Licensors Gain Latitude as Federal Circuit Limits Patent Misuse Defense

October 7, 2010, 3:07 PM

A licensor of intellectual property naturally desires to extract as much value as possible from its patent or copyright. In the collaborative development and manufacturing arrangements that are so common today, where licensors are working with actual or potential competitors, a licensor may also fairly wish to limit its partners ability to compete with the technology the licensor contributes to the venture. Yet, the law imposes limits on a licensors ability to use his intellectual property as leverage. A recent decision by the U.S. Court of Appeals for the Federal Circuit casts new light on one such limit, the defense of patent misuse.

In Princo Corp. v. Intl Trade Comm., No. 2007-1368 (Fed. Cir., August 30, 2010), the Federal Circuit issued en banc one of the most important decisions in recent years on the affirmative defense of patent misuse. The case attracted wide interest, with several organizations filing amicus briefs, and the decision is sure to be controversial. Ultimately, the court actually defined the defense more narrowly than many thought it to be, over the strong dissent of some members.

Misuse is an affirmative defense to claims of patent, copyright and trademark infringement. The defense is most potent in patent law, and misuse defenses are often raised in patent infringement litigation. The theory of misuse is that, if an owner of intellectual property improperly leverages his patent, copyright or trademark rights in ways that are anticompetitive and/or contrary to the policies underlying intellectual property law, the owner is not entitled to enforce its rights.

Because misuse is an affirmative defense, the victim of improper leverage cannot sue the IP owner for misuse; it can only raise misuse as a defense when it is sued for infringement, breach of a license agreement or the like. Yet, the implications of a successful misuse defense are serious enough to cause IP owners to steer clear of questionable practices. A ruling that an improper provision in a license constitutes misuse not only renders that agreement unenforceable, but also renders similar licenses unenforceable until the defect is cured. A single licensee that successfully challenges a patentees or copyright owners license on grounds of misuse, therefore, can render the licensors entire portfolio of comparable licenses unenforceable.

Princo involved a patent pool. Many of us are unfamiliar with patent pools, but we all benefit from them. Patent pools are agreements where multiple companies in a product area pool their technology, develop uniform technical standards for the product, and license the patents practiced in using the standard to those in the pool as well as to others who manufacture products that might use the standard. Because of patent pools, companies can produce compatible and interoperative products, and consumers dont need to worry (as much) whether, for example, the leg bone connects to the knee bone.

Phillips, Sony and others were members of a patent pool that developed standards for digital recording devices and recordable media (CD-Rs and CD-RWs). The standards were published in something called the Orange Book, and licenses for the standard were sold to manufacturers. One of the technical tasks in developing the standard was deciding how position information would be encoded on discs. Phillips and Sony each had patents on techniques for this task. They decided Phillips technology was technically superior and more reliable, so Phillips patent was adopted for use in the standard. Yet, the pool also included Sonys patent in the standard because there was some argument part of the patent was needed to practice the standard. As a result, licensees of the Orange Book standard used the Phillips technology, not the Sony method, and the Sony patent could not be licensed separately.

Princo was a licensee of the standard, but it was sued for infringement after it stopped paying royalties. It raised patent misuse as a defense, arguing that the patent pool required licensees to purchase unnecessary patents (like Sonys) as a condition of access to necessary patents (like Phillips), and that it restrained competition by preventing people from licensing competing technologies (like Sonys). Put differently, Princo argued that the pool amounted to an anticompetitive agreement between competitors in which Philips and Sony agreed that Sony would not compete with Phillips system in exchange for being included in the pool and deriving revenue from its licenses.

The dispute initially came before the International Trade Commission, which had jurisdiction over the importation of Princos supposedly infringing discs. The ITC agreed with Princos misuse argument, but the Federal Circuit (first as a 3-member panel, then as the entire court) reversed. In rejecting Princos misuse defense, the en banc decision of the court defined the defense narrowly, arguably more narrowly than necessary given the facts in dispute. Because the Federal Circuit is the dedicated court of appeals for claims of patent infringement, the decision will govern all patent misuse defenses, at least until it or the Supreme Court construe the defense differently.

The Princo decision is noteworthy in at least two respects. First, it construed the doctrine as limited to efforts to expand improperly patent rights:

"The doctrine of patent misuse is thus 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. [T]he key inquiry under the patent misuse doctrine is whether, by imposing the condition in question, the patentee has impermissibly broadened the physical or temporal scope of the patent grant and has done so in a manner that has anticompetitive effects."

Slip op. at 17-18 (citations and quotations omitted). An agreement between competitors that does not expand the physical or temporal scope of the patent grant cannot be the basis of misuse, it reasoned, even if that agreement is anticompetitive and in violation of antitrust law. The defense, it asserted has been confined to a handful of specific practices. Id at 18 (citations and quotations omitted).

The court found that, in its agreement with Sony as part of the pool agreement, Phillips did not leverage its own patent and expand its own rights in unpatented subject matter by agreeing with Sony not to market the Sony patent. Any agreement was with Sony, not licensees, and licensees were not forced to accept an improper enlargement of Phillips patent rights. See id. at 24-25. In short, it is not enough that an agreement relating to a patent restrain competition; the agreement must operate to leverage and expand the patent holders rights and impose those restraints on users of the patent.

Because an agreement restricting the Sony patent didnt make Phillips rights any broader or impose undue restrictions on Phillips licensees, the court of appeals reasoned, there was no misuse. Princo thus limits misuse to practices that rely on the patent in question to impermissibly restrict licensees and broaden the patentees rights. See id. at 24. Other conduct, no matter how unlawful under antitrust or other law, does not render patent licenses unenforceable on the basis of misuse.

Second, the court appears to require that there have been an antitrust violation for misuse to exist (it made clear that an antitrust violation not improperly broadening the scope of a patent is not misuse, however, see id. at 19). The majority decision never squarely states that the defense is limited to cases where an antitrust violation (involving the patent in an improper way) has been proven, but its language and analysis strongly suggest as much. See id. at 29-32.

The majority held that a party raising the misuse defense has the burden of proving an anticompetitive effect. Applying an antitrust rule of reason analysis, the court concluded that the Orange Book agreement had legitimate pro-competitive purposes, and that Princo had not met its burden of proving that an agreement precluding Sony from marketing its patent separately had any actual anticompetitive effect. Id. at 36-37. Princo had to prove that there was a reasonable probability that the Sony technology would have otherwise become a strong competitive force, and this it did not do. Id. at 38.

It is not surprising that the Federal Circuit found that a patent pool restraint of trade survives rule of reason analysis: patent pools do bring benefits, and for that reason such joint ventures have generally survived antitrust challenges in recent years. It is perhaps more surprising that the majority was not more receptive to the argument that the agreement with Sony did, in fact, operate like a license restraining a licensee. More notable, as the dissent noted, the majority appears to have pronounced a broad rule that would preclude asserting misuse when a patent holder engages in many practices that stifle nascent technology. And the majority, in requiring proof of actual anticompetitive effect, effectively limits the defense to situations where these is strong proof of an antitrust violation. Thus, the dissent argued that the majoritys opinion effectively limited the misuse defense to unlawful tying arrangements and efforts to extend impermissibly a patents term. Slip op. at 2 (Dyk, J., dissenting). The dissent also noted, correctly in my view, that misuse has been available historically in other situations where there was no proof of an antitrust violation, and even to situations where the defendant raising the defense was not subject to the cited restraint. See id. at 12 (Dyk, J., dissenting).

Perhaps most surprising, the majority decision pays only lip service to one oft-repeated rationale for the defense: to neutralize practices that, whether or not antitrust violations, subvert he policies underlying patent or other intellectual property law. Part of the policy underlying intellectual property law is to encourage innovation and competition, and to allow the public to exploit innovations when they fall in the public domain. Patentees can use the leverage they have in their patents to induce others not to innovate or not to compete without broadening the physical or temporal scope of their patents. That is what Princo alleged that Phillips did. Such practices quite plausibly undermine the policies inherent in intellectual property law. Yet, under the majoritys analysis, such practices cannot constitute misuse.

The majority reasoned that it was relying on precedent; the dissent characterized the decision as a radical curtailment of the misuse defense. Whichever is correct, it is clear that, in the wake of Princo: (1) only those agreements with licensees that rely on a patentees rights to improperly expand those rights can form the basis of a misuse defense; and (2) where such agreements exist, defendants asserting misuse have a very high burden of proof, and must show actual harm to competition under conventional antitrust analysis.

The Princo decision may leave the patent misuse defense bloodied. Future decisions will tell us how much. In the meantime, Princo gives patent licensors room to be somewhat more aggressive in imposing restraints on licensees and others. Yet, it does not give them carte blanche. Patent misuse remains a viable defense in some settings, especially in traditional tying arrangements where a licensor conditions access to the licensed patent upon the licensees agreement to use or purchase some unpatented technology. In my next post, I will move from case parsing to some reminders of some particular practices that, even in the wake of Princo, may constitute misuse or otherwise render a license unenforceable. --Christopher J. Mugel