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Ninth Circuit Finds Grocers’ Revenue-Sharing Agreement Must Go Through Full Rule of Reason Check-Out

Recently posted in the National Law Review an article by attorney Scott Martin of Greenberg Traurig, LLP regarding Sitting en banc and affirming a district court decision, the U.S. Court of Appeals for the Ninth Circuit recently held:

Sitting en banc and affirming a district court decision, the U.S. Court of Appeals for the Ninth Circuit recently held in California ex rel. Harris v. Safeway, Inc.,[1]that an agreement among four large competing Southern California supermarket (“chains”) to share revenues during a labor dispute was neither protected from antitrust scrutiny under the non-statutory labor exemption nor so inherently anticompetitive as to be condemned per se or evaluated under a truncated “quick look” test. Rather, the agreement — which reimbursed to a chain targeted by a strike an estimation of the incremental profits, for a limited period of time, on sales that flowed to the other chains in the arrangement as a consequence of the strike — was subject to traditional rule of reason analysis, balancing any legitimate justifications against any substantial anticompetitive impacts.

Dissenting in part, Chief Judge Kozinski (joined by Judges Tallman and Rawlinson) stated that the majority’s “groundbreaking” ruling on the inapplicability of the non-statutory labor exemption was “very likely an advisory opinion,” and had “no basis in the record, common sense or precedent.”

The case arose from circumstances surrounding 2003 labor negotiations between local chapters of the United Food and Commercial Workers (UFCW) union and three of the supermarket chains that, with the union’s consent near the expiration of the labor contract, formed a multi-employer bargaining unit to negotiate. Along with the fourth chain (which also had a labor agreement that expired within months), the supermarket chains entered into a Mutual Strike Assistance Agreement (MSAA). The MSAA provided that if one of the chains was targeted for a selective strike or picketing (a so-called “whipsaw” tactic by which unions increase pressure on one employer within a bargaining unit), the other chains[2] would lock out all of their employees within 48 hours. As part of the MSAA, the chains also entered into a revenue-sharing provision (RSP), under which any of them that earned revenues during a strike or lockout above their historical shares relative to the other chains would pay 15 percent of those excess revenues to the other chains in order to restore their pre-strike shares.[3]

After negotiations with the UFCW broke down, a strike ensued. Picketing was focused on only two of the chains in the bargaining unit, and lasted for approximately four-and-a-half months. The two picketed chains ultimately were reimbursed under the RSP to the tune of approximately $146 million.

While the strike was underway, the State of California filed suit, claiming that the RSP was an unlawful restraint of trade under Section One of the Sherman Act.The grocers sought summary judgment on the ground that the RSP was immune from Sherman Act scrutiny pursuant to the non-statutory labor exemption, which shield certain restraints from Sherman Act challenge in order to allow for meaningful collective bargaining. The State also sought summary judgment on the grounds that the provision was unlawful per se, or should have been analyzed under an abbreviated (“quick look”) analysis. The district court denied both motions, and the parties pursued a streamlined appeal, after agreeing to a stipulated final judgment for defendants under which the State would not pursue the theory that the RSP was unlawful under a full rule of reason analysis, and the grocers would not pursue their affirmative defenses other than the non-statutory labor exemption.

On appeal to the Ninth Circuit, the original panel (in an opinion by Judge Reinhardt, who dissented in part[4]from the later en banc opinion that requires a full rule of reason analysis) considered the history of profit-sharing arrangements and the circumstances and details of the chains’ arrangement, applying a “quick look” analysis of sorts, and concluded that the RSP was likely to have an anticompetitive effect. The Ninth Circuit panel rejected the application of the non-statutory labor exemption, and also found that “driving down compensation to workers” as a consequence of the agreement did not constitute “a benefit to consumers cognizable under our laws as a ‘pro-competitive’ benefit.”[5]The Circuit then agreed to hear the case en banc.

In the en banc decision, the majority declared that “novel circumstances and uncertain economic effects” of the RSP required “open discovery and fair consideration of all factors relevant under the traditional rule of reason test,” thus approving the district court’s original determination of the proper standard. The Ninth Circuit majority acknowledged that application of the full test was “not a simple matter,” but concluded that “[g]iven the limited judicial experience with revenue sharing for several months pending a labor dispute, [it could not be said] that the restraint’s anticompetitive effects are ‘obvious’ under a per se or quick look approach.” The court distinguished the RSP from other profit-pooling arrangements subject to stricter scrutiny on the grounds that, by its terms, the RSP (i) was effective only for a limited and unknown duration, thus arguably preserving incentives to compete during the revenue-sharing period; and (ii) did not include all participants in the relevant markets, leaving other competitors in the market who could discipline pricing.

However, the majority then opined that the RSP was not entitled to protection from antitrust analysis under the non-statutory labor exemption. In so doing, the court distinguished the supermarket chains’ RSP from the agreement among a group of NFL teams to unilaterally impose terms and conditions from a lapsed collective bargaining agreement that was considered in the U.S. Supreme Court’s decision in Brown v. Pro Football, Inc., 518 U.S. 231 (1996) (holding that the non-statutory labor exemption may extend to an agreement solely among employers). The Ninth Circuit majority determined that revenue-sharing is not an accepted practice in labor negotiations with a history of regulation; does not play a significant role in collective bargaining; is not necessary to permit meaningful collective bargaining; does not relate to the “core subject matter of bargaining” (wages, hours and working conditions); and restricts a business or “product” market, not a labor market.

Because the State of California had stipulated to a dismissal in the event that it did not prevail on a categorical basis under a per se or quick look analysis (which it did not), Chief Judge Kozinski wrote in dissent that the majority had in effect written an impermissible advisory opinion, and had gone “out of its way to rule on thenon-statutory labor exemption.” Chief Judge Kozinski went even further, however, In his view, “all of the relevant Brown factors weigh heavily in favor of exempting the RSP from antitrust review.” This was not a case of employers using a labor dispute as a pretext for price-fixing, but rather one of employers responding to union strike tactics, and then only to the degree that the tactics were effectively deployed. According to Chief Judge Kozinski, adding to strikes “the additional threat of antitrust liability — with its protracted litigation, unpredictable rule of reason analysis and treble damages — will no doubt force employers to think twice before entering into a revenue-sharing agreement in the future” and, contrary to precedent and policy, force employers “to choose their collective-bargaining responses in light of what they predict or fear antitrust courts, not labor law administrators, will eventually decide.”[6]

With the Ninth Circuit having effectively elevated the antitrust laws over the labor laws, one might postulate a fair chance of a petition for certiorari being accepted by the U.S. Supreme Court in this case implicating significant questions of both law and public policy. Unfortunately, in light of the stipulated dismissal, such review may have to wait, as the grocery chains may lack standing, let alone incentive, to seek it here.

[1]Nos. 08-55671, 08-55708 (9th Cir. July 12, 2011).

[2]The fourth chain, which was not in the original multi-employer bargaining unit, was not required by the MSAA to engage in the lockout.

[3]The RSP would be in effect until two weeks following the end of a strike or lockout, and it required the chains to submit weekly sales data for an eight-week period prior to the strike or lockout to a third-party accountant.

[4]Judges Schroeder and Graber joined in Judge Reihardt’s partial dissent.

[5]California ex rel. Brown v. Safeway, Inc., 615 F.3d 1171, 1192 (9th Cir. 2010).

[6]Quoting Brown, 518 U.S. at 247.

Guilty Plea for Altering HSR Documents

Recently posted in the National Law Review an article by Jonathan M. Rich and Sean P. Duffy of Morgan, Lewis & Bockius LLP about penalties for dishonesty in Hart-Scott-Rodino (HSR) filings:

The U.S. Department of Justice (DOJ) has provided a jarring reminder of the penalties for dishonesty in Hart-Scott-Rodino (HSR) filings. On August 15, the DOJ announced that Nautilus Hyosung Holdings Inc. (NHI) agreed to plead guilty to criminal obstruction of justice for altering documents submitted with an HSR filing. NHI agreed to pay a $200,000 fine, but the DOJ can still pursue criminal prosecution—and potential incarceration—of an NHI executive.

Companies must make HSR filings with the DOJ and Federal Trade Commission (FTC) and observe a waiting period before closing to enable the agencies to evaluate the likely impact of the transaction on competition. Item 4(c) of the HSR notification form requires parties to provide copies of “all studies, surveys, analyses and reports which were prepared by or for any officer or director . . . for the purpose of evaluating or analyzing the acquisition with respect to market shares, competition, competitors, markets, potential for sales growth or expansion into product or geographic markets.” Such “4(c) documents” provide the agencies with their first insight into the potential impact of a transaction on competition.

NHI, a manufacturer of automated teller machines (ATMs), made a filing in August 2008 in connection with its proposed acquisition of Trident Systems of Delaware (Trident), a rival ATM manufacturer. According to the plea agreement filed in the U.S. District Court for the District of Columbia, an unnamed NHI executive altered 4(c) documents to “misrepresent and minimize the competitive impact of the proposed acquisition on markets in the United States and other statements relevant and material to analyses . . . by the FTC and DOJ.”

Despite the altered documents, the DOJ initiated a merger investigation and requested additional documents from NHI, including copies of preexisting business plans and strategic plans relating to the sale of ATMs for the years 2006-2008. The company submitted the requested materials in early September 2008. According to the plea agreement, an NHI executive altered the business and strategic plans to misrepresent statements concerning NHI’s business and competition among vendors of ATMs.

In early 2009, NHI told the DOJ that an executive had altered 4(c) and other documents produced to the government. NHI and Trident abandoned the proposed transaction shortly thereafter. According to the plea agreement, NHI provided substantial cooperation with the DOJ’s obstruction of justice investigation.

According to the DOJ, the recommended fine of $200,000-$100,000 for each count-takes into account the nature and extent of the company’s disclosure and cooperation. NHI could have faced a maximum fine of up to $500,000 per count of obstruction of justice under 18 U.S.C. § 1512(c). The plea agreement reserves the DOJ’s right to pursue criminal prosecution of the executive involved in the alterations.

Italian Competition Authority Finds Abusive Conduct in Withholding Data and Internal Communications Praising Company Strategy

Posted on August 25th in the National Law Review an article by Veronica Pinotti and Martino Sforza of McDermott Will & Emery which highlights the dangers faced by a dominant market player that owns intellectual property rights or data that are essential for other companies to compete.

On 5 July 2011, the Italian Competition Authority imposed fines of €5.1 million on a multinational crop protection company for having abused its dominant position on the market for fosetyl-based systemic fungicides in breach of Article 102 of the Treaty on the Functioning of the European Union. In addition, the Authority issued an injunction restraining the company from such conduct in the future.

The Authority considered that the multinational was able to increase its prices for finished products on the downstream market while increasing the volume of its own sales, showing a high degree of pricing policy independence.

In making its decision, the Authority also took into account the fact that, in addition to its high market share, the multinational was the only vertically integrated manufacturer with significant financial capability and it owned certain research data required for the commercialisation of fosetyl-based products. According to the Authority, these data are vital for accessing the market, given that they are indispensable for competitors seeking to renew marketing authorisations, because the current legislation restricts the repetition of tests on vertebrate animals. The Authority noted that certain competitors that had joined a task force for the purpose of negotiating access to the multinational’s data were disqualified from renewal of their marketing authorisations and had to leave the market. Refusal by the multinational to grant access to the data was therefore found to be abusive.

The Authority reviewed a number of the multinational’s internal communications that praised the results obtained in the fosetyl-based business in Italy, thanks to the strategy adopted by the company. According to the Authority, these communications proved that the company was aware of the anti-competitive character of their conduct.

In the Authority’s view, the company’s conduct constituted a serious infringement and therefore deserved a very high fine.

Comment

The case highlights the dangers faced by a dominant market player that owns intellectual property rights or data that are essential for other companies to compete. The case also illustrates the importance of the language used by businesses in their internal communications, given that internal communications are often used by the Authority when reaching a decision on potential infringements. Refusals to licence or grant access to market-essential data can only be made if there are objective grounds for doing so. This is a difficult issue on which dominant companies should seek legal advice.

FTC And DOJ Issue Proposed Statement Of Antitrust Policy Regarding Accountable Care Organizations Seeking To Participate In The Medicare Shared Savings Program

Recently posted at the National Law Review by Scott B. Murray of Sills Cummis & Gross P.C. information about the Federal Trade Commission (“FTC”) and Department of Justice’s Antitrust Division (“DOJ”) joint Proposed Statement of Antitrust Enforcement Policy Regarding Accountable Care Organizations:

The Federal Trade Commission (“FTC”) and Department of Justice’s Antitrust Division (“DOJ”) recently issued a joint Proposed Statement of Antitrust Enforcement Policy Regarding Accountable Care Organizations Participating in the Medicare Shared Savings Program (the “Policy Statement”). The Policy Statement details how the federal antitrust agencies will apply the nation’s antitrust laws to accountable care organizations (“ACOs”) created pursuant to the health care reform act, the Patient Protection and Affordable Care Act (the “Act”). Public comments were to be submitted by May 31, 2011.

The agencies identify the potential advantages and disadvantages of ACOs that they will examine under the antitrust laws. The agencies “recognize that ACOs may generate opportunities for health care providers to innovate in both the Medicare and commercial markets and achieve for many consumers the benefits Congress intended for Medicare beneficiaries through the Shared Savings Program.” Policy Statement, at p. 2. However, the agencies also understand that “not all such ACOs are likely to benefit consumers, and under certain conditions ACOs could reduce competition and harm consumers through higher prices or lower quality services.” Id.

ACOs Covered By Policy Statement

The Policy Statement applies to “collaborations among otherwise independent providers and provider groups, formed after March 23, 2010, that seek to participate, or have otherwise been approved to participate, in the Shared Savings Program.” Id. “[C]ollaboration” is defined to mean an agreement or set of agreements, other than merger agreements, thus, the Policy Statement does not apply to mergers among health care providers, which will still be analyzed under the Horizontal Merger Guidelines. Id.

The Rule of Reason Will Be Applied To ACOs

The agencies have previously stated that joint price agreements among competing health care providers are evaluated under the Rule of Reason, if the providers are financially or clinically integrated and the agreement is reasonably necessary to accomplish the pro-competitive benefits of the integration. The Rule of Reason “evaluates whether the collaboration is likely to have substantial anticompetitive effects and, if so, whether the collaboration’s potential pro-competitive efficiencies are likely to outweigh those effects.” Id., at p. 4. Thus, “the greater the likely anticompetitive effects, the greater the likely efficiencies must be to pass muster under the antitrust laws.” Id.

In prior pronouncements regarding health care provider collaborations, the agencies have stated that sufficient financial integration exists if the collaboration’s participants have agreed to share substantial financial risk, because such risk-sharing generally establishes both an overall efficiency goal for the venture and the incentives for the participants to meet that goal. The agencies have previously provided a number of examples of satisfactory financial risk-sharing arrangements, while noting that the examples did not represent an exhaustive list.

Regarding clinical integration, while not previously providing specific examples, the agencies have noted that such integration must be “sufficient to ensure that the venture is likely to produce significant efficiencies.” Id., at p. 4. The Act authorizes CMS to approve ACOs meeting certain eligibility criteria, and the Policy Statement indicates that “CMS’s proposed eligibility criteria are broadly consistent with the indicia of clinical integration that the Agencies previously set forth [and that] organizations meeting the CMS criteria for approval as an ACO are reasonably likely to be bona fide arrangements intended to improve quality, and reduce the costs, of providing medical and other health care services through their participants’ joint efforts.” Id., at p. 5. Because many health care providers will want to use the ACO structure in both the commercial market and the Medicare context, “if a CMS-approved ACO provides the same or essentially the same services in the commercial market the Agencies will provide rule of reason treatment to an ACO if, in the commercial market, the ACO uses the same governance and leadership structure and the same clinical and administrative processes as it uses to qualify for and participate in the Shared Savings Program.” Id., at p. 5. The Rule of Reason analysis applies to ACOs for the length of their participation in the Shared Savings Program.

Streamlined Approach For The Rule Of Reason Analysis Of ACOs

The Policy Statement provides a streamlined approach to determining market shares for the common services provided by an ACO’s participants. The first step is to list the common services provided by two or more of the ACOs’ participants. The list of services for the various types of health care providers ( i.e., physicians, inpatient facilities, and outpatient facilities) will be made available by CMS. The second step is to determine the Primary Service Area (“PSA”) for each common service of the ACO participants. “The PSA is defined as the lowest number of contiguous postal zip codes from which the participant draws at least 75 percent of its patients for that service.” Id., at pp. 7 & 12.

If the ACO participants do not provide any common services in any of the same PSAs, then the ACO needs to determine if any ACO participant is a “Dominant Provider,” meaning a participant with greater than 50 percent market share for a service in a PSA. If the ACO does include a Dominant Provider, such participant must be non-exclusive to ACO, and the ACO cannot require commercial payers to be exclusive to ACO or otherwise restricted in dealing with other ACOs or providers.

Safety Zone Applies If ACO Has Less Than 30 Percent Combined Market Share For All Common Services In All PSAs

If there are common services provided by two or more ACO participants in the same PSA, then the ACO must calculate its combined market share for each such common service in each PSA. CMS will make available Medicare fee-for-service data sufficient for physicians and outpatient facilities to calculate their market shares. For inpatient facilities, market shares should be calculated based on “inpatient discharges, using state-level all-payer hospital discharge data where available, for the most recent calendar year for which data are available.” Id., at p. 13. Where such data is not available, Medicare fee-for-service payment data should be used, or other available data if such Medicare data is insufficient.

If the combined market share for each common service in each PSA is less than 30 percent, then the ACO falls within the “safety zone,” meaning that there will be no agency challenge of the ACO absent extraordinary circumstances. If the combined share for even one common service is greater than 30 percent in a PSA, the safety zone does not apply.

In addition, for the safety zone to apply, any hospital or ambulatory surgery center participating in the ACO must be non-exclusive – i.e., allowed to contract or affiliate with other ACOs or commercial payers – regardless of its PSA market shares. If the ACO falls within the safety zone, but includes a Dominant Provider, then the same Dominant Provider requirements described above must be met.

An ACO may include one physician per specialty from each “rural county” (as defined by the U.S. Census Bureau), and a Rural Hospital, on a non-exclusive basis and still qualify for the safety zone even if the inclusion of the rural provider or Rural Hospital makes the ACO’s combined market share for a common service greater than 30 percent in a PSA.

Mandatory Review By The Agencies Applies If ACO Has Greater Than A 50 Percent Combined Market Share For Any Common Service In A PSA

If an ACO’s combined market share for any common service in any PSA is greater than 50 percent, the ACO must make a submission to the agencies for a mandatory initial review of the ACO’s potential competitive effects. Thus, if the combined share for even one of the ACO’s common services is greater than 50 percent in a PSA, review by the antitrust agencies is mandatory. The mandatory review requirement does not mean that the ACO is presumed to be anticompetitive, but only that an initial review is necessary.

The ACO must submit to the agencies a copy of its application and all supporting documents that the ACO plans to submit, or has submitted, to CMS or that CMS requires the ACO to retain as part of the Shared Savings Program application process. In addition, the ACO must submit other documents that will allow the agencies to analyze the ACO’s potential competitive effects. If the agencies receive all such documentation in a timely fashion, they have committed to completing the review in an expedited, 90-day time period. The additional documents that must be submitted include documents relating to the ability of the ACO’s participants to compete with the ACO, the ACO’s business strategies, competitive plans, and likely impact on prices, cost, or quality of any service the ACO provides, any other ACOs created by or affiliated with the proposed ACO or its participants, the ACO’s market share calculations, the identity of the ACO’s five largest payer customers, and the identity of any competing ACOs. Id., at pp. 9-10.

After receiving this documentation, the reviewing agency will advise the ACO within 90 days of whether it has no intent to challenge the ACO or is likely to challenge it. CMS will not approve an ACO that has received a letter of likely challenge.

No Man’s Land If > 30 Percent, But << 50 Percent Combined Share

Given the safety zone and mandatory review thresholds, there is a no man’s land for ACOs with market shares for common services that fall between these two thresholds – i.e., if the ACO has a combined market share for any common service in any PSA greater than 30 percent, but no combined market share greater than 50 percent in any PSA. While there is no presumption that ACOs falling in this no man’s land will have anticompetitive effects, the agencies have identified certain conduct that such ACOs should avoid to reduce the risk of challenge by the antitrust agencies:

1. Steering or incentivizing commercial payers away from providers outside the ACO.

2. Tying sales of the ACO’s services to the purchase of non-ACO services (and vice versa).

3. Contracting with ACO participants on an exclusive basis (except for primary care physicians, who can be exclusive to an ACO).

4. Prohibiting commercial payers from providing health plan participants with the ACO’s cost, quality or other performance information.

5. Sharing price or other competitive information among the ACO’s participants that can be used to collude regarding non-ACO services.

ACOs with market shares requiring mandatory review should also avoid such conduct to reduce the risk of antitrust challenge.

If an ACO falling within the no man’s land desires to obtain further certainty regarding whether it will face an antitrust challenge, it can request expedited antitrust review by the agencies similar to the mandatory review process.

Likely Concerns Regarding The Proposed Policy Statement

Potential public comments to the Policy Statement include:

1. Whether non-exclusivity should be required for a hospital or ambulatory surgery center if the ACO still falls within the safety zone for all common services and does not include a Dominant Provider for any service.

2. Whether the 30 percent and 50 percent market share thresholds are appropriate.

3. Are PSAs an appropriate proxy for the relevant antitrust geographic market?

4. Will the Medicare and other publicly available data allow for accurate market share calculations?

5. Will the mandatory review process represent an unreasonable time and cost burden to be incurred by proposed ACOs?

6. Should the Policy Statement include additional examples of market share calculations for hypothetical ACOs?

The Policy Statement represents a substantial and welcome effort on the part of the agencies to provide guidance to the health care industry regarding the antitrust analysis to be applied to ACOs seeking to participate in the Shared Savings Program; however, it is likely that some procedural and substantive modifications will be necessary to help health care providers fully achieve the goals of the Act through the formation of ACOs.

This article appeared in the June 2011 issue of The Metropolitan Corporate Counsel.

The views and opinions expressed in this article are those of the author and do not necessarily reflect those of Sills Cummis & Gross P.C.

Texas Supreme Court Makes Enforcement of Noncompete Agreements Easier for Employers

Posted this week at the National Law Review by Morgan, Lewis & Bockius LLP a good recap of the Texas Supreme Court decision which clarifies the standards for enforcing noncompete agreements:

On June 24, the Texas Supreme Court issued a long-awaited decision clarifying the standards for enforcement of noncompete agreements under the Texas Business and Commerce Code. In Marsh USA Inc. and Marsh & McLennan Cos. v. Rex Cook, the court considered whether an employee’s receipt of stock options could sustain an agreement that prohibited the employee from soliciting or accepting business from certain customers of Marsh McLennan (Marsh).

Noncompete agreements, which include prohibitions on working for a competitor and limitations on an employee’s ability to solicit customers, are governed in Texas by the Texas Business and Commerce Code. Under that statute, such agreements may be enforced only if they contain reasonable limitations with respect to geography, time, and scope of activity to be prohibited and only if they are “ancillary to or part of an otherwise enforceable agreement.” Texas courts, as well as practitioners and employers, have struggled with this latter requirement. The Cook case represents a significant change in Texas law and a departure from the Texas Supreme Court’s previous analysis of noncompete agreements.

Under previous court decisions, the analytical focus was on the type of consideration provided by the employer in exchange for the employee’s promise to refrain from competing. Specifically, a Texas employer seeking to enforce a noncompete agreement must have been able to show that the consideration it provided to the employee “gave rise to an interest” in restraining competition. For example, an employer’s promise of trade secrets or confidential information was deemed sufficient consideration to support a noncompete agreement whereas simple cash consideration was not.

In Cook, the Texas Supreme Court considered whether an employer’s grant of stock options satisfied the “ancillary” prong of the Texas Business and Commerce Code. Cook joined Marsh in 1983 and signed an agreement under which he could exercise certain stock options in exchange for signing an agreement limiting his ability to solicit or accept business from clients of Marsh with whom he had business dealings during his employment. Cook thus signed the noncompete agreement not when he was provided the original grant of stock options, but rather when he chose to exercise the options.

After his separation from employment with Marsh, Cook went to work for a competitor. He thereafter was sued by Marsh for breach of his contract and for breach of fiduciary duty. Cook filed a motion for summary judgment in the district court on the grounds that the agreement was unenforceable under the Texas Business and Commerce Code. The trial court granted Cook’s motion and an appellate court affirmed that ruling.

The Texas Supreme Court, in a 6-3 opinion, disagreed with the lower courts and reversed the grant of summary judgment. Significantly, the court overruled previous authority that focused on the type of consideration provided by the employer and the assessment of whether or not that consideration “gives rise” to an interest in restraining competition. Rather, the court construed the Texas Business and Commerce Code as requiring simply that there be a nexus between the noncompete agreement and the employer’s interests, holding that the noncompete agreement “must be reasonably related to the [employer’s] interest worthy of protection.” The court emphasized Cook’s high-level executive position with the company and found that, by providing an ownership interest in the company, the stock options provided to Cook were “reasonably related to the company’s interest in protecting its goodwill, a business interest the [Texas Business and Commerce Code] recognizes as worthy of protection.” The noncompete was thus enforceable on that basis.

As a practical matter, Cook should make enforcement of noncompete agreements easier in Texas. The decision represents a shift from the previous, more technical focus on the type of consideration provided in the noncompete agreement to a more generalized assessment of the employer’s interests in restraining competition. Cook follows a trend of other recent Texas Supreme Court cases that have found that the enforcement of noncompete agreements should be decided in the context of the overall purpose of the Texas Business and Commerce Code, which is to provide for reasonable restrictions that protect legitimate business interests.

U.S. Supreme Court Establishes State-of-Mind Requirement for Inducing Infringement Liability

As posted in the National Law Review yesterday by R. (Ted) Edward Cruz of Morgan, Lewis & Bockius LLP – a good overview of the knowledge a patent infringement plaintiff needs to prove:

Today (May 31), the U.S. Supreme Court issued its decision in Global-Tech Appliances, Inc., et al. v. SEB S.A., No. 10-6 (2011), holding that to prove inducing infringement under 35 U.S.C. § 271(b) a plaintiff must prove that the infringer had knowledge that “the induced acts constitute patent infringement.” The Court also held that this knowledge requirement can be satisfied by evidence of “willful blindness.”

Morgan Lewis represented SEB in this case. The leader of our U.S. Supreme Court and Appellate Litigation Practice, Ted Cruz, argued the case on February 23. In today’s decision, by an 8-1 vote, our client prevailed.

On the facts of the case, SEB had developed an innovative method to produce household deep fryers and received a U.S. patent for this invention. A foreign competitor, Global-Tech Appliances, purchased one of SEB’s fryers in Hong Kong where it would not have patent markings, reverse-engineered SEB’s fryer, and then copied the SEB fryer’s unique technology. Global-Tech hired a patent attorney to conduct a patent search, but deliberately chose not to tell that attorney that its fryer was a copy of another company’s commercially successful fryer. The attorney did not locate SEB’s patent in its patent search. Global-Tech then sold its fryers to U.S. companies to sell within the United States. SEB sued Global-Tech for patent infringement and inducing infringement, and the jury found for SEB on all counts.

On appeal, Global-Tech challenged the finding on inducing infringement liability due to a lack of evidence of its actual knowledge of SEB’s patent. Section 271(b) provides that “[w]hoever actively induces infringement of a patent shall be liable as an infringer.” Over the last two decades, the Federal Circuit has offered various formulations of what mental-state requirement must be proven to establish liability under § 271(b). On appeal in this case, the Federal Circuit held that the mental-state requirement could be satisfied by evidence of “deliberate indifference of a known risk that a patent exists” and that Global-Tech’s actions constituted such deliberate indifference.

The Supreme Court rejected the Federal Circuit’s analysis but nonetheless affirmed the judgment. The Court held that inducing infringement liability under § 271(b) requires evidence that the infringer had knowledge that “the induced acts constitute patent infringement.” Adopting the argument advanced by SEB, the Court held that this knowledge requirement could be satisfied by evidence of “willful blindness.” After analyzing the record, the Court held that the judgment for SEB could be affirmed based on the evidence of Global-Tech’s willful blindness. The Court focused on Global-Tech’s decision to purchase the fryer to reverse-engineer it overseas (where it would not have U.S. patent markings) and then to deliberately withhold from its attorney the basic information that its fryer was a copy of SEB’s fryer.

This decision clears up an issue of long-standing confusion in the Federal Circuit as to the mental-state requirement of § 271(b). The Court’s explication of the standard should be welcome news to both innovators and holders of patents. The decision prevents frivolous claims of inducing infringement by requiring proof of knowledge of infringement. At the same time, it allows companies to protect their intellectual property rights against those companies that willfully blind themselves to a lawful patent in order to copy a commercially successful product. Corporations hiring attorneys to conduct patent searches should be sure to disclose to their attorneys any products copied or relied upon in developing a new technology.

Prevailing Antitrust Defendants Recover $367,000 in e-Discovery Costs

Posted yesterday at the National Law Review by Eric S. O’Connor of Sheppard Mullin – a recent case out of the Western District of PA – Race Tires America v. Hoosier Racing Tire Corp., where prevailing antitrust defendants were awarded by the court $367,000 in e-discovery costs incurred by their vendor.

Recently, prevailing antitrust defendants were awarded $367,000 in e-discovery costs incurred by their vendor. See Race Tires America v. Hoosier Racing Tire Corp., 2011 WL 1748620 (W.D. Pa. May 6, 2011). While the Court labeled the facts as “unique” and that its holding was limited, the Court’s opinion is very thorough and the facts may be familiar to many antitrust defendants.

In today’s age where the costs of e-discovery can run several hundred thousand dollars or more and outside vendors are routinely hired to help, this holding can be used as a shield and a sword. During discovery, a party can alert the other side that aggressive discovery requests and a demand for many electronic search terms is a major factor in awarding costs of e-discovery – if the responding party prevails. And, if a party should prevail, the potential for an award of the costs of e-discovery can be an additional bonus and/or leverage for any post-verdict resolution without appeal.

The facts are simple. Plaintiff Specialty Tires America (STA) brought antitrust claims against Hoosier Racing, its tire supplier competitor, and Dirt Motor Sports, Inc. d/b/a World Racing Group, a motorsports racing sanctioning body. STA claimed that a so-called “single tire rule” by various sanctioning bodies like Dirt Motor Sports, as well as the related exclusive supply contracts between some of these sanctioning bodies and Hoosier violated Section 1 and 2 of the Sherman Act and caused STA in excess of $80 million in damages. See Race Tires America v. Hoosier Racing Tire Corp., 614 F. 3d 57, 62-73 (3d Cir. 2010). The District Court granted summary judgment in favor of defendants finding that STA had failed to demonstrate antitrust injury, and the Third Circuit Court of Appeals affirmed. Id. at 83-84.

The normal rule that “costs — other than attorney’s fees — should be allowed to the prevailing party” (Fed. R. Civ. P. 54(d)(1)) creates a “strong presumption” that all costs authorized for payment will be awarded to the prevailing party, so long as the costs are enumerated in 28 U.S.C. § 1920, the general taxation-of-costs statute. As prevailing parties, the defendants each filed a Bill of Costs in which the majority of amounts requested were e-discovery costs. Plaintiff objected arguing that e-discovery costs were not taxable under 28 U.S.C. § 1920(4).

Section 1920(4) allows recovery of “[f]ees for exemplification and the costs of making copies … necessarily obtained for use in the case.” 28 U.S.C. § 1920(4). There are two statutory interpretation questions that have divided Courts. First, costs of electronic scanning of documents can be recoverable as “necessary” or unrecoverable as a mere “convenience.”

The other issue takes a few different forms, but focuses on whether the terms “exemplification” and “copying”, which originated in the world of paper, should be limited to physical preparation or rather updated to take into account changing technology and e-discovery. The Court discussed a litany of these cases. Some courts that have applied § 1920(4) to today’s e-discovery demands, have limited exemplification and copying to just the costs for scanning of documents, which is considered merely reproducing paper documents in electronic form, and refused to extend the statute to cover processing records, extracting data, and converting files. Courts are also divided on whether extracting, searching, and storing work by outside vendors are unrecoverable paralegal-like tasks, or whether such costs are recoverable because outside vendors provide highly technical and necessary services in the electronic age and which are not the type of services that paralegals are trained for or are capable of providing.

In this case, because the Court and the parties anticipated that discovery would be in the form of electronically stored information and because plaintiff aggressively pursued e-discovery (e.g., directing 273 discovery requests to one defendant and imposing over 442 search terms), defendants’ use of e-discovery vendors to retrieve and prepare e-discovery documents for production was recoverable as an indispensable part of the discovery process. The Court also found that the vendor’s fees were reasonable, especially because the costs were incurred by defendants when they did not know if they would prevail at trial.

The Court also denied the plaintiff’s request for a Special Master to assess the reasonableness of e-discovery costs incurred by the prevailing defendants as an unnecessary cost and delay.

Antitrust, Intellectual Property Rights, and the Online Music Industry: An Antitrust Analysis of Apple’s Combination of Services and Products

The National Law Review would like to congratulate Rui Li of the The University of Iowa College of Law one of our Spring 2011 Student Legal Writing Contest Winners. Rui’s topic is An Antitrust Analysis of Apple’s Combination of Services and Products:

I. INTRODUCTION

For many music consumers, the ideal medium for music is digital. It offers many advantages over CDs, including easier distribution, decreased physical size, greater choice in the medium of sound reproduction, and the ability to include digital data such as artistic information and graphic artwork.ⁱ Online music stores offer more variety than consumers would get in a brick-and-mortar store, including reviews, recommendations, and other interactive features which increase the choices for consumers.ⁱⁱ The advantages of digital music, coupled with the efficiency of online purchasing, have helped online music stores such as Apple’s iTunes Store become the most prevalent form of commercial music distribution.ⁱⁱⁱ However, online music piracy has been harming the music industry via lost CD sales even before commercial distribution of music over the Internet became prevalent. As online music firms attempt to tackle online music piracy, both antitrust enforcement agencies and private plaintiffs have raised concerns. Some of the solutions implemented by online music firms appear to promote competition by protecting intellectual property rights. However, others require closer scrutiny because some actions taken to protect these intellectual property rights have been, at times, abusive.

The tactics used by Apple to combat digital piracy have drawn legal scrutiny from a number of sources in recent years. In June 2006, the antitrust enforcement agencies of Norway, Sweden and Denmark filed a complaint against Apple regarding the restrictions it placed on iTunes audio downloads, an action that was later joined by Germany and France.^iv On December 31, 2007, a group of plaintiffs brought an antitrust lawsuit against Apple in the United States District Court for the Northern District Court of California, charging Apple with maintaining an illegal monopoly on the digital music market.^v On December 28, 2008, the court granted plaintiffs’ motion for class certification against Apple.^vi On May 25, 2010, the New York Times reported that the United States Department of Justice was examining Apple’s tactics in the market for digital music.^vii In light of this scrutiny, in 2009 Apple stopped selling music downloads with its proprietary digital rights management (“DRM”) restrictions, a technology that prevented audio downloads purchased through the iTunes Store from playing on portable media players other than Apple’s iPod.^viii Given the dominant position of iTunes in online music distribution, the effect of Apple’s decision to remove DRM restrictions on the online music industry and the fight against online music piracy remains to be seen.^ix

Apple’s digital music business has important ramifications for antitrust law that this Note explores. Part II of this Note examines Apple’s digital music business practices with particular emphasis on the manner in which Apple combines products and services. Part III engages in an antitrust analysis of four possible causes of action against Apple’s business conduct with an eye toward the market structure of the digital music industry. The Note concludes that Apple’s combination of products and services is procompetitive, and, in addition, offers a promising solution to digital music piracy.

II. IPOD, ITUNES AND ITUNES STORE

In 2001, Apple introduced the iTunes music software application to help music consumers organize, browse, and play digital media. In 2003, Apple launched the iTunes Store which, in April 2008, became the number one music vendor in the United States.^x On February 24, 2010, the Store had its 10 billionth song download and a music catalog of over 12 million songs.^xi iTunes Store now accounts for seventy percent of the worldwide digital music download retail market.^xii

Until January 2009, Apple restricted iTunes Store and iTunes Software to work only with its own portable media player, the iPod, a product that currently claims 70 percent of the portable media player market.^xiii Apple restricted the iPod so it could only play files embedded with Apple’s own DRM downloads called “FairPlay”, and no one else’s. Likewise, files downloaded from the iTunes Store could only be played on an iPod. Apple maintained this closed system through regular updates and the threat of legal action. Most notably, in 2005, Apple forced RealNetworks to abandon its “Harmony” technology through software updates and the threat of patent infringement lawsuit.^xiv Harmony allowed music downloads purchased through RealNetworks direct playback on iPod.

III. ANTITRUST ANALYSIS WITH AN EYE TOWARD THE MARKET STRUCTURE OF THE MUSIC INDUSTRY

As a precursor to an analysis of Apple’s conduct from an antitrust perspective, an inquiry must be made into the market structure of the music industry.

A. The Equilibrium Between Major Labels, Online Music Vendors, and Customers

The music market is highly concentrated, dominated by a small number of large firms (hereinafter “Major Labels”: Sony Music Entertainment, Universal Music Group, Warner Music Group, and EMI Music Group). Major Labels’ collective catalogs comprise about 85 percent of the distribution rights in the music industry.^xv Each of these firms has exclusive control of a large and fungible catalog of intellectual property. In the past, Major Labels have taken advantage of their dominant position to extend market power into downstream distribution channels.^xvi These practices have at times drawn the attention of antitrust enforcement agencies. In 2000, the Major Labels settled the Federal Trade Commission’s charge of restraining competition in the music market.^xvii

The significant economies of scale achieved through the grouping of thousands of authors’ and composers’ copyrighted music products operate as a barrier for other firms to enter the music licensing market. This concentrated market structure lays the groundwork for a tacitly collusive environment in which Major Labels can achieve collusive results in the online music market through the non-collusive exercise of their power in the licensing market. Under this tacitly collusive structure, they may be able to reach a consensus about how to develop the online music market without explicitly agreeing with each other. If one of the Major Labels sets a high and relatively profitable licensing price, the rest of the Major Labels may follow the practice of the price-setting firm even though they do not formally communicate with each other.

The appearance of online music vendors poses a threat to this shared dominant market position. Scholars estimate that Major Labels would lose thirty to forty percent of their profit margins if online music vendors could freely compete with Major Labels.^xviii To protect their advantage, it is in the Major Labels’ best interest to either deny market entry to online music vendors or bring them into the fold in an advantageous manner. Fortunately for the Major Labels, this is not much of a challenge because the barriers to entry are high and the products are fungible.^xix In addition, copyright laws have given Major Labels influence over online music vendors.^xx Major Labels can potentially use licensing practices to create prohibitive barriers to entry or to contractually bind online music vendors to the pricing structure of the CD market.^xxi Because of this market structure, online music vendors stand little chance of success competing with the traditional distribution networks established by the Major Labels over the decades.^xxii

A major, common priority of Major Labels is to gain control of the digital music distribution market. To achieve this goal, in descending order of preference, Major Labels have the potential strategies of: 1) attempting to terminate online music piracy through vigorous infringement suits or other form of antipiracy enforcement measures, 2) extracting shared monopoly profits from online sales at a rate higher than or equal to that from CD sales, or 3) expanding volume of online sales at lower profit levels by licensing online music at reasonable rates.^xxiii An examination of the economic theories explaining the behaviors of oligopolies lends support to the prediction of strategies laid out above.^xxiv The part that follows will compare the actual practices of Major labels to the behaviors predicted above.

Strategy No.1: Terminating online music piracy through vigorous infringement suits or other form of antipiracy enforcement measures. In 2003, the Recording Industry Association of America (RIAA), the representative of Major Labels, began attacking online music piracy by filing mass infringement suits. However, this approach, besides being expensive and time consuming, backfired.^xxv It not only failed to win public sympathy for the music industry but also demonized the plaintiffs, the Recording Industry Association of America and the copyright holders they represented.^xxvi In light of this, the RIAA announced in December 2008 that it was ending its mass infringement suits and attempting to cooperate with Internet Service Providers whereby Internet Service Providers will suspend or terminate Internet users’ service after repeated RIAA notices of alleged piracy.^xxvii

Strategy No.2: Extracting shared monopoly profits from online sales at a rate higher than or equal to that from CD sales. In 2001, Major Labels pooled their catalogs into two non-overlapping online music vendors, MusicNet and Pressplay.^xxviii They refused to license music for less than two dollars per song, and, in some cases, as much as three and a half dollars.^xxix In addition, the music downloads are not transferable to CDs. In 2002, the Major Labels licensed Listen.com for a price of 99 cents per song, roughly the equivalent to the price of a CD.^xxx Still, most of that music could not be burned to a CD.^xxxi In March 2001, U.S. Department of Justice opened an investigation into alleged collusion in the online market.^xxxii However, the DOJ later dropped the investigation in 2003 because “major labels licensed their music to a broader array of third-party music services that compete on price and features” and that unrelated firm Roxio’s acquisition of Pressplay diminished the possibility of collusion.^xxxiii

Strategy No.3: Expanding volume of online sales at lower profit levels by licensing online music at reasonable rates. By the end of 2002, the Major Labels had licensed their catalogs to all major online music vendors which charged a nine to ten dollars per month subscription fee, plus 99 cents per burnable download.^xxxiv

During this period Apple launched iTunes Store with a market model combining iTunes Store, iTunes Software, and iPod. The combination proved to be a huge success. Apple was thus able to dispense with subscription fees.^xxxv In 2008, Apple became the number one music vendor.^xxxvi The entrance of a radically efficient product model, the iTunes-iPod combination, coupled with the shared interest of Apple and Major Labels in eliminating online music piracy, promoted competition, lowered costs, improved services, and increased overall economic efficiency in the music industry.

The evolution of the online music market showed that even though Major Labels’ preference of options may partially be explained as legitimate attempts to eliminate online music piracy, they still had every incentive to thwart the development of the online music market despite the fact that customers preferred music downloads. Major Labels thought the rising of the online music market and the new business models for delivering music would deprive them of their control over the market. But when they realized they were not able to stop the development of online music distribution, they attempted to control the pace and the manner of development of online music.^xxxvii

Apple’s business model combines pricing, ease of use, and technical prohibition in a way that significantly decreases the incentives for customers to choose pirated music. However, it remains to be seen whether the appearance of powerful market participant such as Apple will eventually create a more competitive environment, bring down the costs of online music, and terminate online music piracy. Therefore, the courts and the antitrust enforcement agencies should understand the equilibrium between the music industry’s interest in controlling mechanisms of distribution, the threat of online music piracy, online music vendors’ interest in lowering licensing costs, and the consumers’ interest in innovative and effective access to music. The courts could consider refraining from imposing direct legal action against online music vendors such as Apple. History has shown that time and market forces often provide equilibrium in balancing interests, whether the new technology is a player piano, a copier, a tape recorder, a video recorder, a personal computer, or a MP3 player.

B. The Alleged “Tying Arrangement” of iPod, iTunes Music Store, And iTunes Software

“Tying” occurs when a seller insists that the buyer take a second, or “tied”, product as a condition of obtaining the seller’s initial “tying” product.^xxxviii Tying arrangements can be condemned either as contracts in restraint of trade under section 1 of the Sherman Act, or else under the more explicit provisions of section 3 of the Clayton Act.^xxxix

Prior to January 2009, Apple had created something that resembles a tying arrangement by using its FairPlay technology to require owners of iPods to purchase digital music from the iTunes Store (users could still use music ripped from CDs or downloaded from unauthorized websites).

Tying is illegal per se when the defendant ties two separate products and has market power in the tying product.^xl The “leverage” theory articulated by Justice Brandeis in Caprice was the only theory articulated by the Supreme Court supporting the per se approach. The theory understood tying arrangements as inherently anticompetitive because it permitted a monopoly firm to “leverage” its market power to a product market in which it lacked market power, increasing its monopoly profits.^xli The leverage theory has largely been discredited by economists who argue that when the second product is imposed as a cost of using the first monopoly product, the monopolists are not necessarily better off because the elevated price of the tied product reduces the consumers’ willingness to pay for the tying product. It is now widely accepted most tying arrangements are procompetitive and efficient.^xlii While the “leverage” theory of tying has been largely debunked, the market foreclosure theory continues to have relevance. It is now understood that tying arrangements are anticompetitive only in the rare cases that tying denies rivals access to markets.^xliii However, economists have argued that this “access denial” or “entry barrier” theory is only marginally more plausible than the “leverage” theory.^xliv

Courts have followed the lead of economists and become skeptical of antitrust claims based on tying theories. In the Microsoft case, the D.C. Circuit Court held that integration in the software industry involving computer operating systems promised significant efficiencies and that even relatively low-tech ties typically produce significant efficiencies by enabling firms to control the quality of collateral products.^xlv The D.C. Circuit Court further concluded that the rule of reason should be applied to the Windows and Internet Explorer tie because a per se rule could act as an irrational restraint on efficiency and innovation, which often consists in combining features or functions that previously were separate.^xlvi The court recognized the difficulty in distinguishing anticompetitive forced package sales from those that are efficient and effective. This is exactly the reason why a “rule of reason” analysis should be applied to all tying arrangements, the court explained.

In a “rule of reason” analysis, an antitrust enforcer proceeds by asking first whether the tying arrangement unreasonably excludes rivals.^xlvii If the products are widely available separately, then there is no market foreclosure because widespread availability of alternatives indicates that no rival is foreclosed by the tie.^xlviii Applying this analysis to the subject of this Note, Apple’s online music business, it is clear that alternatives to iTunes Music Store and iPod are widely available. Alternatives to iTunes Music Store include: RealNetworks, Wal-Mart, Amazon, Napster and Yahoo. In the portable media player market, alternatives to the iPod include: Microsoft, Sony, Creative, and SanDisk. Therefore, no rival is foreclosed by the tying from a properly defined market.

Courts should not substitute their own product designs for those generated by the market. Nevertheless, courts are often asked to determine whether a tying bundle is unreasonably anticompetitive. iTunes Music Store, the dominant online music vendor, needs to combat online music piracy and perform additional functions besides distributing music in order to develop the online music market. iTunes Music Store now offers customer support, a platform for customer reviews, Podcasts subscriptions, music and audio book previews, and iTunes U online service at no extra cost. A price-cutting online music vendor or online music piracy service might take advantage of the fact that Apple cannot charge separately for these services. The other vendors might charge a lower markup and refuse to provide essential services such as combating online music piracy and developing the online music market, knowing that the consumer will keep enjoying the free services provided by iTunes Store. Undoubtedly, iTunes Store cannot survive by only supplying uncompensated services that benefit other dealers. One strategy Apple can employ to minimize free riding is to tie iTunes and iPod to ensure a healthy supply of consumers who have subscribed to either iPod or iTunes.

While all these practices are readily defended as procompetitive, the defense is unnecessary in the first place when there is no injury to competition. The purchasers of iPod and iTunes bundle simply want a smaller product than the one that Apple is offering. But that desire does not harm competition. Apple’s bundle is simply the equivalent of the land developer who refuses to subdivide before selling. It is not the purpose of antitrust law to regulate the size of the products that Apple chooses to sell.

C. Refusal To License FairPlay Patent

Apple used its FairPlay digital rights management system to require owners of iPods to purchase digital music from iTunes Store. Apple refused to license its patented FairPlay technology to other portable media player manufacturers such as Microsoft and declined to support alternative digital rights management systems such as RealNetworks’ Harmony technology that circumvented Apple’s FairPlay system. Generally, the owner of an intellectual property right does not have a duty to deal with a competitor, even if the owner refusing to deal is a monopolist, as long as there are valid business reasons for refusing to deal. In CUS, L.L.C. v. Xerox Corp., the Federal Circuit held that a “patent holder may enforce the statutory right to exclude others free from liability under the antitrust laws” in the “absence of an indication of illegal tying, fraud in the Patent and Trademark Office, or sham litigation.”^xlix In addition, the patent statute contains no compulsory licensing provisions and even stipulates that there is no patent “misuse” when a patentee refuses to license its patent to competitors.^l The provisions of 35 U.S.C. § 271 provide that “No patent owner shall be denied relief or deemed guilty of misuse or illegal extension of the patent right by reason of his having refused to license or use any rights to the patent.”^li Although in Image Technical Services, Inc. v. Eastman Kodak Co.^lii, the Ninth Circuit Court of Appeals affirmed a finding of antitrust violation where Kodak refused to sell patented products to competitors, it is now widely accepted that the Ninth Circuit Court of Appeals made a significant error. In that case, Kodak refused to license its patented parts to firms that wanted to compete with Kodak in the repair of Kodak photocopiers.^liii The court determined that Kodak was unlawfully creating a second monopoly in service by refusing to sell the patented parts.^liv The court based its decision on the theory that under the patent laws, a patent may legally create a monopoly in only one market.^lv Kodak reflects an erroneous understanding of the nature and functions of a patent. Rather than market rights, patent claims create exclusive rights in technologies.^lvi A compulsory licensing of intellectual property rights is only justified where a monopolist’s refusal to license is profitable only because it tends to extend or preserve a monopoly.^lvii Apple’s refusal to license its FairPlay technology to any other online music vendor and MP3 manufacturer would easily pass this test because licensing FairPlay to a rival such as Microsoft or RealNetworks would deprive Apple of both online music and iPod sales and that is always an adequate business justification. A compulsory licensing of Apple’s FairPlay technology to competitors would effectively turn Apple into a public utility and places the court in the undesirable position of price regulator.

D. Patent Misuse

Patent misuse refers to improper acts committed by a patent or other intellectual property rights holder.^lviii In 1952 and again in 1988 Congress amended the Patent Act to bring the concept of misuse more closely in line with antitrust principles.^lix Congress intended to put a stop to the expansionist applications of patent misuse doctrine to reach practices which were not anticompetitive under any definition.^lx For example, in Brulotte v. Thys Co., 379 U.S. 29 (1964), the Supreme Court condemned a contract under the patent misuse doctrine demanding royalty payments after the patent expired, even though there was no showing of anticompetitive practices.^lxi In response to the Court’s application of the patent misuse doctrine to reach practices which are irrelevant to the concerns of antitrust law, Congress limited the use of the doctrine by providing that a patent owner is not guilty of patent misuse if it refuses to license, requires licensees to purchase goods that would work effectively only with the patent, or ties different products in the absence of showing of market power in the primary product.^lxii Therefore, whether Apple’s use of FairPlay technology is a patent misuse may not have independent relevance when Congress limited its scope to antitrust violations. Thus, there is no need to make an independent inquiry as to whether Apple’s use of FairPlay technology is a patent misuse.

E. Product Design: Strategic Creation of Incompatibility

Apple engaged in strategic creation of incompatibility by designing an exclusive combination or system of iPod, iTunes Software, and iTunes Store. Generally speaking, antitrust courts are not competent to second-guess decisions about product design.^lxiii In most circumstances, the conduct that creates excessive incompatibility is also self-deterring.^lxiv The market provides strong discipline for firms that produce innovations that customers reject. This suggests that truly anticompetitive product redesigns are uncommon.^lxv Therefore, Apple’s regular updates to iTunes Software and iPod, which add new features as well as maintain the closed system of iPod, iTunes software, and iTunes Store are presumably procompetitive. However, Microsoft showed that a product redesign is anticompetitive if the firm has very substantial market power and the redesign is sufficient to exclude complementary products from the market.^lxvi Moreover, the firm must intend the injury caused by the selection of a particular technology.^lxvii In addition, the injury must greatly outweigh the benefits that the redesign produces for consumers.^lxviii As explained in Part B, Apple’s redesign serves the purpose of its unique product model. It provides consumers through various updates with new features such as visual music, podcasts, playback capacities, and seamless management of music. Unlike the case in Microsoft, there is integrative benefit from combining the iTunes and iPod.

IV. CONCLUSION

Apple’s business practices of combining services and products have raised antitrust concerns. This Note analyzed Apple’s practices with an eye toward the realities of the music market. For courts and antitrust enforcement agencies to continue to serve as competition and innovation facilitators, they need to fully understand what the structure and the landscape of the music market are and how the entrance of a new and aggressive business model such as Apple’s exclusive system alters the competitive landscape of the music market. The most serious impact of a court’s finding of antitrust violation is not the large damages awarded to the plaintiffs. Rather, it is the loss of healthy competition and the innovative and effective access to copyrighted materials. An antitrust analysis of the possible causes of action against Apple shows that Apple’s conduct may not have harmed competition after all. If balancing is required to determine whether certain restraint is anticompetitive or not, antitrust should stand aside, trusting that the market rather than the government will strike the right balance.

i Brendan M. Schulman, The Song Heard ‘Round the world’: The Copyright Implications of MP3s and the Future of Digital Music, 12 HARV. J.L. & Tech. 589, 626-27 (1999).

ii Press Release, NDP Group, Amazon Ties Wal-Mart as Second-Ranked U.S. Music Retailer, Behind Industry-Leader iTunes, May 26, 2010, available at http://www.npd.com/press/releases/press_100526.html.

iii Press Release, Apple, Inc., iTunes Store Top Music Retailer in the U.S., Apr. 3, 2008, available at http://www.apple.com/pr/library/2008/04/03itunes.html.

iv Thomas Crampton, Apple Faces Fresh Legal Attacks in Europe, New York Times, June 6, 2006, available at http://www.nytimes.com/2006/06/09/technology/08cnd-apple.html.

v In re Apple iPod iTunes Antitrust Litig., C05-00037 JW, 2009 WL 249234 (N.D. Cal. Jan. 15, 2009).

vi Id.

vii Brad Stone, Apple Is Said To Face Inquiry About Online Music, New York Times (May 25, 2010), available at http://www.businessweek.com/news/2010-05-26/justice-department-said-to-s….

viii Press Release, Apple, Inc., Changes Coming To The iTunes Store (Jan. 6, 2009), available at http://www.apple.com/pr/libarary/2009/01/06itunes.html.

ix See NDP Group Press Release, supra note 2.

x See Apple Press Release, supra note 3.

xi Press Release, Apple, Inc., iTunes Store Tops 10 Billion Songs Sold (Feb. 25, 2010), available at http://www.apple.com/pr/library/2010/02/25itunes.html.

xii See NDP Group Press Release, supra note 2.

xiii Jessica Hodgson, Leap Year Trips Zune in Black Eye for Microsoft, WALL ST. J. (Jan. 2, 2009), at A9, available at http://online.wsj.com/article/SB123074469238845927.html.

xiv Real Reveals Real Apple Legal Threat, MACWORLD(Aug. 10, 2005), available at http://www.macworld.co.uk/news/index.cfm?Rss&NewsID =12310.

xv In re Time Warner et al., F.T.C. File No.971-0070 (2000) (Statement of Chairman Robert Pitofsky and Commissioners Shelia F. Anthony, Mozelle W. Thompson, Orson Swindle, and Thomas B. Leary), available at http://www.ftc.gov/opa/2000/05/cdpres.shtm.

xvi Greg Kot, Are We Finally Buying It?: New Model Will Change the Way Musicians Approach Craft, Chicago Tribune, May 11, 2003, § 7, at 1.

xvii See FTC Press Release, supra note 15.

xviii Matthew Fagin et al., Beyond Napster: Using Antitrust Law to Advance and Enhance Online Music Distribution, 8 B.U. J. Sci. & Tech. L. 451, 457 (2002).

xix Anthony Maul, Are the Major Labels Sandbagging Online Music? An Antitrust Analysis of Strategic Licensing Practices, 7 N.Y.U. J. Legis. & Pub. Pol’y 365, 373-75 (2004).

xx Id.

xxi Id.

xxii Id.

xxiii Id. at 373-74.

xxiv Herbert Hovenkamp et al., Antitrust Law, Policy and Procedure: Cases, Materials, Problems 290-96 (6th ed., 2009).

xxv Sarah McBride & Ethan Smith, Music Industry to Abandon Mass Suits, WALL ST. J. (Dec. 19, 2008), available at http://online.wsj.com/article/SB122966038836021137.html.

xxvi Id.

xxvii Id.

xxviii See Maul, supra note 19.

xxix Id.

xxx Id.

xxxi Id.

xxxii Id.

xxxiii Statement by Assistant Attorney General R. Hewitt Pate, Regarding the Closing of the Digital Music Investigation, (Dec. 23, 2003) available at http://www.usdoj.gov/atr/public/press_releases/2003/201946.htm.

xxxiv See Maul, supra note 19.

xxxv Id.

xxxvi See NDP Group Press Release, supra note 2.

xxxvii See Maul, supra note 19.

xxxviii N. Pac. Ry. Co. v. United States, 356 U.S. 1, 5-6 (1958).

xxxix Id.

xl Id.

xli Cabrice Corp. v. American Patents Development Corp., 283 U.S. 27, 31-32 (1931).

xlii Herbert Hovenkamp, The Antitrust Enterprise: Principle and Execution 261 (1st ed., 2005).

xliii Id. at 263.

xliv Id.

xlv United States v. Microsoft Corp., 253 F.3d 34, 84-90 (D.C. Cir.), cert. denied, 534 U.S. 952 (2001).

xlvi Id.

xlvii Hovenkamp, supra note 42, at 265.

xlviii Id.

xlix CSU, L.L.C. v. Xerox Corp., 203 F.3d 1322, 1328 (Fed. Cir. 2000).

l Hovenkamp, supra note 42, at 265.

li 35 U.S.C § 271(d).

lii Eastman Kodak Co. v. Image Technical Servs., 125 F.3d 1195, 1196 (9th Cir. 1997), cert. denied, 523 U.S. 1094 (1998).

liii Id.

liv Id. at 1218-1219.

lv Id.

lvi Hovenkamp, supra note 42, at 269.

lvii Id. at 270.

lviii Id. at 272.

lix 35 U.S.C. § 271(d).

lx Hovenkamp, supra note 42, at 274.

lxi Brulotte v. Thys Co., 379 U.S. 29 (1964).

lxii 35 U.S.C. § 271(d).

lxiii Hovenkamp, supra note 4, at 274.

lxiv Id. at 275.

lxv Id.

lxvi See Microsoft, supra note 45.

lxvii Hovenkamp, supra note 42, at 276.

lxviii Id.

Category: Antitrust

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