FEDERAL CIRCUIT HOLDS EN BANC REHEARING OF PATENT MISUSE CASE AFFECTING PATENT POOLS AND OTHER JOINT VENTURES

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1 CLIENT MEMORANDUM FEDERAL CIRCUIT HOLDS EN BANC REHEARING OF PATENT MISUSE CASE AFFECTING PATENT POOLS AND OTHER JOINT VENTURES On March 3, 2010, the U.S. Court of Appeals for the Federal Circuit heard oral arguments in the en banc rehearing of Princo Corp. v. International Trade Commission, 1 a decision that addressed whether certain licensing practices related to a patent pool involving several companies compact disc-related patents constitute patent misuse. The Federal Circuit s decision has potentially significant implications for patent holders that want to license their patents through pools for use in industry standards, or to engage in other joint conduct concerning related patent rights. An overview of this notable case and its implications are provided immediately below. A more detailed discussion of the case then follows. Overview Princo involves a patent pool administered by U.S. Philips Corporation ( Philips ) relating to the Orange Book standard for recordable and rewritable compact disc technology that was developed by Philips, Sony, and other companies. Philips sued Princo Corp. ( Princo ) for infringement at the International Trade Commission (the Commission ). The Commission held that Princo infringed six Philips patents and rejected Princo s patent misuse defense. Princo alleged that Philips committed patent misuse based on two theories: (1) that Philips included a Sony patent (the Lagadec patent ) that was not essential to the standard in the Orange Book patent pool along with Philips patents that were essential to the standard (the tying theory ); and (2) that Philips agreed with Sony not to license the Sony patent for use in technologies that compete with the Orange Book standard (the price-fixing theory ). The Federal Circuit panel decision, now being reviewed en banc, held that Philips did not commit patent misuse based on the tying theory because the Sony patent was essential to the standard. In so ruling, the court created a new test for determining essentiality: a patent is essential if it could have been viewed as reasonably necessary to practice the standard at the time the licenses were executed. That definition of essentiality could make it more difficult for alleged infringers to succeed on patent misuse defenses based on tying theories. Regarding the price-fixing theory, however, the panel majority remanded to the Commission to determine whether Philips committed misuse. The Federal Circuit panel decision found that an agreement between competitors not to license patents for use outside the pool could constitute misuse if it potentially foreclosed competition. The court directed the Commission to determine (1) whether the Sony patent could have contributed to a viable alternative to the Orange Book standard and (2) whether there was an agreement between Philips and Sony not to license the 1 Princo Corp. v. Int l Trade Comm n, 563 F.3d 1301 (Fed. Cir. 2009) ( Princo ), reh g en banc granted, 583 F.3d 1380 (Fed. Cir. Oct. 13, 2009). An audio file of the oral argument is available at NEW YORK WASHINGTON PARIS LONDON MILAN ROME FRANKFURT BRUSSELS in alliance with Dickson Minto W.S., London and Edinburgh

2 Sony patent for use in a technology that competed with the standard. Circuit Judge Bryson, dissenting in part, would have rejected Princo s price-fixing theory because Princo did not prove any actual harm to competition. The Federal Circuit granted the petitions for rehearing en banc filed by Philips and the Commission and asked for briefing from the parties addressing primarily the price-fixing portion of the panel decision. The Federal Circuit denied Princo s petition, which was directed primarily to its tying theory. The New York Intellectual Property Law Association (the NYIPLA ) and the Intellectual Property Owners Association (the IPO ) filed briefs amici curiae supporting Philips. The American Antitrust Institute (the AAI ) filed a brief amicus curiae supporting Princo. The American Intellectual Property Law Association (the AIPLA ) and the U.S. Federal Trade Commission (the FTC ) filed briefs amici curiae in support of neither party. During oral argument, the en banc court addressed many of the issues that had been raised in the briefs amici curiae, including: (1) whether the panel decision would have a chilling effect on standard-setting activities, given that companies involved in standard setting almost always make choices between different technologies; (2) whether Princo needed to prove that it actually wanted to license the Sony patent for a use that competed with the Orange Book; (3) whether an agreement of the type alleged should be considered inherently suspect ; and (4) whether the panel decision, if adopted, would be an extension of Federal Circuit law relating to patent misuse. Possible Implications Of The Forthcoming Decision The Federal Circuit s en banc decision could have significant implications for patent holders that want to license their patents through patent pools or to participate in other forms of collaboration. If the full court upholds the tying portion of the decision, Princo could make it harder for an infringer to assert a successful misuse defense based on a tying theory. The panel decision enunciated a fairly low standard for determining if a patent is essential to a standard. A patent qualifies as essential if an objective manufacturer would have believed the patent (or at least one of its claims) was reasonably necessary to practice the pool technology at the time of the license. That standard for identifying essential patents also could have implications for patent holders outside of the patent-pool context. For example, the anticompetitive effects of patent settlements can hinge on whether the patents at issue are blocking (i.e., essential ) patents for the settling parties. By providing a low standard for essentiality, the Federal Circuit decision could make it harder for challengers to prove that a license or cross-license entered into as part of a settlement agreement is anticompetitive. 2 If the full court upholds the price-fixing portion of the decision, Princo likely would increase the risks for patentees who license their patents for exclusive use, including as part of a patent pool. 2 Indeed, the comments in the leading treatise cited by the Federal Circuit for support relate to the identification of blocking patents in patent settlement cross-license agreements. See id. at

3 The panel majority stated that, [i]n contrast to tying arrangements, there are no benefits to be obtained from an agreement between patent holders to forego separate licensing of competing technologies. 3 This statement raises the question of whether and how parties to such an agreement may be able to rely on the logic of antitrust precedents that allow joint venturers to agree not to compete against the venture to avoid having one venturer free ride on the efforts of the others. Unless and until the full court decides otherwise, patent holders that want to collaborate in licensing patents should proceed with caution before agreeing to any restrictions. The panel decision arguably exposes any exclusive patent licensing arrangement, or other agreement not to compete against a patent pool or other joint venture, to attack for patent misuse. The panel decision also highlights the potentially harsh consequences for patentees that commit misuse. The panel opinion could be read to hold that a patent holder may be guilty of misuse for agreeing not to license its patent outside the pool, even if there is no evidence that anyone wanted such a non-pool license. Further, the panel opinion can be understood to say that an agreement not to license one essential patent in the pool for a competing use could make the entire pool unenforceable against all potential infringers until the misuse is purged. Even if the full court reverses the panel decision on the price-fixing theory, that decision likely will not change the general rule that unenforceability is the penalty for patent misuse. Background During the late 1980s and early 1990s, Philips and Sony jointly developed a standard relating to recordable compact discs ( CD-Rs ) and rewritable compact discs ( CD-RWs ) called the Orange Book standard. In establishing the standard, Philips and Sony agreed to pool their patents relating to the standard and allow Philips to administer the pool. Philips sued Princo before the Commission after Princo ceased paying royalties under a package license with Philips covering the Orange Book patents. Princo admitted that its products were within the scope of Philips patents, but asserted patent misuse by Philips as a defense. As part of its misuse defense, Princo alleged that Philips forced manufacturers to take licenses to nonessential pool patents to obtain licenses to essential pool patents. The Commission initially agreed with Princo, finding that Philips committed misuse by tying four nonessential patents. The Federal Circuit reversed the Commission in Philips v. International Trade Commission, holding that Philips s inclusion of those four patents in the package license was not misuse, and remanded to the Commission to address Princo s remaining theories of misuse. 4 On remand, Princo asserted misuse arguments regarding Sony s Lagadec patent. The Lagadec patent and two Philips patents (the Raaymakers patents ) relate to mechanisms for guiding a laser when it is writing data to an unrecorded CD-R or CD-RW. Philips developed an analog solution, while Sony developed a digital solution. The two methods are incompatible with each other, and a disc made using one approach will not work in a CD recorder designed to read information encoded using the other approach. 5 3 Id. at U.S. Philips Corp. v. Int l Trade Comm n, 424 F.3d 1179, (Fed. Cir. 2005). 5 Princo, 563 F.3d at

4 Philips and Sony defined the Orange Book standard to use the analog approach developed by Philips. Nevertheless, licenses to the Raaymakers and Lagadec patents were all included in the Orange Book patent pool. The licenses offered by Philips allowed the pooled patents, including the Lagadec patent, to be used only to produce Orange Book compliant discs. The licenses thus did not grant the right to use the Lagadec patent to produce a disc using the digital method. 6 Patent Misuse Based On Princo s Tying Theory The unanimous panel decision in Princo held that inclusion of the Lagadec patent in the pool did not constitute misuse based on Princo s tying theory. The court found that claim 6 of the Lagadec patent, which is broader than the digital method that is generally taught by that patent, could have been seen as a blocking patent to the Orange Book standard. 7 The court concluded that it would have been reasonable for a manufacturer to believe that a license to claim 6 was necessary at the time the licenses were executed, and thus the Lagadec patent is essential. 8 The court noted that many procompetitive efficiencies can be generated by patent pools, including reduced transaction costs, reduced litigation expenses, and reduced uncertainty associated with investment decisions. 9 The court explained that prohibiting the inclusion of an arguably essential patent because it might ultimately prove not to be essential would undercut or eliminate those efficiencies. The court clarified the standard for determining whether a pool administrator can include a patent in a package license without committing misuse: [P]erfect 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. 10 Patent Misuse Based On Princo s Price-Fixing Theory The majority of the original panel held that Princo s price-fixing theory could have merit. The court understood Princo s claim to be (1) that the Lagadec patent represented or could have represented an alternative technological solution to the Raaymakers patents and (2) that Philips and Sony agreed not to license the Lagadec patent for use in a competing technology. 11 The majority found that Philips alleged behavior could constitute misuse under the rule of reason Id. at Id. at Id. at Id. at Id. 11 Id. at Id. at Because the practice could violate the rule of reason, the majority did not determine whether or not the alleged licensing practices should be evaluated under a per se rule. Id. at 1314 n

5 The majority explained that the Lagadec patent s status as a blocking patent, which immunized its inclusion in the pool, could not immunize an agreement not to compete. 13 The majority said that the essential nature of the Lagadec patent to the Orange Book standard could not 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; it is quite another to refuse to license the competing technologies on any other basis. 14 The majority observed that agreements between competitors not to compete are classic antitrust violations and that agreements that prevent licensing of patents to competing technologies can also be violations. 15 The majority found that, in contrast to other conduct that can produce efficiencies (including patent pools and mergers), the alleged agreement was unlikely to have any efficiencies that could not be achieved equally well through a non-exclusive agreement. 16 The majority discussed the extent to which the Lagadec patent must present a potentially viable alternative technology in order to find misuse. Philips argued that the Lagadec patent must have been developed to the point of commercial viability before misuse could be found. The court disagreed, saying that the rationale of Princo s price-fixing theory is that Philips and Sony suppressed the technology taught by the Lagadec patent so that it could not become a viable competitor. The majority said that horizontal competitors cannot insulate themselves from misuse liability simply by agreeing to suppress competing technologies before they become commercially viable. 17 Because standardization and development of patent pools often occur early in the development of a technology, requiring stringent proof of commercial viability would effectively immunize manufacturers who agree to suppress competition from alternative technologies. 18 The majority presented four considerations to bear in mind in determining the appropriate standard under the rule of reason. First, the fact that a patent s disclosed embodiments may not be commercially viable cannot be dispositive because [t]echnology disclosed in a patent typically needs to be further developed before a viable commercial embodiment is possible. 19 Second, it may be difficult to show that the patented technology would or would not be commercially viable in the absence of market incentives to commercialize the technology. 20 Third, even a faulty technology may provide some meaningful competition. 21 Fourth, there are no benefits to be achieved from suppression of potentially competing technology and thus there would be no harm to competition from adopting a protective rule Id. at Id. at Id. 16 Id. at 1315, Id. at Id. at Id. 20 Id. 21 Id. 22 Id

6 The majority did not make a final determination, however, of what showing must be made to invoke a misuse defense. Instead, the majority remanded for the Commission to decide, in the first instance, where on the continuum between certainly would have been viable and certainly could not have been viable the appropriate standard lies and whether the evidence presented by Princo satisfies that standard. 23 The majority also remanded to the Commission to determine if there was an agreement between Philips and Sony not to license the Lagadec patent as competing technology. If not, there would be no misuse under Princo s price-fixing theory. 24 Arguments Presented By Amici Curiae The price-fixing portion of the decision was addressed by numerous amici curiae, who presented arguments primarily relating to the appropriate legal standard, which party should bear the burden of proof, and whether proof of actual competitive harm is necessary. All amici curiae agreed that collaborative standard-setting activities can generate efficiencies and be procompetitive, and thus they all suggested that the court evaluate the alleged agreement using some version of the rule of reason. However, the amici curiae differed widely on what the legal standard should be. At one end of the spectrum, the NYIPLA argued that the agreement in issue is vertical and procompetitive and should be presumptively lawful. At the other end of the spectrum, the AAI argued that the alleged agreement is an inherently suspect horizontal agreement that is presumptively unreasonable. Perhaps most interesting is the FTC position, which criticized the majority for failing to recognize that agreements like the one at issue could create efficiencies. The FTC explained that an agreement not to license patents for use outside of the pool could be justified if it was reasonably necessary to achieve an efficient collaboration. The FTC s approach, which relies heavily on the D.C. Circuit s 2005 decision in Polygram, 25 is very fact-specific and depends in large part on the timing of the agreements (1) to collaborate and (2) to restrict competition. If the latter agreement was necessary ex ante to facilitate the former, then it might be justified. In contrast, if the agreement to restrict was entered ex post, after the agreement to collaborate, then it is inherently suspect. The FTC also disagreed with the dissent s standard for finding competitive harm. The FTC explained that an agreement between competitors to suppress a nascent alternative technology could be condemned without proof that such technology necessarily could have been commercialized. The FTC took the same position as the AAI that the agreement is inherently suspect, and would place the burden on the patent holder to prove that the agreement was reasonably necessary to achieve the procompetitive efficiencies of the pool collaboration. 23 Id. at Id. at Polygram Holding, Inc. v. FTC, 416 F.3d 29 (D.C. Cir. 2005), aff g Polygram Holding, Inc., 136 F.T.C. 310 (2003)

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