Patent Pools and Standards

Princo v ITC“Hard facts make bad law”

“No facts make worse law”

David Healey, Principal, Fish & Richardson One Houston Center, Suite 2800

1221 McKinney St.Houston, Texas 77010

713-654-5300Healey@fr.com

Slides can be obtained by email or from website:

www.patentmath.com

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Princo – the Stats

• Arose out of a patent pool• De facto (private) standards on CD-R and

CD-RW• 2 big companies: Phillips and Sony• 2 choices of technology for CD-R and CD-

RW– Analog (Phillips) or Digital (Sony)

• En Banc Federal Circuit – 3 decisions, majority, concurrence in part, dissent

Part 1

Traditional Views of Antitrust and Patent Misuse

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Antitrust Statutes– Sherman Act Section 1: Makes it a felony for two or more competitors to

collude with each other in a way that restrains trade in a relevant market.

– Sherman Act Section 2: Makes it a felony for a competitor acting alone using unfair business practices, or 2 or more competitors unfairly colluding with each other, to attempt to monopolize a relevant market, or successfully doing so.

– Clayton Act: Private cause of action for violations of Sherman Act, requires proof of standing and damages resulting from harm to competition in the impacted market.

– Private Attorney General: Sherman Act is a criminal/regulatory statute. The Clayton Act gives private litigants standing to enforce it, and rewards success with treble damages and attorneys’ fees.

– FTC Act: A regulatory unfair competition statute that allows only the Federal Government to bring suit.

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Antitrust Elements and Concepts

• Relevant Market: A market for a product (which is all available substitute products that compete with each other in a geographic area); or fungible technologies that can compete with each other (e.g. competing technical solutions for an interoperability standard); or possibly R&D (e.g., resources and incentive to innovate in a specific technology).

• Market power: The ability to force other competitors to take actions in the relevant market that they would not otherwise do (e.g., reduce production, increase price, etc.)

• Monopoly power: The power to control output or price or both in a relevant market.

• “Rule of Reason”: In evaluating a restraint on trade as “unreasonable” for purpose of Sherman Section 1: The anticompetitive harm caused in a relevant market is balanced against the pro-competitive benefits of the concerted actions challenged (e.g., does the restraint of trade alleged hurt consumers and competition more than it helps to make more products available at cheaper prices).

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Decline of Per Se Rules in a Tech Economy

• “Quick Look Rule”: Court takes a “quick look” at the balance of negative and positive impact on the relevant market of the defendants’ actions; and if on initial evaluation the balance of the restraints on competition appear more harmful than helpful, the burden of going forward by the plaintiff is met, and shifts to the defendant.

• Per se violation: Practices that over time have been designated as facially so destructive to competition that they are illegal without having to show harm to relevant market: E.g.,– Price-fixing between competitors at the same level of the

market (e.g., all retailers)– Group boycott– The movement in the law is away from per se liability except

where explicitly established in US Supreme Court case law.

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Patents vs. Antitrust• A patent is the exclusive right given to its owner to exclude others

from practicing the inventions in the issued claims for a period of time.

• A “patent monopoly” is generally not (and in fact rarely is) the same as a monopoly over a relevant market (economic market) because typically there are alternative goods, methods, processes, etc. that compete as substitutes with the claimed inventions.

• When there is no substitute that can compete with the claimed invention, a patent monopoly may be co-extensive with an economic monopoly.

• A patent owner acting alone and within the rights of his patent grants is immune from antitrust liability.

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Standards-Patents-Antitrust

• Industry standards: Protocols typically created to permit for interoperability of different manufacturers’ equipment to permit for more competition at each level of the market: E.g., electrical outlets, wireless standards, USB, semiconductor pin-out and size, etc.

• Industry standards: Product specifications and certifications to meet minimum safety and quality requirements to protect consumers or otherwise needed for public welfare can also be standardized: E.g., U.L. Certification, Fire Code Standards, “Clean Air” formulations for gasoline, etc.

• De Jure Industry Standards: Standards or certification processes by groups of competitors/industry players: E.g., JEDEC, ETSI, IEEE, ASME, PIP, 3GPP, or even government bodies: E.g. Gasoline formulations.

• De Facto Industry Standards: Standards created by individual competitors or closed coalitions of competitors: E.g., SD Cards, “Orange Book”, CDMA, VHS, etc.

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Standards-Patents-Antitrust• Patent or patents that cover a successful standard generally give their

owner market or monopoly power over the relevant market for technology and goods compliant with the standard.

• Standards that do not promote a pro-competitive purpose on balance or that do not provide other public safety benefits:

– Can be illegal restraints on trade violating Sherman Section 1; or – Unlawful attempts to monopolize a market under Sherman Section 2; E.g.

standards for pasta; State Bar minimum fee schedules; Dental Association rules on release of records and prices to insurers; etc.

– Violate the FTC Act

• Corruption of standard-setting process or product certification process in a standards setting organization (“SSO”) is unlawful even if the rules of the group are followed by the wrong-doer. E.g., packing a vote, failure to disclose patents the owner knows it will assert covers the standard.

• Post-adoption leveraging of standards is unlawful: E.g., refusing to honor commitments to license to standards groups ( In re N-data, Broadcom v Qualcomm); onerous license provisions on price, grant-backs, etc.

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Patent Misuse under 271(d)(5)• Patent misuse grows out of equitable “unclean hands”, and traditionally

applied to anticompetitive conduct of the patent owner in use of its patents that had the effect of extending the patent monopoly beyond the statutory grant.

• 271(d)(5) limited patent misuse for tying and other antitrust like conduct to situations where the patent owner has market power.

• Modern trend in the law of tying, as with most restraints in standard-setting, as well as patent licensing, is to review licensing restraints and standard-setting conduct under the “rule of reason”: This trend is captured in DOJ-FTC guidelines.

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Patent Misuse Compared…

• Patent misuse– Applies to the patent’s

enforcement outside of litigation, not litigation conduct.

– Renders patent unenforceable.

– Can be “purged”. – No standing required:

• Anyone can raise it even if not a victim

• Compared to…– Unclean hands is

litigation conduct.– Inequitable conduct

is in the application process in PTO.

– Sherman/Clayton claims require standing

– FTC Act government only has standing

– No “purging”

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Actual Harm Required

• If there are no acceptable substitutes for the claimed invention, then any market power is the result of the invention not the collusion, even if the invention is put into a de facto or de jure standard, or license terms are at monopolistic prices.

• But unlawful action and harm might be shown if:

– There are in fact substitutes for the technology or patent or product;

– “Design-arounds” or alternatives would or could be competitive, if either,• A patent had been timely disclosed in the process prior to adoption or

implementation of a standard; or• A license for a standard does not interfere with development of other

alternatives or unnecessarily diminish incentives of others to develop alternatives.

– Product certification is unfairly denied to an acceptable substitute.

Part 2

Summary of Facts Leading To ITC Action As

Determined From ALJ’s Initial Determination

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The Orange and Red Books• “Orange Book” is set of standards for different versions of CDs.

• “Red Book” is a set of standards for manufacturers of devices that use CDs.

• “Orange Book” and “Red Book” are the result of de facto standard-setting – Phillips and Sony developed the standards outside of a standard-setting group.

• Standards for compatibility of CDs are critical for interoperability of CDs and devices.

• “Orange Book” is a “turn-key” technical specification for any manufacturer to make compliant CDs:

– Covers specs both “essential” (no design around and required for interoperability) and “commercially essential” (only practical way to implement a feature required for functionality even if not required for interoperability or design around is theoretically or actually possible).

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De Facto CD-R & RW Standards

• Phillips had an analog technology for CD-R and CD-RW.

• Sony had a digital technology for CD-R and CD-RW.

• Phillips and Sony engineers agreed the Phillips analog path was easier to implement, with fewer errors and greater reliability than Sony’s digital technology for CD-R and CD-RW.

• Phillips and Sony decide to put Phillips’ analog technology in the “Orange Book” as the specification for CD-R and CD-RW.

• All CD versions in the “Orange Book” had to be and were backward compatible with each other so that each would work with the consumer devices made according to past and present “Red Book” specifications.

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Orange Book Patent Pools• Phillips operates patent pool for package licenses needed to implement

“Orange Book” and “Red Book” specifications.

• “Independent” evaluator decided what patents go in the pool and each license, as “essential” and which as “commercially essential”.

• Phillips only licenses patents in the pool for “field of use” of devices compliant with “Orange Book” or “Red Book”.

• Sony agrees not to license its patents in the pool to others outside of Phillips’ licensing program (e.g., for development of alternative technology).

• Sony gets large share of royalties from each pool.

• Sony got large share of royalties from CD-R and CD-RW pools even though its digital technology was inapplicable to the pools.

• Phillips will not license individual patents or let licensees pick and choose from among the patents.

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Twisted History of the Specs…• Phillips and Sony do not disclose in the Orange Book which patents are

essential or commercially essential for which specifications or if any specifications do not implicate infringement: “turn-key” approach.

• Although the “independent” evaluator put one claim of one Sony digital patent in the CD-R and CD-RW pool as “essential”, this claim clearly was not applicable to analog specifications.

• Phillips charges minimum fees for patent pool licenses regardless of selling price of CDs.

• Taiwan FTC in 2001 found these practices anticompetitive and ordered that each pool member be required to also license its own patents separately from the other members and in any combination requested by licensee.

• Sony and its affiliates reduced their prices for patent licenses when forced to license themselves in Taiwan.

• Phillips charged same price for each package.

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Patents of Other Companies In Pool that Were “Non-Essential”

• Phillips also included several ‘other patents’ that arguably were not essential to implementation of the Orange Book interoperability specifications (internal functions) in the patent pool.

– These ‘other patents’ related to specific operations within the manufacturing process.

– Respondents presented evidence there was at least one technical alternative to each of these ‘other’ patents.

• Phillips licensed most of the market and makers of CD products, but could never capture all manufacturers in its licensing program.

• Phillips and Sony agreed that Sony would not license its digital technology for CD-R or CD-RW development.

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Commoditization and Princo

• Overtime, CDs became commodity products where price was not directly driven by cost or margin, but mainly by market demand and supply.

– CD manufacturing became focused in countries with low manufacturing costs.

– CD manufacturers generally purchased “turn-key” equipment systems and licenses.

– Phillips could tell CD manufacturers which package license each needed based on the manufacturing equipment purchased.

• Princo got into the CD-R and CD-RW on a “turn-key” basis:– Purchased manufacturing equipment.– Purchased pool license from Phillips.

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Princo’s Actions• Princo saw prices for CD-R and CD-RW fall as supply increased, but

minimum royalty remained constant.

• Princo stopped paying royalties.

• No evidence ever discussed in public opinions that Princo sought to:

– Implement alternatives to any non-essential patent (that is, to change operation of manufacturing equipment to implement an alternative technique at any step in the process).

– Develop or invest in development of digital technology.

– Asked Sony for license to the digital technology patent(s) separately

from the Phillips managed patent pool packages.

Part 3

THE ITC CASE, ALJ INITIAL DETERMINATION AND

COMMISSION DECISION

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Phillips Brings ITC Action

• Phillips brings ITC Action against Princo and other CD manufacturers not paying royalties.

• The ALJ finds all patents infringed.

• The ALJ finds all patents valid.

• But the ALJ finds Phillips Patent Pools are riddled with various types of misuse.

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Patent Pool Defined

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Patent Pools: Good and Bad

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What Belongs in a Pool?

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The CD-R and RW Pools

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Digital v Analog

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ALJ’s Patent Misuse Definition

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Patent Misuse > Antitrust Law

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ALJ’s Relevant Markets

• 2 relevant markets found:– Standardized product for which no other

product is compatible (CD-R and CD-RW).

– Patent licenses to manufacture product according to interoperability standards.

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ALJ’s Decision on Essentiality

• Phillips said essential and non-essential patents were in the Pool to allow manufacturers to buy equipment, tweak it, and produce CD-R and CD-RW on a “turn-key” basis.

• Respondents said Pool should be limited to those patents for a required standard for which there was no substitute.– Pointed out Orange Book does not match standards

and patents.– Opposite of Phillips’ “turn key” approach.

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The Scam?• Independent patent advisor called Sony’s

Lagadec patent essential.• ALJ found the patent was not essential but in

fact was wholly inapplicable to Orange Book CD-R and CD-RW.

• And as a result was an available alternative technology if manufacturing process changed.

• Other patents on very specific features were found non-essential and that potential alternatives existed to implement each feature.

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Phillips Meets 271(d)(5)

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Rates Sound Bad?

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Minimum Fees Show Market Power

• Pool charged minimum fees.

• Fees and rates were high (1/3-1/2 or more of sales).

• ALJ said minimum fees put a cost squeeze on manufacturers, and was something they would not agree to in a market unless distorted by anticompetitive conduct.

– Taiwan FTC’s order to allow individual patent/patent owner licensing resulted in drop in royalties for non-essential patents.

• Phillips minimum royalty prevents CD-R and CD-RW product prices from going down below certain point.

• Phillips sold CDs made for it by Taiwan manufacturer royalty-free.

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Some License is Needed

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Commission Focused Only On Tying—Both Per Se and “R of R”

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Balance: Impact v. Injury

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Commission Finds Harm

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Was there actual harm?

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Digital Patents Not Asserted

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Part 4Fast-Forward to the August 30, 2010 Federal Circuit En Banc

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Same Facts:3 Opinions, 3 Theories• Majority: Phillips and Sony

have a joint venture:– Agreeing between themselves

not to license their own patents to compete with the “Orange Book” is not an unreasonable restraint.

– Since the engineers agreed that the analog technology is better, there is no harm no foul.

– Other non-essential patents were on minor specifications and proof of alternatives was thin.

• Dissent: Phillips has paid off Sony to keep the competing technology off the market:– Even if Sony had no interest in

developing the digital technology, others might have but for Phillips’ paying off Sony.

– The Sony Lagadec patent did not belong in a pool with the Phillips analog patents, and forcing manufacturers to license is tying.

– Even if other alternative patents are thin, can’t prevent choice or development of choice.

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Majority: Patent misuse limited to “leverage” of patent in suit: Extend term or scope (tying) – no “leverage” of Lagadec patent and did not sue on Lagadec Patent

Concurrence: No proof of harm to competition so no violation of 271(d)

Dissent: Pool’s agreements among members and licensees fail quick look test because collusion excludes competing technologies

Factually: No harm, no foul

Decide case on facts only for failure of proof of harm to markets

Enough proof of harm to competition to develop facts and go past “quick look”

Legally: Sherman 1 violation is not the same as patent misuse even when based on conspiracies on patent licensing

1) No proof there was a viable digital alternative

2) No proof Princo wanted to develop any alternatives (choose turn key)

Absurd to hold that in theory an antitrust violation (a felony crime) based on patent licenses is not patent misuse.

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Final Comments

• Cert. petition window is still open for another month or more.

• Patent leveraging theory is too narrow – especially for the ITC where no counterclaims can be brought for Antitrust violations. (ITC is place you need the defense of patent misuse).

• If something is an Antitrust violation but not patent misuse can you still enforce the patent?

Discretion is the Better Part of Valor….

For slides or discussion see www.patentmath.com or email or call

David Healey713-654-5300 and healey@fr.com