Important Considerations in Licensing Know-How with Patents

Important Considerations in Licensing Know-How with Patents

Companies own many forms of intellectual property (IP) — patents, trademarks, copyrights, and know-how (e.g., unpatented inventions, technical information, specifications, and trade secrets) — and depending on the industry, a given company may own more of a particular type of IP over others. While many companies monetize patents through license agreements, know-how is also a valuable IP asset that can be monetized.

When licensing patents and the technology embodied within the patents, a know-how license is often included to supplement the patent license agreement. For instance, utilization of patented technology might be based on knowledge and skills which, per se, are not patentable, but must be transferred in order to enable full utilization and exploitation of the patented technology. Know-how includes unpublished confidential information, which extends the competitive advantage of the patented technology. For a drug manufacturer, the know-how may include knowledge of synthesis process parameters, including optimum temperature, pressure, and reaction conditions for improved yield.

Know-how should be licensed with patent rights when its use will enable the licensee to fully and effectively exploit the technology, which will benefit commercialization of the patented invention. This will increase sales and ultimately the royalties the licensor receivesd from the licensee.

A patent license agreement, which includes know-how, has provisions common to both forms of IP, such as field of use, territory, and exclusivity terms. Using the above example, the synthesis method may apply to an intermediate molecule useful for a variety of end products, while its field of use may be limited to use of the intermediate for synthesis of only one end product. Similarly, a patent and know-how can be licensed on a non-exclusive or exclusive basis.

When licensing patents and know-how, however, it is important to understand the differences between the protection of patents versus know-how. For example, patents must be obtained on a country-by-country basis with a statutory expiration date. By contrast, know-how has no set expiration date, with the exception of trade secrets for which the protection exists as long as the licensor can maintain its secrecy. Trade secrets are a special form of know-how. To constitute a trade secret, the know-how must be commercially valuable information that is not readily known or ascertainable that creates a competitive advantage for company and which is subject to protections by the company to maintain its secrecy. The existence of reasonable security precautions is an essential element of a protectable trade secret.

Moreover, a patent license combines matters of federal and state law since patents are subject to federal law whereas contracts are subject to state law. State law, however, applies in interpreting and enforcing a know-how license, which can vary in its application. The intersection of federal law with respect to patent licenses, and state law with respect to know-how licenses can lead to conflicting interpretations. For instance, under federal law the courts have held that a patent license is not assignable unless expressly permitted. Assignability of a know-how license is a matter of state law and the courts have varied on the issue, though state law courts generally construe restrictions on assignment narrowly.

Other issues that must be included in a know-how license that generally do not arise in patent licenses, include the scope of the licensed know-how, whether the know-how can be used to develop improvements or derivative works and the parties’ rights associated therewith, and an equitable relief provision allowing the licensor to seek injunctive relief to prevent and/or mitigate the misappropriation of the licensed know-how. The know-how license should also address how the know-how will be transferred to the licensee, for example, through documentation, training, and/or technical support.

In a hybrid agreement, where both patents and know-how are licensed, the license grant, term and royalties schedule for each should be separate. Know-how may have an indefinite term as long as it is kept secret. Patents have a defined term (20 years from filing) and the royalty obligations cannot continue beyond the life of the patent. Courts will only recognize non-patent royalties if the license agreement has a different rate schedule for patent versus know-how royalties or if it is clear that royalties occurring after the patent’s expiration are tied to the know-how. As a result, some hybrid agreements include an upfront payment for the license of know-how, with ongoing royalties for the patent license.

The U.S. Supreme Court in Brulotte v. Thys Co. 379 U.S. 29 (1964) considered a patent license agreement, addressing post-patent royalties. In Brulotte, Thys sold a hop-picking machine to Brulotte that required pre- and post-patent royalty payments. Brulotte refused to pay post-patent royalty payments and Thys sued.

The court sided with Brulotte, holding that a royalty agreement that extends beyond the expiration date of the patent is unlawful per se.1 Thus, by charging the same rate and enforcing the same restrictions in the pre- and post-expiration periods of the patent, attempted to artificially extend the patent term. In response, the majority held that the patent terms were “[a] monopoly power in the post-expiration period when the patent has entered the public domain.”2

The same issue was litigated in Kimble v. Marvel Entertainment LLC, 135 S. Ct. 2401 (2015). Kimble was awarded U.S. Patent No. 5,072,856 (the ‘856 patent) for a toy comprised of a glove attached to a pressurized container containing foam string delivered to the glove by flexible tubing. Kimble met with Marvel Entertainment, makers of Spider-Man products, seeking to sell or license the ‘856 patent, but the parties failed to execute a licensing agreement. Instead, Marvel began selling the “Web Blaster,” its own web-shooting glove, absent any license or contract. Kimble sued in the district court and was granted breach of contract, but not patent infringement. Both sides appealed and settled, with Kimble agreeing to sell Marvel the ‘856 patent for a $500,000 lump sum and a three percent royalty on Marvel’s future sales of the Web Blaster. The parties, unaware of Brulotte, set no end date for royalty, agreeing royalties would continue “for as long as kids want to imitate Spider-Man.”3

Later, Marvel uncovered Brulotte, discovering that binding precedent prohibited royalty payments beyond 2010, or the expiration of the ‘856 patent. The District Court agreed with Marvel that the “royalty provision was unenforceable after expiration of the Kimble patent.”4 The Court of Appeals for the Ninth Circuit reluctantly affirmed, criticizing Brulotte as “counterintuitive [with] rationale [that] is arguably unconvincing.”5 In response, Kimble petitioned the Supreme Court to overrule Brulotte and certiorari was granted.

Kimble argued that Brulotte should be overruled because (1) the holding rests on a mistaken view of the competitive effects of post-expiration royalties,6 and (2) Brulotte suppresses technological innovation and as such harms the nation’s economy.7 The court, in a 6-3 decision, was not convinced a “special justification” or something significantly more than a belief “that the precedent was wrongly decided” was offered that justified overturning Brulotte.

Kimble maintains precedent that licensing agreements cannot include royalty payments after patent expiration. Interestingly, although the court appears to recognize that such a rule makes little sense, the majority was unwilling to challenge it. Instead, the court implied other types of “business arrangements” allowed for compensation payment in the post-patent expiration period. The court offered three approaches for maximizing flexibility in negotiating patent licenses within the Brulotte framework.

In sum, it is important to understand the differences when licensing patents versus know-how and to carefully draft the terms accordingly in order to avoid unintended consequences which can include the loss of valuable trade secrets and/or the full value of the consideration to be paid for licensed IP.

[1] Id. at 32.

[2] Id. at 33.

[3] Kimble v. Marvel Entertainment LLC at 2406.

[4] Id.

[5] Id.

[6] Id. at 2412.

[7] Id. at 2414.