Intellectual Property

The recent decision of the United States Supreme Court (USSC) in Kimble v. Marvel Entertainment LLC (Kimble) highlights how a lack of knowledge of the law governing the intellectual property that is the subject of a transaction or litigation settlement can have serious consequences.
Kimble confirmed that an obligation to pay post-patent royalties relating to a patented invention is prohibited in the United States. This bulletin discusses the decision and how the result would likely have differed under Canadian law.
What makes this case of particular interest is that the parties acknowledged that the dispute arose because, at the time of the transaction, neither party (nor presumably respective counsel) was aware of the USSC decision in Brulotte v. Thys Co. (Brulotte) that has been fundamental to U.S. patent law since 1964. In Brulotte, the USSC held that a patentee may not continue to receive royalties for sales by a licensee of a patented invention after the patent expires.
In the context of a settlement, Marvel Entertainment (Marvel) purchased Stephen Kimble’s patent for a toy in exchange for a lump sum plus a royalty on future sales. The agreement did not provide an end date for royalties. As the minority said:
“No one disputes that, when ‘negotiating the settlement, neither side was aware of Brulotte.’ … [T]he parties agreed that Marvel would pay 3% in royalties on all of its future sales. If the parties had been aware of Brulotte, they might have agreed to higher payments during the patent term. Instead, both sides expected the royalty payments to continue until Marvel stopped selling toys that fit the terms of the agreement. But that is not what happened.”
As the patent was about to expire, Marvel “discovered” Brulotte and sought a declaratory judgment confirming that it could stop paying royalties to Kimble. The district court granted relief to Marvel and this disposition was affirmed on appeal.
On further appeal, in a 6-3 decision, the USSC held that the doctrine of stare decisis required adherence to Brulotte and affirmed that Marvel was relieved of its royalty obligation. The majority said that, upon the expiry of a patent, the unrestricted right to exploit the patented invention passes to the public.
The USSC has carefully guarded the significance of the expiration date, declining to enforce laws and contracts that restrict free public access to inventions for which patents have expired. In Brulotte, the USSC held that a post-patent royalty provision was “unlawful per se” because it continued the patent monopoly beyond the patent’s term and thereby conflicted with patent law’s policy of “post-expiration…public domain.”
Kimble argued that the effect of Brulotte is to suppress technological innovation and harm the economy by preventing agreements to commercialize patents. The majority could not assess whether that was accurate but said that Brulotte leaves parties free to enter alternative arrangements that may accomplish the parties’ payment deferral and risk-spreading goals. The majority spelled out a number of approaches which intellectual property transaction counsel regularly use, such as:
  • A licensee may defer payments for pre-expiration exploitation of a patent into the post-expiration period. Brulotte only bars royalties for exploiting an invention after expiration. For example, a licensee could agree to pay the licensor a sum equal to 10 per cent of sales during the 20-year patent term, but to amortize that amount over 40 years. Such an arrangement would reduce costs in the early years.
  • Post-expiration royalties are permitted as long as they relate to a non-patent right, even one closely related to a patent. For example, a licence involving both a patent and a trade secret can set a five per cent royalty during the patent term (as compensation for the two combined) and a four per cent royalty after (as payment for the trade secret alone).
  • Parties have more options when an agreement covers multiple patents because royalties may run until the expiry of the last-to-expire patent covered by the agreement.
  • Brulotte poses no bar to business arrangements other than royalties, such as joint ventures, that enable parties to share the risks and rewards of invention commercialization.
Kimble contended that such alternatives are not enough and asked the court to abandon Brulotte in favour of a flexible, case-by-case analysis of post-expiration royalty clauses “under the rule of reason.” In anti-trust law, the rule of reason requires courts to evaluate a practice’s effect on competition by taking into account a variety of factors, including information specific to the situation. The majority declined to reverse or depart from Brulotte.
The minority dissented because, in its view, Brulotte “was not based on anything that can plausibly be regarded as an interpretation of the terms of the Patent Act,” but instead on a “debunked” economic theory. The minority said that Brulotte interferes with the parties’ ability to negotiate licence agreements that reflect the true value of a patent and disrupts contractual expectations. It stated that stare decisis does not require the retention of a “baseless and damaging precedent.” 
The minority interpreted Brulotte as misperceiving the purpose and effect of post-expiration royalties because it rested on the view that such royalties extend the patent term by means of an anti-competitive tying arrangement. The minority said that, as the Brulotte court understood such an arrangement, the patentee leverages its monopoly power during the patent term to require payments after the term ends, when the invention would otherwise be available for free public use.
The minority reasoned that agreements to pay licensing fees after a patent expires do not extend the patent monopoly. Rather, once a patent expires, and all that is left “is a problem about optimal contract design.” 
The minority determined that there are good reasons why parties sometimes prefer post-expiration royalties, and why such arrangements have pro-competitive effects. When patentees and licensees are unsure whether a patented invention will yield significant economic value or it will take years to monetize an innovation, an agreement that requires royalties after patent expiry may be economically efficient.
Post-expiry royalties encourage innovators such as universities, hospitals and other institutions to invest in research for products that may not be commercialized for many years and encourage businesses to develop more products by spreading licensing fees over longer periods. By prohibiting these arrangements, Brulotte erects an obstacle to efficient patent use.
The minority argued that the majority downplays this harm by insisting that parties can often find ways around Brulotte. The minority said that the need to avoid Brulotte is an economic inefficiency in itself because the suggested alternatives do not provide the same benefits as post-expiration royalty agreements.
The minority noted that Brulotte “most often functions to upset the parties’ expectations,” and said that the majority’s suggestion that some parties rely on Brulotte is “fanciful.” “Parties are not always aware of the prohibition — as this case amply demonstrates.” When Marvel discovered Brulotte, it used the decision to nullify a key part of the agreement and “shattered” the parties’ contractual expectations.
Had this issue been litigated in Canada, the result would likely have been different. Although there is not much case law on this issue, in Culzean Inventions Ltd. v. Midwestern Broom Company Ltd. (Culzean), a post-expiration royalty obligation for the licence of a patented invention was held to survive expiry of the patent.
The court said that, in the absence of an express provision, a licence continues until the expiration of the term of a patent, but not beyond. However, an express stipulation in the contract as to the duration of the licence, even beyond expiry of the patent, controls.
In Culzean, the royalty obligation extended for “the term of the agreement” and expiry of the patent was not a basis for termination. There was no evidence that the licence agreement at issue was in restraint of trade, unreasonable, unconscionable or, in any way, contrary to public interest. The court held that the obligation to pay royalties arises by virtue of the agreement, not the patent, and may extend beyond expiry of the patent.
Although Kimble was not an antitrust case, the USSC’s opinions employed commonly understood competition law principles and the question is open as to whether competition law would be capable of achieving the same result as in Kimble. In Canada, there are no competition law cases that address the subject, but the Competition Bureau has published its Intellectual Property Enforcement Guidelines and other guidance documents. None of these documents address the specific matter at issue in Kimble, but they are generally concerned with agreements among competitors or potential competitors and anti-competitive conduct by businesses with dominant positions that have the effect of preventing or lessening competition substantially in a market. 
Where the parties to an agreement that provides for post-patent royalties are actual or potential competitors in a market, or one party to the agreement is dominant in the market and engaged in an anti-competitive act, as in any other situation where such an agreement prevents or lessens, or is likely to prevent or lessen competition substantially in that market, the Competition Bureau may seek to review the agreement and potentially seek to make an order to prohibit or modify activity under the agreement.
Those who are involved in litigation settlements or transactions that transfer intellectual property rights should have, or be assisted by someone with, knowledge of the law regarding the underlying intellectual property rights. In the context of an agreement covering multi-jurisdictional rights in the U.S. and Canada, they must be aware that the law in Canada is not always the same as in the U.S.
For further information, please contact:
Sheldon Burshtein   416-863-2934
or any other member of our Intellectual Property group.
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Tags: Corporate & Commercial, Information Technology, Intellectual Property, Litigation & Dispute Resolution, United States

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