In 1990, Stephen Kimble obtained a patent for a toy that allowed children and adults to shoot “webs” from the palms of their hands. Kimble met with the president of Marvel Enterprises, Marvel Entertainment’s predecessor, to discuss his toy and patent. Marvel, at that time, created and marketed products that featured Spider-Man. Marvel proceeded to market the “Web Blaster,” a toy with functionality similar to Kimble’s. Kimble, who was not compensated by Marvel, sued Marvel in 1997 alleging patent infringement. The parties agreed to a settlement pursuant to which Marvel would purchase Kimble’s patent for a lump sum of about $500,000 and a 3 percent royalty on future sales of the “Web Blaster” and similar products. The agreement did not set an end date for Kimble’s royalty payments.
Years after the settlement, Marvel came across Brulotte v. Thys Co., 379 U.S. 29 (1964), a case in which the Supreme Court prevented a patent licensor from receiving royalties for sales made after the patent’s expiration date. Marvel sought declaratory judgment with the federal district court, which confirmed that Marvel did not have to pay royalties after 2010 – the year Kimble’s patent expired. The Ninth Circuit Court of Appeals reluctantly affirmed the decision, and the Supreme Court granted certiorari to decide whether it should overrule Brulotte.
The Supreme Court’s June 22, 2015, decision in Kimble v. Marvel Entertainment, LLC upheld the Court’s 1964 rule barring patent licensors from collecting royalties for sales made after the underlying patent’s expiration date.
Practical Implications for Attorneys
The Court held that the Kimble/Marvel contract was unenforceable after the expiration of Kimble’s patent, despite the fact that the parties had intentionally entered into a royalty arrangement for a term that extended beyond the patent’s expiration. In its decision, the Court noted that there were ways to navigate this holding, citing the following as alternatives that could achieve the same ends as royalty arrangements and that would be enforceable under Brulotte:
- Draft a Payment Deferral Arrangement: “a licensee [can] defer payments for pre-expiration use of a patent into the post-expiration period” so that parties can agree to a percentage of sales for the twenty-year patent term, but amortize that amount over a longer period of time. The Court noted that the ability to spread payments out over an extended period of time is expressly allowed, which would permit risks and rewards to be allocated throughout development. Drafting a payment deferral arrangement is expressly differentiated from a royalty for post-expiration sales;
- Draft a Multi-Patent Agreement: agreements with multiple patents allow for royalties to run “until the latest-running patent covered in the parties’ agreement expires”;
- Draft a Hybrid Agreement: agreements with patent and non-patent rights (e.g., technology, know-how, or trade secrets) can layer royalty payments and thus allow for post-expiration royalties so long as certain royalties are expressly tied to non-patent rights. If, however, the patent and non-patent rights are not expressly delineated, as was the case in Kimble, then the agreement will be unenforceable beyond the expiration date of the underlying patent; or
- Structure an alternative business arrangement: a joint venture would likely be excluded under the Kimble analysis.
The decision has several ramifications for transactional lawyers. In drafting licensing arrangements in which it is envisioned that royalties will extend beyond a patent’s stated expiration, care should be taken to follow the Kimble decision and to either structure the agreement to include multiple patent or other divisible trade secret, know-how, technology, or other intellectual property rights or structure an alternative business arrangement among the parties, such as a joint venture. Also, transactional attorneys must carefully review patent licensing arrangements during diligence for M&A transactions through the Kimble/Brulotte lens. In light of Kimble, to the extent that a contract’s subject matter is just the patent, and the parties have negotiated an end date for royalties after the patent’s expiration, this should be flagged and discussed. If left unaddressed, expected cash flows from royalties that may not be enforceable could impact deal modeling and underlying valuations.
While the issues decided in Kimble have important ramifications, they can be navigated appropriately with outside counsel guidance.