EU Draft Regulations Are A Nightmare For Intellectual Property—And Innovation

The EU has formulated some frankly alarming draft regulations about standard essential patents (SEPs) that will affect many tech companies, large and small. Among other things, the new rules would give the EU Intellectual Property Office the authority to set what it considers fair royalty rates for these fundamental technologies, rather than leaving that to the market. I’m adding this top-down rate-setting scheme to my list of Very Bad Ideas from Regulators, right next to the ill-founded opposition to the Broadcom-VMware and Adobe-Figma deals.

Based on conversations with IP experts and my own research, these regulations seem certain to do a lot of harm, which isn’t a surprise when you assign bureaucrats to set prices. I have no idea why the EU thinks that agency officials with no experience in operating a business, let alone negotiating SEP deals, will be able to administer prices for patents that affect everything from cellular telephony to semiconductors, but that’s what they’re proposing to do.

Unsurprisingly, the draft regs have drawn vigorous responses from various quarters, starting with big patent holders like Qualcomm (who practically wrote the book on IP licensing) and Nokia. Joining the chorus are U.S. Senator Chris Coons, who chairs the relevant subcommittee of the Senate Judiciary Committee, and U.S. Secretary of Commerce Gina Raimondo, both of whom are rightly concerned about how this would damage the competitiveness of U.S. and European firms—to the benefit of China.

There’s still a little time to get it right, but the EU needs to use the current comment period to listen to all the relevant stakeholders, climb down from what right now is a flatly unreasonable approach to SEPs and find a new path forward.

Why SEPs matter so much

As the name implies, SEPs are essential chunks of IP used in technology development, for example in 5G networks. So whatever the EU decides about how it handles SEPs will carry enormous implications for both the organizations that develop fundamental IP (the inventors) and the companies that put those innovations to use (the implementers). If we stick with the mobile connectivity example, the inventors include companies like Qualcomm, Nokia and Ericsson, while the implementers include both smartphone makers—with Apple at the head of the list—and other manufacturers such as automakers.

SEPs are a notoriously complex area of IP, which is reflected in the EU’s own recently-published report about the challenges involved in SEP licensing. That long, detailed study was written by a panel of European and U.S. experts on IP and covers many associated topics in depth. The corresponding regulations benefited from a couple of years’ worth of meetings that took input from the various stakeholders in the industry.

One of the good things to emerge from that collective effort is a new user-friendly database that clarifies exactly which inventors hold which patents. This is a laudable effort that helps implementers, including smaller ones like auto parts suppliers, to find out which IP they will need to license for a specific device and which company they will need to license it from. Both inventors and implementers contributed to the project, and ultimately all parties will benefit from having this new database.

Unfortunately, that collaborative working environment came under immense scrutiny at the end of April when the EU changed its tune abruptly. All the complexity and nuance of SEPs, plus the years of cooperative input from everyone, didn’t stop the EU commissioner responsible for IP, Thierry Breton, from coming out with guns blazing against the inventors when he announced the draft regulations. Without naming names, he accused at least some of the patent-generating companies of acting in “bad faith” and operating as “de facto monopolies”—which he intends to “bust.”

The EU tries to regulate SEPs far beyond Europe

The sudden shift in tone obviously isn’t a great way to make friends. Neither is the EU’s assertion of its authority to unilaterally set a fair, reasonable and nondiscriminatory (FRAND) price for each patent that comes under its jurisdiction. As a practical matter, SEP license agreements are negotiated between companies on a global basis. So, for example, if Apple needs to incorporate some of Qualcomm’s IP into a new iPhone model, the two companies sit down, work out a price that’s in line with the market rate and then go on about their business. Sure, there are lots of factors that come into play, and of course there are various legal avenues to pursue if someone believes they’re being cheated. Indeed, observers of this industry will immediately recall that Qualcomm did exactly that when it sued Apple across multiple jurisdictions for misusing its IP. (Apple initiated the legal spat and ultimately settled for a large sum.) But fundamentally it’s a market-driven transaction.

With the proposed new regulations, however, the EU looks like it’s engaged in a power grab to become not just Europe’s but the world’s central rulemaking authority for SEPs, specifically because it wants to set the single most important term of any deal: the price. It wants to do that by setting royalty rates for patents. Then it wants to determine who’s being a good actor or a bad actor—and “bust” the bad ones. And it wants the whole world to fall in line with whatever it decides.

Set aside for a moment the patent holders who stand to be unfairly harmed by the regulations. It’s no wonder that lawmakers in the U.S., the U.K. and other jurisdictions are likewise up in arms.

Likely impacts if the EU regulations go ahead

Another complaint from the inventor side is that the regulations don’t address the issue of “hold-out,” which happens when an implementer uses IP but withholds payment for it. This practice favors implementers because it allows them to delay payment, sometimes to the point that they can force the patent holder to accept a lower price than it otherwise would have.

Hold-out has been a significant thorn in the side of SEP holders for years, but Breton’s comments when the draft regulations were announced didn’t address it. Nor did he extend his criticism to implementers in any other ways, which only reinforced the message that he sees patent holders as bad actors in the SEP arena. So it makes sense to extrapolate that Apple, the automakers and other implementers would benefit from the proposed new regulatory regime.

Meanwhile, there are plenty of downsides to go around for everyone else. Categorically, the new regs are too invasive in terms of price-setting, and both Breton’s statements and the wording of the regulations themselves make it clear that patent holders will be on the firing line. I’ve also seen analyses from longtime IP watchers who believe that the new rules probably won’t even reduce litigation. On top of that, I understand that one of the judges for the EU’s brand-new Unified Patent Court (UPC)—which only began to operate on June 1—has criticized the proposed regulation for effectively taking a key point of jurisdiction away from the UPC even before the court has gotten off the ground.

In the bigger picture, Senator Coons, Secretary Raimondo and their counterparts in the U.K. and elsewhere are right to worry about sustaining the competitiveness of tech-driven businesses in their countries. To be clear, those who are concerned about this include many business leaders within the EU itself who see the writing on the wall for what slow, non-market-driven price-setting, not to mention the regulations’ other shortcomings, would do to weaken the environment for technological innovation there.

Building great technology is hard enough when regulatory regimes are streamlined and compliance costs are low. Commissioner Breton has said some nice things about encouraging patent-protected innovation, but I don’t think he registers just how chilling it will be if these regulations go into effect. Why would people want to risk their capital to start a company and invent a groundbreaking product if they can’t set a fair market price on that product? Far from fostering the kind of environment where innovation can thrive, these rules will inject higher transaction costs (more lawyers etc.) and more uncertainty into doing business in the EU.

You have to think that’s an unintended consequence of the new regs. But being unintended will be little consolation when the rules work to undercut the innovation, especially among SMEs, that the EU says it wants to promote.

For the parts that ain’t broke — don’t fix them

That study on the challenges involved in SEP licensing that I mentioned earlier? It concluded, in a nutshell, that those challenges were not severe enough to discourage either inventors or implementers from participating in the current system. So why the sudden push to completely reframe the way SEPs and FRAND determinations are handled?

Not to be hyperbolic, but centralized price-setting died out in Europe with the collapse of the Soviet Union—and good riddance. Nobody needs a top-down, government-driven rate-setting scheme, especially when the current system has worked for decades. Seriously- has price setting ever done well for any country long-term?

Improvements like the new transparency database and the creation of the UPC are welcome, because they stand to make the whole system run smoother. But if a major revision to the fundamental rules of engagement was in order, the best time to handle that would have been during the drafting phase, when all the relevant parties could engage in constructive dialogue.

Next steps for SEP holders

Qualcomm is Exhibit A of a company that has used patent R&D and licensing to drive innovation while building a great, durable business. I had the chance to get a refresher on the Qualcomm business model with some of its leadership team a few months ago, and it’s clear to me that their approach to licensing sets the industry standard. They’ve also worked hard to support a collaborative process for the new EU regulations, and from talking with them more recently I can tell they’re as stymied as I am by the direction that the EU has now taken.

You can bet that the EU regs will be top-of-mind for the IP experts gathered at the IPBC Global 2023 conference in San Diego that starts on June 12. Two senior executives for Qualcomm, John Han and Bob Giles, will be speakers at the event. (Han is general manager of Qualcomm Technology Licensing, while Giles is Qualcomm’s chief IP counsel.) I’m going to follow up after the event with them and other attendees to find out what’s the latest thinking on these EU regulations from the IP experts who deal with these issues in the real world.

Meanwhile, I’m frustrated to see another installment in the recent sequence of regulators who seem to lack an understanding of how business genuinely works, what motivates people, how markets are created and how they die. Why would any company invest tons of money, ever, in SEP-creating research for market-forces to be cast aside and set by bureaucrats who have never run a business themselves?

I hope that the EU regulators will do the right thing with SEPs—or maybe it will come down to members of the European Parliament who are motivated to get to the bottom of the issue. One way or another, what we need is a balance between the companies that invent technology and the companies that implement it into their products.

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