Illustration of the patent hold-up problem through the Rambus v. FTC trial ECON 490 - University of Michigan - Fall 2014 Presentation by Jonathan Zimmermann

1. Rambus v. FTC
Illustration of the patent hold-up
problem

2. 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
2
Overview of the facts

3. Overview of the facts
FTC:
• 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
3

4. • 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
4
Standard Setting Organizations (SSOs)

5. • 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
5
Standard Setting Organizations (SSOs)

6. • 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
6
Patent ambush and hold-up problem
Definition

7. • 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
7
Hold-up problem – illustration

8. • 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) 8
Hold-up problem – illustration

9. • 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
9
Hold-up problem – illustration

10. • 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
10
Patent Hold-up

11. • 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? 11
Patent ambush – necessary conditions

12. 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 12
Patent ambush – imperfect contract

13. • 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
13
Patent ambush – imperfect contract

14. • 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)
14
Patent ambush – costs

15. • 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 15
Patent ambush – costs

16. 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
16
Patent ambush – costs

17. 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. 17
Patent ambush – costs

18. • 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
18
Patent ambush – costs

19. • 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
19
Legal reasoning in the US – First trial

20. • 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
20
Legal reasoning in the US – First trial

21. • 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)
21
Legal reasoning in the US – Second trial

22. • 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
22
Legal reasoning in the US – Third trial

23. 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
23
Legal reasoning in the US – Third trial

24. • 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
24
Legal reasoning in the US – Third trial

25. 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
25
Legal reasoning in the US – Third trial

26. • 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
26
Legal reasoning in the US – certiorari

27. • 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)
27
Consequences

28. • 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
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If it had to be done again

29. • 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
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Potential legal reforms

30. • 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
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European Case