Still Unlawful to Charge Patent Royalties Beyond Patent’s Expiration Date

In July 2013, the The Ninth Circuit U.S. Court of Appeals in Kimble v. Marvel Enterprises Inc., No. 11-15605 (9th Cir. July 16, 2013), followed the Supreme Court’s holding in Brullote v. Thys Co., 379 U.S. 29 (1964). In Brullote, charging patent royalties beyond a patent’s expiration date is “unlawful per se.”

In Kimble, the dispute arose in the context of a hybrid intellectual property agreement involving a bundle of patent, trade secret, and other intellectual property rights. In the agreement, there was a single royalty rate beyond the expiration date of the patent included in the bundle of rights. The Ninth Circuit, like others, extensively criticized Brulotte, noting that applying the Brulotte rule to the instant hybrid agreement likely resulted in the agreement having less actual value than the parties understood when they entered into the agreement. The court reasoned that absent “a discounted rate for the non-patent rights [a ‘step-down’] or some other clear indication that the royalty at issue was in no way subject to patent leverage” in the agreement, even though the “patent leverage in this case was vastly overshadowed” by non-patent rights, the ability to collect royalties beyond the life of the patent is improper.

The U.S. Supreme Court (USSC) in Brullote held royalty payments beyond the expiration date of a patent unlawful per se. The Brullote court viewed such royalties as impermissibly extending the duration of a patent monopoly. The USSC rejected arguments that post-expiration royalties were merely deferred payments for use of a patent during the pre-expiration period. The USSC also refused to conjecture what the parties’ bargaining position would have been and what agreement might have resulted had post-expiration royalties been separated from the patent. Later in Aronson v. Quick Point Pencil Co., 440 U.S. 257 (1979), the USSC clarified that patent law permits indefinite royalty payments where no patent is ultimately issued. The Aronson decision largely turned on the fact that the parties had agreed to a 5% royalty, but if a patent application was not allowed within five years, the royalty stepped-down to 2.5%.

The Kimble dispute arose over a Spider-Man Web Blaster toy. Kimble contended he had met with a representative of Marvel Entertainment’s predecessor, Toy Biz, and shared ideas Kimble had about a gloved toy that could shoot foam string. Some of those ideas were allegedly covered by a then-pending patent application of Kimble. Kimble further contended that the Toy Biz representative promised to compensate him if it used any of his ideas.

After the meeting, Marvel launched their foam-string-shooting Spider-Man Web Blaster, and Kimble sued for patent infringement and breach of contract. The trial court proceeded to grant Marvel’s motion for summary judgment of non-infringement of the patent, and sent the contract claim to a jury. The jury found breach of contract, and awarded Mr. Kimble 3.5% of the past, present and future net product sales of the Web Blaster.

Both sides appealed, and a settlement was eventually reached. Under the settlement, Marvel bought the patent for about $500,000, plus 3% of “net product sales” as the term was used in the judgment (which had no time limit). The settlement agreement also stated that new product sales “shall be deemed to include product sales that would infringe the Patent but for the purchase and sale thereof pursuant to this Agreement as well as sales of the Web Blaster product that was the subject of the Action and to which the Judgment refers.” Marvel’s counsel conceded at oral argument that the parties were not then aware of Brulotte. (Whoops!)

Royalty payment disputes eventually erupted among the parties, and a new lawsuit emerged. In it, Marvel reaffirmed its view that the Web Blaster did not infringe the patent, but also sought a declaration that it was no longer obliged to pay royalties as the patent had expired. The district court found the settlement agreement to be a “hybrid” rights agreement and that royalty payments therefore had to stop upon the patent’s expiration.

In affirming, the Ninth Circuit joined other circuits in interpreting Brullote and Aronson as prohibiting indefinite royalties under hybrid agreements encompassing inseparable patent and non-patent rights. Therefore, to be enforceable under Brullote, an agreement with a royalty running after a patent expires needs to either include a discount for the non-patent rights from the patent-protected rate (often termed a “step-down”) or, in the absence of a discount, “some other clear indication that the royalty was in no way subject to patent leverage.” Applying these principles to Kimble and Marvel, the Ninth Circuit deemed the rights in the settlement agreement to be an intertwined hybrid and so applied the Brullote rule to affirm the judgment that royalties were no longer payable under the settlement agreement.

The Ninth Circuit did so reluctantly. It noted that the case arguably deprived Kimble of part of his bargain based on a technical detail the parties at the time deemed insignificant. It criticized the logic behind Brullote, quoting extensively from similar criticisms of the case from the Seventh Circuit. Observing that any patent leverage in the case before it was “vastly overshadowed” by non-patent rights and that Kimball probably would have sought a higher royalty had the parties understood the effect of the Brullote rule, the court cited the binding nature of Brullote as the key reason for applying it to the settlement agreement

This case illustrates the complexities involved in negotiating and drafting royalty provisions in intellectual property agreements. Parties often want to create simple, easy to manage payment arrangements that do not necessarily require them to try to negotiate allocations of future value to particular kinds of intellectual property or create complicated payment structures. The Brullote rule must be kept in mind. Parties must carefully draft royalty and other future payment schemes involving bundles of patent and non-patent rights to comply with judicial precedent.