Royalty Payments for Hybrid Patent and Technology Rights Should Decrease After the Patents Expire or Be Shown Not to Be Subject to Patent Leverage

By D. Brian Kacedon, Douglas W. Meier, and John C. Paul

Inventor Stephen Kimble invented a Spider-Man toy that allowed a user to "role play" as Spider-Man by mimicking Spider-Man's web-shooting abilities with foam string. Mr. Kimble got a patent on this toy, which expired in May 2010. In late 1990, Mr. Kimble met with the president of Marvel's predecessor to discuss his idea, which was covered by the then-pending application for what would become Mr. Kimble's patent. According to Mr. Kimble, Marvel agreed that it would pay him if it used any of his ideas. Later, Marvel told Mr. Kimble that it was not interested in his ideas. Nevertheless, Marvel then started making a toy similar Mr. Kimble's idea, which it called the "Web Blaster."

In 1997, Mr. Kimble sued Marvel for patent infringement and breach of contract, claiming that Marvel had used his ideas to develop the Web Blaster without paying him. The court granted Marvel's motion for summary judgment of noninfringement on the patent claim, but the case went to trial on the contract claim. The jury sided with Mr. Kimble, and the court awarded him 3.5% of past, present, and future Web Blaster net sales. Kimble appealed on the patent-infringement claim, and Marvel appealed on the contract claim.

In 2001, while the appeals were still pending, the parties agreed to settle the case. Marvel agreed to buy the patent from Mr. Kimble. The parties also agreed to a release, under which Mr. Kimble released Marvel except for Marvel's obligations under the settlement agreement itself, and except for those obligations under the alleged verbal agreement that was the subject of the action. The settlement agreement had no expiration date and did not include any specific time limit on Marvel's obligation to pay 3% of net product sales.

The parties coexisted for several years without any significant disagreement. Web Blaster sales were significant and Marvel paid over $6 million in royalties to Mr. Kimble. Then, in 2006, disagreements arose between Marvel and Mr. Kimble over the royalties, including the calculation of the royalty payments for subsequent iterations of the Web Blaster that included additional functions or that were packaged with other role-play toys.

Mr. Kimble sued again, and Marvel counterclaimed, seeking a declaration that it was no longer obligated to pay Kimble under the settlement agreement based on the sales of products after the expiration of Mr. Kimble's patent. The district court referred the summary-judgment motions to a magistrate judge, who found that under Brulotte, Mr. Kimble could not recover royalties under the settlement agreement beyond the expiration date of the patent. The magistrate judge reasoned that the settlement agreement transferred patent rights and that it was less clear that it transferred any nonpatent rights. He observed that the release clause suggested that Mr. Kimble reserved the nonpatent rights from the verbal agreement and did not transfer them to Marvel. Alternatively, he found that Brulotte applied because the settlement agreement was a "hybrid" agreement transferring inseparable patent and nonpatent rights, and because the patent rights were used as leverage to negotiate the agreement. Over Mr. Kimble's objection, the district court adopted the magistrate's recommendation. Specifically, the district court found that the agreement did not distinguish between royalties for patent and nonpatent rights and therefore the agreement was a "hybrid" and that the royalties had to end when the patent expired. The parties appealed.

Decision

On appeal, the Ninth Circuit began its analysis by reviewing Brulotte. In Brulotte,¹ the Supreme Court held that a patentee's use of a royalty agreement projecting beyond the expiration date of the patent is unlawful per se, explaining that Congress had granted inventors the exclusive rights to their discoveries for a limited time, after which the rights become public property. According to the Court, any attempt to reserve or continue the patent monopoly after expiration runs counter to the policy and purpose of the patent laws, regardless of what legal device is employed. But in a later decision, Aronson,² the Supreme Court found that patent law did not preclude the enforcement of an agreement to provide royalty payments indefinitely where no patent had issued. In Aronson, a company had agreed to pay a 5% royalty to an inventor for the exclusive right to sell her invention, but if the patent application was not allowed within five years, the company would pay 2.5% to the inventor as long as it continued to sell the invention. A patent never issued on the application, and the company ultimately sued, seeking a declaration that the contract for the 2.5% royalty was preempted by patent law. The Court found that the agreement was not inconsistent with patent-law principles because it did not withdraw any idea from the public domain. The Court noted that the inventor had disclosed the design to the party in confidence and, had the party tried to exploit the design in breach of that confidence, it would have risked legal liability. The Court also accepted that if the inventor had obtained the patent, she would have received a 5% royalty only on sales during the life of the patent.

The distinction between the contracts in Brulotte and Aronson rested, according to the Supreme Court, on the fact that the extended-royalty term in Aronson was not negotiated with the leverage of a patent but rested on the contingency that no patent would issue within five years.

Because of these decisions, according to the Ninth Circuit in Marvel,³ several other circuits have applied the Brulotte rule to preclude payment of royalties beyond the expiration date of patents under so-called hybrid agreements encompassing inseparable patent and nonpatent rights. The Ninth Circuit phrased the rule as "a license for inseparable patent and nonpatent rights involving royalty payments that extends beyond a patent term is unenforceable for the post-expiration period unless the agreement provides a discount for the nonpatent rights from the patent-protected rate."

Applying this rule to the situation between Mr. Kimble and Marvel, the Ninth Circuit upheld the district court's finding that the settlement agreement was a hybrid and that the royalties had to end when the patent expired. Specifically, the court noted that the agreement plainly involved one royalty rate for both patent and nonpatent rights, with no discount or other clear indication that the Web Blaster royalties were not subject to patent leverage. At the time the parties negotiated the agreement, the patent-infringement claim was not definitively resolved. The district court had found that the Web Blaster did not infringe the patent, but Mr. Kimble was appealing that decision. Because the infringement claim remained disputed, the parties could resolve their dispute only by including Web Blaster sales in a patent license.

In addition, the settlement agreement did not include a discounted rate for the nonpatent rights. As the court explained, the point of requiring a discount from the patent-protected rate is that it shows that the royalty at issue was not subject to patent leverage. The court found that even though a discounted rate may not be necessary to avoid Brulotte in every case, in the absence of a discounted rate, some other clear indication must show that the royalty was in no way subject to patent leverage.

The Ninth Circuit noted that it did not necessarily agree with the conclusion but that it was bound to follow Supreme Court precedent and that it was also guided by the "particularly strong national uniformity concerns" present in patent cases.

Strategy and Conclusion

This case demonstrates the value of drafting settlement agreements that separate the compensation for patent rights and nonpatent rights. To the extent nonpatent rights are involved, it is useful to be able to show that those rights are not subject to patent leverage if the patentee intends to maintain rights to compensation after the patents expire.

Endnotes
¹ The Brulotte decision can be found at http://scholar.google.com/scholar_case?q=brulotte&hl=en&as_sdt=20000003&case=16958573214093141655&scilh=0. 

² The Aronson decision can be found at http://scholar.google.com/scholar_case?q=aronson&hl=en&as_sdt=20000003&case=3272869600785657356&scilh=0.

³ The Kimble v. Marvel Enterprises Inc. decision can be found at http://www.finnegan.com/files/upload/LES_Insights_Column/2013/Kimble_v_Marvel.pdf.

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