What Are Essential Patents?

Essential patents, or standard-essential patents (SEPs), are patents, such as a software patent, that a company owns and shares with other companies to create a technology standard. Think of an essential patent as one part of a future product that would benefit an industry. Usually, these patents become licensed to standards organizations or companies with the same goal.

When essential patents are licensed, an agreement exists among all those with stake in the patent.

  • The Institute of Electrical and Electronics Engineers (IEEE) often gets essential patents from companies. The IEEE then uses their skills to make new products. The deal between this standards organization and the patent holder is that the essential patent can't be used on its own. Instead, the patent must be used to create something all people interested in the patent want.

The IEEE is one of many Standard Setting Organizations, or SSOs. Each of these organizations help define technical standards. They help determine the new or future standards and technical specs. In addition, they determine which SEPs may benefit a standard's development. This development also changes the landscape of SEPs. Because of determinations made by SSOs, some SEPs were not made valid because of:

  • Changes in standard specification
  • Change of patent claim scope

Due to SSOs and the changes brought about, figuring out the actual amount of real SEPs can be difficult. You should look at current and future SEPs, who holds them, and how many each company may have. Also keep in mind both the current and future market for SEPs.

Essential patent agreements also include a Letter of Assurance, which promises that the standards organization uses the patent for the greater good of the industry. The company then agrees that if the technology furthers the industry, the company gets a fair share of money. This agreement is also known as a fair, reasonable, and non-discriminatory (FRAND) licensing agreement or reasonable and non-discriminatory (RAND) agreement.

The reason for FRAND agreements is that no way exists to figure royalties. Market changes and product popularity are the two biggest factors. Still, coming up with a price can be difficult. The licensing company may also be making a product that uses the patent. Holding all other factors constant, including a company's revenue from licensed products sales, the company whose essential patent portfolio provides less value to the standard in question will pay a net-balance royalty.

A handful of companies in each industry own most essential patents. In the mobile phone business, Qualcomm, Nokia, and Huawei control 27 percent of essential patents. However, according to the European Telecommunications Standards Institute, more than 110,000 essential patents exist in this industry. Close to 21,500 companies control these patents. Of these 110,000 claimed essential patents, Thomas Reuters found that few are essential. LG was the leader in the ratio of true essential patents with 49 percent.

Why Are Essential Patents Important?

Essential patents are important to many industries because they help create better machines and processes. By sharing patent portfolios, companies can use each other's technology to make an improved product that benefits consumers. In the tech industry, these patents are quickly becoming the standard.

How Royalties Work With Essential Patents

To explain how royalties work on essential patents, consider a car purchase. When you take your old car into a dealer, the dealer gives you a fair value based on mileage, appearance, and brand. The nicer the car, the more money you get toward a new vehicle.

Essential patents work the same way. When two or more companies pool their patents, each owns a share of that stake. When the product gets invented, the companies weigh how much each patent was worth. Then, the companies distribute the funds as necessary. If either party decides to opt out, like a dealer who stops taking trade-ins, then the agreement becomes a one-way agreement. The licensee then gets royalties from the licensor.

In some cases, courts have to decide how much the royalties are worth. Judges typically use rulings in older cases to help figure out how much is owed. This process is difficult because even though one party may have a more valuable overall portfolio, that party may not sell as many units as thought by borrowing an essential patent from the other party.

If the issue of royalties goes to court, the following can be used to determine the value:

  • Comparable licenses or deals in the industry
  • The commitments of the parties

Legal Issues With Essential Patents

One of the biggest problems with essential patents deals with infringement. In traditional patent infringement cases, the patent holder can sue for injunctive relief or money. Injunctive means that the infringing company can't produce any more products with the other company's patent.

In essential patent cases, this area is a topic of debate. Although landmark cases don't exist, some law experts agree that essential patents that have FRAND agreements can't result in suing the licensor. However, federal district courts have the power to offer injunctive relief based on:

  • Public interest in the product
  • Impact on competition
  • Details of the FRAND agreement
  • Details of a patent holdup. This holdup happens when companies leverage their patents for high royalties.
  • Patent pool arrangements
  • Not confined to the first time of patent infringement

Critics of injunctive relief say that licensing a product and suing the company using the essential patent violates antitrust laws and cannot be given consideration.

The International Trade Commission (ITC) functions in contrast to federal district courts. This regulatory agency determines if infringement has taken place. However, the ITC can only order exclusion, such as non-importation of an invention. It cannot award monetary damages.

More on FRAND Agreements

A big problem with FRAND agreements is that they aren't held to any laws. Standards organizations created the agreements to avoid legal cases surround patent infringement. Because of the nature of these agreements, they aren't always airtight.

Many of these standards organizations, such as the IEEE, require SEP holders to make a FRAND agreement. However, since FRANDs aren't standardized and become written in different formats, figuring them out can be difficult.

Nevertheless, FRAND agreements are contractual agreements, and many law experts argue that these agreements fall under state law. If there is a basis for a case at the federal level, the case can only be heard by passing through district court. This scenario took place in the Microsoft Corp vs. Motorola Inc. ruling. Along with the Georgia-Pacific court case, these two examples were successful in defining royalties and how to come to agreeable terms for both parties.

Reasons to Consider Using an Essential Patent

A business might consider using essential patents for several reasons:

  • Protection and Product Development. In the past, essential patents have become important tools in business strategy. One reason is that they help develop new technology. The other reason is that they protect a company from infringement from rivals.
  • Following Trends and Generating Profits. More companies are using essential patents than ever before, and with good reason. For example, Qualcomm made $7.8 billion in 2014 from licensing essential patents. Estimates also show that in the mobile phone industry, revenue from essential patents will reach more than $100 billion worldwide.

Reasons to Consider Not Using an Essential Patent

Sometimes, an essential patent isn't worthwhile. Below are a few reasons to avoid them:

  • Loss of Importance. In changing fields, essential patents are only valuable for a short time. If you expect to take years to use an essential patent to create your new product, the patent could be wasted.
  • Royalty Considerations. If you use an SEP to develop a product, you owe royalties to the company from whom you're licensing. For startups, this arrangement could mean losing profits.

Frequently Asked Questions

  • What are the differences between RAND and FRAND?

Outside of wording, you won't find significant differences. Both terms get used interchangeably. FRAND is the more recent term.

  • What countries use SEPs and FRAND agreements?

Most countries around the world use these agreements. However, each country has its own set of rules for SEPs and FRAND agreements.

  • Who uses essential patents the most?

Large corporations use essential patents more than anyone else. These corporations have massive resources, owned patents, and research and development capabilities to find new products.

Get Help With Essential Patents

While you may not use an essential patent in your small business, you should know what one is. If you ever hold a patent you wish to license, that patent becomes a crucial part of your revenue stream. Turn to the legal professionals at UpCounsel. You can post your essential patent questions on UpCounsel's marketplace and work with lawyers who have experience handling legal matters for essential patents. UpCounsel accepts only the top 5 percent of lawyers to its site.

Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies such as Google, Stripe, and Twilio.