Archives for May 2009

Promises Not to Challenge the Validity of a Patent after MedImmune: Are they Enforceable?

In MedImmune, Inc. v. Genentech, Inc., 549 U.S. 118, 127 S. Ct. 764 (2007), the Supreme Court held that a licensee had standing to challenge the validity of the licensed patent, despite the licensee’s failure to breach the agreement by refusing to pay royalties.  In the wake of this opinion, there was much debate about the effect that it would have in future cases.  For example, many observers predicted that there would be a wave of licensees rushing to the courthouse to file declaratory judgment actions to challenge the validity of the underlying patents, while incurring no risks because they continued to comply with their contractual obligations.  Patent licensors expressed concern over the possibility that licensees would now seek to “have their cake and eat it, too.”

Contrary to the speculation immediately after MedImmune was decided, there has been no wave of DJ actions filed by licensees trying to challenge patent validity while continuing to pay royalties.  In fact, there appear to have been very few actions filed by licensees at all.

The primary reason for this lack of activity is likely that patent litigation remains expensive, and licensees and licensors alike prefer to avoid the expense and uncertainty inherent in patent litigation if possible.  While MedImmune made it clear that a licensee need not repudiate the license agreement prior to challenging the validity of a patent in a declaratory judgment action, the Court did not eliminate any of the confusion surrounding the status of the doctrine of licensee estoppel.

Consequently, while there is no question that a licensee can now sue without repudiating the agreement, questions regarding whether certain contractual provisions designed to deter a licensee from challenging the validity of a patent are enforceable remain open.  Provisions such as increased royalty rates or the option of termination by the licensor in the event of a challenge by the licensee or other punitive measures may deter licensees from even considering filing suit in the first place.  Moreover, even if a licensee believed that these provisions in the contract would not be enforced, there still remains the question whether the licensee will prevail on an invalidity challenge, one that does not have an obvious answer in the vast majority of cases.  In cases where the licensee is convinced that there is a high likelihood of invalidating the patent, it may be more likely that the licensee would choose to stop paying royalties.

To understand what the state of the law is and whether punitive provisions for challenging the validity of a patent  would be enforced, the MedImmune decision should be considered in light of Lear v. Adkins and its progeny.  The holding of MedImmune was limited to the determination of whether a justiciable controversy exists in a declaratory judgment action by a licensee that had not repudiated the license agreement.  See MedImmune, Inc. v. Genentech, Inc., 549 U.S. 118, 135-36 (2007).

Although the Court could have addressed the confusion spawned by its 1969 Lear v. Adkins decision, it did not, instead choosing to focus on whether the district court had declaratory judgment jurisdiction:   “We express no opinion on whether a nonrepudiating licensee is similarly relieved of its contract obligation during a successful challenge to a patent’s validity–that is, on the applicability of licensee estoppel under these circumstances.”  Id. at 124.

Prior to the Supreme Court’s decision in Lear, the doctrine of licensee estoppel prevented a licensee from challenging the validity of the licensed patent.  Lear v. Adkins, 395 U.S. 653, 656 (1969).  The rationale behind the doctrine is that a licensee should not be permitted to enjoy the benefits of the license agreement only to argue later that the patent that forms the basis of the agreement is void.  Id.

In Lear, the Court held that a licensee who had repudiated the license agreement should not be precluded from challenging the validity of the licensed patent.  Id. at 670-71.  The Court recognized that while it is important that parties be bound by their contracts, the public interest in eliminating invalid patents is paramount.  Id. According to the Court, challenges to invalid patents would be best accomplished by “the only individuals with enough economic incentive” to do so, and therefore, ruled that provisions prohibiting the licensee from challenging the validity of the patent or requiring the licensee to pay royalties during a challenge are unenforceable.  Id. at 670-74.

While Lear has been characterized as the death of licensee estoppel, see, e.g., Diamond Scientific Co. v. Ambico, Inc., 848 F.2d 1220, 1223 (Fed. Cir. 1988), the effect of the decision has been limited in subsequent decisions by lower courts to prevent the inequities that would arise in the event of an unqualified rule allowing the owner of a patent to prevent a challenge to the validity of the patent in every case.  For example, the Federal Circuit has held that the policy of Lear does not apply in the case of an assignment of a patent.  Mentor Graphics Corp. v. Quickturn Design Systems, Inc., 150 F.3d 1374, 1377 (Fed. Cir. 1998); Diamond Scientific Co. v. Ambico, Inc., 848 F.2d 1220, 1224 (Fed. Cir 1988).

Similarly, the policy of providing finality to litigation settlements and consent decrees has won out over the policy of eliminating invalid patents.  See, e.g., Flex-Foot, Inc. v. CRP, Inc., 238 F.3d 1362, 1368 (Fed. Cir. 2001); Diversey Lever, Inc. v. Ecolab, Inc., 191 F.3d 1350, 1352 (Fed. Cir. 1999); Hemstreet v. Spiegel, Inc., 851 F.2d 348, 350 (Fed. Cir. 1988); Foster v. Hallco Mfg. Co., 947 F.2d 469, 483 (Fed. Cir. 1991).

The Federal Circuit has also looked in disfavor on the argument that under Lear a licensee does not owe royalties under the license agreement prior to the date the validity of the patent is challenged even though the patent is declared invalid.  In Shell Oil, the licensee continued to account for royalties under the agreement except with regard to one process of which it never informed the licensor; the court distinguished Lear because the licensee in Lear had stopped the payment of royalties prior to its challenge of the licensed patent and had given notice of the challenge of invalidity.  Studiengesellschaft Kohle m.b.H. v. Shell Oil Co., 112 F.3d 1561, 1568 (Fed. Cir. 1997).  Quoting its Diamond Scientific decision, the court noted that the policy of Lear should be balanced with the equities of the contractual relationship between the parties:

To allow the assignor to make that representation [of the worth of the patent] at the time of the assignment (to his advantage) and later to repudiate it (again to his advantage) could work an injustice against the assignee…. Despite the public policy encouraging people to challenge potentially invalid patents, there are still circumstances in which the equities of the contractual relationships between the parties should deprive one party … of the right to bring that challenge.

Id. at 1567.  Interestingly, in discussing the policy behind the Court’s decision in Lear, the Federal Circuit noted the fears of the Supreme Court were expressed “[i]n tones that echo from a past era of skepticism over intellectual property principles.”  Id. Some would say the same skepticism is apparent in today’s Supreme Court.

In Shell Oil, the Federal Circuit refused to apply Lear because there was no frustration of federal patent policy in enforcing a license agreement to allow the licensor to recover royalties until the date the licensee first challenged the validity of the patent.  Id. The licensee received the benefits of using a licensed process while being insulated from competition, insulated from investigations of infringement, and even insulated from paying royalties until the discovery of the process at issue by the licensor.  Id. The court reasoned that the licensee should be required to pay the back royalties to prevent the injustice of allowing the licensee to exploit the protection of contract and patent rights for a number of years only to later abandon its obligations under those rights.  Id. Thus, a licensee that has not stopped paying royalties has not repudiated the license agreement and is therefore not entitled to invoke the protection of LearId. Consequently, to invoke Lear, a licensee must (1) stop paying royalties under the license agreement and (2) give notice to the licensor of the challenge to the invalidity of the patent.  Id.

Although the Federal Circuit requires a licensee to stop paying royalties under a license agreement before the protection of Lear can be invoked, this rule no longer prevents a licensee from filing a declaratory judgment action to challenge the validity of a patent under the Supreme Court’s decision in MedImmune.  It only prevents the licensee from later claiming that royalties are not due or that royalties must be paid back if in fact the licensee continues to pay royalties while challenging the patent.  Prior to MedImmune, the Federal Circuit had effectively precluded a licensee from challenging the validity of a patent while taking advantage of the protections of the license agreement by holding that there is no case or controversy until the licensee stops paying royalties under the license agreement.  See, e.g., Gen-probe, Inc. v. Vysis, Inc., 359 F.3d 1376, 1381-82 (Fed. Cir. 2004)(holding no Article III standing absent breach).

The question then is whether policy considerations dictate that a promise by the licensee not to challenge the validity of the patent should be enforced when the licensee continues to pay royalties under the agreement while challenging the validity of the patent.  A blanket rule allowing the enforcement of a licensee’s agreement not to challenge the validity of the licensed would be contrary to the public policy of encouraging licensees to challenge invalid patents.  However, failure to enforce such a provision in situations where the licensee has not repudiated the license agreement would allow a licensee to challenge the validity of the patent with impunity while still reaping the benefits of the license during the challenge and after the challenge if unsuccessful.  Enforcement of an agreement not to challenge the validity of the patent should not be an absolute bar to challenging the validity of the patent.  The appropriate policy balance is to allow enforcement of such provisions where the licensee has not repudiated the license agreement.

It should be noted, as discussed above, that the rush to the courthouse by licensees that some predicted after MedImmune has not occurred.  In fact, I have been unable to find a single case after MedImmune of a licensee challenging the validity of a licensed patent while continuing to pay royalties under the license agreement.

The Court’s decision in MedImmune did nothing to ameliorate the uncertainty that exists as a result of Lear and progeny.  Because of the uncertainty that exists in the law at present, licensors and licensees alike cannot be sure whether provisions that seek to prevent a licensee from challenging the validity of a licensed patent will be enforced.  Uncertainty leads to greater costs for both sides, particularly where litigation ensues.  Enforcing a covenant not to challenge the validity of a licensed patent where the licensee has not repudiated the license agreement should be permitted and would not frustrate the policies behind federal patent law.

Indeed, under such a rule, a licensee could still challenge the validity of a patent by discontinuing royalty payments and giving notice to the licensor of the challenge.  The rule would also provide more certainty in the law in that a licensor can be assured that a licensee will not be allowed to take a license only to later challenge the validity of the patent while taking advantage of the benefits of the license agreement.  This will lead to lower costs for the licensee ultimately because presently the licensor must build into the price of the license the possibility that the licensee might challenge the validity of the patent. This is typically accomplished by either requiring a larger up-front royalty payment or a higher ongoing royalty rate.

Moreover, preventing a licensee from challenging the license agreement with impunity will result in challenges to the patent only where the licensee has a good faith basis for doing so.  Most importantly, enforcing agreements not to challenge the validity of the patents where the licensee fails to repudiate the agreement will increase certainty in the negotiation and enforcement of license agreements, something that was requested by the Licensing Executives Society in an amicus brief “In Support of Neither Party” in the appeal of MedImmune to the Supreme Court.  The brief of the Licensing Executives Society requested that the Court ask the Supreme Court for guidance on behalf of licensors and licensees alike and noted:

Licensees and licensors now often do not know prior to entering into a license agreement whether, when, or how licensees will be permitted to challenge patent validity. Similarly, licensees and licensors often do not know to what extent licensors can prevent, hinder, or ameliorate the impact of such validity challenges.

Brief of Licensing Executives Society (U.S.A. & Canada), Inc. as Amici Curiae Supporting Neither Party at 2, MedImmune, Inc. v. Genentech, Inc., 549 U.S. 118 (2007).  Unfortunately, the Supreme Court did not clarify any of the confusion spawned by Lear and progeny.