Regular audits of technology license agreements may reduce your patent royalty payments

published in McAfee & Taft tIPsheet | January 12, 2016
William D. Hall
William D. Hall

 By William D. Hall

Patent license royalty payments can be habit-forming. Some patent licenses have terms extending for potentially two decades or longer. As a result, patent licenses are frequently filed away never to be seen again. Unfortunately, as time passes, organizational knowledge of the agreements fades. For example, the original executive managing the operations using the licensed technology may retire. As a result, royalty payments become part of the standard operational budget and go unquestioned potentially leading to significant unnecessary payments.

The 2015 decision by the U.S. Supreme Court in Kimble v. Marvel Entertainment LLC, 135 S. Ct. 2401 (2015), highlighted another potential problem with older license agreements. Specifically, some license agreements may extend the obligation to pay royalties beyond that permitted by current law. The Kimble decision focused on a patent license covering a patent that expired in 2010. The patent license did not set a termination date on the royalty obligation. Subsequently, Marvel Entertainment discovered the 1964 Supreme Court decision of Brulotte v. Thys, 379 US 29 (1964). The Brulotte decision set forth the principal that a patent owner cannot collect royalties beyond the term of the patent. Relying upon Brulotte, Marvel Entertainment successfully removed the obligation to royalties after the patent expired.

The Supreme Court’s Kimble decision did not establish any new law. Rather, it simply confirmed that a patent owner cannot collect royalties after a patent has expired. The lesson learned from Kimble is that any company can make a mistake in the terms and conditions of a license agreement. Therefore, regular audits of technology license agreements may produce considerable savings by eliminating unnecessary patent royalty payments.

What your audit should look for

A license agreement audit should begin by identifying all current royalty payments and associating the payments with the appropriate license agreement. Following this step, several sections of each license agreement should be reviewed. Sections of interest include: Term and Termination, License Grant, Confidentiality, Royalty Payments, Schedule of Patents licensed, and Schedule of Technology licensed. Each of these sections may identify a basis for terminating royalty payments.

Term and Termination Section

The Term and Termination section is an obvious starting point for determining the ongoing obligation to pay royalties. This section should be read in conjunction with the other identified clauses. For example, many Term sections will tie the required royalty payments to the expiration of patents identified in the Schedule of Patents. Other Term and Termination clauses or Royalty Payment clauses may allow a licensee to terminate royalty payments after reaching a certain dollar threshold in royalty payments.

License Grant Clause

The License Grant clause will identify specifically what has been licensed under the agreement. Some contracts appear to license both technical know-how and patents; however, the License Grant clause may limit the contract to only patented technology with the technical know-how exchange occurring under a separate agreement. If the license covers only patents, then the royalty payments may not extend beyond the termination date of the last patent identified in the Schedule of Patent. However, License Grant section may permit the addition of new patents to the Schedule of Patents. The addition of new patents to the Schedule of Patents will allow for an extension of royalty payments.

In instances where the License Grant does apply to both patents and technical know-how, then the Royalty Payment and Term and Termination sections must be reviewed carefully. As established by Brulotte and subsequently affirmed by Kimble, patent royalties may not be collected after a patent expires. Thus, an obligation to pay royalties under a patent license may not extend beyond the term of the last expiring patent. Therefore, Royalty Payment clauses must be carefully crafted if the License Grant covers both patents and technical know-how and if the obligation to pay royalties continues beyond the term of the last expiring patent.

Under these conditions, compliance with the requirements established by the Supreme Court warrants a two-tier royalty schedule. The two-tier royalty schedule recognizes the diminution in value in the license following the expiration of the last licensed patent. Thus, following expiration of the last license patent, the second-tier royalty obligation will be less than the first tier.

If the License Grant applies to both patents and technical know-how, yet the contract does not provide a two-tier royalty schedule, then the agreement will be considered per se unlawful. Accordingly, the licensor will be prevented from collecting royalties after termination of all licensed patents.

Confidentiality Section and Schedule of Technology

The Confidentiality section and the Schedule of Technology should also be reviewed to determine if any of the licensed technical know-how has entered the public domain. Depending upon the language of the License Grant, Confidentiality, and Royalty Payments sections, passage of technical know-how into the public domain may negate the need to pay royalties. However, the wording of the sections will be critical to this determination as technology licenses can be enforced for technology in the public domain.

Finally, if operational changes have occurred since executing the license agreement, one should also determine if the licensed patents and technology are currently being used. Perhaps that technology has been eliminated and the License Agreement should be terminated.