Licensing and Antitrust:
Common Goals and Uncommon Problems
WILLARD K. TOM
Deputy Director , Bureau of Competition
Federal Trade Commission
American Conference Institute
9th National Conference on
Licensing Intellectual Property
October 12, 1998
I am delighted to be here today to speak about licensing and antitrust. When I speak on this subject to gatherings of intellectual property practitioners, I sometimes feel as if I am attempting to bridge an ocean almost as wide as the one Columbus undertook to cross five centuries ago. So it is perhaps entirely fitting that this time I am doing it on the holiday dedicated to his memory. You can tell me at the end whether I have succeeded in the proposition that it really is one world after all, or whether instead I have sailed off the edge. But unlike Columbus, who took three shiploads of crew members along with him on his risky voyage, let me hasten to add the traditional disclaimer that the views I express here are my own, and do not necessarily represent those of the Commission or any individual Commissioner.
How wide is this ocean? For almost this entire century, vast indeed, for antitrust and intellectual property have long been considered antithetical to each other. To illustrate this point, I hope you'll indulge me while I review a little history. I'll start with the 1902 case of E. Bement & Sons v. National Harrow Co.(1) The case arose from a patent pooling arrangement. After years of patent infringement litigation, manufacturers of "float spring tooth harrows" settled their lawsuits and assigned all of their spring tooth harrow patents to the National Harrow Company, in exchange for shares of the Company and a license to make, use, and sell harrows made with patents licensed back to the manufacturers by National Harrow. The pool grew quickly to 22 firms accounting for over 90% of all manufacturing and sales of float spring tooth harrows in the United States. Each firm was required to adhere to uniform price schedules for the sale of all products manufactured under the National Harrow license. And here's the kicker: each firm was required to use only the harrow manufacturing technology it had assigned to the patent pool, not the technology others had assigned to the pool. When the pool sued Bement--one of the pool members--for selling below the scheduled prices in violation of the license, Bement argued that the pooling agreement was unlawful and unenforceable because it violated the Sherman Act. The Supreme Court held for the pool, explaining that:
. . . the general rule is absolute freedom in the use or sale of rights under the patent laws of the United States. The very object of these laws is monopoly, and the rule is, with few exceptions, that any conditions which are not by their very nature illegal with regard to this kind of property, imposed by the patentee and agreed to by the licensee for the right to manufacture or use or sell the article, will be upheld by the courts. The fact that the conditions in the contracts keep up the monopoly or fix prices does not render them illegal.(2)
Thus, the law in 1902 was that the patent laws were an absolute trump against an antitrust case. In the Court's view, the very purpose of the patent law was to create a monopoly, so that even the hardest of the hard core antitrust violations, price-fixing, had to fall before the expansive rights given to the patent holder.
From today's perspective, this result seems grotesque. Remember, each firm was required to use only the harrow manufacturing technology it had assigned to the patent pool. From a technological standpoint, nothing had happened:
Each manufacturer put some technology in, took the same technology out, and went on producing the same products it had been producing before by the same methods. Formation of the pool did not make possible the use of complementary technology that could not have been brought together without the pool. The only thing the pool accomplished was to let the pool members fix prices. Yet the Court said this was OK, because the very purpose of the patent law was to create monopolies.
Now fast-forward about half a century, to United States v. Line Material Co.(3) in 1948. There, the Supreme Court reviewed a cross-licensing arrangement between two patent owners, Line Material Company and Southern States Equipment Corporation. Southern held a patent covering a dropout fuse with a complicated and expensive mechanism to break electric circuits when current became excessive.(4) Although Line patented a simpler and less expensive version of the dropout fuse release mechanism, it could not be used without infringing Southern's patent.(5) To resolve the blocking position, Line and Southern entered into a cross-licensing arrangement and further agreed to sublicense their combined patents to several third-party licensees.(6) You can see this in the diagram below.
Notice that in this diagram, what comes out of the pool is better and more complete than the inputs that went in. In any event, Line, Southern, and the parties to the sub-license arrangements agreed to minimum price levels for the sale of products made with the patents Line and Southern had cross-licensed.(7)
The Court held that the parties had engaged in price-fixing in violation of the Sherman Act. In the Court's view, the price fixing was obvious: "[b]y the patentees' agreement the dominant . . . and the subservient . . . patents were combined to fix prices."(8)
What had happened to the notion in Bement that the very purpose of the patent laws was to create monopolies, and therefore actions involving patents could not be antitrust violations? As the role of the antitrust laws in American life grew, the Bement approach quickly came to seem unsatisfactory. It may not be coincidence that passage of the Clayton Act and the FTC Act came at about the same time as the recognition that patent rights are subject to the "general law,"(9) including the "positive prohibitions" of the Sherman Act.(10) Still, the notion that the very purpose of the patent law was to create monopolies had not disappeared. If it was no longer satisfactory to think that the patent law was a kind of "get out of jail free" card with respect to all antitrust violations, some other resolution had to be found.
And so it was. The idea that patents conferred an immunity to the antitrust laws was kept, but overlaid on it was the idea that antitrust immunities should be narrowly construed. As the Court declared in 1942 in United States v. Masonite Corp.: "Since patents are privileges restrictive of a free economy, the rights which Congress has attached to them must be strictly construed . . . ."(11) Similarly, in Line Material, the Court concluded that the patents conferred no immunity from the antitrust laws because the price fixing agreement went beyond simple enjoyment of the rights conferred by the patents. In the Court's words: "the possession of a valid patent or patents does not give the patentee any exemption from the provisions of the Sherman Act beyond the limits of the patent monopoly."(12)
Thus, the Court hardly paused over the fact that, but for the Line/Southern cross-licensing arrangement, the blocking positions of the relevant patents made it impossible for "the public or the patentees [to] obtain the full benefit of the efficiency and economy of the inventions"(13) or that the patents cross-licensed by Line and Southern were "not commercially competitive."(14) Instead, since, in the Court's words, quote, "[t]here is no suggestion in the patent statutes of authority to combine with other patent owners to fix prices on articles covered by the respective patents,"(15) unquote, such a practice was "outside the patent monopoly" and unlawful.(16)
Thus, like siblings trying to share a bedroom, the argument in the decades after cases like Masonite and Line Material was over exactly where the sheet should go that divided the two sides of the room. It was critically important to know where the boundary was, because within the scope of the patent conferred by Congress, the right of the patent holder was almost absolute. One step over the line demarcated by the patent grant, however, and the patent holder subjected himself to potential antitrust liability, to loss of enforceability of the patent through the doctrine of patent misuse, or both. As one might expect under this type of legal regime, the courts devoted considerable energy to deciding precisely what conduct was within the scope of the patent grant,(17) and what conduct "overstepped" the boundaries.(18)
Now, what's the point of this little history tour? It is not to make fun of the Supreme Court, or to complain that they're always getting things wrong. Every member of those two Courts was undoubtedly a lot smarter than I am. The point is that if you start from the proposition that antitrust and intellectual property are inevitably in conflict, and that the very purpose of the intellectual property laws is to create monopoly, you are bound to end up with one of two answers: either one trumps the other, or they have to be confined to their respective spheres. The Court has tried both over the course of this century, and neither has proved satisfactory. The Bement approach condones licensing arrangements that restrict competition but make no contribution whatsoever to efficiency, and the Line Material approach condemns highly efficient arrangements.
Well, where are we today? I think we've grown up a little in the fifty years since Line Material. Rather than siblings sharing a room, the two bodies of law are more like parents running a household. As with parents looking out for the best interest of the children, the guiding principle is the best interest of consumers. Thus, as the Federal Circuit observed in Atari Games Corp. v. Nintendo of America,(19) "the aims and objectives of patent and antitrust laws may seem, at first glance, wholly at odds. However, the two bodies of law are actually complementary, as both are aimed at encouraging innovation, industry and competition."
Thus, another half-century after Line Material, we have another patent pooling case, and I think the differences from both Line Material and Bement are instructive. I'm referring, of course, to the FTC's recent settlement with Summit Technology and VISX, Inc., accepted for public comment on August 21, 1998.(20)
Summit and VISX are the only two firms legally able to market laser equipment to be used for PRK in the United States. Instead of competing with each other, the firms placed their competing patents in a patent pool.
The pool established a $250 licensing fee to be paid to the pool each and every time a laser produced by either firm was used to perform PRK. The proceeds from these license fees were then split between the two firms according to a predetermined formula. The effect of this per-procedure fee was that neither firm had an incentive to charge doctors less than $250 per procedure.
Under Bement, this kind of arrangment would simply be an exercise of the parties' patent rights, and therefore lawful. Under Line Material, this would clearly be "outside the patent monopoly" and therefore unlawful price fixing.(21)
Things are a little more nuanced today. The 1995 IP Guidelines recognize that cross-licensing and pooling arrangements may provide procompetitive benefits by, among other things, clearing blocking positions. We understand that if two firms possess patents that would block the other from using its respective technologies, and if it is not possible for either party to invent around the other's position, then it is misleading to think of the firms as horizontal competitors. If such firms were prevented from collaborating, each would seek to take a monopoly markup that would maximize its own royalty stream without regard to the impact that the decrease in quantity would have on the profits of the other. The result would be a price that is even higher, and more harmful to consumers, than would be set by a single monopolist. This "double-marginalization" problem is familiar to us from the analysis of vertical restraints--that is, restraints between parties at different stages of a chain of manufacturing and distribution, such as a manufacturer and a retailer. Indeed, the IP Guidelines teach us that blocking relationships are vertical, not horizontal. More generally, the Guidelines teach us that we are dealing with a vertical rather than horizontal relationship if the parties would not "have been actual or likely potential competitors in a relevant market in the absence of the license."(22)
This was the standard that was used in charging Summit and VISX with unlawful price fixing in connection with their patent pool. As charged in ¶ 8 of the Complaint, "in the absence of the PPP Agreement, VISX and Summit could have and would have competed with one another." Because the relationship was horizontal, an agreement between the two parties that set a price floor under their product clearly harmed competition -- in fact, amounted to garden-variety price fixing.
Let me address one other nuance that you will see in the Analysis to Aid Public Comment in the Summit case. And that is, in the real world things may not be absolutely black or white. For example, what if the firms believe that their respective technologies are competing rather than blocking, but either they perceive the risk of litigation, or such litigation has already commenced? One approach would be to say that the slightest whiff of litigation makes the relationship blocking and therefore any and all conduct designed to resolve that blocking relationship is OK. Another would be to say that all that matters is how things turned out, and any perceived risks are irrelevant. The Summit/VISX settlement follows neither of these extremes. Instead, it separates the analysis into two separate questions The first is whether competition was in fact restrained or threatened. Since the patents were not in fact blocking, the answer is yes. The second is whether the terms of the pool were a reasonable way of achieving the legitimate but separate goal of avoiding or reducing the cost and risk of litigation. Here the answer is clearly no. The parties could have used significantly less restrictive means, such as cross-licenses that did not dictate prices to users or restrict entry. Therefore, the arrangement was unreasonably restrictive of competition, and had to be condemned. Note that we are not saying that patent pools or other cross-licensing arrangements that set prices are always unlawful because arrangements that don't set prices are always a less restrictive alternative. That would take us back to a Line Materials approach. We first have to be sure that competition was restrained or threatened. Only then do we ask whether the restraints are reasonably necessary to achieve a procompetitive purpose.
Let me turn now to the merger of Ciba Geigy and Sandoz, two giant pharmaceutical companies that are leaders in gene therapy.(23) There are a number of interesting aspects to this merger, but I'm only going to focus on the one most relevant to today's topic.
To make a commercially viable gene therapy product to treat a disease such as brain cancer, one needs a lot of things. One needs the ability, and the right as a matter of intellectual property law, to work with the specific genetic material that has the therapeutic benefit. One needs the vectors to gt that genetic material into the cell. One needs manufacturing facilities that have been certified by FDA as adhering to good manufacturing practices. And so on. In the interest of time, I'm going to vastly oversimplify, and focus only on the intellectual property rights to the therapeutic genes and the intellectual property rights to the vectors. And again to oversimplify, I'm going to treat the situation as if Sandoz had the IP rights to vectors that are used to get genes into cells in a process by which cells are removed from the body, the genetic material is inserted, and the cells are returned to the body. This is called the ex vivo process, in contrast to the in vivo process, in which the genetic material is inserted while the cells remain in the body. Ciba had sufficient rights to in vivo technologies, so that the cooperation of Sandoz was not necessary for insertion of genetic material through an in vivo process. I'm also going to assume that, with a little bit of work and investment, the same genes can be inserted into cells through either the ex vivo or in vivo process.
Now, there are dozens of firms with scientists doing quite exciting research into various sorts of gene therapies. Some of those firms have the right to the genetic material necessary to work with, say, certain types of brain tumors, or with hemophilia, or graft versus host disease; other firms are doing research to try to discover genes for other medical conditions. All of these firms know, however, that for their discoveries to do any good, the genes have to get into the cell via either an in vivo or ex vivo process. That is, they are going to have to deal either with Ciba or with Sandoz--through a joint venture, a licensing arrangement, or a sale of their company to one or the other.
What is happening in this situation is closely related to the earlier diagram about how two firms with blocking patents might have to get together to produce a product:
What we were faced with in Ciba-Sandoz was much like that, except that the many research labs working on gene therapies needed either Ciba or Sandoz, but not both.
As long as they can play one off against the other, the potential rewards are so great that it pays the firms to continue their research. Post-merger, however, the combined entity becomes a single bottleneck. Since the research firms can no longer play one off against the other, the terms on which they can partner with the combined entity change markedly for the worse. Indeed, they would change so much for the worse that we had reason to believe many of those research efforts would simply fold up and go away. As a result, the Commission challenged the merger and entered into a consent order that allowed the transaction as a whole to go through, but required licensing of the intellectual property necessary for research competition to continue to flourish.
I suggested earlier that if you start from the proposition that antitrust and intellectual property are inevitably in conflict, and that the very purpose of the intellectual property laws is to create monopoly, you are bound to end up with the wrong answer. Instead we start with the proposition that intellectual property is much like other forms of property. That an inventor may lay claim to the domain marked out by his intellectual property is no more antithetical to antitrust than that a firm lays claim to its factory. In the Ciba-Sandoz diagram, it matters little whether Ciba and Sandoz lay claim to the only vectors into a cell or to the only bridges over a river. In either case, we don't challenge their ownership of the property, only their attempt to carry out a merger that combines two alternative paths into one bottleneck.
Recognizing the degree to which intellectual property is like other forms of property for antitrust purposes helps us to recognize that the two bodies of law, far from being inevitably conflicting, are instead complementary ways of achieving a common goal. Competition is a spur to innovation and a way to spread the benefits of innovation to the consumer; intellectual property helps the inventor reap the rewards of innovation and thereby preserves the incentive to innovate. Done well, antitrust enforcement and intellectual property law advance these goals; done badly, either one can be a hindrance. The challenge of the next decade will be to apply well the principles of the Guidelines in concrete situations, thus serving the common goal of both bodies of law to encourage innovation, industry and the well-being of consumers.
1. 186 U.S. 70 (1902).
2. 2 Id. at 91 (emphasis added).
3. 333 U.S. 287 (1948).
4. Id. at 290 n.4.
5. After an interference proceeding, the Patent Office had awarded "dominant claims to Southern and subservient claims to Line." Id. at 291 n.5 ( "Only when both patents could be lawfully used by a single maker could the public or the patentees obtain the full benefit of the efficiency and economy of the inventions.").
6. Id. at 292-93, 297.
7. Id. at 293-297.
8. Id. at 307.
9. Motion Picture Patents Co. v. Universal Film Mfg. Co., 243 U.S. 502, 513 (1917).
10. United States v. Standard Sanitary Mfg. Co., 226 U.S. 20, 49 (1912).
11. 316 U.S. 265, 280 (1942).
12. 333 U.S. at 308 (emphasis added).
13. Id. at 291, 297.
14. Line Material at 311.
15. Id. at 312.
17. See, e.g., United States v. Line Material Co., 333 U.S. 287, 309-310 (1948); Ethyl, 309 U.S. at 452; United States v. Univis Lens Co., 316 U.S. 241(1942).
18. See, e.g., Q-Tips, Inc. v. Johnson & Johnson, 109 F. Supp. 657, 661 (D.N.J. 1951), modified, 207 F.2d 509 (3d Cir. 1953), cert. denied, 347 U.S. 935 (1954).
19. 897 F.2d 1572, 1576 (Fed. Cir. 1990).
21. 333 U.S. at 312.
22. 22 U.S. Department of Justice and Federal Trade Commission, Antitrust Guidelines for the Licensing of Intellectual Property at § 3.3 (1995), reprinted in 4 Trade Reg. Rep. (CCH) ¶ 13,132.