7th Circuit Addresses Patent Misuse Doctrine and Jurisdiction in Patent Cases

September 18, 2007. The U.S. Court of Appeals (7thCir) issued its opinion in Country Materials v. Allan Block, a case regarding the doctrine of patent misuse.

Summary. A patent owner (regarding concrete block technology) licensed technology to a concrete block maker. The license agreement included a covenant that the licensee would not make or sell competing concrete blocks within a limited geographic area for 18 months after the termination of the agreement.

The concrete block maker later decided to terminate the agreement, and make and sell competing blocks, without waiting 18 months. It filed a declaratory judgment action in federal court asserting that the non-compete agreement was unenforceable for violating federal patent policy.

The Court of Appeals affirmed the summary judgment of the District Court for the patent owner. First, it rejected the argument that this appeal must be heard by the Federal Circuit.

Second, it rejected the patent misuse claim. It wrote that a patent misuse claim is essentially an antitrust claim to which principles of competition analysis apply. The Court of Appeals held that the rule of reason applies, and that for a misuse claim to succeed, there the patent holder's practice or act must hurt competition.

The Court of Appeals viewed this as a vertical restriction scenario, and noted that recent analysis shows that some of these are pro-competitive. Finally, the Court of Appeals held that since the plaintiff had not shown harm to competition in the market for concrete blocks, the patent misuse claim fails.

Facts. County Materials Corporation is a Wisconsin corporation that makes concrete blocks. It is the plaintiff below, and the appellant.

Allan Block Corporation is a Minnesota corporation that develops, markets, and licenses technology for the manufacturing of concrete blocks. It does not make concrete blocks. It is the defendant below, and the appellee.

The predecessor of County Materials entered into an agreement with Allan Block, that included a covenant not to compete. Under this agreement, Allan Block granted County Materials the exclusive right to manufacture Allan Block's patented block products in northwest Wisconsin. The agreement also granted County Materials the right to sell these products under the Allan Block trademark. Allan Block also agreed to provide County Materials with technical, marketing, and strategic support. The agreement also provided that for the 18 months following the termination of the agreement, County Materials could not engage in the manufacture and/or sale of any other competing block in the exclusive production territory.

County Materials terminated the agreement, and proceeded to develop its own competing concrete block for sale, without waiting for the expiration of the 18 month period. Allan Block threatened to sue.

District Court. County Materials, anticipating that it would be sued by Allan Block, filed a complaint in U.S. District Court (WDWisc) against Allan Block seeking a declaratory judgment that the covenant not to compete was unenforceable because it violated federal patent policy. It also pled a related state law claim.

There was diversity of citizenship under 28 U.S.C. § 1332.

The District Court granted summary judgment to Allan Block, finding no violation of federal patent policy.

County Materials brought the present appeal in the Court of Appeals for the 7th Circuit.

Court of Appeals: Jurisdiction. Allan Block argued that jurisdiction over the appeal lies in the U.S. Court of Appeals for the Federal Circuit.

28 U.S.C. § 1338(a) provides that "The district courts shall have original jurisdiction of any civil action arising under any Act of Congress relating to patents, plant variety protection, copyrights and trademarks. Such jurisdiction shall be exclusive of the courts of the states in patent, plant variety protection and copyright cases."

Subsection 1338(b) provides that "The district courts shall have original jurisdiction of any civil action asserting a claim of unfair competition when joined with a substantial and related claim under the copyright, patent, plant variety protection or trademark laws."

Then 28 U.S.C. § 1295(a)(1) provides that the Federal Circuit has "exclusive jurisdiction ... of an appeal from a final decision of a district court of the United States ... if the jurisdiction of that court was based, in whole or in part, on section 1338 of this title".

The Court of Appeals held that it has appellate jurisdiction because the District Court had jurisdiction based upon diversity of citizenship (under Section 1332), but did not have jurisdiction based upon a claim "arising under any Act of Congress relating to patent" (under Section 1338).

The Court of Appeals relied upon the Supreme Court's opinion in Holmes Group, Inc. v. Vornado Air Circulation Systems, Inc., 535 U.S. 826 (2002). See, story titled "Supreme Court Rules on Appellate Jurisdiction of Federal Circuit" in TLJ Daily E-Mail Alert No. 443, June 4, 2002.

In the Holmes case the Supreme Court held that the Federal Circuit's appellate jurisdiction cannot be based solely upon a patent counterclaim. Critics of the Holmes opinion have argued that this reduces federal control over IP cases, reduces uniformity of patent law, and encourages forum shopping.

The Court of Appeals wrote that "Looking as we must at the well-pleaded complaint, it is apparent that federal patent law does not create the cause of action here. It is instead a claim about the enforceability of a contract or license agreement."

The Court of Appeals also cited its 2002 opinion in Scheiber v. Dolby Laboratories, Inc., 293 F.3d 1014 (2002) that "Federal jurisdiction over the suit is based on diversity of citizenship, because a suit to enforce a patent licensing agreement does not arise under federal patent law", and the defendant's affirmative defense of patent misuse is "irrelevant to jurisdiction".

The Court of Appeals added in the present case that "The same is true for a declaratory judgment action, where the roles of plaintiff and defendant are reversed", where the plaintiff was "essentially raising an anticipatory patent misuse defense to its planned breach of the Agreement".

See, story titled "7th Circuit Criticizes But Follows Brulotte" in TLJ Daily E-Mail Alert No. 453, June 8, 2002.

It should be noted that the Congress, and especially the House Judiciary Committee (HJC) and Rep. Howard Berman (D-CA), have endeavored to enact legislation that would amend the federal jurisdictional statutes to undo the effect of Holmes v. Vornado.

See, HR 2955 (109th Congress), the "Intellectual Property Jurisdiction Clarification Act of 2005". The HJC approved this bill on March 2, 2006, and reported this bill on April 4, 2006. See, House Report No. 109-407). See also, story titled "House Judiciary Committee Approves Amendment Regarding Jurisdiction of Federal Circuit" in TLJ Daily E-Mail Alert No. 1,325, March 8, 2006.

However, having concluded that it had appellate jurisdiction, the Court of Appeals then relied upon Federal Circuit precedent on the substantive issue.

Court of Appeals: Patent Misuse. The Court of Appeals affirmed the judgment of the District Court on the patent misuse issue.

First, the Court of Appeals characterized the agreement between Allan Block and County Material as a "patent license".

The Court of Appeals also wrote that Allan Block was not attempting to extend the term of a patent, so Brulotte v. Thys Co., 379 U.S. 29 (1964) does not apply. Rather, County Material's argument is that the non-compete clause is unenforceable for violating federal patent policy because it allows Allan Block to use its patent to exclude competition in the market for unpatented products.

The Court of Appeals thus analyzed the patent misuse argument for potential anticompetitive effects.

The Court of Appeals concluded that the rule of reason, rather than the per se rule, applies.

The Court of Appeals cited 35 U.S.C. § 271(d), which provides that "No patent owner otherwise entitled to relief for infringement or contributory infringement of a patent shall be denied relief or deemed guilty of misuse or illegal extension of the patent right by reason of his having done one or more of the following ..." This subsection then enumerates five types of actions.

The Court of Appeals reasoned that "the concept of patent misuse is cabined" by subsection 271(d) "which essentially eliminates from the field of ``patent misuse´´ claims based on tying and refusals to deal, unless the patent owner has market power".

The Court of Appeals next reviewed the Federal Circuit's opinion in Virginia Panel Corp. v. MAC Panel Co., 133 F.3d 860 (1997).

The Court of Appeals wrote that "If a practice is not per se unlawful nor specifically excluded from a misuse analysis by § 271(d)", then (quoting extensively from Virginia Panel), "a court must determine if that practice is reasonably within the patent grant, i.e., that it relates to subject matter within the scope of the patent claims. If so, the practice does not have the effect of broadening the scope of the patent claims and thus cannot constitute patent misuse. If, on the other hand, the practice has the effect of extending the patentee's statutory rights and does so with an anti-competitive effect, that practice must then be analyzed in accordance with the rule of reason. Under the rule of reason, the finder of fact must decide whether the questioned practice imposes an unreasonable restraint on competition, taking into account a variety of factors, including specific information about the relevant business, its condition before and after the restraint was imposed, and the restraint’s history, nature, and effect."

The Court of Appeals also cited the Federal Circuit's opinion in Windsurfing Int’l, Inc. v. AMF, Inc., 782 F.2d 995 (1986).

In that case the Federal Circuit wrote that patent misuse does not exist unless the party asserting it can "show that the patentee has impermissibly broadened the 'physical or temporal scope' of the patent grant with anti-competitive effect."

The Court of Appeals (7th Circuit) wrote that this standard is satisfied by showing some overall harm to competition, and takes into account the fact that patents exist to spur progress and innovation. It added that the Federal Circuit's Windsurfing "standard for patent misuse necessarily considers whether progress and innovation have been stymied and allows courts concretely to answer the vague question whether progress has been slowed."

The Court of Appeals noted that "Most of the cases on which County Materials relies come from an era before the Supreme Court recognized the efficiencies that might flow from vertical restrictions, which is the type of restriction we have when a patent owner (which does not compete in the manufacturing sector) imposes restraints on a manufacturing licensee." (Parentheses in original.)

The Court of Appeals cited as authority for this several cases, including Leegin Creative Leather Products v. PSKS. The Supreme Court issued its opinion [55 pages in PDF] on June 28, 2007. See, stories titled "SCUS Holds That All Vertical Price Restraints Are Subject to Rule of Reason" in TLJ Daily E-Mail Alert No. 1,603, June 28, 2007, and "Supreme Court Grants Certiorari in Antitrust Cases" in TLJ Daily E-Mail Alert No. 1,501, December 8, 2006.

With these conclusions and standards regarding patent misuse, the Court of Appeals proceeded to apply the facts of the present case to the law of patent misuse.

The Court of Appeals concluded that the agreement "shows no sign of one-sidedness or abuse of power" by Allan Block, and County Materials "received significant benefits". Moreover, the covenant not to compete was short in time, and of limited geographic area. In addition, "there does not appear to be any evidence in the record showing that these limited requirements have hurt competition for cement blocks in County Materials’s former exclusive territory".

It concluded that "Without a showing that this clause had any effect on the broader market for concrete block (as opposed to an effect only on County Materials), its purported patent misuse defense cannot succeed." (Parentheses in original.)

This case is Country Materials Corp. v. Allan Block Corp., U.S. Court of Appeals for the 7th Circuit, App. Ct. No. 06-2857, an appeal from the U.S. District Court for the Western District of Wisconsin, D.C. No. 05-C-675-S, Judge John Shabaz presiding. Judge Wood wrote the opinion of the Court of Appeals, in which Judges Manion and Kanne joined.