Overview of the Supreme Court Decision

On January 9, 2007, the U.S. Supreme Court decided a case that is very likely to have far-reaching and significant impact on patent licensing and technology transfer agreements. In MedImmune, Inc. v. Genentech, Inc.,[1] the Supreme Court removed a significant barrier for licensees that contemplate a legal action to challenge the validity or enforceability of the patents that they have licensed pursuant to an agreement with a patent owner.

In a nearly unanimous opinion (Justice Thomas being the only dissenter), the Supreme Court reversed and effectively eliminated the bright-line rule previously formulated and followed by the Court of Appeals for the Federal Circuit[2] (“Federal Circuit”). The Federal Circuit, consistent with its own earlier precedent in Gen-Probe Inc. v. Vysis Inc.,[3] held that MedImmune, a patent licensee, must terminate or breach its license in order to create a case or controversy necessary to pursue a declaratory judgment action in federal court and seek to have the underlying patents declared invalid, unenforceable or not infringed.

The Supreme Court reversed the Federal Circuit and overruled all prior Federal Circuit decisions to the contrary, holding that a patent licensee is not required to breach or terminate its patent license, and thereby incur the risk of possible injunction, treble damages and possible attorney fees, before seeking a declaratory judgment that challenges patents covered by the license. In addition, the Supreme Court concluded that the fact that MedImmune continued making royalty payments to Genentech “under protest” and enjoyed protection against infringement pursuant to a license agreement did not strip MedImmune of standing[4] to challenge the covered patents in a declaratory judgment action.

The Court’s decision in MedImmune has left open a number of unsettled issues, but it is very likely to have important business implications for both patent owners and licensees, who should reevaluate their existing patent licensing agreements, as well as consider the impact of this decision on future agreements and licensing negotiations.

Background

MedImmune is a medical manufacturing company that produces Synagis®, a medication for preventing respiratory tract disease in infants and young adults. In 1997, MedImmune entered into a patent license agreement with Genentech Inc., covering Genentech’s patent and then-pending patent application directed to methods and technologies for producing therapeutic antibodies. Pursuant to this agreement, MedImmune agreed to pay royalties on manufacture, use and sales of its products that would infringe claims of the Genentech’s patents.

When Genentech’s pending application issued as the “Cabilly II patent” in 2001, Genentech sent a notice letter to MedImmune that the Cabilly II patent covered MedImmune’s best selling product, Synagis® and demanded royalty payments based on the sales of that product. MedImmune disagreed, and expressed its belief that the Cabilly II patent was invalid and that Synagis® did not infringe any claim in that patent, and therefore was not covered by the agreement or Genentech’s patents. Despite this position, MedImmune was reluctant to risk the potentially catastrophic consequences of a lawsuit in which Genentech should prevail; namely, the possibility of treble damages, attorney’s fees, and an injunction against the continued sale of Synagis® (which accounted for 80 percent of MedImmune’s revenue.)[5] Faced with this dilemma, MedImmune decided to continue paying patent royalties “under protest and with reservation of all of its rights,”[6] and relied on the fact that Genentech could not terminate its patent license with MedImmune if the royalties were paid and the agreement was not otherwise breached. At the same time, without interrupting royalty payments, MedImmune brought a declaratory judgment action, seeking declaration that the Cabilly II patent was invalid, unenforceable and not infringed.[7]

At the time when MedImmune’s declaratory judgment lawsuit was pending in the district court, Federal Circuit rendered its decision in Gen-Probe, which vacated a declaratory judgment of patent invalidity and noninfringement for lack of subject matter jurisdiction under Article III[8] of the U. S. Constitution or the Declaratory Judgment Act[9] because licensee failed to establish a “reasonable apprehension” of an infringement action when it continued paying royalties and was in compliance with its patent license.[10] Relying on Gen-Probe, the district court dismissed the MedImmune’s lawsuit for lack of subject matter jurisdiction, holding that there was no “case or controversy” under the Declaratory Judgment Act because there was no threat of legal action so long as MedImmune paid royalties and did not breach or terminate its license agreement with Genentech.[11]

On appeal, the Federal Circuit affirmed,[12] noting that MedImmune (like the licensee in Gen-Probe) “assiduously avoided” breaching the contract and therefore has “contracted away its right to sue.”[13] The Supreme Court granted certiorari to hear the appeal.

The MedImmune Decision

The issue presented to the Supreme Court was whether subject matter jurisdictional requirements of Article III of the U.S. Constitution and Declaratory Judgment Act required a patent licensee to terminate or breach its license agreement before it may bring a declaratory judgment action that the underlying patent is invalid, unenforceable, or not infringed.[14]

In the 8-to-1 majority opinion, Justice Scalia found that Genentech’s royalty demand letter supported the existence of threatened harm to MedImmune. The Court further found that MedImmune’s election to pay royalties and retain the protection of a license agreement did not eliminate the threat of litigation, and that royalty payments had been “effectively coerced” by the “threat of treble damages and serious injury to business” hidden behind Genentech's demand letter.[15]

The Supreme Court started its analysis of the jurisdiction issue with the principle and reasoning of its earlier decisions that involved the threat of government action.[16] In these cases, the Supreme Court held that a plaintiff need not expose himself to liability before challenging the validity of a law in court.[17] For example, a person who believes that a criminal law is unconstitutional need not violate the law and risk prosecution before being able to seek a declaratory judgment action to challenge the constitutionality of that law. The Court applied the same rationale to situations when the threat of litigation comes from a private party rather than the government. According to the Court, MedImmune did not have to “bet the farm, or (as here) risk treble damages and the loss of 80 % of its business, before seeking a declaration of its actively contested legal rights.”[18] The Supreme Court found this threat “every bit as coercive” as a criminal fine.[19] In other words, the Court concluded that a licensee (MedImmune) who pays patent royalties “under protest,” out of fear of a patent infringement action by a licensor (Genentech), is being coerced in a way that creates an actual controversy, and therefore confers jurisdiction to seek a declaratory judgment to challenge the underlying patents.

To support its ruling, the Supreme Court also quoted from and relied on its 1943 decision in Alvater v. Freeman,[20] which held that a licensee under a license agreement was entitled to a declaratory judgment on the validity of a licensed patent while making royalty payments required by a court-imposed injunction from a previous lawsuit.[21] The Supreme Court found that the Federal Circuit’s narrow reading of the holding in Alvater was erroneous, and that the issue and facts in that case (that royalty payments were made “under protest” from a licensee) were similar to the facts in MedImmune. Contrary to the Federal Circuit’s view expressed in Gen-Probe, the Supreme Court did not consider the issue of injunction in Alvater to be the key distinguishing factor conferring an otherwise unavailable jurisdiction for a declaratory judgment action. Instead, the Court considered to be most relevant such factors as signing of a license “under protest” and the ”involuntary or coercive nature” of the licensor’s demands for royalties in a situation where the validity and enforceability of the underlying patents were in dispute.[22] It then found that these factors were also present in the case at issue.

Accordingly, the Supreme Court reversed the Federal Circuit and remanded the case back to district court level, holding that MedImmune had established a genuine controversy with Genentech and that there was sufficient evidence of coercion to satisfy jurisdictional requirements for a declaratory judgment action.[23]

In addition to deciding jurisdiction issue, the Supreme Court also held that MedImmune sufficiently alleged in its amended complaint (and could therefore pursue) a contract claim that its products did not infringe Genentech’s Cabilly II patent and that no royalties were owed pursuant to a license agreement.[24]

Issues Left Unresolved By The MedImmune Decision

The MedImmune decision sparked a considerable debate among patent attorneys and in the U.S. patent community in general because it left unresolved a number of important issues.

First, it is important to note that the Supreme Court limited its MedImmune decision to the question of federal jurisdiction. The Supreme Court declined to decide whether discretionary[25] dismissal under the Declaratory Judgment Act could still be appropriate (even if jurisdictional requirements for a declaratory judgment action have been satisfied). Because discretionary dismissals are typically vested with district courts, the Supreme Court left that issue and resolution of any merits-based[26] arguments raised by Genentech for the lower courts’ consideration on remand.[27]

Second, the Supreme Court expressed no opinion on whether a declaratory judgment action by a licensee could be barred by an express “no challenge” clause in a license agreement (no such clause was present in the MedImmune license) in a situation when the licensee does not repudiate or breach the agreement.[28]

Third, MedImmune decision left unanswered the question of whether an express license provision that permits licensor to terminate its agreement in the event of “protest” from a licensee would be enforceable in courts. If so, it could provide a practical solution to neutralize the tactical advantage gained by a licensee who “protests,” but does not repudiate or breach the agreement. It would allow the licensor to terminate patent license, bring infringement action against the “protesting” licensee and collect damages for the infringing activities that follow after the termination.

Fourth, the passage from Alvater that was quoted by Justice Scalia in the MedImmune decision states that “the involuntary or coercive nature of the exaction preserves the right to recover the sums paid.”[29] This statement could be interpreted by some courts as authorizing the ”protesting” licensee to recover royalties that had been paid during pendency of a successful patent validity challenge in court.

Finally, the Court in MedImmune calls into question the Federal Circuit’s reasonable-apprehension-of-imminent-suit test in general; not only in the context of disputes with licensees.[30] Thus, the applicability of this test remains unclear in other types of actions, such as a declaratory judgment action brought by an accused infringer who receives a licensing offer or in a declaratory judgment action brought by a generic pharmaceutical company in the context of the Hatch-Waxman Act (which does not involve any licensing negotiations at all).[31]

These are just some of the issues with which lower courts will undoubtedly have to deal as they attempt to apply and interpret the MedImmune decision in the future.

Implications of the MedImmune Decision and Practical Considerations

The decision in MedImmune has far-reaching implications and has significant impact on the existing and future licenses and negotiations. Both licensees and licensors may want to review and reevaluate their existing agreements in light of this decision and possibly reevaluate and modify their strategy and contract terms in the future contract negotiations.

The removal of this jurisdictional hurdle by the Court in MedImmune gives licensees greater freedom to challenge the validity of patents while keeping their licenses intact. As a result, a licensee can now better predict its financial exposure in the event that it loses its declaratory judgment action against licensor; the license agreement itself provides the royalty rate that the licensee would be required to pay. This provides licensees with greater bargaining power to negotiate new agreements or renegotiate existing licenses.

The types of licenses that are particularly susceptible to challenges by licensees involve relatively small up-front payments and large “reach through” royalties. In order to reduce the likelihood of a declaratory judgment action by a licensee, the licensor may want to consider restructuring its licenses to include the following contractual provisions:

• Higher up-front payments – To the extent that it is possible, restructure royalty payments to have larger up-front or initial payments and lesser “reach through” royalty payments.

·         Termination Trigger Provision – Allow licensor to terminate the agreement in the event that licensee indicates its “protest” to payment of royalties or brings a validity challenge to a patent licensed under the agreement.

·         No Recovery of Paid Royalties – Expressly provide that a licensee is not entitled to recover royalty fees that it pays during the time the patent is being challenged in court.

·         Increased Royalty Rates – Require licensee to pay higher royalties in the event of a validity challenge to the licensed patents. (It must be noted that some courts might perceive this provision as a liquidated damages clause, and, as such, could refuse to enforce it).

·         Accelerated Payments – Provide for acceleration of the remaining royalty payments in the event of “protest” or invalidity challenge the underlying patents by a licensee.

• Attorney Fees – Require licensee to pay licensor’s attorney fees and litigation costs if the licensee’s patent challenge is not successful.

·         Favorable Jurisdiction and Forum Provision – Select a more favorable jurisdiction and patent-friendly forum for any challenges to the licensed patents, including any declaratory judgment action. Also, make sure that the this provision is effective whether or not a licensee repudiates, breaches or terminates the agreement.

·         Pre-suit Notification Requirement – Require licensee to give notice prior to filing a declaratory judgment action. This would give licensor an opportunity to evaluate the strength of the licensee's claim, prepare for litigation and possibly renegotiate its license.

In sum, the MedImmune decision is likely to have significant impact on the balance of power and leverage in negotiations between patent licensors and licensees. Consequently, both licensors and licensees are strongly encouraged to reevaluate their existing patent licensing agreements and negotiation strategies in light of this decision.