932 F.2d 1467 (D.C. Cir. 1991)

WILLIAM, CIRCUIT JUDGE

Inslaw, Inc., after filing for reorganization under Chapter 11 of the Bankruptcy Code, invoked § 362(a) to secure bankruptcy court adjudication of … its prolonged dispute with the Department of Justice over the Department’s right to use a case-tracking software system that Inslaw had provided under contract. Inslaw claimed that the Department had violated the stay provision by continuing, and expanding, its use of the software [PROMIS] in its U.S. Attorneys’ offices [after the bankruptcy filing]. The bankruptcy court found a willful violation and the district court affirmed on appeal. [We reverse.]

[Inslaw’s] major allegation concerns the Department’s use of enhanced PROMIS after the filing of the bankruptcy petition. The bankruptcy court concluded first that the privately-funded enhancements to PROMIS were proprietary trade secrets owned by Inslaw, and then that the Department’s continued use of these enhancements, and in particular its post-petition installation of enhanced PROMIS in 23 U.S. Attorneys’ offices (in addition to the 22 where Inslaw had made installations), were a “willful exercise of control over the property of the estate.”

The automatic stay protects “property of the estate.” This estate is created by the filing of a petition and comprises property of the debtor “wherever located and by whomever held,” including (among other things) “all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. § 541(a)(1) (1988). It is undisputed that this encompasses causes of action that belong to the debtor, as well as the debtor’s intellectual property, such as interests in patents, trademarks and copyrights. The estate also includes property recoverable under the Code’s “turnover” provisions, which allow the trustee to recover property that “was merely out of the possession of the debtor, yet remained ‘property of the debtor.’”

In its brief, Inslaw refers rather vaguely to its interest in the enhanced PROMIS software as the “property of the estate” over which the Department supposedly exercised control. But for meaningful analysis, Inslaw’s interests must be examined separately. One set of interests consists of (1) the computer tapes containing copies of the source and object codes that Inslaw sent to the Department on April 20, 1983 and (2) the copies of enhanced PROMIS that Inslaw installed on Department hardware between August 1983 and January 1984. As to these, Inslaw held no possessory interest when it filed for bankruptcy on February 7, 1985. Nor can it claim a possessory interest over them through the Code’s turnover provisions, [because] as Inslaw freely admits, the Department held possession of the copies under a claim of ownership (its view of the contract …) and claimed the right to use enhanced PROMIS without further payment. [A] debtor cannot use the turnover provisions to liquidate contract disputes or otherwise demand assets whose title is in dispute. Indeed, Inslaw never sought possession of the copies under the turnover provisions.

The bankruptcy court instead identified the relevant property as Inslaw’s intangible trade secret rights in the PROMIS enhancements. It then found that the Department’s continuing use of these intangible enhancements was an “exercise of control” over property of the estate.

If the bankruptcy court’s idea of the scope of “exercise of control” were correct, the sweep of § 362(a) would be extraordinary – with a concomitant expansion of the jurisdiction of the bankruptcy court. Whenever a party against whom the bankrupt holds a cause of action (or other intangible property right) acted in accord with his view of the dispute rather than that of the debtor-in-possession or bankruptcy trustee, he would risk a determination by a bankruptcy court that he had “exercised control” over intangible rights (property) of the estate.

[Such] assertions of bankruptcy court jurisdiction raise severe constitutional problems. Even apart from constitutional concerns, Inslaw’s view of § 362(a) would take it well beyond Congress’s purpose. The object of the automatic stay provision is essentially to solve a collective action problem – to make sure that creditors do not destroy the bankrupt estate in their scramble for relief. Fulfillment of that purpose cannot require that every party who acts in resistance to the debtor’s view of its rights violates § 362(a) if found in error by the bankruptcy court. Thus, someone defending a suit brought by the debtor does not risk violation of § 362(a)(3) by filing a motion to dismiss the suit, though his resistance may burden rights asserted by the bankrupt. Nor does the filing of a lis pendens violate the stay (at least where it does not create a lien), even though it alerts prospective buyers to a hazard and may thereby diminish the value of estate property. And the commencement and continuation of a cause of action against the debtor that arises post-petition, and so is not stayed by § 362(a)(1), does not violate § 362(a)(3). Since willful violations of the stay expose the offending party to liability for compensatory damages, costs, attorney’s fees, and, in some circumstances, punitive damages, see 11 U.S.C. § 362(h) (1988), it is difficult to believe that Congress intended a violation whenever someone already in possession of property mistakenly refuses to capitulate to a bankrupt’s assertion of rights in that property.

[Our] understanding of § 362(a) does not expose bankrupts to any troubling hazard. Here, for example, Inslaw retains whatever intangible property rights it had in enhanced PROMIS at the time of filing. If the Department has violated the [contract,] Inslaw as debtor-in-possession has all the access to court enjoyed by any victim of a contract breach by the United States government. If [the alleged modification of the contract] was induced by fraud, [then] Inslaw has its contract remedies or perhaps a suit for conversion. Assuming that its privately-funded enhancements to PROMIS qualify as proprietary trade secrets, [it] may be able to sue the government under the Trade Secrets Act or even under the Administrative Procedure Act for improper disclosures of its trade secrets by government officials.

[Because] the Department has taken no actions since the filing of the bankruptcy petition that violate the automatic stay, the bankruptcy court must, as both a statutory and constitutional matter, defer to adjudication of these matters by other forums. So ordered.

32 F.3d 426 (9th Cir. 1994)

NOONAN, CIRCUIT JUDGE

This case, of first impression in any circuit, turns on whether license fees, paid by a licensee for the use of technology, patents, and proprietary rights, are “royalties” within the meaning of 11 U.S.C. § 365(n)(2)(B) and, as such, must continue to be paid after the licensor in bankruptcy has exercised its statutory right to reject the contract.

Facts

The debtor, Prize Frize, Inc., is the owner and licensor of all technology, patents, proprietary rights and related rights used in the manufacture and sale of a French fry vending machine. On March 6, 1991, the debtor entered into a License Agreement granting an exclusive license to utilize the proprietary rights and to manufacture, use and sell the vending machine. In consideration for the license to use the proprietary information and related rights, the licensee agreed to pay the debtor a $1,250,000 license fee – $300,000 to be paid within ten days of execution of the agreement with the balance due in $50,000 monthly payments. The licensee also agreed to pay royalty payments based on a percentage of franchise fees, of net marketing revenues and of any sales of the machines or certain related products. The license agreement also provided that if there was a failure of design and/or components of the machines to the extent that they were not fit for their intended use and were withdrawn from service, then the licensee’s obligations would be suspended for a period of 180 days, during which time the debtor was entitled to cure any defect. Encino Business Management, Inc. (EBM) is the successor licensee under this license.

The debtor filed its Chapter 11 petition on March 12, 1991. In September of 1991, EBM, which had become the licensee, stopped making the $50,000 per month license fee payments and has made no payments since. EBM contends that there is a design defect in the machines which caused the machines to be withdrawn from service and which allowed the suspension of its obligation to pay the debtor.

The debtor subsequently filed a motion to reject the license agreement with EBM and to compel EBM to elect whether it wished to retain its rights under section 365(n)(1). EBM did not file a written response to the motion. At the hearing, EBM’s counsel indicated that he did not oppose rejection. He disputed, however, that EBM should be required to immediately pay $350,000 in past due license fee payments, contending that the obligation to make such payments was suspended because of the purported design defect.

The bankruptcy court entered an order indicating that the debtor might reject the agreement, that EBM might elect whether to retain its rights under the agreement pursuant to section 365(n)(1) and that if EBM elected to retain its rights under the agreement it must do the following: (1) make all license fee payments presently due in the amount of $350,000 within seven days of its election; (2) pay the $400,000 balance of the license fee in monthly installments of $50,000; and (3) waive any and all rights of setoff with respect to the contract and applicable non-bankruptcy law and any claim under section 503(b) arising from performance under the agreement. The court’s order also stated that assuming, arguendo, that EBM’s payment obligations were properly suspended, the 180-day suspension period had ended and the September to March monthly payments were now due.

EBM appealed.

Analysis

Section 365 of the Bankruptcy Code is an intricate statutory scheme governing the treatment by the trustee in bankruptcy or the debtor-in-possession of the executory contracts of the debtor. There is no dispute that the license agreement between EBM and the debtor was executory, i.e. there were obligations on both sides which to some extent were unperformed. Consequently, the debtor had the right to reject the contract. However, section 365(n)(1) qualifies this right when the debtor is “a licensor of a right to intellectual property.” There is no dispute that the debtor is such a licensor. Consequently, EBM as “the licensee under such contract” could make an election. § 365(n)(1). EBM could either treat the contract as terminated as provided by (n)(1)(A), or EBM could retain its rights to the intellectual property for the duration of the contract and any period for which the contract might be extended by the licensee as of right under applicable nonbankruptcy law.

EBM elected to retain its rights. It was then obligated to “make all royalty payments due under such contract.” By the terms of the statute EBM was also “deemed to waive any right of setoff it may have with respect to such contract under this title or applicable nonbankruptcy law.”

Section 365(n) has struck a fair balance between the interests of the bankrupt and the interests of a licensee of the bankrupt’s intellectual property. The bankrupt cannot terminate and strip the licensee of rights the licensee had bargained for. The licensee cannot retain the use of those rights without paying for them. It is essential to the balance struck that the payments due for the use of the intellectual property should be analyzed as “royalties,” required by the statute itself to be met by the licensee who is enjoying the benefit of the bankrupt’s patents, proprietary property, and technology. [The] legislative history buttresses this commonsense interpretation of “royalties” in the statute.

EBM’s principal argument is that the licensing agreement itself makes a distinction between what the agreement calls “license fees” and what the agreement calls “royalty payments.” The “royalty payments” in the agreement are percentages payable on the retail sales price of each machine sold by EBM; the “license fees” in the agreement are the sums here in dispute which were to be paid for the license to manufacture and sell the vending machine. EBM’s argument is not frivolous. Nonetheless the parties by their choice of names cannot alter the underlying reality nor change the balance that the Bankruptcy Code has struck. Despite the nomenclature used in the agreement, the license fees to be paid by EBM are royalties in the sense of section 365(n). Section 365(n) speaks repeatedly of “licensor” and “licensee” with the clear implication that payments by licensee to licensor for the use of intellectual property are, indifferently, “licensing fees” or “royalties,” and, as royalties, must be paid by the licensee who elects to keep its license after the licensor’s bankruptcy. The same indifference to nomenclature in referring to a licensee’s lump sum or percentage-of-sales payments as royalties is apparent in patent cases.

EBM’s fallback position on appeal is that the debtor has been freed by its rejection of the contract from the obligations assumed by the debtor under Article V (“Representations, Warranties and Covenants by PFI”) of the agreement. These obligations included the debtor’s agreement to hold EBM harmless from any claim arising out of events preceding the agreement, to defend any infringement suit relating to technology or design included in the machine, and to prosecute at its own expense any infringers of the rights granted by the agreement. The debtor also represented that the design of the Stand-Alone Machine was free from material defects. These obligations raise the question whether it is proper to consider all of the license fees as royalties or whether some portion of the fees should be allocated to payment for the obligations assumed by the debtor. Neither the bankruptcy court nor the BAP addressed this possibility. They did not because EBM did not present this question to them. It is consequently too late to raise it here. EBM still has its unsecured claim for breach of the entire license agreement that § 365(g) accords it. As its appeal was non-frivolous, no attorney’s fees are awarded.

As what the licensing agreement denominates “license fees” must be regarded as “royalty payments” for purposes of § 365(n)(1)(B), the judgment [is] AFFIRMED.

Heather J. Meeker, 4th ed., 2018 at 90–93

An independent trustee—usually a firm in the business of doing technology escrows—is appointed as the escrow agent for licensor and licensee. The parties enter into a three-way agreement that is essentially a trust arrangement. The licensor delivers a copy of the source code to the escrow agent, and is usually required to deliver a source code update whenever it delivers a corresponding object code update to the licensee under the agreement. Upon occurrence of a triggering event, the escrow agent delivers the escrowed source code to the licensee. The escrow agreement, or the original license agreement, should include a license grant that is effective upon delivery by the escrow agent.

Most of the provisions of escrow agreements are not heavily negotiated. Sometimes the parties negotiate who will pay the fees. Typically the licensee pays these fees, if only because a licensor nearing bankruptcy may not place escrow fees at the top of its financial priorities, and the escrow agent may not be willing to release an escrow deposit with fees due in arrears. Parties also negotiate the dispute resolution mechanism if there is a disagreement over whether a triggering event has occurred. Licensees usually want fast arbitration, because obtaining the source code a year after a bug has appeared and maintenance has ended does not do much to address the licensee’s quiet enjoyment issue.

The heavily negotiated provisions are the trigger events. Some of them relate to bankruptcy, and some do not:

• Filing of Chapter 7 (also cessation of business in the ordinary course, liquidation without filing of a bankruptcy provision). This trigger is ubiquitous and seldom controversial.

• Filing of Chapter 11. The licensor may argue that, for the reasons discussed above, Chapter 11 will not be likely to interrupt maintenance services.

• Breach of the Licensor’s Maintenance Obligations. Licensors are wary of agreeing to this, particularly if the maintenance obligations in the agreement are vague or stringent.

• Change of Control of Licensor. This is a “poison pill” for an acquisition of the licensor, and the licensor usually tries to negotiate against it.

When drafting and negotiating licenses that involve escrows, the parties may attach an executed escrow agreement as an exhibit to the document. However, the parties often do not have time to set up the escrow or have the escrow agent sign the document before executing the underlying license. In those cases, you might use the following provision, which is drafted to favor the licensor:

Note the present language of grant in the license: “Licensor hereby grants to Licensee … provided that Licensee may exercise such rights only in the event of a release of such materials pursuant to such source code escrow agreement.” This is the proper way to draft this provision, as opposed to: “Licensor shall grant to Licensee … upon a release of such materials pursuant to such source code escrow agreement.” This is an issue for the licensee’s counsel to spot. The obligation to grant a license may be more difficult to enforce, because it could require a court to mandate the granting of a license, and courts are reluctant to grant mandatory injunctions.

The Flow-Down Problem

There is a lurking issue in software escrows that is rarely considered by licensees. Few software developers today develop their entire product from scratch. Suppose a licensor (DevCo) provides an escrow for a licensee (DistyCo) that intends to redistribute the software. DistyCo’s customers also want an escrow of source code in the event DistyCo goes out of business. But part of the software provided by DistyCo to its customers belongs to licensors like DevCo. DistyCo’s escrow for its customers will not work, because DistyCo probably cannot grant its customers any rights in Devco’s source code. If it did, then in the type of escrow provision described above, a failure of the business of DistyCo would trigger release of the source code of DevCo. DevCo is likely to take a dim view of this.

If this problem arises, one way to solve it is as follows:

This will address the customer’s need for continuing access to technology, but not force DevCo to lose control of its source code.

Escrows in the 21st Century

Escrows have always had their issues. They are often not properly updated by the Licensor, so the binaries the Licensee is using does not correspond with the software in escrow. Source code is often poorly documented, and the Licensee often does not have the human resources to fix problems, even if it has access to source code. Software runs in a larger computing environment, and it is very difficult to capture that environment in an escrow.

Software escrows used to be ubiquitous in software licensing deals, but today, they are much rarer. One reason is that computing has tended to become vertically dis-integrated, so it may be easier to find substitutes for software whose vendor is no longer available. Another is that many technologists are skeptical about the value of escrows, for the reasons given above. Another reason is the rise of cloud computing or SaaS—it is nearly impossible to properly capture a SaaS product in an escrow. So, today, many licensees dispense with the escrow terms of license agreements.

The good news is that open source software has changed how escrows are done. It might be counterintuitive, but open source is great to put in escrow—mainly so that a licensee can capture the exact computing environment for the application it is licensing, with no worries about the right to include these third party components. Open source software has also changed the expectations of licensees; engineers now expect to get source code and not just binaries from vendors, so the function of escrows has changed.

Twenty years ago, asking for an escrow was an expected part of a software license. Today, if you demand an escrow on behalf of a licensee, the licensor may challenge you about why it is necessary, so be prepared to discuss the practicalities of software escrows.

Figure 21.1 Some technology escrow providers.

210 L. Ed. 2d 689 (U.S. 2021)

KAGAN, JUSTICEFootnote ²

In Westinghouse Elec. & Mfg. Co. v. Formica Insulation Co., 266 U. S. 342 (1924), this Court approved the “well settled” patent-law doctrine of “assignor estoppel.” That doctrine, rooted in an idea of fair dealing, limits an inventor’s ability to assign a patent to another for value and later contend in litigation that the patent is invalid. The question presented here is whether to discard this century-old form of estoppel. Continuing to see value in the doctrine, we decline to do so. But in upholding assignor estoppel, we clarify that it reaches only so far as the equitable principle long understood to lie at its core. The doctrine applies when, but only when, the assignor’s claim of invalidity contradicts explicit or implicit representations he made in assigning the patent.

The invention sparking this lawsuit is a device to treat abnormal uterine bleeding, a medical condition affecting many millions of women. Csaba Truckai, a founder of the company Novacept, Inc., invented the device—called the NovaSure System—in the late 1990s. He soon afterward filed a patent application, and assigned his interest in the application—as well as in any future “continuation applications”—to Novacept. The NovaSure System, as described in Truckai’s patent application, uses an applicator head to destroy targeted cells in the uterine lining. To avoid unintended burning or ablation (tissue removal), the head is “moisture permeable,” meaning that it conducts fluid out of the uterine cavity during treatment. The PTO issued a patent, and in 2001 the Food and Drug Administration (FDA) approved the device for commercial distribution. But neither Truckai nor Novacept currently benefits from the NovaSure System patent. In 2004, Novacept sold its assets, including its portfolio of patents and patent applications, to another company (netting Truckai individually about $8 million). And in another sale, in 2007, respondent Hologic, Inc. acquired all patent rights in the NovaSure System. Today, Hologic sells that device throughout the United States.

Not through with inventing, Truckai founded in 2008 petitioner Minerva Surgical, Inc. There, he developed a supposedly improved device to treat abnormal uterine bleeding. Called the Minerva Endometrial Ablation System, the device (like the NovaSure System) uses an applicator head to remove cells in the uterine lining. But the new device, relying on a different way to avoid unwanted ablation, is “moisture impermeable”: It does not remove any fluid during treatment. The PTO issued a patent for the device, and in 2015 the FDA approved it for commercial sale.

Meanwhile, in 2013, Hologic filed a continuation application requesting to add claims to its patent for the NovaSure System. Aware of Truckai’s activities, Hologic drafted one of those claims to encompass applicator heads generally, without regard to whether they are moisture permeable. The PTO in 2015 issued the altered patent as requested.

A few months later, Hologic sued Minerva for patent infringement. Minerva rejoined that its device does not infringe. But more relevant here, it also asserted that Hologic’s amended patent is invalid. The essential problem, according to Minerva, is that the new, broad claim about applicator heads does not match the invention’s description, which addresses their water-permeability. In response, Hologic invoked the doctrine of assignor estoppel. Because Truckai assigned the original patent application, Hologic argued, he and Minerva (essentially, his alter-ego) could not impeach the patent’s validity. The District Court agreed that assignor estoppel barred Minerva’s invalidity defense, and also ruled that Minerva had infringed Hologic’s patent. At a trial on damages, a jury awarded Hologic about $5 million.

The Court of Appeals for the Federal Circuit mainly upheld the judgment, focusing on assignor estoppel. The court first “decline[d] Minerva’s invitation to ‘abandon [that] doctrine.’” Citing both this Court’s precedents and equitable principles, the court affirmed the doctrine’s “continued vitality.” An assignor, the court stated, “should not be permitted to sell something and later to assert that what was sold is worthless, all to the detriment of the assignee.” The assignor makes an “implicit representation” that the rights “he is assigning (presumably for value) are not worthless.” It would “work an injustice,” the court reasoned, to “allow the assignor to make that representation at the time of assignment (to his advantage) and later to repudiate it (again to his advantage).” The court then applied assignor estoppel to bar Truckai and Minerva from raising an invalidity defense. Here, the court rejected Minerva’s argument that because “Hologic broadened the claims” after “Truckai’s assignment,” it would “be unfair to block Truckai (or Minerva) from challenging the breadth of those claims.” Relying on circuit precedent, the court deemed it “irrelevant that, at the time of the assignment, the inventor’s patent application[] w[as] still pending” and that the assignee “may have later amended the claims” without the inventor’s input.

We granted certiorari to consider the important issues raised in the Federal Circuit’s judgment. Assignor estoppel, we now hold, is well grounded in centuries-old fairness principles, and the Federal Circuit was right to uphold it. But the court failed to recognize the doctrine’s proper limits. The equitable basis of assignor estoppel defines its scope: The doctrine applies only when an inventor says one thing (explicitly or implicitly) in assigning a patent and the opposite in litigating against the patent’s owner.

Courts have long applied the doctrine of assignor estoppel to deal with inconsistent representations about a patent’s validity. The classic case (different in certain respects from the one here) begins with an inventor who both applies for and obtains a patent, then assigns it to a company for value. Later, the inventor/assignor joins a competitor business, where he develops a similar—and possibly infringing—product. When the assignee company sues for infringement, the assignor tries to argue—contrary to the (explicit or implicit) assurance given in assigning the patent—that the invention was never patentable, so the patent was never valid. That kind of about-face is what assignor estoppel operates to prevent—or, in legalese, estop. As one of the early American courts to use the doctrine held: The assignor is not “at liberty to urge [invalidity] in a suit upon his own patent against a party who derives title to that patent through him.” Woodward v. Boston Lasting Mach. Co., 60 F. 283, 284 (CA1 1894). Or as the Federal Circuit held in modern times: The assignor’s explicit or “implicit representation” that the patent he is assigning is “not worthless … deprive[s] him of the ability to challenge later the [patent’s] validity.”

Assignor estoppel got its start in late 18th-century England and crossed the Atlantic about a hundred years later. In the first recorded case, Lord Kenyon found that a patent assignor “was by his own oath and deed estopped” in an infringement suit from “attempt[ing] to deny his having had any title to convey.” That rule took inspiration from an earlier doctrine—estoppel by deed—applied in real property law to prevent a conveyor of land from later asserting that he had lacked good title at the time of sale. Lord Kenyon’s new patent formulation of the doctrine grew in favor throughout the 1800s as an aspect of fair dealing: When “the Defendant sold and assigned th[e] patent to the Plaintiffs as a valid one,” it “does not lie in his mouth to say that the patent is not good.” Within a decade or two, the doctrine was “so well established and generally accepted that citation of authority is useless.”

This Court first considered—and unanimously approved—assignor estoppel in 1924, in Westinghouse v. Formica. Speaking through Chief Justice Taft, the Court initially invoked the doctrine’s uniform acceptance in the lower courts. The first decision applying assignor estoppel, the Court recounted, was soon “followed by a myriad.” “[L]ater cases in nearly all the Circuit Courts of Appeal” were “to the same point” as the first, adding up to a full “forty-five years of judicial consideration and conclusion.” Such a “well settled” rule, in the Court’s view, should “not [be] lightly disturb[ed].” And so it was not disturbed, lightly or otherwise. Rather, the Court added its own voice to that pre-existing “myriad.” We announced that an assignor “is estopped to attack” the “validity of a patented invention which he has assigned.” “As to the rest of the world,” the Court explained, “the patent may have no efficacy”; but “the assignor can not be heard to question” the assignee’s rights in what was conveyed.

Westinghouse, like its precursor decisions, grounded assignor estoppel in a principle of fairness. “If one lawfully conveys to another a patented right,” the Court reasoned, “fair dealing should prevent him from derogating from the title he has assigned.” After all, the “grantor purports to convey the right to exclude others”; how can he later say, given that representation, that the grantee in fact possesses no such right? The Court supported that view of equity by referring to estoppel by deed. Under that doctrine, the Court explained, “a grantor of a deed of land” cannot “impeach[] the effect of his solemn act” by later claiming that the grantee’s title is no good. Westinghouse, 266 U. S., at 350. “The analogy” was “clear”: There was “no reason why the principles of estoppel by deed should not apply to [the] assignment of a patent right.” In the latter context too, the Court held, the assignor could not fairly “attack” the validity of a right he had formerly sold.

After thus endorsing assignor estoppel, the Court made clear that the doctrine has limits. Although the assignor cannot assert in an infringement suit that the patent is invalid, the Court held that he can argue about how to construe the patent’s claims. Here, the Court addressed the role in patent suits of prior art—the set of earlier inventions (and other information) used to decide whether the specified invention is novel and non-obvious enough to merit a patent. “Of course,” the Court said, the assignor cannot use prior art in an infringement suit “to destroy the patent,” because he “is estopped to do this.” But he can use prior art to support a narrow claim construction—to “construe and narrow the claims of the patent, conceding their validity.” “Otherwise,” the Court explained, a judge “would be denied” the “most satisfactory means” of “reaching a just conclusion” about the patent’s scope—a conclusion needed to resolve the infringement charge. “The distinction” thus established, the Court thought, “may be a nice one, but seems to be workable.” And, indeed, the Court applied it to decide the case at hand for the assignor, finding that he had not infringed the properly narrowed claim.

Finally, the Court left for another day several other questions about the contours of assignor estoppel. One concerned privity: When was an assignor so closely affiliated with another party that the latter would also be estopped? Another related to consideration: What if an assignor had received only a nominal amount of money for transferring the patent? But the question that most interested the Court was whether estoppel should operate differently if the assignment was not of a granted patent but of a patent application—as in fact was true in that case. The Court saw a possible distinction between the two. In a patent application, the Court began, the inventor “swor[e] to” a particular “specification.” But the exact rights at issue were at that point “inchoate”—not “certainly defined.” And afterward, the Court (presciently) observed, the claims might be “enlarge[d]” at “the instance of the assignee” beyond what the inventor had put forward. That might weaken the case for estoppel. But the Court decided not to decide the issue, given its holding that the assignor had not infringed the (narrowed) patent claim anyway.

Minerva’s main argument here, as in the Federal Circuit, is that “assignor estoppel should be eliminated”—and indeed has been already. We reject that view. The doctrine has lasted for many years, and we continue to accept the fairness principle at its core. Minerva’s back-up contention is that assignor estoppel “should be constrained.” On that score, we find that the Federal Circuit has applied the doctrine too expansively. Today, we clarify the scope of assignor estoppel, including in the way Westinghouse suggested.

This Court recognized assignor estoppel a century ago, and we reaffirm that judgment today. But as the Court recognized from the beginning, the doctrine is not limitless. Its boundaries reflect its equitable basis: to prevent an assignor from warranting one thing and later alleging another. Assignor estoppel applies when an invalidity defense in an infringement suit conflicts with an explicit or implicit representation made in assigning patent rights. But absent that kind of inconsistency, an invalidity defense raises no concern of fair dealing—so assignor estoppel has no place.

For these reasons, we vacate the judgment of the Federal Circuit and remand the case for further proceedings consistent with this opinion.

It is so ordered.

395 U.S. 653 (1969)

HARLAN, JUSTICE

In January of 1953, John Adkins, an inventor and mechanical engineer, was hired by Lear Incorporated for the purpose of solving a vexing problem the company had encountered in its efforts to develop a gyroscope which would meet the increasingly demanding requirements of the aviation industry. The gyroscope is an essential component of the navigational system in all aircraft, enabling the pilot to learn the direction and altitude of his airplane. With the development of the faster airplanes of the 1950’s, more accurate gyroscopes were needed, and the gyro industry consequently was casting about for new techniques which would satisfy this need in an economical fashion. Shortly after Adkins was hired, he developed a method of construction at the company’s California facilities which improved gyroscope accuracy at a low cost. Lear almost immediately incorporated Adkins’ improvements into its production process to its substantial advantage.

At the very beginning of the parties’ relationship, Lear and Adkins entered into a rudimentary one-page agreement which provided that although “[a]ll new ideas, discoveries, inventions etc. related [to] vertical gyros become the property of Mr. John S. Adkins,” the inventor promised to grant Lear a license as to all ideas he might develop “on a mutually satisfactory royalty basis.” As soon as Adkins’ labors yielded tangible results it quickly became apparent to the inventor that further steps should be taken to place his rights to his ideas on a firmer basis. On February 4, 1954, Adkins filed an application with the Patent Office in an effort to gain federal protection for his improvements. At about the same time, he entered into a lengthy period of negotiations with Lear in an effort to conclude a licensing agreement which would clearly establish the amount of royalties that would be paid.

These negotiations finally bore fruit on September 15, 1955, when the parties approved a complex 17-page contract which carefully delineated the conditions upon which Lear promised to pay royalties for Adkins’ improvements. The parties agreed that “if the United States Patent Office refuses to issue a patent on the substantial claims [contained in Adkins’ original patent application] or if such a patent so issued is subsequently held invalid then in any of such events Lear at its option shall have the right forthwith to terminate the specific license so affected or to terminate this entire Agreement …”

As the contractual language indicates, Adkins had not obtained a final Patent Office decision as to the patentability of his invention at the time the licensing agreement was concluded. Indeed, he was not to receive a patent until January 5, 1960.

The progress of Adkins’ effort to obtain a patent followed the typical pattern. In his initial application, the inventor made the ambitious claim that his entire method of constructing gyroscopes was sufficiently novel to merit protection. The Patent Office, however, rejected this initial claim, as well as two subsequent amendments, which progressively narrowed the scope of the invention sought to be protected. Finally, Adkins narrowed his claim drastically to assert only that the design of the apparatus used to achieve gyroscope accuracy was novel. In response, the Office issued its 1960 patent, granting a 17-year monopoly on this more modest claim.

During the long period in which Adkins was attempting to convince the Patent Office of the novelty of his ideas, however, Lear had become convinced that Adkins would never receive a patent on his invention and that it should not continue to pay substantial royalties on ideas which had not contributed substantially to the development of the art of gyroscopy. In 1957, after Adkins’ patent application had been rejected twice, Lear announced that it had searched the Patent Office’s files and had found a patent which it believed had fully anticipated Adkins’ discovery. As a result, the company stated that it would no longer pay royalties on the large number of gyroscopes it was producing at its plant in Grand Rapids, Michigan (the Michigan gyros). Payments were continued on the smaller number of gyros produced at the company’s California plant for two more years until they too were terminated on April 8, 1959 (the California gyros).

As soon as Adkins obtained his patent in 1960, he brought this lawsuit in the California Superior Court. He argued to a jury that both the Michigan and the California gyros incorporated his patented apparatus and that Lear’s failure to pay royalties on these gyros was a breach both of the 1955 contract and of Lear’s quasi-contractual obligations. Although Lear sought to raise patent invalidity as a defense, the trial judge directed a verdict of $16,351.93 for Adkins on the California gyros, holding that Lear was estopped by its licensing agreement from questioning the inventor’s patent. The trial judge took a different approach when it came to considering the Michigan gyros. Noting that the Company claimed that it had developed its Michigan designs independently of Adkins’ ideas, the court instructed the jury to award the inventor recovery only if it was satisfied that Adkins’ invention was novel, within the meaning of the federal patent laws. When the jury returned a verdict for Adkins of $888,122.56 on the Michigan gyros, the trial judge granted Lear’s motion for judgment notwithstanding the verdict, finding that Adkins’ invention had been completely anticipated by the prior art.

Once again both sides appealed, this time to the California Supreme Court, which took yet another approach to the problem presented. The court rejected the Court of Appeals’ conclusion that the 1955 license gave Lear the right to terminate its royalty obligations in 1959. Since the 1955 agreement was still in effect, the court concluded, relying on the language we have already quoted, that the doctrine of estoppel barred Lear from questioning the propriety of the Patent Office’s grant. The court’s adherence to estoppel, however, was not without qualification. After noting Lear’s claim that it had developed its Michigan gyros independently, the court tested this contention by considering “whether what is being built by Lear [in Michigan] springs entirely” (emphasis supplied) from the prior art. Applying this test, it found that Lear had in fact “utilized the apparatus patented by Adkins throughout the period in question,” reinstating the jury’s $888,000 verdict on this branch of the case.

Figure 22.1 The gyroscope invention in Lear v. Adkins.

Since the California Supreme Court’s construction of the 1955 licensing agreement is solely a matter of state law, the only issue open to us is raised by the court’s reliance upon the doctrine of estoppel to bar Lear from proving that Adkins’ ideas were dedicated to the common welfare by federal law. In considering the propriety of the State Court’s decision, we are well aware that we are not writing upon a clean slate. The doctrine of estoppel has been considered by this Court in a line of cases reaching back into the middle of the 19th century. Before deciding what the role of estoppel should be in the present case and in the future, it is, then, desirable to consider the role it has played in the past.

The uncertain status of licensee estoppel in the case law is a product of judicial efforts to accommodate the competing demands of the common law of contracts and the federal law of patents. On the one hand, the law of contracts forbids a purchaser to repudiate his promises simply because he later becomes dissatisfied with the bargain he has made. On the other hand, federal law requires that all ideas in general circulation be dedicated to the common good unless they are protected by a valid patent. When faced with this basic conflict in policy, both this Court and courts throughout the land have naturally sought to develop an intermediate position which somehow would remain responsive to the radically different concerns of the two different worlds of contract and patent. The result has been a failure. Rather than creative compromise, there has been a chaos of conflicting case law, proceeding on inconsistent premises. Before renewing the search for an elusive middle ground, we must reconsider on their own merits the arguments which may properly be advanced on both sides of the estoppel question.

210 U.S. 339 (1908)

DAY, JUSTICE

The complainant in the circuit court, appellant here, the Bobbs-Merrill Company, brought suit against the respondents, appellees here, Isidor Straus and Nathan Straus, partners as R. H. Macy & Company, in the Circuit Court of the United States for the Southern District of New York to restrain the sale of a copyrighted novel, entitled “The Castaway,” at retail at less than $1 for each copy. The circuit court dismissed the bill on final hearing. The decree of the circuit court was affirmed on appeal by the circuit court of appeals.

The appellant is the owner of the copyright upon “The Castaway,” obtained on the eighteenth day of May, 1904, in conformity to the copyright statutes of the United States. Printed immediately below the copyright notice, on the page in the book following the title page, is inserted the following notice:

Macy & Company, before the commencement of the action, purchased copies of the book for the purpose of selling the same at retail. Ninety percent of such copies were purchased by them at wholesale at a price below the retail price by about forty percent, and ten percent of the books purchased by them were purchased at retail, and the full price paid therefor.

Figure 23.1 The Castaway: Three Great Men Ruined in One Year – A King, A Cad and a Castaway, by Hallie Ermine Rives (1904).

It is stipulated in the record:

The present case involves rights under the copyright act. The facts disclose a sale of a book at wholesale by the owners of the copyright at a satisfactory price, and this without agreement between the parties to such sale obligating the purchaser to control future sales, and where the alleged right springs from the protection of the copyright law alone. It is contended that this power to control further sales is given by statute to the owner of such a copyright in conferring the sole right to “vend” a copyrighted book.

Recent cases in this Court have affirmed the proposition that copyright property under the federal law is wholly statutory, and depends upon the right created under the acts of Congress passed in pursuance of the authority conferred under Article I, § 8, of the federal Constitution:

The learned counsel for the appellant in this case, in the argument at bar, disclaims relief because of any contract, and relies solely upon the copyright statutes, and rights therein conferred. The copyright statutes ought to be reasonably construed with a view to effecting the purposes intended by Congress. They ought not to be unduly extended by judicial construction to include privileges not intended to be conferred, nor so narrowly construed as to deprive those entitled to their benefit of the rights Congress intended to grant.

At common law, an author had a property in his manuscript, and might have redress against anyone who undertook to realize a profit from its publication without authority of the author.

While the nature of the property and the protection intended to be given the inventor or author as the reward of genius or intellect in the production of his book or work of art is to be considered in construing the act of Congress, it is evident that to secure the author the right to multiply copies of his work may be said to have been the main purpose of the copyright statutes.

This fact is emphasized when we note the title to the act of Congress, passed at its first session: “An Act for the Encouragement of Learning, by Securing the Copies of Maps, Charts, and Books, to the Authors and Proprietors of Such Copies, during the Times Therein Mentioned.” 1 Stat. at Large, by Peters, c. 15, p. 124.

In order to secure this right, it was provided in that statute, as it has been in subsequent ones, that the authors of books, their executors, administrators, or assigns, shall have the “sole right and liberty of printing, reprinting, publishing, and vending” such book for a term of years, upon complying with the statutory conditions set forth in the act as essential to the acquiring of a valid copyright. Each and all of these statutory rights should be given such protection as the act of Congress requires, in order to secure the rights conferred upon authors and others entitled to the benefit of the act. Let us see more specifically what are the statutory rights, in this behalf, secured to one who has complied with the provisions of the law and become the owner of a copyright. They may be found in §§ 4952 … of the Revised Statutes of the United States, and are as follows:

It is the contention of the appellant that the circuit court erred in failing to give effect to the provision of § 4952, protecting the owners of the copyright in the sole right of vending the copyrighted book or other article, and the argument is that the statute vested the whole field of the right of exclusive sale in the copyright owner; that he can part with it to another to the extent that he sees fit, and may withhold to himself, by proper reservations, so much of the right as he pleases.

What does the statute mean in granting “the sole right of vending the same?” Was it intended to create a right which would permit the holder of the copyright to fasten, by notice in a book or upon one of the articles mentioned within the statute, a restriction upon the subsequent alienation of the subject matter of copyright after the owner had parted with the title to one who had acquired full dominion over it and had given a satisfactory price for it? It is not denied that one who has sold a copyrighted article, without restriction, has parted with all right to control the sale of it. The purchaser of a book, once sold by authority of the owner of the copyright, may sell it again, although he could not publish a new edition of it.

In this case, the stipulated facts show that the books sold by the appellant were sold at wholesale, and purchased by those who made no agreement as to the control of future sales of the book, and took upon themselves no obligation to enforce the notice printed in the book, undertaking to restrict retail sales to a price of one dollar per copy.

The precise question therefore in this case is, does the sole right to vend (named in § 4952) secure to the owner of the copyright the right, after a sale of the book to a purchaser, to restrict future sales of the book at retail, to the right to sell it at a certain price per copy, because of a notice in the book that a sale at a different price will be treated as an infringement, which notice has been brought home to one undertaking to sell for less than the named sum? We do not think the statute can be given such a construction, and it is to be remembered that this is purely a question of statutory construction. There is no claim in this case of contract limitation, nor license agreement controlling the subsequent sales of the book.

In our view, the copyright statutes, while protecting the owner of the copyright in his right to multiply and sell his production, do not create the right to impose, by notice, such as is disclosed in this case, a limitation at which the book shall be sold at retail by future purchasers, with whom there is no privity of contract. This conclusion is reached in view of the language of the statute, read in the light of its main purpose to secure the right of multiplying copies of the work – a right which is the special creation of the statute. True, the statute also secures, to make this right of multiplication effectual, the sole right to vend copies of the book, the production of the author’s thought and conception. The owner of the copyright in this case did sell copies of the book in quantities and at a price satisfactory to it. It has exercised the right to vend. What the complainant contends for embraces not only the right to sell the copies, but to qualify the title of a future purchaser by the reservation of the right to have the remedies of the statute against an infringer because of the printed notice of its purpose so to do unless the purchaser sells at a price fixed in the notice. To add to the right of exclusive sale the authority to control all future retail sales by a notice that such sales must be made at a fixed sum would give a right not included in the terms of the statute, and, in our view, extend its operation, by construction, beyond its meaning, when interpreted with a view to ascertaining the legislative intent in its enactment.

The decree of the circuit court of appeals is Affirmed.

621 F.3d 1102 (9th Cir. 2010)

CALLAHAN, CIRCUIT JUDGE

Timothy Vernor purchased several used copies of Autodesk, Inc.’s AutoCAD Release 14 software (“Release 14”) from one of Autodesk’s direct customers, and he resold the Release 14 copies on eBay. Vernor brought this declaratory judgment action against Autodesk to establish that these resales did not infringe Autodesk’s copyright. The district court issued the requested declaratory judgment, holding that Vernor’s sales were lawful because of two of the Copyright Act’s affirmative defenses that apply to owners of copies of copyrighted works, the first sale doctrine and the essential step defense.

Autodesk distributes Release 14 pursuant to a limited license agreement in which it reserves title to the software copies and imposes significant use and transfer restrictions on its customers. We determine that Autodesk’s direct customers are licensees of their copies of the software rather than owners, which has two ramifications. Because Vernor did not purchase the Release 14 copies from an owner, he may not invoke the first sale doctrine, and he also may not assert an essential step defense on behalf of his customers. For these reasons, we vacate the district court’s grant of summary judgment to Vernor and remand for further proceedings.

The Copyright Act confers several exclusive rights on copyright owners, including the exclusive rights to reproduce their works and to distribute their works by sale or rental. Id. § 106(1), (3). The exclusive distribution right is limited by the first sale doctrine, an affirmative defense to copyright infringement that allows owners of copies of copyrighted works to resell those copies. The exclusive reproduction right is limited within the software context by the essential step defense, another affirmative defense to copyright infringement that is discussed further infra. Both of these affirmative defenses are unavailable to those who are only licensed to use their copies of copyrighted works.

Figure 23.2 Autodesk’s AutoCAD 14 software.

This case requires us to decide whether Autodesk sold Release 14 copies to its customers or licensed the copies to its customers. If CTA owned its copies of Release 14, then both its sales to Vernor and Vernor’s subsequent sales were non-infringing under the first sale doctrine. However, if Autodesk only licensed CTA to use copies of Release 14, then CTA’s and Vernor’s sales of those copies are not protected by the first sale doctrine and would therefore infringe Autodesk’s exclusive distribution right.

We turn to our precedents governing whether a transferee of a copy of a copyrighted work is an owner or licensee of that copy. We then apply those precedents to CTA’s and Vernor’s possession of Release 14 copies.

IV. We hold today that a software user is a licensee rather than an owner of a copy where the copyright owner (1) specifies that the user is granted a license; (2) significantly restricts the user’s ability to transfer the software; and (3) imposes notable use restrictions. Applying our holding to Autodesk’s SLA, we conclude that CTA was a licensee rather than an owner of copies of Release 14 and thus was not entitled to invoke the first sale doctrine or the essential step defense.

Autodesk retained title to the software and imposed significant transfer restrictions: it stated that the license is nontransferable, the software could not be transferred or leased without Autodesk’s written consent, and the software could not be transferred outside the Western Hemisphere. The SLA also imposed use restrictions against the use of the software outside the Western Hemisphere and against modifying, translating, or reverse-engineering the software, removing any proprietary marks from the software or documentation, or defeating any copy protection device. Furthermore, the SLA provided for termination of the license upon the licensee’s unauthorized copying or failure to comply with other license restrictions. Thus, because Autodesk reserved title to Release 14 copies and imposed significant transfer and use restrictions, we conclude that its customers are licensees of their copies of Release 14 rather than owners.

CTA was a licensee rather than an “owner of a particular copy” of Release 14, and it was not entitled to resell its Release 14 copies to Vernor under the first sale doctrine. 17 U.S.C. § 109(a). Therefore, Vernor did not receive title to the copies from CTA and accordingly could not pass ownership on to others. Both CTA’s and Vernor’s sales infringed Autodesk’s exclusive right to distribute copies of its work.

Because Vernor was not an owner, his customers are also not owners of Release 14 copies. Therefore, when they install Release 14 on their computers, the copies of the software that they make during installation infringe Autodesk’s exclusive reproduction right because they too are not entitled to the benefit of the essential step defense.

Although our holding today is controlled by our precedent, we recognize the significant policy considerations raised by the parties and amici on both sides of this appeal.

Autodesk, the Software & Information Industry Association (“SIIA”), and the Motion Picture Association of America (“MPAA”) have presented policy arguments that favor our result. For instance, Autodesk argues in favor of judicial enforcement of software license agreements that restrict transfers of copies of the work. Autodesk contends that this (1) allows for tiered pricing for different software markets, such as reduced pricing for students or educational institutions; (2) increases software companies’ sales; (3) lowers prices for all consumers by spreading costs among a large number of purchasers; and (4) reduces the incidence of piracy by allowing copyright owners to bring infringement actions against unauthorized resellers. SIIA argues that a license can exist even where a customer (1) receives his copy of the work after making a single payment and (2) can indefinitely possess a software copy, because it is the software code and associated rights that are valuable rather than the inexpensive discs on which the code may be stored. Also, the MPAA argues that a customer’s ability to possess a copyrighted work indefinitely should not compel a finding of a first sale, because there is often no practically feasible way for a consumer to return a copy to the copyright owner.

Vernor, eBay, and the American Library Association (“ALA”) have presented policy arguments against our decision. Vernor contends that our decision (1) does not vindicate the law’s aversion to restraints on alienation of personal property; (2) may force everyone purchasing copyrighted property to trace the chain of title to ensure that a first sale occurred; and (3) ignores the economic realities of the relevant transactions, in which the copyright owner permanently released software copies into the stream of commerce without expectation of return in exchange for upfront payment of the full software price. eBay contends that a broad view of the first sale doctrine is necessary to facilitate the creation of secondary markets for copyrighted works, which contributes to the public good by (1) giving consumers additional opportunities to purchase and sell copyrighted works, often at below-retail prices; (2) allowing consumers to obtain copies of works after a copyright owner has ceased distribution; and (3) allowing the proliferation of businesses.

The ALA contends that the first sale doctrine facilitates the availability of copyrighted works after their commercial lifespan, by inter alia enabling the existence of libraries, used bookstores, and hand-to-hand exchanges of copyrighted materials. The ALA further contends that judicial enforcement of software license agreements, which are often contracts of adhesion, could eliminate the software resale market, require used computer sellers to delete legitimate software prior to sale, and increase prices for consumers by reducing price competition for software vendors. It contends that Autodesk’s position (1) undermines 17 U.S.C. § 109(b)(2), which permits non-profit libraries to lend software for non-commercial purposes, and (2) would hamper efforts by non-profits to collect and preserve out-of-print software. The ALA fears that the software industry’s licensing practices could be adopted by other copyright owners, including book publishers, record labels, and movie studios.

These are serious contentions on both sides, but they do not alter our conclusion that our precedent from Wise through the MAI trio requires the result we reach. Congress is free, of course, to modify the first sale doctrine and the essential step defense if it deems these or other policy considerations to require a different approach.

603 F.3d 1133 (9th Cir. 2010)

WILLIAM A. FLETCHER, CIRCUIT JUDGE

We are asked to decide whether the sale by Au-Tomotive Gold (“Auto Gold”) of marquee license plates bearing Volkswagen badges purchased from Volkswagen constitutes trademark infringement, or whether the sale of the plates is protected by the “first sale” doctrine. In Au-Tomotive Gold, Inc. v. Volkswagen of America, Inc. (“Auto Gold I”), 457 F.3d 1062 (9th Cir. 2006), we concluded that Auto Gold’s production and sale of automobile accessories bearing Volkswagen’s trademarks created a sufficient likelihood of confusion to constitute trademark infringement. We remanded to the district court to address Auto Gold’s “first sale” and other defenses. On remand, the district court granted summary judgment and a permanent injunction to Volkswagen.

We affirm. We hold that the “first sale” doctrine does not provide a defense because Auto Gold’s marquee license plates create a likelihood of confusion as to their origin.

Facts and Proceedings Below

Auto Gold produces and sells automobile accessories for specific makes of cars. Volkswagen and its subsidiary Audi are car manufacturers with well-known trademarks. The trademark at issue in this appeal is the familiar Volkswagen logo consisting of the letters “VW” inside a circle.

Beginning in the 1990s, Auto Gold produced and sold products bearing Volkswagen and Audi trademarks without permission from Volkswagen or Audi. It sold four products: license plates, license plate frames, key chains, and marquee license plates. The first three products used replicas of the companies’ trademarks. However, the marquee license plates used actual VW badges purchased on the open market from a Volkswagen dealer. Auto Gold asserts its “first sale” defense only as to the marquee plates.

The marquee license plates are plain silver or black plates on which Auto Gold has mounted the VW badges. These badges are sold by Volkswagen and are ordinarily used as replacements for the badges found on the hoods or trunks of Volkswagen vehicles. Auto Gold purchased the badges, altered them by removing prongs and (in some cases) gold-plating them, and mounted them on the marquee plates. The plates were packaged with labels that explained that the plates were not produced or sponsored by Volkswagen.

Both parties accept for purposes of this appeal that Volkswagen had knowledge of Auto Gold’s products as early as January 1999. In September 1999, a Volkswagen representative sent a letter to Auto Gold requesting that it cease using the trademarks. When Auto Gold refused to do so, a Volkswagen representative sent a second letter in October 1999. A Volkswagen representative sent a third letter in February 2001.

On April 19, 2001, Auto Gold filed suit seeking a declaratory judgment that its activities did not constitute an infringement or dilution of Volkswagen or Audi trademarks. Volkswagen and Audi counterclaimed, alleging federal trademark counterfeiting and infringement under § 32 of the Lanham Act, false designation, trademark dilution, and related state-law claims. Both parties moved for summary judgment.

The district court granted summary judgment to Auto Gold on all claims, holding that under the doctrine of “aesthetic functionality” the trademarks were “functional” and therefore not protected by trademark law. We reversed. We held that “the use of Volkswagen and Audi’s marks is neither aesthetic nor independent of source identification.” Rather, we held, consumers buy Auto Gold products because of the products’ identification with the companies’ brands. We then remanded to the district court for consideration of Auto Gold’s “first sale” and other related defenses.

The district court rejected Auto Gold’s “first sale” [defense] and granted Volkswagen summary judgment and a permanent injunction. Auto Gold timely appealed.

Discussion

Auto Gold argues that because it purchased actual VW badges from a Volkswagen dealer for use on the marquee license plates, the “first sale” doctrine protects the sale of the plates. We hold that the “first sale” doctrine does not provide a defense because the plates create a likelihood of confusion as to their origin. We do not base our holding on a likelihood of confusion among purchasers of the plates. Rather, we base it on the likelihood of post-purchase confusion among observers who see the plates on purchasers’ cars.

Background

The “first sale” doctrine was first introduced in an opinion by Justice Holmes in Prestonettes, Inc. v. Coty, 264 U.S. 359 (1924). Prestonettes purchased toilet powder and perfumes produced and trademarked by Coty. Prestonettes incorporated the Coty products into its own products by combining the powder with a binder to create a cream and by rebottling the perfumes into smaller bottles. The Supreme Court held that Prestonettes did not violate trademark law. “The defendant of course by virtue of its ownership had a right to compound or change what it bought, to divide either the original or the modified product, and to sell it so divided.”

The Court further held that Prestonettes could identify the components of its products as being Coty trademarked products so long as its labels were not misleading. For example, Prestonettes could place a label on the perfume bottles stating, “Prestonettes, Inc., not connected with Coty, states that the contents are Coty’s … independently rebottled in New York.” It rejected Coty’s argument that Prestonettes should not be allowed to use the Coty trademark in its description of the product because Prestonettes’s products might be inferior. It wrote, “If the compound was worse than the constituent, it might be a misfortune to [Coty], but [Coty] would have no cause of action, as [Prestonettes] was exercising the rights of ownership and only telling the truth. The existence of a trademark would have no bearing on the question.” The Court relied on the fact that consumers would not be confused about the manufacturer of the product. “A trade-mark only gives the right to prohibit the use of it so far as to protect the owner’s good will against the sale of another’s product as his.”

Application of the “first sale” doctrine has generally focused on the likelihood of confusion among consumers. In Sebastian Int’l, Inc. v. Longs Drug Stores Corp., 53 F.3d 1073, 1077 (9th Cir. 1995), we held that the “first sale” doctrine protected Longs when it purchased Sebastian hair products from a distributor and sold them in its own store despite Sebastian’s efforts to allow only “Sebastian Collective Members” to sell the products. We recognized the principle that “the right of a producer to control distribution of its trademarked product does not extend beyond the first sale of the product.” We emphasized that this rule “preserves an area of competition by limiting the producer’s power to control the resale of its product,” while ensuring that “the consumer gets exactly what the consumer bargains for, the genuine product of the particular producer.”

Figure 23.3 In Enesco v. Price/Costco, Costco repackaged porcelain angels manufactured by Enesco in allegedly inferior packaging.

We also applied the “first sale” doctrine in Enesco Corp. v. Price/Costco Inc., 146 F.3d 1083, 1084–85 (9th Cir. 1998), in which Costco purchased porcelain figurines manufactured by Enesco, repackaged them in allegedly inferior packaging, and sold them in its own stores. We held that Costco could repackage and sell the Enesco figurines, but that it was required to place labels on the packages that disclosed to the public that Costco had repackaged Enesco’s original product. We rejected Enesco’s argument that it would be harmed, even with this disclosure, because of the poor quality of the packaging. “The critical issue is whether the public is likely to be confused as a result of the lack of quality control.”

A separate line of cases further illustrates the central role of the likelihood of confusion, including post-purchase confusion, in trademark infringement claims. In this line of cases, we have held that producers committed trademark infringement by selling refurbished or altered goods under their original trademark. None of these cases directly addressed the “first sale” doctrine, but they establish that activities creating a likelihood of post-purchase confusion, even among non-purchasers, are not protected.

In Karl Storz Endoscopy-America, Inc. v. Surgical Tech., Inc. (“Surgi-Tech”), 285 F.3d 848, 852–53 (9th Cir. 2002), SurgiTech repaired Storz endoscopes at the request of hospitals that owned them. Surgi-Tech sometimes rebuilt the endoscopes, replacing every part and retaining only the block element bearing Storz’s trademarks. At an earlier time, Surgi-Tech had etched its own mark into rebuilt endoscopes to make clear what it had done, but Surgi-Tech had stopped that practice. Storz submitted evidence of confusion on the part of surgeons who were not the purchasers of the endoscopes but who used them and mistakenly blamed Storz when they malfunctioned. We held that there was a triable issue of fact on Storz’s trademark infringement claim, even though there was no claim of purchaser confusion. We relied entirely on the possibility of confusion among non-purchasers, noting that such confusion “may be no less injurious to the trademark owner’s reputation than confusion on the part of the purchaser at the time of sale.”

We also relied on the likelihood of non-purchaser confusion in Rolex Watch, U.S.A., Inc. v. Michel Co., 179 F.3d 704 (9th Cir. 1999). The defendant sold used Rolex watches that had been “reconditioned” or “customized” with non-Rolex parts. We agreed with the district court that “retention of the original Rolex marks on altered ‘Rolex’ watches … was deceptive and misleading as to the origin of the non-Rolex parts, and likely to cause confusion to subsequent or downstream purchasers, as well as to persons observing the product.”

In both Surgi-Tech and Rolex, we made clear that the defendants did not deceive the direct purchasers of the products. Rather, in both cases, we found trademark infringement based on a likelihood of confusion on the part of non-purchasers.

84 U.S. 453 (1873)

On the 26th day of May, 1863, letters-patent were granted to Merrill & Horner, for a certain improvement in coffin lids, giving to them the exclusive right of making, using, and vending to others to be used, the said improvement.

On the 13th day of March, 1865, Merrill & Horner, the patentees, by an assignment duly executed and recorded, assigned Lockhart & Seelye, of Cambridge, in Middlesex County, Massachusetts, all the right, title, and interest which the said patentees had in the invention described in the said letters-patent, for, to, and in a circle whose radius is ten miles, having the city of Boston as a centre. They subsequently assigned the patent, or what right they retained in it, to one Adams.

Adams now filed a bill in the court below, against a certain Burke, an undertaker, who used in the town of Natick (a town about seventeen miles from Boston, and therefore outside of the circle above mentioned) coffins with lids of the kind patented, alleging him to be an infringer of their patent, and praying for an injunction, discovery, profits, and other relief suitable against an infringer.

The Defendant Pleaded in Bar:

“That he carries on the business of an undertaker, having his place of business in Natick, in said district; that, in the exercise of his said business, he is employed to bury the dead; that when so employed it is his custom to procure hearses, coffins, and whatever else may be necessary or proper for burials, and to superintend the preparation of graves, and that his bills for his services in each case, and the coffin, hearse, and other articles procured by him, are paid by the personal representatives of the deceased; that, since the date of the alleged assignment to the plaintiff of an interest in the invention secured by the said letters-patent, he has sold no coffins, unless the use of coffins by him in his said business, as above described, shall be deemed a sale; has used no coffins, except in his said business as aforesaid; and has manufactured no coffins containing the said invention; and that since the said he has used in his business as aforesaid, in Natick, no coffin containing the invention secured by said letters-patent, except such coffins containing said invention as have been manufactured by said Lockhart & Seelye, within a circle, whose radius is ten miles, having the city of Boston as its centre, and sold within said circle by said Lockhart & Seelye, without condition or restriction.”

Mr. Justice MILLER delivered the opinion of the court.

The question presented by the plea in this case is a very interesting one in patent law, and the precise point in it has never been decided by this court, though cases involving some of the consideration which apply to it have been decided, and others of analogous character are frequently recurring. The vast pecuniary results involved in such cases, as well as the public interest, admonish us to proceed with care, and to decide in each case no more than what is directly in issue.

We have repeatedly held that where a person had purchased a patented machine of the patentee or his assignee, this purchase carried with it the right to the use of that machine so long as it was capable of use, and that the expiration and renewal of the patent, whether in favor of the original patentee or of his assignee, did not affect this right. The true ground on which these decisions rest is that the sale by a person who has the full right to make, sell, and use such a machine carries with it the right to the use of that machine to the full extent to which it can be used in point of time.

The right to manufacture, the right to sell, and the right to use are each substantive rights, and may be granted or conferred separately by the patentee. But, in the essential nature of things, when the patentee, or the person having his rights, sells a machine or instrument whose sole value is in its use, he receives the consideration for its use and he parts with the right to restrict that use. The article, in the language of the court, passes without the limit of the monopoly. That is to say, the patentee or his assignee having in the act of sale received all the royalty or consideration which he claims for the use of his invention in that particular machine or instrument, it is open to the use of the purchaser without further restriction on account of the monopoly of the patentees.

If this principle be sound as to a machine or instrument whose use may be continued for a number of years, and may extend beyond the existence of the patent, as limited at the time of the sale, and into the period of a renewal or extension, it must be much more applicable to an instrument or product of patented manufacture which perishes in the first use of it, or which, by that first use, becomes incapable of further use, and of no further value. Such is the case with the coffin-lids of appellant’s patent.

It seems to us that, although the right of Lockhart & Seelye to manufacture, to sell, and to use these coffin-lids was limited to the circle of ten miles around Boston, that a purchaser from them of a single coffin acquired the right to use that coffin for the purpose for which all coffins are used. That so far as the use of it was concerned, the patentee had received his consideration, and it was no longer within the monopoly of the patent. It would be to engraft a limitation upon the right of use not contemplated by the statute nor within the reason of the contract to say that it could only be used within the ten-miles circle. Whatever, therefore, may be the rule when patentees subdivide territorially their patents, as to the exclusive right to make or to sell within a limited territory, we hold that in the class of machines or implements we have described, when they are once lawfully made and sold, there is no restriction on their use to be implied for benefit of the patentee or his assignees or licensees.

A careful examination of the plea satisfies us that the defendant, who, as an undertaker, purchased each of these coffins and used it in burying the body which he was employed to bury, acquired the right to this use of it freed from any claim of the patentee, though purchased within the ten-mile circle and used without it.

The decree of the Circuit Court dismissing the plaintiff’s bill is, therefore,

AFFIRMED.

137 S. Ct. 1523 (2017)

ROBERTS, CHIEF JUSTICE

The underlying dispute in this case is about laser printers—or, more specifically, the cartridges that contain the powdery substance, known as toner, that laser printers use to make an image appear on paper. Respondent Lexmark International, Inc. designs, manufactures, and sells toner cartridges to consumers in the United States and around the globe. It owns a number of patents that cover components of those cartridges and the manner in which they are used. When toner cartridges run out of toner they can be refilled and used again. This creates an opportunity for other companies—known as remanufacturers—to acquire empty Lexmark cartridges from purchasers in the United States and abroad, refill them with toner, and then resell them at a lower price than the new ones Lexmark puts on the shelves. Not blind to this business problem, Lexmark structures its sales in a way that encourages customers to return spent cartridges. It gives purchasers two options: One is to buy a toner cartridge at full price, with no strings attached. The other is to buy a cartridge at roughly 20 percent off through Lexmark’s “Return Program.” A customer who buys through the Return Program still owns the cartridge but, in exchange for the lower price, signs a contract agreeing to use it only once and to refrain from transferring the empty cartridge to anyone but Lexmark. To enforce this single-use/no-resale restriction, Lexmark installs a microchip on each Return Program cartridge that prevents reuse once the toner in the cartridge runs out.

Lexmark’s strategy just spurred remanufacturers to get more creative. Many kept acquiring empty Return Program cartridges and developed methods to counteract the effect of the microchips. With that technological obstacle out of the way, there was little to prevent the re-manufacturers from using the Return Program cartridges in their resale business. After all, Lexmark’s contractual single-use/no-resale agreements were with the initial customers, not with downstream purchasers like the remanufacturers.

Lexmark, however, was not so ready to concede that its plan had been foiled. In 2010, it sued a number of remanufacturers, including petitioner Impression Products, Inc., for patent infringement with respect to two groups of cartridges. One group consists of Return Program cartridges that Lexmark sold within the United States. Lexmark argued that, because it expressly prohibited reuse and resale of these cartridges, the remanufacturers infringed the Lexmark patents when they refurbished and resold them. The other group consists of all toner cartridges that Lexmark sold abroad and that remanufacturers imported into the country. Lexmark claimed that it never gave anyone authority to import these cartridges, so the remanufacturers ran afoul of its patent rights by doing just that.

Eventually, the lawsuit was whittled down to one defendant, Impression Products, and one defense: that Lexmark’s sales, both in the United States and abroad, exhausted its patent rights in the cartridges, so Impression Products was free to refurbish and resell them, and to import them if acquired abroad. Impression Products filed separate motions to dismiss with respect to both groups of cartridges. The District Court granted the motion as to the domestic Return Program cartridges, but denied the motion as to the cartridges Lexmark sold abroad. Both parties appealed.

The Federal Circuit considered the appeals en banc and ruled for Lexmark with respect to both groups of cartridges. The court began with the Return Program cartridges that Lexmark sold in the United States. Relying on its decision in Mallinckrodt, Inc. v. Medipart, Inc., 976 F. 2d 700 (1992), the Federal Circuit held that a patentee may sell an item and retain the right to enforce, through patent infringement lawsuits, “clearly communicated … lawful restriction[s] as to post-sale use or resale.” The exhaustion doctrine, the court reasoned, derives from the prohibition on making, using, selling, or importing items “without authority.” When you purchase an item you presumptively also acquire the authority to use or resell the item freely, but that is just a presumption; the same authority does not run with the item when the seller restricts post-sale use or resale. Because the parties agreed that Impression Products knew about Lexmark’s restrictions and that those restrictions did not violate any laws, the Federal Circuit concluded that Lexmark’s sales had not exhausted all of its patent rights, and that the company could sue for infringement when Impression Products refurbished and resold Return Program cartridges.

Judge Dyk, joined by Judge Hughes, dissented. In their view, selling the Return Program cartridges in the United States exhausted Lexmark’s patent rights in those items because any “authorized sale of a patented article … free[s] the article from any restrictions on use or sale based on the patent laws.”

[The Court’s discussion of international exhaustion is contained in Section 23.6]

We granted certiorari to consider the Federal Circuit’s decisions … and now reverse.

A

First up are the Return Program cartridges that Lexmark sold in the United States. We conclude that Lexmark exhausted its patent rights in these cartridges the moment it sold them. The single-use/no-resale restrictions in Lexmark’s contracts with customers may have been clear and enforceable under contract law, but they do not entitle Lexmark to retain patent rights in an item that it has elected to sell.

The Patent Act grants patentees the “right to exclude others from making, using, offering for sale, or selling [their] invention[s].” 35 U. S. C. §154(a). For over 160 years, the doctrine of patent exhaustion has imposed a limit on that right to exclude. The limit functions automatically: When a patentee chooses to sell an item, that product “is no longer within the limits of the monopoly” and instead becomes the “private, individual property” of the purchaser, with the rights and benefits that come along with ownership. A patentee is free to set the price and negotiate contracts with purchasers, but may not, “by virtue of his patent, control the use or disposition” of the product after ownership passes to the purchaser. United States v. Univis Lens Co., 316 U. S. 241, 250 (1942). The sale “terminates all patent rights to that item.” Quanta Computer, Inc. v. LG Electronics, Inc., 553 U. S. 617, 625 (2008).

This well-established exhaustion rule marks the point where patent rights yield to the common law principle against restraints on alienation. The Patent Act “promote[s] the progress of science and the useful arts by granting to [inventors] a limited monopoly” that allows them to “secure the financial rewards” for their inventions. But once a patentee sells an item, it has “enjoyed all the rights secured” by that limited monopoly. Keeler v. Standard Folding Bed Co., 157 U. S. 659, 661 (1895). Because “the purpose of the patent law is fulfilled … when the patentee has received his reward for the use of his invention,” that law furnishes “no basis for restraining the use and enjoyment of the thing sold.” Univis, 316 U. S., at 251.

This venerable principle is not, as the Federal Circuit dismissively viewed it, merely “one common-law jurisdiction’s general judicial policy at one time toward anti-alienation restrictions.” Congress enacted and has repeatedly revised the Patent Act against the backdrop of the hostility toward restraints on alienation. That enmity is reflected in the exhaustion doctrine. The patent laws do not include the right to “restrain[] … further alienation” after an initial sale; such conditions have been “hateful to the law from Lord Coke’s day to ours” and are “obnoxious to the public interest.” Straus v. Victor Talking Machine Co., 243 U. S. 490, 501 (1917). “The inconvenience and annoyance to the public that an opposite conclusion would occasion are too obvious to require illustration.” Keeler, 157 U. S., at 667.

But an illustration never hurts. Take a shop that restores and sells used cars. The business works because the shop can rest assured that, so long as those bringing in the cars own them, the shop is free to repair and resell those vehicles. That smooth flow of commerce would sputter if companies that make the thousands of parts that go into a vehicle could keep their patent rights after the first sale. Those companies might, for instance, restrict resale rights and sue the shop owner for patent infringement. And even if they refrained from imposing such restrictions, the very threat of patent liability would force the shop to invest in efforts to protect itself from hidden lawsuits. Either way, extending the patent rights beyond the first sale would clog the channels of commerce, with little benefit from the extra control that the patentees retain. And advances in technology, along with increasingly complex supply chains, magnify the problem.

This Court accordingly has long held that, even when a patentee sells an item under an express restriction, the patentee does not retain patent rights in that product. In Boston Store of Chicago v. American Graphophone Co., for example, a manufacturer sold graphophones—one of the earliest devices for recording and reproducing sounds—to retailers under contracts requiring those stores to resell at a specific price. When the manufacturer brought a patent infringement suit against a retailer who sold for less, we concluded that there was “no room for controversy” about the result: By selling the item, the manufacturer placed it “beyond the confines of the patent law, [and] could not, by qualifying restrictions as to use, keep [it] under the patent monopoly.”

Two decades later, we confronted a similar arrangement in Univis. There, a company that made eyeglass lenses authorized an agent to sell its products to wholesalers and retailers only if they promised to market the lenses at fixed prices. The Government filed an antitrust lawsuit, and the company defended its arrangement on the ground that it was exercising authority under the Patent Act. We held that the initial sales “relinquish[ed] … the patent monopoly with respect to the article[s] sold,” so the “stipulation … fixing resale prices derive[d] no support from the patent and must stand on the same footing” as restrictions on unpatented goods.

It is true that Boston Store and Univis involved resale price restrictions that, at the time of those decisions, violated the antitrust laws. But in both cases it was the sale of the items, rather than the illegality of the restrictions, that prevented the patentees from enforcing those resale price agreements through patent infringement suits. And if there were any lingering doubt that patent exhaustion applies even when a sale is subject to an express, otherwise lawful restriction, our recent decision in Quanta settled the matter. In that case, a technology company—with authorization from the patentee—sold microprocessors under contracts requiring purchasers to use those processors with other parts that the company manufactured. One buyer disregarded the restriction, and the patentee sued for infringement. Without so much as mentioning the lawfulness of the contract, we held that the patentee could not bring an infringement suit because the “authorized sale … took its products outside the scope of the patent monopoly.”

Turning to the case at hand, we conclude that this well-settled line of precedent allows for only one answer: Lexmark cannot bring a patent infringement suit against Impression Products to enforce the single-use/no-resale provision accompanying its Return Program cartridges. Once sold, the Return Program cartridges passed outside of the patent monopoly, and whatever rights Lexmark retained are a matter of the contracts with its purchasers, not the patent law.

314 U.S. 488 (1942)

STONE, CHIEF JUSTICE

Respondent brought this suit in the district court for an injunction and an accounting for infringement of its Patent No. 2,060,645, of November 10, 1936, on a machine for depositing salt tablets, a device said to be useful in the canning industry for adding predetermined amounts of salt in tablet form to the contents of the cans.

Upon petitioner’s motion … the trial court, without passing on the issues of validity and infringement, granted summary judgment dismissing the complaint. It took the ground that respondent was making use of the patent to restrain the sale of salt tablets in competition with its own sale of unpatented tablets, by requiring licensees to use with the patented machines only tablets sold by respondent. The Court of Appeals for the Seventh Circuit reversed because it thought that respondent’s use of the patent was not shown to violate § 3 of the Clayton Act, as it did not appear that the use of its patent substantially lessened competition or tended to create a monopoly in salt tablets.Footnote ⁴ We granted certiorari because of the public importance of the question presented and of an alleged conflict of the decision below with [prior cases].

The Clayton Act authorizes those injured by violations tending to monopoly to maintain suit for treble damages and for an injunction in appropriate cases. But the present suit is for infringement of a patent. The question we must decide is not necessarily whether respondent has violated the Clayton Act, but whether a court of equity will lend its aid to protect the patent monopoly when respondent is using it as the effective means of restraining competition with its sale of an unpatented article.

Both respondent’s wholly owned subsidiary and the petitioner manufacture and sell salt tablets used and useful in the canning trade. The tablets have a particular configuration rendering them capable of convenient use in respondent’s patented machines. Petitioner makes and leases to canners unpatented salt deposition machines, charged to infringe respondent’s patent. For reasons we indicate later, nothing turns on the fact that petitioner also competes with respondent in the sale of the tablets, and we may assume for purposes of this case that petitioner is doing no more than making and leasing the alleged infringing machines. The principal business of respondent’s subsidiary, from which its profits are derived, is the sale of salt tablets. In connection with this business, and as an adjunct to it, respondent leases its patented machines to commercial canners, some two hundred in all, under licenses to use the machines upon condition and with the agreement of the licensees that only the subsidiary’s salt tablets be used with the leased machines.

It thus appears that respondent is making use of its patent monopoly to restrain competition in the marketing of unpatented articles, salt tablets, for use with the patented machines, and is aiding in the creation of a limited monopoly in the tablets not within that granted by the patent. A patent operates to create and grant to the patentee an exclusive right to make, use and vend the particular device described and claimed in the patent. But a patent affords no immunity for a monopoly not within the grant and the use of it to suppress competition in the sale of an unpatented article may deprive the patentee of the aid of a court of equity to restrain an alleged infringement by one who is a competitor. It is the established rule that a patentee who has granted a license on condition that the patented invention be used by the licensee only with unpatented materials furnished by the licensor, may not restrain as a contributory infringer one who sells to the licensee like materials for like use.

The grant to the inventor of the special privilege of a patent monopoly carries out a public policy adopted by the Constitution and laws of the United States, “to promote the Progress of Science and useful Arts, by securing for limited Times to … Inventors the exclusive Right” to their “new and useful” inventions. But the public policy which includes inventions within the granted monopoly excludes from it all that is not embraced in the invention. It equally forbids the use of the patent to secure an exclusive right or limited monopoly not granted by the Patent Office and which it is contrary to public policy to grant.

It is a principle of general application that courts, and especially courts of equity, may appropriately withhold their aid where the plaintiff is using the right asserted contrary to the public interest. Respondent argues that this doctrine is limited in its application to those cases where the patentee seeks to restrain contributory infringement by the sale to licensees of competing unpatented articles, while here respondent seeks to restrain petitioner from a direct infringement, the manufacture and sale of the salt tablet depositor. It is said that the equitable maxim that a party seeking the aid of a court of equity must come into court with clean hands applies only to the plaintiff’s wrongful conduct in the particular act or transaction which raises the equity, enforcement of which is sought; that where, as here, the patentee seeks to restrain the manufacture or use of the patented device, his conduct in using the patent to restrict competition in the sale of salt tablets does not foreclose him from seeking relief limited to an injunction against the manufacture and sale of the infringing machine alone.

Undoubtedly equity does not demand that its suitors shall have led blameless lives; but additional considerations must be taken into account where maintenance of the suit concerns the public interest as well as the private interests of suitors. Where the patent is used as a means of restraining competition with the patentee’s sale of an unpatented product, the successful prosecution of an infringement suit even against one who is not a competitor in such sale is a powerful aid to the maintenance of the attempted monopoly of the unpatented article, and is thus a contributing factor in thwarting the public policy underlying the grant of the patent. Maintenance and enlargement of the attempted monopoly of the unpatented article are dependent to some extent upon persuading the public of the validity of the patent, which the infringement suit is intended to establish. Equity may rightly withhold its assistance from such a use of the patent by declining to entertain a suit for infringement, and should do so at least until it is made to appear that the improper practice has been abandoned and that the consequences of the misuse of the patent have been dissipated.

The reasons for barring the prosecution of such a suit against one who is not a competitor with the patentee in the sale of the unpatented product are fundamentally the same as those which preclude an infringement suit against a licensee who has violated a condition of the license by using with the licensed machine a competing unpatented article, or against a vendee of a patented or copyrighted article for violation of a condition for the maintenance of resale prices. It is the adverse effect upon the public interest of a successful infringement suit in conjunction with the patentee’s course of conduct which disqualifies him to maintain the suit, regardless of whether the particular defendant has suffered from the misuse of the patent. Similarly equity will deny relief for infringement of a trademark where the plaintiff is misrepresenting to the public the nature of his product either by the trademark itself or by his label. The patentee, like these other holders of an exclusive privilege granted in the furtherance of a public policy, may not claim protection of his grant by the courts where it is being used to subvert that policy.

It is unnecessary to decide whether respondent has violated the Clayton Act, for we conclude that in any event the maintenance of the present suit to restrain petitioner’s manufacture or sale of the alleged infringing machines is contrary to public policy and that the district court rightly dismissed the complaint for want of equity.

REVERSED.

Figure 24.1 G.S. Suppiger Co. leased its patented salt-depositing machines to canneries with a contractual requirement that they purchase unpatented salt tablets exclusively from Suppiger. When Suppiger sued Morton Salt for selling an allegedly infringing salt-depositing machine, Morton accused Suppiger of misusing its machine patents to corner the market for salt tablets.

339 U.S. 827 (1950)

MINTON, JUSTICE

This is a suit by respondent Hazeltine Research, Inc., as assignee of the licensor’s interest in a nonexclusive patent license agreement covering a group of 570 patents and 200 applications, against petitioner Automatic Radio Manufacturing Company, Inc., the licensee, to recover royalties. The patents and applications are related to the manufacture of radio broadcasting apparatus. Respondent and its corporate affiliate and predecessor have for some twenty years been engaged in research, development, engineering design and testing and consulting services in the radio field. Respondent derives income from the licensing of its patents, its policy being to license any and all responsible manufacturers of radio apparatus at a royalty rate which for many years has been approximately one percent. Petitioner manufactures radio apparatus, particularly radio broadcasting receivers.

The license agreement in issue, which appears to be a standard Hazeltine license, was entered into by the parties in September 1942, for a term of ten years. By its terms petitioner acquired permission to use, in the manufacture of its “home” products, any or all of the patents which respondent held or to which it might acquire rights. Petitioner was not, however, obligated to use respondent’s patents in the manufacture of its products. For this license, petitioner agreed to pay respondent’s assignor royalties based upon a small percentage of petitioner’s selling price of complete radio broadcasting receivers, and in any event a minimum of $ 10,000 per year.

This suit was brought to recover the minimum royalty due for the year ending August 31, 1946, for an accounting of other sums due, and for other relief. The District Court … sustained the motion of respondent for judgment. The validity of the license agreement was upheld against various charges of misuse of the patents, and judgment was entered for the recovery of royalties and an accounting, and for a permanent injunction restraining petitioner from failing to pay royalties, to keep records, and to render reports during the life of the agreement. The Court of Appeals affirmed, and we granted certiorari in order to consider important questions concerning patent misuse and estoppel to challenge the validity of licensed patents.

The questions for determination are whether a misuse of patents has been shown, and whether petitioner may contest the validity of the licensed patents, in order to avoid its obligation to pay royalties under the agreement.

It is insisted that the license agreement cannot be enforced because it is a misuse of patents to require the licensee to pay royalties based on its sales, even though none of the patents are used. Petitioner directs our attention to the “Tie-in” cases. These cases have condemned schemes requiring the purchase of unpatented goods for use with patented apparatus or processes, prohibiting production or sale of competing goods, and conditioning the granting of a license under one patent upon the acceptance of another and different license. Petitioner apparently concedes that these cases do not, on their facts, control the instant situation. It is obvious that they do not. There is present here no requirement for the purchase of any goods. Hazeltine does not even manufacture or sell goods; it is engaged solely in research activities. Nor is there any prohibition as to the licensee’s manufacture or sale of any type of apparatus. The fact that the license agreement covers only “home” apparatus does not mean that the licensee is prohibited from manufacturing or selling other apparatus. And finally, there is no conditioning of the license grant upon the acceptance of another and different license.

But petitioner urges that this case “is identical in principle” with the “Tie-in” cases. It is contended that the licensing provision requiring royalty payments of a percentage of the sales of the licensee’s products constitutes a misuse of patents because it ties in a payment on unpatented goods. That which is condemned as against public policy by the “Tie-in” cases is the extension of the monopoly of the patent to create another monopoly or restraint of competition – a restraint not countenanced by the patent grant. See, e. g., Mercoid Corp. v. Mid-Continent Investment Co., 320 U.S. 661, Morton Salt Co. v. Suppiger Co., 314 U.S. 488. The principle of those cases cannot be contorted to circumscribe the instant situation. This royalty provision does not create another monopoly; it creates no restraint of competition beyond the legitimate grant of the patent. The right to a patent includes the right to market the use of the patent at a reasonable return.

The licensing agreement in issue was characterized by the District Court as essentially a grant by Hazeltine to petitioner of a privilege to use any patent or future development of Hazeltine in consideration of the payment of royalties. Payment for the privilege is required regardless of use of the patents. The royalty provision of the licensing agreement was sustained by the District Court and the Court of Appeals on the theory that it was a convenient mode of operation designed by the parties to avoid the necessity of determining whether each type of petitioner’s product embodies any of the numerous Hazeltine patents. The Court of Appeals reasoned that since it would not be unlawful to agree to pay a fixed sum for the privilege to use patents, it was not unlawful to provide a variable consideration measured by a percentage of the licensee’s sales for the same privilege.

The mere accumulation of patents, no matter how many, is not in and of itself illegal. And this record simply does not support incendiary, yet vague, charges that respondent uses its accumulation of patents “for the exaction of tribute” and collects royalties “by means of the overpowering threat of disastrous litigation.” We cannot say that payment of royalties according to an agreed percentage of the licensee’s sales is unreasonable. Sound business judgment could indicate that such payment represents the most convenient method of fixing the business value of the privileges granted by the licensing agreement. We are not unmindful that convenience cannot justify an extension of the monopoly of the patent. But as we have already indicated, there is in this royalty provision no inherent extension of the monopoly of the patent. Petitioner cannot complain because it must pay royalties whether it uses Hazeltine patents or not. What it acquired by the agreement into which it entered was the privilege to use any or all of the patents and developments as it desired to use them. If it chooses to use none of them, it has nevertheless contracted to pay for the privilege of using existing patents plus any developments resulting from respondent’s continuous research. We hold that in licensing the use of patents to one engaged in a related enterprise, it is not per se a misuse of patents to measure the consideration by a percentage of the licensee’s sales.

The judgment of the Court of Appeals is Affirmed.

MR. JUSTICE DOUGLAS, with whom MR. JUSTICE BLACK concurs, dissenting.

We are, I think, inclined to forget that the power of Congress to grant patents is circumscribed by the Constitution. The patent power, of all legislative powers, is indeed the only one whose purpose is defined. Article I, § 8 describes the power as one “To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.” This statement of policy limits the power itself.

The Court in its long history has at times been more alive to that policy than at other times. During the last three decades it has been as devoted to it (if not more so) than at any time in its history. I think that was due in large measure to the influence of Mr. Justice Brandeis and Chief Justice Stone. They were alert to the danger that business – growing bigger and bigger each decade – would fasten its hold more tightly on the economy through the cheap spawning of patents and would use one monopoly to beget another through the leverage of key patents. They followed in the early tradition of those who read the Constitution to mean that the public interest in patents comes first, reward to the inventor second.

Mr. Justice Brandeis and Chief Justice Stone did not fashion but they made more secure one important rule designed to curb the use of patents. It is as follows: One who holds a patent on article A may not license the use of the patent on condition that B, an unpatented article, be bought. Such a contract or agreement would be an extension of the grant of the patent contrary to a long line of decisions. For it would sweep under the patent an article that is unpatented or unpatentable. Each patent owner would become his own patent office and, by reason of the leverage of the patent, obtain a larger monopoly of the market than the Constitution or statutes permit.

That is what is done here. Hazeltine licensed Automatic Radio to use 570 patents and 200 patent applications. Of these Automatic used at most 10. Automatic Radio was obligated, however, to pay as royalty a percentage of its total sales in certain lines without regard to whether or not the products sold were patented or unpatented. The inevitable result is that the patentee received royalties on unpatented products as part of the price for the use of the patents.

The patent owner has therefore used the patents to bludgeon his way into a partnership with this licensee, collecting royalties on unpatented as well as patented articles.

A plainer extension of a patent by unlawful means would be hard to imagine.

395 U.S. 100 (1969)

WHITE, JUSTICE

Petitioner Zenith Radio Corporation (Zenith) is a Delaware Corporation which for many years has been successfully engaged in the business of manufacturing radio and television sets for sale in the United States and foreign countries. A necessary incident of Zenith’s operations has been the acquisition of licenses to use patented devices in the radios and televisions it manufactures, and its transactions have included licensing agreements with respondent Hazeltine Research, Inc. (HRI), an Illinois corporation which owns and licenses domestic patents, principally in the radio and television fields.

Until 1959, Zenith had obtained the right to use all HRI domestic patents under HRI’s so-called standard package license. In that year, however, with the expiration of Zenith’s license imminent, Zenith declined to accept HRI’s offer to renew, asserting that it no longer required a license from HRI. Negotiations proceeded to a stalemate, and in November 1959, HRI brought suit in the Northern District of Illinois, claiming that Zenith television sets infringed HRI’s patents on a particular automatic control system. Zenith’s answer alleged invalidity of the patent asserted and noninfringement, and further alleged that HRI’s claim was unenforceable because of patent misuse as well as unclean hands through conspiracy with foreign patent pools. On May 22, 1963, more than three years after its answer had been filed, Zenith filed a counterclaim against HRI for treble damages and injunctive relief, alleging violations of the Sherman Act by misuse of HRI patents, including the one in suit …

The District Court, sitting without a jury, ruled for Zenith in the infringement action … On the counterclaim, the District Court ruled, first that HRI had misused its domestic patents by attempting to coerce Zenith’s acceptance of a five-year package license, and by insisting on extracting royalties from unpatented products.

With respect to Zenith’s patent misuse claim, the Court of Appeals affirmed the treble-damage award against HRI, but modified in certain respects the District Court’s injunction against further misuse.

We granted certiorari.

[The] only misuse issue we need consider at length is whether the Court of Appeals was correct in striking the last clause from Paragraph A of the injunction, which enjoined HRI from

This paragraph of the injunction was directed at HRI’s policy of insisting upon acceptance of its standard five-year package license agreement, covering the 500-odd patents within its domestic licensing portfolio and reserving royalties of the licensee’s total radio and television sales, irrespective of whether the licensed patents were actually used in the products manufactured.

In striking the last clause of Paragraph A the Court of Appeals, in effect, made two determinations. First, under its view of Automatic Radio Mfg. Co. v. Hazeltine Research, Inc., 339 U.S. 827 (1950), conditioning the grant of a patent license upon payment of royalties on unpatented products was not misuse of the patent. [W]e reverse the Court of Appeals. We hold that conditioning the grant of a patent license upon payment of royalties on products which do not use the teaching of the patent does amount to patent misuse.

The trial court’s injunction does not purport to prevent the parties from serving their mutual convenience by basing royalties on the sale of all radios and television sets, irrespective of the use of HRI’s inventions. The injunction reaches only situations where the patentee directly or indirectly “conditions” his license upon the payment of royalties on unpatented products – that is, where the patentee refuses to license on any other basis and leaves the licensee with the choice between a license so providing and no license at all. Also, the injunction takes effect only if the license is conditioned upon the payment of royalties “on” merchandise not covered by the patent – where the express provisions of the license or their necessary effect is to employ the patent monopoly to collect royalties, not for the use of the licensed invention, but for using, making, or selling an article not within the reach of the patent.

A patentee has the exclusive right to manufacture, use, and sell his invention. The heart of his legal monopoly is the right to invoke the State’s power to prevent others from utilizing his discovery without his consent. The law also recognizes that he may assign to another his patent, in whole or in part, and may license others to practice his invention. But there are established limits which the patentee must not exceed in employing the leverage of his patent to control or limit the operations of the licensee. Among other restrictions upon him, he may not condition the right to use his patent on the licensee’s agreement to purchase, use, or sell, or not to purchase, use, or sell, another article of commerce not within the scope of his patent monopoly. His right to set the price for a license does not extend so far, whatever privilege he has “to exact royalties as high as he can negotiate.” And just as the patent’s leverage may not be used to extract from the licensee a commitment to purchase, use, or sell other products according to the desires of the patentee, neither can that leverage be used to garner as royalties a percentage share of the licensee’s receipts from sales of other products; in either case, the patentee seeks to extend the monopoly of his patent to derive a benefit not attributable to use of the patent’s teachings.

In Brulotte v. Thys Co., the patentee licensed the use of a patented machine, the license providing for the payment of a royalty for using the invention after, as well as before, the expiration date of the patent. Recognizing that the patentee could lawfully charge a royalty for practicing a patented invention prior to its expiration date and that the payment of this royalty could be postponed beyond that time, we noted that the post-expiration royalties were not for prior use but for current use, and were nothing less than an effort by the patentee to extend the term of his monopoly beyond that granted by law. Brulotte thus articulated in a particularized context the principle that a patentee may not use the power of his patent to levy a charge for making, using, or selling products not within the reach of the monopoly granted by the Government.

Automatic Radio is not to the contrary; it is not authority for the proposition that patentees have carte blanche authority to condition the grant of patent licenses upon the payment of royalties on unpatented articles.

The Court’s opinion in Automatic Radio did not deal with the license negotiations which spawned the royalty formula at issue and did not indicate that HRI used its patent leverage to coerce a promise to pay royalties on radios not practicing the learning of the patent. No such inference follows from a mere license provision measuring royalties by the licensee’s total sales even if, as things work out, only some or none of the merchandise employs the patented idea or process, or even if it was foreseeable that some undetermined portion would not contain the invention. It could easily be, as the Court indicated in Automatic Radio, that the licensee as well as the patentee would find it more convenient and efficient from several standpoints to base royalties on total sales than to face the burden of figuring royalties based on actual use. If convenience of the parties rather than patent power dictates the total-sales royalty provision, there is no misuse of the patents and no forbidden conditions attached to the license.

The Court also said in Automatic Radio that if the licensee bargains for the privilege of using the patent in all of his products and agrees to a lump sum or a percentage-of-total-sales royalty, he cannot escape payment on this basis by demonstrating that he is no longer using the invention disclosed by the patent. We neither disagree nor think such transactions are barred by the trial court’s injunction. If the licensee negotiates for “the privilege to use any or all of the patents and developments as [he] desire[s] to use them,” he cannot complain that he must pay royalties if he chooses to use none of them. He could not then charge that the patentee had refused to license except on the basis of a total-sales royalty.

But we do not read Automatic Radio to authorize the patentee to use the power of his patent to insist on a total-sales royalty and to override protestations of the licensee that some of his products are unsuited to the patent or that for some lines of his merchandise he has no need or desire to purchase the privileges of the patent. In such event, not only would royalties be collected on unpatented merchandise, but the obligation to pay for nonuse would clearly have its source in the leverage of the patent.

We also think patent misuse inheres in a patentee’s insistence on a percentage-of-sales royalty, regardless of use, and his rejection of licensee proposals to pay only for actual use. Unquestionably, a licensee must pay if he uses the patent. Equally, however, he may insist upon paying only for use, and not on the basis of total sales, including products in which he may use a competing patent or in which no patented ideas are used at all. There is nothing in the right granted the patentee to keep others from using, selling, or manufacturing his invention which empowers him to insist on payment not only for use but also for producing products which do not employ his discoveries at all.

Of course, a licensee cannot expect to obtain a license, giving him the privilege of use and insurance against infringement suits, without at least footing the patentee’s expenses in dealing with him. He cannot insist upon paying on use alone and perhaps, as things turn out, pay absolutely nothing because he finds he can produce without using the patent. If the risks of infringement are real and he would avoid them, he must anticipate some minimum charge for the license – enough to insure the patentee against loss in negotiating and administering his monopoly, even if in fact the patent is not used at all. But we discern no basis in the statutory monopoly granted the patentee for his using that monopoly to coerce an agreement to pay a percentage royalty on merchandise not employing the discovery which the claims of the patent define.

Judgment of Court of Appeals affirmed in part and reversed in part, and case remanded.

MR. JUSTICE HARLAN, dissenting in part.

I do not join Part III [of the Court’s opinion], in which the Court holds that a patent license provision which measures royalties by a percentage of the licensee’s total sales is lawful if included for the “convenience” of both parties but unlawful if “insisted upon” by the patentee.

My first difficulty with this part of the opinion is that its test for validity of such royalty provisions is likely to prove exceedingly difficult to apply and consequently is apt to engender uncertainty in this area of business dealing, where certainty in the law is particularly desirable. In practice, it often will be very hard to tell whether a license provision was included at the instance of both parties or only at the will of the licensor. District courts will have the unenviable task of deciding whether the course of negotiations establishes “insistence” upon the suspect provision. Because of the uncertainty inherent in such determinations, parties to existing and future licenses will have little assurance that their agreements will be enforced. And it may be predicted that after today’s decision the licensor will be careful to embellish the negotiations with an alternative proposal, making the court’s unraveling of the situation that much more difficult.

Such considerations lead me to the view that any rule which causes the validity of percentage-of-sales royalty provisions to depend upon subsequent judicial examination of the parties’ negotiations will disserve rather than further the interests of all concerned. Hence, I think that the Court has fallen short in failing to address itself to the question whether employment of such royalty provisions should invariably amount to patent misuse.

[A] possible justification for the Court’s result might be that a royalty based directly upon use of the patent will tend to spur the licensee to “invent around” the patent or otherwise acquire a substitute which costs less, while a percentage-of-sales royalty can have no such effect because of the licensee’s knowledge that he must pay the royalty regardless of actual patent use. No hint of such a rationale appears in the Court’s opinion. Moreover, under this theory a percentage-of-sales royalty would be objectionable largely because of resulting damage to the rest of the economy, through less efficient allocation of resources, rather than because of possible harm to the licensee. Hence, the theory might not admit of the Court’s exception for provisions included for the “convenience” of both parties.

Because of its failure to explain the reasons for the result reached … the Court’s opinion is of little assistance in answering the question which I consider to be the crux of this part of the case: whether percentage-of-sales royalty provisions should be held without exception to constitute patent misuse. A recent economic analysis argues that such provisions may have two undesirable consequences. First, as has already been noted, employment of such provisions may tend to reduce the licensee’s incentive to substitute other, cheaper “inputs” for the patented item in producing an unpatented end-product. Failure of the licensee to substitute will, it is said, cause the price of the end-product to be higher and its output lower than would be the case if substitution had occurred. Second, it is suggested that under certain conditions a percentage-of-sales royalty arrangement may enable the patentee to garner for himself elements of profit, above the norm for the industry or economy, which are properly attributable not to the licensee’s use of the patent but to other factors which cause the licensee’s situation to differ from one of “perfect competition,” and that this cannot occur when royalties are based upon use.

If accepted, this economic analysis would indicate that percentage-of-sales royalties should be entirely outlawed. However, so far as I have been able to find, there has as yet been little discussion of these matters either by lawyers or by economists. And I find scant illumination on this score in the briefs and arguments of the parties in this case. The Court has pointed out both today and in Automatic Radio that percentage-of-sales royalties may be administratively advantageous for both patentee and licensee. In these circumstances, confronted, as I believe we are, with the choice of holding such royalty provisions either valid or invalid across the board, I would, as an individual member of the Court, adhere for the present to the rule of Automatic Radio.

Figure 24.5 Decided nearly two decades apart, Automatic Radio and Zenith both involved licenses by Hazeltine, an early electronics patent aggregator and licensing entity.

911 F.2d 970 (4th Cir. 1990)

SPROUSE, CIRCUIT JUDGE

Appellants and defendants below are Larry Holliday, president and sole shareholder of Holiday Steel Rule Die Corporation (Holiday Steel), and Job Reynolds, a computer programmer for that company. Appellee is Lasercomb America, Inc. (Lasercomb), the plaintiff below. Holiday Steel and Lasercomb were competitors in the manufacture of steel rule dies that are used to cut and score paper and cardboard for folding into boxes and cartons. Lasercomb developed a software program, Interact, which is the object of the dispute between the parties. Using this program, a designer creates a template of a cardboard cutout on a computer screen and the software directs the mechanized creation of the conforming steel rule die.

In 1983, before Lasercomb was ready to market its Interact program generally, it licensed four prerelease copies to Holiday Steel which paid $35,000 for the first copy, $17,500 each for the next two copies, and $2,000 for the fourth copy. Lasercomb informed Holiday Steel that it would charge $2,000 for each additional copy Holiday Steel cared to purchase. Apparently ambitious to create for itself an even better deal, Holiday Steel circumvented the protective devices Lasercomb had provided with the software and made three unauthorized copies of Interact which it used on its computer systems. Perhaps buoyed by its success in copying, Holiday Steel then created a software program called “PDS-1000,” which was almost entirely a direct copy of Interact, and marketed it as its own CAD/CAM die-making software. These infringing activities were accomplished by Job Reynolds at the direction of Larry Holliday.

There is no question that defendants engaged in unauthorized copying, and the purposefulness of their unlawful action is manifest from their deceptive practices … When Lasercomb discovered Holiday Steel’s activities, it registered its copyright in Interact and filed this action against Holiday Steel, Holliday, and Reynolds on March 7, 1986. Lasercomb claimed copyright infringement, breach of contract, misappropriation of trade secret, false designation of origin, unfair competition, and fraud. Defendants filed a number of counterclaims. On March 24, 1986, the district court entered a preliminary injunction, enjoining defendants from marketing the PDS-1000 software.

Holliday and Reynolds [do] not dispute that they copied Interact, but they contend that Lasercomb is barred from recovery for infringement by its concomitant culpability. They assert that, assuming Lasercomb had a perfected copyright, it impermissibly abused it. This assertion of the “misuse of copyright” defense is based on language in Lasercomb’s standard licensing agreement, restricting licensees from creating any of their own CAD/CAM die-making software.

The offending paragraphs read:

1. D. Licensee agrees during the term of this Agreement that it will not permit or suffer its directors, officers and employees, directly or indirectly, to write, develop, produce or sell computer assisted die making software.

2. E. Licensee agrees during the term of this Agreement and for one (1) year after the termination of this Agreement, that it will not write, develop, produce or sell or assist others in the writing, developing, producing or selling computer assisted die making software, directly or indirectly without Lasercomb’s prior written consent. Any such activity undertaken without Lasercomb’s written consent shall nullify any warranties or agreements of Lasercomb set forth herein.

The “term of this Agreement” referred to in these clauses is ninety-nine years.

Defendants were not themselves bound by the standard licensing agreement. Lasercomb had sent the agreement to Holiday Steel with a request that it be signed and returned. Larry Holliday, however, decided not to sign the document, and Lasercomb apparently overlooked the fact that the document had not been returned. Although defendants were not party to the restrictions of which they complain, they proved at trial that at least one Interact licensee had entered into the standard agreement, including the anticompetitive language.

The district court rejected the copyright misuse defense for three reasons. First, it noted that defendants had not explicitly agreed to the contract clauses alleged to constitute copyright misuse. Second, it found “such a clause is reasonable in light of the delicate and sensitive area of computer software.” And, third, it questioned whether such a defense exists. We consider the district court’s reasoning in reverse order.

The philosophy behind copyright … is that the public benefits from the efforts of authors to introduce new ideas and knowledge into the public domain. To encourage such efforts, society grants authors exclusive rights in their works for a limited time.

Although the patent misuse defense has been generally recognized since Morton Salt, it has been much less certain whether an analogous copyright misuse defense exists. This uncertainty persists because no United States Supreme Court decision has firmly established a copyright misuse defense in a manner analogous to the establishment of the patent misuse defense by Morton Salt. The few courts considering the issue have split on whether the defense should be recognized, and we have discovered only one case which has actually applied copyright misuse to bar an action for infringement.

We are of the view, however, that since copyright and patent law serve parallel public interests, a “misuse” defense should apply to infringement actions brought to vindicate either right.

[And] while it is true that the attempted use of a copyright to violate antitrust law probably would give rise to a misuse of copyright defense, the converse is not necessarily true – a misuse need not be a violation of antitrust law in order to comprise an equitable defense to an infringement action. The question is not whether the copyright is being used in a manner violative of antitrust law (such as whether the licensing agreement is “reasonable”), but whether the copyright is being used in a manner violative of the public policy embodied in the grant of a copyright.

Lasercomb undoubtedly has the right to protect against copying of the Interact code. Its standard licensing agreement, however, goes much further and essentially attempts to suppress any attempt by the licensee to independently implement the idea which Interact expresses. The agreement forbids the licensee to develop or assist in developing any kind of computer-assisted die-making software. If the licensee is a business, it is to prevent all its directors, officers and employees from assisting in any manner to develop computer-assisted die-making software. Although one or another licensee might succeed in negotiating out the noncompete provisions, this does not negate the fact that Lasercomb is attempting to use its copyright in a manner adverse to the public policy embodied in copyright law, and that it has succeeded in doing so with at least one licensee.

The language employed in the Lasercomb agreement is extremely broad. Each time Lasercomb sells its Interact program to a company and obtains that company’s agreement to the noncompete language, the company is required to forego utilization of the creative abilities of all its officers, directors and employees in the area of CAD/CAM die-making software. Of yet greater concern, these creative abilities are withdrawn from the public. The period for which this anticompetitive restraint exists is ninety-nine years, which could be longer than the life of the copyright itself.

Figure 24.6 Lasercomb’s software related to the computer-aided design of steel rule dies for cutting cardboard.

We previously have considered the effect of anticompetitive language in a licensing agreement in the context of patent misuse. Compton v. Metal Products, Inc., 453 F.2d 38 (4th Cir.1971), cert. denied, 406 U.S. 968 (1972). Compton had invented and patented coal auguring equipment. He granted an exclusive license in the patents to Joy Manufacturing, and the license agreement included a provision that Compton would not “engage in any business or activity relating to the manufacture or sale of equipment of the type licensed hereunder” for as long as he was due royalties under the patents. Suit for infringement of the Compton patents was brought against Metal Products, and the district court granted injunctive relief and damages. On appeal we held that relief for the infringement was barred by the misuse defense, stating:

We think the anticompetitive language in Lasercomb’s licensing agreement is at least as egregious as that which led us to bar the infringement action in Compton, and therefore amounts to misuse of its copyright. Again, the analysis necessary to a finding of misuse is similar to but separate from the analysis necessary to a finding of antitrust violation. The misuse arises from Lasercomb’s attempt to use its copyright in a particular expression, the Interact software, to control competition in an area outside the copyright, i.e., the idea of computer-assisted die manufacture, regardless of whether such conduct amounts to an antitrust violation.

In its rejection of the copyright misuse defense, the district court emphasized that Holiday Steel was not explicitly party to a licensing agreement containing the offending language. However, again analogizing to patent misuse, the defense of copyright misuse is available even if the defendants themselves have not been injured by the misuse. In Morton Salt, the defendant was not a party to the license requirement that only Morton-produced salt tablets be used with Morton’s salt-depositing machine. Nevertheless, suit against defendant for infringement of Morton’s patent was barred on public policy grounds. Similarly, in Compton, even though the defendant Metal Products was not a party to the license agreement that restrained competition by Compton, suit against Metal Products was barred because of the public interest in free competition.

Therefore, the fact that appellants here were not parties to one of Lasercomb’s standard license agreements is inapposite to their copyright misuse defense. The question is whether Lasercomb is using its copyright in a manner contrary to public policy, which question we have answered in the affirmative.

US Department of Justice, October 18, 2006

WASHINGTON – A federal grand jury in San Francisco today returned an indictment against two executives from Samsung Electronics Ltd. (Samsung) and one executive from Hynix Semiconductor America Inc. (Hynix America) for their participation in a global conspiracy to fix DRAM prices, the Department of Justice announced.

Including today’s charge, four companies and 16 individuals have been charged and fines totaling more than $731 million have resulted from the Department’s ongoing antitrust investigation into the DRAM industry. The $731 million in criminal fines is the second highest total obtained by the Department of Justice in a criminal antitrust investigation into a specific industry.

The indictment, filed today in the U.S. District Court in San Francisco, charged that Il Ung Kim, Young Bae Rha, and Gary Swanson participated with co-conspirators in the conspiracy from on or about April 1, 2001, until on or about June 15, 2002. At the time of the conspiracy, Kim was vice president of marketing for the memory division at Samsung. Rha was vice president of sales and marketing for the memory division at Samsung. Both Kim and Rha are citizens and residents of Korea. At the time of the conspiracy, Swanson was senior vice president of memory sales and marketing for Hynix America, the U.S.-based subsidiary of Hynix Semiconductor Inc. (Hynix), which is headquartered in Korea. Swanson is a resident and citizen of the United States.

DRAM is the most commonly used semiconductor memory product, providing high-speed storage and retrieval of electronic information for a wide variety of computer, telecommunication and consumer electronic products. DRAM is used in personal computers, laptops, workstations, servers, printers, hard disk drives, personal digital assistants (PDAs), modems, mobile phones, telecommunication hubs and routers, digital cameras, video recorders and TVs, digital set-top boxes, game consoles and digital music players. There were approximately $7.7 billion in DRAM sales in the United States alone in 2004.

The indictment charges that Kim, Rha, Swanson, and their co-conspirators carried out the conspiracy in a variety of ways, including:

• Attending meetings and participating in telephone conversations in the U.S. and elsewhere to discuss the prices of DRAM to be sold to certain original equipment manufacturers (OEMs);

• Agreeing during those meetings and telephone conversations to charge prices of DRAM at certain levels to be sold to certain OEMs;

• Exchanging information on sales of DRAM to certain OEM customers, for the purpose of monitoring and enforcing adherence to the agreed-upon prices;

• Agreeing during those meetings and telephone conversations to raise and maintain prices of DRAM to be sold to certain OEMs;

• Agreeing during those meetings and telephone discussions to rig the online auction, sponsored by Compaq Computer Corporation on Nov. 29, 2001, by not submitting a bid in the auction, or by submitting intentionally high prices on the bids in the auction …

The Samsung employees agreed to serve prison terms ranging from seven to eight months and to each pay a $250,000 fine. In total, four companies have been charged with price-fixing in the DRAM investigation. Samsung pleaded guilty to the price fixing conspiracy and was sentenced to pay a $300 million criminal fine in November 2005. Hynix, the world’s second largest DRAM manufacturer, pleaded guilty and was sentenced to pay a $185 million criminal fine in May 2005. Japanese manufacturer Elpida Memory pleaded guilty and was sentenced to pay an $84 million fine in March 2006. German manufacturer Infineon pleaded guilty and was sentenced to pay a $160 million criminal fine in October 2004.

405 U.S. 596 (1972)

MARSHALL, JUSTICE

The United States brought this action for injunctive relief against alleged violation by Topco Associates, Inc. (Topco), of § 1 of the Sherman Act. Following a trial on the merits, the United States District Court for the Northern District of Illinois entered judgment for Topco, and we now reverse the judgment of the District Court.

Topco is a cooperative association of approximately 25 small and medium-sized regional supermarket chains that operate stores in some 33 States. Each of the member chains operates independently; there is no pooling of earnings, profits, capital, management, or advertising resources. No grocery business is conducted under the Topco name. Its basic function is to serve as a purchasing agent for its members.Footnote ¹³ In this capacity, it procures and distributes to the members more than 1,000 different food and related nonfood items, most of which are distributed under brand names owned by Topco. The association does not itself own any manufacturing, processing, or warehousing facilities, and the items that it procures for members are usually shipped directly from the packer or manufacturer to the members. Payment is made either to Topco or directly to the manufacturer at a cost that is virtually the same for the members as for Topco itself.

All of the stock in Topco is owned by the members, with the common stock, the only stock having voting rights, being equally distributed. The board of directors, which controls the operation of the association, is drawn from the members and is normally composed of high-ranking executive officers of member chains. It is the board that elects the association’s officers and appoints committee members, and it is from the board that the principal executive officers of Topco must be drawn. Restrictions on the alienation of stock and the procedure for selecting all important officials of the association from within the ranks of its members give the members complete and unfettered control over the operations of the association.

Topco was founded in the 1940’s by a group of small, local grocery chains, independently owned and operated, that desired to cooperate to obtain high quality merchandise under private labels in order to compete more effectively with larger national and regional chains.Footnote ¹⁴ With a line of canned, dairy, and other products, the association began. It added frozen foods in 1950, fresh produce in 1958, more general merchandise equipment and supplies in 1960, and a branded bacon and carcass beef selection program in 1966. By 1964, Topco’s members had combined retail sales of more than $2 billion; by 1967, their sales totaled more than $2.3 billion, a figure exceeded by only three national grocery chains.

Members of the association vary in the degree of market share that they possess in their respective areas. The range is from 1.5% to 16%, with the average being approximately 6%. While it is difficult to compare these figures with the market shares of larger regional and national chains because of the absence in the record of accurate statistics for these chains, there is much evidence in the record that Topco members are frequently in as strong a competitive position in their respective areas as any other chain. The strength of this competitive position is due, in some measure, to the success of Topco-brand products. Although only 10% of the total goods sold by Topco members bear the association’s brand names, the profit on these goods is substantial and their very existence has improved the competitive potential of Topco members with respect to other large and powerful chains.

It is apparent that from meager beginnings approximately a quarter of a century ago, Topco has developed into a purchasing association wholly owned and operated by member chains, which possess much economic muscle, individually as well as cooperatively.

II The United States charged that, beginning at least as early as 1960 and continuing up to the time that the complaint was filed, Topco had combined and conspired with its members to violate [§ 1 of the Sherman Act] in two respects. First, the Government alleged that there existed:

The division of marketing territories to which the complaint refers consists of a number of practices by the association. Article IX, § 2, of the Topco bylaws establishes three categories of territorial licenses that members may secure from the association:

1. (a) “Exclusive—An exclusive territory is one in which the member is licensed to sell all products bearing specified trademarks of the Association, to the exclusion of all other persons.

2. (b) “Non-exclusive—A non-exclusive territory is one in which a member is licensed to sell all products bearing specified trademarks of the Association, but not to the exclusion of others who may also be licensed to sell products bearing the same trademarks of the Association in the same territory.

3. (c) “Coextensive—A coextensive territory is one in which two (2) or more members are licensed to sell all products bearing specified trademarks of the Association to the exclusion of all other persons …”

When applying for membership, a chain must designate the type of license that it desires. Membership must first be approved by the board of directors, and thereafter by an affirmative vote of 75% of the association’s members. If, however, the member whose operations are closest to those of the applicant, or any member whose operations are located within 100 miles of the applicant, votes against approval, an affirmative vote of 85% of the members is required for approval. Because, as indicated by the record, members cooperate in accommodating each other’s wishes, the procedure for approval provides, in essence, that members have a veto of sorts over actual or potential competition in the territorial areas in which they are concerned.

Following approval, each new member signs an agreement with Topco designating the territory in which that member may sell Topco-brand products. No member may sell these products outside the territory in which it is licensed. Most licenses are exclusive, and even those denominated “coextensive” or “non-exclusive” prove to be de facto exclusive. Exclusive territorial areas are often allocated to members who do no actual business in those areas on the theory that they may wish to expand at some indefinite future time and that expansion would likely be in the direction of the allocated territory. When combined with each member’s veto power over new members, provisions for exclusivity work effectively to insulate members from competition in Topco-brand goods. Should a member violate its license agreement and sell in areas other than those in which it is licensed, its membership can be terminated under the bylaws. Once a territory is classified as exclusive, either formally or de facto, it is extremely unlikely that the classification will ever be changed.

Figure 25.3 Some of the brands developed by Topco.

The Government maintains that this scheme of dividing markets violates the Sherman Act because it operates to prohibit competition in Topco-brand products among grocery chains engaged in retail operations. The Government also makes a subsidiary challenge to Topco’s practices regarding licensing members to sell at wholesale. Under the bylaws, members are not permitted to sell any products supplied by the association at wholesale, whether trademarked or not, without first applying for and receiving special permission from the association to do so. Before permission is granted, other licensees (usually retailers), whose interests may potentially be affected by wholesale operations, are consulted as to their wishes in the matter. If permission is obtained, the member must agree to restrict the sale of Topco products to a specific geographic area and to sell under any conditions imposed by the association. Permission to wholesale has often been sought by members, only to be denied by the association. The Government contends that this amounts not only to a territorial restriction violative of the Sherman Act, but also to a restriction on customers that in itself is violative of the Act.

Topco’s answer to the complaint is illustrative of its posture in the District Court and before this Court:

Topco essentially maintains that it needs territorial divisions to compete with larger chains; that the association could not exist if the territorial divisions were anything but exclusive; and that by restricting competition in the sale of Topco-brand goods, the association actually increases competition by enabling its members to compete successfully with larger regional and national chains.

On its face, § 1 of the Sherman Act appears to bar any combination of entrepreneurs so long as it is “in restraint of trade.” Theoretically, all manufacturers, distributors, merchants, sellers, and buyers could be considered as potential competitors of each other. Were § 1 to be read in the narrowest possible way, any commercial contract could be deemed to violate it. The history underlying the formulation of the antitrust laws led this Court to conclude, however, that Congress did not intend to prohibit all contracts, nor even all contracts that might in some insignificant degree or attenuated sense restrain trade or competition. In lieu of the narrowest possible reading of § 1, the Court adopted a “rule of reason” analysis for determining whether most business combinations or contracts violate the prohibitions of the Sherman Act. An analysis of the reasonableness of particular restraints includes consideration of the facts peculiar to the business in which the restraint is applied, the nature of the restraint and its effects, and the history of the restraint and the reasons for its adoption.

While the Court has utilized the “rule of reason” in evaluating the legality of most restraints alleged to be violative of the Sherman Act, it has also developed the doctrine that certain business relationships are per se violations of the Act without regard to a consideration of their reasonableness. In Northern Pacific R. Co. v. United States, 356 U.S. 1, 5 (1958), Mr. Justice Black explained the appropriateness of, and the need for, per se rules:

It is only after considerable experience with certain business relationships that courts classify them as per se violations of the Sherman Act. One of the classic examples of a per se violation of § 1 is an agreement between competitors at the same level of the market structure to allocate territories in order to minimize competition. Such concerted action is usually termed a “horizontal” restraint, in contradistinction to combinations of persons at different levels of the market structure, e.g., manufacturers and distributors, which are termed “vertical” restraints. This Court has reiterated time and time again that “(h)orizontal territorial limitations … are naked restraints of trade with no purpose except stifling of competition.”

We think that it is clear that the restraint in this case is a horizontal one, and, therefore, a per se violation of § 1. The District Court failed to make any determination as to whether there were per se horizontal territorial restraints in this case and simply applied a rule of reason in reaching its conclusions that the restraints were not illegal. In so doing, the District Court erred.

United States v. Sealy, Inc., is, in fact, on all fours with this case. Sealy licensed manufacturers of mattresses and bedding to make and sell products using the Sealy trademark. Like Topco, Sealy was a corporation owned almost entirely by its licensees, who elected the Board of Directors and controlled the business. Just as in this case, Sealy agreed with the licensees not to license other manufacturers or sellers to sell Sealy-brand products in a designated territory in exchange for the promise of the licensee who sold in that territory not to expand its sales beyond the area demarcated by Sealy. The Court held that this was a horizontal territorial restraint, which was per se violative of the Sherman Act.

Whether or not we would decide this case the same way under the rule of reason used by the District Court is irrelevant to the issue before us. The fact is that courts are of limited utility in examining difficult economic problems. Our inability to weigh, in any meaningful sense, destruction of competition in one sector of the economy against promotion of competition in another sector is one important reason we have formulated per se rules.

In applying these rigid rules, the Court has consistently rejected the notion that naked restraints of trade are to be tolerated because they are well intended or because they are allegedly developed to increase competition.

Antitrust laws in general, and the Sherman Act in particular, are the Magna Carta of free enterprise. They are as important to the preservation of economic freedom and our free-enterprise system as the Bill of Rights is to the protection of our fundamental personal freedoms. And the freedom guaranteed each and every business, no matter how small, is the freedom to compete—to assert with vigor, imagination, devotion, and ingenuity whatever economic muscle it can muster. Implicit in such freedom is the notion that it cannot be foreclosed with respect to one sector of the economy because certain private citizens or groups believe that such foreclosure might promote greater competition in a more important sector of the economy.

The District Court determined that by limiting the freedom of its individual members to compete with each other, Topco was doing a greater good by fostering competition between members and other large supermarket chains. But, the fallacy in this is that Topco has no authority under the Sherman Act to determine the respective values of competition in various sectors of the economy. On the contrary, the Sherman Act gives to each Topco member and to each prospective member the right to ascertain for itself whether or not competition with other supermarket chains is more desirable than competition in the sale of Topco-brand products. Without territorial restrictions, Topco members may indeed “(cut) each other’s throats.” But we have never found this possibility sufficient to warrant condoning horizontal restraints of trade.

The Court has previously noted with respect to price fixing, another per se violation of the Sherman Act, that:

A similar observation can be made with regard to territorial limitations.

There have been tremendous departures from the notion of a free-enterprise system as it was originally conceived in this country. These departures have been the product of congressional action and the will of the people. If a decision is to be made to sacrifice competition in one portion of the economy for greater competition in another portion this too is a decision that must be made by Congress and not by private forces or by the courts. Private forces are too keenly aware of their own interests in making such decisions and courts are ill-equipped and ill-situated for such decisionmaking. To analyze, interpret, and evaluate the myriad of competing interests and the endless data that would surely be brought to bear on such decisions, and to make the delicate judgment on the relative values to society of competitive areas of the economy, the judgment of the elected representatives of the people is required.

Just as the territorial restrictions on retailing Topco-brand products must fall, so must the territorial restrictions on wholesaling. The considerations are the same, and the Sherman Act requires identical results.

We also strike down Topco’s other restrictions on the right of its members to wholesale goods. These restrictions amount to regulation of the customers to whom members of Topco may sell Topco-brand goods. Like territorial restrictions, limitations on customers are intended to limit intra-brand competition and to promote inter-brand competition. For the reasons previously discussed, the arena in which Topco members compete must be left to their unfettered choice absent a contrary congressional determination.

We reverse the judgment of the District Court and remand the case for entry of an appropriate decree.

551 U.S. 877 (2007)

KENNEDY, JUSTICE

In Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U. S. 373 (1911), the Court established the rule that it is per se illegal under §1 of the Sherman Act, 15 U. S. C. §1, for a manufacturer to agree with its distributor to set the minimum price the distributor can charge for the manufacturer’s goods. The question presented by the instant case is whether the Court should overrule the per se rule and allow resale price maintenance agreements to be judged by the rule of reason, the usual standard applied to determine if there is a violation of §1. The Court has abandoned the rule of per se illegality for other vertical restraints a manufacturer imposes on its distributors. Respected economic analysts, furthermore, conclude that vertical price restraints can have procompetitive effects. We now hold that Dr. Miles should be overruled and that vertical price restraints are to be judged by the rule of reason.

Petitioner, Leegin Creative Leather Products, Inc. (Leegin), designs, manufactures, and distributes leather goods and accessories. In 1991, Leegin began to sell belts under the brand name “Brighton.” The Brighton brand has now expanded into a variety of women’s fashion accessories. It is sold across the United States in over 5,000 retail establishments, for the most part independent, small boutiques and specialty stores. Leegin’s president, Jerry Kohl, also has an interest in about 70 stores that sell Brighton products. Leegin asserts that, at least for its products, small retailers treat customers better, provide customers more services, and make their shopping experience more satisfactory than do larger, often impersonal retailers. Kohl explained: “[W]e want the consumers to get a different experience than they get in Sam’s Club or in Wal-Mart. And you can’t get that kind of experience or support or customer service from a store like Wal-Mart.”

Respondent, PSKS, Inc. (PSKS), operates Kay’s Kloset, a women’s apparel store in Lewisville, Texas. Kay’s Kloset buys from about 75 different manufacturers and at one time sold the Brighton brand. It first started purchasing Brighton goods from Leegin in 1995. Once it began selling the brand, the store promoted Brighton. For example, it ran Brighton advertisements and had Brighton days in the store. Kay’s Kloset became the destination retailer in the area to buy Brighton products. Brighton was the store’s most important brand and once accounted for 40 to 50 percent of its profits.

Figure 25.4 Brighton handbag and belt by Leegin.

In 1997, Leegin instituted the “Brighton Retail Pricing and Promotion Policy.” Following the policy, Leegin refused to sell to retailers that discounted Brighton goods below suggested prices. The policy contained an exception for products not selling well that the retailer did not plan on reordering. In the letter to retailers establishing the policy, Leegin stated:

Leegin adopted the policy to give its retailers sufficient margins to provide customers the service central to its distribution strategy. It also expressed concern that discounting harmed Brighton’s brand image and reputation.

A year after instituting the pricing policy Leegin introduced a marketing strategy known as the “Heart Store Program.” It offered retailers incentives to become Heart Stores, and, in exchange, retailers pledged, among other things, to sell at Leegin’s suggested prices. Kay’s Kloset became a Heart Store soon after Leegin created the program. After a Leegin employee visited the store and found it unattractive, the parties appear to have agreed that Kay’s Kloset would not be a Heart Store beyond 1998. Despite losing this status, Kay’s Kloset continued to increase its Brighton sales.

In December 2002, Leegin discovered Kay’s Kloset had been marking down Brighton’s entire line by 20 percent. Kay’s Kloset contended it placed Brighton products on sale to compete with nearby retailers who also were undercutting Leegin’s suggested prices. Leegin, nonetheless, requested that Kay’s Kloset cease discounting. Its request refused, Leegin stopped selling to the store. The loss of the Brighton brand had a considerable negative impact on the store’s revenue from sales.

PSKS sued Leegin in the United States District Court for the Eastern District of Texas. It alleged, among other claims, that Leegin had violated the antitrust laws by “enter[ing] into agreements with retailers to charge only those prices fixed by Leegin.” Leegin planned to introduce expert testimony describing the procompetitive effects of its pricing policy. The District Court excluded the testimony, relying on the per se rule established by Dr. Miles. At trial PSKS argued that the Heart Store program, among other things, demonstrated Leegin and its retailers had agreed to fix prices. Leegin responded that it had established a unilateral pricing policy lawful under §1, which applies only to concerted action. The jury agreed with PSKS and awarded it $1.2 million. Pursuant to 15 U. S. C. §15(a), the District Court trebled the damages and reimbursed PSKS for its attorney’s fees and costs. It entered judgment against Leegin in the amount of $3,975,000.80.

The Court of Appeals for the Fifth Circuit affirmed. On appeal Leegin did not dispute that it had entered into vertical price-fixing agreements with its retailers. Rather, it contended that the rule of reason should have applied to those agreements. The Court of Appeals rejected this argument. We granted certiorari to determine whether vertical minimum resale price maintenance agreements should continue to be treated as per se unlawful.

The rule of reason is the accepted standard for testing whether a practice restrains trade in violation of §1. In its design and function the rule distinguishes between restraints with anticompetitive effect that are harmful to the consumer and restraints stimulating competition that are in the consumer’s best interest.

The rule of reason does not govern all restraints. Some types “are deemed unlawful per se.” The per se rule, treating categories of restraints as necessarily illegal, eliminates the need to study the reasonableness of an individual restraint in light of the real market forces at work; and, it must be acknowledged, the per se rule can give clear guidance for certain conduct. Restraints that are per se unlawful include horizontal agreements among competitors to fix prices or to divide markets.

Resort to per se rules is confined to restraints, like those mentioned, “that would always or almost always tend to restrict competition and decrease output.” To justify a per se prohibition a restraint must have “manifestly anticompetitive” effects and “lack of any redeeming virtue.”

As a consequence, the per se rule is appropriate only after courts have had considerable experience with the type of restraint at issue, and only if courts can predict with confidence that it would be invalidated in all or almost all instances under the rule of reason. It should come as no surprise, then, that “we have expressed reluctance to adopt per se rules with regard to restraints imposed in the context of business relationships where the economic impact of certain practices is not immediately obvious.” And, as we have stated, a “departure from the rule-of-reason standard must be based upon demonstrable economic effect rather than … upon formalistic line drawing.”

The Court has interpreted Dr. Miles as establishing a per se rule against a vertical agreement between a manufacturer and its distributor to set minimum resale prices. In Dr. Miles the plaintiff, a manufacturer of medicines, sold its products only to distributors who agreed to resell them at set prices. The Court found the manufacturer’s control of resale prices to be unlawful. It relied on the common-law rule that “a general restraint upon alienation is ordinarily invalid.” The Court then explained that the agreements would advantage the distributors, not the manufacturer, and were analogous to a combination among competing distributors, which the law treated as void.

The reasoning of the Court’s more recent jurisprudence has rejected the rationales on which Dr. Miles was based. By relying on the common-law rule against restraints on alienation, the Court justified its decision based on “formalistic” legal doctrine rather than “demonstrable economic effect”. Yet the Sherman Act’s use of “restraint of trade” “invokes the common law itself, and not merely the static content that the common law had assigned to the term in 1890.” The general restraint on alienation, especially in the age when then-Justice Hughes used the term, tended to evoke policy concerns extraneous to the question that controls here. Usually associated with land, not chattels, the rule arose from restrictions removing real property from the stream of commerce for generations. The Court should be cautious about putting dispositive weight on doctrines from antiquity but of slight relevance.

Dr. Miles, furthermore, treated vertical agreements a manufacturer makes with its distributors as analogous to a horizontal combination among competing distributors. In later cases, however, the Court rejected the approach of reliance on rules governing horizontal restraints when defining rules applicable to vertical ones. Our recent cases formulate antitrust principles in accordance with the appreciated differences in economic effect between vertical and horizontal agreements, differences the Dr. Miles Court failed to consider.

The reasons upon which Dr. Miles relied do not justify a per se rule. As a consequence, it is necessary to examine, in the first instance, the economic effects of vertical agreements to fix minimum resale prices, and to determine whether the per se rule is nonetheless appropriate.

448 F.2d 43 (9th Cir. 1971)

MERRILL, CIRCUIT JUDGE

This antitrust suit is a class action in which certain franchisees of Chicken Delight seek treble damages for injuries allegedly resulting from illegal restraints imposed by Chicken Delight’s standard form franchise agreements. The restraints in question are Chicken Delight’s contractual requirements that franchisees purchase certain essential cooking equipment, dry-mix food items, and trademark bearing packaging exclusively from Chicken Delight as a condition of obtaining a Chicken Delight trademark license. These requirements are asserted to constitute a tying arrangement, unlawful per se under Sec. 1 of the Sherman Act.

After five weeks of trial to a jury in the District Court, plaintiffs moved for a directed verdict, requesting the court to rule upon four propositions of law: (1) That the contractual requirements constituted a tying arrangement as a matter of law; (2) that the alleged tying products – the Chicken Delight name, symbols, and system of operation – possessed sufficient economic power to condemn the tying arrangement as a matter of law; (3) that the tying arrangement had not, as a matter of law, been justified; and (4) that, as a matter of law, plaintiffs as a class had been injured by the arrangement.

The court ruled in favor of plaintiffs on all issues except part of the justification defense, which it submitted to the jury. On the questions submitted to it, the jury rendered special verdicts in favor of plaintiffs. Chicken Delight has taken this interlocutory appeal from the trial court rulings and verdicts.

Factual Background

Over its eighteen years existence, Chicken Delight has licensed several hundred franchisees to operate home delivery and pick-up food stores. It charged its franchisees no franchise fees or royalties. Instead, in exchange for the license granting the franchisees the right to assume its identity and adopt its business methods and to prepare and market certain food products under its trademark, Chicken Delight required its franchisees to purchase a specified number of cookers and fryers and to purchase certain packaging supplies and mixes exclusively from Chicken Delight. The prices fixed for these purchases were higher than, and included a percentage markup which exceeded that of, comparable products sold by competing suppliers.

The Existence of an Unlawful Tying Arrangement

In order to establish that there exists an unlawful tying arrangement plaintiffs must demonstrate First, that the scheme in question involves two distinct items and provides that one (the tying product) may not be obtained unless the other (the tied product) is also purchased. Times-Picayune Publishing Co. v. United States, 345 U.S. 594, 613–614 (1953). Second, that the tying product possesses sufficient economic power appreciably to restrain competition in the tied product market. Northern Pacific R. Co. v. United States, 356 U.S. 1, 6 (1958). Third, that a “not insubstantial” amount of commerce is affected by the arrangement. International Salt Co. v. United States, 332 U.S. 392 (1947). Chicken Delight concedes that the third requirement has been satisfied. It disputes the existence of the first two. Further it asserts that, even if plaintiffs should prevail with respect to the first two requirements, there is a fourth issue: whether there exists a special justification for the particular tying arrangement in question.

547 U.S. 28 (2006)

STEVENS, JUSTICE

In Jefferson Parish Hospital Dist. No. 2 v. Hyde, 466 U. S. 2 (1984), we repeated the well-settled proposition that “if the Government has granted the seller a patent or similar monopoly over a product, it is fair to presume that the inability to buy the product elsewhere gives the seller market power.” This presumption of market power, applicable in the antitrust context when a seller conditions its sale of a patented product (the “tying” product) on the purchase of a second product (the “tied” product), has its foundation in the judicially created patent misuse doctrine. In 1988, Congress substantially undermined that foundation, amending the Patent Act to eliminate the market power presumption in patent misuse cases. 35 U. S. C. §271(d). The question presented to us today is whether the presumption of market power in a patented product should survive as a matter of antitrust law despite its demise in patent law. We conclude that the mere fact that a tying product is patented does not support such a presumption.

Petitioners, Trident, Inc., and its parent, Illinois Tool Works Inc., manufacture and market printing systems that include three relevant components: (1) a patented piezoelectric impulse ink jet printhead; (2) a patented ink container, consisting of a bottle and valved cap, which attaches to the printhead; and (3) specially designed, but unpatented, ink. Petitioners sell their systems to original equipment manufacturers (OEMs) who are licensed to incorporate the printheads and containers into printers that are in turn sold to companies for use in printing barcodes on cartons and packaging materials. The OEMs agree that they will purchase their ink exclusively from petitioners, and that neither they nor their customers will refill the patented containers with ink of any kind.

Respondent, Independent Ink, Inc., has developed an ink with the same chemical composition as the ink sold by petitioners. After an infringement action brought by Trident against Independent was dismissed for lack of personal jurisdiction, Independent … alleged that petitioners are engaged in illegal tying and monopolization in violation of §§1 and 2 of the Sherman Act.

After discovery, the District Court granted petitioners’ motion for summary judgment on the Sherman Act claims. It rejected respondent’s submission that petitioners “necessarily have market power in the market for the tying product as a matter of law solely by virtue of the patent on their printhead system, thereby rendering [the] tying arrangements per se violations of the antitrust laws.” Finding that respondent had submitted no affirmative evidence defining the relevant market or establishing petitioners’ power within it, the court concluded that respondent could not prevail on either antitrust claim.

After a careful review of the “long history of Supreme Court consideration of the legality of tying arrangements,” the Court of Appeals for the Federal Circuit reversed the District Court’s decision as to respondent’s §1 claim. We granted certiorari to undertake a fresh examination of the history of both the judicial and legislative appraisals of tying arrangements. Our review is informed by extensive scholarly comment and a change in position by the administrative agencies charged with enforcement of the antitrust laws.

American courts first encountered tying arrangements in the course of patent infringement litigation. Such a case came before this Court in Henry v. A. B. Dick Co., 224 U. S. 1 (1912), in which, as in the case we decide today, unpatented ink was the product that was “tied” to the use of a patented product through the use of a licensing agreement. Without commenting on the tying arrangement, the Court held that use of a competitor’s ink in violation of a condition of the agreement—that the rotary mimeograph “‘may be used only with the stencil, paper, ink and other supplies made by A. B. Dick Co.’”—constituted infringement of the patent on the machine. Chief Justice White dissented, explaining his disagreement with the Court’s approval of a practice that he regarded as an “attempt to increase the scope of the monopoly granted by a patent … which tend[s] to increase monopoly and to burden the public in the exercise of their common rights.” [I]n this Court’s subsequent cases reviewing the legality of tying arrangements we, too, embraced Chief Justice White’s disapproval of those arrangements.

In the years since A. B. Dick, four different rules of law have supported challenges to tying arrangements. They have been condemned as improper extensions of the patent monopoly under the patent misuse doctrine, as unfair methods of competition under §5 of the Federal Trade Commission Act, as contracts tending to create a monopoly under §3 of the Clayton Act, and as contracts in restraint of trade under §1 of the Sherman Act. In all of those instances, the justification for the challenge rested on either an assumption or a showing that the defendant’s position of power in the market for the tying product was being used to restrain competition in the market for the tied product. As we explained in Jefferson Parish, “[o]ur cases have concluded 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 into 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.”

Over the years, however, this Court’s strong disapproval of tying arrangements has substantially diminished. Rather than relying on assumptions, in its more recent opinions the Court has required a showing of market power in the tying product. Our early opinions consistently assumed that “[t]ying arrangements serve hardly any purpose beyond the suppression of competition.” Standard Oil Co., 337 U. S., at 305–306. In 1962, in Loew’s, 371 U. S., at 47–48, the Court relied on this assumption despite evidence of significant competition in the market for the tying product. And as recently as 1969, Justice Black, writing for the majority, relied on the assumption as support for the proposition “that, at least when certain prerequisites are met, arrangements of this kind are illegal in and of themselves, and no specific showing of unreasonable competitive effect is required.” Fortner Enterprises, Inc. v. United States Steel Corp., 394 U. S. 495, 498–499 (Fortner I). Explaining the Court’s decision to allow the suit to proceed to trial, he stated that “decisions rejecting the need for proof of truly dominant power over the tying product have all been based on a recognition that because tying arrangements generally serve no legitimate business purpose that cannot be achieved in some less restrictive way, the presence of any appreciable restraint on competition provides a sufficient reason for invalidating the tie.”

Reflecting a changing view of tying arrangements, four Justices dissented in Fortner I, arguing that the challenged “tie”—the extension of a $2 million line of credit on condition that the borrower purchase prefabricated houses from the defendant—might well have served a legitimate purpose. In his opinion, Justice White noted that promotional tie-ins may provide “uniquely advantageous deals” to purchasers. And Justice Fortas concluded that the arrangement was best characterized as “a sale of a single product with the incidental provision of financing.”

The dissenters’ view that tying arrangements may well be procompetitive ultimately prevailed; indeed, it did so in the very same lawsuit. After the Court remanded the suit in Fortner I, a bench trial resulted in judgment for the plaintiff, and the case eventually made its way back to this Court. Upon return, we unanimously held that the plaintiff’s failure of proof on the issue of market power was fatal to its case—the plaintiff had proved “nothing more than a willingness to provide cheap financing in order to sell expensive houses.” United States Steel Corp. v. Fortner Enterprises, Inc., 429 U. S. 610, 622 (1977) (Fortner II).

The assumption that “[t]ying arrangements serve hardly any purpose beyond the suppression of competition,” rejected in Fortner II, has not been endorsed in any opinion since. Instead, it was again rejected just seven years later in Jefferson Parish, where, as in Fortner II, we unanimously reversed a Court of Appeals judgment holding that an alleged tying arrangement constituted a per se violation of §1 of the Sherman Act. Like the product at issue in the Fortner cases, the tying product in Jefferson Parish—hospital services—was unpatented, and our holding again rested on the conclusion that the plaintiff had failed to prove sufficient power in the tying product market to restrain competition in the market for the tied product—services of anesthesiologists.

In rejecting the application of a per se rule that all tying arrangements constitute antitrust violations, we explained:

Notably, nothing in our opinion suggested a rebuttable presumption of market power applicable to tying arrangements involving a patent on the tying good. Instead, it described the rule that a contract to sell a patented product on condition that the purchaser buy unpatented goods exclusively from the patentee is a per se violation of §1 of the Sherman Act.

Justice O’Connor wrote separately in Jefferson Parish. In her opinion, she questioned not only the propriety of treating any tying arrangement as a per se violation of the Sherman Act, but also the validity of the presumption that a patent always gives the patentee significant market power, observing that the presumption was actually a product of our patent misuse cases rather than our antitrust jurisprudence. It is that presumption, a vestige of the Court’s historical distrust of tying arrangements, that we address squarely today.

Justice O’Connor was, of course, correct in her assertion that the presumption that a patent confers market power arose outside the antitrust context as part of the patent misuse doctrine. That doctrine had its origins in Motion Picture Patents Co. v. Universal Film Mfg. Co., 243 U. S. 502 (1917), which found no support in the patent laws for the proposition that a patentee may “prescribe by notice attached to a patented machine the conditions of its use and the supplies which must be used in the operation of it, under pain of infringement of the patent.” Although Motion Picture Patents Co. simply narrowed the scope of possible patent infringement claims, it formed the basis for the Court’s subsequent decisions creating a patent misuse defense to infringement claims when a patentee uses its patent “as the effective means of restraining competition with its sale of an unpatented article.” Morton Salt Co. v. G. S. Suppiger Co., 314 U.S. 488, 490 (1942).

Without any analysis of actual market conditions, these patent misuse decisions assumed that, by tying the purchase of unpatented goods to the sale of the patented good, the patentee was “restraining competition,” Morton Salt, 314 U. S., at 490, or “secur[ing] a limited monopoly of an unpatented material,” Mercoid, 320 U. S., at 664. In other words, these decisions presumed “[t]he requisite economic power” over the tying product such that the patentee could “extend [its] economic control to unpatented products.” Loew’s, 371 U. S., at 45–46.

The presumption that a patent confers market power migrated from patent law to antitrust law in International Salt. In that case, we affirmed a District Court decision holding that leases of patented machines requiring the lessees to use the defendant’s unpatented salt products violated §1 of the Sherman Act and §3 of the Clayton Act as a matter of law. Although the Court’s opinion does not discuss market power or the patent misuse doctrine, it assumes that “[t]he volume of business affected by these contracts cannot be said to be insignificant or insubstantial and the tendency of the arrangement to accomplishment of monopoly seems obvious.”

Indeed, later in the same Term we cited International Salt for the proposition that the license of “a patented device on condition that unpatented materials be employed in conjunction with the patented device” is an example of a restraint that is “illegal per se.” And in subsequent cases we have repeatedly grounded the presumption of market power over a patented device in International Salt.

Although the patent misuse doctrine and our antitrust jurisprudence became intertwined in International Salt, subsequent events initiated their untwining. This process has ultimately led to today’s reexamination of the presumption of per se illegality of a tying arrangement involving a patented product, the first case since 1947 in which we have granted review to consider the presumption’s continuing validity.

Three years before we decided International Salt, this Court had expanded the scope of the patent misuse doctrine to include not only supplies or materials used by a patented device, but also tying arrangements involving a combination patent and “unpatented material or [a] device [that] is itself an integral part of the structure embodying the patent.” Mercoid, 320 U. S., at 665. In reaching this conclusion, the Court explained that it could see “no difference in principle” between cases involving elements essential to the inventive character of the patent and elements peripheral to it; both, in the Court’s view, were attempts to “expan[d] the patent beyond the legitimate scope of its monopoly.”

[See discussion of the Patent Misuse Reform Act of 1988 in Section 24.2.]

While the 1988 [Patent Act] amendment does not expressly refer to the antitrust laws, it certainly invites a reappraisal of the per se rule announced in International Salt. A rule denying a patentee the right to enjoin an infringer is significantly less severe than a rule that makes the conduct at issue a federal crime punishable by up to 10 years in prison. It would be absurd to assume that Congress intended to provide that the use of a patent that merited punishment as a felony would not constitute “misuse.” Moreover, given the fact that the patent misuse doctrine provided the basis for the market power presumption, it would be anomalous to preserve the presumption in antitrust after Congress has eliminated its foundation.

After considering the congressional judgment reflected in the 1988 amendment, we conclude that tying arrangements involving patented products should be evaluated under the standards applied in cases like Fortner II and Jefferson Parish rather than under the per se rule applied in Morton Salt and Loew’s. While some such arrangements are still unlawful, such as those that are the product of a true monopoly or a marketwide conspiracy, that conclusion must be supported by proof of power in the relevant market rather than by a mere presumption thereof.

Rather than arguing that we should retain the rule of per se illegality, respondent contends that we should endorse a rebuttable presumption that patentees possess market power when they condition the purchase of the patented product on an agreement to buy unpatented goods exclusively from the patentee. Respondent recognizes that a large number of valid patents have little, if any, commercial significance, but submits that those that are used to impose tying arrangements on unwilling purchasers likely do exert significant market power. Hence, in respondent’s view, the presumption would have no impact on patents of only slight value and would be justified, subject to being rebutted by evidence offered by the patentee, in cases in which the patent has sufficient value to enable the patentee to insist on acceptance of the tie.

As we have already noted, the vast majority of academic literature recognizes that a patent does not necessarily confer market power. Similarly, while price discrimination may provide evidence of market power, particularly if buttressed by evidence that the patentee has charged an above-market price for the tied package, it is generally recognized that it also occurs in fully competitive markets. We are not persuaded that the combination of these two factors should give rise to a presumption of market power when neither is sufficient to do so standing alone. Rather, the lesson to be learned from International Salt and the academic commentary is the same: Many tying arrangements, even those involving patents and requirements ties, are fully consistent with a free, competitive market. For this reason, we reject both respondent’s proposed rebuttable presumption and their narrower alternative.

Congress, the antitrust enforcement agencies, and most economists have all reached the conclusion that a patent does not necessarily confer market power upon the patentee. Today, we reach the same conclusion, and therefore hold that, in all cases involving a tying arrangement, the plaintiff must prove that the defendant has market power in the tying product.

Reversed.

909 F.2d 1245 (9th Cir. 1990)

BREWSTER, DISTRICT JUDGE

The Movie 1 & 2 (“The Movie”) appeals a district court judgment dismissing its case against numerous antitrust defendants. This case involves allegations that two motion picture exhibitors in Santa Cruz, California, entered into an illegal film licensing agreement in which 19 national film distributors participated, and that the exhibitors attempted to monopolize, conspired to monopolize, and did monopolize the film exhibition market in Santa Cruz. The United States District Court for the Northern District of California … granted the defendants’ multiple motions for summary judgment as to all of the antitrust claims.

Background

Appellant The Movie is a general partnership consisting of Harold Snyder and his two sons, David and Larry Snyder. In February of 1984, the Snyders opened a motion picture theatre in Santa Cruz, California. The two-screen theatre, which has 225 seats in each auditorium, is located in downtown Santa Cruz in a converted storefront which it shares with a moped shop. The Snyders’ intent was to exhibit both “commercial” and “art” films on a first-run basis.

The exhibitor defendants in this case were two of The Movie’s competitors, UA, which operates five theaters in Santa Cruz with a total of twelve screens, and the Nickelodeon, which operates two theatres with a total of four screens. The distributor defendants included ten major motion picture distributors (“Group I”) and nine smaller independent distribution companies (“Group II”).

The relevant geographic market in this case is the greater Santa Cruz area, which includes Aptos, Scotts Valley, and Capitola. The relevant product market is first-run motion pictures. Although theatres can either show “first-run” films or subsequently run “sub-run” films, first-run films provide the greatest grossing potential. The Santa Cruz area has only ten theatres at present. UA’s five theatres exhibit primarily first-run “commercial” films. The Nickelodeon’s two theatres exhibit primarily first-run and vintage “art” films. The only other competitors in Santa Cruz are two non-defendant independent exhibitors who apparently show primarily sub-run films.

This circuit has recognized the existence of relevant submarkets within a product market. We are satisfied with the appellant’s division of the relevant market in this case into two categories, “commercial” and “art” films.

The appellant alleges that The Movie was unable to obtain licenses to first-run commercial or art films from the defendant distributors, who concertedly refused to deal with it. Appellant alleges that the distributors cooperated in an illegal “split agreement” between UA and the Nickelodeon, whereby nearly all first-run commercial films were licensed to UA and nearly all first-run art films were licensed to the Nickelodeon. A split agreement is an exhibitor agreement which divides a normally competitive market by allocating films to particular members with the understanding that there will be no bidding among members for licensing rights to the films assigned.

Appellant alleges that the split agreement in this case was part of a boycott against The Movie, which had the purpose of eliminating it as a competitor, a restraint of trade in violation of section 1 of the Sherman Act.

Discussion

Section 1 of the Sherman Act prohibits “[e]very contract, combination … or conspiracy, in restraint of trade.” Appellant’s section 1 claims allege an illegal agreement between the exhibitors and the distributors in the form of a “group boycott” aimed at excluding The Movie from the Santa Cruz theatre market.

Figure 25.8 The Nickelodeon Theater in Santa Cruz, Cal.

The Supreme Court has emphasized, however, that the Sherman Act does not restrict “the long recognized right of a trader … engaged in an entirely private business, freely to exercise his own independent discretion as to the parties with whom he will deal.” United States v. Colgate Co., 250 U.S. 300, 307 (1919). Because of a supplier’s right to choose his customers and set his own terms, antitrust plaintiffs are required to do more than merely allege conspiracy and unequal treatment in order to take a case to trial. According to the law of this circuit, once a defendant rebuts the allegations of conspiracy with “probative evidence supporting an alternative interpretation of a defendant’s conduct,” the plaintiff must come forward with specific factual support of its conspiracy allegations to avoid summary judgment.

The defendants in this case did offer some evidence from which a trier of fact could reasonably have found that their refusal to deal with The Movie was based on legitimate and sound business judgment. Following such a showing of a plausible and justifiable reason for a defendant’s conduct, a plaintiff must provide specific factual support for its allegations of conspiracy which tends to show that the defendant was not acting independently. Accordingly, we examine appellant’s evidence in support of its conspiracy allegations.

486 U.S. 492 (1988)

BRENNAN, JUSTICE

The National Fire Protection Association (Association) is a private, voluntary organization with more than 31,500 individual and group members representing industry, labor, academia, insurers, organized medicine, firefighters, and government. The Association, among other things, publishes product standards and codes related to fire protection through a process known as “consensus standard making.” One of the codes it publishes is the National Electrical Code (Code), which establishes product and performance requirements for the design and installation of electrical wiring systems. Revised every three years, the Code is the most influential electrical code in the nation. A substantial number of state and local governments routinely adopt the Code into law with little or no change; private certification laboratories, such as Underwriters Laboratories, normally will not list and label an electrical product that does not meet Code standards; many underwriters will refuse to insure structures that are not built in conformity with the Code, and many electrical inspectors, contractors, and distributors will not use a product that falls outside the Code.

Among the electrical products covered by the Code is electrical conduit, the hollow tubing used as a raceway to carry electrical wires through the walls and floors of buildings. Throughout the relevant period, the Code permitted using electrical conduit made of steel, and almost all conduit sold was in fact steel conduit. Starting in 1980, respondent began to offer plastic conduit made of polyvinyl chloride. Respondent claims its plastic conduit offers significant competitive advantages over steel conduit, including pliability, lower installed cost, and lower susceptibility to short circuiting. In 1980, however, there was also a scientific basis for concern that, during fires in high-rise buildings, polyvinyl chloride conduit might burn and emit toxic fumes.

Respondent initiated a proposal to include polyvinyl chloride conduit as an approved type of electrical conduit in the 1981 edition of the Code. Following approval by one of the Association’s professional panels, this proposal was scheduled for consideration at the 1980 annual meeting, where it could be adopted or rejected by a simple majority of the members present. Alarmed that, if approved, respondent’s product might pose a competitive threat to steel conduit, petitioner, the Nation’s largest producer of steel conduit, met to plan strategy with, among others, members of the steel industry, other steel conduit manufacturers, and its independent sales agents. They collectively agreed to exclude respondent’s product from the 1981 Code by packing the upcoming annual meeting with new Association members whose only function would be to vote against the polyvinyl chloride proposal.

Combined, the steel interests recruited 230 persons to join the Association and to attend the annual meeting to vote against the proposal. Petitioner alone recruited 155 persons – including employees, executives, sales agents, the agents’ employees, employees from two divisions that did not sell electrical products, and the wife of a national sales director. Petitioner and the other steel interests also paid over $100,000 for the membership, registration, and attendance expenses of these voters. At the annual meeting, the steel group voters were instructed where to sit and how and when to vote by group leaders who used walkie-talkies and hand signals to facilitate communication. Few of the steel group voters had any of the technical documentation necessary to follow the meeting. None of them spoke at the meeting to give their reasons for opposing the proposal to approve polyvinyl chloride conduit. Nonetheless, with their solid vote in opposition, the proposal was rejected and returned to committee by a vote of 394 to 390. Respondent appealed the membership’s vote to the Association’s Board of Directors, but the Board denied the appeal on the ground that, although the Association’s rules had been circumvented, they had not been violated.Footnote ³⁸

In October, 1981, respondent brought this suit in Federal District Court, alleging that petitioner and others had unreasonably restrained trade in the electrical conduit market in violation of § 1 of the Sherman Act. A bifurcated jury trial began in March, 1985. Petitioner conceded that it had conspired with the other steel interests to exclude respondent’s product from the Code, and that it had a pecuniary interest to do so. The jury, instructed under the rule of reason that respondent carried the burden of showing that the anticompetitive effects of petitioner’s actions outweighed any procompetitive benefits of standard-setting, found petitioner liable. In answers to special interrogatories, the jury found that petitioner did not violate any rules of the Association and acted, at least in part, based on a genuine belief that plastic conduit was unsafe, but that petitioner nonetheless did “subvert” the consensus standard-making process of the Association. The jury also made special findings that petitioner’s actions had an adverse impact on competition, were not the least restrictive means of expressing petitioner’s opposition to the use of polyvinyl chloride conduit in the marketplace, and unreasonably restrained trade in violation of the antitrust laws. The jury then awarded respondent damages, to be trebled, of $3.8 million for lost profits resulting from the effect that excluding polyvinyl chloride conduit from the 1981 Code had of its own force in the marketplace. No damages were awarded for injuries stemming from the adoption of the 1981 Code by governmental entities.

[The Court’s discussion of the Noerr–Pennington doctrine, which immunizes certain conduct that can be characterized as petitioning the government, is omitted.]

Typically, private standard-setting associations, like the Association in this case, include members having horizontal and vertical business relations. There is no doubt that the members of such associations often have economic incentives to restrain competition and that the product standards set by such associations have a serious potential for anticompetitive harm. See American Society of Mechanical Engineers, Inc. v. Hydrolevel Corp., 456 U. S. 556 (1982). Agreement on a product standard is, after all, implicitly an agreement not to manufacture, distribute, or purchase certain types of products. Accordingly, private standard-setting associations have traditionally been objects of antitrust scrutiny. When, however, private associations promulgate safety standards based on the merits of objective expert judgments and through procedures that prevent the standard-setting process from being biased by members with economic interests in stifling product competition, those private standards can have significant procompetitive advantages. It is this potential for procompetitive benefits that has led most lower courts to apply rule-of-reason analysis to product standard-setting by private associations.

[T]he validity of [petitioner’s efforts to influence the Code] must … be evaluated under the standards of conduct set forth by the antitrust laws that govern the private standard-setting process. The antitrust validity of these efforts is not established, without more, by petitioner’s literal compliance with the rules of the Association, for the hope of procompetitive benefits depends upon the existence of safeguards sufficient to prevent the standard-setting process from being biased by members with economic interests in restraining competition. An association cannot validate the anticompetitive activities of its members simply by adopting rules that fail to provide such safeguards …

What petitioner may not do (without exposing itself to possible antitrust liability for direct injuries) is bias the process by, as in this case, stacking the private standard-setting body with decisionmakers sharing their economic interest in restraining competition.

570 U.S. 136 (2013)

BREYER, JUSTICE,

Company A sues Company B for patent infringement. The two companies settle under terms that require (1) Company B, the claimed infringer, not to produce the patented product until the patent’s term expires, and (2) Company A, the patentee, to pay B many millions of dollars. Because the settlement requires the patentee to pay the alleged infringer, rather than the other way around, this kind of settlement agreement is often called a “reverse payment” settlement agreement. And the basic question here is whether such an agreement can sometimes unreasonably diminish competition in violation of the antitrust laws. See, e.g., 15 U.S.C. § 1 (Sherman Act prohibition of “restraint[s] of trade or commerce”).

In this case, the Eleventh Circuit dismissed a Federal Trade Commission (FTC) complaint claiming that a particular reverse payment settlement agreement violated the antitrust laws. In doing so, the Circuit stated that a reverse payment settlement agreement generally is “immune from antitrust attack so long as its anticompetitive effects fall within the scope of the exclusionary potential of the patent.” And since the alleged infringer’s promise not to enter the patentee’s market expired before the patent’s term ended, the Circuit found the agreement legal and dismissed the FTC complaint. In our view, however, reverse payment settlements such as the agreement alleged in the complaint before us can sometimes violate the antitrust laws. We consequently hold that the Eleventh Circuit should have allowed the FTC’s lawsuit to proceed.

A

Apparently most if not all reverse payment settlement agreements arise in the context of pharmaceutical drug regulation, and specifically in the context of suits brought under statutory provisions allowing a generic drug manufacturer (seeking speedy marketing approval) to challenge the validity of a patent owned by an already-approved brand-name drug owner. We consequently describe four key features of the relevant drug-regulatory framework established by the Drug Price Competition and Patent Term Restoration Act of 1984. That Act is commonly known as the Hatch–Waxman Act.

First, a drug manufacturer, wishing to market a new prescription drug, must submit a New Drug Application to the federal Food and Drug Administration (FDA) and undergo a long, comprehensive, and costly testing process, after which, if successful, the manufacturer will receive marketing approval from the FDA.

Second, once the FDA has approved a brand-name drug for marketing, a manufacturer of a generic drug can obtain similar marketing approval through use of abbreviated procedures. The Hatch–Waxman Act permits a generic manufacturer to file an Abbreviated New Drug Application specifying that the generic has the “same active ingredients as,” and is “biologically equivalent” to, the already-approved brand-name drug. In this way the generic manufacturer can obtain approval while avoiding the “costly and time-consuming studies” needed to obtain approval “for a pioneer drug.”

Third, the Hatch–Waxman Act sets forth special procedures for identifying, and resolving, related patent disputes. It requires the pioneer brand-name manufacturer to list in its New Drug Application the “number and the expiration date” of any relevant patent. And it requires the generic manufacturer in its Abbreviated New Drug Application to “assure the FDA” that the generic “will not infringe” the brand-name’s patents.

The generic can provide this assurance in one of several ways. It can certify that the brand-name manufacturer has not listed any relevant patents. It can certify that any relevant patents have expired. It can request approval to market beginning when any still-in-force patents expire. Or, it can certify that any listed, relevant patent “is invalid or will not be infringed by the manufacture, use, or sale” of the drug described in the Abbreviated New Drug Application. Taking this last-mentioned route (called the “paragraph IV” route), automatically counts as patent infringement, and often “means provoking litigation.” If the brand-name patentee brings an infringement suit within 45 days, the FDA then must withhold approving the generic, usually for a 30–month period, while the parties litigate patent validity (or infringement) in court.

Fourth, Hatch–Waxman provides a special incentive for a generic to be the first to file an Abbreviated New Drug Application taking the paragraph IV route. That applicant will enjoy a period of 180 days of exclusivity (from the first commercial marketing of its drug). During that period of exclusivity no other generic can compete with the brand-name drug. If the first-to-file generic manufacturer can overcome any patent obstacle and bring the generic to market, this 180–day period of exclusivity can prove valuable, possibly worth several hundred million dollars. Indeed, the Generic Pharmaceutical Association said in 2006 that the “vast majority of potential profits for a generic drug manufacturer materialize during the 180–day exclusivity period.” The 180-day exclusivity period, however, can belong only to the first generic to file.

A

Solvay’s patent, if valid and infringed, might have permitted it to charge drug prices sufficient to recoup the reverse settlement payments it agreed to make to its potential generic competitors. And we are willing to take this fact as evidence that the agreement’s “anticompetitive effects fall within the scope of the exclusionary potential of the patent.” But we do not agree that that fact, or characterization, can immunize the agreement from antitrust attack.

For one thing, to refer, as the Circuit referred, simply to what the holder of a valid patent could do does not by itself answer the antitrust question. The patent here may or may not be valid, and may or may not be infringed. “[A] valid patent excludes all except its owner from the use of the protected process or product”. And that exclusion may permit the patent owner to charge a higher-than-competitive price for the patented product. But an invalidated patent carries with it no such right. And even a valid patent confers no right to exclude products or processes that do not actually infringe. The paragraph IV litigation in this case put the patent’s validity at issue, as well as its actual preclusive scope. The parties’ settlement ended that litigation. The FTC alleges that in substance, the plaintiff agreed to pay the defendants many millions of dollars to stay out of its market, even though the defendants did not have any claim that the plaintiff was liable to them for damages. That form of settlement is unusual. And, for reasons discussed in Part II-B, infra, there is reason for concern that settlements taking this form tend to have significant adverse effects on competition.

Given these factors, it would be incongruous to determine antitrust legality by measuring the settlement’s anticompetitive effects solely against patent law policy, rather than by measuring them against procompetitive antitrust policies as well. And indeed, contrary to the Circuit’s view that the only pertinent question is whether “the settlement agreement … fall[s] within” the legitimate “scope” of the patent’s “exclusionary potential,” this Court has indicated that patent and antitrust policies are both relevant in determining the “scope of the patent monopoly”—and consequently antitrust law immunity—that is conferred by a patent.

Thus, the Court in Line Material explained that “the improper use of [a patent] monopoly,” is “invalid” under the antitrust laws and resolved the antitrust question in that case by seeking an accommodation “between the lawful restraint on trade of the patent monopoly and the illegal restraint prohibited broadly by the Sherman Act.” To strike that balance, the Court asked questions such as whether “the patent statute specifically gives a right” to restrain competition in the manner challenged; and whether “competition is impeded to a greater degree” by the restraint at issue than other restraints previously approved as reasonable. In short, rather than measure the length or amount of a restriction solely against the length of the patent’s term or its earning potential, as the Court of Appeals apparently did here, this Court answered the antitrust question by considering traditional antitrust factors such as likely anticompetitive effects, redeeming virtues, market power, and potentially offsetting legal considerations present in the circumstances, such as here those related to patents. See Part II-B, infra. Whether a particular restraint lies “beyond the limits of the patent monopoly” is a conclusion that flows from that analysis and not, as the Chief Justice suggests, its starting point.

For another thing, this Court’s precedents make clear that patent-related settlement agreements can sometimes violate the antitrust laws. In United States v. Singer Mfg. Co., 374 U.S. 174 (1963), for example, two sewing machine companies possessed competing patent claims; a third company sought a patent under circumstances where doing so might lead to the disclosure of information that would invalidate the other two firms’ patents. All three firms settled their patent-related disagreements while assigning the broadest claims to the firm best able to enforce the patent against yet other potential competitors. The Court did not examine whether, on the assumption that all three patents were valid, patent law would have allowed the patents’ holders to do the same. Rather, emphasizing that the Sherman Act “imposes strict limitations on the concerted activities in which patent owners may lawfully engage,” it held that the agreements, although settling patent disputes, violated the antitrust laws. And that, in important part, was because “the public interest in granting patent monopolies” exists only to the extent that “the public is given a novel and useful invention” in “consideration for its grant.”

Similarly, both within the settlement context and without, the Court has struck down overly restrictive patent licensing agreements—irrespective of whether those agreements produced supra-patent-permitted revenues. We concede that in United States v. General Elec. Co., 272 U.S. 476 (1926), the Court permitted a single patentee to grant to a single licensee a license containing a minimum resale price requirement. But in Line Material, the Court held that the antitrust laws forbid a group of patentees, each owning one or more patents, to cross-license each other, and, in doing so, to insist that each licensee maintain retail prices set collectively by the patent holders. The Court was willing to presume that the single-patentee practice approved in General Electric was a “reasonable restraint” that “accords with the patent monopoly granted by the patent law,” but declined to extend that conclusion to multiple-patentee agreements: “As the Sherman Act prohibits agreements to fix prices, any arrangement between patentees runs afoul of that prohibition and is outside the patent monopoly.” In New Wrinkle, 342 U.S., at 378, the Court held roughly the same, this time in respect to a similar arrangement in settlement of a litigation between two patentees, each of which contended that its own patent gave it the exclusive right to control production. That one or the other company (we may presume) was right about its patent did not lead the Court to confer antitrust immunity. Far from it, the agreement was found to violate the Sherman Act.

Finally in Standard Oil Co. (Indiana), the Court upheld cross-licensing agreements among patentees that settled actual and impending patent litigation, which agreements set royalty rates to be charged third parties for a license to practice all the patents at issue (and which divided resulting revenues). But, in doing so, Justice Brandeis, writing for the Court, warned that such an arrangement would have violated the Sherman Act had the patent holders thereby “dominate[d]” the industry and “curtail[ed] the manufacture and supply of an unpatented product.” These cases do not simply ask whether a hypothetically valid patent’s holder would be able to charge, e.g., the high prices that the challenged patent-related term allowed. Rather, they seek to accommodate patent and antitrust policies, finding challenged terms and conditions unlawful unless patent law policy offsets the antitrust law policy strongly favoring competition.

Finally, the Hatch–Waxman Act itself does not embody a statutory policy that supports the Eleventh Circuit’s view. Rather, the general procompetitive thrust of the statute, its specific provisions facilitating challenges to a patent’s validity, see Part I-A, supra, and its later-added provisions requiring parties to a patent dispute triggered by a paragraph IV filing to report settlement terms to the FTC and the Antitrust Division of the Department of Justice, all suggest the contrary. Those interested in legislative history may also wish to examine the statements of individual Members of Congress condemning reverse payment settlements in advance of the 2003 amendments. See, e.g., 148 Cong. Rec. 14437 (2002) (remarks of Sen. Hatch) (“It was and is very clear that the [Hatch–Waxman Act] was not designed to allow deals between brand and generic companies to delay competition”).

The FTC urges us to hold that reverse payment settlement agreements are presumptively unlawful and that courts reviewing such agreements should proceed via a “quick look” approach, rather than applying a “rule of reason.” We decline to do so. In California Dental, we held (unanimously) that abandonment of the “rule of reason” in favor of presumptive rules (or a “quick-look” approach) is appropriate only where “an observer with even a rudimentary understanding of economics could conclude that the arrangements in question would have an anticompetitive effect on customers and markets.” (Breyer, J., concurring in part and dissenting in part). We do not believe that reverse payment settlements, in the context we here discuss, meet this criterion.

That is because the likelihood of a reverse payment bringing about anticompetitive effects depends upon its size, its scale in relation to the payor’s anticipated future litigation costs, its independence from other services for which it might represent payment, and the lack of any other convincing justification. The existence and degree of any anticompetitive consequence may also vary as among industries. These complexities lead us to conclude that the FTC must prove its case as in other rule-of-reason cases.

It is so ordered.

283 U.S. 163 (1931)

BRANDEIS, JUSTICE

This suit was brought by the United States in June, 1924, in the federal court for northern Illinois, to enjoin further violation of section 1 and section 2 of the Sherman Anti-Trust Act. The violation charged is an illegal combination to create a monopoly and to restrain interstate commerce by controlling that part of the supply of gasoline which is produced by the process of cracking. Control is alleged to be exerted by means of seventy-nine contracts concerning patents relating to the cracking art. The parties to the several contracts are named as defendants. Four of them own patents covering their respective cracking processes, and are called the primary defendants. Three of these, the Standard Oil Company of Indiana, the Texas Company, and the Standard Oil Company of New Jersey, are themselves large producers of cracked gasoline. The fourth, Gasoline Products Company, is merely a licensing concern. The remaining forty-six defendants manufacture cracked gasoline under licenses from one or more of the primary defendants. They are called secondary defendants.

The violation of the Sherman Act now complained of rests substantially on the making and effect of three contracts entered into by the primary defendants. The history of these agreements may be briefly stated. For about half a century before 1910, gasoline had been manufactured from crude oil exclusively by distillation and condensation at atmospheric pressure. When the demand for gasoline grew rapidly with the widespread use of the automobile, methods for increasing the yield of gasoline from the available crude oil were sought. It had long been known that from a given quantity of crude, additional oils of high volatility could be produced by “cracking”; that is, by applying heat and pressure to the residum after ordinary distillation. But a commercially profitable cracking method and apparatus for manufacturing additional gasoline had not yet been developed. The first such process was perfected by the Indiana Company in 1913; and for more than seven years this was the only one practiced in America. During that period the Indiana Company not only manufactured cracked gasoline on a large scale, but also had licensed fifteen independent concerns to use its process and had collected, prior to January 1, 1921, royalties aggregating $15,057,432.46.

Meanwhile, since the phenomenon of cracking was not controlled by any fundamental patent, other concerns had been working independently to develop commercial processes of their own. Most prominent among these were the three other primary defendants, the Texas Company, the New Jersey Company, and the Gasoline Products Company. Each of these secured numerous patents covering its particular cracking process. Beginning in 1920, conflict developed among the four companies concerning the validity, scope, and ownership of issued patents. One infringement suit was begun; cross-notices of infringement, antecedent to other suits, were given; and interferences were declared on pending applications in the Patent Office. The primary defendants assert that it was these difficulties which led to their executing the three principal agreements which the United States attacks; and that their sole object was to avoid litigation and losses incident to conflicting patents.

The three agreements differ from one another only slightly in scope and terms. Each primary defendant was released thereby from liability for any past infringement of patents of the others. Each acquired the right to use these patents thereafter in its own process. Each was empowered to extend to independent concerns, licensed under its process, releases from past, and immunity from future claims of infringement of patents controlled by the other primary defendants. And each was to share in some fixed proportion the fees received under these multiple licenses. The royalties to be charged were definitely fixed in the first contract; and minimum sums per barrel, to be divided between the Texas and Indiana companies, were specified in the second and third.

[P]ooling arrangements may obviously result in restricting competition. The limited monopolies granted to patent owners do not exempt them from the prohibitions of the Sherman Act and supplementary legislation. Hence the necessary effect of patent interchange agreements, and the operations under them, must be carefully examined in order to determine whether violations of the Act result.

The Government contends that the three agreements constitute a pooling by the primary defendants of the royalties from their several patents; that thereby competition between them in the commercial exercise of their respective rights to issue licenses is eliminated; that this tends to maintain or increase the royalty charged secondary defendants and hence to increase the manufacturing cost of cracked gasoline; that thus the primary defendants exclude from interstate commerce gasoline which would, under lower competitive royalty rates, be produced; and that interstate commerce is thereby unlawfully restrained. There is no provision in any of the agreements which restricts the freedom of the primary defendants individually to issue licenses under their own patents alone or under the patents of all the others; and no contract between any of them, and no license agreement with a secondary defendant executed pursuant thereto, now imposes any restriction upon the quantity of gasoline to be produced, or upon the price, terms, or conditions of sale, or upon the territory in which sales may be made. The only restraint thus charged is that necessarily arising out of the making and effect of the provisions for cross-licensing and for division of royalties.

The Government concedes that it is not illegal for the primary defendants to cross-license each other and the respective licensees; and that adequate consideration can legally be demanded for such grants. But it contends that the insertion of certain additional provisions in these agreements renders them illegal. It urges, first, that the mere inclusion of the provisions for the division of royalties, constitutes an unlawful combination under the Sherman Act because it evidences an intent to obtain a monopoly. This contention is unsound. Such provisions for the division of royalties are not in themselves conclusive evidence of illegality. Where there are legitimately conflicting claims or threatened interferences, a settlement by agreement, rather than litigation, is not precluded by the Act. An interchange of patent rights and a division of royalties according to the value attributed by the parties to their respective patent claims is frequently necessary if technical advancement is not to be blocked by threatened litigation. If the available advantages are upon on reasonable terms to all manufacturers desiring to participate, such interchange may promote rather than restrain competition.Footnote ¹⁵

The Government next contends that the agreements to maintain royalties violate the Sherman [Act] because the fees charged are onerous. The argument is that the competitive advantage which the three primary defendants enjoy of manufacturing cracked gasoline free of royalty, while licensees must pay to them a heavy tribute in fees, enables these primary defendants to exclude from interstate commerce cracked gasoline which would, under lower competitive royalty rates, be produced by possible rivals. This argument ignores the privileges incident to ownership of patents. Unless the industry is dominated, or interstate commerce directly restrained, the Sherman Act does not require cross-licensing patentees to license at reasonable rates others engaged in interstate commerce. The allegation that the royalties charged are onerous is, standing alone, without legal significance; and, as will be shown, neither the alleged domination, nor restraint of commerce, has been proved.

The main contention of the Government is that even if the exchange of patent rights and division of royalties are not necessarily improper and the royalties are not oppressive, the three contracts are still obnoxious to the Sherman Act because specific clauses enable the primary defendants to maintain existing royalties and thereby to restrain interstate commerce. The provisions which constitute the basis for this charge are these. The first contract specifies that the Texas Company shall get from the Indiana Company one-fourth of all royalties thereafter collected under the latter’s existing license agreements; and that all royalties received under licenses thereafter issued by either company shall be equally divided. Licenses granting rights under the patents of both are to be issued at a fixed royalty – approximately that charged by the Indiana Company when its process was alone in the field. By the second contract, the Texas Company is entitled to receive one-half of the royalties thereafter collected by the Gasoline Products Company from its existing licensees, and a minimum sum per barrel for all oil cracked by its future licensees. The third contract gives to the Indiana Company one-half of all royalties thereafter paid by existing licensees of the New Jersey Company, and a similar minimum sum for each barrel treated by its future licensees, subject in the latter case to reduction if the royalties charged by the Indiana and Texas companies for their processes should be reduced.Footnote ¹⁶ The alleged effect of these provisions is to enable the primary defendants, because of their monopoly of patented cracking processes, to maintain royalty rates at the level established originally for the Indiana process.

The rate of royalties may, of course be a decisive factor in the cost of production. If combining patent owners effectively dominate an industry, the power to fix and maintain royalties is tantamount to the power to fix prices. Where domination exists, a pooling of competing process patents, or an exchange of licenses for the purpose of curtailing the manufacture and supply of an unpatented product, is beyond the privileges conferred by the patents and constitutes a violation of the Sherman Act. The lawful individual monopolies granted by the patent statutes cannot be unitedly exercised to restrain competition. But an agreement for cross-licensing and division of royalties violates the Act only when used to effect a monopoly, or to fix prices, or to impose otherwise an unreasonable restraint upon interstate commerce. In the case at bar, the primary defendants own competing patented processes for manufacturing an unpatented product which is sold in interstate commerce; and agreements concerning such processes are likely to engender the evils to which the Sherman Act was directed. We must, therefore, examine the evidence to ascertain the operation and effect of the challenged contracts.

No monopoly, or restriction of competition, in the business of licensing patented cracking processes resulted from the execution of these agreements. Up to 1920 all cracking plants in the United States were either owned by the Indiana Company alone, or were operated under licenses from it. In 1924 and 1925, after the cross-licensing arrangements were in effect, the four primary defendants owned or licensed, in the aggregate, only 55 percent of the total cracking capacity, and the remainder was distributed among twenty-one independently owned cracking processes. This development and commercial expansion of competing processes is clear evidence that the contracts did not concentrate in the hands of the four primary defendants the licensing of patented processes for the production of cracked gasoline. Moreover, the record does not show that after the execution of the agreements there was a decrease of competition among them in licensing other refiners to use their respective processes.

No monopoly, or restriction of competition, in the production of either ordinary or cracked gasoline has been proved. The output of cracked gasoline in the years in question was about 26 percent of the total gasoline production. Ordinary or straight run gasoline is indistinguishable from cracked gasoline and the two are either mixed or sold interchangeably. Under these circumstances the primary defendants could not effectively control the supply or fix the price of cracked gasoline by virtue of their alleged monopoly of the cracking processes, unless they could control, through some means, the remainder of the total gasoline production from all sources. Proof of such control is lacking. Evidence of the total gasoline production by all methods, of each of the primary defendants and their licensees is either missing or unsatisfactory in character. The record does not accurately show even the total amount of cracked gasoline produced, or the production of each of the licensees, or competing refiners.

No monopoly, or restriction of competition, in the sale of gasoline has been proved. On the basis of testimony relating to the marketing of both cracked and ordinary gasoline, the master found that the defendants were in active competition among themselves and with other refiners; that both kinds of gasoline were refined and sold in large quantities by other companies; and that the primary defendants and their licensees neither individually or collectively controlled the market price or supply of any gasoline moving in interstate commerce. There is ample evidence to support these findings.

Thus it appears that no monopoly of any kind, or restraint of interstate commerce, has been effected either by means of the contracts or in some other way. In the absence of proof that the primary defendants had such control of the entire industry as would make effective the alleged domination of a part, it is difficult to see how they could by agreeing upon royalty rates control either the price or the supply of gasoline, or otherwise restrain competition. By virtue of their patents they had individually the right to determine who should use their respective processes or inventions and what the royalties for such use should be. To warrant an injunction which would invalidate the contracts here in question, and require either new arrangements or settlement of the conflicting claims by litigation, there must be a definite factual showing of illegality.

Figure 26.2 In this iconic 1904 illustration from Puck, the Standard Oil Company is depicted as a malignant octopus wrapping its tentacles around state and federal legislatures, the White House and representatives of the steel, copper and shipping industries.

US Department of Justice Antitrust Division, June 26, 1997

The Proposed Arrangement

The Portfolio License

The planned license from MPEG LA to users of the MPEG-2 standards is a worldwide, nonexclusive, nonsublicensable license under the Portfolio patents for the manufacture, sale, and in most cases, use of: (1) products and software designed to encode and/or decode video information in accordance with the MPEG-2 standard; (2) products and software designed to generate MPEG-2 program and transport bitstreams; and (3) so-called “intermediate products,” such as integrated circuit chips, used in the aforementioned products and software.

The Portfolio license expires January 1, 2000, but is renewable at the licensee’s option for a period of not less than five years, subject to “reasonable amendment of its terms and conditions.” That “reasonable amendment” may not, however, increase royalties by more than 25%. Each Portfolio licensee may terminate its license on 30 days’ written notice. The per-unit royalties are those agreed upon in the Agreement Among Licensors, but they are subject to reduction pursuant to a “most-favored-nation” clause. The royalty obligations are predicated on actual use of one or more of the licensed patents in the unit for which the royalty is assessed. The Portfolio license imposes no obligation on the licensee to use only the licensed patents and explicitly leaves the licensee free independently to develop “competitive video products or video services which do not comply with the MPEG-2 Standard.”

The Portfolio license will list the Portfolio patents in an attachment. It also explicitly addresses the licensee’s ability, and possible need, to obtain Essential Patent rights elsewhere. The Portfolio license states that each Portfolio patent is also available for licensing independently from the MPEG-2 Licensor that had licensed it to MPEG LA and that the license may not convey rights to all Essential Patents.

The license’s grantback provision requires the licensee to grant any of the Licensors and other Portfolio licensees a nonexclusive worldwide license or sublicense, on fair and reasonable terms and conditions, on any Essential Patent that it has the right to license or sublicense. The Licensors’ per-patent share of royalties is the basis for determining a fair and reasonable royalty for the grantback. Alternatively, a licensee that controls an Essential Patent may choose to become an MPEG-2 licensor and add its patent to the Portfolio. Failure to honor the grantback requirement constitutes a material breach of the license, giving MPEG LA the right to terminate the license unless the licensee has cured the breach within 60 days after MPEG LA sends it notice of the breach.

A separate provision allows for partial termination of a licensee’s Portfolio license as to a particular MPEG-2 Licensor’s patents. Pursuant to Section 6.3, an MPEG-2 Licensor may direct MPEG LA to withdraw its patents from the Portfolio license if the licensee has (a) brought a lawsuit or other proceeding against the MPEG-2 Licensor for infringement of an Essential Patent or an MPEG-2 Related Patent (“Related Patent”) and (b) refused to grant the MPEG-2 Licensor a license under the Essential Patent or MPEG-2 Related Patent on fair and reasonable terms and conditions. As with the grantback, the per-patent share of Portfolio license royalties is the basis for determining a fair and reasonable royalty for the licensee’s patent. Upon the withdrawal of the MPEG-2 Licensor’s patents from the licensee’s Portfolio license, the licensee may seek a license on the withdrawn patents directly from the MPEG-2 Licensor, which remains subject to its undertaking to the ISO and/or the ITU-T to license on fair and reasonable terms and conditions.

Figure 26.4 Patents covering many important standards today are licensed through patent pools.

Analysis

Conclusion

Like many joint licensing arrangements, the agreements you have described for the licensing of MPEG-2 Essential Patents are likely to provide significant cost savings to Licensors and licensees alike, substantially reducing the time and expense that would otherwise be required to disseminate the rights to each MPEG-2 Essential Patent to each would-be licensee. Moreover, the proposed agreements that will govern the licensing arrangement have features designed to enhance the usual procompetitive effects and mitigate potential anticompetitive dangers. The limitation of the Portfolio to technically essential patents and the use of an independent expert to be the arbiter of that limitation reduces the risk that the patent pool will be used to eliminate rivalry between potentially competing technologies. Potential licensees will be aided by the provision of a clear list of the Portfolio patents, the availability of the Portfolio patents independent of the Portfolio, and the warning that the Portfolio may not contain all Essential Patents. The conditioning of licensee royalty liability on actual use of the Portfolio patents, the clearly stated freedom of licensees to develop and use alternative technologies, and the imposition of obligations on licensees’ own patent rights that do not vitiate licensees’ incentives to innovate, all serve to protect competition in the development and use of both improvements on, and alternatives to, MPEG-2 technology.

For these reasons, the Department is not presently inclined to initiate antitrust enforcement action against the conduct you have described. This letter, however, expresses the Department’s current enforcement intention. In accordance with our normal practices, the Department reserves the right to bring an enforcement action in the future if the actual operation of the proposed conduct proves to be anticompetitive in purpose or effect.