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Revisiting Brulotte and Royalty Agreements for Patented Inventions

Posted in Patent Law

By James Kachmar

On September 5, 2007, the Ninth Circuit issued its opinion in Zila, Inc. v. Tinnell, in which it considered the issue of a contract for payment of royalties on a patented invention in light of the 1964 U.S. Supreme Court Case, Brulotte v. Thys.   In what the Court considered to be an “otherwise unremarkable case,” the Ninth Circuit found it necessary to consider “the impact and bounds of Brulotte” in determining whether Tinnell was entitled to royalty payments on a patented invention he had assigned to Zila, Inc.

In 1976, Tinnell developed a liquid solution to treat lesions caused by herpes. He applied for a patent on the liquid treatment in 1977 and shortly thereafter acquired a defunct California corporation which he named Zila, Inc. Zila was intended to be a vehicle for marketing and selling the treatment which is now sold under the brand name Zilactin. 

In September 1980, Tinnell and Zila entered into an agreement by which Tinnell assigned all of his rights in the Zilactin treatment in exchange for a 5% royalty on the gross sales of Zilactin without any restriction as to time. The Zila corporate officers who signed the 1980 agreement testified that they did not know whether any patents would issue on Zilactin at the time they entered into the agreement. They also confirmed that it was the parties’ intent that the duration of Zila’s obligation to pay Tinnell royalties was not related to any patents that might issue on the invention. 

In August 1981, Zila secured the first of several patents on the Zilactin product. It later secured a continuation for the 1981 patent and, in December 1985, secured a Canadian patent. In January 1992, Zila obtained an additional patent for an improvement made to the treatment which added a thickener allowing it to be sold as a gel.

Over time, the royalty payments to Tinnell grew substantially. In 1987, Zila paid Tinnell approximately $6,400 in royalties on the sales of Zilactin. In 2000, however, Zilactin’s gross sales increased to over $8 million resulting in an approximate $500,000 royalty owing to Tinnell. 

In July 2000, Zila’s patent counsel advised the company to terminate Tinnell’s royalties on the ground that under Brulotte v. Thys, Tinnell’s right to royalties ended on August 1998 when the 1981 patent expired. Shortly thereafter, Zila stopped making royalty payments to Tinnell. Although the Canadian patent did not expire until 2002, Zila stopped payment of the royalties on that patent on the ground that it had overpaid Tinnell on the American patents. Zila then filed a complaint in federal court requesting, among other things, a declaratory judgment that Tinnell’s right to royalties under the 1980 agreement ceased after August 25, 1998. 

The District Court granted summary judgment in Zila’s favor finding that under Brulotte, “the 1980 agreement was `unlawful per se under federal patent law,’ because it ‘project[ed] beyond the expiration date of the patent’.” The District Court further held that Tinnell had no rights to continued royalties under the Canadian patent. The District Court noted, however, that “this result appeared inequitable but read Brulotte to require it.”

The Ninth Circuit first considered Brulotte which involved various patents held by the Thys Company which sold farmers a hop-picking machine for a flat sum but required them to purchase a license for the patents on the machines in order to use the product. The license was intended to be in perpetuity despite the fact that the patent incorporated into the machines expired in 1957. When the farmers refused to pay the royalty after the expiration of the patent, Thys Company sued them to enforce the licensing contract. 

The U.S. Supreme Court found in the farmers’ favor holding that the royalty agreements “were unenforceable to the extent that they extended `beyond the expiration date of the patent[s].’” The Ninth Circuit stated “[s]imply put, Brulotte indicates that under some circumstances patent owners cannot exact royalties for use of patented devices beyond the duration of their patents.” The Court considered, however, that although the doctrine appeared straightforward, it runs counter a court’s usual task in a contract case which is to interpret the terms agreed to by the parties. Recognizing that the foundation of Brulotte had been criticized, the Ninth Circuit was concerned that it not “expand Brulotte’s holding beyond its terms.” It found that a key difference between the Zila and Brulotte cases was that in Zila, the contracting parties contemplated the possible future issuance of a patent but the royalty provision did not depend on such an issuance; whereas in Brulotte, the patent had already issued. 

To determine whether this distinction was material, the Ninth Circuit considered the 1979 U.S. Supreme Court case, Aronson v. Quick Point Pencil Co. There, an inventor filed an application for a patent on a design of a key holder. While the patent application was pending, she negotiated a contract with the manufacturer to make and sell the product, which included a 5% royalty in return for an exclusive license to sell the invention. The agreement in Aronson was silent as to the duration of the royalty. The agreement provided, however, that in the event a patent did not issue, the manufacturer would pay the inventor a lesser royalty amount. Five years later, when a patent did not issue, the manufacturer reduced its royalty payments to the lower rate and sued to have the royalty agreement declared unenforceable. The U.S. Supreme Court rejected the manufacturer’s claims and held that the Brulotte doctrine did not apply where the contract does not rely on the issuance of a patent, especially where the parties contemplate an alternative obligation if no patent should issue.

The Ninth Circuit considered whether Zila could be distinguished from Brulotte on the grounds that Brulotte involved the sale of a physical machine along with a use license as opposed to the sale of intellectual property alone. In fact, the U.S. Supreme Court had suggested that the sale of only intellectual property, such as in the Zila case, was considerably more complex since “the concepts underlying Brulotte do not necessarily transfer to that context readily.”

The Ninth Circuit recognized that had it been writing on a clean slate, it may have decided the issue differently. But given the binding precedence, it adopted “the majority approach and consider[ed] not whether but the extent to which Brulotte preempts state law with regard to a contract for payment of royalties on the sale of an invention that may be patented, if a patent indeed issues on the invention.”   

First, the Ninth Circuit found that the District Court had erred in striking down the entire royalty agreement. The Ninth Circuit recognized that “Brulotte does not render an entire contract void and unenforceable merely because it includes an invalid licensing agreement. Rather, Brulotte renders unenforceable only that portion of a license agreement that demands royalty payments beyond the expiration of the patent for which the royalties are paid.” Thus, the Court found that Tinnell was entitled to royalties for those years in which the patent was in effect.

Second, the Ninth Circuit rejected the District Court’s extension of the Brulotte doctrine to the royalty payments on the Canadian patents. The Court held that the Brulotte decision was limited to only those “patent rights in the United States, . . . The rights and obligations bestowed by the international patent regime played thus no role in Brulotte.” The Court found that this was necessary because “[t]he Canadian patent is an entirely separate asset from the U.S. patent.” Thus, the Court reversed the summary judgment against Tinnell on his claim for the unpaid Canadian royalties.

Finally, the Ninth Circuit considered the issue as to which patent(s) Tinnell was entitled to royalty payments. First, the Court found that it was clear that Tinnell was entitled to some royalty payments under the 1980 patent which expired in 1987. Zila argued that it had improved Tinnell’s invention and that Tinnell should not be entitled to royalties on the patent for the improved product. The Ninth Circuit rejected this argument. The Court found that “[a]lthough the subsequent improvements to Tinnell’s invention were contingent at the time of the contract, they were contemplated by the parties. The 1980 Agreement alluded to `improvements thereon and Letters Patent thereon . . . including any present or future improvement . . . .” Thus, the Ninth Circuit found that “Brulotte poses no bar to the collection of royalties so long as Zilactin incorporates a valid patent for a compound invented by Tinnell pursuant to the 1980 agreement.”

Having turned 50 this year, the Brulotte decision continues to survive. Parties entering into licensing/royalty agreements in connection with patented products should be advised that the validity of any royalty agreements will only be enforceable until the expiration of the patent. Parties should also contemplate incorporating language into the agreement that provides for a lesser royalty payment, or “alternative obligation,” in the event that a patent does not issue so that their right to royalties are protected.