Insolvency of parties
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This article is written by Prerana Das, pursuing 6-Month Growth Camp: Preparation for LLM Abroad from LawSikho. The article has been edited by Zigishu Singh (Associate, LawSikho) and Smriti Katiyar (Associate, LawSikho).

The origins of Kimble v. Marvel

In 2015, the Supreme Court of the United States heard Kimble v. Marvel, a major decision that examined whether a licensor can continue to receive royalties after his product’s patent had expired. On June 22, the Supreme Court refused to overrule the per se norm established in Brulotte v. Thys Co., siding with the defendant, Marvel. Almost two decades of discussions, two lawsuits, and an appeal went into the case. It also raised crucial problems about what patent law protects, what rights can be transferred, and how royalties are calculated.

In 1990, a man called Stephen Kimble received a patent for a Spider-Man toy he’d created: a “web blaster” glove that allowed the wearer to shoot foam streams from their hand (US Patent No. 5,072,856). The patent on this invention was expected to expire in 2010. Kimble claims that he discussed the idea with the president of Marvel Enterprises, Inc. and that Marvel would compensate him for the use of his patent. The two sides were unable to reach an agreement on compensation, but Marvel proceeded to make a toy that Kimble claimed was quite similar to his design. In 1997, he filed a patent infringement lawsuit in response. The parties entered into an agreement in 2001. Marvel paid approximately $500,000 for the patent and agreed to pay royalties of 3% of net product sales. The obligation had no specified expiration date or time limit, and there was no strategy for a decreased cost once the patent expired.  

Patent sale, re-license and lawsuit

Fast forward to 2006, when Marvel licenced the patent to Hasbro, Inc., allowing the latter to manufacture the toy in question. This resulted in conflicts between the parties by 2008. Kimble believed he was being short-changed on royalties. He claimed that the original patent and contract were infringed due to a lack of sufficient royalty payments. He filed a lawsuit in Arizona, and the case was eventually transferred to a federal district court. Marvel, for its part, argued that after the underlying patent expired, it shouldn’t owe any royalties at all.

Using precedent

The district magistrate determined that Marvel and Kimble’s settlement was a hybrid arrangement. As a result, the rights in question (patent and non-patent rights) were not possible to separate. Brulotte v. Thys Co., an earlier case considered by the Supreme Court, constituted the basis for this ruling. The concept of deciding legal issues based on precedent is known as stare decisis.

The Supreme Court decided in the Brulotte case in 1964 that when a patent is sold for royalties, the buyer has no obligation to continue paying after the patent expires. The courts reasoned that doing so would overcompensate the original patent owner and extend patent monopoly protections beyond what was intended. When Kimble and Marvel negotiated their first settlement, neither of them was aware of the Brulotte case. Marvel requested a declaratory judgement in federal district court after learning of it throughout the course of this second action, stating that the business could stop paying royalties until the patent expired in 2010. The judge agreed. On the recommendation of the magistrate, the federal district court granted summary judgment in favour of Marvel; that patent rights were transferred upon sale. However, the court noted that non-patent rights were still unclear.

Upon appeal, the Court of Appeals for the Ninth Circuit reluctantly upheld the decision of the federal district court. The Court of Appeals noted that the reasoning behind the Brulotte rule did not seem to make much sense. Nevertheless, they did believe the rule applied to the Kimble case. Kimble filed an appeal and argued to the Supreme Court via the U.S. Ninth Circuit that the agreement transferred all rights and that he still deserved payment for the toy itself.

Kimble’s argument 

In the Supreme Court, Kimble attempted to overturn Brulotte’s decision. He contended that Brulotte’s understanding of competition after a patent expires is incorrect. As a result, it works to stifle future technical innovation, hurts the economy, and fails to preserve the patent law’s innovative spirit. Extending royalty rights beyond the conclusion of a patent, according to Kimble, would result in reduced royalty rates and hence increase competition. He also claimed that economics had evolved in the 50 years since Brulotte’s time. These alterations, he argued, jeopardised the Brulotte decision’s rationale. In essence, Kimble was arguing that Brulotte should be overturned and replaced with a case-by-case precedent for reviewing patent agreements. He thought the “rule of reason” outlined under antitrust law should be applied.

Marvel triumphs

Despite a barrage of scientific and judicial criticism, the Supreme Court affirmed the district court’s decision in Brulotte and declined to overrule it. Justice Kagan wrote the opinion, which was joined by Justices Breyer, Ginsberg, Kennedy, Scalia, and Sotomayor. In the end, the Supreme Court decided that this was a patent law problem rather than an antitrust one. As a result, Kimble’s arguments were dismissed by the Court. They ruled that reversing Brulotte, in this case, would amount to a change in the essence of the law, and that it wasn’t within their power to do so. They believed that, while economic theory had evolved since the 1960s, there was still a distinction to be drawn between statute-based cases like this one and those based on the Sherman Act, which created key features of patent law. In terms of the economic issues, the Court stated that it has no way of knowing what the economy would do in the future. Because Brulotte is at the intersection of property and contract law, the Court felt that more evidence was required to reverse it. In the case of Kimble, there was no such justification. 

Post Kimble licensing options

Due to judicial clarification, licencing options following Kimble are now better informed. In the future, licensees should be encouraged to request clear, simple agreements that explicitly divide the royalty payment for each piece of intellectual property being licenced. Stakeholders should rest easy knowing that the following practises and tactics are Brulotte compliant, according to Justice Kagan.

Lump-sum

The most straightforward alternative is a one-time payment that is not contingent on the use of a patent. Previously, courts have approved paid-in-full lump-sum licences that cover all past and future uses of the patented product for the life of the patent period. Another option is to divide the lump sum into instalments, which could be paid even after the patent expires.

Lump-sum licences may be advantageous for a patent holder who wants to recuperate her costs and use the money to fund additional research or other company needs. Lump-sum licencing, on the other hand, has significant disadvantages because the value of new technology can be difficult to forecast. A lump-sum licence necessitates rudimentary guesswork in pricing, which could result in royalty costs that are either too high (for a technology that quickly becomes obsolete) or too low (for a technology that suddenly becomes popular).

Partnerships and joint ventures

A joint venture is another Kimble-compliant option. Given Justice Kagan’s phrasing, joint ventures are likely to be the “most wide” choice for royalty agreements that conform with Brulotte. Joint ventures offer the benefits of (1) lowering high entry barriers, (2) sharing risk for high-risk yet uncertain ventures, and (3) breaking into new, undeveloped markets. The challenge of combining two separate organisations’ cultures, management styles, and working relationships is one of the disadvantages of joint ventures. Poorly written agreements may fail to provide clear goals and lead to misunderstandings about each company’s responsibilities.

Hybrid licenses

Other types of intellectual property, such as copyright, trademarks, and trade secrets, are included in hybrid licences. They can provide royalties that last beyond the expiration of any patents involved if correctly designed. Hybrid licences are discussed by both Brulotte and Kimble, as well as the need of incorporating a step-down provision that reduces the royalties on patent expiration. The majority of the royalties should be placed on the rights that last the longest, such as a trade secret, according to one drafting strategy. 

Trade secret licences with no expiration date have a lengthy history of being upheld by the courts. The step-down provision in Aronson v. Quick Point Pencil Co. protected trade secrets divulged while the patent application was pending, even if the patent did not issue. More famously, in Warner-Lambert Pharmaceutical Co. v. Reynolds, the licensee for Listerine’s secret formula, was required to continue paying royalties even after the secret was widely known. Although trade secrets are vulnerable to revelation, even if the public is aware of the secret, the parties’ agreement remains intact.

Hybrid licences provide the advantage of conforming to standard licencing practises, as organisations frequently licence many types of intellectual property. The objective is to specify the prices and terms for each technology that is being licenced. While several of Kimble’s amicus filings chastised this provision, having explicit agreements is excellent policy,  licence agreements which have no ambiguity are simple to read and comprehend. Having to carefully design phrases has a drawback in that it might generate complications if done incorrectly. Certain types of property, such as trade secrets, might be difficult to value since their value fluctuates over time, although this is an inherent risk in most licencing agreements.

Traditional licenses

Traditional licencing alternatives, such as charging royalties based on a specific monetary amount or a percentage of the sales price, are also available. They cannot, however, collect fees for the use of the patent after it has expired. Kimble gives considerable leeway, allowing royalties to continue until “the most recent patent covered by the parties’ agreement expires.”

Conclusion

Patentees are allowed to keep the royalty base for the duration of the patent and spread the payments out over time. This complies with Kimble since the accrual is exclusively based on the patent period, and the payments are amortised after the patent expires, allowing the licensee to pay a lower royalty for a longer period of time. The downside is that, due to accrual deferral, licensors are unable to charge for use after the patent expires. This is what Kimble and his associates were looking for, the ability to generate revenue through licence agreements even after the patent expires. Sometimes it takes a long time for an innovation to become profitable, but patent law makes no guarantee that every patent will create a profit, let alone a large windfall, for the patentee. This is a patent duration issue at its core and one that should be addressed directly with Congress.


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