U.S. Court of Appeals Holds No-Challenge Clause in Agreement Settling Patent Infringement Allegation Prior to Litigation Void for Public Policy Reasons

by Orrick, Herrington & Sutcliffe LLP
Contact

[authors: Ramsey, Gabriel M.; Knerr, Derek F.]

On July 10, 2012, the Second Circuit issued a noteworthy opinion in Rates Technology, Inc. v. Speakeasy, Inc. (No. 11-4462-cv) regarding the enforceability of no challenge clauses in agreements settling patent infringement allegations prior to litigation between the parties. The Court, in an opinion by Judge Lynch, held that a no-challenge clause— that is, a clause that bars a patent licensee from later challenging the patent’s validity— in an agreement settling allegations of patent infringement prior to litigation is void for public policy reasons under the Supreme Court’s decision in Lear v. Adkins, 395 U.S. 653 (1969).

Analysis of the Opinion

According to the complaint, Rates Technology (“RTI”) is the owner of two patents that relate to the automatic routing of telephone calls. In April 2007, RTI notified Speakeasy, Inc. (“Speakeasy”) that it believed Speakeasy was infringing these patents. On April 20, 2007, RTI and Speakeasy entered into an agreement (the “Agreement”) settling the alleged infringement. In the Agreement, Speakeasy denied infringing the patents, but acknowledged their validity and agreed to make a one-time payment to RTI in exchange for a release and covenant not to sue from RTI. The Agreement also included a provision in which Speakeasy— defined in the Agreement to include Best Buy, which was in the process of acquiring Speakeasy— represented that it would not “challenge, or assist any other individual or entity to challenge, the validity of any of the claims of the Patents.” The Agreement provided for liquidated damages if Speakeasy did not meet to this representation.

On June 10, 2010, Best Buy announced it planned to sell Speakeasy and merge it into entities associated with Covad Communications Company (“Covad”). Shortly thereafter, RTI notified Covad that it believed Covad was infringing its patents. On July 23, 2010, Covad responded by filing a declaratory judgment action against RTI seeking a declaration that the patents were invalid.

On August 31, 2010, RTI brought a lawsuit against Covad, Best Buy, and Speakeasy in which it alleged that Best Buy and Speakeasy breached the Agreement’s no-challenge clause by providing information to Covad that was used in formulating the declaratory judgment action. RTI sought to enforce the Agreement’s liquidated damages provision. Thereafter, Covad voluntarily dismissed the declaratory judgment action, and the defendants moved to dismiss RTI’s lawsuit.

The District Court (Cote, J.) granted the motion to dismiss RTI’s lawsuit, holding that under Lear v. Adkins, the no challenge clause was invalid as it was contrary to the “public interest in litigating the validity of patents.”  RTI appealed the dismissal to the Federal Circuit, which transferred the appeal to the Second Circuit because the District Court’s jurisdiction did not arise under the laws governing Federal Circuit’s appellate jurisdiction and because the contract dispute did not require the resolution of a related question of patent law.

The Second Circuit began its analysis with a discussion of Lear v. Adkins, the decision in which the Supreme Court abandoned the doctrine of licensee estoppel for patent cases. In Lear, the Supreme Court found that because the position of the patent licensor was already buttressed by the presumption of patent validity, the equities did not compel a bar on validity challenges by a licensee; instead, the Supreme Court established a “balancing test” between the equities of the licensor and “the important public interest in permitting full and free competition in the use of ideas which are in reality a part of the public domain.” The Lear Court also held that a licensee could not be required to comply with a contractual provision requiring it to pay royalties until the patent was actually held invalid.

The Second Circuit considered subsequent decisions applying the Lear “balancing test” in view of the methods by which patent disputes can be resolved. First, such a dispute could be litigated to a final decision, which would ordinarily trigger the doctrine of res judicata. The Second Circuit agreed with the Federal Circuit’s statement in Foster v. Hallco Manufacturing Co., 947 F.2d 469 (Fed. Cir. 1991), that it was aware of no decision even suggesting that Lear abrogated the principle of res judicata in patent litigation.

Second, a patent dispute could be resolved through a consent decree issued by a court following litigation. The Second Circuit noted that it, along with other courts, has held that consent decrees estop future challenges to a patent’s validity.

Third, a dispute about patent infringement and validity could be settled privately following the initiation of litigation. In Warner-Jenkinson Co. v. Allied Chemical Corp., 567 F.2d 184 (2d Cir. 1977), the Second Circuit held that a settlement that did not contain a no-challenge clause did not preclude a later validity challenge. While the Warner-Jenkinson decision also suggested in dictum that a no-challenge clause might change the result, the Second Circuit observed that it has never reached that question in the context of a post-litigation settlement agreement. But the Second Circuit recognized that in Flex-Foot, Inc. v. CRP, Inc., 238 F.3d 1362 (Fed. Cir. 2001), the Federal Circuit concluded that a “clear and unambiguous” no-challenge clause in a settlement entered after the accused infringer had an opportunity to conduct discovery on validity issues was enforceable.

Lastly, a patent dispute could be resolved privately by agreement between the parties prior to any litigation. The Ninth Circuit addressed this situation in Massillon-Cleveland-Akron Sign Co. v. Golden State Advertising Co., 444 F.2d 425 (9th Cir. 1971), and found a covenant that purported to bar a licensee from challenging the licensed patent’s validity void in light of the strong public policy of facilitating the free and full use of ideas in the public domain. The Second Circuit found Massillon persuasive on the balance of policy concerns, and noted that enforcing no-challenge clauses found in any patent license agreement would effectively render Lear dead letter law.

Turning to the merits of RTI’s appeal, the Second Circuit found it particularly significant that Speakeasy never had an opportunity to conduct discovery regarding the validity of RTI’s patents. The Court contrasted the situation addressed by the Federal Circuit in Flex-Foot, and observed that discovery suggests that the alleged infringer is making an informed decision to give up its validity challenge and evidences the resolution of a genuine dispute over the patent’s validity—rather than an attempt by the patent owner “to prevent its monopoly from being challenged by characterizing ordinary licensing agreements as settlement agreements.”  The Second Circuit left the door open for a different rule with respect to no-challenge clauses in post-litigation settlements, but held that “covenants barring future challenges to a patent’s validity entered into prior to litigation are unenforceable, regardless of whether the agreements are styled as settlement agreements or simply as license agreements.”

The Court rejected RTI’s various arguments that the no-challenge clause should be held enforceable, including that the Court’s rule would require parties to go through the “charade” of filing and settling a lawsuit in order to obtain a comprehensive settlement. The Court noted that nothing in its opinion prevents a patentee from settling an infringement dispute or collecting royalties without engaging in litigation, and that “[t]o the extent our rule may discourage the insertion of such [no-challenge] clauses into licenses or settlement agreements, that is a desirable consequence for the reasons stated in Lear.”

In ruling that no-challenge clauses in pre-litigation settlements are unenforceable, the Second Circuit also declined to follow dicta in Baseload Energy, Inc. v. Roberts, 619 F.3d 1357 (Fed. Cir. 2010). In Baseload, the Federal Circuit suggested that if a release settling a contract dispute had contained a no-challenge clause, it would have enforced the clause provided the waiver was clear and unambiguous. In a footnote, the Second Circuit stated that the Federal Circuit’s earlier decision in Flex-Foot, which blessed a no-challenge clause where the accused infringer had an opportunity to conduct discovery on validity, “seems to us to strike a more plausible balance between the policies of patent law articulated in Lear and policies favoring the resolution of disputes.”

Practical Considerations

The Second Circuit’s ruling effectively requires a patent holder to take on the risk of a future validity challenge if it wishes to settle with an accused infringer without resorting to litigation. Although the Court “doubt[s] that parties would find it desirable to conduct expensive discovery in order to validate a no-challenge clause,” Rates Technology leaves a fundamental question unanswered:  how much discovery—if any—is required to validate a no-challenge clause in a settlement entered following the filing of a lawsuit?  As long as this question remains unanswered, even patent holders eager to settle patent disputes amicably are likely to file lawsuits because the mere initiation of a lawsuit should not affect the willingness of an accused infringer to settle the dispute. In fact, the filing of a lawsuit ought to encourage settlement as a party accused of infringement will still be able to avoid the cost of discovery if it settles immediately, and the patent holder will be able to offer a discount if the accused infringer agrees to a no challenge provision that remains—potentially at least—enforceable.

The calculus for patent holders would change, however, if courts were to enforce no-challenge clauses only following discovery on validity issues. Because patent holders would not be able to obtain the value of a no-challenge clause without burdening the accused infringer with discovery costs, there would be no advantage to the “charade” of filing a lawsuit if the parties were eager to settle. However, a rule that only enforced no-challenge clauses following the “expensive discovery” envisioned by the Second Circuit would present administrability problems. And until the courts provide clarity about how much discovery it takes to validate a no-challenge clause, patent holders will have an incentive to file lawsuits to resolve infringement disputes. Nevertheless, parties accused of infringement may be heartened by the Second Circuit’s decision to the extent it maintains another avenue to challenge invalid patents.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Orrick, Herrington & Sutcliffe LLP | Attorney Advertising

Written by:

Orrick, Herrington & Sutcliffe LLP
Contact
more
less

Orrick, Herrington & Sutcliffe LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!