Grantbacks, Territorial Restraints and the Type of Follow-On Innovation: The 'But for...' Defence

Abstract

We analyse the effect of grant-back clauses in licensing contracts. Because they require the licensee to “give back” further innovation to the licensor without compensation of for a compensation that is not linked to the value of the follow-on innovation, grantback clauses decrease the licensee’s ex post incentives to innovate, which is why competition authorities have expressed some concerns. The usual defence is that grantback clauses are required for the patent-owner to agree to license its technology: since familiarity with the technology increases the licensee’s ability to further innovate and improve on the original technology, the initial patent-holder might prefer not to license in the first place as follow-on innovation might make its own technology obsolete. We examine the validity of this “but for” defence. Under current EU Law, grant-back clauses that apply to “non-severable” (read “infringing”) innovations are considered to be innocuous while clauses that apply to “severable” innovations are much more likely to be frowned upon. We show that the current rule is questionable. In fact, grantback clauses do not increase the patent-holder’s incentives to license when non-severable innovations are at stake but they do when severable innovations are concerned – suggesting that the “but for” defence might be valid for severable innovations but not for non-severable ones. These results are obtained under the assumption that licensing contracts can legally contain territorial restrictions between the market served by the licensor and the market served by the licensee. We revisit the analysis under the alternative assumption that such territorial restraints cannot be enforced. For non-severable innovations, licensing of the basic technology still occurs both with and without a grantback clause. However, the owner of the basic technology is now strictly better off with a grant-back clause, while the licensee is worse off. With severable innovations, licensing can only occur without a grantback clause and provided that barriers to trade are sufficiently high. For parameters such that licensing occurs, the owner of the basic technology would actually strictly prefer not to use a grantback clause in the licensing contract. This further undermines the traditional “but for” defence and suggests a form of complementarity between territorial restraints and grantbacks.

Keywords: licensing, grantback, innovation, competition policy

JEL Classification: K21, L24, O31