Patent Pools – Some Not-So-Frequently Answered Questions

In our previous article, Fragmented Patent Pools Will Not End Smartphone ‘Wars’, we wrote about two separate initiatives intended to make patent licences more easily available, and affordable, for companies wishing to implement standard mobile communications technology.

These initiatives are known as ‘patent pools’.  This is not a new concept, and the notion of companies ‘banding together’ to share access to patented technologies, sometimes with anticompetitive effects, has existed for well over a century.

However, the contemporary structure of patent pools, generally intended to facilitate access to patents required to implement an industry standard or some other widely-desired technology, is a relatively recent development.  Modern pool operators are mindful of the anticompetitive potential of patent pools, and are careful to establish legal structures and agreements which do not fall foul of competition or antitrust laws and regulators.

Patent pool arrangements began to gain official sanction from competition regulators back in the 1990s.  In 1995, the US Department of Justice (DoJ) and the Federal Trade Commission (FTC) issued the Antitrust Guidelines for the Licensing of Intellectual Property (PDF, 230 kB), which highlighted the potential pro-competitive benefits of pools.  On 26 June 1997, the DoJ Antitrust Division issued a Business Review Letter in response to a request by the MPEG LA group, which was proposing to establish a pool to license patents essential to the implementation of the MPEG-2 digital video coding standards, which were in the process of being widely adopted for a range of commercial applications, including DVD-video, digital video transmission and broadcast, and digital video recording and storage.

The DoJ gave its stamp of approval to the proposed MPEG LA pool arrangements, and these have become a template for subsequent patent pools seeking to avoid violating antitrust and unfair competition laws.

While the idea of pooling patents seems simple, there are a number of subtleties that are perhaps not so readily appreciated.  With this in mind, we ask and answer a few basic questions about modern patent pooling arrangements.

What is a patent pool?

According to Wikipedia:

…a patent pool is a consortium of at least two companies agreeing to cross-license patents relating to a particular technology. The creation of a patent pool can save patentees and licensees time and money, and, in case of blocking patents, it may also be the only reasonable method for making the invention available to the public.

This is fine as far as it goes, however modern pro-competitive patent pools are less focussed on cross-licensing (i.e. companies making their mutually-blocking patents available to each other) and more upon out-licensing, i.e. making a collection of disparately-owned patents available to companies which may not have patents of their own to contribute to the pool.

Modern patent pools have the following typical characteristics:

1. combining patents owned by two or more companies;
2. usually (though not necessarily) covering collections of inventions which are all necessary in order to implement an established industry standard (e.g. MPEG video compression, DVD technology or Blu-ray disc technology);
3. licensed as a whole, i.e. while licences for individual patents may be available from their respective owners, the pool licence is available only as a package, on an ‘all or nothing’ basis; and
4. available to any non-member for licensing under a standard agreement and royalty rates, on a non-discriminatory basis (however, members who have contributed patents to the pool may receive more favourable terms recognising the ‘cross-licensing’ nature of their relationship to the pool).

Note that if a single company owns a portfolio of patents which are made available according to similar arrangements, this is not generally considered to be a patent pool.  A defining feature of a pool is the bringing together of patents from different owners to create a ‘one-stop licensing shop’, where one otherwise would not exist.

What are the antitrust issues with patent pools?

Often the companies participating in a patent pool arrangement are competitors.  For example, the original members of the MPEG LA group which sought DoJ approval for their proposal included Fujitsu, General Instrument, Lucent Technologies, Matsushita Electric Industrial Co., Ltd. (now better known as Panasonic), Mitsubishi Electric, Philips Electronics, and Sony.

The concern in such cases is that the pool participants may obtain favourable licensing terms, while charging high royalty rates to non-members which might effectively exclude new competitors from the market.  In other words, a ‘patent pool’ could be just another name for a ‘cartel’!

It should be understood that this issue arises only because a group of competitors agree to combine their patents together into a pool.  It is the collusive nature of this activity which generates an antitrust concern.  A single patent owner with a portfolio of patents is generally entitled to charge high royalties, or to choose to use its patents to exclude competition.  It is a feature of the patent laws that a limited monopoly is awarded in exchange for disclosure of an invention, as an incentive to conduct and share innovative activity.

So how do pools avoid antitrust problems?

The MPEG LA proposal which received DoJ approval back in 1997 included a number of features which together served to alleviate antitrust concerns.

1. The pool was designed to include only those patents which are essential to implementing the technology covered by a pool licence.  Licensees are not forced to license patents that are not required.  Nor are they forced to obtain a pool license even if their intention is to implement a competing technology (e.g. non-MPEG video coding).
2. The patents in the pool are clearly identified.  This is beneficial for prospective licensees, who can easily find and evaluate the licensed patents for themselves.  In the absence of a pool, it might be far more difficult to find all of the essential patents and their owners.
3. Licenses are made available on a world-wide, non-exclusive basis.  Again, this significantly simplifies widespread access to the essential patents.
4. All of the pool participants remain willing to license their patents independently of the pool.  Thus nobody is forced to take a pool license if they determine (for whatever reason) that their particular product/service requires a licence only to a subset of the patents.
5. Liability for royalties is conditioned upon actual use of the patents.  There is, for example, no fixed minimum annual royalty designed to ensure some income to the licensors.  Even if the licence has a set termination date, it will cease to cost anything if the licensee stops making the patented products.
6. There are no constraints on the ability of licensees to develop new, competing, technologies.
7. Licensors and licensees are required to make available and/or to contribute to the pool, any patents that they may own or obtain that are also essential to implementing the relevant technology.  In this way, the pool operates to extend access to essential patents.

Competition regulators are not generally concerned with the impact of the patent pool on competition in some absolute sense.  Rather, they compare the likely situation both with and without the pool, and assess whether the pool will have the effect of lessening competition relative to the situation without the pool.  It is in the nature of patents to place some constraints on free competition, so this in itself is not sufficient to prevent the formation of a patent pool.

As the DoJ concluded in its letter replying to MPEG LA:

Like many joint licensing arrangements, the agreements you have described for the licensing of MPEG-2 Essential Patents are likely to provide significant cost savings to Licensors and licensees alike, substantially reducing the time and expense that would otherwise be required to disseminate the rights to each MPEG-2 Essential Patent to each would-be licensee. Moreover, the proposed agreements that will govern the licensing arrangement have features designed to enhance the usual procompetitive effects and mitigate potential anticompetitive dangers.

How does a patent pool work?

In most cases, a single licensing entity is created or appointed to operate the pool.  This entity may be one of the patent holders (Philips, for example, administers a number of patent pools on behalf of itself and fellow patent owners), or it may be an independent licensing company (such as MPEG LA, LLC).

The patent holders generally retain ownership of their patents, and license them to the pool operator on a non-exclusive basis, with sublicensing rights.  The non-exclusive nature of this licence enables the patent owners to continue to license their patents independently, while the sublicensing provision enables the pool operator to issue licences to pool licensees.

The pool operator is responsible for management of licensing and licensees.  Licensees report sales and pay royalties to the pool operator which, in turn, monitors the licensees and enforces the licence conditions.

Royalties are distributed to the pool members according to a formula which may or may not be transparent to non-member licensees – this is a matter resolved between the pool operator and amongst the patent owners.  The pool operator retains an management fee.

Can a pool operator sue for patent infringement?

Except in the limited case in which the pool operator is also a pool member, it generally cannot sue for patent infringement.

In most jurisdictions, the parties with standing to sue for infringement are limited to the patent owner(s) and (in some cases) an exclusive licensee.  It is not generally possible to license or assign a ‘right to sue’ to another party, unless it is accompanied by all of the other substantive rights associated with the patent.

So if someone implements the patented technology without taking a pool licence, there is nothing the pool operator can do about this.  It is up to one or more of the individual patent owners to take action to sue the unlicensed party for infringement.  Of course, the pool operator may become involved in any settlement discussions which might occur, since one option for the accused party, to avoid continuing infringement, is to obtain a pool licence.

So is the pool operator powerless, then?

Certainly the pool operator has very limited power to encourage prospective licensees to sign up to a pool licence.  However, in conjunction with one or more of the patent-holding members of the pool – which can, in turn, offer individual licences to their own portfolios – the pool operator may be able to satisfy a prospective licensee that a pool license is the most commercially-attractive option available, in order to avoid being sued by one or more of the patent-holding members.  As the DoJ noted in its letter in response to MPEG LA, a centralised pool with a single management entity can deliver considerable savings in transaction costs.

However, once a licensee has signed a pool licence, this is typically a binding contract with the pool operator.  At this stage, the pool operator is in a position to sue the licensee for breach of contract if they do not keep up their end of the deal!

Pool licences are typically structured so that it is very difficult for the licensee to terminate early.  For a licensee in good standing this is not a problem, because you only pay for what you use under a pro-competitive pool licence.  If you are no longer making the patented products, there is no longer anything to pay, whether the licence is terminated or not.

So what is the down-side of a patent pool?

This all sounds great, but all is not always quite so perfect in practice.

One problem with patent pools is incomplete coverage.  No patentee can be compelled to contribute patents to a pool – participation is entirely voluntary.  For practicing entities (i.e companies which themselves manufacture competing products in accordance with the patents) there are some benefits to joining a pool, especially if the company holds a relatively small number of relevant patents.  If your main business is developing and marketing consumer goods or services, running a licensing program on the side might be a distraction, and outsourcing that function to a pool operator can be a good option.  But for non-practicing entities and companies with larger portfolios of relevant patents, running an independent licensing/enforcement program may be more lucrative than sharing with the pool. 

We are unaware of any pool which provides full coverage of all patents required to make a standardised product.  There are, for example, at least three distinct pools of patents said to be essential to various aspects of DVD technology (including the MPEG-2 pool operated by MPEG LA).  The royalties from all of these separate pools stack up, and there is no question that greater consolidation would reduce total overheads, operating an transaction costs, resulting in lower prices and better outcomes overall.

Another potential problem is the ‘one size fits all’ approach to licensing of patent pools.  The requirement that all comparable licensees be treated equally, and the need to keep the management, monitoring and auditing of licensees reasonably simple, generally leads to fixed per-unit royalties as opposed to, for example, royalties based on a percentage of gross or net sales.

This might be a problem for the LTE standards discussed in our earlier article.  These mobile communications technologies are implemented in a very wide range of products, from USB interface units which sell for a few tens of dollars, through low-end smartphones and tablets under $200, high-end phones and tablets selling for $600-800, up to laptop PCs which may sell for over $1000.

Manufacturers of the high-end devices will often argue that percentage rates are inequitable, because the basic ability to connect wirelessly has the same value to the consumer regardless of the cost of the device.  On the other hand, fixed per-unit royalties have a disproportionate impact on the retail price of low-end devices, effectively limiting the benefits of competition at the most affordable end of the market.  Arguably, from a market perspective, consumers who wish to spend more money on premium products should be making greater contributions to the licensing income stream, enabling stronger competition across all price-points.

There is no simple solution to this issue, and any attempt to negotiate with licensees on a case-by-case basis, such that they are not all treated identically, risks falling foul of the competition regulators.

CONCLUSION

Patent pools may be the only practical solution to the problem of licensing the hundreds of patents necessary for the implementation of complex standardised technologies.

A well-run patent pool offers many benefits, not least greater ease of access to essential patents at competitive prices.

But patent pools are not (yet) a universal panacea for the problems associated with licensing standards-essential patents.  We can only hope that some enterprising and innovative patent pool operator comes up with some new licensing arrangements addressing some of the outstanding issues, while avoiding the antitrust pitfalls.

Tags: Licensing, Patent pools