We previously reported on a leaked draft of European Commission regulations for standard-essential patent (SEP) licensing. The Commission has since released its official proposal. An underreported aspect of the proposed European regulations is their compatibility with the so-called “top-down” approach to calculating fair, reasonable and non-discriminatory (FRAND) rates for SEPs—a compatibility that, despite the absence of any explicit reference to top-down in the regulations, seems too coincidental to be accidental.
At a high level, the top-down approach is a simple two-step method to calculate the FRAND rate owed to a particular SEP licensor. First, the appropriate aggregate royalty for a given standard (that is, a reasonable price for a license to all patents covering the standardized technology) is determined. This can be done in any number of ways. For example, courts have calculated aggregate royalties based on rates for comparable patent pools and portfolios (Microsoft Corp., 2013 WL 2111217 (W.D. Wash. 2013)), profit margins of accused products (In re Innovatio IP Ventures, LLC, 2013 WL 5593609 (N.D. Ill. 2013)) and SEP holders’ public statements on the appropriate rate (TCL Comm. Tech. Holdings, Ltd., 2018 WL 4488286 (C.D. Cal. 2018)). Theoretically, the aggregate top-down royalty could even be based, in whole or in part, on a patent-by-patent valuation of individual SEPs, a method colloquially known as “bottom-up” and often viewed as a competitor to the top-down approach (although to prevent royalty stacking, such a calculation may require more than merely summing up the individual values of all SEPs on a standard).
Second, the aggregate royalty is apportioned among the various SEP owners. This apportionment might be as simple as multiplying the aggregate royalty by a ratio representing a given SEP licensor’s share of patents essential to the pertinent standard, according to the following formula:
where RL is the royalty owed to SEP licensor L; RAgg is the aggregate royalty; NSEP,L is the number of SEPs (or SEP families) owned by SEP licensor L; and NSEP,Tot is the total number of SEPs (or SEP families) on the standard. More sophisticated adjustments can also be made to account for factors such as patent quality, the relative contribution of a licensor’s IP to the standard, the geographic scope of patent coverage and patent expiration.
The top-down approach is viewed as a solution to two perceived problems with a pure “bottom-up” approach: uncertain licensing costs and royalty stacking. These issues can be particularly vexing in the context of standardization, where it is not unusual for numerous licensors to independently demand royalties on hundreds or even thousands of alleged SEPs.
Several courts in the United States and the United Kingdom have applied top-down in the SEP context. In Innovatio, Microsoft and TCL, three different US district courts used top-down approaches to calculate FRAND rates for SEPs. The record at the US appellate level is mixed, however. The US Court of Appeals for the Ninth Circuit blessed the district court’s top-down analysis in Microsoft (See 795 F.3d 1024, 1056-57 (9th Cir. 2015)), while in TCL the US Court of Appeals for the Federal Circuit remanded on Seventh Amendment right-to-jury-trial grounds without addressing the trial court’s top-down methodology (943 F.3d 1360, 1375-76 (Fed. Cir. 2019)). In the United Kingdom, courts have been open to the top-down approach at least as a cross-check on benchmark royalties derived from comparable licenses analysis (See Unwired Planet Int’l Ltd. v. Huawei Techs. (UK) Co. Ltd., 2017 E.W.H.C. 711 (2017) (applying top-down as a cross-check on benchmark rate based on comparable license analysis) and Interdigital Tech. Corp. v. Lenovo Group Ltd., 2023 E.W.H.C. 539 (2023) (considering top-down cross-check but ultimately rejecting it as out of line with what the court found to be the correct comparable licenses analysis)).
In addition to courts, commentators, lawmakers and interested parties also continue to explore the top-down approach to SEP licensing. Academics have suggested interpleader as a procedural route to a more holistic top-down determination compared to ad hoc litigations. In 2022, reportsemerged that the US Senate Judiciary Committee was reviewing draft legislation known as the Standard Essential Royalty Act that would establish a special-purpose court and exclusive cause of action to determine FRAND rates for US SEPs based on a top-down approach. SEP owners often band together in patent pools, which apply a top-down approach of their own: licensees obtain rights to practice all patents in the pool in exchange for a single royalty, which is apportioned among the pool’s members (often based, at least in part, on their respective pro rata share of the SEPs or SEP families in the pool).
Despite its appeal for reducing royalty stacking and uncertainty, the top-down approach has drawn criticism. Some commentators argue that it is difficult if not impossible to identify all SEPs on a given standard; that the lack of quality control in SEP declaration procedures of the pertinent standard-setting organizations could skew royalty apportionment in favor of low-quality, high-volume patent filers; and that the relevant industry—not courts—should determine the aggregate royalty rate (See, e.g., Nikolic, Licensing Standard Essential Patents, Hart Publishing (2021) at 110-114 (discussing objections to the top-down approach)).
The proposed European regulations include provisions that seem tailor-made for the top-down approach and address its primary criticisms head-on. In particular, the regulations outline procedures that would help quantify each input to the basic top-down formula:
RAgg – Title III, Chapter 2 specifies a procedure whereby SEP owners can submit their view of, and both SEP owners and implementers can request a non-binding expert opinion on, the aggregate royalty.
NSEP,L and NSEP,Tot – The requirements that SEP owners register their European SEPs (Title III, Chapter 3) and that the EU Intellectual Property Office spot-check registered patents for essentiality (Title V) would help quantify the share of SEPs owned by a given licensor.
These procedures also are designed such that they would avoid (or at least mitigate) the alleged pitfalls of the top-down approach. Although limited to patents in force in an EU Member State, the mandatory SEP registry and essentiality checks could improve the accuracy of top-down apportionment. Compared to current declaration policies in force at various standard-setting organizations, which often allow “blanket” FRAND declarations, the proposed SEP registry would require specifically identifying each alleged SEP. The essentiality checks would also provide a measure of quality control on SEP counting and combat the problem of over-declaration. And because the aggregate royalty determination would be driven primarily by SEP owners (potentially with input from implementers), it would give the industry a significant voice in setting the aggregate rate.
Even under the proposed regulations, however, top-down calculations of FRAND rates would remain merely advisory. The Commission considered but ultimately declined to propose an “SEP clearing house” feature that would have given binding effect to the aggregate royalty determination and apportioned that royalty among SEP licensors. But by implementing deliberative procedures that would quantify the key inputs to the top-down formula and mitigate its potential pitfalls, the proposed regulations would at least lend additional credibility to litigants and negotiating parties advocating for a top-down approach to calculating FRAND rates.