Addressing contracts law in the context of patent licensing, the U.S. Court of Appeals for the Second Circuit held that a provision of a patent license purporting to bar future challenges to the validity of the licensed patent is unenforceable. Rates Tech. Inc. v. Speakeasy Inc. et al., Case No. 11-4462 (2d Cir., July 10, 2012) (Lynch, J.).

Plaintiff Rates Technology owned two patents directed to automatic routing of telephone calls based on cost. In 2007, Rates notified defendant Speakeasy of alleged patent infringement. Later, Speakeasy took a license to the patents. The license included a provision purporting to bar Speakeasy from ever challenging the validity of the patents.

In 2010, Rates notified defendant Covad of alleged patent infringement of the same patents. At that point, Speakeasy had been acquired by Covad. Covad filed a declaratory judgment action for patent invalidity. Rates, in return, initiated the present lawsuit, arguing breach of the no-challenge clause of the Rates-Speakeasy 2007 license.

The 2d Circuit ruling clarified the 1969 U.S. Supreme Court decision in Lear, which held that a patent licensing agreement cannot bar a licensee from later challenging the patent’s validity. In Lear, the Supreme Court found that the public interest of filtering out invalid patents outweighs the concern for contract law, departing from the doctrine of licensee estoppel, which did not allow a licensee to challenge patent validity.

Rates, citing post-Lear cases that upheld no-challenge clauses, argued that the strong public interest in settling ongoing litigation can justify the enforcement of no-challenge clauses that might otherwise be deemed invalid under Lear. Rates further argued that Lear is limited to continuing royalty payments, and not, as in this case, to a one-time cash payment. The 2d Circuit disagreed.

Recognizing the need to balance the policy concerns articulated in Lear with the competing policy interests in favor of holding parties to their contracts, the 2d Circuit adopted a broad reading of the Supreme Court’s decision in Lear. The 2d Circuit stated that the cases upon which Rates relied dealt with no-challenge clauses that had been negotiated after the parties had engaged in litigation over the validity of the asserted patents. In contrast, Rates had licensed its patents to Speakeasy before any litigation had begun.

The 2d Circuit explained that “[o]nce an accused infringer has challenged patent validity, has had an opportunity to conduct discovery on validity issues, and has elected to voluntarily dismiss the litigation with prejudice under a settlement agreement containing a clear and unambiguous undertaking not to challenge validity and/or enforceability of the patent in suit, the accused infringer is contractually estopped from raising any such challenge in any subsequent proceeding.” However, when parties enter an agreement in a pre-litigation context, they “will not have had an opportunity to conduct discovery that may shed light on the patent's validity.”

Practice Note: While this case indicates that a patent license provision barring future validity challenges will likely be unenforceable, contract language that includes incentives to a licensee to not challenge a patent’s validity or includes an alternative dispute resolution clause, will likely still be enforceable.