Post-patent expiry royalty payments - US and EU positions differ

13 July 2015


The terms on which royalties are paid are some of the most fundamental aspects of a patent licence. Together with the royalty rate, the period for which royalties are payable will determine the amount that the patentee will receive for granting the licence. In Europe, there are no legal limits on the length of the royalty term but in the US, following the decision of Brulotte v Thys in 1964, royalties are only payable while the licensed patents are in force.

In the recent decision of Kimble v Marvel, the US Supreme Court was invited to overturn the decision in Brulotte which would have aligned its licensing law, in this respect at least, with Europe. It failed to do so.

Background

In many pure patent licensing agreements there is no commercial issue about the royalty term - it is tied to a valid claim of an issued patent being in force and in some cases pending applications will also be included.

However, in some circumstances, it may make commercial sense for royalties to continue after the licensed patent has expired. For example, if the patent covers a platform technology that enables the discovery of new products, but the patent has only a few years to run and the products will not come onto the market until the platform patents have expired. Another example is where the royalty rate required by the licensor to recover its costs of developing the patented technology over the remaining term of the patent would be too high to make the licensed products economic, and so the royalty rate is set at a lower rate over a longer (post patent expiry) period.

The Position in Europe

In Europe there is no restriction on payment for sales made after patent expiry. The issue is addressed in the Guidelines to the Technology Transfer Block Exemption Regulation:

"187. Notwithstanding the fact that the block exemption only applies as long as the technology rights are valid and in force, the parties can normally agree to extend royalty obligations beyond the period of validity of the licensed intellectual property rights without falling foul of Article 101(1) of the Treaty. Once these rights expire, third parties can legally exploit the technology in question and compete with the parties to the agreement. Such actual and potential competition will normally be sufficient to ensure that the obligation in question does not have appreciable anti-competitive effects."

This gives parties the freedom to adjust the royalty term of a pure patent licence as they wish.

The Position in the US

In contrast, as mentioned above, the position in the US under Brulotte is that the patentee cannot continue to receive royalties for sales made after the last licensed patent has expired. Many commentators have expressed the view that Brulotte was wrongly decided and that parties to a licence agreement should have the right to agree whatever royalty term they like on the basis that: (a) there is no anti-competitive effect of royalties continuing post expiry; and (b) statutory patent law makes no mention of royalty terms and therefore patent law should not be extended into contract law.

So it was with much anticipation that licensing lawyers read the decision of the US Supreme Court in Kimble v Marvel, in which the court was given the chance to overrule Brulotte.

In this case Marvel had agreed to buy Mr Kimble's patent for a Spider-Man toy for a lump sum and 3% royalties. The agreement set no end date for the royalties, but Marvel subsequently discovered the Brulotte case and asked the court to decide that, despite the terms of the licence agreement, royalties should cease on patent expiry. Frustratingly (on the basis of a 6-3 decision), the court decided that there was not a good enough reason to overturn Brulotte.

The Supreme Court concluded that the rule of "stare decis" (i.e. the court should stand by previous decisions) meant that even if the court now thinks that the previous decision was wrongly decided it must respect it unless there is a "special justification" not to do so. The main reason appears to be that if Brulotte was wrongly decided then the law should be changed by Congress rather the Supreme Court.

Although the decision by Kagan J is entertainingly written with several Spider-Man allusions (e.g. "patents endow their holders with certain superpowers…"), to a European mind the dissenting opinion of Alito J (which refers to Brulotte as a "baseless and damaging decision") is more persuasive.

The Supreme Court decision mentions that parties can find their way around the rule in Brulotte. One way that is suggested is to pay the licensor a sum equal to 10% royalties on sales during the patent term, but amortise the amount over a longer term. But as such an arrangement is only based on actual sales during the patent term it would not deal with the issue where sales during the patent term are low or non-existent. (This may be the case, for example, in the platform technology situation mentioned above, or where the patent term does not have long left to run and it will take a significant time to build the market for the product).

Another way that is suggested in Kimble, and one that is used more in practice, is to tie royalties to both know how (or other IP rights) as well as patents. The usual formula in such a case is for the royalty term to be the longer of the life of the patents or 10 years from first commercial sale. In the Kimble decision the court suggests a 5% royalty (as consideration for patents and know how) pre-patent expiry with a step down to 4% post-patent expiry (as consideration for just the know how). Whether such a royalty step down is actually required in order to avoid the Brullotte/Kimble rule is uncertain (and a matter of US law which is outside the writer's bailiwick) but to be on the safe side and to demonstrate that royalties are not being paid in respect of patents then it would seem be sensible to provide for it.

Conclusion

It seems that the US Supreme Court has missed the chance to make US patent licensing law more pragmatic and also to bring it in line with that in the EU. European entities should be aware of the Kimble decision if their licences extend to US patents and they wish to extend the royalties beyond the patent term.


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