Supreme Court: Licensee in Good Standing May File Declaratory Judgment

MedImmune v. Genentech (Supreme Court 2007).

Declaratory judgment (DJ) actions are often used by potential defendants to obtain a declaration that a patent is invalid, unenforceable, or not infringed.  Under Federal Circuit law, a licensee cannot challenge a patent without first breaching the license.  The CAFC's reasoning was that a licensee in good standing feels no apprehension of suit since the license is essentially a settlement between the parties. Without an apprehension of suit, the DJ action would not rise to an actual controversy as required by the Constitution.

In a broadly worded opinion, the Supreme Court has scrapped the Federal Circuit's "reasonable-apprehension" test on declaratory judgment standing in favor of a rule that allows licensee's in good-standing to file DJ actions.

We hold that petitioner was not required, insofar as Article III is concerned, to break or terminate its 1997 license agreement before seeking a declaratory judgment in federal court that the underlying patent is invalid, unenforceable, or not infringed.

There are several things to note immediately:

Not Limited to Patents: This case at least extends to all licensing issues and likely to most contracts -- whether or not they involve patents or intellectual property.

Suggested Contractual Work-Around: Reading between the lines, the opinion may indicate that a contractual "prohibition against challenging the validity of the patents." may serve to block challenges by licensee's in good standing. Without the clause, however, the Court found no such prohibition:

To begin with, it is not clear where the prohibition against challenging the validity of the patents is to be found. It can hardly be implied from the mere promise to pay royalties on patents

Regarding apprehension of suit, the Opinion's footnote 11 is a complete divergence from common practice -- finding that a licensee who pays royalties either in fear of an injunctions or for fear of treble damages is being coerced in a way that creates an Article III case or controversy.

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32 thoughts on “Supreme Court: Licensee in Good Standing May File Declaratory Judgment

  1. federal circuit watcher, you stated that “Lear cannot be construed as making a holding about what contract provisions are enforceable or whether they have been breached” and you corrected that to note that “the Court couldn’t have made such a holding _that can be used as precedent overriding state court precedent_.”

    I don’t think that is a correct view of Lear. That case specifically held that particular contract provisions were unenforceable as a matter of federal patent policy:

    “Enforcing this contractual provision would give the licensor an additional economic incentive to devise every conceivable dilatory tactic in an effort to postpone the day of final judicial reckoning. We can perceive no reason to encourage dilatory court tactics in this way. Moreover, the cost of prosecuting slow-moving trial proceedings and defending an inevitable appeal might well deter many licensees from attempting to prove patent invalidity in the courts.”

    395 U.S. at 693.

    In other words, the provision requiring the licensee to pay until the challenge succeeded was unenforceable under federal law, even though the California Supreme Court held that it was largely enforeceable under state law.

    See also: “The parties’ contract, however, is no more controlling on this issue than is the State’s doctrine of estoppel, which is also rooted in contract principles. The decisive question is whether overriding federal policies would be significantly frustrated if licensees could be required to continue to pay royalties during the time they are challenging patent validity in the courts.

    Id. at 673.

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  2. Tom Bai: The right to sue usually belongs to just one person, the patentee. It is part of the “bundle of sticks” that is the patent property and cannot be separated from control of the patent. If the patentee grants enough control of the patent to a licensee, the licensee instead has the right to sue. In this case, the patentee retained too much control over the patent. It thus doesn’t matter what the contract (or it might be better to say here “license”, as technically a federal court can only make precedent on patent licenses, not on contracts) said; the patentee did not have the right to unbundle control of the patent from the ability to sue for infringing the patent. A party cannot promise in a contract what it doesn’t have the legal right to perform: such a clause is null and void.

    It’s a bit like a prescription drug. If I sign a contract to transfer to you my prescription, or a license to take some of its pills, that contract or license clause is null because a prescription is inalienable property and cannot be resold or given away by the patient.

    Of course the patent here could be sold or licensed so completely as to give away control over it. In such cases the right to sue would follow the control. It’s thus a case of required bundling (the right to sue and control) not a case of outright prohibition on resale. There is probably a better analogy from real estate law where you can’t contract to separate an easement (of some kind) from the property it appurtenant to. But I’m not enough of a real property guru to be confident of a specific real property example.

    Bottom line: this is not a matter of contract law, but of property law (a special federal property law, patent law): you can’t unbundle some kinds of “sticks” that make up the “bundle of sticks” that is a patent. A contract (or perhaps better to say license) clause that purports to do so is null like any other contract clause to do something illegal. In many ways patent law is a kind of property law (albeit a special federal one) and it comes across in cases like these.

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  3. To nitpick my own post, I should have said “the Court couldn’t have made such a holding _that can be used as precedent overriding state court precedent_.” Of course the Court like other federal courts can decide contractual issues under pendant jurisdiction, but their precedential authority is inferior to that of the state courts.

    One has to nitpick here, because that is exactly what the Federal Circuit is going to do to MedImmune, nitpick it to pieces.

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  4. Lear cannot be construed as making a holding about what contract provisions are enforceable or whether they have been breached. The Court couldn’t have made such a holding because federal courts must follow state precedents in contract law under Erie. The federal courts can only hold that breach of the contract, or continuing to practice the invention when the contract has been terminated, does not constitute patent infringement.

    In the case of TC’s clause it might hold this by holding that the _license_ (as a matter of patent law) has not been terminated even though the corresponding contract has. Or it might hold that the challenger retains a constructive license for the duration of the challenge even though the express license has been terminated.

    However until TC’s clause or similar workarounds reach the Supreme Court, which may be forever, I expect the Federal Circuit to uphold such clauses and even to find infringement with treble damages if the challenger keeps practicing the patent after termination. The Federal Circuit has usually found ways to ignore Supreme Court patent holdings it doesn’t like with a variety of clever workarounds like TC’s. After all, up until MedImmune it had found a way to ignore Lear. Although the 8-1 vote this time might give at least a few of the judges pause.

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  5. One more reason why a “challenge means termination” provision will be upheld: judicial resource considerations. As discussed above, if a license merely determines what the licensee will pay if its validity challenge is unsuccessful, the patentee will have a very strong incentive to file suit in order to have the dispute resolved through a consent decree that is not subject to later challenge.

    In other words, striking down such a provision would mean a sharp increase in patent litigation — not a popular concept in the federal judiciary.

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  6. mmmbeer, Lear is about assuring that licensees can challenge patents. There is nothing in Lear or MedImmune to suggest that this policy in favor of challenging patents is so strong that the licensee should be able to make this challenge, but with the safety net of knowing that it can do so with no risk of losing its license rights.

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  7. mmmbeer…

    I see that you are standing back and looking at the “lay of the land”, a good practice before delving in to the vagaries of Supreme Court jurisprudence. Long years of experience (almost 30 years) have taught me that the thought process employed by the Court oftentimes consists of answering a question, and then trying to figure out some form of rationale justifying the answer. Of course the Justices would never admit it, but “gut reaction” does play an important role. For that reason I mull these decisions over for a while before jumping into the fray of “here is how to get around it”. Clients are looking for answers, and not for theoretical solutions that may or may not pass muster at some date in the distant future.

    Clearly the current lay of the land is a strong disposition to strike down approaches that impose limitations on challenges to patent validity by anyone, including licensees.

    I do agree that the word “coercive” has introduced a new wrinkle of the type that will keep law professors busy writing yet another series of largely meaningless journal articles on just what that term really means. Unfortunately, the word provides virtually no meaningful guidance to those dealing with real life clients.

    Lear, and its rejection of licensee estoppel, is alive and well. Practitioners would in my view be well advised to measure possible licensing approaches with Lear in mind.

    I also agree that contract law will not prove to be particularly effective in trumping the effects of Lear and Medimmune. Lear, as your correctly note, is an expression of the policy balance that has been drawn as a line in the sand between private and public interests. I daresay that over time contractual provisions will be subject to an an enhanced level of judicial scrutiny to see if that balance has been retained.

    Given that balance as is evident from Medimmune, I would not at all be surprised to see a decision in KSR reinforcing the notion of consistency with the policy balance the Supreme Court has struck, namely that the “Patent System” is being moved in a direction to reinforce the perceive need to reduce the incidence of what is perceived as the continual allowance of patents arguably invalid from the “get go”.

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  8. Andrew, given Lear’s language, resting your hopes on contract law is not going to be fruitful. For one thing, patents represented a “carefully” crafted balance between public and private benefits. Again, a patentee that seeks to tilt that balance by extending his or her rights through contract provisions, if not merely unenforceable, might actually be construed as patent misuse.

    If there is any limiting principle in this opinion it is the word “coercive:” the risks must be sufficiently high that a licensee feels the only choice is to enter the license.

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  9. Michael, even when the ink is drier, I don’t think I’ll see an opinion about how patent challenges should be encouraged. The court went only so far as to reject the subject matter jurisdictional dismissal. The policy of Lear is indeed hornbook law, but I don’t see how it was extended here.

    All I see is a court saying that even if the license prohibits the challenge & preserve strategy, that’s a matter of contract law, not a limit on the court’s jurisdiction.

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  10. The ink is barely dry on the opinion and already persons as postulating ways to nullify its effect.

    Perhaps is would help to stand back a bit and consider basic considerations that led the majority to give an 8 to 1 opinion. Lear is hornbook law and has been so for many years. Licensor estoppel is dead, at least for a while. Medimmune seems to be an extension of the Lear rationale to the extent that is recognizes situations do arise where challenges should likewise be encouraged, albeit in the context of an ongoing license. There is a common thread. Attempts to squelch challenges to the validity of a patent by a licensee are viewed with disfavor.

    I plan to mull the disfavor of restricting challenges by licensees for a while before positing approaches that may pass judicial muster.

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  11. Andrew: Since other persons had referred to Lear, I thought I’d quote it in hopes that they would observe, as you did, that its holding and rationale do not require that the licensee be able to retain its license rights.

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  12. Sure, SF, but the policy requiring that a licensee be allowed to challenge validity, nothwithstanding contractual provisions, does not also require that the same licesee be allowed to keep its license rights should that challenge fail, does it?

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  13. In Lear, the lower court held “one of the oldest doctrines in the field of patent law establishes that so long as a licensee is operating under a license agreement he is estopped to deny the validity of his licensor’s patent in a suit for royalties under the agreement. The theory underlying this doctrine is that a licensee should not be permitted to enjoy the benefit afforded by the agreement while simultaneously urging that the patent which forms the basis of the agreement is void.”

    Reversing, the Supreme Court stated, “Licensees may often be the only individuals with enough economic incentive to challenge the patentability of an inventor’s discovery. If they are muzzled, the public may continually be required to pay tribute to would-be monopolists without need or justification.” At least partially based on this rationale, it concluded that “the technical requirements of contract doctrine must give way before the demands of the public interest in the typical situation involving the negotiation of a license after a patent has issued.”

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  14. mmmbeer, I don’t read this opinion as suggesting that as a matter of policy, licensees should be able to preserve their license rights while simultaneously challenging validity and infringement.

    At page 17 of the slip opinion, the court explicitly leaves open the possibility that Genentech will show that the contract (implicitly, in all likelihood) prohibits MedImmune’s challenge while preserving its license rights. The court is simply saying that MedImmune’s actions thus far do not create an Article III subject matter (i.e., case or controversy) problem.

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  15. Well, it seems like the Court thread a very tiny needle eye. I think the decision is very limited to those circumstances where a licensee can well establish without doubt that continuation of the license is absolutely critical to the licensee’s existence. Would this decision apply to a licensee with merely 5 percent of its sales in the disputed patent. Note the reservation of right in agreeing to make the payments to the patentee. I thought that was really essential to showing that the payment was under reservation. That’s very common in insurance claims disputes.

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  16. The case may not be important if a “thou shalt not challenge validity” clause will accomplish what formerly was taken for granted. However, if the clause won’t work, then cases now have become more difficult to settle because the patentee will need to get more money up front. Plus, a whole raft of cases thought to be settled with finality are now no longer settled.

    This causes me to wonder if the Court has become too idealogical such that it concentrates far too much on principles and fails to look sufficiently at the consequences.

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  17. Other possible contractual approaches to protect licensors from patent challenges from licensees include:
    - increasing the royalties if a licensee’s validity challenge fails,
    - one time lump sum payments rather than ongoing payments over the life of a patent,
    - exclusive licenses so that a licensee sees value to maintaining the validity of the patent to exclude other parties from practicing the claimed invention, and
    - assignments.

    This case may be a godsend for exclusive licensees who do not enjoy a monopoly in the claimed invention because the patent owner is not suing infringers. Rather than suing the infringers themselves, the exclusive licensee can attempt to invalidate the patent to end the license or to threaten such a suit to force the patent owner to sue the infringers.

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  18. Well the enumerated reasons were the ones I could think of for holding such a provision unenforceable (or for not wanting to include it) off the top of my head.

    It would devalue existing licenses (at least in the eyes of the licensor) because most would not contain such a clause. Since they don’t have that clause the licensee would end up with more value than bargained for and greatly diminishing the ordinary expectation of a licensor: that this licensee will no longer seek litigation except at the risk of treble damages.

    However, if such a provision were enforceable, it would be interesting if such a clause were implied into amicably entered agreements. That is licensee and licensor were both happy to enter into the agreement. This may be the reason the opinion stated over and over that Medimmune did not think it should have to enter this agreement and stated that it is really only paying royalties “under protest.”

    This may be a good solution to the “patent troll” problem. The threat of treble damages created a significant incentive not to continue to infringe and to litigate the issue.

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  19. In my view, the Supremes are likely to look at anything that limits, restricts or burdens patent challenges as unenforcable for public policy (getting rid of bad patents) reasons.

    I agree that it will take some time for these cases to work their way up through the system, but I doubt that they will come from state courts. I expect they will come in contract counterclaims to federal declaratory judgment actions and that the district court and CAFC will hold onto these claims as part of the patent infringement/invalidity jurisdiction.

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  20. Interesting points SB and mmmbeer.

    I am not sure what “under protest” means definitely, but if it means that you are intending to challenge the validity of the patent (and taking steps to do so), then it could well constitute anticipatory breach.

    Mmmbeer, what is your assessment that the Supremes will overturn a negotiated contract containing the clause merely on the grounds of the public policy?

    In addition, how would this devalue existing license relationships in a manner that any other decision affecting licenses wouldn’t?

    Moreover, as this would turn on a point of contract law, it seems that it would have to go through the state courts before it got to the Supremes. I am also unsure how this would be patent misuse by extending the patent term (or the scope in general).

    I would appreciate hearing more of your thoughts on these matters.

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  21. Alan’s probably right. I am going to imagine that any clause which purports to terminate the license upon a suit challenging a licensed patent will probably be per se unenforceable.

    There’s a couple reasons for this. First, it seems to go immediately against the public interest reason put forth by the SCOTUS in this opinion. That is, it would significantly burden challenging a patent to the point that this holding would be rendered silly.

    Second, it would be devalue existing license relationships negotiated in good-faith before this rule.

    Third, and possibly the worst case scenario, it may be that it is patent misuse. It may be that foreclosing patent challenges may be an “improper expansion of the scope of the term of a patent.”

    Anyway, who wants to be the first to add the clause so that I can see how it turns out?

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  22. I may be totally off base on this, but in the current mood of the Supremes I can forsee a case where a clause terminating a license for challenge of the patent or for paying royalties “in protest” is held to be unenforcable as being against the policy of having those most interested in getting rid of bad patents doing so.

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  23. TC is absolutely right. A “callenge the patent means termination” clause will most likely bar the advantages Medimmune bestows onto licensees.
    This got me thinking. Maybe, even without such a clause, the licensor can argue that a challenge to the patent is the functional equivalent of a repudiation of the license. Thus, although the licensee is paying royalties “in protest”, the licensor should be allowed to reject the royalty payments given that the licensee has taken an affirmative position against the validity of the patents and he’s actively trying to get back those paid royalties.
    The logic goes even farther. If the licensee is paying royalties in protest, but then goes to court and takes action with the clear objective of getting back the paid royalties, shouldn’t that constitute an “anticipatory breach”. Is there any difference between not paying royalties at all, or paying the royalties and then taking action in trying to get it back. It’s the functional equivalent of not paying in the first place, and that should constitute repudiation.
    This should defeat the entire “payment in protest” advantage Medimmune is currently enjoying.
    Genentech should argue the following: “If you believe that you owe us nothing under the license, and you’re actually trying to get back the already paid royalties, then fine, keep those royalties, and then from our point of view there’s a repudiation.”

    Here’s another way to put it. Just as Medimmune is paying Genentech “in protest”, Genentech can return the royalties payments to Medimmune “in protest”, in response to Medimmune’s lawsuit, which is seeking the return of the royalties.

    I wonder if this argument can be supported by some case law.

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  24. Matt said: “Why not just sue and THEN license, especially assuming the hostile party is going to get their day in court anyway?”

    I agree. If the license forms part of a settlement agreement to dismiss a lawsuit, it could have a preclusive effect preventing relitigation. However, this would require the Court to view naked licenses differently from licenses incorporated into a settlement. This could be good or bad policy, depending on who you are.

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  25. I think you’re absolutely right, TC. A “challenge the patent means termination” clause would seem to be perfectly consistent with MedImmune and Lear. It allows licensees to challenge patents while preventing them from preserving their license rights during the challenge.

    With the appropriate new contractual language, I think MedImmune will have little effect on new licenses. However, it will lead to some nasty and unfair results for many patent holders whose licenses had no such language.

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  26. Why not insert a clause in the license that state that any challenge to the validity of any of the patents covered by the license may terminate the license?

    This seems to me to avoid any problem with enforcement since it now becomes a contractual issue (of when the license terminates) rather than one of limition of rights. That is, the licensee can sue for DJ of invalidity, but then risks the license being terminated by the licensor.

    Am I way off base here?

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  27. Agreeing with P.A., assuming you could even enforce such a contract clause not to challenge under Lear, where is the incentive to license to a hostile party now?

    Why not just sue and THEN license, especially assuming the hostile party is going to get their day in court anyway?

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  28. Scalia’s on a roll. I hope he writes the opinion for KSR, too. These justices will be credited with fixing the patent system that was on the verge of losing credibility with the public.

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  29. “Scalia sometimes seem stuck in his law school days.”
    Seven of the eight other justices (i.e., all but Thomas) joined in Scalia’s opinion. I think Thomas got it right. I do not see how a licensee is in any way coerced. A party does not have to take a license in the first place. (Wow. With 8 justices against my position, I’m certainly out of step.)
    Perhaps a contract provision barring challenges would be interpreted as a requirement that a licensee must put its license at risk in order to challenge a licensed patent.

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  30. Scalia sometimes seem stuck in his law school days.

    As for the rule that licensees can file DJs – this is the right outcome and a great solution to the problem, too bad we had to get to the SC for it.

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  31. Dennis wrote: “a contractual “prohibition against challenging the validity of the patents.” may serve to block challenges by licensee’s in good standing.”

    However, don’t we already know from Lear etc. that such a provision in a contract would be unenforcable on its face? I would have thought that Scalia would have known that…

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  32. A no-challenge provision of a license agreement may cause problems if the license also includes European patents taking into account the EU block exemption

    link to eur-lex.europa.eu

    See Article 5(1)(c)

    Best,

    Eric

    Reply

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