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Wi-Fi, Bluetooth, 4G/5G. These communication technologies are now essential infrastructure for our lives and businesses. However, did you know that there are significant risks for companies that manufacture and sell products that use these technologies? That is the problem with Standard Essential Patent (SEP).
In the past, the SEP issue was resolved through cross-licensing between communications equipment manufacturers. However, with the rapid spread of the Internet of Things (IoT), SEP disputes have spread to industries previously unrelated to communication technology, such as automobiles, home appliances, medical equipment, and industrial machinery. One day, a foreign patent holder suddenly demands a huge license fee - such cases are rapidly increasing.
The key to protecting companies in such situations is knowledge and strategies for license negotiations based on FRAND (Fair, Reasonable and Non-Discriminatory) terms. This article provides a comprehensive explanation of the basics of SEP, the practice of FRAND terms, and the specific measures that companies should take.
Table of Contents
1. What is a Standard Essential Patent (SEP)?
Relationship between standardization and patents
Modern information and communication technology functions based on "technical standards" developed by international standards organizations. Technical standards are like rulebooks that allow devices from different manufacturers to connect and communicate with each other. For example, a smartphone and wireless earphones can be connected via Bluetooth because both devices comply with the Bluetooth standard.
Major international standardization bodies and standards
- IEEE (Institute of Electrical and Electronics Engineers): Wi-Fi (IEEE 802.11), Ethernet (IEEE 802.3)
- ITU (International Telecommunication Union): Video compression standards (H.264/H.265), communication infrastructure standards
- 3GPP: Mobile communication standards such as 3G (UMTS), 4G (LTE), 5G (NR), etc.
- Bluetooth SIG: Bluetooth Classic, Bluetooth Low Energy (BLE)
- ETSI (European Telecommunications Standards Institute): European telecommunications standard, to which 3GPP standards are transposed
Many companies and research institutes participate in the development of these standards, which incorporate cutting-edge technology. Some of these technologies include those for which specific companies hold patent rights. In this way, when a company's patented technology is adopted in a standard, that patent becomes a "standard-essential patent."
SEP definition and unavoidability
A Standard Essential Patent (SEP) is a patent that must necessarily be used to implement a certain technology standard. For ordinary patents, patent infringement can be avoided by adopting alternative technology. However, this is not the case with SEP. As long as it complies with the standards, they have no choice but to use the patented technology.
Serious risk that cannot be avoided
SEP cannot be "designed around". When manufacturing products with Wi-Fi functionality, it is inevitable to use Wi-Fi-related SEPs. This means you have to choose between obtaining a license or removing the feature from your product. If communication functionality is core to your product, you effectively have no choice but to obtain a license.
The table below provides an overview of the major technical standards and their associated SEPs.
| Technical standards | Main usage | Example of SEP holding company | Industries affected |
|---|---|---|---|
| Wi-Fi (802.11) | Wireless LAN communication | Qualcomm, InterDigital | Home appliances, IoT in general |
| 4G LTE / 5G NR | Mobile communications | Huawei, Nokia, Ericsson | Automotive, medical equipment |
| Bluetooth / BLE | Near field communication | Philips, Ericsson | Wearable, smart home |
| H.264 / H.265 | Video compression | MPEG LA Patent Pool | Video distribution, surveillance camera |
| NFC | Contactless communication | NXP, Sony | Payment terminal, transportation IC |
2. Why are SEP disputes rapidly increasing in different industries
Traditionally, SEP licensing negotiations were completed within the telecommunications industry. Major telecommunications equipment manufacturers each hold numerous patents, and they have prevented conflicts by entering into cross-licenses (agreements for mutual use of patents). Because of this "mutual" relationship, SEP was recognized as an "internal issue" in the telecommunications industry.
However, the rapid spread of IoT has fundamentally changed this structure. Nowadays, all products are connected to the Internet, and the number of products equipped with communication modules (Wi-Fi, Bluetooth, LTE, etc.) is rapidly increasing. Connected cars, where cars are constantly connected to the internet, medical devices that work with smartphones, and IoT sensors that monitor factory production lines in real time - all of these can be subject to SEP.
Structural weaknesses faced by manufacturers in different industries
Manufacturers not from the telecommunications industry have three fatal weaknesses with SEP. First, because we do not have a communications-related patent portfolio, we do not have a cross-license negotiation card. Second, the company lacks experience and knowledge in negotiating SEP licenses. Third, the cost of communications technology is not factored into the product price structure, so the burden of licensing fees directly eats into profits.
As if to exploit this structural weakness, the number of cases in which SEP holders and PAEs (Patent Assertion Entities, so-called patent trolls) request licenses from manufacturers in other industries is rapidly increasing worldwide.
Case study: Connected cars and SEP dispute
The automotive industry is at the forefront of SEP disputes. Connected cars are equipped with 4G/5G modules to enable functions such as vehicle-to-vehicle communication (V2V), vehicle-to-vehicle communication (V2I), and telematics. Major telecommunications patent holders seek direct licensing negotiations with automakers, and tend to target vehicle manufacturers (OEMs) rather than parts manufacturers (Tier 1 suppliers).
This is because by calculating royalties based on the sales price of the completed vehicle, they can charge higher licensing fees. The insistence that royalty rates be applied to the price of the entire vehicle rather than the price of a single communication module poses a major threat to automakers.
3. What is FRAND condition
Since SEPs are unavoidable, patent holders may have monopolistic power. Therefore, standards bodies impose an obligation on SEP holders to provide licenses on FRAND (Fair, Reasonable and Non-Discriminatory) terms. This is a promise based on the "FRAND declaration" that SEP holders make when participating in the standardization process.
Fair
License terms are fair. This principle states that patent holders must not abuse the "lock-in effect" that results from incorporating a patent into a standard and demand unreasonably high royalties. One guideline is the price level (ex-ante value) that would be determined in a competitive situation before the standard is formulated. In other words, the conditions must be commensurate with the inherent value of the technology, which will be determined by comparison with alternative technologies, before it is adopted as a standard.
Reasonable
The license is at a reasonable level. Specifically, considerations include ensuring that the royalty rate is commensurate with the technical contribution of the patent, that it does not unduly put pressure on the licensee's business, and that the cumulative royalty (total amount paid to multiple SEP holders) does not exceed the product's profit margin. Courts may use comparable licenses or a top-down approach (calculating the contribution of individual patent portfolios from cumulative industry-wide royalties) when determining FRAND royalties.
Non-Discriminatory
Licenses are provided on equal terms and without discrimination to all similarly situated licensees. It is not permissible to offer conditions that are only advantageous to large companies or to charge unreasonably high royalties to companies in a particular country or industry. However, differences in conditions due to differences in license scale (shipment quantity) or business scale may be permitted within a reasonable range.
Holdup problem
The reason behind the emphasis on FRAND terms is the Hold-up problem. This is an act in which SEP holders take advantage of the bargaining advantage they have gained through the adoption of a standard by demanding a high license fee that far exceeds the FRAND conditions, or threatening an injunction (a court order prohibiting the manufacture and sale of a product) in order to gain an advantage in negotiations.
Typical pattern of hold-up
A typical case is that the SEP holder files an injunction, threatens to stop selling the product, and then offers a royalty rate that significantly exceeds the FRAND standard. The claimant will be forced to accept unreasonably high terms in order to avoid damage caused by the suspension of product sales (supply chain disruption, customer penalties, damage to the brand image). Although EU competition law and German court precedents place certain restrictions on injunction requests by patent holders who have made a FRAND declaration, they are not completely excluded.
Royalty stacking
Another serious problem is'Royalty Stacking'. There may be dozens to hundreds of SEP holders for a single technical standard. If each SEP holder charges royalties separately, there is a risk that the total amount (cumulative royalties) will represent an unreasonably high percentage of the product price.
The reality of royalty stacking
For example, the 5G standard has tens of thousands of SEP declarations. If each SEP holder were to charge a royalty of 0.5% of the product price, the total payments to all holders would amount to several tens of percent of the product price. In order to prevent such "piling up," an approach (top-down approach) is being discussed in which a reasonable aggregate royalty rate is set for the industry as a whole, and each holder's share is divided proportionately from there.
4. License negotiation process and practice
Licensing negotiations regarding SEP generally proceed through the following steps. Understanding the considerations at each step is critical to avoiding unfair conditions.
Step 1: Receipt of warning letter (license offer)
In many cases, the starting point is the receipt of a letter (warning letter, license offer letter) requesting license negotiations from the SEP holder (or the license management company or patent pool acting on its behalf). This letter provides specific information about the covered SEPs, covered products, and outlines the proposed licensing terms.
Important points:The most important thing at this stage is to properly record the fact that you received the letter and promptly consult a specialist (patent attorney/attorney). The date of receipt may be important in later legal proceedings.
Step 2: Signing of NDA (non-disclosure agreement) and information disclosure
Before licensing negotiations begin in earnest, it is common for both parties to conclude an NDA (Non-Disclosure Agreement). This protects trade secrets and technical information disclosed during the negotiation process, such as patent claim analysis materials, details of license terms, and sales data.
Key Takeaway:The scope of an NDA should be carefully considered. An overly broad NDA can be detrimental in subsequent litigation. Additionally, the scope of the NDA may be limited so that information obtained through negotiations with other SEP holders cannot be misappropriated.
Step 3: Claim chart verification and technical analysis
The "Claim Chart" presented by the SEP holder is a comparison table that shows which technical elements of the target product the patent claims (scope of rights) correspond to. This verification is the core of the negotiation and requires close scrutiny of the following points:
- Is the patent really “standard essential”? (Essentiality Check)
- Are the constituent elements of the patent claim implemented in your product?
- Validity of patent (Is there any reason for invalidation?)
- Has the patent term expired?
Step 4: Negotiate license terms and conclude contract
Based on technical verification, we will begin negotiating specific license conditions. The main negotiation points are as follows.
- Royalty rate:Is it a fixed percentage of sales (running royalty) or a fixed amount per unit?
- Royalty base: Finished product price or communication module price (SSPPU problem)
- Geographic scope:Global license or specific country only
- Target period:Presence and scope of retroactive payments (Past Royalty)
- Scope of target products:Does it include only existing products or future products?
Key point:In negotiations, comparable license agreements with other companies and industry benchmark information are important negotiating materials. Additionally, if a patent pool exists (a mechanism in which multiple SEP holders jointly operate a licensing program), it may be possible to obtain a license more efficiently than through individual negotiations.
Risk of ignoring/ignoring (holdout)
Ignoring a warning letter or unreasonably prolonging negotiations may be considered ahold-out. Holdout is an act in which a licensee intentionally avoids or delays obtaining a license under FRAND conditions. If a holdout is determined, courts are more likely to grant an injunction, and companies face a fatal risk of having their products stopped from being sold. European case law has repeatedly confirmed the importance of proactively demonstrating that a person is a "willing licensee."
5. Three points that companies should pay attention to
Point 1: Over declaration (excessive declaration)
SEP holders declare their patents to standards organizations as "standard essential." However, in reality not all declared patents are truly essential to the implementation of the standard. This is the problem of“over-declaration”.
Why does overdeclaration occur?
Declarations to standards bodies are based on "self-declaration" and are generally not subject to third-party review of essentiality. For SEP holders, declaring more patents as SEPs increases their bargaining power, creating an incentive to declare even non-essential patents. Industry research suggests that only a small percentage of declared patents are actually essential to implementing the standard.
Required rate data
According to multiple academic studies and analyzes by third-party evaluation organizations (e.g. Fairfield Resources, PA Consulting), it has been reported that the percentage of declared SEPs that are actually determined to be essential to the standard (required rate) remains at about 20-30%. In other words, the size of a SEP holder's claimed patent portfolio may significantly exceed the actual number of essential patents. This fact becomes an extremely important bargaining chip in licensing negotiations.
Point 2: SSPPU (Small Sellable Patent Working Unit)
The basis for calculating royalties is an extremely important issue. Smallest Salable Patent-Practicing Unit (SSPPU) means the smallest salable part or component implementing patented technology.
Why SSPPU is a hot topic
For example, consider a connected car (selling price: several million yen) equipped with a communication module (price: several hundred to several thousand yen). If the SEP holder applies the royalty rate to the price of the entire vehicle, the royalty amount will be an order of magnitude higher than if it were applied to the communication module alone. Under the SSPPU principle, it can be argued that the basis of royalties should be the smallest component implementing the patented technology (in this case the communication module). However, under U.S. case law, if the patented technology is driving the demand for the entire product (Entire Market Value Rule), it may be permitted to use the finished product as the basis, and decisions differ from case to case.
Point 3: Division of responsibility in the supply chain
For manufacturers who purchase communication modules as components, incorporate them into finished products, and sell them, the question of "who should obtain the SEP license" is a critical issue. If a component supplier is already licensed, a finished product manufacturer using that component may not need an additional license (exhaustion theory).
Notes in the supply chain
However, in reality, suppliers may not be licensed for all SEPs. Additionally, there is a conflict between the position that SEP holders can request licenses from companies at any level of the supply chain ("license to all") and the position that they should only request licenses from certain levels (usually end product manufacturers). Finished product manufacturers should consider including an indemnification clause regarding SEP in their parts procurement contracts. It is also important to regularly check what kind of SEP licenses the suppliers you procure have.
6. Benefits and summary of consulting with a patent attorney
SEP and FRAND issues are an area where technology, law, and business intersect in complex ways. It is difficult to deal with this problem within the company alone, and early consultation with experts is essential to protect the company's interests.
Advantage 1: The necessity of SEP can be technically verified
By closely analyzing both the patent claim interpretation and the technical standard specifications, patent attorneys can verify whether the claimed SEPs are truly essential to the implementation of the standard. By pointing out the possibility of overdeclaration and excluding patents that are not actually essential from license negotiations, we contribute to the optimization of royalties.
Advantage 2: Can negotiate appropriate royalty level based on FRAND terms
Experts familiar with SEP license negotiations use industry benchmark information, FRAND royalty calculation methods from past court precedents, and SSPPU discussions to arrive at reasonable license terms for your company. In addition, various solutions can be considered, such as the use of patent pools and the possibility of cross-licensing.
Advantage 3: Possible to take strategic measures with a focus on litigation risk
If SEP disputes are not resolved through license negotiations, they may develop into litigation (injunctions, claims for damages) or arbitration. Patent attorneys help ensure that you are in a favorable position in the unlikely event of a lawsuit by keeping an eye on litigation risks from the negotiation stage and keeping appropriate records of your actions as a "willing licensee." We also provide advice on the use of patent invalidation trials and the possibility of counterclaims.
Summary
In the IoT era, SEP issues are no longer just an issue for the telecommunications industry. All product manufacturers that include communication features such as Wi-Fi and Bluetooth are at risk from SEP licensing. A correct understanding of FRAND terms and an appropriate negotiation strategy are essential to protecting a company's business.
If you receive a warning letter regarding SEP, or if your product implements the communication standard, we strongly recommend that you consult a professional before the problem becomes serious. Appropriate responses are the key to preventing unreasonable license fees and maintaining a company's competitiveness.
Free consultation on SEP/FRAND
If you have any concerns regarding SEP, such as negotiating licenses for standard essential patents, responding to warning letters, and verifying FRAND conditions, please consult an intellectual property expert.
Standard essential patent
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AUTHOR
Takefumi SUGIURA （杉浦 健文）
EVORIX Intellectual Property Law Firm Managing Patent Attorney
Supports clients across IT, manufacturing, startups, fashion, and medical industries, covering patent, trademark, design, and copyright filings through trials and infringement litigation. Specialized in IP strategy for AI, IoT, Web3, and FinTech. Member of the Japan Patent Attorneys Association (JPAA), Asian Patent Attorneys Association (APAA), and Japan Trademark Association (JTA).
