United States: U.S. Supreme Court Reaffirms Prohibition On Post-Expiration Patent Royalties, And The Vitality Of Stare Decisis, In The Kimble "Spider-Man" Case

On June 22, 2015, in a 6-3 decision in Kimble et al. v. Marvel Enterprises, LLC, 576 U.S. (2015), the United States Supreme Court reaffirmed its holding in Brulotte v. Thys, 379 U.S. 29 (1964), that it is per se patent misuse for a patentee to charge royalties for the use of its patent after the patent expires.  While acknowledging the weak economic underpinnings of Brulotte, the Court relied heavily on stare decisis and Congressional inaction to overrule Brulotte in also declining to do so itself.  Although Kimble leaves Brulotte intact, the decision restates the rule of that case and provides practical guidance to avoid its prohibition on post-expiration royalties.  Critically, the Court appears to condone the collection of a full royalty for a portfolio of licenses until the last patent in the portfolio expires.  In addition, the Court's reasoning provides guidance as to how patent licensors can draft licenses to isolate the effect of a later finding that patents conveyed under those licenses were previously exhausted.

Brulotte v Thys

In Brulotte, the owner of several patents for hop-picking machines sold the machines for a flat sum and issued licenses that required the payment of royalties after the date that the last patent expired.  The licensees claimed that the arrangement was patent misuse and refused to make royalty payments.  The trial court ruled in favor of the patent holder and the Supreme Court of Washington affirmed.  The U.S. Supreme Court reversed insofar as the judgment allowed royalties which accrued after the last of the patents incorporated into the machines had expired.

The Brulotte Court conducted a straightforward application of patent law.  It noted that patent rights terminate upon the expiration of the patent, but in the contract at issue the royalty payments for the post-expiration period were for product use during the post-expiration period, and did not constitute deferred payments accrued during the pre-expiration period.  Nor were the royalties paid for the use of non-patented articles.  In short, in the Court's view, the licensor was using the licenses impermissibly to achieve the effective extension of its patent rights beyond the patent period.  "[W]e conclude that a patentee's use of a royalty agreement that projects beyond the expiration date of the patent is unlawful per se.  If that device were available to patentees, the free market visualized for the post-expiration period would be subject to monopoly influences that have no proper place there."  Brulotte, 379 U.S. at 33.  Justice Harlan dissented, pointing out that the economic substance of the transaction could be achieved through different contract terms that remained lawful.

The Brulotte decision was met with withering criticism over the years.  Perhaps most succinctly and famously, Judge Richard Posner explained the weak economic underpinnings of the decision as follows:

The Supreme Court's majority opinion reasoned that by extracting a promise to continue paying royalties after expiration of the patent, the patentee extends the patent beyond the term fixed in the patent statute and therefore in violation of the law. That is not true. After the patent expires, anyone can make the patented process or product without being guilty of patent infringement. The patent can no longer be used to exclude anybody from such production. Expiration thus accomplishes what it is supposed to accomplish. For a licensee in accordance with a provision in the license agreement to go on paying royalties after the patent expires does not extend the duration of the patent either technically or practically, because . . . if the licensee agrees to continue paying royalties after the patent expires the royalty rate will be lower. The duration of the patent fixes the limit of the patentee's power to extract royalties; it is a detail whether he extracts them at a higher rate over a shorter period of time or a lower rate over a longer period of time.

Scheiber v. Dolby Labs., Inc., 293 F.3d 1014, 1017 (7th Cir. 2002) (Posner, J.); see also U.S. Dep't of Justice & FTC, Antitrust Enforcement and Intellectual Property Rights: Promoting Innovation and Competition 12, 116–19, 122–23 (2007) (discussing criticisms of Brulotte and suggesting that generally the rule of reason should apply to post-expiration royalties).  Despite consistent criticism of Brulotte, courts felt bound to apply it or found ways to distinguish the cases before them.  See, e.g., Zila, Inc. v. Tinnell, 502 F.3d 1014 (9th Cir. 2007) (applying Brulotte but discussing efforts made to distinguish it in other cases).

Kimble v. Marvel Entertainment

In Kimble, petitioner Stephen Kimble obtained a patent for a toy that enables a child to act like Spider-Man by shooting webs—actually, foam strings—"from the palm of [the] hand."  Slip op. at 1 (citation omitted).  He met with the president of Marvel's corporate predecessor to discuss his patent, and that company then began marketing a similar toy called "Web Blaster."  Kimble sued Marvel in 1997 for, among other things, patent infringement.  The parties later settled:  Marvel would purchase Kimble's patent for a lump sum of approximately $500,000 and a royalty of 3% on future sales.  The parties did not include a termination date for the royalties.  Later, Marvel learned of Brulotte and filed a declaratory relief action seeking a ruling that it need not pay royalties after Kimble's patent expired in 2010.  The district court granted that relief and the Ninth Circuit reluctantly affirmed, noting that "the Brulotte rule is counterintuitive and its rationale is arguably unconvincing."  Kimble, et al. v. Marvel Enterprises, Inc., 727 F.3d 856, 857 (9th Cir. 2013).

Given the widespread criticism of Brulotte, many believed that the Supreme Court agreed to hear Kimble to clean up one of the last remaining areas of per se condemnation in the licensing context, particularly in light of the Court's steady adoption of the rule of reason as the framework for antitrust analysis.  See, e.g., FTC v. Actavis, 570 U.S. __ (2013) (rule of reason applies to pharmaceutical reverse payment settlements); Leegin Creative Leather Prods., Inc. v PSKS, Inc., 551 U.S. 877 (2007) (rule of reason applies to resale price maintenance).  Not so.   The Court declined to overrule Brulotte and, in an extended discussion of stare decisis, instead reaffirmed its per se prohibition on post-expiration royalties.

Justice Kagan's Majority Opinion

Justice Kagan, writing for the majority, began with the principle that a patent holder has the exclusive rights to the patent, including licensing it, for 20 years, but that its right expires when the patent does.  See 35 U.S.C. § 154(a)(2).  In explaining that the Brulotte rule naturally follows from this temporal limit on the exercise of a patent right, the Court acknowledged that the rule "prevents some parties from entering into deals they desire," but analogized this to other rules that make contract provisions unenforceable.  Slip op. at 5.  She noted the extensive criticism of the rule, but in an apparent effort to ameliorate the effects of imposing a per se prohibition on a potentially dubious economic basis then explained that "parties can often find ways around Brulotte, enabling them to achieve those same ends."  Id. at 6.  For example, Brulotte "allows a licensee to defer payments for pre-expiration use of a patent into the post-expiration period"; "parties have still more options when a licensing agreement covers either multiple patents or additional non-patent rights"; "post-expiration royalties are allowable so long as tied to a non-patent right—even when closely related to a patent"; and, perhaps most critically, "[u]nder Brulotte, royalties may run until the latest-running patent covered in the parties' agreement expires."  Id.  And, of course, "Brulotte poses no bar to business arrangements other than royalties—all kinds of joint ventures, for example—that enable parties to share the risks and rewards of commercializing an invention."  Id.

Having clarified Brulotte's limited restriction on the ability of parties to construct the licensing arrangements they desire, Justice Kagan turned to the doctrine of stare decisis as the main ground for declining to overrule Brulotte.  She acknowledged that the economics underlying Brulotte are somewhat of a relic, but emphasized that stare decisis is particularly appropriate when the Court has interpreted a statute and Congress has declined to overrule the decision despite the opportunity to do so, as it has with Brulotte on several occasions.  Id. at 7-9.  In addition, she noted, the doctrine is particularly appropriate in the context presented by this case:  "Brulotte lies at the intersection of two areas of law: property (patents) and contracts (licensing agreements).  And we have often recognized that in just those contexts—'cases involving property and contract rights'—considerations favoring stare decisis are 'at their acme.'"  Id. at 9 (citation omitted).  Nor have there been changed circumstances—another ground on which prior precedent has been abandoned:  "Brulotte's statutory and doctrinal underpinnings have not eroded over time," and "nothing about Brulotte has proved unworkable."  Id. at 10-11.

The Court then disposed of Kimble's main arguments.  Id. at 12-18.  In doing so, it acknowledged that post-expiration royalties can be pro-competitive, that Brulotte may have "relied on an economic misjudgment," and that stare decisis has "less-than-usual force in cases involving the Sherman Act."  Id. at 12-14.  Nonetheless, the Court was not persuaded by any of those points because, it said, Kimble is a patent case, not an antitrust case.  Thus, according to the Court, Congress is the proper forum for efforts to repeal the Brulotte rule.  Id.  In any event, the Court said, Brulotte did not actually turn on an economic misjudgment that post-expiration royalties harm competition.  Id. at 14-15.  Rather, it simply applied "a categorical principle that all benefits, and all benefits from them, must end when their patent terms expire."  Id. at 15.  The Court also rejected Kimble's argument that barring post-expiration royalties harms innovation, largely because of the options for working around the rule noted above.  Id. at 16-18.

Justice Alito's Dissent

Justice Alito, joined by Chief Justice Roberts and Justice Thomas, dissented.  He argued that Brulotte was not based on a serious attempt to interpret the Patent Act, but instead was simply a "bald act of policymaking" and was not "really statutory interpretation at all."  Dissent at 2.  He reiterated the many criticisms of the misunderstood economics underlying Brulotte, explaining that by prohibiting post-expiration royalties the decision "erects an obstacle to efficient patent use."  Id. at 3.  In addition, he argued, the rule frustrates the intention of parties—like Kimble and Marvel, as well as in many other cases—who are unaware of the rule and only come across it after entering into a license agreement.  Id. at 4-5.  Finally, he disagreed with Justice Kagan's analysis and application of stare decisis, arguing that Brulotte is a judge-made rule, not an interpretation of a statute, and that in any event it actually was "an antitrust decision masquerading as a patent case" (and so entitled to less deference under stare decisis)—in fact, the decision expressly characterized post-expiration royalties as anticompetitive tying arrangements, which clearly is an antitrust concept.  Id. at 5-8.

Discussion

Although much can be said regarding the majority opinion's analysis and the dissent's criticism of it, we note the following three important points.

First, although the per se prohibition on post-expiration royalties remains, the Court outlined several mechanisms parties can use to arrange for royalty payments after a patent expires.  The Court seems to have been particularly swayed by the argument that nothing in Brulotte prohibits payments in the post-expiration period for royalties earned during the pre-expiration period.  These sorts of deferred payments can address concerns regarding hefty royalty payments in the pre-expiration period acting as a prohibitive hurdle on the implementation of new technologies.

Second, the Court's decision can be read to allow collection of a full royalty for a portfolio of patents until the last patent in the portfolio expires:  "Under Brulotte, royalties may run until the latest-running patent covered in the parties' agreement expires."  Id. at 6.  This issue has percolated among the circuit courts of appeal for some time and there currently is a split.  Some circuits have held that royalties must decrease as patents expire.1  Other circuits have ruled that when a portfolio license is voluntarily entered into, it is not improper to require payment of an undiminished royalty beyond the expiration of some, but not all, of the licensed patents.2 Although neither Brulotte nor Kimble squarely analyzes the issue in full, Kimble's citation to Brulotte may encourage courts to find that not diminishing royalties as patents in a portfolio expire does not constitute per se patent misuse and, indeed, may be per se legal.

Third, although not discussed in the decision, the majority's reasoning may have important implications in future disputes regarding what effect, if any, a finding of patent exhaustion has on existing licenses for that patent. Under the "first sale" doctrine, the first unrestricted sale by a patent owner of a patented product exhausts the patent owner's control over that particular item.3 Some licensees have argued that a finding of exhaustion may entitle them to stop paying royalties under a patent license, on the basis that the licensee would no longer be liable for infringement.4 But Justice Kagan's majority opinion provides a way around that argument. If a licensor can still collect full royalties after a patent's expiration provided that other non-patent rights are conveyed as part of that license, then there is no reason why that same licensor would not be able to continue collecting full royalties after a finding that the patent has been exhausted by some prior sale. Thus, by including other non-patent rights in drafting licenses, a licensor can point to the Kimble decision as justification that no royalty offset is required in the event that a patent conveyed thereunder is later deemed to be unenforceable due to exhaustion.

Conclusion

The Supreme Court's decision in Kimble settles an issue that has plagued courts for five decades since its ruling in Brulotte—albeit in a way that may be seen as perpetuating an economic mistake. But coupled with the Court's list of alternative approaches to avoid Brulotte's per se rule, the decision may also be seen as minimizing the consequences of the mistake. In any event, the opinion provides patentees, licensees and courts with much needed direction, and that may be most important. As Justice Kagan herself noted, "it is usually 'more important that the applicable rule of law be settled than that it be settled right.'" Slip op. at 7 (quoting Burnet v. Coronado Oil & Gas Co., 285 U. S. 393, 406 (1932) (Brandeis, J., dissenting)). The fact remains, however, that many courts will continue to try to distinguish the cases before them to avoid Brulotte's effects on patentees and licensees who simply were not aware of the rule when they entered into their licenses.

It goes without saying that the Court's decision not to apply the rule of reason to post-expiration royalties marks a significant departure from the trend of U.S. enforcement agencies to apply the rule of reason to IP licensing issues and, more generally, the Court's adoption of the rule of reason for the analysis of most antitrust issues other than some horizontal restraints of trade. There is every reason to believe, however, that Kimble is a one-off decision based on stare decisis and that it will be confined to its facts in light of the Court-endorsed alternatives that diminish the anticompetitive effects of Brulotte's prohibition on post-expiration royalties.

Footnotes

1 E.g., Rocform Corp. v. Acitelli-Standard Concrete Wall, Inc., 367 F.2d 678, 681 (6th Cir. 1966) (a licensing arrangement where one important patent about to expire is grouped with others of longer duration for "leverage" constitutes patent misuse when the contract contains no diminution of the license fee at the expiration of the most important patent); AmericanSecurit Co. v. Shatterproof Glass Corp., 268 F.2d 769, 777 & n.18 (3d Cir. 1959) (provision requiring payment of undiminished royalty rate until last-expiring patent constitutes patent misuse per se).

2 E.g.,Zila, Inc. v. Tinnell, 502 F.3d 1014, 1026 (9th Cir. 2007) (permitting collection of undiminished royalty, so long as one patent in the license remained valid, even if that patent was issued after the license was executed, because the license contemplated the inclusion of subsequently issued patents); Hull v. Brunswick Corp., 704 F.2d 1195, 1202-03 (10th Cir. 1983) (holding that last-to-expire provision did not run afoul of Brulotte where royalties were only payable upon the use of at least one unexpired patent); In re Yarn Processing Patent Validity Litig., 541 F.2d 1127, 1139-40 (5th Cir. 1976); Beckman Instruments, Inc. v. Technical Dev.Corp., 433 F.2d 55, 60-61 (7th Cir. 1970); McCullough Tool Co. v. Well Surveys, Inc., 343 F.2d 381, 409-10 (10th Cir. 1965).

3 Quanta Computer, Inc. v. L.G. Electronics,Inc., 553 U.S. 617, 625 (2008).

4 For example, in MPEG LA, LLC v. Audiovox Electronics Corp., 33 Misc. 3d 802, 823 (N.Y.S. 2011), the court agreed with the licensee that patent exhaustion could be a defense to a claim for breach of contract due to failure to pay royalties, but ruled that the patents at issue were not exhausted.

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