U.S. Philips Corp. v. International Trade Commission

United States Court of Appeals for the Federal Circuit

04-1361

U.S. PHILIPS CORPORATION,

Appellant,

v.

INTERNATIONAL TRADE COMMISSION,

Appellee,

and

PRINCO CORPORATION, PRINCO AMERICA CORPORATION,
GIGASTORAGE CORPORATION TAIWAN,
GIGASTORAGE CORPORATION USA, and LINBERG ENTERPRISE INC.,

Intervenors.

A. Douglas Melamed, Wilmer Cutler Pickering Hale and Dorr LLP, of
Washington, DC, argued for appellant. With him on the brief were William J. Kolasky,
Edward C. DuMont, Jonathan G. Cedarbaum, and Barbara R. Blank.

Clara Kuehn, Attorney, Office of General Counsel, United States International
Trade Commission, of Washington, DC, argued for appellee. With her on the brief were
James M. Lyons, Acting General Counsel, and Wayne W. Herrington, Acting Deputy
General Counsel for Litigation.

Alan D. Smith, Fish & Richardson P.C., of Boston, Massachusetts, argued for
intervenors. With him on the brief were Charles H. Sanders of Boston, Massachusetts;
and Richard G. Green and Tina M. Chappell, of Washington, DC. Of counsel was
Ahmed J. Davis, of Washington, DC.

John DeQ. Briggs, III, Howrey Simon Arnold & White, LLP, of Washington, DC,
for amicus curiae Intellectual Property Owners Association. With him on the brief were
Marc G. Schildkraut and Joseph P. Lavelle. Of counsel on the brief was J. Jeffrey
Hawley, President, Intellectual Property Owners Association, of Washington, DC.

David F. Ryan, Fitzpatrick, Cella, Harper & Scinto, of New York, New York, for
amicus curiae New York Intellectual Property Law Association. With him on the brief
was Matthew S. Seidner. Of counsel on the brief was John D. Murnane, President,
New York Intellectual Property Law Association, of New York, New York. Of counsel
was Joseph B. Divinagracia.

Appealed from: United States International Trade Commission
 United States Court of Appeals for the Federal Circuit
04-1361

U.S. PHILIPS CORPORATION,

Appellant,

v.

INTERNATIONAL TRADE COMMISSION,

Appellee,

and

PRINCO CORPORATION, PRINCO AMERICA CORPORATION,
GIGASTORAGE CORPORATION TAIWAN,
GIGASTORAGE CORPORATION USA, and LINBERG ENTERPRISE INC.,

Intervenors.

___________________________

DECIDED: September 21, 2005
___________________________

Before BRYSON, GAJARSA, and LINN, Circuit Judges.

BRYSON, Circuit Judge.

U.S. Philips Corporation appeals from a final order of the United States

International Trade Commission, in which the Commission held six of Philips’s patents

for the manufacture of compact discs to be unenforceable because of patent misuse.

The Commission ruled that Philips had employed an impermissible tying arrangement

because it required prospective licensees to license packages of patents rather than

allowing them to choose which individual patents they wished to license and making the

licensing fee correspond to the particular patents designated by the licensees. In re
Certain Recordable Compact Discs & Rewritable Compact Discs, Inv. No. 337-TA-474

(Int'l Trade Comm'n Mar. 25, 2004). We reverse and remand.

I

Philips owns patents to technology for manufacturing recordable compact discs

(“CD-Rs”) and rewritable compact discs (“CD-RWs”) in accordance with the technical

standards set forth in a publication called the Recordable CD Standard (the “Orange

Book”), jointly authored by Philips and Sony Corporation. Since the 1990s, Philips has

been licensing those patents through package licenses. Philips specified that the same

royalty was due for each disc manufactured by the licensee using patents included in

the package, regardless of how many of the patents were used. Potential licensees

who sought to license patents to the technology for manufacturing CD-Rs or CD-RWs

were not allowed to license those patents individually and were not offered a lower

royalty rate for licenses to fewer than all the patents in a package.

Initially, Philips offered four different pools of patents for licensing: (1) a joint CD-

R patent pool that included patents owned by Philips and two other companies (Sony

and Taiyo Yuden); (2) a joint CD-RW patent pool that included patents owned by Philips

and two other companies (Sony and Ricoh); (3) a CD-R patent pool that included only

patents owned by Philips; and (4) a CD-RW patent pool that included only patents

owned by Philips. After 2001, Philips offered additional package options by grouping its

patents into two categories, which Philips denominated “essential” and “nonessential”

for producing compact discs compliant with the technical standards set forth in the

Orange Book.

04-1361 2
 In the late 1990s, Philips entered into package licensing agreements with Princo

Corporation and Princo America Corporation (collectively, “Princo”); GigaStorage

Corporation Taiwan and GigaStorage Corporation USA (collectively, “GigaStorage”);

and Linberg Enterprise Inc. (“Linberg”). Soon after entering into the agreements,

however, Princo, GigaStorage, and Linberg stopped paying the licensing fees. Philips

filed a complaint with the International Trade Commission that Princo, GigaStorage, and

Linberg, among others, were violating section 337(a)(1)(B) of the Tariff Act of 1930, 19

U.S.C. § 1337(a)(1)(B), by importing into the United States certain CD-Rs and CD-RWs

that infringed six of Philips’s patents.

The Commission instituted an investigation and identified 19 respondents,

including GigaStorage and Linberg. Additional respondents, including Princo, were

added through intervention. In the course of the proceedings before an administrative

law judge, the respondents raised patent misuse as an affirmative defense, alleging that

Philips had improperly forced them, as a condition of licensing patents that were

necessary to manufacture CD-Rs or CD-RWs, to take licenses to other patents that

were not necessary to manufacture those products. In particular, the respondents

argued that a number of the patents that Philips had included in the category of

“essential” patents were actually not essential for manufacturing compact discs

compliant with the Orange Book standards, because there were commercially viable

alternative methods of manufacturing CD-Rs and CD-RWs that did not require the use

of the technology covered by those patents. The allegedly nonessential patents

included U.S. Patent Nos. 5,001,692 (“the Farla patent”), 5,740,149 (“the Iwasaki

patent”), Re. 34,719 (“the Yamamoto patent”), and 5,060,219 (“the Lokhoff patent”).

04-1361 3
 The administrative law judge ruled that the intervenors had infringed various

claims of the six asserted Philips patents. The administrative law judge further ruled,

however, that all six of the asserted patents were unenforceable by reason of patent

misuse. Among the grounds invoked by the administrative law judge for finding patent

misuse was his conclusion that the package licensing arrangements constituted tying

arrangements that were illegal under analogous antitrust law principles and thus

rendered the subject patents unenforceable.

Philips petitioned the Commission for review of the administrative law judge’s

decision. In an order that addressed only the findings concerning patent misuse, the

Commission affirmed the administrative law judge’s ruling that Philips’s package

licensing practice “constitutes patent misuse per se as a tying arrangement between (1)

licenses to patents that are essential to manufacture CD-Rs or CD-RWs according to

Orange Book standards and (2) licenses to other patents that are not essential to that

activity.” The Commission found that the Farla, Iwasaki, Yamamoto, and Lokhoff

patents were not essential to manufacturing CD-Rs or CD-RWs. Specifically, the

Commission found that the Farla and Lokhoff patents were nonessential with respect to

the Philips-only CD-RW and CD-R licenses, and that the Farla, Iwasaki, Yamamoto,

and Lokhoff patents were nonessential with respect to the joint CD-RW license. The

Commission concluded that the four nonessential patents were impermissibly tied to

patents that were essential to manufacturing CD-Rs and CD-RWs, because “none of

the so-called essential patents could be licensed individually for the manufacture of CD-

RWs and CD-Rs apart from the package” that Philips denominated as “essential.” The

Commission also found, based on the administrative law judge’s findings and analysis,

04-1361 4
that the joint license for CD-R and CD-RW technology unlawfully tied patents for CD-Rs

and CD-RWs in accordance with the Orange Book standards to patents that were not

essential to manufacture such discs.

The Commission explained why it concluded that each of the four patents was

nonessential. According to the Commission, the Farla and Iwasaki patents were not

essential because there was an economically viable alternative method of writing

information to discs that did not require the producer to practice those patents; the

Yamamoto patent was not essential because there was a potential alternative method

of creating master discs that did not require the producer to practice that patent; and the

Lokhoff patent was not essential because there were alternative possible methods of

accomplishing copy protection that did not require the producer to practice that patent.

Based on those findings, the Commission concluded that the four “nonessential” patents

constituted separate products from the patents that were essential to the manufacture of

the subject discs.

The Commission ruled that Philips’s patent package licensing arrangement

constituted per se patent misuse because Philips did not give prospective licensees the

option of licensing individual patents (presumably for a lower fee) rather than licensing

one or more of the patent packages as a whole. The Commission took no position on

the administrative law judge’s ruling that patent pooling arrangements between Philips

and its colicensors constituted patent misuse per se based on the theories of price fixing

and price discrimination, and it took no position on the administrative law judge’s

conclusion that the royalty structure of the patent pools was an unreasonable restraint

of trade.

04-1361 5
 As an alternative ground, the Commission concluded that even if Philips’s patent

package licensing practice was not per se patent misuse, it constituted patent misuse

under the rule of reason. Adopting the administrative law judge’s findings, the

Commission ruled that the anticompetitive effects of including nonessential patents in

the packages of so-called essential patents outweighed the procompetitive effects of

that practice. In particular, the Commission held that including such nonessential

patents in the licensing packages could foreclose alternative technologies and injure

competitors seeking to license such alternative technologies to parties who needed to

obtain licenses to Philips’s “essential” patents. The Commission took no position with

respect to the portion of the administrative law judge’s rule of reason analysis in which

the administrative law judge concluded that the royalty rate structure of the patent

pooling arrangements constituted an unreasonable restraint on competition.

Philips took this appeal from the Commission’s order.

II

Patent misuse is an equitable defense to patent infringement. It “arose to

restrain practices that did not in themselves violate any law, but that drew

anticompetitive strength from the patent right, and thus were deemed to be contrary to

public policy.” Mallinckrodt, Inc. v. Medipart, Inc., 976 F.2d 700, 704 (Fed. Cir. 1992).

The purpose of the patent misuse defense “was to prevent a patentee from using the

patent to obtain market benefit beyond that which inheres in the statutory patent right.”

Id. As the Supreme Court has explained, the doctrine of patent misuse bars a patentee

from using the “patent’s leverage” to “extend the monopoly of his patent to derive a

benefit not attributable to the use of the patent’s teachings,” such as requiring a licensee

04-1361 6
to pay a royalty on products that do not use the teaching of the patent. Zenith Radio

Corp. v. Hazeltine Res., Inc., 395 U.S. 100, 135-36 (1969). The “key inquiry is whether,

by imposing conditions that derive their force from the patent, the patentee has

impermissibly broadened the scope of the patent grant with anticompetitive effect.”

C.R. Bard, Inc. v. M3 Sys., Inc., 157 F.3d 1340, 1372 (Fed. Cir. 1998); Windsurfing Int’l,

Inc. v. AMF, Inc., 782 F.2d 995, 1001 (Fed. Cir. 1986).

This court summarized the principles of patent misuse as applied to “tying”

arrangements in Virginia Panel Corp. v. MAC Panel Co., 133 F.3d 860, 868-69 (Fed.

Cir. 1997). The court there explained that because of the importance of anticompetitive

effects in shaping the defense of patent misuse, the analysis of tying arrangements in

the context of patent misuse is closely related to the analysis of tying arrangements in

antitrust law. The court further explained that, depending on the circumstances, tying

arrangements can be viewed as per se patent misuse or can be analyzed under the rule

of reason. Id. The court noted that certain specific practices have been identified as

constituting per se patent misuse, “including so-called ‘tying’ arrangements in which a

patentee conditions a license under the patent on the purchase of a separable, staple

good, and arrangements in which a patentee effectively extends the term of its patent

by requiring post-expiration royalties.” Id. at 869 (citations omitted). If the particular

licensing arrangement in question is not one of those specific practices that has been

held to constitute per se misuse, it will be analyzed under the rule of reason. Id. We

have held that under the rule of reason, a practice is impermissible only if its effect is to

restrain competition in a relevant market. Monsanto Co. v. McFarling, 363 F.3d 1336,

1341 (Fed. Cir. 2004); Windsurfing Int’l, 782 F.2d at 1001-02.

04-1361 7
 The Supreme Court’s decisions analyzing tying arrangements under antitrust law

principles are to the same effect. The Court has made clear that tying arrangements

are deemed to be per se unlawful only if they constitute a “naked restrain[t] of trade with

no purpose except stifling of competition” and “always or almost always tend to restrict

competition and decrease output” in some substantial portion of a market. Broad.

Music, Inc. v. Columbia Broad. Sys., Inc., 441 U.S. 1, 19-20 (1979). The Supreme

Court has applied the per se rule only when “experience with a particular kind of

restraint enables the Court to predict with confidence that the rule of reason will

condemn it . . . .” Arizona v. Maricopa County Med. Soc’y, 457 U.S. 332, 344 (1982);

see Broad. Music, 441 U.S. at 9-10 (“It is only after considerable experience with certain

business relationships that courts classify them as per se violations.”), quoting United

States v. Topco Assocs., 405 U.S. 596, 607-08 (1972); Cont’l T.V., Inc. v. GTE Sylvania

Inc., 433 U.S. 36, 49-50 (1977) (per se rules are “appropriate only when they relate to

conduct that is manifestly anticompetitive”); see also Jefferson Parish Hosp. Dist. v.

Hyde, 466 U.S. 2, 14 (1983) (“[T]he law draws a distinction between the exploitation of

market power by merely enhancing the price of the tying product, on the one hand, and

by attempting to impose restraints on competition in the market for a tied product, on the

other.”). Conduct is not considered per se anticompetitive if it has “redeeming

competitive virtues and . . . the search for those values is not almost sure to be in vain.”

Broad. Music, 441 U.S. at 13; Nat’l Collegiate Athletic Ass’n v. Bd. of Regents of the

Univ. of Okla., 468 U.S. 85, 104 n. 26 (1983) (“[W]hile the court has spoken of a ‘per se’

rule against tying arrangements, it has also recognized that tying may have

04-1361 8
procompetitive justifications that make it inappropriate to condemn without considerable

market analysis.”).

While the doctrine of patent misuse closely tracks antitrust law principles in many

respects, Congress has declared certain practices not to be patent misuse even though

those practices might otherwise be subject to scrutiny under antitrust law principles. In

35 U.S.C. § 271(d), Congress designated several specific practices as not constituting

patent misuse. The designated practices include “condition[ing] the license of any rights

to the patent or the sale of the patented product on the acquisition of a license to rights

in another patent or purchase of a separate product,” unless, in view of the

circumstances, the patent owner “has market power for the patent or patented product

on which the license or sale is conditioned.” Id. § 271(d)(5). Because the statute is

phrased in the negative, it does not require that patent misuse be found in the case of

all such conditional licenses in which the patent owner has market power; instead, the

statute simply excludes such conditional licenses in which the patent owner lacks

market power from the category of arrangements that may be found to constitute patent

misuse.

Although section 271(d)(5) does not define the scope of the defense of patent

misuse, but merely provides a safe harbor against the charge of patent misuse for

certain kinds of conduct by patentees, the statute makes clear that the defense of

patent misuse differs from traditional antitrust law principles in an important respect, as

applied to tying arrangements involving patent rights. In the case of an antitrust claim

based on a tying arrangement involving patent rights, this court has held that ownership

of a patent on the tying good is presumed to give the patentee monopoly power. See

04-1361 9
Indep. Ink, Inc. v. Ill. Tool Works, Inc., 396 F.3d 1342, 1349 n.7 (Fed. Cir.), cert.

granted, 125 S. Ct. 2937 (2005). Section 271(d)(5) makes clear, however, that such a

presumption does not apply in the case of patent misuse. To establish the defense of

patent misuse, the accused infringer must show that the patentee has power in the

market for the tying product. See id. at 1349 n.7.

Philips argues briefly that it lacks market power and that it is thus shielded from

liability by section 271(d)(5). Based on detailed analysis by the administrative law

judge, however, the Commission found that Philips has market power in the relevant

market and that section 271(d)(5) is therefore inapplicable to this case. We sustain that

ruling.

Philips contends that at the time Philips and Sony first created their package

license arrangements, CDs had significant competition among computer data storage

devices and thus Philips lacked market power in the market for computer data storage

discs. However, Philips first created the package licenses long before GigaStorage and

Princo entered into their agreements. According to the administrative law judge, the

patent package arrangements were instituted in the early 1990s. Yet Princo did not

enter into its agreement until June of 1997, and GigaStorage did not enter into its

licensing agreement until October of 1999. Thus, any lack of market power that Philips

and its colicensors may have had in the early 1990s is irrelevant to the situation in the

late 1990s, when the parties entered into the agreements at issue in this case. At that

time, according to the administrative law judge’s well-supported finding, compact discs

had become “unique products [with] no close practice substitutes.” Philips’s argument

about lack of market power is therefore unpersuasive, and for that reason section

04-1361 10
271(d)(5) does not provide Philips a statutory safe haven from the judicially created

defense of patent misuse.1

Apart from its specific challenge to the Commission’s ruling on the market power

issue, Philips launches a more broad-based attack on the Commission’s conclusion that

Philips’s patent licensing policies constitute per se patent misuse. In so doing, Philips

makes essentially two arguments: first, that the Commission was wrong as a legal

matter in ruling that the package licensing arrangements at issue in this case are among

those few practices that the courts have identified as so clearly anticompetitive as to

warrant being condemned as per se illegal; and second, that the Commission erred as a

factual matter in concluding that Philips’s package licensing arrangements reflect the

use of market power in one market to foreclose competition in a separate market. We

address the two arguments separately.

A

In its brief, the Commission argues that it is “hornbook law” that mandatory

package licensing has been held to be patent misuse. While that broad characterization

can be found in some treatises, see 6 Donald S. Chisum, Chisum on Patents § 19.04[3]

(2003), cited in C.R. Bard, Inc., 157 F.3d at 1373; 8 Ernest B. Lipscomb III, Lipscomb’s

1
Before the Commission, Philips argued that section 271(d)(5) abolished
the doctrine of per se patent misuse as applied to tying arrangements. In making that
argument, Philips relied heavily on the legislative history of the 1988 Act that adopted
section 271(d)(5). Because Philips has not renewed that argument in this court, we do
not address it, although we note that the legislative history cited by Philips before the
Commission indicates congressional skepticism about treating tying arrangements in
the context of patent licensing as per se patent misuse, rather than analyzing such
arrangements under the rule of reason. See 134 Cong. Rec. 32,294-95 (1988)
(statement of Rep. Kastenmeier); id. at 32,471 (statement of Sen. DeConcini); id. at
32,471-72 (statement of Sen. Leahy).

04-1361 11
Walter on Patents § 28:27 (3d ed. 1989 & Supp. 2003), Philips invites us to consider

whether that broad proposition is sound. Upon consideration, we conclude that the

proposition as applied to the circumstances of this case is not supported by precedent

or reason.

In its opinion, the Commission acknowledged that the Virginia Panel case and

many other patent tying cases “involve a tying patent and a tied product, rather than a

tying patent and a tied patent.” (emphasis in original). The Commission nonetheless

concluded that “finding patent misuse based on a tying arrangement between patents in

a mandatory package license is a reasonable application of Supreme Court precedent.”

In so ruling, the Commission relied primarily on two Supreme Court cases: United

States v. Paramount Pictures, Inc., 334 U.S. 131, 156-59 (1948), and United States v.

Loew’s, Inc., 371 U.S. 38, 44-51 (1962). Those cases condemned the practice of

“block-booking” movies to theaters (in the Paramount case) and to television stations (in

the Loew’s case) as antitrust violations.

Block-booking is the practice in which a distributor licenses one feature or group

of features to exhibitors on the condition that the exhibitors agree to license another

(presumably inferior) feature or group of features released by the distributor during a

given period. In Paramount and Loew’s, the Court held that block-booking, as practiced

in those cases, was per se illegal. The Commission reasoned that the practice of block-

booking that was the focus of the Court’s condemnation in Paramount and Loew’s is

similar to the package licensing agreements at issue in this case and that under the

analysis employed in Paramount and Loew’s, Philips’s package licensing agreements

must be condemned as per se patent misuse.

04-1361 12
 We do not agree with the Commission that the decisions in Paramount and

Loew’s govern this case. In Paramount, the district court held that the defendant movie

distributor had engaged in unlawful conduct because it offered to permit exhibitors to

show the films they wished to license only if they agreed to license and exhibit other

films that they were not interested in licensing. The Supreme Court affirmed that ruling.

The Court held that block-booking was illegal because it “prevents competitors from

bidding for single features on their individual merits,” and because it “adds to the

monopoly of a single copyrighted picture that of another copyrighted picture which must

be taken and exhibited in order to secure the first.” 334 U.S. at 156-57. The result, the

Court explained, “is to add to the monopoly of the copyright in violation of the principle

of the patent cases involving tying clauses.” Id. at 158.

Because the block-booking arrangement at issue in Paramount required the

licensee to exhibit all of the films in the group for which a license was taken, the

Paramount block-booking was more akin to a tying arrangement in which a patent

license is tied to the purchase of a separate product, rather than to an arrangement in

which a patent license is tied to another patent license. Indeed, all of the patent tying

cases to which the Supreme Court referred in Paramount involved tying arrangements

in which, as the Court described them, “the owner of a patent [conditioned] its use on

the purchase or use of patented or unpatented materials.” 334 U.S. at 157. Because

the arrangement in the Paramount case was equivalent in substance to a patent-to-

product tying arrangement, Paramount does not stand for the proposition that a pure

04-1361 13
patent-to-patent tying arrangement, such as Philips’s package licensing agreement, is

per se unlawful.2

Philips gives its licensees the option of using any of the patents in the package,

at the licensee’s option. Philips charges a uniform licensing fee to manufacture discs

covered by its patented technology, regardless of which, or how many, of the patents in

the package the licensee chooses to use in its manufacturing process. In particular,

Philips’s package licenses do not require that licensees actually use the technology

covered by any of the patents that the Commission characterized as nonessential. In

that respect, Philips’s licensing agreements are different from the agreements at issue

in Paramount, which imposed an obligation on the purchasers of package licenses to

exhibit films they did not wish to license. That obligation not only extended the

exclusive right in one product to products in which the distributor did not have exclusive

rights, but it also precluded exhibitors, as a practical matter, from exhibiting other films

that they may have preferred over the tied films they were required to exhibit. Because

Philips’s package licensing agreements do not compel the licensees to use any

particular technology covered by any of the licensed patents, the Paramount case is not

a sound basis from which to conclude that the package licensing arrangements at issue

in this case constitute patent misuse per se.

2
The Commission argues that the Supreme Court’s later decision in Automatic
Radio Co. v. Hazeltine, 339 U.S. 827 (1950), supports its broad interpretation of the
Paramount case because the Supreme Court in Automatic Radio characterized
Paramount as having “condemned” an arrangement “conditioning the granting of a
license under one patent upon the acceptance of another and different license.” Id. at
830-31. We do not, however, interpret that shorthand characterization of Paramount as
effecting a broadening of the holding of the earlier case and an extension of its rationale
to a class of cases far beyond Paramount’s facts.

04-1361 14
 In the Loew’s case, the district court determined that the licensee television

stations were required to pay fees not only for the feature films they wanted, but also for

additional, inferior films. As in Paramount, the fact that the package arrangement

required the television stations to purchase exhibition rights for the package at a price

that was greater than the price attributable to the desired films made the tying

arrangement very much like a tying arrangement involving products. Thus, the

Supreme Court explained that a “substantial portion of the licensing fees represented

the cost of the inferior films which the stations were required to accept.” Lowe’s, 371

U.S. at 49. Following the approach employed in Paramount, the Supreme Court applied

the principles of cases involving tying arrangements between patents and unpatented

products and concluded that the tying arrangements in the case before it had all the

anticompetitive features of the block-booking arrangements in Paramount and no

redeeming procompetitive features.

In this case, unlike in Loew’s, there is no evidence that a portion of the royalty

was attributable to the patents that the Commission characterized as nonessential.

While the administrative law judge found that GigaStorage “inquired into obtaining a

license to less than all of the patents on Philips’s patent list,” the administrative law

judge noted that GigaStorage did so because it “hoped that by eliminating some patents

the royalty rate would be lower.” There is no evidence that GigaStorage had any basis

for its expectation that a smaller patent package might result in a lower royalty rate. In

fact, the administrative law judge found that Philips had responded to that overture from

GigaStorage by explaining that “the royalty is the same regardless of the number of

patents used.” Moreover, the administrative law judge found that the royalty rate for

04-1361 15
licensing Philips’s patents “remains the same regardless of which option(s) in the

agreement one selects,” and that the royalty rate “does not increase or decrease if more

or fewer patents are used.” Thus, it is clear that the royalty charged by Philips was not

increased because of the inclusion of the Farla, Iwasaki, Yamamoto, and Lokhoff

patents. There is therefore no basis for conjecture that a hypothetical licensing fee

would have been lower if Philips had offered to license the patents on an individual

basis or in smaller packages.

Aside from Paramount and Loew’s, the Commission relies on cases involving

tying arrangements in which the patent owner conditions the availability of a patent

license on the patentee’s agreement to purchase a staple item of commerce from the

patentee. See Va. Panel, 133 F.3d at 869; Senza-Gel Corp. v. Seiffhart, 803 F.2d 661

(Fed. Cir. 1986). Those cases, however, are readily distinguishable because of the

fundamental difference between an obligation to purchase a product and the extension

of a nonexclusive license to practice a patent.

A nonexclusive patent license is simply a promise not to sue for infringement.

See Rite-Hite Corp. v. Kelley Co., 56 F.3d 1538, 1552 (Fed. Cir. 1995) (en banc);

Spindelfabrik Suessen-Schurr Stahlecker & Grill GmbH v. Schubert & Salzer

Maschinenfabrik Atkiengesellschaft, 829 F.2d 1075, 1081 (Fed. Cir. 1987). The

conveyance of such a license does not obligate the licensee to do anything; it simply

provides the licensee with a guarantee that it will not be sued for engaging in conduct

that would infringe the patent in question.

In the case of patent-to-product tying, the patent owner uses the market power

conferred by the patent to compel customers to purchase a product in a separate

04-1361 16
market that the customer might otherwise purchase from a competitor. United States v.

U.S. Gypsum Co., 333 U.S. 364, 400 (1948); Int’l Salt Co. v. United States, 332 U.S.

392, 395 (1947); Morton Salt Co. v. G.S. Suppiger Co., 314 U.S. 488, 493 (1942). The

patent owner is thus able to use the market power conferred by the patent to foreclose

competition in the market for the product.

By contrast, a package licensing agreement that includes both essential and

nonessential patents does not impose any requirement on the licensee. It does not bar

the licensee from using any alternative technology that may be offered by a competitor

of the licensor. Nor does it foreclose the competitor from licensing his alternative

technology; it merely puts the competitor in the same position he would be in if he were

competing with unpatented technology.

A package license is in effect a promise by the patentee not to sue his customer

for infringing any patents on whatever technology the customer employs in making

commercial use of the licensed patent. That surrender of rights might mean that the

customer will choose not to license the alternative technology offered by the patentee’s

competition, but it does not compel the customer to use the patentee’s technology. The

package license is thus not anticompetitive in the way that a compelled purchase of a

tied product would be.

Contrary to the Commission’s characterization, the intervenors were not “forced”

to “take” anything from Philips that they did not want, nor were they restricted from

obtaining licenses from other sources to produce the relevant technology. Philips

simply provided that for a fixed licensing fee, it would not sue any licensee for engaging

in any conduct covered by the entire group of patents in the package. By analogy, if

04-1361 17
Philips had decided to surrender its “nonessential” patents or had simply announced

that it did not intend to enforce them, there would have been no way for the

manufacturers to decline or reject Philips’s decision. Yet the economic effect of the

package licensing arrangement for Philips’s patents is not fundamentally different from

the effect that such decisions would have had on third parties seeking to compete with

the technology covered by those “nonessential” patents. Thus, we conclude that the

Commission erred when it characterized the package license agreements as a way of

forcing the intervenors to license technology that they did not want in order to obtain

patent rights that they did.3

The Commission stated that it would not have found the package licenses to

constitute improper tying if Philips had offered to license its patents on an individual

basis, as an alternative to licensing them in packages. The Commission’s position,

however, must necessarily be based on an assumption that, if the patents were offered

on an individual basis, individual patents would be offered for a lower price than the

patent packages as a whole. If that assumption were not implicit in the Commission’s

conclusion, the Commission would be saying in effect that it would be unlawful for

3
The effect of a nonexclusive license was different before the Supreme Court,
in Lear, Inc. v. Adkins, 395 U.S. 653 (1969), abolished the patent doctrine of licensee
estoppel. Before Lear, a nonexclusive license had a legal effect that made it more than
a mere covenant by the licensee not to sue. Acceptance of the license barred the
licensee from challenging the validity of the patent. Some of the early decisions
regarding patent-to-patent tying arrangements appear to have been based, at least in
part, on that feature of pre-Lear patent licenses. See, e.g., Am. Securit Co. v.
Shatterproof Glass Corp., 268 F.2d 769, 777 (3d Cir. 1959); Int’l Mfg. Co. v. Landon,
336 F.2d 723, 731 (9th Cir. 1964); see also Duplan Corp. v. Deering Milliken, Inc., 444
F. Supp. 648, 699 (D.S.C. 1977), aff’d in pertinent part, 594 F.2d 979 (4th Cir. 1979). In
the post-Lear era, the “acceptance” of a license has no such restrictive effect on the
licensee’s freedom.

04-1361 18
Philips to charge the same royalty for its essential patents that it charges for its patent

packages and to offer the nonessential patents for free. Yet that sort of pricing policy

plainly would not be unlawful. See Directory Sales Mgmt. Corp. v. Ohio Bell Tel. Co.,

833 F.2d 606, 609-10 (6th Cir. 1987).4

To the extent that the Commission’s decision is based on an assumption that

individual licenses would necessarily be available for a lower price than package

licenses, that assumption is directly contrary to the evidence and even to the

administrative law judge’s findings of fact. As noted above, the administrative law judge

found that the royalty rate under Philips’s package licenses depended on the number of

discs the manufacturer produced under the authority of the license, not the number of

individual patents the manufacturer used to produce those discs. That is, the royalty

rate did not vary depending on whether the licensees used only the essential patents or

used all of the patents in the package. Thus, it seems evident that if Philips were forced

to offer licenses on an individual basis, it would continue to charge the same per unit

royalty regardless of the number of patents the manufacturer chose to license. That

alteration in Philips’s practice would have absolutely no effect on the would-be

competitors who wished to offer alternatives to the technology represented by Philips’s

4
Of course, in a tying case if the evidence shows that the price of a bundled
product reflects any of the cost of the tied product, “customers are purchasing the tied
product, even if it is touted as being free.” Multistate Legal Studies, Inc. v. Harcourt
Brace Jovanovich Legal & Prof’l Publ’ns, Inc., 63 F.3d 1540, 1548 (10th Cir. 1995),
citing 3 Phillip E. Areeda & Donald F. Turner, Antitrust Law ¶ 733a (1978) (tying may
exist “when a machine is sold or leased at a price that covers ‘free’ servicing”); see also
United States v. Microsoft Corp., 253 F.3d 34, 68 (D.C. Cir. 2001) (“the antitrust laws do
not condemn even a monopolist for offering its product at an attractive price, and we
therefore have no warrant to condemn Microsoft for offering either IE or the IEAK free of
charge”). The evidence in this case, however, does not indicate that there is a hidden
charge for the so-called nonessential patents in the Philips patent packages.

04-1361 19
so-called nonessential patents, since those patents would effectively be offered for free,

and the competitors would therefore still have to face exactly the same barriers—the

availability of a free alternative to the technology that they were trying to license for a

fee.

More generally, the Commission’s assumption that a license to fewer than all the

patents in a package would presumably carry a lower fee than the package itself

ignores the reality that the value of any patent package is largely, if not entirely, based

on the patents that are essential to the technology in question. A patent that is

nonessential because it covers technology that can be fully replaced by alternative

technology that is available for free is essentially valueless. A patent that is

nonessential because it covers technology that can be fully replaced by alternative

technology that is available through a license from another patent owner has value, but

its value is limited by the price of the alternative technology. Short of imposing an

obligation on the licensor to make some sort of allocation of fees across a group of

licenses, there is no basis for the Commission to conclude that a smaller group of the

licenses—the so-called “essential” licenses—would have been available for a lower fee

if they had not been “tied to” the so-called nonessential patents.

It is entirely rational for a patentee who has a patent that is essential to particular

technology, as well as other patents that are not essential, to charge what the market

will bear for the essential patent and to offer the others for free. Because a license to

the essential patent is, by definition, a prerequisite to practice the technology in

question, the patentee can charge whatever maximum amount a willing licensee is able

to pay to practice the technology in question. If the patentee allocates royalty fees

04-1361 20
between its essential and nonessential patents, it runs the risk that licensees will take a

license to the essential patent but not to the nonessential patents. The effect of that

choice will be that the patentee will not be able to obtain the full royalty value of the

essential patent. For the patentee in this situation to offer its nonessential patents as

part of a package with the essential patent at no additional charge is no more

anticompetitive than if it had surrendered the nonessential patents or had simply

announced a policy that it would not enforce them against persons who licensed the

essential patent. In either case, those offering technology that competed with the

nonessential patents would be unhappy, because they would be competing against free

technology. But the patentee would not be using his essential patent to obtain power in

the market for the technology covered by the nonessential patents. This package

licensing arrangement cannot fairly be characterized as an exploitation of power in one

market to obtain a competitive advantage in another.5

Aside from the absence of evidence that the package licensing arrangements in

this case had the effect of impermissibly broadening the scope of the “essential” patents

with anticompetitive effect, Philips argues that the Commission failed to acknowledge

the unique procompetitive benefits associated with package licensing. Philips points to

5
The implication of the Commission’s decision is that a party with both an
essential patent and a nonessential patent is not allowed to package the two together
and only offer the package for a single price. That would have the perverse effect of
potentially putting a party owning both an essential patent and a nonessential but
related patent in a worse position than a party owning only the essential patent. The
party owning only the essential patent would be free to charge any licensing fee up to
the maximum that a manufacturer would be willing to pay to practice the patented
technology, while a party owning both the essential patent and a nonessential patent
would be barred from extracting that maximum licensing fee for its essential patent and
assuring the manufacturer that it would not be subject to suit on the nonessential patent.

04-1361 21
the federal government’s guidelines for licensing intellectual property, which recognize

that patent packages “may provide procompetitive benefits by integrating

complementary technologies, reducing transaction costs, clearing blocking positions,

and avoiding costly infringement litigation. By promoting the dissemination of

technology, cross-licensing and pooling arrangements are often procompetitive.” U.S.

Department of Justice and Federal Trade Commission, Antitrust Guidelines for the

Licensing of Intellectual Property § 5.5 (1995); see also Herbert Hovenkamp, IP and

Antitrust § 34.2c, at 34-7 (2004).

Philips introduced evidence that package licensing reduces transaction costs by

eliminating the need for multiple contracts and reducing licensors’ administrative and

monitoring costs. See Tex. Instruments, Inc. v. Hyundai Elecs., 49 F. Supp. 2d 893,

901 (E.D. Tex. 1999) (describing how “extremely expensive and time-consuming” it is

for parties to license and manage the licensing of technology by using individual patents

and how it is preferable to employ a patent portfolio). Package licensing can also

obviate any potential patent disputes between a licensor and a licensee and thus

reduce the likelihood that a licensee will find itself involved in costly litigation over

unlicensed patents with potentially adverse consequences for both parties, such as a

finding that the licensee infringed the unlicensed patents or that the unlicensed patents

were invalid. See Steven C. Carlson, Patent Pools and the Antitrust Dilemma, 16 Yale

J. on Reg. 359, 379-81 (1999). Thus, package licensing provides the parties a way of

ensuring that a single licensing fee will cover all the patents needed to practice a

particular technology and protecting against the unpleasant surprise for a licensee who

learns, after making a substantial investment, that he needed a license to more patents

04-1361 22
than he originally obtained. Finally, grouping licenses in a package allows the parties to

price the package based on their estimate of what it is worth to practice a particular

technology, which is typically much easier to calculate than determining the marginal

benefit provided by a license to each individual patent. In short, package licensing has

the procompetitive effect of reducing the degree of uncertainty associated with

investment decisions.

The package licenses in this case have some of the same advantages as the

package licenses at issue in the Broadcast Music case. The Supreme Court

determined in that case that the blanket copyright package licenses at issue had useful,

procompetitive purposes because they gave the licensees “unplanned, rapid, and

indemnified access to any and all of the repertory of [musical] compositions, and [they

gave the owners] a reliable method of collecting for the use of the their copyrights.” 441

U.S. at 20. While “[i]ndividual sales transactions [would be] quite expensive, as would

be individual monitoring and enforcement,” a package licensing agreement would

ensure access and save costs. Id. Hence, the Supreme Court determined that such

conduct should fall under “a more discriminating examination under the rule of reason.”

Id. at 24.

In light of the efficiencies of package patent licensing and the important

differences between product-to-patent tying arrangements and arrangements involving

group licensing of patents, we reject the Commission’s conclusion that Philips’s conduct

shows a “lack of any redeeming virtue” and should be “conclusively presumed to be

unreasonable and therefore illegal without elaborate inquiry as to the precise harm they

have caused or the business excuse for their use.” N. Pac. Ry. Co. v. United States,

04-1361 23
356 U.S. 1, 5 (1958). We therefore hold that the analysis that led the Commission to

apply the rule of per se illegality to Philips’s package licensing agreements was legally

flawed.6

B

In the alternative, Philips argues that the Commission’s finding of per se patent

misuse was not justified by the facts of this case. In particular, Philips contends that the

evidence did not show that there were commercially viable alternatives to the

technology covered by the so-called “nonessential” patents in the Philips licensing

packages that any of its licensees would have preferred to use.

In order to show that a tying arrangement is per se unlawful, a complaining party

must demonstrate that it links two separate products and has an anticompetitive effect

in the market for the second product. The Supreme Court explained that the “essential

characteristic” of an invalid tying arrangement

lies in the seller’s exploitation of its control over the tying product to force
the buyer in to the purchase of a tied product that the buyer either did not
want at all, or might have preferred to purchase elsewhere on different
terms. When such “forcing” is present, competition on the merits in the
market for the tied item is restrained . . . .

Jefferson Parish, 466 U.S. at 12; id. at 20-21 (“[A] tying arrangement cannot exist

unless two separate markets have been linked.”); B. Braun Med., Inc. v. Abbott Labs.,

6
The Supreme Court recently granted certiorari in Independent Ink, Inc. v.
Illinois Tool Works, Inc., 396 F.3d 1342 (Fed. Cir.), cert granted, 125 S. Ct. 2937 (2005),
a case involving a tying arrangement involving a patent and an unpatented product. It is
possible that the Supreme Court’s decision in that case will offer some guidance with
respect to the patent misuse issue presented by this case, but because the
circumstances of the two cases are quite different, we have determined that the proper
course is to resolve this appeal without waiting for the Supreme Court’s decision in
Independent Ink.

04-1361 24
124 F.3d 1419, 1426 (Fed. Cir. 1997) (impermissible tying in the context of patent

misuse if patentee uses a patent “which enjoys market power in the relevant market . . .

to restrain competition in an unpatented product”). The Commission found that the

“nonessential” patents, i.e., the Farla, Iwasaki, Yamamoto, and Lokhoff patents,

constituted separate products from the “essential” patents in the package and that the

package licensing agreements adversely affected competition in the market for the

nonessential technology.7 The Commission’s analysis of that factual issue was flawed,

however.

Patents within a patent package can be regarded as “nonessential” only if there

are “commercially feasible” alternatives to those patents. See Int’l Mfg. Co. v. Landon,

336 F.2d 723, 729 (9th Cir. 1964). If there are no commercially practicable alternatives

to the allegedly nonessential patents, packaging those patents together with so-called

essential patents can have no anticompetitive effect in the marketplace, because no

competition for a viable alternative product is foreclosed. In such a case, the only effect

of finding per se patent misuse is to give licensees a way of avoiding their obligations

under the licensing agreements, with no corresponding benefit to competition in any

real-world market.

The Department of Justice has recognized that the availability of commercially

viable alternative technology is relevant to the analysis of package licensing

7
The intervenors note that “there existed a number of commercially-
available CD-R discs utilizing alternative technology that did not infringe these
supposedly essential patents.” For support, intervenors cite the opinion of the
administrative law judge, who determined that two patents held by Taiyo Yuden were
not essential. Because the Commission did not address those patents, however, they
are not relevant to this appeal.

04-1361 25
agreements. In particular, the Department has stated that patent packages do not have

the undesirable effects of tying if they include patents to technology for which there is no

practical or realistic alternative. See, e.g., Business Review Letter, U.S. Department of

Justice, Antitrust Division (Dec. 16, 1998). That principle is consistent with the main

purpose of the separate-products inquiry in tying cases generally, which is to ensure

that conduct is not condemned as anticompetitive “unless there is sufficient demand for

the purchase of [the tied product] separate from the [tying product] to identify a distinct

product market in which it is efficient to offer [the tied product].” Jefferson Parish, 466

U.S. at 21-22; see Mallinckrodt, 976 F.2d at 704 (tying is misuse only when the

patentee uses its patent to obtain “market benefit” beyond that conferred by the patent).

In this case, the evidence did not show that there were commercially viable

substitutes for the Farla, Iwasaki, Yamamoto, and Lokhoff patents that disc

manufacturers wished to use in making compact discs compliant with the Orange Book

standards. There was thus insufficient evidence that including the four “nonessential”

patents in the Philips patent packages had an actual anticompetitive effect. That is, the

evidence did not show that there were commercially viable substitutes for those four

“nonessential” patents that disc manufacturers wished to use in making compact discs

compliant with the Orange Book standards.

Two of those four patents, the Farla and Iwasaki patents, cover a method of

controlling the recording of information onto compact discs, i.e., a “write strategy,”

including an “optimum power control procedure.”8 The Commission found that another

8
In its amicus curiae brief, the New York Intellectual Property Association
notes that, unlike the other three allegedly nonessential patents, the Iwasaki patent

04-1361 26
company, Calimetrics, Inc., had developed a commercially viable, alternative method of

performing the write strategy and the optimum power control procedure that is not

covered by the Farla and Iwasaki patents. In making that finding, the Commission

relied solely on the testimony of Dr. Stephen McLaughlin, Calimetrics’s principal

scientist, who had helped to create the technology in question. Dr. McLaughlin testified

that Calimetrics had created a general write strategy; that “in the development of [that]

technology [Calimetrics] determined that this write strategy was applicable to CD-R and

CD-RW systems”; and that the company has “spent an enormous amount of effort

promoting [its] idea . . . .” While that testimony was sufficient to support the

Commission’s finding that there was an alternative technology to the Farla and Iwasaki

patents, it did not show that the Calimetrics technology was an alternative that Philips’s

licensees wished to use in place of the technology covered by the Farla and Iwasaki

patents. The Commission did not point to any evidence that any licensee or potential

licensee asked to have any of the four “nonessential” patents removed from the

package license and that Philips refused to do so. Although, as noted, GigaStorage

asked about obtaining a license to only certain patents, in the hope that by eliminating

some patents the royalty rate would be lower, the evidence did not show that

would expire after all of the undisputedly essential patents. As a result, the presence of
the Iwasaki patent in a patent licensing package could have the effect of extending the
obligation to pay royalties beyond the expiration date of the “essential” patents. A
provision requiring that royalties be paid beyond the life of a patent has been held to be
unenforceable. See Brulotte v. Thys Co., 379 U.S. 29, 30 (1964). However, because
neither the Commission nor the administrative law judge addressed the impact of that
potential temporal extension of the royalty obligation, and none of the parties addressed
that issue on appeal in their briefs, we do not address the issue here.

04-1361 27
GigaStorage’s request related to the four “nonessential” patents or that GigaStorage

had any interest in licensing Calimetrics’s technology.

Dr. McLaughlin testified, regarding a hypothetical situation, that “[w]hen we go

and try to license this technology, the companies say we have technology that performs

a function of this type, and . . . I presume they would be referring to [the nonessential

CD-R/CD-RW] patents.” That testimony, however, falls short of showing that any of

Philips’s licensees were forced by the package license agreements to license the Farla

and Iwasaki patents when they would have preferred to use Calimetrics’s technology.

Dr. McLaughlin did not testify as to even a single specific instance on which a disc

manufacturer expressed a preference for the Calimetrics technology but was dissuaded

from licensing it by Philips’s insistence on licensing the Farla and Iwasaki patents as

part of its package license arrangements. The evidence thus did not show that there

was a demand for the Calimetrics technology that went unmet because of the coercive

effect of Philips’s inclusion of the Farla and Iwasaki patents in its package licensing

agreements.

As for the Yamamoto patent, which covers a method of creating master discs by

using one laser beam, the Commission again relied on the testimony of Dr. McLaughlin.

The Commission found that Calimetrics had developed a commercially viable alternative

method of creating master discs by using two laser beams. Dr. McLaughlin’s testimony,

however, does not support the Commission’s finding. Dr. McLaughlin stated that it was

“fairly easy to conceive of alternative methods for implementing the functionality of the

intention of . . . what [the Yamamoto] patent is directed towards” and that it would

“certainly [be] possible to do this using two beams . . . .” Yet the mere possibility that

04-1361 28
alternative technology might at some point become available is not sufficient to support

a finding that at the time the Philips licenses were executed, there was actually a

commercially available alternative to the technology claimed in the Yamamoto patent.

Finally, the Commission found that the Lokhoff patent was not “technically

essential” to manufacturing discs compliant with the Orange Book standard. The

Lokhoff patent covers a system for providing copy protection by placing a “copy bit” into

a compact disc for the purpose of determining the type of information that may be

received for recording. The Commission found that an alternative exists to the Lokhoff

patent. In so doing, the Commission again relied on testimony by Dr. McLaughlin, who

stated that copy protection could be achieved by “embedding copy protection and user

data,” instead of by using a copy bit. Dr. McLaughlin’s testimony, however, does not

establish that the alternative technology was commercially available to be substituted

for the technology of the Lokhoff patent. He stated that the alternative embedding

method was a “very wide area of research. There’s a lot of activity going on these days

in using this general approach . . . .” That testimony indicates research interest in a

possible approach to solving the problem of embedding, but it does not establish the

existence of an available, commercially practicable alternative to Philips’s technology.

Beyond the absence of factual support for the Commission’s findings, the

Commission’s analysis of the four “nonessential” patents demonstrates a more

fundamental problem with applying the per se rule of illegality to patent packages such

as the ones at issue in this case. If a patentholder has a package of patents, all of

which are necessary to enable a licensee to practice particular technology, it is well

established that the patentee may lawfully insist on licensing the patents as a package

04-1361 29
and may refuse to license them individually, since the group of patents could not

reasonably be viewed as distinct products. See Landon, 336 F.2d at 729. Yet over

time, the development of alternative technology may raise questions whether some of

the patents in the package are essential or whether, as in this case, there are

alternatives available for the technology covered by some of the patents. Indeed, in a

fast-developing field such as the one at issue in this case, it seems quite likely that

questions will arise over time, such as what constitutes an “essential” patent for

purposes of manufacturing compact discs compliant with the Orange Book standard.

Roger B. Andewelt, Analyzing Patent Pools Under the Antitrust Laws, 53 Antitrust L.J.

611, 616 (1985) (“the line between competitive patents and blocking or complementary

patents is frequently very difficult to draw”). Under the Commission’s approach, an

agreement that was perfectly lawful when executed could be challenged as per se

patent misuse due to developments in the technology of which the patentees are

unaware, or which have just become commercially viable. Such a rule would make

patents subject to being declared unenforceable due to developments that occurred

after execution of the license or were unknown to the parties at the time of licensing.

Not only would such a rule render licenses subject to invalidation on grounds unknown

at the time of licensing, but it would also provide a strong incentive to litigation by any

licensee, since the reward for showing that even a single license in a package was

“nonessential” would be to render all the patents in the package unenforceable. For

that reason as well, we reject the Commission’s ruling that package agreements of the

sort entered into by Philips and the intervenors must be invalidated on the ground that

they constitute per se patent misuse.

04-1361 30
 III

In the alternative, the Commission held that Philips’s package licensing

agreements constituted patent misuse under the rule of reason. The Commission’s

analysis under the rule of reason largely tracked the analysis that led it to conclude that

the package licensing agreements constituted per se patent misuse.

As in the case of its ruling on per se patent misuse, the fulcrum of the

Commission’s conclusion that Philips was guilty of patent misuse under the rule of

reason was its conclusion that the package licenses at issue in this case had “the

anticompetitive effect of foreclosing competition in the alternative technology that

competes with the technology covered by a nonessential patent that was included as a

so-called ‘essential’ patent.” On that issue, the Commission adopted the administrative

law judge’s analysis and conclusions with respect to the Farla, Iwasaki, Yamamoto, and

Lokhoff patents, but it took no position with respect to other patents that the

administrative law judge found to be nonessential.

Focusing particularly on the Farla and Iwasaki patents, the Commission found

that those patents were not essential to manufacturing CD-Rs and CD-RWs compliant

with the Orange Book standards and that including those patents in the patent

packages foreclosed competition by Calimetrics. The Commission briefly addressed

the assertedly procompetitive effects of the package licensing arrangements but upheld

the administrative law judge’s conclusion that those arrangements had a net

anticompetitive effect because “the convenience to manufacturers of a broad package

of patents was outweighed by the anticompetitive effect on alternative technologies of

packaging nonessential patents with essential patents.”

04-1361 31
 Under the rule of reason, the finder of fact must determine if the practice at issue

is “reasonably within the patent grant, i.e., that it relates to subject matter within the

scope of the patent claims.” Va. Panel, 133 F.3d at 869, quoting Mallinckrodt, 976 F.2d

at 708. If the practice does not “broaden the scope of the patent, either in terms of

covered subject matter or temporally,” then the patentee is not chargeable with patent

misuse. Va. Panel, 133 F.3d at 869. More specifically, “the finder of fact must decide

whether the questioned practice imposes an unreasonable restraint on competition,

taking into account a variety of factors, including specific information about the relevant

business, its condition before and after the restraint was imposed, and the restraint’s

history, nature and effect.” Va. Panel, 133 F.3d at 869, quoting State Oil Co. v. Khan,

522 U.S. 3, 10 (1997); see also Monsanto Co., 363 F.3d at 1341.

The Commission’s rule of reason analysis is flawed for two reasons. Most

importantly, its conclusion was largely predicated on the anticompetitive effect on

competitors offering alternatives to the four so-called nonessential patents in the Philips

patent packages. Yet, as we have already held, the evidence did not show that

including those patents in the patent packages had a negative effect on commercially

available technology. The Commission assumed that there was a foreclosure of

competition because compact disc manufacturers would be induced to accept licenses

to the technology covered by the Farla and Iwasaki patents and therefore would be

unwilling to consider alternatives. As noted, however, there was no evidence before the

Commission that any manufacturer had actually refused to consider alternatives to the

technology covered by those patents or for that matter that any commercially viable

alternative actually existed.

04-1361 32
 In addition, as in its per se analysis, the Commission did not acknowledge the

problems with licensing patents individually, such as the transaction costs associated

with making individual patent-by-patent royalty determinations and monitoring possible

infringement of patents that particular licensees chose not to license. The Commission

also did not address the problem, noted above, that changes in the technology for

manufacturing compact discs could render some patents that were indisputably

essential at the time of licensing arguably nonessential at some later point in the life of

the license. To hold that a licensing agreement that satisfied the rule of reason when

executed became unreasonable at some later point because of technological

development would introduce substantial uncertainty into the market and displace

settled commercial arrangements in favor of uncertainty that could only be resolved

through expensive litigation.

Finally, the Commission failed to consider the efficiencies that package licensing

may produce because of the innovative character of the technology at hand. Given

that the technology surrounding the Orange Book standard was still evolving, there

were many uncertainties regarding what patents might be needed to produce the

compact discs. As noted, package license agreements in which the royalty was based

on the number of units produced, not the number of patents used to produce them, can

resolve in advance all potential patent disputes between the licensor and the licensee,

whereas licensing patent rights on a patent-by-patent basis can result in continuing

disputes over whether the licensee’s technology infringes certain ancillary patents

owned by the licensor that are not part of the group elected by the licensee.

04-1361 33
 We therefore conclude that the line of analysis that the Commission employed in

reaching its conclusion that Philips’s package licensing agreements are more

anticompetitive than procompetitive, and thus are unlawful under the rule of reason, was

predicated on legal errors and on factual findings that were not supported by substantial

evidence. For these reasons, we cannot uphold the Commission’s decision that

Philips’s patents are unenforceable because of patent misuse under the rule of reason.

Because the Commission did not address all of the issues presented by the

administrative law judge’s decision under both the per se and rule of reason analysis,

further proceedings before the Commission may be necessary with respect to whether

Philips’s patents are enforceable and, if so, whether Philips is entitled to any relief from

the Commission. Accordingly, we reverse the Commission’s ruling on patent misuse for

the reasons stated, and we remand this case to the Commission for further proceedings

consistent with this opinion.

REVERSED AND REMANDED.

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