An unofficial version of the EU’s anticipated regulatory proposal on standard essential patents (SEPs), along with a related impact assessment, was leaked earlier this month, generating reactions that range from disquiet to disbelief (but mostly disbelief).
Our friend Igor Nikolic wrote about it here on Truth on the Market, and we share his his concern that:
As it currently stands, it appears the regulation will significantly increase costs to the most innovative companies that participate in multiple standardization activities. It would, for instance, regulate technology prices, limit the enforcement of patent rights, and introduce new avenues for further delays in SEP-licensing negotiations.
It also might harm the EU’s innovativeness on the global stage and set precedents for other countries to regulate, possibly jeopardizing how the entire international technical-standardization system functions.
The regulation originates from last year’s call by the European Commission to establish principles and implement measures that will foster a “balanced,” “smooth,” and “predictable” framework for SEP licensing. With this in mind, the reform aims “to promote an efficient and sustainable SEP licensing ecosystem, where the interests of both SEP holders and implementers are considered” [emphasis added]. As explicitly mentioned in the call, the main problems affecting the SEP ecosystem are holdup, holdout, and forum shopping.
Unfortunately, it is far from clear these premises are correct or that they justify the sort of regulation the Commission now contemplates.
The draft regulation purports to fix a broken regime by promoting efficient licensing and ensuring a fair balance between the interests of patent holders and implementers, in order to mitigate the risks of both holdup and holdout as requested in well-established case law and, in particular, by the Court of Justice’s (CJEU) landmark Huawei v. ZTE case.
There is, however, scant evidence that the current SEP-licensing regime is inefficient or unbalanced. The best evidence is that SEP-reliant industries are no less efficient than other innovative industries. Likewise, SEP holders do not appear to be capturing the lion’s share of profits in the industries where they operate. In short, it’s not clear that there is any problem to solve in the first place.
There is also scant evidence that the Commission has taken account of hugely important geopolitical considerations. Policymakers are worried that Chinese companies (with the support of Chinese courts and authorities) may use litigation strategies to obtain significantly lower “fair, reasonable, and non-discriminatory” (FRAND) rates.
Indeed, the EU filed a case against China at the World Trade Organization (WTO) last year that complained about the strategic use of anti-suit injunctions (ASIs)—that is, orders restraining a party either from pursuing foreign proceedings or enforcing a judgment obtained in foreign proceedings. As explained in a recent paper, this trend could have severe economic repercussions, given that the smooth implementation of mobile-telecommunication standards is crucial to the economic potential of both the so-called “Internet of Things” and U.S. communications infrastructure writ large.
By disproportionately targeting inventors (as we argue below), the draft regulation penalizes precisely those companies that, from the perspective of geopolitics, it should be protecting (or, at least, not undermining). Indeed, as the Commission’s impact assessment warns, the share of SEPs owned by Chinese companies has increased dramatically in recent years. Penalizing European inventors will only exacerbate this trend.
Missing the Mark
Given the importance of achieving a balance between holdup and holdout, as well as avoiding steps that could reinforce China’s position on the geopolitical map, the leaked version of the forthcoming EU regulation is deeply concerning, to say the least.
Rather than wrestling with these complex issues, the proposal essentially focuses on ensuring that implementers receive licenses at affordable royalty rates. In other words, it would create significant red tape and compliance costs in an attempt to address an issue that is mostly peripheral to the stated aims, and arguably already dealt with by EU courts in Huawei v. ZTE. That decision, notably, forces parties to negotiate royalties in good faith before they can pursue judicial remedies, such as ASIs.
Critically, the proposal surmises that there is currently little transparency regarding the aggregate royalties that implementers pay for all the SEPs that underpin a standard. The proposal assumes that making this information public would enable implementers to make better determinations when they negotiate royalties.
To address this, the proposal creates several mandatory procedures that ultimately serve to make information on total royalty burdens public. It also creates a procedure that parties can use to obtain nonbinding FRAND royalty determinations from third-party arbitrators. More precisely, if contributors do not agree on an aggregate royalty sufficiently early before components and products implementing the standardized technology are put on the market, implementers and/or contributors can ask the EU Intellectual Property Office (EUIPO) to appoint conciliators with recommending an aggregate royalty (with exceedingly limited ability to appeal such decisions).
The proposal has at least two important drawbacks.
To start, it is unclear what a nonbinding royalty recommendation would achieve. On the one hand, backers might hope the nonbinding recommendations will, de facto, be transposed by national courts when they rule on FRAND disputes. This may well be correct, but it is far from ideal. One of the great strengths of the current system is that courts in different jurisdictions compete to become the forum of choice for royalty disputes. In doing so, they constantly refine the way they rule on such disputes. Replacing this emergent equilibrium with a one-size-fits-all approach would be a great loss.
Conversely, it’s plausible that national courts will continue to go about their daily business, largely ignoring the EUIPO royalty recommendations. If that were the case, one could legitimately ask what a lengthy and costly system of nonbinding royalty determinations really achieves. Whatever the case, the draft regulation offers little vision as to how its planned royalty determinations will improve actual outcomes.
A second important issue is that, in its current form, the proposal seems myopically focused on prices. This is a problem because licensing negotiations involve a much broader range of terms. Such considerations as available remedies and penalties, license-termination conditions, cross-licensing, and jurisdiction are often just as important as price.
Not only are these issues conspicuously absent from the draft regulation, but properly accounting for them would largely undermine the regulation’s price-comparison mechanism, as this heterogeneity shows such comparisons are essentially apples to oranges.
Along similar lines, the draft regulation also includes a system of sampling to determine whether patents are truly essential to the underlying standard. These checks would be conducted by independent evaluators selected according to criteria to be determined by the Commission, and based on a methodology to be developed by the Commission, to ensure that the sample can produce statistically valid results.
It’s unclear how much such a mechanism would enhance the status quo. Moreover, according to the proposal, the results of these essentiality checks would also not be legally binding. Rather than enhancing SEP-licensing negotiations and safeguarding the effectiveness of essentiality checks, this solution would just exacerbate holdout concerns. Indeed, implementers may use the process to delay negotiations or avoid payment of royalties while the process is ongoing.
The Commission’s proposal also sends all the wrong signals internationally. In turn, this may undermine the geopolitical interests of both the EU and the United States.
By signaling its willingness to more closely interfere with the royalty rates agreed between inventors and implementers—even for patents registered outside the EU—the EU is effectively inviting other jurisdictions to do the same (or legitimizing ongoing efforts to do so).
This is far from ideal. For instance, Chinese government officials and courts have increasingly sought to influence and rule on global FRAND disputes, generally in ways that favor its own firms, which are largely on the implementer side of disputes. The EU’s proposal sends a strong signal that it is fair game for government agencies to more directly influence global FRAND royalty rates, as well as seeking to override the decisions of foreign courts.
In short, the EU’s draft regulation will embolden foreign jurisdictions to respond in kind and seek further authority over the royalty rates agreed upon by private parties. Ultimately, this will infuse the SEP-licensing space with politized oversight and vindicate China’s moves to depress the value of the West’s intellectual property, thus giving its state-backed rivals a leg up. At a time when geopolitical tensions between China and the West are historically high, such a move seems particularly ill-advised.
In sum, rather than strike a balance between patent owners’ and implementers’ interests, the EU proposal is one-sided. It only introduces burdens on SEP holders and disregards the significant risks of holdout strategies. Such a framework for SEP licensing would be at odds with the framework crafted by the CJEU in Huawei.
Further, it would also undermine the value of many SEPs in ways that would be particularly appreciated by Chinese policymakers. The consequences of such an approach would be disruptive for entire SEP-reliant industries, and for the EU’s economic interests.