Archives For Patents

An important but unheralded announcement was made on October 10, 2018: The European Committee for Standardization (CEN) and the European Committee for Electrotechnical Standardization (CENELEC) released a draft CEN CENELAC Workshop Agreement (CWA) on the licensing of Standard Essential Patents (SEPs) for 5G/Internet of Things (IoT) applications. The final agreement, due to be published in early 2019, is likely to have significant implications for the development and roll-out of both 5G and IoT applications.

CEN and CENELAC, which along with the European Telecommunications Standards Institute (ETSI) are the officially recognized standard setting bodies in Europe, are private international non profit organizations with a widespread network consisting of technical experts from industry, public administrations, associations, academia and societal organizations. This first Workshop brought together representatives of the 5G/Internet of Things (IoT) technology user and provider communities to discuss licensing best practices and recommendations for a code of conduct for licensing of SEPs. The aim was to produce a CWA that reflects and balances the needs of both communities.

The final consensus outcome of the Workshop will be published as a CEN-CENELEC Workshop Agreement (CWA). The draft, which is available for public comments, comprises principles and guidelines that prepare a foundation for future licensing of standard essential patents for fifth generation (5G) technologies. The draft also contains a section on Q&A to help aid new implementers and patent holders.

The IoT ecosystem is likely to have over 20 billion interconnected devices by 2020 and represent a market of $17 trillion (about the same as the current GDP of the U.S.). The data collected by one device, such as a smart thermostat that learns what time the consumer is likely to be at home, can be used to increase the performance of another connected device, such as a smart fridge. Cellular technologies are a core component of the IoT ecosystem, alongside applications, devices, software etc., as they provide connectivity within the IoT system. 5G technology, in particular, is expected to play a key role in complex IoT deployments, which will transcend the usage of cellular networks from smart phones to smart home appliances, autonomous vehicles, health care facilities etc. in what has been aptly described as the fourth industrial revolution.

Indeed, the role of 5G to IoT is so significant that the proposed $117 billion takeover bid for U.S. tech giant Qualcomm by Singapore-based Broadcom was blocked by President Trump, citing national security concerns. (A letter sent by the Committee on Foreign Investment in the US suggested that Broadcom might starve Qualcomm of investment, preventing it from competing effectively against foreign competitors–implicitly those in China.)

While commercial roll-out of 5G technology has not yet fully begun, several efforts are being made by innovator companies, standard setting bodies and governments to maximize the benefits from such deployment.

The draft CWA Guidelines (hereinafter “the guidelines”) are consistent with some of the recent jurisprudence on SEPs on various issues. While there is relatively less guidance specifically in relation to 5G SEPs, it provides clarifications on several aspects of SEP licensing which will be useful, particularly, the negotiating process and conduct of both parties.

The guidelines contain 6 principles followed by some questions pertaining to SEP licensing. The principles deal with:

  1. The obligation of SEP holders to license the SEPs on Fair, Reasonable and Non-Discriminatory (FRAND) terms;
  2. The obligation on both parties to conduct negotiations in good faith;
  3. The obligation of both parties to provide necessary information (subject to confidentiality) to facilitate timely conclusion of the licensing negotiation;
  4. Compensation that is “fair and reasonable” and achieves the right balance between incentives to contribute technology and the cost of accessing that technology;
  5. A non-discriminatory obligation on the SEP holder for similarly situated licensees even though they don’t need to be identical; and
  6. Recourse to a third party FRAND determination either by court or arbitration if the negotiations fail to conclude in a timely manner.

There are 22 questions and answers, as well, which define basic terms and touch on issues such as: what amounts as good faith conduct of negotiating parties, global portfolio licensing, FRAND royalty rates, patent pooling, dispute resolution, injunctions, and other issues relevant to FRAND licensing policy in general.

Below are some significant contributions that the draft report makes on issues such as the supply chain level at which licensing is best done, treatment of small and medium enterprises (SMEs), non disclosure agreements, good faith negotiations and alternative dispute resolution.

Typically in the IoT ecosystem, many technologies will be adopted of which several will be standardized. The guidelines offer help to product and service developers in this regard and suggest that one may need to obtain licenses from SEP owners for product or services incorporating communications technology like 3G UMTS, 4G LTE, Wi-Fi, NB-IoT, 31 Cat-M or video codecs such as H.264. The guidelines, however, clarify that with the deployment of IoT, licenses for several other standards may be needed and developers should be mindful of these complexities when starting out in order to avoid potential infringements.

Notably, the guidelines suggest that in order to simplify licensing, reduce costs for all parties and maintain a level playing field between licensees, SEP holders should license at one level. While this may vary between different industries, for communications technology, the licensing point is often at the end-user equipment level. There has been a fair bit of debate on this issue and the recent order by Judge Koh granting FTC’s partial summary motion deals with some of this.

In the judgment delivered on November 6, Judge Koh relied primarily on the 9th circuit decisions in Microsoft v Motorola (2012 and 2015)  to rule on the core issue of the scope of the FRAND commitments–specifically on the question of whether licensing extends to all levels or is confined to the end device level. The court interpreted the pro- competitive principles behind the non-discrimination requirement to mean that such commitments are “sweeping” and essentially that an SEP holder has to license to anyone willing to offer a FRAND rate globally. It also cited Ericsson v D-Link, where the Federal Circuit held that “compliant devices necessarily infringe certain claims in patents that cover technology incorporated into the standard and so practice of the standard is impossible without licenses to all incorporated SEP technology.”

The guidelines speak about the importance of non-disclosure agreements (NDAs) in such licensing agreements given that some of the information exchanged between parties during negotiation, such as claim charts etc., may be sensitive and confidential. Therefore, an undue delay in agreeing to an NDA, without well-founded reasons, might be taken as evidence of a lack of good faith in negotiations rendering such a licensee as unwilling.

They also provide quite a boost for small and medium enterprises (SMEs) in licensing negotiations by addressing the duty of SEP owners to be mindful of SMEs that may be less experienced and therefore lack information from which to draw assurance that proposed terms are FRAND. The guidelines provide that SEP owners should provide whatever information they can under NDA to help the negotiation process. Equally, the same obligation applies on a licensee who is more experienced in dealing with a SEP owner who is an SME.

There is some clarity on time frames for negotiations and the guidelines provide a maximum time that parties should take to respond to offers and counter offers, which could extend up to several months in complex cases involving hundreds of patents. The guidelines also prescribe conduct of potential licensees on receiving an offer and how to make counter-offers in a timely manner.

Furthermore, the guidelines lay down the various ways in which royalty rates may be structured and clarify that there is no one fixed way in which this may be done. Similarly, they offer myriad ways in which potential licensees may be able to determine for themselves if the rates offered to them are fair and reasonable, such as third party patent landscape reports, public announcements, expert advice etc.

Finally, in the case that a negotiation reaches an impasse, the guidelines endorse an alternative dispute mechanism such as mediation or arbitration for the parties to resolve the issue. Bodies such as International Chamber of Commerce and World Intellectual Property Organization may provide useful platforms in this regard.

Almost 20 years have passed since technology pioneer Kevin Ashton first coined the phrase Internet of Things. While companies are gearing up to participate in the market of IoT, regulation and policy in the IoT world seems far from a predictable framework to follow. There are a lot of guesses about how rules and standards are likely to shape up, with little or no guidance for companies on how to prepare themselves for what faces them very soon. Therefore concrete efforts such as these are rather welcome. The draft guidelines do attempt to offer some much needed clarity and are now open for public comments due by December 13. It will be good to see what the final CWA report on licensing of SEPs for 5G and IoT looks like.

 

Last week, the UK Court of Appeal upheld the findings of the High Court in an important case regarding standard essential patents (SEPs). Of particular significance, the Court of Appeal upheld the finding that the defendant, an implementer of SEPs, could have the sale of its products enjoined in the UK unless it enters into a global licensing deal on terms deemed by the court to be fair, reasonable and non-discriminatory (FRAND). The case is noteworthy not least because the threat of an injunction of this sort has become increasingly rare in other jurisdictions, arguably resulting in an imbalance in bargaining power between patent holders and implementers.

The case concerned patents held by Unwired Planet (most of which had been purchased from Ericsson) that it had declared to be essential to the operation of various telecommunications standards. Chinese telecom giant Huawei had incorporated these patented technologies in its products but disputed the legitimacy of Unwired Planet’s (UP) patents and refused to license them on the terms that were offered.

By way of a background to the case, in March 2014, UP resorted to suing Huawei, Samsung and Google and claiming an injunction when it found it hard to secure licenses. After the commencement of proceedings, UP made licence offers to the defendants. It made offers in April and July 2014 respectively and during the proceedings, including a worldwide SEP portfolio licence, a UK SEP portfolio licence and per-patent licences for any of the SEPs in suit. The defendants argued that the offers were not FRAND. Huawei and Samsung also contended that the offers were in breach of European competition law. UP  settled with Google. Three technical trials of the patents began and UP was able to show that at least two of the patents sued upon were valid and essential and had been infringed. Subsequently, Samsung secured a settlement (at a rate below the market rate) and the FRAND trial went ahead with just Huawei.

Judge Birss delivered the High Court order on April 5, 2017. He held that UP’s patents were valid and infringed and it did not abuse its dominant position by requesting an injunction. He ordered a FRAND injunction that was stayed pending appeal against the two patents that had been infringed. The injunction was subject to a number of conditions which are applied because the case was dealing with patents subject to a FRAND undertaking. It will cease to have effect if Huawei enters into the FRAND license determined by the Court. He also observed that the parties can return for further determination when such license expires. Furthermore, it was held that there was one set of FRAND terms and that the scope of this FRAND was world wide.

The UK Court of Appeal (the bench consisting of Lord Justice Kitchin, Lord Justice Floyd, Lady Justice Asplin) in handing down a 291 paragraph, 66 page judgment dealing with Huawei’s appeal, upheld Birss’ findings. The centrality of Huawei’s appeal focused on the global nature of the FRAND license and the non-discrimination undertaking of UP’s FRAND commitments. Some significant findings of the Court of Appeal are briefly provided below.

The Court of Appeal in upholding Birss’ decision noted that it was unfair to say that UP is using the threat of an injunction to leverage Huawei into taking a global license, and that Huawei had the option to take the global license or submit to an injunction in the UK. Drawing attention to the potential complexities in a FRAND negotiation, the Court observed:

..The owner of a SEP may still use the threat of an injunction to try to secure the payment of excessive licence fees and so engage in hold-up activities. Conversely, the infringer may refuse to engage constructively or behave unreasonably in the negotiation process and so avoid paying the licence fees to which the SEP owner is properly entitled, a process known as “hold-out”.

Furthermore, Huawei argues that imposition of a global license on terms set by a national court based on a national finding of infringement is wrong in principle. It also states that there is currently an ongoing patent litigation in both Germany and China and that there are some countries where UP holds “no relevant” patents at all.

In response to these contentions, the Court of Appeal has held that it may be highly impractical for a SEP owner to seek to negotiate a license of its patent rights in each country and rejected the submission made by Huawei that the approach adopted by Birss in these proceedings is out of line with the territorial nature of patent litigations. It clarified that Birss did not adjudicate on issues of infringement or validity concerning foreign SEPs and did not usurp the rights of foreign courts. It further observed that such an approach of Birss  is consistent with the Council and the European Economic and Social Committee dated 29 November 2017 (COM (2017) 712 final) (“the November 2017 EU Communication”) which notes in section 2.4:

For products with a global circulation, SEP licences granted on a worldwide basis may contribute to a more efficient approach and therefore can be compatible with FRAND.

The Court of Appeal however disagreed with Birss on the issue that there was only one set of FRAND terms. This view of the bench certainly comes as a relief since it seems to appropriately reflect the practical realities of a FRAND negotiation. The Court held:

Patent licences are complex and, having regard to the commercial priorities of the participating undertakings and the experience and preferences of the individuals involved, may be structured in different ways in terms of, for example, the particular contracting parties, the rights to be included in the licence, the geographical scope of the licence, the products to be licensed, royalty rates and how they are to be assessed, and payment terms. Further, concepts such as fairness and reasonableness do not sit easily with such a rigid approach.

Similarly, on the non- discrimination prong of FRAND, the Court of Appeal agreed with Birss that it was not “hard-edged” and the test is whether such difference in rates distorts competition between the licensees. It also noted that the “hard-edged” interpretation would be “akin to the re-insertion of a “most favoured licensee” clause in the FRAND undertaking” which does not seem to be what the standards body, European Telecommunications Standards Institute (ETSI) had in mind when it formulated its policies. The Court also held :

We consider that a non-discrimination rule has the potential to harm the technological development of standards if it has the effect of compelling the SEP owner to accept a level of compensation for the use of its invention which does not reflect the value of the licensed technology.

Finally, the Court of Appeal held that UP did not abuse its dominant position just because it failed to strictly comply with the safe harbor framework laid down by Court of Justice of the European Union in Huawei v. ZTE. The only requirement that must be satisfied before proceedings are commenced by the SEP holder is that the SEP holder give sufficient notice to or consult with the implementer.

The Court of Appeal’s decision offers some significant guidance to the emerging policy debate on FRAND. As mentioned at the beginning of this post, the decision is significant particularly for the reason that UP is one of a total of two cases in the last two years, where an injunctive relief has been granted in instances involving standard essential patents. Such reliefs have been rarely granted in years in the first place. The second such instance of a grant of injunction pertains to Huawei v. Samsung where the Shenzhen Court in China held earlier this year that Huawei met the FRAND obligation while Samsung did not (negotiations were dragged on for 6 years). An injunction was granted against Samsung for infringing two of Huawei’s Chinese patents which are counterparts of two U.S. asserted patents (however Judge Orrick of the U.S. District Court for the Northern District of California enjoined Huawei from enforcing the injunction).

Current jurisprudence on injunctive relief with respect to FRAND encumbered SEPs is that there is no per se ban on these reliefs. However, courts have been very reluctant to actually grant them. While injunctions are statutory remedies, and granted automatically in most cases when a patent is found to be infringed, administrative agencies and courts have held a position that shows that FRAND commitments certainly limit this premise.

Following the eBay decision in the U.S., defendants in infringement claims involving SEPs have argued that permanent injunctions should not be available for FRAND-encumbered SEPs and were upheld in cases such as Apple v. Motorola in 2014 (where Judge Randall Radar also makes a sound case for evidence of a hold out by Apple in his dissenting order). However, in an institutional bargaining framework of FRAND, which is based on a mutuality of considerations, such a recourse is misplaced and likely to inevitably disturb this balance. The current narrative on FRAND that dominates policymaking and jurisprudence is incomplete in its unilateral focus of avoiding the possible problem of a patent hold up in the absence of concrete evidence indicating its probability. In Ericsson v D-Links Judge Davis of the US Court of Appeals for the Federal Circuit underscored this point when he observed that “if an accused infringer wants an instruction on patent hold-up and royalty stacking [to be given to the jury], it must provide evidence on the record of patent hold-up and royalty stacking.”

Remedies emanating from a one sided perspective tilt the bargaining dynamic in favour of implementers and if the worst penalty a SEP infringer has to pay is the FRAND royalty it would have otherwise paid beforehand, then a hold out or a reverse hold up by implementers becomes a very profitable strategy. Remedies for patent infringement cannot be ignored because they are also core to the framework for licensing negotiations and ensuring compliance by licensees. A disproportionate reliance on liability rules over property rights is likely to exacerbate the countervailing problem of hold out and detrimentally impact incentives to innovate, ultimately undermining the welfare goals that such enforcement seeks to achieve.

The Court of Appeal has therefore given valuable guidance in its decision when it noted:

Just as implementers need protection, so too do the SEP owners. They are entitled to an appropriate reward for carrying out their research and development activities and for engaging with the standardization process, and they must be able to prevent technology users from free-riding on their innovations. It is therefore important that implementers engage constructively in any FRAND negotiation and, where necessary, agree to submit to the outcome of an appropriate FRAND determination.

Hopefully this order brings with it some balance in FRAND negotiations as well as a shift in the perspective of courts in how they adjudicate on these litigations. It underscores an oft forgotten principle that is core to the FRAND framework- that FRAND is a two-way street, as was observed in the celebrated case of Huawei v. ZTE in 2015.

On Monday, the U.S. Federal Trade Commission and Qualcomm reportedly requested a 30 day delay to a preliminary ruling in their ongoing dispute over the terms of Qualcomm’s licensing agreements–indicating that they may seek a settlement. The dispute raises important issues regarding the scope of so-called FRAND (“fair reasonable and non-discriminatory”) commitments in the context of standards setting bodies and whether these obligations extend to component level licensing in the absence of an express agreement to do so.

At issue is the FTC’s allegation that Qualcomm has been engaging in “exclusionary conduct” that harms its competitors. Underpinning this allegation is the FTC’s claim that Qualcomm’s voluntary contracts with two American standards bodies imply that Qualcomm is obliged to license on the same terms to rival chip makers. In this post, we examine the allegation and the claim upon which it rests.

The recently requested delay relates to a motion for partial summary judgment filed by the FTC on August 30, 2018–about which more below. But the dispute itself stretches back to January 17, 2017, when the FTC filed for a permanent injunction against Qualcomm Inc. for engaging in unfair methods of competition in violation of Section 5(a) of the FTC Act. FTC’s major claims against Qualcomm were as follows:

  • It has been engaging in “exclusionary conduct”  that taxes its competitors’ baseband processor sales, reduces competitors’ ability and incentives to innovate, and raises the prices to be paid by end consumers for cellphones and tablets.  
  • Qualcomm is causing considerable harm to competition and consumers through its “no license, no chips” policy; its refusal to license to its chipset-maker rivals; and its exclusive deals with Apple.
  • The above practices allow Qualcomm to abuse its dominant position in the supply of CDMA and premium LTE modem chips.
  • Given that Qualcomm has made a commitment to standard setting bodies to license these patents on FRAND terms, such behaviour qualifies as a breach of FRAND.

The complaint was filed on the eve of the new presidential administration, when only three of the five commissioners were in place. Moreover, the Commissioners were not unanimous. Commissioner Ohlhausen delivered a dissenting statement in which she argued:

[T]here is no robust economic evidence of exclusion and anticompetitive effects, either as to the complaint’s core “taxation” theory or to associated allegations like exclusive dealing. Instead the Commission speaks about a possibility that less than supports a vague standalone action under a Section 5 FTC claim.

Qualcomm filed a motion to dismiss on April 3, 2017. This was denied by the U.S. District Court for the Northern District of California. The court  found that the FTC has adequately alleged that Qualcomm’s conduct violates § 1 and § 2 of the Sherman Act and that it had entered into exclusive dealing arrangements with Apple. Thus, the court asserted, the FTC has adequately stated a claim under § 5 of the FTCA.

It is important to note that the core of the FTC’s arguments regarding Qualcomm’s abuse of dominant position rests on how it adopts the “no license, no chip” policy and thus breaches its FRAND obligations. However, it falls short of proving how the royalties charged by Qualcomm to OEMs exceeds the FRAND rates actually amounting to a breach, and qualifies as what FTC defines as a “tax” under the price squeeze theory that it puts forth.

(The Court did not go into whether there was a violation of § 5 of the FTC independent of a Sherman Act violation. Had it done so, this would have added more clarity to Section 5 claims, which are increasingly being invoked in antitrust cases even though its scope remains quite amorphous.)

On August 30, the FTC filed a partial summary judgement motion in relation to claims on the applicability of local California contract laws. This would leave antitrust issues to be decided in the subsequent hearing, which is set for January next year.

In a well-reasoned submission, the FTC asserts that Qualcomm is bound by voluntary agreements that it signed with two U.S. based standards development organisations (SDOs):

  1. The Telecommunications Industry Association (TIA) and
  2. The Alliance for Telecommunications Industry Solutions (ATIS).

These agreements extend to Qualcomm’s standard essential patents (SEPs) on CDMA, UMTS and LTE wireless technologies. Under these contracts, Qualcomm is obligated to license its SEPs to all applicants implementing these standards on FRAND terms.

The FTC asserts that this obligation should be interpreted to extend to Qualcomm’s rival modem chip manufacturers and sellers. It requests the Court to therefore grant a summary judgment since there are no disputed facts on such obligation. It submits that this should “streamline the trial by obviating the need for  extrinsic evidence regarding the meaning of Qualcomm’s commitments on the requirement to license to competitors, to ETSI, a third SDO.”

A review of a heavily redacted filing by FTC and a subsequent response by Qualcomm indicates that questions of fact and law continue to remain as regards Qualcomm’s licensing commitments and their scope. Thus, contrary to the FTC’s assertions, extrinsic evidence is still needed for resolution to some of the questions raised by the parties.

Indeed, the evidence produced by both parties points towards the need for resolution of ambiguities in the contractual agreements that Qualcomm has signed with ATIS and TIA. The scope and purpose of these licensing obligations lie at the core of the motion.

The IP licensing policies of the two SDOs provide for licensing of relevant patents to all applicants who implement these standards on FRAND terms. However, the key issues are whether components such as modem chips can be said to implement standards and whether component level licensing falls within this ambit. Yet, the resolution to these key issues, is unclear.

Qualcomm explains that commitments to ATIS and TIA do not require licenses to be made available for modem chips because modem chips do not implement or practice cellular standards and that standards do not define the operation of modem chips.

In contrast, the complaint by FTC raises the question of whether FRAND commitments extend to licensing at all levels. Different components needed for a device come together to facilitate the adoption and implementation of a standard. However, it does not logically follow that each individual component of the device separately practices or implements that standard even though it contributes to the implementation. While a single component may fully implement a standard, this need not always be the case.

These distinctions are significant from the point of interpreting the scope of the FRAND promise, which is commonly understood to extend to licensing of technologies incorporated in a standard to potential users of the standard. Understanding the meaning of a “user” becomes critical here and Qualcomm’s submission draws attention to this.

An important factor in the determination of a “user” of a particular standard is the extent to which the standard is practiced or implemented therein. Some standards development organisations (SDOs) have addressed this in their policies by clarifying that FRAND obligations extend to those “wholly compliant” or “fully conforming” to the specific standards. Clause 6.1 of the ETSI IPR Policy, clarifies that a patent holder’s obligation to make licenses available is limited to “methods” and “equipments”. It defines an equipment as “a system or device fully conforming to a standard.” And methods as “any method or operation fully conforming to a standard.”

It is noteworthy that the American National Standards Institute’s (ANSI) Executive Standards Council Appeals Panel in a decision has said that there is no agreement on the definition of the phrase “wholly compliant implementation.”  

Device level licensing is the prevailing industry wide practice by companies like Ericsson, InterDigital, Nokia and others. In November 2017, the European Commission issued guidelines on licensing of SEPs and took a balanced approach on this issue by not prescribing component level licensing in its guidelines.

The former director general of ETSI, Karl Rosenbrock, adopts a contrary view, explaining ETSI’s policy, “allows every company that requests a license to obtain one, regardless of where the prospective licensee is in the chain of production and regardless of whether the prospective licensee is active upstream or downstream.”

Dr. Bertram Huber, a legal expert who personally participated in the drafting of the IPR policy of ETSI, wrote a response to Rosenbrock, in which he explains that ETSI’s IPR policies required licensing obligations for systems “fully conforming” to the standard:

[O]nce a commitment is given to license on FRAND terms, it does not necessarily extend to chipsets and other electronic components of standards-compliant end-devices. He highlights how, in adopting its IPR Policy, ETSI intended to safeguard access to the cellular standards without changing the prevailing industry practice of manufacturers of complete end-devices concluding licenses to the standard essential patents practiced in those end-devices.

Both ATIS and TIA are organizational partners of a collaboration called 3rd Generation Partnership Project along with ETSI and four other SDOs who work on development of cellular technologies. TIA and ATIS are both accredited by ANSI. Therefore, these SDOs are likely to impact one another with the policies each one adopts. In the absence of definitive guidance on interpretation of the IPR policy and contractual terms within the institutional mechanism of ATIS and TIA, at the very least, clarity is needed on the ambit of these policies with respect to component level licensing.

The non-discrimination obligation, which as per FTC, mandates Qualcomm to license to its competitors who manufacture and sell chips, would be limited by the scope of the IPR policy and contractual agreements that bind Qualcomm and depends upon the specific SDO’s policy.  As discussed, the policies of ATIS and TIA are unclear on this.

In conclusion, FTC’s filing does not obviate the need to hear extrinsic evidence on what Qualcomm’s commitments to the ETSI mean. Given the ambiguities in the policies and agreements of ATIS and TIA on whether they include component level licensing or whether the modem chips in their entirety can be said to practice the standard, it would be incorrect to say that there is no genuine dispute of fact (and law) in this instance.

Last Friday, drug maker Allergan and the Saint Regis Mohawk Tribe announced that they had reached an agreement under which Allergan assigned the patents on its top-selling drug Restasis to the tribe and, in return, Allergan was given the exclusive license on the Restasis patents so that it can continue producing and distributing the drug.  Allergan agreed to pay $13.75 million to the tribe for the deal, and up to $15 million annually in royalties as long as the patents remain valid.

Why would a large drug maker assign the patents on a leading drug to a sovereign Indian nation?  This unorthodox agreement may actually be a brilliant strategy that enables patent owners to avoid the unbalanced inter partes review (IPR) process.  The validity of the Restasis patents is currently being challenged both in IPR proceedings before the Patent Trial and Appeal Board (PTAB) and in federal district court in Texas.  However, the Allergan-Mohawk deal may lead to the dismissal of the IPR proceedings as, under the terms of the deal, the Mohawks will file a motion to dismiss the IPR proceedings based on the tribe’s sovereign immunity.  Earlier this year, in Covidien v. University of Florida Research Foundation, the PTAB determined that sovereign immunity shields state universities holding patents from IPR proceedings, and the same reasoning should certainly apply to sovereign Indian nations.

I’ve published a previous article explaining why pharmaceutical companies have legitimate reasons to avoid IPR proceedings–critical differences between district court litigation and IPR proceedings jeopardize the delicate balance Hatch-Waxman sought to achieve between patent owners and patent challengers. In addition to forcing patent owners into duplicative litigation in district courts and the PTAB, depriving them of the ability to achieve finality in one proceeding, the PTAB also applies a lower standard of proof for invalidity than do district courts in Hatch-Waxman litigation.  It is also easier to meet the standard of proof in a PTAB trial because of a more lenient claim construction standard.  Moreover, on appeal, PTAB decisions in IPR proceedings are given more deference than lower district court decisions.  Finally, while patent challengers in district court must establish sufficient Article III standing, IPR proceedings do not have a standing requirement.  This has led to the exploitation of the IPR process by entities that would never be granted standing in traditional patent litigation—hedge funds betting against a company by filing an IPR challenge in hopes of crashing the stock and profiting from the bet.

The differences between district court litigation and IPR proceedings have created a significant deviation in patent invalidation rates under the two pathways; compared to district court challenges, patents are twice as likely to be found invalid in IPR challenges.  Although the U.S. Supreme Court in Cuozzo Speed Technologies v. Lee concluded that the anti-patentee claim construction standard in IPR “increases the possibility that the examiner will find the claim too broad (and deny it)”, the Court concluded that only Congress could mandate a different standard.  So far, Congress has done nothing to reduce the disparities between IPR proceedings and Hatch-Waxman litigation. But, while we wait, the high patent invalidation rate in IPR proceedings creates significant uncertainty for patent owners’ intellectual property rights.   Uncertain patent rights, in turn, lead to less innovation in the pharmaceutical industry.  Put simply, drug companies will not spend the billions of dollars it typically costs to bring a new drug to market when they can’t be certain if the patents for that drug can withstand IPR proceedings that are clearly stacked against them (for an excellent discussion of how the PTAB threatens innovation, see Alden Abbot’s recent TOTM post).  Thus, deals between brand companies and sovereigns, such as Indian nations, that insulate patents from IPR proceedings should improve the certainty around intellectual property rights and protect drug innovation.

Yet, the response to the Allergan-Mohawk deal among some scholars and generic drug companies has been one of panic and speculative doom.  Critics have questioned the deal largely on the grounds that, in addition to insulating Restasis from IPR proceedings, tribal sovereignty might also shield the patents in standard Hatch-Waxman district court litigation.  If this were true and brand companies began to routinely house their patents with sovereign Indian nations, then the venues in which generic companies could challenge patents would be restricted and generic companies would have less incentive to produce and market cheaper drugs.

However, it is far from clear that these deals could shield patents in standard Hatch-Waxman district court litigation.  Hatch-Waxman litigation typically follows a familiar pattern: a generic company files a Paragraph IV ANDA alleging patent owner’s patents are invalid or will not be infringed, the patent owner then sues the generic for infringement, and then the generic company files a counterclaim for invalidity.  Critics of the Allergan-Mohawk deal allege that tribal sovereignty could insulate patent owners from the counterclaim.  However, courts have held that state universities waive sovereign immunity for counterclaims when they file the initial patent infringement suit.  Although, in non-infringement contexts, tribes have been found to not waive sovereign immunity for counterclaims merely by filing an action as a plaintiff, this has never been tested in patent litigation.  Moreover, even if sovereign immunity could be used to prevent the counterclaim, invalidity can still be raised as an affirmative defense in the patent owner’s infringement suit (although it has been asserted that requiring generics to assert invalidity as an affirmative defense instead of a counterclaim may still tilt the playing field toward patent owners).  Finally, many patent owners that are sovereigns may choose to voluntarily waive sovereign immunity to head off any criticism or congressional meddling. Given the uncertainty of the effects of tribal sovereignty in Hatch-Waxman litigation, Allergan has concluded that their deal with the Mohawks won’t affect the pending district court litigation involving the validity of the Restasis patents.  However, if tribes in future cases were to cloud the viability of Hatch-Waxman by asserting sovereign immunity in district court litigation, Congress could always respond by altering the Hatch-Waxman rules to preclude this.

For now, we should all take a deep breath and put the fearmongering on hold.  Whether deals like the Allergan-Mohawk arrangement could affect Hatch-Waxman litigation is simply a matter of speculation, and there are many reasons to believe that they won’t. In the meantime, the deal between Allergan and the Saint Regis Mohawk Tribe is an ingenious strategy to avoid the unbalanced IPR process.   This move is the natural extension of the PTAB’s ruling on state university sovereign immunity, and state universities are likely incorporating the advantage into their own licensing and litigation strategies.  The Supreme Court will soon hear a case questioning the constitutionality of the IPR process.  Until the courts or Congress act to reduce the disparities between IPR proceedings and Hatch-Waxman litigation, we can hardly blame patent owners from taking clever legal steps to avoid the unbalanced IPR process.

Today the International Center for Law & Economics (ICLE) Antitrust and Consumer Protection Research Program released a new white paper by Geoffrey A. Manne and Allen Gibby entitled:

A Brief Assessment of the Procompetitive Effects of Organizational Restructuring in the Ag-Biotech Industry

Over the past two decades, rapid technological innovation has transformed the industrial organization of the ag-biotech industry. These developments have contributed to an impressive increase in crop yields, a dramatic reduction in chemical pesticide use, and a substantial increase in farm profitability.

One of the most striking characteristics of this organizational shift has been a steady increase in consolidation. The recent announcements of mergers between Dow and DuPont, ChemChina and Syngenta, and Bayer and Monsanto suggest that these trends are continuing in response to new market conditions and a marked uptick in scientific and technological advances.

Regulators and industry watchers are often concerned that increased consolidation will lead to reduced innovation, and a greater incentive and ability for the largest firms to foreclose competition and raise prices. But ICLE’s examination of the underlying competitive dynamics in the ag-biotech industry suggests that such concerns are likely unfounded.

In fact, R&D spending within the seeds and traits industry increased nearly 773% between 1995 and 2015 (from roughly $507 million to $4.4 billion), while the combined market share of the six largest companies in the segment increased by more than 550% (from about 10% to over 65%) during the same period.

Firms today are consolidating in order to innovate and remain competitive in an industry replete with new entrants and rapidly evolving technological and scientific developments.

According to ICLE’s analysis, critics have unduly focused on the potential harms from increased integration, without properly accounting for the potential procompetitive effects. Our brief white paper highlights these benefits and suggests that a more nuanced and restrained approach to enforcement is warranted.

Our analysis suggests that, as in past periods of consolidation, the industry is well positioned to see an increase in innovation as these new firms unite complementary expertise to pursue more efficient and effective research and development. They should also be better able to help finance, integrate, and coordinate development of the latest scientific and technological developments — particularly in rapidly growing, data-driven “digital farming” —  throughout the industry.

Download the paper here.

And for more on the topic, revisit TOTM’s recent blog symposium, “Agricultural and Biotech Mergers: Implications for Antitrust Law and Economics in Innovative Industries,” here.

Nicolas Petit is Professor of Law at the University of Liege (Belgium) and Research Professor at the University of South Australia (UniSA)

This symposium offers a good opportunity to look again into the complex relation between concentration and innovation in antitrust policy. Whilst the details of the EC decision in Dow/Dupont remain unknown, the press release suggests that the issue of “incentives to innovate” was central to the review. Contrary to what had leaked in the antitrust press, the decision has apparently backed off from the introduction of a new “model”, and instead followed a more cautious approach. After a quick reminder of the conventional “appropriability v cannibalizationframework that drives merger analysis in innovation markets (1), I make two sets of hopefully innovative remarks on appropriability and IP rights (2) and on cannibalization in the ag-biotech sector (3).

Appropriability versus cannibalization

Antitrust economics 101 teach that mergers affect innovation incentives in two polar ways. A merger may increase innovation incentives. This occurs when the increment in power over price or output achieved through merger enhances the appropriability of the social returns to R&D. The appropriability effect of mergers is often tied to Joseph Schumpeter, who observed that the use of “protecting devices” for past investments like patent protection or trade secrecy constituted a “normal elemen[t] of rational management”. The appropriability effect can in principle be observed at firm – specific incentives – and industry – general incentives – levels, because actual or potential competitors can also use the M&A market to appropriate the payoffs of R&D investments.

But a merger may decrease innovation incentives. This happens when the increased industry position achieved through merger discourages the introduction of new products, processes or services. This is because an invention will cannibalize the merged entity profits in proportions larger as would be the case in a more competitive market structure. This idea is often tied to Kenneth Arrow who famously observed that a “preinvention monopoly power acts as a strong disincentive to further innovation”.

Schumpeter’s appropriability hypothesis and Arrow’s cannibalization theory continue to drive much of the discussion on concentration and innovation in antitrust economics. True, many efforts have been made to overcome, reconcile or bypass both views of the world. Recent studies by Carl Shapiro or Jon Baker are worth mentioning. But Schumpeter and Arrow remain sticky references in any discussion of the issue. Perhaps more than anything, the persistence of their ideas denotes that both touched a bottom point when they made their seminal contribution, laying down two systems of belief on the workings of innovation-driven markets.

Now beyond the theory, the appropriability v cannibalization gravitational models provide from the outset an appealing framework for the examination of mergers in R&D driven industries in general. From an operational perspective, the antitrust agency will attempt to understand if the transaction increases appropriability – which leans in favour of clearance – or cannibalization – which leans in favour of remediation. At the same time, however, the downside of the appropriability v cannibalization framework (and of any framework more generally) may be to oversimplify our understanding of complex phenomena. This, in turn, prompts two important observations on each branch of the framework.

Appropriability and IP rights

Any antitrust agency committed to promoting competition and innovation should consider mergers in light of the degree of appropriability afforded by existing protecting devices (essentially contracts and entitlements). This is where Intellectual Property (“IP”) rights become relevant to the discussion. In an industry with strong IP rights, the merging parties (and its rivals) may be able to appropriate the social returns to R&D without further corporate concentration. Put differently, the stronger the IP rights, the lower the incremental contribution of a merger transaction to innovation, and the higher the case for remediation.

This latter proposition, however, rests on a heavy assumption: that IP rights confer perfect appropriability. The point is, however, far from obvious. Most of us know that – and our antitrust agencies’ misgivings with other sectors confirm it – IP rights are probabilistic in nature. There is (i) no certainty that R&D investments will lead to commercially successful applications; (ii) no guarantee that IP rights will resist to invalidity proceedings in court; (iii) little safety to competition by other product applications which do not practice the IP but provide substitute functionality; and (iv) no inevitability that the environmental, toxicological and regulatory authorization rights that (often) accompany IP rights will not be cancelled when legal requirements change. Arrow himself called for caution, noting that “Patent laws would have to be unimaginably complex and subtle to permit [such] appropriation on a large scale”. A thorough inquiry into the specific industry-strength of IP rights that goes beyond patent data and statistics thus constitutes a necessary step in merger review.

But it is not a sufficient one. The proposition that strong IP rights provide appropriability is essentially valid if the observed pre-merger market situation is one where several IP owners compete on differentiated products and as a result wield a degree of market power. In contrast, the proposition is essentially invalid if the observed pre-merger market situation leans more towards the competitive equilibrium and IP owners compete at prices closer to costs. In both variants, the agency should thus look carefully at the level and evolution of prices and costs, including R&D ones, in the pre-merger industry. Moreover, in the second variant, the agency ought to consider as a favourable appropriability factor any increase of the merging entity’s power over price, but also any improvement of its power over cost. By this, I have in mind efficiency benefits, which can arise as the result of economies of scale (in manufacturing but also in R&D), but also when the transaction combines complementary technological and marketing assets. In Dow/Dupont, no efficiency argument has apparently been made by the parties, so it is difficult to understand if and how such issues have played a role in the Commission’s assessment.

Cannibalization, technological change, and drastic innovation

Arrow’s cannibalization theory – namely that a pre-invention monopoly acts as a strong disincentive to further innovation – fails to capture that successful inventions create new technology frontiers, and with them entirely novel needs that even a monopolist has an incentive to serve. This can be understood with an example taken from the ag-biotech field. It is undisputed that progress in crop protection science has led to an expanding range of resistant insects, weeds, and pathogens. This, in turn, is one (if not the main) key drivers of ag-tech research. In a 2017 paper published in Pest Management Science, Sparks and Lorsbach observe that:

resistance to agrochemicals is an ongoing driver for the development of new chemical control options, along with an increased emphasis on resistance management and how these new tools can fit into resistance management programs. Because resistance is such a key driver for the development of new agrochemicals, a highly prized attribute for a new agrochemical is a new MoA [method of action] that is ideally a new molecular target either in an existing target site (e.g., an unexploited binding site in the voltage-gated sodium channel), or new/under-utilized target site such as calcium channels.

This, and other factors, leads them to conclude that:

even with fewer companies overall involved in agrochemical discovery, innovation continues, as demonstrated by the continued introduction of new classes of agrochemicals with new MoAs.

Sparks, Hahn, and Garizi make a similar point. They stress in particular that the discovery of natural products (NPs) which are the “output of nature’s chemical laboratory” is today a main driver of crop protection research. According to them:

NPs provide very significant value in identifying new MoAs, with 60% of all agrochemical MoAs being, or could have been, defined by a NP. This information again points to the importance of NPs in agrochemical discovery, since new MoAs remain a top priority for new agrochemicals.

More generally, the point is not that Arrow’s cannibalization theory is wrong. Arrow’s work convincingly explains monopolists’ low incentives to invest in substitute invention. Instead, the point is that Arrow’s cannibalization theory is narrower than often assumed in the antitrust policy literature. Admittedly, Arrow’s cannibalization theory is relevant in industries primarily driven by a process of cumulative innovation. But it is much less helpful to understand the incentives of a monopolist in industries subject to technological change. As a result of this, the first question that should guide an antitrust agency investigation is empirical in nature: is the industry under consideration one driven by cumulative innovation, or one where technology disruption, shocks, and serendipity incentivize drastic innovation?

Note that exogenous factors beyond technological frontiers also promote drastic innovation. This point ought not to be overlooked. A sizeable amount of the specialist scientific literature stresses the powerful innovation incentives created by changing dietary habits, new diseases (e.g. the Zika virus), global population growth, and environmental challenges like climate change and weather extremes. In 2015, Jeschke noted:

In spite of the significant consolidation of the agrochemical companies, modern agricultural chemistry is vital and will have the opportunity to shape the future of agriculture by continuing to deliver further innovative integrated solutions. 

Words of wisdom caution for antitrust agencies tasked with the complex mission of reviewing mergers in the ag-biotech industry?

Ioannis Lianos is Professor of Global Competition Law and Public Policy, UCL Faculty of Laws and Chief Researcher, HSE-Skolkovo Institute for Law and Development

The recently notified mergers in the seed and agro-chem industry raise difficult questions that competition authorities around the world would need to tackle in the following months. Because of the importance of their markets’ size, the decision reached by US and EU competition authorities would be particularly significant for the merging parties, but the perspective of a number of other competition authorities in emerging and developing economies, in particular the BRICS, will also play an important role if the transactions are to move forward.

The factors of production segment of the food value chain, which has been the focus of most recent merger activity, has been marked by profound transformations the last three decades. One may note the development of new technologies, starting with deliberate hybridization to marker-assisted breeding and the most recent advances in genetic engineering or genetic editing with CRISPR/Cas technology, as well as the advent of “digital agriculture” and “precision farming”. These technologies are of course protected by IP rights consisting of patents, plant variety rights, trademarks, trade secrets, and geographical indications.

These IP rights enable seed companies to prevent farmers from saving seeds of the protected variety, sharing it with their neighbours or selling it informally (“brown bagging”), but also to prevent competing plant breeders from using a protected variety in the development of a new variety (cumulative innovation), as well as to prevent competing seed producers from multiplying and marketing the protected variety without a license or using a protected product name and logos. Seed laws requiring compulsory seed certification with the aim to police seed quality also offer some form of protection to breeders, in the absence of IPRs.

Technology-driven growth has not been the only major transformation of this economic sector. Its consolidation, in particular in the factors of production segment, has been particularly important in recent years.

The consolidation of the factors of production segment

Concentration in the world and EU markets for seeds

In the seeds sector, a number of merger waves, starting in the mid-1980s, have led to the emergence of a relatively concentrated market structure of 6 big players thirty years later (Monsanto, Syngenta, DuPont, BASF, Bayer, and Dow).

The most recent merger wave started in July 2014 when Monsanto made a number of acquisition offers to Syngenta. These offers were rejected, but the Monsanto bid triggered a number of other M&A transactions that were announced in 2015 and 2016 between the various market leaders in the factors of production segment. In November 2015, Syngenta accepted the offer of ChemChina (which owns ADAMA, one of the largest agrochemical companies in the world). In December 2015, Dupont and Dow announced their merger. In September 2016, Bayer put forward a merger deal with Monsanto. During the same month, a deal was announced between two of the leaders in the market for fertilizers, Potash Corp and Agrium. In November 2015, it was reported that Deere & Co. (the leader in agricultural machinery) had agreed to buy Monsanto’s precision farming business. This deal was opposed by the US Department of Justice as it would have led Deere to control a significant part of the already highly concentrated US high-speed precision planting systems market.

The level of concentration varies according to the geographical market and the type of crop. If one looks at the situation in Europe, with regard to the sale of seeds, the market appears to be less concentrated than the global seed market. The picture is also slightly different for certain types of crop. For instance, it is reported that the seed market for sugar beets shows the largest concentration, with the first three companies (CR3) controlling a staggering 79% of the market (HHI: 2444), while for Maize seeds CR3 is 56% (HHI: 1425). High levels of concentration are also noted in the market for tomato seeds with Monsanto controlling 20% of registered seed varieties. What is more striking, however, is the speed of this consolidation process, as the bulk of this increase in the concentration level of the industry occurred in the last twenty years, the levels of concentration in the mid-1990s being close to those in 1985.

But the existence of a relatively concentrated market constitutes the tip of a much bigger consolidation iceberg between the market leaders that takes various forms: joint ventures, various cross-licensing and trait licensing agreements between the “Big Six”, distribution agreements, collaborations, research agreements and R&D strategic alliances, patent litigation settlements, to which one may add the recently concluded post-patent genetic trait agreements. Furthermore, one may not exclude the possibility of consolidation by stealth, in view of the important growth in common ownership in various sectors of the economy, as institutional investors simultaneously hold large blocks of other same-industry firms.

Which concentration level will be considered for merger purposes?

Market structure and concentration is, of course, just one step in the assessment of mergers and should be followed by a more thorough analysis of the possible anticompetitive effects and efficiencies, if the level of concentration resulting from the merger raises concerns. While the EU market for seeds could not be characterized as highly concentrated before this most recent merger wave, if one applies the conventional HHI measure, it remains possible that if the mergers first notified to the European Commission are approved without conditions with regard to seed markets, the concentration level that the Commission will consider when assessing the following notified merger will respectively increase. One may project that, as the Dow/Dupont merger has been recently cleared without conditions relating to the seed industry, it will be more difficult for the ChemChina/Syngenta merger to be approved without conditions, and even more so for the Bayer/Monsanto merger that will be the last one examined. Indeed, as the Commission made clear in its press release announcing its decision on the Dow/Dupont transaction,

The Commission examines each case on its own merits. In line with its case practice, the Commission assesses parallel transactions according to the so-called “priority rule” – first come, first served. The assessment of the merger between Dow and DuPont has been based on the currently prevailing market situation.

The assessment as to whether a merger would give rise to a Significant Impediment of Effective Competition (SIEC) is based on a counterfactual analysis where the post-merger scenario is compared to a hypothetical scenario absent the merger in question. The latter is normally taken to be the same as the situation before the merger is consummated. However, the Commission may take into account future changes to the market that can “reasonably be foreseen”. The identification of the proper counterfactual can be complicated by the fact that there can be more than one merger occurring in parallel in the same relevant market. Under the mandatory notification regime, the Commission does not factor into the counterfactual analysis a merger notified after the one under assessment. On the basis of the identified counterfactual, the Commission then proceeds with the definition of the relevant product and geographic market. That means that when assessing the Dow/Dupont merger, the Commission did not take into account the (future) market situation that would result from the notified merger between ChemChina and Syngenta, which was a known fact during the period of the assessment of the Dow/Dupont merger, as this was notified a few months after the notification of the Dow/Dupont transaction.

Explaining concentration levels

The consolidation of the industry may be explained by various factors at play. One may put forward a “natural” causes explanation, in view of the existence of endogenous sunk costs that may lead to a reduction in the number of firms active in this industry. John Sutton has famously argued that high concentration may persist in many manufacturing industries, even in the presence of a substantial increase in demand and output, when firms in the industry decide to incur, in addition to “exogenous sunk costs”, that is the costs that any firm will have to incur upon entry into the market, “endogenous sunk costs”, which include cost for R&D and other process innovations, with the aim to increase their price-cost margin. If all firms invest in endogenous sunk costs, in the long run this investment will produce little or no profit, as the competitive advantage gained by each firm’s investment will be largely ineffective if all other firms make a similar investment. This may lead to a fall in the industry’s profitability in the long-term and to a concentrated market. The recent consolidation movement in the industry may also be understood as a way to deal with externalities arising out of the expansion of the IP protection in recent decades.

Consolidation may also occur because of the merging companies’ quest for market share by purchasing potential competition, acquiring local market leaders or companies with diversified distribution networks and an established customer base. Market leaders may also strive to constitute one-stop shop platforms for farmers, combining an offering of seeds, traits, and chemicals, that would enhance the farmers’ technological dependence vis-à-vis large agrochemical and seed companies.

These large agro-chem groups forming a tight oligopoly will be able to exploit eventual network effects that may result from the shift towards data-driven agriculture and to block new entry in the factors of production markets. It is increasingly clear that market players in this industry have made the choice of positioning themselves as fully integrated providers, or the orchestrators/partners of an established network, offering a package of genetic transformation technology and genomics, traits, seeds, and chemicals. One may argue that this package of ‘complementary’ products and technologies may form a system competing with other systems (‘systems competition’). A question that would need to be tackled, when assessing the plausibility of the “system competition” thesis, would be to determine the existence of distinct relevant markets affected by the mergers. Could research, breeding and development/marketing of the various kinds of seeds be considered as part of the same or of different relevant markets? I address this question and the effects of these mergers on output, prices, and consumer choice in more detail in a separate paper (I. Lianos & D. Katalevsky, Merger Activity in the Factors of Production Segments of the Food Value Chain: A Critical Assessment (forthcoming)).

Theories and assessment of harm to innovation

Because of space constraints, I will only focus here on the assessment of the possible effects of these mergers on innovation. The emergence of integrated technology/traits/seeds/chemicals platforms may place barriers to new entry, as companies wishing to enter the market(s) would need to offer an integrated solution to farmers. This may stifle disruptive innovation if, in the absence of the merger, firms were able to enter one or two segments of the market (e.g. research and breeding) without the need to offer an “integrated” platform product. One should also take note of the fact that although traditional breeding methods required important resources and a considerable investment of time (because of long breeding cycles) and thus provided large economies of scale leading to the emergence of large market players, the latest genome-editing technologies, particularly CRISPR/Cas, may constitute more efficient and less resource intensive and time-consuming breeding methods, that offer opportunities for the emergence of more competitive and less integrated market structures in the traits/seeds segment(s).

Assessing the effects on innovation will be a crucial part of the merger assessment, for the European Commission as well as for all other competition authorities with jurisdiction to examine the specific merger(s). It is true that the EU market is mainly a conventional seed market, and not a GM seeds market, but it is also clear that all of the Big Six have an integrated strategy for R&D for all types of crops, working on “traditional” marker-assisted breeding, or the more recent forms of predictive breeding that have become commercially possible with the reduction of the cost of genome sequencing and the use of IT, but also on genetically engineered seeds. Assessing the possible effects of each merger on innovation will be a quite complex exercise in view of the need to focus not only on existing technologies but also on the possibility of new technologies emerging in the future.

Competition authorities may use different methodologies to assess these future effects: the definition of innovation markets as it is the case in the US, or a more general assessment of the existence of an effect on innovation constituting a SIEC in Europe. In its recent decision on the Dow/Dupont merger, the European Commission found that the merger may have reduced innovation competition for pesticides by looking to the ability and the incentive of the parties to innovate. The Commission emphasised that this analysis was not general but was based on “specific evidence that the merged entity would have lower incentives and a lower ability to innovate than Dow and DuPont separately” and “that the merged entity would have cut back on the amount they spent on developing innovative products”. That said, the Commission also mentioned the following, which I think may be of relevance to the competition assessment of the other pending mergers:

Only five companies (BASF, Bayer, Syngenta and the merging parties) are globally active throughout the entire R&D process, from discovery of new active ingredients (molecules producing the desired biological effect), their development, testing and regulatory registration, to the manufacture and sale of final formulated products through national distribution channels. Other competitors have no or more limited R&D capabilities (e.g. as regards geographic focus or product range). After the merger, only three global integrated players would remain to compete with the merged company, in an industry with very high barriers to entry. The number of players active in specific innovation areas would be even lower than at the overall industry level.

This type of assessment looks close to the filter of the existence of at least four independent technologies that constitute a commercially viable alternative, in addition to the licensed technology controlled by the parties to the agreement, that the Commission usually employs in its Transfer of Technology Guidelines in order to exclude the possibility that a licensing agreement may restrict competition and thus infringe Article 101 TFEU. There is no reason why the Commission would apply a different approach in the context of merger control. The above indicate that the Commission may view more negatively mergers that lead to less than four or three independent technologies in the relevant market(s).

Hidden/Not usually considered social costs

One may also assess the mergers in the seeds and agro-chem market from a public interest perspective, in view of the broader concerns animating public policy in this context and the existence of a nexus of international commitments with regard to biodiversity, sustainability, the right to food, as well as the emphasis put by some competition law regimes on public interest analysis (e.g. South Africa). The aim will be to assess the full social costs of these transactions, to the extent, of course, this is practically possible. This may be more achievable in merger control regimes where it is not courts that make the final decisions to clear, or not to clear, the merger, as there may be limits to the adjudication of certain broader public interest concerns, but integrated competition law agencies, or branches of the executive power, as it is formally the case in the EU.

Although public interest considerations do not form part of the substantive test of EU merger control, Article 21(4) EUMR includes a legitimate interest clause, which provides that Member States may take appropriate measures to protect three specified legitimate interests: public security, plurality of the media and prudential rules, and other unspecified public interests that are recognised by the Commission after notification by the Member State. If a Member State wishes to claim an additional legitimate interest, other than the ones listed above, it shall communicate this to the Commission. And the Commission must then decide, within 25 working days, whether the additional interest is compatible with EU law, and qualifies as an article 21(4) legitimate interest. This should not be excluded a priori, in particular in view of the importance of biodiversity, environmental protection, and employment in the EU treaties as well as broader international commitments to the right to food.

Food production is, of course, an area of great economic and geopolitical importance. According to UN estimates, by 2050 the world population will increase to nine billion, and catering to this additional demand would require an increase of 70% more food. This puts a strong pressure to increase output, which intensifies even more environmental impact, given increasing sustainability challenges (degradation of soil and reduction of arable land due to urban sprawl, water scarcity, biofuel consumption, climate change, etc.). Food security becomes an increasingly important issue on the agenda of the developing world.

The projected mergers in the seed and agro-chem industry will greatly affect the future control of food production and innovation in order to improve yields and feed the world. One may ask if such important decisions should be based on a narrowly confined test that mostly focuses on effects on output, price and to a certain extent innovation, or if one should adopt a broader consideration of the full social costs of such transactions, to the extent that these may be assessed and eventually quantified.

This may have the additional benefit to enable the participation in the merger process as third parties of a number of NGOs representing broader citizens’ interests in environmental protection and biodiversity, which is currently impossible with the quite narrow procedural requirements for third party intervenors in EU merger control (as the test for admission as third party intervenors is usually met only by competitors, suppliers, and customers). I think that all the affected interests and stakeholders should be offered an opportunity to participate in the decision-making process, thus increasing its efficiency (if one takes a participation-centred approach) and legitimacy, in particular for matters of major social importance as is the control of the global food supply chain(s).

It may be argued, if one takes a pessimistic, Malthusian perspective, that we are doomed to face famine and malnutrition, unless considerable amounts of investment are made in R&D in this sector. In view of the fall of public investments and the important role private investments have played in this area, one may argue that higher levels of consolidation in the sector could lead to higher profitability (at the expense of farmers) without necessarily leading to immediate effects on food prices, as the farming segment is driven by atomistic competition in most markets, and therefore farmers will not have the ability to pass on, at least in the short term, the eventual overcharges to the final consumers. Of course, such an approach may not factor in the effects of these mergers to the livelihood of around half a billion farmers in the world and their families, most of whom do not benefit from subsidies guaranteeing an acceptable standard of living.

It also assumes that higher profitability would lead to higher investments in R&D, a claim that has been recently questioned by research indicating that large firms prefer to retain earnings and distribute them to shareholders and the management rather than invest them in R&D. But, more generally, a simple question that one may ask is “are the projected mergers necessary in order to promote innovation in this sector”? Answering this question may bring a great sense of clarity as to the various dimensions of these mergers competition authorities would need to take into account. And the burden of proof to provide a convincing answer to this question remains on the notifying parties!

The U.S. Supreme Court’s unanimous June 13 decision (per Chief Justice John Roberts) in Halo Electronics v. Pulse Electronics, overturning the Federal Circuit’s convoluted Seagate test for enhanced damages, is good news for patent holders.  By reducing the incentives for intentional patent infringement (due to the near impossibility of obtaining punitive damages relief under Seagate), Halo Electronics helps enhance the effectiveness of patent enforcement, thereby promoting a more robust patent system.

The complexity and unwieldiness of the Seagate test is readily apparent from this description:

35 U.S.C. § 284 provides simply that “the court may increase the damages up to three times the amount found or assessed.” Nevertheless, in In re Seagate Technology, LLC, 497 F.3d 1360 (2007) (en banc) the Federal Circuit erected a two-part barrier for patentees to clear before a district court could exercise its enhancement discretion under the statute. First, a patent owner must “show by clear and convincing evidence that the infringer acted despite an objectively high likelihood that its actions constituted an infringement of a valid patent.” This first part of the test is not met if the infringer, during infringement proceedings, raises a substantial question as to the validity or non-infringement of the patent, regardless of whether the infringer’s prior conduct was egregious. Second, the patentee must demonstrate that the risk of infringement “was either known or so obvious that it should have been known to the accused infringer.” On appeal, the Federal Circuit would review the first step of the test—objective recklessness—de novo; the second part—subjective knowledge—for substantial evidence; and the ultimate decision—whether to award enhanced damages—for abuse of discretion.

In short, under Seagate, even if (1) the patentee presented substantial evidence that the infringer intentionally infringed its patent (under the second part of the test), and (2) the infringer’s prior conduct was egregious, the infringer could avoid enhanced damages merely by raising a “substantial question” as to the validity or non-infringement of the patent.  Because in most cases mere “questions” as to validity or non-infringement could readily be ginned up ex post, intentional infringers, including truly “bad actors,” could largely ignore the risk of being assessed anything more than actual damages.

Moreover, the Seagate test should be viewed in light of other major policy changes that have diminished the value of patents, such as the near impossibility of obtaining permanent injunctive relief for patent infringement following the Supreme Court’s 2006 eBay decision (see, for example, here), plus the recent downward trend in patent damage awards (see, for example, here) and increasingly common administrative patent invalidations (see, for example, here).  All told, these developments have incentivized parties to “go ahead and produce,” without regard to the patents they might be infringing, in the knowledge that, at worst, they might at some future time be held liable for something akin to the reasonable royalties they should have agreed to pay in the first place.

Chief Justice Roberts’ opinion for the Court in Halo Electronics in effect reinstates the longstanding historical understandings that in patent infringement cases:  (1) district court judges enjoy broad discretion to assess enhanced damages “for egregious infringement behavior”; and (2) the standard “preponderance of the evidence” standard of civil litigation (rather than the far more exacting “clear and convincing evidence” standard of proof) applies to enhanced damages determinations.  In so doing, it puts potential infringers on notice that exemplary damages for egregious infringing actions cannot be avoided after the fact by manufactured theories (“questions”) of possible patent invalidity or non-applicability of a patent’s claims to the conduct in question.  This in turn should raise the expected costs of intentional patent infringement, thereby increasing the incentive for technology implementers to negotiate ex ante with patent holders over license terms.  To the extent this incentive change results in a higher incidence of licensing ex ante, a lower incidence of costly infringement litigation, and higher returns to patentees, economic welfare should tend to rise.

Halo Electronics’ “halo effect” should not, of course, be oversold.  The meaning of “egregious infringement behavior” will have to be hashed out in federal litigation, and it is unclear to what extent federal district courts may show a greater inclination to assess enhanced damages.   Furthermore, recent legislative and regulatory policy changes and uncertainties (including rising “anti-patent” sentiments in the Executive Branch, see, for example, here) continue to constrain incentives to patent, to the detriment of economic welfare.  Nevertheless, while perhaps less than “heavenly” in its impact, the Halo Electronics decision should have some effect in summoning up “the better angels of technology implementers’ nature” (paraphrasing Abraham Lincoln, a firm believer in a robust patent system) and causing them to better respect the property rights imbedded in the patented innovations on which they rely.

Tomorrow, Geoffrey Manne, Executive Director of the International Center for Law & Economics, will be a panelist at the Cato Institute’s Policy Forum, “The ITC and Digital Trade: The ClearCorrect Decision.”  He will be joined by Sapna Kumar, Associate Professor, University of Houston Law Center and Shara Aranoff, Of Counsel, Covington and Burling LLP, and former Chairman of the U.S. International Trade Commission (“ITC”).

The forum is focused on a recent Federal Circuit decision, ClearCorrect v. ITC, in which a divided three judge panel overturned a 5-1 majority decision of the ITC holding that the Tariff Act granted it the power to prevent the importation of digital articles that infringe a valid U.S. patent. Key to the Federal Circuit’s decision was a hyper-textualist parsing of the term “article” as understood in 1929–a move that stands in stark contrast to the Federal Circuit’s recent en banc decision in Suprema, which was crucially based on a wider reading of the context of the Tariff Act in order to understand the the full meaning of the phrase “articles … that infringe” as contained therein.

Critics of the ITC’s interpretation in this matter contend that such jurisdiction would somehow grant the ITC the power to regulate the Internet. However, far from being an expansive power grab, the ITC’s decision was in fact well reasoned and completely consistent with the Tariff Act and Congressional intent. Nonetheless, this remains an important case because the cost of the Federal Circuit’s error could be very high given the importance of IP to the national economy.

Full details on the event:

“The ITC and Digital Trade: The ClearCorrect Decision”
Wednesday, December 9, 2015 at 12 PM EDT.
F. A. Hayek Auditorium (located on the lobby level of the Cato Institute)
1000 Massachusetts Ave., N.W.
Washington, D.C.

Registration begins at 11:30 a.m.

 

More from us on this and related topics:

False Teeth: Why An ITC Case Won’t Chew Up The Internet (Forbes)

Suprema v. ITC: The Case for Chevron Deference

The Federal Circuit Misapplies Chevron Deference (and Risks a Future “Supreme Scolding”) in Suprema Inc. v. ITC

 

Today, in ClearCorrect Operating, LLC v. International Trade Commission, the U.S. Court of Appeals for the Federal Circuit held that electronic transmissions of digital data from abroad do not involve the importation of “articles” for purposes of Section 337 of the Tariff Act (“Section 337,” 19 U.S.C. § 1337), thereby stripping the U.S. International Trade Commission (“ITC”) of jurisdiction over infringement of intellectual property (IP) facilitated through such transmissions.  If allowed to stand, this unfortunate and ill-reasoned 2-1 panel decision will incentivize IP infringement schemes involving data imports, thereby harming U.S. IP holders (including holders of federally-protected patents, copyrights, trademarks, and designs) and rewarding unfair methods of import competition, contrary to the broad statutory purpose of Section 337.

Align Technology, Inc. held various patents covering the production of orthodontic tooth-straightening appliances, known as aligners.  ClearCorrect Operating, LLC (“ClearCorrect US”) used patented Align Technology without authorization to create digital models of patients’ teeth, and electronically transmitted those models to its Pakistani affiliate, Clear Correct Pakistan.  The Pakistani affiliate manipulated those models and then transmitted final digital models back to the United States, which ClearCorrect US utilized to make orthodontic aligners.  Align Technology complained to the ITC, which found that Clear Correct Pakistan engaged in infringing activity in Pakistan and that data transmission of its digital models to the U.S. violated Section 337(a)(1)(B)(ii), in that it involved the importation of articles covered by the claims of a valid and enforceable United States patent.  ClearCorrect appealed the ITC’s determination to the Federal Circuit.

Judge Sharon Prost’s majority opinion, while conceding that the term “articles” is not defined in the Tariff Act, nevertheless found that because “dictionaries point to the fact that ‘articles’ means ‘material things’”, the term “’articles’ does not cover electronically transmitted digital data.”  Thus, finding the term “articles” to be clear (“commonsense dictates that there is a fundamental difference between electronic transmissions and ‘material things[.]’”), Judge Prost rejected the ITC’s findings under step one (is there statutory ambiguity) of Chevron deference analysis.  Even assuming that “articles” is ambiguous, however, Judge Prost held that the ITC’s interpretation of that term was “unreasonable,” and thus failed step two (was the agency’s interpretation permissible) of Chevron analysis.  Specifically, Judge Prost deemed the ITC’s definition as inconsistent with dictionary definitions and with the Tariff Act’s legislative history.

In her short concurring opinion, Judge Kathleen O’Malley reasoned that the ITC’s definition of “articles” would give it jurisdiction over all incoming international Internet data transmissions, something Congress had not foreseen – “[b]ecause Congress did not intend to delegate such authority to the Commission, I would find the two step Chevron inquiry inapplicable in this case”.  Judge O’Malley added, however, that assuming Chevron applies, “I agree with the majority’s ruling that the Commission erred when it determined that it had jurisdiction over the disputed digital data.”  (Judge O’Malley’s apparent concern that upholding the ITC’s determination would have given that agency excessive regulatory control over the Internet appears to wrongly conflate the protection of property rights through a targeted and carefully-tailored provision (Section 337) with far-reaching command and control regulation – something that is clearly beyond the scope of the ITC’s authority.)

In her dissent, Judge Pauline Newman pointed out that Section 337 was written in broad terms that are adaptable to changes in technology.  She noted compellingly that contrary to the majority’s crabbed reading of “articles,” the term “was intended to be all-encompassing”, and “[t]he Supreme Court [itself] defined ‘articles of commerce’ to include pure information”.  Accordingly, limiting Section 337’s application to the non-digital technology that existed in the 1920s and 1930s (when the statutory core of the Tariff Act was enacted) makes no sense.  Summing it up, Judge Newman trenchantly concluded that “[o]n any standard, the Commission’s determination is reasonable, and warrants respect.  The panel majority’s contrary ruling is not reasonable, on any standard.”

U.S. patentees are not the only IP holders that face serious harm from the Federal Circuit’s regrettable holding.  For example, the Motion Picture Association of America stated that “[t]his ruling, if it stands, would appear to reduce the authority of the ITC to address the scourge of overseas web sites that engage in blatant piracy of movies, television programs, music, books, and other copyrighted works”.

An en banc Federal Circuit (or, better yet Supreme Court) reversal of this decision would prove helpful, but judicial processes move slowly.  Given the potential for serious harm to U.S. IP-dependent industries stemming from this holding, Congress may wish to seriously consider clarifying that the term “articles” in Section 337 is applicable to all forms of commerce, including digital transmissions.