United States: In re Union Oil Co. of California: A Setback for FTC’s Standard-Setting Enforcement Agenda

Federal Trade Commission Administrative Law Judge D. Michael Chappell rebuffed two of FTC Chairman Timothy Muris’ key antitrust initiatives last November, when he dismissed the FTC staff’s complaint against Union Oil Co. of California ("Unocal").¹ One of a series of investigations and cases involving alleged opportunistic conduct by intellectual property owners in connection with standard setting,² Unocal also embodies the Chairman’s aim to limit the scope of Noerr-Pennington antitrust immunity for some forms of governmental petitioning. Oral argument in the appeal from Judge Chappell’s decision was held on March 10; the Commission’s decision, and perhaps a subsequent appeal to a federal court of appeals, will reveal how much life remains in the Chairman’s Noerr initiative. If the matter is remanded to the ALJ for further consideration on the antitrust merits, the case could yet be an important addition to the impoverished antitrust case law of standard-setting.

The suit attacks Unocal’s conduct with respect to low-emission reformulated gasoline ("RFG") standard-setting by the California Air Resources Board ("CARB"), a department of the California Environmental Protection Agency. The California Clean Air Act directs CARB to promulgate and enforce the RFG standards³ through rulemaking proceedings under the California Administrative Procedures Act, which subjects CARB’s decisions to administrative and judicial review. CARB developed the RFG standards in three phases of rulemakings; the first imposed relatively modest new requirements, including the elimination of lead. The Phase 2 rulemaking ended in 1991 with a standard that imposed much more costly demands. It specified limits for eight properties of gasoline, including content levels for benzene and some hydrocarbons, and temperatures at which the gasoline evaporated.⁴ This standard required substantial capital investment by refiners, amounting, by CARB’s own estimate, to between $2 billion and $5 billion.⁵ California implemented the Phase 2 standard in 1996.

According to the Complaint, Unocal recognized the business value of a CARB Phase 2 standard that infringed a Unocal invention, and, as the standard took shape, amended its proposed patent claims language to more closely track the standard.⁶ The Complaint alleges that, in anticipation of the Phase 2 proceeding, Unocal embarked on inhouse emissions research in January 1990.⁷ After Unocal’s Executive Board reviewed the preliminary research results in May 1990, reflecting the "purportedly novel discovery" of a relationship between emission levels and eight fuel properties, it authorized the filing of a patent application on the discovery.⁸ Unocal filed the application, covering the composition of RFG based on the eight properties and related methods, in December 1990; it ultimately yielded five patents claiming priority to that filing date.⁹ The first patent to issue, U.S. Patent No. 5,288,393, is at the heart of the Commission’s case; it issued in February 1994, well after refiners had embarked on the capital investments necessary for compliance with the Phase 2 standard.¹⁰ According to the Complaint, not until nearly a year later did Unocal publicize the ‘393 patent, announcing that "’it covers many of the possible fuel compositions that refiners would find practical to manufacture and still comply with the strict [CARB] Phase 2 requirements.’"¹¹

Simultaneously, the complaint alleges, Unocal officers discussed "how to induce the regulators to use information supplied by Unocal" in developing the standard.¹² To that end, Unocal allegedly "provided information to CARB for the purpose of obtaining competitive advantage," in the course of private meetings with CARB staff, public workshops and hearings, and through participation in two industry groups that themselves took part in CARB’s rulemakings.¹³ In particular, Unocal advocated the adoption of a specification for T50, the temperature at which half of a fuel evaporates, and the use of a predictive model, which would allow refiners to meet the overall emissions standard, even while failing under some specifications, if they also exceeded other specifications.¹⁴

The Commission claims that the information Unocal provided, which appears to concern both the fact of the relationship between the eight fuel properties and emission levels, and test data indicating the precise extent of the relationship, was "materially misleading."¹⁵ This was not because the information was inaccurate, or because of any affirmative misrepresentations Unocal made in connection with the information, but rather because of "Unocal’s suppression of facts relating to its proprietary interests in its emissions research results and Unocal’s active prosecution of patents based on these research results."¹⁶ Notably, it is alleged that Unocal management had "decided not to disclose" its pending patent application to CARB staff in the course of its presentation to them.¹⁷ According to the Complaint, in July 1991, when Unocal provided CARB with a set of prediction equations based on the data, it asked CARB to keep them confidential, suggesting that it viewed them as a potential source of a "competitive advantage."¹⁸ In late August 1991, however, Unocal informed CARB that it "now consider[ed] this data to be non-proprietary and available to CARB, environmental interest groups, other members of the petroleum industry, and the general public upon request."¹⁹

The Complaint alleges that this representation "created the materially false and misleading impression that Unocal agreed to give up any ‘competitive advantage’ it may have had relating to its purported invention and arising from its emissions research results."²⁰ The "misleading impression" followed from Unocal’s failure "to disclose to CARB its proprietary interests in the ‘5/14 Project’ data and equations, its prosecution of a patent application, or its intent to enforce its proprietary interests to obtain licensing income."²¹

Unocal participated in the Phase 2 proceedings not only directly, but also indirectly as a member of two industry groups. The first, the Auto/Oil Air Quality Improvement Research Project ("Auto/Oil"), was an emissions-control research-and-development consortium of the "big three" U.S. automobile manufacturers and 14 oil companies. According to the Complaint, the project members had agreed that data and information they presented to the program for consideration would be dedicated to the public domain.²² Unocal presented the data and equations from its research to Auto/Oil in September 1991, two months before CARB adopted the infringing standard. As with its presentation to CARB, Unocal told Auto/Oil that the data were in the public domain, and would be made freely available.²³ The Complaint does not indicate clearly that Auto/Oil then pressed CARB to adopt a Phase 2 standard that would infringe Unocal’s invention.²⁴ However, it alleges the presentation to Auto/Oil was "an integral part of [Unocal’s] strategy of deception for the purpose of obtaining a competitive advantage therefrom."²⁵ And Auto/Oil’s refiner members were among those who made "substantial progress in their capital investment and refinery modification plans for compliance" with the Phase 2 regulations.²⁶

Unlike Auto/Oil, the Western States Petroleum Association ("WSPA") did participate in the Phase 2 rulemaking.²⁷ WSPAsubmitted three cost studies to CARB, including one relating to "process royalty rates associated with non- Unocal patents," which CARB used in determining the cost-effectiveness of its proposed standard.²⁸ This study, the Complaint alleges, "could have" incorporated costs relating to Unocal’s patent position had WSPA been aware of it.²⁹ But when Unocal presented the results of its research to WSPA in September 1991, it did not alert them to its pending application; the presentation thus "created the materially false and misleading impression" that the research results were in the public domain.³⁰

The standard CARB adopted in November 1991 incorporated a specification for T50; according to the Complaint, CARB based the specification on Unocal’s equations, and published them, "in reasonable reliance on Unocal’s representation" that the information was not proprietary.³¹ In 1994, CARB added a predictive model to the Phase 2 standard, based on the "urging of numerous companies, including Unocal,"³² which told CARB that the predictive model would add flexibility, "furthering CARB’s mandate of ‘cost-effective’ regulations."³³ This assertion, the Complaint alleges, was "materially false and misleading because Unocal suppressed the material fact that assertion of its proprietary rights would materially increase the cost and reduce the flexibility of the proposed regulations."³⁴

According to the Complaint, by the time the PTO issued the ‘393 patent in February 1994, most oil companies were "locked in" to the Phase 2 standard, and thus, in the FTC’s view, to the ‘393 patent.³⁵ Unocal’s press-release claim that the patent "‘covers many of the possible fuel compositions that refiners would find practical’" might suggest something less than market power, let alone monopoly power.³⁶ But the complaint itself characterizes Unocal’s position less modestly: the Phase 2 standard, it asserts, "overlapped almost entirely with Unocal’s pending patent rights."³⁷ Consequently, in the Commission’s view, Unocal’s conduct created market power in two markets: that for technology for the production and supply of "CARB-compliant ‘summertime’ gasoline in California"; and that for the gasoline itself. Unocal exercised that power through "enforcement of its patent rights," i.e., infringement suits against refiners and licensing.³⁸

Indeed, Unocal did enforce its patent rights.³⁹ After Unocal publicized the ‘393 patent, six major oil companies sued it for a declaratory judgment of invalidity, contending also that the patent was unenforceable due to inequitable conduct before the PTO. Unocal filed an infringement counterclaim. A jury found the patent valid and infringed, and the court rejected the inequitable conduct defense, holding that Unocal had acted in good faith. The infringement defendants were held liable for a royalty of 5.75 cents per gallon for their sales of reformulated gas from March 1996 through December 31, 2000. The Federal Circuit affirmed the judgment, including the rejection of the inequitable conduct defense. Union Oil Co. Of Cal. v. Atlantic Richfield Co., 208 F.3d 989 (Fed. Cir. 2000). Unocal has also sued another firm, Valero Energy Co., for willful infringement, and seeks the same 5.75 cents per gallon royalty as it obtained in the litigation with the other refiners.⁴⁰ According to the complaint, Unocal has licensed eight other firms under its five RFG patents, incorporating a standard volume- based royalty ranging from 1.2 to 3.4 cents per gallon.

This program of enforcement, the complaint contends, "is the proximate cause of substantial competitive harm and consumer injury";⁴¹ the particular injuries the Complaint cites are (a) increased royalties for the use of low-emissions RFG technology; (b) increased prices for low-emissions RFG in California; (c) reduced output of low-emissions RFG in California (analytically equivalent to (b)); and (d) reduced incentives to produce low-emissions RFG in California.⁴² Utilizing the 5.75¢/gallon royalty Unocal won from the infringing oil companies, the complaint estimates that Unocal’s enforcement of its patent rights will produce annual royalties of more than $500 million, 90 percent of which would be borne by consumers.⁴³

Had any of the FTC staff’s case survived the Noerr issue, it could have given rise to tremendously interesting case law on standard-setting and intellectual property rights. In particular, the case presents the question of what conduct could constitute an actionable offense in the absence of any rule requiring disclosure of blocking intellectual property rights. Based on the above account, it is not at all clear what Unocal meant when it told CARB that the data from its research was proprietary, and later when it told CARB and the two private organizations that the data was in the public domain. There is at least a plausible argument that the data is distinguishable from the underlying invention, in the same way that a patent’s explanation of an invention is freely available while the invention itself is the patentee’s. Further, examination of exactly what degree of power Unocal’s patents gave it over the Phase 2 standard, including whether viable Phase 2-compliant alternatives existed, would also have enriched the case law.

Perhaps the Commission’s opinion will address these issues. Judge Chappell’s analysis, however, left them untouched. He held instead that Unocal’s conduct directed at CARB, whether directly or through Auto/Oil and WSPA, was immune under Noerr. CARB, he held, performed a legislative, not quasi-judicial, function, and therefore whether Unocal made misrepresentations to it was immaterial. He pointedly rejected the Complaint’s assertion that Unocal was not immune under Noerr "as a matter of law and as a matter of fact," holding that the applicability of the doctrine "clearly is a matter of law," and that the Complaint’s assertion to the contrary was not a "properly plead factual allegation" that he would have to credit in ruling on Unocal’s motion to dismiss.⁴⁴ The Judge concluded that, contrary to the staff’s theory, CARB’s proceedings "were legislative, and not adjudicative," pointing to:

• the "broad discretion" California law gave CARB to carry out its mandate;
• that CARB had authority to set policy and establish rules, rather than simply to apply "’a pre-existing legal standard to a well-defined set of controverted facts to determine whether a particular person or group of persons should receive a benefit or penalty";⁴⁵
• the procedures CARB employed, which "do not bear the indicia of a formal adjudicatory proceeding," such as cross-examination, evidence rules and burdens of proof;⁴⁶ and
• the relevant statutory authority for CARB’s rulemaking, which indicated that CARB was performing a legislative function.⁴⁷

For much the same reasons, the Judge dismissed staff’s theory that CARB was "solely dependent on [Unocal] for information," as in, for example, a ratemaking; CARB’s quasi-legislative powers and procedures meant that it received information and advocacy from numerous interested parties.⁴⁸ The Judge also rejected the argument that Noerr does not apply where the governmental entity was "unaware that it is being asked to adopt or participate in a restraint of trade."⁴⁹ The Complaint made it "clear that [Unocal] engaged in petitioning conduct," as distinguished from the boycott condemned in FTC v. Superior Court Trial Lawyers Ass’n.⁵⁰ In the Judge’s view, the staff’s argument would improperly graft the state action doctrine onto Noerr.⁵¹

Unocal’s statements to Auto/Oil and WSPA, however, present at least the possibility that they were not subject to Noerr, inasmuch as they were not governmental entities. However, the Judge concluded that "it is clear from the allegations of the Complaint that [Unocal’s] actions with respect to the Auto-Oil Group and WSPA were part of an alleged scheme to induce these third parties to influence CARB," and accordingly, were themselves immune under Noerr.⁵²

Despite this categorical statement, there still remained the possibility that, as described in the Complaint, some of Unocal’s representations to Auto-Oil and WSPA were designed not so much to encourage them to lobby CARB as to lull the groups’ members into relying on access to Unocal’s technology rather than other means of complying with the Phase 2 standard.⁵³ Conceivably, such statements could have led the groups’ members to ignore alternative compliant technologies until they had already locked themselves in to Unocal’s. If so, those statements would be a source of injury entirely apart from CARB’s adoption of the Phase 2 standard. ⁵⁴ But whether they actually caused any injury would depend on, among other things, "the scope of Respondent’s patents, whether or not Auto/Oil Group and WSPA could have invented around these patents, and whether any such newly created products or methods could have avoided infringement."⁵⁵ These "fundamental and substantial patent issues," the Judge determined, meant that the claim with respect to these representations to Auto/Oil and WSPA "arise[] under patent law" within the meaning of 28, U.S.C. § 1338(a), which gives jurisdiction over such cases to the federal courts. Thus, "these substantial questions of federal patent law vitiate jurisdiction under Section 5 of the FTC Act as this case is alleged."⁵⁶ Accordingly, to the extent that any Unocal communications to Auto/Oil and WSPA were not already immune under Noerr, the Judge dismissed them on this jurisdictional ground.

It is hard to see why the same rationale would not also vitiate the Commission’s jurisdiction over the Noerr-protected communications in this case – and thus the Judge’s ability even to declare those communications immune from antitrust scrutiny. Absent Noerr, the competitive impact of CARB’s adoption of the Phase 2 standard would depend upon the extent to which Unocal’s patents blocked it, which in turn depends on the validity and scope of Unocal’s patents – the same patent-law questions that, in the Judge’s view, divested the FTC of jurisdiction. The Judge’s logic suggests that he lacked jurisdiction even to determine that Unocal’s conduct was immune – the entire case belonged in federal district court.

It probably goes without saying that this jurisdictional theory will get a frosty reception from the Commission. It follows almost inevitably from the Judge’s conclusion here that the Commission has no jurisdiction over most any antitrust case involving patents, as the competitive significance of any patent is dependent in the first instance on its scope and validity, both fundamental questions of patent law. In their recent cases attacking patent infringement settlements, both the FTC and FTC staff have resisted the argument that antitrust liability requires an examination of the underlying patent merits. But if the appeal of In re Schering-Plough led to the restoration of the ALJ’s opinion in that case, the combined impact of that ALJ decision and the one in Unocal would be to take the infringementsettlement cases out of the FTC’s bailiwick.

In addition, the Judge’s decision, if upheld, could lead to a jarring shift in the adjudication of patent-related antitrust cases brought under the Sherman Act. If Sherman Act cases based on facts like those in Unocal were held to "aris[e] under [an] Act of Congress relating to patents," within the meaning of 28 U.S.C. § 1338, they would be subject to the exclusive appellate jurisdiction of the Court of Appeals for the Federal Circuit. See Holmes Group, Inc. v. Vornado Air Circulation Systems, Inc., 535 U.S. 826 (2002). This is not unthinkable; it is certainly arguable, as the Judge has concluded, that "’the plaintiff’s right to relief’" in antitrust cases based on the scope and validity of patents "’necessarily depends on resolution of a substantial question of federal patent law.’" Holmes Group, at 830 (quoting Christianson v. Colt Industries Operating Corp., 486 U.S. 800, 809 (1988)). A district court reached a similar conclusion in In re Tamoxifen Citrate Antitrust Litig., 222 F. Supp. 2d 326, 331 (E.D.N.Y. 2002)(denying state-law antitrust plaintiffs’ motion to remand to state courts suit attacking patent infringement settlement; "plaintiffs cannot succeed on their claims without proving the invalidity or unenforceability of Zeneca’s patent"). But other courts have seen it differently, e.g., In re Ciprofloxacin Hydrochloride Antitrust Litig., 166 F. Supp. 2d 740, 748 (E.D.N.Y. 2001)(remanding state-law antitrust action arising from infringement settlement to state courts where one theory of relief did not depend on an adjudication of the underlying patent), and it is hard to imagine that the FTC, which has devoted so many resources to the field over the last decade, would willingly concede that it has no jurisdiction there.

So far, Unocal has signified a serious defeat for the Commission’s efforts to regulate the exercise of intellectual property rights in standard-setting and to limit the scope of Noerr immunity. While it is quite possible that the Commission will reverse the Judge’s ruling, ultimate resolution of the issues may require a court of appeals decision that will have important implications for the FTC’s jurisdiction in standard-setting and other patent-related cases.

Copyright © 2007, Mayer, Brown, Rowe & Maw LLP. and/or Mayer Brown International LLP. This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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