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The decision contradicts Bill Gates' statement last week that he was committed to making the settlement a success.
District Judge Colleen Kollar-Kotelly today called for further negotiations with the six states but John Warden, lead trial counsel for Microsoft, said the company had given enough and more talks were pointless.
"The issues in this case have been beaten to death, and they have been beaten to death by people who are worn out," said Warden. "Microsoft believes the settlement process has come to an end."
The decision means Microsoft and the dissenting states will face a series of remedy hearings scheduled to begin in March 2002.
Microsoft chairman and chief software architect Bill Gates was upbeat about last week's ruling saying: "While this settlement imposes some very tough rules and restrictions on our business, we believe that resolving this case now is the right thing to do for our customers, for the entire technology industry and for the economy."
Massachusetts, which has publicly rejected the settlement and California - which has the money and expertise to continue the case and is home to some of Microsoft's staunchest competitors - are expected to take the lead in pursuing the case.
Once those hearings are concluded, it will be Kollar-Kotelly's job to impose a remedy against Microsoft, which was found to have violated US antitrust law by illegally maintaining its monopoly.
But it was clear from Tuesday's hearing that future settlement talks aimed at bringing this historic case to a close are unlikely to succeed.
Tony Lock, senior analyst at Bloor Research, told CW360.com: "This was almost inevitable. States in the US have their independence and look to demonstrate their independence. We also have to remember that it's still going on in Europe.
In previous court appearances, Kollar-Kotelly urged the two sides to settle, citing the softening economy and other events "in this time of rapid national change".
Now, the judge faces the prospect of conducting two different proceedings. There is nothing precluding the federal government and Microsoft from settling the case on their own. In fact, New Mexico reached its own agreement with Microsoft earlier this year.
Last week's settlement was widely attacked by industry groups that have supported the government case, but defended by Justice Department officials.
US Attorney General John Ashcroft last week said the "proposed settlement puts in place enforcement measures that will require Microsoft to disclose internal operating system interfaces and protocols. Those disclosures in turn will create opportunities for independent software vendors to develop products that will be competitive with Microsoft's products."
However, Dan Kusnetzky vice-president, systems software research at analysts IDC said: "It is fairly clear that the PC is not the only way to access information and its days are numbered. The one area that will reduce in importance is that which the agreement demanded to be open."
Simon Moores, chairman of the Microsoft Forums agreed. "Microsoft has won the battle but it has not won the war," Moores said about last week's settlement.
Since the antitrust case began the goalposts have been moved, he said. The battle is no longer over the dominant Web browser but "through .Net, Microsoft is attempting to own the middleware - the key to Web services".