The Impact of Princo on Patent Misuse As a Defense

The Federal Circuit recently issued an en banc opinion with important implications for patent licensing and litigation. In Princo, U.S. Philips Corporation (“Philips”) defeated efforts by an infringer to assert a patent misuse defense based on an alleged horizontal agreement between Philips and Sony Corporation (“Sony”) to license technology developed by Philips and suppress technology developed by Sony. Princo Corp. v. International Trade Commission and U.S. Philips Corp., No. 2007-1386, __ F.3d __, 2010 WL 3385953 (Fed. Cir. Aug. 30, 2010). The majority, in an opinion by Judge William C. Bryson and joined by Chief Judge Randall R. Rader and Judges Pauline Newman, Alan D. Lourie, Richard Linn and Kimberly A. Moore, emphasized the “narrow scope of the [patent misuse] doctrine” in arriving at this holding. In the dissent's view, this decision “emasculate[d] the doctrine so that it will not provide a meaningful obstacle to patent enforcement.” Princo at *20.

Patent misuse is a long-recognized judicially created equitable defense to an action of patent infringement. If a patent owner is found to have misused a patent, the patent is unenforceable until such time as the misuse is corrected or “purged.” The controlling inquiry is whether the patentee “impermissibly broadened the 'physical or temporal' scope of the patent grant with anticompetitive effect.” Princo at *7. The Federal Circuit in Princo explained that “what patent misuse is about, in short, is patent leverage, i.e., the use of the patent power to impose over-broad conditions on the use of the patent in suit that are not within the reach of the monopoly granted by the Government.” Id. at *10. This “patent leverage” test requires a connection between the patent right and the misconduct in question “such that the patent in suit must itself significantly contribute to the practice under attack. Patent misuse will not be found when there is 'no connection' between the patent right and the misconduct in question ' or no 'use' of the patent.” Id. Applying this test, the court concluded that the required connection was missing between the patents asserted against Princo and the alleged misconduct arising from the purported horizontal agreement. The court further concluded that Princo failed to carry its burden of demonstrating an “actual adverse effect on competition in the marketplace” and did not show that the suppressed technology had technical or commercial prospects. Id. at *16-17. Given the Federal Circuit's exclusive appellate jurisdiction over patent infringement cases, the decision will likely serve to limit the availability of misuse as a defense in such cases and have an impact on patent licensing practices going forward.

Background

In the 1980s and 1990s, Philips and Sony were the principal developers of the CD-R and CD-RW technology that allowed consumers to create discs readable by CD players or CD-ROM drives. During development, a problem arose regarding encoding “position information” in writable discs. Two proposed solutions were developed ' Sony's digital solution was set forth in its “Lagadec patent” while Philips' analog solution was set forth in its “Raaymakers patents.” The engineers of both companies reviewed the proposed solutions and agreed to use the Raaymakers solution which “was simple and worked well” in comparison with the Lagadec solution which “was prone to error and would have been very difficult to implement.” Id. at *1. Thus, the Raaymakers approach was incorporated in the “Recordable CD Standards” (informally known as the “Orange Book”) that codified the industry standards for recordable CD-R and CD-RW technology.

Philips and Sony, along with several other patent holders, created a patent pool to license patents that were essential to manufacture CD-R/RW discs in accordance with the Orange Book standards, including the Lagadec patent. The package licenses contained field-of-use limitations limiting the use of all the patents to Orange Book-compliant disc production.

Princo initially obtained a license from Philips but then stopped paying licensing fees even though it continued to import patented CD-Rs and CD-RWs into the United States, thus prompting Philips to file suit at the International Trade Commission (“ITC”) to block such imports. Although the administrative law judge determined that Princo had infringed claims of the six patents Philips asserted, relief was denied because patent misuse rendered the patents unenforceable. The next six years of proceedings at the ITC and Federal Circuit leading up the Federal Circuit's en banc review centered on Princo's patent misuse defenses, including assertions that Philips foreclosed competition from an alternative standard built around the Lagadec patent by including the Lagadec patent in the patent pool and thus securing Sony's adherence to the Orange Book standard.

The Federal Circuit's En Banc Decision

The Federal Circuit addressed the following question: “When a patentee offers to license a patent, does the patentee misuse that patent by inducing a third party not to license its separate, competitive technology?” Id. at *10. The court found that there was no patent misuse in the circumstances before it.

After reviewing the history of patent misuse law, the court explained that the defense of patent misuse is “not available to a presumptive infringer simply because a patentee engages in some kind of wrongful commercial conduct, even conduct that may have anticompetitive effects.” Id. at *8. Rather, the misuse “must be of the patent in suit” and must leverage the patent power to restrict the use of the patent in a way that is outside of the broad scope of the patent right. Id. Because the patents in suit were the Philips' Raaymakers patents and not the allegedly suppressed Sony Lagadec patent, the court found that the alleged misuse was not of the patents in suit and hence not patent misuse. The court further supported its “recogni[tion of] the narrow scope of the doctrine” by arguing that “Congress enacted section 271(d) [of the Patent Act] not to broaden the doctrine of misuse, but to cabin it.” Id. at *9. Section 271(d) exempted five categories of conduct (none of which were applicable in the case at hand) from the patent misuse doctrine.

The court applied the rule of reason (and declined to adopt a per se or “quick look” rule) under the antitrust laws, highlighting the pro-competitive effects of research joint ventures and standard setting. The court went on to find that Princo had failed to carry its burden of showing actual or probable anticompetitive effects of the alleged horizontal agreement because Princo could not provide evidence of the commercial viability of the Lagadec technology.

The dissent sharply criticized the majority's interpretation of the scope of the doctrine. Arguing for a vigorous misuse defense that would include antitrust violations, the dissent cited Illinois Tool Works for the proposition that “it would be absurd ' to provide that the use of a patent that merited punishment as a felony [under antitrust laws] would not constitute misuse.” Illinois Tool Works v. Indep. Ink, 547 U.S. 28, 42 (2006). The dissent argued that the holding would protect anticompetitive agreements that suppress alternative technologies for the purpose of insulating a technology from competition.

Implications of Princo

The availability of patent misuse as a defense in patent litigation may be substantially constrained as a result of this decision. Going forward, defendants should be mindful of tailoring how they plead this defense in light of the requirements of Princo. Motions to strike the defense may now also become more common as infringement plaintiffs seek to avoid the diversion and discovery involved in litigating a misuse defense. The required finding that the “patent leveraging” be such that it has an actual adverse effect on competition in the marketplace and of “commercial viability” may be difficult to prove in cases of nascent or developing technologies where the required evidence may not yet be present. From a patent licensing perspective, although the decision potentially introduces more flexibility in how agreements may be structured while avoiding patent misuse claims, patent owners should still be mindful of potential antitrust claims and be cautious in entering into horizontal agreements without careful review of the facts and circumstances.

Charan J. Sandhu, a partner, and Ausra Pumputis, a litigation associate, are in the New York office of Weil, Gotshal & Manges LLP. Sandhu, a member of the firm's Technology and Intellectual Property Transactions practice, can be reached at [email protected]. Pumputis, a member of the firm's Antitrust/Competition practice, can be reached at [email protected].

The Federal Circuit recently issued an en banc opinion with important implications for patent licensing and litigation. In Princo, U.S. Philips Corporation (“Philips”) defeated efforts by an infringer to assert a patent misuse defense based on an alleged horizontal agreement between Philips and Sony Corporation (“Sony”) to license technology developed by Philips and suppress technology developed by Sony. Princo Corp. v. International Trade Commission and U.S. Philips Corp., No. 2007-1386, __ F.3d __, 2010 WL 3385953 (Fed. Cir. Aug. 30, 2010). The majority, in an opinion by Judge William C. Bryson and joined by Chief Judge Randall R. Rader and Judges Pauline Newman, Alan D. Lourie, Richard Linn and Kimberly A. Moore, emphasized the “narrow scope of the [patent misuse] doctrine” in arriving at this holding. In the dissent's view, this decision “emasculate[d] the doctrine so that it will not provide a meaningful obstacle to patent enforcement.” Princo at *20.

Patent misuse is a long-recognized judicially created equitable defense to an action of patent infringement. If a patent owner is found to have misused a patent, the patent is unenforceable until such time as the misuse is corrected or “purged.” The controlling inquiry is whether the patentee “impermissibly broadened the 'physical or temporal' scope of the patent grant with anticompetitive effect.” Princo at *7. The Federal Circuit in Princo explained that “what patent misuse is about, in short, is patent leverage, i.e., the use of the patent power to impose over-broad conditions on the use of the patent in suit that are not within the reach of the monopoly granted by the Government.” Id. at *10. This “patent leverage” test requires a connection between the patent right and the misconduct in question “such that the patent in suit must itself significantly contribute to the practice under attack. Patent misuse will not be found when there is 'no connection' between the patent right and the misconduct in question ' or no 'use' of the patent.” Id. Applying this test, the court concluded that the required connection was missing between the patents asserted against Princo and the alleged misconduct arising from the purported horizontal agreement. The court further concluded that Princo failed to carry its burden of demonstrating an “actual adverse effect on competition in the marketplace” and did not show that the suppressed technology had technical or commercial prospects. Id. at *16-17. Given the Federal Circuit's exclusive appellate jurisdiction over patent infringement cases, the decision will likely serve to limit the availability of misuse as a defense in such cases and have an impact on patent licensing practices going forward.

Background

In the 1980s and 1990s, Philips and Sony were the principal developers of the CD-R and CD-RW technology that allowed consumers to create discs readable by CD players or CD-ROM drives. During development, a problem arose regarding encoding “position information” in writable discs. Two proposed solutions were developed ' Sony's digital solution was set forth in its “Lagadec patent” while Philips' analog solution was set forth in its “Raaymakers patents.” The engineers of both companies reviewed the proposed solutions and agreed to use the Raaymakers solution which “was simple and worked well” in comparison with the Lagadec solution which “was prone to error and would have been very difficult to implement.” Id. at *1. Thus, the Raaymakers approach was incorporated in the “Recordable CD Standards” (informally known as the “Orange Book”) that codified the industry standards for recordable CD-R and CD-RW technology.

Philips and Sony, along with several other patent holders, created a patent pool to license patents that were essential to manufacture CD-R/RW discs in accordance with the Orange Book standards, including the Lagadec patent. The package licenses contained field-of-use limitations limiting the use of all the patents to Orange Book-compliant disc production.

Princo initially obtained a license from Philips but then stopped paying licensing fees even though it continued to import patented CD-Rs and CD-RWs into the United States, thus prompting Philips to file suit at the International Trade Commission (“ITC”) to block such imports. Although the administrative law judge determined that Princo had infringed claims of the six patents Philips asserted, relief was denied because patent misuse rendered the patents unenforceable. The next six years of proceedings at the ITC and Federal Circuit leading up the Federal Circuit's en banc review centered on Princo's patent misuse defenses, including assertions that Philips foreclosed competition from an alternative standard built around the Lagadec patent by including the Lagadec patent in the patent pool and thus securing Sony's adherence to the Orange Book standard.

The Federal Circuit's En Banc Decision

The Federal Circuit addressed the following question: “When a patentee offers to license a patent, does the patentee misuse that patent by inducing a third party not to license its separate, competitive technology?” Id. at *10. The court found that there was no patent misuse in the circumstances before it.

After reviewing the history of patent misuse law, the court explained that the defense of patent misuse is “not available to a presumptive infringer simply because a patentee engages in some kind of wrongful commercial conduct, even conduct that may have anticompetitive effects.” Id. at *8. Rather, the misuse “must be of the patent in suit” and must leverage the patent power to restrict the use of the patent in a way that is outside of the broad scope of the patent right. Id. Because the patents in suit were the Philips' Raaymakers patents and not the allegedly suppressed Sony Lagadec patent, the court found that the alleged misuse was not of the patents in suit and hence not patent misuse. The court further supported its “recogni[tion of] the narrow scope of the doctrine” by arguing that “Congress enacted section 271(d) [of the Patent Act] not to broaden the doctrine of misuse, but to cabin it.” Id. at *9. Section 271(d) exempted five categories of conduct (none of which were applicable in the case at hand) from the patent misuse doctrine.

The court applied the rule of reason (and declined to adopt a per se or “quick look” rule) under the antitrust laws, highlighting the pro-competitive effects of research joint ventures and standard setting. The court went on to find that Princo had failed to carry its burden of showing actual or probable anticompetitive effects of the alleged horizontal agreement because Princo could not provide evidence of the commercial viability of the Lagadec technology.

The dissent sharply criticized the majority's interpretation of the scope of the doctrine. Arguing for a vigorous misuse defense that would include antitrust violations, the dissent cited Illinois Tool Works for the proposition that “it would be absurd ' to provide that the use of a patent that merited punishment as a felony [under antitrust laws] would not constitute misuse.” Illinois Tool Works v. Indep. Ink , 547 U.S. 28, 42 (2006). The dissent argued that the holding would protect anticompetitive agreements that suppress alternative technologies for the purpose of insulating a technology from competition.

Implications of Princo

The availability of patent misuse as a defense in patent litigation may be substantially constrained as a result of this decision. Going forward, defendants should be mindful of tailoring how they plead this defense in light of the requirements of Princo. Motions to strike the defense may now also become more common as infringement plaintiffs seek to avoid the diversion and discovery involved in litigating a misuse defense. The required finding that the “patent leveraging” be such that it has an actual adverse effect on competition in the marketplace and of “commercial viability” may be difficult to prove in cases of nascent or developing technologies where the required evidence may not yet be present. From a patent licensing perspective, although the decision potentially introduces more flexibility in how agreements may be structured while avoiding patent misuse claims, patent owners should still be mindful of potential antitrust claims and be cautious in entering into horizontal agreements without careful review of the facts and circumstances.

Charan J. Sandhu, a partner, and Ausra Pumputis, a litigation associate, are in the New York office of Weil, Gotshal & Manges LLP. Sandhu, a member of the firm's Technology and Intellectual Property Transactions practice, can be reached at [email protected]. Pumputis, a member of the firm's Antitrust/Competition practice, can be reached at [email protected].