United States: U.S. Supreme Court Upholds Ban On Post-Patent Expiration Royalties

Fifty years ago, in Brulotte v. Thys Co., the U.S. Supreme Court held that "a patentee's use of a royalty agreement that projects beyond the expiration date of the patent is unlawful per se." 379 U.S. 29, 32 (1964). On June 22, 2015, in Kimble v. Marvel Entertainment, LLC (a 6-3 decision), the U.S. Supreme Court upheld the Brulotte rule.

Factual Background in Kimble v. Marvel Entertainment, LLC

Around 1990, Kimble invented a Spider-Man toy that allowed a user to mimic Spider-Man's web-shooting abilities with foam string. Kimble v. Marvel Enters. Inc., 727 F.3d 856, 857-58 (9th Cir. 2013). After filing a patent application on this invention, Kimble met with Marvel's predecessor company to discuss the idea covered by Kimble's pending patent application and other ideas and know-how. According to Kimble, Marvel's predecessor verbally agreed to compensate him if the company used any of his ideas. The company subsequently told Kimble that it was not interested in developing his idea, but later began manufacturing a similar Spider-Man role-playing toy.

In 1997, Kimble sued Marvel for patent infringement and breach of contract. The parties ultimately settled that litigation. The settlement agreement had no expiration date and did not include any specific time limit on Marvel's obligation to pay Kimble three percent of net product sales.

Subsequently, the parties had a number of disagreements about royalty payments. Kimble filed suit for breach of contract, and Marvel counterclaimed seeking a declaration that it was no longer obligated to pay Kimble under the settlement agreement based on sales of products after the expiration of the patent. Applying the Brulotte rule, the district court held that the royalties had to end when the patent expired. Kimble v. Marvel Enters., Inc., 692 F.Supp.2d 1156, 1159-1161 (D. Ariz. 2009).

The Ninth Circuit Court of Appeals affirmed. Kimble, 727 F.3d 856. Because the settlement agreement was limited to a royalty for patent rights alone (it did not, for example, include a discounted rate for the non-patent rights) or otherwise indicate that the royalty was in no way subject to patent leverage, the Ninth Circuit held that no royalties were due under the settlement agreement after the patent expired. Although the Ninth Circuit characterized the Brulotte rule as "counterintuitive" and "its rationale... arguably unconvincing," the court recognized that it was bound by Supreme Court authority.

Supreme Court's Opinion in Kimble v. Marvel Entertainment, LLC

In its June 22, 2015 opinion in Kimble, the U.S. Supreme Court acknowledged that "[a] broad scholarly consensus supports Kimble's view of the competitive effects of post-expiration royalties, and we see no error in that shared analysis." For example, "[a] more extended payment period coupled (as it presumably would be) with a lower rate, may bring the price the patent holder seeks within the range of a cash-strapped licensee." However, the Court indicated that it was bound to adhere to the principles of stare decisis and declined to overrule Brulotte. In doing so, the Court stated that "[r]especting stare decisis means sticking to some wrong decisions." In fact, the Court noted that stare decisis only has consequences when it is used to sustain incorrect decisions; "correct judgments have no need for that principle to prop them up."

According to the majority, stare decisis in this case was "superpowered." First, the majority believed that Brulotte interpreted a statute, 35 U.S.C. § 154. Despite amending patent law several times since Brulotte, Congress has declined to amend that law to reverse Brulotte's effect. In addition, there was a "reasonable possibility" that parties have structured their business transactions based on Brulotte, which lies at the intersection of property and contract rights.

In view of this "superpowered" case of stare decisis, the Court needed a "superspecial justification" to warrant reversing Brulotte, but found none. First, the Court determined that Brulotte's statutory and doctrinal underpinnings remained intact. Section 154 continues to cut off patent rights after a set number of years. And Scott Paper Co. v. Marcalus Mfg. Co., 326 U.S. 249 (1945), which the Court characterized as the decision on which Brulotte primarily relied, remains good law. Second, the Court found that nothing about Brulotte was unworkable. Indeed, the decision "is simplicity itself to apply," since a court need only ask whether the contract requires post-patent expiration royalties.

Although the Court recognized the possibility that the Brulotte rule may hamper competition or technologic innovation, it determined that "[c]ritics of the Brulotte rule must seek relief not from this Court but from Congress."

Writing in dissent, Justice Alito (joined by Chief Justice Roberts and Justice Thomas) countered that Brulotte "was not based on anything that can plausibly be regarded as an interpretation of the terms of the Patent Act. It was based instead on economic theory — and one that has been debunked." According to the dissent, Brulotte also "poses economic barriers that stifle innovation" since deferred royalty agreements can be economically efficient. In addition, Brulotte unsettles contractual expectations where the parties are completely unaware of the ban on post-patent expiration royalties, as Kimble and Marvel were. The dissent characterized Brulotte as an "obvious mistake" that the Court should have corrected.

The dissent also said that Brulotte "does not represent a serious attempt to interpret the Patent Act. The dissent noted that:

"A licensing agreement that provides for the payment of royalties after a patent's term expires does not enlarge the patentee's monopoly or extend the term of the patent. It simply gives the licensor a contractual right. Thus, nothing in the text of the Act even arguably forbids licensing agreements that provide for post-expiration royalties."

From this the dissent concluded that " Brulotte was thus a bald act of policy making."

TheBrulotte Rule Going Forward

In the Kimble opinion, the U.S. Supreme Court provided some guidance regarding licensing arrangements that would be enforceable under Brulotte. As a threshold matter, the Court made clear that "all the decision bars are royalties for using an invention after it has moved into the public domain." In accord with this, the Court confirmed that Brulotte "allows a licensee to defer payments for pre-expiration use of a patent into the post-expiration period...." Thus, "[a] licensee could agree, for example, to pay the licensor a sum equal to 10 percent of sales during the 20-year patent term, but to amortize that amount over 40 years."

The Court also confirmed that a hybrid license covering patent and non-patent rights is enforceable under Brulotte, for example, where that license provides a step-down royalty rate that applies upon patent expiration. As the Court explained, "a license involving both a patent and a trade secret can set a 5 percent royalty during the patent period (as compensation for the two combined) and a 4 percent royalty afterward (as payment for the trade secret alone)." Such post-expiration royalties for a non-patent right are acceptable even where the non-patent right is "closely related to a patent." While using this as an example, the Court did not discuss whether a portion of a royalty that is based explicitly on both patent and non-patent rights ( e.g. know-how) could be enforced at a lower rate based on evidence presented of the value of the non-patent rights relative to the patent rights.

Courts will likely continue to require evidence, such as in the contract itself, that any post-patent expiration royalties are not for use of expired patents, but are instead, for example, for use of non-patent rights ( e.g., know how, trade secrets) or are amortized payments for use of the patented technology during the patent term. Courts will also likely limit the holding of Kimble to its narrow facts, which were that a royalty based exclusively on a patent cannot be extended beyond the expiration of that patent.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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