United States: In The Aftermath Of Medimmune v. Genentech, Is It All Doom And Gloom For Licensors Or Are There Rays Of Hope In The Future?

Originally published in BNAI IP & Technology Programme, April 2007
Copyright © Finnegan, Henderson, Farabow, Garrett & Dunner, LLP

The United States Supreme Court does not traditionally grant certiorari in many patent cases but the recent flurry of decisions by the high court may provide a bleak outlook for patent owners. While Congress has yet to provide a meaningful patent reform, the Court’s decisions could have a significant effect on the patent system. The combination of the Supreme Court’s decisions in, first, eBay Inc. v. MercExchange L.L.C. and, second, MedImmune v. Genentech has created a one-two punch signaling the Court’s new and unsympathetic attitude toward patentees. At first glance the forecast does not appear bright for patent owners, but in light of MedImmune v. Genentech, there are rays of hope that may provide optimism to patentees.

The Supreme Court’s first blow to patent owners came by way of its holding in eBay, Inc. v. MercExchange L.L.C., 126 S. Ct. 1837 (2006). Before eBay, the Federal Circuit continually indicated that injunctions should be denied to a patentee only in the "unusual" case," in "exceptional circumstances," and "‘in rare instances’ ... to protect the public interest." Id. at 1841. However, in a decision adversely affecting patent holders, the Supreme Court held a patentee must demonstrate a traditional-four factor test to have a permanent injunction granted and no such categorical grant of an injunction (as applied by the Federal Circuit) should be permitted. Id.

The Court delivered a second blow to patent owners in MedImmune, Inc. v. Genentech, Inc. by holding that a licensee is no longer required to terminate or materially breach its license agreement in order to bring a suit challenging validity or infringement of a patent. 127 S. Ct. 764 (2006). The Court’s decision provides a gloomy outlook to patent owners as it shifts strength within a license agreement from the licensor-patentee to the licensee. Licensees now have increased bargaining power to renegotiate existing licenses. Additionally, the MedImmune decision may create broad and negative consequences for patentees because it calls into question the Federal Circuit’s declaratory judgment jurisdiction outside the licensing context. Despite these adverse consequences for patent owners, there are rays of hope that may ease the blow of the Court’s ruling.

The Court’s decision will inevitably change the way license agreements are drafted. The patentee-licensor may protect itself by adding various provisions to the contract and limiting the licensee’s incentive to file a declaratory-judgment action against the licensor-patentee. For instance, instead of opting for a running royalty for the patented good, a licensor may seek to obtain a paid up license at signing of the agreement. In addition, a licensor may seek protection by inserting a provision into the license agreement that allows for termination of the agreement should the licensee contest the validity of the licensed patent. A patentee-licensor may also deter the licensee’s motivation to file a declaratory-judgment action by inserting a provision in the agreement that mandates a forum in the event of an invalidity suit initiated by the licensee. The patentee may also seek a no-challenge concession from the licensee. Another technique a licensor may use is to limit any recoupment of royalties previously paid by the licensee during a validity challenge. Because the Court’s ruling provides little finality with respect to license agreements, may have some leverage to demand a higher royalty rate from the licensee the patentee to protect its interests.

A number of Supreme Court and Federal Circuit decisions have created the foundation for the Court’s MedImmune decision. In 1969, the Supreme Court decided the principal case governing the licensee’s right to contest the validity of a licensed patent. In Lear, Inc. v. Adkins, the Court overruled the doctrine of licensee estoppel, allowing a licensee to challenge the validity of a patent while stopping the payment of royalties. 395 U.S. 653, 673 (1969). In reaching its decision, the Court emphasized the strong public interest in challenging invalid patents. Id. After this decision, a licensee’s dilemma was created if the licensee discovered it was paying royalties on an invalid patent. The licensee was faced with the choice of ceasing royalties and breaching the contract, and concomitantly bringing a declaratory-judgment action for patent invalidity, or continuing to pay the licensor for essentially free technology.

Since its inception, the Federal Circuit has shown its skepticism of the holding in Lear by applying a number of limitations. The Federal Circuit has held that Lear does not apply to assignments because "unlike the licensee, who, without Lear might be forced to continue to pay for a potentially invalid patent, the assignor who would challenge the patent has already been fully paid for the patent rights." Diamond Scientific Co. v. Ambico, Inc., 848 F.2d 1220, 1224 (Fed. Cir 1988). In a later case, the Federal Circuit excluded the application of Lear to assignor estoppel--an equitable doctrine preventing an assignor from later contending that the assigned patent is invalid. Acoustical Design, Inc. v. Control Elec. Co., 932 F.2d 939, 943 (Fed. Cir. 1991). The Federal Circuit also found consent judgments were unaffected by the decision in Lear because requiring validity litigation before the consent decree supported the Lear policy of early determination of patent validity. Foster v. Hallco Mfg. Co., 947 F.2d 469 (Fed. Cir. 1991). In yet another limitation of Lear, the Federal Circuit found that it does not apply to a license resulting from the settlement of litigation. Hemstreet v. Spiegel, Inc. 851 F.2d 348 (Fed. Cir. 1988). The combination of these decisions demonstrates the number of limitations the Federal Circuit has placed on Lear.

In 2004, the Federal Circuit addressed whether a licensee in good standing could bring a declaratory judgment of invalidity. Traditionally, federal courts require that a live case or controversy exist before recognizing the standing of the licensee to bring suit under the Declaratory Judgment Act, 28 U.S.C. § 2201. Therefore, a federal court will not rule on the validity of a patent in the absence of an actual and concrete dispute. In Gen-Probe v. Vysis Inc., the Federal Circuit held that when a patent licensee complies with its royalty obligations, there is no "actual controversy" under the Declaratory Judgment Act and Article III of the Constitution. 359 F.3d 1376 (Fed. Cir. 2004). More specifically, a licensee must, at a minimum, stop paying royalties and thereby materially breach the license agreement to establish subject-matter jurisdiction. Id. at 1381. Because a license is essentially a covenant not to sue for infringement, the Federal Circuit found there can be no "actual controversy," unless there is a "reasonable apprehension on the part of the declaratory judgment plaintiff that it will face an infringement suit." Id. According to the Federal Circuit, the "Lear doctrine . . . does not grant every licensee in every circumstance the right to challenge the validity of the licensed patent." Id. Allowing such actions would "discourage patentees from granting licensees" and force licensors to "bear all the risk." Id. at 1382. This conclusion conflicts with the Supreme Court’s decision in Lear v. Adkins, which held that a public-policy interest in invalidating weak patents permitted a licensee to challenge patent validity.

The facts of Altvater v. Freeman provides the framework for the Supreme Court’s decision in MedImmune. In Alvater, jurisdiction existed for a declaratory-judgment claim of patent invalidity even though the licensee continued to pay royalties under protest. 319 U.S. 359 (1943). As a result of an earlier litigation, Altvater was required by an injunction to pay royalties to Freeman. But in a later suit against a different infringer, many of Freeman’s claims were held invalid. Altvater was paying royalties by compulsion of an injunction decree, and unless the injunction decree were modified, the only other course of action would be to defy it and to risk not only actual but treble damages in infringement suits. Id. at 365. As a result, the Court concluded, "[R]equirements of a case or controversy are met where payment of a claim is demanded as of right and where payment is made, but where the involuntary or coercive nature of the exaction preserves the right to recover the sums paid or to challenge the legality of the claim." Id.

In 1997, MedImmune entered into a license agreement with Genentech for U.S. Patent No. 4,816,567 ("Cabilly I"), which expired in 2006. MedImmune, 127 S. Ct. at 768. The agreement also granted a license to MedImmune under continuations of Cabilly I. Id. At the time of the agreement, Genentech had a pending continuation application of Cabilly II. Id. After Cabilly II issued, Genentech demanded that MedImmune pay royalties on MedImmune’s Synagis product. Id. Although MedImmune paid royalties under protest, it contended that Genentech’s patents were invalid and not infringed by Synagis. Id. Later, MedImmune filed suit seeking declaratory judgment of invalidity, unenforceability, non-infringement, and declaration of contractual rights and obligations. Id.

The specific question presented to the Supreme Court was whether the actual-controversy requirement of the Declaratory Judgment Act required a patent licensee to refuse payment of royalties and commit a material breach of the license agreement before suing to declare the patent invalid, unenforceable, or not infringed. Id. at 767. The Court held that a patent licensee need not breach its license agreement in order to file a declaratory-judgment action regarding non-infringement, invalidity, or unenforceability. Id. at 777.

In reaching its decision, the Court analogized the patent licensee at hand to a plaintiff exposing itself to liability before bringing suit to challenge the constitutionality of a law threatened to be enforced. Id. at 772. The plaintiff's own action (or inaction) in failing to violate the law eliminates the imminent threat of prosecution, but nonetheless does not eliminate Article III jurisdiction similar to a patent licensee’s refusing to materially breach an agreement before filing suit. Id.

In its only decision on point, the Supreme Court held that a licensee’s failure to cease its royalty payments did not render nonjusticiable a dispute over the patent’s validity. Altvater, 319 U. S. at 364. The Court acknowledged that Altvater involved an injunction, under which the licensees had the option of stopping payments in defiance of the injunction. Id. at 365. But the consequence of doing so would be to risk "actual [and] treble damages in infringement suits" by the patentees, a consequence also threatened in this case. Id.

Finally, the Court rejected two arguments presented by Genentech. First, the Court rejected the view that a license represents a promise that the licensee gets immunity from suit as long as it pays royalties and does not challenge the patent’s validity. Id. at 775-776. The Court found that a promise not to challenge validity cannot be implied from a promise to pay royalties for patents that have not been held invalid. Id. at 776. Second, the common law rule that a party to a contract could not challenge its validity and continue to reap its benefits was inapplicable. Id. In the case at hand, MedImmune, the licensee, was not repudiating the contract while continuing to reap its benefits. Id. Rather, it was asserting that the contract, properly interpreted, did not prevent it from challenging the patents, and did not require the payment of royalties because the patents did not cover its products and the patents were invalid. Id. Therefore, the licensee was not required to terminate its license agreement before seeking a declaratory judgment that the underlying patent was invalid, unenforceable, or not infringed. Id. at 777.

The MedImmune decision creates a gloomy outlook for many patentee-licensors, yet there are rays of hope the patent owner may strategically use for protecting its interests. The Supreme Court has initiated a wide spread policy reform by calling into question the legal framework constructed by the Federal Circuit. Because the Supreme Court has focused this alteration on the privileges of the licensor-patentee, it is critical that a licensor be cognizant of different methods of defending its interests.

MedImmune calls into doubt the Federal Circuit's existing law regarding declaratory-judgment actions providing a gloomy outlook for the patentee. Thus far, the Federal Circuit has permitted jurisdiction for a declaratory-judgment action when there is a reasonable apprehension on the part of the declaratory judgment plaintiff that it will face an infringement suit. But the Supreme Court has potentially lowered the hurdle for showing a "case or controversy" sufficient to meet the Declaratory Judgment Act, thereby expanding opportunities for potential declaratory-judgment plaintiffs. A recent Federal Circuit opinion is indicative of this change. Scandisk Corp. v. STMicroelectronics, Inc., No. 05-1300 (Fed. Cir. March 26, 2007).¹ The Court found where a patentee asserts rights under a patent based on certain identified ongoing or planned activity of another party, and where that party contends that it has the right to engage in the accused activity without license, an Article III case or controversy will arise and the party need not risk a suit for infringement by engaging in the identified activity before seeking a declaration of its legal rights. Id. at slip op. 15. In footnote 11 of the MedImmune opinion, the Supreme Court broadly called the Federal Circuit's declaratory-judgment jurisprudence into question, i.e., the reasonable-apprehension test created by the Federal Circuit conflicts with many decisions of the Supreme Court. This ruling could take the idea of "certainty" to an extreme, essentially allowing a party to challenge a patent before it even begins to build a plant that operates a potentially infringing process or before it brings a potentially infringing product to market.

As acknowledged by Judge Bryson in a recent opinion, many decisions under existing Federal Circuit law are now called into question². Scandisk Corp. v. STMicroelectronics, Inc., No. 05-1300, (Fed. Cir. March 26, 2007) (concurring opinion at slip op. 2). For instance, the Federal Circuit had previously found that it may be possible for patentees to provide actual notice under 35 U.S.C. § 287(a) but not trigger a controversy sufficient to create declaratory judgment-jurisdiction. See SRI Int'l, Inc. v. Advanced Tech. Labs., Inc., 127 F.3d 1462 (Fed. Cir. 1997) (holding that actual notice may be achieved without creating an actual controversy). If the Supreme Court has in fact created a new jurisdictional test for a declaratory-judgment action, the reasonable-apprehension test may no longer apply.

The uncertainty of the Supreme Court’s decision in MedImmune may take time to be fully appreciated. At least one district court, WS Packaging Group, Inc. v. Global Commerce Group, 2007 U.S. Dist. LEXIS 5187 (E. D. Wis. Jan. 24, 2007), has continued to apply the Federal Circuit’s reasonable-apprehension test, finding the Supreme Court’s decision in MedImmune does not set forth a new jurisdictional test for declaratory-judgment actions. The district court applied the reasonable-apprehension test to the context of a licensee’s bringing a declaratory-judgment action against a licensor despite the Supreme Court’s statements that even if Altvater could be distinguished, it would still contradict the Federal Circuit’s reasonable-apprehension-of- suit test.

MedImmune also creates a gloomy effect for the patentee-licensor’s good-faith attempt to license its patent. Specifically, the licensor must be careful of any and all statements to a licensee so as not to provoke a declaratory-judgment action. The requirements of a "case or controversy" within the meaning of Article III is unclear after the Court’s decision. An innocent statement by the licensor may potentially spark a declaratory-judgment action, landing the licensor in district court the next day. Perhaps, a licensee may now have a valid dispute if it states that payments are paid under protest or if it states a belief that the patent is invalid.

Yet another gloomy effect for the patentee will be the lack of finality for current license agreements. These license agreements were written before this ruling was anticipated and parties may have entered into the agreement as an alternative to costly litigation. The MedImmune decision, however, now creates a potential for continuing litigation as the licensee no longer is required to materially breach its license agreement in order to bring suit. As a result, the licensee has a newly found bargaining power to renegotiate existing licenses. Furthermore, current licensees now have the freedom to contest patent validity at any time without the risk of losing the license.

Despite these many gloomy effects resulting from the Court’s decision, there are rays of hope the patentee may use to protect its interests. MedImmune may cause licensors to demand higher royalties. More specifically, the incentive to compromise is reduced if the licensor knows that the license agreement is not a final resolution, but rather that the licensee can simply turn around and file a declaratory-judgment action challenging the validity of the patent. Therefore, licensors should consider applying a higher rate during a validity challenge and an even higher royalty rate if a validity challenge is unsuccessful.

MedImmune may increase licensing costs, as a form of risk premium for potential later legal costs when validity is challenged. New license agreements are likely to directly address this issue in a variety of ways. A licensor may insert a provision to terminate the license under challenge. Alternatively, the patentee may consider seeking a no-challenge provision. Although such clauses raise the stakes for a licensee as an infringer, the clause may be challenged for its legality.

The licensor may use a license agreement as a tactical advantage in delaying an inevitable litigation. Specifically, the licensor should consider that by entering into a license it is the only party compromising the right to sue. The licensor has less incentive to enter into a license agreement. Nevertheless, the licensee agreement may serve as a temporary delay to an inevitable litigation. On the other hand, licensor’s may be less willing to enter into licensee agreements unless a provision is inserted to protect itself in the event a licensee brings a declaratory-judgment action.

The licensor may add a number of provisions to a license agreement, thereby creating a disincentive for a licensee to bring suit. First, license agreements may attempt to include different royalty rates in the event of a validity challenge or if validity is unsuccessful. Second, licensors may also demand paid-up licenses rather than running royalties rates in any license agreement. Third, licensors could require arbitration as opposed to a expensive declaratory-judgment action in federal district court.

The Supreme Court’s recent grant of certiorari in a number of patent cases have affected the rights of patent owners. In MedImmune v. Genentech, a licensee is no longer required to terminate or materially breach its licensee agreement in order to bring a suit challenging the validity or infringement of a patent. MedImmune has changed the licensing landscape, and both licensees and licensors will need to reevaluate their priorities. In addition, the Federal Circuit’s jurisdictional test for a case or controversy under Article III may now be called into question. The decision creates some interesting challenges to patentee-licensors in future and existing licensee agreements. However, the licensor may not be without recourse, employing various strategies and using different provisions in license agreements to protect its interests in light of MedImmune.