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Over the past five to 10 years, patent pools have become increasingly popular vehicles for licensing patents. In fact, patent pools have become so prevalent for licensing the rights to well-known technologies, such as the digital versatile disc (DVD), compact disc-recordable (CD-R), compact disc-rewritable (CD-RW) and the Moving Picture Experts Group (MPEG) (an international standards organization), that they account for billions of dollars of licensing revenue each year. With such high revenues at stake, a virtual “who’s who” of Fortune 500 companies have decided to dive in. Although the waters appear warm and inviting, dangerous undercurrents may exist. Patent pools are private contractual agreements through which rival patentees or companies jointly license their patents. Often, the patents of a patent pool are licensed in a single package, they are usually licensed by a single entity or “licensing agent” and the licensing revenues are split among contributors by agreement. The revenues are usually split by the perceived value of each entity’s contribution to the patent pool. For instance, Philips, Sony and Pioneer jointly license DVD-related patents through their 3C (three company) DVD patent pool. The 3C DVD pool is arranged to permit a licensee to use the pooled patents to manufacture discs that conform to DVD specifications. Philips is the licensing entity for the 3C DVD pool, and it carries out the actual negotiations and licensing. Used properly, patent pools can function as an efficient way of licensing patents necessary to practice a technology. Complimentary rights, i.e., different technical aspects required to practice a technology, held by various companies can be packaged together in one place and licensed on a “one-stop shopping” basis. This can theoretically reduce transaction costs, clear blocking positions and avoid costly infringement litigation. Patent pools, however, can also pose a serious anti-competitive threat. For example, if a pool is structured or licensed improperly, competition between potentially competing technologies may be eliminated, a disincentive to innovate may be created, price fixing may occur or collective price or output restraints may be established. This diminution in competition would have a direct, negative impact on the consuming public by denying consumers what might be the best technology or artificially inflating prices, or both. Through the years, patent-pooling arrangements have received differing degrees of deference from the courts and agencies charged with antitrust enforcement. Until the mid-1940s, patent pools were relatively commonplace, and included the sewing machine, airplane and radio pools. In 1945, the U.S. Supreme Court stepped in, and, in Hartford-Empire Co. v. United States, 323 U.S. 386 (1945), affirmed the dissolution of a well-known glassware manufacturing patent pool. The Hartford-Empire decision exposed the ugly side of patent pools: It revealed the anti-competitive acts, including output restraints and market division, that competitors could carry out when they combine their patents and license them collectively. EVOLVING PERSPECTIVE OF DOJ After the Hartford-Empire decision, and particularly in the 1960s and 1970s, the U.S. Department of Justice (DOJ) evaluated patent pools closely. DOJ’s stance, at any point in time, on patent licensing and antitrust law is important because it has the authority to bring its own lawsuits to remedy what it perceives are antitrust violations. In 1970, the legendary “Nine No-Nos” — a list of nine separate, specific instances of patent-licensing behavior that DOJ considered to be akin to a per se antitrust violation — were created. In 1995, DOJ issued its Antitrust Guidelines for the Licensing of Intellectual Property, which represented a departure from the Nine No-Nos in that they articulated a less rigid and more pragmatic approach to the evaluation of the licensing of patent rights. See www.usdoj.gov/atr/public/guidelines/ipguide.htm. The 1995 guidelines contain a section devoted to patent pooling, and state that pooling arrangements may be pro-competitive by integrating complementary technologies, reducing transaction costs, clearing blocking positions and avoiding costly infringement litigation. The guidelines, however, also warn that certain anti-competitive effects can result from patent pooling. As examples, they point to collective price or output restraints in pooling arrangements, price-fixing or market division, and arrangements that retard innovation. This diminution in competition would have a direct and negative impact on the consuming public by denying consumers what might be the best technology, artificially inflating prices or both. The 1995 guidelines were significant in that patent owners saw them as a sign that DOJ’s antitrust enforcement policy as it applies to patent pooling had shifted. Using the guidelines as a road map, several patent owners formed patent pools. One group of patent owners applied for a “business review letter” for an MPEG-2 patent pool. A business review letter contains a statement of DOJ’s enforcement intentions for a particular arrangement that is proposed and described to DOJ. In 1997, DOJ responded by issuing the MPEG-2 business review letter. It was the first post-guidelines business review letter relating to a patent pooling arrangement. Subsequently, Philips, Sony and Pioneer also applied for, and received, a business review letter in 1998 for the 3C DVD patent pool. In each instance, DOJ indicated that, based on the information and assurances provided, it did not intend to initiate an enforcement action at the time. THE ‘ESSENTIALITY’ ANALYSIS One of the factors that DOJ relied on in refraining from initiating an enforcement action was the “essentiality” aspect of the proposed pooling arrangements. The essentiality aspect, which calls for an independent patent evaluator to examine patents to be included in the pools and to identify those patents that are necessary, or essential, to practice the technology associated with the pools, is a mechanism designed to integrate complementary technologies into a pool and clear blocking positions. In its 3C DVD business review letter, DOJ explained the importance of the essentiality determination and the anti-competitive harm that could result if it were not performed correctly. It stressed that essential patents are patents that have no substitutes, and it warned of the following anti-competitive effects that would result if nonessential patents were present in the pool: There could be foreclosure of the use of competing patents because a licensee that obtains a license to a patent through the pool would not normally choose to license any competing patents, even if they were superior; and price fixing could result if substitute patents were in the pool. In that regard, DOJ scrutinized the “essentiality” definition provided by the DVD business review letter applicants, and it forewarned of the grave consequences that would result if they erred in its application. ARE ANY POOLS IN JEOPARDY? Several of today’s pools, including some examined by an independent evaluator, could quickly sink if they are subjected to a rigorous essentiality analysis. For instance, a defendant to a patent infringement action involving a pooled patent can assert an antitrust-based patent misuse defense by pointing to an improper tying arrangement. A successful patent misuse defense will render the misused patents entirely unenforceable. Patent misuse is the impermissible expansion by the patentee of its patent right beyond the patent’s physical or temporal scope. See, e.g., Windsurfing Int’l Inc. v. AMF Inc., 782 F.2d 995, 1001 (Fed. Cir. 1986). The use of a patent, along with market power, as a means to consummate the mandatory sale of an unpatented product or the mandatory license of another patent, i.e., a tie, is an impermissible expansion of the patent and constitutes patent misuse. See, e.g., 35 U.S.C. 271(d)(5); Morton Salt Co. v. G.S. Suppiger Co., 314 U.S. 488, 490 (1942); Senza-Gel Corp. v. Seiffhart, 803 F.2d 661, 669 (Fed. Cir. 1986). Consequently, if it is determined that nonessential patents have been included in a pool and market power exists in connection with the essential patents, there is patent misuse. Under those circumstances, licensees are forced to accept nonessential patents as part of a license to the essential patents necessary to practice a technology. This is a classic tying arrangement — the use of patents in which market power exists (the tying items) to force licensees to accept unnecessary patents (the tied items). The anti-competitive harm from impermissible tying arrangements is well recognized throughout the case law, e.g., Jefferson Parish Hospital District No. 2 v. Hyde, 466 U.S. 2, 12 (1984), and, as discussed above, by DOJ. By tying unnecessary patents to necessary ones, a pool can foreclose competition between technologies covered by the unnecessary patents and alternative technologies. In such an atmosphere, companies not involved in the pool cannot effectively sell or license their alternate technologies because the prospective customers have already licensed the competing (nonessential) patents as part of the pools. Consequently, the alternate technologies do not have the opportunity to compete with the nonessential technology that is included in the pools, and innovation, the licensing market and the companies holding these alternate technologies are harmed. There are several parallels between many of the patent pools in existence today. First, the same evaluator makes the essentiality determinations for several of the pools, including the 3C DVD pool. Second, that evaluator uses “the exact same methodology” in making his essentiality determinations. Additionally, the royalty provisions in several pools include a “floor” rate that kicks in and holds the royalty steady if the net selling price of the royalty-bearing products (CD-Rs, CD-RWs, or DVDs) falls below a certain value. Due to falling prices, that floor rate may kick in relatively quickly, and, before long, manufacturers performing under the pooling licenses may not be able to make a profit after they pay the royalty rate and expend the costs to make the products they sell. These facts, along with declining prices in the markets that the pools govern, may force companies to make the decision to fight rather than die. If they do, they may find that nonessential patents have been improperly included as part of the pooling arrangement, and that the inclusion of those patents has harmed competition. STAYING OUT OF HOT WATER Companies involved in patent pools would be wise to make sure that an essentiality analysis has been properly performed on the patents in their pool. Performing an accurate essentiality analysis will ensure that the pool does not include an impermissible tying arrangement. Essentiality definitions that are commonly applied to pools encompass patents that are either “technically essential” or “essential as a practical matter.” Technically essential patents are patents that are inevitably infringed by compliance with the specifications of the pooled technology, i.e., they expressly cover the specifications. Patents that are “essential as a practical matter” do not expressly cover the specifications of the pooled technology, but are patents that have no existing economically feasible alternatives and are used in arriving at technology covered by the specifications. Companies participating in patent pools that ensure that an essentiality analysis has been properly performed will reduce the risk that they fall victim to a tying defense for licensing nonessential patents with essential patents. That means that the essentiality analysis should ensure that no economically viable substitutes exist for any patents in the pool that have been deemed “essential as a practical matter.” It also means that patents that cover expressly optional sections of the specifications for the pooled technology should not be deemed “technically essential.” Taking this step correctly should address DOJ’s concerns about the foreclosure of the use of competing patents and price fixing. Alexander J. Hadjis is a partner at New York-based Weil, Gotshal & Manges, and leads the firm’s Washington patent litigation group. While at another firm, he acted as lead trial counsel representing three defendants against Philips in Certain Recordable Compact Discs and Rewritable Compact Discs , Inv. No. 337-TA-474 (USITC 2004), in which the U.S. International Trade Commission accepted an antitrust-based patent misuse defense against Philips and thus struck down the CD-R/RW pools at issue. He can be reached at [email protected]. If you are interested in submitting an article to law.com, please click here for our submission guidelines.

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