Patent147631712In Kimble v. Marvel Entertainment, 576 U.S. ____ (2015), the U.S. Supreme Court considered whether to overturn Brulotte v. Thys, 379 U.S. 29 (1964), its 1964 decision holding that it was per se unlawful for a patent owner to charge royalties for use of a patented invention after the licensed patent has expired. In a 6-3 decision by Justice Elena Kagan, the court in Kimble concluded that it was required by stare decisis to affirm the Brulotte rule.

Petitioner Stephen Kimble had obtained a patent in 1990 on a Spider-Man-inspired toy that allowed the user to shoot “webs” made of foam string from his or her palm. After Marvel began marketing a similar product, Kimble sued for patent infringement. The case eventually settled. Under the terms of the settlement, Marvel purchased Kimble’s patent for a lump sum payment and a 3 percent royalty in perpetuity on future sales of any products covered by the patent. Though, apparently, neither party knew about the Brulotte decision during settlement negotiations, Marvel later discovered it and successfully obtained a declaratory judgment that its obligation to pay royalties to Kimble would end upon patent expiration in 2010.

Brulotte was based on a “tying” theory that an agreement to pay royalties for use in the post-expiration period is necessarily extracted using the patentee’s monopoly leverage during the patent term. But as courts and commentators have pointed out, this rationale is flawed from an economics perspective: since the patent has no force after expiration, it cannot be used to extract anything. Therefore, no matter how the license is structured, a licensor will agree to pay only for use of the patent during the patent term. Post-expiration, the invention is in the public domain, there is nothing to purchase, and no license is needed. As Judge Richard Posner of the U.S. Court of Appeals for the Seventh Circuit has concisely stated, “The duration of the patent fixes the limit of the patentee’s power to extract royalties; it is a detail whether he extracts them at a higher rate over a shorter period of time or a lower rate over a longer period of time.”

Wrongly decided, but not wrong enough

The Kimble majority all but admitted that Brulotte was wrongly decided, acknowledging that the decision has been much criticized by courts and commentators—the Ninth Circuit calling it “counterintuitive” and the Seventh Circuit finding its reasoning “dubious.” Overcoming stare decisis, however, requires more than merely showing that a decision was wrong on the merits. According to the majority, stare decisis is further “superpowered” in this instance because Brulotte (1) is based on an interpretation of a statute, meaning Congress has the ability to intervene; and (2) deals with an intersection of property law and contract law, where reliance on default rules is particularly likely. The court noted that Congress has had opportunities to address the Brulotte ruling, and in fact had specifically declined bills that would have legislatively overruled it, but has never done so. The majority further contended that Brulottes legal underpinnings have not eroded, since modern patent decisions continue to aggressively police the boundaries of the patent scope, rejecting activity—even private contract provisions—threatening to extend patent benefits beyond statutory limits. Finally, the court noted, the issues of patent policy raised by Brulotte are more appropriately resolved by Congress than the courts.

With respect to Congress’ failure to act, the dissent noted that this fact is not a reliable indicator that Congress approves Brulotte, but may simply reflect the reality that “passing legislation is no easy task.” More fundamentally, the dissenters believed that Brulotte did not interpret the Patent Act, but rather was “an antitrust decision masquerading as a patent case” premised on a now-debunked economic theory. With respect to reliance, the majority acknowledged that Marvel had not identified any examples of parties that had relied upon Brulotte to provide a default rule. The dissent ridiculed this suggestion as “fanciful” and without support. To the extent any reliance was at issue, the dissenters believed, it was reliance on the expectation that parties are free to structure patent royalties as they like.

The majority did not dispute that the Brulotte rule may be unsound as a matter of economics because a license including post-expiration royalties potentially has pro-competitive benefits. The court recognized the Brulotte rule can prevent some parties from structuring deals in ways that may be advantageous in certain circumstances. For example, an extended payment period at a lower royalty rate might be preferable to a liquidity-challenged licensee. An extended payment term might also better allocate risks and rewards associated with innovation, especially when a lengthy development period is needed to commercialize the patented concept. The court noted, however, that while Brulotte bars royalties based on use or sale outside the patent term, it leaves open other alternatives that may accomplish the same objectives. For example, (1) parties are free to spread payments for pre-expiration use over any period they desire; (2) when licensing multiple patents, Brulotte does not kick in until all of the licensed patents have expired; (3) post-expiration royalties for nonpatent rights are permitted—so a license for a patent and a trade secret could be structured to pay royalties only for the trade secret after the patent expires; and (4) nothing in Brulotte restricts business arrangements not involving royalties, such as joint ventures, that may facilitate sharing the risks and rewards associated with an invention.

Implications for patent licensing

Though the Kimble decision is frustrating in preserving a rule that, seemingly, no one likes, the significance of the decision may be limited. As noted, there are work-arounds to Brulotte that provide adequate flexibility to the vast majority of parties. The dissent correctly points out that merely spreading pre-expiration royalties over a longer payment period will not help parties to share in the rewards of an invention that only becomes profitable post-expiration. However, a license that couples a patent to a nonpatent right, with a royalty step-down when the patent ends, is permitted and is nearly equivalent in effect. The dissent does not address this more versatile alternative. Indeed, practitioners can now feel more comfortable employing these alternative structures in light of the Supreme Court’s sign-off on these practices. Prior to Kimble, there may have been some hesitance to do so based on a fear that a court might find these practices violative of Brulotte in substance, if not in form. With a little creativity, capable lawyers should be able to find ways to craft licensing arrangements that meet most clients’ licensing goals without running afoul of the Brulotte prohibition.

Of course, the decision also highlights the importance of consulting with capable counsel to navigate these traps for the unwary, since courts are unlikely to correct them even if counterintuitive or wrong. As the dissenters pointed out, Brulotte has “upended the parties’ expectations” in many cases.

Implications for antitrust

Interestingly, the majority suggested that the outcome in Brulotte might have been different if it were an antitrust case, since stare decisis has “less-than-usual force in cases involving the Sherman Act.” In antitrust cases, the court has more “law-shaping authority” and is “relatively free to revise [its] legal analysis as economic understanding evolves and … to reverse antitrust precedents that misperceived a practice’s competitive consequences.” In the majority’s view, however, Brulotte, was not an antitrust case, but a patent case, and was not based on the competitive significance of post-expiration royalties, but on the “categorical principle” that all patent benefits must end when the patent term expires. Of course, the dissent disagreed entirely—believing that Brulotte was an antitrust case and not a patent case.

As Kimble demonstrates, it is anyone’s guess how the Supreme Court will come out on issues involving the intersection between antitrust and intellectual property. In Kimble, patent policy (in the majority’s view) prevailed over the efficiency and competition-related concerns of antitrust law. In the 2013 Federal Trade Commission v. Actavis, 570 U.S. ___ (2013), decision, by contrast, a majority held that antitrust law trumped patent law when assessing the legality of “reverse payment” patent infringement settlement from a brand-name drugmaker to a generic rival, even though, from a patent law perspective, this activity would be within the exclusionary scope of a valid patent. In Actavis, the majority dismissed concerns that a rule-of-reason analysis would be “unfeasible administratively” in evaluating reverse payments. In Kimble, by contrast, the majority rejected the rule of reason as a tool for assessing the competitive merits of post-expiration royalties, calling it an “ʻelaborate inquiry’ produc[ing] notoriously high litigation costs and unpredictable results,” calling to mind the Actavis dissenters’ concern with using the “unruly rule of reason” in the reverse-payment context. And in Kimble, the dissent placed considerable weight on the fact that a post-expiration royalty arrangement may be pro-competitive and economically efficient. Yet an overlapping dissent in Actavis (Justices Antonin Scalia and Clarence Thomas dissented in both opinions) was largely undisturbed by the possibility that reverse-payment settlements are used to buy off challenges to invalid patents—a highly anticompetitive and inefficient practice. We shall see where the court strikes the balance the next time around. Stay tuned.

Reprinted with permission from the July 6, 2015 issue of The Legal Intelligencer. Copyright 2015. ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.