First published in LES Insights
A licensee successfully invoked the "most-favored" licensee clause in its paid-up lump-sum license agreement to retroactively apply the more favorable price terms of a later paid-up lump-sum license agreement of a subsequent licensee. This resulted in a refund of $69 million, the difference between the amount it paid under its original license agreement ($70 million) and the amount required to be paid under the later license agreement with more favorable terms ($1 million).
Licensees who sign up early may try to ensure that later licensees do not get a better deal by including "most-favored licensee," provisions in their license agreements. However, at a later time, the parties may disagree as to how those clauses are interpreted and applied.
In JP Morgan Chase Bank, N.A. v. DataTreasury Corp., JP Morgan sued DataTreasury for breaching the most-favored licensee clause in their lump-sum license agreement relating to patented check processing technology, claiming that DataTreasury later granted a similar license to another entity for a lesser lump-sum amount. In a case of first impression, the United States Court of Appeals for the Fifth Circuit found that JP Morgan was entitled to retroactively apply the more favorable terms of the lesser lump-sum license agreement and receive a refund for the difference between the two lump-sum license agreements.
DataTreasury Corporation sued JP Morgan Chase Bank, N.A. for willful infringement of patents relating to electronic check-processing systems.
In 2005, they settled the case, and JP Morgan received a license in exchange for a lump-sum payment of $70 million, paid in installments of $30 million in 2005, $5.5 million each year from 2006 to 2011, and $7 million in 2012. The JP Morgan license included a "most-favored licensee" clause, requiring DataTreasury to notify JP Morgan of any subsequent licenses and entitling JP Morgan to the benefit of any more favorable terms of those licenses.
In 2012, after JP Morgan made the last payment on the JP Morgan license, DataTreasury separately entered into another license agreement with Cathay General Bancorp involving the same patents but with different lump-sum price terms. The lump-sum price was $250,000 for Cathay’s sole use plus $250,000 for each entity Cathay later acquired. No such provision regarding later-acquired entities existed in the JP Morgan license.
JP Morgan sued DataTreasury in Texas for breaching the most-favored licensee clause in the JP Morgan license, claiming that DataTreasury had failed to notify JP Morgan of the Cathay License, and that payment terms of the Cathay license were more favorable than the JP Morgan license.
In an issue of first impression, the district court agreed that the most-favored licensee clause gave JP Morgan the right to the more favorable terms of the Cathay license because both licenses were for unlimited use and the Cathay license cost less.
The court also concluded that the only way to give effect to the most-favored licensee clause was to apply the new terms from the Cathay license retroactively and have DataTreasury refund JP Morgan the amount that its payment exceeded the payment terms in the later license to Cathay. The court reasoned that in retroactively replacing the terms of the JP Morgan license with the more favorable terms of the Cathay license, it must also apply the Cathay license terms requiring an additional license payment of up to $250,000 for each after-acquired entity. Because JP Morgan had acquired three entities after 2005, the district court found that JP Morgan owed an additional $750,000 license, for a total of $1 million. The district court therefore entered a final judgment in favor of JP Morgan in the amount of $69 million—the $70 million JP Morgan paid under its original license less the $1 million total it owed under the retroactively applied terms of the Cathay License.
The JP Morgan Decision
On appeal by DataTreasury, the Fifth Circuit first found that DataTreasury had waived any arguments as to the district court's conclusion that DataTreasury breached the JP Morgan License and therefore considered only the amount of damages.
DataTreasury argued that the most-favored licensee clause could not be applied retroactively to obtain a refund of amounts previously paid. Instead, DataTreasury argued that the most-favored licensee clause could only apply prospectively from the date the new terms were recognized. Under DataTreasury’s theory, JP Morgan could escape only from payments it owed under its license at the time the Cathay agreement was executed and the most-favored licensee clause of JP Morgan’s license was affected. In JP Morgan's case, that amount would be zero because JP Morgan had paid all installments due on its license before the Cathay License was executed.
The court first distinguished between the different types of royalties available under a license, explaining that a licensee can pay a "running royalty," which includes a rate that typically requires a payment based on the number of products sold, or a lump-sum amount for unlimited use, the type of royalty JP Morgan paid DataTreasury. The court acknowledged that a licensee cannot obtain a refund of amounts paid under a previously applicable running royalty by invoking a most-favored licensee clause. But the court found the scenario involving a paid-up lump-sum license and a later, more favorable paid-up lump-sum license to be a matter of first impression.
In noting that the JP Morgan and Cathay licenses were identical in most respects—both were paid-up lump-sum licenses granting unlimited use of the patented technology—the court found that the only material differences in payment terms were that the JP Morgan License cost $70 million, while the Cathay License cost only $250,000 plus $250,000 for each entity it later acquired. It was immaterial that the JP Morgan License called for payment in installments, while the Cathay License was a single payment.
The court explained that DataTreasury's theory would render the most-favored licensee clause effectively meaningless in situations involving two paid-up lump-sum licenses that differ only in the total license cost, because once the first licensee had fully paid its license fee, it could receive no practical benefit from invoking the most-favored licensee clause. This would mean JP Morgan would not be entitled to any refund because it had already paid the final installment on its license agreement before DataTreasury executed the Cathay license—a result causing a most-favored licensee clause to "mean virtually nothing."
The court concluded that such "an unreasonable result" violated Texas law for contract interpretation and that potential problems can be avoided by reasonable restrictions on the most-favored licensee clause, such as limiting the effective time period of a licensee to exercise their right under the clause.
A dissenting opinion concluded that JP Morgan should not be entitled to recoup sums paid before DataTreasury granted the lower-priced license to Cathay because the language of the most-favored licensee clause was prospective and that the parties would not have agreed to language reaching the result JP Morgan sought. The dissent noted that DataTreasury's prospective-only theory would not render the most-favored licensee clause meaningless because it would still give JP Morgan the ability to skip future payments if DataTreasury entered into a more favorable license before JP Morgan finished paying.
The dissent also questioned how JP Morgan could be placed at a competitive disadvantage in view of the finite lifespan of patents—JP Morgan enjoyed the right to practice the two licensed patents until their respective expiration dates in 2016 and 2017, for seven years more than Cathay. This was an interpretation the majority opinion rejected, because it found no support for this position in the plain language of the most-favored licensee clause or in the nature of JP Morgan’s payment obligation.
Accordingly, the Fifth Circuit affirmed the district court's conclusion that the most-favored licensee clause in the JP Morgan license required the court to apply the price terms of the Cathay license retroactively and granted JP Morgan a refund for the difference in payments under the two agreements in the amount of $69 million.
Strategy and Conclusion
This case illustrates how a most-favored licensee clause in a paid-up lump-sum license agreement can be applied not only to royalties paid after a subsequent license is granted to another licensee on more favorable terms, but also retroactively to royalties paid before the subsequent license is granted. This could result in a refund of the difference in payments by the most favored licensee and the subsequent licensee even though the payments by the most favored licensee were fully completed before the subsequent license agreement arose.