Higher regional court decision
Supreme Court decision
On November 25 2010 the Supreme Court in Civil Matters ruled on the consequences of the termination for cause of a know-how licence agreement.(1) The decision strengthens the position of know-how licensors in cases where the licensee breaches its contractual obligation to maintain the know-how confidential.
The parties entered into an exclusive know-how licence and consultancy agreement on January 15 2003, under which the plaintiff agreed to provide know-how for the manufacture of elastic bags that could contain large quantities of fluids (known as 'Flexitanks') and to assist the defendant in the development and manufacture of such bags. The defendant agreed to pay a consultancy fee during the development period and a royalty for each Flexitank and respective equipment sold.
The agreement provided that the defendant was not permitted to use confidential information to manufacture competing products or to release such confidential information to third parties.
The agreement was entered into for a period of 20 years from the date of the first sale. Termination of the agreement was possible only for cause.
In March 2003 the defendant informed the plaintiff that it intended to involve a third party in the manufacture of prototypes. The plaintiff asked the defendant to enter into a confidentiality agreement with the third party, but this did not happen. Nevertheless, the defendant placed orders with the third party and provided the polypropylene fibres necessary for production to the third party.
At the end of July 2004 the plaintiff became aware that the third party had supplied polypropylene fibres to another competitor. Since trilateral negotiations proved unsuccessful, the plaintiff terminated the know-how licence agreement for cause.
The plaintiff then demanded that the defendant disclose information on sales, as well as paying damages for breach of contract. The defendant held that there was no breach of contract and it refused the plaintiff's claims. The plaintiff then filed suit.
Higher regional court decision
The higher regional court agreed with the plaintiff's position that termination for cause was justified. The court found that the plaintiff had provided the defendant with know-how regarding the properties that the polypropylene fibres must meet in order to manufacture Flexitanks. The higher regional court held that even if the defendant had argued that it already had sufficient know-how and received little practical know-how from the plaintiff, it was sufficient that before the agreement had been entered into, the defendant did not have Flexitanks in its product portfolio and that the parameters for the fibre were developed jointly.
The higher regional court dismissed the defendant's statement that polypropylene fibres could be bought anywhere as the know-how did not concern the manufacture of the fibres as such, but rather the properties that the fibres required for the manufacture of Flexitanks. Accordingly, the breach of contract was not the supply of fibres to the third party, but rather the disclosure of information permitting the third party to manufacture tissue for Flexitanks using such fibres.
In addition, the higher regional court dismissed the defendant's argument that the plaintiff was aware that a third party had to be involved for the manufacturing of the tissue. According to the agreement, the defendant was not prohibited from involving other suppliers and contract manufacturers. However, disclosing know-how to such third parties without asking them to sign a confidentiality agreement, and thus enabling them to use the know-how in a competitive manner, constituted a breach of the agreement.
However, the higher regional court limited the defendant's obligation to provide information in several respects. It found that the defendant was obliged to provide information only for a period of five years. The reason for the limitation was that the court found that the plaintiff had been active for the defendant for merely one year. Thus, the court concluded that the plaintiff could not be seen as responsible for the success of the product beyond this time. In addition, the court held that it was not necessary for the defendant to provide monthly reports or to disclose the names of customers.
Both parties appealed to the Supreme Court.
Validity of termination
The Supreme Court concurred with the higher regional court in regard to the validity of the termination. By disclosing know-how on the manufacture of Flexitanks without imposing confidentiality obligations on the third party, the defendant had materially breached the agreement.
The Supreme Court found that even if the higher regional court had not examined in detail which know-how was provided by the plaintiff to the defendant, its reasoning was sensible. As mentioned above, the higher regional court had concluded that the parameters for the manufacture of the Flexitanks must have been developed at least jointly because:
- the defendant did not have Flexitanks in its product portfolio before its cooperation with the plaintiff; and
- the plaintiff had been engaged as consultant for the development of such Flexitanks.
Given this situation, the Supreme Court held that it was not necessary to identify which information disclosed to the third party originated from the plaintiff and which from the defendant.
Timeliness of termination
The Supreme Court also found that the termination was timely even if notice had been given approximately one month after the plaintiff became aware of the breach. Paragraph 314 of the Civil Code requires that notice be given within a "reasonable period" of obtaining knowledge of the reason for termination.
The Supreme Court stated that in this case, the one-month period was to be considered reasonable in view of the fact that the plaintiff entered into trilateral negotiations, which eventually failed. The Supreme Court held that the defendant could not assume that the plaintiff would tolerate the breach of contract independently from the outcome of the negotiations, either from the fact that the plaintiff had entered into negotiations, or from the duration of the negotiations. Thus, the termination was timely.
Temporal limitation of damages
The Supreme Court disagreed with the higher regional court's limitation of the obligation to provide information. In particular, the Supreme Court stated that the claim for damages was not limited to a period of five years.
The Supreme Court explained that if a contract is terminated for cause, the terminating party is entitled to damages. Such damages should compensate the loss incurred because of the early termination of the agreement. Usually, damages are owed for the period lasting until the agreement could have been terminated ordinarily. However, if ordinary termination is excluded – as was the case here – damages are owed for the entire duration of the agreement.
In view of the higher regional court's concern that the plaintiff had been active for the defendant for one year only, the Supreme Court stated that if the defendant had not breached the agreement, it would have continued in existence for a period of 20 years and the plaintiff would have been entitled to royalties for the entire duration, regardless of whether the economic success of the product was owed to its input. Even if the defendant had modified the Flexitanks in a way such that the know-how provided by the plaintiff ceased to be of importance, the defendant still owed damages since by its breach of contract, the defendant has annihilated the plaintiff's chance to contribute to the amendments.
Other limitations of claims
The Supreme Court emphasised that the extent of the information to be provided did not depend on which know-how the defendant disclosed in breach of the contractual obligations. The damage was not caused by the fact that the third party had obtained information; rather, it was caused by the fact that through the termination of the agreement, the plaintiff failed to receive royalties.
The Supreme Court further established that the defendant was obliged to provide information on all sales starting from the date on which the parties entered into the agreement. The Supreme Court referred to patent litigation and explained that it is generally recognised that patent owners can demand from infringers disclosure of information on all – past and future – actions that infringe the patent in a certain way. The same must apply to the infringement of know-how. Therefore, the Supreme Court held that independent of whether the duration of the agreement was to be calculated starting from the date of the first sale of products, the defendant had to provide information on all sales starting from the date on which the parties entered into the agreement.
The Supreme Court also disagreed with the higher regional court in regard to the obligation to provide monthly reports. The Supreme Court held that the view of the higher regional court was tainted by the assumption that the obligation to provide information lasted for only one year. Since, however, according to the Supreme Court damages were owed for 20 years, the defendant was obliged to provide monthly reports as provided for in the agreement.
The Supreme Court also disagreed with the higher regional court in regard to the limitation of the information regarding customers. The Supreme Court repeated that the plaintiff was entitled, under the agreement, to a report on the quantities of Flexitanks manufactured and sold by each customer, with details of the type, size and average price for each month. This comprised the obligation to provide names. Although this was not expressly provided for in the agreement, the fact that the agreement did state that the quantities and other information were to be provided for each customer implied that customers were to be identified. The alternative, an anonymised list, would considerably diminish the value of the information.
The decision strengthens the position of know-how licensors. By exempting licensors from the burden to identify in detail the know-how that is supplied to the licensee, the Supreme Court has facilitated the prosecution of cases in which licensees illicitly disclose or use the know-how. In addition, by dismissing the arguments that the know-how of the licensor is not relevant and that the licensee had know-how of its own, the Supreme Court took into account that the licensee had obviously considered the licensor's know-how to be significant and its own know-how to be insufficient when it entered into the know-how licence agreement.
The decision is also interesting in regard to the Supreme Court's findings on the timeliness of termination. The defendant had referred to Paragraph 626 of the Civil Code, which relates to services agreements. According to Paragraph 626, notice of termination must be given within two weeks of becoming aware of the cause. The Supreme Court clearly dismissed any applicability of this provision. It found that a balance of interests was required which was inconsistent with a fixed term. Thus, the termination was considered timely even if more than one month had passed before notice was given.
Finally, in determining the extent of the obligation to provide information, which would be used to determine damages, the Supreme Court made clear that the agreement must be considered. Therefore, in regard to not only the duration, but also the extent of the obligation, the Supreme Court relied on what the parties had agreed in the licence agreement.
For further information on this topic please contact Nora Keßler at Klinkert Zindel Partner by telephone (+49 69 972 65 600), fax (+49 69 972 65 6099) or email ([email protected]).