Royalty for a patent: what do you really pay for?

Published onSeptember 2016

The Court of Justice of the European Union issued a very important decision last summer that may very well prove disturbing for individuals and companies committed into IP licence agreements (CJEU, 7 July 2016, case C‑567/14).

The case is rather complex and includes several proceedings in different countries since 2008 and originates in a patent licence agreement signed in 1992.

A German company (Behringwerke AG) had originally granted a worldwide non-exclusive licence to an American company (Genentech Inc.) for the use of a technology (a human cytomegalovirus enhancer), said technology being the subject of a European patent and two U.S. patents. Royalties were threefold, a one-off fee when the agreement was signed, a fixed annual fee and a running royalty.

The licensee paid the one-off fee and regularly paid the fixed annual fee but never paid the running royalty to the patentee (German company Hoechst GmbH, the successor company to Behringwerke AG). In 2008, a subsidiary of the patentee (German company Sanofi-Aventis Deutschland GmbH) asked details about the products marketed by the American company in order to assess the amount of the running royalty. The licensee Genentech replied by terminating the licence agreement. Soon afterwards German companies brought an action before the U.S. courts for infringement of the licensed patents whereas the American company brought an action for revocation of those patents still in the U.S. Parallel to these proceedings, the patentee Hoechst initiated arbitration proceedings against the licensee for the payment of royalties.

U.S. courts dismissed the actions of both parties whereas, in 2013, the arbitrator issued a decision against the licensee Genentech ordering it to pay more than EUR 108 million in damages. An appeal was lodged against the arbitral award before the Court of Appeals of Paris which decided to stay the proceedings and to refer a question to the Court of Justice for a preliminary ruling.

The issue was the following. Literally interpreting the licence agreement, the licensee took the view that it was not required to pay the running royalty proportional to the use of the technology since (a) the technology was not was present in the finished products marketed by the licensee and (b) the use of the technology was not infringing the licensed patents.

Apart from the IP side of the matter, the American company considered that the payment of a running royalty in the absence of any infringement would imposes on it unjustified expenses in breach of Article 101 of the Treaty on the Functioning of the European Union which prohibits agreements which restrict competition within the internal market.

Well, to simplify the ruling of the Court, there is nothing problematic in being contractually bound to pay a patent royalty even though you do not use the patented technology.

In the language of the CJEU, it reads as follows: “Article 101(1) TFEU must be interpreted as not precluding the imposition on the licensee, under a licence agreement such as that at issue in the main proceedings, of a requirement to pay a royalty for the use of a patented technology for the entire period in which that agreement was in effect, in the event of the revocation or non-infringement of a licenced patent, provided that the licensee was able freely to terminate that agreement by giving reasonable notice”.

The Court also reminds that, when a licence agreement can be terminated by the licensee, “the obligation to pay a royalty, even after the expiry of the period of validity of the licensed patent, may reflect a commercial assessment of the value to be attributed to the possibilities of exploitation granted by the licence agreement” (CJEU, 12 May 1989, Ottung, case 320/87). In other words, since a licensee may enter a licence agreement for other reasons than just for obtaining the authorization to use specific IP titles or IP rights, the obligation to pay a royalty is not exclusively related to said IP rights.

One might think about all complements usually surrounding the grant of a licence, such as know-how transmission, technology transfer, technical cooperation, business or commercial partnership, trade secrets communication, etc. Such elements may appear of lesser importance at first but they may very well be of crucial interest for the licensee in the end. It may even be that such elements have more value to the licensee than the patent or the patented technology itself.

There is nothing wrong here and it is even a good thing that the Court takes into account the business relationships between the patentee and the licensee from a global and economic point of view. But is the Court not going too far when stating that the “royalty is the price to be paid for commercial exploitation of the licensed technology with the guarantee that the licensor will not exercise its industrial-property rights”?

We do believe so. It is one thing to admit that a patent licence is not only a patent licence, it is another thing to admit that the royalty is only a sort of insurance premium of non-infringement, a sort of price to pay to get peace from the patentee. It would be missing the main reason for paying a royalty. You pay a royalty because you believe what you pay for has value. That is why we do hope that this finding of the Court will remain isolated and within the context of this specific ruling.

But even in the context of this specific case, this finding is questionable. In this case, the licensee took the view that it did not infringe the IP rights of the patentee. In theory, the licensee was consequently paying a royalty for a technology that was not covered by an IP right. So how can one say that the royalty is the price to pay to avoid an IP infringement action whereas, in the absence of IP right, there can be no IP infringement action?

The fact remains that the decisive criterion for the Court is that the licence agreement can be terminated freely (by giving reasonable notice). It is in fact a way to make licensees aware of their responsibilities. And the Court must be approved for that. After all, if the licensee does think he is not infringing the licence-granted IP rights, he must take responsibility for himself and his actions, terminate the agreement and maybe face the patentee before the courts. On the contrary, if the licensee accepts to pay a royalty for the use of a technology that it does not really use, it is the licensee’s responsibility alone and it cannot hide behind competition law to prevent the enforcement of the agreement.

In this case, the opinion of the Advocate General was clearer perhaps because it only focused on the main question which was the applicability of competition law to the contested licence agreement. The Advocate General did not suggest any interpretation on the nature or definition of a royalty. The Advocate General reminded that, according to the arbitral award that it is not in his power to criticize, “Genentech’s obligation to pay royalties flowed not from the use of a technology protected by valid patents, but from the licence agreement alone” and that “the commercial purpose of the licence agreement was to avert patent litigation and, in consequence, the calculation of royalties was wholly independent of the existence or otherwise of a valid patent over the finished product”. In fact, the payment of the royalty was in a way disconnected or unrelated to IP rights in this case and this is the reason why the licensee could not refrain from paying the royalty for the sole reason that it was not using the patented technology.

What you need to remember

The Court’s decision and more generally the case itself must be seen as a warning for licensees or future licensees. Of course, all aspects and all provisions of a licence agreement must be treated and negotiated carefully. However, three main points are clearly decisive.

One, when negotiating the licence agreement, you need to pay great attention to the provisions defining and determining the royalty and the basis for the royalty. Moreover, if the licence agreement is mainly motivated by a patented technology, it would be wise to make the payment of the royalty dependent of the validity of the patent.

Two, you should not overlook non-competition clauses that are often included in the licence agreement to prevent the licensee to try and bypass the patented technology because such clauses may significantly increase the undertakings of the licensee.

Three, during the implementation of the licence agreement and as long as the licence agreement remains effective, you need to regularly assess the strategic, commercial or industrial interest and value of the agreement.

And of course, as a licensee, you should not hesitate to terminate a licence agreement when the granted IP title or IP right is no longer of interest. In such circumstances, you should at least try and renegotiate the licence agreement to bring back some balance between the granted IP rights and the real use you are making of them.

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