There is no practical alternative to the Ethernet standard, which enables machines to communicate
in local area networks. Used in nearly every computer in the country, both computer makers and users are locked into the standard. It goes without saying, then, that the patents covering part of that standard are crucial.

Not surprisingly, the owner of these patents, Negotiated Data Solutions (NDS), decided to take advantage of the situation by demanding more money from companies that wanted to build or sell computers capable of Ethernet communication.

But the Chicago-based company had one small problem: It wasn’t supposed to increase its licensing fees. This was part of a quid pro quo with the Institute of Electrical and Electronics Engineers (IEEE), the independent standard-setting body that set up the Ethernet standard in 1994. The IEEE incorporated the patented technology into the standard only after the patentee gave assurances it would license the technology for a flat fee of $1,000 to anyone who asked.

Eight years later, the patentee renegotiated its deal with the IEEE and then increased its royalty rates for licensees. While the IEEE didn’t object to this, the Federal Trade Commission (FTC) did, and it went after NDS.

In January, the FTC announced a controversial consent decree with NDS that effectively forces the patent owner to revert to the original $1,000 royalty. This groundbreaking action markedly expands the scope of the FTC’s enforcement powers and signals that the agency will more actively police the way IP owners exploit their rights, according to many legal experts. But it is unclear how far this new oversight will go.

“My sense is that the FTC recognizes competition is affected by the bad behavior of IP owners, and it is trying to draw some lines around the absolute power that IP owners claim they have to license their property,” says Carole Handler, an IP litigator at Foley & Lardner. “We may be seeing that the absolute right to exploit IP is limited not just by antitrust considerations, but also by unfair competition.”

Sectioned Off
The consent decree with NDS is a significant departure from prior FTC actions, according to many legal experts. In the past, the agency has acted almost exclusively against those who violate or seek to violate antitrust law. In this case, however, NDS’s actions raised no antitrust issues. The agency found merely that NDS’s price increase violated Section 5 of the FTC Act, which says unfair methods of competition and unfair acts or practices are unlawful.

For years the FTC has asserted that Section 5 lets it to go beyond the realm of antitrust violations. This interpretation is disputed, however, by the Justice Department and many antitrust experts.

Many experts are concerned that if Section 5 is cut loose from antitrust law, there will be no clear standards for determining when activity is unfair. “Does this empower future commissions to reach out and stop whatever they think is inappropriate?” asks A. Douglas Melamed, an antitrust partner at Wilmer Cutler Pickering Hale and Dorr. Melamed represents NDS in this matter.

“Section 5 sets no limits on what one can and can’t do,” says Geraldine Alexis, an antitrust litigator at Perkins Coie. “So how can in-house counsel advise their internal clients about what they can and can’t do?”

Power Struggle
The FTC’s action is especially significant to IP owners. It demonstrates that the FTC intends to keep an eye on the way these owners exploit their rights–particularly if the IP affects an industry standard.
The FTC has been active in this area before. The agency has chastised Rambus (in 2006), Dell (in 1996) and other companies for allegedly taking advantage of the process for setting industry standards. These companies have gotten into trouble because they supposedly participated in standard-setting without disclosing that they had patents covering aspects of the proposed new standards.

The NDS case goes beyond this. It indicates that once a patentee makes a licensing commitment to a standard-setting organization, the patentee must essentially stick with that deal or risk FTC enforcement action. Even if the standard-setting organization agrees to a revised licensing commitment and there are no antitrust concerns, the FTC may still declare (as it did with NDS) that the revision is an unfair act or method of competition that violates the law.

IP owners thus need to be wary about their dealings with standard-setting organizations. If a company is participating in a standard-setting process, it must fully disclose, in advance, any IP interests it may have in the standard. A company also needs to think long and hard before making licensing commitments to a standard-setting organization because the company may be permanently stuck with those commitments.

Companies considering the purchase of IP rights now need to determine if the rights they seek to acquire are encumbered by prior commitments to standard-setting organizations. “A patent may not be as valuable as you thought,” says Albert Marcellino, a patent lawyer at Woodcock Washburn.

Patent Patrol
The FTC’s action with NDS heralds tougher agency oversight of the exploitation of IP rights, according to many patent experts. “There will definitely be more FTC actions,” Handler says. “I think they will go after a lot of IP practices that are not antitrust violations.”

These new enforcement efforts might not be limited to the intersection of IP and industry standards. Businesses, economists, academics and IP experts have been complaining for years that instead of promoting innovation, patents are too often being used to hamper innovation and hurt the economy. Several Supreme Court justices have echoed these concerns. In Justice Stephen Breyer’s 2006 dissent in Laboratory Corp. of America Holdings v. Metabolite Labs. Inc., he wrote, “[T]oo much patent protection can impede” progress.

All this could embolden the FTC to act against perceived patent abuses that occur beyond the standard-setting context. “[It could] go after a patent owner tying the sale of a patented article to the sale of an unpatented article,” Handler says. “It could also go after excessive pricing or bundling and may take a look at whether business method patents are anti-competitive.”

It is far from clear whether the FTC will reach into these areas. “A lot will depend on the FTC’s budget,” Handler says. “With the war in Iraq, the budget for enforcement has been drastically cut.”
The upcoming election also will be significant. “If the Democrats take the White House, the FTC is likely to be even more active in this area,” Handler says.