Rambus v. FTC

Illustration of the patent hold-up problem

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Rambus:• Founded in 1990• Publicly traded• Non-practicing entity• Sometimes labelled as a “patent troll”• Participated in the JEDEC Solid State Technology

Association from 1991 to 1996• Purposely failed to reveal its current patent pending

applications regarding the memory standard (DRAM) that was being created

Overview of the facts

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Overview of the factsFTC:• filed an administrative complaint against Rambus

in June 2002• Because Rambus:– Exploited its participation to expand the scope of its

patents and ease their enforcement– And after the industry-wide incorporation of the

standard, asked for considerable royalties– Therefore obtained a monopoly on the standard

• Violation of Sherman Act section 2 and FTC Act section 5

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• Antitrust law forbids collusion• A SSO is implicitly an agreement not to manufacture,

distribute or purchase certain types of products SSOs should be illegal• But coordination through direct communication is a necessary

requirement for the development of many advanced technologies

• Without standards, decades would be required before the technology be commonly used

• In the end, market would reach an equilibrium of tacit collusion instead of explicit collusion Same effect on competition

Standard Setting Organizations (SSOs)

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• Therefore, the Supreme Court decided to make an exception for SSOs and apply the “rule of reason”

• SSOs are allowed, but only on the condition that they will be conducted in a non-partisan manner offering procompetitive benefits Good faith and cooperation are not only expected from the members by the SSO itself, but also by the law

• Courts should take that consideration when evaluating a deceptive conduct

Standard Setting Organizations (SSOs)

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• Patent ambush: arises when, during the development of a standard, a member of a SSO withholds information regarding relevant patents he owns. Specific form of the hold-up problem

• Hold-up problem: occurs when a party to a future transaction has to make non-contractible future relationship-specific investments before the transaction takes place

Patent ambush and hold-up problemDefinition

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• Company A is mandated by company B to produce product X• Equal bargaining power (they split the surplus, given each

firm’s outside options)• X’s value to B is Y(L) = 20L0.5+12• L is a discretionary amount spent by A to improve the quality

of X• Total cost of production = 2 + L• A signs a contract with B saying A will be paid at least 7 if it

sells X to B (fair ex-ante contract if L = 0)• No other possible ex-ante agreement (B doesn’t know how

well A works, i.e. doesn’t know Y(L) yet)• No other firm can use X, and L is a sunk cost

Hold-up problem – illustration

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• Socially optimal setting: L = 100• But if A produces X with L = 100, B will only agree to buy X

for 106 Profit of A = 4 < 5 (profit with L = 0)

• A will choose L = 25, because then B would buy X for 56 Profit of A = 6 > 5 > 4

• If it was possible to have a perfect contract, both companies would have agreed to the following contract: “A will produce X with L = 100, and B will pay 55 for that product”

• If both companies have equal bargaining power and can use perfect contracts they will always agree on the most jointly efficient investment level (L = 100) and share the resulting profits equally (assumption that the imperfect contract is not an outside option when a perfect contract is available)

Hold-up problem – illustration

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• In this example, the hold-up problem generated an underinvestment of 75 and cost 48 to the society

• In addition to the cost, there is the inequity component: firm A loses 49, and B earns 1 more due to the hold-up

• Sometimes, Hold-up problem makes certain types of transaction not even possible

Hold-up problem – illustration

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• In the example above, the issue was in the relation between the producer and the buyer

• In a patent hold-up, it is between the patentholder and the producer, due to the difficulty or impossibility to identify all the relevant patents before the development of the product (contrary to real properties, patents have subjective borders)

• Even if relevant patents found, patentholders have excessive bargaining power

• Patentholders have an incentive to stay hidden to lock the producer as much as possible with an infringing product

• A patent ambush is the same as a patent hold-up, except it is in the context of a SSO

Patent Hold-up

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• 2 conditions:- Imperfect contract- Perpetrator has some bargaining power

• Patents implicated in patent ambush generally have some at least partial substitutes. But once a standard it adopted by a whole industry, very difficult to even slightly modify it The second condition holds

• SSOs generally have a clause in their internal policy requiring members to disclose any current or future intellectual property potentially in conflict with the standardization projects. So how could the first condition be satisfied despite this clause?

Patent ambush – necessary conditions

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Potential issues that could challenge the efficiency of the duty to disclose clause:• Relatively rare form of contract, and boilerplate contract

– A lack of clarity in those cases doesn’t beneficiate to the author (the SSO)

– Clarity of the clause was a major issue in the Rambus case

• Clause considered disproportionate (therefore illegal)– Even more important in boilerplate contracts– Has been invoked, but was only a minor issue

• Burden of the proof of the violation– A high suspicion is not always enough, and absolute proof not always

possible– Wasn’t really a problem in Rambus case (courts easily admitted that

Rambus used deception), but represents an additional heavy litigation cost to the SSO

Patent ambush – imperfect contract

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• The accused member may sell its patents to a patent troll– Doesn’t violation the policy since the troll is not a member of the SSO– Accused member still liable for violation, but not for enforcement– Fortunately, Rambus didn’t use an ad hoc entity

• Patent ambush may arise from non-member if SSO negotiations are public– JEDEC was considered partially public– Fortunately, Rambus was (in the beginning) a member

• Possible “double burden of the proof”– In addition to proving the violation, you may have to prove the

damage– Main reason for the defeat of the FTC

Patent ambush – imperfect contract

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• Costs to the producer due to the hold-up:Total damage = first degree damage + second degree damage

• Total damage = difference between the outcome that would result from a fair negotiation with a perfect contract and the outcome with an imperfect contract = 49 in the example above

• Fair negotiation = negotiation where the bargaining power is not affected by the hold-up problem (imperfect contract situations are not considered as outside options)

Patent ambush – costs

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• First degree damage = difference between the outcome that would result from an unfair negotiation with a perfect contract and the outcome with the imperfect contract Generally source of unfairness AND inefficiency because induces underinvestment

• Second degree damage = difference between the outcome that would result from a fair negotiation with a perfect contract and the outcome with the unfair perfect contract Generally gets bigger as the number of future opportunities of renegotiation increases Generally only a source of unfairness because it affects the distribution of the surplus generated through the perfect contract, but not a source of inefficiency because it doesn’t impact the level of investment

Patent ambush – costs

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A perfect contract with SSO’s members results in: • Perfect investment level in the standardized

technology because not afraid of future injunctions by members after having spent money on the standard

• Efficient search for substitute less expensive technologies

• If two technologies were perfect substitutes, we should observe a Bertrand competition where the equilibrium license price is 0

Patent ambush – costs

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If patent ambushes exist, industries don’t know in advance if they will be threatened by an injunction if they adopt the standard. This results in:• Low efforts to develop the standard• Delayed and less generalized adoption of the standard

In addition, when the ambush actually occurs, we also have:• High litigation costs• A possible redesign cost

Finally, we have unfairness because the patentholders receive a portion of the sunk costs of the threatened industries, higher than the value of the patent.

Patent ambush – costs

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• Fair negotiation = RAND• Unfair negotiation = RAND + additional amount that the

patentholder will ask because it knows that even without agreement, there is a probability that the SSO still defines a standard using the disputed patent and then accepts the consequences of the hold-up

• As said before, the second degree damage shouldn’t affect the optimal investment it shouldn’t be the main concern of antitrust authorities but only of courts

• But royalties generally defined as a per-unit cost rather than a fixed cost it affects the optimal production and consumption of the standardized good

Patent ambush – costs

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• Judge dismissed complaint of the FTC because of insufficient proof

• Agreed that:– Rambus acquired a worldwide monopoly power in each of

the four relevant DRAM technology markets– This monopolization was only possible thanks to the

incorporation of Rambus’s technology into JEDEC’s standards

Legal reasoning in the US – First trial

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• But disagreed on the other facts and claimed that:– Rambus didn’t violate JEDEC’s policy because it was too unclear and

ambiguous to impose an affirmative duty on Rambus to disclose plans to amend patent applications

– A clause forcing to systematically reveal trade secrets is a disproportionate measure

– Absent a valid contractual disclosure duty, purposely hiding a patent is not a violation of antitrust laws but a right guaranteed by the patent law as an additional incentive to innovate

– JEDEC’s members knew that Rambus’s patent portfolio was growing and could potentially include some technologies in conflict with the standard, but still accepted those risks

– Rambus’s technology was so superior that, even if JEDEC was aware of the patents, they would still have used the technology in the standard

Legal reasoning in the US – First trial

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• On a second trial, the FTC overturned the ruling and forced Rambus to license its patents at a RAND rate. The FTC made the following arguments:– Even without a valid clause, Rambus’s behavior is an illegal exclusionary

conduct, and it isn’t even necessary to prove that the conduct was willful– The internal documents of Rambus prove that the conduct was intentional– Rambus’s argument that disclosing its pending patents would have

jeopardized its ability to obtain foreign patents and enabled competitors to slow down the patent application process were too undocumented to be admissible, and most other pro-competitive justifications normally valid cannot be accepted in the context of a cooperative atmosphere of a SSO

– If Rambus was so concerned about its trade secrets, it could have elected not to participate in JEDEC at all

– Without the deception, JEDEC would either have chosen a different technology or asked for a RAND guarantee. If Rambus didn’t believe that, then they wouldn’t have used deception (attempt to reverse the burden of the proof)

Legal reasoning in the US – Second trial

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• On a third trial, after an appeal from Rambus, the D.C. Circuit reversed the FTC’s decision in April 2008. This time, the court analyzed the two legal basis (Sherman Act and FTC Act) very differently

• Regarding the Sherman Act violation, they agreed with the FTC on two facts:– The internal policy doesn’t need to be valid to find a violation– Without the deceptive conduct, JEDEC would either [1] have adopted

a different technology or [2] asked for a RAND guarantee.

• But then, the court made some very different arguments for each of those two scenarios

Legal reasoning in the US – Third trial

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Scenario 1:• If the deception caused scenario 1, the deception is illegal• But the FTC could not prove scenario 1• Therefore, liability under scenario 1 is not possible

Scenario 2:• Since liability under scenario 1 wasn’t proved, we can now only find

liability under scenario 2• Since we know that there is liability, and since this liability has to be either

attributed to scenario 1 or 2, the whole liability has to be attributed to scenario 2

• But applying the Nynex v. Discon precedent to that case by analogy, it is legal to use deception to charge a higher price (evade from a RAND commitment) in an otherwise lawful monopoly

• Therefore, no liability can be found under the Sherman Act

Legal reasoning in the US – Third trial

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• This application of the Sherman Act is very controversial• Extremely difficult to prove scenario 1 ex-post in the context

of advanced technologies• Overlooks the fact that royalties are not a lump sum and will

be directly incorporated in the price of the final product, therefore generating a suboptimal production level, and raising antitrust concerns

• Unfair, in addition to the flawed economic interpretation

FTC Act violation:• No definitive decision

Legal reasoning in the US – Third trial

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Regarding the FTC Act violation:• No definitive decision was taken• The court asked to the FTC to decide whether they want to

continue the trial with the FTC Act violation• But enforcement under that legal basis, contrary to Sherman

Act, is likely to require a valid duty to disclose clause• The clause is likely to be found invalid• The FTC knew it would be difficult to win, so dropped the trial

Legal reasoning in the US – Third trial

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• The FTC filed a petition for writ of certiorari in the Supreme Court

• Was supported by many large groups of corporations, distinguished scholars, SSOs and other prominent organizations

• Denied on February 23, 2009

D.C. Circuit’s decision forms now a definitive jurisprudence on the application of the Sherman Act to standard-related patent hold-up conduct in the United States and will probably be used for many years in future trials

Legal reasoning in the US – certiorari

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• Sherman Act is virtually useless against patent ambush• FTC Act, or ordinary breach of contract, should be used in

future cases• Duty to disclose clause of most SSOs should be rewritten

– Should be more specific about what information should be revealed and when

– Could add a systematic RAND insurance unless agreed differently during the standardization process

– Shouldn’t be disproportionate (which could discourage honest firms to join the SSO, or be made invalid by courts)

Consequences

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• FTC could have used a different argument: the deception allowed Rambus to benefit from earlier-starting and longer-lasting patent terms

• Estimated that it allowed Rambus to gain from 1 to 3 years• Rambu’s revenue in 2005 due to the 4 patents: estimated

between several hundred million dollars up to $2.5 billion

• Easier to prove (no need to go into technical considerations)• More likely to be illegal under the Sherman Act

If it had to be done again

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• Jurisprudence unlikely to change• The patent ambush is the reflection of broader structural

issues• Comprehensive patent law reforms would be required (ex:

Patent Reform Act of 2011), notably to improve access to information about intellectual property

• More specific solution: prescription of patent infringement (creates incentives for patentholders to declare their patents as soon as they observe infringement)

• Even more specific: loss of patent validity if no statement following the month of the publication of the standard

Potential legal reforms

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• European Commission was much more effective• Used a legal principle absent in the US: Abuse of

Dominant position• US forbids monopolization only. EU also forbids an

abuse of an already acquired legal monopoly position• Less proof required

European Case