Supreme Court Gives Licensees a Leg Up

In an 8-1 decision on January 9, 2007, the U.S. Supreme Court ruled that a patent licensee is not required to terminate or breach its license agreement before it can seek a declaratory judgment that the licensed patent is invalid, unenforceable or not infringed.  MedImmune, Inc. v. Genentech, Inc., et al., No. 05-608, 549 U.S. ___ (2007). The Court overturned a decision by the Court of Appeals for the Federal Circuit, which upheld dismissal of the suit for lack of subject-matter jurisdiction.  MedImmune, Inc. v. Genentech, Inc., et al., 427 F. 3d 958 (2005). In doing so, it rejected Federal Circuit decisions holding that a licensee must have a reasonable apprehension of suit, generally by ceasing to pay royalties, before a Federal court could have subject-matter jurisdiction over a declaratory judgment complaint alleging patent invalidity.  See Gen-Probe Inc. v. Vysis, Inc., 359 F. 3d 1376 (2004). Breaching a license agreement by not paying royalties puts the licensee at risk for an injunction and treble damages for willful infringement, if its challenge is unsuccessful.  Now, licensees can rely on the safety net of the license agreement and challenge the licensed patent without any downside risk. Clearly, this decision shifts the balance of power between licensors and licensees, and it creates significant uncertainties for licensors. It will encourage many licensees to attempt to renegotiate their agreements, and it is likely to lead to a host of lawsuits, as licensees challenge agreements and as licensors, licensees, and the lower courts sort out its implications.

Background

MedImmune makes Synagis, a drug used to prevent certain respiratory tract infections in infants and young children. The product has accounted for more than 80% of the company's revenue from sales since 1999. In 1997, MedImmune had entered into a license agreement with Genentech to license a patent (known as Cabilly I after its inventor) relating to the production of chimeric antibodies and a patent application relating to the co-expression of immunoglobulin chains in recombinant host cells.

Shortly after the application issued in December 2001, Genentech delivered a letter to MedImmune expressing its belief that Synagis was covered by the patent (known as Cabilly II) and stating its expectations that MedImmune would pay royalties starting March 1, 2002. MedImmune believed the patent to be invalid, unenforceable and not infringed by Synagis and, therefore, that no royalties were due. However, it considered the letter to be a clear threat to enforce the patent and, therefore, paid the royalties under protest.

The Cabilly II patent is broadly directed to the production of recombinant antibodies, which constitute a significant portion of current blockbuster biotech drugs. Genentech has widely licensed Cabilly II and reportedly earns $200M - $300M per year in royalties. The breadth of the patent and the manner in which it came to be issued have been criticized, and it is currently under re-examination in the U.S. Patent and Trademark Office.

MedImmune filed a declaratory judgment action ("DJ action") on April 11, 2003, alleging that the Cabilly II patent resulted from a collusive and fraudulent interference settlement between Genentech and Celltech R&D, Ltd., also a defendant in this case. Because of the time involved in the interference and a subsequent court proceeding, the settlement resulted in the extension of patent protection on the technology from March 28, 2006, the expiration date of Cabilly I, to December 18, 2018, the expiration of Cabilly II. The District Court granted Genentech's motion to dismiss for lack of subject-matter jurisdiction, relying on the Federal Circuit's decision in Gen-Probe. Gen-Probe had held that a patent licensee in good standing could not establish a case or controversy under Article III of the Constitution with regard to validity, enforceability or scope of the patent because the license agreement "obliterate[s] any reasonable apprehension" that the licensee will be sued for infringement.  Id., at 1381. The Federal Circuit affirmed the District Court, also relying on Gen-Probe. 427 F. 3d 958 (2005).

Supreme Court Opinion

The principal issue in the case was whether or not the Federal courts had jurisdiction over the dispute. Article III of the Constitution limits the jurisdiction of the Federal courts to "cases" and "controversies."  This limitation is reflected in the Declaratory Judgment Act, 28 USC § 2201(a), which permits the Federal courts to "declare the rights…of any interested party" in "a case of actual controversy within its jurisdiction…." (Emphasis added.) 

In addressing this issue, Justice Scalia, writing for the Court, reviewed the history of Supreme Court decisions dealing with the compatibility of DJ actions with Article III.  He noted that there was no bright-line test and concluded by quoting from Maryland Casualty Co. v. Pacific Coal & Oil Co., 312 US 270, 273 (1941): "Basically, the question in each case is whether the facts alleged, under all the circumstances, show that there is a substantial controversy, between parties having adverse legal interests, of sufficient immediacy and reality to warrant the issuance of declaratory judgment." The Court noted that the Maryland Casualty standard would have been satisfied if MedImmune had taken the final step of refusing to pay the royalties and noted further that "[t]he factual and legal dimensions of the dispute are well defined and, but for the petitioner's continuing to make royalty payments, nothing about the dispute would render it unfit for judicial resolution." Slip Opinion at p. 9.

In holding that it was not necessary for MedImmune to terminate the agreement, or breach it by refusing to pay royalties, for jurisdiction to apply under the Declaratory Judgment Act, the Court relied on Altvater v Freeman , 319 US 359 (1943), which held that a licensee's failure to stop paying royalties did not render non-justiciable a dispute over the validity of the patent. In that case, several patentees had sued their licensees to enforce territorial restrictions in the license. The licensees filed a counterclaim for a declaratory judgment that the underlying patents were invalid, in the meantime paying "under protest" royalties required by an injunction that the patentees had obtained in an earlier suit. The Court in that case had rejected the patentees' argument that there was no real controversy as long as the licensees continued to pay royalties, noting that the royalties were being paid under protest and under compulsion of an injunction.

Justice Scalia noted that the Federal Circuit's Gen-Probe decision had distinguished Altvater on the ground that it involved the compulsion of an injunction. However, the Court did not find this distinction significant. According to Scalia, Altvater did not say that the coercion was governmental, but suggested the opposite; i.e., that the coercion was of a private nature. The licensees could stop payments in defiance of the injunction, but the consequence of doing so would be to risk actual and treble damages in infringement suits by the patentees. Significantly, according to Scalia, the opinion did not mention the threat of prosecution or contempt or any type of governmental action. However, Justice Scalia failed to mention that the lower courts had found that the license had been terminated. Therefore, the "licensees" were at risk, and Altvater would appear to be no more relevant to the facts of this case than any other case where the licensee had breached or terminated the agreement.

Genentech had argued that there was no substantial controversy because the dispute had been settled when the parties entered into the 1997 license agreement. The agreement immunized MedImmune from suit for infringement as long as it paid the royalties. According to Genentech, permitting a patent validity challenge, without a breach of the agreement, alters the deal. In rejecting this argument, the Court said that there was nothing in the contract prohibiting such a challenge.

Genentech had also argued that, under the common law, a party to a contract cannot challenge its validity and continue to reap its benefits. The Court responded that MedImmune was not repudiating the contract. Instead, it was asserting that the contract, as properly interpreted, does not prevent it from challenging the patent and does not require the payment of royalties because the product does not infringe any valid claim.

Thus, the Court viewed the case as a contract dispute as to whether or not royalties were due, and it held that there was a sufficient controversy for the suit to go forward. The fact that the contract had not been breached or terminated, and the fact that the resolution of the contract dispute would require a determination of the validity, enforceability and infringement of the underlying patent, were irrelevant.

Dissent

The lone dissenter, Justice Thomas, took a very different view of the issues. Without a breach, he saw the case as a hypothetical one. He also disagreed with the court's characterization of the case as a contractual dispute, stating that MedImmune simply alleged that it is not bound by the contract because the patent is invalid. However, Thomas noted that the license required the company to pay royalties until the relevant claims were held invalid by a competent body, which had not happened. He stated that patent invalidity was an affirmative defense, not a freestanding cause of action.  Therefore, neither Genentech nor MedImmune had a cause of action against the other. According to Thomas, MedImmune's request for declaratory relief was only a request for an advisory opinion about an affirmative defense it might use in some future litigation. Lastly, he found Altvater to be inapplicable because of the lower courts' findings that the license had been terminated prior to the filing of the case.

Implications

The decision dramatically changes the relationship between licensors and licensees, creates more uncertainty for licensors and is likely to lead to increased litigation.

The decision will certainty make it easier for licensees to challenge the validity of licensed patents. To the extent that such challenges lead to the removal of invalid patents or the scaling back of overly broad ones, it facilitates the social policy articulated in Lear v. Atkins, 395 U.S. 653 (1969). Lear held that a licensee is not estopped from attacking the validity of a licensed patent because of the public interest in the free use of ideas that are really part of the public domain and because licensees are often the only party with sufficient economic interest to challenge the patent.  (Lear was not directly applicable to this case because the licensee had breached the contract by stopping royalty payments.) However, MedImmune is also likely to increase the social and economic costs of patent litigation by spawning a host of suits as licensees institute such challenges and as licensors, licensees and the courts sort out the ultimate implications and scope of the decision.

The decision tilts the risk-benefit scale of licensor-licensee relations significantly in the favor of licensees. A licensee can take a license early in product development and challenge the patent later, if and when product revenues are sufficient to provide an economic incentive to do so and the cash flow to finance the litigation. This tactic may be especially attractive to licensees who believe they are the victims of so-called patent trolls. A license will remove the immediate problem of the troll, while preserving the option of fighting the troll under more favorable financial circumstances in the future.

Licensees also will have increased leverage to renegotiate existing agreements. Although U.S. patents are presumed by law to be valid and many will survive litigation, there are almost always points of attack and areas of dispute regarding validity and infringement. The threat of a DJ action should increase the ability of licensees to extract concessions in many instances.
 
Licensors can expect a significant increase in uncertainty and risk associated with their licenses. Those with extensively licensed portfolios may face a parade of licensees who want to renegotiate their licenses under the threat of DJ actions, and they will need to be concerned about the potential for litigation over matters they thought were settled.

Practice Suggestions

Licensors should re-evaluate their standard license provisions. Although Lear permits licensees to challenge the validity of licensed patents, it should be permissible to add provisions that permit the licensor to terminate the agreement, if the licensee challenges the validity, enforceability or infringement of the licensed patent. Termination permits the licensor to sue for willful infringement, and the risk of treble damages will change the licensee's risk-benefit calculus in deciding whether or not to bring a DJ action. Such provisions should not be limited to court challenges. They should include challenges by way of an interference, re-examination or opposition. The prohibition should also include supporting the challenges of others. Licensors should also consider provisions permitting termination, if the licensee makes any formal assertion of invalidity, unenforceability or non-infringement or states that it is paying under protest.

Licensors should also try to get as much of the monetary consideration as possible up front or early in the product development process, such as through larger milestone payments. Prior to sales, the licensee will have less economic incentive to challenge the patent, and, if a later challenge is successful, the licensor will have lost less of its total expected compensation. Licensors should also consider requiring significant annual royalties that are waived if there is no challenge but become due if the licensee makes a challenge. These should be tied to the economic value of the fact that the licensor relinquished its ability to exclude the licensee from using the patented invention.

Licensees will want to review their significant license agreements, look again at the strength and applicability of the licensed patent(s), and do a new risk-benefit calculus. They may find a reasonable basis to try to negotiate lower royalties or other compensation or remove onerous provisions, such as broad grantbacks of improvements. They may even find themselves heading directly to court.