Reforming EU Antitrust and Refusals to Supply

April 9th, 2006

Vertical foreclosure can be anticompetitive. According to the Discussion Paper, examples include halting supplies to punish buyers for dealing with competitors and refusing to supply buyers that do not agree to exclusive dealing or tying arrangements and mainly refusals to supply, that is “situations where a dominant company denies a buyer access to an input in order to exclude that buyer from participating in an economic activity” (# 209). The Discussion Paper distinguishes three situations: where an existing supply relationship is terminated, where there is a refusal to commence supplying an input, including situations where this input is covered by IPRs, and where the input is information necessary for interoperability.

The Discussion Paper states that four conditions have to be fulfilled in order to find the termination of such a supply relationship to be abusive: (i) the behaviour must be properly characterised as a termination of the supply arrangement; (ii) the refusing undertaking must be dominant; (iii) the refusal must be likely to have a negative effect on competition; and (iv) the refusal must not be justified objectively or by efficiencies. There is no reference to the need to show that the input is “indispensable”. This implies that the termination of an existing supply relationship is more likely to be abusive than a refusal to supply a new customer. Assuming dominance and a termination of a supply arrangement are proven, the Commission would simply have to demonstrate that the termination is likely to have a “negative effect on competition” in order to establish a prima facie case that the conduct is abusive. The dominant supplier could, thereafter, only escape a finding of abuse by showing that the refusal is justified objectively or by efficiencies.

If the dominant supplier has not previously supplied the input to a potential buyer, an additional criterion is added to the four criteria mentioned above: the input must be “indispensable” to carry on normal economic activity in the downstream market. A facility will be an “indispensable” input, or a socalled “essential facility”, only when the duplication of the existing facility is impossible or extremely difficult, either because it is physically or legally impossible to duplicate, or because a second facility is not economically viable. Nevertheless, the Discussion Paper correctly points out that “to maintain incentives to invest and innovate, the dominant firm must not be unduly restricted in the exploitation of valuable results of the investment. For these reasons the dominant firm should normally be free to seek compensation for successful projects that is sufficient to maintain investment incentives, taking the risk of failed projects into account. To achieve such compensation, it may be necessary for the dominant firm to exclude others from access to the input for a certain period of time. The risks facing the parties and the sunk investment that must be committed may thus mean that a dominant firm should be allowed to exclude others for a certain period of time in order to ensure an adequate return on such investment, even when this entails eliminating effective competition during this period” (# 235).

The Section of the Discussion Paper on Refusal to Supply seems to start from the existing case-law, but still raises many controversial policy issues that need further consideration by the European Commission:

• Necessary or sufficient conditions: It is not clear whether the conditions for finding an abuse are necessary or simply sufficient. The Discussion Paper qualifies that “normally” those conditions must be fulfilled; therefore, it seems to leave open the possibility that on a case-by-case basis the Commission could identify other criteria beyond those listed above. This significantly undermines legal certainty and potentially leads to open-ended cases of intervention.
• Different thresholds: The Discussion Paper does not explain the basis for the view that, in general, continuing a supply relationship should be presumed to be pro-competitive. We consider that this should be the result of a case-by-case assessment of the economic circumstances of each case and not the subject of a legal presumption. We submit that the threshold for intervention should be the same as for cases of de novo refusals to supply and, therefore, the requirement that the input is indispensable should also be added for termination of existing supply relationships.
• Indispensable input: The definition of the indispensable input does not address the necessary economic analysis that should be carried out to decide whether duplication of the input is impossible, difficult or expensive for any competitor or for “as efficient” competitors. The Commission should clarify that the focus of the analysis should be on whether a second, substitute product can be created by “as efficient” competitors, rather than whether any competitors will in fact make the investment to create it. This approach would be consistent with the Commission’s objective of protecting competition on the merits.
• Foreclosure effect: The standard for intervention by the Commission is not fully developed. In particular, the Discussion Paper does not give sufficient guidance on the degree of the likely anticompetitive foreclosure effects in the market. It states that the market distorting foreclosure effect should not be understood to mean the complete elimination of all competition, but it does not specify to what extent competition in the downstream market should be affected for an abuse to be found. Furthermore, there is no mention of the economic analysis that should be carried out of the effects of the abuse, in particular to assess the degree of efficiency of excluded competitors. The Commission should clarify that the foreclosure effect should be substantial and at least amount to the creation of dominance in the downstream market (in terms of price increases or output reduction) resulting from the exclusion of “as efficient” competitors.
• Finally, the thresholds to argue efficiencies and objective justifications seem to be too high to be realistically successful in practice. Furthermore, the Discussion Paper fails to acknowledge that an input may become indispensable simply as a result of a company’s superior business performance. A duty to deal/supply should not be imposed simply because consumers prefer the dominant undertaking products.

Compulsory licensing of intellectual property rights is a very sensitive and controversial area under Article 82 and, therefore, deserves particular attention. It is important to preserve companies’ incentives to engage in research and development and other ventures aimed at generating innovative products and services. We welcome a number of pronouncements in the Discussion Paper that appreciate the benefits of the IPR regime and IPR protection. The Discussion Paper clearly states the priority of IPRs protection saying that “[i]mposing on the holder of the rights the obligation to grant to third parties a licence for the supply of products incorporating the IPR, even in return for a reasonable royalty, would lead to the holder being deprived of the substance of the exclusive right”. Hence, another more restrictive criterion is added in the case of a refusal to license IPRs: the undertaking which requests the licence should intend to produce new goods or services not offered by the owner of the IPRs and for which there is a potential consumer demand. This additional criterion is in line with established case-law, but the Commission introduces an exception to this criterion. It states that a refusal to license IPR-protected technology which is indispensable for follow-on innovation may be abusive even if the license is not sought to directly incorporate the technology in clearly identifiable new goods and services since “[T]he refusal of licensing an IPR protected technology should not impair consumers’ ability to benefit from innovation brought about by the dominant undertaking’s competitors” (# 240). However, this exception is not motivated by economic analysis and inconsistent with its mainstream theories: there are not serious economic arguments supporting the view that weakening IPRs would strengthen innovation in the long run: while this may happen in the short run, the current approach of the Discussion Paper on this matter may have strong negative consequences for EU innovation in the long run.

In setting out the exceptional circumstances where refusal to licence an IPR may constitute an abuse, the Discussion Paper starts from the principles and approach well established in the case-law of the Court of Justice (notably and most recently, IMS Health). However, it then fails to give guidance on some key issues still left open by IMS Health and, in some instances, expands the scope of potential compulsory licensing to cover cases beyond the requirements of exceptional circumstances set out in IMS Health, thus potentially having a chilling effect on incentives to invest and innovate.

a) Exceptional Circumstances

The Discussion Paper sets out that the refusal by a dominant company to license access to an IPR could be considered abusive when the five conditions for de novo refusal to start supplying an input are satisfied, AND “the refusal to grant a licence prevents the development of the market for which the licence is an indispensable input, to the detriment of consumers”. The threshold for intervention in cases of refusals to license IPRs is therefore higher than in other cases of refusals to supply. In summary, the conditions under the Discussion Paper are as follows:

• The behaviour can be properly characterised as a refusal (again, including cases of constructive refusals such as delaying tactics in supplying, imposing unfair trading conditions, or charging excessive prices for the input);
• The company refusing to license must be dominant in the market where input is provided;
• The input must be indispensable (i.e., it must not be possible to turn to any workable alternative technology or to “invent around” the IPR – the Discussion Paper mentions as examples cases where the technology has become the standard or where interoperability is necessary);
• The refusal is likely to have a negative effect on competition;
• There is no objective justification; AND
• The additional condition is that the refusal prevents the development of new goods or services and for which there is a potential consumer demand.

b) Unresolved Issues

The Discussion Paper does not give guidance on some of the key issues left open by IMS Health :

Dominance in an upstream market: The dominance requirement as set out in # 227 of the Discussion Paper broadens the scope of potential reach of compulsory licenses for IPRs that have no commercial or independent use (i.e. that are not marketed separately), but are only used as an input in other commercial products or services. Under IMS Health, there must be two identifiable markets as a necessary condition for IPR compulsory licensing. The Discussion Paper states that it is sufficient to identify a “captive”, “potential” or even a “hypothetical” upstream market, and that “such is the case where there is actual demand for the input on the part of the undertakings seeking to carry out the activity for which the input is indispensable” . This broad construction can lead to a greater number of compulsory licensing of IPRs (provided the other conditions are met) by covering IPRs that are only used as an input without the need to identify a distinct product or service that would be sold or licensed separately. Furthermore, there is no reference or explanation in the Discussion Paper of the qualification given by the Court of Justice in IMS Health that the potential market must at least correspond to an identifiable “stage of production”. Finally, there is no economic assessment of the conditions under which holding an IPR could amount to market power, which should be the correct framework of analysis without any presumption that holding an IPR may automatically give rise to market power. Without further qualification, such a potentially broad application of Article 82 could have a negative impact on incentives to invest in developing IPRs and investing in new production processes and research.

“New product” requirement: There is no explanation of the requirement that the refusal to license must prevent the appearance of new goods or services. The Discussion Paper says that the company requesting the licence should not limit itself to the duplication of goods/services already offered. However, it does not provide any guidance on the criteria to identify or define a “new” product. The Commission should clearly specify that it must be a new kind of product (rather than just an incremental or minor improvement of an existing product) that must expand the market rather than steal sales. In this respect, it would helpful to clarify, consistently with IMS Health, that the new product should satisfy consumer demand that is not satisfied by existing products.

c) Concerns

Despite having some deference for IPRs in a number of welcome pronouncements as explained above, the Discussion Paper does not fully carry them through and goes significantly beyond the exceptional circumstances for compulsory licensing set out in IMS Health. We are concerned about the following sections that may carry the risk of reducing the incentives to invest and innovate in the long term.:

For follow-on innovations, the additional condition that the refusal prevents the development of new goods or services is not necessary. In # 240 of the Discussion Paper states that “a refusal to licence an IPR protected technology which is indispensable as a basis for follow-on innovation by competitors may be abusive even if the licence is not sought to directly incorporate the technology in clearly identifiable new goods and services. The refusal of licensing an IPR protected technology should not impair consumers’ ability to benefit from innovation brought about by the dominant undertaking’s competitors.” This goes much further than the exceptional circumstances set out in IMS Health and the statements of principle in the Discussion Paper. This would be a worrying departure from the established principles of the European case-law, because it effectively means the introduction of open compulsory licensing to competitors for a myriad of IPRs. Furthermore, the Discussion Paper does not define what could amount to “follow-on innovation” and does not explain why intervention is required in this area to bring benefits to consumers. Finally, inefficient competitors may effectively have the possibility to free-ride on the investments and risks taken by a dominant undertaking. For all these reasons, companies may be deterred from investing and innovating in the first place, with a potential much bigger negative impact on consumers in the medium-long term.

Finally, the Discussion Paper states that leveraging market power from one market to another by refusing to supply interoperability information may be abusive. “Although there is no general obligation even for dominant companies to ensure interoperability, leveraging market power from one market to another by refusing interoperability information may be an abuse of a dominant position” (#241). The Commission will, even if such information is considered a trade secret, not apply the same high threshold as regards IPRs. However, there is no guidance on the lower standards that the Commission will apply and on the definition of “information needed for interoperability” and this statement appears to open doors to a systematic possibility that innovative firms are forced not only to reveal IPRs but even trade secret. The same uncertainty induced by this ambiguous wording is likely to jeopardize the incentives to invest in R&D with dangerous consequences for (future) consumer welfare, exactly the opposite of what the Discussion Paper was aiming to.

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