24 June 2015
In Kimble v. Marvel Entertainment, LLC the US Supreme Court, while acknowledging the criticism of other judges and scholars, chose to uphold the long-standing rule in Brulotte v. Thys Co., 379 U.S. 29 (1964), that renders unenforceable an agreement requiring payment of royalties for a patent after that patent expires. While Brulotte remains good law, Kimble enumerates several Supreme Court-sanctioned workarounds for parties seeking to extend royalty fee payments beyond the life of a patent.
Summary of Kimble Decision
Petitioner Stephen Kimble invented and obtained a patent on a hand-worn toy that allows users to mimic Marvel’s Spider-Man by shooting pressurized foam string. After failed licensing discussions and litigation, Marvel agreed to pay Kimble a lump-sum payment and a perpetual 3 percent royalty for Marvel’s future sales of web-slinging toys.
Later, after Marvel “stumbled across” Brulotte, the company sought declaratory judgment that it no longer needed to pay royalties after Kimble’s patent expired. Based on Brulotte, the district court granted Marvel the relief it sought, and the Ninth Circuit (grudgingly) affirmed.
On appeal to the Supreme Court, Kimble argued that Brulotte should be overturned in favor of a case-by-case analysis of post-expiration royalty clauses under a “rule of reason” analysis. But the Court rejected that argument, explaining that overruling Brulotte would further complicate the law and risk upturning a stable legal principle on which license drafters rely. Bowing to stare decisis and opining that Congressional action is the proper means for change, the Court declined to overturn Brulotte and affirmed the decision rendering Kimble’s licensing agreement unenforceable.
Justice Alito (joined by Chief Justice Roberts and Justice Thomas) dissented. His dissent argued that Brulotte was based on a “debunked” economic theory, “interferes with the ability of parties to negotiate licensing agreements that reflect the true value of a patent, and … disrupts contractual expectations.” Justice Alito found nothing in the Patent Act that forbids post-expiration royalty payments, calling the Brulotte decision “a bald act of policymaking.”
Although it declined to abolish the Brulotte rule, the Supreme Court provided licensors with clear justification for several workarounds in use. First, the Court instructed that “Brulotte allows a licensee to defer payments for pre-expiration use of a patent into the post-expiration period.” With careful drafting, this should allow parties to agree to royalty terms during the patent term but spread the payments over a longer period. However, payments in post-expiration royalty periods should not be tied to post-expiration sales. Instead, parties may need to rely on sales projections for the period immediately following termination to set the overall rate.
Second, parties may continue royalty payments past a patent’s expiration date when post-expiration payments are tied to a non-patent right, such as trade secrets. For example, Brulotte and Kimble permit so-called step-down agreements, in which a party pays a higher rate for both patent and non-patent rights while the patent is in force, and a lower rate after the patent expires. This also applies for rights “closely related to a patent,” according to the Court. Parties will need to take care to have a business justification for the amount of the step-down. In one example from a prior decision, the Supreme Court held that the practice of specifying an ongoing (but lower) royalty payment for patent-pending technology if a patent never issues passes muster under Brulotte.1
Third, the Court explained that Brulotte does not bar “business arrangements other than royalties—all kinds of joint ventures, for example.” However, complex business arrangements may not make sense in most simple licensor/licensee scenarios. If possible, parties can consider ongoing technical services under the license to justify ongoing payments.
Although Brulotte remains in force, the Supreme Court has highlighted several holes in its application. Parties now have additional justification for several options for circumventing the ban on post-expiration royalties—including by stretching pre-expiration payments beyond the patent term, tying post-expiration royalties to non-patent rights, and employing non-royalty business arrangements.
1 See Aronson v. Quick Point Pencil Co., 440 U.S. 257 (1979) (upholding a license agreement whereby the parties agreed to a 5 percent royalty rate for the life of the patent in the event the patent issued and, if no patent issued, a 2.5 percent royalty rate for as long as the licensee sold products practicing the technology).