Competition, Regulation and the New Economy

COMPETITION, REGULATION AND THE NEW ECONOMY In addition to being the principal medium for communication, education and e...

Author: Cosmo Graham | Fiona Smith

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COMPETITION, REGULATION AND THE NEW ECONOMY In addition to being the principal medium for communication, education and entertainment, the new economy is now a leading provider of goods and services through electronic channels. The new economy rides on the crest of technological developments in computers, telecommunications and satellites creating new interactive mediums and on the deregulation and privatisation of state-owned enterprises in the telecommunications and broadcasting sectors. Whilst the economic viability of the dotcoms is questioned, the existence of a new economy with novel methods of production, distribution and exchange is here to stay. Evidence of this is the fact that there are 300 million active computers in the world, with 350 million people who use the world wide web (expected to grow to one billion in four years), and the speed of microprocessors continuously increases, facilitating the use of IT. The question which is pursued in the series of essays in this book is whether the conceptual underpinnings of competition law and international regulatory mechanisms are adequate or appropriate to deal with the developments raised by the new economy.

Competition, Regulation and the New Economy Edited by

Cosmo Graham and Fiona Smith The University of Leicester

OXFORD AND PORTLAND OREGON 2004

Published in North America (US and Canada) by Hart Publishing c/o International Specialized Book Services 5804 NE Hassalo Street Portland, Oregon 97213-3644 USA © The editors and contributors severally 2004 The Editors and Contributors have asserted their right under the Copyright, Designs and Patents Act 1988, to be identified as the authors of this work. Hart Publishing is a specialist legal publisher based in Oxford, England. To order further copies of this book or to request a list of other publications please write to: Hart Publishing, Salters Boatyard, Folly Bridge, Abingdon Rd, Oxford, OX1 4LB Telephone: +44 (0)1865 245533 Fax: +44 (0)1865 794882 email: [email protected] WEBSITE: http//:www.hartpub.co.uk British Library Cataloguing in Publication Data Data Available ISBN 1-84113-384-1 (hardback) Typeset by Olympus Infotech Pvt Ltd, India, in Sabon 10/12 pt Printed and bound in Great Britain by Lightning Source UK Ltd

Contents 1. Introduction COSMO GRAHAM 1. The New Economy and its Characteristics 2. Potential Problems for Competition Policy A. Predation B. Tying and Bundling C. Intellectual Property Rights D. Collective Conduct E. Mergers 3. Conclusions on Competition Policy 4. Regulatory Questions 5. Subsequent Chapters 2. Article 82 EC and New Economy Markets GIORGIO MONTI 1. Competing Perspectives of New Economy Markets A. Neo-structuralism B. Neo-Schumpeterianism C. The Response of the Authorities 2. Relevant Market Analysis A. On-Line Music B. Top-Level Internet Service Providers C. Structuralism Prevails 3. Dominance A. The Traditional Test: Market Shares Plus Entry Barriers B. Neo-Schumpeterian Definitions of Dominance 4. Abuse A. Protecting One’s Dominant Position B. Obligations to Co-operate with Competitors C. Extending Dominance 5. An Innovation Defence? 6. Remedies 7. Conclusion

1 2 4 6 7 8 8 9 9 10 12 17

18 18 22 24 24 25 28 31 31 32 33 36 36 41 45 47 50 53

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3. Abuse of a Dominant Position and Intellectual Property Rights: A Suggestion to Reconcile the Community Courts’ Case Law ESTELLE DERCLAYE 1. Confusion in the Case Law A. The Factual Background of the Case B. Conditions Required to Establish the Abuse 2. An Illustration of the Confusion: The IMS Case A. The Factual Background of the Case B. The Decision of the Commission C. The Orders of the President of the Court of First Instance D. Comments 3. How to Solve the Dilemma: A Suggestion A. Argument B. A Few Other Corroborating Arguments 4. Conclusion 4. B2B E-Marketplaces: A New Challenge to Existing Competition Law Rules? JOACHIM LÜCKING 1. B2B E-Marketplaces: Technical and Commercial Developments 2. Regulatory Responses 3. The Legal Assessment of B2B E-Marketplaces under EC Competition Law A. Legal Basis B. Market Definition C. Competition Issues D. Co-ordination Effects E. Market Dominance and Foreclosure 4. Best Practice Guidelines 5. Conclusion 5. Authorities, Competition and Electronic Communication: Towards Institutional Competition in the Information Society PLG NIHOUL 1. National Systems Replaced by a European Organisation A. First Stage of the Reform B. The 1987 Green Paper C. What Legal Basis? D. An Institutional Provision

55 56 57 59 61 61 62 64 64 65 66 73 74

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Contents

2.

3.

4.

5.

6.

E. Modification of the Rapport de Forces F. Legislative Power The Debate Between Harmonisation and Liberalisation A. Second Stage of the Reform B. Rules Adopted by the Commission C. New Interpretation of Competition Law D. Harmonisation Process E. Harmonisation Directives F. Two Categories of Rules G. Contradictions Conflict at National Level A. Third Stage of the Reform B. National Regulatory Authorities (NRAs) C. National Competition Authorities (NCAs) D. National Courts Convergence from an Institutional Point of View A. Fourth Stage of Development B. Illustration An Institutional Interpretation of the Reform A. Conflict and Competition Among Authorities B. The Process of Regulatory Competition C. Institutional Competition in Electronic Communications D. Competition Among Authorities Within the Same Legal Order E. Expanding the Line of Business What Can We Learn About the Future? A. More Competition among Authorities B. First Difficulty: Regulation Not an Ordinary Good C. Solution: Competition Within a Given Framework D. Second Difficulty: Legal Certainty and Predictability E. Place of Unity in Society and the Legal System F. Conformity with an Information and Communication Based Society?

6. Controlling the New Media: Hybrid Responses to New Forms of Power ANDREW MURRAY AND COLIN SCOTT 1. New Media and the Problems of Effective Control A. The Regulatory Arbitrage Problem B. The Anonymity Problem

vii 96 97 99 99 99 100 101 101 103 104 106 106 107 108 109 109 109 110 111 111 112 114 115 116 119 119 120 120 121 122 123

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C. The Scarce Resources Problem 2. Extending the ‘Modalities of Regulation’ Analysis 3. Putting Controls to Work A. Hierarchy/Community B. Hierarchy/Competition C. Hierarchy, Competition and Design D. Other Forms of Control E. Excluding Hierarchy 4. Conclusion 7. Regulating E-Commerce in the WTO: Exploring the Classification Issue FIONA SMITH 1. Background 2. Defining E-Commerce 3. Applying GATT and GATS to E-Commerce: Is E-Commerce Trade in Goods or Services? A. GATT B. GATS 4. Conclusion 8. Public Services in the New Economy ERIKA SZYSZCZAK 1. The Provision of Public Services 2. The Political Economy of State Intervention 3. Challenges to the Provision of Public Services 4. The Challenge to State Autonomy 5. Hybridisation 6. The Provision of Public Services by Non-State Actors A. Economic Regulation B. Market Power and Special Responsibility 7. Conclusion

132 136 143 143 146 150 152 156 156

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172 173 175 183 185 185 187 189 191 194 199 202 203 205

1 Introduction COSMO GRAHAM *

I

N ADDITION TO being the principal medium for communication, education and entertainment, the new economy is now a leading provider of goods and services through electronic channels. It rides on the crest of new technological developments in computers, telecommunications, broadcasting and satellites, thereby creating new interactive mediums. Primarily, it is the result of entrepreneurial activity in the computer sector, but the deregulation and liberalisation of state owned enterprises in the telecommunications and broadcasting sectors have played a contributory role. Whilst the initial dotcom bubble has now burst, the existence of a new economy with novel methods of production, distribution and exchange is here to stay: there are now 300 million active computers in the world, with 350 million people using the World Wide Web (expected to grow to one billion in four years); the speed of microprocessors continuously increases, facilitating the use of Information Technology (IT). The new economy is seen as central to future prosperity, but regulating it is complex because it moves at great speed and produces novel forms of cooperation and competition. As a result, there has been great debate about whether the existing forms and principles of competition law, in particular, are effective to address regulatory problems. This is not simply an issue for competition law, but also a general problem for schemes designed to control aspects of the new economy. Indeed, this was one of the impulses behind the passing of the Communications Act 2003. The current volume looks at aspects of both issues:1 the first three chapters examine some difficult

* Cosmo Graham is Professor of Law at the University of Leicester. He is a public lawyer who specialises in the law relating to the regulation of public utilities. His other main specialism is in competition law and he has teaching interests in company law. He is the Director of the Centre for Utility Consumer Law. He is also a member of the UK Competition Commission. 1 This collection of essays originates in a seminar on this topic held in Leicester in July 2001 sponsored by the Modern Law Review. Chs 2, 4, 5, 6 and 8 began life as papers presented to

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competition law issues raised by the new economy. The next three chapters consider a variety of regulatory issues, focusing on institutional design and the book ends with a discussion of the implications of the European Union (EU) law concept of public services on high technology industries. This first chapter attempts to set the scene for the contributions that follow by discussing briefly what we regard as the new economy and its salient characteristics. The discussion then outlines some general issues for competition law raised by the new economy and concludes by putting these issues into the context of recent developments in United Kingdom and EU competition policy. Finally, the contributions to the book are summarised and put into that context.

1.

THE NEW ECONOMY AND ITS CHARACTERISTICS 2

What do we mean by the phrase the ‘new economy’? On one level, it can be restricted to the use of computer software and hardware and its application through digitalisation to the communications industry, especially the use of the Internet to business transactions. But this focuses narrowly on the industries themselves and neglects wider regulatory problems. To be comprehensive therefore, when determining the scope of the ‘new economy’, it makes more sense to discuss the general characteristics that distinguish these industries from the ‘old economy’, which then allows a discussion of the challenges for the development of competition and regulatory policy. It will become apparent that the majority of characteristics affect a wide range of industries beyond computers and communications embracing, for example, biotechnology and agriculture. Although the notion of the new economy sounds vague, there is substantial agreement amongst the commentators regarding its distinguishing features.3 One of the most obvious features of new economy industries is that they are characterised by rapid technical or technological change, which leads to the alteration of the markets under consideration either through the creation of new markets or the transformation of old ones. Computers are a good example of this: in the 1960s the industry focused on mainframe computing,

that seminar. We would like to thank the contributors to that occasion for their thoughts which have helped to shape the contributions to this volume. 2 See also 3 General

ch 2. discussions can be found in D Teece and M Coleman, ‘The Meaning of Monopoly: Antitrust Analysis in High-Technology Industries’ (1998) Antitrust Bulletin 801; Office of Fair Trading, Innovation and Competition Policy (2002) Economic Discussion Paper 3—Part I; and D Evans and R Schmalensee, Some Economic Aspects of Antitrust Analysis in Dynamically Competitive Industries (2001) National Bureau of Economic Research Working Paper 8268.

Introduction

3

whereas the growth of personal computing in the 1980s has moved the industry from one selling primarily to large organisations to one which sells directly to individual consumers, as well as of course still to large organisations. The mobile phone market in the UK is another example. The first two mobile licences were issued in 1985 and the next two were only issued in 1991. From those small beginnings, the market has grown to be a sizeable phenomenon both in terms of the services provided and the manufacture of mobile phones. The mobile phone industry is also a good example currently of technological change through the current development of third generation mobile phones. The second characteristic that is usually emphasised is the importance of intellectual property to these developments. Technological changes are focused around intensive research and development with the intention of creating new intellectual property rights, in other words, creating a means of protecting the investment that the firm makes in the new development. There is a well-known potential for tension between intellectual property rights and competition policy and this is something that may become a particularly difficult issue in the high technology industries. Third, the implications of network effects are emphasised in the literature. It is often the case in new economy industries that a network of some kind is involved. The most obvious example is telephones: here, the effect that is most commonly referred to is that the network becomes more valuable, as the number of members increases: this is the so-called ‘network externalities’. This is obvious in relation to networks such as telephones, fax machines and picture messaging, but there may be a similar effect in other sectors that do not immediately rely on a network. For example, the more people who use compatible computer software, the more valuable it becomes because of the ability to swap files and interchange information easily. The popularity of a network may lead to what Shapiro and Varian call demand-side economies of scale,4 that is, people value a product because it is popular. When combined with the more traditional supply-side economies of scale this creates what they refer to as ‘positive feedback’, which allows strong firms to get stronger and weak firms to get weaker, potentially leading to extreme results. To be more precise, one firm and its technology eventually dominate the market. An example here is ‘Word’ word processing software. These network effects lead to competition for markets, rather than competition within markets. The natural outcome is a market dominated by one firm, something traditional competition law looks at with some suspicion. Finally, these industries tend to have high fixed, or sunk costs and low marginal costs. The costs of producing the first CD or software programme 4C

Shapiro and H Varian, Information Rules (Harvard, Harvard Business School Press, 1999) 179.

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are relatively high, while the costs of reproducing it are very low, even negligible. Furthermore, as Shapiro and Varian point out, there may not be any capacity constraints in reproducing certain goods.5 There are capacity limits in a factory producing automobiles and concrete blocks, but the same does not apply to producing additional copies of information. This characteristic has particular implications for the pricing policies of new economy firms. In particular, a central pricing strategy for such firms will be price discrimination. Price discrimination is not a new phenomenon, but new technology makes it much easier for firms to obtain information about price preferences and buying patterns, as well as making it easier to create different versions of the product that they are selling. A further implication of an industry with high fixed or sunk costs and low marginal costs is that it tends to be concentrated because of the high costs of entry. The picture that comes through is of an industry subject to dramatic changes, but dominated by a few firms, or one major player. It is possible that this firm, with a large market share, will engage in price discrimination, create complementary products, encourage customer loyalty and be highly profitable. On the face of it, this is the sort of behaviour of which the competition authorities have always been highly suspicious. It is argued, however, that this is to misunderstand the nature of what is happening in these industries.6 In these circumstances, these high market shares are fragile and potentially temporary because the rapid pace of technological change means that markets can change radically quite quickly. Consequently, on this hypothesis, intervention by the competition authorities is not needed, as the market will provide the appropriate correction. The more appropriate question for competition authorities should be which is the best characterisation of a market in a particular industry; unfortunately, there is no simple answer. This can be illustrated by examining the problems posed for the application of competition policy methods in the context of high technology industries.

2.

POTENTIAL PROBLEMS FOR COMPETITION POLICY

The starting point for all competition inquiries is the question of market definition. Once that is agreed upon, the crucial question is whether or

5 Ibid, 21. 6 See eg C

Ahlborn, D Evans and J Padilla, ‘Competition Policy in the New Economy: Is European Competition Law up to the Challenge?’ [2001] 22 European Competition Law Review 156 and C Veljanovski, ‘EC Antitrust in the New Economy: Is the European Commission’s View of the Network Economy Right? [2001] 22 European Competition Law Review, 115.

Introduction

5

not the firm or firms under investigation have market power or are dominant in the context of European Community (EC) competition law. There is a substantial amount of literature on how to define the relevant market and all the competition authorities have provided guidance on how they undertake this task.7 Much of the criticism of the competition authorities’ approach has emphasised the need to avoid a ‘static’ approach to market definition. In other words, to take into account not only how the market is at the moment, but also how it will develop in the future. The implication is that with a dynamic high technology industry, competition will be for the market and that a wide market definition is generally required.8 In terms of the principles that the authorities apply in Europe and the United Kingdom, this criticism is overstated. The guidance recognises that market definition is a tool in the inquiry and that the issue is establishing whether market power exists. In doing this, the authorities recognise that they must look at supply-side substitutability and, although strictly not an issue of market definition, potential future constraints on the companies concerned. Indeed, the issue generally for competition authorities in merger cases is what will be the impact of the merger on competition in the future; therefore, almost by definition, they cannot adopt a static view of the market, but must instead try and predict future events. This is not an easy exercise and opinions will differ on whether, in any one case, the authorities have adopted the correct approach. A more interesting point has been raised in the OFT’s paper on competition policy and high technology industries. The authors argue that market power is usually defined as a firm having power over prices and hence output. They go on to argue that it is important to include exclusionary power within the context of market power because in dynamically competitive industries competition issues generally arise from exclusionary power rather than pricing power.9 This is in the context of a general argument that the competition authorities should apply a ‘first principles’ approach to their analysis in particular cases. By this they mean that: it would focus the analysis from the beginning upon the alleged anti-competitive conduct. It would then use the definition and analysis of markets, market power (both pricing and exclusionary), and competitive constraints broadly

7 European

Commission, Commission Notice on the Definition of the Relevant Market for the Purposes of Community Competition Law; Competition Commission, Merger References: Competition Commission Guidelines and Market Investigation References: Competition Commission Guidelines both in section 2; Office of Fair Trading, Mergers: Substantive Assessment Guidance (May 2003, OFT paper 516). 8 A good example is Ahlborn, Evans and Padilla above n 6, 161–62. 9 Above n 3, pt I para 4.11. Much of this is derived from work in the US, as acknowledged in the report.

6

Cosmo Graham defined to determine whether the alleged anti-competitive behaviour did have anti-competitive effects and whether these effects caused significant consumer harm. … It would … allow for explicit analysis of whether a particular firm had the ability, power, or incentive to carry out the alleged anti-competitive act. … Further, one could analyse explicitly what the effect would be upon innovation, short-term competition, long-term competition, price in the shortand long-run, and upon product diversity and quality.10

A.

Predation

This has been one of the most controversial areas in competition policy for a long time and there are a number of new twists brought about by the development of high technology industries. Traditionally, it is perceived as a rule about pricing which prevents dominant firms from charging prices that are so low that they will drive out competitors. Substantial controversy exists over whether or not predation is an economically rational strategy and, furthermore, what the test for predation should be in the context of EC law. In particular, there has been a debate about whether or not the alleged predator must be able to recoup their losses once the other firm or firms have been driven from the market. Given that high technology industries are characterised by high fixed costs and very low marginal costs, a number of problems for the analysis of predatory pricing are created, as the Office of Fair Trading (OFT) point out.11 It may be possible for a firm to price above its variable costs, but this will still undercut a smaller competitor who may be forced to exit the market. Alternatively, with very low marginal costs, there are circumstances in which it would be sensible to price below variable costs, for example to build market share. Under current EC competition law there would be a presumption that such behaviour was predatory even though it may just be a sensible business practice, particularly in the context of ‘winner take all’ markets.12 Neither of these are actually new problems in relation to predatory pricing. The issue of whether or not pricing above average total costs can be predatory has recently been discussed in Compagnie Maritime Belge13 where the European Court of Justice (ECJ) concluded that this was indeed possible. Wider discussions have also taken place over the reasons why firms might price below marginal costs.

10 Ibid para 4.69. 11 Ibid para 5.8. 12 Shapiro and Varian above 13 Cases C–395/96 P and

n 4, ch 2. Case C–396/96 P Compagnie Maritime Belge Transports v Commission [2000] ECR I–1365 [2000] 4 CMLR 1076.

Introduction

7

In addition, the OFT paper argues that the concept of predation should be extended beyond pricing to cases where: A firm either incurs costs or undertakes other actions which may be cost free or cost reducing, that it otherwise would not have taken had it not been for the anti-competitive benefits to the firm undertaking these actions.14

This would be an extension of the current concept of predation, but the idea is to catch certain practices such as product pre-announcements that, it is alleged, have been used in a way to stifle competition.

B.

Tying and Bundling

This is another area of controversy where there are likely to be important repercussions for high technology industries. As Shapiro and Varian point out, any evidence of such behaviour is likely to be a red flag to antitrust authorities.15 The OFT indicates that there are a number of different practices which need to be distinguished and that there can be perfectly good reasons for businesses undertaking such practices.16 The report distinguishes between tying, which it defines as where there is a contractual link between products, and bundling, where a group of products are sold together. It further distinguishes between pure bundling, where only the bundle of products are sold, and mixed bundling, where the products may be sold as a bundle or separately, albeit more expensively. It goes on to argue that there are a number of plausible reasons, not related to anticompetitive practices that would encourage businesses to engage in tying and bundling. These range from concerns over the quality of products to being able to sell more products through this method. The authors of the report do argue that there are certain situations where such practices may be aimed at market foreclosure. They claim that in a market for tied goods, that is Good A and Good B are sold together, the ability to reduce the sales volume of a competitor for Good B may reduce the competitor’s profits to the point where they exit the market. This is also the case where entry is undertaken through the provision of two goods, rather than just the one. In that case, bundling and tying practices may again have detrimental effect on competition. The overall conclusion is that there needs to be a thorough analysis in each case as to why tying and bundling is being used and what the effects are.

14 Above n 3, para 5.17. 15 Shapiro and Varian above n 4, 309. 16 The analysis in this section is drawn

paras 5.37–5.69.

from Innovation and Competition Policy above n 3,

8 C.

Cosmo Graham Intellectual Property Rights

The OFT report discusses two broad issues in relation to intellectual property rights (IPRs): the conditions under which such rights are licensed and the issue of access to those rights. In relation to the first issue, it is clear that competition authorities must be alert to conditions in licences that restrict competition. Broadly speaking, these will be conditions that are not related to the protection of the right in question. For example, a condition limiting the geographic area in which a licensee may use his or her rights would not be a problem from the point of view of economic analysis. By contrast, a condition, which limited the licensee’s abilities in other markets, would be problematic as in the case where a licence to write software for a particular platform prevented the software producers from writing for any other platforms. The essential facilities doctrine is discussed in more detail in chapter three, in the context of recent case law from the EC and wider literature on the subject. As the OFT report puts it: the core of the issue is balancing short run gains in efficiency with long run incentives to invest and compete dynamically17

In order to determine this question, the report notes a number of further key questions. These include, is the market for the underlying facility dynamic or potentially dynamic? What is the size of the benefit? Has the dominant firm invested in the facility? What is the potential impact on future investment? Can access be priced appropriately and what are the costs of monitoring the access regime? Although these are difficult questions, they are all questions that have commonly been asked in the context of the so-called essential facilities cases.

D.

Collective Conduct

In addition to the issues discussed above, further problems arise in relation to standard setting and joint ventures with the latter being discussed more fully in chapter four. In information and high technology industries the need for compatible standards between different manufacturers may be critical. Shapiro and Varian18 make the point that it may be better for competitors to co-operate over standards, rather than fight a standards war as this may have the effect of increasing the market for the product. Sometimes standard setting is needed for the product to take off at all. 17 Innovation and Competition 18 Above n 4, 259.

Policy above n 3, para 5.101.

Introduction

9

When there is co-operation between parties, there must be a careful assessment of the arrangement by the competition authorities. It has been suggested that there are a number of critical questions. Do the firms together have market power? Is membership open or closed? Do they possess blocking patents or other IPRs? What ancillary restraints are imposed on members of this group?19

E.

Mergers

The most important question for mergers is to characterise the type of competition: is it competition in the market or competition for the market?20 The European Commission has been very concerned in the new economy cases that have come before it to ensure that the future development of markets is not restricted by the creation of bottlenecks over which the parties have control.

3.

CONCLUSIONS ON COMPETITION POLICY

The debate about the application of competition policy to new economy industries will continue, particularly in the light of the European Commission’s investigations into Microsoft and its practices. Its recent statements argue that Microsoft is leveraging its dominant position from the personal computer (PC) market into low-end servers and that Microsoft’s tying of Windows Media Player to the Windows PC operating system weakens competition on its merits, stifles product innovation and ultimately reduces consumer choice.21 What this very brief overview suggests is that the problems facing competition policy are not necessarily conceptual ones, but will arise from the generic difficulty of applying general principles to specific factual situations and, in particular, the need to take a view about the future development of markets. It is now useful to remind readers of developments in EU and UK competition law and policy, which will form the context within which such decisions are taken. At EC level the two most striking developments are the increasing emphasis on economic analysis adopted by the European Commission (Commission) and demanded by the courts and the new procedural framework that will follow enlargement. The new procedural framework comes into place from May 2004 and gives more responsibility for enforcement of

19 Innovation and Competition Policy above n 3, paras 6.22–28. 20 Ibid para 7.37. 21 See Commission Press Release IP 03/1150, 6 August 2003.

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EC competition law to national authorities and courts. The hope is that it will free up resources in the Commission, so that it is able to concentrate more on serious European-wide cases of breach of competition law. This may help with the issue of economic analysis. The greater emphasis on this issue can be seen as a Commission response in part to some long-standing criticisms of the operation of the system under Article 81 EC, illustrated initially in the block exemption on vertical restraints. The need for better and more accurate analysis of the cases’ facts before it is one of the themes in three recent merger cases before the Court of First Instance (CFI), where the Commission’s decisions were annulled in each instance.22 The decisions came at a time when the Merger Control Regulation was under review and prompted the Commission to undertake certain reforms in its internal procedures, notably the creation of a panel to have a second look at merger cases and the position of Chief Economist. On the substantive level, the Commission appealed the Tetra Laval case to the ECJ because it involves the proper approach to be taken to leveraging, which is also an issue in the GE/Honeywell case, currently also before the EC courts. At the UK level, major changes have come about through the Enterprise Act 2002 as regards the control of mergers and market investigations. Broadly speaking, the role of politicians has been dramatically decreased and the final decisions in these areas have been given to the Competition Commission which will decide, in essence, on the basis of whether or not there has been, or will be, a substantial lessening of competition in the case in front of it. In legal terms, this represents a move away from the very broad range of criteria that could be taken into account under the public interest provisions of the Fair Trading Act 1973. In terms of the new economy, this should lead to a more focused investigation, with less chance of non-economic policy goals intruding, although there are special provisions for broadcasting and media mergers.

4.

REGULATORY QUESTIONS

One of the issues surrounding the new economy is what alternatives are there if a pure competition approach is deemed inadequate? One of the usual policy reactions to the failure of competitive markets to meet public interest goals is to set up a regulatory system for the industry concerned. As regards the new economy industries with the characteristics identified above, this is a hazardous undertaking because most experience of regulation has been with industries that have not been characterised by such 22 Case T–342/99 Airtours v Commission [2002] ECR II–2585, Case T–5/02 Tetra Laval v Commission [2002] ECR II–4381 (under appeal to the ECJ), Case T–310/01 Schneider Electric v Commission [2002] ECR II–4071.

Introduction

11

a rate of technological change—the water industry for example. It is not impossible to regulate a fast moving industry, or to use a statutory framework in this context. Over the past 20 years regulation of the financial services industry has moved from a system dominated by practitioner regulation to one regulated under the Financial Services and Markets Act 2000. In this context, there are four broad regulatory questions that can be asked. First, is industry specific regulation necessary or would competition law alone be appropriate? Second, if industry specific regulation is needed, what are the aims and objectives of such regulation? Third, what are the best institutional arrangements and, finally, what are the best techniques or instruments? In dealing with the first question, in the context of new economy industries, the popular answer is that only competition law is needed. This is the basic assumption behind the EU’s new framework for communications regulation, although there is provision for other forms of regulation for operators with significant market power. In the UK, the regulator for telecommunications has been given concurrent competition law powers with the OFT, which suggests that policy makers felt there was room for both. The argument that you cannot just simplistically move from industry specific regulation to competition regulation is explored in depth by Pierre Larouche who argues that in addition to the areas that are not suitable, attempting to extend competition law to these areas may have detrimental effects on its integrity.23 This links into the second question because, if we distinguish between economic (price control) regulation and social regulation,24 then the assumption is that the new economy will not be subject to the former. Again, this may be subject to exceptions, particularly in the case of infrastructure networks, but there are many broad social objectives that may be desirable for new economy industries to accomplish. This is seen clearly in the broadcasting sector and the arrangements in the UK provided by the Communications Act 2003,25 but is also a theme underlying the EU discussion of public services, as further examined in chapter eight. The aims and objectives of regulation will affect the type of institutions chosen as well as the methods of regulation that are considered most suitable; these are both themes examined in depth in chapters five and six. In a general sense, the move is away from politically controlled regulatory agencies towards those that are considered, in some sense, independent and there is also increasing discussion and interest in notions of self-regulation

23 P Larouche, Competition Law and Regulation in European Telecommunications (Oxford, Hart Publishing, 2000). 24 See A Ogus, Regulation (Oxford, Oxford University Press, 1994) for this distinction. 25 For discussion prior to the act, see M Feintuck, ‘Walking the High-Wire: The UK’s Draft Communications Bill’ (2003) European Public Law 105.

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and co-regulation. As Andrew Murray and Colin Scott recognise at the end of chapter six, this raises questions about the legitimacy of such agencies’ activities. In terms of competition regulation, increasingly the answer seems to be a resort to reliance on agency expertise, on the basis of a bounded mandate, with checks provided by judicial mechanisms. This does not, however, provide an answer in terms of social regulation where, although expertise can be prayed in aid, the relevant range of considerations is much wider. All these issues suggest that the debate about new economy industries’ regulation is only just beginning and that, as well as throwing up some old problems in new guises, it is also likely to bring forward some new questions.

5.

SUBSEQUENT CHAPTERS

In chapter two, Giorgio Monti conducts an overview of Article 82 EC: how it has been applied to new economy markets; and how analysis under this provision should be structured for future cases. He distinguishes between two broad approaches to competition law enforcement: the ‘neo-structuralists’ who favour aggressive antitrust enforcement in the appropriate circumstances and the ‘neo-Schumpeterians’ who view dominance in new economy markets as temporary and short-lived. He concludes that the competition authorities in the EC and the US have preferred the neo-structuralist approaches, which have on the whole been backed by the courts. He argues that neo-Schumpeterian ideas do not easily fit within the current competition law culture, or the analytical framework of Article 82 EC. He notes that although the authorities have engaged in aggressive enforcement, they have focused not on imposing financial sanctions but on ex post behavioural remedies and ex ante divestitures. The problem is that these types of remedy turn competition law into a market regulator, a task for which it is ill equipped. Since one of the aims of this approach, he argues, is to remove dominance by facilitating entry, the more pressing question is whether this policy will eliminate incentives to innovate. This leads into Estelle Derclaye’s discussion in chapter three of the application of Article 82 EC to the licensing of intellectual property rights, which is the subject of some notoriously confusing case law. This is done in the context of a careful discussion of the recent IMS Health case26 where the central issue is whether or not there is an essential facilities doctrine. At issue in the case is whether the structure that IMS Health created for analysing

26 Commission

Decision 2002/165/CE, 3 July 2001, Case COMP D3/38.044, NDC Health/IMS Health: interim measures [2002] OJ L 59/18; Case T–184/01 IMS Health v Commission [2001] ECR II–2349; [2001] ECR II–3193.

Introduction

13

sales of drugs by German pharmacies must be shared with its competitors. On its analysis of the case law, the Commission argued that it should, and imposed interim measures requiring sharing. In the initial proceedings, the ECJ did not agree that the imposition of such measures was appropriate. Derclaye argues that the Commission’s interpretation of the case law is incorrect and that there is a distinction in the case law between cases dealing with intellectual property rights and those dealing with other forms of property. The result of this is that since the conditions under which a refusal to license are cumulative, then it will only be in rare cases that they are all fulfilled. Consequently abuse of dominance of intellectual property rights will be unusual and IMS Health should, on this interpretation, win the case. In chapter four Dr Joachim Lücking examines the challenges for competition law rules set by business-to-business (B2B) electronic marketplaces. He distinguishes between four different types and discusses the case law that has grown up in the EC around such marketplaces. He identifies that issues can potentially either arise under the Merger Control Regulation or under Article 81 EC, although the working of the market may raise either Article 81 or 82 EC concerns. He goes through the appropriate approach to market definition, possible co-ordination effects, the concern with foreclosure, before discussing best practice guidelines. His conclusion is, however, that the current competition rules are fully capable of dealing with B2B electronic marketplaces because they do not raise issues that are uniquely outside the existing framework. In the second part of the book, the focus switches to regulatory issues, beginning with Paul Nihoul’s examination of the relationship between institutional competition and the information society. He begins this by an examination of the reform of telecommunications regulation at EU level, ending in the new framework for the regulation of electronic communications. He interprets this in part as a process of competition between various regulators, both at EU and national level, as well as between levels. Putting this into the context of the convergence of communications markets and drawing parallels with the experience of international law, he asks what lessons can be learnt. He suggests that for the future, we abandon the idea of law and regulation having a central unifying authority. Instead, a plurality of regulators, albeit operating within some common framework, would allow operators to have a wider range of choice over which regulatory systems they deal with. In chapter six, Andrew Murray and Colin Scott examine the issue of what regulatory techniques should be applied to the new media, in particular the Internet. They discuss the argument that the Internet is not capable of regulation, although they find that view flawed. They extend Lawrence Lessig’s work on the modalities of regulation27 to draw up a typology of

27 L

Lessig, Codes and Other Laws of Cyberspace (New York, Basic Books, 1999).

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Cosmo Graham

four types of control system: hierarchical control, community-based control, competition based control, and design based control. Within each of these four types, there are three techniques: standard setting, information gathering and behaviour modification. They argue that within the new media are existing forms of control mechanisms and that the challenge is to find ways of stimulating or steering those mechanisms towards meeting the public interest objectives of regulation. Thus, for example, hierarchy can be used to steer systems that involve control based in community market or design. This feeds into Nihoul’s idea of a common framework, although Murray and Scott also point out that effective control can involve any of these systems, with or without hierarchical control. In chapter seven, Fiona Smith looks at a specific issue, namely the regulation of e-commerce by the World Trade Organisation. This is really a specific example of the need for an existing regulatory mechanism to adapt to new ways of working by industries, in this case, new ways of trading. She focuses on the problems raised by the definition of e-commerce adopted by the WTO Work Programme on Electronic Commerce. Specifically, the discussion focuses on the classification of e-commerce as trade in goods and/or trade in services and the implications of failing to clarify where that boundary lies. She explores the disagreements and arguments over how e-commerce is to be classified for the purposes of the various agreements. She argues that in marginal cases the classification decision will be made by the member state potentially making a decision based on the needs of its domestic economy, rather than on global considerations. This arguably leads to an inappropriate politicisation of the decision and she concludes that the classification issue needs to be resolved if the WTO is to be used as an appropriate regulatory framework. Finally, Erika Szyszczak examines the provision of public services in the new economy, of which the most important in this context is the universal service obligations imposed on telecommunications providers. The discussion begins by explaining the general context of the debate over the definition of the concept of ‘public services’ in the EU and goes on to examine in some depth the recent case law on the concept of an ‘undertaking’ and the definition of state aid. She argues that it is important to understand and clarify where the boundaries end for the state to claim total immunity from the market and where the market rules begin. She maintains that under the existing legal tools the ECJ has been unable to offer either clarity or consistency in addressing this question. Although the insertion of Article 16 EC has signalled a greater respect for the role of public services, this has not yet provided the legal base for a positive set of EU values. The Commission’s Green Paper28 takes a holistic approach to the issue and this may bring together the so far fragmentary discussion. 28 COM

(2003) 270 final.

Introduction

15

We cannot pretend that the essays in this volume cover all aspects of the relationship between competition, regulation and the new economy industries. We hope that by bringing them together in this format, the collection raises some valuable questions and stimulates discussion on what will continue to be an important policy problem for the 21st century.

2 Article 82 EC and New Economy Markets GIORGIO MONTI*

T

HE AIM OF this chapter is to provide an overview of the application of Article 82 EC, which prohibits the abuse of a dominant position by one or more undertakings, in new economy markets. The ‘new economy’ is normally associated with three high technology industries: computer software, Internet-based businesses, and communication services.1 There is broad agreement that these industries present a unique set of characteristics that distinguish them from traditional manufacturing industries. In particular, four features are associated with new economy markets: economies of scale, network effects, consumer lock-in, and high rates of innovation.2 There is much less agreement over the implications of these differences for competition policy. In broad terms, we can identify two divergent approaches: those which focus on the first three attributes and particularly on the dangers of network effects as a reason to justify aggressive antitrust enforcement; and those which focus on the dynamic characteristic of these industries, suggesting that any dominance is temporary as markets are contestable. According to the latter camp, antitrust enforcement is largely unnecessary.3 These opposed views are reminiscent of a more general debate over the role of competition law: on the one hand the Chicago School argues for a

* Law Department, London School of Economics. An earlier version of this chapter was presented at the Competition Law and the New Economy Conference on 12 July 2001, organised by the University of Leicester. I am grateful for the many helpful and encouraging points raised by the participants and for the comments of an anonymous referee. All errors and views expressed are mine. 1 R Posner, Antitrust Law 2nd edn (Chicago, University of Chicago Press, 2000) 245. 2 Eg RE Litan, ‘Antitrust Law and the New Economy’ (2001) 62 University of Pittsburgh Law Review 429; SN Weinstein, ‘Sherman Act Violations: Monopolization: Tying’ (2002) 17 Berkeley Technology Law Journal 273. 3 These are ideal types; there are many positions in between these extremes.

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limited role for competition law because markets tend to be contestable, whilst its opponents criticise the Chicago School for being overly optimistic about the market’s abilities to cure itself, noting that certain market structures are likely to lead to dominance and result in anticompetitive practices. In my view, the current controversies over the role of competition law in new economy markets are an extension of that more general debate, with novel economic arguments. The chapter is structured in this manner: part one outlines the two conflicting perspectives over new economy markets—the ‘neo-structuralist’ which favours aggressive antitrust enforcement when anti-competitive structures manifest themselves, and the ‘neo-Schumpeterian’, for which dominance in new economy markets tends to be temporary and short-lived. To date, enforcement agencies have favoured the neo-structuralist view. This is evidenced in the next three parts of the chapter, which review market definition, the concept of dominance and the notion of abuse in new economy markets. This focus on neo-structuralism may be criticised for failing to take into account the adverse effect that aggressive competition law enforcement might have on innovation. Consequently the fifth section of this chapter suggests how the promotion of innovation might affect findings of abuse under Article 82. The sixth section observes that the kinds of remedies that are likely to prevail in new economy markets are behavioural and structural, designed to regulate the markets rather than to penalise the dominant firms. While the focus is on Article 82, it will be useful to refer to comparable case law from the United States,4 where a number of significant antitrust cases in new economy markets have already been considered and to examine the approach of the EC and US authorities under the merger rules because considerations of dominance and potential abuses of dominance if the merger is allowed to be consummated show the fears that competition authorities perceive in new economy markets and can serve as an indicator of the kinds of actions likely to be taken under Article 82.

1.

A.

COMPETING PERSPECTIVES OF NEW ECONOMY MARKETS

Neo-structuralism

From a neo-structuralist perspective, there are three market characteristics which indicate the likelihood of dominance in new economy markets. 4 The

US approach under s 2 of the Sherman Act is comparable. In US v Grinnell Corp 384 US 563, 570–71 (1966) the Court defined illegal monopolisation as ‘(1) the possession of monopoly power in the relevant market and (2) the wilful acquisition or maintenance of that power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident’.

Article 82 EC and New Economy Markets

19

First, many products (for example computer software) are characterised by significant economies of scale—whilst it is very expensive to devise new software, once the programme is written, it is virtually costless to reproduce, marginal costs are almost zero, which leads to a situation where one dominant firm can capture most of the market.5 However, in itself this does not lead to dominance unless the high market shares can be held for some time. This is where the other two characteristics of new economy markets support the risk of dominance: network effects and lock-in. Many new economy businesses are characterised by network effects— the more people use a particular service, the more value it has to an individual user.6 For example, the more people use a fax machine, the more valuable a fax machine is to each user because it can be used to communicate with more people. In these markets there will be a convergence to the most popular network standard. Much like the periodic table of elements, once enough chemists agree to use a set of abbreviations for chemicals, then the minority who use alternative formulae will have to abandon these if they wish to participate in scientific discourse. The difference between the symbols in the periodic table and a network like the ‘instant messaging’ service operated by an Internet Service Provider (ISP) is that the latter is owned by an undertaking, consequently those outside the network cannot communicate to those within, because each ISP uses its own separate and incompatible standard so that only its customers can communicate through it.7 If enough consumers migrate to one instant messaging system, then that provider will have a dominant position, because new consumers will wish to enter the network which has the greatest number of users; similarly, those consumers using smaller networks will migrate to the larger network where they can communicate with more people. The upshot is that a proprietary network creates risks of dominance if there is sufficient consumer demand for the services that can be obtained via the network and if other networks are not compatible. All three elements are necessary in order to characterise a network effect as potentially anticompetitive. 8 Instant messaging networks are a good example of incompatible proprietary networks where there are still many players on the market because there is not sufficient consumer demand for a single network. Similarly, the market in video games consoles is characterised by more than one network and is

5O

Shy, The Economics of Network Industries (Cambridge, Cambridge University Press, 2001) 5. 6 ’The utility that a user derives from consumption of the good increases with the number of other agents consuming the good’: ML Katz and C Shapiro, ‘Network Externalities, Competition and Compatibility (1985) 75 American Economic Review 424. 7 See C Veljanovski, ‘EC Antitrust in the New Economy’ (2001) 22 European Competition Law Review 115 who notes correctly that proprietary standards and incompatibility between standards are necessary conditions for the theory of network effects to apply. 8 Thus the existence of a network does not mean a fortiori that there is or will be dominance.

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Giorgio Monti

highly competitive. In contrast, in the early decades of the 20th century, when AT&T was developing the local telephone it refused to connect with independent competitors and because there was strong consumer demand for a telephone network that would allow a user to communicate with all other users, AT&T became dominant.9

Figure 2.1

Network effects can also manifest themselves in an indirect manner: the owner of a dominant, proprietary network may attract businesses wishing to sell consumers products that run on the dominant network, thus strengthening the dominance of the network. A good example of the competition authorities seeing indirect network effects is the EC Commission’s analysis of AOL’s position in the dial-up Internet access market in the UK.10 AOL has a network of users that navigate through its site. Navigating with AOL is not the same thing as surfing the whole Internet because AOL has created a more limited network of sites that can be reached by clicking on its pages. Thus whilst an AOL customer may feel like she is surfing the World Wide Web, it is a smaller web that she is surfing. Moreover, its web design is so attractive that many users never step outside the web pages that it supplies. This ‘stickiness’ allows AOL to enter into lucrative

9 HA Shelanski and JG Sidak, ‘Antitrust Divestiture in Network Industries’ (2001) 68 University of Chicago Law Review 1, 8. 10 AOL/Time Warner [2001] OJ L/268/28.


21

contracts with content providers who want presence in its territory. In the view of the Commission, the more content providers contract with AOL, the more people will subscribe, and in a virtual circle, the more consumers, the more content providers want to be present on the AOL network. This is sometimes called a ‘snowball effect’. AOL’s dominance would increase dramatically if it were vertically integrated with a leading music content provider, transforming it into an ‘on-line store/essential facility’.11 Music would attract many new subscribers, because music is one of the most popular and sought after elements of Internet content.12 This approach suggests that an internet service provider (ISP) could consolidate a dominant position either by vertical integration with popular internet content or presumably, by having exclusive access to popular internet content, without ownership. The operator of a complex proprietary network attracts both consumers and suppliers of goods that run on the network. The network is strengthened by the number of participants on either side: the more consumers, the greater the network’s ability to draw more consumers and more ancillary content, and the more ancillary content, the more consumers are drawn to the network. In this setting a new entrant has to promise consumers a superior network and superior ancillary content also, if the existing ones cannot run on the new network. This makes entry even more difficult because two markets may have to be broken into by a new competitor. By gathering enough content, AOL could become the dominant ISP, causing many more Internet subscribers and content providers to migrate to its system. This analysis assumes that there are certain ancillary products that add so much value to the network so as to allow the creation of a dominant position. This is an indirect variation of the network effects theory because the network effect is caused by the presence of other property linked to the network, but the anticompetitive risks are similar: a dominant network owner can behave independently of competitors, who will find it difficult to secure sellers of ancillary products wishing to place them with an ISP that has a low number of consumers, and independently of customers wishing to supply goods that run on the existing network because they need the network more than the network needs them. While network effects create entry barriers for new competitors and invite more consumers to the dominant network, another phenomena— consumer lock-in, affects the ability of consumers to look for substitutes. Lock-in occurs when the cost of switching to a new product is higher than the marginal benefits to be gained by the use of the new product. In terms of computer software, for example, a consumer will find it too costly to

11 Ibid 12 Ibid

para 82. para 82.

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Giorgio Monti

switch from one brand of software to another because of the need to learn how to use new software and the problem of transferring files from one programme to the next. Only a considerably better product will induce those who are locked-in to switch. This makes entry more demanding, and locked-in consumers risk exploitation by the dominant firm.

B.

Neo-Schumpeterianism

In response to these concerns about the risks of dominance, some have argued that the new economy moves on Internet time—where it is said that competitive advantages are temporary and markets contestable. 13 The incentives to contest markets are also high: whoever finds the new ‘killer application’ will take a large chunk of the market and the prize is extremely high profits. Many commentators have argued that the dominance achieved, even through the creation of a successful network, is always temporary. Thus, the dynamism of the new economy can cancel out dominance.14 Joseph Schumpeter had set out this vision of competition in the 1940s: Competition from the new commodity, the new technology … which strikes not at the margins of the profits of the existing firms but at their foundations and their very lives.15

If the holder of a network is in constant fear of being outdone by a new product, that will diminish the dominance of the network vis-à-vis its consumers. In addition, the fear of an alternative network evolving will also create incentives for the network owner to co-operate with producers of ancillary goods, because the provision of these to its consumers is a way of making the network more competitive. According to Teece and Coleman ‘antitrust authorities need to be cognizant of the self-corrective nature of dominance’ in new economy markets.16 The consequences of the market being so dynamic also impact on the strategies of firms: if markets change so quickly then predatory strategies to exclude competitors become much more difficult to plan because of the uncertainty that they will succeed in consolidating the predator’s dominance.

13 Eg MA Cusumano and DB Yoffie, Competing on Internet Time (New York, Touchstone, 2000). 14 Shelanski and Sidak above n 9 relying on Joseph Schumpeter’s analysis. 15 J Schumpeter, Capitalism, Socialism and Democracy 3rd edn (originally publ 1950, repr London, Routledge, 1992) 84. 16 DJ Teece and M Coleman, ‘The Meaning of Monopoly: Antitrust Analysis in High-Technology Industries’ (1998) Antitrust Bulletin 801.


23

Furthermore, recoupment of predatory losses is obviously threatened by a paradigm shift.17 The implication of this analysis is that competition law is largely unnecessary: new economy monopolists are fragile and exclusionary tactics are unlikely to be successful. Moreover, competition law intervention may even be counterproductive: if industry develops at such quick speeds, then it is more difficult for the competition authorities to impose remedies that improve competition—there is an obvious regulatory lag between the anticompetitive act and the imposition of a penalty and therefore conditions may have changed by the time the competition authorities are able to intervene.18 A related point is that the dynamism of the market is caused, in great part, by the possibilities of the winner making profits. One concern is that with heavy handed regulation the incentives to invent new products will diminish significantly. This argument applies especially to requirements that a dominant firm grant access to its ‘essential facilities’ which can work as a tax on innovation. Finally, even if one were to concede that network effects exist, these effects are demand led and therefore have increased consumer welfare. If so, where is the antitrust problem? Moreover, when considering remedies, how can one be sure that the remedy will not lead to a less efficient provision of services? Take the AOL example used above—the Commission is concerned if the owner of popular Internet content enters the market for service provision, yet arguably could there be synergies in this vertical integration? On this view, the competition authorities should not attempt to recreate perfect competition market structures, as these may not be the most efficient in promoting consumer welfare.19 In sum, under a neo-Schumpeterian model, new economy firms with large market shares have little incentive to exploit consumers, because these will quickly find a substitute, and little incentive to damage rivals, because such tactics will be counterproductive. Thus, dominance is rare in new economy markets. Moreover, even assuming there is dominance, the role of competition law remedies is questioned: the remedy may arrive too late, and the market may have already cured itself; alternatively, the remedy may give firms less incentives to develop new products, reducing consumer welfare.

17 Ibid 18 Ibid

at 810. at 803. They also add that the markets are complex and this makes intervention even more risky. This point cannot be accepted—every market is complex, so that cannot be an argument against intervention. 19 C Ahlborn, DS Evans and AJ Padilla, ‘Competition Policy in the New Economy (2001) European Competition Law Review 156, 160.

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C.

The Response of the Authorities

The competition authorities so far have sided with the neo-structuralists. Mario Monti’s position is that ‘even if the pace of high technology sectors means that market failures last only for a short time—and I have serious doubts about this—this does not mean that we should be less concerned’.20 Similarly, the former Chairman of the Federal Trade Commission, Robert Pitofsky, said that it would be ‘naïve’ to conclude that there is no role for competition law when market power is based on intellectual property; rather competition law is flexible enough to play a role in regulating the new economy.21 In his view, a firm with demand-side economies of scale and high consumer switching costs due to network effects can make market power more durable.22 This rhetoric is matched by actions—most notably the high profile lawsuit against Microsoft, but also a number of other investigations into the risks of dominance in new economy markets. In the three parts that follow we review how competition law analysis has been adapted to apply to new economy markets, following the structure of analysis under Article 82: market definition, dominance and abuse. In each section we reveal how the neo-structuralist model has been applied and the criticisms of that model by the neo-Schumpeterians. One theme running through these sections will be why the neo-Schumpeterian position has failed to gain acceptance.

2.

RELEVANT MARKET ANALYSIS

Market definition focuses upon consumer needs and identifies what products consumers could switch to if the products under scrutiny became more expensive and whether suppliers might enter the market with little time delay. According to the Commission’s Notice on Market Definition, the emphasis is upon demand substitution, using empirical and econometric evidence to identify product markets.23 This approach should not change when considering new economy markets, so long as the special characteristics of the industry are taken into account.

20 M

Monti, ‘Competition and Information Technologies’ (18 September 2000). Pitofsky, ‘Antitrust and Intellectual Property: Unresolved Issues at the Heart of the New Economy’ (2001) 16 Berkeley Technology Law Journal 535–36. 22 JD Balto and R Pitofsky, ‘Antitrust and High-Tech Industries: The New Challenge’ (1998) 66 Antitrust Bulletin 583, 585; R Pitofsky, ‘Challenges of the New Economy: Issues at the Intersection of Antitrust and the New Economy’ (2001) 68 Antitrust Bulletin 913. 23 EC Commission Notice on the Definition of the Relevant Market for the Purposes of Community Competition Law [1997] OJ C/372/5. 21 R


25

In this section we examine the approach to defining markets in two decisions: AOL/Time Warner and WorldCom/Sprint. In the former, the Commission faced the difficulty of determining whether the delivery of online music, an emerging mechanism of distribution, could be considered a relevant product market. In the latter the Commission analysed whether top-level Internet Service Providers (ISPs) were distinct from lower-level ISPs. From a neo-structuralist perspective the market definitions are convincing; however a neo-Schumpeterian perspective would criticise these market definitions as unnecessarily narrow, for two reasons: first in AOL/Time Warner the Commission failed to deploy the correct econometric methodology favouring a set of factors that make little economic sense; secondly while the market definition in WorldCom/Sprint is more persuasive, it fails to take into account the dynamic nature of the new economy. These critiques are not unprecedented: the EC has long been accused of defining certain markets too narrowly.24 In addition to these criticisms, it will be argued that the AOL/Time Warner decision seems to adopt an unnecessarily narrow definition of the market for policy reasons—the wish to regulate the development of the on-line industry. A.

On-Line Music

In AOL/Time Warner, the Commission found a market for on-line music, distinguishing between on-line music and other sales channels. However, at first sight it is difficult to see why the on-line music market should be isolated from the market for the sale of music in general. The merged entity would hold between 30 and 40 per cent of music publishing rights and the general risk identified by the Commission was: One entity controlling such a sizeable music catalogue could exercise substantial market power, by refusing to license its rights, or threatening not to license them, or imposing high or discriminatory prices and other unfair commercial conditions on its customers wishing to acquire such rights (such as Internet retailers offering music downloads and streaming).25

The approach is problematic in two respects—first because it is unclear whether from the perspective of consumers’ on-line music is a separate market. On the demand side the Commission pointed out that consumers have immediate access to music. This may be so, but as most people like to listen to music in places other than their computer chair, they will still need

24 V

Korah, An Introductory Guide to EC Competition Law and Practice 7th edn (Oxford, Hart Publishing, 2000) 84–85. 25 AOL/Time Warner above n 10, para 47.

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to go out and buy some blank CDs to burn the music on. The fact that they can download single tracks is also unconvincing on its own—it points to a physical difference, but says nothing about whether this difference would affect consumer choice. That special hardware needs to be obtained to download on-line music but does not show that on-line music is a separate market. On the supply side, it is true that the structure of music supply on-line is different for the supplier, but this does not make the two markets separate for the consumer, and it is the consumer perspective which should determine the relevant product market. The fact that the prices of CDs have not decreased as a result of on-line supply of music can be explained by the fact that the level of Internet penetration is low, and that not all consumers will use the Internet to download music—some will simply not see it as a viable ‘market’ for purchasing music.26 However, the recent losses reported by record companies are a sign that pirate copies downloaded on-line have had a negative impact on sales of CDs, indicating that the two markets are substitutable, not separate. Lastly, the Commission also noted that on-line supply of music was an emergent market, but it does not follow that it should be a separate market.27 It is also worth noting that the Internet distribution channel is not always seen as a separate market—for example in Telefonica/Terra/ Amadeus28 the Commission thought that an on-line travel agency was in the same product market as traditional travel agencies. However, it is difficult to see why buying music on-line is so different from buying music from shops, whereas buying a travel ticket from the web is the same as going to a travel shop. In sum, the first criticism which may be levelled at the Commission’s Market Definition in this case is that it eschews the methodology propounded in the Notice on Market Definition (under which the emphasis should be upon whether consumers, on the basis of econometric evidence, find on-line music supply a separate market) in favour of a general, subjective evaluation based exclusively upon product characteristics. This approach is particularly unhelpful in the new economy because high technology products are all highly differentiated but may still be considered as substitutes. Thus, as Pleatsikas and Teece observe, the traditional approach

26 M Haig, ‘A Battle for the Future of Digital Music’ The Independent (20 August 2001) review s 8. 27 AOL/Time Warner above n 10, para 21. 28 Decision of 28 April 2000 (text in Spanish available from ). To be fair, there was no need for the Commission to analyse market definition in depth because even under a narrow market definition it would have concluded that no dominance was likely to result; moreover the Commission noted that the markets may change and a reassessment of the relevant market may be warranted (para 12 of the decision).


27

to market definition does not reflect the manner of competition in new economy industries.29 The second criticism is that the Commission’s principal concern does not seem to be that the merger would lead to higher prices for consumers, but that it would foreclose entry by potential competitors. There are two ways through which an owner of substantial music content could foreclose entry on the on-line music market. First, if a lot of on-line music is formatted with one proprietary standard, then the owner of that technology can control the development of music player software by not licensing this technology unless the software manufacturers promise not to support other technologies; in addition other music publishers will find it necessary to format their music according to the technical standard of the leading firm, which would act as a gatekeeper. Second, a large music publisher could also enter the downstream market and format its music to fit its own music player, thus eliminating other music player software.30 The Commission’s market definition therefore seems to be policy oriented, because it allows the Commission to find dominance in the market for on-line music and by allowing it to prevent the creation of such dominance, the Commission can protect the development of competing technological alternatives and prevent the foreclosure of emerging markets. These considerations were articulated expressly when the Commission blocked mergers in the field of digital pay TV in the German market, noting that technological progress would be adversely affected if the dominant programme supplier on digital pay TV were to join forces with the dominant supplier of technical services for pay TV.31 Arguably, the narrow market definition does allow the Commission to regulate the development of technical standards in emerging markets, and also the development of this emerging industry. Whilst this is laudable, it is questionable whether this is something to be achieved by competition law through a narrow market definition in a merger case. The narrow market definition is used as a means to an end—it allows for the creation of new markets and protects those that are developing new technologies (here software manufacturers).

29 C Pleatsikas and D Teece, ‘New Indicia for Antitrust Analysis in Markets Experiencing Rapid Innovation’ in J Ellig (ed), Dynamic Competition and Public Policy (Cambridge, Cambridge University Press, 2001) 112–17. 30 Note similar fears about the development of the pay TV market in Germany if the merger in Deutsche Telekom/BetaResearch [1999] OJ L/53/3 were to be allowed: paras 33–34 (concerns that BetaResearch’s d-box technology would become the digital standard); paras 35–36 (concerns over the development of new technology); paras 37–39 (concerns that all new operators would be dependent on BetaResearch’s licensing policies). See 28th Competition Report (1998) paras 96 and 141. 31 Bertlesmann/Kirch/Premeire [1999] OJ L/53/1 passim, but esp paras 119–22. Again, one could question whether digital pay TV is in a separate product market from terrestrial TV.

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If the concern is about standards and about access by new entrants, then these seem to be issues best left to regulation rather than to competition enforcement. A regulatory body specifically charged with overseeing the industry would be a more direct and effective means through which to safeguard the interests of market participants. In the United States, similar concerns about the market for Internet music and the development of player software have led to legislative proposals to reform the copyright laws. These proposals also stemmed from increased vertical integration between record companies and on-line music distributors and are designed to make it easier for other on-line companies to obtain licences to sound recordings, providing further that the record companies may not dictate the use of any particular digital music player.32 B.

Top-Level Internet Service Providers

In mergers of Internet Service Providers (ISPs), the concept of network effects has been deployed to aid the process of market definition. For the Internet to work, there has to be an infrastructure that allows for computers to communicate with one another and for communication lines to allow for worldwide connectivity—this infrastructure works like this:33 consumers contract with ISPs to gain access to the Internet, and ISPs enter into contracts with each other to ensure that their customers can communicate with customers of other ISPs. Now, it would be quite expensive and time consuming for an ISP to enter into commercial relations with all other ISPs, especially given the entry of new competitors. To facilitate the process, the market has evolved so that there are a group of ‘top-level’ ISPs and a smaller ISP can merely contract with one of these to allow its customers to access all other Internet users.34 The top-level ISPs have high capacity transmission facilities and ‘peering’ arrangements among themselves whereby they receive traffic from other top-level ISPs free of charge. The smaller ISPs enter into so-called ‘transit’ arrangements with one of the toplevel ISPs, for which there is a charge, in exchange for which the smaller ISPs can offer their customers universal access to the Internet. Thus, the infrastructure is hierarchical and top-level ISPs are in a separate market. This is supported by the finding that most Internet communications are carried over top-level networks.35 32 Music

Online Competition Act 14 HR 2724 107th Cong § 4(b). For comment see A Davie and C Soares, ‘The Music Online Competition Act of 2001: Moderate Change or Radical Reform?’ (2001) Duke Law and Technology Review 0031. 33 This analysis is taken from WorldCom/MCI [1999] OJ L/116/1 and US v WorldCom and Sprint complaint by the Department of Justice (26 June 2000) . The analysis in the two jurisdictions is very similar. 34 DOJ WorldCom/Sprint ibid para 22. 35 DOJ WorldCom/Sprint ibid para 27.


29

Figure 2.2 The analysis by the EC and US Authorities sees a market where the consumer wishing to connect to an ISP can either connect directly to a Tier 1 ISP or to a Tier 2. If he chooses to connect with a Tier 2 ISP, it is necessary for the Tier 2 ISP to be connected to a Tier 1 ISP so that the customer can connect to all other internet users.

With this perspective, top-level Internet service provision is a separate market, so if one firm owned all or a substantial part of the top-level, it would hold a dominant position. This conclusion is sustained by the theory of network effects—an Internet consumer will prefer to join an ISP which will guarantee universal connection and if universal connection is only available if the consumer can contact directly or indirectly, the top-level ISPs, then the first tier is a compulsory partner for any ISP and indirectly, for any Internet user. In fact, the EC Commission concluded that a dominant top-level firm would own a network which could be characterised as an ‘essential facility.’36 Crucial to this analysis was the finding that the Internet only works hierarchically. As the Department of Justice’s (DOJ) analysis makes clear, the market has evolved so that it works in a hierarchical manner because it is convenient. But the real question to be asked is whether, if the top tier firms raise prices, the shape of Internet communications would change—for

36 WorldCom/MCI

above n 33, para 126 (the DOJ did not use this theory in their complaint).

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example, could not all communications be re-routed to lower tiers? The DOJ answered this question in the negative. It stated that top-level ISPs have two advantages: a cost advantage because they have peering relationships with other top-level ISPs and therefore do not need to buy transit in order to provide universal service connection. In addition lower level ISPs exchange traffic at inferior public interconnection facilities, whereas the larger ISPs own private interconnection facilities meaning data transmission is more secure. Consequently, the fewer the number of network connections connecting to a large top-level network, the fewer the cross-network connections.37 Moreover, as the EC Commission pointed out, the cost of lower level routing of all Internet communications would entail a lot of connections, each carrying very low levels of traffic, so the connections would not be cost effective. In addition, even if the lower level ISPs managed to create a sub-network, this would not provide universal access because the customers of the top-level ISP could not be connected unless a transit arrangement was entered into with the top-level ISP.38 Thus, for universal connectivity, contact with the top-level is needed and no supply substitution is readily available. This is a laudable application of economic evidence to the market and stands in stark contrast to the less rigorous approach in AOL/Time Warner. This carefully constructed analysis by EC Commission and DOJ shows that network effects can be deployed to define the relevant product market. However, the rejoinder from the advocates of dynamic markets is that the above market analysis is already out of date. There have been at least two developments that challenge the identification of top-tier ISPs as a separate market. First, the cost of alternative routing has become cheaper, consequently peering at lower levels of the Internet hierarchy is now economical.39 Second, corporate users now resort to multi-homing: purchasing connections from more than one provider. The impact of this is that top-tier ISPs are no longer a compulsory partner for much Internet traffic and an economic study has noted that these developments have had the effect of reducing the bargaining advantage of the tier 1 ISPs.40 These observations cast some doubts over the accuracy of using network effects to decide upon market definition. The difficulty is that the approach is unduly static, which some have said is unsuitable in markets where there is rapid innovation, because it will lead to unnecessarily narrow markets.41

37 DOJ WorldCom/Sprint above n 33, paras 27–30. 38 WorldCom/MCI above n 33, paras 75–76. 39 The new routing standard is known as BGP4. 40 Besen et al, ‘Advances in Routing Technologies &

American Economic Review 292. 41 Pleatsikas and Teece above n 29, 131.

Internet Peering Agreements’ (2001) 91(2)

Article 82 EC and New Economy Markets C.

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Structuralism Prevails

The two decisions considered above illustrate that the Commission favours a structural approach to defining markets. Why have the neoSchumpeterian criticisms not found a place in the competition law analysis of the Commission? There seem to be two reasons. First, it is difficult to translate the commission’s economic insights into rules of market definition— how can one take rapid innovation (which necessarily occurs in the future) into account when determining the relevant product market? Moreover, this kind of consideration can be taken into account at the next stage, when assessing dominance, for long-term supply substitutability is considered fully at that stage in Article 82 cases. 42 The second reason is that if the definition of the market is policy-driven, then the analysis will shun all evidence that contradicts the narrow market definition which aids the Commission in targeting a market it is concerned about.

3.

DOMINANCE

A firm is dominant if it has a high market share which is protected by barriers to entry. This is a structural approach which allows the court to infer dominance.43 Direct proof of dominance would require evidence of monopoly prices maintained over time, but this would be hard to obtain and may not be the way in which dominance manifests itself, specifically because dominance need not be absolute, it is merely ‘a position of economic strength enjoyed by an undertaking which enables it to prevent effective competition from being maintained on the relevant market by giving it the power to behave to an appreciable extent independently of its competitors, customers and ultimately of its consumers’.44 This is significant because it does not tally with an economist’s conception of monopoly—in EC and US antitrust law there can be some competition in a market dominated by one firm and dominance is the power to defeat that competition, not to ignore it.45 Therefore, to prove dominance, the competition authorities have to show that the firm is likely to be able to defeat the challenges posed by potential competitors. Dominance in most

42 EC Commission Notice on the Definition of the Relevant Market above n 23, paras 23–24. 43 US v Microsoft 253 F 3d 34 (DC Cir 2001) (en banc). 44 Case 27/76 United Brands [1978] ECR 207 para 65. 45 Similarly, Faull and Nikpay (eds), The EC Law of Competition (Oxford, Oxford University

Press, 1999) paras 3.25–3.30; Judge Wyzanski in US v United Shoe Machinery 110 F Supp 295 (DMA 1953) also thought that monopolisation for the purposes of s 2 of the Sherman Act merely required the power to exclude competition.

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cases is thus based upon the combination of high market shares and high barriers to entry.46

A.

The Traditional Test: Market Shares Plus Entry Barriers

For most products, market shares can easily be calculated by looking at the level of sales.47 However in other markets the calculation of market shares may require different means of measurement. In markets for Internet services, for example, the Commission used revenue and traffic flows to determine market shares.48 Given the speed of market developments, the relevance of market shares can be questioned—if dominance is ‘fragile’ as the neo-Schumpeterians claim, then the relevance of market shares diminishes considerably. As Ahlborn, Evans and Padilla put it: ‘imagine what Nokia’s market share would be two years from now if it left innovation to Ericsson, Siemens, Motorola or any of a dozen of firms with the technical capacity to create mobile phones with a greater number of functionalities: it would plunge irremediably’.49 However, it must be recalled that market shares are not the exclusive measure of dominance.50 Barriers to entry, as will be shown below, are as important; consequently this criticism on its own is not tenable. In the Microsoft case, the barrier to entry which the court found was labelled an ‘applications barrier to entry’.51 Consumers want to buy an operating system for which a large number of applications have already been written and developers of applications prefer to write for an operating system that has a substantial consumer base—the upshot is that once Microsoft has such a large market share for its operating system, then applications writers will prefer to write applications for Microsoft, further consolidating its dominance. This conclusion rests on the theory of indirect network effects, although it is not a real network where consumers speak to each other, but a virtual network, created by consumer demand.52 It is an indirect network effect because the utility of each user increases as the number of users increases because the more users, the more applications

46 Although

other factors will also come into play. These are set out in Faull and Nikpay above n 45, paras 3.73–3.84. 47 Eg Microsoft’s 95% share of the market for Intel-compatible operating systems. US v Microsoft 84 F Supp 2d 9 (DDC 1999) (Findings of Fact). 48 WorldCom/MCI above n 33, paras 104 ff. 49 Ahlborn et al above n 19, 162. 50 See eg Case 85/76 Hoffmann La Roche [1979] ECR 461; Case C–62/86 AKZO [1991] ECR I–3359. 51 US v Microsoft above n 47, 19–24. 52 Ibid, 20.


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will be written for the operating system, and the greater the number of applications, the greater the utility of consumers. It leads to dominance because an application written for one operating system is not compatible with other systems. The fact that Microsoft had created this network effect through superior marketing and excellent product design does not remove the fact that the network effect placed Microsoft in a dominant position. The Microsoft court defined entry barriers as ‘factors … that prevent new rivals from timely responding to an increase in price above the competitive level’.53 As in all competition cases, barriers to entry were looked at using a short-run analysis.54 This short-run analysis, coupled with a static approach to market definition has been criticised as inappropriate in new economy markets where it is said that long-run fears of technological paradigm shifts that render contemporary technology obsolete loom large in the minds of fragile monopolists. As a result, neo-Schumpeterians have suggested several alternative approaches to analysing dominance, which are reviewed below.

B.

Neo-Schumpeterian Definitions of Dominance

Two alternative approaches have been suggested to modify the test of dominance to better reflect the realities of new economy markets. One author has suggested three points which should be borne in mind when deciding whether a firm is dominant: (1) the existence of competing networks as opposed to simply competing products; (2) the history of innovation in the industry, with special attention to the rate of innovation; (3) barriers to innovation rather than barriers to entry.55 Competing networks can provide the same uses to consumers and should be included in the product market, a history of innovation in the market can serve to undermine the probative value of a large market share, and low barriers to innovation can allow new products to supplant existing standards, like CDs did for vinyl discs or the VHS standard did for Betamax. A barrier to innovation could be defined as a factor which makes innovation more costly for the new

53 Above n 43, referring to S Pac Communications Co v AT&T 740 F 2d 980, 1001–2 (DC Cir 1984). The court expressly refused to decide whether a barrier to entry should be identified when rivals face higher costs than the incumbent, or whether it exists when rivals face the same costs as the incumbent. The court simply found that even adopting the narrower definition of entry barriers, Microsoft did not face the same costs as new entrants because: (1) Microsoft did not face an incumbent dominant firm when it introduced its operating systems (although it did face a highly uncertain market and it did manage to create substantial consumer demand for its product) and (2) the cost to Microsoft of an upgrade from say Windows 95 to 98 was lower than the introduction by a new firm of an operating system. 54 Approved by the Court of Appeal, above n 43. 55 Note ‘Antitrust and the Information Age’ (2001) 114 Harvard Law Review 1623.

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entrant than for the incumbent, for example if all research facilities are owned by the incumbent, or the unavailability of a distribution channel for new products.56 The examination of competing networks is clearly of value, but applying this to the Microsoft case, it can be seen that the court did consider potentially competing networks, but rejected these as unlikely to pose a threat to Microsoft. The argument that such potential networks should be included rests upon the assumption that entry is speedy, but the court found that it would only be in the long run that competing networks could enter.57 The history of innovation, for example, past displacement of market leaders,58 is not all that useful, because the rate of innovation does not follow any set pattern in any industry. Barriers to innovation are useful only insofar as one is able to predict that the new product will supplant the existing incumbent. This is a very speculative exercise. To find simply that there are a number of products that could challenge the pre-eminence of the ‘PC plus operating system’ paradigm, that innovation here is occurring at frenetic speeds, and that there is current investment in alternatives to Microsoft’s operating system, does not allow a judge to conclude that Microsoft will not be dominant in the near future. Barriers to entry analysis is much less speculative—the court already knows that there is consumer demand for the product and if another person can offer it, then the new entrant will be successful. The main weakness of this proposal is that it requires the courts to speculate upon future events in the market. This need not make the suggestion worthless, but the facts show that Microsoft has been dominant for several product generations and no new product has been able to eat away at its dominance for so many years. Even if we were to concede that its dominance is now waning, this could affect the remedy that is chosen by the courts, but not the conclusion as to dominance. Of course, the suggestion above might be more applicable in other markets where it is easier to prove that market innovations are regularly threatening the incumbent’s position, but such regular threats can already be covered by the short-run barrier to entry analysis. Another way of measuring dominance in new economy markets was suggested by Richard Schmalensee at the Microsoft trial.59 In his view, the structural approach is inappropriate in dynamic markets where market boundaries are not well defined. In these markets, what is important is to assess whether a firm is fragile, hence market definition and market shares

56 Ibid 1638. 57 Above n 47, p 14 58 R Schmalensee,

ff. ‘Antitrust Issues in Schumpeterian Industries’ (2000) 90 American Economic Review (Papers and Proceedings) 192, 194. 59 Direct Testimony of RL Schmalensee, Direct Testimony of 3 January 1999 available at: (visited 4 February 2002). See also Schmalensee above n 58.


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are not as important. Instead, a behavioural approach should be adopted which identifies: (1) constraints that limit the ability of firms to behave anticompetitively; (2) whether the accused firm acts like a firm with monopoly power. The examination of constraints is similar but more expansive than the barriers to entry analysis, considering past, present and future constraints of market power. Applying this standard, Microsoft faced competition first from its past behaviour (in that consumers who had bought earlier versions of its operating system would have to be persuaded to buy the upgrade); in the present, higher prices would increase the risks of piracy and lead to some consumers to buy other goods; and as for the future, Schmalensee identified a number of firms that were Microsoft’s potential competitors for the long run. On this basis, the structure of the market does not only include Intel compatible operating systems and on either the structural or behavioural approach, Microsoft lacks monopoly power. In considering Microsoft’s behaviour, Schamlensee said that its prices were much lower than the monopoly prices that Microsoft could have charged if it were a monopolist. Moreover, in the context of Microsoft’s tactics to exclude Netscape, the relevant question is whether Microsoft would be able to recoup the costs of its predatory strategy in the long run, a possibility precluded by the existence of many other potential competitors.60 This approach is also speculative in that by focusing on long-run possibilities defendants can always claim that there will be threats to dominance. Moreover, it would require a considerable change of direction for EC competition law. The Commission would have to examine the market in the long run, whilst at present only short-run constraints are examined, and it would have to amend the concept of abuse to require a finding that the abuse is likely to create a monopoly. This explicitly is not the case in predatory pricing in the EC,61 and is not a requirement for other types of abuse either (for example refusal to supply). Furthermore, the approach does not fit within the methodological approach taken in dominance cases, either under the Sherman Act or the EC Treaty, for it confuses the concepts of abuse and dominance. However attractive these neo-Schumpeterian alternatives may seem, they share two features which makes their adoption unlikely by competition authorities: they require great faith in time curing many anticompetitive risks and consider that what is anticompetitive about dominance is only the ability to exploit consumers. These two perspectives contrast with the approach to competition that is taken today: the principal concern is the

60 This

is supported by Brooke Group v Williamson 509 US 209 (1993) which requires proof of the possibility of recoupment following predatory pricing. 61 Case C–333/94P Tetra Pak 2 [1996] ECR I–5951 expressly refuses to include recoupment.

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Giorgio Monti

unlawful suppression of competitors and because this is the main concern, a short-run analysis of the market is more suitable. The fact that dominance may be eroded five years from today by market forces will not stop antitrust action if the authorities perceive that with some regulation dominance can be eroded more quickly; the authorities will also take the view that by preventing a dominant firm from prolonging its dominance, they are promoting innovation. Consequently, the above suggestions are problematic in two respects: they are difficult to put into practice (because of speculation about long-term effects) and are inimical to the type of antitrust culture that exists at present. 4.

ABUSE

The abusive behaviour which most worries the competition authorities in new economy markets is that exercised against potential competitors. In the EC context this has traditionally been the case, witness the formulation of abuse in one frequently cited passage: [B]ehaviour … [which] has the effect of hindering the maintenance of the degree of competition still existing in the market or the growth of that competition.62

The concern here is not with higher prices, but with exclusionary conduct by the dominant firm. Below we review three types of exclusionary strategies which might be checked by Article 82: protecting dominance; refusal to co-operate with competitors; extension of dominance to new markets. 63 Neo-Schumpeterians find it hard to work out why these exclusionary tactics are a problem: so long as these tactics exclude less efficient competitors, consumers do not suffer and more efficient competitors will be able to enter the market because a paradigm shift will transfer power to the holder of the new technology. As the three examples of abuse below demonstrate, the neo-Schumpeterian view of the aim of competition law is not accepted by the courts keen to protect market access for competitors.

A.

Protecting One’s Dominant Position

The most well known case representing this kind of abuse is Microsoft. The US courts found the company guilty of exclusionary conduct designed to

62 Hoffmann La Roche above n 50, para 91. 63 Space precludes a comprehensive review, but

it is hoped that the examples selected offer a representative survey of the types of legal and economic issues that arise.


37

maintain its monopoly by preventing the distribution of potential competitors’ products. This has been achieved inter alia by attempting to prevent the Netscape browser from gaining a significant foothold in the browser market. Microsoft’s reason for preventing the establishment of a competing browser was not so much so that it could dominate the browser market with Internet Explorer, but because a browser is another means of access to applications. If applications are written to work with a particular browser, then it does not matter which operating system the consumer is using, so long as she has the browser in question. If Netscape were able to circulate enough copies of its browser to attract applications designers to write applications for it, then the Netscape browser could provide a competitive threat to the Microsoft operating system monopoly, because it would not matter which operating system people bought so long as they could run Netscape.

Figure 2.3

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Giorgio Monti

Before the entry of browsers, Microsoft’s applications barrier to entry made it hard for a competing operating system to enter the operating systems market. If Netscape Browser gains a significant foothold, then it does not matter what operating system consumers have, they will access applications through the browser. This would make the operating systems browser more competitive. Microsoft achieved its aim by foreclosing the most cost effective ways by which Netscape might have been able to place its browser onto many consumers’ PCs and promoting its own browser, Internet Explorer. The two most cost effective ways of promoting a browser are to have it pre-installed on a PC or to have Internet access providers promote a browser. Microsoft used contractual and technological means to ensure that Original Equipment Manufacturers (OEMs) pre-installed Internet Explorer to the exclusion of other browsers and entered into agreements with Internet access providers whereby many promoted Internet Explorer on an exclusive basis. The upshot is that Netscape was prevented from entering the browser market using the most cost effective ways because of Microsoft’s actions,64 thereby foreclosing any possibility for Netscape to challenge the Operating System monopoly. On these facts the same conclusion would have been reached under EC competition law.65 One additional circumstance in this kind of scenario, noted by the EC Commission in Tetra Pak 2 and the court in Microsoft, was that attempts by a dominant firm to bind purchasers to its products were aggravated in a market characterised by rapid technological development: this slows the evolution of competing technologies, both by existing competitors and by potential investors in new technologies.66 However, it might be argued that if Netscape’s strategy had been successful, then everyone would wish to have the Netscape browser in order to access the largest range of applications. On this basis, it might be legitimately argued that the welfare effects of shifting from ‘operating system dominance’ to ‘browser dominance’ are non-existent because one is simply replacing one dominant firm with another. Moreover, it may be argued that it is more efficient to have an operating system with an integrated browser. However, recall that competition in network industries is territorial—the undertaking is competing for the market, not in the market. Consequently, if Netscape is allowed to compete for the network, this will give incentives to other firms to compete Netscape’s future dominance away, or conceivably a new operating system could be devised that runs applications more efficiently than a

64 Microsoft

also carried out similar actions to exclude Java but the legal reasoning is analogous to that deployed when considering Netscape and will not be reviewed here. 65 See Tetra Pak 2 above n 61. 66 Tetra Pak 2 [1992] OJ L/72/1; Microsoft above n 47, 111–12.


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browser and the market might then shift back to operating systems. The anticompetitive nature of the acts by Microsoft his not only in the fact that by preventing the emergence of a successful browser it protects its dominance in the operating system market, but also that such tactics thwart innovation by other competitors. One possible market outcome if Netscape had been allowed to enter the market unobstructed could have been the creation of two competing networks—like in video games where multiple standards exist. Microsoft’s licensing practices in the EC during the early 1990s can also be seen as attempts to safeguard dominance: Microsoft forced OEMs to pay royalties for Windows on every PC sold, regardless of whether or not Microsoft software was loaded. As many consumers wanted Windows loaded on the machine, OEMs were forced to deal with Microsoft, but its licensing practices discouraged OEMs to install competing software packages. Microsoft subsequently undertook to amend its licensing practices.67 It has been argued that it is important to prevent these tactics because they also foreclose innovation.68 Thus, a neo-structuralist approach does not deny the dynamism of markets, but is concerned about maintaining dynamism in the market. The neo-structuralism that prevailed in Microsoft is also evidenced by the Court of Appeal’s approach to the question of causation. Here, the plaintiff was unable to prove that but for Microsoft’s conduct the operating system market would have been competitive, but held that the causation inquiry should simply address whether (1) the exclusion of new threats is a type of conduct reasonably capable of contributing to monopoly and (2) whether Navigator and Java constituted such a nascent threat. Significantly for the purposes of this discussion, the court said: ‘it would be inimical to the purpose of the Sherman Act to allow monopolists free reign to squash nascent, albeit unproven, competitors at will—particularly in industries marked by rapid technological advance and frequent paradigm shifts’.69 On this view, the court believes that the dynamic nature of industry is a reason for higher, not lower antitrust scrutiny because the more dangerous innovations are for incumbent, the greater the incentive to eliminate competitors. Thus the suggestion that the courts should instead require proof that the practices of the dominant firm are likely to be successful in consolidating dominance in order to establish liability (as Schmalensee would suggest) is inappropriate because it would not allow competition law to safeguard innovation.

67 Undertaking of 15 July 1994 (see Commission’s Press Release of 68 M Dolmans, ‘Restrictions on Innovation: The EU Antitrust

17 July 1994). Approach’ (1997–98) 66

Antitrust Law Journal 455. 69 Microsoft above n 43. The same low standard of causation is applied in EC Law: see Faull and Nikpay above n 45, paras 3.131–134.

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In sum, the neo-structuralist approach adopted by the authorities is designed to ensure participation by new entrants and to safeguard the potential for future innovation rather than relying on innovation to demolish the dominant firm. The Microsoft decision has affected Microsoft’s stance in its negotiations with Kodak. Microsoft’s new operating system, Microsoft XP, contains digital photography software and Kodak (who also developed such software) complained that Microsoft would give unfair preference to its software at the expense of Kodak. Microsoft has now agreed that when consumers plug in their digital cameras they will be able to select a variety of services (including Kodak’s) and will not be led to choose Microsoft’s software.70 Critics of this analysis posit that the line distinguishing anticompetitive conduct and aggressive competition has been drawn inaccurately. Klein for example suggests that the better way to test whether Microsoft’s practices were abusive is to examine their effect on consumers and whether the practices were efficient.71 On this analysis he suggests that both Netscape and Microsoft were able to compete for distribution of their browsers through Internet access providers but that Netscape failed to keep up with Microsoft’s efforts. Moreover he notes that Microsoft’s practices merely raised Netscape’s distribution costs but did not make entry prohibitively expensive. Combined with the fact that consumers benefited from a more advanced product manufactured by Microsoft, the tactics used should not be declared anticompetitive. In this light, competition law seems to have been used to protect a competitor. This again illustrates the differences between a neo-structuralist and a neo-Schumpeterian view of new economy markets: according to the former, there is competition and innovation if many firms are able to participate actively in the marketplace, according to the latter, there is competition so long as the incumbent feels sufficiently threatened by potential competition that it takes steps to innovate and increase the quality of its product so as to keep competitors out. The fact that innovation is carried out by Microsoft and not by other firms is not of concern to a neo-Schumpeterian, but is of concern to those adopting a neostructural approach.72 A neo-structuralist interpretation of the competition laws seems therefore to embrace considerations of distributive justice.

70 M Pesola, ‘Kodak Persuades Microsoft on XP Photo Changes’ <www.ft.com> (13 August 2001). Although there are still controversies. See P Spiegel, ‘Microsoft gives in to Kodak’ <www.ft.com> (14 August 2001). 71 B Klein, ‘Did Microsoft Engage in Anticompetitive Exclusionary Behaviour?’ (2001) 46 Antitrust Bulletin 71, 108. 72 Eg FM Fisher,’Innovation and Monopoly Leveraging’ in J Ellig (ed) Dynamic Competition and Public Policy (Cambridge, Cambridge University Press, 2000) 1156–57. A related criticism of the neo-structuralist analysis of Microsoft is the emphasis they place on Microsoft’s intention to damage competitors; however intention is generally irrelevant as a means to establish an infringement of competition law.

Article 82 EC and New Economy Markets B.

41

Obligations to Co-operate with Competitors

The presence of network effects in many new economy industries can lead to claims that the holder of a dominant network has an ‘essential facility’ which gives rise to obligations to make this available to other market players. For example, the Commission hypothesised that a single firm dominating the top level of Internet connectivity would control an essential facility to which all lower level ISPs would have to connect;73 a duty to collaborate with lower level ISPs can be imposed by analogy with the case law on refusals to supply,74 and is comparable to the undertaking offered by IBM to the Commission in 1984 where it agreed to provide advance technical information to manufacturers of computer peripheral products to allow them to manufacture competing peripheral equipment.75 The Commission has identified a number of other bottlenecks where the dominant incumbent must co-operate.76 Similarly, in an indirect network scenario, the dominant supplier of on-line music which combines the distributional might of AOL’s ‘on-line outlet’ will become a compulsory partner for other music companies. Moreover, if AOL develops a technological standard for downloading music it could impose this standard on others, and ‘because of its control over the relevant technology the new entity would be in a position to control downloadable music and streaming over the Internet’.77 Here too, liability may be imposed for a refusal to co-operate with other firms wishing to participate in markets that require access to the AOL network.78 The duty of dominant firms to co-operate with other market participants has been set out in a controversial line of cases under the headings ‘essential facilities’ or ‘refusal to supply’. Even before the advent of the new economy, this jurisprudence was criticised from three perspectives: as an intrusion into the commercial freedom of undertakings; as a tax on

73 WorldCom/MCI above n 33. 74 The refusal to deal and the ‘essential

facilities’ case law address the same point and no distinction need be drawn between them for the purposes of this discussion. The difference between the two concepts was identified by AG Jacobs: in essential facilities cases a duty to supply arises because of the facility held and is not related to any other action by the dominant firm (eg discontinuation of supplies to existing customers). Case C–7/97 Oscar Bronner [1998] ECR I–7791 para 50. For a recent review see B Doherty, ‘Just What Are Essential Facilities?’ (2001) 38 Common Market Law Review 397. 75 Fourteenth Report on Competition Policy (1984) paras 94–95. 76 Eg telecoms markets in Germany and France (Atlas [1996] OJ L/239/23); transatlantic cables (BT/MCI II [1997] OJ L/336/1); technical and administrative services in the pay TV market (MSG Media Services [1994] OJ L/364/1); digital pay TV markets (Bertelsmann/Kirch/ Premiere above n 31). 77 AOL/Time Warner above n 10, para 56. 78 On analogy with US v Associated Press 326 US 1 (1945). The same principle underpins the case law on Art 86 where the ECJ condemns the grant of two conflicting rights that create a conflict of interest (eg Case C–260/89 ERT [1991] ECR I–2925).

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firms that innovate (for their incentive to innovate is dented by the fact that they are subsequently forced to share their discoveries); and as often being concerned about protecting competitors rather than competition.79 Consequently, attempts have been made to limit its scope. Three points arise: first, which market players have a right to demand access? Second, what property is so essential that it must be shared? Third, can a duty to share be imposed when the property in question is protected by intellectual property rights? First, in terms of who has the right to seek access, EC competition law places no restriction on who can demand access so long as they can establish that the access to the dominant firm’s property is essential for them to enter the market. This is justified by reliance on the principle that the abuse of a dominant position does not have to be in a market where the dominant firm is present.80 In fact, Article 82(b) that identifies as an abuse ‘limiting production, markets or technical development to the prejudice of consumers’ makes no reference as to whether the dominant firm needs to be present on the market where the anti competitive effects occur. 81 In contrast, in the Intel case the US courts have placed a limit on the persons entitled to seek access to essential facilities. In this case Intergraph, a manufacturer of workstations for Intel-compatible computers, required access to technical information about new Intel chips so that its workstation could operate jointly with the Intel chip. Any refusal by Intel to communicate technical information in advance of the release of the new chip could seriously undermine Intergraph’s position because it would not be able to develop compatible software until after the release of the Intel chip. Intel arguably holds a dominant position in the market for microprocessors: on the FTC’s analysis it has an 80 per cent share of the market and high barriers to entry (eg large sunk costs of design and manufacture, economies of scale, the need of a new entrant to attract the support of software developers and reputation).82 When Intel refused to give advance technical information to Intergraph, the Court of Appeals found that the essential facilities doctrine could not apply because no court has taken it beyond the situation of competition with the controller of the facility, whether the competition is in the field of the facility itself or in a vertically related market that is controlled by the facility. That is, there must 79 See AG Jacobs in Bronner above n 74, paras 53–62. 80 ‘[T]here is no doubt … that an abuse of a dominant position

on one market may be censured because of effects which it produces on another market’. Case T–128/98 Aéroports de Paris v Commission [2000] ECR II–3929 para 164 (affirmed by the ECJ: Case C–82/01, judgment of 24 October 2002, not yet reported). 81 It has been suggested that the same result will not occur under section 2 because it is only concerned with monopolisation and not with abuses of monopoly power. 82 FTC Analysis of Proposed Consent Order to Aid Pubic Comment 17 April 2003 (available at <www.ftc.gov>).


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be a market in which plaintiff and defendant compete, such that the monopolist extends its monopoly to the downstream market by refusing access to the facility it controls.83

On the facts, Intel was not competing with Intergraph and no duty to supply was found. However, it is submitted that competition between plaintiff and defendant should not be a sine qua non for liability: the same anti-competitive effects can arise for example, if the dominant firm only supplies to one undertaking downstream, then that one undertaking will hold a dominant position and a refusal to supply another creates dominance downstream. Another type of anticompetitive effect could arise if some companies develop a totally new type of software that Intel has objections to—if Intel makes it impossible for the market for this new software to be created, then the market does not evolve. In this context there may be a loss of consumer welfare and possibly a diminution of innovation. In addition, if the refusal to supply one firm is as a means to another end,84 then again, the courts should be ready to see an anticompetitive effect.85 Second, the duty to supply is only required when the facility held is truly essential. This requires adequate market definition and an appropriate definition of when facilities are essential. We have noted above that sometimes the market definition appears to be too narrow, which may overstate whether a facility is truly essential by excluding potential substitutes, and in defining ‘essential’ the court in Bronner held that a refusal to supply may be unlawful only if (1) it is likely to eliminate all competition in the relevant market on the part of the undertaking requesting the service, and (2) the service is ‘indispensable for the requesting undertaking’s business’.86 The second limb is appropriately narrow, indeed the ECJ went on to say that to characterise a facility as indispensable one would have at least to establish that it is not economically viable to duplicate it, either alone or in collaboration with others.87 However, the first limb is worrying because it does not require that competition in the market be eliminated—only that competition from the requesting undertaking be eliminated.88 However, the

83 Intergraph 84 Intel had a

v Intel 195 F 3d 1346 (Fed Cir 1999). longstanding intellectual property dispute with Intergraph that led to Intel’s lack of co-operation. The FTC forbade Intel from using the IP dispute as a justification for refusing advance access to relevant information (see FTC above n 82). 85 Analogous with the refusal to resume supplies to disobedient distributors in United Brands above n 44. 86 Bronner above n 74, para 41. But against AG Jacobs at para 65 holding that the dominant firm must also have dominance on the related market. 87 Above n 74, para 46. 88 Against Doherty above n 74, 427, who says that if there are other competitors who are not eliminated by the refusal, this just means that the facility held by the dominant firm is not essential because there are alternative suppliers. But if this were so then the two requirements are unnecessary, while para 41 of Bronner clearly envisages two conditions.

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elimination of a competitor does not mean that the market is then monopolised; what one should look for is the effect on competition in general. The Advocate-General’s reasoning in Bronner (comparable to the CFI’s definition in European Night Services89) is preferable, requiring proof that it is ‘extremely difficult not merely for the undertaking demanding access but for any other undertaking to compete’.90 Confined to such limits, and combined with an appropriate market definition, refusals to co-operate will only breach Article 82 when there is a tangible effect on competition. This limitation would also bring EC law more in line with US antitrust. The third issue, which is of particular importance in new economy markets, is whether the duty to co-operate can extend to situations when the defendant’s ‘essential facility’ is protected by intellectual property rights. Insofar as EC competition law is concerned, this is not a major issue: the jurisprudence is such that the exercise of intellectual property rights falls under the scope of EC law and the court in Magill had no qualms in finding that when the circumstances warrant it, an order to license IP rights could be made.91 However the case law is not particularly clear as to whether the criteria for imposing a duty to share IP rights are stricter than those for other property rights. The recent decision in Bronner failed to resolve this point conclusively. The argument is still open that for a licence of IP rights, the claimant has to fulfil the Bronner requirements and also establish that the refusal prevents the appearance of a new product for which there is consumer demand and that the refusal would exclude all competition in a secondary market.92 It seems difficult to justify a different treatment for IP rights. The policy of the ‘essential facilities’ doctrine is to prevent foreclosure of markets, and the ECJ does allow for a defence of ‘objective justification’ which, as will be explored in the following section, can be used by defendants to justify the non-imposition of a duty to share when this would have the effect of stifling innovation. A similar controversy has affected the application of the essential facilities doctrine to IP rights in the United States. While some writers take the view that the doctrine should apply to IP rights without any differentiations, some courts

89 ‘[A]

product or service cannot be considered necessary or essential unless there is no real or potential substitute’ Joined Cases T–374/94, T–375/94, T–384/94 and T–388/94, ENS [1998] ECR II–3141 para 208. 90 Above n 74, para 66 (emphasis added). 91 Joined Cases C 241 and 242/91 P RTE and ITP v Commission [1995] ECR I–743. 92 I justify this reading by reference to para 41 of Bronner where the court considered whether ‘the case law on the exercise of an intellectual property right [is] applicable to the exercise of any property right’. This indicates that there may be two separate tests. Case T–504/93 Tiercé Ladbroke SA v Commission [1997] ECR II–923 also suggests two tests at para 131: either the product is essential for the exercise of the activity in question or it is a new product whose introduction might be prevented despite consumer demand. For a view that there is a single, unified test set out in Bronner see: F Fine, ‘NDC/IMS: A Logical Application of the Essential Facilities Doctrine’ (2002) 23 European Competition Law Review 457.


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have restricted the application of the doctrine to cases where the patent holder is seeking to use his rights to extend his monopoly into another market.93 All this suggests that while the policy arguments in favour of imposing an obligation to co-operate with competitors are based upon the desire to prevent market foreclosure, the case law is still incoherent—at times the case law goes too far and protects individual competitors and not the process of competition (eg the first limb of the Bronner test); while at times the law is too restrictive, showing a tendency to limit the scope of obligation only to cases where the holder seeks to extend the dominance into new markets. The reason for the unsettled state of the law is probably due to concerns that by imposing too extensive an obligation to share, innovation would be stifled. Here, some of the neo-Schumpeterian concerns appear to have influenced the decisions of the court. However it is submitted that these concerns are best addressed more openly by seeking a mechanism to balance the competing demands of market access and innovation. Section 5 charts a possible approach.

C.

Extending Dominance

A related strategy by a dominant firm is to use ‘its monopoly power in one market to gain a competitive advantage in another’.94 Three examples of leveraging in the new economy case law have been canvassed. First, such a possibility was noted in the Internet markets by the Department of Justice: a dominant top-tier ISP would be able to enter the market for new internet services and exclude other ISPs—for example by developing a proprietary protocol for voice over the Internet, which only its subscribers can use. This tactic has anti-competitive effects in two markets: first it will further undermine the position of other ISPs and will drive more consumers to join the dominant firm;95 second, it will also have an anti-competitive effect in the market for voice transmission over the Internet because there will only be one firm supplying it. Second, the Commission’s current investigation of Microsoft also rests upon the theory of leveraging. Microsoft is suspected of refusing to disclose

93 Contrast LA Sullivan and WS Grimes, The Law of Antitrust (St Paul, MN, West Publishing, 2000) 848–53 with the ruling in CSU and Others v Xerox 203 F 3d 1322 (Fed Cir 2000), criticised for failing to strike a balance between IP and competition law by R Pitofsky ‘Challenges of the New Economy: Issues at the Intersection of Antitrust and Intellectual Property’ 68 Antitrust Law Journal 913, 2001. 94 Berkey Photo v Eastman Kodak 603 F 2d 263, 276 (2nd Cir 1979)—no requirement of dominance in second market, whilst some circuits require acquisition of monopoly in second market (eg Alaska Airlines v United Airlines 948 F 2d 536 (9th Cir 1991) ). 95 DOJ WorldCom/Sprint above n 33, para 46.

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information about its operating system (where it has a dominant position) to developers of server software, preventing the possibility of developing software that works on a computer with a Windows operating system. The accusation is that Microsoft is attempting to extend its dominance in the market for servers as well. The press release by the Commission notes that Microsoft did not refuse to disclose such information to everyone, but that it disclosed it on a discriminatory basis, according to a ‘friend–enemy’ scheme.96 Third, using the concept of ‘tipping’, the DOJ considered that a dominant top-level ISP could try to drive the customers of competing top-level ISPs firms away from them by lowering the quality of the services offered to competing ISPs.97 This would make users of lower level ISPs migrate to the top-level, where connectivity is better. Top-level ISPs may also raise the price of transit agreements, costs which lower level ISPs would pass on to consumers who would then switch to the top-level ISP who would be offering lower rates.98 As the Commission pointed out, the top-level ISP could pick off competitors one by one and take over the market gradually.99 This theory of liability might apply by analogy with Aspen Skiing—the owner of certain ski slopes who refused to continue to co-operate with the neighbouring owner of fewer ski slopes in the expectation that skiers would prefer to buy its ski pass for a greater number of slopes.100 This strategy made it more difficult for the smaller operator to attract skiers. None of these scenarios may merit the imposition of liability. As for the first, if a company creates a new service; which consumers want, it would be inefficient to penalise the provision of that service; furthermore, the exclusion of others from that market should be seen as the reward that the firm deserves for creating the new service. On this basis the analysis of the DOJ is flawed for failing to take into account innovation. The reason for heightened scrutiny is the theory of network effects, which might suggest that a dominant network holder can very easily become dominant in a related market: in the example of voice over the internet, if two ISPs develop proprietary technology but one has a larger network, that firm’s technology will prevail. This prevents competition over technological standards. However, if a dominant firm wins the race to produce the next generation of products because of network effects and with a somewhat inferior product, this is not necessarily an anticompetitive outcome.101 In fact, the dominant firm has not done anything to harm competition.

96 EC Commission Press Release, 3 August 2000. 97 DOJ WorldCom/Sprint above n 33, para 35. 98 Ibid paras 40–41. 99 MCI/WorldCom above n 33, paras 120–22. 100 Aspen Skiing v Aspen Highland Skiing 472 US 585 101 Teece and Coleman above n 16, 816.

(1985).


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This makes the DOJ’s analysis hard to sustain.102 Moreover, it is not clear what competition law can do to remedy this situation. Similarly, the Commission’s evidence against Microsoft does not (yet) make it clear whether there has been harm to competition in the server market or whether there has only been harm to Sun Microsystems (one of the firms which did not receive information about the operating system software). In the US for example, the Federal Court of Appeals takes the view that leveraging requires an anticompetitive effect in the second market.103 This requirement is necessary—the sheer fact that a dominant firm can enter another segment of the market should not in itself be objectionable unless consumers suffer. The third scenario is also one which seems to protect competitors rather than competition—if the dominant ISP wanted to increase its profits it would be able to raise the transit charges—thus vertical integration would not raise prices or reduce output any more than if the dominant firm raised transit charges.104 In these cases, the neo-structuralist approach leads to the protection of competitors without any apparent benefit to competition in general as the anticompetitive effects are assumed to result from the exclusion of rivals.105 It may be doubted whether there will be many leveraging cases which fall outside the scope of the essential facilities doctrine. To date the antitrust authorities prefer to prevent the possibilities of leveraging through merger control, by ensuring that the market structure does not facilitate the extension of monopoly power.

5.

AN INNOVATION DEFENCE?

The review of how the concept of abuse might be deployed in the new economy demonstrates the pre-eminence of neo-structural analysis: dominant

102 In

California Computer Products v IBM 613 F 2d 727 (9th Cir 1979) the court refused to impose liability on IBM when it introduced a new line of computers that integrated the central processing and memory units, causing disk drives losses to manufacturers. 103 Intel above n 83. 104 The analysis borrows from Hovenkamp’s sceptical treatment of leveraging claims in Federal Antitrust Policy (St Paul, MN, West Publishing, 1994) 284. The decision in Aspen (above n 100) may be justified because the refusal to co-operate reduced consumer welfare by removing an existing product (a four mountain ski pass) from the market. However, my analysis of the third scenario might be challenged by considering the facts of the Kodak case (Eastman Kodak Co v Image Technical Services 112 S Ct 2072 (1992) ) where after denying independent repairers access to its spare parts, Kodak raised the price of the spare parts it supplied directly to consumers. 105 In the US this follows from the reasoning in Aspen Skiing (above n 100) and Kodak (above n 104) as summarised in Data General v Grunman Sys Support Corp 36 F 3d 1147, 1183 (1st Cir 1994): ‘a monopolist’s unilateral refusal to deal with its competitors (as long as the refusal harms the competitive process) may constitute prima facie evidence of exclusionary conduct in the context of a Section 2 claim’.

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firms are not allowed to safeguard their positions by unlawfully excluding other market players, nor may they extend dominance to other markets and must even co-operate to support other market participants.106 It has even been suggested that in new economy industries the duty to co-operate will encourage innovation by fringe firms who will be confident of being able to interconnect with the goods or services of the dominant firm.107 However, as noted above in some cases the authorities at times are protecting competitors and not competition, resulting in an unjustifiably aggressive policy. More fundamentally, from a neo-Schumpeterian perspective, all impositions of duties to co-operate, and all restrictions on business expansion are suspect, for two reasons: first, even if it appears that competition is being suffocated, dominance may be overthrown quickly (the fragile monopoly point again); second, the imposition of cooperative obligations dents the incentive of undertakings (dominant and non-dominant) to develop new products knowing that they will be forced to share the fruits of their investment. To a certain extent, the restrictive interpretation of the essential facilities doctrine in Intel may be a response to these concerns. The first objection can be countered by setting a strict definition of whether co-operation with the dominant firm is necessary.108 If technical innovations can quickly surmount the entry barrier created by the network effects, then co-operation is unnecessary. The second objection, about eliminating the incentives to innovate is an important one: too expansive a duty to co-operate and a too far-reaching restriction on extending one’s market to new products can act as a tax on innovation and retard future developments. To date this concern has not been addressed fully—while intellectual property rights are offered as a reward for innovative activity by the incumbent, there is no rule of law that balances the risk that a dominant firm may foreclose market access with the potential benefits which might accrue to society if the dominant firm is left unregulated. One possible way of taking into account the pro and anticompetitive effects of practices carried out by dominant firms in the new economy is by drawing on Teece and Coleman’s suggestion that before imposing liability for breach of competition law, there should be proof that liability will not impede aggregate innovation in the industry.109 This would ensure dynamic efficiency is not killed off by the enforcement of the antitrust laws. In what

106 In certain contexts access to essential facilities is regulated by statute (eg Art 9 of Dir 97/33 [1997] OJ L/199/32; s 251(c) of the Telecommunications Act 1996). 107 JB Baker, ‘Promoting Innovation Competition Through the Aspen/Kodak Rule’ (1999) 7(3) George Mason Law Review 495. 108 As noted above the ECJ’s definition is still too wide. 109 Teece and Coleman above n 16, 838.


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follows, I consider two questions: first, how an ‘efficiency defence’ might work; and second, whether it would be juridically acceptable within the framework of Article 82.110 The way the innovation defence would operate is to require the decision maker to consider whether the imposition of liability or an obligation to co-operate with competitors would have the effect of stifling innovation and whether this effect would outweigh the foreclosure effects of the anticompetitive activity. In considering whether innovation would be stifled, one would have to consider both innovation on the part of the defendant, and also more generally how other firms might be affected by the judgment—law after all is an incentive mechanism and the potential repercussions on imposing liability in one instance will be felt by others in a similar position to the defendant.111 There are some easy cases where the innovation defence would fail, for example Magill. As AG Jacobs observed, the copyright protection afforded to the information in Magill was hard to justify ‘in terms of rewarding or providing an incentive for creative effort’. Here it would be impossible for the defendant to justify a refusal to co-operate with competitors on the basis that it would stifle innovation. Marginal cases will be more difficult to resolve as current economic theory has no suggestion for how to balance the incentives to invest with the costs of abuse of dominance.112 However, a precise balance is unnecessary and a qualitative analysis will suffice—for example, applying the innovation defence to the Intel scenario, Intel’s non participation in Intergraph’s market means that granting the latter access would not diminish Intel’s economic incentives to develop new products; in fact, by allowing others to develop complementary products, demands for Intel goods should rise. This kind of approach will be criticised as being too imprecise to be workable, but it does address the need to ensure that competition and innovation are both safeguarded. Moreover, this method can be justified on three grounds. First, the lack of a precise cost benefit analysis is not a fatal weakness (for example we are quite happy to tolerate this in the context of the duration of an IP right: while IP rights are designed as an incentive to innovation,113 the level of protection is not set on a case by case basis (as it should be to provide perfect incentives) but there is a standard level available

110 For

a formal model along these lines which considers the balance between static and dynamic efficiency at the remedy stage, see Shelanski and Sidak above n 9. 111 This point is one which is recognised in English common law. See the discussion of the majority and the dissenting Law Lords in Donoghue v Stevenson [1932] AC 562 as to the potential impact of imposing negligence liability on manufacturers. 112 For a demonstration of how malleable the arguments are, see RM Brunell, ‘Appropriability in Antitrust: How Much is Enough?’ (2001) 69 Antitrust Law Journal 1. 113 R Posner, Economic Analysis of Law 5th edn (New York, Aspen, 1998) 43.

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whether you patent a new safety mechanism that saves thousands of lives or a new toy for toddlers). Second, it is more legitimate to try to ensure that competition law is applied so as to maximise competition and innovation by trying to measure the potential effects of imposing liability than to draw arbitrary lines to distinguish the lawful from the unlawful, as is currently the case in the field of essential facilities. Third, the type of imprecise balancing process recommended above is not uncommon in legal reasoning: it occurs also in applying the exemption in Article 81(3) EC and the efficiency defence in merger cases;114 and it is, like common law reasoning, partly subjective and impressionistic.115 Through pragmatic decision making a reliable set of precedents will allow for the evolution of imperfect but workable criteria for assessing the consequences of imposing a duty to share on dynamic efficiency. Juridically, the innovation defence could be used as an additional objective justification under Article 82. This places the burden of proof on the defendant, who must demonstrate that his abusive conduct is necessary and proportionate to preserve incentives to innovate, and that this outweighs the potential reduction in competition.116 The value of innovation is recognised in Article 157 EC and Article 82 should be interpreted purposively so as to ensure that the aims of the Treaty are met. This defence will be able to counter the aggressive use of the essential facilities doctrine as well as counter leveraging claims.

6.

REMEDIES

Remedies must ‘unfetter a market from anticompetitive conduct’.117 Achieving this in new economy markets is complex. Usually the Commission issues a cease and desist order plus a fine.118 The order may put at an end the enjoined practice, but does not prevent the deployment of other, equally anticompetitive practices119 and the level of fines set by the

114 On the basis of Art 2(1)(b) of Reg 4064/89 as amended by Reg 1310/97. Consolidated text at [1997] 5 CMLR 387. See eg Bertelsmann/Kirch/Premiere [1999] OJ L/53/1 paras 119–22. 115 It is not unlike consequentialist reasoning by the English courts. See N McCormick, Legal Reasoning and Legal Theory rev edn (Oxford, Oxford University Press, 1994) chs 5 and 6, esp 101–16. Space precludes further discussion at this time, but it is submitted that competition law rules cannot be derived purely from economic tests which are absolutely true or accurate—consequently at the margins where the controversy is significant, the decision maker has to rely upon a subjective perspective and rest the decision upon settled legal principles. 116 This is contrary to the suggestion by Teece and Coleman (above n 16) for whom the burden of proof should be on the competition authority. 117 Ford Motor Co v US 405 US 562, 577 (1972). 118 See Arts 3(1) and 15 of Reg 17/62 OJ Sp Ed [1962], no 204/62. 119 Eg the legal wranglings over Microsoft’s 1995 consent decree: US v Microsoft 147 F 3d 935 (DC Cir 1998).


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EC may not deter many undertakings,120 although the possibility of treble damages in the US may offer adequate deterrence. Moreover, a fine will often not be the most direct way of remedying the anticompetitive situation. Consequently, the Commission will often require that the dominant firm act in a specific way (eg licensing IP rights or entering into collaborative relations with undertakings). Such orders, like the recent interim measures in IMS Health,121 or the decision in Aéroports de Paris,122 require the dominant firm to co-operate with other undertakings in a way which is nondiscriminatory and commercially reasonable. The parties fix all terms by agreement, but in cases of disagreement (eg as to the level of royalties) an independent expert will be appointed to fix the terms of the agreement. These positive obligations, provided they can be implemented in a timely fashion,123 are a more effective and direct way of preventing future anticompetitive conduct. Perhaps the most eagerly anticipated remedy requiring co-operation is the recently concluded Microsoft consent decree. In brief, this obliges Microsoft to ensure that competitors have access to the market (for example preventing Microsoft from forcing Original Equipment Manufacturers (OEM) to exclude competing products), and to disclose information to aid interoperability between its products and those of competitors.124 According to the judge the latter was in the public interest because ‘such disclosure has the potential to increase the ability of competing middleware to threaten Microsoft’s Operating Systems monopoly’.125 In addition the enforcement order provides for the setting up of a committee to enforce the final judgment, aided by a technical committee. The judge praised this order for being ‘forward looking’ and designed to eliminate the effects of Microsoft’s illegal conduct. However, even though the decree will only last for five years, it seems as if this kind of forward looking enforcement might be best left to a permanently appointed regulator who can intervene when necessary. Competition law remedies seem ill suited to guide the market in a forward looking manner. In complex network markets, one issue which has been of concern to the Commission in merger cases is the separation of complementary functions—the owners of content are not allowed to own the means of

120 Department

of Trade and Industry, A World Class Competition Regime, July 2001, Cm 5233 Box 7.3. 121 Press Release IP/01/1232, 3 July 2001. 122 Above n 80. 123 The risk of delay in new economy markets is particularly problematic. 124 US v Microsoft, final judgment of 12 November 2002 (available at <www.usdoj.gov>). 125 US v Microsoft, US District Court for District Columbia, 1 November 2002 (Kollar-Kotelly J) (available at <www.dcd.uscourts.gov>).

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distribution of that content. The reasoning to justify this concern is either: (1) if a firm owns two segments of the market, this raises barriers to entry for newcomers who would also have to own both segments; (2) one of the segments may be an essential facility, in which case the holder has an inherent interest in favouring its content and will discriminate against others.126 In merger cases, divestiture is not too controversial a remedy because the parties will agree to this or refuse to merge. The Commission has devoted considerable efforts to prevent vertical integration in network sectors like media and telecommunications using the merger regulation and Article 81(3) EC127 and has also imposed obligations on undertakings that are vertically integrated to ensure non-discriminatory access to other market participants.128 In the merger cases in media and telecommunications, the Commission often states that preventing such vertical consolidation is intended to allow the new markets to grow on a competitive basis.129 More problematic is divestiture ex post, when an undertaking is accused of abusing its dominant position. In US law divestitures have been ordered infrequently,130 while the EC has only recently obtained the power to divest.131 In contemplating divestiture, two matters should be grasped: when this remedy should be imposed and how the firm should be divested. Only the first question will be addressed here.132 As a matter of law divestiture must be necessary to restore an acceptable level of competition. Consequently, the remedy should be imposed only if there is no less restrictive remedy that would achieve broadly similar results. If a less restrictive remedy offers as good a competitive effect as divestiture, it is submitted that the less restrictive remedy should be selected, because the risks of an unsuccessful divestiture are so high (viz the new companies may not be successful, the market as a whole may not function as effectively, innovation is retarded, loss of economies of scale) that antitrust authorities should be satisfied with an outcome that reintroduces some competition, even if it is a second best. At a practical level, the authority must consider the time lag 126 On 127 See

analogy with ERT above n 78. generally MJ Reynolds, ‘Article 81 and the Merger Regulation: Breaking the Network Access Bottleneck’ in CD Ehlermann and L Gosling (eds), European Competition Law Annual 1998: Regulating Communications Markets (Oxford, Hart Publishing, 2000), 387. 128 The type of regulatory effort here is analogous to that in the telecoms field. See for similar analysis in the context of broadband services: P Kremmyda, ‘Walled Gardens? Cable Provided Broadband Internet and Competition Law’ (2001) 24 World Competition 181. 129 See eg Bertelsmann/Kirch/Premiere above n 31. 130 E Gellhorn, Antitrust Law and Economics 4th edn (Minnesota, West Publishing, 1994), 134–36. 131 Art 7 Council Reg no 1/23 of 16 December 2002, [2003] OJ L/1/1, 4 January 2003. 132 The second is mostly a matter of economic analysis of specific factual situations. For analyses supporting the divestiture of Microsoft into two firms, see Romer’s and Shapiro’s submissions at Romer, 27 April 2000, and 4642.htm Shapiro, 28 April 2000, respectively.


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between the proposal of this remedy and its final imposition: the firm is likely to raise several legal challenges that are likely to delay the implementation making it uncertain whether the proposed divestiture will still be effective when it can finally go ahead. This practical consideration probably influenced the DOJ’s decision not to seek a divestiture of Microsoft, considering that a prompt but effective behavioural remedy was preferable.133 These considerations suggest that it will only be in exceptional circumstances that divestiture should be called for. However, it is submitted that in those rare cases where an undertaking is so powerful that no fine or behavioural order is likely to restrain its powers or avoid anticompetitive effects, it may be more effective to establish a system of public regulation—this would avoid any loss of synergies that a break-up may engender and would also allow for a more coherent and flexible means of ensuring competitiveness as well as other social goals. This was recognised by the DOJ in the WorldCom/Sprint merger where it noted that if one firm became the dominant top-tier ISP, ‘restoring the market to a competitive state often requires extraordinary means, including some form of government regulation’.134 To a certain extent some of the remedies imposed in merger cases, in cases of essential facilities, and in the Microsoft case, are already regulatory in nature, suggesting that competition law principles are being over-stretched.135

7.

CONCLUSION

The new economy creates markets that require different economic tools to examine the behaviour of undertakings. Economists agree as to the aims: maintaining competition and promoting innovation, but disagree on how these should be obtained: non-enforcement according to neo-Schumpeterians, more aggressive enforcement according to the neo-structuralists. In litigation, this debate continues as defendants deploy neo-Schumpeterian arguments and plaintiffs follow the dictates of the neo-structuralists. The competition authorities in the EC and US have preferred the neo-structuralist approach, which explains both their preference for narrower market definitions, which seek to ensure the proliferation of participants in new economy markets, and its preference for a structural analysis of dominance. The courts on the whole have backed this approach.

133 On

6 September 2001: . The DOJ was already embarrassed when after 13 years of trying to divest IBM, it gave up realising that market forces had made the divestiture unnecessary. 134 Above n 33, para 41. 135 For further elaboration of this theme see P Larouche, Competition Law and Regulation in European Telecommunications (Oxford, Hart Publishing, 2000).

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Neo-Schumpeterian concepts are unlikely to gain favour, for two reasons: first, a lot of optimistic speculation about future market developments is required; second, neo-Schumpeterians take a narrower view about the aims of competition law—damage that dominant firms can do to other undertakings is irrelevant unless it can be shown that there will be loss to consumer welfare in the long run as a result of the acts of the dominant firm. However, current competition law is concerned with the elimination of competitors per se, observing that this carries the risk of the dominant firm being alone on the market or deterring new entrants.136 Thus, neo-Schumpeterian ideas do not fit easily within the current competition law culture, and their theories do not fit within the analytical framework of Article 82 EC. The task for neo-Schumpeterians is to translate their economic theories into workable legal models. One suggestion which this chapter has made which might facilitate the integration of neoSchumpeterian concepts in competition law analysis is to develop an innovation defence which would force the courts to consider the impact of Article 82 decisions on the incentives to innovate more openly than is done at present. In spite of the authorities’ aggressive stance, firms have escaped with little financial sanctions. Microsoft for example escaped liability in spite of committing flagrant breaches of the Sherman Act, but may yet face private lawsuits.137 Instead, the authorities have focused on ex post behavioural remedies and ex ante divestitures. As some authorities have recognised, these types of remedies turn competition law into a market regulator, a task for which it is not well equipped. These developments suggest that the focus on neo-structuralism by the authorities aims to regulate the new economy to afford market access for all participants, rather than to deter dominant firms with large fines. Competition law here is forward looking in seeking remedies that remove dominance by facilitating the entry of others. Whether or not this goal should be achieved through Article 82, a more pressing question is whether this policy will eliminate incentives to innovate, frustrating the dynamism of new economy markets.

136 This

concern may also be grounded in a political concern about excessive power— R Pitofsky, ‘The Political Content of Antitrust’ (1979) 127 University of Pennsylvania Law Review 1051 and G Amato, Antitrust and the Bounds of Power (Oxford, Hart Publishing, 1997). 137 AOL is reported to be seeking damages. Financial Times (24 January 2002).

3 Abuse of a Dominant Position and Intellectual Property Rights: A Suggestion to Reconcile The Community Courts’ Case Law ESTELLE DERCLAYE*

T

HIS CHAPTER CONCERNS the application of Article 82 of the EC Treaty to intellectual property rights (IPR). The conditions1 when a refusal to license an IPR amounts to an abuse are obscure. As a matter of fact, the actual rulings by the European Court of Justice (ECJ) and the Court of First Instance (CFI) on the application of Article 82 to IPR are difficult to reconcile. Is there abuse if only one of the conditions identified by the ECJ are met, or do several have to be met? If the latter, are the conditions cumulative or alternative? Do they apply indistinctly to all forms of property? The recent IMS2 case clarifies the confusion that currently exists as regards the way the relationship between Article 82 and IPR must be regulated and provides an excellent illustration of the problem. The purpose of this chapter is to give a suggested way of reconciling the case law and thus clarify under which circumstances the holder of an IPR abuses its dominant position under Article 82.

* LLM, DES, Lecturer in Intellectual Property Law, Queen Mary Intellectual Property Research Institute, University of London. The author is most grateful to friends who carefully read and commented on a previous draft. She also wishes to thank the anonymous referees for their comments. All potential errors remain the author’s. 1 The words ‘conditions’ and ‘circumstances’ will be used as synonyms. The European Court of Justice in the Magill case originally used the term ‘circumstances’. However, the headings of the cases generally use the term ‘conditions of abuse’ and the literature refers to conditions and circumstances interchangeably: see eg V Korah, ‘The Interface Between Intellectual Property and Antitrust: The European Experience,’ (2002a) Antitrust Law Journal 801, 814; H Schmidt, ‘Article 82’s “Exceptional Circumstances” That Restrict Intellectual Property Rights’ (2002) 22 European Competition Law Review 210, 214. 2 Abbreviation of Intercontinental Marketing Services Health Inc. The shorter version (IMS) will be used throughout the chapter.

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The chapter is divided into three sections. After a short review of the conditions under which Article 82 applies, section one addresses the various decisions of the ECJ and CFI dealing with refusals to license by holders of IPRs preceding the IMS case.3 The facts will be first described, then the rulings. The analysis will show the existing confusion as to the circumstances in which there is abuse by an IPR holder. Section two discusses the IMS case. The case serves to illustrate further the confusion identified in section one. First, the facts of the case will be summarised. Then the rulings of the Commission and the President of the CFI will be explained, commented upon and contrasted. Section two concludes with remarks on the consequences that the conflict between the decisions entails. Section three suggests a way of reconciling the cases. It first develops the argument and then draws some consequences, including a preferred way of deciding the IMS case. A few arguments corroborating the suggested interpretation of the case law are finally given. In conclusion, it is hoped that the IMS case will be a catalyst for the court to clarify the conditions at which an IPR holder should be forced to grant a license.

1.

CONFUSION IN THE CASE LAW

The five conditions which trigger the application of Article 82 are as follows: there must be (1) any type of abuse (2) by one or more undertakings (3) in a dominant position (4) within the common market or a substantial part of it and (5) the abuse must actually or potentially affect trade between Member States. The area where most of the confusion lies in the case law is the first condition (abuse). The only requirement on which the discussion focuses is thus the notion of abuse. The other requirements (dominant position etc) will not be reviewed here. Article 82 lists a few examples of abuses. These examples do not form an exhaustive list.4 Abuses such as refusals to deal with a competitor are not 3 Constraints

of space prevent us making a detailed analysis of those cases. Therefore basic knowledge of the decisions will be assumed. For such an account, see eg E Derclaye, ‘Abus de position dominante et droits de propriété intellectuelle dans la jurisprudence de la Communauté européenne: IMS survivra-t-elle au monstre du Dr. Frankenstein ?’ (2002) 15 Les Cahiers de Propriété Intellectuelle 21, 26 ff and the comparative table, 54–55. For similar reasons, this discussion will not review the essential facilities doctrine nor criticise it. The substance of the doctrine can be summarised as follows: ‘An essential facility means one to which undertakings require access in order to produce goods or provide services for their customers, but which they could not reproduce themselves without prohibitive expense or inordinate delay’ (F Wooldridge, ‘The Essential Facilities Doctrine and Magill II: The Decision of the ECJ in Oscar Bronner’ (1999) Intellectual Property Quarterly 256). As a consequence, the dominant firm which refuses to supply an essential good or grant access to an essential facility to its downstream competitor(s) will be forced to do so by the competition authorities at a non-discriminatory price. 4 Case C–6/72 Europemballage Corp and Continental Can Co Inc v Commission [1973] CMLR 199, para 26. See also eg R Greaves, ‘The Herchel Smith Lecture 1998: Article 86 of the

Abuse of a Dominant Position and IP Rights

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listed, but the ECJ has since the 1970s included them within the scope of Article 82.5 There are at least two types of refusal to deal: refusals to supply and refusals to license.6 Refusals to supply seem to be connected to tangible property while refusals to license, to intellectual property. As refusals to deal are not listed in Article 82, the conditions under which such refusals will be abusive similarly are not listed. Thus a fortiori the conditions under which a refusal to license by the holder of an IPR is abusive are not mentioned either. However, the Community courts have decided that Article 82’s scope encompasses refusals to license and have, in a number of decisions, laid down conditions at which such a refusal is abusive. The remedy for an abusive refusal to license an IPR is to impose a compulsory license onto the holder of the IPR.

A.

Factual Background to the Case

There are four cases in which the ECJ and the CFI have elaborated conditions or circumstances in which an IPR holder will be forced, under Article 82, to grant a license to its competitors. In chronological order, these are: Renault, 7 Volvo, 8 Magill 9 and EC Treaty and Intellectual Property Rights’ (1998) European Intellectual Property Review 380; S Weatherill and P Beaumont, EU Law 3rd edn (London, Penguin Books, 1999) 845; R Whish, Competition law 4th edn (London, Butterworths, 2001) 150. 5 Cases C–6 and 7/73 Istituto Chemioterapico Italiano SpA & Commercial Solvents Corporation v Commission [1974] ECR 223; Case C–27/76 United Brands Continental BV v Commission [1978] ECR 207. 6 P Roth QC (ed), Bellamy & Child, European Community Law of Competition 5th edn (London, Sweet & Maxwell, 2001) n 9–092–110 do not make the distinction exactly as such but make an attempt to distinguish refusals to supply and refusals to license. The structure in which they discuss this area of the law is as follows: (v) refusals to supply; including (a) refusals to supply existing customers; (b) access to essential facilities; (c) refusals to supply in other circumstances and (vi) abuses of IPR. Whish above n 4, 611 ff only speaks of refusals to supply and classifies them in several headings similar to those of Bellamy & Child and also discusses abuses of IPR within a separate category (698). 7 Case C–53/87 Consorzio italiano della componentistica di ricambio per autoveicoli & Maxicar v Régie nationale des usines Renault [1988] ECR 6039. 8 Case C–238/87 AB Volvo v Erik Veng (UK) Ltd [1988] ECR 6211. On the Renault and Volvo decisions, see eg I Govaere, The Use and Abuse of Intellectual Property Rights in EC Law: Including a Case Study of the EC Spare Parts Debate (London, Sweet & Maxwell, 1996) 195 ff; V Korah, ‘No Duty to License Independent Repairers to Make Spare Parts: The Renault, Volvo and Bayer & Hennecke Cases’ (1988) European Intellectual Property Review 381; P Groves, ‘The Use of Registered Designs to Protect Car Body Panels’ (1989) Business Law Review 117. 9 Case T–69/89 Radio Telefis Eireann v Commission [1991] ECR II–485 and Case T–76/89 ITP v Commission [1991] ECR II–575 (both CFI’s judgments carry the same substance); Cases C–241/91 P and C–242/91 P Radio Telefis Eireann (RTE) & Independent Television Publications Ltd (ITP) v Commission [1995] ECR I–743. The literature abounds in comments on the decisions of the Commission, the CFI and the court, of which only a few will be mentioned here. B Sufrin, ‘Comment on The Magill Case’ (1992) Entertainment Law Review 67; A Reindl, ‘The Magic of Magill: TV Program Guides as a Limit to Copyright Law?’ (1993)

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Ladbroke.10 In addition, even if it does not deal with an IPR, the Bronner11 case is relevant to the analysis for at least two reasons. First, the court, to reach its decision in Bronner relied upon the above cited cases. Second, the Commission has heavily relied on that ruling to decide the IMS case.12 The facts of the cases can be summarised briefly as follows. In the Renault and Volvo cases,13 Renault and Volvo had design rights on their models for car body panels. They refused to grant a license of their design rights to independent repairers thereby preventing them from supplying spare parts. In the Magill case, the Irish and British broadcasters BBC, RTE and ITP,14 each respectively holders of copyright on their weekly television listings, denied Magill, an Irish publisher of comprehensive weekly television guides, a license to reproduce them. In Ladbroke, the French sociétés de courses, held copyright in the pictures and sound of horse races. They refused to grant to Ladbroke, a Belgian bookmaker, a license to rebroadcast French horse races live. Finally, in Bronner, Mediaprint, an Austrian newspaper publisher, refused to distribute the daily newspaper of another

International Review of Industrial Property and Copyright Law 60; C Miller, ‘Magill: Time to Abandon the “Specific Subject Matter” Concept’ (1994) European Intellectual Property Review 417; R Thompson, ‘Magill: ECJ Upholds Use of Article 86 to Control Conduct of Copyright Holders on Ancillary Markets’ (1995) Entertainment Law Review 143; R Greaves, ‘Magill est arrivé’ (1995) European Competition Law Review 244; S Taylor, ‘Copyright Versus Right to Compete: The Judgment of the ECJ in Magill’ (1995) Computer and Telecommunications Law Review 99; T Vinje, ‘The Final Word on Magill: The Judgment of the ECJ’ (1995) European Intellectual Property Review 297; H Calvet and T Desurmont, ‘L’arrêt Magill: une décision d’espèce ?’ (1996) 167 Revue Internationale de Droit Economique 3; Govaere above n 8, 135–50, n 5.47–5.67; S Anderman, EC Competition Law and Intellectual Property Rights: The Regulation of Innovation (Oxford, Oxford University Press, 1998) 204 ff. 10 Case T–504/93 Tiercé Ladbroke SA v Commission of the European Communities [1997] ECR II–923. See eg D Fitzgerald, ‘Magill Revisited’ (1998) European Intellectual Property Review 154; V Korah, ‘The Ladbroke Saga’ (1998) European Competition Law Review 169. 11 Case C–7/97 Oscar Bronner GmbH & Co KG v Mediaprint Zeitungs- und Zeitschriftenverlag GmbH & Co KG, Mediaprint Zeitungsvertriebsgesellschaft mbH & Co KG & Mediaprint Anzeigengesellschaft mbH & Co KG [1998] ECR 7791. For comments on the Bronner case, see P Treacy, ‘Essential Facilities—Is the Tide Turning,’ (1998) European Competition Law Review 501; F Wooldridge, ‘The Essential Facilities Doctrine and Magill II: The Decision of the ECJ in Oscar Bronner’ (1999) Intellectual Property Quarterly 256; M Bergman, ‘The Bronner Case: A Turning Point for the Essential Facilities Doctrine’ (2000) European Competition Law Review 59. 12 See Commission’s decision, analysed below and also C Stothers, ‘The End of Exclusivity? Abuse of Intellectual Property Rights in the EU’ (2002) European Intellectual Property Review 88. 13 The facts and rulings of the two cases are substantially the same; thus the cases will be discussed together. 14 ITP was not strictly speaking a broadcaster but ITV and Channel 4 had granted it their copyright in their television programmes. NB: copyright will be used throughout this article in its broad meaning, ie encompassing both civil law author’s right and common law copyright.


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smaller Austrian publisher, Oscar Bronner, through its national newspaper home delivery scheme. Only the broadcasters were compelled to give a license. In all the other cases, no compulsory license was forced onto the right holders. All cases have been decided by the ECJ except the Ladbroke case which was decided by the CFI.

B.

Conditions Required to Establish the Abuse

When is a refusal to license by the holder of an IPR an abuse? In other words, in what circumstances can a compulsory license be imposed onto an IPR holder? First of all, it is well established that the mere ownership and mere exercise of an intellectual property right (here, the mere refusal to grant a license) cannot in itself confer a dominant position nor consist in an abuse of such a position.15 Thus there will only be an abuse when the IPR is exercised in certain—exceptional—circumstances. These circumstances in which an abuse may be found have been laid down in the five cases. In the Renault and Volvo cases, the court did not set out circumstances in which a refusal to license is abusive, but merely gave non-exhaustive examples of abusive conduct resulting from the exercise of an IPR, namely: the arbitrary refusal to supply spare parts to independent repairers, the fixing of prices for spare parts at an unfair level and the decision no longer to produce spare parts for a particular model even though many cars of that model are still in circulation.16 As can be seen, the refusal to license was not even listed, but only the refusal to supply,17 and it was only cited as one example. No conditions were given at which such refusal was abusive. Thus, Renault and Volvo only set the scene for the more detailed ruling in Magill. Magill constitutes the first case in which the Court addressed in detail the conditions under which a refusal to license18 will be abusive. It stated that 15 See

eg Parke Davis & Co v Probel, Case 24/67 [1968] ECR 55. The ECJ recalls this principle in each of the above mentioned decisions whereas in Ladbroke, the CFI omits to do so. 16 Paras 9 of the Volvo decision and 15 of the Renault decision. 17 F Siiriainen, ‘ “Droit d’auteur” contra “droit de la concurrence”: versus “droit de la regulation” ’ (2001) Revue Internationale de Droit Economique 422 thinks that Volvo and Renault were not really concerned with a refusal to license but rather with a refusal to supply. However, it can be said that in effect, the car manufacturers’ refusal to supply amounted to a refusal to license, as it was not possible to make spare parts without having a proper license. 18 Some think that Magill is actually a case of refusal to supply raw materials (ie here information), not a refusal to license the reproduction of works protected by copyright, probably due to the fact that the copyright held by the broadcasters was on basic information. See M Van Kerckhove, ‘Magill: A Refusal to License or a Refusal to Supply?’ (1995) 51 Copyright World 26. However, it is to be noted that despite that fact, one cannot deny that there was copyright in the television listings and that strictly speaking it was a refusal to license (ie not to allow a third party to reproduce a copyright work).

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these conditions must remain exceptional. These are: (1) the prevention of the appearance of a new product which the IPR holder did not offer and for which there was a potential consumer demand, (2) the refusal is not justified and/or (3) the IPR holder reserves to himself a secondary market by excluding all competition on that market.19 In Ladbroke the CFI refined one of the conditions in Magill: a refusal to license will infringe Article 82 if it is a new product whose introduction might be prevented, despite specific, constant and regular potential demand on the part of consumers.20 However, it added a new alternative condition: a refusal to license will infringe Article 82 if it concerns a product or service which is essential for the exercise of the activity in question, in that there was no real or potential substitute.21 Finally the Court in Bronner set a tripartite test which combines conditions from Magill and Ladbroke: (1) the refusal of the service comprised in the home delivery must be likely to eliminate all competition in the daily newspaper market on the part of the person requesting the service; (2) such refusal cannot be objectively justified;22 and (3) the service in itself must be indispensable to carrying on that person’s business, in as much as there is no actual or potential substitute in existence for that home delivery scheme.23 As it transpires from this brief summary, it is difficult to know exactly under which conditions a refusal will be abusive and which conditions should be applied in subsequent cases.24 First, the conditions set down in the cases differ: some are restated in the same terms, others with a change in the wording, some are withdrawn, some are added. Second, there is uncertainty as regards whether the conditions should be applied in a cumulative or alternative way (and if so which ones). Indeed from the wording of the Magill ruling, it is impossible to know whether the Court intended the circumstances to be alternative or concurrent.25 In Ladbroke, the CFI

19 See paras 54–56 20 Para 131 of the

of the Magill decision. Ladbroke decision (emphasis added). This wording already appeared in its judgments RTE (para 62) and ITP (para 48) which were appealed to the ECJ in the Magill case. 21 Para 131 of the Ladbroke decision. 22 Emphasis added. The Court here adds to the Magill ruling by further qualifying the refusal. 23 Para 41 of the Bronner decision. 24 See eg P Landolt and J Ysewyn, ‘Intellectual Property Rights and EC Competition Law’ (2001) 111 Copyright World 19, 19 note that the cases decided by the ECJ and the CFI display a lack of finality. 25 The court’s wording in paras 54–56 is unclear. Upon reading para 54, it seems that the condition set out there is sufficient to establish abuse. However, the court goes on to enumerate other conditions in paras 55 and 56 without using the term ‘and’ to connect them. Finally, it concludes, in para 57: ‘in light of all those circumstances, the Court of First Instance did not err in law in holding that the appellants’ conduct was an abuse of a dominant position within the meaning of Article 86 of the Treaty’. This final statement seems to infer that the conditions are cumulative but this is only speculation. The Commission sees the conditions as alternative,


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sets two alternative conditions. Ladbroke thus broadens the Magill ruling.26 Finally, in Bronner, the court takes the opposite stance and opts for a cumulative test. What happened in the IMS case? Not too surprisingly, the Commission on the one hand and the Presidents of the CFI and of the Court, on the other, made two different, and conflicting, interpretations of the case law.

2.

A.

AN ILLUSTRATION OF THE CONFUSION: THE IMS CASE

The Factual Background of the Case

In Germany, IMS27 provides reports informing pharmaceutical companies of regional sales of their pharmaceutical products. To provide this data, any provider must comply with the German data protection law and thus ensure that individual sales by any given pharmacy cannot be identified (at least three pharmacies must be grouped in a geographical zone, also called ‘brick’ or ‘module’, for which the data on the sales is given). In order to abide by German law, IMS has created a structure which divides Germany into 1860 modules. On the basis of its structure, IMS wrote reports on sales of pharmaceutical products and provided them to pharmaceutical companies. IMS claimed it had copyright on its structure as a

the President of the CFI, as cumulative. V Korah (2002a), above n 2, 810, 811 and 814, sees the Magill conditions as cumulative even if subsequent case law has suggested that they are alternative. Anderman above n 9, 209–10 and H Lugard, ‘ECJ Upholds Magill: It Sounds Nice in Theory, But How Does it Work in Practice?’ (1995) European Business Law Review 233, also wonder whether some of the Magill conditions are cumulative. F Fine, ‘NDC/IMS: In Response to Professor Korah’ (2002a) 70 Antitrust Law Journal 247, 251 believes that the conditions are alternative: ‘The President therefore read the factors listed in Magill as being cumulative, contrary to what subsequent case law—as even Korah confirms—tells us’. 26 V Korah (2002a) above n 2, 814. 27 On the IMS case see eg P Landolt

and J Ysewyn above n 24; D Paemen and C Norall, ‘IMS Health Reveals EC’s Steel Resolve’ (2001) Managing Intellectual Property, September, 60; Stothers above n 12; D Hull, J Atwood and J Perrine, ‘Intellectual Property and Compulsory Licensing’ (2002) European Antitrust Review 97; J Ratliff, ‘Major Events and Policy Issues in EC Competition Law, 2001: Part 2’ (2002) International Company and Commercial Law Review 64; R O’Donoghue and D Ilan, ‘Court Halts Commission Shake-up of Compulsory Licensing Rules for Intellectual Property’, (2002) 118 Copyright World 8–9; V Korah (2002a) above n 2; F Fine (2002a) above n 25; V Korah, ‘Essential Facilities and a Duty to License— IMS’ paper given at the Fordham Intellectual Property Conference, New York, 4–5 April 2002; J Temple Lang, ‘Comment on Professor Korah’s Paper: “Essential Facilities and a Duty to License—IMS” ’ (2002) paper given at the Fordham Intellectual Property Conference, 4–5 April 2002; F Fine, ‘NDC/IMS: What is the Real Subject Matter?’ (2002) 121 Copyright World 19; S Anderman, ‘Microsoft in Europe’ (2002) paper presented at the 2002 Fordham Conference; Derclaye above n 3, 21–55 (detailed account of the facts and of the several rulings in the case, 36 ff).

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database. In 1999, National Data Corporation Health Information Services (NDC) and Azyx Deutschland GmbH Geopharma Information Services (Azyx) 28 entered the German market by creating a structure which was compatible with that of IMSs. IMS sued NDC for infringement of copyright in its structure in Germany and won. 29 NDC then brought a complaint to the European Commission against IMS for abuse of dominant position because IMS denied NDC a license to use its structure. The Commission decided to oblige IMS to grant a license to all undertakings already present in the market.30 On IMS’s appeal (application for interim relief), the President of the CFI suspended the decision31 and the President of the ECJ confirmed the suspension.32

B.

The Decision of the Commission

First, the Commission established the relevant product and geographic market as being the market for services of data provision on regional sales of pharmaceutical products in Germany alone.33 Second, the Commission established that IMS has a dominant position.34 IMS is in a situation of quasi-monopoly because before NDC and Azyx’s entry on the market, it was the sole player on the market. The respective positions of NDC and Azyx were negligible. In addition, there was an effect on the commerce between Member States.35 As to the question of abuse, the Commission briefly summarised the case law relating to refusals to deal (namely Commercial Solvents,36 United Brands,37 Volvo, Magill, Ladbroke, Bronner).38 The way in which the

28 As

the situations of NDC and Azyx are very similar, reference will be made exclusively to those of NDCs. 29 The Commission was bound by the German decision in this regard as it cannot decide upon the validity of national copyrights. This issue is left to the national courts. 30 Commission’s Decision 2002/165/CE of 3 July 2001, Case COMP D3/38.044, NDC Health/IMS Health: interim measures [2002] OJ L/59/18. 31 First order (provisional stay) of 10 August 2001, Case T–184/01 R, IMS Health Inc v Commission [2001] ECR II–2349. Second order of 26 October 2001, Case T–184/01 R, IMS Health Inc v Commission [2001] ECR II–3193. 32 IMS Health Inc v NDC Health Corp, Case C–481/01, 11 April 2002 [2002] 5 CMLR 1 (ECJ). As this order merely confirms the two orders of the President of the CFI and does not contain a further analysis of the substance of the issues, it will not be discussed. 33 Paras 45 & ff of the Commission’s decision. 34 Ibid paras 57 ff. 35 Ibid paras 175–78. It is generally quite easy to find such an effect because it has been interpreted broadly, see eg R Greaves, ‘The Herchel Smith Lecture 1998: Article 86 of the EC Treaty and Intellectual Property Rights’ (1998) European Intellectual Property Review 380; Paemen and Norall above n 27, 63. 36 Above n 5. 37 Ibid. 38 Paras 63–74 of the decision of the Commission.


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Commission reviews the decisions indicates that it reads them as reflecting a trend towards the adoption of the essential facilities doctrine by the Community courts.39 In the Commission’s view, the case law is to be seen in an evolutionary way where Commercial Solvents reflects the implicit adoption of the essential facilities doctrine40 and Bronner confirms it. The Commission puts all the cases together in a straight line as constituting some sort of proof of the same, single trend. Thus for the Commission, the applicable conditions for judging any abuse of a dominant position under Article 82 (including abuses of IPR) are the three cumulative ones now laid down in Bronner. To justify this interpretation, the Commission reasoned (albeit perhaps implicitly) in the following three-stage way. First, it set out Magill’s exceptional circumstances. Second, it recalled that in the Ladbroke case, the CFI implied that it is not necessary for a refusal to prevent the appearance of a new product in order for it to be considered an abuse.41 In other words, Ladbroke allows Magill’s conditions to be read in an alternative fashion. Third, the Commission found that the Bronner ruling confirms the Ladbroke approach. The reasoning is as follows. The condition of the prevention of a new product, first set out in Magill and restated but in a clear alternative fashion in Ladbroke, is omitted in Bronner. Thus, for the Commission, it is not to be tested anymore. In sum, the Commission’s interpretation of the cases seems to be that Bronner is the definitive test to apply in cases involving refusals to deal, including refusals to license. In other words, for the Commission, Bronner lays down the definitive exceptional circumstances or contains the decisive reinterpretation of the notion of exceptional circumstances as first set in Magill. This is why the Commission based its decision in the IMS case exclusively on the Bronner tripartite test. Applying the Bronner test to IMS’s facts, the Commission came to the conclusion that IMS had abused its dominant position since the three cumulative conditions were fulfilled:42 first, IMS’s refusal was unjustified; second, it eliminated all competition in the market of the provision of regional data because the structure was indispensable for NDC and Azyx to continue their activities, and third, there was no actual or potential substitute to this structure. As a result, the Commission imposed a compulsory license on IMS. 39 Even

if the Commission acknowledges that neither the CFI nor the ECJ has ever referred expressly to the essential facilities doctrine in their judgments (para 64). The doctrine is briefly defined and explained at above n 3. 40 Whish above n 4, at 611, 613 and 615, shares this opinion as well. 41 Paras 68 and 180 of the decision of the Commission. 42 ‘These exceptional circumstances meet the test set out in Bronner for a refusal to supply to be considered an abuse of a dominant position’. (ibid para 181). For a criticism of this finding by the Commission, see Derclaye above n 3, 47 and 52.

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C.

The Orders of the President of the Court of First Instance

The President of the CFI was not convinced that the Commission’s view was the only interpretation that can be given to the case law. In his first order, the President put emphasis on the Magill case. It seems implicit from the rather short reasoning that what should be stressed is the facts of the cases. In substance, his reasoning can be put in the form of a syllogism: (1) the approach underlying the Commission’s decision seems to depend on the notion of exceptional circumstances as elaborated in Magill; (2) there are potentially important differences between the facts of Magill and those of IMS; (3) the facts of IMS and Magill are different, but nevertheless the Commission imposes a compulsory license on IMS despite the difference in their facts, IMS has made a prima facie case that the Commission misapplies Magill.43 In his second order, the President recalled that there are differences between the facts of the Magill and IMS cases and added that the Commission’s interpretation of the Magill ruling (ie as setting alternative conditions) ‘constitutes at first sight an extensive interpretation of the Magill case’.44 The President concluded that while the Commission’s reading of the case law might be correct, there were reasonable grounds to conclude that there may be another interpretation of the case law, such as seeing the Magill conditions as cumulative.45 Thus the order seems to suggest that there may be two interpretations of the Magill case: the conditions for imposing a license are cumulative, or, on the contrary, they are alternative. Given the existence of a serious dispute as to the legal reasoning that must be applied to decide the IMS case, the President, having found that all other conditions to grant interim relief (urgency, balance of interests, etc) were fulfilled, suspended the decision of the Commission. In conclusion, he found that there was clearly a problem of interpretation and only a final decision on the merits could clarify it.

D.

Comments

As the IMS case illustrates, there are at least two possible ways of interpreting the case law. None of them is clearly untenable. It is true that the Commission in its interpretation of the case law failed to apply the first condition set in Magill. But can one criticise this approach in view of the rather confusing state of the case law? The Magill decision is unclear as to 43 President’s order of 10 August 2001, para 24. 44 Para 100 and 102 of the President’s second order,

decision. 45 Para 104 of the second order.

referring to para 67 of Commission’s


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the nature of the circumstances it sets forth (alternative or cumulative). The Ladbroke ruling has set two alternative conditions. The Bronner case, while bringing together conditions deriving from the previous cases, has omitted (or at least considered as non-applicable) the condition of the prevention of the appearance of a new product despite potential consumer demand. Thus it seems difficult at first sight to criticise the Commission’s chronological and in the end, rather logical construction of the case law. In addition, such a construction is hardly surprising. The Commission is naturally bound to prefer such a view, as its prime role in competition matters is to be the guardian of any potential abuses of dominant firms. The different interpretations of the case law reached by the Commission and the President of the CFI lead to different results. If, on the one hand, the conditions in Magill are applied in a cumulative fashion, the number of cases where an abuse will be found will probably be small. If, on the other hand, the Bronner test is solely applicable, it should lead to the opposite result (as the important condition of the prevention of the appearance of a new product is not required). Thus the choice as to which of those interpretations should prevail will have extremely important consequences on the determination of future cases relating to refusals to license. In conclusion, the IMS case raises once again the fundamental question underlying the application of Article 82 to the exercise of an IPR: what are the exceptional circumstances in which there will be abuse of an IPR? And, more generally, what should they be? While this second question is beyond the scope of the discussion as it involves a deeper legal and philosophical analysis of the relationship between IPR and competition law, the following section will attempt to answer the first, namely make sense of the case law as it stands. It will include a discussion of why the Community courts should make a distinction in their treatment of intellectual property compared to other forms of property.

3.

HOW TO SOLVE THE DILEMMA: A SUGGESTION

As illustrated by the abundant literature on the topic and by the IMS case, it appears to be difficult to reconcile the rulings of Magill, Ladbroke and Bronner.46 The root of the problem seems to be the uncertainty over whether the conditions in Magill are cumulative or not. The question is: are the cases irreconcilable? Is there a problem of interpretation of the case law and if so, how can it be solved? If there is no problem, how can the cases be explained? The short answer to this is that there is no dilemma. In other words, the case law is reconcilable. The argument is as follows.

46 For

the literature, see above n 25.

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A.

Argument

The answer lies at the heart of the Bronner ruling. As Bronner is the most recent case on refusals to supply a downstream competitor decided by the ECJ, not surprisingly, the Court reassesses its previous case law. If one reads the decision carefully, the ECJ seems to give the answer to the apparent problem. In paragraph 40, the ECJ restates the Magill conditions, but clearly reinterprets them as cumulative.47 It even reinterprets the third condition in stating that the refusal must be objectively justified.48 Whether this is intentional or not is left to the appreciation of the reader. However, in view of the confusion the Magill decision created as far as the interpretation of the exceptional circumstances is concerned and of the amount of literature it has generated commenting on this imprecise language, one might well take the view that this (re)wording is not innocent. This is reinforced by the language of paragraph 41 which reads: Therefore, even if that case-law on the exercise of an intellectual property right were applicable to the exercise of any property right whatever, it would still be necessary, for the Magill judgment to be effectively relied upon in order to plead the existence of an abuse within the meaning of Article 86 of the Treaty in a situation such as that which forms the subject-matter of the first question, not only that…49

In this paragraph, the ECJ suggests one thing: as regards the application of Article 82, or at least in the case of one type of abuse, refusals to deal, intellectual property rights have to be treated differently from other property rights. In paragraph 41, the Court’s opinion is that it is far from clear that the case law relating to abuses of IPR applies to abuses of other forms of property. The finding that IPR should be treated differently from other types of property has two consequences. First, it is certain that in similar situations

47 ‘In Magill, the Court found such exceptional circumstances in the fact that the refusal in question concerned a product (information on the weekly schedules of certain television channels) the supply of which was indispensable for carrying on the business in question (the publishing of a general television guide), in that, without that information, the person wishing to produce such a guide would find it impossible to publish it and offer it for sale (para 53), the fact that such refusal prevented the appearance of a new product for which there was a potential consumer demand (paragraph 54), the fact that it was not justified by objective considerations (para 55), and that it was likely to exclude all competition in the secondary market of television guides (para 56) ‘ (emphasis added). Schmidt above n 2, 215 suggests that ‘Bronner clearly emphasises the ruling in Magill that all the “exceptional circumstances” should be present before Article 82 can apply to confine the ambit of an IPR’, however without giving the reasons or making a demonstration of his argument. 48 Para 55 of the Magill ruling only states: ‘Second, there was no justification for such refusal either in the activity of television broadcasting or in that of publishing television magazines… .’ 49 Emphasis added.


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to the facts of Bronner—or if it can be extrapolated further, in cases involving other property rights—other conditions must be met (ie the three conditions the court sets forth in paragraph 41 as further characterized in paragraphs 44 and 46). At the risk of stretching the Court’s wording or intention too much, Magill is the authority dealing with IPR and does not in itself have direct application as it stands in other property fields. Second, this suggests therefore, implicitly and a contrario, that in situations dissimilar to those of Bronner, ie in cases involving refusals to license IPR, it is Magill which is to be relied upon. At least it is far from clear that the Bronner conditions should apply. In other words, the ECJ seems to warn that it may not be self-evident that the same conditions should apply to cases involving refusals to license (involving intellectual property) and refusals to supply (involving other types of property (mainly tangible) ). Thus the interpretation of this important part of the Bronner judgment, which is passed over in silence by the Commission, but interestingly pointed to by the President of the CFI in his second order,50 seems to strongly suggest that only Magill should apply to intellectual property rights and not Bronner. It could be argued therefore that the Bronner judgment makes a distinction between cases involving refusals to supply and refusals to license. In the first set of situations, only the tripartite test set out in Bronner applies whereas in the second set, only the cumulative conditions of Magill (as reformulated in paragraph 40 of Bronner) apply. In conclusion, there is no conflict between the several rulings. The important consequence that can be drawn from this interpretation is that the circumstances under which a refusal to license will be abusive being cumulative, it will be rare that they will all be fulfilled. As a result, abuse of IPRs should remain scarce. The IMS case readily illustrates this point. As a result of the suggested interpretation of the case law, it is clear now that IMS should win its case. The first condition set forth in Magill is met by the prevention, by the holder of the IPR, from the appearance on the market of a new product for which there is potential consumer demand. IMS’s refusal does not prevent the appearance of a new product. On the contrary, NDC and Azyx do not wish to either change or improve the structure, nor create new types of report on regional sales of pharmaceutical products; their only desire is to use IMS’s structure in order to provide similar or identical services to those of IMS. There is no potential demand from consumers (ie the pharmaceutical companies) for another new hypothetical product. Therefore the condition is not fulfilled, IMS’s refusal is not abusive and it will not be forced to grant a license. As suggested by the President of the CFI, the facts of Magill are different from those of IMS.

50 In

its para 104, the President seems to hint at the solution by recalling paras 40 and 41 of Bronner. Perhaps this is further evidence of the approach advocated in this article.

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The paragraphs above sought to bring out a coherent legal interpretation of the reasoning of the Community courts in order to understand their case law. The analysis was confined to interpreting the wording of the courts’ judgments. It has been seen that the courts seemingly wish to make a distinction between intellectual property and other forms of property (tangible (such as land, living creatures and goods) and intangible (such as stocks, shares, capital, money)51). However, they do not state the reasons why. The question is then whether a distinction should indeed be made, as a matter of policy, in the treatment of abuse of a dominant position related to intellectual property and other forms of property. This issue is no doubt extremely important but it would require a long and elaborate discussion, which could constitute a whole new article in itself. Within the framework of this chapter, the author will only concentrate on the specific features of copyright (since most of the cases which came in front of the Community courts involved copyright). The discussion will list the differences between copyright and other forms of property,52 and highlight those which point towards justifying a difference in the treatment by competition law of abuses of dominant positions through refusals by copyright holders and holders of other forms of property. This analysis is meant to attract the courts’ attention to the special character of copyright and advise them to reflect carefully before applying a common test, identical to both copyright and other forms of property. For reasons of space, the adequate condition(s)—ie conforming to policy—under which a compulsory license should be imposed to a copyright holder will not be discussed. The author puts this to the agenda for a future article. Copyright is generally categorised, as regards its nature, as a type of intangible property. However, this categorisation is far from being obvious. A long running controversy exists over the exact legal nature of copyright in both common law and civil law jurisdictions. 53 And it is still raging.54 This debate is due to the difficulty of classifying copyright as a type of property since there are important differences between 51 For

a classification of types of property, see F Lawson and B Rudden, The Law of Property 3rd edn (Oxford, Oxford University Press, 2002) 19 ff. In this chapter, these categories will be jointly called under the terms ‘other forms of property’. 52 The accent will be on the UK law of property. The comparison will be made especially between copyright and other forms of personal property because copyright’s characteristics are closer to it than to land law. Indeed s 90(1) of the UK Copyright Act classifies it as personal or moveable property. 53 Although it has been more of an issue in civil law countries. 54 For a detailed account, see A Strowel, Copyright et droit d’auteur, divergences et convergences (Bruxelles, Bruylant, 1993) 80–171 or see C Colombet, Propriété littéraire et artistique et droits voisins 9th edn (Paris, Dalloz, 1999) paras. 16 and ff, 13–14 for a shorter overview. French modern authors generally think that it is vain to try and find a unique nature to author’s rights. It is a combination of property and personality rights. Its nature is hybrid. See Colombet, ibid and A Bertrand, Le droit d’auteur et les droits voisins 2nd edn (Paris, Dalloz, 1999) n 1.54, 76.


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copyright and other forms of property. The result is that it is still uncertain whether copyright can really be said to be a type of property. The author’s aim is not to determine once and for all that copyright is property or that it is not. Rather, even if it is accepted that copyright is (a type of) property, it is submitted that it is so dissimilar from other forms of property that refusals to license copyright should be treated differently from refusals to supply other forms of property. There seems to be broad agreement among scholars that property rights have two essential characteristics. They are rights against the world (in other words, the owner has the right to prevent anyone from interfering with the use and enjoyment of the property)55 and they are transmissible (inter vivos and upon death).56 In addition, property rights are generally perpetual (or durable)57 and absolute.58 It will be seen that copyright lacks all of these crucial characteristics (at least in their full extent). In addition, at least three specific features of copyright can be identified that other forms of property do not have (copyright includes moral rights, the same copyright can be licensed to several persons simultaneously and copyright has an ethical element) which further estrange it from the remainder of property. Copyright is a bundle of economic and moral prerogatives. 59 While economic rights can be alienated,60 moral rights cannot61 and are thus

55 In

other words, property rights are universal or erga omnes. A Bell, Modern Law of Personal Property in England and Ireland (London, Butterworths, 1989) 6 (who defines this characteristic in terms of property being both a defensive and assertive right (7–9): a property right is a defensive right in the sense that no one may interfere with my ownership of a thing without my permission. A property right is also ‘against the world’ in the sense that it can be asserted against anyone into whose hands the property comes; W Murphy and S Roberts, Understanding Property Law 2nd edn (London, Harper Collins Publishers, 1994) 46–47; M Bridge, Personal Property Law (London, Blackstone Press, 1996) 8. 56 In other words, property rights are alienable, assignable or transferable. Bell above n 55, 6; Murphy and Roberts above n 55, 46–47; F Lawson and B Rudden above n 51, 39–40. 57 Murphy and Roberts, above n 55, 47. 58 See eg French and Belgian Civil Code, Art 544: ‘Property is the right to enjoy and dispose of things in the most absolute manner, as long as one does not use it in a way that is prohibited by statute and regulations’ (translation by the author). See also the discussion below. 59 The economic aspects of copyright cannot be severed from their moral counterparts. The Court of Justice has itself declared that the specific subject matter of copyright is to protect the economic and moral rights of right holders (Collins (Phil) v Imtrat Handelsgesellschaft MbH [1993] ECR 545) and that the essential function of copyright law is to protect the moral rights in the work and to ensure a reward for the creative efforts, while respecting the aims of, in particular Art 86 (CFI rulings in Magill, Cases T–69/89 Radio Telefis Eireann v Commission and T–76/89 ITP v Commission above n 9. One cannot thus see copyright amputated from a part of its true nature (ie its moral rights). 60 In some countries, notably Germany, copyright (Urheberrecht) is seen as a unified, unique concept, where moral and economic prerogatives are inseparable. Hence copyright (thus as a whole, comprising both its economic or moral prerogatives) cannot be alienated but only licensed. In this sense, the whole German bundle of copyright rights lack the important property characteristic of transmissibility. 61 Like other national copyright acts, the UK Copyright Act expressly states that copyright is transferable (s 90(1) ). However s 94 states that moral rights are not assignable. JAL Sterling,

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not property. 62 Moral rights protect the personality (name, honour, reputation, integrity) of the author and are therefore classified as personality rights. Unlike other forms of property, the copyright holder can license his/her rights to several people, ie s/he can choose between granting one exclusive license or several non-exclusive licenses.63 Copyright is moral. Copyright has an ethical component that other forms of property do not have: courts will not enforce immoral copyrights, because if they did, they would legitimise immorality.64 Copyright is also territorial. It only forbids unauthorised acts done within the borders of the state in question.65 Even if international conventions66 tend to make copyright ‘truly international’, there are still countries not party to them, so there is still a difference between copyright and other forms of property. In other words, copyright is not strictly a universal right. As soon as the Berne Convention (or the TRIPs Agreement which incorporates it) is applicable in all countries of the world, copyright will be truly a universal right. In addition, copyright is not absolute: intrinsically, by nature, it is limited. Copyright statutes contain in themselves a generally well-thought through and carefully tailored internal balance. Three limitations to copyright’s scope readily exist in the statutes.67 Copyright law is first limited by protection requirements that need to be fulfilled in order to attract protection (ideas are not protected but only their original expression). Once the rights are acquired, they are further limited by exceptions which exist to the benefit of users. Finally, copyright does not last perpetually.68 The limited

World Copyright Law (London, Sweet & Maxwell, 1998) 43 n 2.12; Colombet, above n 54, paras 16 and ff pp 13–4. 62 Lawson

and Rudden, above n 51, 40. Already at the end of the 19th century, commentators criticised the classification of copyright into property because, among other things, it disregards the moral rights aspects of copyright. Thus some theories emerged arguing that copyright is either a personality right or a sui generis right. See Strowel above n 54, 97. Murphy and Roberts above n 55, 47, wrongly generalise that since intellectual property rights are transmissible, they are property. But they omit to see that moral rights are not transferable. 63 Lawson and Rudden above n 51, 123. See also P Roubier, Le droit de la propriété intellectuelle, (Paris, Sirey, 1952) tome 1, 97–8 cited by Strowel above n 54, 104. Indeed, there can only be one lessee of a car, an animal or a house. This is due to the fact that unlike other forms of property, copyright is a public good: it is essentially information and thus infinitely reproducible. 64 J Phillips and A Firth, Introduction to Intellectual Property 4th edn (London, Butterworths, 2001) n 10.13, 136: ‘Neither real nor personal property depends for their continued existence upon criteria of inherent or functional morality, nor is there any reason why they should’. 65 In other words, the work of author X, national of country X, or who has published his work in country X, will not automatically be protected in country Y. 66 The major one being the Berne Convention for the Protection of Literary and Artistic Works of 1886, last amended in Paris in 1971. Lawson and Rudden above n 51, 40. 67 An additional limitation exists in UK copyright law. Copyright is firstly delimited by the fact that only a certain number of subject matter can be protected (the UK Copyright Act uses the system of categorisation of works, see ss 1–8). 68 Phillips and Firth above n 64, n 10.6, 130; Sterling above n 61, n 2.12, 41–42.


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duration, characteristic of copyright, is totally contrary to the durable quality of other forms of property. It does not make sense that a car, land or money ever ‘dies’,69 ie that it is not be owned by someone. It makes sense that someone always owns the object, even if it is not bought by a subsequent owner but is appropriated because it has been abandoned by its original owner. On the contrary, this finding does not make sense in relation to original expressions of thought (be they literary, musical, artistic or other copyright protected works). As a matter of policy, the public should be able to use them freely once the author has recouped his/her investment. Hence the rationale for the limited duration of copyright. This entails an important consequence: since copyright is not perpetual, the monopoly or dominant position it can create will never last for ever, contrary to other forms of property. There are no such limitations on other forms of property law. To become the object of property, a thing does not have to fit in a category nor fulfil certain conditions. As regards rights, copyright is much more limited than other property rights, for instance rights in land.70 Landowners’ rights are indefinable, comprising every possible use of land: a complete list of them cannot be made. The same can be said of personal property. In contrast, copyright rights are well defined in the statute.71 Unlike copyright law, which provides for exceptions to rights, the law relating to other forms of property does not further oblige the owner to let anyone use it once certain conditions are fulfilled.72 In sum, unlike other forms of property, copyright can be adequately envisioned as (primarily) creators’ rights but also as users’ rights. Thus, although there may be rules against abuses or misuses of other forms of property, overall these forms are much more absolute, or at least less limited, than copyright. The reasons for these limitations to copyright are briefly as follows. Copyright works are information goods. The nature of information goods is that they are public goods. Like other public goods, they possess a

69 It

is true that living things such as animals will die but they remain different from copyright in the sense that the duration of their owner’s property is not limited by consideration of public policy at the core of copyright law. 70 J Penner, The Idea of Property in Law (Oxford, Oxford University Press, 1997) 119–20. 71 See also ibid who takes patents as an example: ‘The patent is an exclusive right to a particular use of the invention or idea, that is working it to produce goods for sale in the market. But this is only one of a limitless number of ways in which an idea may be ‘used’; one can study it, use it to illustrate scientific principles, use it as the basis for further inventive endeavours, and so on. That the market use of the idea is often the most valuable use in economic terms (…) that does not alter the fact that it is one use only’. 72 This is especially true of personal property. As regards land, there can be easements on real estates such as grazing rights for instance, but unlike exceptions in copyright law, they are not automatic (ie not every piece of land has them) and their extent is generally less far-reaching than exceptions (or ‘users rights’) in copyright law.

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‘non-rival’ quality. Non-rivalry means that the consumption possibilities of one individual do not depend on the quantities consumed by others. In other words, if one person consumes the good, s/he will not reduce the consumption opportunities of others in the good. Thus there is a potential for collective consumption of the same good (eg the showing of a film). Pure public goods are also non-excludable.73 This means that it is very costly to exclude anyone from enjoying them. In other words, one person cannot exclude another person from consuming the good in question. Copyright works are also generally non-excludable. This non-excludability arises because reproduction costs are generally very low for anybody other than the creator of the good. Because creation costs (for the creator) are high and reproduction costs (for the free rider) are low, if the creator does not have a means to stop the free riders, he will not have the chance to recoup his investment. Therefore a market failure is generated (no one will create as it is not profitable). To remedy this market failure and encourage creation, the state enacts a copyright law which grants an exclusive right to the creator (s/he is the only one to prevent or authorise the use of the work). This right enables him/her to have a chance to recoup his/her investment. At least two out of the above discussed features of copyright plead for a specific treatment by competition law. First, contrary to other forms of property, copyright arises from an individual’s intellectual creation. The author has moral rights in his/her creation. A compulsory license on something so personal should be imposed with extra care. One might object that many creations are now made collectively or under the supervision of a legal entity and that moral rights are less important for certain functional creations.74 Nonetheless, there is a second very important distinctive feature of copyright, which other forms of property do not share: its ‘limitedness’. Copyright is not a complete property right because its scope is restricted in many ways. Copyright law is a legal remedy to the market failure which is the consequence of the non-excludability of works. Parts of these public goods (ie not ideas, but only original expressions of them) are thus artificially privatised for a limited amount of time. The rationale for this is that the privatisation of these public goods is economically efficient (if copyright did not exist, no works or too few would be created, hence the public would be worse off). Copyright is thus in essence fragile and is inherently balanced:75 it is a compromise between the natural free

73 On all these notions see, eg R Cooter and T Ulen, Law and Economics 2nd edn (London, Harper Collins Publishers, 1997) 100 ff. 74 As a matter of fact, in some countries, notably the UK, eg computer programmers do not have moral rights (ss 79(2) and 81(2) ). 75 On this balance see eg T Cotter, ‘Intellectual Property and the Essential Facilities Doctrine’ (1999) Antitrust Bulletin 211.


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use of original expressions by everyone76 and the just (and economically efficient) reward for the creator’s labour. Consequently, more caution must be exercised when further limiting these rights. In other words, there are reasons to be more prudent in imposing compulsory licenses on copyright holders than on owners of other types of property. A difference of treatment, most probably in the direction of a lower incursion of competition law into copyright’s scope than into the scope of other forms of property, is justified.

B.

A Few Other Corroborating Arguments

The first argument which confirms the suggested construction of the case law is the following. It is true that strictly speaking, there is no rule of precedent within the Community courts. The ECJ, and the CFI, are not bound by their own previous decisions and thus in theory, the ECJ is not bound to continue following its Magill ruling. But it is also true that the ECJ, and the CFI, in practice do not often depart from their previous decisions.77 The Bronner case could be said to be an example of this practice. The Court, in Bronner, does not depart from its case law, but refines it. It simply does not overrule Magill but distinguishes between two decisions. Magill and Bronner apply in two different types of situations. Both decisions are equally good law. Second, it can hardly be denied that the Court, if it is consistent, will interpret its ruling in Bronner as being one which already warned litigants that it will be cautious in applying or extending the Bronner ruling (or as some call it, the essential facilities doctrine) to intellectual property situations such as Magill-type situations. This view is at least confirmed by the President of the ECJ in the IMS case. Finally, it is worth noting that this interpretation is in line with other arguments and general policy reasons which plead against too active an incursion of this part of competition law into the realm of intellectual property. It is beyond the scope of this discussion to develop them all here. Instead, the most important one will be mentioned. The Bronner case is seen

76 For

maximum efficiency, public goods should normally be owned publicly, see Cooter and Ulen above n 73, 102. 77 A Arnull, The European Union and its Court of Justice, (Oxford, Oxford University Press, 1999) 529; Weatherill and Beaumont above n 4, 202. In addition, even if the CFI is not bound by decisions of the ECJ (except in a few cases: res judicata and Art 54 of the Statute of the Court, see eg Case T–162/94 NMB France & others v Commission [1996] ECR II–427, para 36), when the precedents of the ECJ are clear, the CFI should follow the ECJ’s decisions. See Arnull, 533 citing Brown and Kennedy, Brown and Jacobs’ the Court of Justice of the European Communities 4th edn (London, Sweet and Maxwell, 1994), 351 and Weatherill and Beaumont above n 4, 207.

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by the Commission and some commentators as the confirmation of the incorporation of the doctrine of essential facilities in European law. However, besides the fact that the court has never referred to the doctrine in any of its judgments,78 legal journals and reviews in Europe and across the Atlantic are literally flooded with academic literature79 heavily criticising the doctrine. In addition, the judiciary has expressed strong reservation about its adoption in the European legal order.80 The argument is that the essential facilities doctrine should not be applicable in competition law or at least should be applied with great care because of its many negative effects. These considerations favour an interpretation of the Bronner decision as either not confirming the doctrine at all or—at most—as adopting it but with extreme prudence and only as regards property rights other than IPR.

4.

CONCLUSION

The interpretation suggested in this chapter is one way to solve the apparent conflict in the case law. This interpretation is based on the wording used in the cases themselves, with some policy reflections on the justification to differentiate between different types of property in their interface with competition law. Perhaps the Community courts are clear on the construction to be given to their cases. However, as shown by the divergent opinions of commentators over the interpretation to give to the cases, confusion still remains in the legal community as regards the exact conditions under which the holder of an IPR abuses it. The IMS case offers a unique opportunity for the European courts to clarify their case law and provide a transparent test to help IPR holders in a

78 Case

C–7/97 Oscar Bronner v Mediaprint [1998] ECR I–7791, per Advocate-General Jacobs, para 35; Commission’s Decision 2002/165/CE of 3 July 2001, para 64, above n 30. 79 Among others, see P Areeda, ‘Essential Facilities: An Epithet in Need of Limiting Principles’ (1989) Antitrust Law Journal 841; J Temple Lang, ‘Defining Legitimate Competition: Companies’ Duties to Supply Competitors and Access to Essential Facilities’ (1994) 18 Fordham International Law Journal 439; D Ridyard, ‘Essential Facilities and the Obligation to Supply Competitors under UK and EC Competition Law’ (1996) European Competition Law Review 438; A Overd and B Bishop, ‘Essential Facilities: The Rising Tide’ (1998) European Competition Law Review 183. See also for strong criticism, H Hovenkamp, Federal Antitrust Policy 2nd edn (St Paul, MN, West, 1999) 305–11. For other references on criticism of the essential facilities doctrine, see E Sheehan, ‘Unilateral Refusals to Deal and the Role of the Essential Facility Doctrine, A US/EC Comparative Analysis’ (1999) World Competition 73, fnn 26 and 28. 80 See Opinion of Advocate-General Jacobs in Bronner above n 78, at paras 56–58 (the doctrine goes against freedom of contract, it stimulates competition on the short-term stimulation but not on the long-term; para 62 (if the doctrine is to be applied at all, it should be applied with even more caution in cases dealing with IPR) and para 69 (difficulty to decide on the compensation to be paid for access); see also Whish above n 4, at 617 and 700; Treacy above n 11, 502.


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dominant position know when they are likely to breach competition law. It is hoped that the Court will, one way or the other, clarify the circumstances in which the refusal to license by a holder of an IPR is abusive. It would be interesting if the reading of the case law suggested in this discussion were to be adopted by the court when deciding the IMS case on the merits. Thus the Court would clarify or confirm what it meant in paragraphs 40 and 41 of the Bronner case. It could also go further and state whether the conditions under which a refusal is abusive are similar for all property rights or whether they should be different for intellectual property rights. If it decides that the conditions are different for the two types of rights, only the Magill case should be relied upon for abuses by holders of IPRs and its conditions should be applied concurrently. Even if the suggested construction is not embraced, adopting the conditions set out in Magill and applying them in a cumulative manner would ensure, better than an application of the Bronner tripartite test or of the essential facilities doctrine, that the cases in which there will be an abuse of an IPR remain truly exceptional. The case law should preferably evolve accordingly in order to maintain the fragile balance between competition and intellectual property laws.

4 B2B E-Marketplaces: A New Challenge to Existing Competition Law Rules? JOACHIM LÜCKING *

B

USINESS-TO-BUSINESS (B2B) e-marketplaces constitute one of the most important developments of the ‘new economy’. They are also an interesting case study for the attempts of competition authorities to find a response to contractual agreements that, in the view of industry itself, offer the potential to revolutionise purchasing and supply-chain management. This chapter briefly reviews the commercial developments in the field of e-marketplaces and the history of the regulatory response to them. It then proceeds to an in-depth discussion of the competition issues raised by e-marketplaces and the analysis the European Commission conducts to examine them.

1. B2B E-MARKETPLACES: TECHNICAL AND COMMERCIAL DEVELOPMENTS

Business-to-Business (B2B) e-marketplaces are specialised Internet sites that allow buyers and suppliers to meet each other virtually and to trade. Their development in Europe can be traced back to 1996 when British Telecom established a Private Digital Exchange known as BT Trading Places.1 It did not work successfully however and was withdrawn. E-marketplaces were more widely developed from 1998 onwards.

* Dr Joachim Lücking is an Administrator in the European Commission, Competition Directorate-General. All views expressed are personal and do not necessarily reflect those of the European Commission. 1 European Commission, E-Marketplaces: New Challenges for Enterprise Policy, Competition and Standardisation (Brussels, Workshop Report, 2001) 2.

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Since then, the development of e-marketplaces has been marked by a change from euphoria to scepticism. Quantitatively, the number of such markets exploded between 1998 and 2001. In 2000 around 200 marketplaces were active in Europe,2 in 2001 this number had grown to more than 500.3 After the dot.com bubble burst, a number of ventures failed and fewer new marketplaces were created. In 2002, between 1000 and 1200 marketplaces are estimated to be active worldwide, in Europe this number is supposed to lie between 380 and 540.4 The number of all business-to-business transactions that are currently conducted through these exchanges is also comparatively low. Less than two per cent of all business-to-business transactions currently take place on these exchanges. This number is however expected to increase sharply.5 There are four general market types under which there are many variations: 1. Buyer-Managed Exchanges: these are markets that are set up by large buyers, often in conjunction with technology partners. An example would be Covisint, a marketplace for car components, set up by General Motors, Ford, DaimlerChrysler, Renault and Nissan as buyers, together with Oracle and i2 as technology partners. 2. Supplier-Managed Exchanges: these markets are being set up by suppliers, such as the aircraft component producers UTC and Honeywell, who together with their technology partner i2, developed a marketplace for aerospace equipment (MyAircraft.com).6 3. Market Makers: these are independent exchanges not controlled by buyers or sellers. They tend to be backed by venture capital and often were early innovators. An example would be the internet auction house Freemarkets. 4. Content Aggregators: content aggregators are sites that build and maintain multi-vendor catalogues which allow customers to access the offerings of several suppliers using a common search structure.

2 UBS Warburg, Europe: The A-Z of B2B (London, UBS Warburg, 2000) 7. 3 Estimate by Jupiter MMXI

(last visited on 20 July 2001). 4 Estimates by Berlecon Research and eMarketService (last visited on 26 April 2002). 5 In 2000, UBS Warburg predicted that in 2005 16 % of all B2B transactions in Europe would be conducted through exchanges, above n 2, 3. Goldman Sachs expected this number to be 13 %, see Goldman Sachs, The Old World Meets the New Economy: B2B in Europe— Book 2 (London, Goldman Sachs, 2000) 52. In 2002, Forrester Research estimated that net trade in Europe will surge from 2% of total business trade in 2002 to 10% in 2004 , (last visited on 26 August 2002). 6 This exchange has since merged with the buyer-managed exchange AirNewCo to form Cordiem.com.

B2B E-Marketplaces

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Another useful categorisation can be built upon the scope of an exchange and its position in the value chain.7 Horizontal exchanges offer uniform, non-strategic products across multiple industries. Examples would be the maintenance, repair, and operations (MRO) exchange Grainger.com or the office supplies provider Staples.com. Vertical marketplaces, on the other hand, concentrate typically on one industry and try to offer all the inputs, strategic and non-strategic, that are required to operate in this industry. Examples would be Covisint for the automotive industry or Rubbernetwork for the tyre industry. In addition, there are multi-industry vertical marketplaces which seek to create trading communities in several industries. An example would be Freemarkets. B2B electronic markets are generally considered as a potential source of significant efficiency gains. They generate efficiencies in three ways. First, they put a downward pressure on purchasing prices by increasing market transparency. Second, they decrease informational costs and expand everyone’s market reach by removing the geographic barriers to buyers and sellers efficiently discovering each other. Third, they allow a reduction in transaction costs and an improvement of inventory management. Transaction costs may not only be reduced through the direct interaction between buyers and sellers via the Internet, but also by allowing buyers to form a more direct relationship with upstream manufacturers cutting out intermediaries (disintermediation). Estimates about the size of these gains vary: UBS Warburg, for example, predicted cost savings from B2B electronic markets of seven per cent of turnover on average.8

2.

REGULATORY RESPONSES

Regulators took note of the existence of e-marketplaces fairly early. In June 2000 the US Federal Trade Commission (FTC) conducted an explanatory workshop to examine competition issues in B2B electronic marketplaces. As a result, the FTC published a staff report in October 2000.9 The UK Office of Fair Trading (OFT) ordered a study on ‘E-Commerce and Its Implications for Competition Policy,’ which it published in August 2000. 10 The OECD held a ‘Mini-Roundtable on Electronic Commerce’ in October 2000 with written contributions from competition

7 DA Devine, CB Dugan, ND Semaca and KJ Speicher, ‘Building Enduring Consortia’ (2001) 2 The McKinsey Quarterly 28. 8 UBS Warburg above n 2, 4. 9 Federal Trade Commission, Entering the 21st Century: Competition Policy in the World of B2B Electronic Marketplaces (Washington, 2000). 10 Office of Fair Trading, E-Commerce and Its Implications for Competition Policy, prepared by Frontier Economics (2000, OFT Report 308).

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authorities of 10 jurisdictions. 11 The EuropeanCommission, finally, followed a twin-track approach. On the one hand, it began to develop and publicise the principles for the assessment of e-marketplaces in a series of conferences.12 On the other hand, it gained practical experience through a number of notifications, both under Article 81 and the European Community Merger Regulation (ECMR). As a result of this public debate, one can identify a common ground of issues which competition authorities across the world consider as important when analysing B2B e-marketplaces. These issues also feed into some form of implicit ‘guidelines’ which industry seems to follow when setting up exchanges in order to pre-empt possible competition concerns and often even the need for a notification.

3.

A.

THE LEGAL ASSESSMENT OF B2B E-MARKETPLACES UNDER EC COMPETITION LAW

Legal Basis

B2B e-marketplaces may be subject to European Community (EC) competition law at different stages in their life cycle. First, the creation of an exchange may constitute a concentration under the ECMR.13 This is the case if the conditions of Articles 1 and 3 ECMR are fulfilled. Article 1 sets the turnover thresholds which are used to define the concept of ‘community dimension’. This concept is employed to divide competence between Member States and the Commission in the field of merger control. Account is taken not of the turnover of the marketplace but of the turnover of the parent companies. In general, their combined aggregate worldwide turnover must exceed e5000 million and the aggregate Community-wide turnover of each of at least two parent companies must exceed e250 million.14 Article 3 defines the notion of a ‘concentration’. In the case of the creation of a joint venture (JV) in particular, it requires that the JV perform on a lasting basis all the functions of an autonomous economic entity. This is normally the case for B2B e-marketplaces which are generally endowed with all the functions necessary to operate in an industry and which do not 11 OECD, Competition Issues in Electronic Commerce (DAFFEE/CLP(2000)32). 12 Conference ‘The E-Economy in Europe: Its Potential Impact on EU Enterprises

and Policies’ on 1–2 March 2001 in Brussels; Conference ‘E-Marketplaces: New Challenges for Enterprise Policy, Competition and Standardisation’ on 23–24 April 2001 in Brussels. 13 Council Reg (EC) No 4064/89 [1989] OJ L/395/1, 30 December 1989, last amended by Council Reg (EC) No 1310/97 [1997] OJ L/180/1, 9 July 1997. 14 Art 1(2) ECMR. In the cases set out in Art 1(3) ECMR, lower turnover figures may be sufficient to indicate a ‘Community dimension’.

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only provide services to the parent companies. Another important criterion is that the JV must be controlled by one or more companies. This is often the case if a B2B e-marketplace is set up by a small number of large industrial companies which jointly control the electronic market. However, if the number of shareholders gets too large, no individual shareholder and no clearly identifiable coalition of shareholders may exercise control. In this case, the agreement to create an exchange does not constitute a merger but may be restrictive of competition in the sense of Article 81 EC. Secondly, the operation of an exchange must comply with Articles 81 and 82 EC. Article 81 covering restrictive agreements could for instance be applicable to agreements between several buyers on an exchange who want to bundle their purchasing volumes. Article 82, which deals with the abuse of a dominant position, could be relevant as regards questions of access to an exchange which has developed into the dominant electronic market.

B.

Market Definition

The definition of the relevant antitrust market is the starting point for almost all antitrust examinations. In many cases, the outcome of the market definition process also determines the outcome of the assessment. The Commission has described the principles of market definition in a Notice.15 These principles remain valid in the context of B2B electronic markets. Their application may become more difficult however due to the lack of reliable sales and price data and the current speed of change in e-commerce markets generally.16 In particular, the definition of the relevant product market will raise two sets of questions: First, whether electronic marketplaces compete with ‘normal’ bilateral sales or whether they constitute a separate, narrower product market. The former would be likely if the parties used electronic marketplaces only as an additional sales channel; the latter if the exchange offered additional services which clearly differentiated them from other sales forms. These questions were first discussed in the Commission’s clearance decision of MyAircraft, a B2B exchange for aircraft parts and services.17 In this case, the Commission investigated the question whether this on-line exchange was part of the wider market for airline equipment or whether it constituted part of a narrower market for exchanges (exchanges for airline equipment). 15 Commission

Notice on the Definition of the Relevant Market for the Purposes of Community Competition Law [1997] OJ C/372/5, 9 December 1997. 16 See OFT above n 10, 37. 17 Case M–1969 —UTC/Honeywell/i2/MyAircraft.com, Art 6(1)b—decision of 4 August 2000.

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The Commission’s market investigation revealed that industry participants in general considered the B2B e-marketplace as one segment among the many modalities by which companies transact business. The exchange would increase the efficiency of communications between aerospace industry participants without changing the way transactions were conducted in the aerospace industry. The Commission also considered whether specific services offered by the exchange constituted product markets in their own right. In this case, the services offered by MyAircraft to its customers included supply chain management tools and e-procurement. To a large extent these services were considered to be an integral part of the services offered by MyAircraft in order to enable customers of the site to use MyAircraft as a purchasing or selling tool. However, some elements of the supply chain management service were regarded as going beyond what is normally required by a user of MyAircraft in order to use this site to make business. This would be the case for the inventory planning tools and forecasting tools in particular. The market investigation revealed, however, that a majority of third parties considered that these services would be distinct components that may be offered separately. The results of the investigation seem to suggest that the B2B electronic marketplace constitutes part of a wider market. It should be noted, however, that in this case the precise relevant product market definition was left open since, irrespective of the market definition chosen, the proposed concentration did not give rise to the creation or strengthening of a dominant position. All decisions since have followed this line, without arriving at any formal conclusion. A second question that might arise when defining the relevant product market is whether or not distinctions can be drawn between different B2B e-marketplaces based on their industry focus. A currently open question concerns the degree of substitution between vertical exchanges that are set up to cater to a given industry, but which may be open to outside buyers and horizontal exchanges which cut across industries but only offer certain goods or services. An example would be a car producer that needed MRO goods: it could turn either to a vertical exchange, such as Covisint, a horizontal exchange, such as Grainger, or to an auction house, such as Freemarkets. For other, more car-specific goods, its choice might be more limited because there may not be a horizontal exchange or the good may not lend itself to an auction. This suggests that the demand side might be faced with a continuum of choices, depending on the number and nature of B2B e-marketplaces that allow trading in a specific good. Again, one should note that the Commission’s decisional practice has so far not addressed this issue, as the marketplaces analysed so far did not create competition problems irrespective of the market definition adopted.

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When looking at the definition of the relevant geographic market, the relevant question is likely to be whether the geographic market will be widened, as location becomes less important for the interaction between buyers and sellers. One can expect that such a widening of the geographic market will indeed be brought about by many B2B electronic marketplaces. However, the Commission did not need to pronounce on this issue, as either the markets concerned were already global (such as the market for aircraft parts), or the creation of the marketplace did not raise any competition concerns irrespective of the delineation of the geographic market.

C.

Competition Issues

Once the relevant market is defined, one can turn to the competition issues which B2B e-marketplaces potentially raise. Here, a distinction can be made between issues relating to co-ordination effects which could be brought about by an exchange and issues relating to market dominance and foreclosure.

D.

Co-ordination Effects

The likelihood of co-ordination effects has been one of the most discussed features of B2B exchanges. The problem arises as B2B electronic marketplaces not only increase the transparency in the market, but also facilitate the exchange of sensitive information between competitors. For competition policy, such an information exchange is of concern as communication is central to collusion.18 A problem of information sharing is created if some or all buyers or sellers can use an electronic market in order to discover or to exchange sensitive information on prices and quantities. This concern is linked to the design of the system, in particular its openness in terms of individual data originating with other parties. When analysing this concern, a distinction can be made on the basis of whether or not information is exchanged between all market participants or only between a sub-group of the market, in particular the owners. Whether or not information sharing between all market participants creates a competition problem depends very much on the nature of the market. In EC competition law the exchange of sensitive and detailed

18 K-U

Kühn, ‘Fighting Collusion by Regulating Communication Between Firms’ (2001) Economic Policy 197.

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information might as such be caught by Article 81(1) EC if it takes place on an oligopolistic market. The judgments of the European Courts in the Tractor cases19 and the Steel Beams cases20 provide useful clarification in this respect. It emanates from these judgments that in addition to the market structure, the following elements need to be taken into account when assessing the potential impact of information sharing: the type of information exchanged, especially the level of aggregation, the age of the information exchanged and the frequency of information exchange. B2B electronic marketplaces are thus less likely to raise concerns if they only provide summary statistics (eg on trade volumes) to all market participants while individual data is only accessible to the owner of such data. Similarly, competition concerns are reduced when the system only allows access to historical data. In the example of an auction market, this could for instance be done by only showing the leading bid without revealing the identity of the bidder and by not specifying the order of other bids. Enforcement practice shows that marketplace operators are well aware of the need to ensure data protection and to impede improper information exchanges. They are therefore setting up ‘firewalls’ and use other technical means which ensure that data flows are limited to necessary information and that they can be controlled. Antitrust agencies will in turn need to provide or acquire the technical expertise that enables them to judge whether or not these safeguards are sufficient. A different concern is raised if only a few market participants have access to certain information. This problem may exist where an on-line marketplace is controlled by a number of market participants. These owner-participants could then receive privileged information about transactions in the market which would create competition problems relating to both information sharing and discrimination. This issue was addressed in the Volbroker case, the first B2B exchange cleared under Article 81. In this case, six major banks set up a joint venture offering an electronic brokerage service for trading foreign currency options. The case raised concerns regarding the access to confidential information by the parent companies. To deal with this concern, the owners of the Volbroker.com exchange gave the following assurances to the Commission: None of Volbroker.com’s staff or management will have any contractual or other obligation towards any of the Parents and vice versa. Volbroker.com’s

19 Case C–8/95/P New Holland Ford v Commission [1998] ECR I–565 and Case C–7/95/P John Deere v Commission [1998] ECR I–3111. 20 Cases T–134/94, T–136/94, T–137/94, T–138/94, T–141/94, T–145/94, T–147/94, T–148/94, T–151/94, T–156/94 and T–157/94 (‘Steel Beams’ Cases) [1999] ECR II–0347.

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staff and management will be in a geographically distinct location from that of the Parents. The representatives of the Parents on Volbroker.com’s Board of Directors will not have access to commercially sensitive information relating to each other or to third parties. The Parents will not have access to the information technology and communication systems of Volbroker.com. The Parents will also ensure that the staff and management of all the parties understand and appreciate the importance of maintaining the confidentiality of sensitive commercial information and that sanctions for breach are spelled out.21

To alleviate further concerns related to market access, the parent companies also agreed to allow so-called voice brokers to participate in Volbroker.com where they are acting as principals. The undertaking thus aims at building ‘Chinese walls’ between the joint venture operating the exchange and the parent companies which are active as market participants. While such a separation can certainly be regarded as a necessary condition to ensure that the marketplace is operated with sufficient independence from the parents, it remains to be seen whether it is also a sufficient condition. Undertakings involving ‘Chinese walls’ are difficult to monitor for a competition authority. While they might be appropriate for financial services industries which are used to such provisions and which have established a certain ‘compliance culture’ based on the financial markets rules, such undertakings may not always be sufficient for other industries or market situations. A second problem regarding possible co-ordination in electronic markets relates to the question whether market participants can effectively bundle purchasing or selling volumes. This question is in principle not different from ‘normal’ joint purchasing or joint commercialisation. Therefore, the discussion of these questions in the Commission’s ‘Guidelines on the Applicability of Article 81 EC to Horizontal Co-operation Agreements’ constitutes a good starting point for the assessment under EC law. It is notable in this respect that these Guidelines propose a safe haven of 15 per cent market share below which a purchasing or commercialisation agreement would be assumed either not to restrict competition or to fulfil the conditions for an exemption.22 These safe havens would also apply to horizontal agreements involving e-commerce. Thus, joint purchasing in an exchange by companies whose combined market share is below 15 per cent on both the purchasing and the selling market would not breach Article 81(1).

21 ‘Commission

Approves the Volbroker.com Electronic Brokerage Joint Venture between Six Major Banks’, Commission Press Release IP/00/896 of 31 July 2000. 22 Guidelines on the Applicability of Article 81 of the Treaty to Horizontal Co-operation Agreements [2001] OJ C/3/2, 6 January 2001, paras 130 and 149.

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Many B2B electronic markets are, however, addressing the possible competition problems of horizontal co-operation not by reference to market shares but by only allowing joint purchasing or commercialisation of accessory or MRO products. For example, an exchange for the widget industry would only provide for joint purchasing of office supplies while the widgets themselves would be bought individually by the member of the exchanges. This would not necessarily bring the joint buying activities within the boundaries of the safe haven provided by the Guidelines. Collectively, the producers of widgets are unlikely to have a market share larger than 15 per cent in the buying market for office supplies. However, their market share on the selling market for widgets may be larger than 15 per cent. They would therefore not fulfil the conditions of the safe haven. It must nevertheless be acknowledged that such a set-up would reduce the risk of collusion significantly. An individual assessment would therefore probably lead to the result that Article 81(1) is not infringed. This becomes very clear from the discussion in the horizontal guidelines. The Guidelines make clear that joint purchasing can be a problem for two reasons: (1) because it creates buyer power; and (2) because it can lead to co-ordination on the downstream market.23 If we assume that the market share of the widget producers in the buying market for office supplies is lower than 15 per cent, we can already conclude that buyer power is probably not a problem. Competition problems on the downstream market could exist if the parties achieve a high communality of costs through joint purchasing.24 Office supplies, however, are unlikely to constitute a high proportion of the total costs of a widget producer. Therefore, the joint purchasing of these products is also unlikely to create competition problems on this front. The joint purchasing of office supplies is unlikely to pose a competition problem.

E.

Market Dominance and Foreclosure

A second set of possible competition problems relates to issues of market dominance and foreclosure. They are created through the network character which is inherent in B2B electronic marketplaces. Positive network externalities and potential problems of network dominance are present when the value of a system to the individual user increases with the number of users.25 They can lead to market ‘tipping’ and the creation of a 23 Ibid paras 127–29. 24 Ibid para 128. 25 M Katz and C Shapiro,

‘Network Externalities, Competition, and Compatibility’ (1985) 75(3) American Economic Review 424.

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dominant position if the network effects are strong enough to induce all market participants to use the same network. This problem could potentially arise in the context of B2B electronic marketplaces, as the benefits will often increase with the number of buyers and suppliers which are linked to the same system. The possible prevalence of network effects in B2B electronic markets creates a dilemma for competition policy. On the one hand, it needs to take account of the fact that a larger network can be the source of substantial efficiencies. The fact that exchanges try to sign up as many industry players as possible should therefore not be considered as a competition problem in itself. On the other hand, competition policy needs to acknowledge that network effects can lead to a ‘tipping’ effect which will substantially raise barriers to entry and expansion and which could create substantial market power for the owner-operator of the largest exchange. The likelihood of such ‘tipping’ effects will depend on the value that buyers and sellers put on liquidity. Liquidity is important for B2B electronic marketplaces which operate as true exchanges. Such exchanges are characterised by the interaction of many buyers and sellers and the dynamic setting of a market-clearing price. They therefore require a sufficient amount of liquidity to operate.26 Most B2B electronic marketplaces, however, do not seem to constitute ‘exchanges’ in the sense of a commodity or stock exchange, as there is no trade in standardised products at a market price in an anonymous transaction using intermediaries. Most B2B electronic marketplaces are rather facilitating devices, which allow buyers and suppliers to engage directly in individual transactions. These transactions could take the form of an auction, a reverse auction or of a vendor catalogue. In all these cases, the critical success factor is not so much the volume of actual transactions, but rather the number of buyers and sellers connected to the system that actively monitor it and which could thus potentially make an offer. Network dominance will be harder to achieve in such a context. Any operator trying to build a dominant position would need to base this attempt not only on a ‘tipping effect’, but also on the need to create other lock-in mechanism such as exclusivity provisions. Exclusivity provisions can interact with network effects and create substantial barriers to entry. For users willing to switch B2B exchanges the combination of network externalities and exclusivity provisions creates ‘what can be a prohibitive opportunity cost of joining the new network: cutting themselves off from the larger, established network’.27 Lock-in could also be achieved where

26 L Benzoni, ‘La Place de Marché est-elle proconcurrentielle?’ (2001) 121 Revue de la Concurrence et de la Consommation 7, 8. 27 C Shapiro, ‘Exclusivity in Network Industries’ (1999) 7 George Mason Law Review 673.

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market participants are tied into the market via proprietary supply chain management systems. Competition policy should therefore carefully assess the design of the market and any ancillary provisions to ensure that the owner–operator does not try to enhance any existing network effects by contractual or other means. Competition authorities should in particular generally not accept provisions which require the users of an electronic marketplace to purchase all its requirements of a certain good through an exchange. Minimum purchase requirements expressed in absolute or percentage terms, or other contractual terms which indirectly seek to achieve the same goal should similarly be seen with suspicion. Nevertheless, such requirements may be acceptable during the start-up phase of a marketplace in order to provide a minimum level of liquidity. In the emaro case, where a B2B electronic market for office furniture and equipment was set up by Deutsche Bank and SAP, the Commission accepted that Deutsche Bank would contribute a minimum of 68 per cent to the joint purchases of both parent companies through the exchange. This clause was considered as directly related to and necessary for the setting-up of the market, provided its duration did not exceed three years.28 So far, the Commission’s enforcement experience with B2B electronic markets has not revealed problems related to network effects and market dominance. This is due to the fact that in these cases several e-marketplaces competed heavily even in a narrowly defined market.29 In the future, a shakeout phase leading to a reduction in the number of marketplaces seems, however, unavoidable.30 This raises the question of the appropriate regulatory response as regards access to the remaining marketplaces. Problems of foreclosure could arise if marketplaces, especially those owned by industry participants, exclude certain participants from the most efficient trading platform, consequently putting them at a competitive disadvantage. These problems could be addressed under Article 82 EC, provided that an exchange occupies a dominant position and that it can be considered as an essential facility.31 In this case, an exchange would abuse its dominant

28 Case M–2067—Deutsche Bank/SAP/JV, Art 6(1)b—decision of 13 July 2000. 29 See eg the decisions in cases M–1969—UTC/Honeywell/i2/MyAircraft.com,

Art 6(1)b— decision of 4 April 2000; M–2270—Babcock Borsig/mg technologies/SAP Markets/Deutsche Bank/VA Tech/ec4ec, Art 6(1)b—decision of 22 January 2001; M–2398—Linde/Jungheinrich/ JV, Art 6(1)b—decision of 25 April 2001. 30 Jupiter MMXI, a research company, predicts, for instance, that ‘fewer than 100 Net Markets will survive out of the 500 existing today’: see (last visited on 20 July 2001). 31 On essential facilities in general, see C Esteva Mosso and S Ryan, ‘Article 82—Abuse of a Dominant Position’ in J Faull and A Nikpay (eds), The EC Law of Competition (Oxford, Oxford University Press, 1999) 159–62.

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position if it did not grant access, unless such refusal is objectively justified. The test set out by the European Court of Justice in the Oscar Bronner judgment is fairly strict. It requires that the refusal is likely to eliminate all competition in neighbouring markets; that access must be indispensable for the competitor to carry on its business in that there is no actual or potential substitute in existence to the facility; and that the refusal is incapable of being objectively justified.32 Application of the essential facilities doctrine would thus require not only that the exchange was dominant in relation to other exchanges but also the proof that conventional means of distribution were no longer a substitute to trading through an exchange. While application of the essential facility doctrine to B2B electronic marketplaces remains an uncertain proposition,33 operators of these marketplaces may nevertheless find it in their interest to create a marketplace that is as open as possible. In most circumstances, this will make commercial sense and it will also help to refute any allegations relating to the possible abuse of a dominant position. However, openness does not require that an operator admit every interested party to a marketplace. Earlier Commission decisions concerning a number of commodity exchanges 34 suggest that admission standards would generally seem acceptable, provided that the standards are objectively necessary and are applied on a non-discriminatory basis.

4.

BEST PRACTICE GUIDELINES

From the discussion above, one can deduce a number of rules that companies setting up e-marketplaces may want to follow to ensure that EC competition rules are not infringed. Elements of such ‘guidelines’ are: 1. open, non-discriminatory access from all interested buyers and sellers; 2. no provisions which directly or indirectly try to impose the exclusive use of the exchange by its participants; 3. joint purchasing or commercialisation only within the boundaries set by the Commission’s horizontal guidelines;

32 Case C–7/97 Oscar Bronner GmbH & Co v Mediaprint Zeitungs-und Zeitschriftenverlag GmbH & Co KG [1998] ECR I–7791, 41. 33 Other commentators are, however, of the opinion that B2B e-marketplaces may quickly turn into essential facilities: see F Stroud, ‘B2B E-Marketplaces—The Emerging Competition Law Issues’ (2001) 24(1) World Competition 125, 134. 34 London Sugar Futures Market [1985] OJ L/369/25, London Cocoa Terminal Markets Association [1985] OJ L/369/28, Coffee Terminal Market Association of London [1985] OJ L/369/31.

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EC enforcement experience shows that many e-marketplaces seem to follow these principles. The press release issued on the occasion of the Covisint clearance35 states for instance that ‘the agreements show that Covisint is open to all firms in the industry on a non-discriminatory basis, is based on open standards, allows both shareholders and other users to participate in other B2B exchanges, does not allow joint purchasing between car manufacturers or for automotive-specific products, and provides for adequate data protection, including firewalls and security rules’.36 Adherence to these ‘guidelines’ may also explain the relatively small number of notifications under Regulation 17/62. Most companies setting up e-marketplaces seem to assess themselves whether or not Article 81(1) is infringed and arrive at the conclusion that their agreement is not restrictive of competition. The Commission should welcome this development as it corresponds to its proposals for the future application of Article 81.37 It obviously has the option of examining any such non-notified agreement, either on its own initiative or following a complaint, if an e-marketplace threatens to create competition problems.

5.

CONCLUSION

B2B e-marketplaces have generated a large degree of interest both in the business world and the antitrust community. The theoretical debate and decisional practice has however shown that the current competition rules are fully capable of dealing with this new phenomenon because most emanations of the ‘new economy’ B2B e-marketplaces are not so unique that they cannot be analysed within the existing framework.

35 This

joint venture between General Motors, Ford, DaimlerChrysler, Renault, Nissan, Oracle and i2 was found to be not restrictive of competition. Accordingly, the Commission issued a negative clearance ‘comfort letter’. 36 ‘Commission clears the creation of the Covisint Automotive Internet Marketplace’, Commission Press Release IP/01/1155 of 31 July 2001. 37 Proposal for a Council Regulation on the implementation of the rules on competition laid down in Art 81 and 82 of the Treaty and amending Reg (EEC) No 1017/68, (EEC) No 2988/74, (EEC) No 4056/86 and (EEC) No 3975/87 (‘Regulation Implementing Articles 81 and 82 of the Treaty’ [2000] OJ C/Sol.365, 19 December 2000).

5 Authorities, Competition and Electronic Communication: Towards Institutional Competition in the Information Society PLG NIHOUL*

T

HIS CHAPTER EXPLORES the links existing between authorities1 and competition, in the context of measures adopted in electronic communications within the European Union over the last 15 years. As we know, these measures have given rise to numerous commentaries most of them concentrating on economic matters.2 These economic * Prof Dr PLG Nihoul is Professor of Law, Jean Monnet Chair on the European Information Society, Director of the Centre on Consumer Law (Consumer Choice), University of Louvain, Belgium; and Professor of Law, University of Groningen, The Netherlands. The paper on which this chapter is based was presented at a workshop held at the University of Leicester on the relationship between competition law and the information society. It was also delivered as the inaugural speech when the author was appointed as a Professor of Law at the Rijksuniversiteit Groningen in May 2002. A first version has been published under the same title in (2001) The Journal of Policy, Regulation and Strategy for Telecommunications, Information and Media. This is a slightly different version, where more emphasis is placed on the relationship between institutional competition and the information society. I would like to thank the editor of the aforementioned journal for allowing republication and the editor of this book for taking interest in the manuscript although already published in an earlier version. 1 This latter term is used in the chapter without any technical meaning. It generally refers to organs established by, or under the control of, the European Union, the Member States or a component thereof. It thus designates a public entity the task of which is to carry out missions entrusted to it by the above mentioned levels of power. I have avoided using ‘institution’ as this has a special meaning in European law where it refers to specific bodies: the European Parliament, the Court of Justice of the European Communities, the Council of Ministers, the European Commission and the Court of Auditors. See LWG Gormley, Introduction to the Law of the European Communities (Deventer, Kluwer Law International, 1998) 181. 2 Thus, some commentators have glorified the introduction of competition on markets that were formerly organised on other bases. They have underlined, in substance, that competition leads to greater efficiency and hence produces better economic results. Others have by contrast lamented that competition would probably imply the disappearance of a ‘public service’

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considerations will not be addressed in this discussion, which instead focuses on institutional issues. For many analysts, rules are relevant in so far as they modify behaviour: norms deserve study because they influence society. That opinion is certainly worthwhile, but I am inclined to think that reasons explaining the adoption of rules should also be taken into account. Among these reasons, those with an institutional character often play a significant role. The chapter is constructed as follows. First, I will introduce the major developments that have shaped, in my opinion, the institutional side of the reform that has recently taken place in European electronic communications. Second, I will try to analyse what role considerations of an institutional nature may have played in the process. Third, I will embark on a prospective venture and consider what we can learn from these developments for the future of public intervention.

I.

A.

NATIONAL SYSTEMS REPLACED BY A EUROPEAN ORGANISATION

First Stage of the Reform

The first development is related to the adoption of the instruments which officially launched reform within the Community.3 Prior to this, electronic communications were characterised by national monopolies within the European territory. Member States entrusted one undertaking—often a department within their administration—with the task of installing and operating a network in their national territory. This undertaking was also responsible for providing services through infrastructure, limited to voice telephony in many instances. The monopolistic undertaking had an exclusive right to commercialise terminal equipment and to establish the technical requirements to be satisfied for connection. That situation was deemed unsatisfactory by the European Commission.4 Traditionally it has been argued that this reaction was motivated by a

mentality. They argue a profit making attitude would further develop in society as a result of the necessity of seeing all activities on the basis of their cost. 3 For a general presentation on EU law on electronic communications, see L Garzaniti, Telecommunications, Broadcasting and the Internet (London, Sweet & Maxwell, 2000); P Larouche, Competition Law and Regulation in European Telecommunications (Oxford, Hart Publishing, 2000); P Nihoul, Droit européen des télécommunications—L’organisation des marchés (Brussels, Larcier, 1999); Simmons & Simmons, Telecommunications: The EU Law (London, Palladian Law Publishing, 1999); I Walden and J Angel, Telecommunications Law (London, Blackstone Press, 2001). 4 European Commission, Towards a Dynamic European Economy—Green Paper on the Development of the Common Market for Telecommunications Services and Equipment, COM

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comparison with the state of affairs in the United States: (1) American customers seemed to have access to better communications at lower tariffs; (2) American companies appeared to have a technological advantage Europe would not be able to compensate without immediate action;5 (3) regulatory action was undertaken in America to encourage further development in the communications sector in that country; it was feared that Europe would definitely be left aside if no similar move was taken on this side of the Atlantic.6

B.

The 1987 Green Paper

On the basis of these findings, the Commission published a Green Paper7 where it outlined the measures it thought should be taken in order to support and develop electronic communications in Europe. Among other measures, this document suggested the introduction of competition in the telecommunications markets (liberalisation). This proposal did not raise much enthusiasm among the Member States. It was indeed running counter to the system that had governed electronic communications for decades within the national territories. These activities had been consistently reserved to one undertaking by the Member States. The European Commission was proposing to set that system aside and to let all interested firms enter the markets. Member States voiced their opposition, but the Commission decided to go ahead.8 It successively adopted two Directives which converted the liberalisation goals envisaged in the Green Paper into law. Competition was thus successively introduced in the

(87) 290 final (30 June 1987); H Ungerer, Télécommunications en Europe: le libre choix pour l’utilisateur sur le grand marché européen de 1992 et l’enjeu pour la Communauté européenne (Brussels, Office des Publications Officielles des Communautés Européennes, Luxembourg, 1988). 5 Innovations made in communications are essential to sustain economic growth. Firstly, communications per se constitute an important sector in the economy. Growth in that sector has a substantial effect on economic activity. Secondly, innovations in communications have an impact on other activities. Economic activities generally imply and presuppose information and data exchange. Innovation in that field acts as leverage to increase dynamism in other sectors. 6 Y Benkler, Rules of the Road for the Information Superhighway: Electronic Communications and the Law (St Paul, MN, West Publishing, 1996); HJ Brands and ET Leo, The Law and Regulation of Telecommunications Carriers (Norwoord, Artech House, 1999); CH Kennedy, An Introduction to US Telecommunications (Norwoord, Artech House, 2001). 7 Towards a Dynamic European Economy—Green Paper on the Development of the Common Market for Telecommunications Services and Equipment, COM (87) 290 final (30 June 1987). 8 For an excellent account see P Larouche, Competition Law and Regulation in European Telecommunications (Oxford, Hart Publishing, 2000) 1–17.

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markets for terminals,9 services10 and infrastructure.11 Through these instruments, the Member States were instructed to suppress the special and exclusive rights they had granted to national operators.12

C.

What Legal Basis?

As a legal basis for these instruments, the Commission invoked a treaty provision that had not been used earlier—Article 90 EC renumbered to Article 86 EC after the Treaty of Amsterdam.13 In its first paragraph, that provision makes it clear that Member States must respect treaty provisions as regards undertakings they have close relationships with. These relationships may be in the form of participation in the capital of these entities. They may also derive from regulatory advantages granted to these undertakings in order to facilitate their activities (special or exclusive rights). Pursuant to Article 86(1) EC, Member States may not take any measure contrary to the treaty in respect of these undertakings. All rules contained in the treaty are concerned, but Article 86 EC specifically refers to those relating to competition. The second paragraph of Article 86 EC concerns undertakings entrusted by Member States with the operation of services of a general economic interest. According to that provision, these undertakings may be granted an exemption with respect to the rules of the treaty, including those on competition. As a result of such an exemption, the provision, an undertaking concerned is exempt from the relevant rules. An exemption may only be granted where a legitimate objective is pursued. Furthermore, it only applies in so far as it is useful and necessary to allow firms to perform the particular tasks assigned to them in connection with such an objective. 9 Dir 88/301 of 16 May 1988 on competition in the markets in telecommunications terminal equipment [1988] OJ L/131/73. 10 Dir 90/388 of 28 June 1990 on competition in the markets for telecommunications services [1990] OJ L/192/10. 11 Dir 96/19 of 13 March 1996 amending Dir 90/388 with regard to the implementation of full competition in telecommunications markets [1996] OJ L/174/13. All directives adopted by the Commission in electronic communications may be found in Simmons & Simmons, Telecommunications: The EU Law (London, Palladian Law Publishing, 1999). They can also be found on the internet at ⬍http://europa.eu.int/information_society/topics/telecoms/regulatory/index_en.htm⬎. 12 The vocabulary then used by the Commission echoes words used during the French Revolution. The Commission announced that special and exclusive rights would be abolis, in the same way that the sans-culottes required in 1789 the abolition of the Monarchy, the Ancien Regime and the privileges that were attached to these institutions. Dir 88/301, Art 2 and Dir 90/388, Art 2—both in the French version. 13 All articles mentioned in this paper are numbered after the changes introduced in the Treaty of Amsterdam. See mainly JL Buendia Sierra, Exclusive Rights and State Monopolies under EC Law—Article 86 (Former Article 90) of the EC Treaty (Oxford, Oxford University Press, 2000).


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A relationship can be established between the first and the second paragraphs of Article 86 EC. As they are undertakings with an exclusive right, monopolies fall under the rules of competition as provided by the first paragraph. That situation does not appear, however, to conform entirely14 to the requirements of competition. Competition normally requires the presence of several undertakings, all struggling to obtain resources from potential partners. In order to justify the apparent contradiction, Member States referred to the second paragraph of Article 86 EC. Their argument was that exclusive rights were necessary to fulfil objectives of a public nature. According to them, the monopoly holders had to be protected against rivals. That was a condition for these monopolists to achieve the public objectives assigned to them. These objectives could not be reached in a competitive environment alone.15 An exemption was thus warranted, along the lines laid down in Article 86(2) EC.

D.

An Institutional Provision

In addition to regulating monopolies and the general interest, Article 86 EC contains an institutional measure (paragraph 3). Pursuant to it, the Commission has power to adopt directives or decisions as deemed necessary to implement the first and second paragraphs. Thereby, the Commission is granted power to ensure the application of treaty provisions to firms with special or exclusive rights (paragraph 1).16 The Commission also has the

14 The

Court of Justice has repeatedly insisted that exclusive rights should not as such be considered contrary to the rules of competition. However, it has ruled that the exercise of such rights could be abusive in violation of Art 82 EC (abuse of dominant position). Later, it adopted the line that such exercise was necessarily abusive. According to the Court, the mere exercise of a right of that nature will lead the firm to abuse its dominant position. Thereby, the Court’s interpretation endorses the general economic literature in which a firm will tend to increase prices and diminish output where it is in a monopolistic situation. P Nihoul, La concurrence et le droit (Paris, EMS, 2001) 236–38. 15 A typical example is the natural monopoly. Previously, the Member States justified exclusive rights granted to their telecom operator by arguing that these rights merely stated in law a structure that was imposed by the markets. According to them, it was less costly for society to finance one infrastructure and concentrate demand on it. The alternative—letting competitors install their own network—would lead to redundancy, losses and bankruptcy. Granting exclusive rights further allowed the national authorities to impose public policy objectives on firms holding the monopoly. For instance, these firms were ordered in various Member States to wire the whole national territory irrespective of the cost such operation would imply for some regions that could not be accessed easily. On that point, profit making or even financial balance were considered less important than the establishment of a national infrastructure. FM Scherer, Industrial Market Structure and Economic Performance (Boston, Houghton Mifflin Company, 1980); W Sharkey, The Theory of Natural Monopoly (Cambridge, Cambridge University Press, 1982); R Schmalensee, The Control of Natural Monopolies (Lexington, Lexington Books, 1979). 16 As well as to public undertakings.

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authority to verify that exemptions are conferred in accordance with the conditions laid down in the treaty (paragraph 2). On the basis of that provision, the Commission claimed a legal mandate to organise the telecom markets in Europe on a competitive basis. It considered that competition rules had to be applied to that sector (paragraph 1). According to the Commission, competition implied that markets should in principle be opened to new entrants. Exemptions could admittedly be accepted (paragraph 2). They would however have to be assessed with care and precaution. (1) As to the scope, these exemptions should be limited to specific services—those recognised as being of general economic interest in national legislation on the basis of criteria laid down at European level (universal service obligations). (2) As for modalities, exemptions must be made available to all firms without discrimination. One should thus not grant any firm an automatic right to a derogatory status in the name of the general interest. A procedure should be organised whereby all interested firms would be given an opportunity to apply, if interested, for the provision of these services and selection would be on the merits. The selected firm would be allowed to perform these services, if need be, under derogatory conditions (monopoly).

E.

Modification of the Rapport de Forces

The initiative taken by the Commission was not accepted by all Member States. An application was submitted to the Court of Justice of the European Communities (hereinafter ECJ) to obtain the annulment of the directives involved. The ECJ issued two judgments—one per directive. In both decisions, it confirmed the Commission’s power to act.17 The position adopted by the ECJ will not be discussed here as it has already been the subject of excellent academic commentaries. What is important for us to note is that in its judgments, the ECJ substantially modified the institutional rapport de forces that existed before between the Commission and the Member States. The ECJ in fact ruled that legislative power vested in the Commission for the application of treaty provisions to 17 Cases

C–202/88 France v Commission (1991( ECR I–1223 and 271/90, Spain v Commission (1992) ECR I–5833. Through these judgments, the Commission was given a green light to go ahead with its projects for the telecom sector. As a result, it adopted other directives that completed and even went beyond the ideas submitted in the Green Paper. Competition was extended to infrastructure whereas that step had not earlier been envisaged. For a list of all directives adopted by the European Commission in electronic communications, see the references mentioned above n 12.


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public monopolies. According to the ECJ, Article 86 EC entrusts the Commission with the power to specify, by way of general instruments, the consequences deriving from the treaty for the organisation of economic activities carried out by this kind of undertaking. The judgments confirmed the Commission’s willingness to act as a legislative authority to organise services of a general economic interest and/or services provided under derogatory conditions (special or exclusive rights). Yet, the legislative power was undisputedly vested with the Council before these judgments were issued. Until the European Parliament was granted more legislative power, the Council of Ministers was considered to be the legislative organ of the European Communities. As we know, the Council is made up of the representatives of the Member States. It could thus be said that the Member States exercised legislative power through their representation in the Council, pursuant to the rules provided therefore in the treaties. That competence was not limited to a particular given field. On the contrary, it applied to the majority of activities directly or indirectly covered by the Treaty.18 F.

Legislative Power

That division of power applied, amongst others, to the making and implementation of European competition policy. In that area, the legislative power is clearly, explicitly and without any doubt granted to the Council by several treaty provisions. These provisions are located in chapter one: ‘Rules of competition’, within title five: ‘Common rules on competition, taxation and approximation of laws’, of the treaty establishing the European Community. They roughly contain four ideas with respect to the institutional allocation of power in that context. 1. The Council is granted power to adopt the instruments that are necessary in order to give effect to the competition provisions contained in the treaty: Article 83(1) EC. A distinction is established depending on the period when these instruments were adopted. Where the enactment took place within three years after the entry into force of the treaty, unanimity is required. Since that date, measures only have to be adopted with a qualified majority. Within three years of the entry into force of this Treaty the Council shall, acting unanimously on a proposal from the Commission and after consulting the 18 That situation was modified with the adoption and ratification of new treaties. The principal modifications brought by these treaties did not affect, however, the institutional balance between the Council and the Commission. They rather promoted the position of the Parliament vis-à-vis both institutions: the Parliament was progressively given a greater say in the legislative process. LWG Gormley, Introduction to the Law of the European Communities (Deventer, Kluwer Law International, 1998) 209.

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PLG Nihoul European Parliament, adopt any appropriate regulations or directives to give effect to the principles set out in Articles 81 and 82. If such provisions have not been adopted within the period mentioned, they shall be laid down by the Council, acting by a qualified majority on a proposal from the Commission and after consulting the European Parliament. (Article 83(1) EC)

2. The Council also has power to determine how the treaty provisions on competition apply in the various branches of the economy: Article 83(2)(c) EC. That article implies that the Council and not the Commission is the authority in charge of determining what the consequences of competition should be in a given sector such as electronic communications. The regulations or directives … shall be designed in particular: … (c) to define, if need be, in the various branches of the economy, the scope of the provisions of Articles 81 and 82. (Article 83(2)(c) EC)

3. The Council also has authority to define the role other institutions may be allowed to play in the implementation of the rules of competition contained in the treaty: Article 83(2)(d) EC. In that context, the Council has the right to determine what role is granted to the Commission and how the latter is permitted to act in the framework of competition. The regulations or directives … shall be designed in particular: … (d) to define the … functions of the Commission … in applying the provisions laid down in this paragraph. (Article 83(2)(d) EC)

4. As appears from the first quotation above, the Commission is not absent from the procedure in cases where the Council adopts competition law instruments in application of the treaty. However, the treaty sees the Commission enjoying only a limited role. On the one hand, it has to draft the documents on which the Council adopts its directives or decisions (Article 83(1) EC quoted above). On the other hand, the Commission is granted power to apply the rules of competition in concrete cases: Article 85 EC. As seen above, the rules to be applied by this institution are embodied in the treaty. They also encompass the instruments adopted by the Council pursuant to the treaty provisions, as seen above. 1. [T]he Commission shall … ensure the application of the principles laid down in Articles 81 and 82 … [T]he Commission shall investigate cases of suspected infringement of these principles. If it finds that there has been an infringement, it shall propose appropriate measures to bring it to an end.


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2. If the infringement is not brought to an end, the Commission shall record such infringement of the principles in a reasoned decision. The Commission may publish its decision and authorise Member States to take the measures, the conditions and details of which it shall determine, needed to remedy the situation. (Article 85 EC)19

2.

A.

THE DEBATE BETWEEN HARMONISATION AND LIBERALISATION

Second Stage of the Reform

A second institutional development can be found in the opposition debate to the Commission and the Council in the course of the reform. We have analysed how the reform was unleashed by an initiative taken by the Commission (adoption of liberalisation directives). We have also commented on the reaction of the Member States (judicial application). When they saw they could not win the judicial debate, the Member States decided to adopt their own measures. Their hope was thereby to reach a balance which reflected their own choices. To that effect, they used the power to adopt harmonisation directives originally granted by the treaty to the Council before its extension to the European Parliament.20

B.

Rules Adopted by the Commission

In the liberalisation directives, the Commission went far beyond ordering the disappearance of special and exclusive rights. It specified what the Member States would still be allowed to do if they wanted to organise activities in the sector. It thus distinctly traced borders Member States would not be allowed to cross. Measures of that nature were also introduced in decisions adopted on the basis of Article 81 EC (anticompetitive agreements), Article 82 EC (abuse of a dominant position) as well as the merger control

19 That provision may be interpreted as giving the Commission a certain margin for manoeuvre. That margin is however limited. The means it may use are restricted: investigation, possibility to propose measures, possibility to record the infringement in a decision. In drafting that provision (Art 85 EC), Member States have obviously exercised extreme caution to avoid giving the Commission too much room in the application of competition rules. It is difficult to find in such a provision a basis to claim that the Commission has authority to set aside an organisation set in place and maintained for decades by Member States. 20 Above n 19.

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(Regulation 4064/89, as amended). Two examples are given hereinafter. Distinct publications may be looked at for other examples:21 Example 1. Member States often want to control firms before letting them carry out their economic activities. That control gives authorities an opportunity to impose conditions or obligations on these undertakings. In several instruments, the Commission strictly regulated the matter because it feared that burdensome intervention might deter undertakings from entering markets, which would contradict the objective it pursued for the sector—introducing and stimulating competition (presence of several participants).22 Example 2. The Commission also determined how the universal service obligation should be financed. Several Member States remained committed to maintaining a system whereby some fundamental services would be made available to the population at equal and reasonable conditions. The question was to determine how these services would be financed.23 The Commission did not want new entrants to have any obligation to contribute imposed upon them. An obligation of that kind, it felt again, would increase the cost of entry and have a deterrent effect to entrance on the markets contrary to what was being sought in the reform.24

C.

New Interpretation of Competition Law

The measures adopted by the Commission were greeted with surprise. Competition rules had long been understood to concern principally undertakings (Articles 81 to 85 EC).25 Admittedly, some treaty provisions are addressed to the Member States in connection with competition. For instance, Article 87 EC prohibits national authorities from granting financial 21 P

Larouche, Competition Law and Regulation in European Telecommunications (Oxford, Hart Publishing, 2000) 37; P Nihoul, ‘European Telecommunications: A Real Departure from Regulation?’ in G Haibach (ed), Services of General Interest in the EU: Reconciling Competition and Social Responsibility (Maastricht, European Institute of Public Administration, 1999) 127–66; P Nihoul, ‘Norme, régulation et réforme des télécommunications’ (1998) 4 Annales de Droit de Louvain 389; P Nihoul, ‘Convergence in European Telecommunications—A Case Study on the Relationship between Regulation and Competition (Law)’ (1998) 2 International Journal of Communications Law and Policy ⬍http://www.digital-law.net/ IJCLP⬎. 22 Dir 97/13 of 10 April 1997 on a common framework for general authorisations and individual licenses in the field of telecommunications services [1997] OJ L/117/15. 23 The said services are provided at derogatory conditions with respect to those provided by the markets. The tariffs, for instance, are not based on costs. They are set by an authority below cost. The loss must then be compensated by funds coming from another source. 24 Dir 97/33 of 30 June 1997 on interconnection in telecommunications with regard to ensuring universal services and interoperability through application of the principles of Open Network Provision (ONP) [1997] OJ L/199/32, Arts 5 and ff; for vocal telefony, Dir 98/10 of 26 February 1998 on the application of ONP to voice telefony and on universal service for telecommunications in a competitive environment [1998] OJ L/101/24, Arts 3 and ff. 25 See title V, ch 1, s 1, with the heading: ‘Rules Applying to Undertakings’.


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advantages that would improve the competitive position of one or several firms to the detriment of others. Article 86(1) EC further prohibits Member States from enacting or maintaining in force any measure contrary to the rules of the treaty, including the rules of competition. Yet, the position of these provisions has generally been considered peculiar in the treaty. Competition by its nature concerns undertakings. Public intervention is warranted in that context where the equilibrium is challenged by one or several firms holding market power. Public bodies are not expected to damage that equilibrium by granting advantages of a financial or regulatory nature. That prohibition had however not been interpreted as implying that rules would be adopted at European level in order to systematically determine what Member States would still be allowed to do and what initiative taken by them would be analysed as unacceptable given their (sometimes remote) effect on the market. D.

Harmonisation Process

As we have seen, Member States did not succeed in their judicial challenge against the liberalisation Directives. They thus resorted to legislative action in a bid to assert their presence and influence market organisation in a direction closer to their own choices. To that effect, they used an instrument provided for by the treaty—harmonisation. Harmonisation (officially called ‘approximation of laws’) is organised by several treaty provisions. Among them, Article 95 EC (formerly Article 100(a) EC) is generally considered the standard basis. Pursuant to that provision, approximation may be carried out where national rules hinder by reason of their disparity the establishment and/or the functioning of the internal market. The provision is thus meant to realise the internal market. Rules generally differ among Member States. They express choices that have long been made in separate contexts. Approximation provides the Council and the Parliament with a mandate to establish a common field where undertakings will carry out activities on a similar basis. In the process of approximating the rules, these institutions have the opportunity to decide what norms will apply to undertakings throughout the Union. They are thus in a position to regulate entire sectors of the economy. E.

Harmonisation Directives

In the harmonisation framework, the Council and the Parliament adopted several electronic communications directives.26 may be found at ⬍http://europa.eu.int/information_society/topics/telecoms/index_en. htm⬎ (visited 11 January 2002).

26 They

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Terminal equipment Some of them regulate the conditions under which terminal equipment can be commercialised and connected to infrastructure in the various Member States. The aim underlying these measures is to ensure that manufacturers will not have to adapt their products to specific technical requirements in force in each Member State. Technical standards are thus harmonised throughout the Union. The terminals manufactured in conformity with these standards have to be accepted in the other countries of the Union. The directives further harmonise the formalities that can be imposed at national level in order to determine whether these technical requirements are complied with.27 Provision of services Similar measures were taken with regard to services. In the absence of harmonisation, firms are submitted to more or less stringent rules depending on the territory where they are established. Suppose they want to perform services in several European countries, they will normally have to comply with the rules applicable in each national territory. To avoid these situations, the choice was made to determine at European level the obligations that could be imposed on undertakings providing services in the electronic communications. A rapprochement also took place with respect to the formalities firms may have to comply with before starting their activities in the different Member States.28 Open Network Provision (ONP) A third and wide set of measures was adopted with a view to opening networks throughout the Community. The goal was to ensure networks would interconnect easily across Member States. A technical harmonisation was adopted to achieve that end. That process facilitates transmissions implying several Member States. Measures were added to regulate the behaviour of former national operators vis-à-vis operators or service providers from other European countries.29 Behaviour of operators In the same context (Open Network Provision), the Council and the Parliament adopted measures to a lesser extent related 27 Last instrument: Dir 1999/5/EC of the European Parliament and of the Council of 9 March 1999

on radio equipment and telecommunications terminal equipment and the mutual recognition of their conformity [1999] OJ L/091/10. 97/13 of 10 April 1997 on a common framework for general authorisations and individual licences in the field of telecommunications services [1997] OJ L/117/15. Despite these measures, it remains that firms active on several territories will still be subject to the formalities in each Member State. The formalities undertaken in one territory will not automatically be recognised for services to be performed by the same firm in the other countries of the Union. 29 Dir 90/387 of 28 June 1990 on the establishment of the internal market for telecommunications services through the implementation of open network provision [1990] OJ L/192/1; Dir 92/44 of 5 June 1992 on the application of open network provision to leased lines [1992] OJ L/165/27; Dir 97/33 of 30 June 1997 on interconnection in telecommunications with regard to ensuring universal services and interoperability through application of the principles of Open Network Provision (ONP) [1997] OJ L/199/32; Dir 97/51 of 6 October 1997 amending Dirs 90/387 and 92/44 for the purpose of adaptation to a competitive environment in telecommunications [1997] OJ L/295/23; Dir 98/10 of 26 February 1998 on the application of ONP to voice telephony and on universal service for telecommunications in a competitive environment [1998] OJ L/101/24. 28 Dir


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to the market. In some directives, these institutions harmonised the conditions at which network operators have to grant access to service providers. Such an intervention was certainly useful to establish common conditions throughout the European market—and thus ensure all undertakings would be placed on equal terms. It was not specifically related, however, to the situation of network operators or service providers wishing to carry out cross border activities and being hindered in their project by disparity between national rules. Thus, the Council and the Parliament regulated via the harmonisation directives the behaviour network operators could, or could not, adopt vis-à-vis service providers. They determined for instance under what conditions interconnection should be given or could be refused. They imposed an obligation on operators to provide some kind of service or infrastructure. They also established accountancy constraints, in the hope that activities would be easier to control.30 Social measures The Council and the Parliament further adopted measures to protect certain categories of people. These measures are not specifically related to the internal market either, with the reserve that they establish common rules across the European territory (influence on the competitive position of companies). Thus, provisions relating to a universal service obligation were introduced: Member States were granted the right to set up a system whereby some fundamental services could be made available to the whole population at reasonable and equal conditions. These provisions also determine how the system can be financed, what costs can be taken into account and who may be asked to pay for them. Other provisions were adopted in consideration of handicapped persons or other groups deserving special protection.31

F.

Two Categories of Rules

As a result of harmonisation and the application of competition rules, two categories of rules were adopted in European electronic communications by different authorities or groups of authorities. They are based on diverging legal bases (harmonisation: Article 95 EC; competition rules: Articles 81 and 82 and 86 EC as well as the Merger Regulation). They also rest on different concepts (achieve the internal market in one case; introduce and maintain competition in the other one). Despite these differences, both categories were used to regulate similar issues. Liberalisation and competition were interpreted widely by the Commission. Thus, that institution considered it its duty to regulate anything that may 30 Above n 30. 31 In particular

Dir 98/10 as cited above in n 29.

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directly or indirectly affect competition. Yet, all rules have an effect of that nature. As they force firms to act in given directions or prohibit them to adopt actions, rules necessarily influence behaviour and positions on the markets. Hence, the Commission undertook to regulate the sector of electronic communications entirely. Parallel to that, a similar stance was adopted by the Council and the European Parliament through harmonisation directives. These instruments sought to eliminate disparities that may affect activities. Yet, rules necessarily differ among Member States as they result from diverging contexts. The Council and the Parliament thus sought to establish common grounds for activities across the European territory. Consequently, they regulated just about any behaviour in the electronic communications sector.

G.

Contradictions

As both categories of rules governed similar issues, contradictions were inevitable. Some indeed occurred in various instances. One example is examined below, with respect to the determination of undertakings that may have obligation to contribute to the cost of the universal service imposed upon them.32 Example As we have seen, the Commission, the Council and the Parliament agreed that the Member States could organise the provision of fundamental services at derogatory conditions. These services would be performed at prices below the cost. The loss would however have to be compensated. The compensation could either come through public intervention or through contributions paid by a fund set up to that effect. In this latter case, the fund would collect payments by undertakings. The question was to determine what obligation to pay could be imposed on undertakings. At the same time, the Commission sought to prevent such obligations being imposed on new entrants, as this might deter these new undertakings from entering the markets. This would signal a failure for the purpose sought by the Commission—to introduce competition by allowing new participants on the markets. To avoid that result, the Commission stated that the fund should ideally be financed by former national operators. These operators would thus face an extra burden. By contrast, new entrants would bear no obligation of that kind. They would thus be at an advantage that would allow them to compete more effectively with former operators.

32 Other

examples are available in distinct publications. A full account may be found in P Larouche, Competition Law and Regulation in European Telecommunications (Oxford, Hart Publishing, 2000) 70 and in P Nihoul, publications cited above n 22.


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The still enormous market share retained by the latter would expectedly shrink to the benefit of competition. In order to achieve that result, the Commission specified in liberalisation Directive 96/19 that universal service obligations could only be financed by operators of public networks— in fact former national monopolies—in states where the cost would be financed by a fund. A different attitude was taken by the Member States via the Council. The Member States appeared to accept liberalisation introduced by the Commission after they realised they could not oppose it. They were also in favour of fundamental services being offered to the population on reasonable conditions, but they thought that the cost of providing such services should be borne by all undertakings present on the telecom markets. Liberalisation would provide opportunities for new entrants. It would be legitimate, according to them, that part of the benefits acquired by these undertakings be transferred to the population in the form of universal service obligations. Member States also feared that placing an extra burden on former national operators might adversely impact on the financial situation of the latter. Such an impact would further complicate any possible negotiation with third parties interested in buying part or all of the shares of these operators (privatisation). It would also force operators to drastically reduce costs, predominantly at the expense of workers. For these reasons, the Council sought to enlarge the circle of undertakings that could be called to contribute to the cost of universal service. These endeavours resulted in several provisions being inserted in ONP Directives 97/33 and 98/10. Pursuant to these instruments, universal service now principally entails the provision of vocal telephony to the public. The Council found it legitimate to provide that a contribution could be required from any firm active in the provision of public telecommunications network or in the provision of public vocal telephony. A contradiction thus emerged between the provisions adopted by the Commission and by the Council (with the Parliament). It was later addressed by a communication adopted by the Commission. Pursuant to that communication, Member States may impose financial obligations in the context of universal service on voice telephony providers (other than former national operators). These obligations however have to be determined in proportion to their usage of public telecommunications networks. Commission: Initiative [A]ny national scheme which is necessary to share the net cost of the provision of universal service obligations entrusted to the telecommunications organisations, with other organisations whether it consists of a system of

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supplementary charges or a universal service fund, shall: (a) apply only to undertakings providing public telecommunications networks.33

Parliament and Council: Reaction Where a Member State determines … that universal service obligations represent an unfair burden on an organisation, it shall establish a mechanism for sharing the net cost of the universal service obligations with other organisations operating public telecommunications networks and/or publicly available voice telephony services.34

Commission: Conciliation The Commission will … interpret both Article 4C of the Commission directive and 5(1) … as allowing contributions only to be imposed on voice telephony providers in proportion to their usage of public telecommunications networks.35 In line with the Full Competition Directive and the Interconnection Directive, only organisations providing public telecommunications networks and/or public voice telephony services may be required under National Schemes to contribute to a Universal Service Fund or to any system of supplementary charges … [C]ontributions may only be imposed on voice telephony providers in proportion to their usage of public telecommunications networks … [T]he Commission will, in the case of an application (extension) of obligations to new entrants and/or mobile operators, assess in particular if the burden is allocated according to objective and non-discriminatory criteria and in accordance with the principle of proportionality.36

3.

A.

CONFLICT AT NATIONAL LEVEL

Third Stage of the Reform

Measures have thus been adopted at European level by several authorities. Some of them produce direct effect in the internal orders of the 33 Commission

Dir 90/388 of 28 June 1990 on competition in the markets for telecommunications services [1990] OJ L/192/10, Art 4(c) introduced by Commission Dir 96/19 of 13 March 1996 amending Dir 90/388 with regard to the implementation of full competition in telecommunications markets [1996] OJ L/74/13. 34 Council and Parliament Dir 97/33 of 30 June 1997 on interconnection in telecommunications with regard to ensuring universal services and interoperability through application of the principles of Open Network Provision (ONP) [1997] OJ L/199/32, Art 5(1). 35 Commission Communication on Assessment Criteria for National Schemes for the Costing and Financing of Universal Service in Telecommunications and Guidelines for the Member States on Operation of Such Schemes, COM (96) 608, 27 November 1996, Annex C: Commission Statement to the Minutes of the 1910th Meeting of Council (Telecommunications), on 27 March 1996 on Who Contributes to Universal Service. 36 Commission Communication above n 36, Guidelines for National Regulatory Authority, point III.


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Member States.37 Most of them, however, have to be implemented in the national orders. The legislators and the government play an important role in that regard, as they adopt the national rules necessary for implementation. Other more specialised authorities are called on to intervene as well. As we will see, several authorities or public bodies are entrusted with the task of ensuring a proper application at national level of the European rules that have been adopted in the telecom sector. The co-existence of these authorities partly mirrors the division into two categories that we have mentioned while studying liberalisation (‘competition law’) and harmonisation (‘sector specific regulation’).

B.

National Regulatory Authorities (NRAs)

As part of the measures they have adopted in electronic communications, Member States have created National Regulatory Authorities. These authorities are in charge of implementing the European regulation on electronic communications in their territory. The establishment of these authorities is the result of an obligation imposed on the Member States by the harmonisation rules due to the Council and the Parliament. Such authorities were to be created as early as 1985 38 in order to ensure proper treatment in other European countries of requests for recognition of terminal equipment legally manufactured in a Member State. Other duties were assigned to these bodies in the course of the directives adopted by the Council and the Parliament. The Commission also played its part, namely by imposing on the Member States an obligation to separate operational and regulatory tasks, as well as insisting that the latter mission had to be entrusted to independent bodies.39 NRAs must fulfil a variety of tasks. Among them is the obligation to ensure that sector specific regulation is properly implemented in the national orders. These authorities also intervene in the rule making process, among others by determining under what conditions dominant operators provide interconnection.40

37 Decisions

adopted by the Commission on the basis of Art 81 EC, Art 82 EC and the Merger Reg; regulation adopted by the Council on specific aspects (eg on unbundling the local loop). Some provisions contained in directives may have direct effect after the deadline set for their implementation by the Member States. 38 See Council Dir 86/361/EEC of 24 July 1986 on the initial stage of the mutual recognition of type approval for telecommunications terminal equipment, [1986] OJ L/217/21. 39 Formerly, the national operators were entrusted with regulatory tasks in addition to their operational activities. In its liberalisation directives, the Commission insisted that these tasks should be assigned to different bodies. 40 P Nihoul, Droit européen des télécommunications—L’organisation des marchés (Brussels, Larcier, 1999) 239.

108 C.

PLG Nihoul National Competition Authorities (NCAs)

In addition, competition authorities have been created at national level. There does not appear to exist, at the present time, any explicit obligation for the Member States to set up such bodies in their internal order. One can, however, consider that a constraint of that sort derives from the general provisions of the treaty. In particular, Article 10 EC provides that Member States are to take all measures that are appropriate to ensure the implementation of treaty objectives. Yet, one of these objectives is to establish a market where competition is undistorted. In accordance with this obligation, Member States have established competition authorities. At the present time, these authorities are principally responsible for the application of national rules relating to competition.41 European rules have indeed largely been applied so far in that field by the European Commission.42 That situation is now changing. The Commission has prepared a project aimed at decentralising the application of European competition rules. Should the project be adopted, the responsibility for applying these rules will mainly be assigned to the NCAs.43 As a result of decentralisation, national authorities will hold responsibility for applying all rules related to competition within the European legal order. Among these rules are the competition principles laid down in the treaty (Article 81(s) EC). To these rules we have to add the instruments adopted by European institutions on the basis of these principles, including: the directives and regulations adopted by the Council (see Article 83 EC discussed above); as well as the directives adopted by the Commission in the framework of telecom liberalisation. In connection with that latter category of instruments, one can thus say that NCAs will have authority to apply the rules introduced by the European Commission on the basis of Article 86 EC within the electronic communications sector.

41 They

already have a certain authority to apply European competition rules. As public organs, they are under a general obligation to ensure proper application of European rules. They however have to respect the power granted to the European Commission, including the exclusive competence of that authority to grant individual exemption pursuant to Art 81(3) EC. 42 National authorities always had a role, but the Commission incontestably remained the leading figure. The reasons for these are probably (1) the absence of competition authorities in some countries during a long period and (2) the clear desire, on the part of the Commission, to maintain some sort of leadership in the area. 43 These authorities would have full responsibility for applying the prohibitions contained in Arts 81 (anticompetitive agreements) and 82 EC (abuse of a dominant position). The Commission would retain authority to withhold cases in the Community interest. It would also retain exclusive competence under the Merger Reg, for operations falling in the scope of such regulation. The White Paper is available at ⬍http://www.europa.eu.int/comm/competition/ antitrust/wb_modernisation_en.pdf⬎ (visited 11 January 2002). On the basis of the White Paper, the Commission has proposed a Regulation that is available at ⬍http://www.europa. eu.int/comm/competition/antitrust/others/modernisation/comm_2000_582/en.pdf⬎.

Authorities, Competition and Electronic Communication D.

109

National Courts

We have mentioned the power vested in national specialised authorities for the application of competition law (NCAs) as well as sector specific regulation (NRAs). One also has to take into account the competence national courts have in that same area. On the one hand, national courts have a general jurisdiction to apply European rules. That jurisdiction includes the possibility of applying rules adopted at European level in the field of competition. Courts may for instance rule over applications introduced by undertakings or customers aiming at obtaining the nullity of an agreement, or at getting payments in reparation of damages caused by violation of European competition rules. That power is not limited to a given sector. It thus applies to electronic communications as well, in so far as competition rules apply to this sector. On the other hand, national courts normally hold power to apply national competition rules. That competence is mainly regulated by national law. It is generally accepted in the Member States that courts should handle civil aspects of claims based on competition rules. They are indeed in national orders the bodies that have charge of the protection of civil rights.44 National competition rules are normally similar in substance to those in force at European level.45 National courts further have jurisdiction to apply telecom sector-specific regulation. Applications may be submitted to them, on the basis of national law, in order to solve disputes involving national rules implementing the European telecom regulation. As these national rules normally reflect those adopted by the European institutions, one may thus consider that national courts apply, in substance, the European rules. Where implementation has not been timely or correctly made, national courts may give precedence to European rules. Some conditions however have to be fulfilled for European rules to be given direct effect in the internal legal order.

4.

A.

CONVERGENCE FROM AN INSTITUTIONAL POINT OF VIEW

Fourth Stage of Development

The three developments we have examined above do correspond to various stages in the reform that has taken place in the European electronic 44 C

Jones, Private Enforcement of Antitrust Law in the EU, UK and USA (Oxford, Oxford University Press, 1999). could not be different, as they would otherwise put into danger the effet utile of European law. They would also affect legal certainty by creating separate standards for the application of a common concept—that of competition. See P Nihoul, La concurrence et le droit (Paris, Editions Management et Société, 2001) 275.

45 They

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communications: the introduction of competition; the negotiation that has followed between the Commission and the Council (with the Parliament), which has given rise to two separate categories of rules; the consequence of this duality in national law where two authorities are entrusted with specific tasks in addition to ordinary public bodies (legislator, government, judiciary). The fourth development is of a different nature. It is not really associated with any given stage in the reform. Therefore it is mentioned at the end of this discussion. As a matter of fact, it appears independent of any institutional dimension, although it has consequences on that point. As we have mentioned, convergence is currently taking place between the technologies that are used in the broadcasting, computing and electronic communications industries. These moves are accompanied by alliances between undertakings within these sectors. They have an effect on regulation, particularly on authorities in charge of these sectors. Prior to this, the said sectors were subject to different rules. From an institutional point of view, they were administered by separate regulators. As a result of convergence, activities now involve hybrid technologies. Thus, they cannot be associated with a particular sector any longer. Given their hybrid character, they fall under the ambit of several regulations and regulators.46

B.

Illustration

As mentioned above, that situation has institutional consequences. Suppose a broadcasting company sends video advertisements via the Internet to all people with an Internet address in a given country. The activity will probably fall under several regulations. As a result, it will call for an intervention from more than one regulator. (1) The broadcasting regulator will probably intervene, as the message is sent by a broadcasting authority and the message is in the form of a video.47 (2) The activity will further attract the attention of the authority entrusted with privacy protection in most Member States.48 (3) The authority in charge of customer protection will also be willing to intervene, should the message contain information that may mislead the addressees. (4) One can additionally envisage the intervention of a competition authority (an NCA or the European Commission as the case may be). Such an intervention may be mandated, for instance, as a result of the power held by a firm that reserves to itself the possibility of 46 C

Blackman and P Nihoul (eds), The Convergence Between Telecommunications and Other Media: How Should Regulation Adapt? (Amsterdam, Elsevier, 1998). 47 In our example, the advertisements are made in the form of a video. They are sent to anyone with an electronic address in a given country. They are meant for the public. 48 In this example, the advertisement was sent to all people with an address in a given country in the absence of a request from these customers. Addresses may have been communicated to the broadcasting company without prior authorisation by the addressee.


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sending messages of that nature via its infrastructure. (5) The NRA may feel involved as well, as telecom sector specific regulation governs relations between the service provider and the network operator. 5.

A.

AN INSTITUTIONAL INTERPRETATION OF THE REFORM

Conflict and Competition among Authorities

The examination that has been carried out above points to the plurality of authorities with competence to intervene in respect of transactions taking place in electronic communications. That situation is remarkable as it reflects in the institutional structure a transformation that has taken place on the telecom markets. As we have seen, markets have been opened to new undertakings after being reserved for decades to a single organisation. The liberalisation that has taken place may also be interpreted in terms of the introduction of a plurality of participants, where singularity was previously the rule with the former monopolists. It now appears, with the observations made above, that this development has not been limited to economic activities. A similar phenomenon has occurred on the institutional side. In the monopolistic era, telecom activities were governed by a single body. Regulatory functions were then entrusted to the undertaking in charge of managing the network and providing the services. This organisation has often been labelled as peculiar, as it allowed a regulatory task to be combined with economic activities.49 We can now emphasise a second feature, as we see that regulation and public control were entrusted to a single authority where several now intervene in the same sector. Not only are several authorities claiming competence in order to regulate the sector, or at least adopt rules that will apply to activities carried out in that sector, in many respects, these authorities also seem to be in conflict with each other. Let us take a look back at the first conflicts we have examined in the first part of this chapter. First conflict. In launching the liberalisation process, the Commission was willing to organise the sector according to the principles it considered were appropriate. Consequently, it wanted to replace an organisation that reflected political and economic conceptions shared by the Member States before the reform was enacted.50 49 This

created a situation that is now perceived as dangerous because governments try to organise authorities in an independent manner. Such independence is considered necessary to allow authorities to reach decisions irrespective of the peculiar interest of any particular undertaking involved. The issue was discussed in Case 41/83 Italy v Commission (British Telecommunications I) [1985] ECR–873. 50 The telecom sector was organised along the same lines in most European States. The United Kingdom was the only country to provide an exception. Still, it should be noted that

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Second conflict. Subsequently, the Commission and the Council were clearly opposed in attempting to define the rules that would govern electronic communications in the European Union. Third conflict. Practitioners underline the difficulties emerging from the existence of several authorities as a result of convergence. Due to that phenomenon, these authorities are in charge of applying European rules in national legal orders. Practitioners fear these authorities may not co-operate, but rather conflict with each other to attract attention and funding. Fourth conflict. As a result of convergence, regulators formerly responsible for separate activities are bound to intervene simultaneously. They will admittedly remain responsible for different aspects of a same activity, but these aspects cannot be totally separated: the intervention of one will normally have consequences on aspects normally regulated by another.51

B.

The Process of Regulatory Competition

As we see from the discussion above, the four developments that have taken place at institutional level during the European electronic communications reform have the form of conflicts. These conflicts may be analysed in terms of competition. In all these cases, two or more authorities are competing for the power to regulate and control. How can we understand this phenomenon? The best way to analyse it is probably to refer to other kinds of conflicts that appear in legal systems. As we talk about regulatory conflicts and competition, one naturally turns to international private and public law. Conflicts have long opposed states that wanted to simultaneously assert their jurisdiction on a given issue. We have experienced several times in the last years this kind of multijurisdictional conflict in the application of competition rules, which is the topic for our discussion. In that field, American and European authorities often tend to apply their rules as soon as their territory, or even merely their the British national operator was originally granted the same position as that enjoyed by its counterparts in the other Member States. The change only occurred a few years before it was introduced by the Commission in the European Union. See M Thatcher, The Politics of Telecommunications, National Institutions, Convergence and Change in Britain and France (Oxford, Oxford University Press, 1999). 51 Thus,

content and transmission were regulated beforehand by separate regulators. Yet, decision taken on one of these aspects will have consequences for others. Suppose an authority wants to ensure cultural pluralism in content production. In order to implement that goal, it must allocate resources in a way that will stop one form of production taking precedence over another. Absent any measure, alternatives will progressively be eliminated. Yet, network capacity constitutes one of these resources. If capacity is limited, the authority will have to allocate that resource to make it possible for producers of alternative programs to reach customers. Transmissions must be regulated therefore to ensure proper allocation in view of pluralism in content.


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interest is affected by a transaction (effects doctrine).52 This situation is no exception. In general, one can say that markets have an increasingly international nature. The result is that authorities assert ever more their jurisdiction simultaneously on transactions, thereby creating numerous potential conflicts that are not always easily solved. Conflicting claims of states have contributed to developing among undertakings the feeling that they should choose, wherever they can, the legal order to which they would like to be subject. Suppose a firm wants to provide Internet services around the globe. As we know, some countries are more stringent than others as regards content that may be published on the Internet. For instance, France does not allow the publication of any material that may encourage racism. By contrast, information of that sort is not prohibited in the United States.53 In the business world, these two regimes will be compared by potential Internet Service Providers (ISPs). On the basis of that comparison, these providers will determine how to structure their operations with respect to these countries. The decisions will presumably be based on one main concern: alleviate costs and thus choose the legal system that will impose the most lenient obligations. In international law, one has traditionally called this behaviour ‘forum shopping’. Firms shop around to determine what regime will be most beneficial. As a matter of fact, the pattern could also be described in terms of ‘competition’. Through their behaviour, undertakings set competition among the various states and legal orders concerned. In that context, the competition process may be analysed a follows.54 Firms must establish their operations in a given territory. To that effect, they still need some sort of territorial resource.55 Territory however does not come alone. It encompasses 52 See

Y Akbar, ‘The Extraterritorial Dimension of US and EU Competition Law: A Threat to the Multilateral System?’ (1999) 53 Australian Journal of International Affairs 113; KM Meessen, Extraterritorial Jurisdiction in Theory and Practice (Deventer, Kluwer Law International, 1996); E Nerep, Extraterritorial Control of Competition under International Law, with Special Regard to US Antitrust Law (Stockholm, Norstedt, 1983). 53 For a discussion, see the judgment issued by the French judiciary in the Yahoo! case. A civil rights association introduced an application against the American ISPs, on the grounds that the latter hosted a site containing racist information and statements in contradiction with French law. The case may be found at ⬍http://www.juriscom.net/txt/jurisfr/cti/tgiparis20001120.htm⬎ (visited 11 January 2002) with a discussion in French and English. 54 P Nihoul, La concurrence et le droit—entreprises, consommateurs et autorités (Paris, Editions Management et Société, 2001) 113. 55 It is uncertain that that necessity will persist in the future, due to the development of virtual worlds. Consider the example of the example of the American on-line music firm Napster. This firm proposed software allowing users to download copyright protected material free of charge. This activity had to be terminated at the request of copyright holders. The request could succeed because the undertaking was located in a given territory, where an action could be brought against it. To circumvent the prohibition, new programs are designed that do not require any physical location on a given territory. These programs are downloaded by users on their computers. They establish a network whereby users exchange their data, including copyright protected material. No intervention of a centrally located server is requested, contrary to what

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political, social and economic conditions. These conditions include the regulatory environment (the type of authority and rule). Where they have to take business decisions, firms analyse the offers that are available in that regard. Among these offers, they choose the option which best corresponds to their needs. As a consequence of ‘forum shopping’, one can observe a type of ‘regulatory’ or—more appropriately—’deregulatory’ competition among states. Countries propose special treatment in the hope of attracting foreign investment or companies. This type of competition is common with respect to taxation. Some countries tax non-resident firms or individuals at very low rates, whereas others grant subsidies to the firms they want to attract. In these situations, firms basically introduce a type of competition among states. Through the possibility they have to select where they establish their presence, they force the states to improve their offer. They choose a territory and a legal order as they would do a supplier of a distribution channel.56

C.

Institutional Competition in Electronic Communications

One may wonder whether these international law situations help us understand the institutional developments associated with European electronic communications. These developments do not appear to involve any international dimension. In conflict one, the Commission was claiming precedence over the Member States. It wanted to organise the telecom sector along the lines of competition, whereas the Member States wanted to maintain their own organisation. In conflict two, the Member States sought to challenge the Commission by adopting harmonisation measures within the Council and in association with the Parliament. That opposition was channelled at national level in conflict three, where NCAs and NRAs may conflict with each other when implementing European and/or national rules relating to electronic communications. None of these three conflicts feature any international law situation similar to those encountered in classical international (private or public) law issues. In short, we do not see in these conflicts states fighting with each other in order to win the right to apply their rules to a given situation. The absence of an international reference is still more obvious in conflict four. happened with Napster. The new system makes it impossible to efficiently initiate a judicial procedure. An action should be brought simultaneously against all users in all countries—which is not materially possible. 56 The competitive process that then takes place is not necessarily positive for all people in society. As they try to improve the offer made to undertakings, states will often lower social protection as well as the level of service that is generally made available to their citizens.


115

As we have seen, this conflict is related to convergence. Before convergence emerged, regulators had jurisdiction over distinct activities. For instance, a Broadcasting Authority would be responsible for broadcasting activities, whereas a Telecom Authority would prepare and implement regulation dealing with telecommunications. These tasks were carried out within a given state and legal order (for instance the British system), outside any international situation.

D.

Competition Among Authorities Within the Same Legal Order

The observations made in electronic communications show that institutional competition is not limited to states. Lawyers have long been aware of inter-state competition.57 It now appears that conflicts are not limited to relations at an international and supranational level. Institutional competition is not based on national boundaries. It opposes authorities attached to different countries, as well as authorities pertaining to the same legal order. Legal orders have traditionally been said to form coherent and consistent systems where authorities would be allocated distinct and specific tasks to be exercised for the common good. A different picture emerges when one looks at the institutional divisions we are experiencing in European electronic communications. From these divisions, one can infer that the idea of a harmonious division of power among authorities has to be abandoned. The division takes place amid rivalry and competition, where each authority uses available instruments (including the power to adopt regulation) to maintain and if possible improve its own situation as well as that of its members. As a result, the conflicts we observe in international law situations should not be analysed as exceptions. They form the visible face of a reality present at all levels of institutional organisation. Institutional competition may be analysed with tools elaborated in international law, if one gives the concept of legal order another definition as well as another scope. Let us consider an analysis of conflict four (result of convergence). Prior to convergence, authorities normally administered activities that were distinct from one another. These regulatory tasks were carried out within the same legal order. For instance, one authority controlled broadcasting in the UK, whereas another one administered telecoms in that same country. As we have seen, convergence brings these activities closer to one another. Authorities remain responsible for distinct aspects of each activity, but conflicts are bound to occur, as one intervention will have an effect on others.

57 That

form of competition was not limited to an regulatory one: it extended in other fields, including economy.

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PLG Nihoul

One can probably compare to territories these various aspects of the same activity. The conflicts emerging among authorities responsible for distinct aspects or areas may be assimilated to oppositions amongst bodies in charge of various territories. The difference between both contexts is that territories refer in one case to material fields (convergence), whereas they are traditionally associated with geographic boundaries (states) in international situations. Regulatory conflicts may thus be described, whatever their level (national or international), in terms of competition among rules and authorities that form different legal orders. The concept of legal order has traditionally been reserved to a system proper to a state. However, it may also be used to describe the sort of competition that appears in conflict four. We propose to define it as ‘any system made of rules that are to be consistent with one another and the object of which is to govern a specific object’. Each body of rules may thus be described as a legal order. In that perspective, one might represent national legal orders as bodies encompassing in themselves a multitude of systems: each of them forming a micro legal order insofar as it aims at governing specific issues in a somewhat coherent fashion. That sort of situation does not appear as an exception. It rather seems to flow from a general trend that may be observed in all economic and social sectors. Throughout the ages, authorities have created rules to govern human activity. Rules have been adopted to administer just about any behaviour, in all its aspects. It can thus be expected that the same behaviour can be scrutinised under several rules corresponding to various aspects that have been regulated through the years. This plurality in rules has been matched by a trend to create bodies, each entrusted with a mission to ensure the proper application of a given set of rules.58 The two trends (creation of rules and authorities) have mutually reinforced themselves. The enactment of rules made it necessary to create bodies to implement them. Conversely, authorities were granted the power to further regulate the areas placed under their command. In that capacity, they issued new regulations. A movement was thus developed whereby activities were being increasingly submitted to various authorities, all eager to apply their rules to the situations they encounter. E.

Expanding the Line of Business

The lesson to be drawn from the reform on an institutional level probably lies here—authorities compete in the same way as undertakings. The four 58 As

we noted above, several authorities were thus created which now hold a certain power relating to electronic communications: national regulatory authorities, broadcasting authorities, authorities competent to monitor the respect of privacy, consumer protection, etc.


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conflicts observed in electronic communications may be interpreted in competitive terms. As competition does for undertakings, these conflicts probably play an important role in the initiatives that are taken by authorities. One should not infer from that statement that competition explains all moves adopted by public bodies. For instance, the European telecom reform can certainly be explained by economic reasons: the willingness to organise European activities in line with modern economic thinking. To believe that the reform can only be explained by considerations of that nature would however be short sighted. One would lose sight of the role competition and conflict play in institutional development. In order to understand that process, one may refer to methods used by firms in the business world. An undertaking normally manufactures products or performs services. A good manner for it to expand activities consists of using one of several methods it has developed in the course of its business in new markets. Take the Internet firm Amazon. That firm was originally engaged in the business of selling books. It thereby developed a specific ability—a ‘business function’ in management terms. That function was to serve as an intermediary between producers (editors) and clients (readers or in some instances other intermediaries closer to the final customers). In a hope to improve its situation, Amazon decided to expand activities. To that end, it entered markets where it could apply that business function. It thus started distributing other products—in the first instance objects similar to books (CDs, etc) and then products that were more remote (travel, etc) but were still offered by a producer for which it could act as an intermediary. A similar pattern of interpretation may be used in order to analyse in institutional terms the reform that has taken place in European electronic communications. The interpretation starts with the position held by the European Commission. That institution considers itself as having the power to design and implement competition policy within the European Union.59 For the Commission, that task constitutes an activity, like selling goods and services constitutes an activity for the American intermediary Amazon. The Commission drafts and implement rules in situations where competition issues emerge.60 59 See

the following statement on the Internet site of DG IV: ‘the mission of Competition Directorate General is to establish and implement a coherent competition policy for the European Union’: ⬍http://www.europa.eu.int/comm/dgs/competition/index_en.htm⬎ (visited 11 January 2002). That position is already the result of expansion. The role of the Commission is indeed confined by the treaty to the implementation of the rules of competition that are embodied in the treaty as well as those that are adopted by the Council, among others those whereby the Council determines what role other institutions—including the Commission— will play in the realm of competition. 60 The European Commission has other tasks as well. We are here focusing on that which is associated with DG IV—the division responsible for competition matters within the Commission.

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PLG Nihoul

Underlying that activity is the ‘business function’ characterising the intervention of the Commission in that context. Through using the expression ‘business function’, we designate a sort of archetypal activity. We thereby determine what the firm or the institution basically does, independent of the accurate and concrete context (identity of the product or service) where it operates. In this case, the business function may be expressed in regulatory terms. The Commission basically ‘talks’ competition rules, whatever the context where it wants to apply these rules and expand the policy it is devising under that name. The regulatory aspects of competition form a legal order, which grants the Commission tools to express its views and intervene in a variety of situations. The legal or regulatory order may be analysed as the equivalent in institutional terms of what we have labelled ‘business function’ using management vocabulary. In a system where power is attributed, institutions may only act on the basis of competence entrusted to them. To expand their activities they have little choice but to receive new powers or to extend those which they have previously received. Given the difficulty of receiving new powers in the course of treaty revisions, their best chance is to apply that power to new contexts. A new equilibrium will thus progressively be reached, between the authorities that could pretend to power in that new context. Conflicts may in some instances be brought to a superior organ, which will then play the role of an arbitrator between these authorities.61 To come back to electronic communications, we can interpret the behaviour of the Commission as that of an authority willing to enter new activities. The rules of competition could be applied to vast sectors of the economy. However, it had never been considered that these rules should also apply to sectors that had so far been regulated by states. We are alluding here to all sectors where states had attributed special or exclusive rights to certain undertakings, as well as to sectors where states had a particularly strong presence through public undertakings. These sectors formed a significant part of the economy. They also provided states with an opportunity still to influence economic structure and strategy within the European Union, at a time when it was felt a European approach might be useful. Electronic communications provided a good opportunity given the reasons mentioned at the outset of this discussion—principally the importance acquired by that sector in the economy as a whole as well as the technological advantages that were developed by American firms in that field. In order to enter these 61 The

ECJ played a role of that nature in the conflict opposing the European Commission and several Member States in the cases relating to the liberalisation directives adopted by the former in the telecommunications sector. The ECJ acted in this role with respect to the conflict opposing the European Commission and several Member States in the cases relating to the liberalisation directives adopted by the former in the telecommunications sector. On the role of arbitrator of the ECJ, see K Lenaerts, Le juge et la constitution aux Etats-Unis d’Amérique et dans l’ordre juridique européen (Brussels, Bruylant, 1988).


119

areas, the Commission applied the function it had developed in other sectors. It thus adopted competition rules meant to organise the sector. Using competition concepts, it designed regulation tailored to the needs of the telecom industry as these needs were perceived by the Commission.62

6.

A.

WHAT CAN WE LEARN ABOUT THE FUTURE?

More Competition among Authorities

As these elements have been presented for an institutional interpretation of the reform, the time is ripe to dare a prospective question. In our analysis, we have seen that authorities compete with each other and that such competition may sometimes play an essential role in the determination of the rules that are adopted in a given sector. Can we envisage a situation where that sort of competition—one which concerns regulation—would be organised further? Competition is structured by law and intervention where it comes to firms and markets. Is that way of organising relations limited to these entities per se—or can it be adopted with respect to institutions and regulatory processes? The question should be further refined as follows. The debate is not set up in terms of: ‘Should we organise authorities in a more competitive manner?’ Such a formulation would entail political choices and considerations that do not have their place in a scientific discussion like the one which is taking place in the context of this seminar. The question should rather be understood in the form of: ‘Are we engaged in a process where relations are increasingly regulated in competition terms, to such an extent that this organisation will not be limited any longer to undertakings but will also be used to tailor institutional relations in the future?’ In order to understand the question better, let us return to conflict three. As we have seen, it is often feared by undertakings that NRAs may compete in the future with NCAs to obtain attention and funds. Does the increasing importance acquired by competition—an importance that is attested by the introduction of rivalry in previously monopolistic markets and the conflicts which have taken place at an institutional level in the European electronic communications—announce an era in which firms will be allowed to choose the authority they see as best to intervene in their situation and solve their legal disputes? On the basis of what we have observed can we predict a time when firms will be allowed to choose ‘their’ authority and ‘their’ legal system as they choose a provider or a distribution channel? Will such a situation occur independent of any international context? 62 As

mentioned above, these rules were enacted in the liberalisation directives as well as in the decisions adopted on the basis of Art 81 EC, Art 82 EC and the Merger Regulation.

120 B.

PLG Nihoul First Difficulty: Regulation Not an Ordinary Good

When we try to envisage such a possibility, a first difficulty readily emerges to the extent that undertakings will probably choose the legal system (rule, authority) that is the most favourable to them. Firms normally sell goods or/and services. A choice is made by customers among these goods and services. In the process, firms adapt their offer to the needs of the customers, in the hope of being selected by the latter. Only on those conditions will these firms obtain the resources that are necessary in order for them to continue their activities and carry out their projects. Can we envisage a similar pattern with authorities? In the representation proposed above, authorities are regarded as bodies offering ‘regulatory’ goods or services. Among the goods and services of that nature, firms and individuals will normally choose the offer they see as best corresponding to their needs. In that process, authorities would probably try to adapt their offer as we have seen undertakings do. There is a risk that authorities will dilute their rules and requirements in order to please their customers. Regulation would then stop fulfilling its mission, which is to provide participants with a platform where all can interact in a manner conforming to public objectives and values.

C.

Solution: Competition Within a Given Framework

The difficulty can probably be overcome by resorting to the mechanism used in auctions. Consider the approach that has been taken by the European authorities with respect to universal services obligations.63 Pursuant to the European regulation, the Member States may decide that some fundamental services will be provided at derogatory conditions on their territory. That decision is based on the perception that these services may be deemed essential to the population in these national legal orders. In the framework established by the European rules, the Member States determine what services may be concerned as well as the conditions under which the latter will have to be provided. Candidate firms are asked to bid a price at which they would be ready to offer all or part of the services. In such a mechanism, firms are called to apply in order to fulfil goals of an objective nature. The application occurs within a framework that is set by authorities and corresponds to the requirements justified by the public interest. That framework is indeed made up of decisions where authorities set the objectives to be reached as well as the criteria that will be used to evaluate performance. Within that framework, competition occurs between the candidates. The best offer will win the auction. The firms thus carry out 63 Above

n 23.


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their tasks in an environment made up of competition within a framework where public goals are to be achieved. A similar system may be imagined for authorities. Objectives may be fixed which authorities will have to implement. These objectives would be fixed by some superior organ—for instance the European Parliament, a solution that appears legitimate in a democratically oriented legal order. Within these objectives, authorities would have to compete. They would need to carry out their tasks so that they are chosen by customers (firms, individuals) without endangering the realisation of the public objectives which have been assigned to them.

D.

Second Difficulty: Legal Certainty and Predictability

A second difficulty may come from the impossibility to determine with certainty and accuracy the solution that might be applied to a legal dispute in an environment where participants (firms, individuals) may choose their regulation as well as their regulatory partner. Economic agents need to know in advance what rules will apply to their behaviour. That is possible, although not always easy, where one solution only may be admitted.64 It is probably more difficult, if not impossible, in cases where two or several solutions may eventually be applied, depending on what legal order is chosen by one or the other party. To understand the problem, let us go back to our example where firms and individuals are allowed to choose between competition law or sector specific regulation (conflict three). Suppose one firm chooses the competition legal order. It enters into conflict with a rival that has opted for the sector specific legal order. What rules and what authority will eventually intervene to solve the dispute? The choice in favour of one or the other may influence the outcome. Yet, the probable outcome of a dispute forms a decisive factor where firms envisage engaging in certain activities in the future.65

64 The

observation of the case law shows that economic agents are not always in a position to determine what solution will apply to their behaviour. That is probably due sometimes to defects in their reasoning but at times to ambiguity and obscurity of the legal system as well. 65 The difficulty is illustrated by the fact that the European system does not allow a choice to be made between competition law or sector specific regulation. Pursuant to legislation, both are to apply simultaneously. Mechanisms are set in place in order to solve possible contradictions. See eg Arts and ff of the Amended Proposal for a Directive of the European Parliament and of the Council on a Common Regulatory Framework for Electronic Communications Networks and Services (taking into account the amendments put forward by the Parliament at its first reading) COM (2001) 380, 4 July 2001, available at ⬍http://www.europa.eu. int/information_society/topics/telecoms/regulatory/new_rf/com2001-380en.pdf⬎ (visited 11 January 2002).

122 E.

PLG Nihoul Place of Unity in Society and the Legal System

This comment refers us back to the importance of unity in the legal system. Unity plays an essential part, because without unity, legal solutions may no longer be identified. Predictability therefore disappears, with the negative consequences such a development may have on business decisions.66 We are touching here on a very delicate issue in terms of how legal systems are now designed. In order to address this issue, let us return to electronic communications. We have seen that telecommunications have long been organised in the form of a monopoly. In that system, one undertaking was granted the right to perform activities. As a result, one infrastructure was established in each national territory. One offer was thus presented to the customers. The demand was even unified, as customers were supposed to form one body interested by standard goods and services. That organisation was not limited to communications. It was applied to other sectors where authorities had a leading role. All public utilities were in fact concerned—water, electricity, gas and transportation. Besides these sectors, non-economic activities were also affected. This unity based organisation was also used to structure legal and administrative arrangements. For instance, each country was supposed to have one legal system where one function was assigned to each category of institutions (legislative, executive, judiciary). The case is particularly clear for judicial competence, as courts normally have distinct jurisdictions, so overlapping powers are considered a major issue that requires the intervention of a superior authority.67 In short, unity appears symptomatic of the way authorities organise tasks and institutions placed under their control whatever the sector and the nature (economic or not) of the activity. That unity is associated with hierarchy. Things are organised in a hierarchical manner. Each is assigned a domain where it will hold exclusive competence. At a higher level, several entities will depend on a superior body that will solve potential contradictions or difficulties.

66 Unpredictability

of legal outcomes is an important factor explaining the difficulties faced by countries in transition, where they endeavour to attract foreign investment and companies. 67 Illustrations about the importance of certainty, predictability and unity are pervasive in the case law of the ECJ. A good example is provided by Case 314/85 Fotofrost [1987] ECR 4225, para 11. In that case, the question for the court was whether national courts could invalidate acts adopted by European institutions. The ECJ claimed exclusive jurisdiction for decisions of that kind. That solution was justified by the necessity to have identical solutions throughout the Community. (National courts may decide differently where asked to evaluate the validity of Community acts.) It was also based on the necessity of achieving consistency among several procedures. As the ECJ has exclusive jurisdiction to rule on direct applications for annulment, the same solution had to apply with respect to preliminary rulings with a similar object. Without such a solution, decisions may have differed on the same act depending on the procedure initiated by the applicant and thus the court that would have been called to intervene.

Authorities, Competition and Electronic Communication F.

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Conformity with an Information and Communication Based Society?

Does this unity based system still conform with society as it develops? We have had unity for a long time in our lives. Our ancestors had one religion, partner, family, political party, employer and place of residence. Their status as well as their activities was organised around that semi-conscious principle of necessary unity. Yet, we see that unity is progressively being replaced by plurality. Monopolies are set aside to welcome participants on the markets—not just in electronic communications. Syncretism is now the norm in religion, where everyone picks up pieces wherever he or she can in order to constitute his/her own religious environment. Families are increasingly built on plurality, with people choosing partners in various periods of their lives and having different families as a result. Political parties cannot hope to attract supporters for their whole program any longer: citizens turn to one for some ideas and to other ones for other inspiration. This evolution poses a challenge to the legal system. Is it going to remain attached to principles such as unity and hierarchy, which have marked the organisation of public power as well as institutional relations for the past centuries—or will it be organised along these new lines being suggested by the appearance of plurality in all sectors of our lives? This challenge may be addressed with the help of technological progress. Thanks to information technology, we are now able to treat larger amount of data and information more quickly. Communications technology has also significantly increased our capacity to transmit information. With this technology, we may envisage regulatory arrangements that are more complex than the ones we have known before. Thanks to it, we may be in a position to introduce plurality in the legal system. Think of the information based mechanisms that are used for products and services, where it comes to giving customers data about the items they are likely to purchase or order. For a more concrete example, take the data that must now be placed on meat packages as a result of decisions recently taken by European authorities. With this data, it is now possible for customers to know the place were the animal was born, where it was raised, where it was slaughtered as well where the packaging took place. Choices are made by economic agents on the basis of the information which is provided to them.68 Can we envisage a similar pattern about legal regimes that may be applied to given behaviour in a society? One can imagine goods and services being accompanied with detail informing customers about the authority and the law that would apply to possible disputes. The system is already 68 Here again, a superior authority has to intervene in order to decide what kind of information has to be provided by the firms.

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used in international transactions, where firms specify the national legal order that will be deemed competent to solve disputes. In our prospective search, a similar mechanism could probably be used with respect to competing authorities and rules dealing with similar issues within a single nation. To illustrate that possibility, let us go back to our ideal world where firms and individuals would be allowed to choose between one legal order based on competition law and another one based on sector specific regulation. In that world, firms could specify the regime they want to be associated with. They should inform possible customers about their choice. Customers would then be in a position to make their decisions based on information of that nature. The situation would be similar to those encountered in international law. In such situations, parties structure their operations in anticipation of the rules that would apply and the authorities that would intervene, should a dispute occur. For instance, they choose to sign an agreement in France because they know that French rules will then be applicable to them. In our prospective thinking, a similar system would apply with different rules and authorities being organised in a competitive manner independent of any national or international consideration. Choosing to deal with a given firm would mean that disputes would be submitted to the rules and authorities selected by that firm. One would thus encounter typical international law related multi-jurisdictional issues, with the difference that the choice would not be attached to a territory. Instead of choosing between, say, French or British law, the protagonists would choose between different legal orders that may co-exist on a given territory and which may offer variable solutions within a framework of public goals and values. In this pattern, the law would stop being considered as a necessarily centrally organised system guiding all participants on the markets or in society in general. It would rather become a part of goods or services, as much as the guarantee possibly granted by the manufacturer is nowadays considered by customers as integral to a product they want to purchase. As observed several times during this chapter, an organisation of the type envisaged here does not eliminate altogether the necessity of a superior authority which would design the framework of public goals and values within which institutional and regulatory competition would flourish. Thus, the expectation should not be that the law as we know it will totally be set aside. At the present stage, one should rather expect an increasing part of it to be organised on a competitive basis—law becoming more and more a commodity within a framework set by classical authorities.

6 Controlling the New Media: Hybrid Responses to New Forms of Power ANDREW MURRAY AND COLIN SCOTT*

T

HE EMERGENCE AND identification of the new media, premised upon the development and application of digital technologies, has created new sources and locations of power, many not fully documented or understood. Those new configurations of power which have been identified have stimulated distinctive literatures about the most appropriate mechanisms of control. With much of the literature, classical or ‘command and control’ regulation is held either to be undesirable or unfeasible in the face of the new policy challenges. For one school of thought, the changing market structures associated with the new media indicate a reduced role for classical regulation and its virtually total displacement by competition law.1 For another school, the emergence of the Internet presents insuperable problems for classical regulation and alternative mechanisms of control based on self-regulation and architecture are more likely to be effective. In this chapter we draw together some of the regulatory problems presented by the new media and apply a developed and modified version of

* Andrew Murray is a Lecturer in Law at the London School of Economics. Colin Scott is Senior Fellow in Public Law, Research School of Social Sciences, Australian National University and a Reader in Law, Centre for the Analysis of Risk and Regulation, London School of Economics. This chapter was originally presented at a Workshop on Competition Law and the New Economy sponsored by the Modern Law Review and was first published in (2002) 65 Modern Law Review 491–516. Though we accept full responsibility for errors and infelicities we gratefully acknowledge the comments on an earlier draft from Workshop participants and from Julia Black, John Braithwaite, Neil Duxbury, Peter Grabosky, Mathias Klang, Robin Mansell and David Post. 1 The Chicago School of Law and Economics supports market control where markets are competitive. If the market is uncompetitive, competition law provides an adequate remedy. This premise has been attacked in relation to layered communications networks. See L Lessig, The Future of Ideas: The Fate of the Commons in a Connected World (New York, Random House, 2001) 110; C Salop and RC Romaine, ‘Preserving Monopoly: Economic Analysis, Legal Standards and Microsoft’ (1999) 7 George Mason Law Review 617.

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Lawrence Lessig’s ‘modalities of regulation’2 analysis to thinking about the range of mechanisms which have been developed to address these problems. Accordingly we first provide a description of some of the key problems identified with controlling the new media. Our modified version of Lessig’s analysis claims that there are four bases of regulation—hierarchy, competition, community and design. We set the analysis to work demonstrating that these four bases of regulation are observable as means of addressing the range of regulatory problems of the new media. The tendency to privilege one basis for regulation over others appears to us to be consistent neither with empirical observation nor with the normative considerations of institutional design for good regulation. What we observe is the prevalence of hybrid forms of control which, when better understood, could provide the basis for a better informed policy debate about the control of the new media. Differences in approach may partly be explained by reference to the cultures and preoccupations within different jurisdictions. The UK and many European Union states have a strong tradition of self-regulation in the media generally and the legitimacy of this form of governance is widely accepted.3 Private governance forms are generally less well recognised and accepted in the United States and have been the subject matter of fierce debate over their legitimacy.4 A related bias in the US literature is the very high value placed on the constitutional ideal of freedom of speech which feeds into a strong libertarian underpinning to much discussion of regulation of new media.5 Though freedom of speech may have some constitutional protection in EU states, the extent to which such a right is qualified by other collective considerations is quite pronounced. American scholarship on new media issues is dominated by the ‘legal centralist’ perspective of law and economics which accords less recognition to the potential for pluralism in the generation of norms than is true of some European scholarship.6 2 L Lessig, Code and Other Laws of Cyberspace (New York, Basic Books, 1999) 88. 3 J Black, ‘Constitutionalising Self-Regulation’ (1996) 59 Modern Law Review 24. 4 The suspicion of private governance institutions in American legal scholarship is forcefully

represented by Michael Froomkin’s critique of the Internet Corporation for Assigned Names and Numbers (ICANN): M Froomkin, ‘Wrong Turn in Cyberspace: Using ICANN to Route Around the APA and the Constitution’ (2000) 50 Duke Law Journal 17; cf the (European) views of W Kleinwächter, ‘The Silent Subversive: ICANN and the New Global Governance’ (2001) 3 Info 259 which are largely approving of the innovation in governance created by ICANN. 5 M Castells, The Internet Galaxy (Oxford, Oxford University Press, 2001) 33. S Venturelli, ‘Inventing E-Regulation in the US, EU and East Asia: Conflicting Social Visions of the Internet and the Information Society’ paper presented to 29th Research Conference on Communication, Information and Internet Policy, October 2001, Alexandria, Virginia available at ⬍http://www.arxiv.org/ftp/cs/papers/0110/0110002.pdf⬎ (visited 19 December 2001). 6 The analysis is succinctly made by R Ellickson, ‘The Aim of Order Without Law’ (1994) 150 Journal of Institutional and Theoretical Economics 97, which provides a summary of the fuller treatment in R Ellickson, Order Without Law (Cambridge, MA, Harvard University Press,

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Whatever the effects of intellectual bias, we suggest that research and thinking on control of new media sectors has generated novel insights on regulation which are of wider application. In particular, the current debate on how forces of control may be used to shape the future development of networks is of wider interest to researchers in the fields of law, economics and social policy. The debate is centred upon the role of the commons in the fledgling third generation Internet. Sunstein’s claim that ‘there is no avoiding “regulation” of the communications market’7 has been met by an equally forceful counterclaim by Lessig that [t]he issue for us will not be which system of exclusive control—the government or the market—should govern a given resource. The question for us comes before: not whether the market or the state but, for any given resource, whether that resource should be controlled or free.’8

Lessig’s call for a debate on this issue provides a powerful rallying call to those lobbying for the deregulation of, in the sense of making free, all layers of the Internet infrastructure. The debate called for by Lessig is not new. The open source movement led by Richard Stallman and the Free Software Foundation has lobbied for deregulation of the code level since the mid-1980s.9 Deregulation at the content level was built into the original Internet infrastructure by network designers such as Paul Baran, Jerome Saltzer, David Clark and David Reed.10 This has since been substantially eroded by the development of intelligent networks such as Resource Reservation Protocol (RSVP).11 There is no doubt many in the new media sector will respond to Lessig’s analysis and over the next five years the wider dialogue of the role of regulation within political science, media and economics will be strongly influenced by this currently narrow legal debate. Thus, while we make extensive use of examples drawn from new media, we suggest that the developed models of control which we discuss are of interest to policy makers and researchers with interests in governance and regulation generally.

1991). See also R Cooter, ‘Against Legal Centrism’ (1993) 81 California Law Review 417; L Lessig, ‘The Regulation of Social Meaning’ (1995) 62 University of Chicago Law Review 943. 7 C Sunstein, Republic.Com (Princeton, Princeton University Press, 2001) 128. 8 Lessig, n 1 above n 12. 9 Ibid 52–61. 10 Ibid 34–44; J Saltzer, D Reed and D Clark, ‘End-to-End Arguments in System Design’

(1984) 2 ACM Transactions in Computer Systems 277. On-line version at ⬍http://web.mit.edu/Saltzer/ www/publications/endtoend/endtoend.pdf⬎ (visited 4 January 2002). 11 Discussed below.

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Andrew Murray and Colin Scott NEW MEDIA AND THE PROBLEMS OF EFFECTIVE CONTROL

Processes of digitalisation associated with the development of new media have brought about important reconfigurations of power. The Internet, for example, provides widespread access to technology based on a network of networks and addressing systems which connect computers globally.12 It is said to create a space where users can engage in a variety of activities with a substantial autonomy from state power which does not exist in non-digital media.13 Digitalisation of broadcasting and mobile telecommunications create niches for new forms of service provider, shifting power away both from those who own the physical infrastructure of networks and from those who own content. We identify in this section three general problems of new media (that is problems which apply generally or to more than one medium) which arise from shifts in power. None of these problems is exclusive to the new media, though each emerges with interesting new features in this context. They are the problems of regulatory arbitrage, anonymity and scarcity of resources. In each case once prevalent governance forms based on public ownership are no longer fashionable (and for some no longer feasible) the urgency of investigating other forms of control is enhanced. We should be clear that these are not the only problems associated with the new media. Among the other pressing policy problems are the issues relating to accessibility of digital broadcasting and communications services to less advantaged consumers (which can be defined both in economic and social terms)14 and the extent to which content of digital broadcasting should be controlled (in the manner that both negative and positive content controls apply to analogue broadcasting).15 Discussion of these issues is precluded for reasons of space and in the belief that the theoretical frame developed is sufficiently addressed by the policy problems which we do discuss. A.

The Regulatory Arbitrage Problem

The problem of regulatory arbitrage emerges wherever subjects of regulation have sufficient mobility in their operations or activities that they can choose Leiner et al, ‘A Brief History of the Internet’ Internet Society available at ⬍http://www. isoc.org/internet/history/brief.shtml⬎ (visited 7 January 2002); Castells n 5 above, ch 1. Sassen, ‘Digital Networks and the State: Some Governance Questions’ (2000) 17 Theory, Culture and Society 19, 20. According to Lessig much of this autonomy is hard-wired into the network by its end-to-end architecture, Lessig above n 1, 26–41. 14 M Lemley and D McGowan, ‘Legal Implications of Network Economic Effects’ (1998) 86 California Law Review 479; P David, ‘The Evolving Accidental Information SuperHighway’ (2001) 17 Oxford Review of Economic Policy 159; M Cave and R Mason, ‘The Economics of the Internet: Infrastructure and Regulation’ (2001) 17 Oxford Review of Economic Policy 188. 15 See C Sunstein, ‘Television and the Public Interest’ (2000) 88 California Law Review 499; D Goldberg, T Prosser and S Verhulst, Regulating the Changing Media: A Comparative Study (Oxford, Oxford University Press, 1998). 12 B 13 S


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to be regulated by one regime rather than another. The effect is to create a form of market for regulation within which dissatisfied subjects can ‘exit’ one regime in favour of another. Regulatory arbitrage, seen as a problem for authorities attempting to capture activities within their web, can also be seen as a solution to problems of excessive or inappropriate regulation as it limits the capacities of authorities.16 The problem has an interesting double-edged character in the new media, since options to relocate to avoid particular regulatory regimes may be available both to service providers and consumers. Thus broadcasters can relocate their operations to different jurisdictions to evade national regulation (and this predates digitalisation) while listeners and viewers can relocate from the more controllable forms of delivery to satellite and Internet. One of the problems raised by regulatory arbitrage is the risk that competing standards for the new digital broadcasting transmission services might develop. This is squarely addressed with harmonised rules requiring all member states to legislate for common standards in the EU, notably in respect of consumer equipment for conditional access to services.17 Under the terms of European Union legislation the EU rules on broadcasting regulation apply only to broadcasters established in a state to which the applicable directive applies.18 The directive’s requirements that Member States apply their domestic broadcasting rules to all broadcasters established within the state has been interpreted so as to require Member States to apply their rules as intensely to broadcasters directing their programming at other Member States.19 This interpretation is intended to preclude countries like the UK from setting themselves up as attractive locations for establishment of overseas broadcasters through the application of a more liberal regime than would apply to domestic broadcasters.20 This is a particular issue with broadcasters seeking to evade what they regard as overly restrictive domestic rules, for example on advertising to children or transmission of pornography. Regulatory arbitrage in Cyberspace (that is applying to the Internet) is a focal point for two opposing schools of thought, the Cyberlibertarians and the Cyberpaternalists. The primary argument of the Cyberlibertarians is that Cyberspace is unregulable due to its design. Cyberspace is a unique jurisdiction, as it has no physicality or real-world existence. It is possible to conceive of Internet users simultaneously in Cyberspace and in a grounded, real-world jurisdiction.21 It is this duality and the non-physicality of 16 See W Bratton, J McCahery, S Picciotto and C Scott (eds), International Regulatory Competition and Coordination (Oxford, Oxford University Press, 1996). 17 Dir 95/47/EC [1995] OJ L/281/51, 23 November 1995 Art 4; Broadcasting Act 1996. 18 Council Directive 89/552/EEC [1989] OJ L/298/23 as amended by Dir 97/36/EC [1997] OJ L/202/ 60, Art 2(1); B Drijber ‘The Revised Television Without Frontiers Directive: Is it Fit for the Next Century’ (1999) 36 Common Market Law Review 87, 92. 19 Commission v United Kingdom Case C–222/94 [1996] ECR I–4025. 20 Broadcasting Act 1990, s 43. 21 Lessig above n 2 190.

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Cyberspace which allows for regulatory arbitrage. In the physical world sovereignty is exercised by governments over defined physical territories. A user who wishes to be regulated by a different regulatory structure may take steps to relocate either themselves or their activities. In Cyberspace users may transcend physical borders with ease and may choose to take on any guise or form desired (see below ‘The Anonymity Problem’). Users who prefer a regulated environment where there are structured discussions on carefully selected topics and where content is closely monitored and censored may choose to join a regulated and monitored Cybercommunity such as America Online (AOL). Users seeking uncensored discussion and complete freedom of speech may make use of a virtual chat room on the USENET system or may use an Internet Service Provider (ISP) to enter unmonitored discussion boards on the Web. These freedoms allow users to choose freely the regulatory structure they wish to follow while in Cyberspace. Thus a citizen of Germany can enter a USENET discussion group on the Holocaust and post denial messages, something he or she would be unable to do freely in their home state. Similarly a UK citizen may post information which is in breach of the Official Secrets Acts. Although strictly speaking these citizens are still committing offences within their physical jurisdiction, they can do so without fear of prosecution as in Cyberspace they have taken on a different personality and therefore are unlikely to be traced and prosecuted.22 These citizens have effectively removed themselves from the regulatory control of their sovereign government and have chosen to be regulated by another set of regulatory values and norms. This is because, as dramatically put by David Post, Cyberspace … does not merely weaken the significance of physical location it destroys it … . they do not cross geographical boundaries (in the way that say environmental pollution crosses geographical boundaries), they ignore the existence of boundaries altogether.23

B.

The Anonymity Problem

The non-physicality of Cyberspace allows Internet users to choose to adopt a different persona from their real-world personality (pseudonymity) or to hide all details of their personality (anonymity). Pseudonymity and anonymity provide a further set of problems for regulators. As well as facilitating regulatory arbitrage by allowing citizens to conceal their identity, 22 With

a degree of computer literacy they can ensure that it would be almost impossible for law enforcement agencies in the physical world to track them down and prosecute. This is discussed further below. 23 D Post, ‘Governing Cyberspace’ (1997) 43 Wayne Law Review 155. On-line version at ⬍http://www.temple.edu/lawschool/dpost/Governing.html⬎ (visited 4 January 2002).


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thereby inhibiting the application of civil, administrative and criminal regimes while in Cyberspace, pseudonymity and anonymity also allow Netizens to carry out transactions in an unregulated manner.24 Two examples which may be given are the distribution of hate or defamatory speech and access to regulated content. To begin with the latter, there are certain areas in our physical societies where we regulate access to certain persons. Children are not permitted access to public bars or licensed sex shops. In addition there are activities that are restricted to certain persons. Only those with driving licences may legally drive and only those who are members of the appropriate professional society may practise as a lawyer. A lack of physical persona makes the regulation of such simple activities much more complex in Cyberspace. A child may take on an adult personality and gain access to pornographic content.25 In the physical world a child entering a licensed sex shop would be removed by the manager, whereas in Cyberspace the elements of physicality are lost and the ability to regulate is impaired. This is not to say the anonymity problem renders regulation of access impossible. Community-based control structures, supported by design-based elements have met with a high degree of success.26 More worryingly, the access control problem allows for the potentially more harmful conduct of adults passing themselves off as children. In the same way that children are prevented from accessing certain adult areas of the physical world, there are areas where unauthorised adults are kept out to protect children.27 Children nowadays are educated to keep away from strangers and to be wary of any unusual adult contact. Again the lack of physicality in Cyberspace raises problems. Users cannot discern the age of others in the chat room intended for children. As it is at the user’s discretion how much information he wishes to reveal about himself there is no practical methodology to ensure adults do not pose as minors for as long as Cyberspace supports an anonymous culture. Given that any attempt to remove the currently available culture of pseudonymity/anonymity would probably lead to a high level of regulatory arbitrage, there is no apparent means to deal with such problems. Further, the easy availability of anonymous messaging allows individuals to take part in activities without being required to meet usual societal norms. Individuals may make antisocial comments without fear of being ostracised by society at large. The technology of anonymous remailers when coupled with encryption technology can ensure an untraceable message source.28 This may be used to distribute comments about an individual or 24 Netizen is the universally accepted term for a ‘citizen of the Internet’. 25 Lessig above n 2, 174. 26 See below 3.D. ‘Other Forms of Control’. 27 Examples would be schools, children’s playgrounds, nurseries and

other controlled environments. 28 The technology is described in some detail by Michael Froomkin in ‘The Internet as a Source of Regulatory Arbitrage’ in B Kahin and C Nesson (eds), Borders in Cyberspace (Cambridge,

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organisation without fear of prosecution or social exclusion.29 Anonymity in Cyberspace creates a unique culture where expression free from the normal constraints of legal and social control is common. Even the United States with its particular emphasis on the right to free speech cannot allow completely unfettered or unrestricted freedom of expression.30 Cyberspace uniquely offers a forum for unfettered free expression.31 Although it may be argued that ISPs or other moderators of discussion groups may remove offending messages, they may be reposted somewhere else in Cyberspace almost immediately. Also Netizens may directly address others via e-mail. Again although this practice, known as spamming, is regulated in Europe by the Distance Selling and E-commerce Directives32 and by other enactments worldwide, the availability of anonymous communications renders such enactments impotent within Cyberspace. He who cannot be caught cannot be punished. Anonymity therefore allows for perfect freedom of expression, which in the physical world has been tempered by even the most liberal of regimes.

C.

The Scarce Resources Problem

Regulators in the new media are called upon to oversee systems of allocation of scarce resources. All new media sectors draw heavily on limited

MA, MIT Press, 1997). On-line version available at ⬍http://www.law.miami.edu/~froomkin/ articles/arbitr.htm⬎ (visited 4 January 2002) 29 Following

the enactment of the Communications Decency Act 1996 a US-based ISP has no third party liability for any libellous messages carried on their system (s 230). In the UK and the European Union ISPs may have third party liability if they fail to act once the nature of a libellous message is drawn to their attention. See Godfrey v Demon, Internet [1999] 4 All ER 342 and the E-Commerce Directive (Dir 2000/31/EC [2000] OJ L/178/1–16), 17 July 2000 Art 12. 30 Sunstein n 7 above, 151–53. For a fuller account of the philosophical foundations upon which restrictions on the first amendment are justified see F Schauer, ‘The Aim and Target in Free Speech Methodology’ (1989) 83 Northwestern University Law Review 562; RK Greenawalt, ‘Free Speech Justification’ (1989) 89 Columbia Law Review 119. 31 Several commentators cited the success of the complainers in UEJF (L’Association Union des Etudiats Juifs de France) et Licra (La Ligue Contre le Racisme et l’Antisémitisme) v Yahoo! Inc., L’Ordonnance du Tribunal de Grande Instance, 20 November 2000 as evidence of the ability of courts to regulate expression in Cyberspace. This confidence has been substantially eroded following the finding of Judge Fogel in Yahoo! Inc v La Ligue Contre Le Racisme et L’Antisemitisme (LICRA), 169 F Supp 2d 1181 (ND Cal 2001), that the French order is not enforceable in the United States as ‘[it] chills Yahoo’s First Amendment Rights … and that the threat to its constitutional rights is real and immediate’ (at 1194). 32 Distance Selling Directive, Dir 97/7/EC [1997] OJ L/144/19–27, 4 June 1997; E-Commerce Dir, Directive 2000/31/EC [2000] OJ L/178/1–16, 17 July 2000. The Distance Selling Directive was implemented in the UK through the Consumer Protection (Distance Selling) Regs 2000 SI 2334. At the date of writing the E-Commerce Directive awaits implementation.


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resources, whether these be natural resources such as spectrum for the telecommunications or broadcasting sectors, or man-made resources such as domain names in relation to Cyberspace. Digital developments do, in some respects, reduce existing scarcity problems. Thus digital broadcasting uses spectrum more efficiently and thus enhances capacity.33 This may in turn create a problem for regulators seeking to maintain controls designed to ensure pluralism in the broadcasting sector.34 The spectrum scarcity problem is exemplified by the emergent market for third generation (3G) mobile communications.35 3G mobile will make multimedia services available to mobile phone users anywhere in the world, combining satellite and terrestrial digital capacities. This development has the potential both substantially to displace a number of current communications technologies, notably second generation mobile and fixed link telephony and to grow new markets in mobile communications. Most EU Member States have concluded that spectrum scarcity permits them to license between 4 and 6 network operators for 3G mobile.36 The objectives of the licence allocation processes have been to promote the development of competitive markets, to allocate the spectrum to those best placed to use it and in many cases to secure windfall fee-income to the finance ministry. Further policy making will be necessary to determine the terms on which service providers who do not have network operators licences can have access to the networks for the provision of services. Scarce resources are also a problem in Cyberspace. The Internet is often seen as a network without resource constraints. If more resources are needed more computers can be added to the network. This though only increases the available processing power of the net; there are other key areas where resources remain scarce. One area is bandwidth.37 Modern telecommunications networks rely on the ability to transmit data from one source to another and in this respect the Internet is no different from mobile telecommunications networks. Network content is increasingly sophisticated. Consumers are demanding faster and more stable access to the network, to allow them to listen to real time audio transmissions and to view streaming video transmissions. These additional network demands are putting the current network protocols under strain and commercial providers of such services are calling for the current protocols to be substantially overhauled to provide for the flow of such services free from the current 33 R Collins, ‘Back to the Future: Digital Television and Convergence in the United Kingdom’ (1998) 22 Telecommunications Policy 383, 384–85. 34 M Cave, ‘Regulating Digital Television in a Convergent World’ (1997) 21 Telecommunications Policy 575, 590. 35 Sometimes known as Universal Mobile Telecommunications System (UMTS) 36 P Curwen, ‘Next Generation Mobile: 2.5G or 3G?’ (2000) 2 Info 455, 461. 37 See J Glasner, ‘Move Over, Pork Bellies’ Wired News, 20 May 1999 (available at ⬍http://www.wired.com/news/business/0,1367,19796,00.html⬎ (visited 4 January 2002); Lessig n 1 above, 47.

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problems of latency (delays in transmission) and jitter (variations in delays).38 These problems are caused by the current network protocol, Internet Protocol version 4 (IPv4) which employs a ‘best effort’ quality of service.39 The best effort service is simply an onward transmission service which routes packets of information based upon information on congestion given to the sender from the next point or node in the network. This means packets of information relating to a single transmission can become separated and can arrive with delay variation causing jitter. Simple Internet applications such as e-mail or web browsing can tolerate these delays and differentials, but streaming audio and video cannot: Internet telephony for example cannot tolerate a delay of more than 250 milliseconds.40 To deal with these problems network designers have suggested the creation of an intelligent network which would allow for quality of service (QoS) solutions.41 The implementation of QoS systems involve either the implementation of a complex virtual overlay network (VON) which would allow traffic from a single network flow to pass through routers without competing with traffic from other network flows42 or, as seems more likely, the implementation of a new network protocol, Internet Protocol version 6 (IPv6).43 IPv6 offers many advances over IPv4. It allows for better homogeneity of transmission. In the event of network queuing it allows for streaming transmissions to be packaged together. This means time critical transmissions such as streaming audio and video may be prioritised over less time sensitive transmissions such as e-mails. Also it crucially supports the Resource Reservation Protocol (RSVP) developed by Cisco Systems and MCI WorldCom which allows service providers to sell bandwidth to users allowing them to prioritise their transmissions over other traffic using the

38 See

eg C Huitema (Microsoft Corporation), ‘How Will IPv6 Change the World?’ paper presented to IPv6 2000, 19–20 October 2000, Washington DC available at ⬍http://www. ipv6forum.com/navbar/events/xiwt00/presentations/html/huitema/⬎ (visited 20 December 2001); Y Pouffary (Compaq), ‘The IPv6 Advantage’ paper presented to IPv6 2000, 19–20 October 2000, Washington DC available at ⬍http://www.ipv6forum.com/navbar/ events/xiwt00/presentations/html/pouffary/⬎ (visited 20 December 2001). 39 David above n 14, 173. 40 Lessig above n 1, 46. 41 Lessig above n 1, 46–47. Generally Lessig is wary of such solutions as adding intelligence to the network allows for control in the content layer. 42 David above n 14, 173; Computer Science and Telecommunications Board, National Research Council, The Internet’s Coming of Age (Washington DC, National Academy Press, 2001) 102–3. Available at ⬍http://bob.nap.edu/html/coming_of_age/⬎ (visited 20 December 2001) 43 IPv6 also solved the problem of a scarcity of Internet Protocol (IP) addresses. Currently there are just under 4 billion available IPv4 addresses. Although this seems a healthy figure, large organisations such as AT&T and MIT hold up to 16 million addresses each. Currently if you use dial-up access you will be allocated a temporary IP address while connected. This allows several users to share the same IP address. With new networked tools some analysts suggested the total fund of IP addresses would be exhausted by 2004. IPv6 allows for 1038 IP addresses—more than enough for the foreseeable future.


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same routers.44 This functionality comes at a cost. These developments will almost certainly lead to the development of fragmented proprietary networks within the wider network structure and an end to the current end-to-end infrastructure of the Internet.45 Although bandwidth scarcity is not unique to Cyberspace, the scarcity of domain names is.46 It may seem bizarre to claim domain names are a scarce resource. The permutation of domain names seems almost limitless. They may be made up of a string of up to 63 characters47 in any permutation and a top-level domain of which there are more than 250.48 Despite this there is a scarcity of usable domain names. Usable domain names reside almost exclusively in the .com top-level domain and are made up of recognisable terms in major languages.49 There is a paucity of such names as usable domain names are of a one mark one owner architecture, whereas previous trade mark systems had been of a one mark many owners architecture.50 Competing demands for usable domain names quickly arose and the bodies charged with overseeing the domain name system (initially the Internet Assigned Numbers Authority (IANA) and Network Solutions Inc., and more latterly the Internet Corporation for Assigned Names and Numbers (ICANN) )51 were required to develop a policy to deal with these competing claims. This policy, the Uniform Domain-Name Dispute-Resolution Policy, attempts to balance the rights of trade mark holders against the first-user 44 ‘Traffic to Take the High Road—for a Price’ Wired News (27 March 1997). Available at ⬍http://search.hotwired.com/search97/s97.vts?Action⫽FilterSearch&Filter⫽docs_filter.hts& ResultTemplate⫽news.hts&Collection⫽news&QueryMode⫽Internet&Query⫽IPv6⬎ (visited 20 December 2001). 45 David n 14 above, 174–78. A Odlyzko, The Economics of the Internet: Utility, Utilization, Pricing, and Quality of Service (AT&T Labs-Research, 1998) 27–28. Available at ⬍http://www. dtc.umn.edu/~odlyzko/doc/internet.economics.pdf⬎ (visited 20 December 2001). 46 M Mueller, ‘Competing DNS Roots: Creative Destruction or Just Plain Destruction?’ paper presented to 29th Research Conference on Communication, Information and the Internet, October 2001, Alexandria, Virginia, available at ⬍http://www.arxiv.org/ftp/cs/papers/ 0109/0109021.pdf⬎ (visited 19 December 2001). 47 A domain name may currently occupy a maximum of 67 characters. See J Jones, ‘Internet Domain Registrars Increases Length of Internet Domain Names’ InfoWorld available at: ⬍http://www.infoworld.com/articles/ic/xml/99/12/16/991216iclonger.xml⬎ (visited 27 March 2002). As the top-level domain uses three characters and the root (dot) takes one character, this leaves 63 characters free for use as a SLD. 48 Currently there are 239 Country Code top-level domains (ccTLDs) detailed in ISO-3166, 12 generic top-level domains (gTLDs) and two US Federal TLDs (.gov & .mil). 49 The latest Network Wizards Domain Name Survey (July 2001) records 37,502,747 .com domains. By comparison the Oxford English Dictionary only contains ‘over half a million words’ (source: ‘About the Oxford English Dictionary’ ⬍http://www.oed.com/public/inside/⬎ (visited 4 January 2002). 50 See for example A Brunel and M Laing, ‘Trademark Troubles with Internet Domain Names and Commercial Online Service Screen Names’ (1997) 5 International Journal of Law and Information Technology 1; A Murray, ‘Internet Domain Names: The Trade Mark Challenge’ (1998) 6 International Journal of Law and Information Technology 285. 51 IANA and ICANN are non-governmental not-for-profit agencies. Network Solutions Inc is a subsidiary of Verisign Inc, a for-profit publicly listed company.

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policy previously applied. It is an extremely controversial policy and will be examined in depth below when we analyse the effectiveness of control mechanisms in the new media.

2.

EXTENDING THE ‘MODALITIES OF REGULATION’ ANALYSIS

Lawrence Lessig’s Code and Other Laws of Cyberspace is widely regarded as one of the most complete analytical attempts to capture the variety of forms which regulation of new media does or may take.52 Lessig contends that there are four distinct modalities of regulation. He attaches to these the labels law, markets, norms and architecture. He thinks of these in terms of constraints on action.53 Thus law constrains through the threat of punishment, social norms constrain through the application of societal sanctions such as criticism or ostracism, the market constrains through price and price-related signals, and architecture physically constrains (examples include the locked door and the concrete parking bollard). Lessig’s work is of great value for reminding us of the importance of architecture as a basis for regulation. The potential for controls to be built into architecture have long been recognised, as exemplified by Jeremy Bentham’s design for a prison in the form of a panopticon (within which the architecture permitted the guards to monitor all the prisoners) and the more recent observations of the way in which visitors to Disney World are controlled by an architecture in which nearly every aspect of the design has a disciplinary function.54 Lessig observed the various constraints that are built into software by their designers. Such architectural constraints in software code are chiefly used for commercial purposes (such as restricting the user’s use to what they have paid for or segmenting the market so as to charge higher prices in

52 n

2 above. Cf the five way analysis of controllers in ordering society put forward by Ellickson, The Aim of Order Without Law above n 6, 131. Ellickson sees order as a product of first party (or self-control) second party (or contractual) control, third party control (based on social forces and norms), organisation (with associated institutional apparatus) and, lastly (significantly) government with the laws. There is a substantial political science literature on alternative instruments of governance: see J Kooiman (ed), Modern Governance (London, Sage, 1993) and C Hood, The Tools of Government (London, Macmillan, 1983). 53 Lessig above n 2, 235–39. 54 M Foucault’s research on the history of the prison has been responsible for generating new interest in surveillance generally and Bentham’s panopticon in particular: See Discipline and Punish: The Birth of the Prison (Harmondsworth, Penguin, 1977, trans A Sheridan), ch 3. C Shearing and P Stenning, ‘From the Panopticon to Disney World: The Development of Discipline’ in A Doob and E Greenspan (eds), Perspectives in Criminal Law (Aurora, Canada Law Book Co, 1984). Crime control through design is exemplified by A Lester, Crime Reduction through Product Design (Australian Institute of Criminology, Trends and Issues in Criminal Justice no 206, 2001); N Kumar Kaytal, ‘Architecture as Crime Control’ (2002) 111 Yale Law Journal 1039.


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some segments without the risk of arbitrage) but may also be used for other regulatory purposes (as with the controls placed on users by Filterware).55 Lessig suggests that as a means of regulation architecture is self-executing and thus different at least from norms and law.56 This claim appears correct up to a point. However the analysis which separates the functions of a control system shows that the standard-setting element of architecture is not self-executing but is, by definition, designed by human hands. Some architecture-based regimes may be self-executing as to monitoring and behaviour modification. A parking bollard, for example, requires no further agency on the part of a regulator to control parking. Other architectural controls do rely on actions by the controller. For example, Bentham’s panopticon requires that prison guards actively monitor prisoners and intervene to control deviance. The panopticon can thus be seen as a hybrid of hierarchy and architecture. The importance of Lessig’s analysis is to draw attention to the variety of bases for control which can be deployed in the face of anxiety that technological change (such as the Internet) and economic change (such as globalisation) tends to make a variety of different forms of conduct unregulatable. The argument that variety in forms of activity requires an equal or greater variety of bases for control if regulation is to be effective has found formal expression in the cybernetics ‘law of requisite variety’. It is expressed in other terms as the principle that ‘only variety can destroy variety’.57 The sceptical position which Lessig challenges is premised in part upon a myth that social and economic activity has traditionally been highly amenable to regulation, conventionally defined. Recent scholarship on the limits to control has emphasised the problems of trying to regulate social and economic activity.58 This work has highlighted the importance of developing regulatory regimes which seek to steer or stimulate activities within the target system indirectly as an alternative to external command and control.59 Lessig’s 55 Filterware is discussed further below. See 3.D. ‘Other Forms of Control’. 56 Lessig above n 2, 236–37. Lessig claims that markets have in common with

norms and law the fact that they require human agency and are not self-executing. This claim is contentious (though Lessig does not recognise this) as the control exerted by a market does not operate at the level of the individual seller and buyer, but rather in an aggregate. In the perfectly competitive market model the decisions of an individual buyer or seller cannot affect the operation of the market. 57 S Beer, Decision and Control (London, Wiley, 1966) 279–80. 58 P Grabosky, R Smith and G Dempsey, Electronic Theft: Unlawful Acquisition in Cyberspace (Cambridge, Cambridge University Press, 2001) 5–11; P Nonet and P Selznick, Law and Society in Transition (New York, Harper Row, 1978); I Ayres and J Braithwaite, Responsive Regulation: Transcending the Deregulation Debate (Oxford, Oxford University Press, 1992); N Gunningham and P Grabosky, Smart Regulation: Designing Environmental Policy (Oxford, Oxford University Press, 1998). 59 This prescription has its origins in systems theory: Beer above n 57; and is found in both the political science literature: A Dunsire, ‘Tipping the Balance: Autopoiesis and Governance’ (1996) 28 Administration and Society 299, and legal literature: G Teubner, ‘Juridification: Concepts, Aspects, Limits, Solutions’ in G Teubner (ed), Juridification of Social Spheres (Berlin, De Gruyter, 1987).

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work has the potential to support efforts to reconceive regulation in a sense that is both more modest in its claims and ambitions and more useful in providing mechanisms not only, or perhaps mainly, of direct control but also of indirect control. A key method of this new approach, which we deploy in this discussion, is to identify effective regulation in whatever form it takes and to seek to support it, develop it or extend it by analogy to other domains in which there are problems of regulation. The concept of regulation deployed in Lessig’s analysis is a broad one, extending beyond the narrowly defined ‘systematic oversight by reference to rules’ to encompass four ‘modalities of regulation’ which have the object or effect of holding behaviour within one state among all the possible states which the behaviour might take. Lessig refers to the ‘ “net regulation” of any particular policy’ domain as the ‘sum of the regulatory effects of the four modalities together’.60 Regulation in this expansive sense is conceptually closer to the usage of biologists and sociologists than to that of lawyers.61 It refers to any control system. To be viable, within the terms of control theory, a control system must have some standard-setting element, some means by which information about the operation of the system can be gathered and some provision for modifying behaviour to bring it back within the acceptable limits of the system’s standards.62 With regulation, information gathering is usually achieved through monitoring by an agency, department or self-regulatory body and deviations addressed by application of formal and informal sanctions (See Figure 6.1 below). When locating Lessig’s description within the stricter analysis of control theory some problems emerge both with the labels and the concepts which they describe. Put simply the conceptual schema, drawn from Lessig’s work in law and economics, needs enriching if it is to capture the institutional variety in control. Our earlier discussion of control theory suggests that the appropriate schema involves not only a four way division between different bases of control, but also a further fine grained analysis of the three different elements necessary to generate a control system (standard-setting, information gathering and behaviour modification). This development of the analysis provides a clearer descriptive framework for understanding how control is or can be achieved and opens up the possibility for identifying the wide range of control systems which appear as hybrids of two or more modalities of regulation. To develop this analysis we draw not only on Lessig’s work, but also on attempts to deploy cultural theory to identify

60 L Lessig, ‘The Law of the Horse: What Cyberlaw Might Teach’ (1999) 113 Harvard Law Review 501, 508. 61 R Baldwin, C Scott and C Hood (eds), ‘Introduction’ in Socio-Legal Reader on Regulation (Oxford, Oxford University Press, 1998); M Clarke, Regulation (London, Macmillan, 2000). 62 C Hood, H Rothstein and R Baldwin, The Government of Risk: Understanding Risk Regulation Regimes (Oxford, Oxford University Press, 2001) 21–27.


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variety in control systems.63 This analytical frame has recently been put to work in analysing variety in risk regulation regimes.64 The term ‘regime’ is apt to capture variety not only in standards and standard-setting (which represents the bias in Lessig’s analysis), but also in the institutional dimensions of information gathering and behaviour modification. The regime analysis makes it transparent that the various functions which contribute to viable control systems can be widely dispersed among state and non-state actors, even within a single regime, and can be assembled in mixed or hybrid forms. Lessig’s conceptualisation of ‘law as command’65 suffers from a weakness in that it fails to capture all of the control systems which are within the set of command based or, as we label it, hierarchical control. Law, in this conception, refers only to state law (whether made by judges, or, more commonly in this context, legislatures)66 and neglects the plurality of forms which hierarchical control structures may take. The richer conception of hierarchy looks to the form of control rather than its source. Thus the regime for developing Internet domain names has important elements which are non-state in character and yet which are distinctly hierarchical (and are discussed further below in Section 3(a)). The term law also suffers from the difficulty that it is often deployed in a way which infers only standards and not the institutional elements of a control system (viz information gathering and behaviour modification). Law in Lessig’s terms is merely the constraint placed upon the individual. Accordingly hierarchical control provides both a better label and a substantively enriched conception of this modality of regulation. The concept of norms as it is deployed in Lessig’s analysis follows a usage developed in the social psychological literature—referring to shared patterns of behaviour—but which is unconventional and unhelpful in the study of law. Even in its psychological usage, the term norm does not describe the institutional dimensions of a control system, but rather a set of standards which exist between a particular social group for the time being. We argue that the preferred meaning of the word norm is as the generic term for standards, guidelines and legal and non-legal rules.67 The control form which involves societal or group standards, peer-based information gathering and behaviour modification based on social sanctions such as ostracisation or disapproval, we refer to as community-based control.

63 C Hood, ‘Control Over Bureaucracy: Cultural Theory and Institutional Variety’ (1996) 15 Journal of Public Policy 207. 64 Hood, Rothstein and Baldwin above n 62, 9–14. 65 Lessig above n 2, 235. 66 Lessig above n 60, 507. 67 P Drahos and J Braithwaite, Global Business Regulation (Oxford, Oxford University Press, 2000) 20.

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This category includes not only the social norms which exist generally or between particular groups, but also some elements of more formalised regimes, as where self-regulatory standards are socially generated and written down and then combined in a hybrid form with hierarchical elements to create a self-regulatory control system which is a hybrid between community and hierarchical bases. The concepts of markets and architecture as they are deployed by Lessig are each under-inclusive. Rivalry and competition provide a form of control in environments where there is no identifiable market. Indeed recent public sector reforms have made widespread use of what we will call competitionbased controls in non-market situations.68 Additionally there is a marked element of regulatory competition applying to the development of regulatory standards in some domains both in the US and the EU.69 Where the conditions for such regulatory competition exist (a topic of hot debate) and states are permitted to develop their own rules, competition for client businesses is said to create a check on any tendency to ‘over-regulate’.70 The concept of architecture, referring in Lessig’s terms to the whole built environment with and without intended effects,71 does not capture the whole set of control mechanisms which are premised upon design as a basis of control. Thus there are social and administrative systems which have design features which create control in a way in which the regulatee cannot affect. A key example is the deployment of ‘contrived randomness’ in the oversight of taxpayers or employees so as to reduce the scope of these groups to exploit a wholly predictable system of opportunities and pay-offs.72 Accordingly we relabel this fourth modality of regulation as design.73 The different elements of each of the four types of regulation are illustrated in Figure 6.1.

68 P Self, Government by the Market (London, Macmillan, 1993). 69 D Esty and D Gerardin (eds), Regulatory Competition and Economic

Integration (Oxford, Oxford University Press, 2001). 70 W Bratton, J McCahery, S Picciotto and C Scott, ‘Introduction: Regulatory Competition and Institutional Evolution’ in Bratton, McCahery, Picciotto and Scott (eds), International Regulatory Competition and Coordination (Oxford, Oxford University Press, 1996). 71 Lessig above n 60, 507–8. 72 Hood above n 63, 211–14. 73 This concept of design has a loose affinity with the deployment of the term ‘technologies’ in the Foucauldian literature on governmentality. It is possible that the term technologies ‘linking together forms of judgement, modes of perception, practices of calculation, types of authority, architectural forms, machinery and all manner of technical devices with the aspiration of producing certain outcomes in terms of the conduct of the governed.’ N Rose, ‘Government and Control’ (2000) 40 British Journal of Criminology 321, 323 infers a rather wider range of instrumentalities than are inferred by the concept of design in this chapter. For deployment of the concept of technologies in regulatory theory see J Black, ‘Decentring Regulation: Understanding the Role of Regulation and Self-Regulation in a “Post-Regulatory” World’ (2001) 54 Current Legal Problems 103.


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Element of a Control System

Hierarchical Control

CommunityBased Control

CompetitionBased Control

Design-Based Control

Standard Setting

Law or other formalised rules

Social norms

Price/Quality ratio (and, equivalents with non-market decisions)

Inbuilt design features and social and administrative systems

Information Gathering

Monitoring Social (by agencies or interaction third parties)

Monitoring by dispersed buyers, clients, etc

Interaction of design features with environment

Social sanctions Aggregate of (eg ostracism, decisions by disapproval) buyers, clients, etc on purchase, take-up, location etc

As for information gathering (self-executing)

Behaviour Enforcement Modification

Figure 6.1

Elements of Control Systems

It is part of Lessig’s argument that there is scope for the use of hybrid forms of regulation which link two or more of the ‘pure’ modalities of regulation noted above.74 In particular, he suggests there is scope to link law and architecture in his terms, for example by mandating software designers to build certain elements into software code in pursuit of public regulatory objectives.75 However we think he underplays the extent to which contemporary control is already based on hybrid regulatory forms and the extent to which a wide variety of regulatory hybrids may be useful in developing regulatory control. Indeed, underlying Lessig’s argument is a claim that there is considerable novelty to the nature of law in Cyberspace, a view seemingly accepted by those Cyberlibertarians who contest the normative dimension to Lessig’s work.76 Nowhere in the work of Lessig or his critics is this claim substantiated. As Lessig himself recognises, features which we might call design or architecture have long been fundamental to the way we are governed, whether by features of the built environment (such as the Parisian boulevard system) or the Byzantine systems of an obscure public 74 Lessig above n 60, 511–14. 75 Ibid 514–22. 76 Lessig above n 2, 5–6; D

Post, ‘What Larry Doesn’t Get: Code, Law and Liberty in Cyberspace’ (2000) 52 Stanford Law Review 1439, 1443.

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bureaucracy or of commercial actors such as banks and insurance companies. It is not clear that design of software is fundamentally different from design in other aspects of social and economic activity. Wherever it is deployed it has controlling effects and a potential for those controlling effects to be turned towards different or modified effects. If each of the four pure bases of regulation is theoretically capable of being deployed on its own and with each of the other three bases (giving four single bases, six pairings, four threesomes and one foursome) then there are fifteen forms of regulation in total. There is no empty set since all domains are subject to some form of regulation (or else, by definition, they could not be a domain since they would not hold a recognisable shape). Even regimes which apparently exhibit a pure basis of regulation may have the dominant form tempered by another. For example, much hierarchical regulatory enforcement is tempered by more co-operative relationships more characteristic of community, and where there is a proliferation of hierarchical regulators in a particular domain (telecommunications and competition authorities in the communications domain for example),77 then hierarchy may be tempered by a form of institutional competition as regulators jockey for position and custom. Among the widely observed hybrid forms are competition law and co-regulation and enforced self-regulation. Though competition law is often equated with competition in its control dimensions, competition law exemplifies hierarchical control, with elements of competition possible where third party actions are widely deployed. Co-regulation and enforced selfregulation each link some of the strengths of community-based control (notably within self-regulatory regimes) with the use of hierarchy, for example by state approval of standards set by industry groups (co-regulation) or mandating firms to establish and sometimes enforce their own standards (enforced self-regulation). Other less prevalent forms are observable but do not have widely accepted labels. Thus mandatory design features (for example in product design) are hierarchy/design hybrids which we could refer to as ‘enforced design’. The form taken by some self-regulatory efforts to inhibit access to undesirable websites is a community/design hybrid. One further set of remarks is necessary concerning the bases of control. Different forms of control work differently in different contexts. Markets, hierarchies, communities and design are each embedded in wider social practices.78 Key social networks may be a factor in explaining relations of

77 C

Scott, ‘Institutional Competition and Coordination in the Process of Telecommunications Liberalization’ in J McCahery, B Bratton, S Picciotto and C Scott (eds), International Regulatory Competition and Coordination (Oxford, Oxford University Press, 1996). 78 JR Hollingsworth and R Boyer (eds), Contemporary Capitalism: The Embeddedness of Institutions (Cambridge, Cambridge University Press, 1997).


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interdependence and thus how power is played out in particular social settings.79 Similarly the effects of controls may vary depending on how they are perceived in the cognition of those whom they affect. Thus some individuals or societies may respond with resistance to controls which are met with compliance by others or at other times. Thus an analysis of modalities of regulation does not, by itself, provide a toolkit for decisions on the design of controls, but rather a more limited analytical understanding of controls which have been observed and might be deployed in certain environments and which might be expected to be effective under appropriate conditions.80

3.

PUTTING CONTROLS TO WORK

The importance of the reconfiguring and development of the modalities of regulation argument further extends to institutional choices for seeking to use controls for public policy objectives. Whereas Lessig places greater emphasis on top-down institutional approaches, of which regulatory agency forms represent the leading example, we contend that an emphasis on hybrid forms of control will tend to lead to the deployment of hierarchical controls as instruments to steer organic or bottom up developments, whether in the form of competition, community or design-based control. In some instances successful regimes have combined three or even all four of the bases for regulation.

A.

Hierarchy/Community

Hierarchy and community-based controls are often combined either to ensure that industries effectively collaborate on controlling their sector or to give sectoral self-regulation greater authority. The hierarchy/community hybrid bases of regulation are exemplified by the structures established to address scarcity in domain names. By regulating the domain name system ICANN plays a key role in the regulation of Cyberspace.81 ICANN and its predecessors, IANA and Network Solutions Inc, have long provided regulatory control over the domain name system not as a function of hierarchical control, but rather to assist in the development of the domain name 79 R Rhodes, Understanding Governance (Buckingham, Open University Press, 1997) esp ch 3. See also P Drahos and J Braithwaite, Global Business Regulation (Oxford, Oxford University Press, 2000) (discussion of ‘regulatory webs’, ch 23); C Scott, ‘Analysing Regulatory Space: Fragmented Resources and Institutional Design’ (2001) Public Law 329. 80 We are grateful to Julia Black for this point. 81 As discussed above ICANN controls the allocation of a scarce resource and therefore plays an important regulatory role.

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system as required by the community and to ensure the system design remained intact. A simple example of the deployment of hierarchical controls to assist in the development of community based controls may be seen in the promulgation by both Network Solutions and ICANN of Domain-Name Dispute-Resolution Policies.82 These procedures are used to counteract the primary problem of misappropriation of scarce resources. The procedure appears to have been extremely successful in countering the problem of ‘cybersquatting’. The practice of cybersquatting was recognised at an early stage of development of the Web. In its simplest form it is the ability of unscrupulous individuals to register valuable domains such as Disney.com and then to offer them on at a profit to the rightful holder of the trade mark in question. Individuals who entered into such practices were quickly dubbed ‘cybersquatters’ by the Web community, a reflection of their standing within the community as equivalent to persons who unlawfully misappropriate physical property in the real world. Community opinion was brought to bear. These people were acting antisocially but social sanctions failed to affect their actions; being ostracised in Cyberspace did not affect their everyday lives. Their actions were, though, more than socially unacceptable; they were also a threat to the developing architecture of the domain name system. By controlling domain names which reflected well-known identifiers from the real world they posed a threat to the system. How could people navigate the Web if they could not rely on the knowledge they had developed in the physical world?83 Although courts could intervene in cases where cybersquatters had misappropriated another’s trade mark, 84 regulatory arbitrage meant enforcement of orders could sometimes prove problematic. What was required was a regulatory regime which would apply to all registrations and could be applied whatever the jurisdiction of the parties. This led directly to the first Network Solutions Inc Domain-Name Dispute-Resolution Policy, a policy which has now been adopted and refined by ICANN. The policy has proven successful as it treats the domain name space as a separate jurisdiction, thus preventing regulatory arbitrage. Anyone who resides in the ICANN domain name space must contractually agree to be bound by the policy and must agree to the arbitration procedure contained therein. Consequently, the values of the Cybercommunity may be upheld by ICANN through the arbitration process. Secondly, the ICANN policy of using low-cost on-line arbitration at the expense of court 82 Kleinwächter n 4 above, 271–72. 83 Eg if cybersquatters controlled

domains such as disney.com, mcdonalds.com and microsoft.com, how would users navigate their way to the sites of these well-known companies? 84 See eg Panavision v Toeppen 945 F Supp 1296 (1996); British Telecommunications plc and Others v One in a Million Ltd [1999] RPC 1.


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proceedings meets the needs of the community. One of the key problems with usable domain names was that they were unusually an inexpensive scarce commodity. Scarce commodities often carry a proportionately high price tag, as demonstrated by the UK and German 3G mobile spectrum licence auctions.85 This is a simple application of the economic model of demand, supply and equilibrium pricing. Domain names though do not fit the economic model particularly well as the market as a whole is oversupplied while a small percentage of that market is undersupplied or scarce. As registrars cannot differentiate useful (and therefore scarce) domain names from the majority, it means market-based controls may be circumvented and a scarce and therefore valuable domain name may be had for as little as $25. This allows for a high degree of speculation in domain names. The previous Network Solutions Domain-Name Dispute-Resolution Policy required the complainer to obtain a court order. This meant it was in many cases cheaper to buy the disputed domain name from the defender than to pursue an action to recover the name, especially if the dispute had an international element. The present ICANN Uniform Domain-Name Dispute-Resolution Policy, through its use of inexpensive arbitration procedures, provides a regulatory process which takes account of market conditions. This is not to say that the policy is not without its critics. There is strong criticism of the ICANN policy on the grounds that it now favours trade mark holders over domain name holders who fail, for whatever reason, to comply with US trademark law.86 This has led to a practice known as ‘Reverse Domain Name Hijacking’ occurring.87 This is a potential flaw in the ICANN policy. As discussed, the policy was originally introduced to deal with cybersquatters who were perceived as a socially unacceptable and a potential threat to continued utility of the architecture of the domain name system. The policy now needs to develop to provide a more balanced approach between the competing interests of the parties. Fortunately there is evidence that the arbiters under the policy may be developing such a mature and balanced approach. There were some initial claims that the policy was being used to restrict free speech.88 Recently though, decisions of 85 The

UK raised US$35.4 bn by auctioning 5 UMTS spectrum licences, while Germany raised $46.1 bn by auctioning twelve spectrum blocks. In both cases the number of interested bidders exceeded the number of licences available creating a scarcity of resources. This may be contrasted with the position in the Netherlands where the auctioning of five licences was met with five serious bidders and raised only $2.5 bn or in Italy where a similar situation to the Netherlands saw the Italian Government raise only $10 bn. 86 See eg Froomkin above n 4, 96–101; C Perry, ‘Trademarks as Commodities: The Famous Roadblock to Applying Trademark Dilution Law in Cyberspace’ (2000) 32 Connecticut Law Review 1127, 1155–57. 87 Examples involving American Express and QVC may be found at ⬍http://www.ejacking.com/⬎ (visited 4 January 2002). 88 These claims are based in the so-called ‘sucks’ cases. Domains such as directlinesucks.com (D2000-0583) and freeservesucks.com (D2000-0585) were transferred to the trade marks holders following arbitration. Claims followed that decisions such as these were restricting free speech.

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the arbitration panels have shown the policy has a degree of flexibility which may allow them to develop the policy to meet the demands of the community at large.89 Clearly the regulatory authority was implementing a hierarchical control system to support the development of communitybased and design-based controls.

B.

Hierarchy/Competition

The combination of hierarchical with competition based controls is well established in the media and communications sectors. Thus regimes which apply economic or content controls more intensely to some firms than to others effectively create a continuum within which firms exerting dominance are often located closer to the hierarchy end, while smaller and/or less powerful firms are located towards the market end. Within the ‘responsive regulation’ theory this approach is labelled ‘partial industry regulation’.90 The logic of the approach is that the benefits sought for regulation may be secured less intrusively by applying regulation only to a proportion of the firms, whilst creating space for other firms to be controlled more by market elements. Typical patterns of more intense regulation of broadcasting over print media are said to have reduced risks of censorship and promoted pluralism.91 In the telecommunications sector ‘asymmetric regulation’ has been deployed to provide tighter controls over dominant incumbents both to maintain service levels and to promote access to the market by new entrants.92 With the new media other forms of control which mix hierarchy and competition have been developed. With the scarcity issue related to spectrum, conventional hierarchical controls have been displaced by a hierarchy/competition hybrid in some domains. In relation to 3G mobile governments have attempted to use spectrum allocation mechanisms to promote competitive markets, to promote efficient allocation of resources and in some cases to secure fee-income windfalls for finance ministries. Attempting to set policies that were

89 Three

recent decisions wallmartcanadasucks.com (D2000-1104), lockheedmartinsucks.com (D2000-1015) and michaelbloombergsucks.com (FA0097077) have all found in favour of the respondent. These cases may signal a new approach in relation to such free speech cases. 90 I Ayres and J Braithwaite, Responsive Regulation (Oxford, Oxford University Press, 1992) ch 5. 91 L Bollinger, ‘Freedom of the Press and Public Access: Towards a Theory of Partial Regulation of the Mass Media’ (1976) 75 Michigan Law Review 1. 92 A Perucci and M Cimatoribus, ‘Competition, Convergence and Asymmetry in Telecommunications Regulation’ (1997) 21 Telecommunications Policy 493. Partial industry regulation in telecommunications is exemplified by US rules which apply greater restrictions to the commercial packaging of digital subscriber lines (DSL) provided by telecommunications companies than apply to functionally equivalent cable modems provided by cable communications (formerly TV) companies: M Lemley and L Lessig, ‘The End of End-to-End: Preserving the Architecture of the Internet in the Broadband Era’ (2001) 48 UCLA Law Review 925.


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friendly to the development of advanced infrastructure, the European Commission initially recommended that Member States should allocate licences to 3G mobile operators free of charge.93 Only Finland and Sweden, among the first movers on Universal Mobile Telecommunications System (UMTS) licensing, followed this policy course. All the other Member States decided to charge for the licences. Cynical accounts claim that the decision to charge was premised upon the greed of finance ministries. But there is a more principled explanation for the policy which is posited as a solution to one of the key problems of scarcity—that governments may fail to allocate scarce resources to those who are best able to exploit them to the general benefit. The conventional instrument for the allocation of scarce spectrum is the exercise of government’s hierarchical authority to examine potential applicants and make a decision along the lines of a ‘beauty contest’.94 This method was used in eight of the Member States.95 The weakness of this method is said to lie in its dependence on the knowledge and judgement of the applicable state bureaucracy both to guess the appropriate fee to charge successful applicants and which applicants are best placed to exploit the spectrum. This ‘limited knowledge’ problem is perhaps more acute in the 3G mobile sector where there is little consensus on the commercial prospects for services which are made possible in the digital environment but which have not yet been tested in the marketplace. The alternative method for allocating spectrum used in the remainder of the member states was to auction the licences, combining hierarchy with competition as the basis of control. Deviating from the sealed bid method used in previous spectrum auctions, the UK government and others decided to use a transparent (ie no sealed bids) simultaneous multi-round ascending auction under which bidders’ offers would be revealed at the end of each round and whoever held the highest bid when the number of bidders was reduced to equal the number of licences would win the particular licence. In this way the price mechanism is used to determine which firms should have access to the scarce resource controlled by government. The outcome of the UK auction was that payments for licences totalling 22 billion pounds were much higher than was expected by commentators and government.96

93 European

Commission, Communication from the Commission to the Council, the European Parliament, the Economic and Social Committee and the Committee of the Regions: Strategy and Policy Orientations with Regard to the Further Development of Mobile and Wireless Communications (UMTS) COM (97) 513 Final. 94 The theoretical basis of the shift towards auctions, which lies in game theoretic approaches, is described in D Salant, ‘Auctions and Regulation: Reengineering of Regulatory Mechanisms’ (2000) 17 Journal of Regulatory Economics 195. 95 Curwen above n 36, 461. 96 M Cave and T Valletti, ‘Are Spectrum Auctions Ruining Our Grandchildren’s Future?’ (2000) 2 Info 347.

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Details of auction rules and incentives resulted in less successful outcomes in some other Member States.97 The UK experience initially suggested that the auction had been successful in revealing a true value of the licences well above government estimates. Commentators still do not agree on whether the high cost of licences, particularly in the UK and Germany, will stifle the market as operators struggle to repay the cost.98 The German regulator has already indicated that it may allow the operators to share infrastructure costs and the same thing may happen in the UK.99 This divergence between the actual operating conditions (and reduction in costs) over those projected at the time of the auctions suggests that the injection of competition in the licence allocation process has generally been less than successful. With the problem of regulatory arbitrage the solutions are often put in terms of regulatory competition or co-ordination. In other words arbitrage may be overcome by providing co-ordinated or harmonised rules across jurisdictions, or arbitrage itself may be seen as a solution to the problem of excessive regulation. Regulatory harmonisation was for a long time the favoured way of providing a level playing field for competition in the internal market of the EU. However, this exercise of hierarchical authority raises practical difficulties in terms of the scale of resources necessary to achieve it and is said to risk stultifying the very markets which are to be liberalised. A partial response to the practical problems of harmonisation was the decision of the European Court of Justice in the Cassis de Dijon case which gave judicial authority to a principle of mutual recognition.100 Regulatory competition is said to provide the flexibility for jurisdictions to develop standards to match the local requirements (whether technical or political) and the capacity to innovate in regulation while encouraging states to adopt rules of minimum necessary burden on business or others (because of the threat that such regulatory clients might shift their business elsewhere). A recent analysis suggests that the choice between competition and co-ordination is a false one both in practice and normatively, and that what we are likely to see is elements of competition (for example between institutions) emerging in domains that are notionally co-ordinated and vice-versa. Thus it is better to talk of ‘regulatory co-opetition’, a hierarchy/community hybrid form of control, both as description of the phenomena and as normative aspiration.101 97 Curwen, above n 36, 474–75. 98 Cave and Valletti above n 96; J

Bauer, ‘Spectrum Auctions, Pricing and Network Expansion in Wireless Telecommunications’ paper presented to 29th Research Conference on Communication, Information and Internet Policy, October 2001, Alexandria, Virginia available at ⬍http://www.arxiv.org/ftp/cs/papers/0109/0109108.pdf⬎ (visited 19 December 2001). 99 ‘MMO2 und T-Mobile schliesen UMTS-Kooperationsvertrag’ Frankfurter Allgemeine Zeitung, 22 September 2001. 100 Rewe-Zentral AG v Bundemonopolverwaltung für Branntwein [1979] ECR 649. 101 D Esty and D Geradin, ‘Regulatory Co-Opetition’ in Esty and Geradin (eds), Regulatory Competition and Economic Integration (Oxford, Oxford University Press, 2001).


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Regulatory arbitrage is a well-recognised phenomenon of Cyberspace, though commentators reach different conclusions as to its significance.102 Cyberlibertarians argue that regulatory arbitrage prevents hierarchical regulation of Cyberspace. This is most clearly and famously put in David Johnson and David Post’s seminal article, Law and Borders—The Rise of Law in Cyberspace.103 For Johnson and Post the practical effect of regulatory arbitrage is that hierarchical controls are rendered impotent. Netizens may choose to reject hierarchical controls they find unpalatable by moving to another part of Cyberspace. As previously outlined, Netizens may choose how they wish to be regulated much more freely than citizens of physical jurisdictions. The only effective regulatory system according to Cyberlibertarian theory is therefore one which is acceptable to all (or the vast majority of) Netizens. Johnson and Post therefore suggest a bottomup or organic regulatory model. They envisage a self-regulatory governance system along similar lines to that developed to regulate the domain name system. Lessig disagrees with their conclusion. He agrees that Cyberspace is a separate space and can be seen as a distinct jurisdiction, but he disagrees though with the conclusion that it is a jurisdiction which requires the organic development of regulatory regimes. For Lessig, once you isolate Cyberspace as a distinct space you may use its unique architecture to establish a hierarchical regulatory structure. The argument of the Cyberpaternalists is therefore that once a recognised regulator emerges in any given activity they may impose regulatory regimes on Netizens through the unique man-made architecture of the Web, its code.104 To the extent that regulatory arbitrage is a problem with new media generally, and usage of the Internet in particular, it remains an open question to what extent the balance between competition and co-ordination might be deployed to resolve issues. For many commentators, the nature of Internet technology makes regulatory arbitrage inevitable and difficult to forestall,

102 See

eg M Froomkin, ‘The Internet as a Source of Regulatory Arbitrage’ above n 28; D Johnson and D Post, ‘Law and Borders—The Rise of Law in Cyberspace’ (1996) 48 Stanford Law Review 1367; L Lessig, ‘Zones in Cyberspace’ (1996) 48 Stanford Law Review 1403; P Samuelson, ‘Five Challenges for Regulating the Global Information Society’ in C Marsden (ed), Regulating the Global Information Society (London, Routledge, 2001). An interesting side effect of regulatory arbitrage is a regression to the least interventionist standard in a given area. This can most clearly be seen in relation to freedom of speech following the decision of the US Supreme Court in ACLU v Reno 177 S Ct 2329 (1997) where an on-line movement towards the US free speech standard may be detected. For further discussion on this see D Vick, ‘Exporting the First Amendment to Cyberspace: The Internet and State Sovereignty’ in N Morris and S Waisbord (eds), Media and Globalisation: Why the State Matters (Lanham, MD, Rowman & Littlefield, 2001). 103 Ibid. On-line version available at ⬍http://www.temple.edu/lawschool/dpost/Borders.html⬎ (visited 4 January 2002). 104 Lessig above n 2, passim. See also L Eko, ‘Many Spiders, One Worldwide Web: Towards a Typology of Internet Regulation’ (2001) 6 Communications Law and Policy 445.

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whatever may be desirable from a policy point of view. It is the high mobility both of providers and users within Cyberspace which makes it difficult to envisage co-ordinative solutions. For some this is a strength militating against excessive control of Cyberspace. It was argued that regulatory arbitrage acted as a (limited) check on stringent UK legislation governing state monitoring of electronic communications generally in the Regulation of Investigatory Powers Act 2000.105 Arguably any solutions here are likely to be a product of co-operation and community-based controls involving both governments and businesses rather than of co-ordination between governments, as through the EU or the World Trade Organisation (WTO).

C.

Hierarchy, Competition and Design

In addition to the use of hierarchical/community controls discussed earlier, ICANN is also applying a design/competition-based hybrid in an attempt to alleviate the pressure on the domain name system. As domain names are a man-made rather than natural phenomenon, they do not have to be rationed in the manner of natural resources such as bandwidth. Whereas governments cannot simply create additional bandwidth to meet the demand of mobile phone operators,106 ICANN hopes to solve the domain name problem by creating additional resources. To this end on 16 November 2000 ICANN announced seven new top-level domains.107 It is the hope of ICANN that by creating competition in new, more specialised domains, demand will be lowered in the oversubscribed .com domain and a solution will be found to the scarcity problem. There has been profound disquiet about allegedly anticompetitive outcomes from ICANN’s allocation of new top-level domain (TLD) names. Thus the allocation of some of these new resources (notably .pro and .info) has been made to organisations already controlling other key TLDs such as .com, .net and .org. The refusal to create other new top-level domain names (for example .xxx for pornography) has been criticised for inhibiting design-based controls over access or exploitation of particular sites. The solution to these problems 105 The

House of Lords debated this possibility at some length at the Report Stage of the Bill (HL Deb vol 615 cols 381–88; cols 400–452, 13 July 2000). See in particular the debate on Amendment No 64 at col 408–18. 106 Lessig offers an alternative solution to the problem of undersupply of bandwidth. Although acknowledging supply of radiocommunications bandwidth is naturally limited, he suggests we are extremely wasteful of the resource available. He rejects the use of beauty contests or auctions to propertise bandwidth as outlined above and suggests instead a design solution allowing a more efficient use of bandwidth as a free or common resource. Lessig above n 1, ch 12. 107 They are .aero, .biz, .coop, .info, .museum, .name and .pro. For further details on these names including who may apply for a name within these new domains see ⬍http://www. icann.org/tlds/⬎ (visited 4 January 2002).


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posited by one key critique is to open the domain name market to greater competition between assignment organisations and use competition as a key form of control. 108 It may, though, already be too late for any competition-based approach to work in relation to domain names. The scarcity of resource problem in relation to domain names appears to be restricted to the .com TLD. As discussed previously, there are already a large number of alternative top-level domains available. Attempts previously to turn country code TLDs into generic TLDs have not released useful domain names. The most concerted effort has been in relation to the .ws (Western Samoa) domain, which is promoted as a ‘World Site’ domain. In many instances holders of current generic TLDs simply replicated their registration in the new domain. There is little evidence that the creation of manufactured additional resources deals with this particular scarce resources problem. The availability of these alternatives has not encouraged sufficient competition to effect the base of the .com domain. The relevant market appears therefore not to be the market in TLDs as a whole, or even generic TLDs, but is restricted to the .com TLD. The .com TLD is, it appears, too well established to be affected by the creation of alternative domains. The creation of such alternatives does not appear to introduce competition within the relevant market; instead it merely creates alternative markets in which mere replication of registration occurs. The only possible methodology which would appear to provide a functioning competition-based solution to the .com problem would be to increase the marketability of competing TLDs. The current ICANN policy is for the creation of alternative TLDs which they expect will increase in marketability through the efforts of the registrars who deal in such names. They are relying upon a free market rhetoric which states that those with saleable assets will work to increase the marketability of their asset through advertising and marketing. ICANN believes that the domain name system is thus a free market in which demand may be created in new products through advertising and marketing. Unfortunately the free market rhetoric does not apply to domain names in this manner. They are more than simply saleable assets. Firstly, valuable domain names are, in many cases, a reflection of currently held trade marks. As has been previously alluded to, the creation of other TLDs fails to release alternative resources due to replication of registrations by current holders of trade marks and valuable .com domain names to prevent any risk of cybersquatting. Secondly, all domain

108 M

Mueller, ‘Domains Without Frontiers’ (2001) Info 97, 99. See also M Froomkin, ‘Is ICANN’s New Generation of Internet Domain Name Selection Process Thwarting Competition?’ presentation to US House of Representatives Committee on Energy & Commerce, Subcommittee on Telecommunications, 8 February 2001. Available on-line at ⬍http://personal.law.miami.edu/~froomkin/articles/commerce8Jan2001.htm⬎ (visited 4 January 2002).

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names are a method of indexing information and navigation. Consequently, they are streetnames not just marketable assets. As with all other communities the Web has its desirable areas and its undesirable areas: in this virtual community .com is the business and financial district: it is the Web’s equivalent of the City of London, Wall Street or Rodeo Drive. Just as businesses in the real world will pay a premium for such addresses, so the focal point for competition in relation to domain names will remain in the .com domain. Due to these problems, the scarcity issue in domain names may be as ingrained as the bandwidth problem in relation to telecommunications and a more radical solution may be required in the future.

D.

Other Forms of Control

The emphasis of current thinking on alternatives to hierarchical control is largely focused on linking hierarchy to competition or to community-based methods of control. This focus largely excludes two major classes of forms of control, one defined in terms of excluding hierarchy and the other defined in terms of including design. (1)

Design-Based Regulation

A key example which is located in both sets (employing design and excluding hierarchy) is the use of regional management codes by DVD producers and equipment manufacturers. Producers and equipment manufacturers have collaborated in a regional coding system which allows for market segmentation within the DVD industry. Regional coding was developed to permit studios to control the home release of movies within different geographical regions allowing the staggering of cinematic releases.109 The studios required that DVD software codes included a simple code that could be used to prevent playback of certain discs in certain geographical regions. The equipment manufacturers assisted by producing region specific DVD players, each player being given a code for the region in which it is sold. The player will refuse to play discs that are not encoded for that region.

109 The

coding also allows studios to sell exclusive distribution rights to a variety of foreign distributors. See D Marks and B Turnbull, ‘Technical Protection Measures: The Intersection of Technology, Law and Commercial Licences’ paper presented to World Intellectual Property Organisation Workshop on Implementation Issues of the WIPO Copyright Treaty (WCT) and the WIPO Performances and Phonograms Treaty (WPPT), 6–7 December 1999, Geneva available at ⬍http://www.wipo.org/eng/meetings/1999/wct_wppt/pdf/imp99_3.pdf⬎ (visited 7 January 2002). The European Commission is currently investigating whether DVD producers are using the technology to partition the market illegally. See European Commission, Directorate-General for Competition, 31st Report on Competition Policy (Office for Official Publications of the European Communities, Luxembourg, 2002) para 5.2.2.


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This means that discs bought in one country may not play on players bought in another country. The addition of regional management codes are entirely optional for the maker of a disc: discs without codes will play on any player in any country. These codes should not be confused with the DVD Content Scramble System, discussed below, which acts as a copy-control measure. Regional management codes are not an encryption system; they are merely one byte of information on the disc, which denotes one of eight different DVD regions.110 Thus an encoded DVD bought in the US will not be viewable on a European DVD player. There is no hierarchical element to this. Customers are not prevented by contract or any other laws from buying DVDs in other countries. The control is effected by features of the diverse product standards which make a DVD useless when paired with a player with a different coding. (2)

Including Design

A related example is the use of a hierarchy/design hybrid in an attempt to manage the high levels of digital piracy which occur on the Web. Copycontrol devices have been employed by almost all copyright holders who trade in digital media. These controls have met with varied degrees of success, but are supported by not only industry groups such as the Motion Picture Association of America (MPAA) and the Recording Industry Association of America (RIAA), but also have been given the force of law through the actions of the World Intellectual Property Organisation (WIPO)111 as enacted within the European Union by the Directive on Certain Aspects of Copyright and Related Rights in the Information Society,112 and in the United States through the Digital Millennium Copyright Act 1998.113 With the legal support offered by these enactments, several copy-control systems have been developed and implemented by bodies representing copyright holders mostly against the wishes of the community at large. One such standard developed by the MPAA for use on DVD releases is the Content Scramble System (CSS). CSS was developed by two hardware companies, Matsushita Electric and Toshiba, for the motion

110 These are as follows: Region 1 USA and Canada; Region 2 Japan, Europe, South Africa and Middle East; Region 3 Southeast and East Asia; Region 4 Australasia, Central and South America and Caribbean; Region 5 Eastern Europe, India and Africa; Region 6 China; Region 7 Reserved and currently unused; Region 8 Special Venues (Planes, Cruise Ships etc). 111 Art 11 WIPO Copyright Treaty requires contracting parties to ‘provide adequate legal protection and effective legal remedies against the circumvention of effective technological measures that are used by authors in connection with their exercise of rights under this Treaty or the Berne Convention and that restrict acts, in respect of their works, which are not authorised by the authors concerned or permitted by law’. 112 Dir 2001/29/EC, Art 6. 113 §§ 1201(a)(1) and 1201 (a)(2).

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picture industry and was adopted as industry standard in 1996. The system involves a dual key encryption system which encrypts all sound and graphic files contained on a DVD release. The files may be decrypted by the appropriate decryption algorithm which is made up of a series of keys stored on both the DVD and the DVD player. This means that only players and discs containing the appropriate keys may decrypt the necessary files and play the movies stored on the DVDs.114 The CSS system did not directly prevent direct copying of DVD discs; the contents of a DVD (while encrypted) could be copied directly from one DVD to another. CSS did however prevent the uploading of the contents of a DVD onto hard disc or a web server. The concern of some users was that CSS systems were only licensed for use on Macintosh and Windows based operating systems (and for dedicated DVD players). Users of open source operating systems such as GNU/Linux could not play a CSS encoded DVD on their system. This led to a campaign of civil disobedience leading to the development of a decryption code for CSS which would allow the playing of CSS encrypted DVDs on any platform. The CSS code was a quite weak 40 bit encryption system and in September 1999 it was successfully hacked independently by an anonymous German hacker and a member of the ‘Drink or Die’ cracking community.115 This development meant that CSS encrypted DVDs could now be used on unlicensed DVD players and that DVD material could be placed directly onto the Web. Such a development was an obvious threat to the continued use of CSS by DVD producers. Action was taken immediately in Norway where Jon Johansen who had been erroneously identified as the author of DeCSS was prosecuted and in the United States where Universal Studios successfully obtained injunctions under the Digital Millennium Copyright Act against several individuals who were distributing the DeCSS code from USbased websites.116 The decision in this case has been extensively criticised by many commentators, including Lessig who argues that ‘DeCSS didn’t increase the likelihood of piracy. All DeCSS did was (1) reveal how bad an

114 For

more detail on CSS see the opinion of Judge Kaplan in Universal Studios Inc v Reimerdes et al 111 F Supp 2d 294 (2000). Affirmed Universal Studios Inc v Corley et al 2001 WL 1505495 (2d Cir 2001) Available at ⬍http://eon.law.harvard.edu/openlaw/ DVD/NY/appeals/opinion.pdf⬎ (visited 4 January 2002). 115 The media wrongly attributed the development of DeCSS to a 15 year-old Norwegian Jon Johansen. Although Mr Johansen was a member of the ‘Masters of Reverse Engineering’ community which released DeCSS he was not the author of the program. This is made clear in a text file which accompanied the release of the program. The text file is available at ⬍http://www.lemuria.org/DeCSS/dvdtruth.txt⬎ (visited 4 January 2002). On 9 January 2002 the Norwegian Economic Crime Unit (ØKOKRIM) charged Jon Johansen with violation of Norwegian Criminal Code s 145(2), which outlaws breaking into another person’s locked property to gain access to data that one is not entitled to access. A campaign to drop all charges was immediately begun by the Electronic Frontier Foundation (see ⬍http://www.eff.org/ IP/DeCSS_prosecutions/Johansen_DeCSS_case/⬎) and at the time of writing was still underway. 116 Universal Studios Inc. v Reimerdes et al above n 114.


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existing encryption system was; and (2) enable disks presumptively legally purchased to be played on Linux (and other) computers.’117 Lessig is extremely critical of the use of law to support these design controls arguing that they create an ‘imbalance where traditional rights are lost in the name of perfect control by content holders’.118 This view taken by Lessig may prove to be unduly pessimistic. There is as yet no evidence of content holders attaining the perfect control he fears in Cyberspace. Indeed the victory of Universal Studios and the MPAA has proved to date to be pyrrhic. As is often the case in Cyberspace when hierarchical/design controls are used to regulate the community at large, the community will rally in an attempt to defeat the regulatory control mechanisms. The DeCSS code may currently be obtained from any one of hundreds of websites which remain out of the reach of the US authorities.119 Currently the producers of DVD titles and the hacking community are involved in a war of code. The motion picture industry has updated the CSS code which means the DeCSS code no longer decrypts the latest DVD releases. This has simply encouraged hackers to produce new, more powerful, second generation decryption codes such as DVD-Decrypter. Both parties continue to battle for the control of DVD encryption/decryption codes. The producers of DVD titles and the community at large are both using design tools to attempt to protect their position. The producers presently have the advantage, due primarily to a weakness of current technology. At the moment the lack of widely available broadband technology prevents distribution of decrypted movie data over the Web: the producers hold the upper hand. As distribution technology improves, the movie industry may find that their design solutions cannot effectively function without either the support of the community at large or far greater reliance upon the hierarchical control elements introduced by the Digital Millennium Copyright Act and the Directive on Copyright and Related Rights in the Information Society. Producers of DVDs will need to decide within the next few years whether they wish to rely on a hierarchy/design hybrid or a community/design hybrid.120 117 Lessig above 118 Ibid 200. 119 The website

n 1, 189. See further 187–90.

operated by Shawn Reimerdes (one of the defendants in the MPAA action) contains the following advice: A Federal Judge removes this link by court order! We are fighting for the right to put this link back up for you! I am not allowed to have this decryption information anymore, so I will just tell you the obvious: Go to your favorite search engine and enter ‘DeCSS.’ You will find one of thousands of websites that has decided to post this information.

Doing so will allow you to locate sites such as the DeCSS mirror site at ⬍http://heavymusic.8m.com/⬎ (visited 20 December 2001); Download.com ⬍http://www.download.cnet.com/⬎ (visited 4 January 2002) and ⬍http://www.lemuria.org⬎ (visited 4 January 2002)—all of which currently have the DeCSS program available for downloading. 120 See further above Lessig n 1, ch 11.

156 E.

Andrew Murray and Colin Scott Excluding Hierarchy

A successful example of a community using design tools to effect a regulatory scheme is the community-based approach to protecting children in Cyberspace. As discussed above, the anonymity problem raises two distinct dangers for minors in Cyberspace. One is that they gain access to materials which are unsuitable for minors and the other is that adults take advantage of anonymity to forge improper relationships with minors. Hierarchical controls fail to remedy these problems, but a community-based solution has proved extremely successful, especially when linked with design-based solutions. Within organised Cybercommunities children may be supervised by the community. Communities such as AOL encourage family membership where parents register the details of the family as a whole and each individual member has his/her own password. Unless the child were to compromise an adult password, their status can therefore be made known to the community and the community can supervise and protect the child while he is online. Children cannot be watched all the time and the community cannot take over all parenting responsibilities. To assist, additional design-based tools may be used. In addition to the community supervision, parents may employ software solutions such as CYBERsitter and Net Nanny. These products allow parents to set acceptable parameters for their children when in Cyberspace.121 Combined, the role of the community and the security provided by these products appear to provide a relatively successful solution to the access problem.

4.

CONCLUSION

New and unpredictable configurations of power are among the hallmarks of the new media. It is not surprising that the problem of control has attracted such a high degree of interest among scholars. Not only are there interesting problems of designing regimes to provide appropriate constraints on undesirable activities, there are also challenges in securing the maximum benefit to the community of new technologies such as the Internet and 3G mobile (each of which is said to be subject to ‘network effects’ such that the more users there are, the greater the benefit to the community generally). The new media phenomena present scholars with at 121 Such

software programs are called alternatively Filterware or Censorware (depending very much upon your political viewpoint). Many programs such as the ones listed use standalone value judgements to categorise websites based on their content. The software provider will review sites and put them on either an ‘allowed’ or a ‘not allowed’ list. Other programs rely upon the Platform for Internet Content Selection (PICS)—a standardised industry system which allows content to be rated in various categories including: topics such as ‘sexual content’, ‘race’, and ‘privacy’, under the control of the user.


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least two temptations. One is to overstate the novelty of the problems presented, with a consequent tendency to reject ‘old’ forms of control.122 The second is to overstate the extent to which the media themselves ‘hardwire’ or constrain the possible means of addressing the problems. Both tendencies are prevalent in analyses of the control problem as it applies to the Internet. The alternative, which we have argued for, is to locate problems of controlling the new media squarely within well-established analyses of problems of regulatory control. Such analysis encourages us to look at the mechanisms of control which already subsist within the target system and to find ways to stimulate or steer those indigenous mechanisms towards meeting the public interest objectives of regulation. Thus a central role for hierarchy is to steer systems which involve other forms of control based in community, market or design (or combination thereof). This does not exclude the possibility that effective control may occur through competition, design or community, together or separately, without hierarchical involvement. A key challenge presented by such novel governance mechanisms is how to deploy them in such a way that are perceived as legitimate. The legitimacy of democratic government is linked to processes of representation and open decision making. Though other governance mechanisms may be legitimated in similar ways, in many cases it will either be alternative process elements and/or outcomes which are more important in generating legitimacy. Judgements on the appropriate balance between democratic and other forms of legitimation are likely to differ within different political cultures. This is evidenced in markedly different responses in Europe and the United States to the creation of ICANN. For some it represents an unacceptable delegation of government authority to a private body.123 For others, it is an efficient technical solution to a pressing problem, even if its decision making is not wholly technical. A key challenge in deploying ideas about the mixture of control forms advanced in this discussion is to balance these twin concerns about efficiency and legitimacy. The conditions for achieving an acceptable balance are likely to vary in different places and different times.

122 A

useful early consideration of the ‘newness’ issue in Cyberspace is I Trotter Hardy, ‘The Proper Legal Regime for “Cyberspace” ’ (1994) 55 University of Pittsburgh Law Review 993. More recently see M Price, ‘The Newness of New Technology’ (2001) 22 Cardozo Law Review 1885. 123 Froomkin, ‘Wrong Turn in Cyberspace’ n 4 above; J Wienberg, ‘Geeks and Greeks’ (2001) 3 Info 313; cf R Marlin Bennett, ‘Icann and Democracy: Contradictions and Possibilities’ (2001) 3 Info 299.

7 Regulating E-Commerce in the WTO: Exploring the Classification Issue FIONA SMITH*

I

N 1998 THE global value of goods and services traded via the Internet1 was $3 billion, with predicted growth anywhere between US$100 billion2 and US$300 billion3 by 2000.4 Despite the notorious dotcom collapses, estimates show that worldwide online trade exceeded US$2000 billion in 2002 with predicted increases in excess of US$12,800 billion by 2006:5 the European Union alone is expected to experience online trade rising from e77 billion in 2001 to e2.2 trillion by 2006.6 Such a shift to on-line trading may challenge existing regulatory systems which are built on the assumption that physical evidence of a contract exists. Consequently, it may be necessary to search for alternative solutions when regulating commerce that are not reliant on traditional legal mechanisms. This shift potentially challenges existing regulatory systems because

*Dr Fiona Smith is a lecturer in law at the University of Leicester, UK, specialising in international economic law, particularly as it relates to the World Trade Organisation. . 1 E-commerce can encompass all transactions using telecommunications networks, but the phenomenon is more usually associated with the Internet: WTO, Electronic Commerce and the Role of the WTO, Special Studies No 2 (Geneva, WTO Publications, 1998) 1. 2 WTO, Global Electronic Commerce, WT/GC/W/86, 23 April 1998, para 2. 3 WTO, Electronic Commerce and the Role of the WTO above n 1, 1. 4 Note the problems of obtaining accurate statistics: UNCTAD, Electronic Commerce and Development Report 2001, UNCTAD/SDTE/ECB/1 (New York and Geneva, United Nations) ch 1. 5 ‘E-Commerce Next Wave: Productivity and Innovation’ presentation given by Mrs Julie Meringer, Group Director, European Research and Managing Director UK Forrester Research at WTO Seminar on E-Commerce, ‘Geneva’ 22 April 2002. 6 R Greenspan, ‘EU B2B Expected to Explode’, 28 August 2002. (last visited 30 October 2002).

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the participants in e-commerce need means to facilitate, legitimate and enforce their transactions. Such challenges operate on two levels: first, those that focus on the nature of the e-commerce transaction itself. In this case, the emphasis centres on the extent to which the transaction is legitimate in law, which inevitably leads to issues of its enforceability.7 For example, when is a contract entered into through electronic means concluded, what are its terms8 and which jurisdiction governs its enforcement?9 In addition, procedural issues occur particularly in relation to the extent to which electronic signatures on contractual documents are acceptable to legitimate any transaction.10 Second, concerns arise over facilitating the transaction, as opposed to ensuring its legitimacy directly. This operates in three ways: in the first case, the emphasis is on ensuring that participants in e-commerce are able to obtain relevant technology, including appropriate computer hardware and software coupled with access to global telecommunication networks, which allows them to enter into electronic transactions. In addition, participants must then be able to import and export products11 that are the subject of those transactions12 without unnecessarily restrictive border controls. Finally, once those products are within the jurisdiction, domestic regulation must not be so restrictive as to ensure that importation is prohibitively expensive. Consequently, regulation at an international level may provide the answer to this dilemma. A common theme running through the regulation of trade via e-commerce is the international character of each element: participants can be located in different countries, products are exported across jurisdictions and the telecommunications networks required to enter into the transactions are necessarily worldwide. Some commentators13 have therefore argued that a global regime that can transcend jurisdictional boundaries is the most effective way of regulating e-commerce.

7 A Terrett and I Monaghan, ‘The Internet—An Introduction for Lawyers’ in L Edwards and C Waelde (eds), Law and the Internet: A Framework for Electronic Commerce (Oxford, Hart Publishing, 2000) 1, 8. 8 AD Murray, ‘Entering Into Contracts Electronically: The Real WWW’ in Edwards and Waelde (eds) above n 7. 17, 18. 9 C Heaven, ‘A Proposal for Removing Road Blocks from the Information Superhighway By Using An Integrated International Approach to Internet Jurisdiction’ (2001) 10 Minnesota Journal of Global Trade 373, 379. 10 See UNCITRAL’s important work in this area: UNCITRAL, Model Law on Electronic Signatures 2001, (New York, United Nations, 2002); also M Hogg, ‘Secrecy and Signatures— Turning the Legal Spotlight on Encryption and Electronic Signatures’ in Edwards and Waelde (eds) above n 7, 37. 11 This is deemed to cover goods and services at this time: for the problems relating to this, see section 2 below. 12 This also covers those products imported in digital form. 13 Eg Heaven above n 9, 379; C Reed, Internet Law: Text and Materials (London, Butterworths, 2000) 2.

Regulating E-Commerce in the WTO

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Devising a completely new regime is complex14 and perhaps unnecessary if Reed’s assertion that commerce based on Internet technology raises no new regulatory issues is accepted.15 Consequently, relying on existing international regulatory structures with proven dispute settlement systems could address the challenges raised by e-commerce’s international character. The World Trade Organisation (WTO) has a comprehensive and reputable dispute settlement system16 that governs its complex rules on international trade in goods, services and intellectual property. This makes the WTO a relevant starting point as a potential governor of e-commerce. Indeed, the WTO itself has already recognised that its rules inevitably impact on e-commerce17 and instigated a work programme in 1998 to investigate their effects fully.18 A working party on e-commerce also was established which reports progress to the WTO General Council.19 The extent to which the WTO can regulate e-commerce has already been the subject of academic commentaries.20 These provide a valuable overview of the ways in which the WTO rules on goods, services and intellectual property potentially affect e-commerce. However, it is clear from these discussions that the WTO is not a panacea for regulating trade via e-commerce and that significant problems exist using its rules in their current form. This chapter builds on previous academic commentaries by focusing on the classification of e-commerce as trade in goods and/or trade in services and the implications of failing to clarify where that boundary lies. It argues that whilst categorising e-commerce in this way is difficult, it is crucial for the effective application of WTO rules because the rule structure adopts a rigid goods/services distinction, with members’ obligations effectively changing dependent on whether the transaction falls within the General Agreement on Tariffs and Trade (GATT) or the General Agreement on

14 Cf Heaven above n 13. 15 See Reed above n 13, 2. 16 See generally J Cameron

and K Campbell (eds), Dispute Resolution in the WTO (London, Cameron May, 1998). 17 WTO, Geneva Ministerial Declaration on Global Electronic Commerce, WT/MIN(98)/DEC/2, 25 May 1998. 18 WTO, Work Programme on Electronic Commerce, WT/L/274, 25 September 1998. 19 WTO, Work Programme on Electronic Commerce: Information Provided to General Council, G/C/W/158, 26 July 1999; following the WTO General Council’s decision of 17 July 2000, the WTO committees on trade in goods, services, intellectual property and trade and development now report individually on the progress on e-commerce within their respective competences: eg WTO, Council for Trade in Goods, Chairman’s Factual Report to the General Council on the Work Programme on Electronic Commerce, G/L/421, 24 November 2000. 20 WJ Drake and K Nicolaidïs, ‘Global Electronic Commerce and GATS: The Millennium Round and Beyond’ in P Sauvé and RM Stern (eds), GATS 2000: New Directions in Services Trade Liberalisation (Harvard University and Washington DC, Center for Business and Government and Brookings Institution Press, 2000) 399; and MD Powell, ‘The Role of the WTO in Cyberspace’ (1998) 4 International Trade Law and Regulation 157.

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Trade in Services (GATS). This problem is acute as many members have not undertaken full liberalisation commitments in all their goods and services’ sectors. GATT and GATS rules do not assist the classification decision because they rely on members first designating items traded as either goods or services in their schedules consequently triggering the application of the relevant rules. It is argued that the only way to use the existing WTO scheme successfully to regulate e-commerce is by clearly defining what constitutes trade in goods and trade in services in the abstract. Such a designation facilitates predictability in a volatile trading environment, as it is clearer which rules apply and to whom. Following the collapse of the Cancun Ministerial Meeting in September 2003, it is imperative for its continued legitimacy that the WTO is seen as meeting the needs of all those who participate in international trade. The discussion is divided into three sections: section one gives an overview of the WTO legal system, particularly concentrating on the rigid rule structure. Section two considers the scope of the WTO’s working definition of e-commerce. Despite appearing comprehensive, it does not address who the participants to the e-commerce transaction are and whether trade in goods or trade in services is involved. These two issues are inextricably linked because GATT and GATS rules impact on participants in different ways. The third section explores the classification issue in more detail, initially looking at what categories products traded via e-commerce could fall into and then assessing what effect the scheduling methodology in GATT and GATS has on the classification dilemma. Rather than resolving the problem, it appears that the methodology only serves to blur the boundary between goods and services further by pushing the decision back to individual members, who will make it based on domestic concerns, rather than international considerations. Consequently, the work programme’s failure to recognise the effect of the WTO’s regulatory structure on on-line trading and to define clearly what constitutes goods and services for the purposes of the rules in this context means that using the WTO in its existing form will not address all the regulatory problems presented by the changing nature of international trade.

1.

BACKGROUND

Following eight years of protracted multilateral trade negotiations in the Uruguay Round, 21 the World Trade Organisation (WTO) finally came

21 On

the Uruguay Round see generally TP Stewart (ed), The GATT Uruguay Round: A Negotiating History 1986–1992 (The Hague, Kluwer, 1993).


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into being in 1995. 22 The Marrakesh Agreement creating the WTO prescribes its scope,23 functions,24 structure,25 relationship with other multilateral agreements26 and includes details on accession27 and decision making.28 The WTO itself is merely an ‘umbrella’29 organisation responsible for the ‘implementation, administration and operation’30 of the multilateral agreements which were concluded during the course of the Uruguay Round.31 These rules are primarily contained in Annex 1 to the Marrakesh Agreement and cover trade in goods,32 services 33 and intellectual property.34 The WTO rules on trade in goods build on the GATT originally negotiated in 1947 as part of the Havana Charter to establish the abortive International Trade Organisation.35 GATT 1947 aimed to liberalise international trade by reducing tariffs and other governmental restrictions on the import and export of goods.36 Emphasis was placed on lowering tariffs on goods listed in countries’ schedules,37 but it also contained rules restricting the use of non-tariff measures including subsidies,38 quantitative restrictions39 and safeguards.40 At the core of the GATT 1947 were two non-discrimination provisions: the most favoured nation (MFN) clause,41 which prevented countries’ offering more favourable treatment to goods from one GATT

22 Art

I Marrakesh Agreement Establishing the World Trade Organisation (the Marrakesh Agreement). 23 Art II Marrakesh Agreement. 24 Art III ibid. 25 Art IV ibid. 26 Art V ibid. 27 Art XII ibid. 28 Art IX ibid. 29 JH Jackson, The World Trading System (Cambridge, MIT Press, 1997) 47. 30 Art III:1 Marrakesh Agreement. 31 This is perhaps overstating the situation as some agreements were already in existence before the start of the Round, but they were subsequently modified during the Uruguay Round and brought within the WTO scheme: eg the TBT Agreement and the WTO Agreement on Subsidies and Countervailing Measures have their roots in the earlier multilateral trade talks in the Tokyo Round: see JH Jackson, WJ Davey and AO Sykes (eds), Legal Problems of International Economic Relations: Cases, Materials and Text (St Paul, MN, West, 1995) 768. 32 Annex 1A. 33 Annex 1B. 34 Annex 1C. 35 See generally JH Jackson, World Trade and the Law of GATT (Indianapolis, Bobbs-Merrill, 1969). 36 See Jackson, Davey and Sykes above n 31, 290. 37 Art II GATT. 38 Art XVI GATT. 39 Art XI GATT. 40 Art XIX GATT. 41 Art I GATT.

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participant over other participants42 and the national treatment clause43 which prohibited discrimination between domestically produced and imported goods once the imported goods were within the participant’s jurisdiction.44 Following the conclusion of the Uruguay Round, GATT 1947 and its subsequent amendments were incorporated into the WTO agreements as GATT 1994 and supplemented by a number of other agreements covering trade in goods negotiated and amended during the Uruguay Round.45 Prior to the creation of the WTO, regulation of international trade was restricted to goods and not services, so the GATS was a completely new addition to the multilateral regime in 1994. GATS disciplines are strikingly similar to GATT, with emphasis placed on liberalising trade in services by reducing restrictive trade barriers46 particularly on those services detailed in members’ schedules.47 Like the GATT, GATS contains MFN48 and national treatment obligations, 49 but in contrast to GATT, GATS’ rules are separated into general and specific commitments: the MFN clause in Article II is included in the general obligations applicable to all trade in services, but there is limited provision for derogations from a member’s MFN commitments. 50 The national treatment 51 and market access52 rules are included in Part III GATS on specific commitments so members only need to comply with these obligations in relation to those service sectors they have specifically agreed to liberalise in their schedules of commitments. GATS’ general rules are also supplemented by specific agreements to liberalise certain sectors, including financial services, basic telecommunications53 and maritime transport.

42 There

are exceptions to this rule: Art XXIV GATT on free trade areas and customs unions and also Art XX GATT which contains a list of general exceptions. 43 Art III GATT. 44 Jackson, Davey and Sykes above n 31, 300. 45 Some agreements were revised from other rounds, most notably the WTO Agreement on Technical Barriers to Trade. See Annex 1A Marrakesh Agreement for the complete list. 46 Para 2 Preamble GATS. 47 On GATS see generally G Feketekuty, ‘Improving the Architecture of GATS’ in Sauvé and Stern above n 20, 85, 90–99. 48 Art II GATS. 49 Art XVII GATS. 50 See generally, Jackson, Davey and Sykes above n 31, 922; also Jackson, The World Trading System, above n 29, 307. 51 Art XVII GATS. 52 Art XVI GATS. 53 Annex on Telecommunications: further negotiations were carried out to liberalise the basic telecommunications sector and were concluded in 1997 and came into effect in 1998. Members’ commitments are separated into the general commitments in the annex itself and then further specific commitments contained in the Reference Paper on Regulatory Principles (1997) 36 International Legal Materials 367, although members have to specifically accede to the commitments in the Reference Paper: see M Naftel and LJ Spiwak¸ The Telecoms Trade War (Oxford, Hart Publishing, 2000) at 102–17; also MG Durantez, ‘WTO/GATS


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Consequently, international trade rules are now divided clearly into three parts covering goods,54 services55 and intellectual property.56 This means that the application of the rules is dependent on the categorisation of the transaction as one relating to goods, services or intellectual property. Whilst identifying an intellectual property issue might be relatively straightforward, dividing the e-commerce transaction along the goods/services boundary is more problematic particularly when items that would usually be categorised as goods are delivered in electronic form reliant on telecommunications services to transmit the final ‘product’.57 Despite some members’ assertions58 that trade in e-commerce effectively continues without resolving whether it involves trade in goods, or trade in services, coupled with the Appellate Body ruling that the WTO’s rules in GATT59 and GATS60 can be applied concurrently anyway,61 the classification discussion remains at the core of the WTO work programme on e-commerce.62 It is clear that resolving the classification issue is important because a WTO member’s commitments to trade liberalisation in the goods and services sectors are contained in schedules annexed to both GATT and GATS: there is no single, common scheduling arrangement where members can indicate their willingness to liberalise trade in both the goods and services sectors at once. Instead separate schedules are required for each agreement.63 Consequently, the scope of these commitments can differ between goods and services dependent on which sectors the member decides to target. Potentially this means that the member’s obligations then either change, or are removed completely dependent upon whether the subject matter in dispute falls within GATT or GATS. For example, separating the MFN and national treatment rules in GATS but not GATT means that the scope of

Negotiations on Basic Telecommunications—An Overview’ (1997) 3 International Trade Law and Regulation 135. On the services covered by the negotiations see <www.wto.org/emglish/ tratop_e/serv_e/telecom_e/telecom_coverage_e.htm> (last visited 11 October 2002). 54 Annex

1A: Multilateral Agreements on Trade in Goods (incorporating the General Agreement on Tariffs and Trade (GATT) 1994). 55 Annex 1B General Agreement on Trade in Services (GATS). 56 Annex 1C: Agreement on Trade-Related Aspects of Intellectual Property (TRIPS). 57 eg books, or CDs. 58 WTO, Work Programme on Electronic Commerce: Submission from the United States, WT/GC/W/493, 16 April 2003, para 8. 59 The General Agreement on Tariffs and Trade 1994. 60 The General Agreement on Trade in Services. 61 European Communities—Regime for the Importation, Sale and Distribution of Bananas WT/DS27/AB/R, 9 September 1997, para 221. 62 The latest designated discussions on e-commerce show the classification discussion at the top of the agenda: WTO, Fourth Dedicated Discussion on Electronic Commerce Under the Auspices of the General Council, WT/GC/W/492, 8 April 2003. 63 Art II:1 GATT and Art XX GATS.

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the member’s liberalisation commitment differs depending on whether the product traded involves goods or services when a member has not undertaken full liberalisation commitments in their GATS’ schedules. Parallel application of both agreements does not address this problem fully either, for two reasons: first, there will be uncertainty over which rules apply until there is a finding made by the WTO dispute settlement panel. Such ambiguity ensures it is difficult for participants to operate effectively in the highly volatile e-commerce market if they are uncertain which rules are applicable.64 Second, the Appellate Body has made it clear that despite sharing common core rules, the scope of members’ obligations differs dependent on the extent to which they have agreed to liberalise sectors in either the goods or services’ sectors.65 Conflicts between the application of the two agreements arise therefore. Despite the WTO’s much praised dispute settlement mechanism,66 the boundary between goods and services has not been resolved judicially,67 but has instead been left to individual members of the WTO to determine through the negotiating process.68 Removing the decision away from the judicial mechanism towards the members inevitably politicises the classification decision as the boundary between goods and services is blurred. This raises broader questions: whether it is appropriate to leave such a crucial delineation to the vagaries of politics when it directly affects individual business strategies; and also, who is the most appropriate arbiter in the regulation of e-commerce and whether this person or body is even the subject of either GATT or GATS. The correct choice of agreement then is crucial because restrictions on trade in e-commerce may be contained within domestic regulations policed by non-governmental bodies.69 GATS

64 A question remains whether the scope of the MFN and national treatment obligations are the same in GATT and GATS: see A Mattoo, ‘MFN and GATS’ in T Cottier, PC Mavroidis and P Blatter, Regulatory Barriers and the Principle of Non-Discrimination in World Trade Law (Ann Arbor, University of Michigan Press, 2000) 51. 65 The scope of the MFN and national treatment obligations is outside the scope of this, but the Appellate Body did recognise that the scope of the most favoured nation (MFN) obligation found in both GATT and GATS could be different: Canada—Certain Measures Affecting The Automotive Industry, WT/DS139/AB/R and WT/DS142/AB/R, 31 May 2000, para 181. 66 See E-U Petersmann, The GATT/WTO Dispute Settlement System: International Law, International Organisations and Dispute Settlement (London, Kluwer, 1997). 67 The question did arise in the Canada—Certain Measures Affecting the Automotive Industry above n 65, but the Appellate Body side-stepped the issue. See section 3 of this article for a fuller discussion. Note that the European Court of Justice has been faced with this dilemma in relation to European Union law and despite making several attempts to resolve the issue, difficulties remain: see LM Woods, Free Movement of Goods and Services within the European Community (Aldershot, Ashgate, 2004, forthcoming). 68 WTO, Work Programme on Electronic Commerce Interim Report to General Council, S/C/8, 31 March 1999: see annex which contains Chairman’s summaries of the informal discussions on classification of e-commerce issues. 69 See Feketekuty above n 47, 86.


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recognises that decisions can be taken at this level, whereas GATT does not directly make this assumption.70 It is evident from the documentation submitted as part of the work programme on e-commerce that there is an inextricable link between the problems caused by the classification issue and the definition of e-commerce adopted by WTO members.

2.

DEFINING E-COMMERCE

At the start of the WTO’s work programme on e-commerce finding a common definition of e-commerce was difficult because there was divergence between those members71 who suggested definitions in their submissions as part of that programme and those who felt that ascertaining how the WTO rules applied was more important than defining e-commerce in the abstract.72 Despite these conceptual difficulties, the WTO devised a working definition in which e-commerce is ‘the production, distribution, marketing, sale or delivery of goods and services by electronic means’.73 This broad view appears to mean that all transactions conducted via telephone, fax, and all other telecommunications systems74 are included,75 even though the term ‘e-commerce’ is usually more commonly associated76 only with business conducted via the Internet.77 During subsequent discussions on issues

70 Cf

the WTO Agreement on Technical Barriers to Trade (TBT Agreement) which does envisage some action taken by other bodies in relation to technical barriers to trade in goods, but members’ liability for their actions appears limited: Art 3:1 TBT Agreement. 71 G/C/W/158 above n 19, para 2.1. 72 WTO, Work Programme on Electronic Commerce: Submission by the United States, WT/GC/16, G/C/2, S/C/7, IP/C/16, WT/COMTD/17, 12 February 1999 at para 3: note that the US does recognise that certain definitional issues must be addressed before the completion of the work programme: ibid. There is still disparity amongst members on this issue, particularly in relation to classification of products: see WTO, Second Dedicated Discussion on Electronic Commerce Under the Auspices of the General Council on 6 May 2002, WT/GC/W/475, 20 June 2002 at para 1. 73 WT/L/274 above n 18, para 1.3; see also Electronic Commerce and the Role of the WTO above n 1, 1. This can be contrasted with the more comprehensive approach taken by the European Union’s work on the information society: see European Commission, Towards a New Framework for Electronic Communications Infrastructure and Associated Services: The 1999 Communications Review, COM (99) 539. 74 eg television, electronic payment mechanisms and electronic data interchange (EDI): E-Commerce and Development Report 2001 above n 4, 1 75 ibid. 76 UNCTAD, E-Commerce, WTO and Developing Countries, Policy Issues in International Trade and Commodities Study Series No 2 (Geneva, United Nations, 2000) 1. 77 Drake and Nicolaïdis above n 20, 399. The Internet grew out of the development of a communications mechanism (ARPANET) devised by university lecturers in the US in the early 1960s. Although originally conceived to assist the US military, this scheme was gradually abandoned in favour of exploitation of commercial usage. In the early period the new communications system was primarily used to send e-mail, but following the standardisation of

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covering a number of legal aspects including the application of GATT and GATS’ rules to e-commerce (the ‘cross-cutting issues’) conducted pursuant to the work programme, members agreed that although the definition appears to place the emphasis on the electronic media through which the transaction occurs, in fact, the product traded should be the starting point for determining how the WTO rules apply.78 This working definition seems comprehensive, but significant difficulties arise because it fails to take into consideration the way that WTO rules operate in practice. On one level, the definition does not acknowledge who the participants in e-commerce are; in particular, whether private parties or businesses are involved, or whether it is limited to governments and other public or private organisations. 79 Ensuring that the WTO definition at least acknowledges that non-state entities take part in e-commerce is important because on the basis of statistical data available, it is evident that whilst e-commerce actors may rely on the Internet as the main tool to undertake their transactions, they are all involved to differing degrees. Transactions between businesses (B2B commerce) account for the greatest proportion of trade conducted via e-commerce80 and projections estimate growth in this sector from e77 billion in 2001 to e2.2 trillion in 2006 within the European Union alone.81 Trade between business and consumers (B2C commerce) accounts for a lesser proportion of on-line trade, but is still expected to grow at a slightly slower rate, rising to e172.4 billion within the European Union by 2007.82 There is also growing interest in the extent to which e-commerce occurs between business and government (B2G commerce), although this has traditionally been more difficult to obtain statistics on.83 This differing participation means that such parties’ transactions may not be covered by WTO rules at all, or they might be affected in different ways dependent on whether trade in goods or trade in services is involved. information flows as a result of the introduction of the TCP/IP protocol in the 1980s, interconnection between networks was more readily achievable. The World Wide Web was established in 1990 and this directly facilitated on-line transaction including shopping and banking: Electronic Commerce and the Role of the WTO above n 1, 10 78 WTO, Dedicated Discussion on Electronic Commerce Under the Auspices of the General Council 15 June 2001, WT/GC/W/436, 6 July 2001, para 1. 79 Electronic Commerce and Development Report 2001 above n 4, 6. 80 UNCTAD estimated that over 80% of e-commerce was conducted via B2B commerce in 2001: ibid. at 7. 81 R Greenspan, ‘EU B2B Expected to Explode’ Cyberatlas, 28 August 2002 site last visited 6 November 2002). 82 Ibid. 83 Electronic Commerce and Development Report 2001 above n 4, 7. Note also that e-government transactions may also be included dependent on how trade in services is defined: see the UK’s ‘e-strategy’: .


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Whilst there is an assumption that the rules only affect states, 84 this is misleading due to the way that GATT and GATS’ rules in particular operate in practice. For example, Article XIII GATS limits the application of the MFN, 85 national treatment 86 and market access 87 rules to government procurement, which changes their impact on those involved in B2G commerce. Similarly, protecting consumers from dubious business practices is more important in B2C commerce, than in B2B commerce where maintaining competitive conditions within the market is paramount. 88 Whilst maintaining competition may protect consumers in the long term, it may be desirable to intervene directly to introduce consumer protection legislation to supplement this.89 Articles VIII and IX GATS address anticompetitive behaviour between businesses in relation to trade in services thereby affecting B2B commerce. However, this occurs in a very generalised way: Article VIII GATS requires members to ensure that monopoly service suppliers do not abuse their dominant position within the domestic territory such that it leads to violation of that member’s general commitments under GATS,90 consequently restricting commercial freedom within the relevant jurisdiction. This potential effect on non-state entities is clear from a pending dispute between the United States and Mexico on the interpretation of GATS, the Annex on Telecommunications and the Telecommunications Reference Paper. 91 The United States alleged that Mexico failed effectively to regulate the activities of its major telecommunications service supplier, Telmex, thereby facilitating anticompetitive behaviour by excluding other potential operators from the Mexican market. Although Mexico is the respondent in the dispute, if the United States succeeds in 84 Only

‘states or separate customs territories possessing full autonomy’ can be members of the WTO: Art XII:1 Marrakesh Agreement Establishing the WTO 1995 (the Marrakesh Agreement). 85 Art II GATS. 86 Art XVII GATS. 87 Art XVI GATS. 88 See J Lücking, ‘B2B E-Marketplaces’, ch 4, this vol. 89 A detailed discussion of the economics of competition policy is beyond the scope of this chapter, but see R Posner, Antitrust Law: An Economic Perspective (Chicago USA, University of Chicago Press, 1976) for a US perspective and DG Goyder, EC Competition Law 4th edn (Oxford, Oxford University Press, 2003) for an EU perspective; also note that Trebilcock and Howse make the point that the extent to which competition law based on the maintenance of a freely competitive market may not be desirable to achieve broader public policy aims: see B Dunlop, D McQueen and M Trebilcock, Canadian Competition Policy (Toronto, Canada Law Books, 1987), 67. 90 Art VIII:1 and 2 GATS. 91 Mexico—Measures Affecting Telecommunications Services WT/DS204 (pending): see WTO, Request for Consultations by the United States, S/L/88, 29 August 2000 for detail on the scope of the dispute. The panel was established on the 26 August 2002, but there has been a request for more time for deliberations as of 17 March 2003 (WT/DS204/5, 17 March 2003).

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its claim on this issue, then amended domestic competition legislation is likely as a result of a successful GATS claim which will inevitably affect Telmex’s business activities.92 However, the exact form of the legislation is uncertain because the WTO rules do not currently insist on effective competition legislation as such. In contrast, there are no direct equivalent measures in GATT, 93 apart from the general exhortation in Article 9 WTO Agreement on Trade-Related Investment Measures (TRIMS) to consider the possibility of incorporating competition and investment policies within the WTO rules.94 This distinction means that anticompetitive behaviour will only be regulated directly if it concerns trade in services not trade in goods. There are no rules that protect consumers directly from anticompetitive behaviour in either GATT or GATS.95 On a more specific level, defining e-commerce in terms of the product traded means that the WTO rules will apply to that product, rather than the media through which it is traded. This categorisation does not go far enough because the delineation between WTO rules on goods in GATT and those on services in GATS96 means that before the rules can be applied, trade in the product must be classified further as falling into one of these categories.97 This boundary is blurred in e-commerce particularly in relation to digital products, making it unclear whether participants’ business activities are affected or not.98 Despite extensive discussions in the work programme,99 members have been unable to decide whether e-commerce concerns trade in goods or services or both, with some members even suggesting that this discussion is unnecessary.100 On one view, the e-commerce transaction is regarded as 92 S/L/88 ibid 93 Trebilcock

para 7(4). and Howse suggest that a number of the WTO agreements covering trade in goods do contain rules which operate to restrict anticompetitive behaviour, but there is no direct equivalent of Art VIII and IX GATS: see MJ Trebilcock and R Howse, The Regulation of International Trade 2nd edn (London and New York, Routledge, 1999) 470. 94 Working Groups on Trade and Competition Policy and Trade and Investment Measures were set up following the first WTO ministerial conference in Singapore in 1996: see WT/MIN(96)/DEC, 18 December 1996. The latest report of the working group is: WTO, Report (2003) of the Working Group on the Interaction between Trade and Competition Policy to the General Council, WT/WGTCP/7, 17 July 2003. 95 The WTO Agreement on the Application of Sanitary and Phytosanitary Measures (SPS Agreement) allows members to impose restrictive trade measures to protect human health: Art 2:1 SPS Agreement. This is a limited exception where the consumer is considered. 96 The Appellate Body has confirmed this situation: see Bananas WT/DS27/AB/R above n 61, para 221. 97 The Appellate Body does argue that the rules can be concurrently applied, but note its practice in Canada—ertain Measures Affecting the Automotive Industry above n 65. 98 On the generally distinction between goods and services see J Bhagwati, ‘Economic Perspective on Trade in Professional Services’ (1986) 1 University of Chicago Legal Forum 45, 45–53 99 Fourth Dedicated Discussion on Electronic Commerce, WT/GC/W/492 above n 62. 100 See WTO, Work Programme on Electronic Commerce: Submission by the United States, WT/GC/W/493, 16 April 2003, para 8. Contrast WTO, Work Programme on Electronic


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trade in goods if the point of the transaction is trade in goods purchased for electronic commerce, such as computers, or if the transaction is conducted electronically, but there is delivery of physical goods.101 Whilst this appears a coherent solution to the dilemma, difficulties occur when digital products are delivered via electronic media:102 here, items like CDs, video, computer software103 and books would constitute goods by analogy if they are traded in their physical form, but if instead their delivery is dependent directly on the relevant electronic media, they could just be seen as ‘the transmitted bytes and data streams [consisting] only of one’s and zero’s’.104 The nature of the product traded changes therefore so that it no longer resembles the original book, or CD that otherwise would be delivered in its non-digital form raising the question whether it is still ‘goods’. Some members have tried to resolve this problem by trying to identify a central characteristic which categorises the digital product as goods, rather than services:105 one interpretation sees such products as goods if they ‘resemble or were close substitutes’ to the physical goods,106 or if they were delivered personally to the consumer, rather than being generally available on the Internet;107 and as services if they are immediately consumed by the purchaser and are not stored.108 However, these views are not satisfactory because they do not try to isolate what the inherent nature of an item is that makes it ‘goods’, but instead either try to identify the product as goods by analogy to a nebulous ‘like product’, or classify the product by its enduse. Whilst this latter idea could be satisfactory if digital products are seen as sui generis, problems arise if all products are classified in this way because this conflicts with the original view that an electronic transaction involving physical delivery of goods is trade in goods: taking this example to its limits, purchase of a chocolate bar over the Internet would be goods if it was then stored, but services if consumed immediately by the consumer. This is clearly an erroneous distinction.109

Commerce: Classification Issue: Submission by the European Communities, WT/GC/W/497, 9 May 2003, paras 8 and 14. 101 G/C/W/158 above n 19, para 2.2(i)–(ii). 102 Ibid para 2.6. 103 See Canada’s non-paper submitted to the

second designated discussion on e-commerce in May 2002: The Classification of Software Delivered Electronically, Job No (02)38 (8 May 2002). Non-papers are not generally available, but see summary in WT/GC/W/475 above n 72, para 1.5. 104 Ibid para 2.10. 105 This view is not universally accepted: see WT/GC/W/436 above n 78, para 1.6. 106 Ibid para 2.7. 107 Ibid para 2.7. 108 Electronic Commerce and the Role of the WTO above n 1, 51; and Drake and Nicolaidïs above n 20, 408. 109 Some members seem to be advocating sui generis treatment for electronic products: G/C/W/158 above n 19, para 2.9.

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This ‘subject matter only’ methodology is not universally accepted by members, as some favour an approach which places greater emphasis on the electronic nature of the product traded: the European Union in particular argues that the underlying need for the appropriate electronic networks to participate in e-commerce means that all products traded as a result must be services and not goods, irrespective of the product that is either physically or electronically delivered at the conclusion of the transaction.110 This view seems to be supported by the WTO Secretariat despite their neutrality, as their 1998 background note does follow the European Union approach closely.111 In addition, the view is growing in popularity amongst members,112 although there is still significant disagreement over the classification of a ‘small number of products made available on the internet … such as books and software’.113 There is consequently still no solution to the classification of digital products, nor to the more general issue of what makes a product goods or services.

3.

APPLYING GATT AND GATS TO E-COMMERCE: IS E-COMMERCE TRADE IN GOODS OR SERVICES?

Achieving consensus amongst members on the correct classification of the e-commerce transaction is crucial because GATT and GATS do not define the terms ‘goods’ or ‘services’;114 instead the rules apply to products in members’ schedules listed according to customs classification codes.115 Significant difficulties arise on two levels: first, defining the product as goods or services at all, and second, finding the correct classification code within GATT or GATS. These problems are acute in relation to digital products. 110 WTO,

Communication from the United States—Work Programme on Electronic Commerce—Scope and Classification Issues, S/C/W/87, 9 December 1998, para 1; this view is also reflected in their paper on the categorisation of computer and related services: WTO, Coverage of CPC 84—Computer and Related Services, TN/S/W/6, 24 October 2002, para 8; it reiterates its view in WTO, Work Programme on Electronic Commerce: Classification Issue: Submission by the European Communities, WT/GC/W/497, 9 May 2003, para 16. 111 WTO, Work Programme on Electronic Commerce: Note by the Secretariat, S/C/W/68, 16 November 1998, 10; see also discussion by Drake and Nicolaidïs above n 20, 409. 112 WT/GC/W/436 above n 78, para 1.3. 113 Work Programme Reflects Growing Importance of Electronic Commerce 15 June 2001, available at <www.wto.org/english/tratop_e_ecom_e/ecom_briefnote_e.htm>. (last visited 9 October 2002) 2. 114 WTO, A Consideration Concerning the Relationship Between the WTO Provisions and the Subjects Listed for Discussion Under Paragraph 3.1 of the Work Programme: Background Note by the Secretariat, G/C/W/128, 5 November 1998 at para 1.2; note some members’ opposition to the secretariat approach which was reiterated in the secretariat background note (Job No (02)37 (1 May 2002) ) to the second dedicated discussion on e-commerce in May 2002: see WT/GC/W/475 above n 72, para 1.11. 115 See Art II GATT and Part III GATS.

Regulating E-Commerce in the WTO A.

173

GATT

GATT generally uses the Harmonised Commodity Description and Coding System (HS) nomenclature,116 which aims to list all goods that could possibly be subject to tariffs. Devised by the World Customs Organisation,117 the HS nomenclature has 97 separate chapters describing goods in terms of physical characteristics; these are sub-divided into headings and subheadings, with the individual goods identified by a six-digit code. This code is then used in the member’s schedule to identify the goods subject to any tariff reduction commitments.118 This methodology apparently resolves the classification issue because if the product is listed in the HS nomenclature, it must be goods; but despite adding explanatory notes to each category, it is difficult to place ecommerce accurately within a specific code. Several problems arise: the HS code does not have a separate classification for the content of any electronic transmission, but instead focuses on the carrier medium used to transmit the content.119 The WTO Secretariat notes that this problem is acute for computer software purchased on the Internet, because the HS code does not have an individual listing for software as such,120 but instead classifies it in terms of either the laser disc, magnetic disc or tape on which it is transported.121 This means that software could be classified under three HS headings.122 Similar difficulties arise in terms of books transferred electronically: here a book physically transported would be covered by the HS code. If the book is purchased on the Internet instead and the content transmitted by laser or magnetic disc, is the book covered by the original code for books, or is it now like the software, classified in terms of the physical media on which it is transmitted to the purchaser?123 Rather than resolving 116 International Convention on the Harmonised Commodity Description and Coding System, 14 June 1983 amended by Customs Co-operation Council Recommendation, 25 June 1999 which entered into force 1 January 2002. See <www.wcoomd.org/ie/En/Topics_Issues/ topics_issues.html> (last visited 10 October 2003). 117 See Jackson, Davey and Sykes above n 31, 394 for a brief history of the development of the HS system. 118 G/C/W/158 above n 19, para 2.1. eg HS Heading 33.01 covers essential oils, and HS Code 2905.44 is the customs classification code for sorbitol: see WTO Agreement on Agriculture Annex 1 defines product coverage in the agreement on terms of the HS Code. See Harmonized System Convention, 12 February 2003, above n 116. The HS Code was amended on 8 January 2002, but there was no change to the essential oils and sorbitol codes. See ibid. 119 WTO, Considerations Concerning the Relationship Between WTO Provisions and the Subjects Listed for Discussion Under Paragraph 3.1 of the Work Programme, G/C/W/128, 5 November 1998, para 2; also G/C/W/158 above n 19, para 2.2. 120 On the classification of software see Job No (02)38 above n 114. 121 This situation has not been resolved in the amendment. 122 Above n 120 at para 2.2. 123 Electronic Commerce and the Role of the WTO above n 1, 51.

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the goods/services dilemma, the uncertainty in the HS coding means that the categorisation decision rests with the member, who will therefore make a pragmatic decision on the status of the product dependent on the importance he or she places on the electronic element of the transaction, consequently bringing the debate back to whether the electronic nature of the transaction changes the inherent characteristic of the product traded from goods to services. Some progress has been made on the liberalisation of trade in certain information technology products under the auspices of the WTO Ministerial Declaration on Trade in Information Technology Products (ITA).124 This agreement lists products essential for the e-commerce transaction including hardware, some software and certain telecommunications products. However, the ITA fudges the classification issue by just listing the products covered, thereby designating them as goods, rather than defining the essential nature of information products. The ITA uses the HS nomenclature and categorises the products based on agreement on code coverage between signatories to the agreement.125 Some members have expressed the view that products already classified under the ITA should remain as ‘goods’ for the purposes of the GATT rules, although this does not actually resolve the problem for non-ITA products, as there is no classification methodology in the ITA as such to use as an analogy in respect of those products not already covered by the agreement.126 Relying on the GATT rules to resolve the classification decision either at the goods/service level, or within the individual codes does not resolve the problem because there is no absolute requirement that members adopt the HS nomenclature at all. This complicates matters further as GATT does not even require a common starting point. In Spain—Tariff Treatment on Unroasted Coffee,127 the panel made it clear that there was ‘no obligation … to follow any particular system for classifying goods, and a contracting party had the right to introduce in its customs tariff new positions or subpositions as appropriate’.128 This position was followed in Canada/Japan: Tariff on Imports of Spruce, Pine Fir (SPF) Dimension Lumber129 where the panel went further and stated that although both parties to the dispute had adopted the HS nomenclature, this ‘had brought about a large measure of harmonisation in the field of customs classification of goods, but this system did not entail any obligation as 124 WT/MIN(96)/16, 13 December 1996. The ITA aims to eliminate tariffs on specified IT products between 1997 and 2000 (2005 for Costa Rica): see NE Scott, ‘WTO DeclarationTrade in IT Products’ (1997) 3 International Trade Law and Regulation 45. 125 WT/MIN(96)/16 ibid. para 5. 126 WT/GC/W/475 above n 72, para 2.2. 127 BISD 28S/102, 11 June 1981, 111. 128 Ibid. 129 BISD36S/167, 19 July 1989.


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to the ultimate detail in the respective customs classification’.130 GATT therefore adopts a laissez-faire approach to classification where the crucial aspect is not how the product is classified per se, but whether the tariff treatment complies with the member’s MFN and national treatment obligations, so that ‘like products’ are treated equally, irrespective of their actual classification.131

B.

GATS

Classifying the e-commerce transaction as trade in services under GATS is more complex than GATT, as it raises problems on three levels: first, whether the e-commerce transaction is trade in services at all; second, if it is, how is that service supplied; and third, how should the e-commerce transaction be categorised for the purposes of members’ schedules? Unlike GATT, which does not define ‘goods’ at all, GATS includes a definition of services. However, it does not define ‘services’ in terms of the inherent characteristics of the products themselves,132 but instead focuses on the manner by which those products are supplied, referred to in GATS as the mode of supply.133 Under Article I GATS, the rules apply to the supply of a service either traded across borders,134 where the consumer is present in another member’s territory to receive the service,135 if the service is supplied through the presence of a commercial entity within the territory of another member,136 or if the service is supplied by the presence of a ‘natural person’ in the other member’s territory.137 The Appellate Body considered GATS’ coverage, particularly the scope of Article I, in Canada—Certain Measures Affecting the Automotive Industry.138 At issue was Canada’s duty free importation scheme for certain manufacturers of cars, buses and other commercial vehicles. Under the scheme, these vehicles enjoyed duty free tariff treatment if they conformed to the terms of the Motor Vehicles Tariff Order 1998 and certain

130 Ibid paras 5.7–5.10. 131 GATT, Panel On Vitamins

BISD 28S/102 at para 4.4. See also European Communities— Customs Classification of Certain Computer Equipment, WT/DS67/AB/R and WT/DS68/AB/R, 5 June 1998, para 90. 132 This is despite the fact that GATS says it covers the product traded: WTO, WTO Agreements and Electronic Commerce, General Council, WT/GC/W/90, 14 July 1998, para 3. 133 Art I GATS. 134 Mode 1: Art 1:2(a) ibid. 135 Ie consumption abroad: Art I:2(b) ibid. 136 Art I:2(c) ibid. 137 Mode 4: Art I:2 (d) ibid.: on the general problems raised by the various modes of supply see G Karsenty, ‘Assessing Trade in Services by Mode of Supply’ in Sauvé and Stern above n 20, 33. 138 WT/DS139/AB/R and WT/DS142/AB/R, above n 65.

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Special Remission Orders:139 the manufacturer had to have built vehicles in Canada of the type it wanted to import duty free during a designated ‘base year’; ensure that the ratio between vehicles it produced in Canada and those it imported in any given period was ‘equal to or higher than’ the ratio from the designated ‘base year’, but that this should not fall below a 75:100 split in any event; and finally, that the value of the Canadian input into the domestic production of the vehicle concerned was ‘equal to or greater than’ the equivalent value put into the vehicle’s manufacture in the base year.140 In addition to the general requirements in the Motor Vehicles Tariff Order, Canada also granted duty free treatment to other manufacturers if they complied with specified requirements in the Special Remission Orders (SROs). These SROs provided different ratios to those in the Motor Vehicles Tariff Order: some operating on a like-for-like basis, that is 100:100, whilst others offered more favourable treatment, with some manufactures only required to meet 60:100 or even a 40:100 ratio instead of the 75:100 in the original order.141 Although allegedly origin-neutral, Japan and the European Union argued the de facto application of the measure meant only certain manufacturers benefited from the duty free treatment. In particular, Japan pointed to the success of Swedish and Belgian manufacturers, Saab and Volvo in obtaining duty free access in contrast to the Japanese manufacturer, Lexus.142 In addition to violations of Article I:1 GATT 1994 and Article 3:1 WTO Agreement on Subsidies and Countervailing Measures, the panel found that the measure breached Article II GATS, as the measure affected trade in services under Article I GATS. On appeal, Canada argued that its duty free tariff scheme failed to impact on ‘wholesale distribution service suppliers in their capacity as service suppliers’.143 Consequently, it claimed the scheme did not come within GATS because the measure did not concern trade in services at all under Article I, but only affected trade in the vehicles as goods, so the legality of the scheme should only be considered under GATT.144 Clearly, Canada was arguing for a definitive categorisation of the products involved based on its own classification criteria, and was not content to allow both the GATT and GATS to apply concurrently to the measure. Both the panel and the Appellate Body rejected this rigid approach, albeit for different reasons.

139 Ibid para 7. 140 Ibid paras 8–10. 141 Ibid para 14. 142 Canada—Certain

Measures Affecting the Automotive Industry—Report of the Panel, WT/DS139/R and WT/DS142/R, 11 February 2000, paras 5.271–6. 143 WT/DS139/AB/R and WT/DS142/AB/R above n 65, para 20. 144 Ibid para 147.


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Superficially, the panel 145 adopted a two stage analysis: first, it considered whether the measure affected trade in services at all to satisfy the threshold test in Article I GATS. Second, it evaluated the breach of Canada’s substantive obligations, particularly under Article II. 146 Although it reiterated Canada’s arguments, the panel did not go on and consider their veracity, but instead pointed to the Appellate Body’s assertion in Bananas147 that there are certain measures which can be assessed simultaneously under GATT and GATS, thereby negating the need to evaluate whether the measures in fact affected trade in services or goods. 148 The fact that the measure could affect trade in services was enough and a determination of whether it did affect trade in services was therefore unnecessary.149 By moving straight to the violation of Article II GATS, the panel fused the threshold test with the assessment of the substantive breach, arguing that as the measure breached Article II it must be within GATS for the purposes of Article I. 150 This interpretation was rejected by the Appellate Body. In contrast to the panel, the Appellate Body reiterated the need to consider GATS’ threshold test in Article I:1 and the substantive obligations separately.151 Whether the transaction involves trade in services must be established first, followed by a determination that the measure at issue affects services trade.152 In the Appellate Body’s view, trade in services will be at issue where a service is provided through one of the designated modes of supply listed in Article I:2 GATS. It went on to state that as the issue in dispute was ‘wholesale trade services in motor vehicles’, which was a listed customs classification category and not disputed as such by Canada, the issue involved trade in services, so no further discussion of the scope of Article I:2 was needed. There was no substantive discussion on the nature of trade in services in the abstract, or whether the customs classification category covered the Motor Vehicle Tariff Order at all.153 It appears that recognition by Canada that it used this customs classification in some way was enough for the application of GATS, irrespective of whether the measure in dispute actually came within it. By adopting this view the Appellate Body therefore side-stepped the classification issue, instead focusing on the mode of supply to determine whether the issue comes within GATS. Although this approach follows the 145 WT/DS139/R and WT/DS142/R, above n 142, paras 10.223–45. 146 Ibid para 10.228. 147 WT/DS27/AB/R above n 61, para 221. 148 WT/DS139/R and WTDS142/R above n 142, paras 10.233–34. 149 Ibid para 10.235. 150 Ibid para 10.235. 151 WT/DS/AB139/AB/R and WT/DS142/AB/R above n 65, paras 150–51. 152 Ibid para 155. 153 Ibid para 157.

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wording of GATS closely, this does not resolve the classification issue for the purposes of digital products.154 This is because placing the emphasis on the mode of supply, rather than any inherent characteristic of the product means that there still must be an initial decision that the product is services before the mode by which that product is traded is ascertained. This is because a product traded across borders could equally be regarded as goods therefore applying GATT, or as services by virtue of mode 1 GATS, so that the mere border transfer in itself cannot be determinative of the product’s status as services. GATS’ technological neutrality155 is arguably irrelevant to this dilemma because it only impacts once the product is within the scope of GATS, so the fact that the product is supplied electronically will not prevent it from being services; but equally, it does not automatically lead to the product being designated as services either.156 Without further guidance from the WTO on the designation of e-commerce products as goods or services per se, members will make the decision based on their own definition, thereby raising the same concerns seen in the GATT context.157 Little assistance is given in the scheduling guidelines adopted by the Council for Trade in Services in March 2001 to assist in the GATS renegotiation discussions.158 Paragraph 28 states that ‘the supply of a service through telecommunications or mail and services embodied in exported goods (ie services supplied in or by a physical medium, such as a computer diskette … ) are all examples of cross-border supply’ under mode 1 GATS.159 Whilst this seems to be arguing that e-commerce transactions could be categorised as services because they are conducted via telecommunications networks, this presumes that the product transmitted via that network is services in the first place because it places the emphasis on how that service is supplied, rather than whether it is a service at all. Adopting this approach without further clarification is difficult therefore because some members do not even accept that transactions conducted on-line in this way are trade in services in the first instance.160 Even if e-commerce is seen as trade in services in the first instance, fitting it within a particular mode of supply to determine what a member’s 154 The Appellate Body noted that the scope of GATS’ coverage was problematic. Although it rejected the panel’s finding on the scope of Art II:1 GATS, it did not go further and complete the analysis, arguing that this should be left to later dispute proceedings where GATS formed a central element of the proceedings: ibid. para 184. 155 WT/GC/W/90 above n 132, para 3. 156 Members recognise the problems of technological neutrality in relation to the application of GATT: WT/GC/W/436 above n 78, para 1.8. 157 See section 2 above. 158 WTO, Guidelines for the Scheduling of Specific Commitments under the General Agreement on Trade in Services (GATS), S/L/92, 28 March 2001. 159 Ibid (emphasis added). 160 WT/GC/W/475 above n 72, para 1.11.


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obligations are in GATS is difficult because the boundary between the four modes becomes blurred. This problem is acute in the boundary between modes 1 and 2.161 Here the mode of supply is determined by the origin of both the consumer of the service and its supplier and the extent to which both can be said to be territorially present within a member’s territory.162 Physical presence of either the supplier or consumer is not a requirement, therefore, as Drake and Nincolaidïs observe, problems arise in relation to provision of services via the Internet because ‘millions of customers can “virtually visit”a foreign country and import services’ without ever leaving their own jurisdiction physically.163 This makes it hard to decide if the consumer has in fact crossed the border to enjoy the service, or whether the service is imported to the consumer instead for the purposes of deciding whether it is mode 1 or 2.164 The Committee on Trade in Financial Services discussed the boundary between modes 1 and 2 in 1997,165 particularly raising the classification of the electronic supply of financial services where the physical presence of the service provider was not required for the delivery of the service.166 Rather than making a definitive suggestion on the classification, the note suggests five interpretations of the transaction which would then designate the transaction within either mode 1 or 2: the service will be mode 1 if either the consumer is resident within the member’s territory, if the transaction takes place under the laws of the member, or if the supply of the service also involves ‘solicitation’. The final solution fudges the issue by suggesting the merger of modes 1 and 2, which could involve the renegotiation of existing reduction commitments if members have only made commitments in relation to either mode 1 or 2 and not both. The financial service paper was later built upon by the Secretariat167 who suggested that rather than trying to distinguish between the modes of supply in the abstract, the distinction should be based on the commitments made in members’ GATS schedules, because the mode is only relevant to determine whether a member has made a commitment in a specific area where its measures are in dispute.168 This does not resolve the problem in relation to e-commerce because there are disparities between members’

161 Ibid para 1.12. 162 GATT, Scheduling

of Initial Commitments in Trade in Services: Explanatory Note, MTN.GNS/W/164, 3 September 1993 (see also Addendum, MTN.GNS/W/164/Add.1, 30 November 1993). 163 Drake and Nicolaidïs above n 20, 413. 164 S/C/8 above n 68, Annex para 2. 165 WTO, Informal Note by the Secretariat for the Committee on Trade in Financial Services: The Distinction Between Modes 1 and 2, incorporated into S/FIN/W/14, 24 June 1997. 166 Ibid para 3. 167 S/C/W/68, above n 111. 168 Ibid para 8.

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views on its correct classification within their schedules, so the proposed solution only moves the original classification decision to a later stage. Classification within members’ schedules is more complex under GATS than GATT: members are required to enter those sectors in which they wish to make commitments in their schedules. They are assumed to make a full commitment to liberalising these sectors, unless they add any reservations in regard to market access or national treatment. If the member’s schedule is silent on a particular sector, then they are not deemed to make any specific commitments in relation to that sector.169 This methodology was more complicated prior to 2001 because there was no universally agreed method of scheduling amongst members as such, which meant that the way that individual commitments and reservations were expressed was left to the discretion of the member.170 The scheduling guidelines adopted by the Council on Trade in Services in March 2001171 do ‘explain, in a concise manner, how specific commitments should be set out in schedules in order to achieve precision and clarity’,172 although the guidelines state that ‘(t)he answers should not be considered a legal interpretation of GATS’.173 Even with the adoption of the guidelines, GATS scheduling for products traded as a result of e-commerce is problematic. This is because there is an inherent conflict between the assertion that the guidelines promote ‘precision and clarity’, 174 and the prospect that they perpetuate the ambiguity which existed prior to 2001. Before the guidelines, members could either adopt their own system of classification for scheduling purposes, use the Services Sectoral Classification List (W/120) prepared by the WTO Secretariat during the course of the Uruguay Round, 175 or adopt the United Nations Central Product Classification System (CPC)176 on which W/120 is based.177 This freedom meant that there were diverse scheduling practices amongst members making it difficult to ascertain in some cases exactly what

169 Feketekuty above n 47, 98. 170 See Electronic Commerce and the Role of the WTO above n 1, 51. 171 S/L/92 above n 158. 172 Ibid para 1. 173 Ibid para 1. 174 Ibid para 1. 175 WTO, Services Sectoral Classification List, Note by the Secretariat,

MTN.GNS/W/120, 10 July 1991. 176 UN, Provisional Central Product Classification, Statistical Papers Series M No 77 Department of International Economic Affairs (New York, United Nations, 1991) currently in version 1.1 ST/ESA/STAT/SER.M/77/Ver.1.1, March 2002. This chapter uses the numbering that members adopt in their submissions to the work programme on e-commerce. Note however, that this does not always correspond with the numbering in Version 1.1 CPC, which only obfuscates the issue further. 177 Electronic Commerce and the WTO above n 1, 51.


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commitment a member was making in which sector.178 To some extent the guidelines address the scheduling problem: they make it clear that generally members should adopt W/120 as the basis of their commitments, which lists each sector according to the CPC’s classification. In the event of an omission in the CPC classification, the guidelines state that members then should rely on another internationally recognised system.179 The guidelines also recognise members’ right to rely on their own methodology for ‘sub-sectoral classification or definitions’ provided that these either comply with the CPC where possible, or they give a ‘sufficiently detailed definition to avoid any ambiguity as to the scope of the commitment’.180 Whilst retaining flexibility within the classification system is important, especially in relation to e-commerce where technology changes rapidly,181 ascertaining the level when a member will be deemed to have given a ‘sufficiently detailed definition to avoid any ambiguity as to the scope of their commitment’182 is uncertain. Although more detail is given on the general methodology concerning scheduling commitments in the guidelines,183 this does not overcome the basic problem of classifying products traded by e-commerce using W/120 and the CPC. W/120 was prepared during the Uruguay Round and categorises services according to a generic list with sub-divisions then listed according to the CPC classification. Consequently, once a member makes a commitment using W/120 in a sector that carries a CPC code, the interpretation of the classification lies in the scope of the CPC listing.184 The CPC classification methodology operates on a coding system that allocates a code number to each main product category. This first category is referred to as the section heading and carries a one-digit code. The section heading is then subdivided into four further levels. Level 2 is the division heading and carries a two-digit code; level 3 is the group heading with a three-digit code; level 4 refers to classes and has a four-digit code and finally level 5 is referred to as the sub-classes and carries a five-digit code.185 Each category includes definitions of the scope of each level of the code. Like the HS nomenclature used in GATT,186 the CPC was designed to be exhaustive, but there are instances where a product is not listed at all and several instances where the CPC has an illusive category listed as ‘other’: for example, computer and

178 See P Low and A Mattoo, ‘Is There a Better Way? Alternative Approaches to Liberalization Under GATS’ in Sauvé and Stern above n 20, 449, 468. 179 S/L/92 above n 158, para 23. 180 Ibid para 24. 181 WT/GC/W/475 above n 72, para 1.2. 182 S/L/92 above n 158, para 24. 183 Ibid paras 23–25. 184 Electronic Commerce and the WTO above n 1, 51. 185 See . 186 See section 2 above.

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related services includes CPC 845 and 849 specified vaguely as ‘other computer and related services’.187 Several problems arise when this nomenclature is applied to e-commerce. First, it is possible for e-commerce to be listed under several CPC headings, including communication services, telecommunication services,188 computer and other related services, as well as professional services. Inevitably, this means that there is the likelihood of considerable disparity between the treatment of e-commerce in members’ schedules. The European Union proposed clarification in relation to the coverage of computer and other related services,189 so that CPC 84 would cover ‘basic functions used to provide all computer and related services: computer programs … data processing and storage, and related services, such as consultancy and training services’.190 This still raises the possibility of conflict between CPC 84 and CPC 86 if some members regard the provision of technical assistance to facilitate better use of the computer networks as technical testing and analysis services191 or under the generic ‘other business services’ category,192 rather than as computer services per se, because a narrow reading of CPC 841 restricts its coverage to consultancy services regarding the installation of the computer hardware only.193 The second problem is illustrated by the conflicting classification problems raised in the European Union’s proposal on computer and related services: if a digital product is traded via the Internet and classified as services in the first instance, should those services be individually classified and if so, how? Should it be by provision of telecommunication services, the provision of access by the Internet Service Provider, the availability of encryption services, data processing services, or even on-line information and data retrieval systems?194 The scheduling guidelines suggest focusing on the type of service provided,195 rather than the service provider, but this does not help identify exactly what type of service is provided when digital products are traded. Finally, despite the classification system in both GATT and GATS, the fundamental problem is that there must still be a decision that a product traded via e-commerce is de facto goods or services before the member can

187 W/120 above n 175, 2. 188 The Telecommunications

Agreement only addresses classification of basic telecommunications: see Naftel and Spiwak above n 53, 102–15. 189 TN/S/W/6 above n 110, and WT/GC/W/497 above n 100. 190 Ibid para 7. 191 CPC 8676. 192 CPC 8790. 193 CPC 841. 194 See Drake and Nicolaidïs above n 20, 412. Also CPC 7523 (on-line information and/or data processing) and 843 (data processing). 195 S/L/92 above n 158, para 23.


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then go on and schedule it under the classification system. This is because both the CPC and the HS nomenclature operate on a descriptive productspecific basis, rather than on the inherent characteristics involved in the items traded. GATT and GATS rules’ silence on this basic issue means that the ultimate classification decision rests with the member, rather than with any independent judicial body and, as such, the decision is removed from the scrutiny of the WTO dispute settlement system, thereby circumventing one of the primary reasons for using the WTO scheme in the first place. Consequently, at this level, the decision shifts from one solely about WTO law, to one incorporating members’ domestic political and policy concerns, including the commercial needs of those participating in e-commerce within the members’ territory. In this way the purpose of using the WTO system to create an international harmonised framework for e-commerce is undermined because regional disparity remains. This brings the debate back to the lack of agreement on the classification of products traded via e-commerce, because without further guidance, members are likely to classify on the basis of their stance on whether they see e-commerce as goods or services. 196 Arguing that inevitably members must retain competence over some decisions unless the WTO adopts a full ‘market integration’ strategy does not take the argument further because the operation of the GATT and GATS means that liberalisation in e-commerce could be patchy without further elaboration on the classification issue.

4.

CONCLUSION

Successfully regulating e-commerce is complicated by the need both to enforce the transaction so that contracts concluded are valid and to facilitate trade conducted through electronic means by the removal of unnecessary border controls and internal restrictions. Using the WTO regulatory structure appears to be the answer to this regulatory dilemma as it has a comprehensive system of rules that govern most aspects of international trade and a proven dispute settlement mechanism. However, it is clear that the inherent rigidity of the WTO rule structure along the goods/services boundary means any product traded must be categorised as involving trade in goods or services before the rules to apply at all. Whilst this structure poses few problems for traditional products, significant disagreement remains amongst WTO members into which category 196 The issue has been fudged to some extent in relation to the imposition of customs duties, as members have agreed not to impose customs duties on ‘electronic transmissions’ until 5th Ministerial Conference in September 2003: WTO Doha Ministerial Declaration WT/MIN/ (01)/DEC/1, 20 November 2001, para 34.

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products traded on-line fall. This dilemma is not resolved by the GATT and GATS’ rules, as they only impact on products listed in members’ schedules annexed to the relevant agreements, with the likelihood of significant divergence between members over whether a product is goods or services and in addition, in services trade, whether they are prepared fully to liberalise the relevant sector in any event. Although GATT and GATS adopt detail scheduling nomenclature to assist the classification of a product as either trade in goods or services, doubts exist where products do not fall firmly within one category: this is acute for digital products. In such marginal cases, the classification decision lies with the member who arguably will make a decision based on the needs of its domestic economy, rather than on the basis of global considerations. This leads to the politicisation of the decision and questions must be asked whether it is appropriate to allow domestic political considerations to impede products traded via e-commerce. Despite the parallel application of GATT and GATS, the classification dilemma remains at the heart of the discussions in the work programme on e-commerce, as members appear reluctant to leave the crucial classification decision to the WTO dispute settlement mechanism to resolve. Following the collapse of the 5th Ministerial Meeting at Cancun in September 2003 the WTO’s relevance to the post-September 11th trading environment is being questioned.197 The application of the WTO’s rules to e-commerce is a significant element of this debate. It is only by recognising the limitations of the existing rule structure that the WTO can be an effective arbitration mechanism for the needs of the on-line trader.

197 WTO,

‘Conference Ends Without Consensus’ press release, 14 September 2003: (last visited 9 October 2003).

8 Public Services in the New Economy ERIKA SZYSZCZAK*

1.

THE PROVISION OF PUBLIC SERVICES

P

UBLIC SERVICES OCCUPY an uneasy space in the new economy, caught between the processes of liberalisation and the Member States’ willingness to recognise the role of public services but not finance their existence in a world of budget constraints and privatisation. During the 1990s public services underwent a revolutionary transformation motivated by the pressures for greater liberalization of markets but also by the growing disinclination of states to continue to finance public services. This led to a fundamental reconsideration of the role of the state in the provision of public services and an active policy of ‘re-inventing government’,1 resulting in privatisation, fragmentation, hybridisation and restructuring of public functions.2 Electorates have been persuaded of the capacity of markets to provide public services and this in turn has led consumers to have different expectations3 of the nature and quality of such services. In short, to expect public services to be more like ‘private’ services, coupled with a belief that

* Erika Szyszczak is the Jean Monnet Professor of European Law ad personam and Professor of European Competition and Labour Law at the University of Leicester, UK. She is also Director of the Centre for European Law and Integration. 1 See D Osborne and T Gaebler (contributor), Reinventing Government: How the Entrepreneurial Spirit is Transforming the Public Sector (Boulder, Perseus Books, 1992); C Hood, C Scott, O James and T Travers, Regulation Inside Government (Oxford, Oxford University Press, 2000). 2 New forms of public management include dividing policy formation from policy implementation, the creation of new independent regulatory agencies and experimenting with new initiatives to fund public services. 3 Technological change is one of the greatest stimulants for these demands, but also new requirements (for example the provision of financial services to a wider sector of the population) as well the ability of the market to provide new services without the intervention (or financing) from public authority. Dissatisfaction with the bureaucratic handling of public services has also played an important role in persuading electorates of the ‘better’ service the private sector can supply. There is an amusing example of this culture in David Landes,

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private enterprise is more efficient than state provision and may be more responsive to consumer demands. This belief in the market to deliver public services complements goals being pursued by the European Union, particularly the exercise of stricter fiscal discipline on public spending. Such goals nestle alongside a tendency to see the liberalisation of the public sector as an unavoidable consequence of the internal market.4 The exposure of public services to the competitive market through litigation using outdated, inadequate and inappropriate legal tools to handle the complex questions has forced the EU to take a greater proactive and central role in organising an agenda for the modernisation of public services in the new economy.5 This agenda was stimulated by the internal market programme and fuelled by the increasing use of Article 86(1) EC by litigants at the national level challenging the hegemony of many monopolists and incumbents in the national markets. Tensions arise with national interests wishing to ‘defend’ public services from erosion in the new economy. One response has been the inclusion of Article 16 EC and the inclusion of Article 36 on access to services of general interest in the Charter of Fundamental Rights.6 This has created the need to establish how national concepts of public services can be transferred into modern ideas in terms of definition, delivery and assessment of the efficiency of such services. The Commission has used soft law processes to iron out differences of opinion on the role of public services in the new economy. In December 2000, the European Council of Nice, approved a declaration developing the principles set out in Article 16 EC, inviting further study of the issues at the EU level. This was followed up in December 2001 by the European Council of Laeken, and Barcelona in March 2002. The Commission was invited to study the feasibility of a

The Wealth and Poverty of Nations (London, Abacus, 1998) 306: ‘The meanness of the French Post Office was notorious. Until the 1990s, airmail letters … paid a surcharge above a weight of 5 grams, stamps included. That meant using specially thin and pricey paper—a boon to the stationery industry. Even so the PO would not have a single stamp for the postage required and would combine 2 or 3 [stamps] to make the amount, and these would tip the scale. One had to experience these exercises in petty tyranny to understand the retardive effects of bureaucratic constipation. Fortunately for the French, the European Community has imposed new standards.’ 4 W Devroe, ‘Privatisations and Community Law: Neutrality versus Policy’ (1997) 34 Common Market Law Review 268. 5 Two Communications (1996 and 2000) set out the position of services of general economic interest. A Report, (2001) was followed by a Communication of June 2002 on the methodology of evaluation of services of general interest. These can be accessed at: ⬍http://europa.eu. int/comm/competition/liberalization/legislation/⬎ (visited 4 June 2002). 6 Art 36 CFR reads: ‘Access to services of general interest. The Union recognises and respects access to services of general economic interest as provided for by national laws and practices, in accordance with the Treaty establishing the European Community, in order to promote the social and territorial cohesion of the Union.’

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Framework Directive, providing a clearer legislative definition of services of general interest by December 2002. The political process was jeopardised by increasing litigation at the national level challenging the behaviour of former public service monopolists and by uncertainty in the European Court of Justice (the Court) case law on the role of public financing for public services. The Commission prepared a Green Paper in March 20037 which went beyond the initial remit of looking at the feasibility of a Framework Directive to exploring the way public services are to be provided and regulated in the new economy.8 This is double-edged. On the one hand the Commission is attempting to reassure the Member States and national interests that the new economy recognises the role of public services, but on the other, many of the policies pursued by the EU towards the new economy intrude upon the Member States’ autonomy to set the national agenda for the delivery of public services.

2.

THE POLITICAL ECONOMY OF STATE INTERVENTION

Article 295 EC states that ‘The Treaty shall in no way prejudice the rules governing the system of property ownership.’ Article 295 EC is interpreted as being neutral or agnostic about the role of state intervention in the economy, leaving the choice to the Member States over whether to use public resources or private markets to underpin economic growth. But in response to the fears by the Member States of the ever-creeping competence of Community activity the Court has not been sympathetic. Until the recent golden shares cases, the scope of Article 295 EC had not received a definitive interpretation by the European Courts. Although Advocate-General Ruiz-Jarabo Colomer saw Article 295 EC as a limitation on Community competence, the Court, in contrast, has not allowed Article 295 EC to be used by Member States to remove areas of economic organisation and activity from the reach of Community law.9 A limitation on the scope of Article 295 EC is hidden in the State Aid rules. The wording of Article 87(1) EC is wide, prohibiting virtually all state activity which affects trade between the Member States. There are

7 COM (2003) 270 final. 8 The Green Paper proposes

30 questions with a reply deadline of 15 September 2003. The range of issues covered includes competence issues as well as external aspects involving the WTO, the place of services of general interest in the policies of co-operation with the South, the relationship between sector based rules and general rules. 9 Case C–367/98 Commission v Portugal, Case C–483/99 Commission v France, Case C–503/99 Commission v Belgium [2002] ECR I–4731; Cases C–463/00 and C–98/01 Commission v Spain and Commission v United Kingdom judgment of 13 May 2003. The cases are discussed later.

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exceptions to the State Aid rules10 and the use of the private-investor principle provides a buffer to Article 87(1) EC11 but there is no specific reference to shield public services. In addition, the idea that there is neutrality over whether to use public or private systems of ownership to deliver goods and services may be illusory when we consider the implications of the goals of the March 2000 Lisbon Summit which committed the EU to becoming the most competitive, dynamic, knowledge based society in the world by 2010.12 Article 4 EC instructs the Member States and the Community to conduct their economic affairs ‘in accordance with the principle of an open market economy with free competition’. This goal is reinforced by Article 98 EC.13 In the hierarchy of treaty norms it is assumed that principles established in the early Articles of the Treaty will take precedence over later provisions.14 The important position of Article 4 EC allows free market principles to dominate all policies of the EU. But since the Treaty of Amsterdam and the evolution of the Lisbon Process the Court is aware of the political need to realign the balance between economic and social goals. It has signalled that the political nature of the substance of the open market economy is an area where the Court would prefer the lead to be taken by the institutional decision-making structure, not the Courts. The Court stated that Articles 4 and 98 EC establish a ‘general principle whose application calls for complex economic assessments which are a matter for the legislature or the national administration’.15 This interpretation of the hierarchy of norms in the Community suggesting a continuing imbalance between the logic of competition and the objectives of public services may be resolved in the new EU Constitution where services of general interest were discussed in the Convention on the Future of Europe.16 In the draft constitution, Article II-52 reproduces Article 36 10 These are to be interpreted narrowly: C–730/79 Philip Morris v Commission [1980] ECR–2263.

Note also Reg 69/2001 establishes a de minimis principle, set at e100,000 granted over a three-year period. The Commission has used soft law processes to regulate this highly political area of state regulation. 11 See the critique by M Parish, ‘On the Private Investor Principle’ (2003) 28 European Law Review 70. 12 Known as the ‘Lisbon Process’. 13 Art 98 EC reads: ‘Member States shall conduct their economic policies with a view to contributing to the achievement of the objectives of the Community, as defined in Article 2, and in the context of the broad guidelines referred to in Article 99(2). The Member States and the Community shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources, and in compliance with the principles set out in Article 4.’ 14 Cf the different view of Advocate-General Colomer in the golden shares cases above n 9. He argues that Art 295 EC should be attributed a higher constitutional status because of its position in the final and general provisions of the treaty which affect all treaty rules. 15 Case C–9/99 Echirolles Distribution SA du Dauphiné and Others [2000] ECR I–8207, para 25. 16 The discussion of services of general interest was focused on in the Working Group XI on Social Europe where there was disagreement as to how to regulate such services at the EU level.


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CHR and III-55 addresses public undertakings and undertakings with special or exclusive rights. The current Article 16 EC has been changed to read: Without prejudice to Articles III-55, III-56 and III-136, and given the place occupied by services of general economic interest as services to which all in the Union attribute value as well as their role in promoting social and territorial cohesion, the Union and the member states, each within their respective powers and within the scope of the application of the Constitution, shall take care that such services operate on the basis of principles and conditions, in particular economic and financial, which enable them to fulfil their missions. European laws shall define these principles and conditions.

This provision (Article III-6) is placed under the heading ‘Clauses of General Application’ and is a significant change of wording allowing for greater EU-level involvement in the delivery of public services.

3.

CHALLENGES TO THE PROVISION OF PUBLIC SERVICES

The use of state intervention to provide public services, especially through the use of public monopolies or companies granted special or exclusive rights was viewed in the post-war period as a necessary response to the devastation reaped upon the European economy. It was seen as a necessary strategy if Europe was to match the United States’ economic dominance. The pervasiveness of state intervention in the economy through public companies and monopolies is seen well into the 1990s until Article 86 EC came into prominence,17 followed by increased scrutiny of public finances under the State Aid rules. Article 86 EC permits the use of public monopolies but subjects the monopolies to the law of the market unless the Member State can show that the application of the free market rules would hinder the provision of a service of general economic interest. This justification is found in Article 86(2) EC and is derogation to the fundamental free market principles. This narrow derogation from the free market rules is the legal vehicle where Member States can justify anticompetitive behaviour: it is the lynchpin upon which public services can survive in competitive markets.18 17 Eg

the role of state intervention was questioned where the national monopolies were inefficient or not receptive to the market: Case C–41/90 Höfner [1991] ECR I–2017; Commission Decision (EEC) 90/16 Courier Postal Services—The Netherlands [1990] OJ L/10/50; Commission Decision (EEC) 90/456 Courier Postal Services—Spain [1990] OJ L/233/22; where there were allegations of failure to move with technological change Case C–179/90 Port of Genoa [1991] ECR I–5928. 18 See A Winterstein, ‘Nailing the Jellyfish: Social Security and Competition Law’ (1999) European Competition Law Review 324.

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Two examples reveal early thinking by the Court in its use of Article 86 EC to control state intervention in the market. Höfner and Elser v Macrotron19 is a decisive turning point in the attitude towards state intervention in the market. The Court suggests that in certain situations by merely creating a monopoly in certain kinds of markets the state is infringing competition law.20 Another example of the Court’s willingness to monitor the necessity for a state monopoly and to scrutinise the behaviour of the monopoly is seen in RTT.21 This is an example where the Belgian monopolist RTT held a monopoly in the telecommunications network as well as the monopoly in the ancillary market in the equipment used for interconnection to the network (telephones). This monopoly was attacked by GB-Inno, a large supermarket which engaged in wide-ranging litigation strategy, not only against state monopolies, but also against state laws and regulations which it alleged were anticompetitive and restrictive of trade. GB-Inno had imported and sold telephones in its supermarkets without RTT’s approval. This was a conflict of interest case since RTT also sold telephones and indeed had the monopoly in deciding which telephony equipment could be connected to its network. GB-Inno raised the argument that RTT’s behaviour was contrary to the free movement of goods and competition rules. The Court chose to deal with the case under Article 86 EC. The Court found an abuse of a dominant position. As a result of the Belgian legislation RTT had been able to extend the dominant position it had on the network for providing telecommunications into the ancillary market of providing and approving equipment which could be used. There was no justification as to why it was necessary to extend the monopoly in this way. This sort of litigation provided the impetus for a European-wide agenda for the liberalisation of a number of sectors which were dominated by national champions: transport, telecommunications, broadcasting, postal services and the utility sectors of electricity and gas. But the Member States were not willing to relinquish total control of national monopolies to the market; most Member States opted for a staged and/or partial liberalisation of their sensitive monopolies. The case law on Article 86 EC is inconsistent, but a more fundamental criticism can be raised at the political institutional structure of the EU which relies upon individual litigation creating a casuistic approach to policy formation in such a fundamental area of traditional state activity. 19 Case C–41/90 [1991] ECR I–2017, para 2. See also Case C–260/89 ERT [1991] ECR I–2962, para 37. 20 See L Gyselen, ‘Commentary on the Port of Genoa and RTT Cases’ (1992) 29 Common Market Law Review 1239 who argues that Höfner and ERT are confined to the particular situation and that the mere existence of exclusive rights does not necessarily lead to a breach of the competition rules. 21 Case C–18/88 [1991] ECR I–5981.

Public Services in the New Economy 4.

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THE CHALLENGE TO STATE AUTONOMY

The Court and the Commission continue to assert that Member States retain the freedom to define public services. Of crucial importance for the continuance of state intervention in the market is the boundary between national competence, where Member States can protect public services from competition, and the reach of the market through Community law competence. Recent case law on the privatisation of state assets shows that even in the initial choice of how to provide public services, the autonomy of the Member States is restrained.22 Subjecting state monopolies to the competitive market took place alongside the most significant political and economic change in the restructuring of the state and the market in the latter part of the 20th century: the sale of state assets to the private sector. How much freedom does a Member State of the EU have in choosing how to privatise public companies? In particular, may the state retain a share in a privatised company: the use of golden shares? Until it was recognised that proper regulation is a better way of maintaining competition, state shares in privatised companies were a useful insurance against anticompetitive activity by the privatised company. Golden shares may also be justified as a temporary measure to allow management to adjust to private sector activity or to protect a sensitive sector from take-overs by foreign companies, especially where such companies are in a dominant position as national champions, for example, in the electricity and postal services sector. As a consequence of the liberalisation process, some Member States encouraged the national champion, not only to continue to dominate the national sector, but also, to increase dominant positions and expand into other markets. Golden shares are used frequently to justify the state’s traditional duty to provide public services and, more generally, to intervene in the economy where the public interest so dictates. Thus, golden shares have become a key tactic in the liberalisation and privatisation programmes of a number of the Member States and continue to be used in the new accession states. These tactics raise a basic constitutional issue for EU law: where to draw the boundaries between the sovereign rights of the Member States to choose how to allocate the ownership of property in their territory and the scope of the EU. The Court23 brought the use of golden shares within Community

22 Above n 9. 23 The Commission

questioned the use of golden shares throughout the 1990s. See the Communication of the Commission on Certain Legal Aspects Concerning Intra-EU Investment [1997] OJ C/220/15. The view of the Commission was that the free movement of establishment rules were infringed by the use of golden shares. In the cases the Court restricts its analysis to the free movement of capital.

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law scrutiny, not wanting to leave such an important area of state activity outside of the control of Community law. Arguing, without much evidence to show how the use of golden shares is a restriction upon the free movement of capital, the Court declared that the use of golden shares is liable to act as a deterrent to investors from other Member States from making such investments.24 Italy conceded the case that special powers reserved for the state and public bodies in a number of public service sectors, including defence, transport, telecommunications and energy resources, was contrary to the EC Treaty provisions on capital, movement and establishment.25 In later cases the Court reinforced its view that restrictions on the four fundamental economic freedoms could not be justified for economic purposes, but conceded that golden shares could be justified provided certain procedural guarantees were implemented. What motivates the Court therefore, is not so much restricting the use of golden shares in privatisations but ensuring that other economic actors are given the opportunity to participate in privatizations of strategic undertakings. The Court’s approach is to employ concepts of good governance to state intervention in the market. Member States have used the idea of defending core public services from the full thrust of competition by accepting that there are certain universal services which should be protected. The Europeanisation of ideas of universal service obligations has generated a new dynamic to the concept of public services and opened up an analysis of the need to scrutinise the delivery of universal service obligations. The concept has also allowed for the development of universal service obligations. Such an obligation can be carried out by private actors, but some Member States have chosen to maintain a number of core State monopolies on the market as incumbents. These incumbents have market power and pose problems for the new economy. Where incumbents have used universal service obligations to protect their market position, there are allegations of anticompetitive behaviour because the incumbents can use their dominant positions, in terms of market and financial power, as well as illegal State Aid, to keep competitors out of the liberalised sectors within their own national territory. They may also use

24 Cf the comments of Advocate-General Colomer in Case C–98/01 Commission v Spain and Case C–463/00 Commission v United Kingdom (BAA), opinion of 6 February 2003: ‘Contrary to the Court of Justice’s finding, … the resulting restriction of the free movement of capital is incidental, rather than inevitable. If that is the case as regards measures affecting the composition of the membership, it is even more true as regards measures restricting the adoption of company resolutions (change of company object, disposal of assets). In the latter cases, the link with the free movement of capital is hypothetical or very tenuous’ para 36. 25 Case C–58/99 [2000] ECR I–3811. See the criticism of the Court’s judgment by AG Colomer in the later cases, above n 9, where he argues that it was inappropriate for the Court to decide significant novel issues of Community law on the basis of a concession by a Member State.


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that market strength to invade other national territories where the sector has been opened up to competition. The notable examples are the aggressive policies of the German Post Office, Deutsche Post, and the French postal service and electricity monopoly, EDF. The Courts have been generous when asked to appraise the financing of public services in the light of the State Aid rules. In FFSA26 the CFI declared that State Aid to a public service provider could be justified under Article 86(2) EC. However, this ruling did not settle the matter of whether such aid should be notified in the usual way under the State Aid procedures. The Court in CELF II27 confirmed that they should. Not only would this subject the aid to Commission investigation, but the standstill arrangements28 would also come into play until the aid had been cleared. In Ferring SA29 the Court took a different line, accepting that where aid is given to offset the additional costs incurred by providing public services, this was compensation for providing the service and not an economic advantage within the meaning of Article 87(1) EC. This approach challenged the political commitment by the Member States to monitor closely the use of State Aid generally within the Community.30 It challenged the Commission’s growing hegemony in the area of controlling state intervention in the market, generating a number of soft law communications, as well as new forms of monitoring such as the State Aid Score Board.31 The Court revisited the issue in Altmark.32 While the Court confirmed the compensation approach of Ferring, it attached a number of conditions to the receipt of the compensation in order to secure compatibility with Community law. First, the recipient undertaking must actually have public service obligations to discharge and those obligations must be clearly defined. Second, the basis on which the compensation is calculated must be established in advance in an objective and transparent manner. Third, the compensation cannot exceed what is necessary to cover all or part of the costs incurred in the discharge of public service obligations, taking into account the relevant receipts and a reasonable profit. Finally, where the undertaking is not chosen in a public procurement procedure, the level of

26 Case T–106/95 [1997] ECR II–229. 27 Case 332/98 Commission v France [2000] ECR I–4833. 28 Art 88(3) EC. 29 Case C–53/00 [2001] ECR I–9067. 30 Ninth Survey on State Aid in the EU COM (2001) 403;

Stockholm European Council, March 2001 SN 100/01 point 20 and 21; Report to the Seville European Council on the status of work on the guidelines for state aid and services of general economic interest; Report from the Commission on the State of Play in the work on the Guidelines for State Aid and Services of General Economic Interest (SGEI) progress report concerning the reduction and reorientation of state aid. Available at ⬍http//:europa.eu.int/competition/state_aid/others/⬎. 31 Available at ⬍http://europa.int/comm/competition/state_aid/scoreboard/⬎ (visited 4 June 2002). 32 Case C–280/00 Altmark Trans GmbH and Regierungspräsidium Magdeburg v Nahverkehrsgesellschaft Altmark GmbH, judgment of 24 July 2003.

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compensation must be determined by a comparison between an analysis of the costs which a typical undertaking in this sector would incur, with the amounts received and a reasonable profit from discharging the obligations. All four conditions must be met for an undertaking to show that it has not enjoyed a real financial advantage which could be considered a State Aid.

5.

HYBRIDISATION

Partial liberalisation and privatisation of state activity has resulted in an experimental approach, using a mixture of public/private legal and financial structures and initiatives to create a set of new hybrid institutions. Member States argue that this new form of economic activity is not, and should not be subject to the law of the market. The Court has not provided a helpful solution to clearly delineating between state activity beyond the reach of the law of the market and state economic activity which should be subject to the market rules. A number of legal techniques have been used to close off the sphere of state activity immune from the market33 but the case law and methodological approach used is not consistent. In Höfner34 the Court took a functional approach, arguing that the legal status and financing of a particular activity are not conclusive to the status of the activity in Community law. The decisive criterion was that the activity was capable of being provided by private market actors. The limitation of this test is seen if we observe the experimentation with privatisation in Europe. This has altered the frontiers between state/market activity; electorates have accepted that a number of public services can be provided by the market in the moves towards private provision of health, education, maintenance of roads, social security.35 Even the coercive powers of the state, for example, the control over immigrants and prison management,

33 These

ideas are discussed in E Szyszczak, ‘State Intervention in the Market’ in D O’Keeffe and T Tridimas (eds), EU Law for the 21st Century: Rethinking the New Legal Order (Oxford, Hart Publishing, 2004). 34 Case C–41/90 [1991] ECR I–1979. 35 To take one example, the classification of health care as an economic service. The issue has been discussed in the context of the free movement provisions where overriding public interest justifications provide the means to allow the Member States to experiment with new forms of medical services provision but also allow for the scrutiny of the compatibility of such schemes with the objectives of the internal market: see Case C–158/96 Raymond Kohll v Union des caisses de maladie [1998] ECR I–1931; Case C–120/95 Nicolas Decker v Caisse de maladie des employés privés [1998] ECR I–1831; Case C–157/99 BSM Geraets-Smits and HTM Peerbooms v Stichting Ziekenfonds VGZ and Stichting CZ Groep Zorgverzekeringen [2001] ECR I–5473; Case C–368/98 Abdon Vanbraekel and others v Alliance nationale des mutualités chretiennes (ANNMC) [2001] ECR I–5363; Case C–385/99 VG Muller Fauré v Onderlinge Waarborgmaatschappij OZ Zorgverzekeringen UA and EEM van Riet v Onderlinge Waarborgmaatschappij OZ Zorgverzekeringen, judgment of 15 May 2003.


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have been handed over to private actors. The use of the market and new actors, private bodies, charities, hybrid bodies to provide goods and services previously delivered by the state has brought a new dimension to the litigation. Courts are now faced with the issue of how far public service justifications can be extended to private actors who are involved in supplying and regulating public services. Wouters36 is an example of a global tendency to attack restrictive practices of regulatory bodies in the service sector. This was a reference challenging the Netherlands’ Bar prohibition on multidisciplinary partnerships (MDPs) between lawyers and accountants. The Court ruled that The Netherlands’ Bar was an association of undertakings and subject to Article 81(1) EC. The Court found that the regulation of the legal profession was a decision of ‘an association of undertakings’ which restricted competition and was technically caught by Article 81 EC since the rules relating to the prohibition of MDPs regulated an economic activity. The prohibition on MDPs was liable to limit production and technical development and affect competition. The Bar was not acting as a public authority because it was acting in a purely regulatory capacity for its own profession; it was not exercising typical public authority powers. The Bar’s governing bodies were elected without government intervention and it was not obliged to act in the public interest. The Court went on to find that the restrictive effects of the regulation did not go beyond what was necessary in order to ensure the proper practice of the legal profession. The case reveals the lack of attention paid in competition law to the exemptions and justifications which may be raised by the state and delegated bodies to provide public services. Advocate-General Léger pointed out that any justification for the infringement of the competition rules under Article 86(2) EC would come up against the problem that an absolute prohibition on MDPs would not satisfy the proportionality requirement. The Advocate-General was willing to conclude that Article 81(1) EC did not apply by virtue of Article 86(2) EC: lawyers performed services essential to a Member State governed by the rule of law. MDPs threatened lawyers’ independence and thus the prohibition of these forms of partnerships could be justified under the competition law rules. However, the Court ruled that The Netherlands’ Bar was not an undertaking within the meaning of Article 82 EC, as it did not carry out an economic activity. Nor could the Bar be considered to be a group of undertakings for the purposes of Article 82 as its members were not linked to constitute a group. The members were not linked to constitute a group as there were insufficient ties to enable the members of the Bar to adopt the same conduct on the market and eliminate competition between themselves. The Court ruled that whilst the prohibition on MDPs was in principle contrary to the 36 Case

C–309/99 [2002] ECR I–1577.

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freedom of establishment (Article 42 EC) and the freedom to provide services (Article 49 EC), the restriction on trade, as with the restriction on competition, was justified. But the Court found that the restriction on trade, as with the restriction on competition, was justified as being a necessary condition for the practice of the legal profession. Consequently, it reads across the public interest justification which may be used in relation to nondiscriminatory rules found in the free movement provisions of Article 49 EC37 into the competition rules. The public financing of health care, social protection schemes and pensions has come under pressure in the new economy. The political process of modernisation has used the open method of co-ordination to force the Member States to rethink the ways in which social protection (and pensions especially) are provided.38 This political process has been pre-empted by litigation. Here the Court has used a new tool, a concept of ‘solidarity’ to organize its thinking on where to draw the line between state autonomy and market law, as well as utilising the flexibility within the concept of ‘solidarity’ to allow for justifications and exemptions from the application of the market rules. An example of the latter is Albany.39 Pension schemes involve a balance of public and private sector provision and the EU is increasingly looking to involve private parties in pension provision. The Netherlands used the social partners (employer and employee representatives) to establish sectoral pension schemes. A number of employers in the textile sector objected to the compulsory nature of these sectoral schemes, arguing that if pension provision was being subject to the market then they should be free to opt out of the sectoral scheme and choose their own pension provider, largely because the sectoral pension funds were too costly. An earlier case, Poucet and Pistre,40 saw the successful use of the concept to defend national social insurance schemes against attacks from EC law. The concept of solidarity is used where there is no apparent inter-state element. The rationale seems purely to protect national social insurance schemes from the application of the rules of the market. The Court in Poucet and Pistre argued that there was no economic activity involved to trigger Community law: 13. It follows that the social security schemes … are based on a system of compulsory contribution, which is indispensable for the application of the principle of solidarity and the financial equilibrium of those schemes. 37 Case C–3/95 Reisburo Broede [1996] ECR I–6511. 38 Objectives and Working Methods in the Area of Pensions:

Applying the Open Method of Co-ordination (Joint Report of the Social Protection Committee and the Economic Policy Committee, November 2001) available at: ⬍http://europa.eu.int/comm/employment_social/ soc-prot/social/index_en.htm⬎ (visited 4 June 2002). 39 Case C–67/96 Albany International Stichting Bedrijfspensioenfonds [1999] ECR I–5751. 40 Joined Cases C–159/91 and C–160/91 Christian Poucet and Daniel Pistre v Assurances Générales de France and Caisse Mutuelle Régionale du Languedoc-Roussillon [1993] ECR I–637.


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18. … [O]rganisations involved in the management of the public social security system fulfil an exclusively social function. That activity is based on the principle of national solidarity and is entirely non-profit-making. The benefits paid are statutory benefits bearing no relation to the amount of the contribution. 19. Accordingly, that activity is not an economic activity.41

‘Solidarity’ is therefore used to delineate clearly between state autonomy and EC law. In Albany ‘solidarity’ is used in a different way. The Court was willing to find that the agreements between the social partners establishing the pension schemes were immune from the competition rules but the pension funds themselves were economic in character. A monopoly with exclusive rights was created and so Article 86 EC could apply. The Court found that because the funds were obliged to offer pensions on the basis of the solidarity principle, meaning here that individuals were not fully risk-rated, it made them less competitive than the comparable services offered by insurance companies. This justified a finding of a public service to be protected. A factor which seems to have influenced the Court is that the sectoral pension schemes displayed many features of Dutch social democracy and this raises a question of how far private providers of public services must mirror the State provision of public services which they are either supplementing or supplanting in order to fall within the definition of a public service. Pavlov42 is an example of another route to avoid the full thrust of the free market rules to a set of economic actors providing a social function. This time medical practioners objected to being made compulsory members of the supplementary medical pension scheme established in The Netherlands under Dutch law. The Court found the activity was an economic activity and therefore the bodies established to administer the pension scheme and the decisions taken were subject to the competition rules of the EC Treaty. But the Court took the view that the effect of these agreements on the market was minimal and applied a de minimis rule, finding also that there was no abuse of a dominant position under Article 82 EC. 41 See

also Case T–106/95 FFSA and Others v Commission [1997] ECR II–229; Case C–218/00 Cisal di Battistello Venanzio & C Sas v Istituto Nazionale per L’assicurazione contro gliIinfortuni sul Lavoro (INAIL) [2002] 691. For a free movement case see Case C–70/95 Sodemare SA and others v Regione Lombardia [1997] ECR I–3395. At para 29 the Court states: ‘It is clear from the documents before the Court that that system of social welfare, whose implementation is in principle entrusted to the public authorities, is based on the principle of solidarity, as reflected by the fact that it is designed as a matter of priority to assist those who are in a state of need owing to insufficient family income, total or partial lack of independence or the risk of being marginalized, and only then, within the limits imposed by the capacity of the establishments and resources available, to assist other persons who are, however, required to bear the costs thereof, to an extent commensurate with their financial means, in accordance with scales determined by reference to family income.’ 42 Case C–180–184/98 Pavlov v Stichting Pensioenfonds Medische Specialisten [2000] ECR I–6451.

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Recently Advocate-General Jacobs argued that the competition rules applied to the German statutory health insurance scheme which inter alia fixes the price of certain medicines.43 Under German law the majority of employees must belong to a statutory health insurance system, unless their income exceeds a certain level. The system is funded by compulsory contributions from the insured persons and the employers. The insurance funds are required to purchase medical services and supplies and supply these to the insured persons. However, certain products have maximum fixed prices and where the product exceeds this maximum price the insured person must bear the remainder of the cost. The fixed amounts are decided by a two-stage process. The first stage involves a committee deciding which types of products are subject to the fixed amount. This committee is composed of representatives of the leading sickness fund associations and associations of doctors. The choices made are then approved by the Ministry of Health. At the second stage, the associations of sickness funds determine the fixed amounts following criteria set out in law. Once set, the fixed amounts are subject to annual review and must be adapted to reflect changes in the market. The fixed amounts must be published and are open to challenge before the courts. A number of pharmaceutical companies challenged the decisions of the leading association of sickness funds in Germany fixing the price of the companies’ products. The Advocate-General argued that this was an economic activity. There was a degree of competition between the sickness funds inter se, and between the sickness funds and private insurers demonstrating that the economic activity could be carried out for profit. The fixing of the price for medicines also fell within the sphere of economic activity, as a sickness fund’s decision regarding the parameters of the services to be offered is indissociable from the core activity of the provision of health insurance. The Advocate-General considered that the second stage of price fixing activity, when the association of sickness funds together determine the fixed amounts, could be considered to be an act of the associations: they act independently of the ministry, there is no requirement to obtain prior approval, the decision making body is composed of the appellants’ representatives and the applicable criteria are insufficiently distinct from the appellant’s interest in setting the fixed amounts at a low level. AdvocateGeneral Jacobs found this behaviour to be contrary to competition law, having the object and effect of restricting competition, behaviour expressly identified in the EC Treaty as an anticompetitive practice. The issue in this case is whether the undertakings were acting independently on their own initiative. If this is the case then Article 81 EC applies. 43 Joined Cases C–264/01, C–306/01, C–354/01 and C–355/01 AOK Bundesverband and others v Ichthyol-Gesellschaft Cordes and Others, opinion of 22 May 2004.


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But if German law required the conduct, then the competition rules would not apply. This is a question of fact for national courts to decide. The Advocate-General suggested that the undertakings were unable to avoid fixing an amount and were not entirely free to choose the fixed amount because of certain rules such as the requirement to determine prices on the basis of the lowest price of comparator groups. In order to make competition law bite, the national courts should look to see if the undertakings had used any remaining discretion to create an appreciably greater restriction on competition than would have resulted from another permissible decision. If this question was answered in the affirmative, the Advocate-General argued that the defence found in Article 86(2) EC was a possible justification. The case law reveals that the transition towards the liberalisation of markets for public services and the consequent reliance upon private markets to provide an increasing number of public goods and services has not been smooth and is far from complete. The existing competition law tools of the European Union were drafted in a different age and seem ill-defined to manage the complex questions raised by the new economy, both where the state acts in a competitive manner and where non-state actors are called upon to supply publics services. Public interest defences are available under the core four economic freedom rules and cases such as Wouters suggest that such public interest defences need to be considered in relation to competition law. Article 86(2) EC has been stretched to cover a number of public interest situations under Article 86 EC and the State Aid rules and it could provide a model for a general public interest defence in the development of the new economy.44 But Article 86(2) EC is only available in limited situations: where there is a public undertaking, or an undertaking granted special or exclusive rights performing a service of general economic interest. The Member State must be able to show why the application of the free market rules will obstruct the performance of the tasks assigned to the undertaking and trade must not be affected to such an extent as would be contrary to the interests of the Community. The concept of proportionality plays an important role in applying these criteria.45 With liberalisation and the privatisation of many state functions notions of public services are changing and a wider idea of services (and goods) which should be protected from the full thrust of the market is necessary. 6.

THE PROVISION OF PUBLIC SERVICES BY NON-STATE ACTORS

The provision of public services by non-state actors in the new economy raises many questions. How far, and on what terms can we ask private 44 A

Gagliardi, ‘United States and European Anti-trust Versus State Regulation of the Economy: Is There a Better Test?’ (2000) 25 European Law Review 353. 45 See J Jans, ‘Proportionality Re-visited’ (2000) 27 Legal Issues of European Integration 239.

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companies to provide public services? And, if we do so, should we call them ‘public services’? In addition, what are the principles of competition law to be applied where public services are provided in competitive markets? Governments are increasingly using competitive markets to deliver new kinds of public services, for example, the use of Internet access to connect remote geographical areas or as a means of implementing a regional, social and economic cohesion policy, or as part of an education policy. These developments are complicated by the tendency to link the delivery of services through competitive markets to notions of citizenship and as a medium for delivering social justice. Consumers of public services now have different and higher expectations of services which can be supplied by the market. The response to this dilemma from the European Union has been to use a mixture of regulation and competition tools to protect the provision of sensitive public services in the liberalised sectors. Regulation was initially portrayed as a conduit to facilitate competition. It envisaged that when a competitive market was established, regulation should give way to competition and that the work of the special regulatory bodies could be transferred to general competition principles and authorities. Consequently, in the liberalisation process we see a complementary mixture where competition and regulation tools are used often within the same liberalising directive. One way in which public services have been ring fenced in the new economy is the use of the idea of universal service obligations. Member States are given some flexibility as to how these are to be delivered and how such services are financed. In some sectors, the notion of universal service obligations creates a new dynamic to the traditional delivery of core services.46 Rather than being a temporary idea, universal service obligations have established a permanent place and are an example of the synergy between competition principles and regulation principles in the new economy. What is emerging in the telecommunications sector, the most advanced area of liberalisation in the EU, is that this combination of regulation and competition principles may be needed for a fairly lengthy transition period to accommodate the new market dynamics of the liberalised sectors. Although competition principles are being used—in regulatory form and in the European Courts’ case law—a number of new ideas and concepts are emerging in the principles applicable to the new economy.47 46 For

example, see VV Comandini, ‘The Provision and Funding of Universal Service Obligations in a Liberalised Environment’ and S Rodrigues, ‘The French Postal Sector: Old Missions, New Challenges’ in D Geradin (ed), The Liberalisation of Postal Services in the European Union (The Hague, Kluwer, 2002). 47 See P Larouche, Competition Law and Regulation in European Telecommunications (Oxford, Hart Publishing, 2000); S Baker and J Dodgson, ‘Market Definition in Postal Services’ and J Derenne and C Stockford, ‘Abuse of Market Power in Postal Services: Lessons from the Commission’s Decisional Practice and Court of Justice Case Law’ in Geradin above n 46.


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An example of new competition principles emerging is seen in the Commission Decision in Deutsche Post.48 Litigation against postal service incumbents has taken place at the national level in the absence of the Commission’s reluctance to respond to the complaints from competitors alleging the use of illegal State Aid through cross-subsidisation between universal service obligation finances and liberalised services.49 Deutsche Post has been the focus of long running complaints by UPS alleging the cross-subsidisation of the parcel service by illegal State Aid.50 A landmark in this litigation is a decision adopted by the Commission in March 2001 against the German incumbent Deutsche Post. UPS, like a number of American companies engaging in competition litigation in Europe, tried to import an American law remedy of divestiture to break up the Deutsche Post monopoly in order to split the market activities of Deutsche Post from the universal service obligation. Such a remedy does not exist as such in EU competition law. The Commission has power to adopt Directives under Article 86 (3) EC and these could be used in a normative way against a Member State. Under the general competition rules, the Commission can merely issue cease and desist orders and fine companies breaking the competition law rules, but cannot order divestiture. UPS’s complaint was that while it held a substantial share in ‘BusinessBusiness’ parcels market, it alleged that it was unable to carry over this success to the ‘mail order parcel services’ market because Deutsche Poste was using cross-subsidies from profitable letter mail where it held the monopoly to supply the universal service. UPS argued successfully that Deutsche Poste was using the cross-subsidy to finance a strategy of below cost selling in business parcel services which had been opened up to competition: a form of predatory pricing. The decision is significant since it breaks new ground. The Commission established that the use of a cross-subsidy which results in a pricing strategy that does not cover the additional or incremental costs of branching out into the commercial sector of parcels delivery is a form of predatory pricing which it calls the ‘economic costs concept’. Without the cross-subsidy

48 Commission

Decision 2001/354/EC of 20 March 2001, [2001] OJ L/125/27. See also Commission Decision 2002/180/EC Hays/La Poste [2002] OJ L/61/32. Here the Commission found that the French incumbent in breach of Art 82 EC where the reserved sector (uso) used persuasive methods to force business-to-business customers for Hays’ DX service to change to La Poste’s DX service by threatening to withdraw preferential postal rates offered to such customers in the separate (reserved) business-to-consumer postal market. 49 See generally Geradin above n 46. 50 UPS has also brought a complaint against the Commission for failure to act: Case T–175/99 UPS Europe v Commission [2002] ECR II–1915; Case T–253/01 pending. The crosssubsidisation of the parcels’ sector through uso resources was tackled as a State Aid by the Commission in June 2002. The original complaint by UPS was made in 1994. See Press Release IP/02/890 ‘Deutsche Post must repay Euro 572 million used to subsidise price undercutting in commercial parcel services’, 19 June 2002.

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Deutsche Post would not have been able to stay in business for long by charging such low prices. Deutsche Post was not fined for this abuse, however, as the Commission admitted that the new test of ‘economic cost concepts’ was not sufficiently developed at the time the abuse occurred. But in order to comply with the requirement of transparency in financial arrangements and also to give legal certainty to competitors in the parcel delivery market Deutsche Post agreed to a restructuring plan which created a new separate company to supply business parcels services. The new company could use the Deutsche Post infrastructure—sorting, delivery, transport services—but must pay for services at market prices.51 The ripple effect of this decision spread across the Atlantic since it also allowed UPS to ask for the revocation of a foreign air freight forwarder licence which had been granted to DHL World Wide Express, which is owned and controlled by Deutsche Post, and which would have allowed DHL to establish an inter-state package delivery service in the US in competition with UPS.52 A.

Economic Regulation

The analytical framework which evolved is one described in a recent speech by Commissioner Monti as one of ‘economic regulation’.53 Economic regulation is based on the perspective that intervention in the market is necessary and beneficial only when it addresses certain kinds of market power and, in particular, market failures which derive from formerly monopolistic market structures. But Commissioner Monti also reveals that the Commission is aiming towards the elimination of sector-specific regulation the same set of tools, the same competition-based philosophy and the same concerns may soon govern regulatory intervention in all sectors where some form of economic regulation can still be useful. 51 Note

also the application of Case 85/76 Hoffman La Roche v Commission [1979] ECR 461 to fidelity rebates used by Deutsche Post: the rebates were not quantity rebates which are acceptable as part of a normal commercial strategy—but fidelity rebates. These foreclose markets are a disincentive for the customer to ‘shop around’ for better service. 52 Press Release, 20 March 2001: ‘EC Ruling Results in Deutsche Post Restructuring and Fine; UPS calls on DoT to Revoke D.P/DHL Licence’ available at: ⬍http://www.pressroom.ups.com/ pressreleases/archives/archive/0,1363,3862,00.html⬎ (visited 4 June 2002). The language of the press release issued by UPS makes interesting analysis. Nowhere is UPS’ commercial interest mentioned. Appeals are made as to why the Commission’s Decision is for the good for the competitive market—the neutrality of the market—but what is also interesting is that UPS thanks EC Commissioner Monti, describing Deutsche Post purely in terms of a commercial company, while UPS takes it upon itself to explain why the Commission’s action is for the good of America. 53 ‘Competition and Regulation in the New Framework’ Public Workshop on The ‘Electronic Communications Consultation Mechanism’ provided for by Art 7 of the Framework Directive 2002/21/EC, Brussels, 15 July 2003. Available at: ⬍http://europa.eu.int/comm/competition/ index_en.html⬎ (visited 4 June 2002).

Public Services in the New Economy B.

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Market Power and Special Responsibility

An example of the synergy between competition law and regulation is seen in the way the Court handled demands for an ‘essential facilities’ doctrine to be imposed under general competition policy. The Court has been responsive to regulating companies with dominant positions which have power to influence the market. In Michelin the Court signalled that private firms who acquire market power are regarded as having a ‘special responsibility’ which forbids the firm from abusing a dominant position.54 This led Amato to comment: Market power, just because it is conceptually accepted, is thus loaded with the burdens and limits which, according to the general principles more of public than of private law, bear upon whoever holds power.55

If we examine how the Court has held back from applying an essential facilities doctrine in mainstream competition law we see the Court does not necessarily view competitiomn law as the vehicle for steering the market in ways which would impose new obligations upon dominant firms or interfere with vested property rights of dominant firms. An essential facilities doctrine would be useful in monopoly situations where utilities are delivered through networks or grids. The questioning of natural monopolies has led to the understanding that even where a grid or network is an efficient way of delivering essential services, such services do not necessarily have to be provided by a monopolist. There can be a competitive market in delivering different goods and services and even competition in different parts of the network. The Commission imported the idea of an essential facilities doctrine in a decision of 1993.56 The Commission deemed Holyhead port in North Wales to be an essential facility. Holyhead was owned by Sealink which was also the main ferry operator from Holyhead to Dublin. The decision obliged Sealink to make the port available to Sea Containers, a rival ferry operator who had argued that there were no effective substitutes to create a competitive market for ferry services to Dublin. The Commission accepted that an alternative service leaving from Liverpool was not an effective substitute since it would be a much longer sea journey. Here the Commission was looking for a flexible idea of essential services since the

54 Case 322/81 Nederlandsche Banden-Industrie Michelin v Commission [1985] ECR 3461. 55 G Amato, Antitrust and the Bounds of Power (Oxford, Hart Publishing, 1997) 66. 56 Commission Decision 94/19/EC of 21 December 1993 relating to a proceeding pursuant to

Art 86 of the EC Treaty (Sea Containers/Stena Link—interim measures) [1994] OJ L/15/8. The Commission also used the essential facilities doctrine in an Art 86(3) EC Decision, Port of Rødby [1994] OJ L/55/52.

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implication of the decision is not that it was physically impossible for competitors to replicate the essential facility, but rather it was commercially unattractive to do so. The Court has not been receptive to the essential services doctrine. In Bronner57 a publisher of a daily newspaper in Germany argued that Mediaprint, another publisher of daily newspapers which had a market share of 45 per cent, was in a dominant position and abused that dominant position by refusing Bronner access to its national home delivery service. Bronner’s sales were too small to justify investing in its own national delivery service and other alternatives (for example, the post or newspaper retail outlets) were inferior. Advocate-General Jacobs and the Court rejected this attempt to muscle in on a competitor’s success at creating an efficient, vertically integrated distribution system for its products. AG Jacobs pointed out that while granting access to the delivery system might increase competition in the short term there would not be long-term gains: there would be no incentive for a competitor to create alternative facilities and no incentive for successful dominant undertakings to invest in efficient facilities if they had to share them with competitors. The Advocate-General therefore saw essential facilities as a last resort: to be used only where all hope of normal competition had been abandoned. Otherwise, this would lead the Courts down the road of detailed regulation involving the fixing of prices, and conditions of supply to large sectors of the economy. He argued that this was unworkable, anticompetitive and scarcely compatible with a free market economy.58 The outcome of Bronner is not surprising. Courts do not like to be conscripted to serve as de facto regulatory bodies. But second, there is an underlying premise of competition law that liability rules and remedies should share a common logic. Determining a ‘just’ price for access to an essential facility is essentially an economic decision: the setting of too high a price would not be of benefit for would be competitors, the setting of too low a price for access would tip European competition laws into punitive rather than civil sanctions. We can compare Bronner with the different approach taken where there is regulation of a liberalised sector. The ruling in Telefónica de España SA v Administración General del Estado59 is an example of the synergy 57 Case C–7/97 Oscar Bronner GmbH & Co KG v Mediaprint Zeitungs-und Zeitschriftenverlag GmbH & Co KG and others [1998] ECR I–7791. See also the CFI ruling in Joined Cases T–374/94, 375/94, 384/94 and 388/94 European Night Services v Commission [1988] ECR II–3146. Cf Case T–139/98 AAMS v Commission [2001] ECR II–3413 Case C–258/98 Re Carra [2000] ECR I–4217; Commission Decision 2002/344/EC La Poste/SNELPD [2002] OJ L/120/19. 58 The Court will be given the opportunity to revisit the essential services doctrine in the pending IMS Health Inc case: COMP D3/38.044 NDC Health/IMS Health; Case C–481/01P NDC Health Corp & NDC Health v IMS Health Inc & Commission, order of 11 April 2002. 59 Case C–79/00 [2001] ECR I–10075.


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between competition and regulation which provides the key to understanding how public services are to be provided by private actors in the market. Here a company authorised to provide telecommunications services challenged the way the Spanish regulator had implemented the EU directive on interconnection, one of the universal service obligations in telecommunications liberalisation.60 Spanish law required a telecommunications operator dominant on the public telecommunications network to provide access to the subscriber loop and offer interconnection to local and higher level switching centres. The Spanish government argued that it had the discretion to require interconnection where it considered the market would not be totally competitive and that users’ interests would not be guaranteed where an operator having significant market power could refuse interconnection to certain levels of the network. The contested provisions of the directive are that dominant operators are required to satisfy only a ‘reasonable request for interconnection’.61 Telfonica argued that this transposition of the directive was ultra vires since the directive did not permit the national regulatory authorities to impose, ex ante, on an operator having significant market power, obligations concerning access and interconnection points on the network. The directive merely allowed national regulatory authorities to advocate inclusion of this question in the agreements negotiated between the operators. In other words, the market would determine the conditions governing interconnection The Court’s judgment shows the synergy between competition and regulation in the liberalised markets. In order to reach the directive’s objectives of the provision of a universal service in an environment of open and competitive markets the directive did rely primarily on commercial negotiations between operators providing telecommunications services. The directive allowed the Member States to limit the freedom of those operators to decide whether to enter into interconnection agreements in order to ensure that the directive’s objectives are reached.

7.

CONCLUSION

Public services are changing dramatically in their function, form and delivery in the new economy. Part of this dynamic change can be attributed to the fact that public services are being delivered in competitive markets. This essay argues that a major task in deciding how public services are to survive

60 Dir

97/33/EC of the European Parliament and of the Council of 30 June 1997 on interconnection in telecommunications with regard to ensuring universal service and interoperability through application of the principles of Open Network Provision (ONP) [1997] OJ L/199/32. 61 Art 4(2) of Dir 97/33.

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in competitive markets begins with a need to understand and clarify where the boundaries end for the state to claim total immunity from market and where the market rules begin. The essay argues that under the existing legal tools inserted in the original 1957 Treaty of Rome, the Court has been unable to offer either clarity or consistency in addressing this question. The use of ad hoc litigation is not a coherent method of addressing the complexity of the issue. The process of liberalization is leading to greater discussion, transparency and understanding of how public services should work in competitive markets and some clarity in definitions is offered by the use of soft law communications. There is less emphasis upon how the transition from national concepts of public services to European marketoriented processes should be facilitated. Since the insertion of Article 16 EC the EU has signalled a greater respect for the role of public services but has not provided the legal base from which a positive set of EU values in relation to public services can be established in legislative form.62 By putting so many questions out to consultation, the Commission’s Green Paper reveals an attempt to focus the modernisation of the regulation of public services upon a holistic approach. This may bind the hitherto fragmentary discussion of the role of public services, which is the legacy of the litigation approach of the 1990s.

62 Cf

Art 36 of the Charter of Fundamental Rights of the European Union. This is another route for securing the role of public services in the EU. This route is limited. Currently the charter has not been integrated into the treaties and has not been used by the European Court, despite a number of references to the charter in Opinions of Advocate-Generals. Art 36 is limited in scope since it does not grant a right to services of general interest and does not guarantee access to such services to everyone in the EU.

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