Product Tying Involving Intellectual Property: Pro or Anti-Innovation Effects

Transcription

1 Product Tying Involving Intellectual Property: Pro or Anti-Innovation Effects by Corina Virginia Dobrean A thesis submitted in conformity with the requirements for the degree of Master of Laws Graduate Department of the Faculty of Law University of Toronto Copyright by Corina V. Dobrean (2011)

2 Product Tying Involving Intellectual Property: Pro or Anti-Innovation Effects Corina Virginia Dobrean Master of Laws Graduate Department of the Faculty of Law University of Toronto 2011 Abstract This paper analyses the effects of tying arrangements involving IP rights on innovation. Tying, with its ability to temporarily exclude others from the potential benefits deriving from innovation, is pro-innovative by providing firms the incentive to allocate resources to realize newer and better products. However, when tying is used with or in place of IP rights to only help protect entry or growth into a market, it could discourage innovation. Market dominance, especially coupled with technological tying can create a barrier towards competition. It is shown that most pro-competitive effects of tying can also be seen as pro-innovatory as intense competition in the marketplace is shown to lead to innovation. In more competitive markets firms are pushed to innovate in order to maintain or improve their positioning for their products. The courts are faced with a difficult balancing judgment regarding product tying involving IP. ii

3 Table of Contents Chapter 1 Introduction...1 Chapter 2 Tying involving IP...4 Chapter 3 Product tying and antitrust...7 Chapter 4 Relevant US case history...22 Chapter 5 Psystar Corp v. Apple Inc...29 Chapter 6 Tying and Intellectual Property in EU...35 Chapter 7 Business, marketing and efficiency perspective of tying...38 Chapter 8 Conclusion...46 Chapter 9 Bibliography...49 iii

4 1 Chapter 1 Introduction The aim of my thesis is to provide a detailed analysis of the impact of product tying involving IP on innovation, and exemplify whether this practice has a pro or anti innovation effect. It is well believed that intellectual property (IP) rights are critical part in the promotion of innovation and ultimately economic growth. 1 IP rights also could potentially grant the ability to exercise market power, at least when similar products are not available and known on the market. 2 The ability to exclude other competitors from the potential benefits deriving from innovation provides the incentive to allocate resources to realize new innovative products. 3 However, when tying is used with or in place of IP rights to help protect entry or growth into a market, it could discourage innovation. Market dominance, especially coupled with technological tying, when one product is technically designed to only work when used in conjunction with another own related product can create a barrier towards competition, even though, through lower pricing, may look beneficial from a consumer point of view. This process encourages companies to use their already established dominance in one independent market to extend into another related market. This trend could have ultimately a negative effect on innovation in the second market as companies are discouraged to invest in research and development because the costs are harder to recover. This will also harm the competitive process and consumers, because of less choice and potentially higher prices. 4 U.S. Department of Justice and the Federal Trade Commission in Antitrust Enforcement and Intellectual Property Rights: Promoting Innovation and Competition describes two distinct forms of accomplishing tying or bundling: one is technological tying and the other is contractual tying. When tying 1 U.S. Department of Justice and the Federal Trade Commission, Antitrust Enforcement and Intellectual Property Rights: Promoting Innovation and Competition, online: < (2007) 2 International Salt Co. v. United States, 332 U.S. 392 (1947) and Jefferson Parish Hospital District No. 2 v. Hyde, 466 U.S. 2 (1984) 3 Massimiliano Gangi, Competition Policy and the exercise of Intellectual Property Rights, online: (1999) 4 N. Banasevic, J. Huby, M. Pena Castellot, O. Sitar and H. Piffaut, (2004) Commission adopts decision in the Microsoft case, Competition Policy Newsletter 2, p.44

5 2 involved intellectual property rights there are various methods used: offering licenses that cover multiple patents or copyrighted materials or tying the sale of two patented goods or one unpatented and one patented good. Such linkages carry various labels, depending on whether the linked product embodies intellectual property, whether one price or separate prices are charged, and whether the linkage is accomplished contractually or technologically. 5 The two forms have significant differences between the two, where technological tie is planned well ahead in the development cycle, as a method to control and protect the initial investment. 6 Perhaps even more important, as explained by Daniel Gaynor, technological tying can be used as a tool to prevent aftermarket entrants from free-riding on the investments of the system developer and preventing this free-riding behavior through a product tie may benefit consumers. 7 Aside from preventing this free-ride behavior, tying can be used in an attempt to protect the reputation of a product or service. For example, a hardware manufacturer will pre-install copyrighted software to ensure their final consumer product meets their expected standards. From a consumer point of view the usable product and their expectations are set on the combination and tying the software to the hardware is one way for the manufacturer to control the quality of the aggregate. Furthermore, tying can also reduce the risk inherent in the licensing of innovation whose commercial value is not well defined. 8 I think this is especially important in 5 Classic contractual patent tying occurs when the tying product is patented, the tied product is an unpatented commodity used as an input for the tying product, and the sale of the patented product is conditioned on the purchase of the unpatented product. A technological tie may be defined as one in which the tying and tied products are bundled together physically or produced in such a way that they are compatible only with each other - U.S. Department of Justice and the Federal Trade Commission, Antitrust Enforcement and Intellectual Property Rights: Promoting Innovation and Competition, online: < (2007) and Hovenkamp, Herbert, Mark D. Janis, and Mark A. Lemley, IP and Antitrust: An Analysis of Antitrust Principles Applied to Intellectual Property Law, (2002) 21.5b2, at Gaynor, Daniel, Technological Tying (August 2006). FTC, Bureau of Economics Working Paper No Available at SSRN: 7 The two features that distinguish the model of technological tying from contractual tying are the link between the (technological) tying behavior and the level of investment in system quality, and the uncertainty of entry into the tied goods market (aftermarket) in the absence of a (technological) tie. The link between investment and tying is appropriately omitted from traditional models of contractual tying because contractual tying is typically considered a marketing decision and as such occurs ex post of system development. - Id. 8 This can be achieved by charging less for the innovation and tying it to an additional good whose demand is correlated with the use of the innovation. - Massimiliano Gangi, UNCTAD, Competition

6 3 computing industry where the investments in research and development are quite significant, innovation pace is quite high and the value of it is not always well understood from the beginning. What are important to be analyzed are the effects of tying and the conditions in which tying becomes a real danger for normal competition. The best way to evaluate the actual impact of product tying by a monopolist is under the rule of reason. 9 The tying practice should ring a bell is when a dominant firm uses it as a means to get rid of competitors from the market, and not to improve its efficiency. In practice it is very difficult if not unachievable to accurately define the concept of reduction in competition. The influence of tying may vary from little impact on the ability of rivals to compete to full elimination of rivals, with a variety of intermediate stages of reduction in competition. 10 Policy and the exercise of Intellectual Property Rights, TD/B/COM.2/CLP/22, page 33. online: < 9 Evans, David S., Padilla, A. Jorge and Ahlborn, Christian, The Antitrust Economics of Tying: A Farewell to Per Se Illegality (2003). Antitrust Bulletin. Available at SSRN: 10 Tirole, Jean, The Analysis of Tying Cases: A Primer. Competition Policy International, Vol. 1, No. 1, pp. 1-25, Spring Available at SSRN:

7 4 Chapter 2 Tying involving IP A tying arrangement is either a contractual or a technological practice where a seller conditions the sale or lease of one good or service ( the tying product ) on the customer s agreement to buy a second good or service ( the tied product ). 11 Typically the two products complement each other from a consumer point of view. The product that will not be sold without the other is called the tying product and generally it is the product in which the defendant has the greatest market power. The tied product is the one that buyers have to take to get the tying product. 12 Aside from tying, bundling, a closely related concept, is said to exist when two or more products are sold in fixed proportions; while requirements tie-in sales involve consumers being compelled under contract, or otherwise, to purchase all future tied products from the tying firm. 13 Case law in the United States sometimes uses the terms tying and bundling interchangeably. 14 In the past, competition law has condemned the practice of tying on the grounds: (1) of inherent unfairness to consumers, in that they are being effectively coerced into accepting a second, tied product that they do not necessarily desire; 15 (2) that an undertaking with considerable market power in the tying market may seek to extend its monopoly power into a second, otherwise competitive, market through the leveraging effects of product tying; 16 and (3) that tying arrangements create considerable barriers to entry, thereby enhancing the market power of the undertaking engaged in tying, by forcing potential entrants to enter the tied market, if at all, only by entering the tying 11 Dennis W. Carlton, Jeffrey M. Perloff, Modern industrial organization, Pearson/Addison Wesley, (2005) 12 Einer Elhauge, Damien Gerardin, Global Competition Law and Economics, (2007) 13 Devlin, Alan J., A Neo-Chicago Perspective on the Law of Product Tying (2007). American Business Law Journal, Vol. 44, No. 521, Available at SSRN: 14 United States v. Loew's, Inc., 371 U.S. 38 (1962) 15 Jefferson Parish Hospital Dist. No. 2 v. Hyde, 466 U.S. 2, 12 (1984) 16 Evans, David, Salinger, Michael, Why Do Firms Bundle and Tie? Evidence from Competitive Markets and Implications for Tying Law, (2005), 22 YALE J. ON REG. 37

8 5 market as well. 17 Current law however has abandoned or reversed its view and recognizes the consumer benefit of tying behaviors. 18 When tying is employed, consumers are constrained to buy the tied good from the tying firm. Products embodying intellectual property can be connected with other goods with or without intellectual property. This can include tying the sale of two patented goods or one unpatented and one patented good. These arrangements are sometimes considered to be price discriminatory, but their effect from an economic point of view has been controversial. Professor Burstein explained that if buyers buy varying amounts of the tying product, tying can extract individual consumer surplus. 19 Therefore, the firm practicing tying would be in a position to take advantage of the surplus by allowing buyers to purchase the tying product at the much lower monopoly price only if they consent to buy the tied product at supracompetitive prices. From a consumer s perspective a tie would not have detrimental effects as long as the burden of paying supracompetitive prices on the tied product is less than the consumer surplus they would lose by being unable to buy the tying product at the monopoly price. 20 As mentioned previously tying can be contractual or technological. A contractual tying involving IP takes place when the tying product is patented, the tied product is not, and the sale of the patented product is conditioned on the purchase of the unpatented product. Commentators explain that technology companies use tying to leverage their supremacy in the tying goods market as a way to extend into another market - of the tied goods. 21 Technological tying exists when a producer designs a product so that it only functions when used in conjunction with another of its own products. This dependency between the two products may be a need to create a better product or it may represent an attempt to close one product from competition and in this case the behavior may be subject to antitrust inquiry. While claims of technological tying have been before the courts since 17 Devlin, Alan J., A Neo-Chicago Perspective on the Law of Product Tying (2007). American Business Law Journal, Vol. 44, No. 521, Available at SSRN: 18 Illinois Tool Works Inc. v. Independent Ink, Inc., 126 S.Ct. 1281, (2006) 19 M.L. Burstein, The Economics of Tie-In Sales, The Review of Economics and Statistics, Vol. 42, No. 1. (February 1960), pp Elhauge, Einer R., Tying, Bundled Discounts, and the Death of the Single Monopoly Profit Theory (October 16, 2009). Harvard Law Review, Vol. 123, No. 2, December 2009; Harvard Law and Economics Discussion Paper No Available at SSRN: 21 Zhou, V., Product Tying Involving Intellectual Property: Recent Developments, UCLA J.L. & Tech, (2004)

9 6 the early 1970s, little has been said regarding a firm s incentives to technologically tie, the effects of a product tie on the firm s decision to innovate, and ultimately how consumers are affected by such tying behavior. 22 Multiple intellectual property rights may themselves be combined into bundles or packages and mandatory package licensing occurs when an owner refuses to license a particular patent or copyright unless a licensee accepts an entire package (or where the patent owner s royalty scale has this effect). 23 In this case, in a way, the scope of the patent or copyright is modified, either expanded or restricted because of the associated and imposed tie. 22 Gaynor, Daniel, Technological Tying (August 2006). FTC, Bureau of Economics Working Paper No Available at SSRN: 23 Richard Gilbert, Carl Shapiro, Antitrust Issues in the Licensing of Intellectual Property: The Nine No- No's Meet the Nineties, (1997). Brookings Papers on Econ. Activity, Microeconomics 283, 317

10 7 Chapter 3 Product tying and antitrust In the this chapter I will discuss the perspective of product tying with respect to antitrust, as this specific topic is one of the most important issues brought forward in most law cases relevant to my analysis. Here I will be explaining the relevance of antitrust matters for tying behavior. The connection between intellectual property and products can appear in various forms, like licenses covering one copyrighted product or a patent. The same situation exists in the selling of two patented goods or one unpatented and one patented good. 24 Since intellectual property law gives exclusive rights for a period of time and antitrust law prevent and act against monopolies, tensions appear between the two. 25 But analyzing them more carefully, the two groups of legislation have many things in common since both of them incentivize scientific progress and the commercialization of inventions and innovative works and this translates in encouraging consumer welfare. 26 The final result of these two sets of laws, intellectual property and antitrust, should be the support of innovation, industry and free competition. Through IP licensing, an innovator is effectively rewarded for his innovation and also encouraged to continue. 27 The risk would be that IP owners obtain unlawful advantage over competition and that is why IP and antitrust legislation cooperate in order to prevent IP owners from getting an improper advantage over their competition. That is why an important issue in antitrust analysis is represented by the ideas of market power, the ability to set prices, and the definition of an independent market where the power is exercised. United States antitrust policy, with 24 U.S. Department of Justice and the Federal Trade Commission, Antitrust Enforcement and Intellectual Property Rights: Promoting Innovation and Competition, online: < (2007) 25 Id. 26 It is not a violation of laws to acquire a monopoly by lawful means, and those means include innovations protected from competition by the intellectual property laws. - Richard A. Posner, Antitrust in the New Economy, 68, ANTITRUST L.J. 925, (2001). 27 The ability to temporarily exclude others from the enjoyment of the potential benefits deriving from innovation contributes to provide the incentive for individuals and enterprises to allocate financial and human resources in research and development (R & D) and other costly activities to realize new discoveries, innovative products and production processes. UNCTAD, COMPETITION POLICY AND THE EXERCISE OF INTELLECTUAL PROPERTY RIGHTS, TD/B/COM.2/CLP/22, page 33. online: <

11 8 respect to tying, had a long travel from the adverse approach of the early per se rule 28 to a modified view that agrees to consider the idea of tying efficiencies. 29 Consequently, the impact of tying by a dominant firm is best assessed under a rule of reason. 30 Part of analysis under the rule is to assess the actual impact of the tie on competition, and this impact has to be precisely quantified and not assumed. 31 It is important to consider some specific effects on competition when tying is employed. The price for the tied product can be considered very low to zero depending on the cost of production for aggregate of tying and tied product considering the efficiencies employed. Depending on these efficiencies realized by the manufacturer that employs tying it might be that a competitor would have to sell their own competing tied product for a very low price. This can have a net anticompetitive effect. However, the variations can be quite big so a case by case analysis needs to happen. 32 It is also important to analyze the impact tying has on competition and ultimately on the consumers. Tying can decrease consumer welfare when it is utilized as a tool of predatory action, 33 or to monopolize a market or a marker segment. However, tying can enhance consumer welfare when it reduces distribution costs, lowers the cost of ensuring compatibility, enhances accountability if a product malfunctions. Sometimes tying can be necessary to protect intellectual property as a competitive response. Firms use such 28 Jefferson Parish Hospital Dist. No. 2 et al. v. Hyde, 466 U.S. 2 (1984) 29 Evans, David S., Padilla, A. Jorge and Ahlborn, Christian, The Antitrust Economics of Tying: A Farewell to Per Se Illegality (2003). Antitrust Bulletin. Available at SSRN: 30 Although intellectual property bundling may have anticompetitive potential in certain circumstances, there may also be significant efficiency justifications for such bundling in some cases. Thus, as a matter of their prosecutorial discretion, the Agencies will apply the rule of reason when evaluating intellectual property tying and bundling agreements. - U.S. Department of Justice & Federal Trade Commission, Antitrust Guidelines for the Licensing of Intellectual Property 5.3 & n.34 (1995), available at 31 First look at the impact of a tie on the ability of rivals to compete in the tied market. Clearly, a tie tends to hurt rivals; the question is how much? It is impossible to define precisely the notion of reduction in competition. In practice, the impact may range from little impact on the ability of rivals to compete to total exclusion of competitors, with various intermediate degrees of reduction in competition. - Tirole, Jean, The Analysis of Tying Cases: A Primer. Competition Policy International, Vol. 1, No. 1, pp. 1-25, Spring Available at SSRN: 32 Consider the hypothetical example of a monopoly car manufacturer, and suppose that cars come with an engine and tires, which for the sake of the argument, have little value in a secondhand market. Given the cost of manufacturing an engine or tires and the concomitant prices, the consumer is unlikely to replace these components with those produced by a company not under contract with the car manufacturer Id. 33 Tying is likely to be systematically harmful to consumers when it is a tool of predatory action, and should not be treated as a separate offense. - Id.

12 9 strategy generally because of efficiency reasons in order to benefit consumers but it can become anticompetitive eliminating competitors from the market therefore the ability of quantifying the market power position changes as a result of a tie is essential. 34 It has been described that in a market in which the tying firm has significant market power, though power falling short of monopoly power, no antitrust concerns should arise as a result of a tie imposed on consumers. Therefore, a tie-in imposed by a firm without monopoly power will be incapable of monopolizing the tied market. 35 I believe that an enterprise that performs its activity in a competitive market, where everyone has access to symmetric information, is not capable to directly impose a tie that is also not useful for consumers, because it will not make any sales. Their outcome is not quite so clear when tying is employed for the purpose of price discrimination; tying is clearly anticompetitive when companies that use it intend to monopolize the competitive fragment of the market or to protect the part in which it has monopoly. I would like next to provide a history of relevant cases involving tying and IP in the United States and the EU perspective on the matter. First, I will have a look into the US Case law history with respect to antitrust and IP. These cases and the way courts approach them, their analysis and the fact that decisions changed over time are important to asses the impact product tying has on innovation and also to exemplify the pro or anti competitive impact. 34 A ready, though often-overlooked, means by which to immediately distinguish potentially damaging from benign tying arrangements involves looking to the market power of the tying firm. - Devlin, Alan J., A Neo-Chicago Perspective on the Law of Product Tying (2007). American Business Law Journal, Vol. 44, No. 521, Available at SSRN: 35 Id.

13 10 Chapter 4 Relevant US case history Tying cases are referred under United States antitrust law in Sherman Act 36, and Clayton Act section Assessment of tying has suffered a significant makeover in US law. US antitrust policy with respect to tying had a long travel from the adverse approach of the early per se rule to a modified view that agrees to consider the idea of tying efficiencies. 38 Early, tying was considered anticompetitive and unlawful practice and their pernicious effect on competition and lack of any redeeming virtue are conclusively presumed to be unreasonable. 39 The Supreme Court stated that it is unreasonable, per se, to foreclose competitors from any substantial market, and in 1949, in Standard Oil Co. v. United States, the Court opined that tying agreements serve hardly any purpose beyond the suppression of competition. Since then, U.S. courts have continued to enforce that tying is per se unlawful but there were cases that escaped this strict rule since then where an analysis was done before directly rejecting this practice. 40 The Supreme Court began to require substantial proof of market power in the tying product before the per se rule would be applied and recently acknowledged that, in contrast to its historical distrust of tying arrangements, 41 there are [m]any tying arrangements... [that] are fully consistent with a free, competitive market. 42 Although the elements of a per se tying violation have been articulated differently, courts generally require that: (1) two separate products or services are involved, (2) the sale or agreement to sell one is conditioned on the purchase of the other, (3) the seller has sufficient economic power in the market for the tying product to enable it to restrain 36 Sherman Antitrust Act, 15 U.S.C Clayton Antitrust Act of 1914, Pub. L. No , 38 Stat. 730, enacted October 14, 1914, codified at 15 U.S.C , 29 U.S.C Friedman, Milton (1999) "The Business Community's Suicidal Impulse," Cato Policy Report, 21(2) 39 N. Pac. Ry. Co. v. United States, 356 U.S. 1, 5 (1958) 40 United States Steel Corp. v. Fortner Enterprises, 429 U.S. 610 (1977) and Jefferson Parish Hospital Dist. No. 2 et al. v. Hyde, 466 U.S. 2 (1984) 41 Kobayashi, Bruce H., Spilled Ink or Economic Progress? The Supreme Court's Decision in Illinois Tool Works v. Independent Ink (January 2008). George Mason Law & Economics Research Paper No Available at SSRN: and Illinois Tool Works Inc. v. Independent Ink, Inc., 126 S.Ct. 1281, 1288 (2006) 42 Illinois Tool Works Inc. v. Independent Ink, Inc., 126 S.Ct. 1281, 1292 (2006)

14 11 trade in the market for the tied product, and (4) a not insubstantial amount of interstate commerce in the tied product is affected. 43 In addition, courts have analyzed bundling as tying and an example of that was United States v. Loew s, Inc., 371 U.S. 38, 45 (1962), where the Supreme Court condemned tying where only bundled films where licensed to TV stations and these bundles only contained films the TV stations did not want to license. 44 A claim of per se illegal tying should prove the following elements in order to be an infringement of section 1 of the Sherman Act, which forbids any contract that creates an unreasonable "restraint in trade or commerce : - The tying and tied products need to be separate. Two items might also be deemed parts of a single product if intellectual law encourages bounding them together The tying products must have been sold conditional upon the purchase of the tied product. This situation can also appear in the form of a package discount. - There should be a significant amount of sales in the tied product. - The seller must have market power in the tying product. 46 The difficult part is that in many cases it is no easy to determine and prove the market power that companies using tying arrangements have. In intellectual property tying cases in the past, the per se rule was strange because the presumption of market power of the that the seller, would lead to the conclusion that any tying arrangement involving products that carry intellectual property, are per se illegal and nobody would even try to determine the actual effect on competition. 47 Courts were in general skeptical about tying, being concerned that the process of tying will help firms to use the monopoly they have in one market in order to get control over the second market, and in this way, having barely any other reason aside from the repression of competition. The presumption of market power in tying cases was harmful 43 ABA Section of Antitrust Law, Antitrust Law Developments 179 (5th ed. 2002) 44 United States v. Loew s, Inc., 371 U.S. 38, 45 (1962) 45 Einer Elhauge, Damien Gerardin, Global Competition Law and Economics, (2007) 46 Hovenkamp, H., Federal Antitrust Policy: The Law of Competition and its Practice 3.1 (2d ed. 1999) 47 Katz, Ariel, Making Sense of Nonsense: Intellectual Property, Antitrust, and Market Power. Arizona Law Review, Vol. 49, No. 4, pp , 2007; U of Toronto, Public Law Research Paper No Available at SSRN: or doi: /ssrn

15 12 because it was a procedural rule that helped plaintiffs establish liability on the basis of a flawed theory of harm under U.S. antitrust law tying arrangements are per se illegal (that is, without a requirement that the plaintiff proves harm to competition) when certain conditions are met. 48 In time, tying was better understood, and it was considered illegal only when certain conditions were met and one of those is the confirmation that the company has market power over the tying product. One of the conditions can be the change in market power as a result of a tie involving IP. 49 In the situations concerning products with intellectual property, it is not very difficult to prove the market power. In the technology industry, the majority of products contain patents. Hence, manufacturers who bundle a patented product with non-patented products could be sued under 1 of the Sherman Act under the presumed market power of the patent, no matter how much or how the tie influenced the actual market power the company has. Competitors bringing the suits need not to prove market power or its restraining effect on commerce, and the burden is on the patent-holder to present evidences to rebut the market power presumption. 50 For a long time, courts treated tying involving intellectual property in an adverse way and failed to recognize that tying involves costs and benefits. 51 The following cases share that approach. International Salt Co. v. United States was a 1947 case that involved a machine supplier that had patented its salt processing machines and then conditioned their leasing on the purchase of the salt or salt tablets processed through the machines also from them, in other words they tied their patented product to an unpatented one. The government brought a case and the company was accused of an antitrust violation through the tying of its products. In its defense, International Salt Co said that they considered the tying 48 Id. 49 The fact that a firm has market power is irrelevant because the focal point of most antitrust questions is the change in market power resulting from a specific practice or conduct. Existing market power can nonetheless be relevant, but only if the conduct is found to be anticompetitive - Id. 50 Zhou, V., Product Tying Involving Intellectual Property: Recent Developments, UCLA J.L. & Tech, (2004) 51 Evans, David S., Padilla, A. Jorge and Ahlborn, Christian, The Antitrust Economics of Tying: A Farewell to Per Se Illegality (April 21, 2003). Antitrust Bulletin, Available at SSRN:

16 13 necessary in order to make sure that the salt used with the machines had a good quality, otherwise, the machines would have been be damaged. The Supreme Court didn t examine the market power and held that the Sherman Act prohibits as per se violations all tying arrangements in which the manufacturer of a product for which he has a legal monopoly (such as a patent), requires buyers to also purchase a product for which the seller has no legal monopoly, as "the tendency of the [tying] arrangement to accomplishment of monopoly seems obvious." 52 So the Court condemned tying as a violation of Section 1 of the Sherman Act and of section 3 of the Clayton Act, and it declared that one cannot defend himself by saying that he wanted to protect the quality of the associated product and that the competitors should be able to meet the set standards: it is unreasonable, per se, to foreclose competitors from any substantial market. 53 Although tying was seen as per se illegal, the Court also stated that, Of course, a lessor may impose on a lessee reasonable restrictions designed in good faith to minimize maintenance burdens and to assure satisfactory operation. 54 The court was understanding of the need of tie in order to protect the product standards but restricted to this purpose only. The limits of a tie were accepted to be fair in terms of quality of the tied products but not in terms of the vendors. A similar opinion was given in 1949, in Standard Oil Co. v. United States, when the Court also took a hostile approach and held that tying agreements serve hardly any purpose beyond the suppression of competition. 55 Courts constantly vary their rationale to find a tying arrangement per se unlawful and choose either the following list or a subset thereof: 1) There must be separate tying and tied products; 2) there must be evidence of actual coercion by the seller that in fact forced the buyer to accept the tied product... 3) the seller must possess sufficient economic power in the tying product market to coerce purchaser acceptance of the tied product... ; 4) there must be anticompetitive effects in the tied market... ; and 5) there 52 International Salt Co., Inc. v. United States, 332 U. S. 392 (1947) 53 Id. 54 Id. 55 Standard Oil Co. of California and Standard Stations Inc. v. United States 69 S.Ct (1949)

17 14 must be involvement of a not insubstantial amount of interstate commerce in the tied product market. 56 Some firms use the high product quality justification for tying. In this circumstances, if a poor quality product is tied to the tying product the quality of the whole aggregate decreases. Customers are less likely to dissociate the two products; the quality of the tying product is depreciated so firms employ tying to protect higher quality of both tying and tied product. However, courts have generally been skeptical about this justification for tying. Representative is the following from the Supreme Court in Standard Oil. Tying agreements serve hardly any purpose beyond the suppression of competition. The justification most often advanced in their defense the protection of the good will of the manufacturer of the tying device fails in the usual situation because specification of the type and quality of the product to be used in connection with the tying device is protection enough. If the manufacturer s brand of the tied product is in fact superior to that of competitors, the buyer will presumably choose it anyway. The only situation, indeed, in which the protection of good will may necessitate the use of tying clauses, is where specifications for a substitute would be so detailed that they could not practicably be supplied. 57 Courts, as in Standard Oil, usually reject the goodwill explanation because there are alternative means of ensuring quality tied goods, such as providing technical specifications. The goodwill explanation can be rejected in many circumstances because it fails to account for buyer rationality. 58 Ultimately the customer is the decider on the aggregate quality and allowing a worse quality tied product to complete the tying product should not be detrimental to the tying product quality or firm s perception on the market. In 1962, in United States v. Loew s the Court reaffirmed the skeptical approach with regards to tying. In this case, the issue was that the defendant tied less demanded films to more demanded copyrighted films in licenses to TV stations. In other words, they conditioned the sale of popular copyrighted films on the acquisition of others that TV stations wouldn t normally want, by selling them only in bundles. The Court decided that 56 Yentsch v. Texaco, Inc., 630 F.2d 46 (2d Cir. 1980) at Standard Oil Co. of California and Standard Stations Inc. v. United States 69 S.Ct (1949) 58 Iacobucci, Edward M., Tying as Quality Control: A Legal and Economic Analysis (December 2001). U Toronto Law and Economics Research Paper No Available at SSRN: or doi: /ssrn

18 15 this practice was unlawful tying and that it was a violation of section 1 of the Sherman Act. The Court worried about two issues that may appear in connection with tying: one of them was that it may force buyers into giving up the purchase of substitutes for the tied product, and the second was that tying arrangements may destroy the free access of competing suppliers of the tied product to the consuming market. 59 It was well understood by the Court that IP rights are exclusive rights that give power to their owners, so they confer market power. A seller having market power by virtue of his position in the market for the tying product, has economic leverage sufficient to induce his customers to take the tied product along with the tying item. The Court held that "the requisite economic power is presumed when the tying product is patented or copyrighted." 60 In cases that followed, the Supreme Court had to some extent backed away from this position on the presumption of market power for intellectual property and the trend in condemning IP cases irrespective of the market power began to change. In a subsequent patent antitrust case about monopolization under section 2 of the Sherman Act, the Supreme Court stated that it was "reluctant to extend [per se illegality] on the bare pleading and absent examination of market effect and economic consequences. Still, this case was not applicable to product tying under section 1 of the Sherman Act. In the following years there were decisions stating that it is a "common misconception that a patent or copyright suffices to demonstrate market power. Again, this statement wasn t about a case involving tying of intellectual property and that is why they didn t rule against Loew s and International Salt. A decision from 1984, however, Jefferson Parish Hospital Dist. No. 2 et al. v. Hyde, 466 U.S. 2 (1984), regarding tying changed the per se illegality rule and acknowledged in this way the beneficial consequences that a tying agreement may have. Even though this decision does not relate to tying arrangements involving intellectual property, it is still 59 United States v. Loew s, Inc., 371 U.S. 38, 45 (1962) 60 Id.

19 16 important as it set the precedent of not only establishing the market power, but also defining and showing its "actual adverse effect on competition." 61 From that moment on, Courts and authorities involved in this issue started to analyze the real effects tying arrangements have on competition when they were supposed to establish their legality. The plaintiff had to prove that the contract would actually have a negative impact on the competition in the market for the tied good. In explaining the tying analysis in Jefferson Parish, the Supreme Court noted the fact that a purchaser is forced to buy a product he would not have otherwise bought even from another seller does not imply an adverse impact on competition. 62 This last sentence means that bundling would not represent unlawful tying if the buyer simply wants to buy less than the entire bundle of products offered for package sale at a reduced price. 63 Therefore, for an unlawful tying claim it is needed to show an exclusionary effect on other sellers as a result of plaintiff s thwarted desire to purchase substitutes for one or more items in the bundle from other sources that harms competition in the market for the tied product. 64 U.S. courts and federal antitrust enforcement agencies focused more on the economic effects of particular tying and bundling arrangements so that the per se rule related to tying was not the first choice in judging in these tying cases.. There was already a good premise that eventually the Supreme Court will formally reject the per se rule and rely on the rule of reason for tying and bundling. 65 The opportunity appeared recently when the Supreme Court approach changed dramatically with respect to tying arrangements that involve intellectual property rights. 66 Illinois Tool Works Inc. v. Independent Ink, Inc. is an antitrust case that involved the tying arrangement of a patented product to a non-patented product. Independent Ink took legal action against Illinois Tool Works Inc for violations of sections 1 and 2 of the 61 Jefferson Parish Hospital Dist. No. 2 et al. v. Hyde, 466 U.S. 2 (1984) 62 Id. 63 Id. 64 Abbott, Alden F. and Wright, Joshua D., Antitrust Analysis of Tying Arrangements and Exclusive Dealing. George Mason Law & Economics Research Paper No ; ANTITRUST LAW AND ECONOMICS, Keith N. Hylton, ed., Edward Elgar Publishing, Forthcoming. Available at SSRN: 65 Illinois Tool Works Inc. v. Independent Ink, Inc., 547 U.S. 28 (2006) and Leegin Creative Products, Inc. v. PSKS, Inc., 127 S. Ct (2007) 66 Kevin D. McDonald, Moving Forward While Facing Backward: Illinois Tool Rejects the Presumption of Market Power in Patent Tying Cases, 20-SUM Antitrust 33 (2006)

20 17 Sherman Act. It was claimed that Trident Inc, one of Illinois Tool Works subsidiaries, illegally tied its unpatented ink to its patented print heads. More specifically, anyone who bought Trident (patented) print heads would also have to purchase its (unpatented) ink. Independent Ink, a competitor on the ink market, sued Illinois Tools for antitrust infringement. First the U.S. District Court granted summary judgment in favor of the defendant based on the failure of the plaintiff to affirmatively prove defendant s market power. 67 There was an appeal to the Federal Circuit, which held that the existence of a patent on the tying product creates a rebuttable presumption that the patent holder has the required "market power" to violate section 1 of the Sherman Act. 68 The Federal Circuit court mostly relied on International Salt Co., Inc. v. United States, 332 U. S. 392 (1947) and United States v. Loew s, Inc., 371 U.S. 38, 45 (1962). 69 The Supreme Court ruled in unanimity that in a tying agreement, the existence of market power should not be presumed if the sale of a patented product is conditioned upon the sale of a second product, that such a contract shouldn t be considered as illegal per se. 70 Simply the existence of a patent in a tying arrangement should not be taken as an evidence of market power, thus making the contract as illegal per se. 71 Instead of that, a plaintiff that claims antitrust violations by tying arrangement must prove that the defendant had power in the relevant market. If market power would have been presumed from patents or copyrights, the threshold to bring lawsuits against technology firms would be greatly reduced because most products incorporate some patents. Firms who tie a patented product with non-patented products could be sued under section 1 of the Sherman Act under the presumed market power of the patent, regardless of how much actual market power the firm has. In many cases for electronic products, it is difficult to distinguish what is a "product bundle" and what are independent products. Many electronic hardware devices contain embedded software codes, which are entitled to copyright protection. It is conceivable that competitors could 67 Independent Ink, Inc. v. Trident, Inc., 210 F.Supp.2d 1155 (C.D. Cal. 2002) 68 Independent Ink, Inc. v. Illinois Tool Works Inc., 396 F.3d 1342, 73 U.S.P.Q.2d (BNA) 1705 (Fed. Cir. 2005) 69 Id. 70 Illinois Tool Works Inc. v. Independent Ink, Inc., 547 U.S. 28 (2006) 71 Id.

21 18 argue that such devices tie copyrighted products (software) to un-patented and uncopyrighted hardware. This line of reasoning could potentially expose virtually all electronics makers to antitrust litigation. 72 There were commentators 73 saying that through the holding that there is no assumption of market power in tying of intellectual property, technology companies will feel encouraged to use their intellectual property as leverages to go into or control other markets. They worried that it would be very difficult for a competitor that brings a lawsuit against a tying arrangement to both define the market and also prove the market power and this will unfavorably have an effect on competition. The litigation time would get longer and longer and especially in the electronics market where everything is changing minute by minute and the life-cycle of goods is really short, a company trying to bring a law suit against a competitor will probably go bankrupt before accomplishing something. In this way, companies will feel encouraged to extend into a related market by using their dominant position in another one, negatively affecting not also competition but innovation too. In March 2006, the Court ruled unanimously that there is not a presumption of market power under the Sherman Antitrust Act when the sale of a patented product is conditioned on the sale of a second product in a tying arrangement. A plaintiff alleging an antitrust violation must instead establish the defendant's market power in the patented product through evidence. 74 This decision can be considered a landmark as it changed the way the Supreme Court approached cases involving tying of intellectual property. From that moment on there was no presumption that these kinds of arrangements necessarily involved market power. Even with this change in approach, it is also important to take into account the effectiveness of the judicial process, what policies or results a presumption may enhance or discourage, and how the presumption interacts with the underlying substantive theories of liability and the relevant procedural and evidentiary rules that apply to such 72 Zhou, V., Product Tying Involving Intellectual Property: Recent Developments, UCLA J.L. & Tech, (2004) 73 Id. 74 Illinois Tool Works Inc. v. Independent Ink, Inc., 547 U.S. 28 (2006)

22 19 cases. 75 There are two components that are important. One, market power needs to be proven and two, intellectual property involved in tying does not automatically mean market power. A better option to the rule of reason would haven been to better quantify the competitive effect of the tying arrangement instead of just taking into account the market power of the seller. 76 From that moment on there was no presumption that these kinds of arrangements necessarily involved market power. One of the most famous cases about tying involving intellectual property was United States v. Microsoft, in Microsoft managed to tie together Microsoft Windows, Internet Explorer, Windows Media Player, Outlook Express and Microsoft Office. The United States claim involved both the contractual and technological tying of the Internet Explorer with its Windows operating system. 77 The government claimed that through this tying, Internet Explorer was difficult to be removed from Windows and not only that, but Microsoft s operating system was designed on purpose to work badly with other web browsers. It was obvious that Microsoft held the monopoly on the operating software market and there aren t many consumers that would prefer buying Internet software without also using the operating system Microsoft had. In these circumstances, there are few, if any, consumers who could or would utilize Internet browsing software without an operating system. 78 This tying allowed Microsoft to obtain a big share in the market for Internet browsing software, since every user of Windows had a copy of Internet Explorer, as Windows actually contained explorer. Microsoft argued that this process of combining the two programs came as the natural outcome of their research and innovation, that they actually were forming one product, 75 Katz, Ariel, Making Sense of Nonsense: Intellectual Property, Antitrust, and Market Power. Arizona Law Review, Vol. 49, No. 4, pp , 2007; U of Toronto, Public Law Research Paper No Available at SSRN: or doi: /ssrn Id. 77 United States v. Microsoft Corp., 253 F.3d 78 Devlin, Alan J., A Neo-Chicago Perspective on the Law of Product Tying (2007). American Business Law Journal, Vol. 44, No. 521, Available at SSRN:

23 20 part of the same operating system, and technologically justified, all of this for the benefit of consumers that were in fact receiving Internet Explorer free of charge. 79 The government stated that the Internet browser should be treated as a distinct and separate market, and that actually it wasn t true that Microsoft gave Internet explorer for free as its development and marketing expenses actually kept the price of Windows higher than normal. In 2001, after almost three years of litigation, the Department of Justice and Microsoft settled. On November 1, 2002, Judge Kollar-Kotelly released a judgment accepting most of the proposed Department of Justice settlement 80 and on June 30, 2004, the US appeals court approved the settlement rejected initially by nine states. In the settlement Microsoft had to share its application programming interfaces with third-party companies and third party representatives were appointed in order to make sure that Microsoft would comply. 81 Many commentators, including the late Nobel economist Milton Friedman said that the over regulation of the technological industry is not healthy: instead of promoting competition, antitrust laws tended to do exactly the opposite, because they tended, like so many government activities, to be taken over by the people they were supposed to regulate and control. And so over time I have gradually come to the conclusion that antitrust laws do far more harm than good and that we would be better off if we didn t have them at all, if we could get rid of them. 82 Furthermore, he believed that using antitrust law in the computer industry, that is moving at such fast peace, would bring no good: From now on the computer industry, which has been very fortunate in that it has been relatively free of government intrusion, will experience a continuous increase in government regulation. Antitrust very quickly becomes regulation. Here again is a case that seems to me to illustrate the suicidal impulse of the business community. 83 I can sustain this opinion, and this over regulation, if applied uniformly, can potentially have significant anti innovation effects, particularly for high technology companies. Their desire to spend the time and resources in developing new products and technologies is lowered by such decisions as in Microsoft case where the 79 United States v. Microsoft Corp., 253 F.3d 80 United States v. Microsoft Corporation, Final Judgment, Civil Action No , November 12, Id. 82 Friedman, Milton (1999) "The Business Community's Suicidal Impulse," Cato Policy Report, 21(2) 83 Id.