Zimmer v. Insall: The Power of Arbitration Agreements in Patent Royalty Disputes

by Dennis Crouch

In the recent case of Zimmer Biomet Holdings, Inc. v. Insall, No. 23-1888 (7th Cir.  July 12, 2024), the Seventh Circuit affirmed an arbitration award requiring Zimmer to continue paying royalties to the estate of Dr. John Insall even after the expiration of the underlying patents.  This decision highlights the significant deference afforded to arbitration agreements and the limited ability of courts to vacate arbitral awards, even when they conflict with Supreme Court precedent.

The key precedents underlying the dispute in Zimmer v. Insall are Brulotte v. Thys Co., 379 U.S. 29 (1964) and Kimble v. Marvel Entertainment, LLC, 576 U.S. 446 (2015). In Brulotte, the 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.” This rule, known as the Brulotte rule, has faced criticism over the years for being economically irrational and inflexible. The Supreme Court directly revisited the rule in Kimble, but ultimately chose to uphold the rule based on stare decisis. However, the Court also clarified that “post-expiration royalties are allowable so long as tied to a non-patent right—even when closely related to a patent.” This left open the possibility for parties to structure royalty agreements to survive patent expiration, as long as the post-expiration royalties are non-separably grounded in a peppercorn of non-patent rights.

• Read the Decision: Zimmer v. Insall

The dispute in Zimmer v. Insall centered around a series of agreements between Zimmer and Dr. John Insall related to knee replacement technology. The original 1991 agreement provided for Zimmer to pay royalties to Insall based on the sale of products covered by Insall’s patents. Subsequent amendments in 1994 and 1998 modified the royalty provisions.

The original agreement defined the covered products according to patent scope, but in 1998, the parties included a statement that that 1% royalty would be calculated on “sales of the NexGen Knee and all subsequently developed articles, devices or components marketed by Zimmer as part of the NexGen Knee family of knee components”

Although Zimmer continues to sell the NexGen Knee products, it stopped stopped paying royalties in 2018 after the last Insall patent expired.  Zimmer argued that Brulotte rendered any post-expiration royalties unenforceable. The parties submitted the dispute to arbitration as required by their agreement. The arbitration panel sided with Insall’s estate, finding that the 1998 amendments had “untied” the royalties from Insall’s patents and created a “new royalty provision untied and no longer dependent on Insall’s patents, products, or technology.”

Zimmer then sought to vacate the arbitration award in federal court, arguing that it violated the public policy established in Brulotte and Kimble. The district court rejected Zimmer’s arguments and confirmed the award.

On appeal, the Seventh Circuit emphasized the extremely limited scope of judicial review of arbitration awards under the Federal Arbitration Act (FAA). Citing precedents like United Paperworkers v. Misco, 484 U.S. 29 (1987), the court noted that it could not reconsider the merits of an award even if the arbitrators made factual or legal errors in interpreting a contract.  Generally, an arbitration award cannot be appealed.

The key potentially applicable exception is a public policy exception, which allows a court to vacate an arbitral award if the award itself violates “some explicit public policy that is well defined and dominant.” Quoting W.R. Grace & Co. v. Rubber Workers, 461 U.S. 757 (1983). However, in evaluating whether an award violates public policy, a court is bound by the arbitrators’ interpretation of the underlying contract.

Here, the critical question was whether the royalties owed under the agreement were based on Insall’s patent rights (and thus unenforceable under Brulotte) or on some non-patent right (and thus potentially permissible under Kimble). The arbitration panel examined the contractual language and extrinsic evidence, including statements from Zimmer’s own witnesses and counsel, and concluded that 1998 amendments to the contract altered the royalty agreement so that it was no  longer based on products using Insall’s patented technology and instead was based upon NexGen marketing.

The Seventh Circuit held that this interpretation of the agreement was squarely within the arbitrators’ unreviewable authority. “An arbitration clause delegates interpretive power to the arbitrators. We do not ask whether they read the contractual language correctly; it is enough that they tried to apply the contract that the parties signed.” Am. Zurich Ins. Co. v. Sun Holdings, Inc., 103 F.4th 475, 477 (7th Cir. 2024). Given the panel’s finding that the post-1998 royalties were not based on any patent rights, the award could not violate the public policy of Brulotte and Kimble.

Zimmer argued that that the focus should be on “why Zimmer paid a royalty.” — and the answer is clear, to license the patents. And, under Brulotte and Kimble, royalties “for post-expiration use of a patent” violate public policy.  As discussed, on appeal, the Seventh Circuit did not directly evaluate the merits of this interpretation. Instead, it emphasized that the arbitrator had a different interpretation of the contract and that interpretation is not directly appealable.

Zimmer v. Insall reinforces a few principles: Courts will afford great deference to arbitrators’ contract interpretations, even when they implicate patent law issues. As long as the arbitrators are arguably interpreting the contract, a court will not second-guess their reading. As explained in Kimble, royalties grounded in both patent and non-patent rights can survive patent expiration. Finally, I want to recognize that is a case where the arbitration agreement favored the patentee, whereas patent licensees are the ones that would more traditionally seek an arbitration agreement. (Although in the IP space, this has always been more balanced than in the consumer sphere).