The Quick Takeaway:
In Ares Trading v. Dyax Corp.,1 the Third Circuit clarified additional scenarios where royalty obligations in patent license agreements that extend beyond the expiration of the licensed patents will not be held unenforceable for patent misuse under the Supreme Court's decisions in Brulotte v. Thys Co.2 and Kimble v. Marvel Entertainment, LLC,3 providing helpful guidance to parties negotiating patent license agreements. In particular, the Court held that royalties that are not calculated based on activities requiring post-expiration use of inventions covered by expired licensed patents are not unenforceable under Brulotte.
The Case Background:
The case involved Ares Trading S.A. ("Ares") and Dyax Corporation ("Dyax") in a dispute over royalty payments related to Ares's cancer drug Bavencio (avelumab), a PD-L1 inhibitor that was granted accelerated approval in 2017 for metastatic Merkel cell carcinoma. Under the terms of the 2006 collaboration and license agreement between the parties (the "CLA"), Dyax identified antibody fragments in its phage library that could bind to the targets provided by Ares. Dyax also licensed certain patents to Ares under the CLA, including some patents owned by Cambridge Antibody Technology relating to phage display technology ("the CAT Patents"), the last of which expired in 2018.
Ares agreed to pay royalties to Dyax calculated based on a percentage of net sales for "Therapeutic Antibody Products," which was defined as any product that "contains, comprises or the process of development or manufacture of which utilizes a Dyax Antibody," which in turn was defined as antibody fragments that Dyax "identifie[d]" using phase display and "deliver[ed]" to Ares.4 Under these definitions, Bavencio qualified as a Therapeutic Antibody Product because Ares developed it from an antibody fragment that Dyax discovered using phage display.
The royalty term provision in the CLA was as follows:
"...on a country-by-country and Product-by-Product basis for a period commencing with the First Commercial Sale in the relevant country and ending ten (10) years after First Commercial Sale; provided, however, in the event that such ten (10) year period for a Product in a particular country ends prior to the expiration of the last CAT Valid Claim in such country, then royalties shall be payable in such country until the expiration of last CAT Valid Claim."5
The Third Circuit noted that the duration of Ares's obligation to Dyax mirrored the duration of the royalty Dyax owed upstream to CAT. Both obligations would be triggered by the same condition – the sale of Bavencio. When Ares sold Bavencio, it owed a percentage of Bavencio's sales to Dyax, and Dyax then owed a portion of the royalty it received from Ares to CAT as part of the 2003 license agreement between CAT and Dyax. As the last CAT Patent expired in 2018 and the first commercial sale of Bavencio occurred in 2017, the two royalty obligations on Bavencio's sales would last until 2027, long after the last CAT Patent's expiration.
Court Analysis on the Application of the Brulotte Rule:
Prior to Ares's appeal, the District Court for the District of Delaware had found that Ares's royalty obligation was not unenforceable under Brulotte because it characterized Ares's royalty obligations as deferred compensation for Dyax's pre-expiration research involving phage display, and in the alternative, not unenforceable under Brulotte because there was one licensed patent in the CLA that would not expire until 2028 (after the royalty term for Bavencio ends in 2027) and under Brulotte, royalties may run until the latest running patent covered in the parties' agreement expired.
The Court of Appeals for the Third Circuit did not comment on the District Court's classification of the royalty obligation as deferred compensation and instead provided that the Brulotte rule simply did not apply to Ares's royalty obligations to Dyax under the CLA. The Court stated that Brulotte was based on federal policy favoring limited durations for patent monopolies. Royalty obligations that conflict with this policy – by restricting a patent licensee's use of inventions after their licensed patents expire – are unenforceable due to "obstacle" preemption. If a royalty obligation is calculated based on activity requiring such post-expiration use, it restricts such use on its face and Brulotte applies.
Brulotte did not apply here, however, as Ares's royalty obligation to Dyax was not calculated based on activity requiring post-expiration use of inventions covered by the CAT Patents. It was calculated based on sales of Therapeutic Antibody Product (i.e., the sale of Bavencio), the definition of which never referred to the CAT Patents, or any of the other definitions that flowed from it. The sale of Bavencio did not depend in any way on the use of the inventions claimed in the CAT Patents, and Ares never practiced the expired CAT Patents to develop Bavencio. Dyax's use of the CAT Patents for the phage display as set forth in the CLA occurred before the expiration of the CAT Patents as well. Thus, Ares's royalty obligation was in no way calculated based on activity requiring any post-expiration use of the CAT Patents and Brulotte was not implicated. Although the Court did not refer to the royalty-bearing product as an "enabled" product (i.e., a product the discovery or development of which is enabled by practicing the licensed patents) or limit its conclusion to such scenarios, the facts, reasoning, and holding of this case further clarify the enforceability of royalties on enabled products, notwithstanding Brulotte and Kimble.
In discussing the scope of post-expiration use, the Court offered the following from Kimble interpreting the Brulotte rule: "A court need only ask whether a licensing agreement provides royalties for post-expiration use of a patent. If not, no problem; if so, no dice."6 The Court then offered three observations about Kimble's definition of Brulotte's rule:
"(i) "post-expiration use" refers to practicing inventions after their patents expire-acts that would have infringed the patents pre-expiration; (ii) to determine whether a royalty is "provided for' post-expiration use, courts must determine whether the royalty is calculated based on activity requiring post-expiration use; and (iii) a royalty may be calculated based on activity requiring post-expiration use even if the royalty's value does not vary with that use."7
Accordingly, the Court held that Brulotte did not apply because Ares's royalty obligation is not calculated based on activity requiring post-expiration use of the CAT Patents. With this holding, the Court rejected a broad interpretation of the Kimble and Brulotte rule, thereby avoiding a ruling that might have cast doubt on the enforceability of a broader universe of private contracts containing royalty clauses.
Implications for License Agreements
The Third Circuit's decision in Ares v. Dyax provides helpful clarification for when Brulotte does not apply to render certain royalties unenforceable. Where a royalty is calculated based on activities that require use of inventions claimed in the licensed patents (e.g., where the manufacture, use, or sale, of a royalty-bearing product is claimed by the licensed patents), then Brulotte applies and therefore upon expiration of the licensed patents either the royalty term must end or, if the underlying agreement is a hybrid agreement involving both patent and non-patent IP, such as know-how, the royalty must decrease, or payments must be structured in some other ways suggested by the Kimble court, or else the post-expiration royalties will be unenforceable. However, where a royalty is not calculated based on activities that require the use of the inventions claimed in the licensed patents, such as royalties on "enabled" products, then the parties are free to agree to any royalty term they wish without fear of it being unenforceable after expiration of the licensed patents.
The Third Circuit's full decision can be found here.
Footnotes
1. Ares Trading S.A. v. Dyax Corp., No. 23-1487 (3d Cir. Aug. 14, 2024).
2. Brulotte v. Thys Co., 379 U.S. 29 (1964).
3. Kimble v. Marvel Entertainment, LLC, 576 U.S. 446 (2015).
4. Ares, No. 23-1487 at 9
5. Ares, No. 23-1487 at 9 - 10.
6. Kimble, 576 U.S. at 458.
7. Ares, No. 23-1487 at 29.
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