The EU Court of Justice Judgment in Huawei v ZTE – important confirmation of practical steps to be taken by Standard Essential Patent holders before seeking injunctions

The Court of Justice of the European Union has ruled that the holder of a Standard Essential Patent that has committed to license its Standard Essential Patent on FRAND terms may be found in breach of the competition rules (Article 102 TFEU) by seeking an injunction against a potential licensee in certain circumstances.  In doing so, the CJEU’s judgment sets out a number of steps that should be followed in SEP patent licensing negotiations.

On 16 July 2015, the Court of Justice of the European Union (CJEU) handed down its long-awaited judgment in Huawei Technologies Co. Ltd v ZTE Corp., ZTE Deutschland GmbH (Case C-170/13), concerning the potential for enforcement action by holders of standard essential patents (SEPs) to infringe EU competition rules against abuse of a dominant position.  As hoped, the judgment resolves the divergence between the approach taken by some national courts in Europe to applications for injunctions against the use of SEPs where licensing terms have not been agreed, and the European Commission’s approach to this issue under its competition law jurisdiction.  At the same time, the judgment provides important guidance for SEP holders and implementers that will assist in framing licensing negotiations.

The reference before the CJEU concerned a case brought by Huawei, the Chinese mobile network technology company, against ZTE, another Chinese company, concerning the latter’s marketing of mobile network products in Germany which incorporated software linked to the 4G “Long Term Evolution” (LTE) standard.  The parties entered into negotiations to conclude a licensing agreement on FRAND terms for Huawei’s patent but failed to reach an agreement. As a result, Huawei brought an action before the Landgericht Düsseldorf (the German Federal Court of Justice) for infringement of its patent, seeking an injunction prohibiting the continuation of the infringement, an order for the rendering of accounts, the recall of products, and an award of damages.

ZTE’s defence before the German court was that Huawei’s application for a preliminary injunction is an abuse of its dominant position contrary to Article 102 of the Treaty on the Functioning of the European Union (TFEU) since ZTE is willing to negotiate a licence to use Huawei’s patent.  Recognising that the questions before it raised a complex and controversial issue concerning the interface between competition law and intellectual property (IP) rights and observing from the Commission’s press releases in Samsung¹ that its approach may be different to the Commission’s approach, the German court stayed the proceedings and referred five questions² to the CJEU concerning the conditions under which an application for an injunction can be made by an SEP holder without infringing competition law.

The CJEU’s judgment adopts the approach described by Advocate General Wathelet as a “middle path” between the interests of the SEP holder in protecting the value of their inventions, and those of the implementers (i.e. companies that use the teaching of the SEP) in developing and marketing products that utilise the standard.³ The CJEU has imposed restrictions that SEP holders must follow to enforce their SEPs in certain circumstances, but in reality many of these will often be taken in the ordinary course of business by SEP holders and licensees.  Perhaps more importantly, the CJEU has set out some limitations to the scope for the European Commission to open investigations under EU competition law rules when patent holders have sought injunctions in the context of patent disputes.

This article sets out the background to the preliminary reference, the CJEU’s judgment, and the implications of the CJEU’s judgment, in particular for the telecommunications sector where standards play an important role.

The development of technical standards can provide an important role in many industries to support compatibility between the products of one company and those of others.  In the telecommunications sector, standards and interoperability ensure that a seller’s handsets are able to work with mobile networks (subject to validation against a mobile operator’s specific requirements).  For example, consumers can expect a chosen handset to connect to the network they subscribe to, as well as to foreign networks on international roaming, and network operators expect new hardware installed within their network to be able to operate with hardware sourced from other suppliers.   As well as network effects, standards also deliver obvious “macro” benefits to the wider economy, for example, efficient resource allocation and encouraging research and development at the technology level.

The LTE standard is a fourth generation (4G) mobile network communication standard which is composed of more than 4,700 declared SEPs.  In fact, both Huawei and ZTE are holders of a number of declared SEPs relating to the LTE standard.  The number of potential SEP holders relating to the LTE standard means that the manufacture of LTE products can potentially require technology companies to take out multiple licenses.  For LTE product makers that hold some SEPs, this can mean entering into complex cross-licensing arrangements with others.

Standard setting bodies have long been alive to the potential for SEP holders to misuse their power in agreeing (or, indeed, refusing to agree) licences to allow the standard to be applied.  This is a key risk when IP is contributed to open standards.  In the mobile telecommunications sector, industry standards are set by the European Telecommunications Standards Institute (ETSI), a body that is composed of network operators, manufacturers, user representatives, service providers, universities, and others.  During the development of an ETSI standard, members are required to inform the standards body of any IP rights which they own that they consider are essential to that standard and commit to offer licences to those SEPs on Fair Reasonable and Non-Discriminatory (FRAND) terms.  On 4 March 2009, Huawei made such a commitment to the ETSI to license a European patent it holds that it declared “essential” to the LTE mobile standard.
Disputes in patent licensing negotiations generally arise when parties are unable to reach agreement on what is “fair” and “reasonable” under the FRAND requirement.  In those circumstances, the SEP holder will usually commence an action against the implementer for infringement of its SEP and also seek an injunction to prevent on-going infringement.

The conduct of SEP holders who have given a commitment to grant licences to third parties on FRAND terms has given rise to a number of actions before the courts in various jurisdictions and investigations by competition authorities.  Increasingly, disputes of this kind have arisen in the mobile technology sector between SEP holders that compete in downstream markets and require reciprocal licensing arrangements, for example the disputes that have arisen in recent years between Apple and Samsung.

These decisions have led to a number of divergent legal approaches and, consequently, a considerable degree of uncertainty. For example, the German courts have taken a patentee-friendly approach, as was established in the Orange Book case, whilst the European Commission has taken an implementer-friendly approach, as established in the recent Samsung and Motorola cases which also involve mobile standards – these are discussed in detail below.

In the US, the Federal Trade Commission (FTC) has also managed to involve President Obama in the debate by persuading him to veto the import ban on Apple products which the International Trade Commission (ITC) held infringed a Samsung SEP.⁴  The veto was exercised on the basis that Samsung had committed to license its SEP on FRAND terms, so should not have sought an import ban for products using the teaching of the patent. The veto was, however, surprising to many, given the ITC’s recognition that Samsung had been negotiating in good faith and that Apple was unwilling to take a licence.

(a) The “Orange Book Standard” defence in Germany

A relatively long line of case law on this issue has been established by the German Courts, dating back to May 2009 and the Orange Book case.⁵ The Orange Book case concerned a de facto standard for CD-Rs (Compact Disc-Recordable). Philips, the patent holder, alleged that CD-Rs must comply with the specifications set out in a document known as the Orange Book such that any party marketing CD-Rs had to obtain a license under Philip’s patent .

Philips commenced patent infringement actions against several manufacturers of CD-Rs that had not sought a licence for its patent.  Philips also applied for an injunction against those manufacturers as well as an award of damages.  In its defence, one of the defendants argued that Philips was abusing its dominant position on the market for CD-Rs by seeking an injunction for its patent, thereby infringing Article 102 TFEU.

The German Federal Court of Justice held that a potential licensee can raise a competition law defence against an application for an injunction in limited circumstances, if it can show that:

1. it has made an unconditional offer to license under terms that cannot be refused by the patent holder without abusing its dominant position; and
2. these terms require the implementer to behave as if a licence were in place by, for example, making royalty payments into an escrow account and waiving its right to challenge the patent.

This approach has been endorsed in a number of subsequent cases, where injunctions had been granted. So the essence of the position under the German case law is the requirement that implementers must take positive steps that do not call into question their willingness to pay royalties. In reality, the competition defence became difficult for implementers to rely on because it required the implementer to effectively accept the validity of the patent and the case on infringement against it.

(b) The European Commission’s decisions in Samsung and Motorola

In the telecommunications sector, SEPs have become a key battleground between technology companies with large patent portfolios as standards have incorporated more technology and consequently a greater number of patents, and as mobile phones have become more sophisticated.

In Germany, Samsung and Motorola were each in negotiation with Apple for the licensing of their respective mobile telecoms SEPs.  Those negotiations subsequently broke down, prompting Samsung and Motorola to bring patent infringement proceedings against Apple in the German Courts.  In the context of those patent infringement proceedings they applied for interim injunctions for their respective SEPs. This encouraged the European Commission to open formal competition investigations against Samsung and Motorola to determine whether those proceedings constitute an abuse of a dominant position.

The Huawei v ZTE case came to trial in Germany after the Commission had adopted a statement of objections⁶ (which is confidential to the parties to the procedure) against Samsung but before a decision had been adopted (and before a non-confidential version of that decision had been published).

However, it was evident from the Commission’s press releases in Samsung at the time that the Orange Book Standard may not be compatible with the Commission’s approach under the competition rules.  The German Court therefore felt it was necessary to stay the Huawei proceedings and make a preliminary reference to the CJEU to ensure consistency between its own decisions and the Commission’s approach.

The Commission has since concluded its cases against Samsung and Motorola.  In the case of an SEP, the Commission’s position is that where a patent holder has given a commitment to license on FRAND terms, and the potential licensee is “willing” to negotiate a licence on that basis, the seeking of an injunction by the patent holder could constitute an abuse of a dominant position contrary to Article 102 TFEU.  This is on the basis that, in the Commission’s view, the SEP holder can use the threat of an injunction to distort licensing negotiations and impose unjustified licensing terms on licensees.

In Samsung, the Commission decided not to proceed to an infringement decision and instead accepted legally binding commitments⁷ (under Article 9 of Regulation 1/2003)⁸ offered by Samsung not to seek injunctions in relation to any of its present and future SEPs for mobile devices for a period of 5 years against any potential licensee that agrees to accept a particular licensing framework for the determination of FRAND terms and conditions.  The detailed licensing framework provides for:

1. a negotiation period of 12 months; and
2. if no agreement is reached, a third party FRAND determination by a court or arbitrator.

In Motorola, the Commission went down another path and adopted an infringement decision⁹ (under Article 7 of Regulation 1/2003) against Motorola finding that it had abused its dominant position by seeking an injunction against Apple in relation to its SEP for the GPRS standard.  However, the Commission exercised its discretion (and exceptionally) did not impose a fine because of the divergent decisions of Member States and the absence of EU case law.

(c) The Advocate General’s Opinion¹⁰

Prior to the CJEU reaching its decision on questions referred by national courts, the EU Court process provides for one of the Advocate Generals (AG) to deliver an opinion on the issues before the CJEU to aid the court.

AG Wathelet’s Opinion, therefore, gave the first indication of how the EU’s highest court would likely approach the interaction between competition law and IP rights in the context of interim injunction applications for SEPs.

The AG first noted the factual differences between the Orange Book case and the dispute in Huawei v ZTE.  The patent in the Orange Book case related to a de facto standard for which the owner of the patent at issue had not given a commitment to grant a licence on FRAND terms.  It is natural that, in those circumstances, the patent owner will have greater negotiating power than in the case of an SEP owner .  In view of the factual differences, the AG’s view was that the Orange Book Standard could not be transposed by analogy to the Huawei case.

The AG opined that a “middle path” needed to be found between excessive protection for the SEP holder and excessive protection for the implementer. The AG criticised the German line of case law (for offering too much protection to the patentee), and the approach of the Commission (for offering too much protection to the implementer).

The AG observed that an injunction has at least the potential to restrict competition.  However, by making a commitment to grant a licence to third parties on FRAND terms, the patent holder does not give up its right to seek an injunction, and the seeking of an injunction cannot by itself constitute an abuse of a dominant position.

The AG’s conclusion in this regard is unsurprising because in most jurisdictions around the world, the claimant in a patent infringement action can seek an injunction against an alleged infringer preventing the latter from continuing to use the inventions claimed in the patent, until the substantive case on infringement (and in some cases also validity) has been determined. The right of a party to go to court and ask for an injunction is a universally recognised right and enshrined in Article 47 of the Charter of Fundamental Rights (right to an effective remedy and to a fair trial).

However, the AG opined that where the standard implementer is “willing” to conclude a licence, seeking an injunction will constitute an abuse of dominance.  The AG identified specific guidelines for the negotiation of licences for SEPs.  These have generally been endorsed by the CJEU as set out below.

Whilst the AG was not asked by the German Court to consider whether an SEP holder is necessarily dominant in the relevant market, the AG commented that an SEP holder may be presumed to be dominant but that it is possible to rebut this presumption with “specific, detailed evidence”.  This observation, and the suggestion of a presumption, was somewhat curious.  It seemed to ignore the fact that a declared SEP may not really be essential to design a product that is standard conformant.

More importantly, depending on the circumstances and the specific SEP, it might be questioned whether an SEP holder can really be dominant by virtue of its ownership of a single SEP where a mobile phone manufacturer (or network hardware maker) must license numerous SEPs from more than one SEP holder in order to comply with a particular standard.  This – the question of dominance – would need to be assessed on the facts of the case.  As mentioned above, the LTE standard has more than 4,700 declared SEPs and mobile telephony equipment makers will typically enter into complex cross-licensing arrangements in relation to the use of numerous patents.  In those circumstances, can it really be the case that all SEP holders for the LTE standard are dominant?

As is often the case, the CJEU’s judgment endorsed the AG’s Opinion.  In providing answers to the German court’s questions, the CJEU acknowledged the balance to be struck between maintaining free competition and safeguarding the SEP holder’s IP rights, and its right to effective judicial protection guaranteed by Article 17(2) and Article 47 of the Charter, respectively.

According to settled EU case law, the exercise of an exclusive right can only constitute an abuse of dominance in exceptional circumstances.  However, the CJEU explained that the situation in the present case can be distinguished from previous case law because it concerned an SEP and because the patent only obtained SEP status in return for the SEP holder’s commitment to ETSI to offer licences to third parties on FRAND terms.

In those circumstances, and having regard to the fact that an SEP holder’s commitment to grant licences on FRAND terms creates a legitimate expectation that the SEP holder will in fact grant such  licences, a refusal by the SEP holder to grant those licences may constitute an abuse of dominance.

Reflecting the AG’s view, the CJEU judgment identifies a number of specific guidelines for SEP patent licensing negotiations which include the steps that an SEP holder needs to comply with in order to prevent an application for an injunction being regarded as an abuse of dominance.

• The SEP holder must alert the implementer in writing of the infringement complained of by noting the relevant SEP and how it is alleged to be infringed.  This is because the implementer may not necessarily be aware that it is using the teaching of an SEP that is both valid and essential to a standard.
• The implementer must express a willingness to conclude a licensing agreement on FRAND terms.
• The SEP holder must provide a specific, written offer for a licence on FRAND terms.  The offer must specify the amount of the royalty and how it is calculated.
• The implementer must “diligently” respond to that offer, in accordance with recognised commercial practices and in good faith, which must be established on the basis of objective factors and which implies, in particular, that there are no delaying tactics.
• If the implementer does not accept the offer made to it, a counter offer that corresponds to FRAND terms must be made promptly and in writing to the SEP holder.
• If the implementer is using the teachings of the SEP before a licensing agreement has been concluded, the implementer must provide appropriate security in respect of its past and future use of the SEP.  For example, a bank guarantee for the payment of royalties or by placing the relevant amount of money on deposit.
• Where an agreement has not been reached on the details of the FRAND terms following the counter-offer by the implementer, the parties may, by agreement, request that the amount of the royalty be determined by an independent third party.
• The implementer cannot be criticised for challenging, in parallel to negotiations for a grant of licence, the validity of the SEP or the essential nature of the SEP or for reserving the right to do so in the future.  Thus, in contrast to the Orange Book Standard that required an “unconditional offer” to license from the implementer (meaning agreement not to challenge the alleged infringement or the validity of the patent), the implementer can defend itself with non-infringement and invalidity arguments.

Therefore, whilst the implementer must proceed on the basis that the patent is valid, it agrees to pay the claimed or negotiated royalty (or pay the difference into escrow), and can still challenge validity separately.

It remains to be seen how the German Court will apply these criteria to the dispute between Huawei and ZTE and how courts in future disputes will do so.  For example, will broad compliance with the general sequence and the spirit of the steps be sufficient?

An SEP holder seeking a recall of products (under national regimes where a court might consider making such an order) would appear to be subject to the same rules as above.  However, the CJEU did not question the SEP holder’s right to seek damages or  the rendering of accounts because those remedies do not have a direct impact on products complying with the relevant standard manufactured by competitors entering or remaining on the market.

Contrary to the AG, the CJEU did not take a position on whether an SEP confers a dominant position, instead choosing to note that the German Court did not refer a question on this point.  It therefore remains the case that national courts are left to consider the extent to which an SEP holder has market power on a case-by-case basis, taking into account competing technologies.

The CJEU’s judgment provides some much-needed clarity on the conditions under which an injunction application can be brought by an SEP holder without infringing competition law.  It provides guidance to SEP holders and implementers engaged in patent licensing negotiations and should require greater transparency on both sides (for example, SEP holders must provide a written licence offer to the implementer which will include the amount of the royalty and how it is calculated, and the implementer must “diligently” respond and provide any counter-offer “promptly”).

The CJEU’s judgment is also an important step towards harmonising the approach of Member States to the conduct of SEP holders who have given a commitment to grant licences to third parties on FRAND terms.  This is an important step towards harmonisation of patent law in the EU, which will be completed with the establishment of the Unified Patent Court.

The CJEU has made it very clear that, in situations where the user of an SEP is notionally prepared to pay a royalty (i.e. “willing” to take a licence) a number of specific steps must be complied with in order to seek an injunction restraining the use of the relevant SEP.  These steps appear to limit the contractual and / or commercial freedom of the SEP holder to set royalty rates.  By impacting the dynamics of the patent licensing negotiation, it remains to be seen whether the CJEU’s decision will have an impact on the royalties paid by implementers and the ultimate prices paid by consumers.  However, although the effect on royalty levels remains to be seen, the judgment includes a clear expectation that an implementer using a declared SEP in advance of agreeing rates must make some advanced provision for royalties, whether through providing a bank guarantee or putting monies in escrow.  This means an immediate impact on earnings for implementers compared to the previous status quo.

The ability to enforce SEPs is crucial for innovation in the telecommunications and other sectors where industry standards are common place such as the information technology sector.  If injunctions are only available in some limited circumstances, this could have an impact of the value of SEPs and in turn on incentives to innovate.

Against this there are legitimate concerns that injunctions can be used by SEP holders to distort licensing negotiations and extract high royalty fees.  In the circumstances, the CJEU arguably offers a reasonable compromise for both parties -  the “middle path” described by the Advocate General in his Opinion.

Of course, the steps set out by the CJEU are sufficiently broad that aspects will be open to interpretation, and could lead to future disputes.  However, the framework provided should ensure that both SEP holders and implementers alike engage in genuine commercial discussions, reducing the scope for premature use of patent enforcement proceedings or recourse to competition rules as weapons in battles between competing technology companies.  If parties are to engage in genuine commercial discussions, we may see patent infringement cases move from the courts to arbitration where the parties can debate the issue of FRAND in a confidential setting and avoid any decisions becoming a legal precedent.

Finally, two key questions still remain.  Firstly, will the guidelines work in practice where an SEP holder is likely to be licensing a portfolio of patents rather than a single patent?  Secondly, what exactly constitutes FRAND terms, in particular what “reasonable” means for royalties?  In view of these outstanding questions, there may be further preliminary references from the national courts to the CJEU.