Patent licensing agreements are often critical to the financial success of the patent owner (licensor). Such agreements are generally lengthy and subject to extensive negotiation between the parties. After all of the blood, sweat, and tears that went into just obtaining the patent, a patent licensor may think that any resulting patent licensing agreement is merely icing on the cake.
Yet a recent order on cross motions for summary judgment out of the U.S. District Court for the Northern District of California serves as a reminder that patent licensing agreements are the subject of complex contract law principles. Thus where a patent licensing agreement is ambiguous and unclear, the courts may well rely on the infamous parole evidence rule every first year law student hears about in contracts class, but often doesn’t fully understand, to try and establish what the parties to the licensing agreement really intended. The result may lead to unexpected surprises for either party to the licensing agreement as the resulting order shows.
In Lotes Co., LTD. v. Hon Hai Precision Industry, Co., Ltd., et al., (N.D. Cal. 2012) the parties had previously entered into a patent licensing agreement (PLA) as part of a litigation settlement agreement involving Hon Hai’s patents. The parties ended up in court again when the parties disputed whether the Settlement and PLA agreements had been followed and/or whether Lotes was infringing on several of Hon Hai’s patents. The order is instructive because it discusses contract law principles in the context of patent licensing agreements and emphasizes the need for careful, unambiguous wording within the licensing agreement. For organizational purposes, this blog is divided into the following three(3) parts:
- Federal Law Issue: Is the Licensee Estopped from Challenging the Validity of the Licensed Patents ?
- State Law Issues: What Was the Intent of the Parties Regarding the Scope of the Covered Patents and the Burden of Proof in any Infringement Action?
- Suggestions for Drafting Patent Licensing Agreements In General
I. Federal Law Issue: Is the Licensee (Lotes) Estopped from Challenging the Validity of the Licensed Patents?
Generally contracts are interpreted according to state law, but here the contract at issue involved the enforcement of patent rights. The threshold issue for the Lotes Court was whether the PLA’s licensee had the right to contest the validity of the licensor’s patents under the PLA. The PLA contained the following provision:
Agreement Not to Challenge: In return for the benefits under this Agreement and License Agreement, Lotes agrees that it will not directly or indirectly challenge, now or in a future proceeding regarding the Licensed Products, Hon Hai’s ownership or the validity or enforceability of the Licensed Products that are the subject of this Agreement.
Lotes at 4.
Licensee Lotes contended that the holding in Lear, Inc. v. Adkins, 395 U.S. 653, 670-671 (1969) supported its position that the foregoing waiver position was unenforceable. In Lear, the U.S. Supreme Court eliminated the doctrine of “licensee estoppel” as it applied to licensing agreements, thereby allowing the licensee of a patent to challenge the validity of the licensed patent that is the subject of the license agreement. In reaching its conclusion, the High Court cited the “ ‘ important public interest in permitting full and free competition in the use of ideas.’ ” Lotes quoting Lear at 670-71. Lotes should therefore be allowed to contest the validity of Hon Hai’s patents despite the waiver provision in the PLA.
The Lotes Court disagreed and distinguished the licensing agreement in Lear from the PLA by noting that the Lotes-Hon Hai Agreement was the result of a litigation settlement agreement. It was not a licensing agreement originally contemplated between two (at the time) non-adversarial parties to promote commercialization and/or distribution of a patented product by the licensee. Under such circumstances, Federal Circuit precedent governed and “ ’ [t]he Federal Circuit has clearly held that where there is a clear and unambiguous waiver of future challenges to the validity of a patent in settlement agreement, an accused infringer is contractually estopped from challenging the validity of the patent in any subsequent proceeding.’ “ Lotes Court citing Flex-Foot, Inc. v. CRP, INC., 238 F.3d 1362, 1370 (Fed. Cir. 2001). Moreover, the licensing agreement at issue in Lear “ ‘did not contain and was not accompanied by any promise by the licensee not to challenge the validity of the patent. ’ ” Lotes at 4 quoting Flex-Foot at 1368.
To further justify its position that the waiver provision was enforceable, the Lotes court opined that whether or not the Federal Circuit had too narrowly construed the Lear decision was of no consequence because the Federal Circuit’s precedent is binding on district courts absent any intervening Supreme Court decision that undermines existing precedent. Lotes at 5 citing U.S. v. Mandel, 914 F.2d 1215, 1220-1221 (9th Cir. 1990). Accordingly, the licensee (Lotes) could not challenge the validity of the patents at issue in the PLA because under Federal Circuit precedent, the clear and unambiguous covenant not to contest the validity of the patents was enforceable. In Flex-Foot, the Federal Circuit had also stated that upholding licensing agreements entered into as the result of litigation settlement “ ‘implicates the important policy of enforcing settlement agreements and res judicata. ’ ” Lotes at 4 quoting Flex-Foot at 1368.
II. State Law Issues: What Was the Intent of the Parties Regarding the Scope of the Covered Patents and the Burden of Proof in any Infringement Action?
Here’s where the case gets interesting from a contract law perspective. The scope of the PLA, as it related to the licensed products covered by the PLA, was ambiguous because it was not clear whether the PLA was applying to product categories or product numbers. Due to the wording of several key provisions of the PLA, different conclusions could be reached as to whether the licensed products were to be defined by product category or product number. A product number definition would narrow the scope of the licensing agreement and was favored by Lotes while the broader product category definition was favored by Hon Hai. Why? A product category may have many associated product numbers as was evidently the case here. If the contract did not list every associated product number with the product category but only certain product numbers, the scope of the PLA would be limited to the actual listed product numbers.
The poor wording of the PLA rendered it ambiguous as to the scope of the “patent-licensing” coverage. Lotes argued that the PLA was intended to apply only to certain product numbers (narrow construction) while Hon Hai argued the parties had intended for the PLA to cover product categories.
Under state law, in this case California state law, ambiguous contracts will be interpreted by the courts to give effect to the mutual intention of the parties at the time the contract was formed. Ideally, this intent can be inferred within the four corners of the contract. Due to the ambiguous provisions governing the scope of the contract, the Lotes Court allowed the introduction of extrinsic evidence (parol evidence) to prove what the parties intended at the time of agreement. The submitted evidence by the parties included communications between the parties discussing the Exhibit to the licensing agreement entitled “Licensed Patents, Licenses Products, and Applicable Royalty Rates. The Lotes Court sided with Lotes that the parties intended the PLA to apply to actual specified product numbers based on the following two (2) communications between the parties:
- In one of the communications between the parties discussing the above exhibit to the agreement, Hon Hai had written: “ ‘If Lotes won’t agree to [listing by the product name instead of product number], we would need its help in listing each product number.’ ”
- Also, a draft of the PLA’s Exhibit had contained the following language after the description of the product categories and their respective royalty rates: “ ‘ We need to agree on the list of product that include those accused and exclude those not addressed by this agreement.’ ”
Lotes at 7-8.
The Lotes Court interpreted the foregoing communications and PLA draft to establish that the parties had intended PLA’s product scope to be defined by actual, specified product numbers.
Finally, Hon Hai sought summary judgment on the issue of whether the PLA altered the burden of proof and shifted the burden to Lotes, as the licensee, to prove non-infringement. Ordinarily patent owners who allege infringement bear the burden of proof on infringement. Under contract law principles, however, and Federal Circuit case law, “ ‘parties are generally free to contract around the legal rules as long as their intent to do so is “clear and unambiguous. ’ ” Lotes at 8 quoting Flex Foot at 1370.
Hon Hai argued that the PLA provision beginning with the words “ ‘ [i]n the event that the Licensee establishes in accordance…. ’ ” meant that Lotes had the burden of proving non-infringement. The Lotes Court found this assertion to be without merit because “establish” does not mean prove, but instead means that Hon Hai or a court of competent jurisdiction ultimately agreed with Lotes’ position. The provision did not meet the clear and unambiguous requirement under Flex Foot for shifting the burden of proof from the patent owner to the alleged infringer. Lotes at 9.
The Lotes Court further noted that the parties were sophisticated with sophisticated patent attorneys. As such, they knew that the patent owner bears the burden of proving infringement in an infringement action. If they intended to contract around this well-known legal rule, they should have included a clear and unambiguous provision in the contract. Lotes at 9.
In summary, Hon Hai, as the patent licensor, prevailed on the issue of the enforceability of the waiver provision so that Lotes could not contest the validity of the patents covered by the PLA. However, as it turned out, the PLA’s scope turned out to less than what perhaps Hon Hai had envisioned it would be. Any settlement negotiation generally involves concessions from both sides, but the practitioner needs to ensure that his/her client understands what exactly those concessions are going to be to arrive at a settlement agreement acceptable to and understood by both parties.
III. Suggestions for Drafting Patent Licensing Agreements In General
The foregoing admonishment by the Lotes Court should serve as a take-home point for the patent licensing practioner: take the time to get it right.
The Lotes decision is instructive because it illustrates the pitfalls that can occur when a patent licensing agreement is not particularly well written. The order reinforces the importance of using clear and explicit language when drafting licensing agreements. Also, the licensor should ensure that the licensing agreement being entered into as part of a litigation settlement agreement contains clear and unambiguous covenants not to challenge the validity of the patents. Although the Supreme Court did eliminate the doctrine of licensee estoppel in Lear, the Federal Circuit has not extended this elimination to the type of licensing agreement at issue in Lotes. Furthermore, the licensing agreement in Lear did not contain a waiver provision.
Moreover, for any patent licensing agreement, care must be taken to carefully define the scope of the licensing agreement. Product numbers, product descriptions, and associated patents etc. should be clearly specified. Counsel should carefully review the provided product numbers against existing catalog numbers and even consider including a provision that any change in the product number of a covered product must be communicated to the licensor. In addition, if the licensing agreement is to cover products sold in different countries under different product numbers, the licensing agreement needs to specify as such.
The Lotes decision also reminds us that a Court will look to extrinsic evidence to resolve any ambiguity in the contract. Careful, detailed drafting can help ensure that the court will look only at the language contained within the licensing agreement in determining the intent of the parties.
Even negotiation discussions may serve as extrinsic evidence to determine the intent of the parties by the courts as happened in Lotes. Ideally, at least all critical issues are unequivocally resolved at the negotiation stage so that “problematic” points during the negotiation stage will end up being clearly and explicitly presented in the final licensing agreement.
© by Troy & Schwartz, LLC.
Disclaimer. The foregoing information is not legal advice, nor should you consider it as such. It is for informational purposes only and your reading of this blog does not constitute an attorney-client relationship. Should you be considering legal action, you should consider consulting with an attorney of your choosing.
