A recent decision by the U.S. Supreme Court has substantially altered the patent licensing landscape, according to some patent executives. The Court's opinion in Medimmune v. Gennentech stands for the proposition that a licensee need not breach its patent license agreement in order to bring an action challenging the validity of a covered patent. In light of this holding, counsel for both licensees and licensors should reevaluate existing patent licensing agreements, as well as consider how to protect themselves in future agreements.
MedImmune v. Genentech: Litigating a Continuing Contractual Relationship
Justice Scalia authored the majority's decision in MedImmune, which held that a patent licensee does not have to materially breach or terminate a license agreement in order to bring an action against the licensor challenging the patent covered by that agreement.
Here, MedImmune, a medicine manufacturer, and Genentech, the "founder of biotech industry," entered into a patent license agreement covering Genentech's then-pending patent application. When that application matured into the "Cabilly II" patent, Genentech sent a letter to Medimmune stating that: 1) Synagis, a children's respiratory drug manufactured by MedImmune, was covered by the patent; and 2) MedImmune now owed royalties under the agreement.
MedImmune's position was that it owed no royalties under the agreement because it believed the "Cabilly II" patent was invalid and unenforceable and was not infringed by Synagis. Genentech's letter was also believed to be a clear threat to enforce the patent, terminate the license agreement, and bring a patent infringement action if Medimmune did not pay the demanded royalties.
If MedImmune were to breach the agreement and sue Genentech for patent invalidity, the stakes would be considerably high. In the event of a court loss, MedImmune risked: 1) being enjoined from selling Synagis, which accounted for over 80% of its sales revenue; 2) paying treble damages; and 3) paying Genentech's attorneys' fees. Instead, MedImmune chose to keep the agreement intact, pay the royalties under protest, and bring a declaratory judgment action against Genentech.
The Declaratory Judgment Act, 28 U.S.C. Section 2201(a), is rooted in Article III of the U.S. Constitution and requires an "actual case or controversy" for a court to exercise jurisdiction. Given the continuing contractual relationship of the parties, the Court was faced with the question of whether a licensee can establish an "actual case or controversy" when it maintains the very license it seeks to challenge.
Coercion: Grounds for Jurisdiction?
Both parties conceded that a concrete and well-defined dispute existed. They also acknowledged that MedImmune would be exposed to a suit if the payments were not made. Clearly, jurisdiction would exist if the payments ceased. The unsettled question remained: Is a threat of suit and coerced payments enough to establish a case, or must the licensee first expose itself to liability?
Lacking an abundance of precedent on this narrow issue, the majority first made analogy to a threat by the government against a private party. In such cases, a private citizen does not have to violate a law and face prosecution in order to challenge that law.
In MedImmune, however, both parties are private entities that freely negotiated and entered into an agreement. To support its ruling, the court relied on Altvater v. Freeman, 319 U. S. 359 (1943). There, a licensee seeking declaratory judgment of patent invalidity continued to pay "under protest" royalties required by an injunction in a previous suit. The Court held "the requirements 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."
In sum, threat of litigation and coerced payment is enough to establish a "case or controversy" among private parties. A licensee need not first expose itself to liability before bringing a declaratory judgment action challenging a patent.
Practical Considerations in the Wake of MedImmune v. Gennentech
The decision in MedImmune v. Gennentech has produced considerable speculation and debate in the U.S. patent community, as many practical issues were unaddressed by the Supreme Court's decision. At the Winter 2007 Meeting of the License Executives Society, the impact of MedImmune on existing and future patent license agreements was an important topic of discussion.
D. Brian Kacedon an attorney at Finnegan, Henderson, Farabow, Garrett & Dunner LLP presented the following views on the likely consequences of the MedImmune decision.
Impact of Decision on Existing License Agreements
Generally, licensees will have a greater freedom to challenge the validity of patents while keeping their licenses intact. After MedImmune, there is now little to no risk to the licensee of losing the license. Licensees will also enjoy greater bargaining power to renegotiate existing licenses, so they should always think about renegotiation before suing.
Licensors, on the other hand, are now exposed to a greater risk of litigation. However, while there will be an increase in litigation, Mr. Kacedon does not foresee a huge influx of MedImmune type cases. Licensees still have to surmount considerable hurdles, such as adhering to the complex process of litigation and overcoming the presumption of patent validity. Licensees must also show an actionable "case or controversy," evidenced by threat of suit and coerced payment on the part of the licensor. This means that licenses will have to communicate with licensors before filing suit, which will preclude "out of the blue" actions for declaratory judgment.
The decision of whether to initiate litigation is a complex equation with factors that differ in every circumstance. Among other considerations, licensees contemplating a MedImmune challenge should weigh the impact of a suit on the larger relationship with the licensor. For example, a licensee who has multiple agreements with a licensor would want to analyze how a suit could jeopardize future relations, as well as agreements not at issue in litigation. On the flip side, a licensor faced with possible litigation should asses whether it has other patents and agreements with the licensee that it can use for leverage to effectuate a settlement.
After MedImmune both licensors and licensees should consider evaluating existing license agreements to determine which are most susceptible to challenge. In particular, licenses with large remaining payments and/or questionable patents would seem to be at greatest risk. For example, if $60M remain in royalty payments and bringing suit costs a mere $3M, this could be an area of concern. Agreements with small upfront payments and large "reach through" royalties may also be particularly vulnerable.
During license evaluation, Mr. Kacedon also suggests determining the agreements' termination rights. Often, licensors have the ability to terminate the license in the event of a validity challenge. Finally, ascertain whether the agreement dictates a particular forum for validity challenges to the patent, as forum selection clauses usually govern contract claims.
Impact of Decision on Future License Agreements
Regarding future license negotiations, Mr. Kacedon believes that licensees are more likely to negotiate first and sue second. As a result of being able to keep a license intact while litigating it, licensees will be able to determine their downside (i.e., the terms of the license) before bringing suit. Even if the licensee loses in court, it knows what the royalty payments will be.
Licensors, on the other, will generally demand higher royalties and up front payments. The rationale being, if a licensor has to accept the MedImmune risk when licensing, it will want more money and possibly more up front because there is little chance those amounts will be recovered. Such up front payments may even act as a disincentive for licensees to sue if the majority of the money due under the license has already been paid.
After MedImmune, Licensors should consider other mechanisms to protect themselves, including:
- Termination provisions - Negotiate a clause that allows licensor to terminate the agreement in the event of a validity challenge to a patent licensed under the agreement.
- Forum selection clauses - If challenges are inevitable, consider controlling where challenges will be heard or arbitrated.
- Pre-suit notification clauses - Such language gives licensor the opportunity to evaluate the strength of the licensee's claim and possibly consider renegotiating the license.
- Differing royalty rates - Consider increasing fees in the event of a validity challenge, keeping in mind that courts frown upon liquidated damage penalties. In addition, licensor may want to insert a clause for payment of attorney's fees and costs of litigation.
It is important to note that some forms of the preceding contractual terms may not always survive judicial scrutiny if contested.
The decision in MedImmune v. Genentech has changed the licensing landscape. Both licensees and licensors may want to reevaluate existing patent licensing agreements in light of the holding. Additionally, both parties should consider how to protect themselves in future agreements.