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Qualification for the competition is decided by competitor teams placing in their domestic league championship, on a quota system, with countries with stronger domestic league competition allocated more teams. Clubs that play in stronger domestic leagues also enter at later stages of the competition.
For example, the three strongest domestic leagues, as rated by UEFA, place their champions and runners-up directly into the group phase, and their third-and fourth-place teams enter at the third qualifying round.
There is one exception to this rule: the current Champions League titleholder is an automatic qualifier for the group stage, regardless of where it finished in its domestic league.
However, until 2005 if the Champions League winner was from a country that was entitled to send four clubs to the competition, it was not assured of entry unless it was in the top four. This issue came to a head after English club Liverpool won the 2004-05 competition. Liverpool finished fifth in the FA Premier League, one spot outside automatic qualifying position.
After Liverpool won the Champions League, The FA was forced to choose whether to send Liverpool to the 2005-06 competition at the expense of the team that finished fourth - namely Everton, the other major club in Liverpool. As the FA had already decided that the top four Premiership clubs would qualify for the competition despite Liverpool's victory, they decided to continue lobbying for a fifth Champions League place following this win. After this FA decision, UEFA president Lennart Johansson went on record as saying that the Champions League winner should be able to defend its title regardless of its league position. Prior to 2005, if a fourth placed team was denied a Champions League place for this reason, it was granted a place in the UEFA Cup.
The last time such a scenario played out was in 2000, when Real Madrid won the title but finished fifth in the Spanish League. As a result, Real Zaragoza was forced into the UEFA Cup. Two years later, Zaragoza was relegated, an unfortunate turn of events that some fans believed to be a direct result of the lost prestige and revenue.
In June 2005, the UEFA committee met to discuss the fate of Liverpool. Liverpool was awarded a place in the first qualifying round without displacing their arch-rivals Everton - England thus entered 5 teams from the qualifying stages of the competition. Liverpool kept one of the top eight seeds but were not treated as an English side for the purposes of the draw, meaning they could play another English side prior to the quarter-finals. Due to the way in which the seeding works, this means Liverpool could have played city rivals Everton in the third qualifying round.
After qualifying, the Reds were ultimately drawn to play Premiership champions Chelsea in the group phase. Everton failed to qualify because of their loss to Villareal and participated briefly in the UEFA Cup before being knocked out 5-1 on aggregate by Dinamo Bucharest in the very first round.
UEFA also said that the rules have been amended and should the situation arise again, the title holders will replace the 4th placed team in the domestic league (with that team being entered into the UEFA Cup, as happened to Zaragoza in 2000). This ensures that in future, the number of teams from every country will remain stable.