Changes to technology licensing in Europe: New competition law analysis will affect existing licences and new negotiations

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1 90 Changes to technology licensing in Europe: New competition law analysis will affect existing licences and new negotiations LAURA BALFOUR, ELLEN LAMBRIX AND SUSIE MIDDLEMISS Slaughter and May, London Overview Parties to technology agreements in Europe have since 2004 been operating under a framework for technology licensing set out in the technology transfer block exemption 1 ( the TTBER ). This expires on 30 April Various amendments to the existing legislation and guidelines 2 have been proposed by the European Commission. Although amendments are still under consideration, the drafts have been the subject of consultation and a final draft is likely to emerge later in 2013, prior to adoption at the end of April Whilst the overall ethos of the current regime looks set to remain, the Commission s proposals (which we refer to as the draft Regulation and draft Guidelines ) make some significant changes to the patent licensing landscape, which will require licensors and licensees to review their licensing strategy for future agreements. Further, given the short transitional period proposed, the changes present challenges for existing licensing arrangements. The proposed changes introduce more of an economics-based approach and will increase the need for individual assessment of some agreements to determine whether the efficiency benefits outweigh the anti-competitive effects. The current TTBER offers a safe harbour for certain agreements in circumstances where the requirements of the regime are satisfied. This enables parties to enter into licences with a degree of reassurance that they should not run into competition law problems. The proposed changes would remove certain types of clauses from that safe harbour, namely provisions relating to the licensing of non-severable improvements and the right to terminate a licence in response to a challenge to the licensed rights, and they introduce prohibitions on passive sales, as explained in more detail below. While such clauses would not necessarily be anti-competitive under the proposed regime, including them in a licence would require the parties to perform a more extensive assessment of the effects of the particular clause or agreement as a whole on competition. This is likely to produce a degree of expense and uncertainty and may act as a deterrent to licensing activity. Alternatively, parties can choose not to use the clauses but may wish to renegotiate other aspects of their agreements to rebalance their respective commercial interests. This article summarises the key changes being proposed and considers in more detail some of the more controversial amendments and their implications for licensing parties if, as expected, they are adopted in the final legislation. 1) Commission Regulation (EC) No 772/ ) The TTBER and its accompanying Guidelines (2004/C101/02).

2 BALFOUR, LAMBRIX AND MIDDLEMISS : CHANGES TO TECHNOLOGY LICENSING IN EUROPE : VOL 13 ISSUE 3 BSLR 91 The Current System The Commission proposes to retain the effects-based approach it introduced in 2004 in line with its rules on vertical and horizontal agreements 3, that is, focusing on the overall impact of the agreement in terms of competitive effects. 4 Licensors will, therefore, continue to operate under a system which provides a safe harbour for technology transfer agreements which meet the requirements of the TTBER: the parties market shares must not exceed certain thresholds, certain banned provisions or hardcore restrictions must not be included, and the restrictions vary depending upon whether the parties are competitors. The draft Regulation also retains the concept of excluded restrictions which must be assessed individually for their compatibility with Article 101(1) TFEU (which prohibits any agreement which may affect trade between Member States and whose object or effect is to prevent, restrict or distort competition). Issues with the Current System The current market share approach is helpful in one sense as it provides parties with something tangible to which they can refer. In practice, however, it has been found that parties often struggle to calculate their market shares accurately and in particular find it difficult to define what the relevant technology market or product market is. 5 Even once these have been determined, market shares must be calculated on the basis of data relating to the preceding year and on market sales value data or, if unavailable, on estimates based on other reliable market information including market sales volume. It can be difficult to identify which of a number of potential markets are relevant and the answer may change over time as the parties relationship develops. These assessments require parties to have the necessary resources in terms of time, expertise and money and can often end up slowing down the negotiation process. This is rather counter to the spirit of the TTBER scheme which is to promote more technology licensing. These difficulties are often particularly keenly felt in the biotechnology field. Often biotech companies are SMEs who may not have the resources and/or expertise to carry out these market share assessments, and in many cases defining the relevant market is particularly difficult; in some fields, a single patented product may be considered to be a market in itself. Alternatively, the agreement may involve plans to develop a product or technology in one field but this may lead to applications in other areas. Further complicating the assessment is the likelihood that the market shares of the parties will change over the lifetime of an agreement, which is difficult for parties constantly to review and assess. In addition, agreements in the biotech sector are often neither clearly outside the scope of Article 101 (that is, de minimis) nor are they obviously going to give rise to significant competition law concerns (given, for example, the market share of the parties) and many feel that the current system does not provide for a simple, commercial approach to be taken to such agreements. However, despite criticisms of these shortcomings, the Commission has chosen to maintain its existing economics-based approach, in line with the rules on vertical and horizontal agreements. In fact, the proposed revisions put increased emphasis on the economics-based approach. Summary of the Key Changes Scope The TTBER covers agreements between two parties concerning the licensing of technology for the purpose of manufacturing goods or services incorporating the licensed technology. However, other types of agreement incorporate technology licensing such as research and development agreements (where two or more parties agree to jointly carry out R&D and to jointly exploit their results) and specialisation agreements (broadly joint production 3) Horizontal agreements are those between parties operating at the same level of the market (for example, two manufacturers) whereas vertical agreements are those between parties operating at different levels of the market (for example, between a manufacturer and a distributor). 4) The Commission s effects-based approach emphasises assessment of the competitive effects of an agreement or practice. This is in contrast to the previous form-based approach which focused on legal form, whereby anti-competitive effects would be inferred from the formal features of such agreement or practice. 5) The draft Guidelines highlight that for the purposes of assessing competitive effects of licence agreements it may be necessary to define the relevant product markets as well as the relevant technology markets.

3 92 agreements). These types of horizontal agreements are covered by the R&D block exemption 6 and the Specialisation block exemption 7 respectively. The draft Regulation and Guidelines consider the interplay between the TTBER and these other block exemptions and state that the TTBER will not apply when the R&D and Specialisation block exemptions apply. In effect, the Commission seems to be stating that the TTBER is subsidiary to the R&D and Specialisation block exemptions and will apply only if these are not applicable. In the biotech field, the R&D and TTBER block exemptions are the most relevant, so this clarification is helpful. The recitals to the draft Regulation also clarify that the TTBER should not apply to agreements whose purpose is merely to reproduce and distribute software copyright protected products, as these are essentially closer to distribution agreements. This may be relevant where an R&D programme involves the use of incorporating software tools. The draft Regulation clarifies that it applies to the production of contract products by the licensee s sub-contractors as well as to technology transfer in respect of contract products produced by the licensee. Lower Market Share Threshold Where Licensee has Substitutable Technology Currently the TTBER exempts agreements between: competitors, provided the parties combined market share of the relevant technology or product market does not exceed 20 per cent, and between non-competitors, provided neither party s market share of the relevant technology or product market share exceeds 30 per cent. This is unchanged. However, the Commission now proposes that a lower market share threshold of 20 per cent should apply where a licensee who does not compete with the licensor owns a technology which is used in-house and can be substituted for the licensed technology. According to the Commission, this proposed change is aimed at capturing the higher potential for anti-competitive effects of this type of agreement on the downstream product market or upstream innovation market. 8 The Commission s reasoning here is somewhat opaque. In practice, this change is likely to create a further burden on parties: as noted above, parties already find it difficult to assess their market shares, particularly with regard to all types of technology they have. It is also inconsistent with the approach the Commission has taken to assessing vertical restraints where in-house production is not included for the purpose of calculating market shares for intermediate goods and services. Licensee Improvements The Commission is proposing to abandon the current distinction between exclusive grant-backs of licences of severable and non-severable improvements. 9 Currently, exclusive grant-backs of severable improvements are an excluded restriction and do not benefit from the TTBER, but grant-backs of non-severable improvements do. However, it is now proposed that, in order for there to be sufficient incentives for follow-on inventions, all exclusive grant-backs should fall outside the TTBER and such clauses will require individual assessment (although the rest of the agreement can still benefit from the TTBER). Licensors are likely to find this problematic. Often, once licensing arrangements have come to an end, licensors will want to use and/or offer a new licensee their technology together with any improvements or developments made by the incumbent licensee during the term of the licence. Lack of access to improvements may delay research and ultimately delay launch of the product, and so shorten the period of exclusivity provided by the patent. Right to Terminate for IP Challenge A significant change proposed by the Commission relates to termination for challenge clauses. It is usual for licensing agreements to include a clause giving a licensor the right to terminate if the licensee challenges the validity of the 6) Regulation No 1217/ ) Regulation No 1218/ ) For example, under the current Regulation, the licensee could foreclose potential entrants to the downstream market by entering into an exclusive licence with the only company licensing out technology, but still benefit from the more beneficial share thresholds for non-competitors (30 per cent). 9) A severable improvement is one that can be exploited without infringing the licensed technology.

4 BALFOUR, LAMBRIX AND MIDDLEMISS : CHANGES TO TECHNOLOGY LICENSING IN EUROPE : VOL 13 ISSUE 3 BSLR 93 licensor s IPRs. This clause currently falls within the safe harbour of the TTBER, in contrast with standalone nochallenge clauses which are an excluded restriction and must therefore be individually assessed. The Commission has stated that it wishes to do away with this distinction by removing the carve out for termination clauses on the basis that the two types of clauses in practice have very similar effects, particularly where the licensee has made substantial investments in the relevant technology (and will therefore be less willing to challenge the licensed IPR for fear of losing the licence to the technology in which it has invested). The result would be that such a clause will no longer benefit from the automatic exemption and will now have to be individually assessed. This change is likely to give rise to significant difficulties for licensors. Inclusion of the right for a licensor to terminate a licence if the licensee challenges the IPR is current standard practice in both UK and international licensing agreements. Without this right of termination, should a licensee challenge the validity of a licensor s patent, the licensor will find himself in the difficult position of defending the validity of his patent from attack by the licensee whilst at the same time being compelled to continue to license the patent essentially allowing a licensee to have his cake and eat it. Commercially this is a very unattractive position for a licensor; it also raises issues relating to the fundamental principle of freedom of contract by forcing a licensor and licensee to continue to remain in a contractual relationship while engaged in a dispute and, potentially, litigation. It is also likely that the licensee (perhaps a larger and well funded company) may have gained information through the relationship that would assist it in such a challenge. Loss of this termination right may well deter licensors from licensing their technology in the first place. It is also not yet clear what impact the proposed change will have on current live licence agreements containing such a termination for challenge clause. The transitional provisions mean that many existing agreements will be caught by the proposed new regime and licensors (often SMEs in the biotech field) may find themselves party to licensing agreements they would either never have entered into or where they would have negotiated different terms. The effect of the proposed change is that such clauses will no longer benefit from the TTBER. Instead they will need to be assessed for individual exemption under Article 101(3) on the basis that the efficiency benefits outweigh the anti-competitive effects. While such clauses will not necessarily be anti-competitive, in practice such assessment is difficult in an active licensing programme. The alternative is for parties to exclude such clauses from their agreements, but licensors may decide in some circumstances not to license at all. The draft Guidelines provide some general guidance on the Commission s approach to the different styles of termination and non-challenge clauses, stating that: non-challenge clauses are likely to be found anti-competitive where the licensed technology is valuable, and therefore creates a competitive disadvantage for parties that are prevented from using it or are only able to use it against payment of royalties. In such cases the conditions of Article 101(3) are unlikely to be fulfilled. a clause obliging the licensee not to challenge the ownership of the technology does not generally constitute a restriction on competition within the meaning of Article 101(1). (emphasis added) If the clauses are found to be anti-competitive under Article 101(1) and cannot benefit from an individual exemption under Article 101(3), they will be automatically void and unenforceable. The agreement as a whole, however, would only be void if the clauses are not severable from the remaining items of the agreement. Furthermore, parties could be exposed to regulatory enforcement action by the competition authorities, which could result in an order for the parties to terminate the anti-competitive behaviour or accept undertakings. The authorities may also impose fines. An alternative may be for licensors to look to include rights to terminate without cause on short notice. This would likely make licensees more cautious about licensing in and investing in new technologies without long-term security. It is foreseeable that the change may result in a more cautious attitude towards and therefore a reduction in, technology transfer in Europe. Settlement Agreements The Commission has provided more guidance on settlement agreements in the draft Guidelines and in particular has clarified its position that so-called pay for delay agreements or reverse payment patent settlements, where the licensee agrees, against a value transfer from the licensor, to more restrictive terms than it would have agreed to purely on the

5 94 strength of the licensor s technology, may under certain circumstances run counter to Article 101 TFEU. The draft Guidelines also note that clauses in settlement agreements not to challenge the patent in the future are problematic if the patent holder knows or should have known that the patent does not meet the patentability criteria. A no challenge clause is often a key term in a settlement agreement, as it is the mutual agreement to resolve existing disputes and avoid future ones that enables the parties to terminate litigation. A requirement to assess the state of knowledge of a party as to patentability is likely to require a complex factual and legal analysis. Given that a number of features of settlement agreements are currently under consideration by the Commission, it would be helpful if the outcome of those deliberations could be considered before changes are made to the existing position. Restrictions on Passive Sales Currently, where parties are non-competing, it is a hardcore restriction to limit the territory into which the licensee may passively sell (that is, sell in response to unsolicited orders 10 ) the contract products, except in specified circumstances. Currently exempted from this is a restriction on passive sales into the exclusive territory/customer group reserved to another licensee for a period of two years from the date on which the protected licensee first markets the licensed products within his exclusive territory. The Commission proposes to remove this exemption so that all passive sales restrictions will be hardcore restrictions unable to benefit from exemption under the TTBER. The draft Guidelines acknowledge that licensees can be individually exempted and that it is for licensees to demonstrate objectively the necessity for such a clause. This change would align the TTBER with the block exemption regulation for vertical restraints. This change is likely to make it more difficult for licensors to assure licensees that they have exclusivity for their territory, since passive sales by other licensees cannot be prevented (unless a full assessment is done as to whether an individual exemption is available). This exposes the licensee to greater risk and will change the licence negotiations. Such a limitation is likely to affect the licensor s strategy for the exploitation of its patents. The less secure it feels about its ability to grant licensees exclusivity in particular territories, the more attractive a licensing strategy with fewer licensees may appear. Technology Pools Agreements establishing technology pools and setting out the terms and conditions for their operation are generally not covered by the TTBER (as this particular type of agreement does not permit a licensee to produce contract products). Similarly, agreements between a technology pool and third parties are also outside the scope of the TTBER (as such agreements are considered multi-party agreements). However, the current and draft Guidelines provide guidance for assessing these types of agreements in order to provide incentives for the creation of pro-competitive technology pools. The draft Regulation provides a safe harbour for these types of agreements, with the draft Guidelines setting out a detailed explanation of the conditions for both the creation and operation of a technology pool and also licensing out of the pool. Conclusion The draft Regulation and draft Guidelines retain the Commission s previous effects-based approach to assessing IP licences in the EU and provide some additional clarity for licensors and licensees in a number of areas, particularly in relation to the scope of the TTBER. However, the Commission also proposes some controversial changes to the TTBER that may significantly affect the licensing landscape in Europe. In particular, it remains to be seen how the proposed exclusion of termination for challenge clauses from the benefit of the TTBER will impact both current and future licences. The Commission is still considering the responses to its consultation and is expected to finalise the draft Regulation and Guidelines by the end of If these changes are implemented in their current form, parties would be wise to review their existing agreements for issues and to consider the likely changes to the regime which might apply to new agreements being negotiated now and in the future. 10) The Commission has long recognised a distinction between restrictions on active sales (that is, a prohibition on a licensee soliciting and selling outside the territory of its licence) and restrictions on passive sales (that is, a prohibition on a licensee selling outside the territory of its licence in response to unsolicited orders). Restrictions on passive sales are generally unacceptable from a competition perspective.