The Geopolitical Implications of Patent Holdout and the Ensuing Race to the Home Court

Compass Lexecon EMEA Chair, Jorge Padilla, and Senior Policy Advisor, Andrew Tuffin, contributed to the Cambridge University Press book, 5G and Beyond: Intellectual Property and Competition Policy in the Internet of Things, with a chapter on the geopolitical implications of patent holdout and the ensuing race to the home court. In this chapter, the authors discuss the danger posed to standardization in wireless technology markets by strategic efforts to initiate SEP-related litigation in courts that are perceived to favor the interests of innovators or implementers.

This article was originally published by Cambridge University Press here. The views expressed in this paper are the sole responsibility of the author and cannot be attributed to Compass Lexecon or any other parties.

Introduction

During the last few decades, patent holders and implementers participating in standards developing organizations (SDOs) have successfully cooperated to develop new wireless standards that have benefited consumers all around the world. Thanks to such collaborative efforts, consumers around the world can communicate with each other, play games, watch movies, and enjoy various other activities using wireless networks.1

The standardization process has been successful because it has made all its participants – innovators, implementers, governments, and consumers – better off. The future of collaborative standards hinges on ensuring that this remains to be the case. That requires two necessary conditions: Implementers must have access to the best technological solutions under terms and conditions that allow them to profitably commercialize the products embedding those standards, and innovators must receive fair compensation for their research efforts. 2

Much of the policy debate during the last 10 years has focused on how to reduce patent holders’ leverage in negotiations with implementers that aim to license their technologies to avoid the risk of patent holdup and, therefore, ensure that the first necessary condition holds (that manufacturers can profitably commercialize products embedding standardized technology). Several authors have repeatedly warned about the risk of patent holdup in the licensing of standard-essential patents (SEPs).3

Holdup is a classic problem in economics; it arises in circumstances when firms negotiate trading terms after they have made costly, relationship-specific investments. 4 Since the costs of these investments are sunk when trading terms are negotiated, they are not factored into the agreed terms. As a result, depending on the relative bargaining power of the firms, the investments made by the weaker party may be undercompensated. In the context of SEPs, patent holdup would arise if SEP owners were able to take advantage of the essentiality of their patents to charge excessive royalties to manufacturers of products reading on those patents that made irreversible investments in the standard.

After years of heated debate, however, there is no consensus about whether holdup exists. Some argue that there is no evidence of holdup in practice.5 If patent holdup were a significant problem, manufacturers would anticipate that their investments would be expropriated and would thus decide not to invest in the first place. But end product manufacturers have invested considerable amounts in standardized technologies. Others claim that while investment is indeed observed, actual investment levels are “necessarily” below those that would be observed in the absence of holdup. They allege that, since that counterfactual scenario is not observable, it is not surprising that more than 15 years after the patent holdup hypothesis was first proposed, empirical evidence of its existence is still lacking.6

The second necessary condition for the proper functioning of the standardization process, namely that patent holders be properly compensated, has received much less attention from scholars and policymakers. As Epstein and Noroozi explain:

By “patent holdout” we mean [. . .] that an implementer refuses to negotiate in good faith with an innovator for a license to valid patent(s) that the implementer infringes, and instead forces the innovator to either undertake significant litigation costs and time delays to extract a licensing payment through court order, or else to simply drop the matter because the licensing game is no longer worth the candle.7

Arguably, the possibility of patent holdout is especially relevant in the standardization context. As SEP owners that made a commitment to license on fair, reasonable, and nondiscriminatory (FRAND) terms are typically limited in their ability to request an injunction in case of patent infringement, they have little or no leverage when negotiating a licensing deal. The very same restrictions that limit the bargaining power of licensors to deal with the alleged risk of holdup aggravate the risk of patent holdout and the likelihood of undercompensating innovation. Furthermore, the risk of holdout is more significant for SEP owners with many complementary patents reading across jurisdictions. Patentees with large and global patent portfolios naturally seek to license their portfolio of SEPs at once to minimize transaction costs. Yet, some implementers refuse to negotiate in this way and choose to challenge the validity and/or essentiality of the SEP portfolio “patent-by-patent” and/or “jurisdiction-by-jurisdiction.”8 This strategy involves excessive litigation costs and is, therefore, inefficient. It may also lead to excessively low royalties and under-compensation. 9

While patent holdout concerns have attracted the attention of the leadership of the US Department of Justice (DOJ) and the United States Patent and Trademark Office (USPTO) in the recent past,10 some authors have rejected them as relatively immaterial.11 However, the risk of holdout is not a mere theoretical curiosum. Heiden and Petit empirically document that some implementers do engage in patent holdout by ignoring correspondence, postponing negotiations, or simply by making counteroffers that are inconsistent with industry practice.12 Other strategies include trying to affect the policies of SSOs or appealing to competition authorities. Of course, by delaying and stalling negotiations, potential licensees aim to obtain better licensing terms.

Indeed, the extant debate about patent holdout is not about whether implementers engage in so-called efficient13 infringement; they do.14 Heiden and Petit argue that the delay and the costs associated to patent holdout may also be related to the significant decrease in licensing coverage in the mobile phone industry, which has dropped from 73% to 36% between 2006 and 2016. Rather, what some scholars, such as Shapiro and Lemley,15 claim is that the patent holdout concern is a theoretical and groundless “chimera,” which at most affects only the distribution of surplus from innovation, stating that, in any case, it could be addressed through ex post court-mandated damages. FTC Commissioner Rebecca Slaughter maintains a similar position:

Holdout, as long as it is unilateral and not done collusively among licensees, fits squarely into the box of problems that have patent law solutions. If a potential licensee has engaged in willful infringement, the patent holder has remedies in patent law, including the potential for enhanced damages. Unilateral holdout does not involve the abuse of market power to stymie consumer choice that holdup does, and therefore does not trigger antitrust concerns in the same way.16

In plain English, their claims are that when a licensee takes actions to stop paying licensors for the patents, it matters to the licensors, but (a) it should not concern consumers, because the latter’s slice of the pie is unchanged, (b) it should not bother the licensees’ competitors that pay religiously for the use of the innovator’s technologies, and, in any event, (c) the licensor can always be compensated in court. However phrased, these claims are wrong. In a recent paper, Llobet and Padilla show that patent holdout can engender significant social-welfare losses under a wide range of realistic circumstances.17 The implications of patent holdout are not merely distributional. They find that implementers may have the incentive to incur significant costs to litigate SEPs sequentially (that is, patent-by-patent and/or jurisdiction-by-jurisdiction) even when this is socially inefficient. Such a strategy leads to lower royalty payments and may result in under compensation of innovation. Furthermore, it is likely to cause the dissipation of social surplus, as it leads to excessive litigation and leads to the exclusion of other implementers that, due to their smaller size or because of their start-up nature, cannot afford to engage in a similar litigation strategy.

In addition, there are powerful reasons to conclude that ex post court-mandated damages are likely to be insufficient to deter such a socially costly holdout strategy. First, it is obvious that if the cost of a patent holdout strategy is payment of reasonable royalties ex post, then (rational) implementers will have no incentive to pay early, given that a dollar today is worth more than a dollar in the future.18 Second, when all that the SEP holder can recover in adjudication is cash royalties, not the other terms and conditions (for example, a cross license) that it would have been able to obtain during good faith bilateral negotiations, then an injunction is strictly needed to make the SEP holder whole. Likewise, when a delay in payment causes the SEP holder’s bankruptcy or undermines its ability to fund valuable R&D, either by exhausting its internal funds or weakening its credit relative to third-party investors, then an injunction may also be strictly needed.19 This is specially likely because holdout tends to occur in cascades: Once a major licensee engages in holdout, all others, insofar as they compete with the former, have an incentive to shirk on their payments too. As we subsequently explain, not even enhanced damages may be able to address the problems identified.

In Llobet and Padilla’s paper, inefficient patent holdout can be prevented in a global court or when a local court is empowered to determine the validity of patents across all jurisdictions. However, this finding rests on some strong (and unrealistic) assumptions. Most importantly, local courts typically lack the authority to adjudicate with respect to the validity and infringement of foreign patents.20 In addition, Llobet and Padilla assume that local courts approach patent disputes based on a similar legal framework – statutes and case law – and possess the same level of technical competency, and their decisions are unbiased (that is, based exclusively on objective information about the patent portfolio and, possibly, the outcome of previous trials). Finally, they implicitly assume that if a court with global jurisdiction were created de novo, it would also apply a similar legal framework and be unbiased.

As of today, we are not aware of any realistic initiative to create a multilateral institution with authority to resolve SEP disputes globally. Instead, we observe courts in various jurisdictions (for example, the United Kingdom and China) attributing to themselves the right to decide global license terms.21 We also see how licensors and licensees file anti-suit, anti-anti-suit injunctions, and anti-anti-anti-suit injunctions seeking to influence which court ends up setting global terms. These maneuvers only make sense if courts are heterogenous, whether their differences are driven by differences in legal statutes, case law, speed, or objectivity.

In this chapter, we explore the implications of these developments for the future of the standardization process. Specifically, we consider the implications of extraterritoriality when licensors and licensees are located in different jurisdictions and local courts may be biased in favor of local litigants.

The pursuit of domestic industrial policy objectives through the biased enforcement of the law is likely to backfire and generate negative effects for everyone. Yet countries and their companies may face a prisoners’ dilemma in which all litigants strive to get their disputes resolved by their local courts. This prisoners’ dilemma may undermine the creation of global standards that, in the past, have contributed to the development and diffusion of technologies, such as mobile telephony, so successfully. It may cause the fragmentation of global standards along geopolitical lines: US firms would contribute with technologies covered by US patents to standards with a US-only geographic scope; EU firms would contribute with technologies covered by EU patents to standards with an EU-only geographic scope; and Chinese firms would contribute with technologies covered by Chinese patents to standards with a Chinese-only geographic scope; and so forth. This fragmented landscape will result in delayed innovation and result in worse and more expensive end products around the world due to lost economies of scale and scope.

The remainder of this chapter is organized as follows. In Section II, we detail the conditions under which patent holdout is socially inefficient. In Section III, we explain why ex post damages, even if somewhat enhanced, are likely to be insufficient to deter willful infringement. In Section IV, we explain how a global dispute resolution mechanism – a global court or mandatory arbitration tribunal – could eliminate the incentives to engage in socially inefficient patent holdout litigation strategies and discuss the institutional framework that would make that possible. In Section V, we document that, in the absence of a global dispute resolution mechanism, local courts around the world are moving to set global license terms and explain the risks and challenges posed by these developments. Most importantly, we expose the risk of fragmentation of otherwise global standards. Section VI concludes with a discussion of alternative ways of dealing with such risks.

Read the full paper here


Jorge Padilla & Andrew Tuffin, The Geopolitical Implications of Patent Holdout and the Ensuing Race to the Home Court, Competition Policy International, https://www.cambridge.org/core/services/aop-cambridge-core/content/view/AFF9EE741CD0CF1B28E8B698F985E0C1/9781009274272AR.pdf/5G_and_Beyond.pdf?event-type=FTLA

  1. Jorge Padilla, John Davies, & Aleksandra Boutin, Economic Impact of Technology Standards: The Past and the Road Ahead (Sept. 24, 2017), www.compasslexecon.com/wp-content/uploads/2018/04/CL_Economic_Impact_of_Technology_Standards_Report_FINAL.pdf. ↩︎
  2. Justus Baron et al., Contribution to the Debate on SEPs (E03600), Eur. Comm’n – Internal Mkt., Indus., Entrepreneurship & SMEs – Indus. Pol’y: Standard Essential Pats. (2021), https://ssrn.com/abstract=3778166. ↩︎
  3. Mark A. Lemley & Carl Shapiro, Patent Holdup and Royalty Stacking, 85 Tex. L. Rev. 1991, 2049 (2007). ↩︎
  4. Oliver Williamson, Markets and Hierarchies: Analysis and Antitrust Implications (1975). ↩︎
  5. Alexander Galetovic & Stephen Haber, The Fallacies of Patent Holdup Theory, 13 J. Competition L. & Econ. 1, 44 (2017). ↩︎
  6. Rebecca Kelly Slaughter, Comm’r, Fed. Trade Comm’n, SEPs, Antitrust, and the FTC, Remarks Prepared for Delivery at the ANSI World Standards Week: Intellectual Property Rights Policy Advisory Group Meeting (Oct. 29, 2021). See also Carl Shapiro & Mark A. Lemley, The Role of Antitrust in Preventing Patent Holdup, 168 U. Pa. L. Rev. 2019, 2060 (2020). ↩︎
  7. Richard A. Epstein & Kayvan B. Noroozi, Why Incentives for “Patent Holdout” Threaten to Dismantle FRAND, and Why It Matters, 32 Berkeley Tech. L.J. 1381, 1384 (2017). ↩︎
  8. Baron et al., supra note 2. ↩︎
  9. In the Unwired Planet v. Huawei case [2017] EWHC 2988 (Pat), Judge Birss asked “[W]hat sort of license for Unwired Planet’s portfolio would be FRAND in terms of its geographical scope when applied to a multinational licensee like Huawei? I will start by asking what a willing licensor and a willing licensee with more or less global sales would do. There is only one answer. Unwired Planet’s portfolio today is (and in 2014 it was) sufficiently large and has sufficiently wide geographical scope that a licensor and licensee acting reasonably and on a willing basis would agree on a worldwide license. They would regard country by country licensing as madness. A worldwide license would be far more efficient.” ↩︎
  10. Makan Delrahim, Assistant Att’y Gen., “Telegraph Road”: Incentivizing Innovation at the Intersection of Patent and Antitrust Law, Remarks at the 19th Annual Berkeley-Stanford Advanced Patent Law Institute (Dec. 7, 2018), www.justice.gov/opa/speech/assistant-attorneygeneral-makan-delrahim-delivers-remarks-19th-annual-berkeley-stanford. ↩︎
  11. Letter from 77 former government enforcement officials and professors of law, economics, and business to Makan Delrahim, Att’y Gen. (May 17, 2018), www.competitionpolicyinternational.com/wp-content/uploads/2018/05/DOJ-patent-holdup-letter.pdf. ↩︎
  12. Bowman Heiden & Nicolas Petit, Patent “Trespass” and the Royalty Gap: Exploring the Nature and Impact of Patent Holdout, 34 Santa Clara High Tech. L.J. 179 (2018); Brian J. Love & Christian Helmers, An Empirical Test of Patent Hold-Out Theory: Evidence from Litigation of standard Essential Patents, Santa Clara Univ. Legal Stud. Rsch. Paper (2021), https://ssrn.com/abstract=3950060. The authors find some evidence of an association between in-litigation holdout and both SEP portfolio size and patent quality; however, they find no evidence associating pre- or in-litigation holdout with the international breadth of SEP rights. ↩︎
  13. Efficient in a private, self-interested sense, but not in the collective interest, of course. ↩︎
  14. The former head of patent licensing at Apple, Boris Teksler, explained that in his opinion “efficient infringement,’ where the benefits outweigh the legal costs of defending against a suit, could almost be viewed as a ‘fiduciary responsibility,’ at least for cash-rich firms that can afford to litigate without end.” The Trouble with Patent-Troll Hunting, Economist (Dec. 14, 2019), www.economist.com/business/2019/12/14/the-trouble-with-patent-troll-hunting. ↩︎
  15. According to the authors, “[p]atent advocates have sought to deflect concerns about patent holdup not only by denying its existence but by concocting a supposedly parallel story of ‘patent holdout.’” They claim that “[p]atent holdout is incoherent as a theoretical matter and rejected as an empirical matter” and conclude that “[t]hose who express concerns about patent holdout seem to want to increase the returns to patent holders whose inventions add little or no incremental value, possibly because they advise SEP owners.” Shapiro & Lemley, supra note 6, at 2047 n.91. ↩︎
  16. Slaughter, supra note 6. ↩︎
  17. Gerard Llobet & Jorge Padilla, A Theory of Socially Inefficient Patent Holdout (2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4021461.198 Jorge Padilla and Andrew Tuffin https://doi.papers.ssrn.com/sol3/papers.cfm?abstract_id=4021461. ↩︎
  18. This could be addressed through enhanced damages. Jonathan M. Barnett & David J. Kappos, Restoring Deterrence: The Case for Enhanced Damages in a No-Injunction Patent System, in this book. ↩︎
  19. David Goldman, Qualcomm Made a Deal with Apple. Its Stock Has Soared 40%, CNN Bus. Apr. 17, 2019), https://edition.cnn.com/2019/04/17/tech/qualcomm-stock/index.html (“With the company no longer at risk of losing one of its most important sources of revenue, Qualcomm’s stock has soared 40% to a 5-year high since it announced Tuesday it had settled all litigation with Apple. Qualcomm will continue charging Apple royalties for its patents, and Apple will pay Qualcomm a substantial fee as part of the agreement.”). ↩︎
  20. Jorge L. Contreras, Global Rate-Setting: A Solution for Standards Essential Patents?, 94 Wash. L. Rev. 701, 757 (2019). ↩︎
  21. Richard Lloyd, UK Supreme Court Hands Unwired Planet and Conversant Victory in Key SEP FRAND Dispute, IAM(Aug. 26, 2020), www.iam-media.com/frandseps/breaking-uk-supreme-courthands-unwired-planet-and-conversant-victory-in-key-sep-frand-dispute; Bing Zhao & Jacob Schindler, Inside Samsung’s Wuhan Anti-suit Injunction against Ericsson, IAM (Jan. 6, 2021), www.iam-media.com/frandseps/more-details-emerge-wuhan-anti-suit-ruling; Bing Zhao, Chinese Judges Can Set Global SEP Rates and License Terms, Supreme People’s Court Confirms, IAM (Sept. 2, 2021), www.iam-media.com/frandseps/chinese-courts-can-set-global-sep-rate-and-licensingterms-spc-confirms; and Jacob Schindler, Sharp-Oppo Patent Dispute Ends with Cross-License Deal, IAM (Oct. 8, 2021), www.iam-media.com/frandseps/sharp-oppo-patent-dispute-ends-cross-licence-deal. ↩︎