March 19, 2012
LES Insights
Authored by Uttam G. Dubal, D. Brian Kacedon and John C. Paul
Royalty disputes under patent-license agreements often arise when there are multiple licensed entities in the supply chain. In particular, disputes often center on whether the manufacturer of a product or the ultimate seller should be responsible for paying the royalties due for a product. Resolving such disputes often requires analysis of whether the sale by the manufacturer-licensee prevents the patent holder from collecting royalties from the seller-licensee based on the doctrine of patent exhaustion. That doctrine generally provides that the first authorized sale of a patented product prevents the patent owner from controlling the further use and resale of that product. In a recent decision in MPEG LA, LLC v. Audiovox Electronics Corp.,1 the trial court in Suffolk County, New York, explored this issue and determined that under the contract at issue the ultimate seller was responsible for paying royalties under the parties' license.
MPEG LA administers a pool of patents that cover digital-compression technology used in consumer digital-video products and offers patent licenses for such products. MPEG LA granted one such license to Audiovox Electronics Corporation to sell products using the patented technology. Audiovox resold to end users products (primarily DVD players) made by others including other MPEG LA licensees. MPEG LA brought suit against Audiovox for breach of contract based on the alleged failure to pay royalties due under the agreement.
Before the court were MPEG LA's motion for summary judgment on its breach of contract claims and Audiovox's motion to renew its prior motion for summary judgment on various contractual defenses. MPEG LA's motion for summary judgment argued that Audiovox breached its contract by not paying royalties on those products manufactured by other MPEG LA licensees but later sold to end users by Audiovox. In particular, MPEG LA claimed that the parties' license agreement required royalties to be paid by the entity who sold the products to an end user. As such, it was Audiovox and not its suppliers' responsibility to pay royalties under any license with MPEG LA.
In response, Audiovox argued that MPEG LA's breach of contract claims should be dismissed because the sale of the products by a MPEG LA licensee to Audiovox triggered patent exhaustion and thus terminated all MPEG LA's patent rights. Thus, in its view, MPEG LA could not require Audiovox to pay royalties on such products regardless of whether those suppliers had paid royalties to MPEG LA. In support, Audiovox also noted that during the litigation MPEG LA had amended its standard license agreement to make explicit that a sale by a supplier was not licensed if no royalties were paid and that it was the licensee who sold the licensed product to the end user who was responsible for paying royalties. Audiovox argued that the changed wording showed that the version of the standard license agreement signed by Audiovox required Audiovox's suppliers to pay royalties and as such the sales by those suppliers were exhausting. MPEG LA responded by arguing that patent exhaustion is a defense only to a claim of patent infringement but not to breach of contract.
The court first addressed the question of whether patent exhaustion may be asserted as a defense to a claim of breach of contract. The court noted that the Supreme Court's recent pronouncements on patent exhaustion in Quanta Computer, Inc. v. LG Electronics, Inc. as well as recent Federal Circuit case law seemed to indicate that even when patent exhaustion barred an infringement claim against a licensee, a licensor might still have a remedy for breach of contract against its licensee. Based on these cases, the court then held that while patent exhaustion may be a defense to a breach of contract claim, it does not always prevent such a suit. Rather, a court would need to examine the language of the contract to determine if exhaustion could act as a defense to such a claim. In this particular case, because the royalty provisions required payment on products that "infringed" the licensed patents, exhaustion could be a defense to MPEG LA's claim.
The court next went on to determine whether exhaustion actually barred MPEG LA's claims. Based on the language of the contract, the court found that the only relevant "authorized sales" under the license agreement were those of the MPEG Decoding Device to end users (i.e., consumers), because the agreement defined "Sale" as the "distribution of an MPEG-2 Royalty Product to an end user either directly or through a chain of distribution." As the definition set forth in the agreement was clear, the court refrained from considering any extrinsic evidence including the change to MPEG LA's standard agreement. As such, the sale of those products by Audiovox's suppliers to Audiovox were not exhausting and thus, patent exhaustion was no defense to MPEG LA's breach of contract claims.
Next, the court addressed MPEG LA's motion for summary judgment. The court found that MPEG offered sufficient evidence to meet its initial burden by showing a breach of contract claim for unpaid royalties for products sold to end users by Audiovox. The court also considered Audiovox's three affirmative defenses—equitable estoppel, waiver, and failure to mitigate damages—and determined that Audiovox presented sufficient evidence to show genuine issues of material fact that precluded the granting of summary judgment.
Regarding equitable estoppel and waiver, the court highlighted testimony by MPEG LA's CEO that a website's list of licensees in good standing was updated continuously and was meant to display names of the entities that had paid their respective royalties. The court found that Audiovox was entitled to demonstrate at trial that it relied on such statements by MPEG LA to its financial detriment in paying millions of dollars to its suppliers. The court also noted an email from MPEG LA stating that any company making MPEG-2 products "needs the essential patent rights the License provides[.]" Regarding the defense of failure to mitigate damages, the court determined that whether MPEG LA's alleged refusal to accept payments from a major Audiovox supplier for Audiovox products was reasonable must be determined by the trier of fact.
This case demonstrates that the doctrine of patent exhaustion does not necessarily prevent a patentee from suing a licensee for alleged breach of contract, although exhaustion may, in certain circumstances, provide a defense of that alleged breach. In addition, it demonstrates the manner in which a licensor could draft a license agreement to place the royalty burden on the ultimate seller of products to the consumer while still licensing other entities in the supply chain.
1 The MPEG LA v. Audiovox decision: http://law.justia.com/cases/new-york/other-courts/2011/2011-21260.html or http://caselaw.findlaw.com/ny-supreme-court/1575836.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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