July 30, 2012
LES Insights
By John C. Paul; D. Brian Kacedon; Christopher L. McDavid
Authored by D. Brian Kacedon, Christopher L. McDavid, and John C. Paul
In Lear, Inc. v. Adk ins, 395 U.S. 653 (1969), the Supreme Court abolished the doctrine of licensee estoppel, which acted to prevent a licensee from challenging the validity of patents it has licensed. The Court justified its ruling by explaining that the important public interest in eliminating invalid patents outweighs the competing interest that a party be bound by the terms of a contract. In particular, the Court observed that "[l]icensees may often be the only individuals with enough economic incentive to challenge [the patents]."
Lear did not directly address the enforceability of an express provision in a license agreement barring future validity challenges (a "no-challenge" clause). But several courts have subsequently read Lear to bar the enforcement of such clauses generally, while permitting their use in certain circumstances such as in consent judgment or agreements in settlement of litigation. See, e.g., Flex-Foot, Inc. v. CRP, Inc., 238 F.3d 1362 (Fed. Cir. 2001); Foster v. Hallco Mfg. Co., Inc., 947 F.2d 469, 474-75 (Fed. Cir. 1991). The potential enforceability of such clauses has become a subject of renewed interest, however, because of the Supreme Court's decision in Medimmune, Inc. v. Genentech, Inc., 549 U.S. 118 (2007), which held that a patent licensee need not breach its license agreement to seek a declaratory judgment of patent invalidity. Due to this decision, licensors are increasingly searching for ways to create disincentives to such challenges including the use of such "no-challenge" clauses.
Recently, the Court of Appeals for the Second Circuit in Rates Technology, Inc. v. Speak easy, Inc.,1 No. 11-4462-cv, 2012 WL 2765081 (2d Cir. July 10, 2012), applied Lear to a settlement ("covenant not to sue") agreement entered into before litigation has commenced. The court held that "covenants barring future challenges to a patent's validity entered into prior to litigation are unenforceable, regardless of whether the agreements containing such covenants are styled as settlement agreements or simply as license agreements."
Plaintiff Rates Technology, Inc. ("RTI") owns two patents relating to automatic routing of telephone calls based upon cost. In 2007, RTI notified Speakeasy, Inc. of its belief that Speakeasy was infringing RTI's patents. RTI offered to settle its claim, however, in exchange for a one-time payment based on the size of the accused infringer's sales.
Shortly thereafter, the parties entered into a settlement agreement in the form of a "covenant not to sue." RTI promised not to sue Speakeasy for any past or future infringement in exchange for a one-time payment of $475,000. Later to become the subject of this dispute, the agreement included a "no-challenge" provision barring Speakeasy from ever challenging, or assisting others in challenging, the validity of the patents. The agreement provided for liquidated damages of $12 million if Speakeasy breached this "no-challenge" clause.
Speakeasy later became affiliated with Covad Communications Co., which RTI also accused of infringing the patents. Covad responded by filing a declaratory-judgment action challenging the patents' validity and enforceability. RTI then sued Speakeasy in the Southern District of New York for allegedly violating the "no-challenge" clause, asserting that Speakeasy assisted Covad in challenging the validity of the patents and seeking to enforce the liquidateddamages provision. The district court dismissed RTI's complaint for failure to state a claim, holding the "no-challenge" clause unenforceable under the public-policy concerns articulated in Lear. RTI appealed.
The Second Circuit evaluated the enforceability of the "no-challenge" clause by employing Lear's balancing test, which weighs the policy concerns of patent law—the public interest against invalid patents—against the countervailing policy of enforcing contracts. Applying the test, the Second Circuit held that the "no-challenge" clause was unenforceable. The timing of the agreement was critical to the court's decision; the parties agreed to the "no-challenge" clause prior to litigation. According to the court, if parties had already conducted discovery in litigation before entering into an agreement, that would have suggested a genuine dispute in which the alleged infringer had an opportunity to assess the patents' validity before abandoning its right to challenge them. But enforcing a "no-challenge" clause entered into prior to litigation "would significantly undermine the public interest in discovering invalid patents."
Realizing that licensors may seek to couch their prelitigation agreements as "settlement agreements," the Second Circuit's opinion emphasized that its decision rested on the timing of the agreement, not on how the parties styled the agreement. In fact, the court explicitly recognized that the important policy interests favoring settlement may support enforcement of "no-challenge" clauses in settlements entered into after the initiation of litigation.
The Second Circuit's opinion suggests that, whether styled as a license agreement, settlement agreement, or covenant not to sue, "no-challenge" clauses entered into prior to litigation are unenforceable due to public-policy concerns under Lear. Licensors may wish to consider, however, the use of other tactics to create disincentives for licensees to challenge licensed patents, short of "no-challenge" clauses. Agreements may include, for example, a termination clause in the event of a licensee challenge or a provision providing that disputes over invalidity be brought only in certain forums. Even those other tactics, however, may face judicial scrutiny under Lear.
1 The Rates Technology decision may be found at: http://caselaw.findlaw.com/us-2nd-circuit/1605675.html.
Copyright © Finnegan, Henderson, Farabow, Garrett & Dunner, LLP. This article is for informational purposes, is not intended to constitute legal advice, and may be considered advertising under applicable state laws. This article is only the opinion of the authors and is not attributable to Finnegan, Henderson, Farabow, Garrett & Dunner, LLP, or the firm's clients.
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