German SEP litigation series #2: Munich Regional Court sets out approach for assessing FRAND royalty rates

In this Part 2 of our blogpost series, we dive into the considerations presented by the Regional Court (Landgericht, LG) Munich in the general guidance issued in the proceedings ZTE v. Samsung for assessing whether offered royalty rates are in fact fair, reasonable and non-discriminatory (FRAND) licensing terms. Since the assessment and determination of FRAND royalty rates are core challenges in SEP licensing, this guidance may have significant implications for SEP licensing negotiations between SEP holders and implementers in Germany going forward (for Part 1 on the new requirement of partial payments click here). 

Comparable licences as preferred method

The general guidance starts out with general remarks on FRAND determination, emphasising that FRAND is a range and that evaluation on a case-by-case basis is very difficult. The LG Munich notes that research institutes have a large pool of qualified personnel but only a limited budget for patent applications, while industrial companies typically have a significantly higher budget for such applications. The court concludes that relying solely on the percentage share of the volume of the standard to set licence rates (so called “Top-Down Approach”) would be inappropriate. 

The Top-Down Approach involves estimating a total royalty burden that would be FRAND for all SEPs covering a given standard and product category and then allocating a share based on the number of SEPs that the patent holder owns. According to the Munich court, the Top-Down Approach is even more inappropriate given that there is little experience with it, and it is therefore very difficult to appropriately assess the value of a technology, such as mobile communications technology, on an abstract basis. 

For these reasons, the court underlines that comparable licences should be the preferred method for determining FRAND royalty rates, since this approach best reflects the value of licences by applying market practices. At the same time, the Munich court expresses doubts whether a supranational determination, such as by a commission, would be feasible, and notes that it remains unclear who would be responsible for determining such FRAND royalty rates.

Key takeaways: Principles for assessing comparable licences 

The general guidance provides valuable insights for both the SEP holders and the implementers for determining and assessing FRAND royalty rates in SEP licensing negotiations through principles for assessing comparable licences and further elements:

• Comparable licences as a benchmark for FRAND royalty rates: A central finding in the general guidance is that comparable licences offer the primary and most reliable basis for setting a FRAND royalty rate as they best reflect market practices. However, outlier licence agreements, meaning those with exceptionally high or low royalty rates, should be excluded from the analysis. 
   
• Top-Down-Approach as a cross-check: The Munich court also clarifies the limited significance of the Top-down Approach due to the difficulties in determining the value of a technology (see above) but does mention its possible value for cross-checking the FRAND range determined otherwise.
   
• Lump-sum payments: For lump-sum payments covering past use, it is important to consider that a licensee cannot retroactively pass on incurred licence costs in product prices. Thus, in most cases, uses occurring before the infringement notice should be excluded or be subject to significant reductions, possibly allowing for a transitional period for fairness. This is one of the few elements in the court’s guidance that implementers will welcome.
   
• Licence agreements qualifying for comparison: According to the Munich court, licence agreements must meet the following criteria to qualify as comparable licenses.
  • As a benchmark for FRAND royalty rates, only licence agreements that have already been concluded, relate to the same patent portfolio and date from a reasonably recent period should be considered. While these licence agreements define the FRAND range as such and constitute a binding commitment by the SEP holder in terms of non-discrimination, they do not set a fixed royalty rate. SEP holders should retain flexibility to adjust prices by at least 15 per cent, so that earlier agreements are not inflexible precedents. This approach creates an opportunity for negotiation, particularly where there is evidence of deviating circumstances.
     
  • Previous agreements between the same parties also carry significant relevance in the FRAND assessment. However, previous agreements are also subject to re-evaluation in light of changed circumstances. Neither party can claim to simply extend the terms previously agreed. Instead, each party should present arguments explaining why prior licensing conditions should continue or why changes are justified. At a minimum, an inflation adjustment will generally be required, except in cases where the licence is revenue-based.
     
  • Third-party licence agreements, without the involvement of the SEP holder at issue, do not have direct legal significance and therefore cannot set binding royalty rates. However, they may serve as a plausibility check, helping to validate the fairness of a proposed royalty rate.

Collectively, the factors presented above mean that both SEP holders and implementers should prepare robust, evidence-based submissions on comparable licences and demonstrably justify any deviation from recent market-based royalty rates.

Per-unit billing as preferred calculation method 

With respect to the method for SEP licensing, the LG Munich expresses a clear preference for per-unit calculation and notes that revenue-based royalty rates are neither typical nor appropriate. Nevertheless, the court recognises that other calculation methods proposed by the parties may be accepted, provided that they are substantiated and can be reviewed for plausibility against the preferred per-unit calculation.

Looking ahead

The general guidance provided by the LG Munich adds substance to the assessment of whether royalty rates are in fact FRAND. Looking ahead, SEP licensing negotiations in Germany may shift towards increased transparency in court proceedings, with more emphasis on recent comparable licence practices. The court’s guidance may incentivise parties to present their royalty proposals with detailed justifications and comparative evidence, knowing that the LG Munich expects negotiation stances to reflect genuine market benchmarks. However, the detailed principles set out by the court apply strictly within the context of litigation. 

In pre-litigation or out-of-court negotiations, these principles are not binding, which may perpetuate imbalances in information and negotiation leverage prior to any court involvement. This could create the difficulty for an implementer of remaining a willing licensee but only being able to see the relevant factors for determining a FRAND licence once negotiations have failed and litigation ensues. However, it remains to be seen overall whether the principles outlined by the LG Munich will be adopted by other German courts.