Patent Damages Laws Regarding Apportionment are Inapplicable to Breach of Contract (FRAND) Claims

“The act of determining the value of a standard-essential patent for purposes of calculating damages is distinct from assessing whether a particular offer made during unique licensing negotiations was fair and reasonable.” – United States Court of Appeals for the Fifth Circuit Judge Jennifer Walker Elrod a previous article, we discussed the difference between a reasonable royalty for patent infringement and a FRAND licensing rate, both in terms of their origins and objectives: the former being a creature of statute and case law that seeks to compensate a patent owner for infringement, whereas the latter is rooted in contract and seeks, amongst other things, to address issues of royalty stacking and discriminatory licensing. Despite these differences, we noted that these two concepts have often been treated interchangeably by courts, often leading to confusing results.

The big question being probed in the previous article and others that followed (which can be found here and here), was why damages for patent infringement were being assessed in view of FRAND-related contractual obligations, especially when such contractual obligations had not been shown to apply in the first place (i.e. the patents in question were not shown to be essential). One case we commented on was HTC’s breach of contract case against Ericsson. Specifically, we questioned how HTC’s breach of its own duty to negotiate in good faith might impact what Ericsson could receive for infringement of its standards related portfolio, but recognized that patent damages were not at issue in that case:

Ericsson did not seek a declaration regarding HTC’s forfeiture, instead pursuing an injunction requiring HTC to enter into a license at Ericsson’s offered rates. Further, Ericsson did not counterclaim for patent infringement, so patent damages were not at issue. As such, the implications of the jury’s decision on the issue of Ericsson’s entitlement to patent damages beyond FRAND rates, remain unknown.

Pursuant to an appeal of that decision, however, the United States Court of Appeals for the Fifth Circuit has now addressed the photonegative question in HTC Corp. et al. v. Telefonaktiebolaget LM et al., case number 19-40643: are patent laws regarding what constitutes a reasonable royalty applicable to questions of compliance with FRAND-related contractual obligations? Though the majority decision did a great job highlighting the distinction between these two different concepts, there was a concurring decision that continues to blur the line.

Lack of Jury Instructions Regarding Apportionment Did Not Impair HTC’s Ability to Present its Breach of FRAND Claims

How the issue of patent damages manifested on appeal was via HTC’s challenge to the district court’s instructions to the jury regarding whether or not a license is FRAND. Specifically, HTC argued that the district court erred by not providing the jury with HTC’s requested instructions regarding apportionment.

Starting with the last reason why the district court did not err, the majority said that such an exclusion would constitute a reversible error only if the proposed instructions “concerned an important point in the trial such that the failure to instruct the jury on the issue seriously impaired [HTC’s] ability to present a given [claim]”, which HTC had not shown. Specifically, the majority pointed out that the parties had agreed apportionment was required and that, at trial, “HTC fought to convince the jury that the patent’s apportioned value should be based on the smallest salable patent-practicing unit rather than the net value of the device” (in comparison to Ericsson, which sought to show the value its patents brought to end products by comparing licenses entered into with other end product vendors). In these circumstances, the majority found that failure to give instructions on an undisputed issue did not impair HTC’s ability to present its claims. The concurring decision of Judge Stephen Higginson agreed on this point.

The Applicability of Patent Law to Determining Breach of a ‘FRAND’ Licensing Commitment

Another reason the majority concluded the district court did not err by refusing to include HTC’s instructions regarding apportionment was because they “were not ‘substantially correct’ statements of the law”, with the majority adding that “[p]roposed jury instructions that rely on inapplicable law cannot be ‘substantially correct.’”

First, the majority noted that the district court had found the licensing commitment made to the European Telecommunications Standards Institute (ETSI) was “governed by the laws of France” and “solely [] contractual [in] nature”, which ruling had not been appealed, yet “HTC’s proposed jury instructions are based on United States patent law” which are inapplicable:

In spite of this, HTC’s proposed jury instructions are based on United States patent law. HTC did not even attempt to justify its proposed instructions under French contract law or to argue that French contract law and United States patent law are equivalent. Nor did it try to support its position by pointing to the specific, governing provisions of Ericsson’s agreement with ETSI. Because HTC relied on inapplicable law to support its proposed instructions, the district court was well within its discretion in refusing to give those instructions.

Further, the majority held that “[e]ven if United States law were to govern the case, none of HTC’s instructions would have been required” as HTC was improperly seeking to rely on “patent-damages cases” for a breach of contract claim:

However, as other courts have recognized, a breach-of-contract case involving a breach-of-FRAND claim “is not a patent law action.” Microsoft Corp., 795 F.3d at 1040. The act of determining the value of a standard-essential patent for purposes of calculating damages is distinct from assessing whether a particular offer made during unique licensing negotiations was fair and reasonable. So, while “the Federal Circuit’s patent law methodology can serve as guidance in contract cases on questions of patent valuation,” id., it does not explicitly govern the interpretation of contractual terms, even terms that are intertwined with patent law. … Thus, although the district court may have been permitted to use United States patent-law principles to guide its instructions (assuming that United States law were to apply), it was not obligated to do so.

Judge Stephen Higginson’s Concurring Judgment

According to Judge Higginson, the district court did err by not incorporating an instruction regarding apportionment. According to Judge Higginson, “[w]hile a breach-of-FRAND case ‘is not a patent law action,’ the ‘Federal Circuit’s patent law methodology can serve as guidance in contract cases on questions of patent valuation’”, and in other patent infringement cases involving patents for which a licensing commitment had been made, the Federal Circuit has required the jury be instructed on apportionment.

With respect to the issue of applicability of U.S. laws to French law, Judge Higginson said the following in a footnote:

Ericsson takes the position that American caselaw is inapplicable because the ETSI FRAND commitment is governed by French law. I am not convinced. First, neither party has presented evidence that foreign law differs from American law on this issue. Indeed, Ericsson states in its brief “under French law and American law alike, the factfinder construes the terms [of an ambiguous contract] based on evidence of ‘the parties’ common intentions’ and the ‘prevailing industry standard or approach.’” As Ericsson has argued elsewhere, “[w]here neither party presents evidence that foreign law differs from American law – as here – a U.S. court must ‘apply [its] own law to the case.’” Corrected Non-Confidential Brief for Appellants Ericsson Inc. and Telefonaktiebolaget LM Ericsson at 39, TCL Comm. Tech. Holdings Ltd. v. Telefonaktiebolaget LM Ericsson, 943 F.3d 1360 (5th Cir. 2019), 2018 WL 3440544, at *39–40 (quoting The Scotland, 105 U.S. 24, 29 (1882)); Second, Ericsson itself cited to American caselaw to support its proposed jury instructions. This means that both parties and the district court relied on American law when assessing the propriety of the proposed jury instructions. Third, Ericsson does not dispute that the jury should engage in an apportionment analysis of some type when assessing a FRAND rate. Indeed, Ericsson emphasizes on appeal that its experts told the jury just that: “Nobody disputed at trial that the FRAND royalty must reflect patent value, apart from the value of other features or standardization itself.” Fourth, as Ericsson told the district court, “no other country today employs juries in adjudicating patent matters.” This leaves a dearth of caselaw from any jurisdiction beyond American borders about how to instruct a jury valuing a patent portfolio.

Setting aside this ruling regarding the applicability of U.S. patent law to French contract law, Judge Higginson’s reasons as to why patent damages law “applies instructively” to breach-of-FRAND cases appear to fall into the trap of unjustifiably treating a reasonable royalty for patent infringement, and a FRAND licensing rate, as one and the same despite their different origins and objectives (emphasis added):

D-Link, though decided in the patent infringement context, applies instructively to breach-of-FRAND cases. While a breach-of-FRAND case “is not a patent law action,” the “Federal Circuit’s patent law methodology can serve as guidance in contract cases on questions of patent valuation.”3 Microsoft Corp. v. Motorola, Inc., 795 F.3d 1024, 1040 (9th Cir. 2015); Bonzel v. Pfizer, Inc., 439 F.3d 1358, 1363 (Fed. Cir. 2006) (noting that a federal circuit court outside of the Federal Circuit may “deem[] it appropriate to apply the law of patent infringement” to a breach of contract case in which the contract is a patent license). That is because a jury assessing patent infringement damages undertakes the same task of assessing whether an offered rate is FRAND. See id.; Realtek Semiconductor, Corp. v. LSI Corp., No. C-12-3451-RMW, 2014 WL 2738226, at *6 (N.D. Cal. June 16, 2014) (“[D]etermining damages for patent infringement is equivalent to declaring the parties’ rights under the RAND contract.”). After finding patent infringement, a jury is tasked with “‘award[ing] the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer.’” VirnetX, 767 F.3d at 1326 (quoting 35 U.S.C. § 284). Similarly, a jury assessing whether a SEP holder has breached its FRAND obligation must determine the value of the SEP holder’s portfolio and compare that value to the offered rates. Valuing the portfolio requires apportionment, just as valuing a patent requires apportionment. See id.

While it may make sense to take guidance from patent law regarding apportionment when determining whether FRAND rates have been offered, it does not follow that patent law rules regarding what is a “reasonable” royalty for purposes of patent damages should be used to determine what is a fair, reasonable, and nondiscriminatory rate as a matter of contract. That is because, unlike the issue of apportionment, which is independent of the differences between a reasonable royalty and a FRAND rate, drawing an equivalency between what is “reasonable” in a patent damages context and a contractual FRAND context ignores their different origins and objectives (i.e. that the latter must take into consideration royalty stacking and, in addition to being reasonable, be fair and non-discriminatory, which is not required of the former). For similar reasons, it does not make sense to read FRAND limitations into reasonable royalty determinations for patent infringement.

Last, but certainly not least, Judge Higginson commented on the smallest salable patent-practicing unit (SSPPU) issue in a footnote, specifically noting that HTC’s instructions regarding apportionment did not require use of the SSPPU, nor preclude the jury from relying on comparable license evidence:

I note that, contrary to concerns expressed by Ericsson and amici, HTC’s proposed apportionment instructions do not dictate any particular patent valuation methodology. HTC’s apportionment instructions do not require use of the SSPPU as the royalty base. HTC’s apportionment instructions merely seek to alert the jury to the risk of awarding unearned, inflated, and unapportioned value to a given SEP portfolio. Ericsson’s point—that SSPPU may not be the appropriate royalty base and should not be mandated to the jury—is well taken. See Commonwealth Sci., 809 F.3d at 1302–03; D-Link, 773 F.3d at 1226–28. But HTC’s proposed instructions do not collide with that concern, nor do HTC’s instructions even preclude the jury from relying on comparable license evidence.

Combined with the decision of the majority that patent law is not applicable to contract law (especially French contract law), Judge Higginson’s statement that “Ericsson’s point – that SSPPU may not be the appropriate royalty base and should not be mandated to the jury – is well taken”, appears to indicate that all of the Circuit Judges on the panel agreed that a jury did not need to be instructed regarding the SSPPU as the appropriate royalty base for compliance with FRAND determinations. Interestingly, in a section titled “HTC’s Proposed Instructions Were ‘Substantially’ Correct” Judge Higginson set forth HTC’s proposed instructions regarding apportionment, including one of which that mentions the “end product”:

The essential requirement is that the ultimate reasonable royalty award must be based on the incremental value that the patented invention adds to the end product.

Notably, none of the recited instructions proposed by HTC regarding apportionment referred to the SSPPU.

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