United States District Court, Southern District of New York
May 24, 2013
KONINKLIJKE PHILIPS N.V.*FN1 AND U.S. PHILIPS CORPORATION
CINRAM INTERNATIONAL, INC., ET AL.; THE ADS GROUP, ET AL.; ENTERTAINMENT DISTRIBUTION COMPANY (USA), LLC, ET AL.; AND OPTICAL EXPERTS MANUFACTURING INC, ET AL.
The opinion of the court was delivered by: Stearns, District Judge.
MEMORANDUM AND ORDER ON DEFENDANTS' EQUITABLE DEFENSES
In August and October of 2012, this court issued summary judgment opinions finding that, inter alia, defendants The ADS Group, Entertainment Distribution Company (USA) LLC and/or Entertainment Distribution Company (collectively EDC), Optical Experts Manufacturing Inc. (OEM), and Universal Music Group Manufacturing & Logistics breached their patent license agreements (PLA) with plaintiffs Koninklijke Philips Electronics N.V. and U.S. Philips Corp. (collectively Philips).*fn2 On March 1, 2013, after a two-week trial on patent validity, the jury returned a verdict that Philips's asserted patent— United States Patent No. 5,068,846 (the ' 846 patent)—was not invalid for anticipation, obviousness, or lack of written description. The jury found that defendants had directly infringed claims 1–4 of the ' 846 patent, and that Universal had indirectly infringed the ' 846 patent by inducing infringement by EDC. Defendants presented additional evidence *fn3 relating to their equitable defenses at a two-day nonjury trial on April 15 and 16, 2013, which was followed by extensive post-trial briefings.
Defendants' equitable defenses arise from three basic factual scenarios. Each will be addressed in turn.
The Inclusion of the ' 301 Patent in the PLA
In 2002, defendants entered into PLAs with Philips for a pool of patents owned by Philips and Sony Corporation covering various aspects of CD disc technology. The pool included both the asserted ' 846 patent and Sony's United States Patent No. 5,305,301 (the ' 301 patent). Both patents were designated as "essential" for the manufacture of CD–Audio discs. Essentiality is an antitrust concept that permits the otherwise forbidden collective licensing of patents by horizontal competitors, when the patents are deemed necessary for the practice of an industry standard.*fn4 The aim is to facilitate the efficient licensing of standardized technologies. As part of the PLA, Philips agreed to hire an independent expert to review the essentiality of the licensed patents and to promptly remove any patent from the essential patents list that was found by the expert to be not essential.*fn5 Under the PLA, licensees retained the right to continue to use any patent deemed nonessential.
Although Philips hired an independent expert to evaluate its ' 846 patent *fn6 (which the expert found essential), Philips did not commission a similar review of Sony's ' 301 patent. In 2001, prior to the offering of the disputed PLA, Sony did commission an expert to evaluate the essentiality of the ' 301 patent, but only for the manufacture of CD–R discs (the expert found the ' 301 patent to be not essential for this format). Sony did not at any relevant time seek an independent evaluation of the essentiality of the ' 301 patent for the manufacture of CD–Audio discs.
Before entering into the 2002 PLA with Philips, defendants had licensed the ' 301 patent through prior licensing agreements, and had practiced the licensed technology—a method of metallizing CD discs by masking the inner and outer edges of the disc before applying the metal layers.*fn7 In 2006, defendants began utilizing an alternative method of metallizing CD–Audio discs that did not depend on the ' 301 patent. In 2009, after the ' 846 patent expired, Philips removed the ' 301 patent (which had not yet expired) from the essential patents list as of the date of the ' 846 patent's expiration.
Defendants contend that Philips is equitably estopped from recovering on the PLA because of its misrepresentations regarding the essentiality of the ' 301 patent; because Philips did not fulfill its obligation under the PLA to commission an independent evaluation of the ' 301 patent; because Philips misused the ' 301 patent and the ' 846 patent by improperly tying the ' 301 patent to the ' 846 patent license; and because Philips soiled its hands in its conduct of the instant litigation.*fn8
To invoke equitable estoppel, a defendants must demonstrate, by clear and convincing evidence,
(1) An act constituting a concealment of facts or a false misrepresentation;
(2) An intention or expectation that such acts will be relied upon;
(3) Actual or constructive knowledge of the true facts by the wrongdoers; [and]
(4) Reliance upon the misrepresentations which causes the innocent party to change its position to its substantial detriment.
Gen. Elec. Capital Corp. v. Armadora, S.A., 37 F.3d 41, 45 (2d Cir.1994); Ritchie Risk–Linked Strategies Trading (Ireland), Ltd. v. Coventry First LLC, 280 F.R.D. 147, 163 (S.D.N.Y.2012) (equitable estoppel must be established by clear and convincing evidence).
The evidence offered at the trial did not clearly show that Philips knowingly misrepresented or concealed material facts regarding the essentiality of the ' 301 patent. During discovery, Philips produced e-mails *fn9 indicating that outside patent counsel had received a copy of Dr. Rubenstein's report in 2001, and had informed Brian Wieghaus, Philips's in-house counsel and trial representative, that the ' 301 patent was not essential to either the CD–Audio or the CD–ROM format.*fn10 Wieghaus in turn queried his counterpart in the Netherlands as whether the ' 301 patent should continue to be listed as essential. The ' 301 patent nonetheless remained on the list for CD–Audio format in the 2002 PLA. Wieghaus testified that he was not given a copy of Dr. Rubenstein's 2001 ' 301 patent analysis until this litigation began. He also denied any responsibility for determining which patents to include in the PLA. He further testified that when he toured defendants' manufacturing facilities in and about 2001, he observed that each defendant was practicing the technology of the ' 301 patent. This led him to believe in the patent's practical, if not technical, essentiality. Wieghaus further testified that Philips would not have presumed to declare a patent belonging to Sony to be nonessential, and moreover, assumed that Sony had obtained the evaluation. *fn11 Dr. Rubenstein corroborated Wieghaus on this issue, testifying that only Sony, as the owner of the ' 301 patent, had the authority to request an essentiality analysis. From these facts, it is impossible to draw a clear inference that Philips knowingly misrepresented or concealed the nonessentiality of the ' 301 patent from defendants in 2002. At most, they indicate that Philips, perhaps mistakenly, believed that its obligation in assembling the PLA extended only to an assessment of the essentiality of its own patents (which obligation it fulfilled), while it remained for Sony to commission an assessment of the patents that it owned.
Defendants have also failed to demonstrate any change in position to their substantial detriment in reliance on the presumed essentiality of the ' 301 patent. As noted earlier, defendants had licensed the ' 301 patent under PLAs prior to 2002, and actively practiced the technology of the ' 301 patent until 2006. Although defendants argue that they would not have entered into a pool license agreement in 2002 (or would have negotiated a lower licensing fee) had they known that the ' 301 patent was not essential (and that alternative manufacturing methods were feasible),*fn12 they got what they paid for—a license for the ' 301 patent technology which they actively practiced. If there was any detriment, it was not substantial.*fn13
To preclude Philips from recovering on its breach of contract claim because of an alleged failure to perform, defendants must prove that Philips breached a material term of the PLA. Merrill Lynch & Co. Inc. v. Allegheny Energy, Inc., 500 F.3d 171, 186 (2d Cir.2007). In determining whether a breach by a contractual party is sufficiently substantial to excuse another party's performance, the court considers "the ratio of the performance already rendered to that unperformed, the quantitative character of the default, the degree to which the purpose behind the contract has been frustrated, the willfulness of the default, and the extent to which the aggrieved party has already received the substantial benefit of the promised performance." Hadden v. Consol. Edison Co. of New York, Inc., 34 N.Y.2d 88, 96, 356 N.Y.S.2d 249, 256 (1974).
Defendants argue with neat mathematical precision that Philips failed to perform 50% of its obligations under the PLA by failing to obtain an independent essentiality analysis of one of the two U.S. patents in the licensing pool,*fn14 and that this failure frustrated the underlying purpose of the PLA. Moreover, defendants lament that they were denied the benefit of an independent essentiality review that would have had the result of removing the ' 301 patent from the essential patents list. Although the court agrees that one purpose of the patent pool—which was to license patents deemed essential *fn15 —was to some extent frustrated by the lack of an independent analysis of the ' 301 patent, the court disagrees with defendants' quantitative characterization of the result.*fn16 The primary benefit to defendants of the PLA was access to licenses to Philips's and Sony's patents, allowing defendants to manufacture CD discs using the licensed technology without fear of patent infringement, a substantial benefit that defendants fully received (or would have fully received had they complied with the terms of the PLA). Once the PLA was in effect, Philips's compliance or noncompliance did not affect defendants' rights to use the licensed technology, including that of the ' 301 patent, even if it was found to be nonessential. *fn17 Because Philips did not materially breach the PLA, defendants are not excused from their obligation of reciprocal performance.
Patent misuse occurs when a patentee "impermissibly broaden[s] the scope of the patent grant with anticompetitive effect." U.S. Philips Corp. v. Int'l Trade Comm'n, 424 F.3d 1179, 1184 (Fed.Cir.2005) ( Philips I ). Defendants argue that Philips misused the ' 846 and ' 301 patents through improper tying.*fn18 In other words, Philips exploited the essentiality of the ' 846 patent to palm off the nonessential ' 301 patent, thereby impermissibly broadening the scope of the ' 846 patent.
This argument, however, does not withstand the Federal Circuit's reasoning in Philips I. In that case, the Court first held that Philips's patent pool licenses for the CD–RW technology did not constitute per se patent misuse, despite the inclusion of four nonessential patents in the pool. Id. at 1193. In reaching this conclusion, the Federal Circuit distinguished the per se tying of patented goods with nonpatented goods from the tying of essential and nonessential patents in a license agreement.
A nonexclusive patent license is simply a promise not to sue for infringement.... The conveyance of such a license does not obligate the licensee to do anything; it simply provides the licensee with a guarantee that it will not be sued for engaging in conduct that would infringe the patent in question.
In the case of patent-to-product tying, the patent owner uses the market power conferred by the patent to compel customers to purchase a product in a separate market that the customer might otherwise purchase from a competitor.... The patent owner is thus able to use the market power conferred by the patent to foreclose competition in the market for the product.
By contrast, a package licensing agreement that includes both essential and nonessential patents does not impose any requirement on the licensee. It does not bar the licensee from using any alternative technology that may be offered by a competitor of the licensor. Nor does it foreclose the competitor from licensing his alternative technology; it merely puts the competitor in the same position he would be in if he were competing with unpatented technology.
Id. at 1189–1190. Because under the PLA, defendants were not required to use the technology of the ' 301 patent (and indeed they stopped using it in 2006), there can be no finding of per se patent misuse.
In Philips I, after finding no per se patent misuse, the Federal Circuit also reversed the International Trade Commission's finding that the patent pool constituted patent misuse under the rule of reason.
Under the rule of reason, the finder of fact must determine if the practice at issue is "reasonably within the patent grant, i.e., that it relates to subject matter within the scope of the patent claims." [Virginia] Panel [Corp. v. MAC Panel Co.], 133 F.3d [860,] 869 [ (Fed.Cir.1997) ], quoting Mallinckrodt[, Inc. v. Medipart, Inc.], 976 F.2d [700,] 708 [ (Fed.Cir.1992) ]. If the practice does not "broaden the scope of the patent, either in terms of covered subject matter or temporally," then the patentee is not chargeable with patent misuse. Va. Panel, 133 F.3d at 869.
Id. at 1197. The Federal Circuit rejected the Trade Commission's finding because "the evidence did not show that including those patents in the patent packages had a negative effect on commercially available technology," id. at 1198, and because "the Commission did not acknowledge problems with licensing patents individually" or consider the effect of the passage of time and the development of new technology on the reasonableness of the pool license. Id. As in Philips I, defendants here have not demonstrated that the PLA had a negative impact on commercially available technology. There is "no evidence ... that any manufacturer had actually refused to consider alternatives to the technology covered by [the ' 301 patent.]" Id. Indeed, defendants developed a design-around in 2006.
Defendants also do not give proper credit to the efficiencies of a pooled licensed agreement. As noted earlier, when defendants entered into the PLA in 2002, they licensed and used not only the ' 301 patent, but also patents for formats other than CDAudio. Under the PLA, defendants were able to enter into one agreement and make a single royalty payment. Defendants cannot entirely discount the benefit of the pooled arrangement in savings on "transaction costs associated with making individual patent-by-patent royalty determinations and monitoring possible infringement of patents that particular licensees chose not to license." Id.
Further, the 2002 PLA did not inaugurate a new patent pool arrangement, but updated an existing patent pool agreement. The inclusion of the ' 301 patent on the essential patents list was an established practice continued from before anyone questioned its essentiality. "To hold that a licensing agreement that satisfied the rule of reason when executed became unreasonable at some later point because of technological development would introduce substantial uncertainty into the market and displace settled commercial arrangements in favor of uncertainty that could only be resolved through expensive litigation." Id.
Moreover, defendants paid a royalty fee only while they were still practicing the technology of the ' 301 patent. Philips removed the ' 301 patent from the essential patents list effective as of the date of expiration of the ' 846 patent, thereby acquiescing in the understanding that a license to the ' 301 patent was not necessary to practice the relevant standards after the last essential patent ran its course. Thus, there was no broadening of the subject matter or temporal scope of the ' 301 patent.
Finally, to preclude Philips from recovery on the basis of unclean hands, *fn19 defendants must demonstrate that Philips "(1) ... is guilty of immoral, unconscionable conduct; (2) the conduct was relied upon by [defendants]; and (3) [defendants were] injured as a result." Sheehy v. New Century Mortg. Corp., 690 F.Supp.2d 51, 68 (E.D.N.Y.2010). Defendants argue that Philips engaged in unclean hands by representing in all three iterations of its Complaint in this case that it had complied fully with its obligation under the PLA to obtain essentiality opinions, before ultimately admitting that it had not done so for the ' 301 patent. Given Philips's not unreasonable belief that responsibility for determining the essentiality of the ' 301 patent lay with Sony, and the fact that this case from the beginning has focused on the ' 846 patent, Philips's pleading allegations cannot fairly be described as either immoral or unconscionable. Nor do defendants explain how they were injured by these allegations, as defendants were given and took full advantage of the opportunity to present evidence of their ' 301–based equitable defenses at both the jury and the nonjury trial.
Philips's Silence as to Non–Compliance under the PLA
The 2002 PLA was structured with two licensing rates. Ordinarily a licensee was obligated to pay the Standard Rate of 3 cents per CD–Audio disc, but if a licensee opted to comply with all the conditions stipulated in the PLA (including, among others, a 30–day payment term, the reporting of third-party customers, and the submission to annual audits), it was eligible to pay the lower Compliance Rate of 1.75 cents per CD–Audio disc. For all licensees, the failure to pay the full amount due triggered a 2% per month (24% per year) interest rate (or the next highest rate allowable by law) on any outstanding balance.
Each of the defendants elected to pay the lower Compliance Rate. However, from the inception, they were not in compliance with all of the PLA's conditions. As explained in the court's summary judgment opinion of August 23, 2012, defendants at times underpaid and underreported royalties, remitted royalties late, omitted information from royalty reports, failed to submit to yearly audits, and failed to keep accurate books and records. Dkt # 475 at 25. That notwithstanding, until the advent of this litigation, Philips never warned defendants that they were not in compliance with the PLA conditions, and were therefore ineligible for the Compliance Rate. Defendants argue that it is unfair this late in the game for Philips to seek to recoup the difference between the two rates and reap substantial penalty interest payments when defendants, had they been given timely notice, could have remedied the breaches while the PLA was still in effect.
Defendants cast this defense under the rubrics of equitable estoppel and laches. To invoke equitable estoppel, defendants argue that Philips's acceptance of the royalty payments without protest, which implied to defendants that Philips considered them in compliance with the PLA, amounted to a false assurance on which defendants relied to their substantial detriment. See Gen. Elec., 37 F.3d at 45. As the court noted on summary judgment, this would be a winning argument, but for the PLA's non-waiver clause. Dkt # 475 at 25. The non-waiver clause provides that "neither the failure nor the delay ... to enforce any provision of this Agreement shall constitute a waiver of such provision or of the right ... to enforce each and every provision of this Agreement." Id. at 25 n. 22. Thus, Philips's failure to object cannot be deemed as acquiescence.*fn20
A claim of laches is "an equitable defense that bars a plaintiff's equitable claim where he is guilty of unreasonable and inexcusable delay that has resulted in prejudice to the defendant." Ikelionwu v. United States, 150 F.3d 233, 237 (2d Cir.1998) (internal quotations and citation omitted). Because Philips's claims for breach of contract against defendants (with the exception of the claim against Universal) are actions at law brought within the statute of limitations, laches is not applicable.*fn21 See Metinol Ltd. v. Boston Scientific Corp., 346 F.Supp.2d 575, 609–610 (S.D.N.Y.2004).
Universal stands in different shoes because its liability hinges on a theory of implied contract. To prove laches, Universal must demonstrate that "(1) the plaintiff knew of the defendant's misconduct; (2) the plaintiff inexcusably delayed in taking action; and (3) the defendant was prejudiced by the delay." Ikelionwu, 150 F.3d at 237. Although Universal argues that Philips inexcusably delayed its claim for partial royalty payments for the 2002–2005 period until the filing of the Second Amended Complaint in 2010, there is no reason to apply a different standard of delay to Philips's implied contract claim (particularly given that the implied contract has the identical terms as the PLA) than the statute of limitations applicable to the contract claims at law. Philips alleged the basic facts regarding Universal's noncompliance with the terms of the PLA in the original 2008 Complaint, within the six-year statute of limitations for a contract action. Because the 2010 Second Amended Complaint fairly relates back to the original Complaint, there was no inexcusable delay in bringing the implied contract claim against Universal.
Universal, however, raises a persuasive argument regarding prejudice, which it has renewed in a motion in limine (Dkt # 883) filed in advance of the impending damages trial. As Universal points out, Philips did not disclose the bulk *fn22 of its damages claim against it until October of 2012. This disclosure came well after the deadline set for the production of opening expert reports in July of 2011, well after the close of expert discovery in October of 2011, and after the court issued its summary judgment ruling in August of 2012, finding in favor of Philips on the breach of contract claim. Indeed, the disclosure came only on the eve of the originally scheduled jury trial in November of 2012. Universal fairly contends that the timing of the disclosure was prejudicial in the extreme, giving it no opportunity to assess or fully contest the demand during the summary judgment phase of the ligation, and no time or opportunity to obtain a competing expert opinion, or even depose Philips's expert witness regarding the contents of his report.
Philips has offered no "good cause" to justify this belated disclosure. Philips improbably asserts that the damages evidence with respect to Universal's breach of contract was inadvertently omitted from its earlier expert reports. True or not, this omission is one that Philips will have to live with. As the plaintiff, it falls to Philips to prove its claim for damages. Philips has consistently and vehemently argued from the outset that it made clear that it was seeking damages related to partially paid royalties during the 2002–2005 period from Universal. The court accepted this argument in ruling that the 2010 Second Amended Complaint related back to the 2008 Complaint. See Complaint, 08–cv–4070 Dkt # 1, ¶ 69 (alleging that Universal was not in full compliance with the conditions of the PLA). Under the circumstances, it is not convincing for Philips say that it simply overlooked the bulk of its claim for damages, or did not realize their significance until just weeks before the originally scheduled trial. Nor does the fact that Philips offered to submit its expert witness for a deposition at the midnight hour ameliorate the prejudice to Universal, which would have had no time to engage a rebuttal expert witness. Consequently, Philips's late-disclosed damages expert report will be excluded and its October of 2012 claim for damages against Universal for partially paid royalties over and above the $431,172 previously claimed for 2002–2005 will be rejected.
Alleged Prosecution Misconduct
On this issue, defendants reprise evidence and arguments presented at the jury trial in an attempt to resuscitate their claim of unclean hands on Philips's part during the prosecution of the ' 846 patent. Defendants argue that Philips artificially contrived to extend the life of the ' 846 patent by refusing to accept the Patent Office (PTO)'s grant of a patent at the time of the original application, and instead sought a continuation. Defendants further argue that Philips never did, but should have, presented the material prior art of the MCA/DiscoVision laser disc to the PTO. Finally, defendants argue that Philips impermissibly expanded the scope of the original application by inserting the term "non-transmissive" into the patent claims, while inducing Dr. Kramer, one of the inventors, into signing untruthful declarations regarding the ' 846 patent's reach.*fn23 None of these allegations rise to the level of "immoral or unconscionable conduct ."
In the first instance, there was nothing untoward in Philips seeking a continuation of the original application. This was a standard practice among patent applicants until the PTO changed the rules on patent life term in 1995. Prior to the change, the life of a patent was calculated from the date of the grant of the patent, giving patentees an incentive to seek continuations. Today, patent life is calculated from the date of the original application, and the prior incentive is eliminated. In doing what was permitted, Philips may have been opportunistic, but it did not act immorally or unconscionably.
So it is also with the non-disclosure of the MCA/DiscoVision laser disc technology. Defendants use the unclean hands doctrine to creatively, but unsuccessfully, steer around the stringent standard for inequitable conduct. Under Therasense, Inc. v. Becton, Dickinson & Co., 649 F.3d 1276, 1291 (Fed.Cir.2011), to obtain relief, defendants must prove that the non-disclosed prior art meets the high standard of but-for materiality (and that Philips acted with the specific intent to deceive the PTO), in other words, they must demonstrated that "the PTO would not have allowed a claim had it been aware of the undisclosed prior art." Id. However, defendants cannot come near to this standard as the jury specifically rejected the MCA/DiscoVision laser disc as invalidating prior art.
Finally, while the court understands defendants' objection to the meaning of the term "non-transmissive" that the court assigned in its Markman construction, it remains convinced that the evidence fully supports the meaning that it ascribed to the term. This is especially so given the jury's verdict that the ' 846 patent is not invalid for lack of written description. Whatever effect the passage of time may have wrought on Dr. Kramer's memory, the jury, in its verdict, found that he was not induced into signing false declarations regarding the scope of the ' 846 patent.
For the foregoing reasons, Philips's October of 2012 claim for damages against Universal from 2002–2005 over and above the $431,172 in late payment interest damages claimed in its First Amended Expert Report of December of 2011 *fn24 is excluded. Philips will, however, be permitted to present damages evidence on its remaining claims for contract liability, subject to the court's rulings on the parties' motions in limine, at the trial scheduled for June 17, 2013.