The Federal Trade Commission yesterday closed its investigation of Google’s search business (see my comment here) without taking action. The FTC did, however, enter into a settlement with Google over the licensing of Motorola Mobility’s standards-essential patents (SEPs). The FTC intends that agreement to impose some limits on an area of great complexity and vigorous debate among industry, patent experts and global standards bodies: The allowable process for enforcing FRAND (fair, reasonable and non-discriminatory) licensing of SEPs, particularly the use of injunctions by patent holders to do so. According to Chairman Leibowitz, “[t]oday’s landmark enforcement action will set a template for resolution of SEP licensing disputes across many industries.” That effort may or may not be successful. It also may be misguided.

In general, a FRAND commitment incentivizes innovation by allowing a SEP owner to recoup its investments and the value of its technology through licensing, while, at the same, promoting competition and avoiding patent holdup by ensuring that licensing agreements are reasonable. When the process works, and patent holders negotiate licensing rights in good faith, patents are licensed, industries advance and consumers benefit.

FRAND terms are inherently indeterminate and flexible—indeed, they often apply precisely in situations where licensors and licensees need flexibility because each licensing circumstance is nuanced and a one-size-fits-all approach isn’t workable. Superimposing process restraints from above isn’t necessarily the best thing in dealing with what amounts to a contract dispute. But few can doubt the benefits of greater clarity in this process; the question is whether the FTC’s particular approach to the problem sacrifices too much in exchange for such clarity.

The crux of the issue in the Google consent decree—and the most controversial aspect of SEP licensing negotiations—is the role of injunctions. The consent decree requires that, before Google sues to enjoin a manufacturer from using its SEPs without a license, the company must follow a prescribed path in licensing negotiations. In particular:

Under this Order, before seeking an injunction on FRAND-encumbered SEPs, Google must: (1) provide a potential licensee with a written offer containing all of the material license terms necessary to license its SEPs, and (2) provide a potential licensee with an offer of binding arbitration to determine the terms of a license that are not agreed upon. Furthermore, if a potential licensee seeks judicial relief for a FRAND determination, Google must not seek an injunction during the pendency of the proceeding, including appeals.

There are a few exceptions, summarized by Commissioner Ohlhausen:

These limitations include when the potential licensee (a) is outside the jurisdiction of the United States; (b) has stated in writing or sworn testimony that it will not license the SEP on any terms [in other words, is not a “willing licensee”]; (c) refuses to enter a license agreement on terms set in a final ruling of a court – which includes any appeals – or binding arbitration; or (d) fails to provide written confirmation to a SEP owner after receipt of a terms letter in the form specified by the Commission. They also include certain instances when a potential licensee has brought its own action seeking injunctive relief on its FRAND-encumbered SEPs.

To the extent that the settlement reinforces what Google (and other licensors) would do anyway, and even to the extent that it imposes nothing more than an obligation to inject a neutral third party into FRAND negotiations to assist the parties in resolving rate disputes, there is little to complain about. Indeed, this is the core of the agreement, and, importantly, it seems to preserve Google’s right to seek injunctions to enforce its patents, subject to the agreement’s process requirements.

Industry participants and standard-setting organizations have supported injunctions, and the seeking and obtaining of injunctions against infringers is not in conflict with SEP patentees’ obligations. Even the FTC, in its public comments, has stated that patent owners should be able to obtain injunctions on SEPs when an infringer has rejected a reasonable license offer. Thus, the long-anticipated announcement by the FTC in the Google case may help to provide some clarity to the future negotiation of SEP licenses, the possible use of binding arbitration, and the conditions under which seeking injunctive relief will be permissible (as an antitrust matter).

Nevertheless, U.S. regulators, including the FTC, have sometimes opined that seeking injunctions on products that infringe SEPs is not in the spirit of FRAND. Everyone seems to agree that more certainty is preferable; the real issue is whether and when injunctions further that aim or not (and whether and when they are anticompetitive).

In October, Renata Hesse, then Acting Assistant Attorney General for the Department of Justice’s Antitrust Division, remarked during a patent roundtable that

[I]t would seem appropriate to limit a patent holder’s right to seek an injunction to situations where the standards implementer is unwilling to have a neutral third-party determine the appropriate F/RAND terms or is unwilling to accept the F/RAND terms approved by such a third-party.

In its own 2011 Report on the "IP Marketplace," the FTC acknowledged the fluidity and ambiguity surrounding the meaning of “reasonable” licensing terms and the problems of patent enforcement. While noting that injunctions may confer a costly “hold-up” power on licensors that wield them, the FTC nevertheless acknowledged the important role of injunctions in preserving the value of patents and in encouraging efficient private negotiation:

Three characteristics of injunctions that affect innovation support generally granting an injunction. The first and most fundamental is an injunction’s ability to preserve the exclusivity that provides the foundation of the patent system’s incentives to innovate. Second, the credible threat of an injunction deters infringement in the first place. This results from the serious consequences of an injunction for an infringer, including the loss of sunk investment. Third, a predictable injunction threat will promote licensing by the parties. Private contracting is generally preferable to a compulsory licensing regime because the parties will have better information about the appropriate terms of a license than would a court, and more flexibility in fashioning efficient agreements.

* * *

But denying an injunction every time an infringer’s switching costs exceed the economic value of the invention would dramatically undermine the ability of a patent to deter infringement and encourage innovation. For this reason, courts should grant injunctions in the majority of cases.…

Consistent with this view, the European Commission's Deputy Director-General for Antitrust, Cecilio Madero Villarejo, recently expressed concern that some technology companies that complain of being denied a license on FRAND terms never truly intend to acquire licenses, but rather "want[] to create conditions for a competition case to be brought."

But with the Google case, the Commission appears to back away from its seeming support for injunctions, claiming that:

Seeking and threatening injunctions against willing licensees of FRAND-encumbered SEPs undermines the integrity and efficiency of the standard-setting process and decreases the incentives to participate in the process and implement published standards. Such conduct reduces the value of standard setting, as firms will be less likely to rely on the standard-setting process.

Reconciling the FTC’s seemingly disparate views turns on the question of what a “willing licensee” is. And while the Google settlement itself may not magnify the problems surrounding the definition of that term, it doesn’t provide any additional clarity, either.

The problem is that, even in its 2011 Report, in which FTC noted the importance of injunctions, it defines a willing licensee as one who would license at a hypothetical, ex ante rate absent the threat of an injunction and with a different risk profile than an after-the-fact infringer. In other words, the FTC’s definition of willing licensee assumes a willingness to license only at a rate determined when an injunction is not available, and under the unrealistic assumption that the true value of a SEP can be known ex ante. Not surprisingly, then, the Commission finds it easy to declare an injunction invalid when a patentee demands a (higher) royalty rate in an actual negotiation, with actual knowledge of a patent’s value and under threat of an injunction.

As Richard Epstein, Scott Kieff and Dan Spulber discuss in critiquing the FTC’s 2011 Report:

In short, there is no economic basis to equate a manufacturer that is willing to commit to license terms before the adoption and launch of a standard, with one that instead expropriates patent rights at a later time through infringement. The two bear different risks and the late infringer should not pay the same low royalty as a party that sat down at the bargaining table and may actually have contributed to the value of the patent through its early activities. There is no economically meaningful sense in which any royalty set higher than that which a “willing licensee would have paid” at the pre-standardization moment somehow “overcompensates patentees by awarding more than the economic value of the patent.”

* * *

Even with a RAND commitment, the patent owner retains the valuable right to exclude (not merely receive later compensation from) manufacturers who are unwilling to accept reasonable license terms. Indeed, the right to exclude influences how those terms should be calculated, because it is quite likely that prior licensees in at least some areas will pay less if larger numbers of parties are allowed to use the same technology. Those interactive effects are ignored in the FTC calculations.

With this circular logic, all efforts by patentees to negotiate royalty rates after infringement has occurred can be effectively rendered anticompetitive if the patentee uses an injunction or the threat of an injunction against the infringer to secure its reasonable royalty.

The idea behind FRAND is rather simple (reward inventors; protect competition), but the practice of SEP licensing is much more complicated. Circumstances differ from case to case, and, more importantly, so do the parties’ views on what may constitute an appropriate licensing rate under FRAND. As I have written elsewhere, a single company may have very different views on the meaning of FRAND depending on whether it is the licensor or licensee in a given negotiation—and depending on whether it has already implemented a standard or not. As one court looking at the very SEPs at issue in the Google case has pointed out:

[T]he court is mindful that at the time of an initial offer, it is difficult for the offeror to know what would in fact constitute RAND terms for the offeree. Thus, what may appear to be RAND terms from the offeror’s perspective may be rejected out-of-pocket as non-RAND terms by the offeree. Indeed, it would appear that at any point in the negotiation process, the parties may have a genuine disagreement as to what terms and conditions of a license constitute RAND under the parties’ unique circumstances.

The fact that many firms engaged in SEP negotiations are simultaneously and repeatedly both licensors and licensees of patents governed by multiple SSOs further complicates the process—but also helps to ensure that it will reach a conclusion that promotes innovation and ensures that consumers reap the rewards.

In fact, an important issue in assessing the propriety of injunctions is the recognition that, in most cases, firms would rather license their patents and receive royalties than exclude access to their IP and receive no compensation (and incur the costs of protracted litigation, to boot). Importantly, for firms that both license out their own patents and license in those held by other firms (the majority of IT firms and certainly the norm for firms participating in SSOs), continued interactions on both sides of such deals help to ensure that licensing—not withholding—is the norm.

Companies are waging the smartphone patent wars with very different track records on SSO participation. Apple, for example, is relatively new to the mobile communications space and has relatively few SEPs, while other firms, like Samsung, are long-time players in the space with histories of extensive licensing (in both directions). But, current posturing aside, both firms have an incentive to license their patents, as Mark Summerfield notes:

Apple’s best course of action will most likely be to enter into licensing agreements with its competitors, which will not only result in significant revenues, but also push up the prices (or reduce the margins) on competitive products.

While some commentators make it sound as if injunctions threaten to cripple smartphone makers by preventing them from licensing essential technology on viable terms, companies in this space have been perfectly capable of orchestrating large-scale patent licensing campaigns. That these may increase costs to competitors is a feature—not a bug—of the system, representing the return on innovation that patents are intended to secure. Microsoft has wielded its sizeable patent portfolio to drive up the licensing fees paid by Android device manufacturers, and some commentators have even speculated that Microsoft makes more revenue from Android than Google does. But while Microsoft might prefer to kill Android with its patents, given the unlikeliness of this, as MG Siegler notes,

[T]he next best option is to catch a free ride on the Android train. Patent licensing deals already in place with HTC, General Dynamics, and others could mean revenues of over $1 billion by next year, as Forbes reports. And if they’re able to convince Samsung to sign one as well (which could effectively force every Android partner to sign one), we could be talking multiple billions of dollars of revenue each year.

Hand-wringing about patents is the norm, but so is licensing, and your smartphone exists, despite the thousands of patents that read on it, because the firms that hold those patents—some SEPs and some not—have, in fact, agreed to license them.

The inability to seek an injunction against an infringer, however, would ensure instead that patentees operate with reduced incentives to invest in technology and to enter into standards because they are precluded from benefiting from any subsequent increase in the value of their patents once they do so. As Epstein, Kieff and Spulber write:

The simple reality is that before a standard is set, it just is not clear whether a patent might become more or less valuable. Some upward pressure on value may be created later to the extent that the patent is important to a standard that is important to the market. In addition, some downward pressure may be caused by a later RAND commitment or some other factor, such as repeat play. The FTC seems to want to give manufacturers all of the benefits of both of these dynamic effects by in effect giving the manufacturer the free option of picking different focal points for elements of the damages calculations. The patentee is forced to surrender all of the benefit of the upward pressure while the manufacturer is allowed to get all of the benefit of the downward pressure.

Thus the problem with even the limited constraints imposed by the Google settlement: To the extent that the FTC’s settlement amounts to a prohibition on Google seeking injunctions against infringers unless the company accepts the infringer’s definition of “reasonable,” the settlement will harm the industry. It will reinforce a precedent that will likely reduce the incentives for companies and individuals to innovate, to participate in SSOs, and to negotiate in good faith.

Contrary to most assumptions about the patent system, it needs stronger, not weaker, property rules. With a no-injunction rule (whether explicit or de facto (as the Google settlement’s definition of “willing licensee” unfolds)), a potential licensee has little incentive to negotiate with a patent holder and can instead refuse to license, infringe, try its hand in court, avoid royalties entirely until litigation is finished (and sometimes even longer), and, in the end, never be forced to pay a higher royalty than it would have if it had negotiated before the true value of the patents was known. Flooding the courts and discouraging innovation and peaceful negotiations hardly seem like benefits to the patent system or the market. Unfortunately, the FTC’s approach to SEP licensing exemplified by the Google settlement may do just that.

In her dissent in Google, Comissioner Ohlhausen articulates the problems with the FTC’s settlement. First, writes Commissioner Ohlhausen,

[T]he majority says little about what “appropriate circumstances” may trigger an FTC lawsuit other than to say that a fair, reasonable, and non-discriminatory (“FRAND”) commitment generally prohibits seeking an injunction. By articulating only narrow circumstances when the Commission deems a licensee unwilling (limitations added since Bosch), and not addressing the ambiguity in the market about what constitutes a FRAND commitment, the Commission will leave patent owners to guess in most circumstances whether they can safely seek an injunction on a SEP.

As Commissioner Ohlhausen points out, the FTC’s treatment of Apple as a “willing licensee” betrays the complexity of such issues and the confusion this settlement may engender. While the FTC acknowledges that injunctions are appropriate when a patentee is faced with a licensee who is unwilling to license its patents at a reasonable rate, if even Apple is here considered a “willing licensee,” then such an acknowledgement is a null set. As Ohlhausen points out, in treating Apple as a willing licensee, the Commission

[D]isregard[s] a federal judge’s decision that Apple revealed itself as unwilling on the eve of trial. As the judge wrote: “[Apple’s intentions] became clear only when Apple informed the court . . . that it did not intend to be bound by any rate that the court determined.” The judge further concluded Apple was trying to use the FRAND rate litigation simply to determine “a ceiling on the potential license rate that it could use for negotiating purposes.…”

The Order allows Google to seek injunctive relief if a party “has stated in writing or in sworn testimony that it will not license the FRAND Patent on any terms”—as Apple did in federal district court. But the Complaint attempts to skirt this issue by vaguely claiming that “[a]t all times relevant to this Complaint, these implementers [including Apple] were willing licensees.… ” I believe it is quite “relevant” that Apple told a federal judge after years of negotiation and litigation with Motorola that it would only abide by the court-determined royalty rates to the extent it saw fit. I cannot endorse characterizing this conduct as that of a willing licensee.

This sort of strategic behavior by licensees is precisely why injunctions are necessary and appropriate in such cases. To turn them into antitrust violations seriously threatens to undermine the licensors’ appropriate bargaining power and the efficient functioning of SEP licensing.

Perhaps most significant, the Commission’s settlement continues the agency’s recent trend of making a hash of its Section 5 authority. As Commissioner Ohlhausen has noted once before (in dissenting from the Commission’s settlement in the Bosch case)—on the same day, as it happens, that Berin Szoka and I did—the FTC is charting a dangerously unprincipled course on Section 5, particularly with respect to its interpretation of its unfairness jurisdiction. In his Separate Statement in Google, Commissioner Rosch sounds a similar concern about the absence of “limiting principles” on the scope of the Commission’s authority to bring Section 5 cases under the Act’s unfair methods of competition prong. In the Google case, the Commission asserts unfairness jurisdiction without even the minimal limitations the agency itself has adopted. As Commissioner Ohlhausen notes:

[T]he Commission gives no principled basis for expanding liability beyond an unfair method of competition to include an “unfair act or practice” on what is essentially the same conduct here as in Bosch. This expansion of liability sows additional seeds of confusion as to what can create liability and even the statutory basis of that liability.

* * *

The allegations in the complaint that Google and Motorola’s conduct constitutes an “unfair act or practice” fail this agency’s unfairness standard. To show an unfair act or practice, the Commission must prove that the challenged conduct “causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition.” In this matter, we are essentially treating sophisticated technology companies, rather than end-users, as “consumers” under our consumer protection authority.… Further, the unfairness count in the complaint alleges merely speculative consumer harm, at best, and thus fails to comply with the Commission’s Unfairness Statement.

Summing up, Commissioner Ohlhausen writes:

In sum, I disagree with my colleagues about whether the alleged conduct violates Section 5 but, more importantly, believe the Commission’s actions fail to provide meaningful limiting principles regarding what is a Section 5 violation in the standard-setting context, as evidenced by its shifting positions in N-Data, Bosch, and this matter.

Ohlhausen is correct that, with the Google settlement, the FTC continues to operate in this realm without meaningful limits—a problem that some in Congress have begun to notice, as well, as Berin and I point out.

A significant problem with the SEP settlement as configured by the FTC is that it seems to make illegal the use of injunctions even to enforce perfectly reasonable royalty rates. Motorola has, since before it was purchased by Google, sought a royalty rate of 2.25% for its SEPs—an amount well in-line with rates charged by others with SEPs that read on the same standards. In its litigation with Microsoft, it is precisely this royalty that Motorola was seeking to enforce—and Microsoft was refusing to pay. There is a legitimate dispute over how that amount is to be calculated, but this is the very definition of a contract dispute, and both Motorola’s past practice as well as overall industry practice suggest it is perfectly consistent with Motorola’s FRAND obligation to seek such royalties.

To turn Motorola’s effort to receive a reasonable royalty for its patents by means of an injunction against a willing—but not willing enough—licensee into an antitrust problem seems directly to undermine the standard-setting process. It also seems to have no basis in law.

As Bruce Kobayahsi and Josh Wright pointed out in discussing the FTC’s N-Data case (cited by the Commission in its Analysis to Aid Public Comment on the Google Complaint):

What is left is the view that the theory in N-Data could be extended to any breach of a contractual commitment that might result in increased royalties, or even a good faith modification of a FRAND commitment to the same effect, always violates the antitrust laws. Perhaps a showing of market power would be required to succeed on such a theory under Section 2, but not Section 5. But it is worth considering when such a breach or modification would not result in liability under the N-Data analysis under either statute? The breach itself is the exclusionary act and evidence of the requisite monopoly power. No evidence of consumer harm is required. An attempt to renegotiate higher royalty rates is all that is needed. This is unsound antitrust policy. A basic lesson of the holdup literature is that the very asset specificity creating the potential for ex-post opportunism also creates the incentives for parties to build flexibility into their contractual relationships, which allows them to reasonably deal with unanticipated post- contractual shocks. However, even good faith modifications of SSO contractual commitments, whether those commitments relate to pricing or other elements of the agreement, would satisfy the N-Data standard for liability.

Thus, there is no principle that would prevent the extension of the N-Data theory to the breach of any contractual commitment by a firm resulting in higher prices to some consumers.

This seems to be precisely the case here—made all the more poignant by the fact that, arguably unlike N-Data, Motorola was seeking not an increase from previously agreed-to royalty rates, but rather the enforcement of royalty rates perfectly consistent with its past practice. As I have noted before in discussing this issue:

One of the clearest statements of the need for antitrust restraint in the standard setting context comes from a June 2011 comment filed with the FTC:

[T]he existence of a RAND commitment to offer patent licenses should not preclude a patent holder from seeking preliminary injunctive relief.… Any uniform declaration that such relief would not be available if the patent holder has made a commitment to offer a RAND license for its essential patent claims in connection with a standard may reduce any incentives that implementers might have to engage in good faith negotiations with the patent holder.

Most of the SSOs and their stakeholders that have considered these proposals over the years have determined that there are only a limited number of situations where patent hold-up takes place in the context of standards-setting. The industry has determined that those situations generally are best addressed through bi-lateral negotiation (and, in rare cases, litigation) as opposed to modifying the SSO’s IPR policy [by precluding injunctions or mandating a particular negotiation process].

The statement’s author? Why, Microsoft, of course.

Patents are an important tool for encouraging the development and commercialization of advanced technology, as are standard setting organizations. Antitrust authorities should exercise great restraint before intervening in the complex commercial negotiations over technology patents and standards. In Motorola’s case, the evidence of conduct that might harm competition is absent, and all that remains are, in essence, allegations that Motorola is bargaining hard and enforcing its property rights.

But the Commission actually explicitly adopts this interventionist posture in defending itself against Commissioner Ohlhausen’s criticism. Writes the Commission:

We also disagree with Commissioner Ohlhausen’s claim that the proposed settlement with Google creates uncertainty for market participants. In our view, it does just the opposite. By taking action that may deter the owners of standard-essential patents from unilaterally defining the terms of FRAND agreements through the exercise of leverage acquired solely through the standard-setting process, we protect the integrity of that process. [Emphasis added].

As Kobayashi and Wright make clear in discussing the N-Data case and its relationship to Supreme Court precedent set by the NYNEX case (and Trinko):

[In NYNEX] the Court distinguished the attempt to evade the pricing constraint from the unlawful acquisition or exercise of monopoly power by pointing out that “consumer injury flowed…from the exercise of market power that is lawfully in the hands of a monopolist.”

This is a fatal problem for the “evasion of a pricing constraint” monopolization theory of patent holdup based on renegotiation or modification of ex-ante contractual commitments made in good faith and in the absence of deception.…

Consider the application of NYNEX to the theory of patent holdup without deception in N-Data. The Commission’s theory of antitrust liability was not that N-Data acquired monopoly power when [its technology was adopted into the standard]. Rather, the theory was that N-Data unlawfully acquired monopoly power at the moment that it violated [a] contractual pricing constraint with its attempt to renegotiate those prior $1,000 licensing commitments. The proponents of this theory cannot argue that monopoly power was acquired at the time the technology was incorporated into the standard because Trinko clearly allows the setting of monopoly prices after monopoly power was lawfully obtained. The alternative is to rely on the evasion of pricing constraint theory, which asserts that the exclusionary conduct and acquisition of monopoly power occur at the moment N-Data attempts to evade its licensing commitments. However, the Court’s reasoning in NYNEX indicates that it would have concluded that N-Data lawfully obtained monopoly power at the time its technology was included in the standard and would characterize the renegotiation as the exercise of that power. Indeed, NYNEX concludes that regulatory fraud by a monopolist, conduct far less economically meritorious than breach of contract, which can be efficient, is not exclusionary even when it generates actual harm to consumers. In sum, there should be little doubt that the Court’s decision in NYNEX compels the conclusion that ex-post opportunism without deception is not exclusionary conduct and not actionable under Section 2.

And thus we come back, full circle, to the problem of Section 5. While Section 2 does not permit a case based on “the exercise of leverage acquired solely through the standard-setting process,” the FTC interprets Section 5 to operate without the sensible economic constraints imposed by the Court on Section 2 cases. As Kobayashi and Wright note:

The truth is that there was little chance the FTC could have prevailed [in N-Data] under the more rigorous Section 2 standard that anchors the liability rule to a demanding standard requiring proof of both exclusionary conduct and competitive harm. One must either accept the proposition that the FTC sought Section 5 liability precisely because there was no evidence of consumer harm or that the FTC believed there was evidence of consumer harm but elected to file the Complaint based only upon the Section 5 theory to encourage an expansive application of that Section, a position several Commissioners joining the Majority Statement have taken in recent years. Neither of these interpretations offers much evidence that N-Data is sound as a matter of prosecutorial discretion or antitrust policy.

Precisely the same could be said of the Google settlement. Whatever its merits in bringing clarity to the licensing of SEPs, the case (and others like it, including Bosch), it really is Time for Congress to Cancel the FTC’s Section 5 Antitrust Blank Check.