The recent United States Supreme Court decision in MedImmune v Genentech significantly changed the law governing the challenge of patent licences in the United States.

Prior to MedImmune, in order to challenge the validity of a licensed patent in court, a licensee first had to breach the licence and risk an injunction and a patent infringement damages award that could far exceed the royalties due under the licence. Otherwise, under Federal Circuit law, the licensee had no “reasonable apprehension” of being sued for patent infringement and, therefore, no right to bring a declaratory judgment action to challenge the patent.

The Supreme Court’s decision in MedImmune changed all of that. Now, a licensee can challenge the infringement, validity or enforceability of a licensed patent without first breaching or terminating the licence and without risking an injunction or large damages award.

The MedImmune decision

In 1997, MedImmune licensed the Cabilly I patent and various related pending patent applications from Genentech. In 2001, the Cabilly II patent issued. Genentech believed that MedImmune’s biggest product, Synagis, was covered by Cabilly II and demanded MedImmune pay royalties on that product. MedImmune disagreed – it believed that it was not required to pay royalties because Synagis was not covered by Cabilly II, and because Cabilly II was invalid and unenforceable.

Genentech’s request put MedImmune in a bind: If MedImmune failed to pay the royalties as requested, Genentech could terminate the licence and sue for patent infringement, and possibly obtain an injunction as well as damages for patent infringement. An injunction would have been catastrophic – Synagis produced more than 80% of MedImmune’s revenue.

MedImmune decided instead to pay the royalties “under protest” and file an action for declaratory relief attacking the licensed patent. If MedImmune succeeded in the suit, it could stop paying royalties. If MedImmune did not succeed, it would still have a licence to the patent. But under then-controlling Federal Circuit law, a licensee was first required to breach or terminate the licence before it could attack the licensed patent. Without such action, the licensee had no reason to fear suit by the patentee and therefore no basis for a declaratory judgment action. The lower courts, not surprisingly, dismissed MedImmune’s action.

The Supreme Court, however, sharply criticised the Federal Circuit’s “reasonable apprehension” test and allowed MedImmune to go forward with the suit. According to the Court, the pertinent question was not whether MedImmune feared suit, but whether “under all the circumstances … there is a substantial controversy, between parties having adverse legal interests, of sufficient immediacy and reality to warrant the issuance of a declaratory judgment”.

The court held that MedImmune need not risk an injunction and damages award to challenge the patent: “The rule that a plaintiff must destroy a large building, bet the farm or (as here) risk treble damages and the loss of 80% of its business before seeking a declaration of its actively contested legal rights finds no support in Article III [of the United States Constitution].”

MedImmune will make it far easier for existing licensees to challenge the validity of licensed patents, while avoiding the risk of an injunction or a large damages award. But the impact of MedImmune is not confined to existing licensees. The Supreme Court went out of its way to criticise the Federal Circuit’s “reasonable apprehension” test for declaratory judgment jurisdiction generally, all but compelling that court’s subsequent abandonment of that test in SanDisk Corp v STMicroelectronics.

In SanDisk, the Federal Circuit permitted SanDisk, a prospective licensee, to sustain a declaratory judgment suit against patentee STMicroelectronics after licensing negotiations broke down, even though STMicroelectronics had expressly disavowed any intention to sue for infringement. The Federal Circuit in SanDisk held that declaratory judgment jurisdiction exists: “Where a patentee asserts rights under a patent based on certain identified ongoing or planned activity of another party, and where that party contends that it has the right to engage in the accused activity without license…”

This rule appears to make it nearly impossible for a patentee to conduct meaningful licensing discussions without risking a declaratory judgment suit by a prospective licensee. But as Judge Dyk remarked in his concurring opinion, the new rule seems to follow from MedImmune: “I see no practical stopping point short of allowing declaratory judgment actions in virtually any case in which the recipient of an invitation to take a patent licence elects to dispute the need for a licence and then to sue the patentee. Although I have reservations about the wisdom of embarking on such a course, I agree with the court that a fair reading of footnote 11 of the Supreme Court’s opinion in MedImmune compels that result…”

In short, the MedImmune decision has fundamentally altered the balance of power between licensors and licensees. It has also injected into the licensing dynamic an element of uncertainty that will make it more difficult to negotiate licences without sparking litigation and more difficult to obtain certainty and peace even after a licence is signed. Both licensors and licensees should recognise the implications of the decision and adjust their approach to licensing in the future.

Implications for licensors

Current licensors are the clear losers from MedImmune. There is relatively little a current patent licensor can do in the wake of MedImmune to mitigate the risk that a licensee will challenge the patent underlying an existing licence. The terms of the deal are already in place and it will generally be too late to secure additional protections.

But there are two important questions a prospective licensor should ask itself before going forward:

  • How can I best approach and negotiate with a prospective licensee while minimising my potential exposure to a declaratory judgment action in an inconvenient forum?
  • How can I make sure a prospective licensee doesn’t simply take a licence in order to cap its potential damages and then sue to invalidate my patent anyway? In other words, how can I make sure the licence will stick and my licensee won’t get a free shot at my patent?

There are no perfect answers to these questions, but prospective licensors can take certain steps to improve their position.

As to the first question, the Federal Circuit recently suggested in SanDisk that a patentee might at the outset of negotiation require a prospective licensee to execute a confidentiality agreement prohibiting the use of anything said during negotiation to establish declaratory judgment jurisdiction. If, however, the prospective licensee refuses to have its hands tied in this manner, the licensor should, if possible, avoid asserting the need for a licence, at least in connection with particular conduct. The approach should be vague: the licensor should speak in terms of the freedom, competitive advantage and enhanced value a licence would confer and avoid asserting that any particular activity or product of the prospective licensee requires a licence. Frankly, however, it may be difficult in the wake of MedImmune and SanDisk to have meaningful licensing negotiations without creating declaratory judgment jurisdiction.

There is one sure, but highly adversarial way a licensor can protect itself. The licensor can bring suit in its preferred forum before contacting the prospective licensee. The licensor can then refrain from serving the complaint for up to 120 days – and negotiate a licence – in the interim. Although this approach may set a more confrontational tone than is desired at the outset of negotiations, it will preserve the licensor’s forum choice should the parties be unable to reach a deal.

As to the second question, the ideal approach would be to include in the licence a provision that prohibits the licensee from challenging the underlying patent. But it is not clear how much of the right to challenge patents the law will allow a licensee to give up. The most obvious method, a promise by the licensee to not challenge the licensed patent, is of questionable enforceability following the Supreme Court’s 1969 Lear v Adkins decision.

A licensor should find additional or alternative ways to discourage a licensee from challenging an underlying patent once they’ve signed a licence. Some possible alternative approaches include:

  • Forum selection clause – while not preventing a declaratory judgment suit, it will prevent the licensee from choosing an inconvenient forum.
  • Front-load royalties – if royalties are front-loaded, rather than running, the licensee will have little to gain by invalidating the underlying patent because past royalties are generally not recoverable even if the patent is later found to be invalid.
  • Provide for increased royalties or other contingencies if the licensee challenges the underlying patent.
  • Provide for termination of the licence if the licensee challenges the underlying patent – this does not prevent a challenge but would force the licensee to accept the risk of an injunction or large damages award if it wants to challenge the underlying patent and, in this sense, restore the pre-MedImmune balance.
  • Provide that the licensee must pay the licensor’s attorney’s fees if the patent is challenged.

The boundaries of the Supreme Court’s Lear decision are still unclear, and some of the above approaches, particularly the latter three, may well be challenged in the future. Still, a licensor is well advised to take whatever steps it can in negotiating future licences to mitigate the effects of MedImmune.

A licensor should also seek to include in any agreement an admission of infringement, validity and enforceability. Even if the licensee is not estopped from challenging the underlying patent under Lear, a written admission may still be admissible in a subsequent suit and have some evidentiary value. A licensor also may wish to include explicit admissions by the licensee that go beyond boilerplate admissions of validity and infringement.

Explicit factual admissions related to validity or infringement likely will be more difficult for a licensee to escape. For example, statements in the licence that none of the prior art of record anticipate the patent or makes prima facie case of obviousness might require the licensee to find new art with which to challenge the patent – often a difficult task. Even if boilerplate validity admissions are not enforceable under Lear, more specific factual admissions may still limit the kinds of argument a licensee can make.

Licensors may also consider filing an infringement suit before licensing, so that a resultant licence will stand not on its own, but rather will be part of the resolution of actual litigation. Including an admission of infringement or validity in a formal settlement, or even more preferably a consent judgment issued by a court, as opposed to a mere licence agreement, may sharpen the teeth of the admission. Any court considering a subsequent challenge initiated by the licensee would have to consider not only the Lear policy in favour of adjudicating the validity of patents, but also the competing policies in favour of finality of judgments and encouraging settlement.

Implications for licensees

Licensees are the clear winners under MedImmune. Many existing licensees will find they now can challenge, with little risk, licensed patents and perhaps avoid paying royalties at some point in the future. And if that weren’t enough, the Supreme Court’s recent decision in KSR Inc v Teleflex Inc has made it easier to prove a patent invalid for obviousness. Today’s licensees will not only have an easier time getting a court to hear their case, but also have an easier time succeeding on the merits. The only real cost is that of the litigation itself and the potential loss of goodwill.

Patent litigation is, of course, expensive but it may well be worth it for the chance to get out of a bad licensing deal. Accordingly, existing licensees would be well advised to review their licences to determine whether any of the underlying patents should be challenged. Even in cases where the licensee determines litigation is not warranted, the post-MedImmune climate may create opportunities for licensees to renegotiate more favourable terms in exchange for more assurance to the licensor that the licensee will not challenge the underlying patent.

Of course, prospective licensees should be aware of the various strategies that licensors may seek to employ to circumvent MedImmune in the future. From the perspective of the licensee, the issue is how much of the MedImmune default position are you willing to give up and what do you want in return?

This article first appeared in Licensing in the Boardroom 2007, an IAM Magazine supplement. For further information please visit www.iam-magazine.com