14. Towards a Transaction Cost Approach to the Essential Facilities Doctrine

As largely driven from American judgements, the doctrine is usually seen to have originated in US Supreme Court’s 1912 Terminal Railroad²⁰ decision, in which denial of third party usage of railroad bridges to St. Louis, owned and maintained by the defendant was challenged. The court opined that ‘the inherent conditions are such as to prohibit any other reasonable means of entering the city, the combination of every such facility under the exclusive ownership and control of less than all of the companies under compulsion to use them violates’²¹ Section 1 and Section 2 of the Sherman Act. Note that the defendant here was an Association that comprised of fourteen railroads serving St. Louis, and therefore invoked a strong sense of competition concerns. However, the Supreme Court did not agree to prosecutor’s (government’s) contention to dissolve the Association and proposed alternate institutional safeguards.²² The idea of invoking antitrust concerns was logical, but there was no explicit mention of the doctrine, and the courts had differing viewpoints on how strictly they want to come out on monopolies.²³ Comparable reliefs were granted by the US Supreme Court in subsequent years, solidifying the existence of doctrine.

In Associated Press²⁴ (AP) case, where AP had prohibited member newspapers to provide any news to nonmember organizations, the court held AP’s practice as an unreasonable restraint of trade violating Section 1 of Sherman Act, even though there was no monopolization that AP exhibited.²⁵ The court’s view was that AP’s bylaws served ‘seriously to limit the opportunity of any new paper to enter’, and that its services ‘give many newspapers a competitive advantage over their rivals.’²⁶ In both these influential cases, there was an element of unfairness rather than fear of market power. Yet, the essentiality of goods/services was pivotal in both the cases. Many cases provide precedents to the similar reasoning: for instance, Eastern States Lumber Dealers’ Association v United States²⁷ and Klor’s, Inc. v Broadway-Hale Stores, Inc.²⁸ Of particular interest is Silver v NYSE²⁹ where the court held the Exchange’s decision to terminate two brokers’ direct wire connection was violating Section 1 of Sherman Act, holding that ‘valuable service germane to petitioner’s business and important to their effective competition with others was withheld from them by collective action.’³⁰

The courts have been cautious however, by avoiding blanket mandates to declare all group-boycotts illegal. For instance, in Northwest Wholesale Stationers, Inc. v Pacific Stationery and Printing Co,³¹ the court expressly held that, ‘Unless the cooperative possesses market power or exclusive access to an element essential to effective competition, the conclusion that expulsion is virtually always likely to have an anticompetitive effect is not warranted…. Absent such a showing with respect to a cooperative buying arrangement, courts should apply a rule-of-reason analysis.’³² Notice that not all cases had issues pertaining to competition but definitely with essential goods/services, unilateral refusals to deal with which was imposing severe fairness considerations.

However, a clearer jurisprudence evolved from interpreting Section 2 of the Sherman Act,³³ where one party’s alleged control of some ‘essential facility’ is enough to invoke the doctrine. Consider United States v Griffith,³⁴ which invalidated the monopoly power of theatres in one geographical market to use their positions and occupy monopoly power in another market. The court stated that ‘the use of monopoly power, however lawfully acquired, to foreclose competition, is unlawful.’³⁵ Note that in both cases, courts were trying to prevent monopoly power to beget further monopoly power. This is indeed the case in owning essential rival goods/services, sole access to which can greatly enhance monopoly power of firms that own them. After Otter Trail³⁶ and Aspen Highlands³⁷ cases, the doctrine was etched in legal memory to be invoked frequently in subsequent cases. In the former case, Otter Trail, which was an integrated electric utility company attempted to prevent entry of distribution players in the business by refusing to sell or transmit wholesale power to them. Even though not specifically articulated in the EFD context, the court held the conduct unlawful because the ‘[u]se of monopoly power ‘to destroy threatened competition’ is a violation of the ‘attempt to monopolise’ clause of Section 2 of the Sherman Act’³⁸ and therefore paved way for broader understanding of EFD. Similarly in Aspen Highlands case, the court declared the refusal to access the three skiing mountains by the owners to the owner of a fourth mountain who wanted to offer a joint lift ticket in cooperation with the three, anticompetitive and therefore unlawful.³⁹ Interestingly, that even in Aspen Highlands, the court never explicitly mentioned EFD. On the contrary, it went to suggest that it was ‘unnecessary to consider the possible relevance of the ‘essential facilities’ doctrine…’⁴⁰ This view is noteworthy for another reason—many firms engage in unilateral actions everyday, both to accept and refuse and there is no reason to believe that all such actions warrant similar judicial reactions.⁴¹ Yet, the common binding factor is that of how refusing access to essential facility could result in potential anticompetitive effects. Scholars have located the doctrinal original in cases including this one and these precedents structure how judicial viewpoints are shaped in time.

Therefore, which cases will strictly fall under EFD could be disputable. Werden⁴² makes a logical categorization and other than Terminal Railroad and Otter Trail, suggests that two other major cases be considered under the category of strictly EFD: Gamco, Inc. v Providence Fruit and Produce Building, Inc.⁴³ and Hecht v Pro-Football, Inc.⁴⁴ but the latter deserves special mention because it was the first case to expressly use the term, ‘essential facility doctrine.’ In Hecht, a covenant prohibiting leasing the stadium to any other professional football team was challenged and the court opined, ‘essential facility doctrine would also support an allegation that the Redskins’ refusal to waive the restrictive covenant constituted illegal monopolization under section 2’. ⁴⁵ The definitional impact of this judgement for EFD was also recognised by Sixth Circuit in 1979.⁴⁶

Perhaps the most significant case that rests entirely on EFD and proposes a systematic test to establish liability for the doctrine is the famous MCI case.⁴⁷ The case involved AT&T refusing access to its local Bell facilities to MCI, which the latter challenged. The court of appeals sustained the jury opinion that AT&T’s action constituted violation of Section 2 of Sherman Act. The court stated that:

the case law sets forth four elements necessary to establish liability under the essential facilities doctrine: (1) control of the essential facility by a monopolist; (2) a competitor’s inability practically or reasonably to duplicate the essential facility; (3) the denial of the use of the facility to a competitor; and (4) the feasibility of providing the facility.⁴⁸

This four-part test was subsequently adopted by the court in Aspen Highlands case.⁴⁹ The doctrine has subsequently been extensively applied in cases involving non-tangible assets.⁵⁰ After the four-part test, the lower courts have construed it rather narrowly.⁵¹

However, recently, American jurisprudence in favor of EFD has suffered limiting checks, especially in appreciating the role of regulatory bodies to address the issue, and encouraging EFD only for those cases where regulation has not been able to settle points of contentions. Of particular importance is the famous Trinko⁵² case. It was a class action suit brought against Verizon (local telephone monopolist), alleging antitrust violations since Verizon had not shared its network with rivals, even when this was mandated in Telecommunications Act 1996.⁵³ The court declined that there was an antitrust liability⁵⁴ while opining that the defendant had no general duty to deal with rivals with whom it did not have a prior course of dealing.⁵⁵ The court announced that the doctrine only ‘crafted by some lower courts’⁵⁶ and that it had ‘never recognized such a doctrine…and find no need either to recognize it or to repudiate it here’.⁵⁷ Post-Trinko era has been characterized by increasing scepticism of EFD, and only those cases have survived the EFD claims who have been operating in unregulated market.⁵⁸ In 2007, the Antitrust Modernization Commission recommended that ‘[r]efusals to deal with horizontal rivals in the same market should rarely, if ever, be unlawful under antitrust law, even for a monopolist’. ⁵⁹ The Justice Department in 2008 suggested that EFD be out rightly abolished.⁶⁰

EFD as it appeared in the US inspired many jurisdictions at multiple levels. Yet, since the doctrine expressly relies on its ability to read issues through competition law lens, there is a need to understand the legal framework that deals with competition law in US and Europe. Section 2 of the Sherman Act in US not only assumes the name of Section 82 of the European Commission (EC), but also differs markedly in spirit.⁶¹ While Section 2 of the Sherman Act punishes willful acquisition or maintenance of monopoly power by the use of exclusionary conduct,⁶² Article 82 EC prohibits abuse of dominant position by an undertaking in the common market.⁶³ In several ways, EC’s approach is more sympathetic to the cause of EFD more than that of US.

It is important to note that the genesis of competition law in Europe reflected a desire to break down trade barriers and promote economic integration, in the hope that this would lead to a period of stability and peace in the post-war European environment.⁶⁴ That is why, the core objectives of Article 82 EC are to protect competition on the market as a means of enhancing consumer welfare, ensuring an efficient allocation of resources⁶⁵ and to ensure fairness and protect small and medium-sized firms.⁶⁶ Basic notions of fairness⁶⁷ and the idea that small and medium sized firms need protection feature more prominently under Article 82 EC than the equivalent provision in US, Section 2 of the Sherman Act. The origins of ‘fairness’ concerns under Article 82 EC reflect the impact of German ordoliberal thinking,⁶⁸ which attached importance to the notion that large firms should not unfairly limit their rivals’ production and access to markets-on the initial drafting of Article 82 EC.⁶⁹

On the other hand, US antitrust law, which is much older, was borne of the desire to dismantle a number of cartels and conglomerates, or ‘trusts’ as they were known, that had come to dominate late 19th century economic life in the US, with adverse effects for consumers. Over a period of time, influenced by the vagaries of Great Depression,⁷⁰ post-war reconstruction efforts,⁷¹ and academic writings, particularly of the Chicago School⁷² informed the fundamental purpose of US antitrust law to protect the public from the failure of the market. As noted by the Supreme Court, ‘the law directs itself not against conduct which is competitive, even severely so, but against conduct which unfairly tends to destroy competition itself.’⁷³ American antitrust laws ‘are for the benefit of competition, not competitors.’⁷⁴

This is precisely why Section 2 of the Sherman Act adopts a more minimalist, or less interventionist, approach to enforcement than Article 82 EC. Section 2 of the Sherman Act encourages a monopolist even, to compete aggressively on merits.⁷⁵ Even if such aggressive competition harms less efficient firms, it is the sort of competition that promotes the consumer interests that the Sherman Act aims to foster.⁷⁶ The underlying principle of US antitrust law is that striving for monopoly is an important element of the free-market system because it induces risk taking that produces innovation and economic growth.⁷⁷ The successful competitor, having been urged to compete, must not be turned upon when he wins.⁷⁸ In contrast, in Europe, dominant firms must be mindful of their rivals and not necessarily celebrate their successes in isolation.⁷⁹ Dominant undertakings have a ‘special responsibility’ not to allow its conduct to impair genuine undistorted competition on the common market.⁸⁰

It is easy to imagine from preceding discourse that the intervening doctrine of essential facility will find more conducive environment in Europe. This is indeed the case. The doctrine was openly introduced by the EC in early 1990s and has indirectly inspired the legislation concerning deregulation of traditional natural monopolies.⁸¹ A nontrivial scholarly literature emerged alongside⁸² and only bolstered the existence of the doctrine in the EU. Like in the US, where judicial pronouncements decided the scope and institutional heaviness of the doctrine, in the EU, the Commission has developed an extensive case law referring to the doctrine expressly, and sometimes subtly.

The first case in which the principle was applied in 1974: Commercial Solvents Corp v Commission of the European Communities.⁸³ The judgement proposed that a dominant supplier of an input abused its dominant position when it refused to supply the input to a customer, the supplier’s competitor in the downstream derivative market. B&I/Sealink⁸⁴ was one of the very first case in which the doctrine was explicitly applied. The case concerned Sealink as the owner of the port changed the timings in a way that its vessels obstructed B&Is loading procedure. A similar case was that of Sea Containers/Stena Sealink,⁸⁵ where the complainant was a new comer desiring entry into the market. The Commission granted interim measures in favour of the complainants in both cases. Up to this point, only a faint picture of ‘essential facilities’ could be drawn including any facility or infrastructure without access to which competitors could not provide services to their customers. There had to be some test to determine which facilities would be truly ‘essential’ or ‘indispensable’ rather than merely desirable. At the same time, the questions pertaining to actual access or sharing of facilities were also not yet answered. It was pertinent to decide whether the parties themselves or some authority, like the Commission, should dictate the terms of such an arrangement.

Other infrastructure related cases involve tunnels,⁸⁶ airports and ports. For instance, in London European/Sabena,⁸⁷ a Belgian firm was asked by the Commission to grant access to its computerized reservation systems to a British firm. In FAG-Flughafen Frankfurt/Main AG,⁸⁸ the company operating the airport was also engaged in ground-handling services without allowing other companies to enter and compete. Notably, Commission’s general attitude in this regard has not changed regardless of whether the defendant is a private party of public authority—something clear from the case of Port of Rødby⁸⁹ and that of ICG/CCI Morlaix (Port of Roscoff),⁹⁰ where the defendants were Danish government and Chamber of Commerce of Morlaix in Brittany.

European approach to EFD is most visibly pronounced in IPR related cases, and in particular by the famous Magill⁹¹ case, which was not only affirmed by European Court of Justice (ECJ) but has generated a significant amount of scholarship.⁹² The case investigated and confirmed that three broadcasters of television programs in their refusal to grant licenses to Mr. Magill for publication of their weekly listing by him were considered engaging into abusive and anticompetitive practices. IMS Health⁹³ case has also given rise to a heated debate.⁹⁴ It involved access of IMS Health’s (a market research company) patented database structure (brick structure) to other firms on market research to produce a more competitive database. The court said that ‘on the premise … that the use of the 1860 brick structure is indispensable to allow a potential competitor to have access to the market’.⁹⁵

Perhaps the most significant case in the segment of IPR is that of Microsoft.⁹⁶ After a lengthy investigation, in 2004, the EC issued its decision against Microsoft. The Commission identified two infringements of Article 82 EC: (a) refusal to supply interface information to competitors to achieve client-to-client and server-to-server interoperability and leveraging its dominant position in the PC-client operating system market into the market for work-group server operating system under Article 82(b) EC, and (b) technological integration or ‘tying’ of Windows with Windows Media Player under Article 82(d), EC. The Commission imposed a record fine of €497 million, in addition to requiring Microsoft to provide the interoperability information and to produce Windows without Windows Media Player. Microsoft appealed and on 17 September 2007, the European Court of First Instance upheld the Commission’s decision that Microsoft had abused its dominant position.

The case of Bronner⁹⁷ reflects the shift in courts’ priorities. It not only restricts the scope of the doctrine by limiting its usage in situations where owner has more than a dominant position but also imposes a forward looking test, thereby ascertaining whether refusal to deal will lead to monopolization in downstream market.⁹⁸ In a way therefore, this case represents a bridging effort of Section 82 of EC Treaty that talks of abuse of dominant position and Section 2 of Sherman Act in US which centralises monopolization in its context.⁹⁹ The case involved Austria’s leading newspaper publishing company refusing to allow another newspaper its delivery services. In addition to addressing the issue on grounds that emerged from existing case laws, the court also held that it is important to observe the refusal is likely to eliminate all competition, and the service being indispensable (there is no actual or potential substitute for home-delivery scheme).¹⁰⁰

Overall, in a way, with Trinko and Bronner cases, the uncertainty in excavating reasonableness in potential EFD cases seems to have increased. It is in this light that the chapter proposes alternative theoretical benchmarks against which one can view the issues. But before that, it may be useful to highlight how EFD legislations and case law have impressed upon regulatory thought in few other jurisdictions.

An interesting theoretical treatment of ‘need for EFD’ can be developed from property-liability dichotomy.¹⁸⁷ The elegant difference between property rules and liability rules was set in the analytical manner in Calabresi-Melamed’s seminal paper published in 1972.¹⁸⁸ This was an interesting and convincing analytical tool stimulating scholars in various disciplines—most notably in law and economics—to cross-navigate beyond established terminology to appreciate functional and formal differences/congruence between two different areas of law—property and liability.¹⁸⁹ The property-liability rule framework has inspired a range of scholarship in issues related to legal protection of information goods,¹⁹⁰ and has been extremely useful in understanding copyright collectives,¹⁹¹ determining appropriate protection of incentives to innovate¹⁹² and explaining relationship between several property, including IP regimes.¹⁹³

Calabresi-Melamed’s work differentiates property and liability approach to entitlement in a fairly neat way:

An entitlement is protected by a property rule to the extent that someone who wishes to remove the entitlement from its holder must buy it from him in a voluntary transaction in which the value of the entitlement is agreed upon by the seller. It is the form of entitlement which gives rise to the least amount of state intervention: once the original entitlement is decided upon, the state does not try to decide its value. It lets each of the parties say how much the entitlement is worth to him, and gives the seller a veto if the buyer does not offer enough… Whenever someone may destroy the initial entitlement if he is willing to pay an objectively determined value for it, an entitlement is protected by a liability rule… Obviously, liability rules involve an additional stage of state intervention: not only are entitlements protected, but their transfer or destruction is allowed on the basis of a value determined by some organ of the state rather than by the parties themselves.¹⁹⁴

But how does one choose which rule to be employed. Their paper establishes that transaction cost¹⁹⁵ is the primary determinant of that choice. Whenever market transaction costs are low, property rules are preferred; while liability rules are favoured when the transaction costs are high.¹⁹⁶ This is easy to understand. Whether parties can negotiate for the transaction of the right is a direct function of how costly the bargaining process is. In other words, transaction costs will determine whether price discovery will be a result of negotiation or a third party will impose prices it has determined on the basis of (so-called) objective criteria. The doctrine asserts that low transaction costs favour negotiation and reaching a Coasian bargain,¹⁹⁷ while high transaction costs will impede any such solution to be achieved.¹⁹⁸ Therefore in case of high transaction costs, parties will not be able to come to a mutually agreeable solution, and hence the need of a third party (tribunal or any government institution) which can declare the damage quantum and ensure the same. Low transaction costs facilitate negotiation and adjustments, so there is no need of a third party to enforce a bargain. The parties themselves can contract mutually. However, when institutional design of voluntary negotiation is ineffective due to high transaction costs, liability rule (third party enforcement) suits best. Low transaction costs would imply that (a) parties to a transaction are easily identifiable to each other, (b) there is no significant difference in bargaining power between the parties so negotiations could conclude favorably, and (c) a third party setting the terms of the exchange would have a difficult time doing so quickly and cheaply, given the specialized nature of the assets and the varied and complex business environments in which the assets are deployed.¹⁹⁹ This approach generally builds the argument that property rules are better suited to protect IP as opposed to liability rules in case of low transaction cost. Liability rules always come with an efficiency loss and their application in presence of low transaction costs does not make sense since the objective can be achieved at a lesser cost. One can imagine such efficiency losses in costs imposed by incomplete information of the third party, inefficient fixation of price, diminished utility of the parties, procedural delays and constraints, administrative expenses, flaws in institutional design, generation of perverse incentives, possibilities of errors, political economy factors, psychological costs or perhaps, the transaction not taking place at all (which happens to be the case many a times). On the other hand, in presence of high transaction costs, liability rules are employed to avoid the danger of adopting a suboptimal solution, a result that flows naturally if Coase theorem is modified and viewed from a non-zero transaction cost perspective.²⁰⁰ The cost of incorporating liability rule in a property rule set-up is offset by the exercise of the transaction, which should yield a higher optimal outcome.

An EFD framework kicks in, when one of the parties has to be forced to offer access to its facility/facilities. This can be viewed as a standard application of liability rule approach to have a property transaction be concluded. Indeed, if the owner of a facility is principally free to decide who to contract with and who to avoid in sharing the facility, an enforced obligation by either the regulatory institutions or competition courts, is imposing liability rule. From theoretical treatment of property-liability framework flowing from Calabresi-Melamed’s paper, it is easy to view EFD from the lens of transaction costs.

EFD therefore portrays liability framework because the rights holders are protected by a ‘liability rule’ (royalty set by the government) instead of a ‘property rule’ (receipt of an injunction with the rights holder then negotiating the price out with potential buyers).²⁰¹ Hence, while EFD stands as a true liability rule, property rule is invoked whenever licenses are given on voluntary basis. From purely legal standpoint, the significant leap that this framework achieves is an alternative view of EFD, justified by theoretical considerations and providing a technical impetus towards sustained usage of the doctrine.

Careful examination of the scope, complexity and quantum of individual transactions involved makes it easier to believe that indeed, transaction costs are very important. These transaction costs rests not necessarily on the ability to identify who owns the property, or on the synchronization of their willingness to pay and accept, but on the difference in bargaining power between the contracting parties. To elaborate on this, authors rely on simple economic framework of bargaining power.

Consider a bargaining space in Cartesian coordinate framework as illustrated in Fig. 1, as simple representation of bargaining space.²⁰² A and B are two players who have their respective reserve levels in the absence of reaching any agreement (or concluding a bargaining process successfully). These reserve levels can be considered as initial endowments. The X-axis shows the utility that B receives in executing the agreement and Y-axis refers to utility of A—this also shows preference orders of both parties—A wants the agreement to be reached as high up along Y-axis, while B would like to stretch bargaining to take the agreement as far along X-axis.

The circle shows all possible sets of outcomes possible. But the bargaining can happen only in the zone of possible alternatives where players are better off in reaching an agreement than without it. This space in Fig. 1 is shown by crosshatched area. Bargaining can conclude anywhere in this space. A subset of this space from where no further gains are possible without incurring at least one of the players lose is called Pareto frontier, denoted by the arc in the bargaining space. Movement towards the frontier creates value for both parties (even if in different sizes) and movement along the frontier changes redistributes the surplus. The Nash bargaining solution (NBS) in the figure is also shown, which is a Pareto efficient solution to this problem.²⁰³

Bargaining power also stems from events outside the bargaining process. This is the concept of outside options in a bargain.²⁰⁴ Outside options are those events that may affect the player’s behaviour towards bargaining process. Mathematical models are shown in which actors restrict the bargaining space in their favor by eliminating some unfavourable outcomes as principally unacceptable.²⁰⁵ A new outside option tends to increase the non-agreement value for one player, and this player achieves a higher bargaining power during the transaction. The outside options increase reserve utility or initial endowment of the player. This pattern is easy to visualise from Fig. 2, where the new NBS has shifted to the right, in favor of B, because B’s initial endowment increased. If the reserve levels increase further, they can actually fall outside the bargaining space, meaning player B will not engage into the bargaining process at all, since payoffs in no-agreement are higher for her, compared to the payoffs in any agreeable situation.

This is exactly what happens in a situation where EFD comes into picture. The transaction costs of engaging into bargaining are so high that property rule approach ceases to act. Liability rule takes over, and solutions are sought after a third party’s intervention. Even though the owner of the facility can take license fee for access to its facility to another party, the total surplus it can gain by retaining/capturing its dominant position in the market is much larger than the revenues accrued from licensing fee. This is indeed, a social loss. The solution therefore comes in the form of an involuntary contract enforced by a third party, invoking EFD. The government authorises itself to allow other parties to use the facility, without the voluntary consent of the owner of the facility, and sets out to dictate licensing agreements and fees. In these cases, the public interest in broader access to the invention is considered more important than the private interest of the right holder to fully exploit his exclusive rights.²⁰⁶

The preceding discussion helps us imagine refusal to license as an act of a party, which has very high bargaining power, relative to the other party. If the difference in bargaining power of randomly selected transacting parties in a society is fairly high, it can be understood to be reflective of high transaction costs of the society.²⁰⁷ This is evident in say, feudal or rural societies where the difference in bargaining power forces non-elites to be evicted from the market and transactions between elites and non-elites become unaffordable for the non-elites.²⁰⁸ In similar vein, the structure of transaction costs can be understood from how a large difference in bargaining power exists between transacting parties. In other words, bargaining power differences act as a robust proxy for how high transaction costs are, in a society.

From the preceding discussion it can be concluded that (a) liability approach is warranted if the transaction costs are high, and (b) high transaction costs result in refusal to license. Refusal to license is a proxy to understand the strength of IPR regime of a society.

A license is a commercial contract between licensor and licensee. Primarily, it specifies two basic features—the subject material which has an intellectual property(IP) and functional use of the subject material. The licensee compensates the licensor for use of licensed subject by a flat fee (lump-sum) and/or through royalties based on income earned by the licensee. The royalty rate can be fixed or varying percentage of licensee’s value of output, units of output, profits or sales.²⁰⁹ Licensees save the expense of independent research and development (R&D) for the licensee and licensor derive fees and royalties.

If IPR regimes are strong—respect for property rights is high, identification of right holder and contours of rights is clear, uncertainties and bargaining costs are low, enforcement is high and there is emphasis on incentives to innovate over access, there is low likelihood that licenses will be reduced. This is simply because as long as willingness to pay is higher than willingness to accept, the trade will happen, and there are no intervening factors that can thwart it. All intervening factors for transaction to be successful—in strong IPR structures—favour the transaction, keeping the costs low. On the other hand, weak IPR regimes are characterised by under-enforcement, blurred and uncertain scope of rights, impetus on access rather than innovation, thinly designed institutions, lack of political will to make IPR stronger and high bargaining costs (which leads to stealth and piracy). In such societies, licensing will be difficult to achieve due to prevalent uncertainty and nebulous character of how rights are drawn. People have incentives to simply get around the system rather than engaging into negotiation. Intuitively also, it is not difficult to understand why licensing thrives in strong IP regimes.²¹⁰ Since stealing is cheaper, and observing infringement is costly, it builds incentives to refuse license. In extreme situations, it leads to situations that invoke EFD.

There have been several studies taking different approaches but arriving at the same conclusions. In 1984, Farok Contractor attempted to correlate patent protection and licensing using cross-sectional data, which explained the determinants of the ratio of receipts in the US of royalties and licensing fees from unaffiliated sources to various measures of direct investment activity.²¹¹ The study defined patent intensity of a nation by flows of new patents in force. Technology transfer on the other hand was used as proxy for licensing. The study found that patent intensity did attract licensing. The argument behind this observation is that patent protection increases the income extractable from licensing. In another well-cited study, Edwin Mansfield established²¹² that multinationals are less likely to engage in technology transfer (licensing) with firms of countries where IP protection is weak.²¹³ In yet another study, Pamela Smith infers²¹⁴ that the effect of stronger IPRs on international licensing depends on the imitative capabilities of host countries, by drawing on cross-sectional data on US multinationals’ licensing activities in 50 countries.²¹⁵

Even after extending the scope and methodology, it is found that strong patent rights and licensing activities are positively correlated. Yang and Maskus extended the analysis of US foreign licensing to a panel data set covering three time periods (1985, 1990 and 1995) and 23 partner countries, of which approximately ten are emerging market economies. They found that countries with stronger patent rights attract larger volumes of licensed technology.²¹⁶ More recently, Michael Nicholson finds that R&D intensive firms are more apt to license when patent protection is strong.²¹⁷ His approach—which involved cross-sectional empirical analysis and it pools together data for 1995 from 49 destination countries and 82 industries—was to focus on count data rather than value data.

While previous studies were using Bureau of Economic Analysis aggregated industry or national level data, Branstetter and others conducted a study using Bureau of Economic Analysis micro-data. A key finding was that IPR reforms—signifying strength of patent protection—stimulate US firms to license abroad to affiliated parties.²¹⁸ Anand and Khanna attempted to explore how much is licensing dependent on IPR protection levels. The study employed data on international licensing contracts from the Joint Ventures and Strategic Alliances database of the Securities Data Company,²¹⁹ and founds that while in some sectors (semiconductor), the dependence is low, but in many others (pharmaceutical and chemical, for instance), IPR levels significantly determine activity in licensing.²²⁰

A research conducted by OECD,²²¹ deserves our special attention because of its elaborate methodology, recent nature and effectiveness of control variables.²²² This study considered the relationship between strengthening of IPR and licensing activities, particularly in 1990s, in developing countries. It employed a regression analysis to draw on an international data set to consider the relationship over time between changes in the host-country patent regime and changes in the number of licensing transactions between developed and developing countries. The strength of IPR was measured by different IP index, like patent rights,²²³ copyrights²²⁴ and trademarks,²²⁵ and finally the fourth index examines enforcement effectiveness.²²⁶ The study finds general support for the proposition that strengthening of IPRs has a net positive effect on technology transfer via licensing. It is interesting to note that licensing fees and royalties were found to vary positively with stronger patent rights and effectiveness of the enforcement.²²⁷

The three analytical statements are:

Therefore, as a corollary, it follows that

This forms the central message of our theoretical treatment. With considerations made in the analysis—which reasonably elaborate on underlying principles—this framework has potential to aid to the existing discourse by adding new dimension to the debate. Once EFD is understood as a liability approach, a country’s IPR strength can be investigated and performance to devise a general approach towards EFD, and varying the narrowness in which EFD clauses can be interpreted both at judiciary and executive level.

From historical standpoint, Indian intellectual tradition has been fairly open in terms of access.²²⁸ The concepts of IP emerged only during colonial rule, and even today, legislative construction has been largely modeled on British statutes. In fact, the emergence of IP globally has been considered purely a European idea, emerging in seventeenth century, strengthening through late nineteenth and twentieth century aided by American impetus, and being transported to non-Western nations through international treaties.²²⁹

The Indian copyright law closely parallels the development of the same law in England. The Copyright Act 1914 of India was basically, an extension of British Copyright Act 1911; just like the present Copyright Act 1957 is borrowed extensively from Copyright Act of the United Kingdom of 1956.²³⁰ This gives it a de jure color of copyright protection, but a de facto culture of fearless infringement. According to studies commissioned by Motion Picture Distributors’ Association (local office of Hollywood’s Motion Picture Association), India tops the chart for maximum film piracy in English-speaking world.²³¹ In 2012, the US Trade Representative’s highest Priority Watch List had figures India amongst thirteen countries with huge online piracy.²³² It continues to remain so.²³³ Story of trademarks is also similar, with huge counterfeit market of goods emerging in India even though two experiments with re-institutionalizing the relevant statutory laws.²³⁴ In fact, earlier studies indicate similar pattern—study sponsored by Ministry of Human Resource and Development of Indian government, copyright piracy has been noted to be significantly high.²³⁵ Socially, this is catapulted from very high levels of poverty and affordability issues. In fact, a strict enforcement of copyright will evict substantial amount of population from accessing copyrighted material and therefore political will to curb infringement is rather low—contextually reasonable. And hence, it is not surprising that through efforts of India, which led the developing nations to adopt Stockholm Protocol of 1967 that enables developing countries to adopt greater access for copyright materials; the Protocol’s adoption created a crisis in international copyright.²³⁶ In its own legislation, India has exempted significant number of uses of copyright material exempted from infringement.²³⁷ The wide interpretation of this fair dealing clause as illustrated in the Act itself gives considerable latitude for accessing copyrighted material without payment. In fact, Consumer International rated Indian Copyright Act 1957 at top position (2009 and 2010) in terms of enabling access to knowledge.²³⁸

Evolution of patent laws is not very different, principally. Pharmaceutical patents were first introduced by the British in 1856.²³⁹ This translated to heavy influence of foreign firms (which controlled 70% of Indian market),²⁴⁰ and high drug prices.²⁴¹ The realization came in 1970, when India enacted Indian Patents Act 1970, that prohibited product patent on medicines. This Act has acted as the main thrust to India’s pharmaceutical industry,²⁴² leading to steep fall in number of patents granted.²⁴³ Although law permitted process patents on medicines,²⁴⁴ it was rarely sought and had limited scope.²⁴⁵ This therefore gave rise to a number of local pharmaceutical firms increasing their share of the market.²⁴⁶ Indian firms employed reverse engineering and developed new processes for the drugs. Over the next three decades, Indian pharmaceutical industry became extremely competitive and diverse²⁴⁷ and by 1990s, India started producing the most inexpensive medicines in the world.²⁴⁸ The situation changed after TRIPS to which India opposed initially,²⁴⁹ but finally acceded. However, it incorporated several flexibilities that the TRIPS allow, notably that of compulsory licensing. Overall, India is labeled ‘pharmacy of the developing world’²⁵⁰ due to its extremely access-friendly patent laws rather than rights-friendly structure. Even though the Patents (Amendment) Act 2005, being TRIPS-complied, has stricter provisions for rights, the reality has not changed significantly. Indian law per se does not allow patents for softwares (it has copyright for softwares) and business methods. Until 2008, merely 22 cases in Supreme Court and High Courts in India dealt with the important issue of revocation of patents (Section 64)—showing not only dismal awareness and litigiousness of IPR cases,²⁵¹ but also highlights that the general framework indicates weakness of IPR regime.

WIPO’s Global Innovation Index Ranking 2017 places India at 60th position, below several East European and Middle East nations.²⁵² That this may be a result of weak IPR regime needs further qualification, but if standard theory is correct, there is definitely some correlation. Scholars have constructed an index of patent rights and have shown that the index is highly correlated with per capita GDP, accordingly Global North (producers of innovation) typically provide stronger patent protection than their counterparts in the Global South (consumers of innovation).²⁵³ India, which clearly falls under the ‘consumers of innovation’ category, makes it abundantly evident that it is characterised by weak IPR regime.

The above finding, when placed in our analytical skeleton of viewing EFD through transaction cost network, reaffirms the view that India requires a proactive approach towards EFD. Since weak IPR regimes require liability approach, and India’s IP regime is indeed weak, there is compelling reason that it adopts an extensive manner to interpret EFD through competition authorities. Since regulatory agencies assume the responsibility to police firms in their jurisdiction to ensure that facilities, which are essential, not be refused to share, given certain conditions, there is a need for such regulatory agency in the domain of IPR as well. IPR has significant spillover effects due to its—basically—a public good nature. And it has dramatic consequence for shaping the contours of competition in a relevant market. In fact it is surprising to imagine that competition authority has not been able to realise its true role and potential, in perhaps the same way as it has been done by regulatory agencies of network goods in infrastructure. Given the theoretical framework developed in this chapter, there is no need for CCI to be painfully cautious in engaging with market players who seem to advocate their rights to IP trumping everything else. At multiple levels, the CCI needs to be proactive in an evolving competition law regime, and developing oversight to an important area of EFD will create poor precedents for future.