After looking unstoppable, Alcatel-Lucent was dealt a big setback in its ongoing MP3 lawsuit against Microsoft by the U.S. Court of Appeals for the Federal Circuit.

Given how few cases are appealed to the Supreme Court, this may spell the end of what would have been a $1.53 billion paycheck from Microsoft (NASDAQ: MSFT) to Alcatel-Lucent (NYSE: ALU).

The ruling upholds the decision that the Redmond, Wash. software giant had properly licensed the MP3 technology in use in Windows Media Player (WMP) from Fraunhofer Labs, a German research institute that Microsoft maintained had held the rightful patent in the MP3 compression codec (define).

The case dates back to 2003 and involved Microsoft's license to use MP3s with WMP. Microsoft paid $16 million to license the codec from Fraunhofer, which developed the MP3 codec in conjunction with Bell Labs and French electronics firm Thomson.

Alcatel-Lucent claimed Bell -- which it owned through through merger of Alcatel and Bell Labs' owner, Lucent, in 2006 -- held several patents related to MP3 before Fraunhofer became involved, however.

Alcatel went after hardware vendors, since they sold PCs with WMP pre-loaded. Dell and Gateway were the first targets, but Microsoft, as provider of the WMP software with Windows XP, stepped up to voluntarily assume the defendant's role in the case.

In February 2007, a jury found that Microsoft had violated those patents and slapped it with the $1.53 billion fine, based on the total value of PCs sold. The presiding judge, Rudi Brewster, vacated that ruling later in the year when Microsoft appealed, claiming that it had already licensed the necessary MP3 encoding technology from Fraunhofer.

"We are disappointed with the court's decision on this matter," said spokeswoman Mary Ward told Reuters. "We will review our options to see what steps we should take."

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The company does at least have the consolation prize of $512 million from another infringement suit, which survived the appeals process.