The Evolving Standard for Patent Misuse in Patent Pools

Authored by Frank A. DeCosta III, Ph.D. and Michael D. Stone

Introduction

Industry standards can benefit product developers, manufacturers, and consumers.  Industry standards promote uniformity, which both simplifies the manufacturing process and increases the compatibility, and interoperability of products, with systems developed by others. The economies of scale and network effects promoted by industry standards have made the intellectual property underlying the standardized technology a valuable asset and the subject of substantial licensing and litigation activity. Frank A. DeCosta, III, Bradley E. Edelman, & Ariana G. Woods, Litigating Intellectual Property Covering Industry Standards, Md. State Bar Ass'n's Annual Intellectual Prop. Law Update (2009). The courts have recognized that patent pools formed by companies to provide access to standardized technology can have pro-competitive efficiencies in the form of, for example, reduced transaction costs, reduced litigation expenses, and reducing the uncertainty associated with substantial investment decisions associated with bringing new products to the market. U.S. Philips v. Int’l Trade Comm'n, 424 F.3d 1179, 1192 (Fed. Cir. 2005). 

The courts, however, have carefully scrutinized the construction and composition of patent pools to guard against arrangements that harm competition. On March 3, 2010, the Court of Appeals for the Federal Circuit heard oral arguments in a case addressing the patent misuse doctrine, in an en banc rehearing of Princo v. Int'l Trade Comm'n, 563 F.3d 1301 (Fed. Cir. 2009). The decision in this case may potentially reshape the doctrine for pooled patent licensing, especially for industry standards involving joint development.

The long-running litigation among Philips, Princo, and the ITC has lasted nearly eight years. Below is a summary of the series of decisions highlighting the evolving standard for patent misuse in patent pools that provide the foundation for the anticipated en banc decision from the Federal Circuit.

The series of cases focus upon the "Orange Book" technical standards for Recordable compact discs, particularly for the manufacture of both recordable compact discs (CD-Rs) and rewritable compact discs (CD-RWs).  The Orange Book standard ensures widespread compatibility of compact discs and includes pooled patents from multiple companies.  Philips administered the patent pool, granted patent licenses covering the standard, and collected royalties based on the number of Orange Book compliant disks produced by the licensees.

Although many patents were at issue in the original litigation before the ITC, the focus has narrowed on appeal to U.S. Patent No. 4,942,565 (the "Lagadec patent") and U.S. Patent Nos. 4,999,825 and 5,023,856 (the "Raaymakers patents").  While developing the standard, Philips and Sony collaborated on solutions to various problems. One particular problem led to Philips proposing an analog solution covered by the Raaymakers patents, while Sony proposed a solution covered by the Lagadec patent, which has been alleged to cover a digital solution. The Orange Book standard uses the analog Raaymakers patents, which are essential to disc manufacturing under the standard. The Raaymakers and Lagadec patent were included in the pool administered by Philips. The inclusion of the Lagadec patent in the package led to Princo's allegation of patent misuse through unlawful tying. Accordingly, a focus of the appeal was whether the Lagadec patent was essential to the Orange Book standard.

Princo alleged that during development of the standard, Philips and Sony agreed not to allow the licensing of the Lagadec patent to prevent it from becoming a potential competitor to the Raaymakers technology. The analysis of this alleged agreement and its effect upon patent misuse lies at the heart of the en banc rehearing. 

In 1997, Princo took a package license from Philips and thereafter ceased paying royalties. Since then, several other manufacturers also stopped paying royalties, which led to Philips filing an action at the ITC. Princo was not originally named in the action, but later intervened. U.S. Philips, 424 F.3d at 1183.

The initial ruling by the Administrative Law Judge ("ALJ") found that all six of the asserted patents were valid and infringed by Princo. Id. The ALJ also found, however, that all six patents were unenforceable due to patent misuse. The ALJ stated that Philips impermissibly tied four non-essential patents to those patents deemed essential for the manufacture of CD-Rs and CD-RWs. Id. The ITC affirmed this ruling, and since then, the case has now spanned several years, and has been the subject of three separate Federal Circuit decisions. See Princo v. Int'l Trade Comm'n, 563 F.3d 1301 (Fed. Cir. 2009); U.S. Philips v. Princo, 173 Fed. Appx. 832 (Fed. Cir. 2006); U.S. Philips v. Int'l Trade Comm'n, 424 F.3d 1179 (Fed. Cir. 2005).

Patent Misuse Doctrine

The Princo series of cases involves the equitable defense to patent infringement known as patent misuse. The defense "arose 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." Mallinckrodt v. Medipart, 976 F.2d 700, 704 (Fed. Cir. 1992). It "prevent[s] a patentee from using the patent to obtain market benefit beyond that which inheres in the statutory patent right." Id. The "key inquiry 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." C.R. Bard v. M3 Sys., 157 F.3d 1340, 1372 (Fed. Cir. 1998); Windsurfing Int'l v. AMF, 782 F.2d 995, 1001 (Fed. Cir. 1986).

The Federal Circuit in Virginia Panel v. MAC Panel summarized the principles of patent misuse as applied to "tying" arrangements. 133 F.3d 860, 869 (Fed. Cir. 1997). Depending upon the circumstances, tying arrangements may be per se patent misuse, or may be analyzed using the rule of reason. Id. Examples of tying arrangements falling under per se patent misuse include a patentee conditioning a patent license on the purchase of a separable, staple good, or a patentee extending the term of a patent by requiring post-expiration royalties. Id. at 869. Arrangements analyzed under the rule of reason are impermissible only if its effect is to restrain competition in a relevant market. Monsanto v. McFarling, 363 F.3d 1336, 1341 (Fed. Cir. 2004); Windsurfing, Int'l, 782 F.2d at 1001-1002. 

Federal Circuit Decision – U.S. Philips v. Int'l Trade Comm'n.

The first Federal Circuit decision addressing the Philips patent licenses reversed the ITC rulings on patent misuse and remanded the case to the ITC for further proceedings. U.S. Philips v. Int'l Trade Comm'n, 424 F.3d 1179, 1182 (Fed Cir. 2005). The decision touched upon four basic issues in reversing the decision.

First, the Federal Circuit found the safe harbor provision of 35 U.S.C. § 271(d)(5) inapplicable to Philips. Id. at 1186. Section 271(d) designates several specific practices that do not constitute patent misuse, including "conditioning the license of any rights to the patent or the sale of the patented product on the acquisition of a license to rights in another patent or purchase of a separate product," unless the patent owner "has market power for the patent or patented product on which the license or sale is conditioned." 35 U.S.C. § 271(d)(5) (2010). The Federal Circuit agreed with the ITC that Philips had market power in the relevant market as compact discs are unique products with no close practical substitutes.  Philips, 424 F.3d at 1186. 

The Federal Circuit next addressed Philips' contention that the ITC erred by ruling the licensing arrangement so clearly anticompetitive to be per se illegal. The Federal Circuit distinguished tying cases, obligating the purchase of a product, from merely extending a nonexclusive license to practice a patent. Id. at 1189. The court stated that a non-exclusive patent licensee simply promises not to sue for infringement and "does not obligate a licensee to do anything." Id. This sharply differs from using a patent's market power to compel purchases of separate products in order to foreclose competition. Id. at 1189. The Federal Circuit also discussed that the uniform royalty rate offered by Philips and its pro-competitive effects weighed against per se illegality. Id. at 1192. Ultimately, the Federal Circuit decided that the application of the per se rule of illegality to the licensing agreements was “legally flawed.” Id. at 1193.

Third, the Federal Circuit reviewed the ITC's finding that the "non-essential" patents constituted separate products from the "essential" patents, and the licensing agreements adversely affected competition in the market for the non-essential technology. Id. at 1194. Again, the Federal Circuit found the ITC analysis flawed. Id. "Non-essential" patents are those that have "commercially feasible" alternatives. Id. (citing Int'l Mfg. v. Landon, 336 F.2d 723, 729 (9th Cir. 1964)). "If there are no commercially practicable alternatives to the allegedly nonessential patents, packaging those patents together with so-called essential patents can have no anticompetitive effect in the marketplace, because no competition for a viable alternative product is foreclosed." Id. The Federal Circuit found the evidence did not support the existence of commercially viable substitutes. 

Lastly, the Federal Circuit reviewed the ITC's rule of reason analysis, and found it unsound for two reasons. Id. at 1198. First, the evidence did not show a negative effect on commercially available technology, and second, the ITC did not acknowledge the problems with licensing patents individually. Id. The case was reversed and remanded to the ITC.

Southern District of New York Decision – U.S. Philips v. Princo

Prior to filing a complaint with the ITC, Philips filed suit against Princo in the Southern District of New York, for patent infringement on the same six patents. U.S. Philips v. Princo, 361 F.Supp.2d 168, 170 (S.D.N.Y. 2005). In that case, Princo similarly raised the defense of patent misuse, and filed a summary judgment motion on this issue. Id. The motion was filed after the final ITC order on the same issue, though the district court noted it was "not bound by the decisions of the ALJ or the ITC." Id. at 181. The court issued a decision reaching the opposite conclusion of the ITC, and dismissed the patent misuse claim. Id. at 183.

Since Princo sought relief under 35 U.S.C. § 271(d)(5), the district court found the tying arrangement must be the type prohibited under the statute. The court concluded that the statute's unlawful tie exists when the licensor is forcing buyers to purchase a second product, therefore multiple patents covering a single product do not implicate the statute. Philips, 361 F.Supp.2d at 182. The court found the statute and its history spoke clearly of two separate products, not two separate patents covering the same product. Id. at 183. Therefore, the court decided that Philips' licensing package did not qualify as tying within the meaning of Section 271(d)(5). Philips, 361 F.Supp.2d at 183.

Princo appealed the district court's decision to the Federal Circuit. Since the previous Federal Circuit decision interpreted the same statute differently, the Federal Circuit vacated and remanded the case in a non-precedential opinion. U.S. Philips v. Princo, 173 Fed. Appx. 832, 833 (Fed. Cir. 2006). In that decision, the Federal Circuit found the district court incorrectly interpreted Section 271(d)(5) with respect to the definition for patent misuse in the context of tying arrangements. Philips, 173 Fed. Appx. at 835. Instead, quoting the Federal Circuit finding in the first Philips appeal, the Federal Circuit stated that Section 271(d)(5) "does not define the scope of the defense of patent misuse, but merely provides a safe harbor against the charge of patent misuse for certain kinds of conduct by patentees." Id. (quoting Philips, 424 F.3d at 1186). Since the district court's interpretation was inconsistent with the proper construction of the statute, the Federal Circuit vacated and remanded the decision. Id.

Second Federal Circuit Decision – Princo v. Int'l Trade Comm'n.

Several years later, the Federal Circuit found the case before it yet again. Princo v. Int'l Trade Comm'n, 563 F.3d 1301 (Fed. Cir. 2009).¹ Princo continued to argue patent misuse, using more specific grounds. Princo argued that Philips impermissibly tied a non-essential patent (i.e., the Lagadec patent) to essential Orange Book patents through its licensing agreements. Id. at 1306. Princo also alleged Sony and Philips foreclosed competition through an agreement about potentially competing technologies included in the packaged patents. Id.

With respect to the tying claim, the Federal Circuit clarified the test to determine when a patent is "essential." The framework of the test is whether at the time of the license, would an objective manufacturer have believed the licensed patent "reasonably necessary" to practice the technology at issue. Id. at 1310. Using this test, the court found it reasonable for manufacturers to believe licensing the questioned patent was necessary to practice the Orange Book standard. Id. Therefore, the Lagadec patent qualified as an "essential" patent. Id. at 1312.

The Federal Circuit next addressed the illegal agreement between Sony and Philips as alleged in Princo's patent misuse claim. Princo first raised the issue that the Lagadec patent represented an alternative technological solution to other patents in the patent package. Id. at 1313. Princo contended that Sony and Philips had agreed not to allow the Lagadec technology to become a possible competitor to the Orange Book standard, by not allowing licensing of the patent outside of the standard. Although the ITC did not address whether the alleged agreement existed, the ITC relied upon several grounds for rejecting Princo's arguments. Id. 

The ITC's first ground for denying Princo's claim was that if the Lagadec patent was a 'technically blocking patent' then no misuse results from including it in the licenses. Id. at 1314. The Federal Circuit noted that licensing blocking patents may not be a form of tying, but agreements to prevent development of alternatives might act to eliminate competition or be a form of price fixing. Id. Therefore, the ITC wrongly relied upon the Federal Circuit's decision in U.S. Philips v. Int'l Trade Comm'n, which did not consider agreements that may constitute misuse. Id. at 1315. 

The ITC also denied Princo's claim because the Lagadec technology was not a substitute technology that could be used to manufacture Orange Book compliant discs. Id. at 1316. Whether a technology could be considered competing technology was critical in this decision. The Federal Circuit found the competing technologies were commercially viable, but were not necessarily developed to viability at the time of the agreement. Id. at 1317. However, the court did not delineate where on "the continuum between 'certainly would have been viable' and 'certainly could not have been viable'" the standard lies. Id. at 1319. The court remanded to the ITC the questions of whether the Lagadec patent represented competing technology and whether Sony and Philips agreed to not license the Lagadec patent in a manner allowing its development as competing technology. Id. at 1321. 

The Rehearing En Banc and the Key Questions

When granting the en banc rehearing in Princo v. Int'l Trade Comm'n the Federal Circuit focused the parties on supplementing their briefing primarily on the alleged agreement between Philips and Sony. 583 F.3d 1380, 1381 (Fed. Cir. 2009). Among other issues, the rehearing was to address whether to treat the alleged agreement between Sony and Philips as per se illegal, or to analyze it under the rule of reason. In its brief, Philips argued that any agreement not to license separately is a "classic example of a facially reasonable ancillary restraint that facilitates a precompetitive joint venture." Brief of Intervener U.S. Philips Corporation on Rehearing En Banc at 19 (Fed. Cir. Nov. 30, 2009). Philips' argument was that a per se approach is inappropriate, and only a rule of reason approach is warranted. A rule of reason analysis requires a definition of the relevant market and analysis of whether any competitive harm occurred within that market. The Federal Trade Commission ("FTC") filed an amicus brief in support of neither party, and the reasoning within the brief represents the opposite end of spectrum. Brief of Amicus Curiae Federal Trade Commission on Rehearing En Banc Supporting Neither Party at 26 (Fed. Cir. Feb. 16, 2010). The FTC views the agreement as "inherently suspect" and presumptively unreasonable. The FTC would place the burden on the patent holder to prove the agreement "reasonably necessary to further the development of new technologies or other precompetitive ends" in order to escape condemnation. Id.

With the issues now narrowly focused, the Federal Circuit now has a prime opportunity to clarify patent misuse law and remove a cloud that has surrounded patent pools for the several years of pendency of this litigation. Because standard-setting organizations and joint development projects often make difficult choices between potentially competing technologies, the forthcoming en banc Federal Circuit decision will likely have a far reaching effect.

Endnotes

¹ Although this decision was vacated by the Federal Circuit's October 2009 order granting Philips' petition for rehearing en banc, the opinion of the panel is a useful look into the issues that will be facing the court during the rehearing.

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