Appeals court victory fleeting for Microsoft

Although the Redmond, Wash.-based software company claimed victory after Thursday's appeals court decision, legal experts characterized it as a loss for the software giant that could complicate its plans for future products. Microsoft dodged the breakup order issued by U.S. District Judge Thomas Penfield Jackson, but the court upheld the core monopoly claims against the company.

"Microsoft may have ducked the murder-one conviction and the death penalty, but they sure look like they've been hit with a murder two," said Rich Gray, a Silicon Valley antitrust attorney who closely followed the trial. "They have been found by the full panel of the D.C. Court of Appeals to have illegally maintained their monopoly in violation of the Sherman Act. That's devastating."

So solid is the government's remaining case, no matter what happens next, that Microsoft will be forced to change how it conducts its business, legal experts say. Breakup also remains a viable option when the case returns to the trial court, where a new judge will craft a remedy.

Before that happens, both sides may also choose to settle out of court. Microsoft Chairman Bill Gates indicated his desire to begin settlement talks during a press conference on Thursday, and reiterated his stance in televised appearances Friday. Also, members of Congress appear to be pushing the Bush administration to settle the case.

"They're going to have to live with the fact they are an adjudicated monopolist, and that's going to have to change how they do business," said Andy Gavil, an antitrust professor at Howard University School of Law. "I don't see that as a victory. There isn't a lot of light at the end of the tunnel that could ultimately get Microsoft to believe they ultimately will be vindicated."

For Microsoft, the decision issued by the U.S. Court of Appeals for the District of Columbia Circuit places in jeopardy the company's recent Windows XP bundling efforts and .Net, its ambitious software-as-a-service strategy. More seriously, the court determined it has a right to tell a monopolist how products should be designed--a decision that could have far-reaching effects on other technology companies.

The ruling also exposes Microsoft to huge legal liabilities, both in existing private antitrust lawsuits brought on behalf of consumers and in cases that could be filed by competitors. The appeals court ruling also could bolster the European Union's investigation into Microsoft's server operating system business, legal experts warn.

The appeals court on Thursday decided on four issues: whether Microsoft violated Section 2 of the Sherman Act by illegally maintaining a monopoly in Intel-based operating systems; whether the company attempted to extend that monopoly to the browser market; if tying Internet Explorer to Windows 95 and 98 constituted an anticompetitive act; and whether U.S. District Judge Thomas Penfield Jackson mishandled the remedy portion of the case, which led to his order to break Microsoft into two companies.

Many legal experts had predicted the appeals court would throw out the breakup order, sending the remedy back to the District Court and assigning a new judge. They also predicted the judges would reverse the attempted monopolization claim. The court delivered on both predictions.

Based on the largely conservative make-up of the court and an earlier ruling in favor of Microsoft, the seven-judge appeals panel also had been expected to toss out the tying claim. That would have cleared the way for Microsoft to more aggressively integrate new products and services into its operating system. Many legal experts also predicted the appeals court would punch large holes in the monopoly maintenance claim.

On Thursday, the appeals court did neither, largely upholding the case's monopoly maintenance portion and sending the tying issue back to the District Court for further review. Both actions could dramatically affect Microsoft's business.

"Microsoft has to be clearly disappointed about this outcome, when they expected to win so much more," said Bob Lande, a professor at the University of Baltimore School of Law. "At best it's a tie and really a net gain for the government."

Smitten monopolist
The appeals court's ruling could cast a large shadow on how Microsoft designs and develops software. Since the company combined DOS and Windows 3.11 in the early 1990s, the company has consistently integrated new features into its operating systems--and vocally expressed its right to do so.

In fact, during the last six months Microsoft has aggressively stepped up its intertwining of products in support of .Net. More fully integrating Windows Media Player into Windows XP or adding support for Microsoft's Passport authentication service already has drawn the ire of competitors and some state trustbusters.

The ruling "puts everything Microsoft is doing in doubt," Lande said.

The appeals court ruling poses two major problems for Microsoft. First, the Court of Appeals' decision to send back to a lower court the question of whether Microsoft's act of tying, or "bolting," its Internet Explorer Web browser to Windows 95 and 98 was anti-competitive leaves unresolved an important issue: Can Microsoft arbitrarily integrate new features into the operating system?

More seriously, the court agreed with Jackson's finding that Microsoft's commingling of Internet Explorer and Windows code "has an anti-competitive effect" because it may deter developers' interest in competitive products. That may also leave the software maker's upcoming products, such as Windows XP and .Net, open to possible antitrust action.

"Everybody thought the appeals court would be hands-off on technology design issues, but here you have the D.C. Circuit Court, which everyone viewed as a favorable court for Microsoft, weighing in and saying, 'There are times when we will second-guess the monopolists' design decisions, and this is one of those times,'" Gray said.

Added Gavil: "Microsoft is now clearly going to have to justify the integration independently. The court says they are going to have to weigh the anti-competitive effects of some of that conduct against the business and technological justification."

Microsoft may immediately have to face some of that design justification as it prepares to launch Windows XP on Oct. 25. During a Thursday conference call with the media, New York Attorney General Eliot Spitzer made it clear that the government would probe Microsoft's behavior with the XP operating system and the company's efforts "to really continue to advance (their) dominance in many other sectors."

Gavil said Microsoft's problems with Windows XP and other products are just beginning because of the appeals court decision. "You can just see the competitors dealing with the Windows XP problem, seizing on that and making as much of that when the case gets remanded" to the trial court, he said.

Lawsuit free-for-all?
Microsoft may face other legal challenges that could keep the company in court for years. While the Court of Appeals removed Jackson from future proceedings, it unexpectedly fully stood by his initial decision, the findings of fact. That document, which served as the basis for his eventual ruling and the appeals court's decision, could be used in the more than 100 consumer antitrust lawsuits pending against Microsoft.

"Not only will this case move on, but other plaintiffs will use these findings as weaponry in their own suits," said Hillard Sterling, an antitrust attorney with Chicago-based Gordon & Glickson. "The private suits will definitely grab and run with the monopoly finding, as well as the whole thing of unlawful monopoly."

AOL Time Warner also could file suit against Microsoft because of the findings of anti-competitive behavior against Netscape Communications.

"But it's not a slam dunk," said Emmett Stanton, an antitrust attorney with Fenwick & West in Palo Alto, Calif. "Had Microsoft lost on the tying claim, AOL Time Warner could write their ticket. They would have a huge claim against Microsoft."

The appeals court decision also could bolster the European Union's investigation of Microsoft's server business.

"This should embolden them, somewhat," said Lande, who is vacationing in Scotland. "Microsoft doesn't have a lot of political muscle over here. So, definitely, this hurts."

Because the appeals court so strongly upheld the monopoly maintenance claim, Microsoft still faces the possibility of a breakup, said Glenn Manishin, an antitrust attorney with Patton Boggs in McLean, Va.

"The heart of the case was, is and always will be maintenance of monopoly power in the operating system market," he said. "That was affirmed."

Manishin emphasized that as a matter of law, the fate of the tying and attempted monopolization claims has little to do with the ultimate remedy decided by the court. "Their reversal (on those issues) doesn't have any effect on whether divestiture would be the appropriate remedy for the monopolization claim," he said.

Legal experts agreed that a breakup of Microsoft remains a possibility. They noted that the appeals court threw out the breakup remedy on technicalities and not on its merits.

"Breakup is definitely still very possible," Gavil asserted. "The Court of Appeals has said it is an extraordinary remedy and that it shouldn't be resorted to lightly, but it surely has not ruled it out as a matter of law."

Going forward, Microsoft's options are limited: Appeal to the Supreme Court or petition for settlement, legal experts say.

Gates already is talking settlement. During a Thursday press conference, he said that "with this ruling, there is a new framework (for settlement), and I think it's a good time for all the parties involved to sit down and see what kind of resolution could be worked out." Gates reiterated his comments on TV talk shows Friday morning, saying he was "very open" to reaching a settlement.

U.S. Attorney General John Ashcroft, at a press conference Thursday, hedged when asked about possible settlement negotiations.

"I don't believe that we're in a weakened position. My own view is that this is a victory for the department, and so the department is not, I believe, in a weakened position here," he said. "The court did find that Microsoft had engaged in unlawful conduct to maintain its dominant position in the computer operating system arena."