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Shifting the Balance

The Federal Circuit essentially has had the last word on IP issues for more than two decades. Since Congress created the specialized court in 1982, the Supreme Court has rarely granted cert on patent cases. But as IP becomes an increasingly important part of business, the Court is taking a more active role in shaping the direction of patent law.

Nowhere is that trend more apparent than in the Court's January decision in MedImmune v. Genentech. Reversing a long-standing Federal Circuit precedent, the High Court ruled that patent licensees have standing to file declaratory judgment actions to invalidate licensed patents.

"MedImmune will have a dramatic effect on patent litigation," says Gary Levin, a partner at Woodcock Washburn. "There is no question it will change the way companies extract value from licensing their IP."

In the wake of the decision, companies are scrambling to determine what steps they should take to revise their licensing strategies and protect themselves from patent litigation. But how courts deal with these new strategies is a question the lower courts will have to sort out in months and years to come.

Nothing to Lose

The most obvious implication of MedImmune is that patent owners are now much more vulnerable to suits from existing licensees. The Supreme Court ruled that the Federal Circuit's old standard--which required a licensee to be in "reasonable apprehension" of an infringement suit from a patent owner before suing to invalidate the licensed patent--was too restrictive. Now, licensees may keep paying royalties while they go to court to ask for a declaratory judgment that the patent is invalid.

"That removes most of the disincentives to litigation," says Richard Kelly, a partner at Oblon, Spivak, McClelland, Maier & Neustadt. "In the past if you asked for a declaratory judgment and lost your case, you didn't have a license and couldn't keep producing your product. Now, licensees can bring these challenges with little risk to their business."

There is little a patent owner can do to prevent existing licensees from filing suits under the newly relaxed standard. But they can prevent future suits by being creative in how they craft licensing agreements going forward. For instance, licensors may add clauses that prohibit licensees from challenging the patent's validity during the term of the license or impose escalated royalty payments or a lump payout upon court challenge by the licensee.

"It comes down to a question of incentive," says Mike Dzwonczyk, partner at Sughrue Mion. "Licensors will either offer licenses at a lower cost to make licensing more economical than suing or put contractual language in their licenses to make challenging the patent very expensive."

But it's unclear whether the courts will view such clauses as coercive and therefore unenforceable.

"The Supreme Court is very concerned with the antitrust implications of patent licensing," says Michael Siekman, shareholder at Wolf, Greenfield & Sacks. "Licensors will come up with many different tactics that courts will evaluate on a case-by-case basis."

Playing Softball

Unfortunately, the Supreme Court's ruling gives scant clues about how the lower courts should strike the balance between the rights of patent owners and antitrust concerns.

Therefore, it's likely licensees will go to court to challenge any tactics that make declaratory judgment actions too financially burdensome.

To avoid running into an antitrust challenge, companies may opt for gentler methods of deterring licensees from litigation, such as contractually subjecting disagreements about the scope or validity of the licensed patent to mandatory arbitration.

"In MedImmune the licensing agreement didn't provide for any mechanism for resolving a dispute about the patent," Kelly notes. "The Supreme Court clearly indicated it will look at the language of the license, so if companies want to do something contractually to stay out of court, they can certainly do that."

In addition, patent owners may alter the structure of how licensees pay for use of the patent, reducing ongoing royalty payments in favor of higher up-front fees and periodic milestone payouts. That structure will maximize the patent owner's profits at the outset of the agreement and minimize the financial impact of a later challenge to the patent.

"MedImmune will change the way licenses are negotiated and structured," Dzwonczyk says. "The licensors will have to be creative in finding ways to mitigate the losses associated with the licensee's new rights."

Hair Trigger

But MedImmune not only will complicate the relationship between licensors and existing licensees, but it also will increase the likelihood patent owners' dealings with potential licensees will land them in court.

While MedImmune establishes that "reasonable apprehension of suit" is too restrictive a standard to trigger the right to bring a declaratory judgment action, the Court did not say what the appropriate standard is. Therefore, it's unclear whether a simple request that a company license a patent could give that company the right to go to court to invalidate it.

"When a patent owner seeks to initiate negotiations with potential licensees, it has to walk a fine line to avoid a declaratory judgment lawsuit but still be firm enough to get potential licensees to come to the table," Siekman says. "Companies have long relied upon the 'reasonable apprehension of suit,' standard when crafting those communications. Now, this is thrown into turmoil."

The bottom line is that until the lower courts decide what the standard for declaratory judgment is, patent owners will have a much harder time extracting value from licensing agreements without putting the validity of their IP on the line. Genentech itself learned that lesson when the PTO revoked the patent that was the subject of MedImmune in February.

"There's more risk to that revenue stream," Kelly says. "If you're licensing a patent that hasn't been tested in court, there's an increased risk of a lawsuit."

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