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Antitrust and Intellectual Property

Client Advisory

April 1, 2006

An area of the law thought to be more confusing and delicate than close study in fact reveals is the topic of Antitrust and the licensing and acquisition of intellectual property. As with many areas of Antitrust practice, the law is relatively straightforward but the conclusions are usually exquisitely fact-sensitive. The long-litigated Intel and Microsoft cases highlight the sometimes inconsistent approaches of the FTC and the Federal Courts in this area. The balance between permissible and protected use of IP and its misuse in the Antitrust sense is especially important given the critical importance of IP to the American economy -- fully 6% of America’s gross domestic product revolves around copyright-related industries, accounting for over $800 billion in business, employing over 4% of America’s workforce and exporting $200 billion in products. Categories of Intellectual Property.  Just like any other valuable asset, the law protects intangible rights such as inventions or ideas just as it does tangible assets like money and real and personal property. 

  • Copyright law protects original, tangibly-expressed works such as books, plays, magazine and newspaper articles, movies, music, pictures, sculpture and art, giving the creator exclusive rights for a limited term, usually expiring 70 years after the author’s death.  The idea itself is not protected; the physical expression of the idea is protected. As soon as the work is expressed, copyright protection applies, with no requirement to actually apply for a copyright. With limited exceptions to enable teaching and research, the law prohibits copying, performing, translating or adapting the work.
     
  • Trademark law protects the identifiers used to distinguish products and services and those that make them, and could be part of the product, or a distinctive symbol, name, shape, color, or even sound or smell, so long as it is not generic, like “car” or does not become generic, like “linoleum.” By “registering” a trademark with the U.S. Patent and Trademark Office, the owner secures the exclusive right to use it in the United States, and can exclude others from using any confusingly similar mark. To register a mark, the owner must show that it is distinctive, not merely descriptive of the goods or services to which it relates, and that it will be used in interstate or foreign commerce. Trademarks can be renewed for so long as they continue to be used.
     
  • Trade Secrets are information with independent economic value which is kept secret by its owner, like the recipe for Coca-Cola.. It is protected so long as it is kept secret from legitimate discovery. If it becomes public, the legal protection vanishes.
  • Patents protect invention and are protected against infringement.

Misuse of Intellectual Property. The misuse of copyrighted materials, stealing trade secrets, or counterfeiting trademarked products is a crime, as well as exposing the purloiner to civil claims by the true owner. This is a very active topic at present in the U.S. Department of Justice, as a result of the October 2004 Report of the DOJ’s Task Force on Intellectual Property. At the same time, the European Union has been implementing their own revised IP Regulation, much more streamlined and directive than the analytical and very thoughtful DOJ Report.

In the U.S., copying a copyrighted work, or downloading software from the Internet without permission, or using technology to bypass encrypted protections, or trafficking in the counterfeit labels, or selling fake Rolexes, all violate U.S. federal criminal laws. Federal criminal law also prohibits the unauthorized disclosure of trade secrets if such disclosure is either intended to benefit a foreign government or is motivated by economic gain. Copyright infringement penalties include fines and imprisonment depending on whether the use is personal or commercial,[1]Trademark penalties also vary for  individuals and corporations,[2] and economic espionage and theft of trade secrets specify the most severe penalties in the IP area.[3]

Intellectual Property Guidelines. In April, 1995, the Antitrust Division of the U.S. Department of Justice (the “DOJ”) and the Federal Trade Commission (the “FTC”) (collectively,  the “Agencies”) released their final joint Guidelines for the Licensing of Intellectual Property (the “IP Guidelines”).  The DOJ alone had previously issued draft Guidelines for the Licensing and Acquisition of Intellectual Property (including patents, copyrights, trade secrets and “know‑how”, but excluding trademarks), but the DOJ and the FTC decided to leave acquisitions  (including exclusive licenses) to the 1992 Horizontal Merger Guidelines, and deal only with licensing in their joint IP Guidelines.  

The IP Guidelines restated the basic U.S. Antitrust tenet that “Market Power” (meaning the power to raise prices or reduce output outside competitive levels without effective commercial rebuttal, gained solely as a consequence of a superior product, business acumen, or historic accident) does not violate the Antitrust laws, and does not impose on the owner of intellectual property any obligation to license it, but Market Power could also be illegally acquired or maintained, and cannot be used to harm competition through unreasonable conduct in connection with intellectual property owned by the holder of Market Power.

The IP Guidelines announced three basic principles that underlie the Agencies’ analysis of licensing and other arrangements involving intellectual property:

1. Intellectual Property Is Property. While intellectual property does have certain special characteristics, those can be taken into account within the framework of standard Antitrust analysis. Intellectual property thus is “neither particularly free from scrutiny under the Antitrust laws, nor particularly suspect under them.”

2. IP Does Not Equal Market Power. While prior case law on this issue was inconsistent, the U.S. Supreme Court in Illinois Tool Works v. Independent Ink held clearly that there is no presumption that a patent, copyright or trade secret necessarily confers market power.

3. Licensing Fosters Competition. Licensing, cross-licensing, assigning or otherwise transferring intellectual property offers procompetitive benefits, and Antitrust enforcement should not unnecessarily interfere.

Antitrust concerns typically arise when a licensing arrangement impedes competition that likely would have taken place in the absence of the arrangement. Throughout the IP Guidelines, the Agencies emphasize three areas of concern: (1) license restrictions on goods or technologies other than the licensed technology; (2) license provisions that deter licensees from dealing with suppliers or products that compete with the licensor; and (3) acquisitions of technology that lessen competition in a relevant market.

Innovation Markets.  The IP Guidelines carry on the often criticized concept that, in certain cases, in addition to evaluating competitive effects in the relevant technology and goods markets, the Agencies also may define and examine competitive impacts in an “innovation market,” defined as the market for R&D that will result in new or improved products. Competitive impacts in the “innovation market” can be considered where “the capacity for research and development activity that likely will produce innovation in technology is scarce and can be associated with identifiable specialized assets or characteristics of specific firms.” If the Agencies cannot reasonably identify firms with the required capacity, they will not try to define an innovation market.   

Invalid Rights.  The IP Guidelines state that the Agencies, in appropriate cases, will challenge assertion of invalid intellectual property rights. The Guidelines specify that this includes both claims involving fraud on the Patent Office, and infringement claims that are “objectively baseless” and brought in bad faith, when the complainant knows the intellectual property right to be invalid.

Horizontal vs. Vertical.  Although the IP Guidelines state that licensing arrangements between firms with a horizontal relationship are not necessarily suspect, the Guidelines place considerable emphasis throughout on the horizontal/vertical distinction. Many, if not most, of the examples in the IP Guidelines where anticompetitive concerns are identified have a horizontal aspect.

International Aspects.  The IP Guidelines add an explicit statement that licensing of intellectual property is often international, and that the principles described apply equally to domestic and international licensing arrangements. However, the Guidelines also explicitly recognize that considerations particular to international transactions, such as jurisdiction and comity, may affect enforcement in an international context, and the contemporaneous Enforcement Guidelines for International Operations discuss these conflicting interests in detail.

Per Se Rule and the Rule of Reason.  Unless a licensing arrangement directly or indirectly involves an agreement constituting a per se violation of the U.S. Antitrust laws, then the arrangement will be tested under the so-called “Rule of Reason” and will be upheld if, on balance, the arrangement is neutral or supportive of competition rather than being anticompetitive (in the Antitrust sense).  Is the restraint reasonably necessary to achieve procompetitive benefits that outweigh the anticompetitive benefits? This is the Rule of Reason. Per se violations include minimum resale price fixing, horizontal market allocation, certain horizontal production or sale  limitations, and certain group boycotts.

Usually it is not the license itself but rather the other restrictions contained in the license agreement which prompt Antitrust questions. Under the IP Guidelines, the Agencies will first determine whether the restraint has anticompetitive effects in a relevant market. The potential for competitive harm greatly increases with the degree of concentration in, the difficulty of entry into, and inelasticities of supply and demand in the market in which the licensor and the licensee are horizontal competitors.

Where the licensor and licensee are in a vertical arrangement, harm to competition can occur where a restraint forecloses access to, or increases competitors’ costs of obtaining, important inputs, or where the restraint facilitates coordination among competitors to raise prices or restrict output in a relevant market.

The IP Guidelines note in particular the potential anticompetitive impacts of licensing arrangements involving exclusivity, while recognizing that such arrangements can be lawful and procompetitive.

If the Agencies find that an arrangement has an anticompetitive effect, they next will consider whether the restraint produces offsetting procompetitive efficiencies. If the restraint does produce such efficiencies, the Agencies will determine whether the restraint is reasonably necessary to achieve the efficiencies, and whether the procompetitive efficiencies outweigh the anticompetitive effects. If so, the Agencies will not challenge the arrangement. This “efficiencies defense” was expressly added as well to the Merger Guidelines in 1997, and it is fair to say that the defense is of use only in very close cases, and that the Agencies give far more credence to an efficiencies argument than do the Courts.

A  Rule of Reason analysis usually is a laborious exercise, but the Agencies suggest that a “truncated” analysis, a “quick look” at some arrangements, could be sufficient if, on the one hand, the restraint involved is one that ordinarily warrants per se treatment, or, on the other hand, the restraint is obviously neutral or procompetitive.

Antitrust “Safety Zone.  The IP Guidelines announced the creation of an Antitrust “safety zone” for intellectual property licensing arrangements. The “safety zone” applies where: (1) the restraint is not facially anticompetitive -- of a type that ordinarily warrants condemnation under the per se rule, and (2) the licensor and its licensees collectively account for no more than twenty percent of each relevant market affected by the restraint. Absent credible market share data, the Agencies will not challenge if there are four or more independent firms with substitutable technology or, in an “innovation market,” if there are four or more independent firms with the assets and incentive to develop substitutes for the technology in question. The “safety zone” does not apply to transactions that “amount to” a merger or acquisition, where the Merger Guidelines apply, and the “safety zone” is not an exclusive safe harbor -- many licenses well outside the safety zone are nonetheless neutral or procompetitive and therefore legal.

Types of Licenses.  A plain vanilla patent or know-how license authorizes the licensee to use the licensor’s rights in return for a fixed price or more often a royalty.  It is often the case, however, that two or more parties own IP rights which are implicated in the same or similar products or processes and accordingly either cross-licenses, package licenses or patent pools are created to enable all participants to use the intellectual property where, without the licenses, perhaps none of them could do so because of possible or probable infringement. 

The Antitrust analysis first examines the underlying IP rights and attempts to conclude whether in good faith the cross or package or pooling agreements are actually required by the apparent conflicts in IP rights held by the participants.  If not, then the restrictions are obviously premised on an illusory foundation and standing alone cannot in all likelihood be upheld under the Rule of Reason. 

To have restrictions you must have underlying rights which are credible and forceful enough to support the restrictions.  For example, if two patents are necessary to design and operate a commercially effective process, then a cross license enabling both owners to use both patents should make competitive sense.  If the patents are not duplicative, in the sense that they cover alternative processes for example, then the government or a private litigant could argue that the agreement is really designed principally to restrict outside users rather than to enable inside owners. 

However, particularly if the underlying IP rights are modest, a cross license or package or pool could be pro-competitive nonetheless, depending upon the facts.  For example, a modest market participant might rightly conclude that its ownership of several weaker patents would be more valuable and productive to it if licensed only as a package rather than being licensed separately with correspondingly lower royalties.  The holder of a stronger patent might rightly conclude that it should cross license against a weaker patent in large part to avoid the burdensome expenses of litigation and to assure certainty in its new product or process. 

Ancillary Restrictions.  The IP Guidelines apply the general principles discussed above to a more specific discussion of the following types of licensing restraints:

  • horizontal restraints, where in particular exclusivity will often incite a challenge;
     
  • resale price maintenance (which the IP Guidelines emphasize is unlawful per se in  an intellectual property license; in 1997 the Supreme Court adjusted this principle to bring maximum resale price maintenance within the Rule of Reason, while continuing to condemn as per se illegal minimum RPM);
  • tying, where the licensor has Market Power in the tying product and adversely affects competition in the tied product without countervailing efficiencies;
     
  • exclusive dealing (where the balance is between promotion of the licensor’s product versus constraint of competing technologies; and
  • grantbacks, where non-exclusive grantbacks are strongly preferred by the Agencies, and where required grantbacks were the principal focus of the Intel Consent Decree and related litigation.
     

Such ancillary restrictions (with the exception of minimum resale price maintenance, and tying where there is market power in the tying product and foreclosure in the tied product) will frequently be lawful, but these are clearly the areas where the Agencies will focus enforcement activity in the context of intellectual property licensing and acquisition. Since business people are in business to make money, usually ancillary restraints are desired for legitimate business reasons which will support a procompetitive conclusion under the Rule of Reason. 

Royalties.  Unless the royalty is a subterfuge, which should be apparent from a close examination of the underlying rights, and unless the doctrine of patent misuse is implicated, in a case where a patent is relied on to impose ancillary rights on non-patented products, or beyond the patent term, royalties usually do not raise serious anticompetitive implications, and the Rule of Reason is likely to be satisfied largely by the fact of independent business people negotiating the best royalty they can on both sides of the transaction. 

Field of Use Limitations.  It is extremely common for a license agreement to empower the licensee only in a particular field of use or territory so as to retain for the licensor and, more importantly, for other potential licensees, the use of the IP rights in other fields or territories, for  additional royalties. Depending always on the facts, such restrictions generally do not present a concern under the Rule of Reason.

Exclusive Rights.  The IP Guidelines definitively state that non‑exclusive licenses that do not contain any ancillary restraints on the competitive conduct of the licensor and licensee generally do not present Antitrust concerns, even if the licensor and licensee are horizontal competitors.  (This statement does not apply to cross‑licenses, however.) As a commercial matter, the typical licensee wants exclusive rights or close to it in at least its field of use in order to justify the effort and expense it will incur in exploiting the licensed rights. 

Correspondingly, an exclusive dealing arrangement, restricting the licensee from dealing in competitive products, is a sound business goal of the licensor since it incentivizes the licensee to fully develop the IP rights and therefore increases the royalties payable.  While alternatives to exclusive dealing clauses exist, rarely does the licensor feel as protected by alternatives such as diminishing royalty rates as it does by a provision limiting the licensee to the licensor’s IP rights and none others.

Tying Arrangements.  Where one product is sold or licensed on the condition that another less desired product also be taken, the Antitrust principles restricting tying arrangements are implicated.  License-related tying arrangements can involve package licensing of more and less desirable products when the licensor has market power in the tying product.  There can also be cases of tied products which must be taken if the licensee accepts an IP license for related technology. 

In general, economic bundling, with better prices if the package is taken, are more supportable than legally tied bundles. 

Improvements and Grantbacks.  The licensor has a legitimate interest in requiring a grantback, at least on a non-exclusive basis, if the licensee makes improvements in the licensed technology; otherwise the licensor might be effectively foreclosed from employing its own technology since new blocking patents could develop from the licensee’s use of the licensed IP rights.  If the grantback is exclusive to the licensor, then the Antitrust inquiry would be whether that arrangement  is reasonable to protect the legitimate business interests and competitive position of the licensor or whether some less intrusive alternative is available.          

The IP Guidelines add a statement recognizing that grantbacks in an intellectual property license may have procompetitive effects, and that a non‑exclusive grantback which leaves the licensee free to license improvements to others, is less likely to have anticompetitive effects than an exclusive grantback provision.

Mergers and Acquisitions.  In recent years the Justice Department has taken increased interest in the area of R&D competition.  Often the IP rights aspects of a commercial merger or acquisition are the prominent focus of the Justice Department or FTC premerger examination of the proposed combination. 

Even if the transaction is limited to a transfer of IP rights, it could fall within the requirements of the Hart-Scott-Rodino premerger notification rules if the size of the transaction and in some cases the parties are of sufficient size.  Because of the draconian penalties for failure to file a premerger notice, great care must be taken in valuing the IP rights involved if a close question is presented as to satisfaction of the thresholds. The parties should also take special care in the preparation of any documents describing the proposed transaction, since such papers could be concluded to be so-called “4(c)” documents which would have to be provided to the DOJ and the FTC as part of the HSR Filing -- often a thoughtless characterization of the effects of a transaction suggests an Antitrust problem which doesn’t exist in the real commercial world, and can greatly complicate the clearance procedure with the Agencies.

The 1992 Merger Guidelines of the DOJ and FTC are useful in this connection, and a separate memorandum of our Firm is available for a detailed discussion of those guidelines.  The so-called HHI index would be applied to assess the potentially combined market shares represented by the intellectual property being transferred and then depending on the degree of concentration an initial assessment could be made of the likelihood of challenge by the DOJ or the FTC.  A common solution to Antitrust concerns under Section 7 of the Clayton Act in recent years has been an agreement by the combined entity to license competitors under critical intellectual property necessary to ensure ongoing competition in existing and even potentially improved products.  The alternative of licensing the competition could be important in assessing the product market initially and even more likely the availability of potential entrance to the market if the combined entity seeks to exert its market power by increasing the prices in the products resulting from the IP rights being combined.  In this area it is particularly important to remember that expiration of the Hart-Scott-Rodino waiting period does not ensure that the combination may not be challenged in the future by the federal Antitrust authorities or a private litigant. 

Intel and Microsoft.  The Intel Corporation litigation history is useful reading to contrast the approaches of the FTC on the one hand, and the courts on the other, in the intellectual property area. The FTC’s Section 5 case against Intel was settled with a consent order, with a 3-1 vote of the Commission approving the order. The order, available at www.ftc.gov, basically prohibited Intel from withholding advance technical information from any company involved in litigation with Intel, for that reason alone, if the customer agreed not to seek an injunction against Intel based on the same core microarchitecture.

Only months after the decree, the Court of Appeals for the Federal Circuit vacated an injunction which had been issued in favor of Intergraph Corporation (one of the complainants in the FTC case) against Intel on basically the same facts as had been the subject of the FTC case. While the case and the Consent Order are arguably consistent, since Intergraph had sought (and received) an injunction, the Court of Appeals held that there was no substantial likelihood of Intergraph’s establishing an Antitrust law violation, stating that a producer’s advantageous or dominant market position based on superiority of a commercial product and ensuing market demand is not the illegal use of monopoly power prohibited by the Sherman Act.

The Court of Appeals’ conclusions in Intel may be further contrasted with the series of holdings and the ultimate consent decree in the Microsoft litigation. That landmark series of rulings is well beyond the scope of this memorandum except to note that it is extremely difficult to resolve the holdings and ultimate conclusions in the Intel and Microsoft cases.

Conclusion

The area of Antitrust and intellectual property rights is considered complex by business persons and lawyers alike, but the basic principles underlying the analysis of Antitrust issues in this area are well settled and the difficulty arises in analyzing the particulars of the IP rights and their effect on future competition resulting from licensing arrangements, ancillary restrictions, and combination of the IP rights involved in a license, merger or acquisition.  It is almost always the case that the facts are difficult while the law is relatively straightforward.  


Questions regarding this advisory should be addressed to Robert A. McTamaney (mctamaney@clm.com) of our New York Office.

Endnotes

[1] 17 U.S.C §506; 18 U.S.C.§§2318, 2319, 2319A; 17 U.S.C. §§1201-1205 (Circumvention of protections, 5-10 years and $500,000-$1 million fine); 47 U.S.C. §553 (Cable services; 6 month-2 years and $1,000-$50,000 for individual use; 2-5 years and $50,000-$100,000 fine for commercial use; and 47 U.S.C. § 605 (unauthorized publication or use of communications)

[2] 18 U.S.C. §2320.

[3] 18 U.S.C. § 2320 (10-20 years and fines up to $15 million); 18 U.S.C. § 1832.



Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. © 2017 Carter Ledyard & Milburn LLP.
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