Judges: Bryson (concurring-in-part and dissenting-in-part), Gajarsa, Dyk (author)

[Appealed from ITC]

In Princo Corp. v. ITC, No. 07-1386 (Fed. Cir. Apr. 20, 2009), the Federal Circuit affirmed the ITC’s determination that Princo Corporation (“Princo”) failed to meet its burden of demonstrating that U.S. Philips Corporation’s (“Philips”) patents are unenforceable due to patent misuse on the ground of tying. The Court, however, vacated and remanded the ITC’s finding that an agreement not to license an allegedly nonessential patent as competing technology to the standard did not constitute patent misuse and remanded for further determination.

Philips and three other companies (Sony, Taiyo Yuden, and Ricoh) own patents directed to the manufacture of recordable and rewritable compact discs (“CD-R” and “CD-RW,” respectively). Some of these patents cover features necessary for these discs to comply with the “Orange Book,” a technical standard that governs the manufacture of CD-R and CD-RW discs to ensure compatibility with CD players and CD-ROM drives installed in commercial electronics products. In the early 1990s, the four companies agreed to pool their Orange Book-related patents. The companies authorized Philips to administer the pool and grant package licenses of the pooled patents to manufacturers wishing to produce Orange Book-compliant compact discs. Licenses to individual patents were not offered.

Princo licensed the package but ceased paying royalties shortly thereafter. Princo then intervened in an ITC proceeding in which Philips alleged that certain manufacturers violated 19 U.S.C. § 1337(a)(1)(B) by importing infringing compact discs. Princo admitted that its products infringe Philips’s patent but contended that Philips improperly expanded the scope of its statutory patent rights through price fixing, price discrimination, and the use of mandatory package licensing to force manufacturers to license “nonessential” pool patents in order to obtain licenses to pool patents that were essential to the manufacture of CD-Rs or CD-RWs.

The ALJ agreed with Princo that Philips’s patents were unenforceable due to patent misuse, both per se and under the rule of reason. The ITC affirmed, although on narrower grounds, concluding that Philips’s mandatory package licensing constituted misuse per se as a tying arrangement between licenses to patents that were essential and licenses to the four allegedly nonessential patents. Philips appealed and the Federal Circuit reversed, holding that there was no misuse per se or under the rule of reason. The Court remanded, instructing the ITC to address all issues presented by the ALJ’s decision.

On remand, Princo focused its arguments on Sony’s U.S. Patent No. 4,942,565 (“the ’565 patent”), which was included in the patent pool, along with Philips’s U.S. Patent Nos. 4,999,825 and 5,023,856 (collectively “the Raaymakers patents”). The Raaymakers patents are undisputedly essential to the Orange Book standard. Both the ’565 patent and the Raaymakers patents stemmed from Sony and Philips’s joint effort to develop recordable compact disc technology. During this development, Philips proposed an analog solution covered by the Raaymakers patents, while Sony proposed a digital solution covered by the ’565 patent. Philips and Sony defined the Orange Book standard using Philips’s solution disclosed in the Raaymakers patents. A license to the ’565 patent, however, was included in the standard package pool licenses offered to manufacturers, which allowed the use of pool patents only to produce Orange Book-compliant discs. The licenses did not allow use of the ’565 patent to produce discs using the digital method for encoding position data disclosed therein.

The ITC reversed the ALJ’s patent misuse rulings on two grounds. First, the ITC disagreed with Princo’s theory that, because the ’565 patent was not essential to the Orange Book standard, it was unlawfully tied to essential patents, including the Raaymakers patents. The ITC also found that Philips did not engage in improper price fixing by agreeing with Sony to make the ’565 patent, which covered a potentially competing technology to the Raaymakers patents, unavailable to manufacturers except through the package license that included the Raaymakers patents. Princo appealed.

On appeal, the Federal Circuit first considered Princo’s tying argument and whether the ITC improperly rejected it in view of the Federal Circuit’s decision in the first of Princo’s appeals from the ITC (“Philips I”). The Court first reminded that, in Philips I, it held that Philips’s practice of licensing essential patents in a package could not constitute misuse per se and survived under the rule of reason.

Princo contended in this second appeal that, because the ’565 patent is not essential as a blocking patent for purposes of the Orange Book standard, Philips I is inapplicable. Citing potential precompetitive benefits of package licensing of patents, the Court disagreed that the ’565 patent is not a blocking patent. The Court did not require certainty that the ’565 patent is essential; rather, it stated that, “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.” Slip op. at 17. Because legitimate questions existed as to the scope of claim 6 of the ’565 patent and its essentiality to the Orange Book standard, the Court concluded that “[c]laim 6, on its face, would have presented an obvious source of concern for an Orange Book manufacturer” and therefore was a blocking patent in this context. Id. at 19. Because the ’565 patent qualified as an essential patent for purposes of the Orange Book pool and manufacturers taking a package license eliminated the uncertainty of potentially infringing claim 6 of the ’565 patent when they manufacture Orange Book-compliant discs, the Court affirmed the ITC’s rejection of Princo’s misuse claim based on a theory of unlawful tying.

In so doing, the Court rejected Princo’s related argument that Philips’s licensing practice violates the Supreme Court’s teaching in Zenith Radio Corp. v. Hazeltine Research, Inc., 395 U.S. 100, 135 (1969), that “conditioning the grant of a patent license upon payment of royalties on products which do not use the teaching of the patent [is] misuse.” (Alteration in original.) In the Court’s view, because manufacturers taking a package license including the ’565 patent “eliminated the uncertainty of potentially infringing Claim 6 of that patent when they manufacture Orange Book compliant discs,” it could not fairly be said that a royalty is paid on products that do not use the teaching of the ’565 patent. Slip op. at 21.

The Court next turned to Princo’s price-fixing theory in which Princo contended that, even if the ’565 patent properly may be included in the package licenses, Philips committed patent misuse by agreeing with Sony not to license the ’565 patent in a way that would allow a competitor to develop, use, or license the ’565 patent digital encoding technology to create a competing product to the analog encoding technology covered by the Raaymakers patents. The Federal Circuit concluded that the ITC erred in holding that this claim could not provide a basis for patent misuse under the rule of reason. First, the Court rejected the ITC’s reasoning that no misuse occurred under Philips I because the ’565 patent is a blocking patent and no misuse can fl ow from including it in the package license. The Federal Circuit found that the ITC read Philips I too broadly when the ITC suggested that the ’565 patent’s status as a blocking patent could immunize an agreement not to compete. The Court noted that its decision in Philips I confirmed only that the package licensing of blocking patents is not patent misuse as a form of tying and did not consider whether an agreement that would prevent the development of alternatives would constitute misuse under a theory of elimination of competition or price fixing. Importantly, the Federal Circuit noted that Philips I did not foreclose such an argument and that the essentiality of the ’565 patent to the Orange Book standard could not justify a refusal to allow it to be licensed for non-Orange Book purposes.

Next, the Federal Circuit disagreed with the ITC that there had been no showing that Sony and Philips would have competed in the technology licensing market absent the pooling arrangement. The Court rejected as inaccurate the analogy of a merger of two companies offered by Philips and accepted by the ITC. In the Court’s view, unlike the alleged agreement not to compete at issue, a merger of two companies has potential countervailing efficiencies that offset potential harms to future competition. The Court found that the agreement alleged by Princo was unlikely to have efficiencies that could not have been achieved equally well through a nonexclusive agreement that would have left open the possibility that the ’565 patent technology could have been further developed.

Finally, the Federal Circuit disagreed with the ITC’s rejection of Princo’s misuse argument on the ground that the ’565 patent could not be used in place of the Raaymakers patents to manufacture Orange Book-compliant discs. The Federal Circuit found this irrelevant to Princo’s misuse claim, since that claim asserted that the alleged agreement to offer the ’565 patent only through the package license harms competition because it is directed to a non-Orange Book technology and could have been a competitive alternative to that technology. The ITC did not determine that the ’565 patent was fundamentally incapable of commercialization as part of an alternative standard or whether, absent an agreement to the contrary, the ’565 patent could have been developed as part of an alternative technological platform.

The Court concluded that the fact that a patent’s disclosed embodiments may not be commercially viable cannot be dispositive under rule of reason analysis. In so doing, the Court rejected Philips’s argument that the ’565 patent must already have been developed to the point of commercial viability before misuse could be found. In the Court’s view, “horizontal competitors can[not] insulate themselves from misuse liability simply by agreeing to suppress competing technologies before they are fully developed.” Id. at 30.

Finally, the Court considered whether there was, in fact, an agreement between Sony and Philips to prevent licensing of the ’565 patent as a competitor to the Orange Book standard. The Court found that the licenses did not allow the use of the ’565 patent to produce discs competitive with the Orange Book. The Court also found evidence that Sony granted Philips an exclusive license to the ’565 patent for CD-R purposes, and that Philips agreed not to license the patent except for the manufacture of Orange Book-compliant discs. Moreover, the Court found evidence that Sony itself may have agreed with Philips not to license the ’565 patent for non-Orange Book purposes. Because the ITC did not determine whether the parties agreed not to license the ’565 patent outside the Orange Book context, the Court remanded, reminding that, if the record contains insufficient evidence to justify a finding that Sony and Philips agreed that the ’565 patent would not be licensed as a competitive technology, there would be no misuse under Princo’s price-f xing theory.

Dissenting-in-part, Judge Bryson would have affirmed the ITC’s final determination without remanding for further findings. With regard to tying, in Judge Bryson’s view, the requirement that purchasers take a license to a pool of patents that included the ’565 patent could not have adversely affected competition because the ’565 patent cannot be used to make an Orange Book-compliant disc. Judge Bryson found that “at most the licensees were required to accept something they did not want and would not have tried to obtain by other means and from other sellers.” Bryson Dissent at 2. Further, Judge Bryson concluded that the profit-maximizing price for the license would be the same regardless of how many unwanted patents it contained, as long as it contained all the patents needed to make Orange Book-compliant discs. Judge Bryson also found no unlawful tying under the Zenith standard because, unlike in Zenith, Philips did not use the leverage of the Orange Book licenses to increase revenues unrelated to its patent rights.

Judge Bryson also regarded the ITC’s factual findings and legal conclusions as sufficient grounds for upholding the ITC’s ruling that Princo failed to satisfy its burden of showing patent misuse through a horizontal pricefi xing agreement. According to Judge Bryson, rather than present evidence that the ’565 patent was a viable potential competitor for the Raaymakers patents, Princo relied on an inference that the ’565 patent must have been a potential competitor for Philips’s Orange Book patents because, otherwise, Philips would not have allowed Sony to share in the patent pool licensing royalties. Judge Bryson found other reasons for Sony’s sharing in the royalties, including evidence that Sony had contributed substantial resources to develop the Orange Book standard. Moreover, Judge Bryson found that the majority’s finding, that the ’565 patent “qualified as an ‘essential’ patent for purposes of the Orange Book pool” undermined Princo’s price-fixing argument, which was based on the legal rule that “the pooling of non-blocking, substitute patents [is] universally recognized as highly anticompetitive” and is unlawful. Id. at 9 (alteration in original). Finally, Judge Bryson found the ITC’s finding that Princo failed to demonstrate that, absent the patent pool agreement, Sony would have competed with the Orange Book technology, either directly or by licensing the ’565 patent, sufficient to support the ITC’s conclusion that the patent pool was not shown to have any anticompetitive effect.