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Last week the Senate Judiciary Committee held a hearing, Intellectual Property and the Price of Prescription Drugs: Balancing Innovation and Competition, that explored whether changes to the pharmaceutical patent process could help lower drug prices.  The committee’s goal was to evaluate various legislative proposals that might facilitate the entry of cheaper generic drugs, while also recognizing that strong patent rights for branded drugs are essential to incentivize drug innovation.  As Committee Chairman Lindsey Graham explained:

One thing you don’t want to do is kill the goose who laid the golden egg, which is pharmaceutical development. But you also don’t want to have a system that extends unnecessarily beyond the ability to get your money back and make a profit, a patent system that drives up costs for the average consumer.

Several proposals that were discussed at the hearing have the potential to encourage competition in the pharmaceutical industry and help rein in drug prices. Below, I discuss these proposals, plus a few additional reforms. I also point out some of the language in the current draft proposals that goes a bit too far and threatens the ability of drug makers to remain innovative.  

1. Prevent brand drug makers from blocking generic companies’ access to drug samples. Some brand drug makers have attempted to delay generic entry by restricting generics’ access to the drug samples necessary to conduct FDA-required bioequivalence studies.  Some brand drug manufacturers have limited the ability of pharmacies or wholesalers to sell samples to generic companies or abused the REMS (Risk Evaluation Mitigation Strategy) program to refuse samples to generics under the auspices of REMS safety requirements.  The Creating and Restoring Equal Access To Equivalent Samples (CREATES) Act of 2019 would allow potential generic competitors to bring an action in federal court for both injunctive relief and damages when brand companies block access to drug samples.  It also gives the FDA discretion to approve alternative REMS safety protocols for generic competitors that have been denied samples under the brand companies’ REMS protocol.  Although the vast majority of brand drug companies do not engage in the delay tactics addressed by CREATES, the Act would prevent the handful that do from thwarting generic competition.  Increased generic competition should, in turn, reduce drug prices.

2. Restrict abuses of FDA Citizen Petitions.  The citizen petition process was created as a way for individuals and community groups to flag legitimate concerns about drugs awaiting FDA approval.  However, critics claim that the process has been misused by some brand drug makers who file petitions about specific generic drugs in the hopes of delaying their approval and market entry.  Although FDA has indicated that citizens petitions rarely delay the approval of generic drugs, there have been a few drug makers, such as Shire ViroPharma, that have clearly abused the process and put unnecessary strain on FDA resources. The Stop The Overuse of Petitions and Get Affordable Medicines to Enter Soon (STOP GAMES) Act is intended to prevent such abuses.  The Act reinforces the FDA and FTC’s ability to crack down on petitions meant to lengthen the approval process of a generic competitor, which should deter abuses of the system that can occasionally delay generic entry.  However, lawmakers should make sure that adopted legislation doesn’t limit the ability of stakeholders (including drug makers that often know more about the safety of drugs than ordinary citizens) to raise serious concerns with the FDA. 

3. Curtail Anticompetitive Pay-for-Delay Settlements.  The Hatch-Waxman Act incentivizes generic companies to challenge brand drug patents by granting the first successful generic challenger a period of marketing exclusivity. Like all litigation, many of these patent challenges result in settlements instead of trials.  The FTC and some courts have concluded that these settlements can be anticompetitive when the brand companies agree to pay the generic challenger in exchange for the generic company agreeing to forestall the launch of their lower-priced drug. Settlements that result in a cash payment are a red flag for anti-competitive behavior, so pay-for-delay settlements have evolved to involve other forms of consideration instead.  As a result, the Preserve Access to Affordable Generics and Biosimilars Act aims to make an exchange of anything of value presumptively anticompetitive if the terms include a delay in research, development, manufacturing, or marketing of a generic drug. Deterring obvious pay-for-delay settlements will prevent delays to generic entry, making cheaper drugs available as quickly as possible to patients. 

However, the Act’s rigid presumption that an exchange of anything of value is presumptively anticompetitive may also prevent legitimate settlements that ultimately benefit consumers.  Brand drug makers should be allowed to compensate generic challengers to eliminate litigation risk and escape litigation expenses, and many settlements result in the generic drug coming to market before the expiration of the brand patent and possibly earlier than if there was prolonged litigation between the generic and brand company.  A rigid presumption of anticompetitive behavior will deter these settlements, thereby increasing expenses for all parties that choose to litigate and possibly dissuading generics from bringing patent challenges in the first place.  Indeed, the U.S. Supreme Court has declined to define these settlements as per se anticompetitive, and the FTC’s most recent agreement involving such settlements exempts several forms of exchanges of value.  Any adopted legislation should follow the FTC’s lead and recognize that some exchanges of value are pro-consumer and pro-competitive.

4. Restore the balance established by Hatch-Waxman between branded drug innovators and generic drug challengers.  I have previously discussed how an unbalanced inter partes review (IPR) process for challenging patents threatens to stifle drug innovation.  Moreover, current law allows generic challengers to file duplicative claims in both federal court and through the IPR process.  And because IPR proceedings do not have a standing requirement, the process has been exploited  by entities that would never be granted standing in traditional patent litigation—hedge funds betting against a company by filing an IPR challenge in hopes of crashing the stock and profiting from the bet. The added expense to drug makers of defending both duplicative claims and claims against challengers that are exploiting the system increases litigation costs, which may be passed on to consumers in the form of higher prices. 

The Hatch-Waxman Integrity Act (HWIA) is designed to return the balance established by Hatch-Waxman between branded drug innovators and generic drug challengers. It requires generic challengers to choose between either Hatch-Waxman litigation (which saves considerable costs by allowing generics to rely on the brand company’s safety and efficacy studies for FDA approval) or an IPR proceeding (which is faster and provides certain pro-challenger provisions). The HWIA would also eliminate the ability of hedge funds and similar entities to file IPR claims while shorting the stock.  By reducing duplicative litigation and the exploitation of the IPR process, the HWIA will reduce costs and strengthen innovation incentives for drug makers.  This will ensure that patent owners achieve clarity on the validity of their patents, which will spur new drug innovation and make sure that consumers continue to have access to life-improving drugs.

5. Curb illegal product hopping and patent thickets.  Two drug maker tactics currently garnering a lot of attention are so-called “product hopping” and “patent thickets.”  At its worst, product hopping involves brand drug makers making minor changes to a drug nearing the end of its patent so that they gets a new patent on the slightly-tweaked drug, and then withdrawing the original drug from the market so that patients shift to the newly patented drug and pharmacists can’t substitute a generic version of the original drug.  Similarly, at their worst, patent thickets involve brand drug makers obtaining a web of patents on a single drug to extend the life of their exclusivity and make it too costly for other drug makers to challenge all of the patents associated with a drug.  The proposed Affordable Prescriptions for Patients Act of 2019 is meant to stop these abuses of the patent system, which would facilitate generic entry and help to lower drug prices.

However, the Act goes too far by also capturing many legitimate activities in its definitions. For example, the bill defines as anticompetitive product-hopping the selling of any improved version of a drug during a window which extends to a year after the launch of the first generic competitor.  Presently, to acquire a patent and FDA approval, the improved version of the drug must be different and innovative enough from the original drug, yet the Act would prevent the drug maker from selling such a product without satisfying a demanding three-pronged test before the FTC or a district court.  Similarly, the Act defines as anticompetitive patent thickets any new patents filed on a drug in the same general family as the original patent, and this presumption can only be rebutted by providing extensive evidence and satisfying demanding standards to the FTC or a district court.  As a result, the Act deters innovation activity that is at all related to an initial patent and, in doing so, ignores the fact that most important drug innovation is incremental innovation based on previous inventions.  Thus, the proposal should be redrafted to capture truly anticompetitive product hopping and patent thicket activity, while exempting behavior this is critical for drug innovation. 

Reforms that close loopholes in the current patent process should facilitate competition in the pharmaceutical industry and help to lower drug prices.  However, lawmakers need to be sure that they don’t restrict patent rights to the extent that they deter innovation because a significant body of research predicts that patients’ health outcomes will suffer as a result.

[TOTM: The following is the fourth in a series of posts by TOTM guests and authors on the FTC v. Qualcomm case, currently awaiting decision by Judge Lucy Koh in the Northern District of California. The entire series of posts is available here. This post originally appeared on the Federalist Society Blog.]

The courtroom trial in the Federal Trade Commission’s (FTC’s) antitrust case against Qualcomm ended in January with a promise from the judge in the case, Judge Lucy Koh, to issue a ruling as quickly as possible — caveated by her acknowledgement that the case is complicated and the evidence voluminous. Well, things have only gotten more complicated since the end of the trial. Not only did Apple and Qualcomm reach a settlement in the antitrust case against Qualcomm that Apple filed just three days after the FTC brought its suit, but the abbreviated trial in that case saw the presentation by Qualcomm of some damning evidence that, if accurate, seriously calls into (further) question the merits of the FTC’s case.

Apple v. Qualcomm settles — and the DOJ takes notice

The Apple v. Qualcomm case, which was based on substantially the same arguments brought by the FTC in its case, ended abruptly last month after only a day and a half of trial — just enough time for the parties to make their opening statements — when Apple and Qualcomm reached an out-of-court settlement. The settlement includes a six-year global patent licensing deal, a multi-year chip supplier agreement, an end to all of the patent disputes around the world between the two companies, and a $4.5 billion settlement payment from Apple to Qualcomm.

That alone complicates the economic environment into which Judge Koh will issue her ruling. But the Apple v. Qualcomm trial also appears to have induced the Department of Justice Antitrust Division (DOJ) to weigh in on the FTC’s case with a Statement of Interest requesting Judge Koh to use caution in fashioning a remedy in the case should she side with the FTC, followed by a somewhat snarky Reply from the FTC arguing the DOJ’s filing was untimely (and, reading the not-so-hidden subtext, unwelcome).

But buried in the DOJ’s Statement is an important indication of why it filed its Statement when it did, just about a week after the end of the Apple v. Qualcomm case, and a pointer to a much larger issue that calls the FTC’s case against Qualcomm even further into question (I previously wrote about the lack of theoretical and evidentiary merit in the FTC’s case here).

Footnote 6 of the DOJ’s Statement reads:

Internal Apple documents that recently became public describe how, in an effort to “[r]educe Apple’s net royalty to Qualcomm,” Apple planned to “[h]urt Qualcomm financially” and “[p]ut Qualcomm’s licensing model at risk,” including by filing lawsuits raising claims similar to the FTC’s claims in this case …. One commentator has observed that these documents “potentially reveal[] that Apple was engaging in a bad faith argument both in front of antitrust enforcers as well as the legal courts about the actual value and nature of Qualcomm’s patented innovation.” (Emphasis added).

Indeed, the slides presented by Qualcomm during that single day of trial in Apple v. Qualcomm are significant, not only for what they say about Apple’s conduct, but, more importantly, for what they say about the evidentiary basis for the FTC’s claims against the company.

The evidence presented by Qualcomm in its opening statement suggests some troubling conduct by Apple

Others have pointed to Qualcomm’s opening slides and the Apple internal documents they present to note Apple’s apparent bad conduct. As one commentator sums it up:

Although we really only managed to get a small glimpse of Qualcomm’s evidence demonstrating the extent of Apple’s coordinated strategy to manipulate the FRAND license rate, that glimpse was particularly enlightening. It demonstrated a decade-long coordinated effort within Apple to systematically engage in what can only fairly be described as manipulation (if not creation of evidence) and classic holdout.

Qualcomm showed during opening arguments that, dating back to at least 2009, Apple had been laying the foundation for challenging its longstanding relationship with Qualcomm. (Emphasis added).

The internal Apple documents presented by Qualcomm to corroborate this claim appear quite damning. Of course, absent explanation and cross-examination, it’s impossible to know for certain what the documents mean. But on their face they suggest Apple knowingly undertook a deliberate scheme (and knowingly took upon itself significant legal risk in doing so) to devalue comparable patent portfolios to Qualcomm’s:

The apparent purpose of this scheme was to devalue comparable patent licensing agreements where Apple had the power to do so (through litigation or the threat of litigation) in order to then use those agreements to argue that Qualcomm’s royalty rates were above the allowable, FRAND level, and to undermine the royalties Qualcomm would be awarded in courts adjudicating its FRAND disputes with the company. As one commentator put it:

Apple embarked upon a coordinated scheme to challenge weaker patents in order to beat down licensing prices. Once the challenges to those weaker patents were successful, and the licensing rates paid to those with weaker patent portfolios were minimized, Apple would use the lower prices paid for weaker patent portfolios as proof that Qualcomm was charging a super-competitive licensing price; a licensing price that violated Qualcomm’s FRAND obligations. (Emphasis added).

That alone is a startling revelation, if accurate, and one that would seem to undermine claims that patent holdout isn’t a real problem. It also would undermine Apple’s claims that it is a “willing licensee,” engaging with SEP licensors in good faith. (Indeed, this has been called into question before, and one Federal Circuit judge has noted in dissent that “[t]he record in this case shows evidence that Apple may have been a hold out.”). If the implications drawn from the Apple documents shown in Qualcomm’s opening statement are accurate, there is good reason to doubt that Apple has been acting in good faith.

Even more troubling is what it means for the strength of the FTC’s case

But the evidence offered in Qualcomm’s opening argument point to another, more troubling implication, as well. We know that Apple has been coordinating with the FTC and was likely an important impetus for the FTC’s decision to bring an action in the first place. It seems reasonable to assume that Apple used these “manipulated” agreements to help make its case.

But what is most troubling is the extent to which it appears to have worked.

The FTC’s action against Qualcomm rested in substantial part on arguments that Qualcomm’s rates were too high (even though the FTC constructed its case without coming right out and saying this, at least until trial). In its opening statement the FTC said:

Qualcomm’s practices, including no license, no chips, skewed negotiations towards the outcomes that favor Qualcomm and lead to higher royalties. Qualcomm is committed to license its standard essential patents on fair, reasonable, and non-discriminatory terms. But even before doing market comparison, we know that the license rates charged by Qualcomm are too high and above FRAND because Qualcomm uses its chip power to require a license.

* * *

Mr. Michael Lasinski [the FTC’s patent valuation expert] compared the royalty rates received by Qualcomm to … the range of FRAND rates that ordinarily would form the boundaries of a negotiation … Mr. Lasinski’s expert opinion … is that Qualcomm’s royalty rates are far above any indicators of fair and reasonable rates. (Emphasis added).

The key question is what constitutes the “range of FRAND rates that ordinarily would form the boundaries of a negotiation”?

Because they were discussed under seal, we don’t know the precise agreements that the FTC’s expert, Mr. Lasinski, used for his analysis. But we do know something about them: His analysis entailed a study of only eight licensing agreements; in six of them, the licensee was either Apple or Samsung; and in all of them the licensor was either Interdigital, Nokia, or Ericsson. We also know that Mr. Lasinski’s valuation study did not include any Qualcomm licenses, and that the eight agreements he looked at were all executed after the district court’s decision in Microsoft vs. Motorola in 2013.

A curiously small number of agreements

Right off the bat there is a curiosity in the FTC’s valuation analysis. Even though there are hundreds of SEP license agreements involving the relevant standards, the FTC’s analysis relied on only eight, three-quarters of which involved licensing by only two companies: Apple and Samsung.

Indeed, even since 2013 (a date to which we will return) there have been scads of licenses (see, e.g., herehere, and here). Not only Apple and Samsung make CDMA and LTE devices; there are — quite literally — hundreds of other manufacturers out there, all of them licensing essentially the same technology — including global giants like LG, Huawei, HTC, Oppo, Lenovo, and Xiaomi. Why were none of their licenses included in the analysis? 

At the same time, while Interdigital, Nokia, and Ericsson are among the largest holders of CDMA and LTE SEPs, several dozen companies have declared such patents, including Motorola (Alphabet), NEC, Huawei, Samsung, ZTE, NTT DOCOMO, etc. Again — why were none of their licenses included in the analysis?

All else equal, more data yields better results. This is particularly true where the data are complex license agreements which are often embedded in larger, even-more-complex commercial agreements and which incorporate widely varying patent portfolios, patent implementers, and terms.

Yet the FTC relied on just eight agreements in its comparability study, covering a tiny fraction of the industry’s licensors and licensees, and, notably, including primarily licenses taken by the two companies (Samsung and Apple) that have most aggressively litigated their way to lower royalty rates.

A curiously crabbed selection of licensors

And it is not just that the selected licensees represent a weirdly small and biased sample; it is also not necessarily even a particularly comparable sample.

One thing we can be fairly confident of, given what we know of the agreements used, is that at least one of the license agreements involved Nokia licensing to Apple, and another involved InterDigital licensing to Apple. But these companies’ patent portfolios are not exactly comparable to Qualcomm’s. About Nokia’s patents, Apple said:

And about InterDigital’s:

Meanwhile, Apple’s view of Qualcomm’s patent portfolio (despite its public comments to the contrary) was that it was considerably better than the others’:

The FTC’s choice of such a limited range of comparable license agreements is curious for another reason, as well: It includes no Qualcomm agreements. Qualcomm is certainly one of the biggest players in the cellular licensing space, and no doubt more than a few license agreements involve Qualcomm. While it might not make sense to include Qualcomm licenses that the FTC claims incorporate anticompetitive terms, that doesn’t describe the huge range of Qualcomm licenses with which the FTC has no quarrel. Among other things, Qualcomm licenses from before it began selling chips would not have been affected by its alleged “no license, no chips” scheme, nor would licenses granted to companies that didn’t also purchase Qualcomm chips. Furthermore, its licenses for technology reading on the WCDMA standard are not claimed to be anticompetitive by the FTC.

And yet none of these licenses were deemed “comparable” by the FTC’s expert, even though, on many dimensions — most notably, with respect to the underlying patent portfolio being valued — they would have been the most comparable (i.e., identical).

A curiously circumscribed timeframe

That the FTC’s expert should use the 2013 cut-off date is also questionable. According to Lasinski, he chose to use agreements after 2013 because it was in 2013 that the U.S. District Court for the Western District of Washington decided the Microsoft v. Motorola case. Among other things, the court in Microsoft v Motorola held that the proper value of a SEP is its “intrinsic” patent value, including its value to the standard, but not including the additional value it derives from being incorporated into a widely used standard.

According to the FTC’s expert,

prior to [Microsoft v. Motorola], people were trying to value … the standard and the license based on the value of the standard, not the value of the patents ….

Asked by Qualcomm’s counsel if his concern was that the “royalty rates derived in license agreements for cellular SEPs [before Microsoft v. Motorola] could very well have been above FRAND,” Mr. Lasinski concurred.

The problem with this approach is that it’s little better than arbitrary. The Motorola decision was an important one, to be sure, but the notion that sophisticated parties in a multi-billion dollar industry were systematically agreeing to improper terms until a single court in Washington suggested otherwise is absurd. To be sure, such agreements are negotiated in “the shadow of the law,” and judicial decisions like the one in Washington (later upheld by the Ninth Circuit) can affect the parties’ bargaining positions.

But even if it were true that the court’s decision had some effect on licensing rates, the decision would still have been only one of myriad factors determining parties’ relative bargaining  power and their assessment of the proper valuation of SEPs. There is no basis to support the assertion that the Motorola decision marked a sea-change between “improper” and “proper” patent valuations. And, even if it did, it was certainly not alone in doing so, and the FTC’s expert offers no justification for determining that agreements reached before, say, the European Commission’s decision against Qualcomm in 2018 were “proper,” or that the Korea FTC’s decision against Qualcomm in 2009 didn’t have the same sort of corrective effect as the Motorola court’s decision in 2013. 

At the same time, a review of a wider range of agreements suggested that Qualcomm’s licensing royalties weren’t inflated

Meanwhile, one of Qualcomm’s experts in the FTC case, former DOJ Chief Economist Aviv Nevo, looked at whether the FTC’s theory of anticompetitive harm was borne out by the data by looking at Qualcomm’s royalty rates across time periods and standards, and using a much larger set of agreements. Although his remit was different than Mr. Lasinski’s, and although he analyzed only Qualcomm licenses, his analysis still sheds light on Mr. Lasinski’s conclusions:

[S]pecifically what I looked at was the predictions from the theory to see if they’re actually borne in the data….

[O]ne of the clear predictions from the theory is that during periods of alleged market power, the theory predicts that we should see higher royalty rates.

So that’s a very clear prediction that you can take to data. You can look at the alleged market power period, you can look at the royalty rates and the agreements that were signed during that period and compare to other periods to see whether we actually see a difference in the rates.

Dr. Nevo’s analysis, which looked at royalty rates in Qualcomm’s SEP license agreements for CDMA, WCDMA, and LTE ranging from 1990 to 2017, found no differences in rates between periods when Qualcomm was alleged to have market power and when it was not alleged to have market power (or could not have market power, on the FTC’s theory, because it did not sell corresponding chips).

The reason this is relevant is that Mr. Lasinski’s assessment implies that Qualcomm’s higher royalty rates weren’t attributable to its superior patent portfolio, leaving either anticompetitive conduct or non-anticompetitive, superior bargaining ability as the explanation. No one thinks Qualcomm has cornered the market on exceptional negotiators, so really the only proffered explanation for the results of Mr. Lasinski’s analysis is anticompetitive conduct. But this assumes that his analysis is actually reliable. Prof. Nevo’s analysis offers some reason to think that it is not.

All of the agreements studied by Mr. Lasinski were drawn from the period when Qualcomm is alleged to have employed anticompetitive conduct to elevate its royalty rates above FRAND. But when the actual royalties charged by Qualcomm during its alleged exercise of market power are compared to those charged when and where it did not have market power, the evidence shows it received identical rates. Mr Lasinki’s results, then, would imply that Qualcomm’s royalties were “too high” not only while it was allegedly acting anticompetitively, but also when it was not. That simple fact suggests on its face that Mr. Lasinski’s analysis may have been flawed, and that it systematically under-valued Qualcomm’s patents.

Connecting the dots and calling into question the strength of the FTC’s case

In its closing argument, the FTC pulled together the implications of its allegations of anticompetitive conduct by pointing to Mr. Lasinski’s testimony:

Now, looking at the effect of all of this conduct, Qualcomm’s own documents show that it earned many times the licensing revenue of other major licensors, like Ericsson.

* * *

Mr. Lasinski analyzed whether this enormous difference in royalties could be explained by the relative quality and size of Qualcomm’s portfolio, but that massive disparity was not explained.

Qualcomm’s royalties are disproportionate to those of other SEP licensors and many times higher than any plausible calculation of a FRAND rate.

* * *

The overwhelming direct evidence, some of which is cited here, shows that Qualcomm’s conduct led licensees to pay higher royalties than they would have in fair negotiations.

It is possible, of course, that Lasinki’s methodology was flawed; indeed, at trial Qualcomm argued exactly this in challenging his testimony. But it is also possible that, whether his methodology was flawed or not, his underlying data was flawed.

It is impossible from the publicly available evidence to definitively draw this conclusion, but the subsequent revelation that Apple may well have manipulated at least a significant share of the eight agreements that constituted Mr. Lasinski’s data certainly increases the plausibility of this conclusion: We now know, following Qualcomm’s opening statement in Apple v. Qualcomm, that that stilted set of comparable agreements studied by the FTC’s expert also happens to be tailor-made to be dominated by agreements that Apple may have manipulated to reflect lower-than-FRAND rates.

What is most concerning is that the FTC may have built up its case on such questionable evidence, either by intentionally cherry picking the evidence upon which it relied, or inadvertently because it rested on such a needlessly limited range of data, some of which may have been tainted.

Intentionally or not, the FTC appears to have performed its valuation analysis using a needlessly circumscribed range of comparable agreements and justified its decision to do so using questionable assumptions. This seriously calls into question the strength of the FTC’s case.

On March 14, the Federal Circuit will hear oral arguments in the case of BTG International v. Amneal Pharmaceuticals that could dramatically influence the future of duplicative patent litigation in the pharmaceutical industry.  The court will determine whether the America Invents Act (AIA) bars patent challengers that succeed in invalidating patents in inter partes review (IPR) proceedings from repeating their winning arguments in district court.  Courts and litigants had previously assumed that the AIA’s estoppel provision only prevented unsuccessful challengers from reusing failed arguments.   However, in an amicus brief filed in the case last month, the U.S. Patent and Trade Office (USPTO) argued that, although it seems counterintuitive, under the AIA, even parties that succeed in getting patents invalidated in IPR cannot reuse their arguments. 

If the Federal Circuit agrees with the USPTO, patent challengers could be strongly deterred from bringing IPR proceedings because it would mean they couldn’t reuse any arguments in district court.  This deterrent effect would be especially strong for generic drug makers, who must prevail in district court in order to get approval for their Abbreviated New Drug Application from the FDA. 

Critics of the USPTO’s position assert that it will frustrate the AIA’s purpose of facilitating generic competition.  However, if the Federal Circuit adopts the position, it would also reduce the amount of duplicative litigation that plagues the pharmaceutical industry and threatens new drug innovation.  According to a 2017 analysis of over 6,500 IPR challenges filed between 2012 and 2017, approximately 80% of IPR challenges were filed during an ongoing district court case challenging the patent.   This duplicative litigation can increase costs for both challengers and patent holders; the median cost for an IPR proceeding that results in a final decision is $500,000 and the median cost for just filing an IPR petition is $100,000.  Moreover, because of duplicative litigation, pharmaceutical patent holders face persistent uncertainty about the validity of their patents. Uncertain patent rights will lead to less innovation because drug companies will not spend the billions of dollars it typically costs to bring a new drug to market when they cannot be certain if the patents for that drug can withstand IPR proceedings that are clearly stacked against them.   And if IPR causes drug innovation to decline, a significant body of research predicts that patients’ health outcomes will suffer as a result.

In addition, deterring IPR challenges would help to reestablish balance between drug patent owners and patent challengers.  As I’ve previously discussed here and here, the pro-challenger bias in IPR proceedings has led to significant deviation in patent invalidation rates under the two pathways; compared to district court challenges, patents are twice as likely to be found invalid in IPR challenges. The challenger is more likely to prevail in IPR proceedings because the Patent Trial and Appeal Board (PTAB) applies a lower standard of proof for invalidity in IPR proceedings than do federal courts. Furthermore, if the challenger prevails in the IPR proceedings, the PTAB’s decision to invalidate a patent can often “undo” a prior district court decision in favor of the patent holder.  Further, although both district court judgments and PTAB decisions are appealable to the Federal Circuit, the court applies a more deferential standard of review to PTAB decisions, increasing the likelihood that they will be upheld compared to the district court decision. 

However, the USPTO acknowledges that its position is counterintuitive because it means that a court could not consider invalidity arguments that the PTAB found persuasive.  It is unclear whether the Federal Circuit will refuse to adopt this counterintuitive position or whether Congress will amend the AIA to limit estoppel to failed invalidity claims.  As a result, a better and more permanent way to eliminate duplicative litigation would be for Congress to enact the Hatch-Waxman Integrity Act of 2019 (HWIA).  The HWIA was introduced by Senator Thom Tillis in the Senate and Congressman Bill Flores In the House, and proposed in the last Congress by Senator Orrin Hatch.  The HWIA eliminates the ability of drug patent challengers to file duplicative claims in both federal court and IPR proceedings.  Instead, they must choose between either district court litigation (which saves considerable costs by allowing generics to rely on the brand company’s safety and efficacy studies for FDA approval) and IPR proceedings (which are faster and provide certain pro-challenger provisions). 

Thus, the HWIA would reduce duplicative litigation that increases costs and uncertainty for drug patent owners.   This will ensure that patent owners achieve clarity on the validity of their patents, which will spur new drug innovation and ensure that consumers continue to have access to life-improving drugs.

[TOTM: The following is the second in a series of posts by TOTM guests and authors on the FTC v. Qualcomm case, currently awaiting decision by Judge Lucy Koh in the Northern District of California. The entire series of posts is available here.

This post is authored by Luke Froeb (William C. Oehmig Chair in Free Enterprise and Entrepreneurship at the Owen Graduate School of Management at Vanderbilt University; former chief economist at the Antitrust Division of the US Department of Justice and the Federal Trade Commission), Michael Doane (Competition Economics, LLC) & Mikhael Shor (Associate Professor of Economics, University of Connecticut).]

[Froeb, Doane & Shor: This post does not attempt to answer the question of what the court should decide in FTC v. Qualcomm because we do not have access to the information that would allow us to make such a determination. Rather, we focus on economic issues confronting the court by drawing heavily from our writings in this area: Gregory Werden & Luke Froeb, Why Patent Hold-Up Does Not Violate Antitrust Law; Luke Froeb & Mikhael Shor, Innovators, Implementors and Two-sided Hold-up; Bernard Ganglmair, Luke Froeb & Gregory Werden, Patent Hold Up and Antitrust: How a Well-Intentioned Rule Could Retard Innovation.]

Not everything is “hold-up”

It is not uncommon—in fact it is expected—that parties to a negotiation would have different opinions about the reasonableness of any deal. Every buyer asks for a price as low as possible, and sellers naturally request prices at which buyers (feign to) balk. A recent movement among some lawyers and economists has been to label such disagreements in the context of standard-essential patents not as a natural part of bargaining, but as dispositive proof of “hold-up,” or the innovator’s purported abuse of newly gained market power to extort implementers. We have four primary issues with this hold-up fad.

First, such claims of “hold-up” are trotted out whenever an innovator’s royalty request offends the commentator’s sensibilities, and usually with reference to a theoretical hold-up possibility rather than any matter-specific evidence that hold-up is actually present. Second, as we have argued elsewhere, such arguments usually ignore the fact that implementers of innovations often possess significant countervailing power to “hold-out as well. This is especially true as implementers have successfully pushed to curtail injunctive relief in standard-essential patent cases. Third, as Greg Werden and Froeb have recently argued, it is not clear why patent holdup—even where it might exist—need implicate antitrust law rather than be adequately handled as a contractual dispute. Lastly, it is certainly not the case that every disagreement over the value of an innovation is an exercise in hold-up, as even economists and lawyers have not reached anything resembling a consensus on the correct interpretation of a “fair” royalty.

At the heart of this case (and many recent cases) is (1) an indictment of Qualcomm’s desire to charge royalties to the maker of consumer devices based on the value of its technology and (2) a lack (to the best of our knowledge from public documents) of well vetted theoretical models that can provide the underpinning for the theory of the case. We discuss these in turn.

The smallest component “principle”

In arguing that “Qualcomm’s royalties are disproportionately high relative to the value contributed by its patented inventions,” (Complaint, ¶ 77) a key issue is whether Qualcomm can calculate royalties as a percentage of the price of a device, rather than a small percentage of the price of a chip. (Complaint, ¶¶ 61-76).

So what is wrong with basing a royalty on the price of the final product? A fixed portion of the price is not a perfect proxy for the value of embedded intellectual property, but it is a reasonable first approximation, much like retailers use fixed markups for products rather than optimizing the price of each SKU if the cost of individual determinations negate any benefits to doing so. The FTC’s main issue appears to be that the price of a smartphone reflects “many features in addition to the cellular connectivity and associated voice and text capabilities provided by early feature phones.” (Complaint, ¶ 26). This completely misses the point. What would the value of an iPhone be if it contained all of those “many features” but without the phone’s communication abilities? We have some idea, as Apple has for years marketed its iPod Touch for a quarter of the price of its iPhone line. Yet, “[f]or most users, the choice between an iPhone 5s and an iPod touch will be a no-brainer: Being always connected is one of the key reasons anyone owns a smartphone.”

What the FTC and proponents of the smallest component principle miss is that some of the value of all components of a smartphone are derived directly from the phone’s communication ability. Smartphones didn’t initially replace small portable cameras because they were better at photography (in fact, smartphone cameras were and often continue to be much worse than devoted cameras). The value of a smartphone camera is that it combines picture taking with immediate sharing over text or through social media. Thus, unlike the FTC’s claim that most of the value of a smartphone comes from features that are not communication, many features on a smartphone derive much of their value from the communication powers of the phone.

In the alternative, what the FTC wants is for the royalty not to reflect the value of the intellectual property but instead to be a small portion of the cost of some chipset—akin to an author of a paperback negotiating royalties based on the cost of plain white paper. As a matter of economics, a single chipset royalty cannot allow an innovator to capture the value of its innovation. This, in turn, implies that innovators underinvest in future technologies. As we have previously written:

For example, imagine that the same component (incorporating the same essential patent) is used to help stabilize flight of both commercial airplanes and toy airplanes. Clearly, these industries are likely to have different values for the patent. By negotiating over a single royalty rate based on the component price, the innovator would either fail to realize the added value of its patent to commercial airlines, or (in the case that the component is targeted primary to the commercial airlines) would not realize the incremental market potential from the patent’s use in toy airplanes. In either case, the innovator will not be negotiating over the entirety of the value it creates, leading to too little innovation.

The role of economics

Modern antitrust practice is to use economic models to explain how one gets from the evidence presented in a case to an anticompetitive conclusion. As Froeb, et al. have discussed, by laying out a mapping from the evidence to the effects, the legal argument is made clear, and gains credibility because it becomes falsifiable. The FTC complaint hypothesizes that “Qualcomm has excluded competitors and harmed competition through a set of interrelated policies and practices.” (Complaint, ¶ 3). Although Qualcomm explains how each of these policies and practices, by themselves, have clear business justifications, the FTC claims that combining them leads to an anticompetitive outcome.

Without providing a formal mapping from the evidence to an effect, it becomes much more difficult for a court to determine whether the theory of harm is correct or how to weigh the evidence that feeds the conclusion. Without a model telling it “what matters, why it matters, and how much it matters,” it is much more difficult for a tribunal to evaluate the “interrelated policies and practices.” In previous work, we have modeled the bilateral bargaining between patentees and licensees and have shown that when bilateral patent contracts are subject to review by an antitrust court, bargaining in the shadow of such a court can reduce the incentive to invest and thereby reduce welfare.

Concluding policy thoughts

What the FTC makes sound nefarious seems like a simple policy: requiring companies to seek licenses to Qualcomm’s intellectual property independent of any hardware that those companies purchase, and basing the royalty of that intellectual property on (an admittedly crude measure of) the value the IP contributes to that product. High prices alone do not constitute harm to competition. The FTC must clearly explain why their complaint is not simply about the “fairness” of the outcome or its desire that Qualcomm employ different bargaining paradigms, but rather how Qualcomm’s behavior harms the process of competition.

In the late 1950s, Nobel Laureate Robert Solow attributed about seven-eighths of the growth in U.S. GDP to technical progress. As Solow later commented: “Adding a couple of tenths of a percentage point to the growth rate is an achievement that eventually dwarfs in welfare significance any of the standard goals of economic policy.” While he did not have antitrust in mind, the import of his comment is clear: whatever static gains antitrust litigation may achieve, they are likely dwarfed by the dynamic gains represented by innovation.

Patent law is designed to maintain a careful balance between the costs of short-term static losses and the benefits of long-term gains that result from new technology. The FTC should present a sound theoretical or empirical basis for believing that the proposed relief sufficiently rewards inventors and allows them to capture a reasonable share of the whole value their innovations bring to consumers, lest such antitrust intervention deter investments in innovation.

[TOTM: The following is the first in a series of posts by TOTM guests and authors on the FTC v. Qualcomm case, currently awaiting decision by Judge Lucy Koh in the Northern District of California. The entire series of posts is available here. This post originally appeared on the Federalist Society Blog.]

Just days before leaving office, the outgoing Obama FTC left what should have been an unwelcome parting gift for the incoming Commission: an antitrust suit against Qualcomm. This week the FTC — under a new Chairman and with an entirely new set of Commissioners — finished unwrapping its present, and rested its case in the trial begun earlier this month in FTC v Qualcomm.

This complex case is about an overreaching federal agency seeking to set prices and dictate the business model of one of the world’s most innovative technology companies. As soon-to-be Acting FTC Chairwoman, Maureen Ohlhausen, noted in her dissent from the FTC’s decision to bring the case, it is “an enforcement action based on a flawed legal theory… that lacks economic and evidentiary support…, and that, by its mere issuance, will undermine U.S. intellectual property rights… worldwide.”

Implicit in the FTC’s case is the assumption that Qualcomm charges smartphone makers “too much” for its wireless communications patents — patents that are essential to many smartphones. But, as former FTC and DOJ chief economist, Luke Froeb, puts it, “[n]othing is more alien to antitrust than enquiring into the reasonableness of prices.” Even if Qualcomm’s royalty rates could somehow be deemed “too high” (according to whom?), excessive pricing on its own is not an antitrust violation under U.S. law.

Knowing this, the FTC “dances around that essential element” (in Ohlhausen’s words) and offers instead a convoluted argument that Qualcomm’s business model is anticompetitive. Qualcomm both sells wireless communications chipsets used in mobile phones, as well as licenses the technology on which those chips rely. According to the complaint, by licensing its patents only to end-users (mobile device makers) instead of to chip makers further up the supply chain, Qualcomm is able to threaten to withhold the supply of its chipsets to its licensees and thereby extract onerous terms in its patent license agreements.

There are numerous problems with the FTC’s case. Most fundamental among them is the “no duh” problem: Of course Qualcomm conditions the purchase of its chips on the licensing of its intellectual property; how could it be any other way? The alternative would require Qualcomm to actually facilitate the violation of its property rights by forcing it to sell its chips to device makers even if they refuse its patent license terms. In that world, what device maker would ever agree to pay more than a pittance for a patent license? The likely outcome is that Qualcomm charges more for its chips to compensate (or simply stops making them). Great, the FTC says; then competitors can fill the gap and — voila: the market is more competitive, prices will actually fall, and consumers will reap the benefits.

Except it doesn’t work that way. As many economists, including both the current and a prominent former chief economist of the FTC, have demonstrated, forcing royalty rates lower in such situations is at least as likely to harm competition as to benefit it. There is no sound theoretical or empirical basis for concluding that using antitrust to move royalty rates closer to some theoretical ideal will actually increase consumer welfare. All it does for certain is undermine patent holders’ property rights, virtually ensuring there will be less innovation.

In fact, given this inescapable reality, it is unclear why the current Commission is continuing to pursue the case at all. The bottom line is that, if it wins the case, the current FTC will have done more to undermine intellectual property rights than any other administration’s Commission has been able to accomplish.

It is not difficult to identify the frailties of the case that would readily support the agency backing away from pursuing it further. To begin with, the claim that device makers cannot refuse Qualcomm’s terms because the company effectively controls the market’s supply of mobile broadband modem chips is fanciful. While it’s true that Qualcomm is the largest supplier of these chipsets, it’s an absurdity to claim that device makers have no alternatives. In fact, Qualcomm has faced stiff competition from some of the world’s other most successful companies since well before the FTC brought its case. Samsung — the largest maker of Android phones — developed its own chip to replace Qualcomm’s in 2015, for example. More recently, Intel has provided Apple with all of the chips for its 2018 iPhones, and Apple is rumored to be developing its own 5G cellular chips in-house. In any case, the fact that most device makers have preferred to use Qualcomm’s chips in the past says nothing about the ability of other firms to take business from it.

The possibility (and actuality) of entry from competitors like Intel ensures that sophisticated purchasers like Apple have bargaining leverage. Yet, ironically, the FTC points to Apple’s claimthat Qualcomm “forced” it to use Intel modems in its latest iPhones as evidence of Qualcomm’s dominance. Think about that: Qualcomm “forced” a company worth many times its own value to use a competitor’s chips in its new iPhones — and that shows Qualcomm has a stranglehold on the market?

The FTC implies that Qualcomm’s refusal to license its patents to competing chip makers means that competitors cannot reliably supply the market. Yet Qualcomm has never asserted its patents against a competing chip maker, every one of which uses Qualcomm’s technology without paying any royalties to do so. The FTC nevertheless paints the decision to license only to device makers as the aberrant choice of an exploitative, dominant firm. The reality, however, is that device-level licensing is the norm practiced by every company in the industry — and has been since the 1980s.

Not only that, but Qualcomm has not altered its licensing terms or practices since it was decidedly an upstart challenger in the market — indeed, since before it even started producing chips, and thus before it even had the supposed means to leverage its chip sales to extract anticompetitive licensing terms. It would be a remarkable coincidence if precisely the same licensing structure and the exact same royalty rate served the company’s interests both as a struggling startup and as an alleged rapacious monopolist. Yet that is the implication of the FTC’s theory.

When Qualcomm introduced CDMA technology to the mobile phone industry in 1989, it was a promising but unproven new technology in an industry dominated by different standards. Qualcomm happily encouraged chip makers to promote the standard by enabling them to produce compliant components without paying any royalties; and it willingly licensed its patents to device makers based on a percentage of sales of the handsets that incorporated CDMA chips. Qualcomm thus shared both the financial benefits and the financial risk associated with the development and sales of devices implementing its new technology.

Qualcomm’s favorable (to handset makers) licensing terms may have helped CDMA become one of the industry standards for 2G and 3G devices. But it’s an unsupportable assertion to say that those identical terms are suddenly the source of anticompetitive power, particularly as 2G and 3G are rapidly disappearing from the market and as competing patent holders gain prominence with each successive cellular technology standard.

To be sure, successful handset makers like Apple that sell their devices at a significant premium would prefer to share less of their revenue with Qualcomm. But their success was built in large part on Qualcomm’s technology. They may regret the terms of the deal that propelled CDMA technology to prominence, but Apple’s regret is not the basis of a sound antitrust case.

And although it’s unsurprising that manufacturers of premium handsets would like to use antitrust law to extract better terms from their negotiations with standard-essential patent holders, it is astonishing that the current FTC is carrying on the Obama FTC’s willingness to do it for them.

None of this means that Qualcomm is free to charge an unlimited price: standard-essential patents must be licensed on “FRAND” terms, meaning they must be fair, reasonable, and nondiscriminatory. It is difficult to asses what constitutes FRAND, but the most restrictive method is to estimate what negotiated terms would look like before a patent was incorporated into a standard. “[R]oyalties that are or would be negotiated ex ante with full information are a market bench-mark reflecting legitimate return to innovation,” writes Carl Shapiro, the FTC’s own economic expert in the case.

And that is precisely what happened here: We don’t have to guess what the pre-standard terms of trade would look like; we know them, because they are the same terms that Qualcomm offers now.

We don’t know exactly what the consequence would be for consumers, device makers, and competitors if Qualcomm were forced to accede to the FTC’s benighted vision of how the market should operate. But we do know that the market we actually have is thriving, with new entry at every level, enormous investment in R&D, and continuous technological advance. These aren’t generally the characteristics of a typical monopoly market. While the FTC’s effort to “fix” the market may help Apple and Samsung reap a larger share of the benefits, it will undoubtedly end up only hurting consumers.

Last week, Senator Orrin Hatch, Senator Thom Tillis, and Representative Bill Flores introduced the Hatch-Waxman Integrity Act of 2018 (HWIA) in both the Senate and the House of Representatives.  If enacted, the HWIA would help to ensure that the unbalanced inter partes review (IPR) process does not stifle innovation in the drug industry and jeopardize patients’ access to life-improving drugs.

Created under the America Invents Act of 2012, IPR is a new administrative pathway for challenging patents. It was, in large part, created to fix the problem of patent trolls in the IT industry; the trolls allegedly used questionable or “low quality” patents to extort profits from innovating companies.  IPR created an expedited pathway to challenge patents of dubious quality, thus making it easier for IT companies to invalidate low quality patents.

However, IPR is available for patents in any industry, not just the IT industry.  In the market for drugs, IPR offers an alternative to the litigation pathway that Congress created over three decades ago in the Hatch-Waxman Act. Although IPR seemingly fixed a problem that threatened innovation in the IT industry, it created a new problem that directly threatened innovation in the drug industry. I’ve previously published an article explaining why IPR jeopardizes drug innovation and consumers’ access to life-improving drugs. With Hatch-Waxman, Congress sought to achieve a delicate balance between stimulating innovation from brand drug companies, who hold patents, and facilitating market entry from generic drug companies, who challenge the patents.  However, IPR disrupts this balance as critical differences between IPR proceedings and Hatch-Waxman litigation clearly tilt the balance in the patent challengers’ favor. In fact, IPR has produced noticeably anti-patent results; patents are twice as likely to be found invalid in IPR challenges as they are in Hatch-Waxman litigation.

The Patent Trial and Appeal Board (PTAB) applies a lower standard of proof for invalidity in IPR proceedings than do federal courts in Hatch-Waxman proceedings. In federal court, patents are presumed valid and challengers must prove each patent claim invalid by “clear and convincing evidence.” In IPR proceedings, no such presumption of validity applies and challengers must only prove patent claims invalid by the “preponderance of the evidence.”

Moreover, whereas patent challengers in district court must establish sufficient Article III standing, IPR proceedings do not have a standing requirement.  This has given rise to “reverse patent trolling,” in which entities that are not litigation targets, or even participants in the same industry, threaten to file an IPR petition challenging the validity of a patent unless the patent holder agrees to specific pre-filing settlement demands.  The lack of a standing requirement has also led to the  exploitation of the IPR process by entities that would never be granted standing in traditional patent litigation—hedge funds betting against a company by filing an IPR challenge in hopes of crashing the stock and profiting from the bet.

Finally, patent owners are often forced into duplicative litigation in both IPR proceedings and federal court litigation, leading to persistent uncertainty about the validity of their patents.  Many patent challengers that are unsuccessful in invalidating a patent in district court may pursue subsequent IPR proceedings challenging the same patent, essentially giving patent challengers “two bites at the apple.”  And if the challenger prevails in the IPR proceedings (which is easier to do given the lower standard of proof), the PTAB’s decision to invalidate a patent can often “undo” a prior district court decision.  Further, although both district court judgments and PTAB decisions are appealable to the Federal Circuit, the court applies a more deferential standard of review to PTAB decisions, increasing the likelihood that they will be upheld compared to the district court decision.

The pro-challenger bias in IPR creates significant uncertainty for patent rights in the drug industry.  As an example, just last week patent claims for drugs generating $6.5 billion for drug company Sanofi were invalidated in an IPR proceeding.  Uncertain patent rights will lead to less innovation because drug companies will not spend the billions of dollars it typically costs to bring a new drug to market when they cannot be certain if the patents for that drug can withstand IPR proceedings that are clearly stacked against them.   And, if IPR causes drug innovation to decline, a significant body of research predicts that patients’ health outcomes will suffer as a result.

The HWIA, which applies only to the drug industry, is designed to return the balance established by Hatch-Waxman between branded drug innovators and generic drug challengers. It eliminates challengers’ ability to file duplicative claims in both federal court and through the IPR process. Instead, they must choose between either Hatch-Waxman litigation (which saves considerable costs by allowing generics to rely on the brand company’s safety and efficacy studies for FDA approval) and IPR (which is faster and provides certain pro-challenger provisions). In addition to eliminating generic challengers’ “second bite of the apple,” the HWIA would also eliminate the ability of hedge funds and similar entities to file IPR claims while shorting the stock.

Thus, if enacted, the HWIA would create incentives that reestablish Hatch-Waxman litigation as the standard pathway for generic challenges to brand patents.  Yet, it would preserve IPR proceedings as an option when speed of resolution is a primary concern.  Ultimately, it will restore balance to the drug industry to safeguard competition, innovation, and patients’ access to life-improving drugs.

An important but unheralded announcement was made on October 10, 2018: The European Committee for Standardization (CEN) and the European Committee for Electrotechnical Standardization (CENELEC) released a draft CEN CENELAC Workshop Agreement (CWA) on the licensing of Standard Essential Patents (SEPs) for 5G/Internet of Things (IoT) applications. The final agreement, due to be published in early 2019, is likely to have significant implications for the development and roll-out of both 5G and IoT applications.

CEN and CENELAC, which along with the European Telecommunications Standards Institute (ETSI) are the officially recognized standard setting bodies in Europe, are private international non profit organizations with a widespread network consisting of technical experts from industry, public administrations, associations, academia and societal organizations. This first Workshop brought together representatives of the 5G/Internet of Things (IoT) technology user and provider communities to discuss licensing best practices and recommendations for a code of conduct for licensing of SEPs. The aim was to produce a CWA that reflects and balances the needs of both communities.

The final consensus outcome of the Workshop will be published as a CEN-CENELEC Workshop Agreement (CWA). The draft, which is available for public comments, comprises principles and guidelines that prepare a foundation for future licensing of standard essential patents for fifth generation (5G) technologies. The draft also contains a section on Q&A to help aid new implementers and patent holders.

The IoT ecosystem is likely to have over 20 billion interconnected devices by 2020 and represent a market of $17 trillion (about the same as the current GDP of the U.S.). The data collected by one device, such as a smart thermostat that learns what time the consumer is likely to be at home, can be used to increase the performance of another connected device, such as a smart fridge. Cellular technologies are a core component of the IoT ecosystem, alongside applications, devices, software etc., as they provide connectivity within the IoT system. 5G technology, in particular, is expected to play a key role in complex IoT deployments, which will transcend the usage of cellular networks from smart phones to smart home appliances, autonomous vehicles, health care facilities etc. in what has been aptly described as the fourth industrial revolution.

Indeed, the role of 5G to IoT is so significant that the proposed $117 billion takeover bid for U.S. tech giant Qualcomm by Singapore-based Broadcom was blocked by President Trump, citing national security concerns. (A letter sent by the Committee on Foreign Investment in the US suggested that Broadcom might starve Qualcomm of investment, preventing it from competing effectively against foreign competitors–implicitly those in China.)

While commercial roll-out of 5G technology has not yet fully begun, several efforts are being made by innovator companies, standard setting bodies and governments to maximize the benefits from such deployment.

The draft CWA Guidelines (hereinafter “the guidelines”) are consistent with some of the recent jurisprudence on SEPs on various issues. While there is relatively less guidance specifically in relation to 5G SEPs, it provides clarifications on several aspects of SEP licensing which will be useful, particularly, the negotiating process and conduct of both parties.

The guidelines contain 6 principles followed by some questions pertaining to SEP licensing. The principles deal with:

  1. The obligation of SEP holders to license the SEPs on Fair, Reasonable and Non-Discriminatory (FRAND) terms;
  2. The obligation on both parties to conduct negotiations in good faith;
  3. The obligation of both parties to provide necessary information (subject to confidentiality) to facilitate timely conclusion of the licensing negotiation;
  4. Compensation that is “fair and reasonable” and achieves the right balance between incentives to contribute technology and the cost of accessing that technology;
  5. A non-discriminatory obligation on the SEP holder for similarly situated licensees even though they don’t need to be identical; and
  6. Recourse to a third party FRAND determination either by court or arbitration if the negotiations fail to conclude in a timely manner.

There are 22 questions and answers, as well, which define basic terms and touch on issues such as: what amounts as good faith conduct of negotiating parties, global portfolio licensing, FRAND royalty rates, patent pooling, dispute resolution, injunctions, and other issues relevant to FRAND licensing policy in general.

Below are some significant contributions that the draft report makes on issues such as the supply chain level at which licensing is best done, treatment of small and medium enterprises (SMEs), non disclosure agreements, good faith negotiations and alternative dispute resolution.

Typically in the IoT ecosystem, many technologies will be adopted of which several will be standardized. The guidelines offer help to product and service developers in this regard and suggest that one may need to obtain licenses from SEP owners for product or services incorporating communications technology like 3G UMTS, 4G LTE, Wi-Fi, NB-IoT, 31 Cat-M or video codecs such as H.264. The guidelines, however, clarify that with the deployment of IoT, licenses for several other standards may be needed and developers should be mindful of these complexities when starting out in order to avoid potential infringements.

Notably, the guidelines suggest that in order to simplify licensing, reduce costs for all parties and maintain a level playing field between licensees, SEP holders should license at one level. While this may vary between different industries, for communications technology, the licensing point is often at the end-user equipment level. There has been a fair bit of debate on this issue and the recent order by Judge Koh granting FTC’s partial summary motion deals with some of this.

In the judgment delivered on November 6, Judge Koh relied primarily on the 9th circuit decisions in Microsoft v Motorola (2012 and 2015)  to rule on the core issue of the scope of the FRAND commitments–specifically on the question of whether licensing extends to all levels or is confined to the end device level. The court interpreted the pro- competitive principles behind the non-discrimination requirement to mean that such commitments are “sweeping” and essentially that an SEP holder has to license to anyone willing to offer a FRAND rate globally. It also cited Ericsson v D-Link, where the Federal Circuit held that “compliant devices necessarily infringe certain claims in patents that cover technology incorporated into the standard and so practice of the standard is impossible without licenses to all incorporated SEP technology.”

The guidelines speak about the importance of non-disclosure agreements (NDAs) in such licensing agreements given that some of the information exchanged between parties during negotiation, such as claim charts etc., may be sensitive and confidential. Therefore, an undue delay in agreeing to an NDA, without well-founded reasons, might be taken as evidence of a lack of good faith in negotiations rendering such a licensee as unwilling.

They also provide quite a boost for small and medium enterprises (SMEs) in licensing negotiations by addressing the duty of SEP owners to be mindful of SMEs that may be less experienced and therefore lack information from which to draw assurance that proposed terms are FRAND. The guidelines provide that SEP owners should provide whatever information they can under NDA to help the negotiation process. Equally, the same obligation applies on a licensee who is more experienced in dealing with a SEP owner who is an SME.

There is some clarity on time frames for negotiations and the guidelines provide a maximum time that parties should take to respond to offers and counter offers, which could extend up to several months in complex cases involving hundreds of patents. The guidelines also prescribe conduct of potential licensees on receiving an offer and how to make counter-offers in a timely manner.

Furthermore, the guidelines lay down the various ways in which royalty rates may be structured and clarify that there is no one fixed way in which this may be done. Similarly, they offer myriad ways in which potential licensees may be able to determine for themselves if the rates offered to them are fair and reasonable, such as third party patent landscape reports, public announcements, expert advice etc.

Finally, in the case that a negotiation reaches an impasse, the guidelines endorse an alternative dispute mechanism such as mediation or arbitration for the parties to resolve the issue. Bodies such as International Chamber of Commerce and World Intellectual Property Organization may provide useful platforms in this regard.

Almost 20 years have passed since technology pioneer Kevin Ashton first coined the phrase Internet of Things. While companies are gearing up to participate in the market of IoT, regulation and policy in the IoT world seems far from a predictable framework to follow. There are a lot of guesses about how rules and standards are likely to shape up, with little or no guidance for companies on how to prepare themselves for what faces them very soon. Therefore concrete efforts such as these are rather welcome. The draft guidelines do attempt to offer some much needed clarity and are now open for public comments due by December 13. It will be good to see what the final CWA report on licensing of SEPs for 5G and IoT looks like.

 

Last week, the UK Court of Appeal upheld the findings of the High Court in an important case regarding standard essential patents (SEPs). Of particular significance, the Court of Appeal upheld the finding that the defendant, an implementer of SEPs, could have the sale of its products enjoined in the UK unless it enters into a global licensing deal on terms deemed by the court to be fair, reasonable and non-discriminatory (FRAND). The case is noteworthy not least because the threat of an injunction of this sort has become increasingly rare in other jurisdictions, arguably resulting in an imbalance in bargaining power between patent holders and implementers.

The case concerned patents held by Unwired Planet (most of which had been purchased from Ericsson) that it had declared to be essential to the operation of various telecommunications standards. Chinese telecom giant Huawei had incorporated these patented technologies in its products but disputed the legitimacy of Unwired Planet’s (UP) patents and refused to license them on the terms that were offered.

By way of a background to the case, in March 2014, UP resorted to suing Huawei, Samsung and Google and claiming an injunction when it found it hard to secure licenses. After the commencement of proceedings, UP made licence offers to the defendants. It made offers in April and July 2014 respectively and during the proceedings, including a worldwide SEP portfolio licence, a UK SEP portfolio licence and per-patent licences for any of the SEPs in suit. The defendants argued that the offers were not FRAND. Huawei and Samsung also contended that the offers were in breach of European competition law. UP  settled with Google. Three technical trials of the patents began and UP was able to show that at least two of the patents sued upon were valid and essential and had been infringed. Subsequently, Samsung secured a settlement (at a rate below the market rate) and the FRAND trial went ahead with just Huawei.

Judge Birss delivered the High Court order on April 5, 2017. He held that UP’s patents were valid and infringed and it did not abuse its dominant position by requesting an injunction. He ordered a FRAND injunction that was stayed pending appeal against the two patents that had been infringed. The injunction was subject to a number of conditions which are applied because the case was dealing with patents subject to a FRAND undertaking. It will cease to have effect if Huawei enters into the FRAND license determined by the Court. He also observed that the parties can return for further determination when such license expires. Furthermore, it was held that there was one set of FRAND terms and that the scope of this FRAND was world wide.

The UK Court of Appeal (the bench consisting of Lord Justice Kitchin, Lord Justice Floyd, Lady Justice Asplin) in handing down a 291 paragraph, 66 page judgment dealing with Huawei’s appeal, upheld Birss’ findings. The centrality of Huawei’s appeal focused on the global nature of the FRAND license and the non-discrimination undertaking of UP’s FRAND commitments. Some significant findings of the Court of Appeal are briefly provided below.

The Court of Appeal in upholding Birss’ decision noted that it was unfair to say that UP is using the threat of an injunction to leverage Huawei into taking a global license, and that Huawei had the option to take the global license or submit to an injunction in the UK. Drawing attention to the potential complexities in a FRAND negotiation, the Court observed:

..The owner of a SEP may still use the threat of an injunction to try to secure the payment of excessive licence fees and so engage in hold-up activities. Conversely, the infringer may refuse to engage constructively or behave unreasonably in the negotiation process and so avoid paying the licence fees to which the SEP owner is properly entitled, a process known as “hold-out”.

Furthermore, Huawei argues that imposition of a global license on terms set by a national court based on a national finding of infringement is wrong in principle. It also states that there is currently an ongoing patent litigation in both Germany and China and that there are some countries where UP holds “no relevant” patents at all.

In response to these contentions, the Court of Appeal has held that it may be highly impractical for a SEP owner to seek to negotiate a license of its patent rights in each country and rejected the submission made by Huawei that the approach adopted by Birss in these proceedings is out of line with the territorial nature of patent litigations. It clarified that Birss did not adjudicate on issues of infringement or validity concerning foreign SEPs and did not usurp the rights of foreign courts. It further observed that such an approach of Birss  is consistent with the Council and the European Economic and Social Committee dated 29 November 2017 (COM (2017) 712 final) (“the November 2017 EU Communication”) which notes in section 2.4:

For products with a global circulation, SEP licences granted on a worldwide basis may contribute to a more efficient approach and therefore can be compatible with FRAND.

The Court of Appeal however disagreed with Birss on the issue that there was only one set of FRAND terms. This view of the bench certainly comes as a relief since it seems to appropriately reflect the practical realities of a FRAND negotiation. The Court held:

Patent licences are complex and, having regard to the commercial priorities of the participating undertakings and the experience and preferences of the individuals involved, may be structured in different ways in terms of, for example, the particular contracting parties, the rights to be included in the licence, the geographical scope of the licence, the products to be licensed, royalty rates and how they are to be assessed, and payment terms. Further, concepts such as fairness and reasonableness do not sit easily with such a rigid approach.

Similarly, on the non- discrimination prong of FRAND, the Court of Appeal agreed with Birss that it was not “hard-edged” and the test is whether such difference in rates distorts competition between the licensees. It also noted that the “hard-edged” interpretation would be “akin to the re-insertion of a “most favoured licensee” clause in the FRAND undertaking” which does not seem to be what the standards body, European Telecommunications Standards Institute (ETSI) had in mind when it formulated its policies. The Court also held :

We consider that a non-discrimination rule has the potential to harm the technological development of standards if it has the effect of compelling the SEP owner to accept a level of compensation for the use of its invention which does not reflect the value of the licensed technology.

Finally, the Court of Appeal held that UP did not abuse its dominant position just because it failed to strictly comply with the safe harbor framework laid down by Court of Justice of the European Union in Huawei v. ZTE. The only requirement that must be satisfied before proceedings are commenced by the SEP holder is that the SEP holder give sufficient notice to or consult with the implementer.

The Court of Appeal’s decision offers some significant guidance to the emerging policy debate on FRAND. As mentioned at the beginning of this post, the decision is significant particularly for the reason that UP is one of a total of two cases in the last two years, where an injunctive relief has been granted in instances involving standard essential patents. Such reliefs have been rarely granted in years in the first place. The second such instance of a grant of injunction pertains to Huawei v. Samsung where the Shenzhen Court in China held earlier this year that Huawei met the FRAND obligation while Samsung did not (negotiations were dragged on for 6 years). An injunction was granted against Samsung for infringing two of Huawei’s Chinese patents which are counterparts of two U.S. asserted patents (however Judge Orrick of the U.S. District Court for the Northern District of California enjoined Huawei from enforcing the injunction).

Current jurisprudence on injunctive relief with respect to FRAND encumbered SEPs is that there is no per se ban on these reliefs. However, courts have been very reluctant to actually grant them. While injunctions are statutory remedies, and granted automatically in most cases when a patent is found to be infringed, administrative agencies and courts have held a position that shows that FRAND commitments certainly limit this premise.

Following the eBay decision in the U.S., defendants in infringement claims involving SEPs have argued that permanent injunctions should not be available for FRAND-encumbered SEPs and were upheld in cases such as Apple v. Motorola in 2014 (where Judge Randall Radar also makes a sound case for evidence of a hold out by Apple in his dissenting order). However, in an institutional bargaining framework of FRAND, which is based on a mutuality of considerations, such a recourse is misplaced and likely to inevitably disturb this balance. The current narrative on FRAND that dominates policymaking and jurisprudence is incomplete in its unilateral focus of avoiding the possible problem of a patent hold up in the absence of concrete evidence indicating its probability. In Ericsson v D-Links Judge Davis of the US Court of Appeals for the Federal Circuit underscored this point when he observed that “if an accused infringer wants an instruction on patent hold-up and royalty stacking [to be given to the jury], it must provide evidence on the record of patent hold-up and royalty stacking.”

Remedies emanating from a one sided perspective tilt the bargaining dynamic in favour of implementers and if the worst penalty a SEP infringer has to pay is the FRAND royalty it would have otherwise paid beforehand, then a hold out or a reverse hold up by implementers becomes a very profitable strategy. Remedies for patent infringement cannot be ignored because they are also core to the framework for licensing negotiations and ensuring compliance by licensees. A disproportionate reliance on liability rules over property rights is likely to exacerbate the countervailing problem of hold out and detrimentally impact incentives to innovate, ultimately undermining the welfare goals that such enforcement seeks to achieve.

The Court of Appeal has therefore given valuable guidance in its decision when it noted:

Just as implementers need protection, so too do the SEP owners. They are entitled to an appropriate reward for carrying out their research and development activities and for engaging with the standardization process, and they must be able to prevent technology users from free-riding on their innovations. It is therefore important that implementers engage constructively in any FRAND negotiation and, where necessary, agree to submit to the outcome of an appropriate FRAND determination.

Hopefully this order brings with it some balance in FRAND negotiations as well as a shift in the perspective of courts in how they adjudicate on these litigations. It underscores an oft forgotten principle that is core to the FRAND framework- that FRAND is a two-way street, as was observed in the celebrated case of Huawei v. ZTE in 2015.

On Monday, the U.S. Federal Trade Commission and Qualcomm reportedly requested a 30 day delay to a preliminary ruling in their ongoing dispute over the terms of Qualcomm’s licensing agreements–indicating that they may seek a settlement. The dispute raises important issues regarding the scope of so-called FRAND (“fair reasonable and non-discriminatory”) commitments in the context of standards setting bodies and whether these obligations extend to component level licensing in the absence of an express agreement to do so.

At issue is the FTC’s allegation that Qualcomm has been engaging in “exclusionary conduct” that harms its competitors. Underpinning this allegation is the FTC’s claim that Qualcomm’s voluntary contracts with two American standards bodies imply that Qualcomm is obliged to license on the same terms to rival chip makers. In this post, we examine the allegation and the claim upon which it rests.

The recently requested delay relates to a motion for partial summary judgment filed by the FTC on August 30, 2018–about which more below. But the dispute itself stretches back to January 17, 2017, when the FTC filed for a permanent injunction against Qualcomm Inc. for engaging in unfair methods of competition in violation of Section 5(a) of the FTC Act. FTC’s major claims against Qualcomm were as follows:

  • It has been engaging in “exclusionary conduct”  that taxes its competitors’ baseband processor sales, reduces competitors’ ability and incentives to innovate, and raises the prices to be paid by end consumers for cellphones and tablets.  
  • Qualcomm is causing considerable harm to competition and consumers through its “no license, no chips” policy; its refusal to license to its chipset-maker rivals; and its exclusive deals with Apple.
  • The above practices allow Qualcomm to abuse its dominant position in the supply of CDMA and premium LTE modem chips.
  • Given that Qualcomm has made a commitment to standard setting bodies to license these patents on FRAND terms, such behaviour qualifies as a breach of FRAND.

The complaint was filed on the eve of the new presidential administration, when only three of the five commissioners were in place. Moreover, the Commissioners were not unanimous. Commissioner Ohlhausen delivered a dissenting statement in which she argued:

[T]here is no robust economic evidence of exclusion and anticompetitive effects, either as to the complaint’s core “taxation” theory or to associated allegations like exclusive dealing. Instead the Commission speaks about a possibility that less than supports a vague standalone action under a Section 5 FTC claim.

Qualcomm filed a motion to dismiss on April 3, 2017. This was denied by the U.S. District Court for the Northern District of California. The court  found that the FTC has adequately alleged that Qualcomm’s conduct violates § 1 and § 2 of the Sherman Act and that it had entered into exclusive dealing arrangements with Apple. Thus, the court asserted, the FTC has adequately stated a claim under § 5 of the FTCA.

It is important to note that the core of the FTC’s arguments regarding Qualcomm’s abuse of dominant position rests on how it adopts the “no license, no chip” policy and thus breaches its FRAND obligations. However, it falls short of proving how the royalties charged by Qualcomm to OEMs exceeds the FRAND rates actually amounting to a breach, and qualifies as what FTC defines as a “tax” under the price squeeze theory that it puts forth.

(The Court did not go into whether there was a violation of § 5 of the FTC independent of a Sherman Act violation. Had it done so, this would have added more clarity to Section 5 claims, which are increasingly being invoked in antitrust cases even though its scope remains quite amorphous.)

On August 30, the FTC filed a partial summary judgement motion in relation to claims on the applicability of local California contract laws. This would leave antitrust issues to be decided in the subsequent hearing, which is set for January next year.

In a well-reasoned submission, the FTC asserts that Qualcomm is bound by voluntary agreements that it signed with two U.S. based standards development organisations (SDOs):

  1. The Telecommunications Industry Association (TIA) and
  2. The Alliance for Telecommunications Industry Solutions (ATIS).

These agreements extend to Qualcomm’s standard essential patents (SEPs) on CDMA, UMTS and LTE wireless technologies. Under these contracts, Qualcomm is obligated to license its SEPs to all applicants implementing these standards on FRAND terms.

The FTC asserts that this obligation should be interpreted to extend to Qualcomm’s rival modem chip manufacturers and sellers. It requests the Court to therefore grant a summary judgment since there are no disputed facts on such obligation. It submits that this should “streamline the trial by obviating the need for  extrinsic evidence regarding the meaning of Qualcomm’s commitments on the requirement to license to competitors, to ETSI, a third SDO.”

A review of a heavily redacted filing by FTC and a subsequent response by Qualcomm indicates that questions of fact and law continue to remain as regards Qualcomm’s licensing commitments and their scope. Thus, contrary to the FTC’s assertions, extrinsic evidence is still needed for resolution to some of the questions raised by the parties.

Indeed, the evidence produced by both parties points towards the need for resolution of ambiguities in the contractual agreements that Qualcomm has signed with ATIS and TIA. The scope and purpose of these licensing obligations lie at the core of the motion.

The IP licensing policies of the two SDOs provide for licensing of relevant patents to all applicants who implement these standards on FRAND terms. However, the key issues are whether components such as modem chips can be said to implement standards and whether component level licensing falls within this ambit. Yet, the resolution to these key issues, is unclear.

Qualcomm explains that commitments to ATIS and TIA do not require licenses to be made available for modem chips because modem chips do not implement or practice cellular standards and that standards do not define the operation of modem chips.

In contrast, the complaint by FTC raises the question of whether FRAND commitments extend to licensing at all levels. Different components needed for a device come together to facilitate the adoption and implementation of a standard. However, it does not logically follow that each individual component of the device separately practices or implements that standard even though it contributes to the implementation. While a single component may fully implement a standard, this need not always be the case.

These distinctions are significant from the point of interpreting the scope of the FRAND promise, which is commonly understood to extend to licensing of technologies incorporated in a standard to potential users of the standard. Understanding the meaning of a “user” becomes critical here and Qualcomm’s submission draws attention to this.

An important factor in the determination of a “user” of a particular standard is the extent to which the standard is practiced or implemented therein. Some standards development organisations (SDOs) have addressed this in their policies by clarifying that FRAND obligations extend to those “wholly compliant” or “fully conforming” to the specific standards. Clause 6.1 of the ETSI IPR Policy, clarifies that a patent holder’s obligation to make licenses available is limited to “methods” and “equipments”. It defines an equipment as “a system or device fully conforming to a standard.” And methods as “any method or operation fully conforming to a standard.”

It is noteworthy that the American National Standards Institute’s (ANSI) Executive Standards Council Appeals Panel in a decision has said that there is no agreement on the definition of the phrase “wholly compliant implementation.”  

Device level licensing is the prevailing industry wide practice by companies like Ericsson, InterDigital, Nokia and others. In November 2017, the European Commission issued guidelines on licensing of SEPs and took a balanced approach on this issue by not prescribing component level licensing in its guidelines.

The former director general of ETSI, Karl Rosenbrock, adopts a contrary view, explaining ETSI’s policy, “allows every company that requests a license to obtain one, regardless of where the prospective licensee is in the chain of production and regardless of whether the prospective licensee is active upstream or downstream.”

Dr. Bertram Huber, a legal expert who personally participated in the drafting of the IPR policy of ETSI, wrote a response to Rosenbrock, in which he explains that ETSI’s IPR policies required licensing obligations for systems “fully conforming” to the standard:

[O]nce a commitment is given to license on FRAND terms, it does not necessarily extend to chipsets and other electronic components of standards-compliant end-devices. He highlights how, in adopting its IPR Policy, ETSI intended to safeguard access to the cellular standards without changing the prevailing industry practice of manufacturers of complete end-devices concluding licenses to the standard essential patents practiced in those end-devices.

Both ATIS and TIA are organizational partners of a collaboration called 3rd Generation Partnership Project along with ETSI and four other SDOs who work on development of cellular technologies. TIA and ATIS are both accredited by ANSI. Therefore, these SDOs are likely to impact one another with the policies each one adopts. In the absence of definitive guidance on interpretation of the IPR policy and contractual terms within the institutional mechanism of ATIS and TIA, at the very least, clarity is needed on the ambit of these policies with respect to component level licensing.

The non-discrimination obligation, which as per FTC, mandates Qualcomm to license to its competitors who manufacture and sell chips, would be limited by the scope of the IPR policy and contractual agreements that bind Qualcomm and depends upon the specific SDO’s policy.  As discussed, the policies of ATIS and TIA are unclear on this.

In conclusion, FTC’s filing does not obviate the need to hear extrinsic evidence on what Qualcomm’s commitments to the ETSI mean. Given the ambiguities in the policies and agreements of ATIS and TIA on whether they include component level licensing or whether the modem chips in their entirety can be said to practice the standard, it would be incorrect to say that there is no genuine dispute of fact (and law) in this instance.

On November 27, the U.S. Supreme Court will turn once again to patent law, hearing cases addressing the constitutionality of Patent Trial and Appeal Board (PTAB) “inter partes” review (Oil States Energy v. Greene), and whether PTAB must issue a final written decision as to every claim challenged by the petitioner in an inter partes review (SAS Institute v. Matal).

As the Justices peruse the bench memos and amicus curiae briefs concerning these cases, their minds will, of course, be focused on legal questions of statutory and constitutional interpretation.  Lurking in the background of these and other patent cases, however, is an overarching economic policy issue – have recent statutory changes and case law interpretations weakened U.S. patent protection in a manner that seriously threatens future American economic growth and innovation?  In a recent Heritage Foundation Legal Memorandum, I responded in the affirmative to this question, and argued that significant statutory reforms are needed to restore the American patent system to a position of global leadership that is key to U.S. economic prosperity.  (Among other things, I noted severe constitutional problems raised by PTAB’s actions, and urged that Congress consider passing legislation to reform PTAB, if the Supreme Court upholds the constitutionality of inter partes review.)

A timely opinion article published yesterday in the Wall Street Journal emphasizes that the decline in American patent protection also has profound negative consequences for American international economic competitiveness.  Journalist David Kline, author of the commentary (“Fear American Complacency, Not China”), succinctly contrasts unfortunate U.S. patent policy developments with the recent strengthening of the Chinese patent system (a matter of high priority to the Chinese Government):

China’s entrepreneurs have been fueled by reforms in recent years that strengthened intellectual property rights—ironic for a country long accused of stealing trade secrets and ignoring IP protections. Today Chinese companies are filing for more patents than American ones. The patent application and examination process has been streamlined, and China has established specialized intellectual property courts and tribunals to adjudicate lawsuits and issue injunctions against infringers. “IP infringers will pay a heavy price,” President Xi Jinping warned this summer. . . .

In the U.S., by contrast, a series of legislative actions and Supreme Court rulings have weakened patent rights, especially for startups. A new way of challenging patents called “inter partes review” results in at least one patent claim being thrown out in roughly 80% of cases, according to an analysis by Adam Mossoff, a law professor at George Mason University. Unsurprisingly, many of these cases were brought by defendants facing patent infringement lawsuits in federal court.

This does not bode well for America’s global competitiveness. The U.S. used to rank first among nations in the strength of its intellectual property rights. But the 2017 edition of the Global IP Index places the U.S. 10th—tied with Hungary.

The Supreme Court may not be able to take judicial notice of this policy reality (although strong purely legal arguments would support a holding that PTAB inter partes review is unconstitutional), but Congress certainly can take legislative notice of it.  Let us hope that Congress acts decisively to strengthen the American patent system – in the interests of a strong, innovative, and internationally competitive American economy.

It’s been six weeks since drug maker Allergan announced that it had assigned to the Saint Regis Mohawk Tribe the patents on Restasis, an Allergan drug challenged both in IPR proceedings and in Hatch-Waxman proceedings in federal district court.  The unorthodox agreement was intended to shield the patents from IPR proceedings (and thus restrict the challenge to district court) as the Mohawks would seek to dismiss the IPR proceedings based on the tribe’s sovereign immunity.  Although Allergan  suffered a setback last week when the federal court invalidated the Restasis patents and, in dicta, expressed concern about the Allergan/Mohawk arrangement, several other entities are following Allergan’s lead and assigning patents to sovereigns in hopes of avoiding IPR proceedings.

As an example, in August, SRC Labs assigned about 40 computer technology patents to the Saint Regis Mohawk Tribe.  Last week, the tribe, with SRC as co-plaintiff, filed lawsuits against Microsoft and Amazon for infringement of its data processing patents; the assignment of the SRC patents to the tribe could prevent a counter-challenge from Microsoft and Amazon in IPR proceedings.  Similarly, Prowire LLC, who has sued Apple for infringement, has assigned the patent in question to MEC Resources, a company affiliated with three tribes in North Dakota.  And state universities (whom the PTAB considers to be arms of the sovereign states, and thus immune to IPR challenges) are in discussions with lawyers about offering their sovereign immunity to patent owners as a way to shield patents in IPR proceedings.

These arrangements that attempt to avoid the IPR process and force patent challenges into federal courts are no surprise given the current unbalance in the IPR system.  Critical differences exist between IPR proceedings and Hatch-Waxman litigation that have created a significant deviation in patent invalidation rates under the two pathways; compared to district court challenges, patents are twice as likely to be found invalid in IPR challenges.

The PTAB applies a lower standard of proof for invalidity in IPR proceedings than do federal courts in Hatch-Waxman proceedings. In federal court, patents are presumed valid and challengers must prove each patent claim invalid by “clear and convincing evidence.” In IPR proceedings, no such presumption of validity applies and challengers must only prove patent claims invalid by the “preponderance of the evidence.” In addition to the lower burden, it is also easier for challengers to meet the standard of proof in IPR proceedings.  In federal court, patent claims are construed according to their “ordinary and customary meaning” to a person of ordinary skill in the art.  In contrast, the PTAB uses the more lenient “broadest reasonable interpretation” standard; this more lenient standard can result in the PTAB interpreting patent claims as “claiming too much” (using their broader standard), resulting in the invalidation of more patents.

Moreover, whereas patent challengers in district court must establish sufficient Article III standing, IPR proceedings do not have a standing requirement.  This has given rise to “reverse patent trolling,” in which entities that are not litigation targets, or even participants in the same industry, threaten to file an IPR petition challenging the validity of a patent unless the patent holder agrees to specific pre-filing settlement demands.  The lack of a standing requirement has also led to the  exploitation of the IPR process by entities that would never be granted standing in traditional patent litigation—hedge funds betting against a company by filing an IPR challenge in hopes of crashing the stock and profiting from the bet.

Finally, patent owners are often forced into duplicative litigation in both IPR proceedings and federal court litigation, leading to persistent uncertainty about the validity of their patents.  Many patent challengers that are unsuccessful in invalidating a patent in district court may pursue subsequent IPR proceedings challenging the same patent, essentially giving patent challengers “two bites at the apple.”  And if the challenger prevails in the IPR proceedings (which is easier to do given the lower standard of proof and broader claim construction standard), the PTAB’s decision to invalidate a patent can often “undo” a prior district court decision.  Further, although both district court judgments and PTAB decisions are appealable to the Federal Circuit, the court applies a more deferential standard of review to PTAB decisions, increasing the likelihood that they will be upheld compared to the district court decision.

Courts are increasingly recognizing that certain PTAB practices are biased against patent owners, and, in some cases, violations of underlying law.  The U.S. Supreme Court in Cuozzo Speed Technologies v. Lee concluded that the broadest reasonable interpretation claim construction standard in IPR “increases the possibility that the examiner will find the claim too broad (and deny it)” and that the different claim construction standards in PTAB trials and federal court “may produce inconsistent results and cause added confusion.”  However, the Court concluded that only Congress could mandate a different standard.  Earlier this month, in Aqua Products, Inc. v. Matal, the Federal Circuit held that “[d]espite repeated recognition of the importance of the patent owner’s right to amend [patent claims] during IPR proceedings— by Congress, courts, and the PTO alike—patent owners largely have been prevented from amending claims in the context of IPRs.”   And the Supreme Court has agreed to hear Oil States Energy Services v. Greene’s Energy Group, which questions whether IPR proceedings are even constitutional because they extinguish private property rights through a non-Article III forum without a jury. 

As Courts and lawmakers continue to question the legality and wisdom of IPR to review pharmaceutical patents, they should remember that the relationship between drug companies and patients resembles a social contract. Under this social contract, patients have the right to reasonably-priced, innovative drugs and sufficient access to alternative drug choices, while drug companies have the right to earn profits that compensate for the risk inherent in developing new products and to a stable environment that gives the companies the incentive and ability to innovate.  This social contract requires a balancing of prices (not too high to gouge consumers but not too low to insufficiently compensate drug companies), competition law (not so lenient that it ignores anticompetitive behavior that restricts patients’ access to alternative drugs, but not so strict that it prevents companies from intensely competing for profits), and most importantly in the context of IPR, patent law (not so weak that it fails to incentivize innovation and drug development, but not so strong that it enables drug companies to monopolize the market for an unreasonable amount of time).  The unbalanced IPR process threatens this balance by creating significant uncertainty in pharmaceutical intellectual property rights.  Uncertain patent rights will lead to less innovation in the pharmaceutical industry because drug companies will not spend the billions of dollars it typically costs to bring a new drug to market when they cannot be certain if the patents for that drug can withstand IPR proceedings that are clearly stacked against them.  Indeed, last week former Federal Circuit Chief Judge Paul Redmond Michel acknowledged that IPR has contributed to “hobbling” our nation’s patent system, “discourag[ing] investment, R&D and commercialization.” And if IPR causes drug innovation to decline, a significant body of research predicts that consumers’ health outcomes will suffer as a result.

In her distinguished tenure as a Commissioner and as Acting Chairman of the FTC, Maureen Ohlhausen has done an outstanding job in explaining the tie between robust patent protection and economic growth and innovation (see, for example, her Harvard Journal of Law and Technology article, here).  Her latest public pronouncement on this topic, an October 13 speech entitled “Strong Patent Rights, Strong Economy,” also makes a highly valuable contribution to the patent policy debate.  Ohlhausen’s speech centers on two key points:  “First, strong patent rights are crucial to economic success.  And, second, economically grounded analysis will reveal the right path through thickets of IP [intellectual property] skepticism.”  Ohlhausen concludes with a reaffirmation of the importance of having the United States lead by example on the world stage in defending strong patent rights:

Patents have been at the heart of US innovation since the founding of our country, and respect for patent rights is fundamental to advance innovation.  The United States is more technologically innovative than any other country in the world.  This reality reflects, in part, the property rights that the United States government grants to inventors.  Still, foreign counterparts take or allow the taking of American proprietary technologies without due payment.  For example, emerging competition regimes view “unfairly high royalties” as illegal under antitrust law.  The FTC’s recent policy work offers an important counterweight to this approach, illustrating the important role that patents play in promoting innovation and benefiting consumers.     

In closing, while we may live in an age of patent skepticism, there is hope. Criticism of IP rights frequently does not hold up upon closer examination. Rather, empirical research favors the close tie between strong IP rights and R&D.  This is not to say that changes to the patent system are always unwarranted.  Rather, the key to addressing the U.S. patent system lies in incremental adjustment where necessary based on a firm empirical foundation.  The U.S. economy stands as a shining reminder of everything that American innovation policy has achieved – and intellectual property rights, and patents, are the important cornerstones of those achievements.

Ohlhausen’s remarks are, as always, thoughtful and well worth studying.