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July 25, 2014

Getting Tangled in the Web of a Hybrid Royalty Clause

Frequently, parties enter into IP license agreements in which the licensor grants a license or other rights to a bundle of its intellectual property (patents, copyrights, trademarks, trade secrets, know-how, etc.) pertaining to a particular product or technology.  In many instances, these agreements include both patents and non-patent IP - often referred to as “hybrid” agreements.  In considering the royalties to be charged in hybrid agreements, licensors must be careful to distinguish royalty payments attributable to any licensed patents from payments for the rights to the non-patent IP.  Failing to do so can lead to an unexpected cut-off of the royalty revenue stream.  Stephen Kimble learned the hard way.

In 1990, Kimble invented a Spider-Man toy that allowed the user to shoot foam string from a canister strapped to the user’s wrist.  He filed a patent application for his invention and ultimately was granted a patent.  While the application was still pending, Kimble met with Marvel Enterprises to discuss his invention.  Kimble claimed that Marvel agreed it would not use his “ideas and know-how” without compensating him.  Marvel told Kimble that it was not interested in his ideas but sometime afterwards began selling a product called the Spider-Man Web Blaster. I am quite familiar with this toy having picked up seemingly miles of foam string that my son joyously sprayed throughout the house and backyard.  But that’s another story, and you know where this one is going.

Kimble, who by then had obtained his patent, sued Marvel for infringement and also for breaching the contract that Marvel would not use his “ideas and know-how” unless it compensated him.  Marvel won summary judgment on the patent infringement claim, but a jury found in Kimble’s favor on the breach of contract claim and awarded him royalties on past, present and future sales of the Web Blaster.  While the case was on appeal, the parties entered a settlement agreement.  Marvel acquired the patent in exchange for a lump sum payment and a continuing royalty of 3% on “net product sales.”  Although Marvel had prevailed on the patent infringement claim and continued to argue that the Web Blaster did not infringe Kimble’s patent, the parties agreed that the “net product sales” for which the 3% royalty would be paid was to include “product sales that would infringe the Patent but for the purchase and sale thereof pursuant to this Agreement as well as to sales of the Web Blaster product that was the subject of the [lawsuit and judgment].”   There was no expiration on the 3% royalty payment obligation.  It would presumably continue for as long as the Web Blaster was sold.

All was good for a while until Kimble and Marvel began disputing the applicability of the royalty obligations on subsequent iterations of the Web Blaster and sales of combo products that included the Web Blaster.  Kimble sued Marvel for breach of the settlement agreement.  Marvel filed a counterclaim contending that its royalty obligations under the settlement agreement ended when Kimble’s patent expired in 2010.  In response, Kimble claimed that because the royalty provision covered both patent and non-patent rights, it should continue to be enforced with respect to the non-patent rights under the settlement agreement.

On July 16, 2013, the Ninth Circuit Court of Appeals “reluctantly” affirmed the summary judgment awarded by the U.S. District Court of Arizona that the royalty obligations in the settlement agreement ended when Kimble’s patent expired (Kimble v. Marvel Enterprises, Inc.).  Although the Ninth Circuit conceded that in the circumstances of this case, “the patent leverage . . . was vastly overshadowed by what were likely non-patent rights,” it held that the settlement agreement language and structure demonstrated that “the rights were intertwined and cannot be separated in any principled manner.”  As such, it was required to follow Supreme Court precedent holding that royalty provisions in hybrid agreements, where patent and non-patent rights are inseparable, cannot be enforced beyond the patent term.  Enforcing such provisions would otherwise improperly extend the patent monopoly.

How can you avoid this result in your license agreements?  One possibility is to include a royalty step down provision that would kick in once the licensed patent expires.  A step-down provision would also be appropriate in cases where applications are pending but no patent has yet issued; if no patent issues within a set period of time, the reduced royalty kicks in for the duration of the agreement.  You might also consider a step-up provision, where the royalty would increase during the patent term and return to the original (or some other) rate once the patent expires.  Alternatively, to avoid the hybrid agreement result, you must include some other language or provisions in the agreement that will make it clear to the court that the royalty negotiated and agreed to was not subject to “patent leverage.”  In any case, although it is very tempting and straightforward to offer a bundled license for one royalty rate, it is a risky proposition to do so without thinking these issues through.  Especially in those situations where non-patent IP rights may provide significant value, or where the issuance of a patent is uncertain, licensors should carefully consider how to structure the royalty provisions to avoid getting caught in the web of a hybrid royalty clause.

©2014 All Rights Reserved. Lewis Roca Rothgerber LLP

About the Author

Sean Garrison, Lewis and Roca law Firm, Patent Attorney
Partner

Mr. Garrison is a partner of the firm’s Intellectual Property and Technology Practice Group. His practice focuses on these major areas:

  • Counseling clients in the identification, selection, clearing, registration, protection and licensing of their intellectual property rights;

  • Prosecuting and defending clients in intellectual property litigation in both federal and state courts, including claims for trademark infringement and counterfeiting, copyright infringement, trade secret misappropriation, patent infringement, domain name infringement and...

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