Awaiting Supreme Court's Ruling on Hybrid Licenses

Hybrid Licenses

The hybrid license attempts to address the fact that intellectual property rights differ in their enforceable terms. When two or more different rights are in a single license and one of the rights extends the revenue period beyond the enforceable term of the other licensed right, the license becomes a hybrid. If the two rights licensed are of a different nature, for example, a patent and a trade secret, it can be easier to differentiate between them.

If we consider the example of a hybrid license with patent and trade secret components, it is easy to see the advantage of the hybrid to the IP owner. A patent has a maximum term of 20 years from the application filing date; trade secrets, so long as they remain secret, can extend into perpetuity. In this case, the licensee will pay an individually identified royalty for each right, or will pay a set royalty until the patent expires and a lower royalty for continued use of the trade secret. Thus, the licensor collects royalties for both rights during the life of the patent and collects a lower royalty for use of the trade secret after the patent is expired. In such a scenario, the trade secret royalties can continue for as long as the market supports sales of a product or service covered by the agreement.

This type of hybrid license would provide the IP owner the additional benefit of protecting some licensing revenue in the event the licensed patent is invalidated in a litigation or U.S. Patent and Trademark Office proceeding. A hybrid license can mutually benefit a licensee that wants to obtain other IP information, such as know-how or formulations not included in a patent, that will let the licensee more quickly maximize the benefits of obtaining the license. It also may enable the licensee to have access to further improvements made by the licensor without the need for a separate negotiation and is desirable in order to reduce setup time, eliminate experimentation, and maximize the commercial benefits of the patented technology to the licensee.

The examples of hybrid licenses with a mix of different statutory patent claims, such as article claims and method of use claims, demonstrate the challenges in navigating the complexities of such an agreement. Those complexities led the parties to the U.S. Supreme Court in Kimble. The central issue in Kimble is whether the U.S. Supreme Court should eliminate the Brulotte rule that a patent license requiring a licensee to make royalty payments beyond the expiration date of the underlying patent is unlawful per se.

The Supreme Court and Hybrids

In Brulotte, the Supreme Court found a hybrid license unenforceable to the extent that the license extended beyond the expiration date of the patents. The court explained its holding with the reasoning that “the present licenses draw no line between the term of the patent and the post-expiration period. ' The contracts are, therefore, on their face a bald attempt to exact the same terms and conditions for the period after the patents have expired as they do for the monopoly period.”

This reasoning seems to be in concert with the statutory bargain between the government and the inventor in the patent laws. The heart of the patent bargain is the exchange of a “full, clear, concise and exact” disclosure that enables “any person skilled in the art” to practice the invention for a limited exclusive right to make, use and sell the same.

There is no universal agreement with the court's reasoning. Many commentators and courts, in criticizing the logic and economics at the heart of the Brulotte decision, argue that post-expiration royalty payments do not extend the patent monopoly because they cease with respect to the public at large when the patent expires and the royalty payments were a bargained-for condition of the license. A license that includes post-expiration royalties was presumptively the result of an arm's-length transaction. The agreed royalty rates could have ' and should have ' accounted for this term or condition. From a contractual viewpoint, Brulotte could be a restraint on free-market economics between two contracting parties. Nevertheless, Brulotte is currently the law and it requires royalty payments associated with a patent to cease upon the expiration of the patent.

Many courts have applied Brulotte to hybrid licenses and require hybrid licenses with a single, undifferentiated royalty for both patent and non-patent intellectual property rights to terminate upon patent expiration.

But in Aronson v. Quick Point Pencil, 440 U.S. 257 (1979), the Supreme Court upheld a hybrid agreement that required royalty payments indefinitely if no patent issued. In Aronson, the licensor's patent application did not issue. The license provisions provided for a 5% initial royalty but provided for a 2.5% reduced royalty if no patent issued within five years. No patent issued and the royalty rate reduced accordingly. The licensee subsequently sought a declaratory judgment of license unenforceability due to the failure to obtain a patent. The Supreme Court held that federal patent law did not pre-empt state trade-secret law where no patent issues and the agreement thus was enforceable. The court differentiated Aronson from Brulotte by reasoning that the extended-royalty term was not negotiated with the leverage of the patent monopoly. Later cases emphasized that enforceability of hybrid agreements turns on whether the patent and non-patent rights are differentiated.

In Kimble, the hybrid agreement involves a single royalty rate for both patent and non-patent rights without any discount or other indication that the non-patent royalties were free of any patent leverage. The U.S. Court of Appeals for the Ninth Circuit held that a reduced royalty may not be required to avoid Brulotte, but the case required differentiation between the basis for the royalty. Kimble clearly does not follow the pattern of Aronson. If the Supreme Court reverses the Ninth Circuit, it is likely to adopt some variation of criticisms raised about the Brulotte rule.

Conclusion

If the Supreme Court affirms the Brulotte rule, Kimble will serve as an important lesson in hybrid agreement drafting ' it must provide some differentiation between the rights and the associated royalties. Alternatively, it may be advisable to use separate agreements, or separate sections within a single agreement. Different royalty rates should be stated clearly for each licensed right. For example, if a patent is the basis for the agreement, the trigger event and the adjusted rate upon that event coming to pass needs to be defined. The conditions related to related trade-secret payments exceeding the length of the patents need to be clearly stated without being tied or associated with the patents to avoid any appearance of patent leverage. Another option is to define large upfront payments for each of the rights and enable the licensee to elect payments over time. This option can turn the agreement into a long-term contractual debt, rather than a hybrid license.

The Supreme Court's forthcoming decision, if it approves of hybrid licensing, could replace complex hybrid agreements with a more economics-based approach that recognizes a bargained-for exchange between willing participants.

Anthony S. Volpe is a shareholder at Volpe and Koenig, an intellectual property law firm with offices in Philadelphia and Princeton, NJ. He has corporate and private-practice experience in securing, licensing and enforcing all aspects of intellectual property rights. Max S. Morgan is an associate with the firm, focusing on the enforcement of intellectual property rights and patent prosecution in the wireless communications and computer technologies industries.

The owner of entertainment intellectual property often faces concerns about maximizing licensing revenues while addressing the restrictions of federal and state laws that create those rights. Because a given IP right may involve federal law ' through patents, trademarks or copyrights ' and state law ' through associated trade secrets or confidential information ' licensing of that IP mix often presents a challenge to maximizing an entertainment IP owner's potential revenue generation.

One approach to solving the problem has been the use of a hybrid license. However, hybrid licenses have had limited success. In Brulotte v. Thys, 379 U.S. 29 (1964), the U.S. Supreme Court held that royalties associated with a patent must stop with a patent's enforceable life. The Court recently heard oral argument in Kimble v. Marvel Enterprises, 13-720, a case involving a Spider-Man role-playing toy in which the court has been asked to overturn Brulotte.

This article examines the hybrid rights issue from the perspective of patents and trade secrets.

Hybrid Licenses

The hybrid license attempts to address the fact that intellectual property rights differ in their enforceable terms. When two or more different rights are in a single license and one of the rights extends the revenue period beyond the enforceable term of the other licensed right, the license becomes a hybrid. If the two rights licensed are of a different nature, for example, a patent and a trade secret, it can be easier to differentiate between them.

If we consider the example of a hybrid license with patent and trade secret components, it is easy to see the advantage of the hybrid to the IP owner. A patent has a maximum term of 20 years from the application filing date; trade secrets, so long as they remain secret, can extend into perpetuity. In this case, the licensee will pay an individually identified royalty for each right, or will pay a set royalty until the patent expires and a lower royalty for continued use of the trade secret. Thus, the licensor collects royalties for both rights during the life of the patent and collects a lower royalty for use of the trade secret after the patent is expired. In such a scenario, the trade secret royalties can continue for as long as the market supports sales of a product or service covered by the agreement.

This type of hybrid license would provide the IP owner the additional benefit of protecting some licensing revenue in the event the licensed patent is invalidated in a litigation or U.S. Patent and Trademark Office proceeding. A hybrid license can mutually benefit a licensee that wants to obtain other IP information, such as know-how or formulations not included in a patent, that will let the licensee more quickly maximize the benefits of obtaining the license. It also may enable the licensee to have access to further improvements made by the licensor without the need for a separate negotiation and is desirable in order to reduce setup time, eliminate experimentation, and maximize the commercial benefits of the patented technology to the licensee.

The examples of hybrid licenses with a mix of different statutory patent claims, such as article claims and method of use claims, demonstrate the challenges in navigating the complexities of such an agreement. Those complexities led the parties to the U.S. Supreme Court in Kimble. The central issue in Kimble is whether the U.S. Supreme Court should eliminate the Brulotte rule that a patent license requiring a licensee to make royalty payments beyond the expiration date of the underlying patent is unlawful per se.

The Supreme Court and Hybrids

In Brulotte, the Supreme Court found a hybrid license unenforceable to the extent that the license extended beyond the expiration date of the patents. The court explained its holding with the reasoning that “the present licenses draw no line between the term of the patent and the post-expiration period. ' The contracts are, therefore, on their face a bald attempt to exact the same terms and conditions for the period after the patents have expired as they do for the monopoly period.”

This reasoning seems to be in concert with the statutory bargain between the government and the inventor in the patent laws. The heart of the patent bargain is the exchange of a “full, clear, concise and exact” disclosure that enables “any person skilled in the art” to practice the invention for a limited exclusive right to make, use and sell the same.

There is no universal agreement with the court's reasoning. Many commentators and courts, in criticizing the logic and economics at the heart of the Brulotte decision, argue that post-expiration royalty payments do not extend the patent monopoly because they cease with respect to the public at large when the patent expires and the royalty payments were a bargained-for condition of the license. A license that includes post-expiration royalties was presumptively the result of an arm's-length transaction. The agreed royalty rates could have ' and should have ' accounted for this term or condition. From a contractual viewpoint, Brulotte could be a restraint on free-market economics between two contracting parties. Nevertheless, Brulotte is currently the law and it requires royalty payments associated with a patent to cease upon the expiration of the patent.

Many courts have applied Brulotte to hybrid licenses and require hybrid licenses with a single, undifferentiated royalty for both patent and non-patent intellectual property rights to terminate upon patent expiration.

But in Aronson v. Quick Point Pencil, 440 U.S. 257 (1979), the Supreme Court upheld a hybrid agreement that required royalty payments indefinitely if no patent issued. In Aronson, the licensor's patent application did not issue. The license provisions provided for a 5% initial royalty but provided for a 2.5% reduced royalty if no patent issued within five years. No patent issued and the royalty rate reduced accordingly. The licensee subsequently sought a declaratory judgment of license unenforceability due to the failure to obtain a patent. The Supreme Court held that federal patent law did not pre-empt state trade-secret law where no patent issues and the agreement thus was enforceable. The court differentiated Aronson from Brulotte by reasoning that the extended-royalty term was not negotiated with the leverage of the patent monopoly. Later cases emphasized that enforceability of hybrid agreements turns on whether the patent and non-patent rights are differentiated.

In Kimble, the hybrid agreement involves a single royalty rate for both patent and non-patent rights without any discount or other indication that the non-patent royalties were free of any patent leverage. The U.S. Court of Appeals for the Ninth Circuit held that a reduced royalty may not be required to avoid Brulotte, but the case required differentiation between the basis for the royalty. Kimble clearly does not follow the pattern of Aronson. If the Supreme Court reverses the Ninth Circuit, it is likely to adopt some variation of criticisms raised about the Brulotte rule.

Conclusion

If the Supreme Court affirms the Brulotte rule, Kimble will serve as an important lesson in hybrid agreement drafting ' it must provide some differentiation between the rights and the associated royalties. Alternatively, it may be advisable to use separate agreements, or separate sections within a single agreement. Different royalty rates should be stated clearly for each licensed right. For example, if a patent is the basis for the agreement, the trigger event and the adjusted rate upon that event coming to pass needs to be defined. The conditions related to related trade-secret payments exceeding the length of the patents need to be clearly stated without being tied or associated with the patents to avoid any appearance of patent leverage. Another option is to define large upfront payments for each of the rights and enable the licensee to elect payments over time. This option can turn the agreement into a long-term contractual debt, rather than a hybrid license.

The Supreme Court's forthcoming decision, if it approves of hybrid licensing, could replace complex hybrid agreements with a more economics-based approach that recognizes a bargained-for exchange between willing participants.

Anthony S. Volpe is a shareholder at Volpe and Koenig, an intellectual property law firm with offices in Philadelphia and Princeton, NJ. He has corporate and private-practice experience in securing, licensing and enforcing all aspects of intellectual property rights. Max S. Morgan is an associate with the firm, focusing on the enforcement of intellectual property rights and patent prosecution in the wireless communications and computer technologies industries.