The Supreme Court of the United States, in a 6-3 decision, left undisturbed the rule from its 51-year-old decision in Brulotte v. Thys Co. (1964), invoking stare decisis and rejecting arguments seeking to overturn the rule barring patent royalty agreements that obligate payment of post-patent expiration royalties. Kimble v. Marvel Entertainment, LLC, Case No. 13-720 (Supr. Ct., June 22, 2015) (Kagan, Justice) (Alito, Justice dissenting). In Kimble, the Court addressed the question of whether parties to a patent license may agree that a licensee must continue paying royalties based on sales of products after the licensed patent(s) expire, and answered the question “No,” continuing the rule that such agreements are unlawful per se.
Since Brulotte was decided 51 years ago, many courts and commentators have criticized the rule it laid down as wrongly decided as a matter of economic policy. While the Kimble decision, based essentially on stare decisis, preserves the Brulotte status quo in patent licensing, Justice Kagan has now raised the profile of this judge-made rule and related economic arguments to the branch of government that the Supreme Court concluded had the exclusive power to change it: Congress.
When the Supreme Court decided Brulotte, it prohibited the extension of the “patent monopoly” beyond the term of the patent. The Court held that “a patentee’s use of a royalty agreement that projects beyond the expiration date of the patent is unlawful per se.” In other words, once the patent expires, the invention is dedicated to the public, and the patent owner cannot continue to demand royalties for use of the patented invention after expirations of the patent term. In dicta, however, the Court distinguished impermissible payments due for use of an invention during the post-expiration period from “deferred payments for use during the pre-expiration period,” which remained permissible.
In this case, an inventor (Kimble) licensed a patent on a novelty Spider Man web-slinging toy to Marvel Entertainment. The parties, unaware of Brulotte at the time of licensing, agreed to a license whereby Marvel would pay Kimble an upfront sum plus a 3 percent royalty for all sales going forward. The license agreement included no fixed term. However, after Marvel learned of the Brulotte rule, it filed a declaratory judgment action, seeking a ruling that it could cease paying Kimble royalties as of the expiration of Kimble’s patent term in 2010. The district court agreed with Marvel, and the U.S. Court of Appeals for the Ninth Circuit affirmed. (IP Update, Vol. 16, No. 8).
In affirming the Ninth Circuit, the Supreme Court rejected Kimble’s arguments seeking to overturn the Brulotte rule. Kimble argued that the economic rationale underlying Brulotte was no longer correct, and that prohibiting post-expiration royalties made it inefficient and difficult to allocate risks and rewards, especially for patented technology that may take a significant amount of time to commercialize (such as pharmaceuticals). Marvel responded simply that stare decisis required the Court to re-affirm Brulotte.
The Supreme Court agreed with Marvel. Justice Kagan explained that stare decisis compelled adherence to Brulotte, and that there was no “special justification” for overturning it. Kagan observed that Congress could overrule the Court’s decision if Congress disagreed with it, and noted that Congress had actually not changed the rule despite repeated amendments of the patent laws since the Court’s Brulotte decision. In an apparent nod to the subject matter of the Marvel Spider Man product, Justice Kagan intoned that the rule of stare decisis is “super powered” and it would require “super special justification” to overturn Brulotte.
After summarizing Kimble’s economic criticisms of the rule in Brulotte—namely that the Brulotte Court was mistaken about the anticompetitive effect of post-expiration royalties and that the rule in Brulotte stifled innovation—the Supreme Court explained that even if true, such arguments provided no grounds to deviate from stare decisis. Accordingly, the Supreme Court affirmed the rule that “when the patent expires, the patentee’s prerogatives expire too, and the right to make or use the article, free from all restriction, passes to the public.” The Court added that post-expiration royalty obligations “conflict with patent law’s policy of stablishing a ‘post-expiration … public domain’ in which every person can make free use of a formerly patented product.”
The Court also re-confirmed the dicta in Burlotte distinguishing between permissible and impermissible licensing structures. For example, the Court wrote:
[P]arties can often find ways around Brulotte, enabling them to achieve those same ends. To start, Brulotte allows a licensee to defer payments for pre-expiration use of a patent into the post-expiration period; all the decision bars are royalties for using an invention after it has moved into the public domain. A licensee could agree, for example, to pay the licensor a sum equal to 10% of sales during the 20-year patent term, but to amortize that amount over 40 years. That arrangement would at least bring down early outlays, even if it would not do everything the parties might want to allocate risk over a long timeframe. And parties have still more options when a licensing agreement covers either multiple patents or additional non-patent rights.
Thus, the Court acknowledges that deferred payments, if based on activity occurring before the patent expiration, are permissible.
Justice Alito (joined by Chief Justice Roberts and Justice Thomas) dissented, asserting that Brulotte was not based on interpretation of the Patent Act, but based on economic theory, which has been “debunked.” The dissent further argued that Patent Act did not demand that the royalty term be compressed to fall within the patent term, and that there are often “good reasons why parties sometimes prefer post-expiration royalties over upfront fees.” For example, such arrangements may yield economic efficiencies where parties are “unsure whether a patented idea will yield significant economic value, and it often takes years to monetize an innovation.” The dissent also explained that the majority decision undermined the parties’ agreed-upon bargain and expectations. Finally, the dissent argued that stare decisis should not insulate Brulotte.
The Kimble decision may yield at least three consequences.
First, Kimble is a reminder to patent holders, patent licensees and patent practitioners alike of the permissible ways that they can structure royalties due for conduct during the period covered by a patent without incurring Brulotte’s—and now Kimble’s—per se rule against post-expiration royalties. As it did for Kimble, the Brulotte rule creates a trap for the unwary.
Second, having considered this matter a second time, and Justice Kagan’s invitation for legislative attention if Congress disagreed with Brulotte, the Kimble decision may motivate Congress to reconsider bills that it has previously “rebuffed” and that “would have replaced Brulotte’s per se rule with the same antitrust-style analysis Kimble now urges.” Of course, Congress itself may prefer the ease of applying the rule from Brulotte as contrasted with, in the Court’s words, the “elaborate” rule-of-reason inquiry, with its “notoriously high litigation costs and unpredictable results.”
Third, going forward, parties will likely take increased care in drafting licenses to take advantage of the Incredible-Hulk-sized exception to the Brulotte rule, i.e., that a license can be structured to provide for “deferred,” “post-expiration” royalties based on pre-expiration use of a licensed patent. The Court clarified Brulotte’s distinction between impermissible enforcement of a patent to preclude post-expiration infringement, and permissible “deferred payments” based on infringing activities occurring before patent expiration. This reinforces the ability of parties to contractually agree to alternative payment arrangements. For example, instead of paying up-front royalties, Kimble acknowledges that parties may contractually extend royalty obligations beyond the life of the patent in the form of “deferred payments,” provided the royalty obligation is premised on pre-expiration use of the patented technology.