New Antitrust Considerations for Tying Schemes

The Supreme Court has recently abolished the presumption that a patent confers 'market power' on the patent owner, ending the presumption of antitrust liability arising from the conditioning of a patent license to the purchase of unpatented articles. See Illinois Tool Works v. Indep. Ink, Inc., 126 S. Ct. 1281 (2006). As discussed below, this decision will have wide-ranging implications to the field of patent licensing, where fear of antitrust liability has tended to dampen the creativity of patent license schemes.

Consider that your client, the CEO of the hypothetical Tie-Co Int'l, excitably arrives at your office, eager to talk about his new product. 'We've invented a new peach scent to go into children's lip gloss,' he tells you, 'it blows all other peach scents out of the water. I bet in a year or so, we have over 90% of the peach scent market for children's lip gloss.'

As you share in his enthusiasm, you become edgy as he describes his scheme for leveraging his invention. He explains that he is going to require his customers (lip gloss manufacturers) to buy his entire line of scents if they want his new peach scent. He gloats that the rest of the scents currently in use are fungible commodities and that his potential customers wouldn't object that much to buying the other scents from him, if it means having access to his new patented peach scent. He expects this new arrangement both to increase his already sizable market share substantially and to enable him to raise his prices 5% across the board.

Having heard about the Supreme Court's March 1, 2006 decision in ITW, he tells you to stop worrying about antitrust problems because he controls less than half the market on lip gloss scent additives. 'Besides,' he tells you, 'peach scented lip gloss represents only 10% of the scented lip gloss market and 40% of all lip gloss for kids is unscented, so where is the monopoly?'

Reluctant to dampen his enthusiasm, you explain that the analysis is not quite that simple. 'If anything,' you tell him 'although the decision in ITW made it harder to prove antitrust liability, it made the determination whether a patent tying arrangement violates the antitrust laws more complicated.'

For years, the rule had been that conditioning, or 'tying' the purchase of an unpatented consumable product, such as razor blades, to a license on or the purchase of a patented device, such as a razor blade holder, was a black letter violation of the antitrust laws. The rule had its beginnings in Motion Picture Patents Co. v. Universal Film Mfg. Co., 243 U.S. 502 (1917), which involved U.S. Patent 707,934 to a 'Projecting Kinetoscope.' The owner of the kinetoscope patent sold movie projectors with an unnegotiated use restriction attached to the projector. The restriction required the projector to be used with unpatented movie film described in Thomas Edison's expired U.S. Patent Re 12,192. In Motion Picture Patents, the Supreme Court concluded that using the projector with third-party film in violation of the unnegotiated use restriction would not result in infringement of the kinetoscope patent. Id. at 516.

The Motion Picture Patents decision formed the basis for the defense of patent misuse in Morton Salt Co. v. G.S. Suppiger Co., 314 U.S. 488 (1942). In Morton Salt, U.S. Patent 2,060,645, which covered a machine for depositing salt into canned goods, was at issue. Lessees of the patented machines were required to purchase the patent owner's unpatented salt. The Supreme Court found that this arrangement created a 'limited monopoly on the [salt]' which improperly expanded the exclusivity in the machine as provided by the patent grant. In finding a 'Patent Misuse' defense, the Supreme Court ruled that the anti-competitive arrangement of tying the unpatented salt to the patented machines was sufficient to deprive the patentee of its ability to enforce its patent on the machine. ITW at 1288.

The Court in Morton Salt did not analyze the effect the patent had on market conditions. Rather, it presumed that the tying arrangement was an automatic or 'per se' improper restraint of trade. 314 U.S. at 490. This presumption that mere patent ownership provided the patent owner with sufficient power to restrain competition was imported from the patent laws to the antitrust laws in Int'l Salt Co. v. United States, 333 U.S. 392 (1947). The Court there did not analyze market conditions, but relied on the decision in Morton Salt to find that the patent gave its owner sufficient power to unlawfully affect competition in the market.

Subsequent changes in economic perspectives and to the patent laws themselves would reinstate the requirement of analyzing market conditions. ITW at 1290. For example, the patent laws were amended to make clear that the use of a patent to control non-staple articles of commerce that have no substantial non-infringing use does not constitute patent misuse per se. Id. In 1988, the patent laws were amended to specify that conditioning the license of rights to the purchase of an unpatented product would not result in patent misuse unless the patent owner had 'market power' in the relevant market. Id.; 35 U.S.C. '271(b)(5). Consequently, because it was the patent misuse defense in Morton Salt that led to the presumption of antitrust conduct in International Salt, the Supreme Court concluded that Congress intended to eliminate from the antitrust laws the presumption that patent ownership led to market power. Id. at 1291. Accordingly, you explain to your client that the Supreme Court in ITW ruled that arrangements involving the tying of a patented product should be evaluated under a rule of reason analysis, and that market power must be proven, not presumed.

Your conversation with the CEO of Tie-Co continues. 'That's so like a lawyer,' he complains, 'you said that the Supreme Court relaxed the rule. How can that make this more complicated?'

You explain that antitrust liability will depend on whether Tie-Co has market power in the peach scent product ' the tying product. After all, the essence of a tying violation is that the seller has sufficient power in one of its products (the tying product) to coerce a purchaser to buy another of his or her products (the tied product). The seller lacks the power to coerce the purchase of the second product if purchasers can simply choose a competing version of the tying product and not be subject to the limitation on their choice as to which brand of the tied product they would buy.

You explain further that before you can assess whether Tie-Co has market power in the peach scent, one would have to define the relevant market. You then state that, from an antitrust perspective, a market has two dimensions: 1) the relevant product market, and 2) the relevant geographic market. Putting those together, a market is comprised of all products and services that compete with each other and which are substitutes for each other, within the geographic area in which that competition takes place.

He asks (appropriately), 'I have a unique product. People want my peach scent. Doesn't that automatically give me market power?' You explain that there was a time when the law thought that way. Today, market power typically means a sufficient degree of market dominance to affect prices and, in the context of tying, the power to coerce a purchaser into buying the full line from Tie-Co on the strength of the purchaser's need for the peach scent. Assuming that your client's eyes have not glazed over, you explore with him what the relevant market is and whether Tie-Co truly has market power in the antitrust sense.

You ask him if the peach scent is distinct. Are there lip gloss manufacturers that have a successful product line without offering a peach scent? While Tie-Co believes it has the category killer item for peach scents, what about its competitor's 'Nectarines of the Gods' scent? When retail customers make their purchases, do they purchase an entire set or do they purchase scents individually? Do retailers typically carry more than one line of scent? Are there any marketing studies about what consumers do when they do not find a peach scent; will they buy the strawberry, or the green apple, or the unscented gloss as a substitute? You also remind the CEO that last month he was complaining about foreign imitations in the U.S. market. Are there foreign manufacturers that export to the United States?

Once you have properly defined the market, the next step is to determine Tie-Co's share of that market. Market share can be calculated as a fraction in which the denominator is the total product in the market (measured by sales (in dollars or units), capacity, or other indicators), and the numerator is Tie-Co's product. Since the Supreme Court's decision in Jefferson Parish Hospital District No. 2 v. Hyde, 466 U.S. 2 (1984), courts have not inferred market power from a market share below 30%. The CEO gulps hard and tells you that if the market is, in fact, limited to peach scents, he thinks he has about 50% of sales.

You next explore the issue of non-infringing alternatives. Does he believe that the scope of his patent is so broad that it precludes other manufacturers from devising alternative ways of manufacturing the scent? Could a manufacturer design around Tie-Co's patent, and aren't many companies already doing that today, even if their products are not of the same quality as Tie-Co's? How different is the peach scent that is used for air fresheners; could one of those manufacturers adapt its product for use by lip gloss manufacturers? In short, even if Tie-Co has a significant market share today, are there barriers to entry or product expansion that will enable Tie-Co to achieve and exert coercive power?

While market share is the most important indicator, the ultimate question is whether Tie-Co has the power to affect prices and dictate market terms. You remind the CEO that several years ago, when scented furry trolls were the 'must-have' products for the tween set, he had tried to raise prices, got undercut, and had to roll back his price increase. Did he think that it would be different today with peach scented lip gloss?

Now, your client concedes, the wisdom of your earlier observation is clear. In ITW, the Supreme Court relaxed the rules against patent tying. Rather than presuming that a patent confers on its owner power over the market, the issue requires more particular economic analysis. The consequence of this is that there is no longer a clear-cut prohibition, but ITW did not result in clear-cut permission either. Answering the client's question about tying non-patented products to patented products, or 'full-line forcing' based on the strength of one patented article, now requires substantial consideration of the economic effects of the proposed tie-in.

Matthew W. Siegal ([email protected]) and Bruce H. Schneider ([email protected]) are partners in the Intellectual Property Group and the Litigation Group of the New York office of Stroock & Stroock & Lavan LLP, which represents Illinois Tool Works before the Patent and Trademark Office, but was not involved in any of the proceedings discussed herein. The views expressed are their own.

The Supreme Court has recently abolished the presumption that a patent confers 'market power' on the patent owner, ending the presumption of antitrust liability arising from the conditioning of a patent license to the purchase of unpatented articles. See Illinois Tool Works v. Indep. Ink, Inc. , 126 S. Ct. 1281 (2006). As discussed below, this decision will have wide-ranging implications to the field of patent licensing, where fear of antitrust liability has tended to dampen the creativity of patent license schemes.

Consider that your client, the CEO of the hypothetical Tie-Co Int'l, excitably arrives at your office, eager to talk about his new product. 'We've invented a new peach scent to go into children's lip gloss,' he tells you, 'it blows all other peach scents out of the water. I bet in a year or so, we have over 90% of the peach scent market for children's lip gloss.'

As you share in his enthusiasm, you become edgy as he describes his scheme for leveraging his invention. He explains that he is going to require his customers (lip gloss manufacturers) to buy his entire line of scents if they want his new peach scent. He gloats that the rest of the scents currently in use are fungible commodities and that his potential customers wouldn't object that much to buying the other scents from him, if it means having access to his new patented peach scent. He expects this new arrangement both to increase his already sizable market share substantially and to enable him to raise his prices 5% across the board.

Having heard about the Supreme Court's March 1, 2006 decision in ITW, he tells you to stop worrying about antitrust problems because he controls less than half the market on lip gloss scent additives. 'Besides,' he tells you, 'peach scented lip gloss represents only 10% of the scented lip gloss market and 40% of all lip gloss for kids is unscented, so where is the monopoly?'

Reluctant to dampen his enthusiasm, you explain that the analysis is not quite that simple. 'If anything,' you tell him 'although the decision in ITW made it harder to prove antitrust liability, it made the determination whether a patent tying arrangement violates the antitrust laws more complicated.'

For years, the rule had been that conditioning, or 'tying' the purchase of an unpatented consumable product, such as razor blades, to a license on or the purchase of a patented device, such as a razor blade holder, was a black letter violation of the antitrust laws. The rule had its beginnings in Motion Picture Patents Co. v. Universal Film Mfg. Co., 243 U.S. 502 (1917), which involved U.S. Patent 707,934 to a 'Projecting Kinetoscope.' The owner of the kinetoscope patent sold movie projectors with an unnegotiated use restriction attached to the projector. The restriction required the projector to be used with unpatented movie film described in Thomas Edison's expired U.S. Patent Re 12,192. In Motion Picture Patents, the Supreme Court concluded that using the projector with third-party film in violation of the unnegotiated use restriction would not result in infringement of the kinetoscope patent. Id. at 516.

The Motion Picture Patents decision formed the basis for the defense of patent misuse in Morton Salt Co. v. G.S. Suppiger Co. , 314 U.S. 488 (1942). In Morton Salt, U.S. Patent 2,060,645, which covered a machine for depositing salt into canned goods, was at issue. Lessees of the patented machines were required to purchase the patent owner's unpatented salt. The Supreme Court found that this arrangement created a 'limited monopoly on the [salt]' which improperly expanded the exclusivity in the machine as provided by the patent grant. In finding a 'Patent Misuse' defense, the Supreme Court ruled that the anti-competitive arrangement of tying the unpatented salt to the patented machines was sufficient to deprive the patentee of its ability to enforce its patent on the machine. ITW at 1288.

The Court in Morton Salt did not analyze the effect the patent had on market conditions. Rather, it presumed that the tying arrangement was an automatic or 'per se' improper restraint of trade. 314 U.S. at 490. This presumption that mere patent ownership provided the patent owner with sufficient power to restrain competition was imported from the patent laws to the antitrust laws in Int'l Salt Co. v. United States , 333 U.S. 392 (1947). The Court there did not analyze market conditions, but relied on the decision in Morton Salt to find that the patent gave its owner sufficient power to unlawfully affect competition in the market.

Subsequent changes in economic perspectives and to the patent laws themselves would reinstate the requirement of analyzing market conditions. ITW at 1290. For example, the patent laws were amended to make clear that the use of a patent to control non-staple articles of commerce that have no substantial non-infringing use does not constitute patent misuse per se. Id. In 1988, the patent laws were amended to specify that conditioning the license of rights to the purchase of an unpatented product would not result in patent misuse unless the patent owner had 'market power' in the relevant market. Id.; 35 U.S.C. '271(b)(5). Consequently, because it was the patent misuse defense in Morton Salt that led to the presumption of antitrust conduct in International Salt, the Supreme Court concluded that Congress intended to eliminate from the antitrust laws the presumption that patent ownership led to market power. Id. at 1291. Accordingly, you explain to your client that the Supreme Court in ITW ruled that arrangements involving the tying of a patented product should be evaluated under a rule of reason analysis, and that market power must be proven, not presumed.

Your conversation with the CEO of Tie-Co continues. 'That's so like a lawyer,' he complains, 'you said that the Supreme Court relaxed the rule. How can that make this more complicated?'

You explain that antitrust liability will depend on whether Tie-Co has market power in the peach scent product ' the tying product. After all, the essence of a tying violation is that the seller has sufficient power in one of its products (the tying product) to coerce a purchaser to buy another of his or her products (the tied product). The seller lacks the power to coerce the purchase of the second product if purchasers can simply choose a competing version of the tying product and not be subject to the limitation on their choice as to which brand of the tied product they would buy.

You explain further that before you can assess whether Tie-Co has market power in the peach scent, one would have to define the relevant market. You then state that, from an antitrust perspective, a market has two dimensions: 1) the relevant product market, and 2) the relevant geographic market. Putting those together, a market is comprised of all products and services that compete with each other and which are substitutes for each other, within the geographic area in which that competition takes place.

He asks (appropriately), 'I have a unique product. People want my peach scent. Doesn't that automatically give me market power?' You explain that there was a time when the law thought that way. Today, market power typically means a sufficient degree of market dominance to affect prices and, in the context of tying, the power to coerce a purchaser into buying the full line from Tie-Co on the strength of the purchaser's need for the peach scent. Assuming that your client's eyes have not glazed over, you explore with him what the relevant market is and whether Tie-Co truly has market power in the antitrust sense.

You ask him if the peach scent is distinct. Are there lip gloss manufacturers that have a successful product line without offering a peach scent? While Tie-Co believes it has the category killer item for peach scents, what about its competitor's 'Nectarines of the Gods' scent? When retail customers make their purchases, do they purchase an entire set or do they purchase scents individually? Do retailers typically carry more than one line of scent? Are there any marketing studies about what consumers do when they do not find a peach scent; will they buy the strawberry, or the green apple, or the unscented gloss as a substitute? You also remind the CEO that last month he was complaining about foreign imitations in the U.S. market. Are there foreign manufacturers that export to the United States?

Once you have properly defined the market, the next step is to determine Tie-Co's share of that market. Market share can be calculated as a fraction in which the denominator is the total product in the market (measured by sales (in dollars or units), capacity, or other indicators), and the numerator is Tie-Co's product. Since the Supreme Court's decision in Jefferson Parish Hospital District No. 2 v. Hyde , 466 U.S. 2 (1984), courts have not inferred market power from a market share below 30%. The CEO gulps hard and tells you that if the market is, in fact, limited to peach scents, he thinks he has about 50% of sales.

You next explore the issue of non-infringing alternatives. Does he believe that the scope of his patent is so broad that it precludes other manufacturers from devising alternative ways of manufacturing the scent? Could a manufacturer design around Tie-Co's patent, and aren't many companies already doing that today, even if their products are not of the same quality as Tie-Co's? How different is the peach scent that is used for air fresheners; could one of those manufacturers adapt its product for use by lip gloss manufacturers? In short, even if Tie-Co has a significant market share today, are there barriers to entry or product expansion that will enable Tie-Co to achieve and exert coercive power?

While market share is the most important indicator, the ultimate question is whether Tie-Co has the power to affect prices and dictate market terms. You remind the CEO that several years ago, when scented furry trolls were the 'must-have' products for the tween set, he had tried to raise prices, got undercut, and had to roll back his price increase. Did he think that it would be different today with peach scented lip gloss?

Now, your client concedes, the wisdom of your earlier observation is clear. In ITW, the Supreme Court relaxed the rules against patent tying. Rather than presuming that a patent confers on its owner power over the market, the issue requires more particular economic analysis. The consequence of this is that there is no longer a clear-cut prohibition, but ITW did not result in clear-cut permission either. Answering the client's question about tying non-patented products to patented products, or 'full-line forcing' based on the strength of one patented article, now requires substantial consideration of the economic effects of the proposed tie-in.

Matthew W. Siegal ([email protected]) and Bruce H. Schneider ([email protected]) are partners in the Intellectual Property Group and the Litigation Group of the New York office of Stroock & Stroock & Lavan LLP, which represents Illinois Tool Works before the Patent and Trademark Office, but was not involved in any of the proceedings discussed herein. The views expressed are their own.