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eBay Inc., et al. v. MercExchange LLC

By Anthony J. Fitzpatrick
July 2006
e-Commerce Law and Strategy

Patent Infringement Injunctions Will Likely Hold Some Surprises Now

The Supreme Court's May 15 decision in eBay Inc., et al. v. MercExchange LLC (eBay) is already a landmark in patent law. The unanimous Court rejected the general rule, previously applied by the Court of Appeals for the Federal Circuit, that a permanent injunction will issue against patent infringement absent exceptional circumstances. Instead, the Supreme Court held that, consistent with the "long tradition of equity practice," a patent holder must satisfy a four-prong test:

  • That it has suffered irreparable injury;
  • That remedies available at law, such as monetary damages, are inadequate to compensate for that injury;
  • That, considering the balance of hardships between the patent holder and patent infringer, a remedy in equity is warranted; and
  • That the public interest would not be disserved by a permanent injunction.
The eBay decision will likely have a significant impact on patent licensing and patent litigation, because the patent holder no longer can assert the significant threat of essentially automatic injunctive relief upon a finding of infringement. Indeed, the first ruling from a trial court employing the eBay framework shows that the decision may lead to surprising results. On June 14, Microsoft persuaded a district court to deny an injunction in a case where Microsoft had been held liable for willful infringement of patents owned by a small software company.

What Happened in eBay?

MercExchange LLC, a patent-holding company, sued eBay Inc. and its subsidiary Inc., alleging infringement of three business-method patents, including U.S. Patent No. 5,845,265, which is directed to facilitating the electronic sale of goods between private individuals by establishing a central authority to promote trust among participants. A jury found the '265 patent valid and infringed, but the district judge denied MercExchange's request for a permanent injunction, finding that MercExchange did not face irreparable harm from eBay's continuing infringement because it did not practice the inventions itself, and it had shown a willingness to license the patents to others. On appeal, the Federal Circuit affirmed the jury verdict. But the Federal Circuit reversed the district court's denial of a permanent injunction, concluding that the case was not "sufficiently exceptional to justify the denial of a permanent injunction."

Writing for the Supreme Court, Justice Clarence Thomas noted that permanent injunctive relief was a matter of equitable discretion, and found that the principles of equity set forth in the traditional four-prong test for granting permanent injunctions applied with "equal force" to disputes arising under the Patent Act. The Court determined that the "right to exclude" others from making, using, offering for sale or selling a patented invention under the Patent Act is distinct from the remedies under the Patent Act. Drawing parallels to the Copyright Act, the Court noted that under 35 U.S.C. §283 of the Patent Act, Congress did not intend a departure from principles of equity, but instead provided that a court "may" issue injunctive relief "in accordance with principles of equity."

The Court did provide some guidance on how the four-prong test should be applied in patent cases. Specifically, the Court rejected the district court's conclusion that the irreparable-harm prong could not be satisfied where the patent holder was willing to license the patent and was not engaged in commercial activity in practicing the patent. The Court wrote that such a patent holder may still be able to satisfy the four-factor test, and found "no basis for categorically denying" patent holders the opportunity to do so. In sum, the Court found that "[j]ust as the District Court erred in its categorical denial of injunctive relief, the Court of Appeals erred in its categorical grant of such relief." Because neither court below correctly applied the traditional four-prong test, the Supreme Court vacated the judgment of the Federal Circuit and remanded the case so that the district court could apply the traditional test in the first instance.

In a concurring opinion, Chief Justice John Roberts, Jr., joined by Justices Antonin Scalia and Ruth Bader Ginsburg, seemed to express the view that the traditional four-factor test should not lead to widespread change. The Chief Justice noted that for two centuries, courts have granted injunctive relief upon a finding of infringement in the vast majority of cases. He wrote that when it comes to applying the four-factor test, "a page of history is worth a volume of logic."

In a separate concurring opinion, however, Justice Anthony Kennedy, joined by Justices John Paul Stevens, David Souter and Stephen Breyer, focused on the recent rise of patent-holding companies that do not use patents "as a basis for producing and selling goods but, instead, primarily for obtaining licensing fees." Justice Kennedy wrote that such companies can use the possibility of injunctive relief "to charge exorbitant fees" to license their patents. While not controlling Supreme Court precedent, it is worth noting that at least four justices are of the view that where the patented invention is a small component of the accused product and the threat of an injunction is employed simply for undue leverage in negotiations, "legal damages may well be sufficient to compensate for the infringement and an injunction may not serve the public interest.

First Trial Court Decision Applying eBay: z4 Technologies v. Microsoft

The first trial-court decision ruling to apply eBay confirms that the Supreme Court's decision will change the outcome of cases, and perhaps in unexpected ways. In 2004, z4 Technologies filed suit against Microsoft in the Eastern District of Texas, alleging infringement of two patents claiming methods for limiting the unauthorized use of computer software. These methods are referred to as "product activation." z4 alleged that Microsoft's Windows and Office software products infringed its patents. Following a trial this April, a jury found z4's patents valid and willfully infringed, and awarded $115 million in damages against Microsoft.

After the trial, z4 moved for a permanent injunction, seeking an order that would require Microsoft to deactivate the servers that control product activation for the infringing products, and to redesign those products to eliminate the infringing technology. z4 itself is a software company that has made and sold its own patented "product activation" software. Under the general rule employed by the Federal Circuit prior to the eBay decision (namely, that a patentee is entitled to a permanent injunction absent exceptional circumstances), z4 would almost certainly have won a permanent injunction against continuing infringement by Microsoft.

But on June 14, Judge Leonard Davis of the Eastern District of Texas denied z4's motion. First, Judge Davis rejected z4's argument that a jury finding of infringement and validity gives rise to a rebuttable presumption that the patentee has suffered irreparable harm. The judge held that this argument was not in line with the Supreme Court's decision in eBay, which requires that the patentee must demonstrate irreparable harm (rather than relying on presumed irreparable harm) to win a permanent injunction.

The z4 Court Found That the Traditional Equitable Test Favored Microsoft

Judge Davis then went on to apply the traditional four-factor test described in eBay. He found that Microsoft uses the infringing technology only as a small component in its Windows and Office software, and that "it is not likely that any consumer of Microsoft's Windows or Office software products purchases these products for their product activation functionality." Judge Davis determined that Microsoft's continuing infringement "does not inhibit z4's ability to market, sell, or license its patent technology" and that z4 "will not suffer lost profits, the loss of brand name recognition or the loss of market share because of Microsoft's continued sale of the infringing products." Accordingly, the judge held that z4 had not demonstrated irreparable harm.

The district court then considered whether monetary damages would be adequate to compensate z4 for Microsoft's future infringement. Again, Judge Davis noted that Microsoft's use of z4's patented technology would not exclude z4 from selling or licensing its technology in the market; the only potential customer from which z4 would be excluded would be Microsoft itself. Judge Davis also pointed to Justice Kennedy's concurring opinion in eBay, noted above, to the effect that where the patented invention is a small component of the accused product, "legal damages may well be sufficient to compensate for the infringement and an injunction may not serve the public interest." The district court, therefore, found that monetary damages (in the form of a reasonable royalty on Microsoft's future sales of infringing products) would be adequate to compensate z4.

Judge Davis also determined that the balance of hardships weighed in Microsoft's favor. Microsoft argued, and the court agreed, that:

  • A redesign of Windows and Office to remove the infringing components would create a significant hardship for the company; and
  • "[T]urning off" its product activation system could lead to the market being flooded with pirated software.
Finally, Judge Davis held that the public interest would likely be "disserved" if a permanent injunction were entered against Microsoft. The judge was persuaded by Microsoft's argument that, because the vast majority of computers run on the Windows operating system and use the Office suite of applications, a redesign of those products would have a detrimental impact on computer manufacturers, retailers and users. The judge also found that deactivation of Microsoft's product activation servers would lead to an increase in pirated software.

A Surprising Application Of the eBay Ruling

All told, the z4 decision is surprising. z4 Technologies is an operating company and does not appear to be one of the patent-holding companies that were the focus of Justice Kennedy's concurring opinion in eBay. Also, the Eastern District of Texas is widely perceived to be a venue that favors plaintiff patent owners. And the jury found not just that Microsoft had infringed z4's patents, but that it had done so willfully; nonetheless, no injunction was granted. One factor that appears to have been important to Judge Davis is the fact that Microsoft's next generations of Windows and Office, which will eliminate the infringing technology, are due for release next year. The judge, then, may have felt that the period of future infringement would be short in this case.

Ramifications of the eBay Decision?

Following are some of the potential consequences of, and issues raised by, the Supreme Court's decision:

  • Companies accused of patent infringement may be more willing to litigate through trial, rather than settle, because the risk of a permanent injunction has been reduced, at least to some degree.
  • Public companies, however, may face practical consequences in opposing permanent injunctions. If a defendant public company were to argue that it would be harmed by a permanent injunction, that might trigger reporting requirements and cause alarm among shareholders. It's interesting to note that in the eBay case, eBay issued a press release when the Federal Circuit reversed the district court's denial of a permanent injunction. In that release, eBay stated its belief that a permanent injunction would not have an impact on its business.
  • Plaintiff patent owners may be more willing to file patent-infringement cases in the U.S. International Trade Commission (ITC), which has jurisdiction when such cases involve imported products. In the ITC, orders barring infringing articles from the United States are available to prevailing patent owners essentially as a matter of right.
  • Patent-holding companies may develop approaches to achieve the maximum chances of winning permanent injunctive relief, for example, by allying themselves with universities or other similarly "sympathetic" co-plaintiffs.
In recent years, many major technology companies have created subsidiary companies to hold legal title to their patents, largely for financial reasons. Because those subsidiaries own the patents, they are necessary plaintiffs in any lawsuits against competitors for patent infringement. In view of the eBay decision, however, technology companies may reconsider the use of such patent-holding companies.

District courts will have to determine how and when to address permanent injunction requests and the consequences of denial of such requests. Should the court hold a separate trial, in which the parties can present evidence on each of the four equitable factors? Should the court bifurcate the issues of patent infringement and validity from the issues of damages and an injunction? If a permanent injunction is denied, how are damages for future infringement to be calculated? In z4, the court ordered z4 to file a new complaint seeking damages for future infringement, and ordered Microsoft to file quarterly reports of its sales of infringing products. This approach may work in a case where the period of future infringement is likely to be short, but may be less practical in a case where the infringement may continue for many years into the future. Just as no standard approach has developed for the timing and conduct of Markman claim-construction hearings, so too the handling of permanent-injunction requests may vary from district to district, and from judge to judge.

If a permanent injunction is denied but the defendant continues to infringe, is such infringement per se willful and, if so, is the patentee entitled to enhanced damages? In eBay, the district court indicated that it would be "more inclined to award enhanced damages for any post-verdict infringement." But in z4, the district court indicated that damages for future infringement would be based on the reasonable royalty rate determined by the jury, rather than on any enhancement thereof.

The ramifications of the eBay decision will take some years to play out, as courts apply the decision in new and different situations that present varying facts. The z4 decision, however, shows that eBay will change the outcome on requests for permanent injunction, and sometimes in surprising ways.

Anthony J. Fitzpatrick is a partner with Duane Morris LLP, based in the firm's Boston office. His practice focuses on Patents and trade secret litigation, and he is co-chair of the firm's Intellectual Property Litigation Practice Group.

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