Technology licensing and competition policy in Europe
Pierre-André Dubois
Kirkland & Ellis International LLP
May 2004 marked a sharp turn in EU competition law and how it impacts on IP licensing, in particular technology licensing. Substantial changes were brought into force as a result of the Modernisation Regulation (Council Regulation 1/2003) and the enactment of a new technology transfer block exemption together with a set of guidelines. As more than a year has now passed since these major changes, and since agreements entered into prior to the enactment of the block exemption must comply with its requirements by March 31 2006 in order to benefit from the safe harbour it offers, it is appropriate to review how the block exemption functions and consider certain other developments in EU competition policy.
In its Competition Policy Report 2004, the European Commission stated that the joint goals of simplifying licensing in Europe and reducing the regulatory burden on companies were achieved by the new block exemption. To a large extent, the new block exemption has simplified the previous, almost straitjacket approach of the 1996 block exemption for technology licensing. However, the new block exemption has not reduced the regulatory burden; on the contrary, it has created new complexities.
Modernisation Regulation
Article 81(1) of the EC Treaty prohibits agreements that have as their object or effect the prevention, restriction or distortion of competition within the common market. Article 81(3) of the EC Treaty provides that if an agreement is caught by Article 81(1), it will nonetheless be defendable if the agreement contributes to improving the production or distribution of goods or to promoting technical or economic progress while allowing consumers a fair share of the resulting profits. Until May 1 2004, parties could notify restrictive agreements to the European Commission to obtain a determination of their legality or a negative clearance. The Modernisation Regulation abolished the system of notification, shifting the burden of assessing compliance with competition law directly onto the parties. It is only when an agreement is challenged before a national court or a competition authority that such court or authority will make a determination as to whether an agreement is in breach of competition law. The Modernisation Regulation facilitates parties bringing direct civil action for damages for breach of competition law. Therefore, drafting an agreement that complies with Article 81 is extremely important to reduce the risks of future litigation.
The block exemption creates a safe harbour for technology licensing. If the parties to an agreement meet the prerequisites of the block exemption and the agreement is drafted in line with its provisions, the agreement is deemed to comply with competition law. If the parties do not qualify under the block exemption or if the agreement contains provisions prohibited by it, there is no presumption of compliance and it is necessary to assess the agreement and make a determination of its legality under Article 81.
The block exemption applies only to agreements between two parties that have as their object patents, know-how, software licensing or a mixture of these rights, and as their purpose the licensing of such rights for the production of goods or the supply of services. The block exemption does not apply to other IP licensing agreements. If the agreement relates to distribution rather than licensing, the vertical restraints block exemption needs to be considered.
Figure 1 illustrates in a summary form how to analyse the application of the block exemption.
Distinction between competitors and non-competitors
All provisions of the block exemption are premised on the distinction between the concepts of ‘competitors’ and ‘non-competitors’. The test to decide whether parties to an agreement are competitors is whether the parties would have been actual or potential competitors in the absence of the agreement. The guidelines adopted by the European Commission provide the following direction on assessing whether parties are competitors:
• If without the agreement the parties would not have been actual or potential competitors in any relevant market, the parties will be deemed to be non-competitors;
• If the parties are both active on the same product or technology market, the parties will be deemed to be competitors;
• If the parties own technology that is either in a one-way (ie, the technology cannot be exploited without infringing on another technology) or a two-way (ie, neither technology can be exploited without infringing upon the other technology) blocking position, the parties will be deemed to be non-competitors; and
• If one of the parties owns breakthrough technology (ie, a technology that renders the technology of the licensee obsolete or uncompetitive), the parties should be considered in most instances to be non-competitors.
The classification of the parties as competitors or non-competitors must be made at the time the parties enter into the licence agreement. While the status of the parties may change during the term of the agreement, the block exemption provides that, if the parties are non-competitors at the time of entering into the agreement, then provided the agreement is not subsequently amended in any material respect, the position of the parties under the block exemption will be deemed to remain the same, even if in fact it changes. This ensures that the parties will benefit from the more liberal approach of the block exemption that applies to non-competitors (as opposed to competitors).
Market share ceilings
The block exemption will apply only if certain market share ceilings are not exceeded. An agreement will be exempted under the block exemption if:
• the combined market share of the parties does not exceed 20 per cent on the affected relevant technology and product markets, if the parties are competitors; or
• the market share of each the parties does not exceed 30 per cent on the affected relevant technology and product market, if the parties are non-competitors.
One of the complexities brought about by the block exemption is that the market share test is ongoing. If the relevant market share threshold is exceeded, the benefit of the block exemption will continue to apply only for a period of two calendar years following the year in which the threshold was first exceeded, after which time the block exemption will cease to apply. This means that the parties must, on an ongoing basis, monitor their relative market shares and consider whether the agreement could be defended under Article 81(3) if the benefit of the block exemption is lost.
Duration
An agreement that is safe-harboured under the block exemption will remain protected for as long as the licensed IP rights have not lapsed, expired or been declared invalid or, in the case of know-how, for as long as the know-how remains confidential. If the know-how becomes public through the fault of the licensee, the block exemption will apply for the term of the agreement.
Hardcore restrictions
An agreement that contains a hardcore restriction will not be safe-harboured under the block exemption. Furthermore, the inclusion of any hardcore restriction in the context of an agreement otherwise falling outside the scope of the block exemption will create a presumption that the agreement is anti-competitive.
The block exemption sets out two lists of hardcore restrictions: one applying to competitors, the other to non-competitors. Figure 2 sets out the various hardcore restrictions.
Excluded restrictions
In addition to hardcore restrictions, the block exemption defines certain excluded restrictions. Such restrictions are not prohibited and do not prevent the application of the block exemption. However, their inclusion in an agreement forces the parties to assess their pro and anti-competitive effect under Article 81(3). Provided that the excluded restrictions can be severed from the rest of the agreement, even if found in breach of Article 81(3), excluded restrictions will not affect the validity of an agreement.
There are three areas of excluded restrictions as follows:
Grant-back clause
An exclusive licence based on severable improvements (ie, improvements that can be separated from the licensed technology) is exempted under the block exemption. However, an exclusive licence to severable improvements or an obligation on the licensee to assign to the licensor its rights to the improvements made to the licensed technology will be considered an excluded restriction.
‘No challenge’ clause
An obligation on the licensee not to challenge the validity or contest the secrecy of the IP rights of the licensor is considered an excluded restriction. If the licensed intellectual property includes invalid rights, preventing a licensee from challenging such rights and forcing the licensee to remain bound to its obligations to pay royalties to the licensor would be anti-competitive.
Restrictions on use of technology
If the parties are non-competitors, any direct or indirect obligation limiting the licensee’s ability to exploit its own technology or limiting the parties’ ability to conduct research and development activities is an excluded restriction, unless such restriction is indispensable to protect the licensed know-how.
Other typical restrictions
The block exemption is silent on a number of other typical provisions found in licence agreements, including tying and bundling obligations, non-compete restrictions and post-termination royalty obligations. The guidelines state that these types of obligations will be permitted under the block exemption provided that they can otherwise be justified from the perspective of competition analysis.
Tying and bundling
Tying and bundling is currently a topic of interest to the European Commission, particularly in light of the Microsoft Case, decided in 2004. Tying is problematic as it is often used by companies in a dominant position. Tying will be considered in breach of Article 82 of the EC Treaty (which prohibits the abuse of a dominant position) if:
• the tying goods and the tied goods are separate products;
• the licensor is dominant in the tying product market;
• the licensor does not give customers a choice as to whether they obtain a tying product with a tied product; and
• tying forecloses competition.
In the Microsoft Case, the issue was whether Microsoft had abused its dominant position in the market for personal computer (PC) operating systems by bundling its media player with the Windows operating system and not allowing users to purchase the media player on its own. The European Commission concluded that as media players and operating systems are two different products, the alleged efficiency resulting from supplying those two products together was not sufficient to counterbalance the anti-competitive effects resulting from the practice of tying the two products together. As a result, Microsoft was ordered to offer PC manufacturers and consumers a version of the Windows PC operating system that did not include the media player.
Non-compete obligations
Non-compete obligations will generally be considered acceptable unless they result in a foreclosure of third-party technologies. This could arise, for example, if the licensor has a significant degree of market power. An obligation not to use the licensed technology (as opposed to a competing technology) after termination is not considered anti-competitive.
Post-termination royalties
Obligations to pay royalties following the expiration of the licensed IP right may be acceptable if there is a good commercial reason to justify such post- termination obligations.
Current trends
As illustrated above, the regime created by the block exemption is, subject to the market-share test, quite liberal in its approach. The inclusion of the market-share test in the block exemption reflects the ongoing concern of the European Commission to monitor parties in dominant positions. This focus and the willingness of the European Commission to impose not only fines for breach of competition law, but also severe behavioural remedies (including forcing a party to disclose some of its underlying intellectual property) was illustrated in the decision in the Microsoft Case (although this is now under appeal). Later this year, the European Commission is expected to publish a new set of guidelines that will define its approach to the issue of abuse of a dominant position under Article 82. Although the focus of these guidelines will be on parties in a dominant position, they will also need to be carefully reviewed by parties in a non-dominant position to ensure that, if ever an agreement is challenged, it can be justified as pro-competitive.
While the interaction of IP law and competition law has always been part of EU law and policy, it can be said that the Modernisation Regulation and the resulting need to focus on possible civil litigation for a breach of competition law has brought this interaction to the forefront of EU law. This means that, combined with the clear intention of the European Commission to intervene in cases of dominant IP owners, parties involved in IP licensing in Europe need to have a firm understanding of those issues and to develop licensing practices that will take into account the increased potential for litigation and regulatory scrutiny.
