A view of valuation and licensing of standard essential patents

Kat friend Roya Ghafele guides Kat readers through the thicket of IP royalties from the perspective of the valuation and licensing of standard essential patents.

As standard essential patents continue to gain economic importance, disputes surrounding them see no end in sight. Given the economic benefits at stake, the question arises how to come to grips with the valuation of standard essential patents. To provide some insight, I consider the Top Down and Comparable License approaches, as they have gained wide- scale recognition.

Top Down Approach

The Top Down approach seeks to identify a cumulative rate for the standard as a whole. In a subsequent step, it then aims to divide this rate between the patents that read on the standard. As such, this valuation approach aims at splitting a given rate for a standard among patents pertaining to that standard.

For example, courts have recognized that the total value of the 4G/LTE standard can be determined with the support of public statements made by major standard essential patent owners. This insight then yields a total percentage rate for the 4G/LTE standard, which can subsequently be divided among the various owners of standard essential patents.

The Top Down approach can also provide further clarity as to what the total licensing costs associated with a standard could be. This is because it offers one aggregate rate for the standard as a whole. Any individual owner of a standard essential patent may hence request only a fraction of the value of the entire standard, but never more than what the perceived value of the entire standard is.

The maximum amount available for paying royalties would thus stay unaffected, regardless of the number of entities holding and asserting standard essential patents. This may allow downstream innovators to adequately price their products from the outset and help avoid unexpected surprises stemming from licensing requests.

For the same reason, the Top Down approach may disincentivize the sale of standard essential patents to patent assertion entities. Because it looks at the value of the standard as a whole, the patent owner cannot expect to get more than what its patents are worth in comparison to the entire standard. Hence, under this valuation rationale, a patent owner may not be able to obtain more licensing revenues by passing on a fraction of its portfolio to a third party.

The determination of a FRAND licensing rate requires both a royalty rate and a royalty base. The Top Down approach remains neutral with respect to the choice of the royalty base. This is because the rate can be based at the component, intermediary or end product level.

This stands in contrast to the Comparable Licenses approach (see below), which usually takes the end product level as the royalty base. Such difference can be explained by the fact that SEPs owners have commonly avoided concluding licenses with component manufacturers. Hence, the Comparable Licenses approach usually uses the end product as the royalty base.

It can be seen that this valuation approach lends itself to preventing the risk of royalty stacking, which means the excessive cumulative royalty burden a licensee may be facing.

The Top Down approach can be used as a principal valuation method or as a cross-check for another valuation approach. For example, in Unwired Planet vs Huawei (UK, 2017), court used the Top Down approach as a cross check.

There, the court started off by identifying comparable licensing rates and then went on to run a sensitivity check with the support of the Top Down approach. This allowed the court to check the risks associated with royalty stacking, even if they were merely hypothetical. The court determined the aggregate rate by counting patents, which is a common market practice.

Comparable Licenses Approach

The Comparable Licenses approach is easily understood. It seeks to establish a valuation by reference to other licensing transactions. As such, it allows to model real world licensing transactions. Being rooted in historical transactions, it offers insights into licensing contracts that have actually been concluded.

Important to note is that, just because a licensing transaction has occurred, it does not necessarily mean that the transaction was commensurate with the FRAND commitment. As with the Top Down approach, the Comparable Licenses approach can be used as a sole or secondary method and, as well, serve as a cross-check or a sensitivity analysis.

It should be clear that key to the successful usage of this method is the identification of comparable licensing rates. Here, Europe is at a disadvantage. Whereas financial authorities in the United States and Canada have strict disclosure requirements in place, GDPR provisions prevailing in Europe may actually prevent the adequate access to comparable licensing rates.

In the United States and Canada, licensing transactions of significant size must be publicly disclosed. No such regulation exists in Europe. To the contrary, data privacy requirements under European GDPR requirements actually do the exact opposite and prevent adequate access to licensing contracts. Accordingly, this method may be more easily used in a North American context.

Conclusions

That standard essential patents can be valued is beyond debate. Both the Top Down and the Comparable Licenses approaches have served as blue prints for significant court decisions involving standard essential patents. Going forward, the key question is not what method to sanction, but to assure better access to licensing contracts and shed further light on licensing rates and conditions in general.

Against this background, European regulators are strongly encouraged to initiate processes that will allow for enhanced transparency in licensing markets and to review the relationship between GDPR requirements and access to comparable licensing transactions.

Upper picture by DWS MontagZen and is licensed under the Creative Commons Attribution-Share Alike 4.0 International license.

Lower picture is painting by Paul Cézanne and is in the public domain.