Expiration of a patent also terminates the rights to collect royalties on that patent – even if a license contract says otherwise. All businesses are reminded to check the termination date of any patent licensed to the business for use of underlying technology. While the license may remain valid, the licensor’s right to collect royalties may be invalid.
According to a recent U.S. Supreme Court case, a party licensing or selling its patent rights cannot receive royalties after a patent expires, regardless of whether or not the contract allows for the payment of such royalties. See Kimble v. Marvel Entertainment, LLC, 576 U.S. ___ (2015). However, parties can still work around the prohibition to achieve similar goals.
Patent holders often sell or license their technology, including rights represented by patents, to other businesses, who use the technology without fear of patent suit. One paying arrangement is a royalty system, where the patent holder earns a royalty based on sales of the technology product derived from the patent. While it is only natural for patent holders to want to profit from their patents as long as possible, according to the Supreme Court patent holders can only earn royalties for sales made before their patents expire. Royalty-bearing licenses like the one in Kimble should be careful in how payments are allocated, or risk partial or total invalidation.
What happens now? Don’t fret: Contract drafters can still achieve payment deferral and risk allocation without a long-term royalty distribution using creative and strategic provisions.
As parties enter into agreements to commercialize patents, they should consider the royalty structure in light of the Brulotte and Kimble decisions. Parties to such an agreement can structure royalty payments so that payment of royalties allows for payment deferral, rather than paying a lump sum up front. This structure may allow for risk allocation for risks associated with commercializing inventions. For example, commercialization often involves a development phase where the party responsible for commercialization is not selling or making a profit. Royalty payment allows that party to invest in research and development and later pay the patent holder when the product is on the market. Although the Supreme Court’s decisions bar the distribution and collection of royalties post-expiration, Kimble provides examples to help parties determine appropriate contractual provisions that still accomplish payment deferral and risk-spreading, including:
- Amortization—A patent licensee could agree to pay the patent licensor a sum equal to, for example, 10% of sales during the patent term, but amortize that sum over a longer period like 40 years.
- Multiple patents under the same agreement—If an agreement covers multiple patents, the patent licensor can still collect royalties until the latest-running patent expires. So long as one of the patents under the agreement is still valid, the patent licensor can still collect royalties.
- Tie to non-patent right—If a license covers a patent right and another non-patent right, the licensor can still collect royalties after the patent term expires. For example, if a patent holder enters into a licensing agreement involving a patent and a trade secret, the patent holder can earn a combined 5% royalty during the patent term, and then a step-down 4% royalty after the patent expires and while the trade secret is still valid.
- Business arrangements other than royalties—The Brulotte rule only disallows a patent holder from collecting royalties after the patent term expires. A patent holder may still enter into an alternate business arrangement with another party, such as a joint venture where the parties share risks and rewards of commercializing a patent.
Even though the Supreme Court declined in Kimble to overrule Brulotte, there are several possible strategies, as indicated above, and others that creative parties will doubtless structure, that will allow parties to achieve the benefits that a long royalty period provides.
What were the circumstances in the Kimble case?
Stephen Kimble obtained a patent on a toy that allows users to shoot webs of pressurized foam string from the palm of their hand, just like the character Spider-Man. Marvel learned about Kimble’s patent and, without permission, began to manufacture and sell “Web Blaster” toys, allowing users to pretend to be Spider-Man. After Kimble sued Marvel for patent infringement, the parties settled and signed an agreement where Kimble sold his patent rights to Marvel in exchange for approximately $500,000 and a 3% royalty on future sales of Marvel’s “Web Blaster.” The parties failed to include a provision in the agreement identifying when Marvel was no longer obligated to pay Kimble royalties. Several years after the parties signed the agreement, Marvel learned of Brulotte v. Thys Co., 379 U.S. 29 (1964), and sought a declaratory order stating that Marvel no longer owed Kimble royalties.
The Brulotte decision contains a bright line rule: a patent holder cannot charge royalties for the use of his invention after its patent term has expired. According to the Kimble majority: “The [Brulotte] decision is simplicity itself to apply. A court need only ask whether a licensing agreement provides royalties for post-expiration use of a patent. If not, no problem; if so, no dice.”
The Supreme Court makes it clear in Kimble: in the event that the parties agree that royalties are to be paid after the expiration of a patent, such a royalty provision is unenforceable for royalties accruing after the patent expires.