The Impact of MedImmune v. Genentech on the Future of Intellectual Property Agreements

By Mark P. Kesslen and Matthew J. Atlas, Lowenstein Sandler PC

Patent holders, licensees, litigators and many others are debating the impact of the Supreme Court’s decision in MedImmune, Inc. v. Genenthech, Inc., 549 U.S. ____ (2007), that a patent licensee does not have to breach or terminate its license agreement before bringing a declaratory judgment action seeking to have the licensed patent declared invalid or unenforceable or not infringed.
 
These practitioners are attempting to decide whether this decision will have a significant effect upon existing intellectual property licenses.  Or is the Court’s ruling much ado about nothing?  That is, can the impact of the Court’s decision simply be solved with a little bit of money and some workarounds in your intellectual property license agreements?

In order to understand the significance of the MedImmune decision, it is necessary to understand the precedents that the justices were grappling with when they agreed to hear this case.  Therefore, in this article, we review the significant precedents to the MedImmune decision.  We also discuss key elements of the Court’s ruling, and finally we assess the implications of the case and offer some suggestions that can be utilized in the future when drafting intellectual property licenses.

Significant Precedents

Two significant decisions set the background for the MedImmune ruling. 

The first, Lear, Inc. v. Adkins, 395 U.S. 653 (1969), involved a license agreement entered into while Adkins’ application for a patent relating to gyroscopes was still pending.  The key provision in that license required Lear, the licensee, to pay royalties “until such time as the ‘patent is held invalid.’”

A few years after entering into the license agreement, but still prior to the patent’s issuance, Lear asserted that the patent was invalid because its claims were not novel and that it was unenforceable because Adkins had engaged in inequitable conduct before the PTO.  When Lear stopped paying royalties, Adkins brought a breach of contract action in California state court.
 
The California state court initially ruled that, because Lear was operating under a license agreement, it was estopped from denying the validity of the patent.  The theory behind this doctrine of licensee estoppel, which has been around since the mid-1880s, was that a licensee should not be permitted to enjoy the benefits afforded by the license while simultaneously arguing that the patent is invalid.

When the case reached the Supreme Court, it specifically addressed the doctrine of licensee estoppel and overturned it.  The Lear court wrote, “Licensees may often be the only individuals with enough economic incentive to challenge the patentability of an inventor’s discovery.  If they are muzzled, the public may continually be required to pay tribute to would-be monopolists without need or justification.”  While the Court’s decision overturned the doctrine of licensee estoppel, it only addressed this issue in the specific factual context of a breach of contract case where the licensee had already breached the license agreement.

Many years passed between the Supreme Court’s 1969 ruling in Lear and the second significant precedent, Gen-Probe, Inc. v. Vysis, Inc., 359 F.3d 1276 (Fed. Cir. 2004), which involved a license for blood screening technologies.  Gen-Probe entered into a patent license with Vysis for certain blood screening technologies, in part because it believed that Vysis might otherwise sue for patent infringement. 

A few years after entering into the license agreement, however, Gen-Probe sought a declaratory judgment that its product did not infringe the Vysis patents and that the patents were invalid.  Notwithstanding the filing of this suit, Gen-Probe continued to pay royalties under the license, although it did so under protest and notified Vysis that it believed that the patents were invalid.

After a two-week trial, the jury returned a verdict in favor of Gen-Probe finding noninfringement and invalidity on the grounds of obviousness and nonenablement of the underlying patent.

On appeal, the Federal Circuit vacated the district court’s decision not to grant Vysis’ pre-trial motion to dismiss on the grounds that the court lacked jurisdiction to hear the declaratory judgment lawsuit.  The Federal Circuit found that “the license, unless materially breached, obliterated any reasonable apprehension of a lawsuit,” and concluded that no actual controversy existed.  As such, it ruled that the licensee did not have standing to bring the declaratory judgment action. 

The Gen-Probe court’s decision implied that a licensee must stop paying royalties, thereby materially breaching the agreement, before bringing a suit to challenge the validity or scope of the licensed patent.  The underlying policy rationale of this decision was that allowing licensees in good standing to challenge the validity of a licensed patent would discourage patent holders from granting licenses in the first place.

Key Elements of the MedImmune Ruling

In overturning the Gen-Probe decision, the Supreme Court ruled in MedImmune that a patent licensee does not need to breach or terminate its license before seeking a declaratory judgment that the licensed patent is invalid or unenforceable or not infringed.  A quick overview of the facts puts the Court’s ruling into context.

 MedImmune manufactures a drug called Synagis that is used to prevent respiratory tract disease in children.  At the time of the suit, Synagis was MedImmune’s best selling product, representing about 80 percent of its revenues.
 
 In 1997, MedImmune entered into a patent license agreement with Genentech for two patents.  One was an issued patent relating to chimeric antibodies.  The other was a pending application related to the coexpression of immunoglobulin host cells.  The following year, the host cells patent issued, and   Genentech informed MedImmune that royalties were due because this newly issued patent covered the Synagis drug.

 While MedImmune believed that the host cells patent was invalid and unenforceable, it also believed that, if it stopped paying royalties, Genentech would sue for infringement, subjecting MedImmune to the threat of treble damages and attorney’s fees.  Worse yet, an adverse judgment could enjoin MedImmune from selling Synagis, which would jeopardize 80 percent of its revenue and effectively put it out of business.

 In light of this threat, MedImmune agreed to pay the royalties under protest, but filed a declaratory judgment action in the Central District of California seeking to invalidate the patent.  The district court granted Genentech’s motion to dismiss finding that a patent licensee in good standing cannot establish a case or controversy under Article III and the Declaratory Judgment Act, 28 U.S.C. Section 2201(a). Citing Gen-Probe, the Federal Circuit upheld the lower court’s decision.

The Supreme Court heard oral arguments in the MedImmune case during last October’s session with much fan fare.  The Supreme Court faced the quandary whether a licensee’s actions of continuing to abide by the terms of the license removed a “reasonable apprehension” of being sued for infringement and, therefore, caused the dispute to fall outside the realm of a case or controversy under the Declaratory Judgment Act.

The Supreme Court reviewed prior cases in which it had held that a person or other entity does not have to first break the law to test the validity of a particular statute or other legal requirement.  It applied this reasoning to the set of facts of a licensee’s agreement to abide by the terms of a patent license while concurrently challenging the validity of the licensed patent.

Writing for the 8-to-1 majority, Justice Scalia stated that “[MedImmune] was not required, insofar as Article III is concerned, to break or terminate its 1997 license agreement before seeking a declaratory judgment in federal court that the underlying patent is invalid, unenforceable, or not infringed.”  Thus, the Supreme Court ruled that MedImmune was entitled to bring its declaratory judgment action, seeking to challenge the licensed patents, even while it remained a licensee in good standing.  The Supreme Court therefore remanded the case back to the district court in California for a determination as to whether the patent is invalid, unenforceable, or not infringed.

Implications of the MedImmune Ruling

In dissent, Justice Thomas wrote that the majority’s holding in MedImmune “has given every patent licensee a cause of action and a free pass around Article III’s requirement for challenging the validity of licensed patents.” 

How many of these cases can we anticipate?

The answer may turn on simple economics and bargaining power.  For example, a deep-pocket company may license a patent from a small player to remove the threat of treble damages and attorney’s fees.  After the license agreement is signed, the deep-pocket company may file a declaratory judgment action to invalidate the patent, which could force the small player to go out of business.  But is this scenario realistic?

From our experience, many patent licenses in the U.S. already include a covenant from the licensee not to challenge the validity of the licensed patent.  Thus, most licensees are contractually blocked from attacking the validity of the licensed patent.  For some reason, this typical covenant was not present in the patent license at issue in MedImmune.

 Prohibiting the licensee from challenging the validity of the licensed patent is just one potential workaround to avoid a MedImmune-type problem.  Other workarounds include license provisions stating that a challenge of the patent’s validity triggers an increase in the royalty rates or an automatic termination of the license agreement.

 Licensees that do not want to have their ability to challenge the licensed patent’s validity restricted may be forced to pay higher royalties as licensors change the financial models of their royalty rates to build in potential litigation costs.  For example, upfront license fees could be required, or the patent holder could negotiate higher or lower rates depending on whether validity challenges are prohibited.
 
 In addition, the most significant impact of the MedImmune decision may be found in footnote 11 of that decision.  Several courts interpreting this footnote have stated that the Supreme Court intended to eliminate the Federal Circuit’s reasonable apprehension of suit test, thereby expanding courts’ ability to hear declaratory judgment actions.  For example, an Iowa federal court stated that in footnote 11 of the MedImmune decision, “the Supreme Court abrogated the Federal Circuit Court of Appeals’ reasonable-apprehension test.”  Highway Equip. v. Cives Corp., 2007 WL 689766, No. 04-CV-147 (N.D.Iowa March 7, 2007), *2.  The Iowa court then found that, based on the totality of circumstances, an Article III controversy existed based on a letter indicating patent infringement and the absence of a covenant not to sue.  Id. at *3; see also Cellco Partnership v. Broadcom Corp. (Fed. Cir. March 19, 2007) (citing to footnote 11 of the MedImmune case in finding that “the district court erred as a matter of law in holding that no actual controversy existed between the parties, as required by the Declaratory Judgment Act, 28 U.S.C. §2201(a) and Article III of the Constitution.”). 

 Likewise, a Wisconsin federal court refused to dismiss a declaratory judgment action on the basis that the reasonable apprehension of suit test had not been satisfied.  Rite-Hite Corp. v. Delta T Corp., 2007 WL 725327, No. 06-C-1187 (E.D.Wis. March 7, 2007).  The Rite-Hite court stated that the MedImmune opinion “strongly hinted that [the Supreme Court] was calling into question the continued viability of ‘the Federal Circuit’s ‘reasonable apprehension of suit’ test’ in patent declaratory judgment actions.  Id. at *5, fn. 2.  The Wisconsin court discussed at length the MedImmune decision and in doing so stated that it was reluctant to employ the reasonable-apprehension test.  As the court there wrote, “Indeed, to do so would be to ignore the Supreme Court’s clear signal that such test has a limited future life expectancy.”  Id. at *8. 

 Thus, the most significant long-term impact of the MedImmune decision may be the elimination of the reasonable-apprehension test and a lower bar to bring a declaratory judgment action.  We have already witnessed generic drug manufacturers arguing, as the two district court opinions described above found, that the Supreme Court rejected the “reasonable apprehension” test in the dicta of footnote 11 in its MedImmune decision. 

 The resolution of how the lower courts will apply footnote 11 is particularly important for patent holders that send a letter seeking royalties or otherwise giving notice of their patent rights.  Such letters are typically drafted carefully to avoid triggering a reasonable apprehension of suit.  If the “reasonable apprehension” test no longer bars a declaratory judgment action, then the standard format for these letters may need to be modified to avoid the recipient’s filing of such an action.

Conclusion

From a business perspective, the ability to avoid a MedImmune-like problem most likely will depend on money and leverage in the negotiations of a patent license agreement.  Weighing in the balance is the leverage that a creative patent litigator will be able to assert, noting the opportunity to initiate more declaratory judgment actions against patent holders in light of the Supreme Court’s MedImmune ruling.  Time will tell what the real ramifications of the ruling will be.