Tyco Healthcare, now Covidien (NYSE:COV), won a legal battle after the U.S Court of Appeals for the 9th Circuit upheld a lower court’s ruling that a marketing campaign for its pulse oximetry equipment did not breach antitrust rules.

The case involves Tyco’s OxiMax blood oxygenation sensors and monitors. A group of hospitals and healthcare providers sued the company for violating sections of the Sherman Act, which prohibits companies from establishing monopolies. The plaintiffs accused Tyco of violating the act by using marketing agreements to shut out competitors like Masimo (NSDQ:MASI) and General Electric (NYSE:GE) and maintaining a monopoly with the OxiMax system, which is not compatible with generic sensors.

Writing for the court (PDF), Judge Barry Silverman ruled that Tyco’s actions did not violate the Sherman Act because “there is no evidence that they foreclosed competition in a substantial share of the sensor market.”

“[T]he undisputed evidence shows that the patented OxiMax design is an improvement over the previous design. Innovation does not violate the antitrust laws on its own, and there is no evidence that Tyco used its monopoly power to force customers to adopt its new product,” Silverman wrote.

The case hinged on Tyco’s early dominance in the pulse oximetry market with its R-Cal sensor and monitor combination. Like other competing devices, the system used simple sensors and a more complicated monitor that determined the parameters to be monitored. Tyco’s R-Cal patent prevented other firms from marketing compatible sensors. With the patent set to expire in November, 2003, Tyco began developing a new pulse oximetry system, the OxiMax, using sensors with memory chips capable of storing data and delivering data to physicians, according to Silverman’s opinion. The new sensors also contained the calibration coefficients formerly carried by the monitor, making the OxiMax monitors incompatible with generic sensors.

For customers, however, the innovation carried benefits. Where they formerly had to buy a new monitor when Tyco introduced a new sensor line, they were now able to buy new sensors for the OxiMax monitor as they were released, rather than shelling out for a whole new system with each upgrade.

“This reduces costs for customers and frees sensor designers from having to use the predefined coefficients programmed into the installed base of monitors,” Silverman wrote. “Moving the calibration coefficients into the sensors therefore facilitates the development and introduction of new types of sensors.”

Tyco launched OxiMax in March, 2002, and discontinued the R-Cal line in February, 2003. To encourage adoption of the new line, it created a pair of marketing agreements. One, so-called “market-share discount” deals inked with hospitals, gave discounts for guarantees that a hospital’s minimum percentage of total pulse oximetry equipment spend would go to the OxiMax system. Customers were not obliged to by the system exclusively and the discounts increased as the minimum percentage purchase rose.

The second marketing arrangement, so-called “sole-source agreements,” were inked with group purchasing organizations, consortiums of healthcare providers that negotiate purchasing contracts. Those deals required GPOs to buy the OxiMax system exclusively, in exchange for deep discounts.

Silverman upheld the lower court’s ruling that the deals did not violate antitrust laws because hospitals’ commitments were “voluntary and [could] be ended at any time, and hospitals [were] thus free to switch to more competitively priced generics.”

“The OxiMax design was a ‘superior and more sophisticated offering than the previous generation R-Cal system’ and Tyco ‘did nothing to force OxiMax monitors on its customers,'” he wrote.