a prerequisite for the abuse of a dominant market position: Does Article 102 TFEU lay down particular requirements with regard to those acts of fulfilment? Is the infringer particularly required to render an account for past acts of use and/or to pay royalties? May an obligation to pay royalties be discharged, if necessary, by depositing a security?”

(5)      “Do the conditions under which the abuse of a dominant position by the proprietor of a[n SEP] is to be presumed apply also to an action on the ground of other claims (for rendering of accounts, recall of products, damages) arising from a patent infringement?”

References are made to Article 102 TFEU, the “Treaty on the Functioning of the European Union”, generally better known as the Treaty of Rome.  Not unusually, the CJEU decided that it wanted to answer slightly different questions, and only gave a straight answer to part of question 5 (rendering of accounts and damages arising from a patent infringement are not an abuse of a dominant position).  In this case, the CJEU stayed very close to the Advocate-General’s Opinion, which proposed broader criteria that could lead to a valid Orange Book style defence.  The CJEU considered both parties to have equal negotiating power, but considered that to achieve a fair commercial result the potential for abuse of a dominant position existed under a broader set of circumstances than held in Orange Book Standard.  The CJEU appeared to be trying to identify the elements of a “fair” negotiation, and defined its criteria so that these would be adopted by both parties.  The criteria are set out by the court as follows:

1. Article 102 TFEU must be interpreted as meaning that the proprietor of a patent essential to a standard established by a standardisation body, which has given an irrevocable undertaking to that body to grant a licence to third parties on fair, reasonable and non-discriminatory (‘FRAND’) terms, does not abuse its dominant position, within the meaning of that article, by bringing an action for infringement seeking an injunction prohibiting the infringement of its patent or seeking the recall of products for the manufacture of which that patent has been used, as long as:

• prior to bringing that action, the proprietor has, first, alerted the alleged infringer of the infringement complained about by designating that patent and specifying the way in which it has been infringed, and, secondly, after the alleged infringer has expressed its willingness to conclude a licensing agreement on FRAND terms, presented to that infringer a specific, written offer for a licence on such terms, specifying, in particular, the royalty and the way in which it is to be calculated, and
• where the alleged infringer continues to use the patent in question, the alleged infringer has not diligently responded to that offer, in accordance with recognised commercial practices in the field and in good faith, this being a matter which must be established on the basis of objective factors and which implies, in particular, that there are no delaying tactics.

2. Article 102 TFEU must be interpreted as not prohibiting, in circumstances such as those in the main proceedings, an undertaking in a dominant position and holding a patent essential to a standard established by a standardisation body, which has given an undertaking to the standardisation body to grant licences for that patent on FRAND terms, from bringing an action for infringement against the alleged infringer of its patent and seeking the rendering of accounts in relation to past acts of use of that patent or an award of damages in respect of those acts of use.

So, does this matter, and if so, why?  Well, yes, I think – it matters because it sets out a clear path to follow in pursuing license negotiations that applies throughout the EU and promises the possibility of an injunction for the patentee if they keep to the dance steps required by the CJEU choreography.  That is not the previous situation, because Orange Book Standard is a German case – while Germany is a key market and a key forum for patent litigation, the uncertainty as to whether other courts would take this approach, the lack of approval from the Commission and the uncertainty as to how the Orange Book defence complicated the position for licensor and licensee.  This uncertainty, and the complications that resulted from it, are now somewhat removed by what we might call the Huawei playbook.   As a licensor, if you follow the Huawei playbook and the potential licensee does not, the potential licensee should not be able to use abuse of a dominant position as a defence.  If the position is reversed, this defence is clearly on the table.  If everybody follows the playbook and the parties still don’t agree – well, let’s see what the courts do with that one.

It’s hard to tell how this one will change behaviour – some early commentary suggests that this is a good result for potential licensees, as the requirements of the Huawei playbook are significantly less onerous than the Orange Book defence – in particular, there is no “unconditional” language and no need to pay vast wads of cash into an escrow account.  However, the licensor has now been presented with a clear EU-wide path for at least the first part of an integrated licensing and litigation strategy for European SEPs.  My guess is that this decision will act as a stimulant to SEP licensing and litigation activity, as the predictability of key process steps that it provides will be of great practical value to licensor companies.

So, that just leaves the question of what FRAND actually means.  Now, where did I put that piece of string?

Richard Lawrence 20 July 2015