In a complex case stemming from a dispute over scientific discoveries made more than three decades ago, the California Supreme Court has provided fresh guidance on determining when a fiduciary relationship exists. This past April, the court reversed the Court of Appeal’s findings that Genentech, Inc. (“Genentech”) violated a fiduciary duty to City of Hope National Medical Center (“City of Hope”) in connection with a 32-year old licensing agreement. Rather, the court held that a fiduciary relationship is not necessarily imposed simply when one party, in exchange for royalty payments, entrusts a secret invention to another party to develop, patent and market the product. This article provides a review of the case and its implications.
City of Hope National Medical Center v. Genentech, Inc., No. S129463.
The case involved two scientists working for City of Hope during the 1970s. They developed a biotech process for manufacturing human proteins. In 1976, City of Hope entered into a royalty agreement with Genentech, in which it transferred its rights to those discoveries to Genentech. While Genentech paid City of Hope royalties on its products which derived from the discoveries by the two scientists, Genentech did not pay City of Hope royalties on licenses for its other products that used the same techniques developed by the scientists. City of Hope sued on the grounds that Genentech was required to pay royalties on its licensees’ product sales, even if those licensees did not follow the manufacturing process created by the two scientists. Genentech responded that the contract did not require it to pay royalties on the licenses.
The California Supreme Court reversed the breach of fiduciary duty claim (although it upheld the breach of contract claim), holding that before one party will be considered a fiduciary of another, that party must “either knowingly undertake to act on behalf and for the benefit of another, or must enter into a relationship which imposes that undertaking as a matter of law” (citing Committee on Children’s Television, Inc. v. General Foods Corp. 35 Cal.3d 197 (1983)). The court held that there were no facts to support the conclusion that Genentech entered into the royalty agreement with the intention to act for the benefit of City of Hope.
The court then turned to the remaining issue: to determine whether an agreement to develop, patent, and commercially exploit a secret scientific discovery in exchange for the payment of royalties is the type of relationship that imposes a fiduciary duty to act on behalf of another as a matter of law.
City of Hope insisted that such fiduciary duty existed because its relationship with Genentech manifested four characteristics indicative of a fiduciary relationship. Those four characteristics included when: (i) one party entrusts its affairs, interests or property to another; (ii) there is a grant of broad discretion to one party, generally because of a disparity in expertise or knowledge; (3) one party must rely on the truth of the other party’s representations because that party has limited ability to monitor the other party; and (4) one party is vulnerable and dependent on the other.
However, the court disagreed with City of Hope’s analysis, stating that a relationship which exhibits these four characteristics did not mean the relationship is fiduciary. The court stated that these four characteristics were common in many contractual arrangements; that it was normal for one party to depend on another party for its superior knowledge or position; and that “every contract requires one party to repose an element of trust and confidence in the other to perform.” The court reasoned that while City of Hope was vulnerable because it had to rely on Genentech’s superior ability in obtaining patents and in marketing products, its vulnerability alone did not establish that Genentech was a fiduciary of City of Hope.
The court’s reasoning stemmed from the analysis in Wolf v. Superior Court 107 Cal. App. 4th 25 (2003), where the Court of Appeals reasoned that because every contract, to some extent, requires a party to repose trust and confidence in the other, one party’s right to contingent compensation does not give rise to fiduciary duty (Wolf, supra, at p. 31). In the present case, Kennard stated: “We agree with the holding in Wolf…that fiduciary obligations are not necessarily created when one party entrusts valuable intellectual property to another for commercial development in exchange for the payment of compensation contingent on commercial success. The secrecy of information provided by one party to another—here the scientific discovery by City of Hope—may be considered by the trier of fact in deciding whether a fiduciary relationship exists, but it does not compel the imposition of fiduciary duties by operation of law.”
Kennard also pointed out that both parties had substantial bargaining power and were represented by counsel throughout the contractual negotiations—possible key facts which the court used to distinguish this case from prior cases in which a party’s vulnerability was “so substantial as to give rise to equitable concerns”.
Case Implications: Narrowing When a Fiduciary Relationship May Be Implied.
The immediate effect of this case is that not all California licensing agreements are subject to the significant argument that a fiduciary relationship is formed when inventors assign a secret idea or device to another party in exchange for royalties (Stevens v. Marco, 147 Cal.App.2d 357 (1956)).
The value of this case goes far beyond the realm of licensing intellectual property from one party to another. Here, the court acknowledged that the royalty contract expressly stated that the parties’ relationship was not a joint venture, partnership or agency. The court’s acknowledgment of this disclaimer may suggest that contractual disclaimers of fiduciary relationships will be enforced when the factual circumstances do not create a fiduciary relationship as a matter of law. Of course, a disclaimer is by no means a guarantee that a court will not look to the parties’ conduct to determine if a fiduciary relationship has been created. Parties who may be at risk for being characterized as fiduciaries should take precautions when entering into contractual relationships by including such disclaimers in their written contracts.