January 16, 2007

Patent Licensors Beware: Supreme Court Allows Licensees to Challenge Patent Validity

An existing license is no longer an absolute bar to a declaratory judgment action challenging the validity, enforceability or scope of the licensed patent. On January 9, 2007, the United States Supreme Court issued an opinion in MedImmune, Inc. v. Genentech, Inc. that opens the door for licensees to bring declaratory judgment actions to do just that. 549 U.S.____(2007) (slip opinion). The Court in MedImmune reversed a rule established by the Federal Circuit several years ago, and held that a licensee who is continuing to make royalty payments under an existing license agreement nevertheless has standing to challenge the validity of the licensed patent. Although the full impact of this ruling remains to be seen, the MedImmune case is sure to have major implications for licensees and licensors when determining litigation strategy relating to existing licenses and in negotiating new patent license agreements.

Factual and Legal Background

In 1997, Genentech granted MedImmune a license to practice within an existing Genentech patent as well as a then-pending patent application. When a patent was issued from the pending application in December 2001, Genentech sent MedImmune a letter asserting that MedImmune's product Synagis, a drug used to treat respiratory diseases in young children, was covered by this new patent and that royalties on Synagis were now due. MedImmune thought that the new Genentech patent was likely invalid or unenforceable. Genentech also was not convinced that Synagis fell within the newly issued claims. But a refusal to pay the royalties as demanded would have subjected MedImmune's business to tremendous risk. Since Synagis accounted for approximately 80 percent of the company's sales, the potential results of a finding of patent infringement – an injunction against all future sales plus liability for up to three times actual damages – would have been devastating.

Unwilling to take this risk, MedImmune opted to pay the demanded royalties, but only "under protest and with reservation of all [its] rights." The value of this reservation of rights was doubtful at the time, as a non-breaching licensee's litigation options were significantly limited under then-prevailing precedent. The Declaratory Judgment Act, 28 U.S.C. § 2201(a), provides potential infringers with the right to challenge the validity of a patent before being sued for infringement, but this right is limited to cases where an "actual controversy" exists. The Federal Circuit has consistently held that an actual controversy exists only when a potential infringer has a reasonable expectation of being sued for infringement. E.g., Teva Pharm. USA, Inc. v. Pfizer, Inc., 395 F.3d 1324, 1333 (2005). Further, in Gen-Probe Inc. v. Vysis, Inc., 359 F.3d 1376 (2004), the Federal Circuit expressly held that a licensee who continues to make royalty payments has no reasonable expectation of being sued because the license agreement "obliterate[s] any reasonable apprehension" that the licensee will be sued for infringement. Under this rule, licensees lack standing to challenge the licensed patent unless and until they place themselves in jeopardy of being sued by refusing to honor the license.

The MedImmune Holding

Despite the existing precedent, MedImmune brought a two faceted declaratory judgment action, arguing first that Synagis did not infringe Genentech's new patent and therefore was not covered by the license agreement and second that Genentech's patent was invalid and unenforceable. It contended that Genentech's letter demanding royalties placed it under a clear threat of litigation if it refused to pay royalties, and that this was sufficient to meet the requirement of an "actual controversy." Both the district court and the Federal Circuit dismissed these claims, citing lack of subject matter jurisdiction. The Supreme Court reversed in an 8 to 1 decision authored by Justice Scalia. Justice Thomas dissented.

The Supreme Court first noted that the only impediment to an imminent threat of harm, and hence indisputable subject matter jurisdiction, was MedImmune's own actions in making royalty payments. "The question before us," Justice Scalia wrote, "is whether this causes the dispute no longer to be a case or controversy within the meaning of Article III." The Court then focused on the significant threat that MedImmune was under prior to making these payments, including a possible injunction foreclosing 80 percent of its business and the possibility of trebled damages if willfulness was found. Next, the Court drew an analogy to a doctrine relating to government action that was articulated in Steffel v. Thompson, 415 U.S. 452 (1974). This doctrine permits an individual who has been threatened with government action to challenge the constitutionality of a law without first violating that law and risking incarceration. In both instances, the Court felt that the plaintiff's self-avoidance of imminent injury was coerced. The Court ultimately concluded that there was no reason, in either case, that the plaintiff should have to "bet the farm" prior to asserting its arguments in court. The Court reasoned that "putting the challenger to the choice between abandoning his rights or risking prosecution" is "a dilemma that it was the very purpose of the Declaratory Judgment Act to ameliorate."

In response, Genentech argued that by allowing MedImmune to assert these claims the Court was effectively changing a settlement agreement – in the form of the license – that had been entered into by the parties to resolve their infringement dispute. The Court rejected this argument for two reasons. First, the Court cited MedImmune's argument that the parties' agreement did not even cover the product that was at issue. Second, the Court noted that the license agreement did not include any express covenant not to challenge the validity of the patent. The Court further stated that a promise to pay royalties did not imply such a covenant into the existing agreement. "Promising to pay royalties on patents that have not been held invalid does not amount to a promise not to seek a holding of their invalidity" (emphasis in original). Since the agreement itself did not prohibit a validity challenge, and since MedImmune was faced with a significant threat when it entered into the agreement, the Court found subject matter jurisdiction despite the fact that MedImmune had not breached or terminated its license agreement.

Implications of MedImmune v. Genentech

For licensees, the MedImmune decision removes, at least in certain cases, the need to risk a court injunction and treble damages in order to challenge the validity or scope of an existing patent license. The case does not, however, give licensees the blanket right to challenge their licensed patents under all circumstances. Instead, it appears that subject matter jurisdiction in declaratory judgment actions will depend on the particular circumstances of the case. Key considerations will include: (1) the level of coercion involved with the decision to enter into a license agreement, or to apply the license to the product or process at issue; (2) whether the license agreement explicitly prohibits validity challenges; (3) whether the licensee takes steps to explicitly preserve its right to assert invalidity despite taking a license; and (4) whether there is a good faith dispute as to whether the license agreement covers the potentially infringing product. Future cases will help to delineate exactly how these considerations will be applied, but it is clear that the Federal Circuit's reasonable apprehension test has been modified to require a more detailed analysis before determining whether subject matter jurisdiction exists.

Seventeen amicus briefs were filed in the MedImmune case, and they predict various (and sometimes contradictory) effects of a decision to allow MedImmune's claim to go forward. The case's overall impact on litigation and licensing remains to be seen, but a few things are clear. The Supreme Court has provided significant leverage to existing licensees currently making royalty payments on suspect patents. Licensees with agreements that do not expressly prohibit validity challenges can be expected to be more bold in bringing (and threatening) legal challenges, as the risks of such actions are greatly reduced: if the action fails, the licensee can fall back on the existing agreement, limiting exposure to the previously negotiated royalty. Indeed, licensees would be wise to review existing agreements to determine whether their specific facts warrant bringing a declaratory judgment action seeking to eliminate royalty obligations.

From a drafting and documentation perspective, licensees will want to preserve any threatening correspondence and will want to include specific language indicating that the license agreement is being entered into under significant threat. It will also be to the licensee's advantage to document the potential consequences of an infringement finding. In addition, licensees will want to avoid specific contractual language limiting their right to challenge patent validity. Finally, licensees should consider including a statement with their royalty payments that the payments are being made under protest and with reservation of all rights.

From a licensor's perspective, it is advantageous to create a record indicating that the agreement is being entered into voluntarily. Explicit language in the agreement to this effect is recommended, as is the avoidance – when possible – of threatening correspondence prior to the agreement. Whenever possible, licensors should also include language in the agreement that bars the licensee from contesting the validity or enforceability of the licensed patents.

The MedImmune decision also could lead to demands by licensors for higher royalty rates or for more fully paid-up licenses rather than running royalties--as means to mitigate the increased risk of litigation now faced by licensors. The impact of the decision on the overall volume of patent licensing seems likely to be neutral. On the one hand, the case may make companies more willing to take licenses since doing so does not automatically take away the right to validity challenges. On the other hand, that result could tend to make patent owners less willing to grant licenses, particularly as a means to settle ongoing disputes.

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