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Licensee Estoppel: Practical Considerations
Law360, New York (April 11, 2014, 12:24 PM ET) -- Are contractual agreements by patent licensees not
to challenge the validity of a licensed patent enforceable? Despite the regularity with which patentees
confront this question, the answer is surprisingly unclear. In the 1950 Hazeltine case, the U.S. Supreme
Court announced the “general rule” known as licensee estoppel, which provides “that the licensee
under a patent license agreement may not challenge the validity of the licensed patent in a suit for
royalties due under the contract.”[1]
Nearly 20 years later, the Supreme Court overruled Hazeltine in Lear Inc. v. Adkins, eliminating the
general rule of licensee estoppel.[2] Since Lear, only traces of licensee estoppel remain. While licensors
may pursue other contractual strategies to address validity challenges to licensed patents, such
strategies must be careful not to run afoul of the policy rationale set forth in Lear.
Background on Licensee Estoppel — Lear Inc. v. Adkins
Understanding the approach by modern courts to licensee estoppel begins with Lear. In that case, Lear
Inc. hired John Adkins to design an improved gyroscope, which Adkins sought to patent. Lear agreed to
license Adkins’ inventions, but it took nearly six years for the U.S. Patent and Trademark Office to issue a
patent to Adkins. During this time, Lear ceased paying royalties and notified Adkins that it believed his
discovery was anticipated by prior art.
Once the patent issued, Adkins filed suit for breach of contract in California Superior Court. At trial, the
jury returned a verdict for Adkins, but the court granted a judgment notwithstanding the verdict that
Adkins’ invention was anticipated by prior art. On appeal, the California Supreme Court held that Lear
was estopped from challenging the validity of Adkins’s patent and reinstated the verdict. The United
States Supreme Court granted certiorari “to reconsider the validity of the Hazeltine rule in light of our
recent decisions emphasizing the strong federal policy favoring free competition in ideas, which do not
merit patent protection.”[3]
The Supreme Court reversed, overruling Hazeltine and abrogating the general rule of licensee estoppel.
Though it recognized that under the common law, a party may not repudiate a contract merely because
it grows dissatisfied with the bargain it made, the court explained that contract law principles must be
balanced against federal patent law requiring “that all ideas in general circulation be dedicated to the
common good unless they are protected by a valid patent.”[4]
In performing that balancing test, the court found that the equities of the licensor “do not weigh very
heavily” against the strong public interest in the free use of ideas in the public domain. The court
therefore held that public policy interests give licensees the right to avoid the payment of royalties by
challenging a patent’s validity.
Since Lear, vestiges of licensee estoppel persist in primarily two contexts: (1) limiting a licensee’s ability
to contest royalty obligations that arose prior to patent validity challenge, and (2) limiting a licensee’s
ability to challenge patent validity after agreeing not to do so in a litigation settlement agreement.
Challenges to Royalty Obligations
The Federal Circuit addressed Lear’s balancing test in Studiengesellschaft Kohle MBH v. Shell Oil Co.[5],
in which Shell, the defendant, had licensed a patent covering a process for converting ethylenes to
plastics. Shell later developed a new process it believed was noninfringing, but neither disclosed this
process to the patentee, nor paid royalties to the patentee on plastics made by the new process. In
response, the patentee terminated the license and brought suit for infringement and unpaid royalties.
The district court granted Shell’s motion for summary judgment, and certified a question to the Federal
Circuit: “Where the Court has found the relevant patent claims invalid, may the Licensor recover
damages for breach of contract for past royalties due on processes allegedly covered by such claims,
from the date of the alleged breach until the date that the Licensee first challenged validity of the
claims?”
On appeal, the Federal Circuit applied Lear’s balancing test by weighing the equities of the licensor
against the federal policy favoring free use of ideas in the public domain. The court found that federal
policy would not be served by allowing a licensee who had failed to timely challenge a patent to
nevertheless avoid its pre-breach obligations under the license. The court therefore held that a licensee
“cannot invoke the protection of the Lear doctrine until it (i) actually ceases payment of royalties, and
(ii) provides notice to the licensor that the reason for ceasing payment of royalties is because it has
deemed the relevant claims to be invalid.”[6] The court remanded the case for “enforcement of the
license” up to the point where Shell first challenged the validity of the claims.
Challenging Validity after Settlement
Licensee estoppel also retains some force in the litigation settlement context. Lear does not disturb the
effects of res judicata in cases where a final judgment has been entered; a licensee is bound by a final
judgment of a court.[7] But a more complicated situation arises where a settlement is reached during
litigation but before a final judgment is entered.
Whether the licensee can challenge the validity of a patent that underlies a litigation settlement
agreement likely depends on whether the agreement includes a clear “no-challenge clause,” in which
the licensee agrees not to challenge the validity of the patent. The Second Circuit in Warner-Jenkinson
Co. v. Allied Chemical Corp. relied on Lear in holding that a licensee was not estopped from challenging
the validity of the licensed patents in a litigation settlement agreement, but indicated that “if a
settlement agreement contains an explicit prohibition on licensee suits during some future period ... a
court may feel that effect should be given to such provision.”[8]
The Federal Circuit addressed the enforceability of no-challenge clauses in litigation settlement
agreements in Flex-Foot Inc. v CRP Inc.[9] There the parties settled while a motion for summary
judgment regarding the invalidity of an asserted patent was pending. The agreement included a nochallenge clause in which the defendant expressly waived its right to challenge the validity or
enforceability of the patent-in-suit. In a subsequent lawsuit between the parties, the district court held
that the defendant was estopped from challenging the validity of the asserted patent because of the nochallenge clause. On appeal, the defendant argued that the no-challenge clause was void under the
public policy rationale in Lear.
The Federal Circuit rejected this argument, holding that the no-challenge clause was enforceable. It
explained that public policy favors enforcement of settlement agreements; therefore, the litigation
settlement context distinguished this agreement from the license at issue in Lear. The court explained
that after the parties have had an opportunity to conduct discovery on validity issues (to permit them to
make an informed decision regarding patent validity), a settlement agreement with a clear and
unambiguous no-challenge provision results in a contractual estoppel from challenging patent validity in
a subsequent proceeding.
While a properly crafted no-challenge clause will likely be enforced in a litigation settlement agreement,
the same clause will likely be found void in a pre-litigation settlement agreement. Although the Federal
Circuit in dicta has suggested that such an agreement could be enforceable, other courts have been
more skeptical. For example, the Second Circuit addressed such a prelitigation no-challenge clause in the
recent Rates Technology case.[10]
There, the parties entered into a settlement agreement after the plaintiff notified the defendantlicensee of its infringement allegations, but before a complaint had been filed. The agreement included
a no-challenge provision, which the Second Circuit held was void as a matter of public policy under Lear.
The court explained that, because it would be easy for licensors to couch license agreements as
“settlement agreements,” enforcing prelitigation no-challenge clauses would undercut the policy
interests in Lear. In doing so, the court distinguished settlement agreements where validity-related
discovery has occurred from prelitigation agreements where it has not.
A question raised by this decision is how far into litigation must the parties proceed before a nochallenge provision becomes enforceable. Recently, a district court addressed this question in a motion
for summary judgment to enforce a no-challenge clause in a settlement agreement entered into early in
litigation (before much discovery had occurred).
The court granted the motion, finding that “Flex–Foot only required litigation to be initiated, thereby
providing an opportunity for the challenger to conduct discovery on validity issues. [Licensee] could
have conducted discovery in the prior litigation if it had so desired, but it chose to forego discovery and
settle the case at an early stage.”[11] While this case is still ongoing, it suggests that courts may not be
sympathetic to an argument that a no-challenge provision is unenforceable simply because it is entered
into early after litigation is initiated.
Practical Considerations
Despite the limitations on licensee estoppel established by Lear, licensors can consider options that
could help protect their interests in the event a licensee later challenges patent validity. For example,
because a validity challenge typically does not affect payment obligations that accrue prior to the
validity challenge, a licensor can “front load” payment obligations so the bulk of payments are made
early in the license term, before any likely validity challenge.
Further, when settling a pending lawsuit, a licensor can forestall future validity challenges by including a
no-challenge clause in the settlement agreement. Such clauses must clearly and unambiguously bar the
right to challenge patent validity — a general waiver clause will likely be insufficient.[12]
Other contractual provisions may also be included in license agreements to help protect a licensor in the
event of a validity challenge. But such options are highly dependent on the circumstances of the
particular license negotiation, and must be evaluated on a case-by-case basis. For example,
consequences in the event a licensee challenges patent validity and is unsuccessful could include the
following (at licensor’s discretion):
converting an exclusive license to a nonexclusive license (consider whether such adjustment
should also include a royalty rate reduction and/or jurisdictional limitations);
restricting future rights to sublicense;
increasing royalty rate(s) for licensed patents;
limiting future obligations of licensor to licensee;
triggering a requirement of licensee to buy out any licensor equity interest in licensee;
shifting any prosecution and enforcement rights of licensed patents held by licensee to licensor;
shifting ownership/control of any joint and/or improvement intellectual property rights from
licensee to licensor;
reducing/increasing the scope of any non-compete provisions for licensor/licensee, respectively;
requiring licensee to pay licensor’s attorney fees resulting from the validity challenge.
The enforceability of such provisions is, for the most part, untested in litigation. Courts will likely
evaluate such provisions based on the policy interests outlined in Lear, and provisions that effectively
deprive licensees of the opportunity to challenge licensed patents will run the risk of being found void.
For example, the settlement agreement in Rates Technology included a clause providing $12 million in
liquidated damages in the event the licensee challenged the patent.
This liquidated damages provision was struck down along with the no-challenge clause as void for public
policy reasons. But provisions that are crafted narrowly to reflect the lack of faith a licensor will have in
its licensee after such a challenge may avoid the appearance of circumventing the basic policies
articulated in Lear. Licensees must be aware that agreeing to any such provisions may bring certain
consequences in the event of an unsuccessful challenge to patent validity.
—By Margaret Sampson, Ajeet Pai and Jeff Gritton, Vinson & Elkins LLP
Margaret Sampson is a partner and Ajeet Pai and Jeff Gritton are associates in Vinson & Elkins' Austin,
Texas, office.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its
clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general
information purposes and is not intended to be and should not be taken as legal advice.
[1] Automatic Radio Mfg. Co. Inc. v. Hazeltine Research Inc., 339 U.S. 827, 836 (1950).
[2] 395 U.S. 653 (1969)
[3] Id. at 656.
[4] Id. at 668.
[5] 112 F.3d 1561 (Fed. Cir. 1997).
[6] Id. at 1568.
[7] See Foster v. Hallco Mfg. Co., 947 F.2d 469, 476 (Fed. Cir. 1991).
[8] 567 F.2d 184, 187–188 (2d Cir. 1977).
[9] 238 F.3d 1362 (Fed. Cir. 2001).
[10] Rates Technology Inc. v. Speakeasy Inc. 685 F.3d 163 (2d Cir. 2012).
[11] Peparlet Co. Ltd. v. Shepherd Specialty Papers Inc., No. 12-492, (N.D. Ohio, May 16, 2013)
[12] See, e.g., Baseload Energy Inc. v. Roberts, 619 F.3d 1357, 1363 (Fed. Cir. 2010).
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