« 27 | Main | Advanced »

April 21, 2009

Peeing on the Pool

Four companies pooled patents covering the industry standard for music and data CDs. The standard, set in the early 1990s, was codified in the "Orange Book." The Orange Book standard created compatibility for CD readers and writers, thus creating a single market. Consumers could buy CDs, knowing that they would work with any player, because of the Orange Book standard. If you want to manufacture a CD writer, you have to first pop to the one-stop shop for a patent pool license.

Princo v. International Trade Commission (ITC) and U.S. Phillips (CAFC 2007-1386)

Widespread marketplace acceptable of media technologies has repeatedly faltered because the major players in the industry didn't line up under a single banner. Back in the 1960s, music cassettes versus cartridges. In the 1970s, videotape VHS versus (Sony) Beta. Sony lost; VHS won. In the early 1990s, DVDs. Just recently, in HDTV DVDs, where, in a reverse from the videotape scrape, Sony prevailed with its Blu-Ray standard.

In the early 1990s, the companies agreed to pool their Orange Book-related CD-R and CD-RW patents. In return for a share of royalties from the pool, Sony, Taiyo Yuden, and Ricoh authorized Philips to administer the pool and to grant package licenses of their pooled patents to manufacturers interested in producing Orange Book compliant compact discs. Philips made available a joint license to the pooled CD-R patents held by Philips, Sony, and Taiyo Yuden and a joint license to the pooled CD-RW patents held by Philips, Sony, and Ricoh. Licensees desiring to produce Orange Book discs could choose one of the packages offered by Philips; licenses to individual patents were not offered. The package licenses required a manufacturer to pay a per-disc royalty on each compact disc produced using at least one licensed patent. The per-disc royalty did not vary depending on which or how many features covered by licensed patents were actually used to produce the disc, "meaning that licensees must pay a royalty based on the number of discs manufactured regardless of how many of the patents are actually used in the manufacturing." Philips III, 478 F.3d at 1348.

Princo enrolled in 1997, then balked, "ceased paying royalties soon thereafter." Princo insinuated itself into a Phillips complaint before the ITC.

Although it initially contested the issue of infringement, Princo now admits that its products are within the scope of Philips's patents. Instead, Princo asserts patent misuse by Philips as a defense. Before the Commission, Princo argued that Philips improperly expanded the scope of its statutory patent rights through price fixing, price discrimination, and the use of mandatory package licensing to force manufacturers to take licenses to "nonessential" pool patents in order to obtain licenses to pool patents that were in fact essential to the manufacture of CD-Rs or CD-RWs. The administrative law judge ("ALJ") agreed, ruling that the Philips patents were unenforceable due to patent misuse per se and under the rule of reason. See In re Certain Recordable Compact Discs & Rewritable Compact Discs, No. 337-TA-474, slip op. at 219-20 (Int'l Trade Comm'n Oct. 24, 2003) ("Initial Determination"). With regard to per se misuse, the ALJ determined that Philips and other pool members fixed prices at higher than competitive levels and charged excessive royalties that would drive manufacturers out of the market, and that Philips committed improper price discrimination by exempting favored disc manufacturers from paying royalties. With regard to misuse under the rule of reason, the ALJ found that anticompetitive effects flowed from the inclusion of nonessential patents in the mandatory package licenses and from the excessive fixed royalty rates set by the pool.

In other words, Princo accused Phillips of misuse through price discrimination among different companies, and from excessive license payments because nonessential patents were included in the pool.

One particular Sony patent, by Lagadec (4,942,565), proposed an analog solution to getting a guide track for writing CDs. The Orange Book standard followed a different, digital method, covered by Phillips patents, inventor Raaymakers (4,999,825 and 5,023,856). Yet Lagadec was part of the patent pool. But licensees could not use the digital Lagadec method under the license. They had to use the Raaymakers analog method.

The full ITC commission narrowed the charge, finding that Phillips had an illegal tying arrangement because the mandatory pool license included four nonessential patents. Nonessential "because for the technology covered by each patent a non-infringing, "economically viable[] alternative technology existed" that could be used to create an Orange Book compliant disc. Id. at 61."

Princo appealed the ruling. The CAFC reversed and remanded. On remand, the ITC found Phillips off the hook and Princo infringing.

The case law backdrop on patent misuse -

Patent misuse is an equitable defense to patent infringement. It was designed "'to restrain practices that did not in themselves violate any law, but that drew anticompetitive strength from the patent right, and thus were deemed to be contrary to public policy.'" Philips I, 424 F.3d at 1184 (quoting Mallinckrodt, Inc. v. Medipart, Inc., 976 F.2d 700, 704 (Fed. Cir. 1992)). The key inquiry in determining whether a patentee's conduct constitutes misuse "'is whether, by imposing conditions that derive their force from the patent, the patentee has impermissibly broadened the scope of the patent grant with anticompetitive effect.'" Id. (quoting C.R. Bard, Inc. v. M3 Sys., Inc., 157 F.3d 1340, 1372 (Fed. Cir. 1998)). Experience has taught that some practices, such as when a patentee having market power conditions a license upon the purchase of a separate, staple good, are sufficiently anticompetitive so as to warrant condemnation on their face. Va. Panel Corp. v. MAC Panel Co., 133 F.3d 860, 869 (Fed. Cir. 1997) (discussing examples of per se misuse).6 Other allegedly-anticompetitive practices beyond the few specific practices identified by the courts as constituting misuse per se are evaluated under the rule of reason to determine whether they "impose[] an unreasonable restraint on competition." Id.; see also Philips I, 424 F.3d at 1185.

6 Congress has created a safe harbor in 35 U.S.C. § 271(d)(5) for certain types of conduct by patentees lacking market power. See Ill. Tool Works Inc. v. Indep. Ink, Inc., 547 U.S. 28, 41-42 (2008). In the present case, "the Commission found that Philips has market power in the relevant market and that section 271(d)(5) is therefore inapplicable." Philips I, 424 F.3d at 1186.

Princo had two arguments on appeal.

Reasonable Expectation

Princo first argues that "Philips has engaged in patent misuse by tying the Lagadec patent to the essential Orange Book patents in a manner prohibited under Philips I." Appellants' Br. 48. Princo's primary contention is that through mandatory package licensing, Philips improperly used its market power to force manufacturers seeking patents essential to the production of Orange Book compliant discs to also take a license to Lagadec, an allegedly-nonessential Sony patent.

The case law history of patent use for antitrust violation revolves around tying arrangements.

Tying arrangements have a long history in both the patent misuse and antitrust contexts. Much of the Supreme Court's early patent misuse doctrine was developed in cases involving a challenge to some form of tying arrangement. In Morton Salt Co. v. G.S. Suppiger Co., 314 U.S. 488, 490-91 (1942), for example, the Court held that a tying arrangement where the patent license was conditioned upon the purchase of a separate, staple product amounted to patent misuse, because in such a case "the patent is used as a means of restraining competition with the patentee's sale of an unpatented product." Id. at 493; see also Ill. Tool Works, 547 U.S. at 45-46 (holding that a patent alone does not confer market power necessary to show unlawful tying). Likewise, the early antitrust cases found that various tying arrangements violated the antitrust laws. See, e.g., N. Pac. Ry. Co. v. United States, 356 U.S. 1, 10-11 (1958); see also United States v. Loew's Inc., 371 U.S. 38, 44-45 (1962); United States v. Paramount Pictures, Inc., 334 U.S. 131, 156-59 (1948).

But tying can be a double-edged sword.

Although tying in many of its varied forms has potential to inflict anticompetitive harms, in more recent times it has been recognized that tying also has potential to create substantial procompetitive efficiencies. See, e.g., Ill. Tool Works, 547 U.S. at 36 ("The assumption that '[t]ying arrangements serve hardly any purpose beyond the suppression of competition,' rejected in [U.S. Steel Corp. v. Fortner Enters., Inc., 429 U.S. 610 (1977)], has not been endorsed in any opinion since."); Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 40-44 (1984) (O'Connor, J., concurring in judgment) ("Tie-ins may entail economic benefits as well as economic harms, and . . . these benefits should enter the rule-of-reason balance."); see also Herbert Hovenkamp, Mark. D. Janis & Mark A. Lemley, IP and Antitrust § 34.4, at 34-20.1 (2009) ("Typical procompetitive benefits [of patent pools] include the clearing of blocking positions, the advantages flowing from integration of complementary technologies, and the cost savings from avoiding litigation.").

The CAFC considered the Orange Book standard pool license copasetic.

In Philips I, we considered one particular form of patent-to-patent tying, where patents essential to the practice of a standardized technology (the Orange Book standard) were licensed together as a package. We concluded that "[i]n light of the efficiencies of package patent licensing and the important differences between product-to-patent tying arrangements and arrangements involving group licensing of patents," Philips's practice of package licensing essential patents together could not be condemned as misuse per se but instead should be evaluated under the rule of reason. Philips I, 424 F.3d at 1193. As we explained, the group of patents essential to practice a particular technology or standard generally may be viewed as a unified product:

If a patentholder has a package of patents, all of which are necessary to enable a licensee to practice particular technology, it is well established that the [patentholder] may lawfully insist on licensing the patents as a package and may refuse to license them individually, since the group of patents could not reasonably be viewed as distinct products.

Id. at 1196; see Hovenkamp, Janis & Lemley, supra, § 22.3 at 22-13, 14. Inclusion in a package license of essential patents to enable the practice of the particular technology by clearing blocking positions is not tying of the type that patent misuse doctrine seeks to prevent. See Philips I, 424 F.3d at 1196; Int'l Mfg. Co. v. Landon, Inc., 336 F.2d 723, 729 (9th Cir. 1964).

On the first appeal (Phillips I), the CAFC found the non-essential patents had no market value because they weren't part of the standard.

We rejected the argument that the four patents were not essential, as the record showed that those patents in fact had "no practical or realistic alternative." Id. at 1194, 1198. As a result, the tying of those four patents to so-called essential patents would have no anticompetitive effect "because no competition for a viable alternative product is foreclosed." Id. at 1194.

On the second appeal, the CAFC panel found that, because licensees might view the Lagadec as essential to the standard, there was no misuse. In other words, a reasonable expectation by a potential licensee that a patent was worthwhile, even if that was found under close scrutiny not to be the case, merits inclusion in a pool license, as it has the effect of "reducing the degree of uncertainty associated with investment decisions."

We conclude that Lagadec can qualify as an essential Orange Book patent if a license to practice Claim 6 of the Lagadec patent could be viewed as reasonably necessary to practice the Orange Book standard. We further conclude that it would have been reasonable for a manufacturer to believe a license under Claim 6 was necessary at the time the licenses were executed.

Philips I recognized that patent pools could generate procompetitive efficiencies in the form of reduced transaction costs, reduced litigation expenses, and most importantly the overall "procompetitive effect of reducing the degree of uncertainty associated with investment decisions." Philips I, 424 F.3d at 1192-93. These efficiencies are not limited to situations in which a potential pool patent is, in fact, a blocking patent. As we noted in Philips I, one of the major potential efficiencies of package licensing in the context of innovative technology is the avoidance of "uncertainty that could only be resolved through expensive litigation." Id. at 1198; see also id. at 1192 ("Package licensing can also obviate any potential patent disputes . . . and thus reduce the likelihood that a licensee will find itself involved in costly litigation."). Prohibiting the inclusion in a package license of a patent that is arguably essential, merely because it ultimately proved not to be essential would undercut, even eliminate, this potential procompetitive efficiency.

We thus think that perfect certainty is not required to avoid a charge of misuse through unlawful tying. Rather, in this context a blocking patent is one that at the time of the license an objective manufacturer would believe reasonably might be necessary to practice the technology at issue. A leading treatise has made a similar observation in the context of patent pools and cross-licensing agreements:

Indeed, even if the patents are only arguably conflicting, there are strong reasons to permit the settlement of patent disputes by means of a cross-licensing agreement. Not only will judicial economy be served and litigation costs reduced by settling such disputes, but the delay and uncertainty associated with blocking patent disputes may prevent either party from going forward with a commercial product for years while litigation is pending. Where two or more patents are arguably blocking, therefore, settling the dispute by means of cross-licensing is likely to be procompetitive.

Hovenkamp, Janis & Lemley, supra, § 3.3, at 3-36 (emphasis added); see also Roger B. Andewelt, Analysis of Patent Pools Under the Antitrust Laws, 53 Antitrust L.J. 611, 616 (1985) ("[T]he line between competitive patents and blocking or complementary patents is frequently very difficult to draw. Obtaining access to patents that appear competitive would provide assurance of access to the needed technology if a court later determines that the patents are blocking.").

Our understanding of the likely procompetitive benefits of package licensing patents which reasonably might be necessary to practice a given technology is further informed by industry practice in the analogous area of standards-setting organizations. Such organizations typically seek to reduce the uncertainty involved in developing a technological standard by requiring of their members disclosure of patents that might cover aspects of the standard being developed, because "nondisclosure . . . could put the [patentee member] in a position in which it could literally block the use of the published [standard] by any company unless the company obtained a separate license from the [patentee]." Qualcomm Inc. v. Broadcomm Corp., 548 F.3d 1004, 1013 (Fed. Cir. 2008). The standard-setting industry organization in Qualcomm did not require its members to disclose only patents actually blocking practice of the standard, however; rather, members understood the duty to require disclosure of those patents that "reasonably might be necessary to practice the [standard]." Id. at 1018 (emphasis added); see also Rambus Inc. v. Infineon Techs. AG, 318 F.3d 1081, 1100 (Fed. Cir. 2003). In the package licensing context, it may be similarly the case that a given patent that appears to be necessary ultimately may prove not to be so. But including the patent within the package license nevertheless may be procompetitive; for example, doing so may beneficially avoid "continuing disputes over whether the licensee's technology infringes certain ancillary patents owned by the licensor that are not part of the group elected by the licensee." Philips I, 424 F.3d at 1198. Indeed, as with disclosure in the standard-setting context, a major goal of package licensing is this type of avoidance of uncertainty and costly litigation.

Interestingly, part of the justification for the decision was that claim construction suffered from unsettled case law. A patent holder gets the benefit of a doubt when the court doesn't have its act together. Wish that were so with patentability, which now is horribly unsettled (Bilski).

This is especially true in light of the fact that the law of claim construction was unsettled in the late 1990s, when the licenses of which Princo complains were executed. See Philips I, 424 F.3d at 1198 (explaining that the propriety of a license generally must be evaluated as of the time when it is issued).

Blocking Competition Through Suppression

Princo had another angle: the Orange Book standard patent pool license prohibited using the digital Lagadec method. The ITC rejected Princo's argument.

[H]ere Princo contends that Philips and Sony agreed from the outset to license Lagadec, a potential competitor to the Raaymakers pool patents, in a way that would necessarily prevent it from ever becoming a commercially viable alternative technology that might compete with the Orange Book standard. The essential nature of the Lagadec patent to the Orange Book standard cannot justify the refusal to allow it to be licensed for non-Orange Book purposes. It is one thing to offer a pooled license to competing technologies;12 it is quite another to refuse to license the competing technologies on any other basis. In contrast to tying arrangements, there are no benefits to be obtained from an agreement between patent holders to forego separate licensing of competing technologies, as counsel for Philips conceded at oral argument. Oral Arg. 26:10-26:25, available at http://oralarguments.cafc.uscourts.gov/mp3/2007-1386.mp3 (Oct. 6, 2008).

Agreements between competitors not to compete are classic antitrust violations. See, e.g., Palmer v. BRG of Ga., Inc., 498 U.S. 46, 49 (1990); Otter Tail Power Co. v. United States, 410 U.S. 366, 377 (1973); United States v. Topco Assocs., Inc., 405 U.S. 596, 608 (1972). Agreements preventing patent licensing of competing technologies also can constitute such violations. Standard Oil Co., Ind. v. United States, 283 U.S. 163, 174 (1931) ("Where domination exists, a pooling of competing process patents . . . is beyond the privileges conferred by the patents and constitutes a violation of the Sherman Act."); id. at 175 ("In the case at bar, the primary defendants own competing patented processes for manufacturing an unpatented product . . .; and agreements concerning such processes are likely to engender the evils to which the Sherman Act was directed."); United States v. New Wrinkle, Inc., 342 U.S. 371, 380 (1952) ("An arrangement was made between patent holders to pool their [competing] patents and fix prices on the products for themselves and their licensees. The purpose and result plainly violate the Sherman Act."); cf. U.S. Dep't of Justice & Fed. Trade Comm'n, Antitrust Guidelines for the Licensing of Intellectual Property § 5.1 ex. 9 (Apr. 6, 1995) ("In the absence of evidence establishing efficiency-enhancing integration from the joint assignment of patent rights, the Agency may conclude that the joint marketing of competing patent rights constitutes horizontal price fixing and could be challenged as a per se unlawful horizontal restraint of trade."). Such agreements are not within the rights granted to a patent holder.

The very thrust of Princo's misuse argument is that the alleged agreement to offer Lagadec only through the joint licenses harms competition because Lagadec is non-Orange Book technology and could have been a competitive alternative to Orange Book technology.

The thrust of Princo's argument is that by agreement Lagadec was effectively suppressed; the result of that suppression was that the technology could not become a viable competitor. It cannot be the case that horizontal competitors can insulate themselves from misuse liability simply by agreeing to suppress competing technologies before they are fully developed. If that were the rule, then patentees engaging in such suppression of potential alternative technologies could never be called to account. In short, because standardization of technology and the development of patent pools are likely to occur early in the development of a given technology market, requiring stringent proof of the destruction of future competition, with its accompanying imponderables, would effectively immunize from misuse manufacturers who agree to suppress competition from alternative technologies.

While we reject the suggestion that a showing of misuse in these circumstances requires proof that an allegedly-suppressed technology was already commercially viable, the question remains as to what showing must be made to invoke the patent misuse defense. On the one hand, evidence that a suppressed technology would have been viable would be sufficient; on the other, proof that a suppressed technology could not have been viable would be sufficient to negate a charge of misuse.

A cliffhanger - what rule of thumb did the the appeals court adopt? None. They punted. Back to the ITC "for the limited purposes of determining (1) whether Lagadec was a potentially workable alternative to the Orange Book technology and (2) whether Princo has established that Sony and Philips agreed that Lagadec would not be licensed in a manner allowing its development as competitive technology."

Affirmed-in-part, vacated-in-part, and remanded.

Judge Bryson, in part dissenting, would have affirmed the ITC decision. Princo had opportunity to offer evidence of blocking competition, and failed to do so.

Posted by Patent Hawk at April 21, 2009 10:41 PM | Antitrust


The rare case of a patent misuse issue where 35 USC 271(d) is inapplicable (because the ITC found market power in the relevant market, see footnote 6 at page 10 of the slip opinion).

Posted by: EG at April 22, 2009 4:18 AM