United States: The Convergence Of The U.S. And European Laws Concerning Compulsory Licensing And Licensing Restrictions...Part IV

IV. The Antitrust Perils of Licensing

A. Licensing Restraints in the U.S.

Today, horizontal restraints are considered per se invalid if they fall within certain broad categories, such as horizontal market division, concerted refusal to deal or horizontal price fixing.[110] Other types of horizontal restraints and vertical restraints (except, perhaps, vertical minimum price fixing arrangements) are assessed under the rule of reason.[111]

1. Patent Tie-Ins

A tying arrangement conditions the sale of one product or service on the purchase of another.[112] The product the purchaser wants to buy is known as the "tying product," while the unwanted attached product is the "tied product." The essential antitrust concern regarding tying is that the illegal arrangements foreclose competing manufacturers or service providers from selling in the tied product market. Tying the sale of goods is expressly prohibited by § 3 of the Clayton Act, 15 U.S.C. § 14. Section 1 of the Sherman Act prohibits tying involving goods or services.

Tying arrangements are nominally regarded as per se illegal, but the law has undergone substantial changes in recent years and modern tying cases indicate that the law of tying may be moving toward a "rule of reason" balancing approach.[113] An illegal tying arrangement under Section 1 has five elements: (1) two products, i.e., a tying and a tied product or service; (2) evidence of actual coercion by the seller that forced the buyer to purchase the tied product; (3) sufficient market power in the seller's tying product market to force the buyer to accept the tied product; (4) anti-competitive effects in the tied product market; and (5) involvement of a "not insubstantial" amount of interstate commerce in the tied product market.[114]

"[W]hether a package consists of one or more separate products depends not on the functional relation between the components, but rather on the character of the demand for them.

. . . The critical question is whether the bundle consists of products which are distinguishable in the eyes of buyers. . . . Courts generally find two products to exist if there is sufficient consumer demand so that it is efficient for a firm to provide them separately, even if the products are functionally linked so that one is useless without the other."[115] Moreover, where products in the tied market are potential partial substitutes for the tying product, "antitrust concerns are heightened because tying agreements not only reduce competition in the tied market, but also reinforce market power in the tying market."[116]

2. Grantbacks

A grantback provision requires the licensee to license back to the licensor any related technology, including patented technology, which the licensee may develop during the life of the original license agreement. The Supreme Court has held that grantback requirements contained in patent licenses are not per se illegal.[117] Thus, they will usually be analyzed under the rule of reason test, which weighs the legitimate business reasons for the arrangement against the anti-competitive effect, if any, and decides whether the restraints are co-extensive with the legitimate business justifications.

3. Price Fixing

In the 1920's, the Supreme Court held that a patentee may, in a license to manufacture and sell the patented product, fix the price at which the licensee will be required to sell the patented product. In a case involving the licensing of Westinghouse by General Electric to manufacture and sell lamps, General Electric required, in the license agreement, that Westinghouse sell the lamps at prices to be fixed by General Electric. The Supreme Court held that the pricing agreement was a valid exercise of patent rights by the licensor.[118] This decision, however, has been limited by subsequent decisions[119] and most practitioners would not now rely on it to protect maximum resale prices. State Oil v. Khan[120] indicates that maximum resale prices would be subjected to a rule of reason analysis in a distribution context, and this precedent may eventually be imported into the law of IP licensing by analogy.

4. Field of Use Restrictions

Field of use restrictions refer to limitations placed upon a licensee as to the types of uses to which the licensee may put the teachings of the patent. Field of use restrictions are generally upheld and any anti-competitive effects they may cause are reviewed in accordance with the rule of reason.[121] Thus, where a patented product is applicable to varying uses, the patentee, as a general rule, may legally restrict a licensee to a particular field of use and exclude the licensee from other fields.[122]

The Supreme Court has upheld a field of use restriction which limited the licensee to production of the patented article for sale in the noncommercial market, i.e., for sale to customers for home use, while the patentee reserved to its subsidiary company the right to manufacture and sell the product for commercial use.[123]

Field of use restraints have also been upheld where applied to limit one licensee to use of a patented drug in the veterinary field and a second licensee to use in the field of human medicine, but were condemned where a licensee of a patented drug was limited to sales in individual dosage as opposed to bulk form.[124]

5. Territorial and Customer Restraints

Horizontal agreements between actual or potential competitors to allocate territories, customers, or products are ordinarily per se illegal.[125] In Continental T.V., Inc. v. GTE Sylvania, Inc.,[126] the Supreme Court held that vertical nonprice restrictions, including territorial and customer restraints, should be evaluated under the rule of reason test. Central to the Court's decision was its recognition that "[t]he market impact of vertical restraints is complex because of their potential for a simultaneous reduction of intrabrand competition and stimulation of interbrand competition."[127] The Supreme Court, however, reserved the possibility of applying a per se rule to certain vertical nonprice restrictions, but noted that "departure from the rule-of-reason standard must be based on demonstrable economic effect rather than . . . upon formalistic line drawing."[128]

In applying the rule of reason, lower courts have examined the purpose for territorial and customer restrictions, the effect of such restrictions in limiting competition in the relevant market, the market share of the supplier imposing the restraint, and the impact on competition after weighing and offsetting pro-competitive benefits of the restraints. Most post-Sylvania decisions have upheld such restrictions under the rule of reason, even if imposed by a manufacturer with a dominant market position.[129]

A patentee is generally permitted to license the manufacture and sale of a product under its patents in one country but not another and to provide by agreement that a foreign licensee will not infringe the licensor's U.S. patents.[130] Territorial restraints in international patent and know-how licensing arrangements have been held unlawful when they have brought about a division of markets substantially beyond the scope and terms of the patents or involved pervasive schemes to restrain U.S. and foreign commerce.[131]

6. Exclusive Dealing Arrangements

"Exclusive dealing arrangements pose two related, but distinct antitrust concerns. First, they threaten to eliminate opportunities for products unable to find other outlets to the marketplace. Second, they raise the barriers to entry in a market because, in order to enter, producers will have to be vertically integrated (i.e., they will have to operate at both the manufacturing and retailing levels)."[132] Recognizing potentially pro-competitive rationales for such agreements, courts apply a rule of reason analysis to determine their legality.[133]

As a threshold matter, a court must determine whether a substantial share of the relevant market is foreclosed (the foreclosure being greater than 40%) and, once such foreclosure is found, court must consider the agreement's actual impact on competition and any pro-competitive justification that may outweigh anti-competitive effects.[134]

1. The Technology Transfer Block Exemption and Its Pitfalls

If a company's IP license contemplates use in the European Union, it probably is subject to EU law. The ECJ asserts jurisdiction over contracts that are "implemented" in the EU.

Under Article 85(3) of the Treaty of Rome, companies may be granted exemptions from Article 85(1) prohibitions against licensing restrictions if such restrictions (a) contribute to "improving the production or distribution of goods or to promoting technical or economic progress," (b) provide consumers with "a fair share of the resulting benefit," (c) do not contain restrictions in excess of those which are "indispensable to the attainment of [the above] objectives," and (d) do not create the "possibility of eliminating competition."

On January 31, 1996, the Commission adopted a new block exemption on the application of Article 85(3) to certain technology transfer agreements.[135] The main purpose of the new regulation, known as TBE, is to provide a safe harbor, without the need for individual notification, for certain categories of pure patent, pure know-how or mixed technology licensing agreements. The TBE does not purport to address Article 86 abuses of dominant position. Nor would the Commission have the power to exempt any such abuses from Article 86.

The TBE contains lists of permitted and prohibited restraints. Permitted restraints in patent and know-how licenses (where only two parties are involved) include: a prohibition of sublicensing; an agreement that the licensor will not itself exploit the IP in the licensed territory; an agreement that licensor will not license others in the licensed territory; a requirement that the licensee not exploit the IP in the territories within the Common Market that the licensor has reserved to itself or to other licensees ("active competition"); a requirement that the licensee not actively market the licensed product in the territories of other licensees; an obligation not to put the licensed product on the market in territories of other licensees in response to unsolicited orders for five years following the product's entry into the EU market ("passive competition"); a requirement that the licensee use the licensor's trademark; and a limitation on production to the quantities the licensee requires for the manufacture of its own products. The restraints are permissible only as long as there are valid parallel patents in both licensor's and the licensee's jurisdictions. The Commission reserves the right to withdraw the benefits of TBE, in particular, where the licensed products have no real competition in the licensed territory or where the licensee has more than 40% of relevant market. The TBE applies to the sublicenses as well as licenses by the IP owner.

In pure know-how licenses -- in which patents are not involved -- most permissible restraints may not exceed 10 years from the date the licensed product is first put on the market within the European Union; a prohibition on passive competition is valid for only five years from the date the product enters the EU market. Requirements that the licensor's trademark be used and that quantities be limited to the licensee's own manufacturing needs, and most restraints listed in the block exemption, are permissible only for so long as the know-how remains "secret and substantial."

For mixed patent and know-how licenses, most permissible restraints are allowed for the duration of the patents, even though the know-how involved may no longer be secret or substantial. Again, a restraint on passive competition is valid for only five years. Mixed patents and know-how licenses qualify for the exemption only for so long as the patents remain in force or so long as the non-patented know-how remains secret and substantial, whichever period is longer.

The TBE also lists several types of contract clauses which are permissible because they are not restrictive of competition and therefore do not fall within article 85 (1). These include: obligations of secrecy, which may extend even after a license agreement has expired; prohibitions on sublicensing; time limits on the license; grantbacks of improvements, which, however, must be non-exclusive grantbacks for improvements which are severable from the licensed product or technology; requirements that the licensor must grant its own improvements to the licensee; obligations to maintain quality or technical requirements; obligations to inform and assist in prosecuting misappropriation; obligations to comply with agreed royalty schedules; field of use limitations; minimum royalty and minimum quantity requirements; an obligation to grant the licensee any more favorable terms later granted to another licensee; an obligation to use the licensor's name in connection with the licensed patent, and other commonly used contractual clauses.

There then follows a long list of specifically prohibited terms, including: resale price agreements for the licensed products; certain restraints on R & D or production which would restrain one party from competing with the other within the common market; agreements to refuse to meet orders from users or resellers in the licensed territory who would market the products in other territories; agreements which would "make it difficult" for users or resellers within the licensed territory to obtain the products from other resellers within the common market; licenses between pre-existing competitors which divide markets between them or restrain competition that existed between them prior to the license, and numerous other clauses. Even more detailed rules apply to patent or know-how pools and to licensing activities between participants in a joint venture.

An expedited procedure is established for notifying the Commission and seeking individual exemptions for technology licenses not falling within the precise terms of the block exemption.

Needless to say, the EU approach differs from that of the U.S. in being more regulatory and in providing specific scrutiny of individual contract clauses. The Commission is especially vigilant in fostering development of an integrated market within the European Union. Restraints on passive competition by licensees outside their sales territory are therefore limited. This contrasts with the U.S. approach, which analyzes vertical territorial restraints according to a weighing of their pro-competitive and anti-competitive effect in a given relevant market.[136]

Under U.S. antitrust law, because a licensor of IP could lawfully refuse to license the IP at all (at least, as discussed earlier, according to most authorities), it generally may carve the IP up into exclusive territories, time periods and/or fields of use as it may deem fit, provided only that the license does not leverage the lawful power of valid IP into an anti-competitive advantage in another market.

The EU requirement that passive sales be accepted after five years reflects the particular concern of the Commission with creating a single European market. Likewise, the limitation of 10 years for territorial restraints in know-how licenses, and the further limitation that such restraints are permissible only so long as the know-how remains "secret and substantial, " reflect the importance in the European Union of creating a single unified market, even at the risk of imposing nebulous and hard-to-administer standards.

The TBE also permits conduct that would be a per se tying violation under U.S. law. In the interest of quality control, a licensee can be required "to procure goods or services from the licensor or from an undertaking designated by the licensor." The licensor is permitted to conduct quality checks to make sure that these requirements are honored.

2. The Doctrine of Exhaustion of IP Rights

The exhaustion principle, or something analogous, exists in most legal systems and typically applies only to goods marketed within national territory. In accordance with the single-market philosophy of the Treaty of Rome the ECJ has consistently applied a Community-wide doctrine of exhaustion: any sale within the territory of the Community, made with the consent of the owner of an intellectual property right, exhausts the right. The justification for that approach is that if the proprietor of the right could preclude the importation and sale of products marketed in another member state by him or with his consent, he would be able to partition the national markets and thus restrict trade between member states.[137]

The exhaustion concept in the European Union is essentially no different from the "First Sale Doctrine" in the United States copyright law.[138] The premise underlying both doctrines is that an IP owner should be able to extract the full monopoly rent when initially placing a work on the market. Like the European exhaustion principle, the United States first sale doctrine extinguishes the distribution right once the copyright owner receives compensation for a copy because a one-time compensation per copy is deemed by the copyright law to provide sufficient incentive to spur creation.

However, the real significance of the European exhaustion principle which applies to patents, trademarks and copyrights, lies in the fact that placing a product on the market in any member state exhausts the proprietor's rights as to that product in all other member states.

In Deutsche Grammophon, the Court dealt with the exhaustion principle in a case involving copyright.[139] The plaintiff, a record production company in West Germany, sold records itself within that country and licensed distribution rights to various other companies in the rest of the Community.[140] When the defendant tried to sell imported goods in Germany distributed by the plaintiff's French licensee, the plaintiff sought an injunction under the West German Copyright Act on the ground that the plaintiff's exclusive distribution right with respect to the products in question had not been exhausted in the German market.[141] The court ruled against the plaintiff, holding that its distribution right had been exhausted throughout the entire Community because the recordings in question were "placed on the market by him or with his consent in another Member State . . . ."[142] This holding points to one important requirement of the exhaustion principle: the product must have been lawfully marketed in the first member state with the consent of the proprietor.[143]

a. The Risk of Re-Import Within the Common Market

In the recent case of Merck & Co., Inc. and Others v. Primecrown Ltd. and Others,[144] plaintiff claimed that defendant infringed the patents which plaintiff held in the United Kingdom for certain pharmaceutical products by importing those products from Spain and Portugal and selling them in the U.K. At the relevant time, Spain and Portugal had joined the Community, but had not yet made patent protection available for the products in question.

Relying mostly on Merck v. Stephar,[145] the ECJ ruled that a patent holder is unable to prevent imports if he chose to market product in a State with no patent protection:

Articles 30 and 36 EC preclude application of national legislation which grants the holder of a patent for a pharmaceutical product the right to oppose importation by a third party of that product from another Member State in circumstances where the holder first put the product on the market in that State after its accession to the European Community but before the product could be protected by a patent in that State, unless the holder of the patent can prove that he is under a genuine, existing legal obligation to market the product in that Member State.[146]

b. Not Applicable to Imports from Non-EU Countries

In a significant ruling of July 16, 1998, Silhouette Int'l v. Hartlauer,[147] the ECJ held that trademark owners are entitled to stop their branded products being imported into the EU from non-Member State.

Silhouette is an Austrian-based supplier of high-quality spectacle frames, whose logo has been registered as a trademark in most countries across the world. The Hartlauer retail chain, on the other hand, sells low-cost spectacles across Austria. Silhouette does not permit Hartlauer to sell its frames, as it considers sales in the latter's shops would undermine its upmarket image.

In October 1995, Silhouette sold the shipment of 21,000 outmoded spectacle frames to another company, which agreed to sell the frames only in Bulgaria or states of the former Soviet Union. However, two months later Hartlauer had acquired the products and was running a pre-Christmas advertising campaign throughout Austria offering cut-price Silhouette spectacles. Silhouette immediately filed an action in an Austrian court, which referred to case to ECJ.

The ECJ had to decide whether the exhaustion of rights doctrine applied even if the product was brought outside the EU market -- in other words, whether or not there was an international exhaustion of rights doctrine in the EU law. The court ruled that no such doctrine applied in the EU.

Hartlauer argued that Article 7(1) of the trademark directive which embodies the EU's exhaustion of trademark rights doctrine, applied only to trade within the EU and that consequently the member states were left with the power to regulate international trade. As Austria had an international exhaustion of right doctrine prior to the directive coming into force, Hartlauer argued that this doctrine still applied in Austria.

The ECJ, rejecting the discounter's arguments, held that the directive applied to all provisions of national trademark law which most directly affect the functioning of the single market. According to the ECJ, if member states were free to determine whether trademark owners could prevent imports from third countries, then the same products would either be subject to parallel imports in some member states but not others, or else would be put into free circulation across the single market, effectively extending the importing state's IP laws to all others.

3. Favorable Reception of Research and Development Joint Ventures

The Commission has the power to block mergers and joint ventures altogether but rather rarely exercises this power. Instead, it prefers to extract concessions to ensure fair competition in the Common Market. Over recent years, finding no potential anti-competitive effect, the Commission allowed several major mergers and joint ventures. The Commission's attitude toward research joint ventures is particularly favorable.[148] The Commission believes that most joint ventures between parties who are not actual or potential competitors can increase competition rather than hinder it. The following constitute only a few examples of joint ventures recently approved by the Commission:

In Re Iridium: The agreements between Motorola, Inc, and Others,[149] the Commission approved the creation of a joint venture company between American Motorola, Inc. and other strategic investors (including two European companies and a number of telecommunication services providers and equipment manufacturers). The joint venture, formed to provide global digital wireless communication services, was held to fall outside the scope of Article 85(1) since it would introduce a viable competitor in the new field of global satellite personal-communication services and none of the partners were to be considered actual or potential competitors in that market.

In Re Uniworld: The agreements between Unisource NV and AT&T,[150] the Commission approved a joint venture to provide seamless, multilateral, and pan-European telecommunications services with global connection to the European business market. The Commission held that the joint venture fell within Article 85(1) (restricted actual and potential competition between the parent companies in the market for non-reserved corporate telecommunications services), but exempted it under Article 85(3) upon several conditions, including prohibition of any tying arrangements.

The Commission views particularly favorably research and development joint ventures. On November 1, 1997, the Commission approved a set of agreements between Kodak, Fuji, Canon, Minolta and Nikon which provides for the joint participation of all five companies in the research and development of a new advanced photographic system ("APS").[151]

The Commission considered that the APS system is a completely new product, the primary goal of which is to stimulate a flagging market and to enable silver halide photography to compete with other means of image production. The investments are such that no single company, even if it had all the necessary expertise, would be able to develop such a system, nor would it be in a position to launch an industry standard. The Commission also considered that the cooperation only covers the development of the system and does not allow the participating companies to eliminate competition from other undertakings in the sector which have access to the technology involved thanks to the licensing agreements.