Reversing long-standing Federal Circuit precedent, the United States Supreme Court has now held that a patentee extinguishes its patent rights on a product upon its sale of that product, regardless of (1) whether the patentee placed a restriction on the sale (prohibiting reuse or resale), or (2) whether the sale occurred within the United States.
Michael V. O'Shaughnessy focuses his practice on patent litigation and appeals. He has handled numerous matters in a variety of technologies, including the pharmaceutical, biotechnology, medical, chemical and automotive fields. He has broad experience in all aspects of patent litigation, including conducting pre-litigation investigation and evaluation, drafting claim construction and summary judgment motions, examining and cross-examining fact and expert witnesses, and managing day-to-day litigation activities. Read Michael V. O'Shaughnessy's full bio.
In a decision written by Judge Marsha S. Berzon, a three-judge panel of the U.S. Court of Appels for the Ninth Circuit affirmed a first-of-its-kind district court judgment relating to royalty rates for standard-essential patents (SEP). As part of the standard setting process, many standards organizations require members who hold patents necessary to implement a given standard to commit to license those patents on reasonable and non-discriminatory terms (RAND). Because inclusion in a standard can increase the importance and value of a patent, parties often differ on what constitutes a reasonable royalty. In this case, district court Judge James Robarts of the U.S. District Court for the Western District of Washington established a multi-factor framework to determine the appropriate royalty rates and ranges for SEPs. Several other courts later employed similar approaches. Motorola’s appeal challenged the district court’s authority to determine the royalty rate at a bench trial. The company also contended that the district court mis-applied Federal Circuit precedent on patent damages. The Ninth Circuit rejected these arguments, finding that Motorola had consented to the bench trial and holding that Judge Robart’s “thoughtful and detailed analysis” was “consistent with the Federal Circuit’s recent approach.” Microsoft Corp. v, Motorola, Inc. et al; Case No 14-35393 (9th Cir, July 30, 2015) (Berzon, J.)
The long-running patent dispute between Microsoft and Motorola spans several courts and countries. The crux of the conflict traces back to October 2010 when Microsoft sued Motorola for alleged infringement of certain smartphone patents. Thereafter, the parties explored a possible cross-licensing arrangement to resolve their dispute. Motorola sent letters proposing licenses for 802.11 and H.264 SEP portfolios, with a proposed royalty rate of 2.25 percent of the price of the end product, which Motorola represented was in keeping with its RAND commitments on the patents. Microsoft disagreed. Soon after, it filed suit in the Western District of Washington, alleging that Motorola had breached its RAND commitments to the Institute of Electrical and Electronic Engineers (IEEE) and the International Telecommunication Union (ITU), the standard-setting organizations that developed the 802.11 and H.264 standards. Motorola responded by filing suit in the U.S. District Court for the Western District of Wisconsin, seeking an injunction to prevent Microsoft from using its H.264 patents. The cases were consolidated before Judge Robart in the Western District of Washington. Motorola also brought patent-enforcement actions before the International Trade Commission and in Germany. Microsoft alleged in an amended complaint that the filing of these injunctive orders constituted a breach of contract on the grounds that a RAND commitment bars a patent holder from seeking injunctive relief.
The proceedings before Judge Robart slowly moved forward throughout 2011 and 2012. The district court held that the RAND commitment made by Motorola to the standard-setting organizations created an enforceable contract, which standard users like Microsoft are able to enforce as third-party beneficiaries. Judge Robart determined, however, that, in order for a jury to determine whether Motorola had breached its RAND commitment, it must first know what the RAND commitment meant. In November 2012, Judge Robart held a bench trial to determine a RAND rate and range for Motorola’s H.264 and 802.11 SEPs. The court subsequently issued a 207-page order setting forth its findings of fact and conclusions of law on the appropriate RAND rate and related issues. The royalty rates and ranges determined by the court (ranging from a fraction of a cent per unit up to less than 20 cents per unit) were substantially lower than those demanded by Motorola in its initial offer to Microsoft. The case then proceeded to a jury trial on the breach of contract claim. In September 2013, the jury returned a verdict for Microsoft. The court denied Motorola’s motions for judgment as a matter of law. Motorola appealed the judgment on the breach of contract claim to the U.S. Court of Appeals for the Federal Circuit, which, on Microsoft’s motion, transferred the appeal to the Ninth Circuit (concluding that under the law of the case doctrine, the appeal properly lay with the regional circuit court that had preciously heard an interlocutory appeal in this case).
The RAND Determination
On appeal, Motorola raised two substantive issues. First, Motorola contended that the district court lacked the legal authority to decide the RAND rate issue separate from the ultimate breach of contract issue tried before the jury. Second, Motorola claimed that the district court’s legal analysis was contrary to Federal Circuit precedent as it relates to patent damages.
On the matter of the district court’s authority to conduct a bench trial to determine the RAND rate, the Ninth Circuit held that Motorola affirmatively consented to the bench trial. The court rejected Motorola’s claims that its consent was taken out of context and limited to a court-crafted license rather than determination of the RAND rate and range. The court noted that Motorola never raised, at trial or on appeal, any Seventh Amendment claim regarding its right to a jury trial on the RAND rate matter. Given Motorola’s affirmative stipulation to a bench trial for the purpose of determining the RAND rate, the court did not consider whether a jury should have made a RAND determination.
Motorola also challenged the district court’s legal analysis in its determination of the RAND rate and range. Judge Robart’s decision was the first to attempt to establish an appropriate RAND rate. The district court relied upon a modified version of a multi-factor test established in Georgia-Pacific Corp. v. U.S. Plywood Corp. and used extensively to determine damages in patent infringements cases. Georgia-Pacific lays out 15 factors for a court to consider in establishing the royalty rate that the parties to the dispute might have agreed upon in a hypothetical negotiation. One of the factors requires the court to set the time of the hypothetical negotiation at the time the infringement began. Motorola claimed that the district court incorrectly applied this factor, as interpreted and applied by the Federal Circuit.
The Ninth Circuit acknowledged that the district court had applied a “partial present-day focus” but denied this constituted error. It pointed to the Federal Circuit’s recent decision in Ericsson v. D-Link, which stated it has “never described the Georgia-Pacific factors as a talisman for royalty rate calculations,” and which recognized that some of the factors “clearly are not relevant to every case.” The court noted that the Federal Circuit had even cited Judge Robart’s decision in support of the view that many of the Georgia-Pacific factors are “contrary to RAND principles” and courts thus need to take a flexible approach to such cases. The court highlighted that Georgia-Pacific’s focus on the date of the patent infringement was inapt in a breach of contract case. It also noted the impracticality of tying the value of the patents to a particular moment in time given the evidence the parties presented. Finally the court emphasized that Motorola had neither shown, nor even argued, that it had been prejudiced by the court’s analysis. The court ultimately concluded that, given the need for flexibility in determining royalty rates for RAND-encumbered patents and given no prejudice was shown; the district court properly applied the hypothetical agreement approach.
The Ninth Circuit’s decision, coming in the wake of last year’s Federal Circuit decision in Ericsson v. D-Link, further confirms that courts will apply a flexible, fact-specific approach to determine the appropriate royalty rate in cases involving RAND-encumbered SEPs. Both the Federal Circuit and the Ninth Circuit have rejected the view that Georgia-Pacific or any other test can be rigidly applied in all circumstances. The approval of the framework employed by Judge Robarts, however, is likely to encourage its continued use as a starting point in future rate determinations.
Indeed, soon after the Western District of Washington decision by Judge Robart, Judge James F. Holderman also held bench trial (using a variation on the RAND analysis pioneered by Judge Robart) to determine RAND rates for 802.11 SEPs, as applied to manufacturers of Wi-Fi equipment in the case of In re Innovatio IP Ventures, LLC Patent Litig., Case No. 11 C 9308 (N.D. Ill. Sept. 27, 2013), another case where the parties waived a jury trial on damages,. In two other RAND cases involving the 802.11 Wi-Fi standard, Ericcson v. D-Link (ED TX, 2013) before Judge Leonard E. Davis and Realtek v. LSI (ND CA 2014) before Judge Ronald M. Whyte, the RAND determinations were made by a jury.
In light of the Ninth Circuit’s decision in Microsoft v. Motorola, practitioners should be aware that, in a breach of contract claim regarding standard-essential patents, the court may conclude that it must determine the RAND terms as a precursor to the breach of contract. By agreeing to hold a hearing on the potential RAND terms, parties must be aware that any terms devised by the court may then be used during the breach of contract proceedings. Thus, if a party does not wish for such terms to be determined and used during trial, they must clearly and un-ambiguously object to any such determination in advance of the breach of contract proceedings
Additionally, parties must be aware that the courts may not adhere strictly to the Georgia Pacific factors when determining RAND rates. Rather, courts may apply the factors flexibly and view the evidence in light of the particular circumstances of the case. If a party disagrees with the characterization of evidence or application of the Georgia Pacific factors, the party must clearly object to the application of the factors, and explain how the party would be prejudiced from deviation from the factors or consideration of the evidence.
In terms of the jurisdictional issue, it should be noted that Congress recently altered the Federal Circuit’s jurisdiction over patent-related appeals. Previously, jurisdiction was based on the nature of the well-pleaded complaint alone. However, under the America Invents Act (AIA), the Federal Circuit now has exclusive jurisdiction over appeals “in any civil action arising under, or in any civil action in which a party has asserted a compulsory counterclaim arising under, any Act of Congress relating to patents.” Since the AIA had not taken effect when Microsoft filed its complaint, the jurisdictional analysis was based on Microsoft’s breach of contract action alone. In any event, inasmuch as the district court held that Motorola’s patent claims were not compulsory counterclaims, even had the broadened appellate jurisdiction of the AIA applied, it would not have conferred Federal Circuit jurisdiction in this instance.
The Supreme Court of the United States, in a 6-3 decision, left undisturbed the rule from its 51-year-old decision in Brulotte v. Thys Co. (1964), invoking stare decisis and rejecting arguments seeking to overturn the rule barring patent royalty agreements that obligate payment of post-patent expiration royalties. Kimble v. Marvel Entertainment, LLC, Case No. 13-720 (Supr. Ct., June 22, 2015) (Kagan, Justice) (Alito, Justice dissenting). In Kimble, the Court addressed the question of whether parties to a patent license may agree that a licensee must continue paying royalties based on sales of products after the licensed patent(s) expire, and answered the question “No,” continuing the rule that such agreements are unlawful per se.
Since Brulotte was decided 51 years ago, many courts and commentators have criticized the rule it laid down as wrongly decided as a matter of economic policy. While the Kimble decision, based essentially on stare decisis, preserves the Brulotte status quo in patent licensing, Justice Kagan has now raised the profile of this judge-made rule and related economic arguments to the branch of government that the Supreme Court concluded had the exclusive power to change it: Congress.
When the Supreme Court decided Brulotte, it prohibited the extension of the “patent monopoly” beyond the term of the patent. The Court held that “a patentee’s use of a royalty agreement that projects beyond the expiration date of the patent is unlawful per se.” In other words, once the patent expires, the invention is dedicated to the public, and the patent owner cannot continue to demand royalties for use of the patented invention after expirations of the patent term. In dicta, however, the Court distinguished impermissible payments due for use of an invention during the post-expiration period from “deferred payments for use during the pre-expiration period,” which remained permissible.
In this case, an inventor (Kimble) licensed a patent on a novelty Spider Man web-slinging toy to Marvel Entertainment. The parties, unaware of Brulotte at the time of licensing, agreed to a license whereby Marvel would pay Kimble an upfront sum plus a 3 percent royalty for all sales going forward. The license agreement included no fixed term. However, after Marvel learned of the Brulotte rule, it filed a declaratory judgment action, seeking a ruling that it could cease paying Kimble royalties as of the expiration of Kimble’s patent term in 2010. The district court agreed with Marvel, and the U.S. Court of Appeals for the Ninth Circuit affirmed. (IP Update, Vol. 16, No. 8).
In affirming the Ninth Circuit, the Supreme Court rejected Kimble’s arguments seeking to overturn the Brulotte rule. Kimble argued that the economic rationale underlying Brulotte was no longer correct, and that prohibiting post-expiration royalties made it inefficient and difficult to allocate risks and rewards, especially for patented technology that may take a significant amount of time to commercialize (such as pharmaceuticals). Marvel responded simply that stare decisis required the Court to re‑affirm Brulotte.
The Supreme Court agreed with Marvel. Justice Kagan explained that stare decisis compelled adherence to Brulotte, and that there was no “special justification” for overturning it. Kagan observed that Congress could overrule the Court’s decision if Congress disagreed with it, and noted that Congress had actually not changed the rule despite repeated amendments of the patent laws since the Court’s Brulotte decision. In an apparent nod to the subject matter of the Marvel Spider Man product, Justice Kagan intoned that the rule of stare decisis is “super powered” and it would require “super special justification” to overturn Brulotte.
After summarizing Kimble’s economic criticisms of the rule in Brulotte—namely that the Brulotte Court was mistaken about the anticompetitive effect of post-expiration royalties and that the rule in Brulotte stifled innovation—the Supreme Court explained that even if true, such arguments provided no grounds to deviate from stare decisis. Accordingly, the Supreme Court affirmed the rule that “when the patent expires, the patentee’s prerogatives expire too, and the right to make or use the article, free from all restriction, passes to the public.” The Court added that post-expiration royalty obligations “conflict with patent law’s policy of stablishing a ‘post-expiration … public domain’ in which every person can make free use of a formerly patented product.”
The Court also re-confirmed the dicta in Burlotte distinguishing between permissible and impermissible licensing structures. For example, the Court wrote:
[P]arties can often find ways around Brulotte, enabling them to achieve those same ends. To start, Brulotte allows a licensee to defer payments for pre-expiration use of a patent into the post-expiration period; all the decision bars are royalties for using an invention after it has moved into the public domain. A licensee could agree, for example, to pay the licensor a sum equal to 10% of sales during the 20-year patent term, but to amortize that amount over 40 years. That arrangement would at least bring down early outlays, even if it would not do everything the parties might want to allocate risk over a long timeframe. And parties have still more options when a licensing agreement covers either multiple patents or additional non-patent rights.
Thus, the Court acknowledges that deferred payments, if based on activity occurring before the patent expiration, are permissible.
Justice Alito (joined by Chief Justice Roberts and Justice Thomas) dissented, asserting that Brulotte was not based on interpretation of the Patent Act, but based on economic theory, which has been “debunked.” The dissent further argued that Patent Act did not demand that the royalty term be compressed to fall within the patent term, and that there are often “good reasons why parties sometimes prefer post-expiration royalties over upfront fees.” For example, such arrangements may yield economic efficiencies where parties are “unsure whether a patented idea will yield significant economic value, and it often takes years to monetize an innovation.” The dissent also explained that the majority decision undermined the parties’ agreed-upon bargain and expectations. Finally, the dissent argued that stare decisis should not insulate Brulotte.
The Kimble decision may yield at least three consequences.
First, Kimble is a reminder to patent holders, patent licensees and patent practitioners alike of the permissible ways that they can structure royalties due for conduct during the period covered by a patent without incurring Brulotte’s—and now Kimble’s—per se rule against post-expiration royalties. As it did for Kimble, the Brulotte rule creates a trap for the unwary.
Second, having considered this matter a second time, and Justice Kagan’s invitation for legislative attention if Congress disagreed with Brulotte, the Kimble decision may motivate Congress to reconsider bills that it has previously “rebuffed” and that “would have replaced Brulotte’s per se rule with the same antitrust-style analysis Kimble now urges.” Of course, Congress itself may prefer the ease of applying the rule from Brulotte as contrasted with, in the Court’s words, the “elaborate” rule-of-reason inquiry, with its “notoriously high litigation costs and unpredictable results.”
Third, going forward, parties will likely take increased care in drafting licenses to take advantage of the Incredible-Hulk-sized exception to the Brulotte rule, i.e., that a license can be structured to provide for “deferred,” “post-expiration” royalties based on pre-expiration use of a licensed patent. The Court clarified Brulotte’s distinction between impermissible enforcement of a patent to preclude post-expiration infringement, and permissible “deferred payments” based on infringing activities occurring before patent expiration. This reinforces the ability of parties to contractually agree to alternative payment arrangements. For example, instead of paying up-front royalties, Kimble acknowledges that parties may contractually extend royalty obligations beyond the life of the patent in the form of “deferred payments,” provided the royalty obligation is premised on pre-expiration use of the patented technology.