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Curbing the Abuses of China’s Anti-Monopoly Law: An Indictment and Reform Agenda

The following is taken from a CPIP policy brief by Professor Richard A. Epstein.  A PDF of the full policy brief is available here.

Curbing the Abuses of China’s Anti-Monopoly Law:
An Indictment and Reform Agenda

Executive Summary

There are increasing complaints in both the European Union and the United States about a systematic bias in China’s enforcement of its Anti-Monopoly Law (AML).  In an extensive report on China’s abuse of its antitrust laws in advancing its own domestic economic policies, for instance, the U.S. Chamber of Commerce noted among many examples a recent action against Microsoft in which Chinese antitrust authorities used a “speculative possibility of licensor hold-up” following Microsoft’s acquisition of Nokia to justify a decree under the AML to “cap license fees for domestic licensees of mobile handset-related software.”

Although the biases in the enforcement of the AML against foreign companies are rooted in systemic problems in China’s political and legal institutions, the abuses are particularly evident in the patent space.  FTC Commissioner Joshua Wright has recognized the “growing concern about some antitrust regimes around the world using antitrust laws to further nationalistic goals at the expense of [intellectual property rights] holders, among others.” He specifically mentioned China as one such antitrust regime that may be finding encouragement or at least rationalization in recent FTC and DOJ actions that presume that “special rules for IP are desirable . . . and that business arrangements involving IP rights may be safely presumed to be anticompetitive without rigorous economic analysis and proof of competitive harm.”

This same theme has been recently echoed by FTC Commissioner Maureen Ohlhausen, who explained that recent American decisions on standard essential patents (SEP), such as the FTC’s use of its merger review power to enforce settlement agreements on SEPs against Bosch and Google, have “created potentially confusing precedent for foreign enforcers.”  This concern was brought home to her when she witnessed Chinese officials invoke these recent FTC actions against Bosch and Google to justify their per se claim under the AML that “an ‘unreasonable’ refusal to grant a license for a standard essential patent to a competitor should constitute monopolization under the essential facilities doctrine.”

Such broad propositions pave the way for Chinese officials to favor domestic, state-run companies who incorporate foreign patented innovation in their own domestic products and services.  These unfettered notions of “unreasonable” conduct become weapons that let Chinese officials force down prices of foreign goods to promote their own nationalist economic policies. Unfortunately, as Commissioner Ohlhausen observed just this past September, recent U.S. antitrust enforcement actions are giving Chinese officials grist for their industrial policy mill.

It is critical that American legal authorities do not give aid and comfort to China’s discriminatory treatment of foreign companies under the AML by the way in which American regulators either speak about or take action on SEPs or other issues relating to patented innovation in this country.  The antitrust laws should not be applied so as to single out patents or any other intellectual property rights for special treatment; all property deployed in the marketplace should be treated equally under the competition laws.

The unfortunate situation in China is one example of a dangerous set of practices which could spread to other countries, motivated either by imitating what China has done or retaliating against its abuses.  The risk is that the disease can spread all too easily.  Until reforms are implemented in both the substance of the AML and the enforcement practices of the Chinese authorities, American policymakers and enforcement authorities should do everything they can to avoid aiding this misuse of antitrust as a domestic economic policy cudgel.


Curbing the Abuses of China’s Anti-Monopoly Law:
An Indictment and Reform Agenda

Richard A. Epstein

I. Introduction

There is a loud chorus of complaints from both the European Union and the United States about a systematic bias in China’s enforcement of its Anti-Monopoly Law (AML).  This bias is evident in a wide range of economic sectors and companies. The Economist reports that China has imposed extra-heavy antitrust penalties on foreign automobile manufacturers, such as Daimler, including a record $200 million penalty on a group of ten Japanese car-parts firms, and the New York Times reports that China has imposed another $109 million penalty on six companies selling infant milk formula.  China has also initiated antitrust enforcement actions against American high-tech companies, such as Microsoft and Qualcomm, and there is an ongoing Chinese probe of Qualcomm (a firm for which I have consulted unrelated issues), which is said to be done with an effort to force a reduction in the prices that it charges for its advanced wireless technology, which China needs to implement a new 4G system for mobile phones.  Similarly, in a wide-ranging report on China’s abuse of the AML to advance domestic industrial policy, the U.S. Chamber of Commerce noted many examples, including a recent action against Microsoft in which Chinese antitrust authorities used its acquisition of Nokia as a basis for a completely “speculative possibility of licensor hold-up” to justify a decree to “cap license fees for domestic licensees of mobile handset-related software.” It is no wonder that many commentators are repeatedly stressing the distinctive foreign focus of China’s recent antitrust activities.

Chinese public officials insist that their stepped-up enforcement of the AML  is even-handed.  “Everyone is equal before the law,” asserted Li Pumin, the head of the National Development and Reform Commission, which takes the lead in investigating foreign firms.  But others in China disagree.  More market-oriented Chinese writers have lamented how China’s commitment to market processes has reversed course since the adoption of the AML law, as China is now using this law as an industrial policy cudgel in promoting its own domestic firms at the expense of foreign ones. Its recent behavior, which provoked expressions of concern from American antitrust officials at both the Federal Trade Commission and the Department of Justice, suggests that this is indeed the case.

II. The Chinese Anti-Monopoly Law

The current situation is an unwelcome reversal of the initial optimism that surrounded the adoption of the AML in 2008, and so a quick overview of the AML’s provisions is necessary.  Hailed at the time as “a tremendous leap forward for China,” the law adopts, at least in the abstract, many of the standard categories of antitrust analysis found in the United States and in the European Union.  In Article 3, it contains the standard prohibitions against horizontal arrangements that raise prices, reduce output, or divide territories, subject to an exemption under Article 15 for agreements that improve technical standards or upgrade consumer products.  The AML also bans “abuse of dominant market positions by business operators,” which under Article 17 includes setting prices in “selling commodities at unfairly high prices or buying commodities at unfairly low prices;” or in selling goods at below costs, refusals to deal, and tie-in arrangements, all “without any justifiable cause.”[i]

In many ways what is most notable about the AML is the extent to which it imitates the major features, both good and bad, of the more developed competition law applied in the United States and the European Union.  But by the same token, it is quite clear that the Chinese law is embedded in a different set of institutional arrangements.  Two elements stand out.

First, the AML reflects the unique Chinese approach to “market socialism” that was first implemented by Deng Xiaoping’s reform policies in the late 1970s as “socialism with Chinese characteristics.”  Article 4 of the AML thus attempts to square the circle: “The State constitutes and carries out competition rules which accord with the socialist market economy, perfects macro-control, and advances a unified, open, competitive and orderly market system.”

Second, the socialist legacy reflected in Article 4 has resulted in an extensive system of state-owned industries in China, and Article 7 of the AML provides special controls, exemptions and protections for this sector of the Chinese economy:

Industries controlled by the State-owned economy and concerning the lifeline of national economy and national security or the industries implementing exclusive operation and sales according to law, the state protects the lawful business operations conducted by the business operators therein. The state also lawfully regulates and controls their business operations and the prices of their commodities and services so as to safeguard the interests of consumers and promote technical progresses.

The scope of Article 7 offers instructive clues toward understanding the current situation.  Its text refers to entire “industries,” not just individual firms, that are given special treatment under the AML. It still speaks in terms of constraining the ability of “industries” to engage in any abusive practices, which at least in principle serve as the basis for competition-focused anti-monopoly law.

Unfortunately, the odds of it remaining focused in this constructive way are necessarily reduced because of its dual operation with respect to both state-owned enterprises (SOEs) and foreign corporations.  The SOEs have a built-in preferential position that can manifest itself in two ways.  Either they can get gentle slaps on the wrist for offenses that prompt far harsher sanctions against private companies, especially foreign companies who are either suppliers or competitors with SOEs, or the SOEs could prod Chinese anti-monopoly enforcement authorities to take action against their foreign competitors.  The AML can all too easily function as a new form of protectionism by virtue of its differential application to foreign firms vis-à-vis SOEs doing business in China.

The difficulties here are increased, moreover, by the structural decision to parcel out enforcement of the AML to several agencies. The National Development and Reform Commission has the lead with respect to enforcement over monopoly agreements.  The State Administration of Industry and Commerce deals with abuses of dominant position.  The division of enforcement authority between these agencies makes it much harder to impose uniform standards on the overall operation of the system. This split in enforcement authority increases the risks of differential enforcement and, more worrisome, the misuse or discriminatory use of the AML.

Therefore, it is evident that no evaluation of the operation of the Chinese anti-monopoly system can be made solely on the basis of the statutory terms in the AML itself.  So much depends on the oft-concealed enforcement practices of the relevant public authorities, who are given very broad powers of inspection and investigation under AML Article 39, which empowers the AML enforcers to run investigations “by getting into the business premises of business operators under investigation or by getting into any other relevant place,” or by forcing them to respond to interrogatories “to explain the relevant conditions” to the public authorities.” Chinese officials also have the power to examine or duplicate all business papers and to seize and retain relevant evidence, and to examine bank records and accounts.  The only procedural protection contained in Article 39, if it can be called that, is that a “written report shall be submitted to the chief person(s)-in-charge of the anti-monopoly authority” before the investigation is approved.  What kind of report and how it is to be reviewed are not stated, even though these substantive and procedural issues are subjects of volumes of statutory, regulatory and decisional law on administrative procedure in the United States and Europe.  Even more significant, there is no mention anywhere in the AML of any probable cause or warrant requirement that must be demonstrated before any independent judicial body.

III. Rule of Law

At the root of the many complaints about the Chinese approach to competition law is the constant concern that its antitrust enforcement practices are inconsistent with the rule of law.  Its legal system invites arbitrary and differential enforcement of anti-monopoly standards.  In dealing with these rule of law issues, it is incumbent to note that they address a critical mix of concerns about both substantive standards and administrative enforcement.

As a general rule of thumb, the more precise the particular rules of conduct that receive government enforcement, the better the prospects to avoid both rule of law violations and the general perception of such government violations.  In this regard, it is worth noting that the ordinary rules of property, contract and tort score very well under this general standard.  As I have argued in my book Design For Liberty:  Private Property, Public Administration and the Rule of Law, these common law rules have several key structural features that facilitate rule of law values.

First, the basic norm with respect to private property is that all other persons need only follow the basic norm “keep off” to comply with the system.  The simplicity of this command means that anyone can follow it regardless of the size of the polity in which this rule operates.  The same command works as well in China with 1.4 billion people as it does in New Zealand with a population just under 4.5 million people.

Second, the content of this simple rule is easily known and understood, so that no one need give special notice of what it requires to the many people who are bound by it.  It is no small deal to have a rule that is not promulgated by statute, which is thereafter interpreted by dense pages of administrative text to which the public has only imperfect knowledge, and which both small and large businesses are able to interpret and apply only with the aid of professional intermediaries such as trade associations and law firms.

Third, the simple rule in question works as well in poor countries as in rich ones, so that there is no awkward transition in rules with increasing development over time.  At this point, the property rules are complemented by the contract rules that allow people within broad limits to decide their own agreements for the provision of goods and services, so that in most cases the key function of the state is to enforce the agreement as designed, not to improve upon its terms with flights of legislative or judicial fancy.

The Chinese AML does not, and cannot, exhibit anything like the requisite level of overall clarity.  In order to determine whether a horizontal arrangement violates the antitrust law, for example, it is necessary to have some sense as to the scope of the market, and the nature of the agreement, to see whether it is or is not in restraint of trade.  It is also necessary to gather evidence about practices that can span both continents and years.  The AML’s standards for dealing with abusive practices are even looser; for example, there is no clear metric by which to determine whether prices are unfairly high or unfairly low. Another nagging question is what it means under the AML for goods to be sold at below cost, because it is completely unclear if the metric is average or marginal cost.  No matter which is chosen, the difficulties of estimation further the scope for abuse of administrative discretion.

This nagging uncertainty about the basic operating rules prompted the late Ronald H. Coase to quip to me long ago in a conversation only partly in jest: “If prices move up in any market, it is surely the result of monopolization. If they remain constant, it is surely the result of market stabilization arrangements.  If they go down, it is surely the result of predation” (quoting from memory).  Coase’s quip ruefully reflects the modus operandi of the Chinese AML.  Since any and all price movements could be associated with some violation of the AML, it follows that in principle no party, and no group of firms, is immune from investigation and criminal prosecution, regardless of how it conducts its own business.  And owing to the vastness of the multinational businesses who are targeted, these investigations can exert a large influence on the behavior of firms and on their key employees who bear the brunt of those investigations, where they are subject to the possibility of criminal sanctions in addition to emotional wear and tear.

IV. The Patent Dimension

The dangers of this system are apparent and easily understood. With respect to accusations of secret horizontal arrangements and price gouging arrangements, the risk comes in the form of extensive and exhaustive investigations that are intended to stifle and not promote competition in the marketplace.  In dealing with these issues, it is critical that our American legal authorities do not give aid and comfort to China’s aggressive regulation of foreign businesses enterprise by the way in which American regulators address similar issues in this country.  We live today in an intensely global environment, and any actions in the United States that overstate the role of the antitrust laws can easily be used as reasons to expand antitrust application overseas.

The point applies to all areas of law, but has especial importance in connection with patents, given that technology that is available in one country is instantly available in all. After the Supreme Court handed down eBay v. MercExchange in 2006, injunctive relief is no longer presumptively available for patent infringement in the United States.  As Professor Scott Kieff, now of the International Trade Commission, and I have written, eBay eased the way for Thailand to impose its regime of compulsory licensing for pharmaceutical patents, at far below market rates.

Evidently, decisions like eBay do not go unnoticed by foreign nations, where they set up a climate in which the weak enforcement of patent rights becomes par for the course.  That same development happens most emphatically in the crossover area between patent and antitrust law.  In general, the proper application of the antitrust law does not single out patents for special treatment of the antitrust laws.  A clear articulation of this principle was recently made by FTC Commissioner Joshua D. Wright in his 2014 Milton Handler Lecture:  “Does the FTC Have a New IP Agenda,”  which stressed the importance of the “parity principle” that states a central tenet in the Department of Justice/Federal Trade Commission 1995 Antitrust Guidelines for the Licensing of Intellectual Property:  “Agencies apply the same general antitrust principles to conduct involving intellectual property that they apply to conduct involving any other form of tangible or intangible property.”

The parity principle is critical to successful antitrust enforcement because it places an important fetter on the arbitrary use of government power, which increases greatly if any government, China included, could use a wide catalogue of novel arguments to justify some deviation from the general rule.  Indeed, this parity principle is an extension of what I have termed elsewhere as the “carry over” principle, which means that intellectual property rights in general should be based on the rules that are applicable to other forms of property, subject only to deviations required by the distinctive features of property rights in information, which chiefly relates to their finite duration to allow for the widespread dissemination of information. But once that key adjustment is made, the standard rules for property used elsewhere, including the rules for injunctive relief, should continue to apply.

Yet as Commissioner Wright mentioned, recent FTC and DOJ actions presume that “special rules for IP are desirable . . . and that business arrangements involving IP rights may be safely presumed to be anticompetitive without rigorous economic analysis and proof of competitive harm.” Commissioner Wright has also recognized the “growing concern about some antitrust regimes around the world using antitrust laws to further nationalistic goals at the expense of [intellectual property rights] holders, among others.” He specifically mentioned China as one such antitrust regime that may be finding encouragement or at least rationalization in these recent actions against IP owners by American antitrust agencies.

This same theme has been recently echoed by FTC Commissioner Maureen Ohlhausen, who noted how foreign nations invoke “‘competition fig leaves’ to address other domestic issues or concerns.” More specifically, Commissioner Ohlhausen explained how this tendency has manifested itself in the debate over standard essential patents (SEPS), that is those patents that are incorporated in setting key technical standards that allow for the interoperability of various technical devices.  She also noted how recent American decisions on SEPs have “created potentially confusing precedent for foreign enforcers.”  That concern was brought home when Chinese officials invoked recent FTC enforcement actions against Bosch and Google SEPs to justify a per se claim under the AML that “an ‘unreasonable’ refusal to grant a license for a standard essential patent to a competitor should constitute monopolization under the essential facilities doctrine.” Such broad propositions pave the way for Chinese officials to favor domestic, state-run companies who incorporate foreign patented innovation in their own domestic products and services.  These unfettered notions of “unreasonable” conduct become weapons that let Chinese officials force down prices of foreign goods to promote their own nationalist economic policies. Unfortunately, as Commissioner Ohlhausen observed just this past September, recent U.S. antitrust enforcement actions are giving Chinese officials grist for their industrial policy mill, by insisting that their heavy-handed antitrust action against foreign patent owners “has support in U.S. precedent,” such as the Google and Bosh settlements.

V. Enforcement Abuses

The suppression of patent licensing rates charged to domestic Chinese firms is just one example of how the AML enforcers have a built-in invitation to run massively intrusive and expensive investigations into any firms. These investigations are unhampered by any clear legal definition of relevance and are undertaken without regard to the high costs incurred by firms seeking to comply with the officials’ edicts, both administrative and reputational.  In some cases, the charge falls within the yawning gap in the AML concerning limits on its enforcement practices.  For example, the European Union Chamber of Commerce has found  that China engages in administrative intimidation, which is intended to short-circuit formal hearings, and forces parties charged to appear before tribunal hearings without the assistance of counsel and without involving their own governments or chambers of commerce in the process.

It is of course impossible for any academic sitting in the United States to make any estimation of the actual level of abuse in any one individual case. But the simple point here is that the Chinese authorities are already low on credibility because of the way in which they conduct themselves in so many other areas.  It takes no great imagination to connect the dots between China’s anti-monopoly investigations of foreign companies doing business in China proper with the Chinese government’s hostile response to the Hong Kong protests against the high-handed way in which Chinese authorities are stifling homegrown democratic activities by insisting on government vetting of all candidates for public office to weed out those who might oppose China’s national agenda.   And it takes no great leap in imagination to realize that the same aggressive attitude that China now takes on territorial issues with Vietnam and Japan can spill over to these investigations. It is also well known that China blocks (censors) service supplied by the mainstays of the internet and social media, including Google, Facebook, Wikipedia, and Twitter, which would provide ample opportunity for information about government (and private) abuses to be widely spread.

It also looks as though the lack of any formal protections in the AML investigative process opens up the entire system to these forms of abuse.  The lack of any reliable reporting on these matters is consistent with wide-scale abuse because of this simple stylized threat: “Be silent and take your punishment and we shall reduce the penalties.  Speak about the matter in public and the penalties will increase.”  These threats are all too credible within a tightly run collectivist society.  The legal system may give little or no relief, and even if the courts were somehow attuned to the civil liberties and procedural issues, the lack of any clear standards for what counts as either a violation or an appropriate penalty reduces the chances that judicial intervention could be used to slow down an official juggernaut.

VI. Reforms

China needs to do more than make bland and predictable protestations that the AML applies on even terms for all players.  The question is how?  At the most basic level, one way to get rid of this problem is to spin off all SOEs into private hands, preferably by bona fide auctions, so that there is less risk of political influence displacing the rule of law.  That path is of course hampered by China’s explicit commitment to socialist principles in the AML and everywhere else.

There is, however, no reason why that has to create an insuperable barrier.  Socialist principles are also inconsistent with private ownership of the means of production, and with the belief that open competition in the marketplace will assure the highest level of social output for any given set of resources. In a sense, the 2007 adoption of the AML itself should be regarded as an implicit rejection of the principles of the socialist economy found in Article 4, because it assumes private companies and a functioning free market.  It should take only a little imagination to push the cycle one step further by privatizing key government industries with auctions or other schemes of devolution, and the Chinese government has already proven resourceful in finding ways to explain how such free market reforms are consistent with its preexisting socialist system.

Even if this approach is not undertaken, it should still be possible to make reforms internal to the AML itself that are not likely to reduce its economic benefits but could do much to control its adverse effects. Within the American system, a strong distinction is taken between the horizontal arrangements that are governed under Section 1 of the 1890 Sherman Act and the variety of vertical arrangements that are covered under the monopolization provisions of Section 2.  The argument in favor of this distinction turns on the anticipated rate of social return from the enforcement of these two provisions.

With the Section 1 prohibition on contracts in restraint of trade, the nature of the societal loss is generally easy to figure out.  The horizontal arrangements that restrict output, raise prices or divide territories do not result only in the transfer of wealth from consumers to producers, but also a reduction in overall social wealth by removing those transactions that could take place for mutual benefit at the competitive price, but which will be foreclosed when the cartel raises its price to the monopoly level. As noted earlier, the Chinese AML tracks that approach, at least on paper.  The enforcement questions here are not easy, but since there is a clear sense of what the wrong is, it should be possible to obtain evidence from examining evidence of cooperation, including from disgruntled employees of the given firms.  And the matter can be helped along immeasurably by rules that waive treble damages to the first cartel member that reports the cartel practices.  These rules apply with great force in the current American enforcement efforts, much of which has been directed toward international cartels.

The dynamics under Section 2 of the Sherman Act are quite different.  In these instances, it is hard to develop a simple explanation as to why various kinds of vertical arrangements are harmful to consumer welfare.  In many cases, the practices that are undertaken by the dominant firm are also undertaken by their smaller rivals that have no element of market power.  The clear implication of this simple point is that the practices that are routinely attacked as restrictive are also practices that have efficiency benefits.  Any effort to ban or punish these factors could both stifle useful innovations and distort the competitive balance between firms of different size.

The situation gets even worse when the only charge leveled under the AML is that prices are “unfairly high” or “unfairly low,” which is just asking for trouble.  At one level the impetus behind this claim is that certain products are sold at higher (or lower) prices in China than in the United States or the European Union. But these simple price comparisons miss so many of the relevant marketplace complications.  Higher prices could stem from higher costs in distribution or in compliance with local laws.  Lower prices could result from the simple fact that the fixed costs of producing these goods are allocated to the home market where demand is higher, such that the foreign sales at a lower price improve the welfare of both the firm (which gets a chance to expand markets and recover an additional fraction of its fixed costs) and its Chinese customers, who get the benefit of low prices that forces local firms to reduce their costs.  It follows therefore that the Chinese antitrust system could do well to narrow the class of offenses that are said to be practiced by dominant firms, avoiding confusing and unclear terms such as “unfair” prices.

Once a sharper definition of monopolization activities is adopted, it reduces the pressure on the enforcement system to engage in overbroad and unfettered investigations or prosecutions, and thus the risks of massive abuse.  Nonetheless, it is a grim fact of life that the investigation of cartel-like behavior is always intrusive, precisely because these arrangements are always carried out in secret, which requires extensive government efforts to ferret them out.  But in this regard, it is imperative that China reform its antitrust system for the benefit of both its own citizens and foreign companies investing in China. It should adopt procedural protections that impose some definitive and clear checks on how investigators can behave in ways that avoid both massive human rights violations on the one hand and routine investigative abuses on the other.

At this point, it is necessary to add into Chinese law the same kinds of safeguards that are commonplace in most countries with respect to other forms of criminal investigation, whether crimes of violence or drug offenses, or simple cases of fraud and nondisclosure in financial circles and elsewhere.  The point here is that the most dangerous sentence in the English language—“trust me I am from the government”—translates perfectly into Chinese.  It is not enough that the abuse stops.  It is absolutely imperative that the appearance of abuse ceases as well.  Those reforms are not beyond the power of the Chinese legal system to implement, but it will take a long overdue switch from the inquisitorial types of system that socialist countries have found all too congenial in the political and economic sphere.

In urging these major antitrust reforms, it is imperative to put the Chinese position into global perspective. The Chinese government is not the only government that uses its anti-monopoly laws as a cudgel to achieve other political or economic objectives.  It has lots of company worldwide.  There are, more specifically, other illustrations of abuse in the United States and the European Union.  The American system is overly exuberant in its discovery processes, especially with respect to international operations under the 1995 guidelines of the United States Department of Justice and the Federal Trade Commission. It offers shameless protection to American export cartels under the Webb-Pomerene Act, passed in 1918 at the end of World War I, when the need for free trade could hardly have been greater. The European Union thrives on broad definitions of “abuse of dominant position” under Article 102 of its 2009 Treaty on the Functioning of the European Union.  The enforcement in many other nations, such as India, with its endless protectionist practices, is also in need of major reform.

In dealing with all these multi-national issues, the fundamental insight is that free trade across international borders offers the best hope for the amelioration of the human condition, especially in developing or underdeveloped countries.  It is widely understood that tariffs and other restrictions impede the flow of goods across international borders, which is why the World Trade Organization maintains global free trade as its primary objective.  The general attack on explicit entry restrictions by foreign firms and goods has borne much fruit in recent years, although there is still work to be done.  But it is precisely because tariffs and other barriers to entry are public and thus verifiable that it is (relatively) easy to control their abuse.

The success of the WTO in controlling these practices does not put to rest the protectionist impulses that have generated too many obstacles to free trade.  The differential enforcement of the anti-monopoly laws poses major dangers in this regard, for the same laws that protect against anticompetitive practices are all too often used to achieve the very abuse that they are intended to guard against.  Commissioner Ohlhausen bluntly puts the point: “Critics claim that China is using its antitrust law to promote industrial policy.” The unfortunate situation in China is but one example of that dangerous set of practices, which unchecked could spread to other countries, motivated either by imitating what China has done or retaliating against its abuses.  The risk is that the disease can spread all too easily.  Other nations can protest against these practices. But ultimately it is for China itself to throw aside the shackles that disadvantage foreign firms and the Chinese people alike.

 

Endnotes:

[i] The AML also contains a prohibition against mergers that lead to “concentration of business operators that eliminates or restricts competition or might be eliminating or restricting competition,” but this is not addressed in this brief essay.  These prohibitions cover only a few large transactions, none of which involve ordinary commercial practices that are the subject of the anti-monopoly and abuse of practice provisions at issue in the current applications of the AML.

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IP Promotes Progress by Securing the Individual Liberty of Inventors and Creators

This is the third in a series of posts summarizing CPIP’s 2014 Fall Conference, “Common Ground: How Intellectual Property Unites Creators and Innovators.” The Conference was held at George Mason University School of Law on October 9-10, 2014. Videos of the conference panels and keynote will be available soon.

The second panel of CPIP’s 2014 Fall Conference analyzed the common moral case for copyrights and patents. The panel was moderated by Professor Chris Newman (George Mason University School of Law). Two of the panelists, Professor Mark Schultz (CPIP, and Southern Illinois University School of Law) and Professor Eric Claeys (George Mason University School of Law) explained the theoretical and normative principles underlying the moral case for intellectual property. The other two panelists, Dr. Ken Anderson (Thermaquatica) and David Lowery (musician, producer, and lecturer at the University of Georgia), then showed how those principles play out in practice.

Professor Schultz noted that the moral case for intellectual property is often overshadowed by (or outright ignored in favor of) the economic case. But in addition to being economically valuable, intellectual property serves important moral functions by enabling artists and inventors to live free and flourishing lives. Intellectual property fosters economic independence, enables the creation of a private sector, and supports political freedom. Patents and copyrights give an important set of choices to creators and inventors, enabling them not only to survive, but also to thrive. As such, intellectual property is a moral right that facilitates individual liberty. While the economic justifications for copyrights and patents remain important, it is equally important not to lose sight of their strong moral underpinnings.

Professor Claeys discussed the moral case for injunctive relief against IP infringement. Starting from a traditional property law perspective, he explained that remedies (such as injunctive relief) are essential in reinforcing and vindicating property rights. Just as with traditional property, copyrights and patents confer exclusive control to their owners to secure to them the value of their productive labors. By protecting copyright and patent owners’ discretion over the deployment of their property, injunctions protect their moral rights in the fruits of their labors. Claeys further noted that this labor-based understanding of intellectual property could inform the balance of equities discussed in eBay v. MercExchange, filing significant gaps in the Supreme Court’s reasoning and likely leading to a different conclusion regarding licensing companies’ ability to obtain injunctions.

Anderson and Lowery addressed the role of IP in their respective fields. Dr. Anderson discussed how patents were crucial to his ability to obtain investors for his green tech company. He invented a new, environmentally-friendly technology to convert “coal, biomass and other organic solids into low molecular weight products.” Being able to protect the value of his work through patent protection (he filed multiple rounds of patents all over the world) has been essential to his company’s success and his ability to commercialize his invention.

Lowery discussed how the lack of copyright enforcement in the digital era has affected the music industry, leading to an environment where internet platforms thrive, but the artists and creators who fuel the value of those platforms struggle mightily to make ends meet. In many ways, musicians are worse off now than they were in the 1950s (an era that s well-known for the exploitation of musicians). Nonetheless, he expressed hope that the third decade of the Internet could embrace legal and technological innovations that make it a better place for artists.

In sum, the panelists illustrated the fundamental moral importance of intellectual property, which applies equally to inventors’ patent rights as it does to artists’ copyrights. Intellectual property isn’t just about economic incentives. IP also promotes progress by securing the individual liberty of inventors and creators.

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Commercialization Conferences Copyright Copyright Licensing Copyright Theory Economic Study High Tech Industry History of Intellectual Property Injunctions Innovation Intellectual Property Theory Internet Inventors Law and Economics Patent Law Patent Licensing Patent Litigation Patent Theory Remedies Software Patent Uncategorized

Intellectual Property Unites Creators and Innovators

This is the first in a series of posts summarizing CPIP’s 2014 Fall Conference, “Common Ground: How Intellectual Property Unites Creators and Innovators.” The Conference was held at George Mason University School of Law on October 9-10, 2014. Videos of the conference panels and remarks, as well as panel summaries, will be available soon.

Introduction by Professors Adam Mossoff and Mark Schultz

Common Ground: How Intellectual Property Unites Creators and Innovators

The creative industries and innovation industries have much in common, but too often this is overlooked. Both industries engage in brilliant intellectual work to bring new products and services into the world, both take great risks to commercialize this work, and both depend on intellectual property – copyrights (for the creative industries) and patents (for the innovation industries). Unfortunately, most accounts of these two industries emphasize their differences and frequently portray them in conflict.

This conference will explore the common ground shared by these two dynamic industries, focusing on the similar values secured by their patents and copyrights and thus their common policy goals and commercial developments.

It should be unsurprising that these two industries share much in common. The work of inventors and artists is much the same. We see hints of this in their respective aspirations. Engineers, for example, often talk of seeking “elegant” or “beautiful” solutions to the technological problems they face. Artists also strive to innovate technically in how they create their works, as demonstrated with much panache in the recent documentary, Tim’s Vermeer. Many creators apply their prodigious talents to both art and invention.

One may think of a Steve Jobs today as exemplifying this truth, but history is replete with examples. Leonardo da Vinci also comes to mind, the quintessential Renaissance Man. In the 19th century, Samuel Morse invented the telegraph, but he was also a successful artist and in fact he developed the telegraph while working as a well-known Professor of Art at New York University.

In modern America, Walt Disney has defined much of our culture not just with his artistic creations, but also with his innovative technological creations in movies, theme parks and products. More recently, filmmakers George Lucas and James Cameron have cast large shadows in popular culture, but their contributions to filmmaking technology may prove even more enduring and pervasive.

These and many other examples are unsurprising when one considers that art and technology both result from the same source: productive intellectual labor.

As the work of artists and inventors is at heart the same, so is the moral and economic case for securing property rights to them. Artists and inventors deserve to own the fruits of their productive labors. In protecting these labors, intellectual property rights secure to them their liberty and their careers. These rights thus fuel the vast economic activity that drives the innovation economy – bringing to market the products and services that ensure full and flourishing lives for them and for the rest of us as well.

Too often, though, the creative and innovation industries are portrayed as being at odds. One popular narrative today – in both scholarly and popular accounts – is that technology disrupts the creative industries, forcing copyright owners to adapt. This is a myopic account of their relationship that ultimately creates a false picture. In truth, creativity and innovation – secured by copyrights and patents – constantly spur each other to greater heights.

The true story of creativity and innovation is more properly viewed as a virtuous circle.

Recording and broadcast technology, for instance, gave musicians and other performers their first worldwide audiences, whose demand for ever-more entertainment and information spurred further improvement and expansion of technology. The invention of the electric guitar, spurred by a series of patented improvements, enabled blues and rock ‘n’ roll, which in turn pushed further developments in music and recording technology.

The Internet certainly created much disruption, but it also has been a fountainhead of creativity. To take just one example, streaming of original, creative content enables television viewers to enjoy storytelling as never before, bringing about what some are now calling a Second Golden Age of Television.

Our technological devices, such as smartphones and iPads, would not be so well loved and so ubiquitous without the games, music, and video content they deliver to hundreds of millions of people the world over.

The common ground and shared aspirations of creators and innovators is clear, but rarely appreciated in the din of today’s policy debates.

Thus, our Annual Conference this year considers afresh the common goals, challenges and needs of the creative and innovation industries. Many distinguished speakers with extensive knowledge and experience in both fields will address how intellectual property rights represent the bedrock of this common ground. We hope that you will enjoy what promises to be enlightening discussion.

**Panel summaries coming soon**

Categories
Copyright Copyright Theory History of Intellectual Property Innovation Intellectual Property Theory Law and Economics Patent Law Patent Litigation Patent Theory Statistics Uncategorized

Intellectual Property, Innovation and Economic Growth: Mercatus Gets it Wrong

By Mark Schultz & Adam Mossoff

A handful of increasingly noisy critics of intellectual property (IP) have emerged within free market organizations. Both the emergence and vehemence of this group has surprised most observers, since free market advocates generally support property rights. It’s true that there has long been a strain of IP skepticism among some libertarian intellectuals. However, the surprised observer would be correct to think that the latest critique is something new. In our experience, most free market advocates see the benefit and importance of protecting the property rights of all who perform productive labor – whether the results are tangible or intangible.

How do the claims of this emerging critique stand up? We have had occasion to examine the arguments of free market IP skeptics before. (For example, see here, here, here.) So far, we have largely found their claims wanting.

We have yet another occasion to examine their arguments, and once again we are underwhelmed and disappointed. We recently posted an essay at AEI’s Tech Policy Daily prompted by an odd report recently released by the Mercatus Center, a free-market think tank. The Mercatus report attacks recent research that supposedly asserts, in the words of the authors of the Mercatus report, that “the existence of intellectual property in an industry creates the jobs in that industry.” They contend that this research “provide[s] no theoretical or empirical evidence to support” its claims of the importance of intellectual property to the U.S. economy.

Our AEI essay responds to these claims by explaining how these IP skeptics both mischaracterize the studies that they are attacking and fail to acknowledge the actual historical and economic evidence on the connections between IP, innovation, and economic prosperity. We recommend that anyone who may be confused by the assertions of any IP skeptics waving the banner of property rights and the free market read our essay at AEI, as well as our previous essays in which we have called out similarly odd statements from Mercatus about IP rights.

The Mercatus report, though, exemplifies many of the concerns we raise about these IP skeptics, and so it deserves to be considered at greater length.

For instance, something we touched on briefly in our AEI essay is the fact that the authors of this Mercatus report offer no empirical evidence of their own within their lengthy critique of several empirical studies, and at best they invoke thin theoretical support for their contentions.

This is odd if only because they are critiquing several empirical studies that develop careful, balanced and rigorous models for testing one of the biggest economic questions in innovation policy: What is the relationship between intellectual property and jobs and economic growth?

Apparently, the authors of the Mercatus report presume that the burden of proof is entirely on the proponents of IP, and that a bit of hand waving using abstract economic concepts and generalized theory is enough to defeat arguments supported by empirical data and plausible methodology.

This move raises a foundational question that frames all debates about IP rights today: On whom should the burden rest? On those who claim that IP has beneficial economic effects? Or on those who claim otherwise, such as the authors of the Mercatus report?

The burden of proof here is an important issue. Too often, recent debates about IP rights have started from an assumption that the entire burden of proof rests on those investigating or defending IP rights. Quite often, IP skeptics appear to believe that their criticism of IP rights needs little empirical or theoretical validation, beyond talismanic invocations of “monopoly” and anachronistic assertions that the Framers of the US Constitution were utilitarians.

As we detail in our AEI essay, though, the problem with arguments like those made in the Mercatus report is that they contradict history and empirics. For the evidence that supports this claim, including citations to the many studies that are ignored by the IP skeptics at Mercatus and elsewhere, check out the essay.

Despite these historical and economic facts, one may still believe that the US would enjoy even greater prosperity without IP. But IP skeptics who believe in this counterfactual world face a challenge. As a preliminary matter, they ought to acknowledge that they are the ones swimming against the tide of history and prevailing belief. More important, the burden of proof is on them – the IP skeptics – to explain why the U.S. has long prospered under an IP system they find so odious and destructive of property rights and economic progress, while countries that largely eschew IP have languished. This obligation is especially heavy for one who seeks to undermine empirical work such as the USPTO Report and other studies.

In sum, you can’t beat something with nothing. For IP skeptics to contest this evidence, they should offer more than polemical and theoretical broadsides. They ought to stop making faux originalist arguments that misstate basic legal facts about property and IP, and instead offer their own empirical evidence. The Mercatus report, however, is content to confine its empirics to critiques of others’ methodology – including claims their targets did not make.

For example, in addition to the several strawman attacks identified in our AEI essay, the Mercatus report constructs another strawman in its discussion of studies of copyright piracy done by Stephen Siwek for the Institute for Policy Innovation (IPI). Mercatus inaccurately and unfairly implies that Siwek’s studies on the impact of piracy in film and music assumed that every copy pirated was a sale lost – this is known as “the substitution rate problem.” In fact, Siwek’s methodology tackled that exact problem.

IPI and Siwek never seem to get credit for this, but Siwek was careful to avoid the one-to-one substitution rate estimate that Mercatus and others foist on him and then critique as empirically unsound. If one actually reads his report, it is clear that Siwek assumes that bootleg physical copies resulted in a 65.7% substitution rate, while illegal downloads resulted in a 20% substitution rate. Siwek’s methodology anticipates and renders moot the critique that Mercatus makes anyway.

After mischaracterizing these studies and their claims, the Mercatus report goes further in attacking them as supporting advocacy on behalf of IP rights. Yes, the empirical results have been used by think tanks, trade associations and others to support advocacy on behalf of IP rights. But does that advocacy make the questions asked and resulting research invalid? IP skeptics would have trumpeted results showing that IP-intensive industries had a minimal economic impact, just as Mercatus policy analysts have done with alleged empirical claims about IP in other contexts. In fact, IP skeptics at free-market institutions repeatedly invoke studies in policy advocacy that allegedly show harm from patent litigation, despite these studies suffering from far worse problems than anything alleged in their critiques of the USPTO and other studies.

Finally, we noted in our AEI essay how it was odd to hear a well-known libertarian think tank like Mercatus advocate for more government-funded programs, such as direct grants or prizes, as viable alternatives to individual property rights secured to inventors and creators. There is even more economic work being done beyond the empirical studies we cited in our AEI essay on the critical role that property rights in innovation serve in a flourishing free market, as well as work on the economic benefits of IP rights over other governmental programs like prizes.

Today, we are in the midst of a full-blown moral panic about the alleged evils of IP. It’s alarming that libertarians – the very people who should be defending all property rights – have jumped on this populist bandwagon. Imagine if free market advocates at the turn of the Twentieth Century had asserted that there was no evidence that property rights had contributed to the Industrial Revolution. Imagine them joining in common cause with the populist Progressives to suppress the enforcement of private rights and the enjoyment of economic liberty. It’s a bizarre image, but we are seeing its modern-day equivalent, as these libertarians join the chorus of voices arguing against property and private ordering in markets for innovation and creativity.

It’s also disconcerting that Mercatus appears to abandon its exceptionally high standards for scholarly work-product when it comes to IP rights. Its economic analyses and policy briefs on such subjects as telecommunications regulation, financial and healthcare markets, and the regulatory state have rightly made Mercatus a respected free-market institution. It’s unfortunate that it has lent this justly earned prestige and legitimacy to stale and derivative arguments against property and private ordering in the innovation and creative industries. It’s time to embrace the sound evidence and back off the rhetoric.

Categories
High Tech Industry Innovation Intellectual Property Theory Internet Inventors Patent Law Patent Theory Patentability Requirements Software Patent Supreme Court Uncategorized

Alice Gets the Most Important Question Right

By far the most important takeaway from today’s Supreme Court decision in Alice Corp. v. CLS Bank  is the Court’s acknowledgment that “many computer-implemented claims are formally addressed to patent-eligible subject matter.”  Despite failing to alleviate the profound confusion caused by its recent §101 analysis in cases like Bilski, Myriad, Mayo, and plenty of earlier cases going all the way back to Benson, the Court once and for all put to rest the absurd notion that computer-implemented inventions are not patentable under §101.

To its credit, the Alice Court issued its opinion without once using the term “software patent,” or even the term “software.”  Many people don’t realize that this is not a term of art in patent law.  There is no category of “software patents” at the PTO, although they do have classifications for every type of invention.  The term is also not an official category in any statutes or court decisions.  Instead, “software patent” is merely a pejorative, rhetorical term used by patent-skeptics in the patent policy debate.  One hears endless arguments about “all those crappy software patents,” or how we need to “fix the software patent problem,” as if there is something deeply wrong with providing patent protection for inventions implemented through software.  But from an inventive or technological standpoint, the notion of creating a separate category of “software patents” doesn’t even make sense. Any process that is implemented through software could also be implemented through hardware (as pointed out succinctly in the IEEE’s amicus brief in Alice), and the efficiencies and design decisions that guide the choice between hardware and software are essentially irrelevant to the core patentability requirements under the Patent Act.

Of course, the Alice Court’s decision still leaves inventors (not to mention patent examiners, lawyers, and judges) with shockingly little guidance for determining whether a claim is “directed to a patent-ineligible concept,” such as an “abstract idea,” and if so, whether it “contains an ‘inventive’ concept sufficient to ‘transform’ the claimed abstract idea into  a patent-eligible application.”  Citing Mayo, the Court again acknowledges that, when broken down into their basic elements, all inventions rely upon abstract ideas, natural phenomena, or laws of nature.  If that’s the case, we might ask why the Court added any of these exceptions into its §101 analysis in the first place.  After all, the Court’s “inventive concept” test for saving claims that are directed at abstract ideas really just looks like a hybrid novelty/non-obviousness determination.

Despite the remaining doctrinal confusion about how to apply the Court’s various pronouncements about which inventions are “abstract ideas” or “laws of nature” and which are not, the Court deserves credit for getting the most important question right.  At long last, it laid to rest the ridiculous argument that software isn’t patentable.  Are claims to computer-implemented inventions patent-eligible subject matter?  Of course they are.  Inventors in the high-tech industry can at least breathe a sigh of relief.  The Court has expressly recognized that the countless incredible technological inventions that form the bedrock of our innovation economy deserve patent protection.

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Commercialization Conferences High Tech Industry Innovation Intellectual Property Theory Law and Economics Legislation Patent Law Patent Licensing Patent Litigation Patent Theory Software Patent Uncategorized

The Unintended Consequences of Patent "Reform"

By Steven Tjoe

Much of today’s patent policy debate focuses on the dynamics of patent litigation.  Sensational anecdotes of abusive demand letters, litigants strategically exploiting bad patents, and tales of so-called “patent trolls” (reinforced by now debunked empirical claims) have captured the public’s imagination and spurred Congress to rush to revise the patent system.  Unfortunately, the fervor to address perceived patent litigation abuses often overlooks the substantial unintended consequences of recent and proposed legislation.

CPIP and WARF’s recent conference, From Lab to Market: How Intellectual Property Secures the Benefits of R&D, featured a panel designed to fill this void in the conversation.  Instead of myopically focusing on trolls and litigation abuse, the panelists, Eb Bright, Robert Sterne, and Carl Gulbrandsen, brought the discussion back to reality and addressed the greater context of how recent and proposed changes to patent law impact our innovation ecosystem at large.

First, an understanding of how ideas are developed and brought to market is crucial to evaluating the ramifications of patent legislation.  Eb Bright, Executive Vice President and General Counsel of ExploraMed, illustrated this often-overlooked process from the perspective of the medical device industry.  In the world of medical device development, the financial risks of bringing an idea to market are very high.  The cost from conception to market can range from approximately $75 million for low-risk devices to approximately $135 million for high-risk devices.  Additionally, it takes 8-10 years on average to begin seeing a return on investment.

The result is that innovators in the medical device space – mostly small start-up companies – must secure significant financing from venture capitalists and other investors to keep their companies alive during this lengthy process.  Strong patents are fundamental to securing this financing.  They are essential to keeping competitors from free-riding on a company’s work and poaching its investors’ returns.  Investors are loathe to finance a start-up without confidence that the company can protect its intellectual property (which often accounts for a significant portion of the company’s value) from free-riders.  In this fragile innovation ecosystem, legislation that weakens patents and makes it harder for small companies to enforce their patent rights could have devastating consequences on start-ups’ ability to secure essential financing.

Carl Gulbrandsen, Managing Director of WARF, discussed proposed patent legislation from the perspective of a large university technology transfer office.  As the University of Wisconsin’s licensing arm, WARF licenses university patents and returns approximately $80 million a year to the university to support further research.  This symbiotic relationship fuels research and also adds significant value to the university’s inventions.  By marketing and licensing inventions to companies (often small start-ups) that take on the substantial effort of turning those inventions into actual products, WARF plays a crucial role in moving innovation from the lab to the marketplace.  Importantly, strong patent rights lie at the center of this virtuous cycle.

Mr. Gulbrandsen observed that proposed legislation would disrupt this process by making it substantially more difficult for universities to enforce their patents, and therefore substantially more difficult for universities to license and commercialize their inventions.  While established organizations like WARF may be able to handle the increased costs and risks, at the margin fewer universities would be able to license their intellectual property.  The result is that fewer inventions would move from lab to market, and universities would have less revenue to fuel future research.

It is against this backdrop that efforts to revise our patent system occur.  Overbroad “patent abuse” legislation that fails to appreciate the economic realities of our innovation ecosystem can lead to significant unintended consequences.  Robert Sterne, Director of Sterne Kessler, illustrated some unintended consequences from the last major patent “reform” legislation, the America Invents Act of 2011 (AIA).  In particular, Mr. Sterne addressed issues arising from the Inter Partes Review (“IPR”) and Covered Business Method Patent Review (“CBM”) procedures implemented under the AIA.

Mr. Sterne spoke about trial practice before the USPTO Patent Trial and Appeal Board (“PTAB”), noting that Rule 42.1(b) establishes that the rules should “be construed to secure the just, speedy, and inexpensive resolution of every proceeding.”  While the resulting procedures are certainly speedy (cases proceed through the USPTO and through appeal at the Federal Circuit within 2 years) and are cheaper than District Court proceedings, the procedures are far from just, and have proved particularly unforgiving for patent owners as a result of vast departures from well-established rules and procedures utilized by the courts.

Mr. Sterne explained how the new IPR procedures include more limited claim construction rules, less stringent burdens of proof to invalidate a patent, and less opportunity to adequately prove non-obviousness.  Of particular concern to patent owners is the inability to show non-obviousness.  In District Court, patent owners generally show non-obviousness by telling the story of the invention.  Inventors recount the state of the technology prior to their invention and the contributions their invention made.  By contrast, PTAB’s narrow time limitations and constraints on responses filed strip patent owners of the ability to do the same in IPR proceedings.

Consequently, the trial outcomes under the new system have yielded startlingly negative results for patent holders.  As of March 7, 2014, the PTAB had issued 19 Final Written Decisions on the merits for IPRs and CBMs.  In all but three of these proceedings, the Board cancelled all claims for which trial was instituted.  In total, 95.2% of all claims for which trial was instituted were cancelled and 82.9% of all claims that were initially challenged by the petitioner were cancelled.

Furthermore, IPR proceedings are always available and may stand alone or exist as part of a litigation strategy.  A patent owner does not have to take any action before being challenged.   New business entities, such as subscription services designed to work around the estoppel provisions, are already being formed to capitalize on the lopsided nature of the process.  It’s important to note that the constant threat of IPR and the risks and costs associated with it are not only detrimental to patent owners, they also affect our entire innovation ecosystem.

The central takeaway from the panel was this:  As we consider patent legislation ostensibly designed to curb abusive litigation, it is crucial to consider the potential unintended consequences of weakening patent rights across the board.  We must recognize the economic realities of our innovation ecosystem, and we must narrowly tailor any solutions to address the limited instances of abuse without harming start-ups, universities, and all the other patent owners that fuel our innovation economy.

Categories
Copyright Copyright Theory History of Intellectual Property Intellectual Property Theory Law and Economics Patent Law Patent Theory Uncategorized

IP as a Source of Personal and Economic Freedom

CPIP’s Mark Schultz authored an excellent essay today in TechPolicyDaily.com advocating intellectual property as a source of personal and economic freedom.  The essay, “A Free Market Perspective on Intellectual Property Rights,” describes parallels between physical property and intellectual property and dispels several denigrating myths about intellectual property’s role in a free market.  It’s a quick read, and well-worth checking out.

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Antitrust Injunctions ITC Patent Law Patent Licensing Patent Theory Remedies Uncategorized

Guest Post by Richard Epstein: The Dangerous Adventurism of the United States Trade Representative – Lifting the Ban against Apple Products Unnecessarily Opens a Can of Worms in Patent Law

The Dangerous Adventurism of the United States Trade Representative:
Lifting the Ban against Apple Products Unnecessarily Opens a Can of Worms in Patent Law

 Richard A. Epstein

In ordinary times, the business of the International Trade Commission does not appear as the lead story in the Wall Street Journal, predicting massive changes in the high-stakes patent battles. But these are not ordinary times, given the ongoing multi-front war between Apple and Samsung, in which each side has accused the other of serious acts of patent infringement. So when the International Trade Commission issued its order excluding Apple’s still popular iPhone 4 and older versions of the iPad, the smart money predicted that the Obama Administration, acting through the United States Trade Representative, would for the first time in 25 years decide to overrule a decision of the ITC, which it pointedly did in a three page letter of August 3, 2012, signed by Ambassador Michael B. G. Froman and addressed to Irving A. Williamson, Chairman of the ITC, whose wings have definitely been clipped.

Injunctions, Damages, or Something in Between

Properly understood, that letter should be regarded as a patent bombshell whose significance goes far beyond the individual case. The choice of remedy in patent disputes has been, at least since the much-cited 2006 Supreme Court decision in eBay v. MercExchange, one of the central issues in patent law. In the academic literature there has been an extensive debate as to whether various forms of injunctive relief should be allowed as a matter of course, or whether the court should place great weight on so-called public interest factors that many modern patent lawyers claim should displace a remedy which under prior legal practice had been awarded largely “as a matter of course.”

That last phrase is not intended to indicate that blanket injunctions should be awarded in any and all cases. Instead, by analogy to traditional equitable principles as applied in various other contexts, including ordinary nuisance cases, the basic principle is subject to some important qualifications that do not undermine the force of the basic rule. First, any patentee may forfeit in whole or in part the right to an injunction by improper conduct on his own part: taking undue delay with respect to enforcement could lead to a loss in some cases of injunctive relief. But the application of this doctrine is within the control of the patentee, who can preserve his rights by promptly asserting them, which means that this issue almost never comes into play with valuable patents that are consistently asserted. Second, traditional doctrine allows a court to delay the enforcement of an injunction to allow the infringer to fix his device, and perhaps even deny the injunction in those cases where a complex device contains many patented components, of which only one is in violation.

The Magic of Section 337 in FRAND Cases

The decision of the Trade Representative did not point to any such complications in the case justifying a departure from the usual remedy of an injunction. Indeed the ITC order was not lightly entered into, for it was agreed by all commissioners that Apple had indeed infringed the Samsung patents in ways that would have resulted in extensive damage awards if the case had been tried in a federal court. The ITC does not have statutory powers to award damages, so the Commission thought, perhaps mistakenly, that it was bound to make an all-or-nothing choice: allow or exclude the importation of the infringing device. Under the applicable statutory provisions of Section 337 of the Tariff Act of 1930, the ITC is supposed to take into account a number of “public interest factors” that address “the effect of such [exclusion or order] upon the public health and welfare, competitive conditions in the United States economy, the production of like or directly competitive articles in the United States, and United States consumers . . .”

The language in this section is quite broad on its face, and if it were applied in a literal fashion, the history of proceedings before the ITC should be replete with decisions that let infringing products into the United   States. The words “public health and welfare” are in modern American English broad enough to allow foreign pharmaceuticals into the United States even if they infringe key pharmaceutical patents. Any mysterious reference to competitive principles would again seem to invite a wide-ranging inquiry that could easily turn this provision of the Tariff Act into an open sesame for infringing products. The 25-year gap between decisions allowing importation of infringing products makes it quite clear that this provision has never been read to invite the broad type of “facts and circumstances inquiry” that the Trade Representative invoked to decide whether to grant or deny injunctive relief.

Against this background, it is critical to note that the dispute in this case boiled down to the question of the scope of Samsung to license its key patent on fair, reasonable and nondiscriminatory, or FRAND terms, to all comers including Apple. In ordinary cases, no owner of property is required to license or sell its property to a competitor. But for hundreds of years, common carriers have by virtue of their monopoly power been under an obligation to take all passengers on fair and reasonable terms. The thumbnail sketch for this position runs as follows. The obligation to do business on these terms is an offset to the dangers of monopoly power. The prohibition against discrimination is intended to make sure that the common carrier does not duck its obligation by offering its products only at prices so high that it is confident that no passenger will pay them. The concern with nondiscrimination is intended to make sure that the firm does not play favorites among potential customers to whom it can supply the essential service at roughly identical cost.

The carryover of FRAND obligations to the patent space arises only in connection with what are termed “standard-essential patents,” which are those patents that cover an invention that is incorporated in an industry standard that all parties must use in order to market and deploy their own products. The FRAND obligation requires parties to enter into negotiations to make sure that all market participants have a fair shot, so that the owner of the essential patent cannot hold out against a potential user.

In dealing with this issue, the Trade Representative took the position that a White House Report from January 2013 dealing with standard-essential patents revealed the manifest risk of holdout that could take place in these contexts, and recommended a fact-specific inquiry be made into each dispute to determine whether the action of the patent holder was unreasonable under the circumstances. The Trade Representative then extended his discretion further into this situation by insisting that “reverse holdouts” (i.e. those by a potential licensee) should be subject to a similar analysis.

How the Trade Representative Overreaches

It would be foolish to respond to the position of the Trade Representative by saying that there is no holdout risk at stake whenever a party has monopoly power. But there is a vast disagreement over the proper institutional arrangements to deal with these FRAND obligations. The implicit subtext of the Trade Representative’s Report is that holdout is a major risk in these settings that requires some heavy lifting to combat, not only before the ITC, but also in ordinary patent disputes. Just that position was taken by Commissioner Dean Pinkert in dissent below, who relied on some recent work by the well-known Professors Mark Lemley of Stanford and Carl Shapiro of Berkeley, who have proposed major intervention in a form of “final offer baseball arbitration,” whereby the arbitrator chooses between the royalty rates proposed by the two parties.

The obvious point is that this baseball form of arbitration seems ill-suited to determine the complex set of terms that are normally found in any complex licensing agreement. Why propose something that no one has ever used in the voluntary market? But put that point aside, and address the prior question of whether any compulsory remedy is needed to deal with the asserted holdout problem at all. The issue is one to which I have some exposure because I have worked on this question as a legal consultant with Qualcomm. On the strength of that work, and other work of my own on the biomedical anticommons, coauthored with Bruce Kuhlik (now general counsel at Merck), I have concluded that the frequency and severity of this problem is in fact far less than asserted by the overwrought statements of those who advance this theory. In work that I did with Scott Kieff and Dan Spulber, we reported that Qualcomm was a member of some 84 standard organizations and reported few if any problems in working through the details with any of them. Indeed, apart from the citation of a few cases that dealt with tangential issues, there is nothing in the Lemley and Shapiro paper that indicates that this problem has serious dimensions.

The question then arises why this might be so, and the answer is a collection of factors, none of which is decisive but all of which are to some degree relevant. The process of standard-setting does not take place in a vacuum, but involves repeat play by individual firms, all of whom know that coordination is key to their mutual success. The common pattern of standard-setting involves having technical people coming up with a sound technical solution before worrying about who holds what patent position. Standard-setting organizations then require their participants to disclose patents that read onto the standard. These organizations typically revisit standards as circumstances and technology change, which creates a subtle threat for patentees that the standard may migrate away from their patented technology if the patentee’s license terms become too risky. The threat of retaliation is real as well, and all parties know that if they hold up a standard they not only hurt their competitors but also themselves. The process may not look pretty, but in the hands of experienced professionals, the evidence is that it works well.

The choice in question here thus boils down to whether the low rate of voluntary failure justifies the introduction of an expensive and error-filled judicial process that gives all parties the incentive to posture before a public agency that has more business than it can possibly handle. It is on this matter critical to remember that all standards issues are not the same as this particularly nasty, high-stake dispute between two behemoths whose vital interests make this a highly atypical standard-setting dispute. Yet at no point in the Trade Representative’s report is there any mention of how this mega-dispute might be an outlier. Indeed, without so much as a single reference to its own limited institutional role, the decision uses a short three-page document to set out a dogmatic position on issues on which there is, as I have argued elsewhere, good reason to be suspicious of the overwrought claims of the White House on a point that is, to say the least, fraught with political intrigue

Ironically, there was, moreover a way to write this opinion that could have narrowed the dispute and exposed for public deliberation a point that does require serious consideration. The thoughtful dissenting opinion of Commissioner Pinkert pointed the way. Commissioner Pinkert contended that the key factor weighing against granting Samsung an exclusion order is that Samsung in its FRAND negotiations demanded from Apple rights to use certain non standard-essential patents as part of the overall deal. In this view, the introduction of nonprice terms on nonstandard patterns represents an abuse of the FRAND standard. Assume for the moment that this contention is indeed correct, and the magnitude of the problem is cut a hundred or a thousand fold. This particular objection is easy to police and companies will know that they cannot introduce collateral matters into their negotiations over standards, at which point the massive and pointless overkill of the Trade Representative’s order is largely eliminated. No longer do we have to treat as gospel truth the highly dubious assertions about the behavior of key parties to standard-setting disputes.

But is Pinkert correct? On the one side, it is possible to invoke a monopoly leverage theory similar to that used in some tie-in cases to block this extension. But those theories are themselves tricky to apply, and the counter argument could well be that the addition of new terms expands the bargaining space and thus increases the likelihood of an agreement. To answer that question to my mind requires some close attention to the actual and customary dynamics of these negotiations, which could easily vary across different standards. I would want to reserve judgment on a question this complex, and I think that the Trade Representative would have done everyone a great service if he had addressed the hard question. But what we have instead is a grand political overgeneralization that reflects a simple-minded and erroneous view of current practices.

The enormous technical advances in all these fields are not consistent with the claim that holdout problems have brought an industry to a standstill. The brave new world of discretionary remedies could easily backfire and undermine cooperative behavior by rewarding those who refuse to cooperate. If the critics of the current system focused on that one background fact, they might well be more diffident about pushing vast industries into uncharted territories on their regrettable overconfidence in their own untested judgments.

Richard A. Epstein is the Laurence A. Tisch Professor of Law at New York University School of Law, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution, and the James Parker Hall Distinguished Service Professor of Law Emeritus and Senior Lecturer at the University of Chicago Law School. He is currently consulting with QUALCOMM on the issues at stake in this case.