Double setback for Microsoft in internet battle

Microsoft, the American computer software giant headed by the billionaire Bill Gates, hit a big hurdle yesterday when its Tokyo offices were searched by Japan's Fair Trade Commission while in America it received an early setback in its high-profile court battle against the US Justice Department. Mary Dejevsky in Washington and Richard Lloyd Parry in Tokyo report.

The Japanese agency searched Microsoft's Tokyo offices on suspicion of breaking anti-monopoly laws by pressurising computer makers into pre- installing its internet browser - known in the trade as "bundling". According to FTC sources the Japanese arm of the company allowed computer manufacturers to license its Windows 95 operating system only on condition that they did not install Internet browsers created by rival software companies.

Microsoft spokesmen were unavailable last night, but company sources denied that Microsoft had broken Japanese law, and said that the inspection was "apparently aimed at gathering information in connection with the legal dispute in the United States". Microsoft Japan's president, Makoto Naruke, said the company would co-operate fully.

Meanwhile, Microsoft and the US Justice Department went back to court yesterday in the latest round of a dispute seen by the US as a crucial test of its competition policy in the new technology sector and by Microsoft as an assault on its commercial freedom.

The specific issue is whether Microsoft can be ruled in contempt because of what the Justice Department regards as its inadequate response to an earlier court judgment. This ordered it to supply its Windows 95 software to computer manufacturers without obliging them to take its Internet Explorer browser - the mechanism that allows access to the Internet. If Microsoft loses, it could be liable for fines of $1m (pounds 600,000) a day.

In court yesterday, District Judge Thomas Penfield Jackson sharply criticised key arguments presented by Microsoft. On three occasions during an opening statement by Microsoft lawyer Richard Urowsky, he challenged the attorney's focus on statements made by the Justice Department. The judge challenged Microsoft's claim that the Justice Department has been inconsistent in its demands for changes in Microsoft's marketing of its Internet Explorer browser. The judge suggested he would not accept Microsoft's effort to buttress its case by pointing to Justice Department filings, which would be a setback to the company.

Microsoft has also objected to the appointment of Professor Lawrence Lessig, a noted computer expert, of Harvard and Yale universities, and has made a formal request for his removal, alleging that he may be partial to Microsoft's chief rival in the browser market, Netscape.

Microsoft told Judge Jackson that Lawrence Lessig was biased against the company and complained that Mr Lessig compared installing a version of Microsoft's Internet explorer product "to selling his soul, presumably equating Microsoft with the devil". Mr Lessig's comment was made in an e-mail message sent last summer to an executive at Netscape Communications Corp, Microsoft's rival.

The original order on 11 December to stop bundling the two products was to take effect immediately to prevent Microsoft from expanding its dominance of the browser market, which was fast becoming a monopoly.

In a move that clearly infuriated the Justice Department, Microsoft responded by saying that it could comply only by supplying an outdated version of its Windows program or one that did not work properly because the "integral" browser had been removed. It is this response that, in the view of the Justice Department, places Microsoft in contempt.

Microsoft will argue that it is being penalised for the success of its Windows program, that the browser is an integral part of it, and that the bundling is not monopolistic because it does not preclude other companies from marketing their own browsers for use with Windows 95.