Are Anti-Trust Laws About to Bite Europe on Its IP Assets?

In the Nov. 11 edition of The Wall Street Journal, Ian Harvey, chief executive of tech firm BTG plc, said “if the European Commission were looking for a way to cripple technological innovation in Europe, it could hardly have come up with a better proposal than its proposed rules on technology transfer.”

Indeed, that proposal will no longer govern merely patents and know-how, but also software-copyright licenses ' a move that might very well have a big impact on a variety of e-commerce business models.

Harvey was referring to the draft European legislation amending the rules on the impact European competition law has on the sale and licensing of intellectual property (IP).

It should, of course, be noted that BTG plc is one of Europe's largest technology companies, and to say Harvey has a vested interest in such matters would be an understatement. Also, Britons are well known for falling out with their European friends over the form and amount of legislation emanating from Brussels. But controls on possible anti-trust abuse of IP rights have existed under European law for many years.

So, what in particular has provoked this level of concern?

The Current Position

Article 81 of the European Treaty prohibits all agreements between undertakings that might affect trade between member states and that have as their object or effect prevention, restriction or distortion of competition within the Common Market. The Article specifically prohibits agreements that:

• Directly or indirectly fix purchase or selling prices or any other trading conditions;
• Limit or control production, markets, technical developments or investment;
• Share markets or sources of supplies;
• Apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage; and
• Make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations, which, by their nature or according to commercial usage, have no connection with the subject of such contracts.

Potential penalties for violating Article 81 are severe. Any agreement that falls foul is automatically void, and parties can face fines up to 10% of their worldwide turnover.

But Article 81's approach is broad and over many years, European authorities have defined particular areas and trading practices that, although they appear to fall within Article 81's ambit, are regarded as relatively benign. These specific areas have then been made the subject of so-called block exemptions – individual European regulations specifying, in particular cases, how Article 81 is to be interpreted. The current block exemption relating to technology-transfer agreements dates from 1996. That legislation exempts pure patent licenses, know-how licenses and joint-patent and know-how licenses from provisions of Article 81, subject to a number of detailed conditions. In practice, given that software patents are far less easily obtained in Europe than in the United States, the impact of this legislation hasn't been felt through the entire IT industry. The legislation exempts only agreements between two parties, and won't cover multiparty arrangements.

In principle, the 1996 legislation will permit granting an exclusive territory license, and allow that agreement to prohibit the licensee from actively seeking business in the licensor's territory, or in other territories granted to other licensees. This latter obligation cannot last for more than 5 years, with the exemption of a know-how license running for no more than 10 years, and the exemption for a pure-patent license running for the life of the relevant patent rights.

Other licensee restrictions are also permitted, including an obligation:

• Not to grant sub-licenses;
• To grant to the licensor a license of the licensee's improvements to the licensed technology;
• To observe minimum quality specifications as long as these are technically justifiable;
• To continue paying royalties to the end of the agreement, even where know-how becomes public other than by action of the licensor; and
• On the licensee to restrict his exploitation of the licensed technology to one or more technical fields of application, or to one or more product markets.

But the 1996 legislation won't protect an agreement from Article 81 if it contains any one, or more, of a number of specified provisions (often referred to as hardcore restrictions), including when one party is restricted in its determination of prices, or is prevented from competing with the other (although licensor may terminate exclusivity and stop licensing improvements to a licensee where the licensee starts to compete with the licensor). Also, a licensee's obligation to assign (as opposed to licensing) improvements of the licensor's technology to the licensor is regarded as a hardcore restriction.

As things stand, the 1996 legislation is in force until 2006, but the European Commission (EC) has proposed new legislation, effective May 1, 2004.

The Draft Legislation

Perhaps the first notable aspect of the draft legislation is that it applies not only to patents and know-how, but to software copyright licensing agreements as well. It could be argued that provisions of the 1996 legislation guided the EC's approach to IP licensing as a whole, but that the position regarding a number of major technologies ' particularly software ' was unclear. Consequently, software vendors might welcome inclusion of software licensing in the draft legislation, but that reception will likely be short-lived once the legislation's details are considered.

A major departure from the 1996 legislation is the setting up of two parallel forms of control ' one for agreements between competitors and another for agreements between noncompetitors. While such a distinction appears in a couple of places in the 1996 legislation, the distinction is a major plank of the proposed approach. Unsurprisingly, stricter rules are to apply to agreements between competitors than apply to agreements between noncompetitors.

Companies will be “competing undertakings” (competitors) under the draft legislation when they license competing technologies, or are active in the relevant product and geographic markets in which the contract products are sold. They're also considered competitors when, realistically, they would undertake the necessary additional investments or other switching costs so they could enter these relevant product and geographic markets in response to a small and permanent increase in relative prices.

In short: Under the draft, companies could be considered competitors ' and subject to the stricter rules ' without actually competing. And, it's evidently possible for a company to become a competitor without realizing it ' plus, there are no grace periods during which supposed noncompetitors who become competitors under the proposal are permitted to rearrange their affairs.

Meeting A Market Threshold

The first hurdle the draft presents before exemption may even be contemplated is showing that the combined market share of the two undertakings that are party to the agreement is below a specified threshold. In the case of an agreement between noncompetitors, the threshold is 30%; in the case of an agreement between competitors, it's 20%. If the parties' market position changes over time, then a grace period of up to 2 years is available, as long as the relevant market share does not exceed 25% (in the case of competitors) or 35% (in the case of noncompetitors), respectively. If these higher thresholds are exceeded, the grace period is 1 year.

The Commission has adopted the market-share approach elsewhere when drafting block exemptions, but it could be argued that the Commission has failed to appreciate that markets and market shares may be very difficult to define when dealing with new and emerging technologies.

Competitor Hardcore Restrictions

Like the 1996 legislation, the draft specifies a number of hardcore restrictions, the presence of which in any agreement will remove that agreement entirely from the protection of the block exemption, and leave it to the less-than-tender mercies of Article 81 itself. Unlike the 1996 legislation, however, the proposed rules have not one, but two, sets of hardcore restrictions – one for competitors and one for noncompetitors. The hardcore restrictions for agreements between competitors include:

• Restriction of a party's ability to determine its prices;
• Limitation of output or sales;
• Allocation of markets or customers (except in a number of specified circumstances, addressed below); and
• Restriction of the licensee's ability to exploit its own technology, or restriction of parties to the agreement from carrying out research and development, unless such restriction is indispensable to prevent disclosure of the licensed know-how to third parties.

According to draft guidelines, royalty-bearing cross licenses between competitors may fall foul of the price-fixing hardcore restriction if reciprocal royalty payments are used as a means of coordinating prices. Allocation of markets or customers is permitted only when it is an obligation on the licensee in a nonreciprocal agreement to exploit the licensed technology within one or more technical fields of use, or one or more product markets. Allocation is also permitted when it's required that the licensee manufactures or provides the contract products only for its own use, including sale of the contract products as spare parts for its own products.

These caveats leave a very broadly drafted hardcore restriction that appears to prevent granting exclusive territories in many cases. The breadth of this restriction, combined with the broad definition of competitor, signals a potentially significant change in law, and is in sharp contrast to the 1996 legislation, which permitted exclusivity subject to a specified time limit.

Noncompetitor Hardcore Restrictions

These include prohibitions against:

• Restriction on a party's ability to determine its own prices, although a maximum sale or recommended sale price can be imposed, provided it doesn't amount to a fixed or minimum sale price in practice.
• Restriction of the territory into which, or the customers to whom, the licensee may sell the contract products. Exclusive territories – and protection of them – are permitted by preventing sales into the exclusive territory of the licensor or another exclusive licensee.
• Restriction of active or passive sales to end users by a licensee that is a member of a selective distribution system and that operates at the retail level, although it's possible to prohibit a member of the system from operating out of an unauthorized place of establishment.

The draft legislation also includes a number of so-called conditions, restrictions that, while not hardcore, the draft doesn't exempt; rather, they will stand or fall by reference to Article 81 itself. Such conditions include a licensee's obligation to grant the licensor an exclusive license of the licensee's improvements to the technology, or to assign those improvements to the licensor, and any obligation not to challenge the validity of the relevant IP rights, though the agreement can be ended if the licensee challenges the validity, or contests the secrecy, of the licensed IP rights.

Conclusion

As things stand, the draft legislation is due to take effect on May 1, 2004. On that date, the European Union increases by another 10 member states, making up a membership of 25 European countries.

As a result, defining markets and calculating market shares, concepts that go to the very heart of the draft legislation, will become ever more difficult, with the result that it may be very hard for the parties to decide whether their agreement falls within the ambit of the draft legislation.

Agreements already in force prior to May 1 that meet the requirements of the 1996 legislation will continue to benefit from exemption until October 31, 2005, but at that stage, all agreements must meet the draft legislation's requirements.

Under the 1996 regime, if a party was unclear as to whether its agreement met the requirements of the block exemption, it could seek an individual exemption from the Commission under Article 81(3). However, under separate legislation already enacted and that also comes into force on May 1, this procedure will no longer be available. The parties will be left on their own to interpret and apply an area of legislation that is becoming more opaque. It is to be noted, however, that the maximum penalties referred to above have not been reduced.

For the reasons discussed above, much of this is new to the IT and e-commerce industries, but if the draft legislation comes into force in its present form, there may be a steep – and rather unpleasant ' learning curve ahead for many. For example, license agreements between application-service providers (ASPs) and large software vendors might come under more scrutiny. It's frequently the case that such licenses contain restrictions on geographic or industry market in which the ASP can provide its services. Since the vendor and the ASP service the same market (those who wish to use the relevant software), they are, it would seem, likely to be regarded as competitors under the draft legislation, and so risk falling foul of the hardcore restriction on allocation of markets and customers. It will no longer be only the Microsofts of the world that may have to do battle with the Commission.

Public comment on the draft ended on Nov. 26. As will be clear from Harvey's very public comments, concern remains high in may quarters that the draft will have an impact on (and potentially outlaw) many IP-licensing practices that are currently permitted in Europe and elsewhere. Considerable lobbying is now going on in Brussels and elsewhere, and over the next few weeks and months, we shall discover just how determined the Commission is to hobble Europe's technology industries.

In the Nov. 11 edition of The Wall Street Journal, Ian Harvey, chief executive of tech firm BTG plc, said “if the European Commission were looking for a way to cripple technological innovation in Europe, it could hardly have come up with a better proposal than its proposed rules on technology transfer.”

Indeed, that proposal will no longer govern merely patents and know-how, but also software-copyright licenses ' a move that might very well have a big impact on a variety of e-commerce business models.

Harvey was referring to the draft European legislation amending the rules on the impact European competition law has on the sale and licensing of intellectual property (IP).

It should, of course, be noted that BTG plc is one of Europe's largest technology companies, and to say Harvey has a vested interest in such matters would be an understatement. Also, Britons are well known for falling out with their European friends over the form and amount of legislation emanating from Brussels. But controls on possible anti-trust abuse of IP rights have existed under European law for many years.

So, what in particular has provoked this level of concern?

The Current Position

Article 81 of the European Treaty prohibits all agreements between undertakings that might affect trade between member states and that have as their object or effect prevention, restriction or distortion of competition within the Common Market. The Article specifically prohibits agreements that:

• Directly or indirectly fix purchase or selling prices or any other trading conditions;
• Limit or control production, markets, technical developments or investment;
• Share markets or sources of supplies;
• Apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage; and
• Make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations, which, by their nature or according to commercial usage, have no connection with the subject of such contracts.

Potential penalties for violating Article 81 are severe. Any agreement that falls foul is automatically void, and parties can face fines up to 10% of their worldwide turnover.

But Article 81's approach is broad and over many years, European authorities have defined particular areas and trading practices that, although they appear to fall within Article 81's ambit, are regarded as relatively benign. These specific areas have then been made the subject of so-called block exemptions – individual European regulations specifying, in particular cases, how Article 81 is to be interpreted. The current block exemption relating to technology-transfer agreements dates from 1996. That legislation exempts pure patent licenses, know-how licenses and joint-patent and know-how licenses from provisions of Article 81, subject to a number of detailed conditions. In practice, given that software patents are far less easily obtained in Europe than in the United States, the impact of this legislation hasn't been felt through the entire IT industry. The legislation exempts only agreements between two parties, and won't cover multiparty arrangements.

In principle, the 1996 legislation will permit granting an exclusive territory license, and allow that agreement to prohibit the licensee from actively seeking business in the licensor's territory, or in other territories granted to other licensees. This latter obligation cannot last for more than 5 years, with the exemption of a know-how license running for no more than 10 years, and the exemption for a pure-patent license running for the life of the relevant patent rights.

Other licensee restrictions are also permitted, including an obligation:

• Not to grant sub-licenses;
• To grant to the licensor a license of the licensee's improvements to the licensed technology;
• To observe minimum quality specifications as long as these are technically justifiable;
• To continue paying royalties to the end of the agreement, even where know-how becomes public other than by action of the licensor; and
• On the licensee to restrict his exploitation of the licensed technology to one or more technical fields of application, or to one or more product markets.

But the 1996 legislation won't protect an agreement from Article 81 if it contains any one, or more, of a number of specified provisions (often referred to as hardcore restrictions), including when one party is restricted in its determination of prices, or is prevented from competing with the other (although licensor may terminate exclusivity and stop licensing improvements to a licensee where the licensee starts to compete with the licensor). Also, a licensee's obligation to assign (as opposed to licensing) improvements of the licensor's technology to the licensor is regarded as a hardcore restriction.

As things stand, the 1996 legislation is in force until 2006, but the European Commission (EC) has proposed new legislation, effective May 1, 2004.

The Draft Legislation

Perhaps the first notable aspect of the draft legislation is that it applies not only to patents and know-how, but to software copyright licensing agreements as well. It could be argued that provisions of the 1996 legislation guided the EC's approach to IP licensing as a whole, but that the position regarding a number of major technologies ' particularly software ' was unclear. Consequently, software vendors might welcome inclusion of software licensing in the draft legislation, but that reception will likely be short-lived once the legislation's details are considered.

A major departure from the 1996 legislation is the setting up of two parallel forms of control ' one for agreements between competitors and another for agreements between noncompetitors. While such a distinction appears in a couple of places in the 1996 legislation, the distinction is a major plank of the proposed approach. Unsurprisingly, stricter rules are to apply to agreements between competitors than apply to agreements between noncompetitors.

Companies will be “competing undertakings” (competitors) under the draft legislation when they license competing technologies, or are active in the relevant product and geographic markets in which the contract products are sold. They're also considered competitors when, realistically, they would undertake the necessary additional investments or other switching costs so they could enter these relevant product and geographic markets in response to a small and permanent increase in relative prices.

In short: Under the draft, companies could be considered competitors ' and subject to the stricter rules ' without actually competing. And, it's evidently possible for a company to become a competitor without realizing it ' plus, there are no grace periods during which supposed noncompetitors who become competitors under the proposal are permitted to rearrange their affairs.

Meeting A Market Threshold

The first hurdle the draft presents before exemption may even be contemplated is showing that the combined market share of the two undertakings that are party to the agreement is below a specified threshold. In the case of an agreement between noncompetitors, the threshold is 30%; in the case of an agreement between competitors, it's 20%. If the parties' market position changes over time, then a grace period of up to 2 years is available, as long as the relevant market share does not exceed 25% (in the case of competitors) or 35% (in the case of noncompetitors), respectively. If these higher thresholds are exceeded, the grace period is 1 year.

The Commission has adopted the market-share approach elsewhere when drafting block exemptions, but it could be argued that the Commission has failed to appreciate that markets and market shares may be very difficult to define when dealing with new and emerging technologies.

Competitor Hardcore Restrictions

Like the 1996 legislation, the draft specifies a number of hardcore restrictions, the presence of which in any agreement will remove that agreement entirely from the protection of the block exemption, and leave it to the less-than-tender mercies of Article 81 itself. Unlike the 1996 legislation, however, the proposed rules have not one, but two, sets of hardcore restrictions – one for competitors and one for noncompetitors. The hardcore restrictions for agreements between competitors include:

• Restriction of a party's ability to determine its prices;
• Limitation of output or sales;
• Allocation of markets or customers (except in a number of specified circumstances, addressed below); and
• Restriction of the licensee's ability to exploit its own technology, or restriction of parties to the agreement from carrying out research and development, unless such restriction is indispensable to prevent disclosure of the licensed know-how to third parties.

According to draft guidelines, royalty-bearing cross licenses between competitors may fall foul of the price-fixing hardcore restriction if reciprocal royalty payments are used as a means of coordinating prices. Allocation of markets or customers is permitted only when it is an obligation on the licensee in a nonreciprocal agreement to exploit the licensed technology within one or more technical fields of use, or one or more product markets. Allocation is also permitted when it's required that the licensee manufactures or provides the contract products only for its own use, including sale of the contract products as spare parts for its own products.

These caveats leave a very broadly drafted hardcore restriction that appears to prevent granting exclusive territories in many cases. The breadth of this restriction, combined with the broad definition of competitor, signals a potentially significant change in law, and is in sharp contrast to the 1996 legislation, which permitted exclusivity subject to a specified time limit.

Noncompetitor Hardcore Restrictions

These include prohibitions against:

• Restriction on a party's ability to determine its own prices, although a maximum sale or recommended sale price can be imposed, provided it doesn't amount to a fixed or minimum sale price in practice.
• Restriction of the territory into which, or the customers to whom, the licensee may sell the contract products. Exclusive territories – and protection of them – are permitted by preventing sales into the exclusive territory of the licensor or another exclusive licensee.
• Restriction of active or passive sales to end users by a licensee that is a member of a selective distribution system and that operates at the retail level, although it's possible to prohibit a member of the system from operating out of an unauthorized place of establishment.

The draft legislation also includes a number of so-called conditions, restrictions that, while not hardcore, the draft doesn't exempt; rather, they will stand or fall by reference to Article 81 itself. Such conditions include a licensee's obligation to grant the licensor an exclusive license of the licensee's improvements to the technology, or to assign those improvements to the licensor, and any obligation not to challenge the validity of the relevant IP rights, though the agreement can be ended if the licensee challenges the validity, or contests the secrecy, of the licensed IP rights.

Conclusion

As things stand, the draft legislation is due to take effect on May 1, 2004. On that date, the European Union increases by another 10 member states, making up a membership of 25 European countries.

As a result, defining markets and calculating market shares, concepts that go to the very heart of the draft legislation, will become ever more difficult, with the result that it may be very hard for the parties to decide whether their agreement falls within the ambit of the draft legislation.

Agreements already in force prior to May 1 that meet the requirements of the 1996 legislation will continue to benefit from exemption until October 31, 2005, but at that stage, all agreements must meet the draft legislation's requirements.

Under the 1996 regime, if a party was unclear as to whether its agreement met the requirements of the block exemption, it could seek an individual exemption from the Commission under Article 81(3). However, under separate legislation already enacted and that also comes into force on May 1, this procedure will no longer be available. The parties will be left on their own to interpret and apply an area of legislation that is becoming more opaque. It is to be noted, however, that the maximum penalties referred to above have not been reduced.

For the reasons discussed above, much of this is new to the IT and e-commerce industries, but if the draft legislation comes into force in its present form, there may be a steep – and rather unpleasant ' learning curve ahead for many. For example, license agreements between application-service providers (ASPs) and large software vendors might come under more scrutiny. It's frequently the case that such licenses contain restrictions on geographic or industry market in which the ASP can provide its services. Since the vendor and the ASP service the same market (those who wish to use the relevant software), they are, it would seem, likely to be regarded as competitors under the draft legislation, and so risk falling foul of the hardcore restriction on allocation of markets and customers. It will no longer be only the Microsofts of the world that may have to do battle with the Commission.

Public comment on the draft ended on Nov. 26. As will be clear from Harvey's very public comments, concern remains high in may quarters that the draft will have an impact on (and potentially outlaw) many IP-licensing practices that are currently permitted in Europe and elsewhere. Considerable lobbying is now going on in Brussels and elsewhere, and over the next few weeks and months, we shall discover just how determined the Commission is to hobble Europe's technology industries.