Evading Portfolio Royalties for Standard-Essential Patents Through Validity Challenges

J. Gregory SidakAbstractA no-challenge clause prevents a patent licensee from challenging the validity of a licensed patent. In the 2014 Guidelines on Technology Transfer Block Exemption Regulation, the European Commission discouraged parties from including a no-challenge clause in a settlement and license agreement concerning standard-essential patents (SEPs).The Commission said that eliminating invalid patents serves the public interest because it promotes competition. For similar reasons, in 2014, the Advocate General of the Court of Justice of the European Union opined in Huawei Technologies Co. v. ZTE Corp. that EU competition law should allow a licensee to retain the right to challenge a licensed SEP’s validity notwithstanding that the licensee has entered into a settlement and license agreement with the SEP holder. I analyze the Commission’s and the Advocate General’s assumption that a licensee’s challenging the validity of SEPs unambiguously benefits consumers. I assess the merits of that legal proposition within the well-established economic framework of cost-benefit analysis. I particularly focus on the marginal benefits and the marginal costs that eliminating no-challenge provisions would generate for consumers. I explain that the Commission and the Advocate General exaggerated the marginal benefits and understated the marginal costs of validity challenges to licensed SEPs, particularly when the typical SEP holder repeatedly licenses its SEPs in a large portfolio to a sophisticated licensee.The discovery that several SEPs in a licensed portfolio of hundreds are invalid would neither surprise the parties nor justify reducing the portfolio royalty.The Commission and the Advocate General ignored that encouraging a licensee to challenge the validity of individual licensed SEPs invites opportunistic litigation by the licensee so as to delay paying the SEP holder the agreed-upon royalty for the use of the many more valid patents in its licensed portfolio.Thwarting the SEP holder’s ability to receive prompt compensation for its innovative contribution lessens the SEP holder’s incentive to invest in innovation and thus decreases quality of collective standard setting. Those effects in turn impose significant marginal harm on consumers. Consequently, the Commission and Advocate General erred to assume that consumers derive a net marginal benefit from the announced policy encouraging a licensee to challenge to the validity of licensed SEPs.

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