Adjacent to the glorious and delicate stained glass of Sainte-Chapelle stands the magnificent “Palace of Justice,” currently housing the Court of Appeal of Paris.1 The court encountered an enigma involving patent royalties and European competition law. A license agreement licensed three patents. One patent was subsequently revoked. The other two patents were later found not to be infringed by the licensee. Yet, the license agreement imposed an obligation on the licensee to pay running royalties throughout the contractual term. Is the imposition of this obligation permitted under Article 101 of the Treaty on the Func tioning of the European Union?
The Court of Appeal of Paris referred this question to the Court of Justice of the European Union.2 On July 7, 2016, the Court of Justice of the European Union issued a judgment answering the question in the affirmative.3
Analyzing the judgment in comparison with legal precedent in the United States evinces differing judicial approaches to interpreting license agreements and discerning the parties' commercial intent when royalty payments and patent monopoly are at issue. Similar cases in the United States, France, and Japan provide practical guidance concerning the licensees' obligation to pay royalties and whether licensees are entitled to a refund when the licensed patents are ultimately invalidated.
License Agreement, Patents, and the Royalty Clause
On August 6, 1992, Behringwerke AG and Genentech executed a non-exclusive license agreement for a technology using a human cytomegalovirus enhancer.4
The patents licensed under this agreement were (i) European Patent No. EP 0173 177 53,5 (ii) United States Patent No. 5,849,522,6 and (iii) United States Patent No. 6,218,140.7 As consideration for the right to use the technology, the agreement set forth (i) a one-time fee of 20,000 Deutschmarks, (ii) a fixed annual fee of 20,000 Deutschmarks, and (iii) a running royalty equal to 0.5 percent of the net sales of “finished products” sold by Genentech, its affiliates, and sub-licensees.8
Genentech allegedly used the licensed technology to market its pharmaceutical product Rituxan in the United States and the product MabThera in the European Union.9 Genentech paid the one-time fee.10 It also paid the fixed annual fee from 1992 to 2008.11 However, it did not pay the running royalty.12
In 1996, Behringwerke assigned its status as a patentee and licensor to Hoechst AG.13 On January 12, 1999, the European Patent Office revoked European Patent No. EP 0173 177 53.14 On June 30, 2008, Hoechst's subsidiary, Sanofi-Aventis Deutschland GmbH, inquired Genentech about the unpaid running royalty.15
The license agreement provided that “the licensee may terminate this agreement and the licenses granted pursuant hereto by giving Behringwerke two (2) months' notice for that purpose, if the licensee decides to stop using the license rights conferred hereunder.”16 Pursuant to this clause, Genentech informed Sanofi-Aventis Deutschland on August 27, 2008, that Genentech will terminate the license agreement as of October 28, 2008.17
On October 24, 2008, Hoechst initiated arbitration against Genentech before the International Chamber of Commerce.18 Hoechst asserted that Genentech used the licensed technology without paying the running royalties set forth in the license agreement.19
Three days later, Sanofi-Aventis Deutschland sued Genentech in the United States District Court for the Eastern District of Texas, alleging infringement of United States Patent Nos. 5,849,522 and 6,218,140.20 On that same day, Genentech filed an action in the United States District Court for the Northern District of California, seeking a declaratory judgment of non-infringement and invalidity of the patents.21
The District Court for the Northern District of California consolidated these two cases.22 The court found, on March 7, 2011, that Genentech did not infringe the patents.23
On September 5, 2012, the arbitrator determined that Genentech must pay the running royalty to Hoechst for the sales of Rituxan manufactured from the date that the United States Patent No. 5,849,522 was issued24 up to the date on which the license agreement was terminated.25
Articles 1518 and 1520 of the Code of Civil Procedure of France allow a party to bring an action for the annulment of an international arbitral award delivered in France if certain conditions are met.26 On December 10, 2012, Genentech filed an action before the Court of Appeal of Paris, seeking annulment of the arbitrator's decision.27
The license agreement imposed an obligation on Genentech to pay running royalties when, in fact, one of the licensed patents was revoked and the other licensed patents were found not to be infringed. The Court of Appeal of Paris was uncertain whether such an agreement is permissible under Article 101 of the Treaty on the Functioning of the European Union.28
The European Union is based on the Treaty of the European Union and the Treaty on the Functioning of the European Union.29 These treaties are considered to be the “primary law” of the European Union.30 A court of a Member State of the European Union may refer a question to the Court of Justice to clarify an issue concerning the interpretation of European Union law.31 In Genentech v. Hoechst, the Court of Appeal of Paris sought guidance from the Court of Justice of the European Union on the royalty provision's compatibility with Article 101.
The Court of Justice of the European Union interpreted the question as follows: When patents protecting the licensed technology are revoked or are not infringed, and the license agreement requires the licensee to pay royalties throughout the term of the license agreement, should Article 101, Section 1 of the Treaty on the Functioning of the European Union be construed as prohibiting the imposition of this payment obligation?32
Article 101 of the Treaty on the Functioning of the European Union prohibits certain anticompetitive agreements. In particular, Section 1 of Article 101 provides that:
Genentech argued that the arbitrator's decision to require Genentech to pay royalties for selling products that do not infringe the licensed patents contravenes Article 101 because Genentech's competitors who are not bound to the license agreement need not pay these royalties, thereby placing Genentech at a competitive disadvantage.34 Meanwhile, Hoechst argued the link between the arbitral award of royalty payments and the trade between Member States of the European Union was tenuous.35
The Court of Justice of the European Union applied its prior judgment in Ottung.36 The Court in Ottung interpreted Article 85(1) of the Treaty Establishing the European Community,37 which is the predecessor of Article 101(1) of the Treaty on the Functioning of the European Union. According to the Ottung judgment, if the licensee is free to terminate an exclusive license agreement by providing a reasonable notice, it is permissible under the Article to require the licensee to pay royalties throughout the term of the agreement, even after the licensed patents have expired.38
Based on Ottung, the Court concluded that the license agreement in Genentech v. Hoechst does not contravene Article 101(1). The Court stated that, even if the licensed patent has expired, and the patentee cannot enforce its patent rights against the licensee, royalty payments are due as long as two conditions are met.39 First, the license agreement must still be in effect.40 Second, the licensee must be capable of freely terminating the license agreement by giving a reasonable notice.41 The Court observed that the royalty is a price that the licensee pays for commercially exploiting the licensed technology without any apprehension that the licensor will enforce its intellectual property rights against the licensee.42
The legality of a contractual provision for royalty payments was also at issue before the United States Supreme Court in Kimble v. Marvel Entertainment, LLC, 135 S.Ct. 2401 (2015). The Court concluded that compelling payments of royalties for use of the patented technology is unlawful per se if the use occurs after the expiration of the licensed patent. “Per se” means “in itself” or “inherently.”43
Mr. Stephen Kimble obtained U.S. Patent No. 5,072,856 for a toy inspired by Spider-Man.44 The toy is a glove that children can wear and pretend as if they are Spider-Men spinning spider webs from their palms.45 The glove is designed to eject pressurized foam, which looks like spider webs.46 Marvel Entertainment manufactured a similar toy called “Web Blaster,” also inspired by Spider-Man.47
After Mr. Kimble sued Marvel Entertainment, the parties entered into a settlement agreement.48 The agreement provided that Marvel Entertainment would pay Mr. Kimble a three percent royalty on its future sales of “Web Blaster” and other analogous products.49
Marvel Entertainment sought a declaratory judgment that it will not need to pay the royalty once U.S. Patent No. 5,072,856 expires.50 The district court granted the request by following Brulotte v. Thys Co., 379 U.S. 29 (1969).51 Brulotteheld that agreements requiring payments of royalties accruing after all the licensed patents have expired are “unlawful per se” under the patent laws.52 The district court's declaratory judgment in Kimble v. Marvel was affirmed by the United States Court of Appeals for the Ninth Circuit, but with reluctance.53 The Court of Appeals opined that Brulotte's decision is “counterintuitive.”54
The Supreme Court of the United States decided whether or not it should overrule Brulotte. The Supreme Court applied the principle of stare decisis. Stare decisis means that a court will adhere to authoritative precedent concerning the same issue.55 The Supreme Court in Kimble v. Marvel stated that, “[a]s against this superpowered form of stare decisis, we would need a superspecial justification to warrant reversing Brulotte.”56
The Supreme Court concluded that there is no sufficient justification for overruling Brulotte.57 Although Brulotte was decided 52 years ago, the Supreme Court explained that “the core feature of the patent laws on which Brulotte relied remains just the same.”58 Once a patent expires, the invention protected by that patent passes to the public domain.59 Anyone is free to exploit the invention after the patent expires.60 Therefore, “[a]ny attempt to limit a licensee's post-expiration use of the invention”61 “runs counter to the policy and purpose of the patent laws.”62 Hence, under Kimble v. Marvel, a provision in a license agreement that requires the licensee to pay royalties for using the invention after the patent has expired is unenforceable.63
Adherence to precedent played a decisive role in both Genentech v. Hoechst and Kimble v. Marvel. The Court of Justice of the European Union reached its judgment by applying its prior judgment in Ottung. Similarly, the Supreme Court of the United States rendered its decision by following its precedent in Brulotte. Nonetheless, the judgment by the Court of Justice of the European Union differs from the decision by the Supreme Court of the United States in multiple respects.
Genentech argued during arbitration that it did not need to pay running royalties because the contractual terms provided that the royalties are due if Genentech's products infringe an unexpired patent claim.77 Unlike Miotoxv.Allergan, the arbitrator in Genentech v. Hoechst rejected this argument as being a “literal interpretation” of the license agreement.78
An issue concerning royalty obligations and the timing of terminating a license agreement is whether royalty payments may be refunded to the licensee. When a court or a tribunal declares that a licensed patent is invalid or that the licensee does not infringe the patent, the licensee might have already paid running royalties up to the termination of the agreement even though, in retrospect, the patent was invalid or not infringed. If so, are licensees entitled to a refund of the royalties? The answer varies among jurisdictions, for example, the United States, France, and Japan.
In the United States, a licensee is responsible for paying royalties under a license agreement up until the date on which the licensee first challenges the validity of the licensed patent.81 Federal courts in the United States have held that a subsequent invalidation of the licensed patent does not allow the licensees to recover royalties that they previously paid, unless the patent was procured by fraud.82
In St. Regis Paper Co. v. Royal Industries, 552 F.2d 309 (2d Cir. 1977), Mr. Gerald Bower obtained U.S. Patent No. 2,767,113 for a plastic strip that could be used to bundle fresh vegetables.83 Mr. Bower assigned his patent rights to Royal Industries.84 The plastic strip was also suitable for packaging bakery products.85 St. Regis Paper Co., a company supplying wrapping paper to the bakery industry, sought to manufacture and sell the plastic strips.86
On May 1, 1963, Royal Industries and St. Regis Paper Co. entered into a license agreement.87 The agreement required St. Regis Paper Co., the licensee, to pay royalties equal to 10 percent of its sales.88 The licensee paid royalties from 1963 to 1967.89 However, the licensee found evidence suggesting that U.S. Patent No. 2,767,113 was invalid.90 The licensee stopped paying royalties after July 19, 1967.91 On April 24, 1968, the licensee filed a lawsuit, seeking a declaration that the licensed patent is invalid. The licensee also sought recovery of the royalties that it had paid.92
The United States Court of Appeals for the Ninth Circuit held that the licensed patent is invalid for obviousness.93 Yet, the Court of Appeals held that the licensee is not entitled to a refund of the royalties that it paid before challenging the validity of the licensed patent.94 The Court of Appeals' concerns were based on the policies of federal patent law:
The possibility of obtaining a refund of all royalties paid might induce a manufacturer to accept a license based on a patent of doubtful validity, derive the benefits of suppressed competition which the patent affords, and challenge validity only after the patent's expiration. The licensee would have a chance to regain all the royalties paid while having enjoyed the fruits of the license agreement.95
In France, the invalidation of a patent will invalidate a license that is based on the patent.96 Despite the invalidation, royalties which were paid in consideration for the privileges enjoyed by the licensee will not be annulled retroactively.97
For example, in a case ultimately decided by LaCour de Cassation of France,98 the owner of a patent for agricultural technology sued an equipment manufacturer for infringing claim 52 of the patent. A court of ap peal in France found the defendant liable for patent infringement. The parties then entered into a settlement and licensing agreement on February 16, 1990. Under the agreement, the defendant was required to pay damages up to the date of the court's decision on infringement. Furthermore, to enable the defendant to manufacture the equipment in the future, the patentee granted a non-exclusive license to exploit the patent. Defendant agreed to pay royalties.
Approximately five years later, on January 24, 1995, an appeals court in France invalidated claim 52 of the patent for lack of inventiveness. The licensee demanded restitution of the payments made under the agreement.
On December 8, 1999, the Court of Appeal of Paris annulled the agreement of February 16, 1990, upheld the validity of the damages payments, and granted the licensee's request for restitution of the royalty payments made before the patent was held to be invalid. The parties appealed.
On January 28, 2003, LaCour de Cassation of France determined that it was proper to void the license agreement because Article L. 613-27 of the French Intellectual Property Code provides that the decision to invalidate a patent has an absolute effect. La Cour de Cassation also affirmed the Court of Appeal's decision that the payment of damages should remain undisturbed. The Court of Appeal's decision on the restitution of royalty payments, however, was overruled. La Cour de Cassation stated that the invalidation of the patent and the resulting annulment of the contract do not trigger the restitution of the royalties that the licensee paid for the privileges under the contract during the period before the court's judgment declaring the invalidity of the patent. Hence, the licensee was not able to obtain a refund of the royalties.
In Japan, the expiration of a Japanese patent or its invalidation extinguishes the rights granted under a license agreement based on the patent.99 The prevailing view is that when the licensee entered into the license agreement, it assumed the risk that a patent will be invalidated.100 Japanese courts examine if the license agreement explicitly provided whether the licensee is entitled to a refund of royalty payments once the licensed patent is invalidated. Courts also query whether the licensor guaranteed the validity of the patent.
For instance, in a case101 involving Japanese Utility Model No. 909305, the future licensee expressed misgivings about the validity of the utility model. In response the owner of the utility model said, “No problem. Don't worry. We won't cause you any hassle.” The license agreement contained a clause stating that royalties paid by the licensee will not be refunded for any reason. The parties signed the agreement. The licensee paid royalties from October 1974 to June 1976. However, the utility model was invalidated on July 19, 1976, and the invalidation was affirmed on January 24, 1980.
The licensee demanded a refund of the royalty payments pursuant to Article 95 of the Civil Code of Japan. The licensee argued that there was a mistake in the signing of the contract because the licensee had assumed that the utility model would remain valid.
The District Court of Tokyo rejected this argument. The district court noted that the contractual language explicitly denied any entitlement to a refund of the royalties paid by the licensee. The district court also found that the licensee accepted these terms while recognizing a reasonable possibility that the utility model might be invalidated. The district court added that the licensor's oral assurance does not override the contractual agreement that royalties are not refundable.
Scholars in Japan are divided as to whether the licensee is entitled to a refund of the royalties when the contract is silent on the subject.102 The decision of the District Court of Tokyo is viewed as a confirmation that Japanese courts will generally give effect to contractual clauses concerning the licensee's ability to obtain a refund of the royalties.103
Running royalties present multiple levels of intricacies. Principles of patent and antitrust laws are intertwined. Running royalties may be viewed as being premised on the validity of the licensed patents, while they can also be viewed as consideration for the licensee's rights, paid under the assumption that the patents might be invalidated. Case law from various jurisdictions provides clarity to issues involving running royalties. Genentech v. Hoechst indicates that running royalties are due under Article 101(1) of the Treaty on the Functioning of the European Union as long as the license agreement is effective and the licensee can terminate the agreement with reasonable notice. Kimble v. Marvel teaches that patent-related royalties cannot be charged for use occurring after the patent's expiration. These judgments provide a helpful guidance for future negotiations and the drafting of cross-border license agreements.
Available at Social Science Research Network (SSRN): https://ssrn.com/abstract=2896187