Cross-Licenses, Royalty Stacking, and Patent Disputes

While the majority of U.S. patent litigation is now NPE litigation (and has been since at least 2009), litigation between operating companies continues to occur at roughly the same rate as it has for the past 20 years.  (So much for the idea that IPR or eBay destroyed the ability for patent owners to enforce their intellectual property.)

These two categories of litigation are often fundamentally different, occurring for completely different reasons.  For every Smartphone War, there are dozens of cases that are fundamentally about getting a competitor to pay a little more for the license they were probably already discussing taking.  That’s true in cellular technology, but it’s true in a lot of other areas as well, ranging from semiconductor manufacturing to automotive to digital video.  It’s relatively rare for an operating company to file a lawsuit without discussing the possibility of a license first—after all, patent litigation is expensive and if you can avoid it, why wouldn’t you?  (This is also why large companies employ entire teams of people whose sole job is to make deals to license patents—at least, once they’re aware those patents exist and have a chance to evaluate infringement.)

But there are a couple of considerations that can make it hard to get to an agreement as to that license. These considerations can result in litigation being filed—and often quickly settled after the parties refocus on negotiations, realizing that they’d far rather have a deal than spend tens of millions on protracted patent litigation.

Cross-Licenses

One such issue is cross-licensing.  Typically, operating company settlements include a cross-license of relevant patents to each other.  There’s no reason for us to come to a deal on your patents, with me paying you $15 million, if we’re just going to turn around and have you pay me $25 million for the patents you need to license from me.  It’s far more desirable for both sides to figure out a deal where they both benefit, often including the technical knowledge that’s just as valuable as (or even more valuable than) the raw patent license.  

But while cross-licenses are more desirable, they’re also more complicated to achieve.  Determining the value of one patent is a complex process—trying to determine the relative value of hundreds of patents in a cross-licensing deal is far more so.  Each side can kick the tires on each patent (or, for large portfolios, on a proxy subset of patents), checking if the patent is valid, if their own products actually use the patent—and even if the other side actually owns the patent.  (Sometimes they don’t, even though they thought they did.) Each of these factors can change the perceived value of the license—and of course, other non-patent considerations like integrating the products of the two sides or the financial health of each party can impact willingness to pay as well. 

All of this can lead to disagreements on the value each side brings to the table, which in turn can make it difficult to reach a settlement.

Royalty Stacking

Another issue is royalty stacking.  When you have a complex multi-component product it could potentially require licensing hundreds or thousands of patents.  Smartphones might implicate more than 250,000 patents.  And if each licensee asks for 1% of the sales price, you can very quickly wind up paying more for licenses than you’ll make from the product—at which point you just don’t make the product.  That’s the essence of the royalty stacking problem.

One analysis, examining the royalty stack problem for smartphones, arrived at an estimate of more than $120 in patent royalties for a $400 smartphone.  Each licensee, individually, might only receive $0.50 or $1.00 or $9.00 per phone—but, when summed up, the licenses approach the cost of the hardware.  That situation recurs in many consumer products—for example, consumer audio-visual devices may need to license Wi-Fi patents, A/V codecs, user interface patents, and other features, all of which can add up quickly on a $50 or $100 device.

Effectively, the royalty stacking problem is a species of tragedy of the commons.  Licensors are incentivized to extract the highest possible royalty from the manufacturer, but if every licensor does so, they run the risk of the product becoming unprofitable and the manufacturer ceasing to manufacture it.  Even worse, licensors generally don’t have knowledge of the total royalty stack of the party they’re negotiating with, meaning that their idea of a reasonable portion of the stack may be very different from what the licensee knows is possible.  (And licensees are generally obligated to keep their licenses secret, meaning they can’t share how much they’re paying as a way of reducing this knowledge gap during negotiation.)

At the end of the day, the licensor may think they’re asking for something reasonable, while the licensee knows the requested royalty is out of line with licenses for similar patents and paying that rate would drive the product into unprofitability, a net loss for all involved.  Again, this can make it difficult to reach a settlement. 

Patent Disputes

So, what happens?  The parties discuss a license for a while, but it might not be at the top of anyone’s to-do list.  And, sometimes, one party files a lawsuit to try to push the process forward if they feel that it’s stalled.  While this is often done by the patent owner, in some cases a prospective licensee will file the suit to push settlement in order to reduce uncertainty.

Sometimes companies sue each other for patent infringement and fight to the bitter end.  But often, patent lawsuits between operating companies are just one more step in the negotiation of a license.

Joshua Landau

Joshua Landau is the Patent Counsel at the Computer & Communications Industry Association (CCIA), where he represents and advises the association regarding patent issues.  Mr. Landau joined CCIA from WilmerHale in 2017, where he represented clients in patent litigation, counseling, and prosecution, including trials in both district courts and before the PTAB.

Prior to his time at WilmerHale, Mr. Landau was a Legal Fellow on Senator Al Franken’s Judiciary staff, focusing on privacy and technology issues.  Mr. Landau received his J.D. from Georgetown University Law Center and his B.S.E.E. from the University of Michigan.  Before law school, he spent several years as an automotive engineer, during which time he co-invented technology leading to U.S. Patent No. 6,934,140.

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