Compulsory Licensing of IP and the Microsoft Saga: A drastic remedy or what the market deserves?

The tension between the ownership of intellectual property rights and the application of EU competition law to their exercise has been brought into sharp relief in the recent European Commission and CFI decisions against Microsoft.[i] According to the Commission, Microsoft abusively refused to supply Sun Microsystems and other rivals with the specification for certain protocols that Windows Work Group servers use, thereby restricting competition in the work group servers market. Microsoft disagreed, asserting, inter alia, that the information required by its rivals was protected by patents, copyright and the law of trade secrets, thereby justifying Microsoft’s refusal to disclose.

Following a five-year investigation, the Commission held that Microsoft had infringed Article 82 – the EU Treaty provision which prohibits abusive or anticompetitive behaviour by a company in a dominant position – by leveraging its near monopoly in the market for PC operating systems onto the market for work group server operating systems (and by bundling its media player with ‘its ubiquitous Windows operating system’).[ii] In so doing, the Commission found that Microsoft had restricted the interoperability of Windows PCs with competitors’ server products, which had the effect of preventing rival vendors from developing competing products on a level playing field with Microsoft. This conduct was alleged to threaten the elimination of competition altogether in the market for work group server operating systems, which are at the heart of corporate IT networks. The Commission therefore ordered Microsoft to remedy this by disclosing complete and accurate interface documentation, thereby allowing non-Microsoft work group servers to achieve full interoperability with Windows PCs and servers and to keep this interface information up to date.

The three product markets at issue in the decision were: (i) the market for client PC operating systems; (ii) the market for work group server operating systems; and (iii) the market for streaming media players. The Commission underwent its usual market definition analysis – based primarily on demand-side substitutability – in order to define these markets.

The Commission found that Microsoft had a near-monopoly in the market for client PC operating systems, in which Microsoft had held a share in excess of 90% for the period of investigation (five years) – Apple, Linux and others having only a negligible market share. According to the Commission:

“Microsoft, with its market share of over 90%, occupies almost the whole market – it therefore approaches a position of complete monopoly, and can be said to hold an overwhelmingly dominant position.[iii]

The Commission went on to note that given Microsoft’s “near–ubiquity” any changes that it introduced in a more recent version of its client PC operating system “will very soon be the reference standard for the market as users upgrade to newer versions”. The Commission also noted that the nature of the barriers to entry in the client PC operating system market served to reinforce Microsoft’s dominance and that these entry barriers derived from the network effects in the market.

The Commission relied on the principles established in previous cases from which the compulsory licensing doctrine has evolved – Commercial Solvents, Magill and IMS Health – in order to support its Article 82 infringement finding and its compulsory licensing remedy. In particular, the Commission found that:

(i) a dominant firm’s refusal to supply an input product to a customer who needed these products to produce derivatives which compete with the dominant firm’s product can constitute an abuse[iv]

(ii) this also applied to services which were indispensable for the activities of other undertakings on another market[v] and

(iii) the refusal to license IPRs can – albeit in exceptional circumstances– constitute an abusive exercise of those rights.[vi]

Whilst Microsoft tried to justify its refusal to license by, inter alia, relying on the IPRs (patents, copyright and trade secrets) it claimed protected against the use by others of the interface information, the Commission did not agree that the mere existence of IPRs could justify such abusive exercise. In particular, the Commission considered that there was no objective justification because the possible negative impact of a compulsory licence on Microsoft’s incentives to innovate was outweighed by the remedy’s positive impact on the level of innovation that would be encouraged in the rest of the industry.

Defeat before the CFI

Microsoft appealed the Commission’s decision to the CFI. [vii] Microsoft also applied to the CFI to have the Commission’s orders set aside pending the outcome of the appeal on the merits.[viii] On 22 December 2004, although the CFI found that Microsoft had made out a prima facie case on the merits, the CFI refused to grant Microsoft interim relief on the ground that Microsoft had not shown that the disclosure of the interface information would cause the company serious and irreparable harm.

Whilst the CFI’s decision on the substantive merits is some years away, the arguments asserted by Microsoft in order to make out its prima facie case, and the Commission’s response, are likely to be replicated in the appeal proceedings. In summary, Microsoft asserted that the four criteria which must be satisfied before a compulsory licence could be ordered were not satisfied in this case. Specifically:

(i) the IPRs that the decision required Microsoft to license to its competitors were not indispensable for the purposes of carrying on a business as a supplier of work group server operating systems

(ii) Microsoft’s refusal to license has not prevented the emergence of any new product for which there is unsatisfied consumer demand

(iii) the fact that Microsoft has retained its technology for its own use has not had the effect of eliminating competition on a secondary market, since – as has been shown by the steady growth of Linux – there is substantial competition among the vendors of work group server operating systems

(iv) the refusal to license is objectively justified.

As regards the objective justification, Microsoft distinguished between, on the one hand, the TV programme guides and the brick structure in the Magill and IMS Health cases and, on the other, the company’s own information which was, by contrast, secret and valuable. Microsoft also considered that the Commission’s “balance of harm to innovation” test was incorrect and that, in any event, it had been wrongly applied, as the compulsory licence would in fact reduce competition between server operating system vendors.

The Commission rejected all of Microsoft’s assertions and, in particular, made clear that a “new product” does not necessarily need to be a completely new product which does not compete with the licensor’s own product, and that it is only necessary for the refusal to license to be “likely” to exclude competition.

Implications of the decisions

While the CFI’s decision on appeal is as far as five years away, the implications of the current decisions are potentially wide-ranging.

Immediate effects of the CFI’s decision on Microsoft – Microsoft must now abide by the Commission’s orders. The Commission expects to see Microsoft subject to real and effective competition in the market for server products (and for media players) over the next few months. Given the dynamic nature of these markets, however, it remains to be seen how effective these orders will be in the medium to long term.

Microsoft’s business model – Microsoft’s business model, which has made it one of the most successful technology companies in the world, has been based on leveraging its virtual monopoly in PC operating systems into other markets by, inter alia, tying in peripheral functionality, applications and other products to the exclusion of third-party competitor offerings. The Commission’s decision censures Microsoft’s use of this strategy with respect to work group servers and media player software. Unless and until the Commission’s decision is overturned, it would be risky for Microsoft to continue with such business practices. Microsoft itself takes the view, however, that the Commission’s decision is limited to the facts of the case and it shows no signs of altering its business model.

Further Commission investigations –When rejecting one of Microsoft’s settlement offers (on the basis that the Commission’s remedies would offer much more to consumers worldwide than Microsoft’s offering), the former EU Competition Commissioner, Mario Monti, said that it was much more important to establish a clear precedent for future cases. The Commission is currently investigating several other complaints against Microsoft. One pending complaint is about Microsoft’s alleged bundling of a number of programs, such as Instant Messenger, Outlook Express and Movie Player with the Windows XP operating system. The Commission is expected to investigate other aspects of Microsoft’s activities as and when the company leverages its market power into various related markets such as those in the digital media sector (e.g. encoding technology), software for the broadcasting of music over the Internet and digital rights management. In particular, Microsoft’s marketing of the next generation of Windows – Longhorn – is expected to generate similar complaints if Microsoft tries to bundle more applications already provided by competitors.

Damages claims in the courts – Microsoft is already being sued in a number of jurisdictions and now faces the prospect of damages claims in EU Member States founded on these European precedents from aggrieved competitors. Microsoft’s settlement with Sun Microsystems, under which Microsoft agreed to pay $1.6 billion to end private antitrust and patent infringement claims will, in effect, silence one of Microsoft’s most vocal and litigious critics. The benefits to European consumers from the decision will arguably be more long-term, in the shape of enhanced innovation and lower prices.

Implications for technology companies – Many technology companies are reluctant to disclose interface information, and the bundling of functionality into integrated software packages is commonplace. European technology and communications companies – from software companies and ISPs to telecoms – will therefore need to review their policies and business practices in light of the Microsoft decision. Challenges to tying and non-disclosure/refusal to license are likely to increase. Pending the appeal, the Microsoft decision will provide the Commission, national competition authorities and national courts with a useful precedent.

Compulsory licensing of interface information/intellectual property – Although the Microsoft decision is the first time that the Commission has condemned in a legally binding decision a failure to provide interface information as an abuse of a dominant position under Article 82, in its decision, the Commission has ordered interface information to be disclosed, regardless of whether the information – as Microsoft clams – is protected by copyright, patents and the law of trade secrets. In the event that the information is protected by IPRs, the Commission relies on the Magill case as justification, citing Microsoft’s overwhelming dominance, indispensability of the interface information to competitors and the risk of elimination of competition in the work group server market.

The Microsoft decision is one of the few instances in which a compulsory IP licence has been mandated under EU competition law. It will continue to remain a highly controversial remedy. Microsoft and the industry await the CFI’s decision. In the meantime, Microsoft continues to fight and settle antitrust claims around the world.

Davina Garrod is a senior associate in the law firm of McDermott Will & Emery UK LLP, based in its London office. She is a member of the EU Competition Department, where her practice focuses on all aspects of EU and UK competition and regulatory law. She also provides strategic and regulatory advice in connection with telecoms, broadcasting and e-commerce activities.