In January the Government released an important discussion paper, Review of Section 36 of the Commerce Act and other matters, on which submissions are due by 1 April.

The rather bland title is prone to mislead. It diverts attention from the very significant proposed reform to remove from the Commerce Act all current exceptions relating to intellectual property rights.

The reform of s 36 of the Commerce Act dealing with misuse of market power has been well signalled. It was the subject of an issues paper released by the Government in November 2015 (See Land, “Reform of misuse of market power law. Is it time for an ‘effects’ test’?” LawTalk 880, 29 January 2016, 38-39). In Australia, misuse of market power law has already been reformed to provide for an effects test. A similar change in New Zealand is overdue given the difficulties in enforcing the current form of s 36.

However, the proposal to remove the intellectual property exceptions was not the subject of prior reform papers in New Zealand. The Minister of Commerce and Consumer Affairs in his cabinet paper made available with the release of the discussion paper, surprisingly says “I am not expecting the issues of the IP provisions … to be particularly controversial.” In my view, they should be.

Given the potential impact on intellectual property rights the proposal needs real scrutiny. The removal of the intellectual property exceptions could have quite significant implications when combined with recent changes to the Commerce Act (namely the increased scope of cartel conduct under s 30) and the proposed changes to misuse of market power law in s 36. To give one important example, the refusal to license patents will under the proposed reforms have a high risk of breaching competition law where the patent holder has a substantial degree of power in a market.

The misuse of market power reform

The proposed reform of s 36 would prohibit conduct by a firm with substantial market power which has the purpose, effect or likely effect of substantially lessening power in a market. That is essentially the same test as was recently adopted by Australia in s 46 of the Competition and Consumer Act 2010.

Such a test will mean that dominant firms would have to be much more careful in engaging in conduct which might have an effect on competitors.

Unlike a number of other jurisdictions, New Zealand competition law currently does not prohibit dominant firms from engaging in conduct with an anti-competitive effect. Instead, what s 36 of the Commerce Act prohibits is conduct with certain anti-competitive purposes.

The current prohibition in s 36 has three limbs or elements.

First, a firm must have a substantial degree of power in a market.

Secondly, the firm must “take advantage” of that market power. The courts have interpreted the take advantage element as requiring the firm to be engaging in conduct that it would not engage in if the firm was in a competitive market (Commerce Commission v Telecom (2008) 12 TCLR 168 at [55]). This test has also been called the “counterfactual” test.

Thirdly, the firm must engage in the conduct for one of three proscribed anti-competitive purposes. The proscribed purposes are:

• to deter the entry of a person into a market;
• to prevent or deter a person from engaging in competitive conduct; or
• to eliminate a person from a market.

It has been the application of the counterfactual test in the second limb that has been the subject of most criticism. The counterfactual test requires a firm’s conduct to be assessed against a hypothetical scenario which has no basis in reality, ie, a hypothetical market in which the firm’s existing market power is assumed not to exist. In deciding whether a firm has “taken advantage” of market power it is necessary to consider what the firm would have done in that hypothetical market. For example, in the Telecom case it was necessary to consider what Telecom would have done in a hypothetical market in which there was another provider of a public switched telephone network (PTSN) competing with Telecom’s own PTSN network.

Such counterfactual analysis can be quite complex. Further, it is not particularly helpful in assessing whether there is a real harm to competition in the market as a result of conduct. Conduct that is quite benign when engaged in a competitive market can have quite serious anti-competitive effects when engaged in by a firm with substantial market power.

The Government proposal for misuse of market power law has two key aspects designed to address the flaws in the current law.

First, the current requirement to prove that a firm has “taken advantage” of its market power will be removed. That in turn means the end of the counterfactual test.

Secondly, the current focus on whether a firm has a purpose of restricting, deterring or eliminating a particular competitor will be replaced with a test that considers whether there is a purpose or effect of substantially lessening competition in the market as a whole.

That substantial lessening of competition test is already used (in s 27) to assess whether contracts arrangements and understandings are anti-competitive. A test based on whether there is an effect or likely effect of substantially lessening competition is also used (in s 47) for assessment of whether business acquisitions are anti-competitive.

The new effects based test for s 36 will be accompanied by a new ability for firms with market power to seek authorisation for their conduct where they can satisfy the Commerce Commission that the conduct would result in public benefits that outweigh the potential harm to competition. At the moment, it is only possible to seek authorisation on public benefit grounds for anti-competitive agreements or arrangements, not for unilateral conduct that might breach s 36.

I agree that s 36 needs reform and that adopting a similar effects-based test for s 36 to that used in Australia is appropriate.

Removal of the IP exceptions

However, the proposal in the discussion paper to remove the intellectual property exceptions in the Commerce Act needs careful consideration. The discussion paper refers to three current provisions affecting intellectual property rights (ss 45, 36(3) and 7(2)) and recommends the repeal of each of them.

Section 45 is an exception that is relevant to the prohibition in s 27 on arrangements that substantially lessen competition and the prohibition in s 30 on cartel provisions (provisions between competitors that fix prices, allocate markets or restrict supply). Section 45 exempts arrangements in so far as they contain a provision authorising any act that would otherwise be prohibited by reason of the existence of a statutory intellectual property right.

The scope of s 45 is probably quite limited. However, granting a licence to use and exploit intellectual property will not, by itself, amount to a breach of s 27 or 30. So, for example, providing a competitor with a licence to use intellectual property in just one geographic section of the market should not amount to market allocation in breach of the recently expanded definition of cartel conduct in s 30.

Section 36(3) is an exception that is relevant to the current prohibition on misuse of market power. It states that a person does not take advantage of a substantial degree of power in a market (within the prohibition in s 36) by reason only that the person seeks to enforce a statutory intellectual property right. I will discuss the implications of removing this provision below.

Finally, s 7(2) provides that the Commerce Act does not limit or affect any rule of law relating to breaches of confidence.

The discussion paper proposes the repeal of all of these provisions. There is very little case law interpreting the provisions and their scope is not entirely clear. That does not mean, however, that the repeal of the provisions would not be important.

Enforcing patent rights as a misuse of market power

One important example of a situation affected by the removal of the IP exceptions concerns the enforcement of intellectual property rights currently protected by s 36(3). This example takes on more importance given the proposed reform of s 36 to include an effects test and to remove the current counterfactual test.

Let us say that a firm with market power seeks to enforce its intellectual property rights by bringing patent proceedings against its only competitor. Under the current law there would be no breach of s 36 due to a combination of the application of the counterfactual test and the exception in s 36(3).

For a firm to be taking advantage of market power it must (under the counterfactual test) be engaging in conduct that it would not engage in if it was in a competitive market. That then means that an enforcement of IP rights is unlikely to be considered a taking advantage of market power under the current law because a firm with IP rights will normally want to enforce those rights regardless of whether it has market power. The exception in s 36(3) puts the point beyond all doubt.

In the context of the proposed new effects test for s 36, however, the absence of an exception that protects the enforcement of IP rights is much more important. The action of enforcing the patent might be argued to have the likely effect of substantially lessening competition in the market under the new effects test proposed for s 36. (Enforcing common law rights in relation to breaches of confidence might potentially give rise to similar concerns in the absence of the savings provision in s 7(2).)

The position is similar in relation to a refusal by a firm with market power to license a patent. Such conduct is unlikely to be a breach of the current form of s 36 (see for example APRA v Ceridale (1990) 97 ALR 497). However, it could be a potential breach of the proposed new form of s 36. The new form of s 36 does not include a counterfactual test and can be contravened by an effect on competition rather than just purpose. Accordingly, a firm with market power that refuses to license its patents could potentially achieve an outcome that has the effect of substantially lessening competition in the market and thereby breach s 36. (Lai, “Competition Law and/ versus Patent Law in New Zealand” (2017) 23 NZBLQ 112 at 124)

There are conflicting views as to whether refusing to license a patent amounts to enforcement of intellectual property rights within the current s 36(3) exception. I agree with the view of Douglas Calhoun and Brendan Brown (now Brown J) that the exception currently does apply to a refusal to license patents (Calhoun and Brown, “New Zealand: Interface between Misuse of Dominant Position and the Exercise of IP Rights” (1990) 12(2) EIPR 437 at 442). If the exception is removed the risk that a refusal to license patents could breach s 36 increases significantly.

It is fair to acknowledge that in Europe the refusal to license intellectual property has been held to be an abuse of dominance in exceptional circumstances (see O’Donoghue and Padilla, The Law and Economics of Article 102 TFEU, 2nd ed, 2013 at pp 530-537 and particularly the Magill and IMS Health cases referred to there). However, the combination of the proposed repeal of s 36(3) and the introduction of an effects test for s 36, runs the risk that a refusal to license IP can amount to a breach of s 36 in more than just exceptional circumstances.

Further review needed

In my view, the repeal of the three IP provisions in the Commerce Act deserves further careful consideration. For example, does removal of the exceptions in ss 36(3) and 45 undesirably decrease the incentive to invent by placing restrictions on patent holders’ ability to grant licences for particular geographic areas and/ or restrictions on patent holders’ ability to refuse to license patents? Further, does removal of the savings provision in s 7(2), combined with the proposed changes to s 36, unfairly restrict firms from being able to protect confidential information?

Practitioners with an interest should consider making submissions by the deadline date of 1 April 2019.

John Land is a senior competition law specialist and commercial litigator at Bankside Chambers in Auckland. Formerly a partner of Kensington Swan for 20 years, he can be contacted on 09 379 1513 or at john.land@bankside.co.nz.