The Perils Of Imposing Compulsory IP Licensing To Achieve Interoperability

Saturday, October 1, 2005 - 01:00

Nicos L. Tsilas
Microsoft Corporation

I. Introduction.

"Interoperability" is fast becoming a technical and business imperative for governments and industry alike. Although interoperability has different meanings in different contexts, in the information technology area the term is generally understood to mean the ability of heterogeneous networks, applications, or components to exchange and use information, i.e., to "talk."

Interoperability can be achieved in various market-driven ways, including: (1) designing products with intrinsic interoperability-enhancing functionality (such as XML), (2) implementation of industry technical standards, (3) voluntary intellectual property (IP) licensing of key technologies, and (4) industry collaboration. At times, however, government agencies or courts have also attempted to force an interoperability solution by imposing a compulsory licensing requirement on a dominant firm. In such circumstances, the agency or court orders the dominant firm to license its IP to third parties, including competitors, in order to ensure that the products of such third parties can interoperate with the products of an IP holder that otherwise might have refused to license such IP.

As shown below, compulsory licensing is an extraordinary remedy that should rarely be used to achieve interoperability. Not only does compulsory licensing discourage innovation by the dominant firm and by its free-rider competitors, but it also raises significant and unworkable practical problems for courts and enforcement agencies. Moreover, studies have shown that, when used in the past, compulsory licensing has not produced the anticipated benefits in terms of long-term structural and competitive improvements in the marketplace. For these reasons, the United States' approach to compulsory licensing - namely, to use it sparingly and in narrowly circumscribed ways - makes eminent sense.

II. The Very Limited Use Of Compulsory Licensing Endorsed By The U.S. Is The Appropriate Approach.

The U.S. patent system has generally been hostile toward the practice of compulsory licensing. In the 1980 case of Dawson Chemical v. Rohm & Haas, the Supreme Court sharply criticized compulsory licenses, saying, "[c]ompulsory licensing is a rarity in our patent system ...Compulsory licensing of patents often has been proposed, but it has never been enacted on a broad scale."1 Generally, when a patentee refuses to license, the U.S. courts have resorted to compulsory licensing only when the patent was obtained fraudulently, the litigation was a sham, or there was an illegal tying arrangement.2 Moreover, as Hovenkamp, Janis, and Lemley, renowned experts in this area, have observed: "The vast majority of compulsory licenses in the U.S. have been imposed in the context of consent decrees. Only in a handful of cases have courts imposed compulsory licensing as an outcome of antitrust litigation."3

This U.S. view stems from several cornerstone principles of U.S. patent and antitrust law. First, "[t]he right to exclude is not simply one of the rights provided by intellectual property, it is the fundamental right, the foundation upon which the entire IP system is built."4 Second, under U.S. antitrust law, a unilateral, unconditional refusal to license a lawfully obtained patent or other form of IP is not in and of itself an antitrust violation. Market power or monopoly power that is solely "a consequence of a superior product, business acumen, or historic accident" does not violate antitrust laws.5 Third, compulsory licensing creates various thorny policy and practical problems and complexities, as discussed below.

A. Compulsory Licensing Discourages Innovators from Investing in the Development of New Technology.

The protection of IP rights encourages firms to innovate by rewarding their investment in creating new technology that is desired by the public.6 Requiring such firms to license their proprietary technology to other firms artificially constrains the returns on their investment, making them less willing to invest in innovation in the future. Moreover, other firms have less incentive to invest in creating competing technology when they can use the dominant firm's compulsorily licensed technology at little or no cost.7

The U.S. Department of Justice has repeatedly endorsed this view in cautioning against the use of compulsory licensing:

There are important policy reasons to cause us to be cautious when considering a compulsory licensing remedy. The most important of these is the concern that an improperly-designed compulsory license can stifle innovation. Some of the risks being taken by today's innovators are massive, with rewards systems that may be very fragile and that could potentially be destroyed by over-aggressive antitrust remedies.8

The U.S. has also made clear that one must analyze the potential effects of a refusal to license and a potential compulsory licensing remedy with a long-term view:

[O]ne cannot merely consider the effect on a rival that is refused a license; one must also consider the alternative world in which the IP owner would have had less of an incentive to innovate because he could not be assured of the right to refuse to license. Would that IP owner have chosen to innovate less? If so, would competition or consumer welfare have been better off with the present state of affairs, including the right to refuse? In the short term, it will always be more efficient to disregard the IP right and allow duplication. The IP system rests on the idea of long -term innovation incentives, so we must think about the long -term effects of a rule imposing liability in this context... Where we cannot reliably predict the effects of enforcement decisions, false positives are likely, and the increased uncertainty itself will raise costs to businesses and enforcers.9

B. Compulsory Licensing Creates Complex Monitoring and Enforcement Problems.

The Justice Department has also noted that there are "practical reasons to tread carefully when considering compulsory licensing" of IP. Specifically, "designing and enforcing such licenses is complex and can be an invitation to endless ancillary compliance litigation." When an enforcement agency imposes compulsory licensing on an innovator, the agency may have difficulty in supervising the terms of the license, as it must "assum[e] the day-to-day controls characteristic of a regulatory agency."10

Worse, when courts order compulsory licensing, the courts are required "to act as central planners... a role for which they are ill-suited."11

Hovenkamp, et al. have agreed, noting that "[t]he decision to impose a compulsory license is complex, but deciding on the terms of the compulsory license is, perhaps, even more complicated."12 Accordingly, in the very rare case where compulsory licensing may be deemed appropriate, U.S. regulators have indicated that there are a number of factors and licensing provisions that should be considered and implemented to ensure that the remedy imposed is straightforward and not excessive. For example, Deputy Assistant Attorney General Makan Delrahim has recently articulated a helpful license checklist which includes the following: 1) use the simplest, minimum-necessary combination of transfer of rights and government oversight; 2) make the benchmarks for compliance clear; 3) make the scope of the license narrow and clear as to field of use, products, and geography; 4) consider the question of future IP, but also consider the negative consequences to innovation if future developments will automatically be licensed; 5) avoid transfer of "know-how" if possible; 6) specify a sunset or at least a mechanism for reconsidering the license as market conditions change, particularly if future patents are involved; and 7) allow for a reasonable royalty.13

C. While the Harms Associated With Compulsory Licensing Are Real and Demonstrable, the Putative Benefits Are Equivocal at Best.

Not only are the harms associated with compulsory licensing - i.e., reduced innovation, diminished R&D investment, and increased practical problems, burdens, and complexities - real and demonstrable, but the asserted benefits are more theory than reality. As Hovenkamp, et al. have declared, "empirical evidence on the effectiveness of compulsory licensing as an antitrust remedy has been equivocal at best."14

For example, one study of patenting activity from 1954 to 1956 showed that patent owners subjected to compulsory licensing decrees reduced their patenting activity significantly relative to all corporate patent owners, suggesting that compulsory licensing decrees could seriously erode research and development incentives.15 And another study of market structure over time (extending generally from the late 1940s to the early 1970s) found that compulsory licensing decrees had effected no statistically significant improvement in market structure (e.g., by reducing industry concentration).16

These data hardly present a ringing endorsement of the compulsory licensing remedy. Rather, they provide further support for the wisdom of the U.S. approach, namely to limit this remedy to only the most exceptional circumstances, and even then to ensure that a balanced and narrow license regime is established, one that will avoid the worst of the policy and practical problems discussed above.

III. Conclusion.

Compulsory licensing of IP is fraught with significant land mines and should, as the Justice Department has said, remain a "rare beast" in a court's or agency's antitrust arsenal.17 As Hovenkamp et al. have described it, compulsory licensing should "be carefully circumscribed [and] used as a last resort - that is, as a 'least-worst remedy'..."18

1 448 U.S. 176, 215 (1980).

2 See Joseph A. Yosick, "Compulsory Patent Licensing for Efficient Use of Inventions," 2001 U. Ill. L. Rev. 1275, 1284 (2001).

3 Herbert Hovenkamp, Mark D. Janis, Mark Lemley, IP and Antitrust: An Analysis of Antitrust Principles Applied to Intellectual Property Law (2003-04 Supplement) at 6-51.

4 See R. Hewitt Pate, "Competition and Intellectual Property in the U.S.: Licensing Freedom and the Limits of Antitrust," 2005 EU Competition Workshop, Florence, Italy, June 3, 2005, at 3 (emphases in original).

5 United States v. Grinnell Corp., 384 U.S. 563, 571 (1966). See also U.S. Department of Justice & Federal Trade Commission, "Antitrust Guidelines for the Licensing of Intellectual Property," Apr. 6, 1995, Sec. 2.2 (noting that even in the case of IP that conveys market or monopoly power, that power does not "impose on the intellectual property owner an obligation to license the use of that property to others").

6 See, e.g., Yosick, supra n.2 at 1290-91.

7 See, e.g., Ward S. Bowman, Jr., Patent and Antitrust Law 3 (1973).

8 Makan Delrahim, Dep. Asst. Attorney Gen., Antitrust Div., U.S. DOJ, "Forcing Firms to Share the Sandbox: Compulsory Licensing of Intellectual Property Rights and Antitrust," presented at British Institute of International and Comparative Law, London, England, May 10, 2004, at 10-11.

9 Pate, supra n.4, at 6-7 (emphases in original).

10 Id. at 10.

11 Verizon Communications Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398, 408 (2004).

12 Hovenkamp, supra n.3, at 6-44. See also Delrahim, supra n.8, at 12 ("Drafting a compulsory license is a difficult process, even for intellectual property licensing lawyers . For antitrust enforcers, licensing is not what we would call our 'core competence.'").

13 See Delrahim, supra n.8, at 15-16. The Supreme Court has previously expressed concern that a royalty-free compulsory license could operate as a mechanism by which the government might effectively confiscate patents without undertaking the ordinary analysis for invalidity or unenforceability. See Hartford Empire Co. v. United States, 323 U.S. 386 (1945). The imposition of royalty-free compulsory licenses remains the rare exception in the U.S. See Hovenkamp, supra n.3, at 6-50.

14 Hovenkamp, supra n.3, at 6-53.

15 F.M. Scherer, The Economic Effects of Compulsory Patent Licensing 66-67 (1977).

16 Id. at 78.

17 Pate, supra n.4, at 10.

18 Hovenkamp, supra n.3, at 6-53 (citations omitted).

Prior to joining Microsoft, Nicos L. Tsilas practiced law at Willkie Farr & Gallagher LLP. Mr. Tsilas is a Senior Attorney at Microsoft Corporation. Mr. Tsilas provides advice on intellectual property, interoperability, and standards matters, and on related regulatory and public policy issues to his Microsoft client. Mr. Tsilas also guest lectures at the University of Washington School of Law in Seattle on the Software Industry and Intellectual Property, IP Licensing, Interoperability, and Open Standards. Mr. Tsilas is a graduate of Georgetown University Law Center and has a Bachelor of Engineering in Electrical Engineering and a Master of Science in Engineering Management from Stevens Institute of Technology. The views expressed herein are solely those of the author and do not necessarily represent the positions of Microsoft or of any lawyer or employee of Microsoft.

Please email the author at ntsilas@microsoft.com with questions about this article.