In a decision issued June 22, 2015 — Kimble v. Marvel Entertainment, LLC — the United States Supreme Court reaffirmed and declined to overrule long-standing precedent holding that a patent holder cannot charge royalties for the use of an invention after its patent term has expired.

The invention: a Spider-Man type web-blaster!

Not all patent cases feature inventions that are easy to understand.  Take, for example, patent cases in the mid/late 2000s featuring orthogonal frequency-division multiplexing (a method of encoding digital data on multiple carrier frequencies).

This case, in contrast, features an invention to which almost all of us can relate.  In 1990, inventor Stephen Kimble obtained a patent on a toy that allowed children to role-play as a “spider person” by shooting “webs” (pressurized foam string) from the palm of their hand.  Kimble met with Marvel Entertainment, the manufacturer of various Spider-Man products, seeking to sell or license his patent.

Marvel apparently liked Kimble’s invention.  Sometime after their meeting, Marvel began marketing a “Web Blaster” — a toy mimicking Kimble’s invention, using a polyester glove and a canister of foam.  But Marvel did not sign any agreement with Kimble, and made no payments to him.

The patent infringement case and settlement

Kimble sued Marvel for patent infringement in 1997.  That case settled, and the settlement agreement provided that Marvel would purchase Kimble’s patent in exchange for a lump sum of approximately $500,000 and a 3% royalty on Marvel’s future sales of the Web Blaster and similar products.  The settlement agreement set no end date for the royalty payments.

In negotiating the settlement, neither party appeared to be aware of a 1967 decision by the United States Supreme Court — Brulotte v. Thys Co. — holding that a patent holder cannot receive royalties for sales made after the patent’s expiration.

The sequel lawsuit

When Marvel finally “stumbled across” (the Court’s words) the Brulotte decision, it filed a new lawsuit for declaratory relief confirming that Marvel could cease paying royalties under the settlement in 2010 — 20 years after the patent issued, which is the duration for most patents.

The District Court sided with Marvel, and the Ninth Circuit affirmed.  The Supreme Court granted certiorari “to decide whether, as some courts and commentators have suggested, we should overrule Brulotte.”

The Supreme Court’s holding

In a 6-3 decision, the Supreme Court affirmed, holding that Brulotte remains good law unless and until Congress  determines otherwise.

The Court observed that in crafting patent laws, Congress struck a balance between fostering innovation and ensuring public access to discoveries.  Patents, the Court held, “endow their holders with certain superpowers, but only for a limited time.”  During the patent’s lifespan, the holder has exclusive rights to the invention, and may sell or license those rights.  But upon expiration, the rights to the invention pass to the public.

The Court rejected Kimble’s invitation to overrule Brulotte and replace it with a “flexible, case-by-case analysis” of post-expiration royalty clauses, noting: “Overruling precedent is never a small matter.”  Brulotte’s “statutory and doctrinal underpinnings,” the Court held, “have not eroded over time.”  Kimble also argued that Brulotte suppressed technological innovation and was based on a mistaken view of the competitive effects of post-expiration royalties.  But the Court essentially told Kimble, and others critical of the Brulotte decision, to direct their concerns to Congress.

Perhaps most noteworthy was the Court’s explanation that parties “can often find ways around Brulotte” in permissible ways, given some creativity in transaction structuring.  For example:

• a licensee can defer payments for pre-expiration use of a patent into the post-expiration period
• licensing agreements covering multiple patents can provide for royalties “until the latest-running patent covered in the parties’ agreement expires”
• licensing agreements covering both patents and closely related non-patent rights (like trade secrets) can provide for continuing royalties after patent expiration as long as the royalties are tied to the non-patent right
• parties may structure their relationship as a joint venture in which the parties share risks and rewards of commercializing inventions but without a royalty component

Takeaway

After a patent expires, patent holders can’t continue charging royalties for use of the invention.  To secure post-expiration revenue streams, patent holders must look to other transaction structures.

When there’s a huge pile of money staring you in the face, it’s easy to overlook some of the potential pitfalls. But a recent $3 billion monster deal provides a cautionary tale for businesses negotiating make/break the company contracts.

Back in the 80’s, Monster Inc. was known for producing high priced (quality?) stereo cables, but as the public began shifting from stereo systems to headphones, Monster sought to expand into the new market. In 2007, Monster signed a deal with Dr. Dre’s company, Beats Electronics, which lead to the “Beats,” the ubiquitous, colorful headphones and ear buds that are today’s cool credential, like wearing Air Jordans back in the day. (I bought the hype and a shiny pair of red Beats, quick review, meh. Here’s what Consumer Reports had to say about them.

But while Monster’s owners might be audio geniuses, they deserve an F in negotiation and contract comprehension. Without a lawyer, they entered a contract whereby Monster transferred all ownership of the trademarks and technology behind the products to Beats Electronics. Monster also shouldered the obligation to manufacture and distribute the products, an expensive proposition.

INSULT-In 2011, HTC, a Taiwanese company purchased a majority stake in Beats Electronics for more than $300 million, but Monster only got a small payout and according to BusinessWeek.com, in 2012 Beats declined to renew the contract with Monster.

INJURY-Beats bought back a majority share from HTC, and in spring of this year, Apple purchased Beats for $3 billion, mostly in cash, and Monster’s share was zero.

FATAL ERROR 1: Recognize your leverage. Monster had the technology. They could have negotiated a non-exclusive license or an exclusive license with an end date, or they could have sold the technology outright at a higher price. Instead, Monster got the worst of both worlds, losing its technology without adequate compensation.

FATAL ERROR 2: Hire a professional. When you’re sick, see a doctor. When your dishwasher starts spewing water, call a plumber. When you’re negotiating the future of your company, call a business lawyer. Even when you’re “negotiating” with an 800 pound gorilla (i.e. Microsoft, Coca Cola) and you have no leverage, at least have a lawyer look at the contract and identify the potential pitfalls. Whether you’re selling your key technology, disclosing your trade secrets, or indemnifying another party, you need to do so with your eyes open.

FATAL ERROR 3: Understand your relationship. The PR regarding the Monster/Beats deal described it as a partnership, but because Beats owned the technology, Monster ended up as a service provider that merely obtained a cut of the profits. When Beats decided not to renew the contract and sold the company, Monster ended up with virtually nothing, even though it developed the key technology behind the Beats products and considered itself a partner.