BioInsights, February 2007 - Issue 9: Supreme Court Rules That a Licensed Patent May Be Challenged Without Breaching the License

February 1, 2007 Advisory

Supreme Court Rules That a Licensed Patent May Be Challenged Without Breaching the License

On January 9, 2007, the United States Supreme Court ruled that a patent licensee is not required to breach its license in order to have standing to challenge the validity of the licensed patent. In MedImmune, Inc. v. Genentech, Inc., (U.S. Supreme Court No. 05-608, 549 U.S. ____ (2007)), the Court decided 8-1 that a patent licensee who continues to pay royalties under the license, and thus is under no threat of any action by the patentee, nevertheless is permitted to bring a declaratory judgment action seeking to have the patent declared invalid or unenforceable. This decision represents a significant reversal in the recent law governing patent licenses, and will likely have an impact on licensee/licensor relationships as well as the financial and contractual terms found in license agreements.

In 1997, MedImmune and Genentech entered into a patent license agreement covering Genentech's then- pending patent application, which matured into the "Cabilly II" patent. Genentech asserted that Synagis, a drug MedImmune manufactured, was covered by the Cabilly II patent, and that MedImmune owed royalties under the agreement. Although MedImmune believed no royalties were due, it considered the letter to be a clear threat to enforce the patent, terminate the license agreement, and bring a patent infringement action if MedImmune did not pay. Because such an action could have resulted in MedImmune being ordered to pay triple damages and attorneys' fees and be enjoined from selling Synagis, which accounted for more than 80 percent of its sales revenue, MedImmune paid the royalties under protest and filed an action for a declaratory judgment that the patent was invalid or unenforceable. The Court of Appeals for the Federal Circuit dismissed MedImmune's suit for lack of an actual case or controversy, because a licensee who continues to pay royalties is under no threat of an infringement suit by the patent owner.

The Supreme Court Decision
The issue presented to the Supreme Court was whether a licensee in good standing (a "non-repudiating" licensee) may bring a declaratory judgment action for patent invalidity. In writing for the 8-1 majority, Justice Scalia indicated that an actual controversy, as required by law, would exist if MedImmune had taken the final step of refusing to make royalty payments, and that but for MedImmune's continuing to make royalty payments, nothing about the dispute would render it unfit for judicial resolution. Justice Scalia noted that in disputes where either the government or a private party threaten enforcement actions, a plaintiff is not required to expose himself to liability before bringing suit to challenge the basis for the threat. In fact, according to Justice Scalia, prior Supreme Court precedent held that "a patent licensee's failure to cease its payment of royalties did not render nonjusticiable a dispute over the validity of the patent" and that "the requirements of a case or controversy are met where payment of a claim is demanded as of right and where payment is made, but where the involuntary or coercive nature of the exaction preserves the right to recover the sums paid or to challenge the legality of the claim." As applied to the facts here, the Court concluded that MedImmune was not required to break or terminate its 1997 license agreement before seeking a declaratory judgment in federal court.

Punitive Practical Consequences of the MedImmune Decision
In terms of practical effects, the MedImmune decision gives licensees power to challenge licensed patents without putting themselves in jeopardy of infringement. This new power may result in an increase in the number of declaratory judgment actions filed with the courts challenging the validity of patents. Of course, whether a licensee has any genuine incentive to bring such an action depends on many factors such as the type of license, the cost of royalty payments weighed against the substantial expense of litigation, and the merit to the validity challenge. It is worth noting that in the MedImmune case, the Cabilly patent was a broad process patent that was the subject of a nonexclusive license. Licensees with exclusive rights are more likely to want broad patent protection around the licensed products and are less likely to challenge the licensed patents and risk losing this protection against third parties.

Licensors will likely respond to the decision by demanding higher royalties and/or larger up-front payments to offset the increased litigation risk. It is also possible that in view of the litigation risks, certain entities, such as universities or not-for-profit organizations with very limited budgets, will be reluctant to license some technologies at all.

The decision will also certainly have an impact on the way licenses are drafted and negotiated. For example, licensors will no doubt give renewed consideration to the inclusion of a "no-challenge" clause which prohibits the licensee from challenging the validity of the licensed patents irrespective of whether the licensee continues to pay royalties. Likewise, "termination-on-challenge" clauses and other "penalty" provisions, such as an automatic royalty increase upon licensee challenge, or that an unsuccessful challenge triggers payment of triple royalties and attorney fees by the licensee, are likely to be incorporated in future license agreements. While the Court appeared to suggest that such terms would have made a difference between Genentech and MedImmune, the Court did not expressly indicate that such contractual language was enforceable. At the present time, the enforceability of such terms remains an open question until a court determines their legality. It is worth noting that EU block exemptions do not cover outright "no challenge" clauses, but expressly permit termination on challenge if the restriction, as a matter of contract law, can be severed from the rest of the agreement. Distinctions between U.S. and EU requirements should be considered carefully when preparing agreements with global application.