September 1, 2010 Litigation and Licensing

Federal Circuit Rejects Broad Application of Patent Misuse Doctrine

SUMMARY On August 30, 2010, the Federal Circuit issued a significant decision rejecting a broad application of the doctrine of patent misuse as a defense to patent infringement. In Princo Corporation v. International Trade Commission, No. 2007-1386, the United States Court of Appeals for the Federal Circuit ruled en banc that the misuse doctrine did not apply to a purported agreement between two companies engaged in a joint patent licensing program for recordable compact discs to prevent one of the companies from separately licensing a patent in the joint program for other allegedly competing technologies. The opinion notes that patent misuse is a “narrow” doctrine that should not be applied expansively in derogation of a patentee’s statutory right to prevent infringement. The court emphasized that the patentee has the right to impose a broad range of conditions on licensees, and reaffirmed that the misuse doctrine is confined to conduct involving the leveraging of an asserted patent in a manner that exceeds the scope of the patent grant with anticompetitive effect.

In sum, the Federal Circuit rejected several possible expansions of the patent misuse doctrine and clarified pre-existing law by:

• affirming and clarifying prior rulings that patent misuse must be based on conduct relating to the asserted patent(s) themselves, e.g., there generally is no “parallel” misuse whereby misuse of patent “x” that is not asserted results in the unenforceability of patent “y” that is asserted; • reaffirming that patent misuse requires a showing of anticompetitive effect; and • rejecting the argument that the prior case law or amendments to the Patent Act suggest that a refusal to license for competing technology by horizontal competitors constitutes misuse, absent anticompetitive effect with respect to the asserted patents. The decision adds greater certainty to the enforceability of patent rights and provides guidance on acceptable licensing practices for companies engaged in technology development, standard setting and patent licensing.

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BACKGROUND The doctrine of patent misuse is a judge-made defense to patent infringement that can render patents unenforceable until the misuse is “cured.” In cases dating back to the early 1900s, the Supreme Court has applied the doctrine to preclude enforcement of patents when, among other things, a patent holder has conditioned the sale or licensing of a patented device on the purchase of unpatented articles from the patent holder or sought to impose a royalty that continued after the expiration of the licensed patent. The doctrine generally precludes patent holders from imposing anticompetitive conditions in a license that would allow the patent holder to exceed the “physical or temporal scope” of the patent grant. The doctrine distinguishes between per se misuse (such as charging royalties on expired patents), which is presumed anticompetitive, and conduct evaluated under the “,” which requires proof of restraint of unlawfully in a defined .1 As stated in the Federal Circuit’s decision, “the doctrine of patent misuse is . . . grounded in the policy-based desire to ‘prevent a patentee from using the patent to obtain market benefit beyond that which inheres in the statutory patent right.’”2 Thus, “[w]hat patent misuse is about, in short, is ‘patent leverage,’ i.e., the use of the patent power to impose overbroad conditions on the use of the patent in suit that are ‘not within the reach of the granted by the Government.’”3

In the 1980s and 1990s, Philips and Sony promulgated a technical standard for the manufacture of recordable and rewritable compact discs (“CR-R/RWs”). Philips and Sony (with others) also agreed to jointly license their patents necessary to manufacture standardized CD-R/RWs in a single uniform license administered by Philips.

In 2002, Philips filed a complaint with the International Trade Commission (“the ITC” or “the Commission”) alleging that numerous unlicensed importers of CD-R/RWs, including Princo, were violating 19 U.S.C. § 1337 by importing discs into the United States that infringed Philips’ patents. After a trial in 2003, an ITC administrative law judge determined that the asserted Philips patents were valid and infringed, but found that the patents were unenforceable based on various theories of patent misuse, including that Philips’ package licensing practices constituted anticompetitive , , price discrimination and

1 Although the patent misuse doctrine is closely related to antitrust law in several respects, a full discussion of which is beyond the scope of this note, the Federal Circuit’s decision makes clear that anticompetitive conduct that may not implicate the misuse doctrine (for example, because it does not involve the leveraging of an asserted patent) may nonetheless violate antitrust laws. See generally slip op. at 24-29. Conversely, the antitrust laws have their own doctrinal limitations, such as the requirements of antitrust standing and injury. 2 Slip op. at 17-18 (quoting Mallinckrodt, Inc. v. Medipart, Inc., 976 F.2d 700, 704 (Fed. Cir. 1992)). 3 Id. at 24 (quoting Zenith Radio Corp. v. Hazeltine Research, Inc., 395 U.S. 100, 136-138 (1969)). -2- Patent Litigation and Licensing September 1, 2010

restraint of trade. The Commission affirmed the administrative law judge’s misuse determination based on tying, but declined to address the remaining bases for the misuse holding.4

In 2005, that determination was reversed in U.S. Philips Corp. v. Int’l Trade Comm’n, 424 F.3d 1179 (Fed. Cir. 2005). The Federal Circuit there held that the inclusion of so-called “nonessential” patents in a package license did not constitute misuse where the licensees had the option of using any of the arguably necessary patents in the package license and Philips charged a uniform fee to permit the manufacture of discs regardless of which patents were used. On remand, the Commission rejected the remaining theories of misuse and entered a general exclusion order precluding the importation of CD-R/RWs into the United States by Princo and other unlicensed companies. Princo appealed. In Princo Corp. v. Int’l Trade Comm’n, 563 F.3d 1301 (Fed. Cir. 2009), a split Federal Circuit panel affirmed the Commission’s determination in part, but vacated and remanded for a determination of whether Philips had committed misuse by agreeing with Sony to prevent the separate licensing of a Sony patent included in the CD- R/RW licensing program for use in technologies that purportedly could compete with the standardized CD-R/RWs. The Federal Circuit then granted the petitions of Philips and the Commission for rehearing en banc of the portions of the panel majority’s opinion remanding the case to the Commission.5

THE FEDERAL CIRCUIT’S OPINION The Federal Circuit’s en banc opinion addressed whether Philips’ alleged agreement with Sony to “suppress” the introduction of a claimed alternative to CD-R/RW technology by refusing to license a Sony patent for uses other than CD-R/RWs constituted patent misuse. The opinion of the court provided two alternative bases for holding that such an agreement would not constitute misuse and “immunize Princo against the legal effects of its acts of infringement.”6

Conduct Must Be With Respect to the Patent-In-Suit. First, the Federal Circuit rejected outright Princo’s contention that the alleged agreement between Philips and Sony not to license a certain Sony patent that was not in suit could constitute misuse of Philips’ patents. The court emphasized that “the key inquiry” under the patent misuse doctrine is whether, by imposing a condition on the licensing or use of a

4 Sullivan & Cromwell LLP represented Philips during part of the ITC proceedings prior to 2005 and continues to represent Philips in various matters, including a related patent infringement action by Philips against Princo pending in Federal Court. 5 The court denied Princo’s request for rehearing and the en banc decision reinstates the portions of the 2009 panel opinion rejecting Princo’s other arguments. Slip op. at 13 n.1. 6 Slip op. at 29. The majority opinion joined by six of the ten members of the court was filed by Judge Bryson. Judge Prost filed a separate concurrence joined by Judge Mayer. Judge Dyk (who wrote the panel opinion) filed a dissent joined by Judge Gajarsa. -3- Patent Litigation and Licensing September 1, 2010

patent that is the subject of a claim of infringement a patentee has “broadened the physical or temporal scope of the patent grant and has done so in a manner that has anticompetitive effects.”7

The court noted that the alleged agreement between Philips and Sony would not restrict the availability of or impose any restrictions on the Philips patents asserted against Princo, and that even though the patents-in-suit were part of the licensing program with the Sony patent at issue, alleged anticompetitive conduct with respect to the Sony patent was not misuse of the patents asserted by Philips.8 The court further rejected Princo’s argument that the use of funds from a lawful licensing program to support other claimed anticompetitive behavior amounted to misuse of the licensed patents. The court went on to note that even conduct actionable under some other scheme of law (such as contract or antitrust law) did not necessarily constitute patent misuse.

Misuse Requires Proof of an Anticompetitive Effect. Second, and apart from Princo’s failure to show that Philips unlawfully leveraged the asserted patents, the court also rejected the misuse defense on the ground that there was no evidence that the alleged agreement had any anticompetitive effect in a relevant market. Stressing that cooperation among joint venturers is almost always analyzed under the rule of reason, the court noted that there was no evidence in the record of an anticompetitive effect from the alleged Sony-Philips agreement, and that the Commission findings indicated that the claimed alternative

7 Id. at 18. The court’s opinion stresses that patentees have broad rights under the patent grant and may impose lawful conditions in patent licenses. In what may be viewed as a comment on the Supreme Court’s 2008 Quanta Computer, Inc. v. LG Electronics, Inc. decision, 553 U.S. 617 (addressing patent exhaustion), the court stated (without citing Quanta): As a general matter, the unconditional sale of a patented device exhausts the patentee’s right to control the purchaser’s use of the device thereafter, on the theory that the patentee has bargained for, and received, the full value of the goods. That “exhaustion” doctrine does not apply, however, to a conditional sale or license, where it is more reasonable to infer that a negotiated price reflects only the value of the “use” rights conferred by the patentee. Thus, express conditions accompanying the sale or license of a patented product, such as field of use limitations, are generally upheld. Slip op. at 17. It is only when license conditions “violate public policy . . . as in the case of price-fixing conditions and tying restraints” that “the underlying patents become unenforceable, and the patentee loses its right to sue for infringement or breach of contract.” Id. 8 In reaching this conclusion, the court rejected Princo’s argument that amendments to section 271(d) of the Patent Act suggest that Congress intended the patent misuse doctrine to capture the sort of alleged horizontal agreement not to compete at issue in the case. Contrary to the position taken in the dissenting opinion, the majority reasoned that the text and legislative history of the amendments to the Act demonstrate Congressional intent to cabin the misuse doctrine. The majority concluded that the statute makes clear that “Congress was concerned about the open-ended scope of the doctrine and sought to confine it to anticompetitive conduct by patentees who leverage their patents to obtain economic advantages outside the legitimate scope of the patent grant.” Slip op. at 20-23 (the opinion also quotes, inter alia, the remarks of Sen. Leahy in the legislative record: “Reform of patent misuse will ensure that the harsh misuse sanction of unenforceability is imposed only against those engaging in truly anticompetitive conduct.”) -4- Patent Litigation and Licensing September 1, 2010

technology to CD-R/RWs which may have been enabled by the Sony patent was not, in fact, technically or commercially viable.

The court also found that, while the “suppression of nascent threats can be construed as anticompetitive behavior under certain circumstances,” the infringer still had the “burden of showing that the hypothesized agreement had an actual adverse effect on competition in the relevant market.”9 In the context of this case, the mere “speculative possibility” that the Sony technology could have matured into a competitive force in the storage technology industry was insufficient; rather, what was required was a “reasonable probability” of anticompetitive effect.

IMPLICATIONS The Federal Circuit’s decision confirms and clarifies existing case law and constitutes a strong reaffirmance that the patent misuse doctrine is “narrow” and will not be applied expansively. In order to prove patent misuse, an alleged infringer must either show per se misuse under existing Supreme Court law or that the patentee attempted to expand the scope of the patent grant of an asserted patent with anticompetitive effect in a relevant market. Coupled with the Supreme Court decision in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) (tightening pleading requirements in the context of an antitrust case), the decision is likely to make it more difficult for alleged infringers to plead and prove patent misuse as a defense to a claim of infringement. Additionally, the decision provides collaborators, standard setting organizations, patent pools and joint licensors with greater certainty that such ventures do not implicate special patent misuse considerations, but rather are subject to the same principles of misuse that apply to all patent holders preventing the imposition of unlawful conditions on the use or licensing of patents.

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Copyright © Sullivan & Cromwell LLP 2010

9 Slip op. at 37. -5- Patent Litigation and Licensing September 1, 2010

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