It is hard to imagine that when Genentech signed a licence agreement in 1992 with Sanofi’s predecessor, it could have foreseen the litigation storm that ensued more than a decade later, which resulted in multiple district and Federal Circuit opinions in the US, an arbitral award in France, and most recently, a decision of the Court of Justice of the European Union. The court ruled that payment of royalties after a patent has been revoked does not run afoul of European competition law provided that the licensee is able to terminate such a licence on reasonable notice.

In a nutshell…

The Court of Justice of the European Union (CJEU) has ruled in Genentech Inc v Hoechst GmbH, Sanofi-Aventis Deutschland GmbH* that royalties can continue to be payable under a licence even after the patent so licensed has been revoked, provided that the licensee is free to terminate such licence on reasonable notice.

The facts of the case

The decision of the CJEU is the latest chapter in a long-running dispute between Hoescht AG (now part of the Sanofi-Aventis group) and Genentech Inc., which has given rise to multiple actions in the United States and in Europe.

In 1992, Hoescht’s predecessor granted a worldwide non-exclusive licence to Genentech for its human cytomegalovirus enhancer technology. This technology was protected by two US patents and one EU patent (issued in 1992 and revoked in 1999). The Agreement defined licensed products as “materials (including organisms), the manufacture, use or sale of which would, in the absence of this Agreement, infringe one or more unexpired issued claims of the Licensed Patent Rights.”

The Agreement was governed by German law and required disputes to be settled by arbitration in accordance with the rules of the International Chamber of Commerce (“ICC”).

Genentech paid a one-off fee and a fixed annual research fee due under the licence but never paid the running royalty of 0.5% on the net sales of its products. When Genentech launched Rituxan® in 1997 and Avastin® in 2004, it did not identify them as licensed products, nor did it pay the royalty on them.

On 24 October 2008, Hoechst commenced ICC arbitration proceedings in Paris over non-payment of the running royalty on the basis that Genentech had used Sanofi’s enhancer technology in the manufacture of its blockbuster drug Rituxan®.

Days later, Genentech terminated the licence and filed a complaint for declaratory judgment of invalidity and non-infringement of the patents in the US District Court of Northern District of California. On the same day, Sanofi filed an infringement complaint in the Eastern District of Texas. After the two proceedings were consolidated, the court in the Northern District of California found on summary judgment that the patents were not infringed. This decision was affirmed by the Court of Appeals for the Federal Circuit. Genentech then filed a motion requesting that the District Court for the Northern District of California stop Sanofi from continuing with the ICC arbitration. This request was denied and affirmed on appeal.

Since the governing law of the Agreement was German, the ICC arbitrator applied German substantive law, not US patent law, to determine whether Rituxan® was a licensed article under the agreement. The ICC arbitrator concluded that Genentech was liable to pay the running royalty for sales of products that it had manufactured using Sanofi’s enhancer technology between 1998 and 2008. This was the case even where (a) the US courts had determined that those patents had not been infringed; (b) the European Patent was revoked in 1999; and (c) patent revocation had retroactive effect.

Dismissing Genentech’s arguments, the arbitrator focused on the commercial purpose of the agreement, which in the arbitrator’s view, was to avoid litigation in relation to the US patents.

Genentech challenged the award before the Paris Court of Appeal, arguing that the requirement to pay royalties for the use of a revoked patent put it at a competitive disadvantage and breached Article 101 of the Treaty on the Functioning of the EU (TFEU), which prohibits agreements that have as their object or effect the prevention, restriction, or distortion of competition within the EU.

The Paris Court of Appeal stayed the proceedings and asked the CJEU to give a preliminary ruling on the following:

“Must the provisions of Article 101 TFEU be interpreted as precluding effect being given, where patents are revoked, to a licence agreement which requires the licensee to pay royalties for the sole use of the rights attached to the licensed patent?”

The CJEU’s decision:

The Court relied on its earlier decision in Ottung (Case 320/87) in which it found that obliging a licensee to pay a royalty, even after the expiry of the period of validity of the licensed patent, may reflect a commercial assessment of the value of exploitation resulting from the licence. It held that Article 101(1) TFEU does not prohibit a contractual royalty obligation for the exclusive use of a technology that is no longer protected by a patent, provided that the licensee is free to terminate the agreement. In the Court’s view, a royalty is the price paid for the commercial exploitation of licensed technology free of the risk that the patent owner will institute infringement proceedings.

With regard to the royalty payments for a patent that is revoked during the term of a licence agreement, the Court reasoned:

That solution [in the Ottung case] applies a fortiori in a situation such as that at issue ... If, during the period in which a licence agreement is in effect, the payment of the royalty is still due even after the expiration of industrial property rights, the same applies, a fortiori, before the validity of those rights has expired. The fact that the courts of the State issuing the patents at issue in the main proceedings have held, following the termination of the licence agreement, that Genentech’s use of the licensed technology did not infringe the rights derived from those patents has, according to the information provided by the referring court on the German law applicable to that agreement, no effect on the enforceability of the royalty for the period prior to that termination.

Accordingly, the Court found that since Genentech had the right to terminate the licence on reasonable notice, the obligation to pay royalty for a revoked patent did not breach EU competition law.

Conclusion and drafting points

Certain aspects of the dispute between Sanofi and Genentech have a “through the looking glass” quality which is due in no small part to the fact that the licence was governed by German law and provided for disputes to be resolved by arbitration before a European arbitrator of the ICC. The consequences that flow from that choice include the evaluation of infringement of US patents under substantive German law and the application of an analysis that is contrary to US law to the payment of royalties on US product sales.

Just last year, the US Supreme Court in the case of Kimble v Marvel [2015] confirmed that the obligation to pay royalties beyond the term of a patent is not enforceable, a decision that stands in stark contrast to the Ottung case relied upon by the Court.

So what can be learned?

While arbitration presents a number of advantages, chief among them confidentiality, this case amply demonstrates the dangers of relying on a single arbitrator to resolve issues as complex as those presented by this dispute. Particularly, the arbitrator’s decision to apply German law to determine whether the manufacture, use or sale of Genetech’s products in the US would infringe US patents should come as a surprise. The final outcome is even more surprising viewed in context of the previous decisions of the US courts finding that the products in question did not infringe the US patents.

In light of this decision, any licence agreement should ideally set out what should happen with regard to royalty payments once a patent is revoked or expires and what law is to be applied to the substantive matters of infringement and validity, especially where the royalty payment is tied to infringement and/or validity of a patent.

Licensees:

• if royalties are to cease on revocation or expiry of the licensed patents then make sure that there is an express clause setting this out in the licence agreement

• if royalties are to continue post revocation then a lower royalty rate that reflects the value of the know-how might be appropriate (and avoids the dilemma of having to choose between either continuing to pay a high royalty rate for non-patented rights or having to terminate)

Licensors:

• if royalties are to continue beyond the date of revocation or expiry ensure that the licence agreement contains reasonable termination provisions

• consider including wording in the licence agreement to explain the commercial rationale for charging royalties beyond the life of the patent

• consider front loading payments in the licence to reduce the risk of missing out on royalties later if the licensee terminates following revocation

*See Sanofi-Aventis Deutschland GmbH v Genentech, Inc. (Fed. Cir. 2013).