What Did I Do Wrong To Harm the Value of My Patents: Consequences of Inattention in License Negotiations and in Corporate Acquisitions and Reorganizations

June 2011

By: David J. Brody

Congratulations! You just won a major victory against your competitor: after years of a hotly contested court battle, the jury found that your competitor’s product infringes your patent, and your competitor’s attack on the patent’s validity failed.   Now it’s time to collect the millions of dollars of profits you lost on the sales you would have undeniably made but for your competitor’s infringement!

But not so fast. On appeal, the court may throw out your case on the ground that you never had the right to sue for infringement in the first place – an argument that the infringer may never have even argued to the trial court or on appeal. Or, not as bad but still bad enough, the court may set aside your multimillion dollar award of lost profits and put you in the position, in effect, of being a compulsory licensor to the infringer; the court may hold that you are entitled to nothing more than a reasonable royalty on the infringer’s sales that you lost only because of the infringement, leaving the infringer with most of the ill-gotten gains it made at your expense.

These distressing situations are real. They are the result of two basic principles of patent law that frequently intersect, but which can easily be overlooked. The first principle is that the only party who can sue for patent infringement is the owner of all, or substantially all, of the rights in the patent. The second principle is that a plaintiff in an infringement action can recover nothing more than its own damages. 

Neither of these principles sounds surprising or menacing. Nevertheless, they create pitfalls for the unwary that can easily ensnare any patent owner, from cash strapped start-ups to large multinational corporations. Because of issues that can arise from an exclusive licensee’s willingness to let its licensor reserve certain rights, or from an entity’s organizational or operational structure, these basic principles can allow an adjudicated infringer to escape from the lawsuit entirely, or with a damage award that is only a fraction of the actual damage that was undeniably caused by the infringement.

Consider the following scenarios. They are derived from actual cases.

Scenario 1: An exclusive licensee sues Infringer and prevails. Infringer never raised the issue of Licensee’s standing to sue, neither at the trial level nor on appeal. Nevertheless, the appellate court raised the standing issue sua sponte. Because standing is a jurisdictional issue in patent infringement actions that cannot be waived, on its own initiative the court picked apart the provisions in the exclusive license that reserved certain rights for the patentee. The court then vacated Licensee’s judgment because the patentee’s reserved rights deprived Licensee of standing to sue without joinder of the patentee. Therefore, the court remanded the action to proceed again only upon joinder of the patent owner. The patent owner was a major university, and the provisions of the exclusive license that destroyed Licensee’s standing are not unusual in academic and other licenses.

Scenario 2: Parent corporation owns a patent, and its Subsidiary A has a successful product based on the patented invention. Infringer steps into the market and causes a substantial loss of sales and profits. Parent sues to recover the profits that were lost to Infringer, but the court accepted Infringer’s argument that Parent cannot recover lost profits because Parent did not suffer any loss of profits; the only entity that suffered any loss of profits was Subsidiary A.

In an effort to cure the problem and recover Subsidiary A’s lost profits, Parent moved to add Subsidiary A as a co-plaintiff. However, the court rejected the motion.  Infringer had discovered that Subsidiary B, located in the far corners of Parent’s organization, had a small product line that also used the patented invention, thereby making Subsidiary A a non-exclusive licensee. As such, Subsidiary A lacked standing to be joined as a co-plaintiff; it could not recover its lost profits; and Infringer was liable to Parent only for a reasonable royalty on the infringing sales, leaving Infringer with most of the profits it had stolen away from Subsidiary A.

Scenario 3: Company owns a patent and sells a product line based on the patented invention. Parent acquires the Company, which then becomes Subsidiary A. The patent remains with Subsidiary A, and the marketing and sales of the patented product is transferred to Parent’s marketing and sales Subsidiary B.

Years later, Subsidiary A sued Infringer and sought to recover lost profits on the sales that Infringer had captured. However, it was Subsidiary B that had lost the sales, and Subsidiary A could not recover the lost profits on Subsidiary B’s lost sales.

Subsidiary A addressed the problem by adding Subsidiary B as a co-plaintiff, arguing that Subsidiary B was, in effect, an exclusive licensee of the patent. Subsidiary B went on to win a multimillion damage award based on its lost profits. However, it soon lost the award on appeal because there was no actual agreement under which Subsidiary A gave exclusive rights under the patent to Subsidiary B. There was only a mere “understanding” within the corporate family based on the way the various sister corporations happened to operate.  This de facto exclusive arrangement was not enough to bestow exclusive legal rights on Subsidiary B and, therefore, Infringer escaped with most of its profits intact.

*          *          *

The takeaway from these scenarios is that preservation of the economic value of an organization’s patents requires careful and ongoing attention. In the negotiation of licenses that give the licensee less than all rights in a given territory, for example, an exclusive field of use license, attention must be given to including provisions sufficient to give the licensee standing to sue and thereby maintain the exclusivity of its rights. For example, in addition to other customary provisions about enforcement, the exclusive field of use license might give the licensee the first right to enforce the patent in its own name against an infringer and, if it exercises that right, exclusive control over the enforcement efforts and an agreement by the licensor not to sue the infringer or grant it any covenant not to sue or other forbearance for any infringement. 

Also, ongoing attention must be given to maintaining proper alignment of the ownership of an organization’s patent with the entity that sells any of the organization’s products that use the patented invention. All use of the patented invention should be limited to a single entity within the organization’s family of companies. In addition, if that operational entity is different from the one that holds legal title to the patent, the entity holding title should execute an agreement granting the operational entity exclusive rights under the patent.

The economic consequences of inattention to these issues can be great, since lost profits can be dramatically greater than a mere reasonable royalty. Therefore, inability to recover lost profits can represent a substantial loss in the value of a patent.

Moreover, the loss of a patent’s value from failure to maintain proper alignment of patent ownership and use can be far greater than the difference between lost profits and a reasonable royalty. The “brass ring” in many infringement actions is an injunction against a competitor’s further infringement. An essential requirement for that remedy is the patentee’s proof that it will suffer irreparable injury if the injunction is not granted. A patentee may have great difficulty in meeting that requirement if its monetary recovery is limited under the above principles to a mere reasonable royalty on the infringer’s sales. If a monetary recovery, namely, a reasonable royalty on all infringing sales, will make the patentee “legally whole,” it may not be possible for the patentee to establish any irreparable injury to support an injunction in the litigation, even though its subsidiary or affiliate – which cannot be joined in the litigation – could easily establish such injury.

Maintaining proper alignment of ownership of the patent rights and the sale of patented products requires attention in a myriad of situations. They range from an inventor’s creation of a one-person corporation to commercialize the patented invention, to acquisitions and corporate restructurings in which patents are among the affected assets, to functional reorganization of a company’s operations in which a patented product line might be moved from one entity in the corporate family to another, to allowing multiple affiliates within a corporate family to use a patent in their commercial operations, to negotiating the details of a patentee’s reservation of rights in a license that is otherwise exclusive.

In all these situations and others, however, preservation of the right to sue for lost profits, and even the ability to obtain an injunction, should not be “the tail that wags the dog.” There are many other issues that may outweigh the preservation of these rights. As just a few examples, these economic benefits of a patent may be outweighed by tax considerations, restrictions in the company’s agreements with third parties, and concerns over a patent becoming part of the collateral for the company’s secured financing. However, loss of a substantial portion of the economic benefits of patent ownership should be the result of a carefully considered decision, not merely the result of inadvertence or oversight. In essence, one should be sure that there really is a “dog” attached to the “wagging tail.”

Overview

June 2011

By: David J. Brody

Congratulations! You just won a major victory against your competitor: after years of a hotly contested court battle, the jury found that your competitor’s product infringes your patent, and your competitor’s attack on the patent’s validity failed.   Now it’s time to collect the millions of dollars of profits you lost on the sales you would have undeniably made but for your competitor’s infringement!

But not so fast. On appeal, the court may throw out your case on the ground that you never had the right to sue for infringement in the first place – an argument that the infringer may never have even argued to the trial court or on appeal. Or, not as bad but still bad enough, the court may set aside your multimillion dollar award of lost profits and put you in the position, in effect, of being a compulsory licensor to the infringer; the court may hold that you are entitled to nothing more than a reasonable royalty on the infringer’s sales that you lost only because of the infringement, leaving the infringer with most of the ill-gotten gains it made at your expense.

These distressing situations are real. They are the result of two basic principles of patent law that frequently intersect, but which can easily be overlooked. The first principle is that the only party who can sue for patent infringement is the owner of all, or substantially all, of the rights in the patent. The second principle is that a plaintiff in an infringement action can recover nothing more than its own damages. 

Neither of these principles sounds surprising or menacing. Nevertheless, they create pitfalls for the unwary that can easily ensnare any patent owner, from cash strapped start-ups to large multinational corporations. Because of issues that can arise from an exclusive licensee’s willingness to let its licensor reserve certain rights, or from an entity’s organizational or operational structure, these basic principles can allow an adjudicated infringer to escape from the lawsuit entirely, or with a damage award that is only a fraction of the actual damage that was undeniably caused by the infringement.

Consider the following scenarios. They are derived from actual cases.

Scenario 1: An exclusive licensee sues Infringer and prevails. Infringer never raised the issue of Licensee’s standing to sue, neither at the trial level nor on appeal. Nevertheless, the appellate court raised the standing issue sua sponte. Because standing is a jurisdictional issue in patent infringement actions that cannot be waived, on its own initiative the court picked apart the provisions in the exclusive license that reserved certain rights for the patentee. The court then vacated Licensee’s judgment because the patentee’s reserved rights deprived Licensee of standing to sue without joinder of the patentee. Therefore, the court remanded the action to proceed again only upon joinder of the patent owner. The patent owner was a major university, and the provisions of the exclusive license that destroyed Licensee’s standing are not unusual in academic and other licenses.

Scenario 2: Parent corporation owns a patent, and its Subsidiary A has a successful product based on the patented invention. Infringer steps into the market and causes a substantial loss of sales and profits. Parent sues to recover the profits that were lost to Infringer, but the court accepted Infringer’s argument that Parent cannot recover lost profits because Parent did not suffer any loss of profits; the only entity that suffered any loss of profits was Subsidiary A.

In an effort to cure the problem and recover Subsidiary A’s lost profits, Parent moved to add Subsidiary A as a co-plaintiff. However, the court rejected the motion.  Infringer had discovered that Subsidiary B, located in the far corners of Parent’s organization, had a small product line that also used the patented invention, thereby making Subsidiary A a non-exclusive licensee. As such, Subsidiary A lacked standing to be joined as a co-plaintiff; it could not recover its lost profits; and Infringer was liable to Parent only for a reasonable royalty on the infringing sales, leaving Infringer with most of the profits it had stolen away from Subsidiary A.

Scenario 3: Company owns a patent and sells a product line based on the patented invention. Parent acquires the Company, which then becomes Subsidiary A. The patent remains with Subsidiary A, and the marketing and sales of the patented product is transferred to Parent’s marketing and sales Subsidiary B.

Years later, Subsidiary A sued Infringer and sought to recover lost profits on the sales that Infringer had captured. However, it was Subsidiary B that had lost the sales, and Subsidiary A could not recover the lost profits on Subsidiary B’s lost sales.

Subsidiary A addressed the problem by adding Subsidiary B as a co-plaintiff, arguing that Subsidiary B was, in effect, an exclusive licensee of the patent. Subsidiary B went on to win a multimillion damage award based on its lost profits. However, it soon lost the award on appeal because there was no actual agreement under which Subsidiary A gave exclusive rights under the patent to Subsidiary B. There was only a mere “understanding” within the corporate family based on the way the various sister corporations happened to operate.  This de facto exclusive arrangement was not enough to bestow exclusive legal rights on Subsidiary B and, therefore, Infringer escaped with most of its profits intact.

*          *          *

The takeaway from these scenarios is that preservation of the economic value of an organization’s patents requires careful and ongoing attention. In the negotiation of licenses that give the licensee less than all rights in a given territory, for example, an exclusive field of use license, attention must be given to including provisions sufficient to give the licensee standing to sue and thereby maintain the exclusivity of its rights. For example, in addition to other customary provisions about enforcement, the exclusive field of use license might give the licensee the first right to enforce the patent in its own name against an infringer and, if it exercises that right, exclusive control over the enforcement efforts and an agreement by the licensor not to sue the infringer or grant it any covenant not to sue or other forbearance for any infringement. 

Also, ongoing attention must be given to maintaining proper alignment of the ownership of an organization’s patent with the entity that sells any of the organization’s products that use the patented invention. All use of the patented invention should be limited to a single entity within the organization’s family of companies. In addition, if that operational entity is different from the one that holds legal title to the patent, the entity holding title should execute an agreement granting the operational entity exclusive rights under the patent.

The economic consequences of inattention to these issues can be great, since lost profits can be dramatically greater than a mere reasonable royalty. Therefore, inability to recover lost profits can represent a substantial loss in the value of a patent.

Moreover, the loss of a patent’s value from failure to maintain proper alignment of patent ownership and use can be far greater than the difference between lost profits and a reasonable royalty. The “brass ring” in many infringement actions is an injunction against a competitor’s further infringement. An essential requirement for that remedy is the patentee’s proof that it will suffer irreparable injury if the injunction is not granted. A patentee may have great difficulty in meeting that requirement if its monetary recovery is limited under the above principles to a mere reasonable royalty on the infringer’s sales. If a monetary recovery, namely, a reasonable royalty on all infringing sales, will make the patentee “legally whole,” it may not be possible for the patentee to establish any irreparable injury to support an injunction in the litigation, even though its subsidiary or affiliate – which cannot be joined in the litigation – could easily establish such injury.

Maintaining proper alignment of ownership of the patent rights and the sale of patented products requires attention in a myriad of situations. They range from an inventor’s creation of a one-person corporation to commercialize the patented invention, to acquisitions and corporate restructurings in which patents are among the affected assets, to functional reorganization of a company’s operations in which a patented product line might be moved from one entity in the corporate family to another, to allowing multiple affiliates within a corporate family to use a patent in their commercial operations, to negotiating the details of a patentee’s reservation of rights in a license that is otherwise exclusive.

In all these situations and others, however, preservation of the right to sue for lost profits, and even the ability to obtain an injunction, should not be “the tail that wags the dog.” There are many other issues that may outweigh the preservation of these rights. As just a few examples, these economic benefits of a patent may be outweighed by tax considerations, restrictions in the company’s agreements with third parties, and concerns over a patent becoming part of the collateral for the company’s secured financing. However, loss of a substantial portion of the economic benefits of patent ownership should be the result of a carefully considered decision, not merely the result of inadvertence or oversight. In essence, one should be sure that there really is a “dog” attached to the “wagging tail.”

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