On July 10, 2012, the United States Court of Appeals for the Second Circuit held in Rates Technology Inc. v. Speakeasy, Inc. that covenants prohibiting challenges to a patent's validity, along with liquidated damages provisions, are unenforceable where the covenants were entered into prior to litigation. This result is the same regardless of whether the agreements containing such covenants are styled as settlement agreements, license agreements or covenants not to sue.1
While it is clear that the Second Circuit considers no-challenge clauses and accompanying liquidated damages provisions to be unenforceable when entered into before litigation, it remains unclear whether certain contractual provisions intended to discourage a licensee from bringing an invalidity action would similarly be considered unenforceable.
In 2007, Rates Technology Inc. entered into a Covenant Not to Sue agreement with Speakeasy, Inc. Under the agreement, Rates agreed not to sue Speakeasy for any past or future infringement of two patents owned by Rates, and Speakeasy agreed to make a one-time payment of $475,000 to Rates. In addition, Speakeasy agreed not to challenge or assist others in challenging the validity of any claims under the patents covered by the agreement, and if it violated this no-challenge agreement, it would pay Rates liquidated damages in the amount of $12 million.
In 2010, Rates brought a lawsuit against Speakeasy and affiliated entities, including Best Buy Co., Inc., on the grounds that Speakeasy violated the no-challenge covenant in the Covenant Not to Sue agreement by assisting an affiliated entity to bring an action against Rates seeking a declaration that the two patents are invalid and unenforceable. The declaratory judgment action was subsequently voluntarily dismissed.
In Lear, Inc. v. Adkins, the United States Supreme Court previously ruled that patent licensees should be free to challenge the validity of the licensed patents and not be required to continue to pay royalties while challenging patent validity in the courts. The Supreme Court reasoned that the public interest in discovering invalid patents outweighs competing interests, including contract law principles supporting the enforceability of contracts.2
The Second Circuit in the Rates case found it helpful to distinguish several methods by which patent disputes regarding infringement and invalidity can be resolved:
In this fourth situation, the Rates court indicated that a pre-litigation licensee does not have the opportunity to conduct discovery on validity issues. Therefore, the licensee does not have a full opportunity to assess validity before deciding whether to enter into the license agreement. Because licensees are the individuals with sufficient economic interests to challenge the patent's validity, the court decided that the public interest in discovering invalid patents would be significantly undermined if no-challenge clauses were enforced in the pre-litigation license context. As a result, the court held theRates no-challenge clause, as well as the $12 million liquidated damages clause, are unenforceable.
The Rates decision means that at least in the Second Circuit (and the Ninth Circuit4), a contractual bar on a pre-litigation licensee (or recipient of a covenant not to sue) from challenging the validity of the underlying patent will not be enforceable, nor will a corresponding liquidated damages provision.
In the wake of the U.S. Supreme Court decision MedImmune, Inc. v. Genentech, Inc., which held that a patent licensee does not have to repudiate the license in order to challenge the validity of the licensed patent5, a number of commentators have suggested that licensors include provisions to discourage licensees from bringing invalidity actions, such as:
Whether these provisions are any more or less enforceable after the Rates decision is unclear. The Ratescourt struck down the $12 million liquidated damages clause along with the no-challenge clause. Would it similarly refuse to enforce a clause that does not prohibit a patent challenge, but instead provides for adverse consequences for the licensee if it does so? Presumably, this would depend on the level of a "chilling effect" the contractual provision would have on the licensee's right to bring an invalidity action, balanced against any competing interests. Perhaps a provision with an enormous deterrent would be more likely to be held unenforceable than a provision with only a moderate deterrent.
If you have any questions about this Alert, please contact David A. Charapp, the author of this Alert; John M. Neclerio; any other member of the Technology Transactions and Licensing Practice Group; or any attorney in the firm with whom you are in regular contact.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, or should be construed, as legal advice. For more information, please see the firm's full disclaimer.
© 1998-2012 Duane Morris LLP
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