Suit by Chinese DVD Makers Seen Hinging on DoJ Patent Pool Guidelines

The plaintiffs, Orient Power Wuxi (OP) and Wuxi Multimedia, seek to invalidate 3C’s patents, receive refunds for royalties paid, triple damages under the Sherman Act and damages under Cal. law (CED Jan 26 p3). In a Dec. 28 amendment to a suit filed in June, OP joined Wuxi in charging 3C with price fixing, unlawful tying of patents, group boycott and conspiracy to monopolize in violation of Secs. 1 and 2 of the Sherman Act. The plaintiffs also requested a judicial declaration that the patents in 3C’s pool are invalid. The complaints, filed in U.S. Dist. Court, San Diego, also made 2 claims of violations of Cal.’s unfair competition law.

Wuxi, which claims it was refused a 3C license without cause, wants the pool’s patents declared invalid under the doctrine of patent misuse, said plaintiff’s attorney Anton Handal. OP, now a 3C licensee, is seeking a refund of all DVD player royalties paid to 3C by OP and all other companies in the class. About 420 companies now make DVD hardware in China, Handal told us. “We see these violations of the law as a concerted effort to control the DVD player market resulting in higher prices and fewer products,” he said. “It is the consumer that ultimately ends up paying for these unlawful acts and 3C must change its philosophy away from licensing manufacturers.” Philips, which administers the 3C pool, hasn’t responded to requests for comment on the charges.

In their claims, the plaintiffs cited a March 11, 2004, ruling by the International Trade Commission (ITC) that patents in similar Philips pools were unenforceable on the grounds of patent misuse in “tying” unessential patents in a mandatory license with those essential for making blank CDs. Those pools, comprising Philips, Ricoh, Sony and Taiyo Yuden, planned to appeal the decision. The final ITC decision didn’t incorporate an administrative law judge’s earlier conclusions that the pool’s licensing practices amounted to price fixing and price discrimination, and the royalty rates were an unreasonable restraint of trade.

Patent pools are “fairly unusual” but come about when multiple companies that have intellectual property needed to launch a technology cross-license one another and create a single source for licensing others, said Lee Bromberg, an IP attorney with Boston firm Bromberg & Sunstein. “This case [3C] is unusual because a standard was adopted” for DVD by 3C and other members of the DVD Forum, including the 6C licensing pool of Hitachi, IBM, JVC, Matsushita, Mitsubishi, Toshiba and Time Warner, Bromberg told us.

Anticompetitive aspects to the pool were outlined by DoJ in its Dec. 16, 1998, review of 3C’s business plan. DoJ laid out a roadmap of practices to minimize antitrust risk, according to the plaintiffs. Among other things, DoJ required 3C to limit patents in the pool to those essential to the DVD standard, keep royalties relatively small to the total cost of manufacturing products to avoid price-fixing, and avoid “grant-back” provisions that limit incentives to innovate. The grant-backs refer to a requirement that 3C licensees give back to the pool licenses for any patent-innovations they make that would be essential to manufacture DVD products.

The DoJ didn’t find “unreasonable” 3C’s royalty of 3.5% per player or a minimum of $5, given that DVD players cost $100 or more at the time, but said the royalty might become unreasonable as a percentage of product cost as DVD player prices declined over time. The DoJ gave similar guidelines to 6C, which filed for a review of its business plan shortly after 3C. Although 6C isn’t named in the lawsuit against 3C, Handal told us the plaintiffs were “researching prospects of other suits against other pools.” The 6C royalty is 4% of player cost or $4 minimum.

In their suit, the plaintiffs allege 3C hasn’t adhered to the DoJ guidelines. Mainly, they charge 3C has tied unessential patents in the mandatory license, the royalty rate doesn’t reflect falling player prices since 1998, and the licensing terms demand patent grant-backs. They also allege that by cross-licensing their patents, DVD’s creators have an unfair advantage in pricing as it’s believed no royalties are exchanged. The royalty structure therefore constitutes predatory pricing and price fixing as patent licensees must pay, but patent holders don’t, the suit charges. It claims that 3C members control “a major portion of sales” of DVD players, which the plaintiffs put as 25% market share, but which Handal agreed is diminishing.

The rising proportion of royalty costs to product costs has long been a complaint among Chinese OEMs. Manufacturing and business costs for DVD players now run as low as $25-$28 before royalties, Handal said. The nearly $20 in royalties -- to 3C, 6C, MPEG-LA, Dolby, Thomson, Discovision, Nissim and others -- is therefore disproportionate, the plaintiffs contend. Asked if he thought the 3C royalty rate was unreasonable, Bromberg said: “On the face of it, I don’t think so. The 3.5% is moderate, not out of line. They're usually about 5%.” It’s the $5 minimum royalty that has Chinese licensees incensed. If applied at the 3.5% rate for a player at $30 cost, the royalty would be about $1 -- the same as the profit Chinese factories take on the hardware, Handal said: “The royalty is a rising cost of the product, and that’s when it becomes an issue of antitrust.”

In challenging the suit, 3C is likely to argue the charges that its licensing practices and royalty rate eliminate competition and affect prices are undermined by the significant price drops for DVD players and discs, and the multiplicity of brands and players. “Absolutely. You'll hear them say, ‘We're enhancing competition and that’s made for significant prices drops for the technology for years.’ That will be a strong policy argument,” Bromberg told us. “I expect they'll have economist experts to testify. They'll also state that the market isn’t monopolized by a single entity.”

Handal said that’s exactly what he expects to hear in court, but he’s not buying it. “That evolution in price would have happened anyway, as it does with every CE product. DVD made for easy entry for manufacturers that didn’t make much themselves but bought components from others, then retails came down and they're caught in a margin squeeze and endangered,” he said. “If you look at the ITC case, it said there was no basis for a fixed royalty. That’s tantamount to price fixing.” The plaintiffs are asking for a jury trial. No court dates are set.