This article was first published on Lexis®PSL IP & IT analysis on 31 March 2016. Click for a free trial of Lexis®PSL.

Claire Smith says that although the Advocate General's opinion in Genentech may not come as much of a surprise, it highlights to lawyers the importance of looking carefully at the duration of any proposed royalty payments when negotiating patent licences.

C-576/14: Genentech Inc v Hoechst GmbH, formerly Hoechst AG

What is the background to this case?

This case raises the issue of whether EU competition laws prohibit a patent owner from charging royalties under a licence agreement where the licensed patents are revoked. The Advocate General also considered whether royalties can be charged on products which do not actually infringe the patents that have been licensed.

This is the latest development in a long-running dispute between German licensor, Hoechst AG (now part of the Sanofi-Aventis group of companies) and US-based licensee, Genentech Inc (owned by Roche).

In 1992, Hoechst’s predecessor and Genentech entered into an agreement (governed by German law) in which
Genentech was granted a worldwide non-exclusive licence to use certain DNA sequences known as ‘enhancers’. When these enhancers are introduced into cells that produce drugs, they enable the cells to produce drugs much faster than would normally be possible. The technology was the subject of a European (EP) patent and two US patents.

In 1999, the EP patent was revoked for lack of novelty. Some years later, in 2008, Genentech terminated the licence agreement for convenience (an express right given to Genentech in the licence, provided it gave two months' notice).

Up until that point, Genentech had paid the upfront fee and the recurring annual fees payable under the licence. However, it never paid the 0.5% running royalty which the licence stipulated was payable on product sales. Specifically, the licence said that royalties were due on finished products that incorporated any materials whose ‘manufacture, use or sale would, in the absence of [the licence] agreement, infringe one or more unexpired claims included in the rights attached to the patents under licence’.

After the licence was terminated, Hoechst and Sanofi Aventis brought the following actions against Genentech:

  • US legal proceedings claiming that, following the termination of its licence, Genentech was infringing the US patents—the US courts found that there was no such infringement (the US patents themselves were upheld, even though Genentech challenged their validity in response to the action)
  • international arbitration proceedings to recover royalties in respect of sales of Genentech’s products, including its block buster cancer drug Rituxan®, which were manufactured from 1998 until the time the licence was terminated in 2008

The arbitrator held that Genentech had manufactured Rituxan® with the help of the enhancer and so was required to pay royalties for sales of Rituxan® (and drugs with the same properties) which it had manufactured during the whole of the period in question. This is despite the fact that:

  • the US patents had not been infringed
  • the EP patent had been revoked early on during the relevant period, and
  • patent revocation has retroactive effect in any event

Although it was not made explicit in the agreement, the arbitrator thought that the object of the agreement was for the licensee to avoid litigation in relation to the US patents and that the payment of royalties was not conditional on the technology being, or remaining, patent protected.

Genentech has contested the arbitrator's decision in the Paris Court of Appeal, arguing that paying royalties for a retroactively revoked patent contravenes Article 101 of the Treaty of the Functioning of the European Union (TFEU) because it places Genentech at a disadvantage to its competitors, who have not been required to pay for the use of the enhancers. The Paris Court of Appeal has now asked the Court of Justice for a preliminary ruling on the following question:

‘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 sole use of the rights attached to the licensed patent?’

On 17 March 2016, Advocate General Wathelet delivered his Opinion on the matter which, although not binding, will nevertheless be influential when the matter comes to be decided formally by the Court of Justice later this year.

What did the Advocate General decide?

The Opinion of the Advocate General was that an obligation to pay royalties for the entire duration of a licence agreement, even if the patents protecting the technology are revoked or are not infringed during that time, does not breach Art 101 TFEU in the situation where the commercial purpose of the agreement is to enable the licensee to avoid patent litigation, provided that the licensee:

  • can terminate the licence agreement on reasonable notice
  • can challenge the validity or infringement of the patents
  • retains its freedom of action after termination

The Advocate General applied the ruling in C-320/87: Ottung by analogy. In that case, the Court of Justice held that a requirement to pay royalties for an indeterminate period, even after the expiry of the patent, is not prohibited per se—but it may infringe Art 101 TFEU if the licensee does not have the right to terminate the agreement on reasonable notice or if the licensor tries to restrict the licensee's freedom of action after termination (eg by imposing a ban on the licensee subsequently manufacturing the once-patented products). However, whether such restrictions actually are anticompetitive will depend on the economic and legal context in which the individual licence agreement has been concluded. In Ottung, the Court of Justice recognised that licence agreements may impose royalty obligations for reasons which are not connected with a patent, but which instead reflect the commercial value of the exploitation possibilities that the licence affords.

Pending the Court of Justice judgment (and regardless of the outcome), does the opinion nonetheless raise any practical issues that lawyers should be aware of?

The Advocate General’s Opinion follows the line of reasoning in Ottung and so may not come as much of a surprise. However, it highlights to lawyers the importance of looking carefully at the duration of any proposed royalty payments when negotiating patent licences.

Issues for licensors

Lawyers acting for licensors should note that charging royalties which extend beyond the life of a patent may fall foul of EU competition laws (and so may be unenforceable) unless the licensee can terminate the licence on reasonable notice, is free to challenge the patents and is not restricted after termination (eg in relation to using the once patented technology). If royalties are payable when the patents are no longer in force, it may be sensible to include an explanation in the licence which explains the commercial rationale (eg recognition that the licensee has obtained a head start in the market place by getting early access to the technology).

Issues for licensees

Lawyers acting for licensees should make sure that the wording of the licence is crystal clear if royalties cease to be payable (or are to be reduced—see below) once a patent is revoked or expires.

Licensees will still be on the hook for royalties on sales made prior to the date of patent revocation (and cannot claw back any past payments made for such sales), even though technically revocation has retroactive effect. If they intend otherwise, the licence should state so expressly—although this is likely to encounter strong resistance from many licensors, who will argue that presence of the patent on the register during that time will have deterred competitors and given the licensee a commercial benefit.

Issues for both parties

It may be sensible (and it will often be in both parties’ interests) to structure the licence using hybrid royalty rates, by providing for the payment of a lower rate after the life of the patent to reflect the value of any remaining know-how or other non-patented rights of the licensor which the licensee may still want to use—rather than being faced with the stark choice of continuing to pay a high royalty rate, or terminating the licence altogether.

This case also raises interesting issues about royalties which are payable on products which do not themselves contain the licensed technology (eg Genentech’s drug Rituxan® was manufactured with the help of, but did not actually contain, Hoechst’s enhancers) or which are one step further removed than this, in the sense they are not even manufactured using the technology but are merely enabled by it (eg a drug which is developed for a target, where that target has been validated using the licensed research tool). If royalty payments will not be dependent on whether the products themselves are covered by the claims of a patent, the licence should make this clear. Licensors might be wary in these cases of giving licensees a right to terminate the agreement and cease paying royalties once the licensee no longer needs (and no longer infringes) the patented research tools—if this would mean not getting fully compensated—in which case it might be worth inserting the commercial rationale for the payments in the agreement and/or structuring the payments so that the licensor receives more of the consideration in the way of lump sum payments, including upfront fees and early milestones, to accommodate the risks.

How does all this tie in with developments in the US?

While EU competition laws do not impose an outright ban on charging royalties beyond the life of a patent, this position in the US is different. The long established rule in Brulotte v Thys Co (1964), which decided that making such payments on US patents were unlawful per se, has been widely criticised but was nevertheless upheld by the US Supreme Court (by a 6:3 majority) in 2015 in the case of Kimble v Marvel Enterprises, LLC. This will continue to present challenges to lawyers working on licences with a US element who will have to structure their agreements around this rule (eg by providing for hybrid royalty rates as mentioned above).