Joint Development Agreements

Many view joint development agreements as the most complicated type of IP agreement. New developments in statutes and case law are adding to that complexity – causing us even to question and revise the basic practices that have, for decades, guided drafting them. From both business and legal perspectives, this session will discuss advanced topics – including these new developments – related to negotiating and drafting joint development agreements, including:

• A model that can be used to make structuring these deals easier;
• Use of a specialized NDA to avoid one of the more common traps posed by case law developments impacting the negotiation phase;
• Handling important ownership allocation and license grant clauses;
• How recent developments in exhaustion principles can impact whether your client profits from participating in a JDA;
• Concerns and tips when dealing with state organizations (e.g., universities) and federal agencies or departments (via CRADA’s);
• A file-keeping tactic that makes negotiation and enforcement easier;
• A drafting strategy to reduce bankruptcy risk; and
• An antitrust pitfall that can be avoided by careful drafting.

Joint Development Agreements:

Advanced Practice and Analysis Outline of Contents

1. Legal Pitfalls that Jeopardize Patent Rights, Business Plans, and Revenues.
   1. Pitfalls under the Exhaustion Doctrine.
      1. Keurig, Inc. v. Sturm Foods, Inc., 108 USPQ 1648 (Fed. Cir. 2013).
      2. Lifescan Scotland, Ltd. v. Shasta Technologies, LLC, 108 USPQ2d 1757 (Fed. Cir. 2013).
   2. Other recent developments in the exhaustion doctrine.
   3. Pitfalls under the Implied License Doctrine.
      1. Met-Coil Systems Corp. v. Korners Unlimited, Inc., 803 F.2d 684, 231 USPQ 474 (Fed. Cir. 1984).
      2. Anton/Bauer Inc. v. PAG Ltd., 329 F.3d 1343, 66 USPQ2d 1675 (Fed. Cir. 2003).
   4. Other Recent Developments in Implied License Law.
   5. Pitfalls under the Repair v. Reconstruction Doctrine.
2. Joint Owners Who Fight over Ownership and Use of Joint Research.
   1. Wisconsin Alumni Research Foundation v. Xenon Pharmaceuticals Inc., 93 USPQ2d 1361 (7th Cir. 2010).
   2. International Nutrition Co. v. Horphag Research Ltd., 59 USPQ2d 1532 (Fed. Cir. 2001).
   3. Massachusetts Eye and Ear Infirmary v. QLT Phototherapeuitics Inc., 75 USPQ2d 1225 (1st Cir. 2005).
   4. Ethicon Inc. v. United States Surgical Corp. 45 USPQ2d 1545 (Fed. Cir. 1998).
   5. Caterpillar Inc. v. Sturman Industries Inc., 73 USPQ2d 1609 (Fed. Cir. 2004).
   6. Lucent Technologies Inc. v. Gateway Inc., 88 USPQ2d 1481 (Fed. Cir. 2008).
3. Avoiding Prior Art Using the Safe Harbor of a Joint Research Agreement.
4. Pitfalls when Commercializing Products Developed from Joint Research.
5. Antitrust Pitfalls Common to Joint Development Agreements.
6. Term Sheet Strategies During Drafting and Negotiation of Joint Development Agreements.

Joint Development Agreements:

Advanced Practice and Analysis

David G. Burleson and David B. Kagan

1. Legal Pitfalls that Jeopardize Patent Rights, Business Plans, and Revenues.

The patent laws exist in key part to encourage research and development.1 This is a risk and reward system. Those who invest in research and development take the risk as to whether the R&D will generate patentable inventions and be commercially successful. If successful, patent owners are rewarded with exclusivity for a lengthy but limited time and the chance to reap corresponding rewards during the term of exclusivity. Commercially important patents can generate substantial revenues for patent owners.2 In exchange for the potential rewards, patent owners must adequately disclose inventions so that the technology falls into the public domain when the period of exclusivity ends.

Joint development arrangements offer multiple paths to convert the dream of patent rewards into actual cash flows. Under one common business model, one or both joint development parties may plan to sell not only patented products but also unpatented, ancillary products to be used with the patented products. For example, a party may sell not only patented manufacturing equipment but also patented and/or unpatented consumables used by the equipment. The party also may sell other products that are to be later combined with the output of the equipment. The party also may even contemplate substantial business from selling replacement parts. The contemplated revenue from selling additional patented and unpatented items is an important part of these business models.

Patent owners commonly sell, or at least try to sell, both the patented and unpatented products at a price premium. Customers, in contrast, have a strong incentive to find products at the lowest cost. Gutsy customers might buy some products from the patent owner while simultaneously seeking out and buying cheaper ancillary products from third parties. The third parties see an opportunity to usurp market share by offering better pricing. The concerned patent owner wants the customer to buy all, not some, of the customer’s product needs from the patent owner. The patent owner then attempts to protect its market share by enforcing its patent rights against the customer for direct infringement and/or against the supplier for indirect infringement, i.e., contributory infringement or induced infringement.

Joint development parties must be aware of three significant, often unexpected legal pitfalls that can nullify patent rights and prevent such enforcement. Implied licenses, patent exhaustion, and the repair v. reconstruction doctrine3 lurk in the backgrounds of these situations. In the right circumstances, any of these devilish doctrines can rein in patent scope significantly so that apparently infringing activity becomes non-infringing. These doctrines allow gutsy customers and competitors to thwart the patent owner by selling products without infringement even though patent claims may literally cover the products or their use. These can surprise a joint development party and severely disrupt the business model and expected cash flow that it expected to earn from its patented technology.

The problem stems, at least in part, from the patent licenses commonly exchanged among parties to joint development agreements. These licenses can taint the patent rights and business of the licensor and/or the licensee. Exhaustion, implied license, and/or repair v. reconstruction traps can be an unpleasant surprise to unsuspecting joint development parties.

1.1 Pitfalls under the Exhaustion Doctrine.

1.1.1 Keurig, Inc. v. Sturm Foods, Inc.4

Keurig shows how unforgiving and brutal the exhaustion defense can be to patentees. The case involved the famous Keurig™ brewing devices and the cartridges used in those brewers. The case does not explicitly state that the machine and its consumables resulted from joint efforts, but that is what happened as a practical matter. As reported by Jesse Eisinger in “Seeking Answers From Green Mountain Coffee,” Dealbook, September 9, 2013, Keurig parent Green Mountain Coffee Roasters expects to make a large portion of its revenues from marketing the K-CUP™ cartridges used in Keurig brewing machines. The article reports, “Green Mountain operates on a razor/razor blade model — selling brewing machines but making its real money on the K-Cups.”

Keurig protected both its brewing machines and the cartridges with patents. Keurig also patented methods of using its brewers to make beverages.

The business model envisioned by Keurig and its parent, Green Mountain, began to take on water when third parties such as Sturm Foods sold competing cartridges to be used in the Keurig machine. The competitive products usurped a significant market share percentage.

Keurig sued Sturm, asserting that Sturm’s customers directly infringed the Keurig method patents and that Sturm induced and contributed to this direct infringement.

Sturm asserted patent exhaustion as a defense.5 Sturm argued that Keurig’s sale of patented brewers exhausted all the corresponding patent rights, including those directed to methods of using the brewers. Hence, those who purchased Sturm cartridges did not infringe the Keurig method patents by using Sturm cups in the Keurig machines.

Keurig countered that the substantial embodiment test from Quanta (see footnote 5) controlled and that Keurig’s method patent rights were not exhausted because its brewer had many non-infringing uses. Taking Keurig’s asserted facts as true, the first prong of the Quanta test could not be satisfied. A slam dunk win for Keurig, right? Wrong!

According to the Court of Appeals for the Federal Circuit, Keurig applied the wrong test. The Quanta test applies to exhaustion of method claims with respect to sales of unpatented items. Keurig was subject to an older, much harsher rule because it sold patented brewers. According to the Federal Circuit, sale by Keurig of a patented brewer exhausted all patent rights to that item. Period.

It did not matter that the brewer had non-infringing uses.

It did not matter that Keurig patented the cartridges in separate but unasserted patents.

The court reasoned that Keurig could not be allowed to use its cartridge and/or method patent rights to impose post-sale restrictions on use of the brewer. Keurig received full value, whether it knew it or not, when it sold the brewers and would not be allowed double recovery.

The holding brutally impacts Keurig and its parent, Green Mountain. In the absence of legitimate sales restrictions,6 a purchaser of a patented brewer from Keurig has a right to use whichever cartridges he or she chooses. In other words, the Keurig decision allows third parties to sell with impunity cartridges that are compatible with Keurig brewers.

Clearly, Keurig and its parent, Green Mountain, will not realize revenue goals if cartridge market share is eroded by Sturm and/or third parties who follow Sturm’s lead.

Keurig attempted to avoid full disruption of all its patent rights by arguing that exhaustion applies on a claim-by-claim basis. Accordingly, even if some of its claims might be exhausted, some claims were not. The claims that were not exhausted were infringed.

The majority of the Federal Circuit panel disagreed and announced that, for purposes of exhaustion, all claims in a patent stand or fall together. If one claim is exhausted, all claims are exhausted!7

You can avoid the hard lessons learned by Keurig and Green Mountain in your own joint development planning if you recognize and better manage exhaustion risks.

1.1.2 Lifescan Scotland, Ltd. v. Shasta Technologies, LLC8

Keurig is not the only recent victim of patent exhaustion. The doctrine also recently victimized Lifescan, Inc., and its affiliate Lifescan Scotland, Ltd. (collectively Lifescan).

Lifescan sells a blood glucose monitoring system used by diabetes patients to monitor blood glucose levels. The system includes meter devices and disposable (consumable) test strips. A patient places a drop of blood on a test strip, which is inserted in the meter. The meter measures the glucose level of the blood sample on the strip.

Lifescan sells 40% of its meters below cost; the other 60% are given away. Clearly, Lifescan’s business model involves earning revenue mainly from sale of the disposable test strips.

Shasta competes with Lifescan in the test strip market and grabbed market share by selling competitive test strips to be used by patients in Lifescan™ meters.

Lifescan sued Shasta for indirect infringement. Lifescan argued that Shasta induced or contributed to direct infringement of patented method claims when Shasta customers used Shasta’s test strips in Lifescan™ meters.

Shasta defended by arguing that Lifescan exhausted its method patent rights upon the sale of a Lifescan™ meter, which permitted a meter purchaser to use it with any brand of test strip.

Because the meters were unpatented, the Quanta substantial embodiment test controlled rather than the more harsh rule applied in Keurig where patented devices were sold.

Lifescan countered that exhaustion was not triggered under the Quanta test for several reasons. First, the meters had several non-infringing uses. Rejecting this argument, the Federal Circuit added an important intent aspect to the exhaustion analysis. Even if suchother uses were possible, the other uses must not only be reasonable but must have been intended by the patent owner at the time of the authorized sale. Lifescan, though, sold its meters with the expectation and sole intent at the time of sale that the meters be used only with Lifescan™ test strips. Other uses proposed by Lifescan, much later during litigation, were not intended at the time of sale and therefore were not relevant for purposes of patent exhaustion analysis.9

Lifescan also argued against exhaustion on grounds that essential features of the patented method were embodied in both the meters and the strips, with innovative technology residing in both, i.e., not just in the meters. Therefore, sale of the meters alone could not trigger exhaustion per the second prong of the Quanta test. The Federal Circuit disagreed, clarifying that what is relevant for the second prong of the Quanta test are those features that distinguish over the prior art. The patent and prosecution history of the Lifescan method patent showed that novelty resided only in the meter features and not at all in the strip features. The court viewed the test strips as non-inventive under these circumstances.

Because it found both prongs of the Quanta test to have been met, the Federal Circuit held that Lifescan triggered exhaustion when it sold its meters. If a first item (such as the strips) are unpatented or protected by an invalid patent, and if the inventive concept resides in other items (such as the meter), then sale of the other items exhausts patent rights on the combination. The Federal Circuit acknowledged that the outcome might be different if the strips themselves had been patented.10

Lifescan also attempted to argue that exhaustion applied only to meters that were sold, not to those given away for free. The Federal Circuit rejected this quite vehemently, while conceding it to be probably an issue of first impression. The court held that exhaustion applies to any authorized, unconditional title transfer, regardless of the amount of consideration received.

The Federal Circuit devoted a substantial portion of its Lifescan opinion to that which it considered to be an important policy. If exhaustion did not apply to Lifescan in these circumstances, then Lifescan could use its combination patent to control unpatented test strips, which would improperly extend the patent exclusivity to unpatented items. This also could offend antitrust principles by improperly tying the sale of unpatented test strips to sale of the meters.

Like Keurig and its affiliate Green Mountain, the Lifescan affiliates fell victim to the exhaustion doctrine. The Lifescan decision allows third parties to sell Lifescan™ meter-compatible test strips with impunity. Clearly, Lifescan and its affiliates will not realize revenue goals if third parties take away market share. In contrast to Lifescan, your joint development planning should recognize and manage exhaustion risks.

1.2 Other recent developments in the exhaustion doctrine.

Purchase of seeds from a licensee cannot be an authorized sale for purposes of exhaustion when that sale extends beyond the license grant. Monsanto Co. v. Scruggs, 459 F.3d 1328, 79 USPQ2d 1813 (Fed. Cir. 2006).

Second generation seeds grown by a buyer of first generation seeds have never been “sold” for purposes of triggering exhaustion. Monsanto Co. v. Bowman, 657 F.3d 1341, 100 USPQ2d 1224 (Fed. Cir. 2011), aff’d, Bowman v. Monsanto, 106 USPQ2d 1593 (US 2013).11

Inapplicability of exhaustion to second generation seeds does not eviscerate exhaustion doctrine as to self-replicating products, because applying exhaustion would eviscerate the patent rights for self-replicating products. Also, the new seeds have never been sold. The patent owner also was compensated only for the first generation seeds, so the patent owner is not unjustly enriched. Monsanto Co. v. Bowman, 657 F3d 1341, 100 USPQ2d 1224 (Fed. Cir. 2011), aff’d, Bowman v. Monsanto, 106 USPQ2d 1593 (US 2013).

The Federal Circuit indicates that sales of first generation of self-replicating product could exhaust patent rights as to second and subsequent generations if the only use of the product was to replicate itself. Monsanto Co. v. Bowman, 657 F3d 1341, 100 USPQ2d 1224 (Fed. Cir. 2011), aff’d, Bowman v. Monsanto, 106 USPQ2d 1593 (US 2013).

The fact that a patented technology replicates itself does not exhaust patent rights to the replicated copies because this eviscerates the rights of the patent holder. Monsanto Co. v. Scruggs, 459 F3d 1328, 79 USPQ2d 1813 (Fed. Cir. 2006).

Depending on language used, a covenant not to sue can authorize sales for purposes of the exhaustion doctrine. Transcore LP v. Electronic Transaction Consultants, 563 F.3d 1271, 90 USPQ2d 1372 (Fed. Cir. 2009).

Sales authorized by earlier covenant not to sue exhausted rights in a future patent. Id.

To invoke protection of exhaustion doctrine, the authorized sale must have occurred under the U.S. patent at issue; sale in foreign territory does not trigger exhaustion, and Quanta did not change this. Ninestar Technology Co. v. ITC, 667 F.3d 1373, 101 USPQ2d (Fed. Cir. 2012), cert. denied, 568 U.S (2013).12

Licensed sales are “authorized” for purposes of exhaustion doctrine even if licensee breached its obligation to pay royalties when timely royalty payment is not a condition of the right to sell. Tessera Inc. v. ITC, 646 F.3d 1357, 98 USPQ2d 1868 (Fed. Cir. 2011).

1.3 Pitfalls under the Implied License Doctrine.

A myriad of law and fact circumstances create implied licenses. Scholars have commented that the law is a morass of doctrines that overlap and/or conflict.13 Nonetheless, a substantial majority of implied license cases fall into one or more of the following categories:

• Fixing an existing contract, such as filling in gaps, correcting mistakes, interpreting ambiguities.
• Conduct/actions, often in combination with words, establish an enforceable contract. (This category is very similar to oral contracts established by words alone. It’s not a big leap that words and conduct also can create an implied contract.)
• Preventing unjust enrichment, such as when a hired manufacturer is allowed to sell patented items to mitigate damages when the patent owner breaches its contract obligations and refuses to buy the manufactured items or such as when patent owners are allowed to earn reasonable rewards but not “private fortunes” or double recoveries.
• Protecting or implementing important patent policies that impact the public such as overbroad extension of patent rights to unpatented items, extending patent term, price fixing, restricting competitive development, etc.

The implied license cases discussed below fall into mainly the last two of these categories and are strongly influenced by equity. There may or may not be patent exhaustion principles at play as well. Often, the cases prevent a patent owner from asserting overbroad patent scope. In others, the cases trim back otherwise legitimate claim scope on principles that the patent owner has already been fairly compensated. Often, there is conduct by the patent owner that induces reliance by the party who at the time, or even much later with hindsight, asserts implied license. In Bandag, Inc. v. Al Bolser’s Tire Stores,14 a nascent Federal Circuit identified detrimental reliance as a key principle that is at play in many implied license cases:

[A]n implied license cannot arise out of the unilateral expectations or even reasonable hopes of one party. One must have been led to take action by the conduct of the other party.

Met-Coil Systems Corp. v. Korners Unlimited, Inc.,15 and Bandag, are early Federal Circuit cases addressing when authorized sales of patented items trigger implied licenses. These cases were decided in the early 1980s but remain good law. The principles of these two early cases were endorsed and expanded in the Anton/Bauer case seventeen years later. The Supreme Court’s Quanta decision from 2008 endorses the law set forth in these cases, too. Several recent cases apply the law in interesting ways. Met-Coil is an optimum place to begin discussion.

1.3.1 Met-Coil Systems Corp. v. Korners Unlimited, Inc.

Met-Coil and its affiliates (collectively Met-Coil) developed and commercialized a duct fabrication system. The product line included three main products that Met-Coil intended to sell to its customers:

• metal duct sections;
• roll forming equipment that shaped the ends of the duct sections, allowing the duct sections to be interconnected with other duct components; and
• “special” corners that were shaped to connect to the roll formed duct sections.

Met-Coil protected the equipment and a method of using the equipment to make ductwork from the equipment, duct sections, and corners. The corners themselves were unpatented.16

Met-Coil customers bought the equipment from Met-Coil; these sales were unrestricted, i.e., without sales terms or notices at the time of sale that imposed an obligation on the equipment customers to buy ducts or corners from Met-Coil. Thus, at the time of sale, the equipment customers had no contract obligation or even knowledge that Met-Coil might require them to buy ducts and corners from Met-Coil. Met-Coil did issue post-sale notices to this effect.

Importantly, the Met-Coil equipment had only one reasonable and intended use, namely to be used to roll form duct sections in the patented method.

Contrary to Met-Coil’s expectations, its equipment customers did not purchase its corners. The customers bought corner pieces from Korners Unlimited, presumably at lower prices.

Met-Coil believed that only customers who bought all three of the equipment, ducts, and corners from Met-Coil had authority to practice the patented method. Consequently, Met-Coil alleged that those customers who instead bought corners from Korners directly infringed the Met-Coil method claims. Met-Coil sued Korners for inducing and contributing to the direct infringement. Clearly, Met-Coil was not happy that Korners usurped Met-Coil’s expected revenue stream from corner sales.

Korners defended that purchasers of the equipment had an implied license to use that equipment to practice the patented method using the third party corners obtained from Korners. Consequently, there was no direct infringement and, hence, no induced or contributory infringement.

The Federal Circuit affirmed summary judgment in favor of Korners on grounds that purchasers of the Met-Coil equipment enjoyed an implied license. As a consequence of the license, those equipment purchasers could buy unpatented corners from any third party. The decision clearly thwarted the business model and desiccated an intended revenue stream of the patent owner, Met-Coil.

In reaching its decision, the Federal Circuit relied on these factors:

• The equipment sale was unrestricted.
• The equipment had only one use, which was to practice the patented method.
• The facts “plainly indicated” that a license should be implied, because there was no contrary notice or contractual obligation at the time of sale. The post-sale notice issued by Met-Coil was ineffective to impact circumstances of the earlier sale itself.
• The corners were unpatented.

The Met-Coil analysis is circular: an implied license exists legally when an implied license exists factually. This is not much guidance. The rule begs the question as to when facts plainly indicate a license.

Not surprisingly, Met-Coil leaves open several questions:

• The meaning of “plainly indicate” is not set forth, so the boundaries of when facts are sufficient to plainly indicate something are uncharted territory.
• What happens if the process in question involves multiple stages so that additional patented equipment is required at those additional stage(s)? Does buying a single piece of equipment from the patent owner authorize the customer to buy additional equipment from someone else under the implied license theory even if the additional equipment is patented by the patent owner?
• If the special corners had been patented, would the result have been different? Could a customer buy special corners from Met-Coil but then buy equipment from a third party?
• If in fact Met-Coil had given notice to its customers at the time of sale, would that one fact have changed the outcome?
• What if the Met-Coil equipment had three uses, but all three were patented by Met-Coil and/or a third party? What if the Met-Coil equipment had two distinct uses, but the two uses are both physically and conceptually easy to separate?

1.3.2 Anton/Bauer Inc. v. PAG Ltd.17

The Federal Circuit decided Met-Coil nearly 30 years ago, back in 1984. In 2003, the Federal Circuit endorsed Met-Coil and extended the reach of implied license law even further in Anton/Bauer.

Anton/Bauer invented a battery connection system that is a combination of a male (M) and female (F) plates. The two plates can be connected mechanically and electrically. The plates are used to couple battery packs to cameras. The F plate is attached to a camera, while the M plate is integrated into a battery housing.

Anton/Bauer patented the combination of the M and F plates; the M and F plates individually were not patented. The F plate sold by Anton/Bauer had one and only one use, namely, to be used in combination with an M plate.

Anton/Bauer sold both F and M plates, but only separately. Anton/Bauer never sold the F and M plates together. Clearly, the Anton/Bauer business model contemplated that revenue would be generated from the individual sales of M and F plates.

PAG disrupted Anton/Bauer’s business model. PAG manufactured and sold M plates specifically designed to be used in combination with the F plates of Anton/Bauer. To the chagrin of Anton/Bauer, customers who bought F plates directly or indirectly from Anton/Bauer bought M plates from PAG,18 not Anton/Bauer. PAG customers thus practiced under the Anton/Bauer patent claims protecting the M-F combination while obtaining only F plates from the patent owner.

PAG thereby usurped M plate sales and the corresponding revenue from Anton/Bauer. Not happy at all about this, Anton/Bauer believed that only customers who bought both F and M plates from Anton/Bauer had authority to practice the patented combination.

Consequently, Anton/Bauer alleged that PAG customers directly infringed the Anton/Bauer combination claims when a PAG M plate was combined with an Anton/Bauer F plates. Because PAG customers were the alleged direct infringers, Anton/Bauer sued PAG for inducing or contributing to the direct infringement.

PAG defended that Anton/Bauer’s F plate customers had an implied license to use a properly obtained F plate in combination with an unpatented M plate to practice the patented combination using PAG’s M plates. Consequently, PAG asserted there was no direct infringement and, hence, no induced or contributory infringement.

The Federal Circuit agreed with PAG and held that purchasers of Anton/Bauer’s F plates, indeed, were impliedly licensed to make the patented combination of M and F plates, even when using unpatented M plates obtained from any third parties.

In reaching its decision, the Federal Circuit relied on these factors:

• Anton/Bauer’s F plate sales were unrestricted.
• The F plate has only one use, which is to practice the patented combination.
• The facts “plainly indicate” that a license should be implied, because there was no contrary notice or contractual obligation at the time of sale. The M plates are unpatented. No Anton/Bauer conduct at the sale would have made a customer think it must buy M plates only from Anton/Bauer.
• The F plate sold by Anton/Bauer is a material, not a minor, component of the patented combination.19

Note that the Anton/Bauer decision arguably both narrowed and expanded the Met-Coil rule. In a narrowing sense, the court expressly required the authorized sale item to be a material part of the claimed combination; this materiality requirement may or may not have been integral to the earlier Met-Coil decision, but certainly was not expressly stated there like it was in the Anton/Bauer case. The Anton/Bauer case broadens the Met-Coil rule by extending the rule to patented combinations based on the sale of material, unpatented portions of the combination.20

Additionally, the Anton/Bauer court explained in dicta how the outcome under an implied license theory might have been different if there had been sale restrictions or if the M plate had been patented. This suggests that sale restrictions may appropriately negate an implied license. This also suggests that patenting components of a combination would be sufficient to negate an implied license if a customer were to buy patented components from a third party.21

1.4 Other Recent Developments in Implied License Law.

Implied licenses can be derived from an express license where the implied license is necessary for the express license to be practiced. Zenith Electronics Corp. v. PDI Communications Systems Inc., 522 F.3d 1348, 86 USPQ2d 1513 (Fed. Cir. 2008).22

Implied licenses cannot be obtained from a licensee who has no authority to confer a right to use. Monsanto Co. v. Scruggs, 459 F.3d 1328, 79 USPQ2d 1813 (Fed. Cir. 2006).

Proof of no non-infringing uses is required when an implied license is derived from an authorized sale but is not required when an implied license is derived from an express license. Zenith Electronics Corp. v. PDI Communications Systems Inc., 522 F.3d 1348, 86 USPQ2d 1513 (Fed. Cir. 2008).

Granting an express license to speakers included an implied license to use the speakers with any compatible television based on the grant language. Zenith Electronics Corp. v. PDI Communications Systems Inc., 522 F.3d 1348, 86 USPQ2d 1513 (Fed. Cir. 2008).

No implied license was found with respect to remote controls based upon speaker sales, because the speakers had non-infringing uses relative to the patented remotes. Zenith Electronics Corp. v. PDI Communications Systems Inc., 522 F.3d 1348, 86 USPQ2d 1513 (Fed. Cir. 2008).

Existence of an implied license and its scope are separate issues. Quanta Computer Inc. v. LG Electronics Inc., 553 US 617, 86 USPQ2d 1673, 1678 (2008); Zenith Electronics Corp. v. PDI Communications Systems Inc., 522 F.3d 1348, 86 USPQ2d 1513 (Fed. Cir. 2008).

A license under a patent as to certain products carries an implied license under narrower or broader continuation patents having the same disclosure absent a clear indication to the contrary in the license. General Protecht Group Inc. v. Leviton Mfg., 651 F.3d 1355, 99 USPQ2d 1275 (Fed. Cir. 2011).

1.5 Pitfalls under the Repair v. Reconstruction Doctrine.

The repair v. reconstruction doctrine (RRD) also limits patent scope. You are significantly impacted by the RRD if you sell patented items, such as capital equipment, for which there is a sizable used equipment or repair markets. You also are significantly impacted by the RRD if you generate a substantial portion of your revenues from replacement parts or service for previously sold patented items. One consequence is that your patent rights might protect you very well in the new sales market, but not at all or poorly in the used market. Your replacement parts business might be vulnerable, too, unless key features of key replacement parts are themselves protected by patents.

The RRD divides refurbishment activity into two main categories: repair and reconstruction. A refurbisher is permitted (i.e., is impliedly licensed) to “repair” a patented item but not to “reconstruct” a patented item.

Repair means that anyone who buys a patented item, or licenses it without applicable license restrictions, has an implied right to repair that item and keep it in proper working order. A refurbisher can repair patented items without violating patent rights that protect the patented item.

In contrast to “repair” rights, a refurbisher has no rights under the RRD to “reconstruct” a patented item. Generally, reconstruction, not repair, occurs if the refurbisher reconstructs a totally worn or spent product to make it operable again,23 or reconstructs the item so extensively that it is transformed into a new article.

A patent owner may have patent rights that cover replacement parts and/or refurbishment methods. Under current case law, the RRD does not authorize a refurbisher to undertake refurbishment activities that involve such patented replacement parts or refurbishment methods. In RRD parlance, such refurbishment constitutes impermissible reconstruction, not repair. This means that a patent owner can obligate you to buy patented replacement parts and patented services only from authorized sources. Interestingly, this also highlights important differences between patents that protect entire products and patents that protect only components. Patents that protect key components and repair methods are very important to protect against refurbishment activity in the used equipment market and might also help protect new sales; patents more broadly protecting entire systems are mainly useful for new sales and are much less potent in the used market.

Overzealous patent owners may try to tie sales of patented items with the sale of unpatented items or services. For example, that new, patented car you just bought from Acme Motors might need an oil change in a few months. Can Acme obligate you to buy unpatented oil change services from them as a condition of their selling the car to you? Apart from the antitrust implications of this tie, the RRD would not permit the tie either. Under the RRD, you have a right to repair your car using unpatented parts and services.

The patent owner cannot leverage patent rights to force you to buy its other unpatented items or services, but force is key. The patent owner can still offer such unpatented items and services to you if undue patent leverage is absent.

To evaluate whether refurbishment activities are proper, understanding the definitions of “repair” and “reconstruction” is crucial. You may think that it is relatively easy to categorize competitive activities as either repair or reconstruction. In some circumstances, it arguably is easy. But in many commercially important scenarios, it is difficult to determine if conduct is repair or reconstruction. The distinction between repair and reconstruction is grey in many fact patterns. Patent owners and refurbishers litigate over the RRD with some frequency.

Trying to predict an outcome can be a minefield for both parties. A patent owner risks violating the antitrust laws via conduct that unduly attempts to restrict repair activities or otherwise overextend its patent rights, which can have criminal and civil ramifications.24

An aggressive refurbisher who falls on the reconstruction side of the fence risks exposure to damages for patent, trademark, trade secret, copyright, contract, or other rights.

In most instances, patented items are sold or licensed. Restrictions on sold goods are more likely to implicate anticompetitive laws and/or be unenforceable. A patent owner can use more restrictions in a license, but even these can be troublesome. Outright restrictions on repair likely would be disfavored as would be provisions that fix prices, mandate that repairs can be performed only by authorized sources, set up boycotts, tie in, tie out, mandate overly broad grant backs of rights, restrict competitive development, etc.

Currently, courts have a strong bias that favors repair over reconstruction. A substantial majority of published decisions reach holdings of repair, not reconstruction. This does not mean that reconstruction is a dead letter, though. The most egregious, clear cut cases might never make it to trial or be appealed. It is fair to presume that the reported trial and appellate decisions tend to involve close cases. Consequently, the bias for repair in the case law means that repair tends to be favored in close cases, not all cases.

Certain fact patterns are common, some of which, and their typical outcomes, are listed in the following table:

2. Joint Owners who Fight over Ownership and Use of Joint Research.

Joint development research often results in the joint creation of an invention. In the patent world, this makes the creators not just joint inventors, but also joint owners of that invention.

The provisions of 35 U.S.C. § 262 expressly state that joint patent owners can act independently absent any agreement to the contrary. Quite often, joint research parties will address such jointly created rights, with the resulting understanding constituting an “agreement to the contrary” under § 262. Sloppy drafting causes problems, however, with parties encumbering freedoms they thought they had under § 262.

2.1 Wisconsin Alumni Research Foundation v. Xenon Pharmaceuticals Inc.25

Xenon and the University of Wisconsin jointly researched enzymes that lower cholesterol. Xenon and the University made a joint invention, and the parties filed a joint patent application. In due course, Xenon exercised an option to exclusively license Wisconsin’s joint interest.

As permitted by the exclusive license, Xenon sublicensed those rights to a third party. But, contrary to the license terms, Xenon sublicensed the third party without paying compensation to Wisconsin. Wisconsin terminated the license and sued.

Xenon argued that the agreement merely encumbered Wisconsin’s joint interest. Its own joint interest remained unaffected so that Xenon was free to sublicense without compensation to Wisconsin.

Xenon failed to persuade the Court of Appeals for the 7th Circuit, which held that Xenon’s failure to pay Wisconsin breached the license and, therefore, that Wisconsin properly terminated the license. This means that Xenon, perhaps unintentionally, encumbered its own joint interest when it secured rights under Wisconsin’s legally distinct joint interest.

The impact of the adverse decision and termination on Xenon is an open question. On the one hand, Xenon owns a joint interest and presumably could practice independently under its interest as authorized by 35 U.S.C. § 262. On the other hand, it is possible that Xenon’s own joint interest is so encumbered that Xenon no longer has any right to sublicense others without authorization of the University.

Locking up the other party’s joint interest in patent rights is a viable and common strategy in joint development relationships, but doing so has consequences under 35

U.S.C. § 262. Depending upon how your “agreement to the contrary” is drafted, you may encumber your own joint interest with obligations as a consequence of securing rights under the other joint interest.

2.2 Intl. Nutrition Co. v. Horphag Research Ltd.26

Sometimes, U.S. patents arise from joint development efforts that occur in other countries. What happens if a joint development agreement would constitute an “agreement to the contrary” under the law of another country but not under US law?

In International Nutrition, the Federal Circuit held that a French joint research contract could be construed under French law to restrict rights of parties to transfer developed patent rights and thus could constitute an “agreement to the contrary” under 35 U.S.C. §

262. As long as French courts acted fairly to allocate ownership rights per the contract, the Federal Circuit saw the situation as analogous to a situation where state law is used to construe IP contracts in the US. Following the French law to adjudicate ownership of a US patent did not offend 35 U.S.C. § 262.

2.3 Massachusetts Eye and Ear Infirmary v. QLT Phototherapeuitics Inc.27

The “agreement to the contrary” clause of § 262 applies to any agreement and is not limited only to written agreements. Indeed, an actual agreement is not even necessary if a party commits to negotiate an agreement but then never negotiates.

A hollow promise to negotiate proved problematic in Massachusetts Eye and Ear. An oral promise to negotiate in good faith to compensate a joint owner in a joint research setting constituted an “agreement to the contrary” sufficient to serve as a basis for equitable relief under a theory of unjust enrichment. In other words, a promise to negotiate can be an enforceable “agreement to the contrary” under § 262!

Massachusetts Eye and Ear also teaches that an “agreement to the contrary” only binds joint owners who are parties. Other joint owners are not restricted. For example, claims added to a patent application might cause inventorship to expand to encompass additional inventors. Those additional inventors become joint owners of the entire patent property per Massachusetts Eye and Ear. Absent any agreement to the contrary, the new owner(s) can exploit the patent rights independently of the other owners.

2.4 Ethicon Inc. v. United States Surgical Corp.28

The rights of a joint owner to act independently under 35 U.S.C. § 262 can undermine the ability of another joint owner to enforce a joint research patent. This is particularly a risk when the rights of all joint inventors are not properly secured, as one joint owner discovered in Ethicon.

A patent resulted from a joint research program. One of the parties to that program believed it was the only owner of a resulting patent and sued an accused infringer. However, it turned out that another individual contributed to the conception of at least one of the patent claims and, therefore, was a joint inventor who had been omitted from the asserted patent.

As a joint inventor, the omitted inventor owned an undivided joint interest in the entire patent and could independently exploit the patent without accounting to the other owner. No agreement existed to the contrary. The omitted inventor owned this joint interest in the entire patent including dozens of claims even though he was a co-inventor on a single claim. An accused infringer recognized this and took a license from that omitted inventor to avoid infringement.

Application of conception law was central to the Ethicon (1998) holding. However, because conception and reduction are at the center of priority disputes under the pre-AIA laws, and because priority disputes are now obsolete under the new AIA laws, some commentators have taken the position that conception and reduction to practice are extinct bodies of law as to newer patent rights. 29 This clearly is not the case under joint development relationships such as Ethicon where proving conception and reduction to practice can be central to proving not priority but rather how joint patent rights are owned or that an invention was made as part of a joint development effort. Ethicon shows that the laws of conceiving and reducing inventions to practice are still very relevant to resolve disputes that arise under joint development relationships.30

2.5 Caterpillar Inc. v. Sturman Industries Inc.31

As discussed above, § 262 expressly approves “agreements to the contrary” so that joint owners can restrict independent action under jointly owned patent rights. But a factor such as one of the following can undermine the effectiveness of these agreements:

1. one or both parties acts as if no agreement exists, such as by selling joint research rights to a third party after ostensibly having already transferred those rights exclusively to the other joint research party;
2. one or both parties secretly pursue patent applications to avoid the agreement;
3. the rights and obligations relating to patent rights resulting from joint research are horribly ambiguous; or
4. one party enforces the agreement in a seriously biased home court before jurors who are so prejudiced that the appeals court deems them to be biased as a matter of law.

Just one of these factors can spark bitter litigation. Unbelievably, all of these factors (according to allegations) were at play in Caterpillar.

Caterpillar started the litigation in federal District Court in Peoria, Illinois, where anecdotal evidence indicates that over half of the 110,000 residents are Caterpillar employees or immediate family members. Still more residents indirectly depend upon Caterpillar for their livelihoods. The District Court was ridiculously biased and saw no problem that the jury included Caterpillar spouses and favored Caterpillar on voluminous claims and defenses, even those that were untenable on appeal. The Federal Circuit, far removed from the home court spell, reversed on many grounds.

2.6 Lucent Technologies Inc. v. Gateway Inc.32

Section 262 is interpreted in a manner that can allow “agreements to the contrary” to govern rights developed both under and outside the agreement. A joint development agreement having a finite term is a good example of this.

The finite term raises the possibility that a patent application claiming fruits of that joint development may not be filed until after the agreement has ended. This raises the further possibility that such a patent application may claim not only fruits developed under the joint development agreement but also fruits developed after the agreement term. If the joint development agreement specifies that the parties will jointly own patents for inventions made under the agreement, how do you handle ownership of a patent where some claims were developed under the agreement but other claims were not?

Lucent makes it clear that the entire patent is subject to the ownership provisions of the joint development agreement. This follows from the principle that an inventor of some claims is an owner of the entire patent.33

The Lucent decision teaches other important principles. First, a jointly owned patent must be enforced in the names of all joint owners. If one joint owner is not present, the other lacks standing to bring an infringement action.

Further, the difference between background rights (“Existing Work”) and developed rights (“New Work”) was critical as to whether a missing party was a joint owner or not. If asserted patent rights constituted background rights, the missing party was not a joint owner of the patent at issue. The lone patentee then would have sufficient standing to bring the infringement action. If the asserted rights constituted New Work developed under the contract, the missing party was essential to standing.

A particular date was critical to resolve the issue. The asserted patent issued from a patent application filed long after the critical date. The lone patentee tried to manufacture standing by claiming priority to an early patent property existing prior to the critical date. This ploy failed to secure standing. The Federal Circuit held that merely claiming priority to an early date did not cause a later invention to become an Existing Work (i.e., a background right). Per the contract terms, the invention at issue had to have been made prior to the critical date to qualify as an Existing Work. The lone patentee provided insufficient evidence to prove that.

Similar to Ethicon, conception was a central issue in Lucent even though Lucent did not involve priority issues. Like Ethicon, Lucent shows that conception and reduction to practice will continue to be at issue in joint development disputes to prove matters such as ownership and when an invention was made.

As another interesting point, Lucent teaches that, if background rights under a joint development agreement are limited to items developed by Parties A and B prior to a critical date, then items developed by Party C prior to the critical date are not background rights.

As still another interesting point, Lucent clarifies that an assignment must convey title to an entire patent. A purported “assignment” that transfers title only to some claims is a license.

3. Avoiding Prior Art Using the Safe Harbor of a Joint Research Agreement.

Prior to December 2004, joint research parties faced a serious obstacle against patenting inventions resulting from joint research efforts. Claimed inventions could be rejected as unpatentable during prosecution, or be invalid if issued, over confidential information shared during the joint research.34 The rejection or invalidity could be avoided only if the inventors had an obligation to assign to a single entity in effect before the invention was made. This rule had a chilling effect on joint research.

This changed in December 2004 when the Cooperative Research and Technology Enhancement (CREATE) Act was enacted. The CREATE Act was enacted in significant part to vitiate Oddzon and thereby unchill and encourage joint research. The joint research provisions of Sections 102 and 103, both under the AIA and under pre-AIA laws, provide a safe harbor that can be very helpful in prosecution to disqualify prior art and thereby gain allowance of a patent application.

Under the CREATE Act, subject matter of one party is disqualified as prior art against a claimed invention of another party if three requirements are met:

1. A joint research agreement (JRA) was in effect on or before the date on which the claimed invention was made;
2. The claimed invention resulted from activities under the JRA; and
3. The corresponding patent application disclosed the parties to the JRA.

The CREATE Act defines a JRA as a written contract, grant, or cooperative agreement entered by two or more entities to perform experiments, development, or research in the field of the claimed invention.35

The CREATE Act disqualifies only prior art arising under 35 U.S.C. § 102(e), (f), and (g) when used to make an obviousness rejection. The 2004 Act does not provide a safe harbor for novelty destroying prior art. This changed under the new provisions of 35 U.S.C. §§ 102, 103 enacted under the America Invents Act (AIA) when the safe harbor became available for novelty, too.

The disqualified prior art and the claimed invention are deemed to be commonly owned for purposes of an obviousness type double patenting rejection. The patent applicant, therefore, may file a terminal disclaimer to overcome the rejection if made. This kind of terminal disclaimer must include statements about enforcement that are not required in other terminal disclaimers.

The CREATE Act governs patent rights subject to pre-AIA laws. Inasmuch as many patent properties remain subject to pre-AIA laws, the CREATE Act remains relevant.

The new provisions of 35 U.S.C. §§ 102 and 103 change the JRA landscape in two significant respects. First, under the CREATE Act of 2004, a JRA had to be in effect as of the date the claimed invention was made in order for the JRA to be eligible to disqualify prior art; now, the JRA must be in effect on or before the effective filing date of the claimed invention. Second, under the CREATE Act of 2004, the JRA safe harbor was not available to disqualify novelty destroying art; now, the safe harbor applies when novelty and/or obviousness are at issue.

The definition of a JRA remains the same under the new laws. Thus, the JRA safe harbor is still available only for written contracts, grants, or cooperative agreements to perform experiments, development, or research in the field of the claimed invention.

Smoke and mirrors also are not a substitute for an actual, written joint research agreement. This charade was attempted in In re Hubbell, 106 USPQ2d 1032 (Fed. Cir. 2013). An application owned by one party was rejected for obviousness type double patenting over an earlier patent naming overlapping but different inventors. The two patent properties were never commonly owned. Although the propriety of rejecting the application for double patenting in these circumstances was challenged by the applicant, the Federal Circuit confirmed that this is a well-established and entirely proper situation to apply the rejection.

The applicant then asserted that he should be able to file a terminal disclaimer to avoid the rejection. The Federal Circuit indicated the applicant could not do this because the application at issue and the patent posing double trouble were never commonly owned.

The applicant countered that the CREATE Act allows independent parties to be treated as common owners if (i) the parties had a JRA in effect at the time the rejected invention was made, (ii) the invention was made under the JRA, and (iii) the application is amended to disclose the JRA parties. The Federal Circuit acknowledged this, but then rebuked the applicant on grounds that applicant had no such agreement and, therefore, could not benefit from the statute. Implicit in the court’s rebuke is the principle that mere overlapping inventorship is not the same as or even a substitute for a joint research agreement.

4. Pitfalls When Commercializing Products Developed From Joint Research.

Joint development agreements often contain supply terms by which one party agrees to sell products to the other party. Those products might already exist or might exist after some joint development.

Supply terms in a joint development relationship can constitute an offer to sell or a sale of an invention as of the date that the product is reduced to practice and/or is transferred to the other party. This was at issue in Enzo Biochem Inc. v. Gen-Probe Inc.36

Enzo sued Gen-Probe under a patent issuing from an application filed in January 1986. However, in 1982, Enzo entered into a joint research agreement with another party under which Enzo developed the patented technology. The joint research obligated Enzo to supply, and the other party to buy, products incorporating the technology. Such a product was in fact transferred to the other party in 1984.

Gen-Probe successfully argued (1) that the agreement constituted a binding, commercial offer to sell at least as early as the date that Enzo supplied the product to the other party and (2) that the offer to sell took place more than one year before Enzo filed its application; therefore, the Enzo patent was invalid.

Enzo tried but failed to sidestep the on-sale bar. Enzo unsuccessfully asserted that the joint research agreement was primarily related to research and development, shielding the supply provisions from triggering the on-sale bar. The Federal Circuit disagreed. The fact that the supply provisions existed within the confines of a research program did not alter the commercial nature of the supply provisions. One party was obligated to sell, and the other party was obligated to buy. This was not an experimental sale, because the product at issue had already been reduced to practice.

One lesson from Enzo is that joint development parties should not delay identifying patentable inventions resulting from the joint research and then should promptly file patent applications on selected opportunities. Another lesson is that research and supply terms perhaps should be set forth in separate agreements37 and perhaps condition the binding aspect of the supply terms on the occurrence of a future milestone.

Many joint development agreements include license grants between the parties. Commonly, the license grant allows a party to commercialize a product yet to be developed. A license grant does not necessarily trigger the on-sale bar in the same manner as Enzo-type supply obligations.38

In re Kollar involved a license for a patented method, and part of the court’s analysis involved the observation that a process is not a tangible item that is sold like a product. This suggests that In re Kollar might apply only when patented methods are at issue.

However, its overall analysis that a license confers merely a right to commercialize should apply conceptually just as well to product licenses. The better view, therefore, is that mere grant clauses in a joint development agreement are not an offer to sell or a sale. Mere grants should not trigger the on-sale bar absent other provisions in the agreement that constitute an offer for sale or constitute binding supply terms.

5. Antitrust pitfalls common to Joint Development Agreements.

In the late 1970s, the Justice Department promulgated the famous “nine no-no’s” to be avoided as antitrust pitfalls when licensing patent rights. In that era, many of the no-no’s were per se unlawful. Even if some were scrutinized under a rule of reason, those were hard to justify. The nine no-no’s included:

1. Tying in: conditioning a license grant on purchase of unpatented items;
2. Grantbacks (grantforwards): mandating that the licensee (or licensor) exclusively or nonexclusively grant or assign improvements to the other party;
3. Restricting resale: limiting or blocking the ability of a customer to sell a patented item in the used market;
4. Restricting competitive development: limiting or blocking the ability of a licensee to deal with products or technologies outside the scope of the licensed patents.
5. Exclusive licenses: problematic if these involve extensive cross licensing, patent pooling, or unduly enhancing market power;
6. Mandatory package licenses: can enhance competition or can be a type of tying arrangement such as when multiple parties pool patents relating to industry standards;
7. Unreasonable royalty: royalty not reasonably related to sale of items covered by the licensed patents;
8. Restrictions on output of patented process: potential problem in some scenarios such as where prices are fixed or customers or territories are restricted:
9. Price fixing: mandating prices for licensed products.

Even with the passage of time, all nine no-no’s still raise anticompetitive flags and are subject to antitrust scrutiny. But, the sense that these nine practices are inherently and inexorably evil has softened to a significant degree. For example, tying used to be a per se violation of antitrust laws with no redeeming features. But now, tying is evaluated under a rule of reason.39 This creates the possibility that tying restrictions can be acceptable in some circumstances. Tying remains risky business, with very little guidance to suggest when a party can tie with impunity as being too weak in the market to have antitrust worries.

Antitrust policies on one hand, and intuition on the other, are at odds in the minds of many joint development parties. Left to intuition, many parties instinctively create joint development provisions that tie in, tie out, restrict competitive development, fix prices and supply, require onerous grantbacks and grantforwards, etc. Parties are not born knowing, but instead must learn, that certain conduct poses antitrust risk.

Restricting competitive development (the fourth of the nine no-no’s) is an excellent example of the conflict between natural business instincts and antitrust policies. Parties with great regularity pen joint development provisions that restrict one or both parties from selling competitive products or from working alone or with others to develop competitive technology. The following is a typical restriction of this ilk:

During the term of this Joint Development Agreement and during the term of any JOINT PROGRAM LICENSE authorizing ACME under BOB’s BACKGROUND RIGHTS and/or BOB’s JOINT PROJECT PATENT RIGHTS to make, use, sell, offer to sell, and/or otherwise distribute RUSTPROOF WIDGETS, ACME shall not develop on its own or with others any widgets or related products that are competitive with the RUSTPROOF WIDGETS.

This clause suppresses competitive development, prohibiting one joint development party from developing competitive products or technology outside the joint development agreement. This kind of competitive suppression is risky under antitrust principles.

Although not a per se antitrust violation, competitive suppression is still analyzed under the rule of reason standard. A patentee generally cannot leverage patent rights so as to unduly block the other party from developing competitive technologies and products without regard to whether or not the licensor’s patent rights are used.

The Federal Circuit recently confirmed judicial hostility to such suppression in Princo Corp. v. ITC, 96 USPQ2d 1233 (Fed. Cir. 2010).40 At issue was whether suppressing competitive technology using Patent A as leverage could be misuse as to Patent B. In other words, does questionable conduct surrounding Patent A affect the enforceability of a different Patent B? The Federal Circuit held that improper behavior relating to Patent A was not a misuse of separate Patent B. Patent B itself had to be misused for that misuse defense to taint Patent B. The court acknowledged, though, that the competitive development restrictions leveraged by Patent A raised antitrust concerns. Because the antitrust concern was not at issue on appeal, the court did not resolve it.

In contrast to clauses that improperly suppress competitive development and technology, joint development parties have much more freedom to control how their own patent rights are used by others. Protecting one’s own patent rights is much different and much less offensive to antitrust policies than restricting how someone else can develop or use its own patent rights. Clauses that limit how the licensee can use the licensor’s patent rights are a viable strategy and might look like the following:

ACME will use BOB’s BACKGROUND PATENT RIGHTS and the JOINT PROGRAMPATENT RIGHTS only for the purpose of manufacturing, making, having made, marketing, selling, offering for sale, importing, or otherwise distributing RUSTPROOF WIDGETS and PRODUCTS and for no other purpose. This use restriction shall survive any expiration or termination of this Agreement.

6. Term sheet strategies helpful to draft and negotiate Joint Development Agreements.

Term sheets offer many advantages. They can simplify the negotiation process and make it less expensive to put in place a fully signed joint development agreement. With a term sheet in hand, the parties can hammer out the main concepts without getting lost in the clutter of specific details needed for a full agreement.

A term sheet can be very useful if a deal is complex.41

The term sheet can also be a useful element of your marketing folio when you are trying to entice another to enter a joint development relationship. Using a term sheet as a discussion guide in talks at these levels often is much easier and effective than a full agreement.

Even if the other party has taken the bait and wants to explore a deal, the term sheet can still be useful to test acceptance of certain aspects of the deal at an abstract level before any party commits to specific details. As just one instance of many possible examples of where this can be useful, a term sheet can specify that an initial fee is required without actually specifying the amount of the initial fee. By selling the concept of an initial fee first, the term sheet may catalyze acceptance of the details to come later. Otherwise, setting out the price too soon can be polarizing. Polarization can increase the likelihood that not just the amount of the initial fee, but also the very concept itself, would be unacceptable to the candidate licensee. Opening with a full agreement does not offer similar selling-the-concept-first opportunities, as the full agreement must be full of the details.

A term sheet also can be useful when one of the parties has little experience with joint development projects. The term sheet can act as a study guide to help the newbie through the agreement drafting, negotiation, and placement process.

A term sheet can also be a great tool for analyzing a full agreement that has been sent to you by the other side or a colleague. Start your agreement analysis by creating your own “ex parte” term sheet – one that only you and your client might see. This will allow you to evaluate the essence and architecture of the deal without obfuscating details. You will know right away whether you need to hammer out concepts or whether you are ready to focus on details. You will be in a better position to assess whether the deal could yield a good return or whether your putative cash cow actually lacks adequate cash (and perhaps the cow).

Clearly, a term sheet can be a useful tool to facilitate the drafting and negotiation of a license. The term sheet may help you reach a final agreement. Or you may not.

If you don’t reach a final agreement, you most likely want to walk away from the negotiation without any obligations or liability. This is where term sheets can be dangerous. If you are not careful in how you draft a term sheet, your term sheet unexpectedly (and undesirably) can end up being a binding, enforceable contract. The proposed joint development terms that you thought were suggestions can become obligations for one party and rights for the other. This can be quite a surprise if you intended the term sheet only to be a guide for negotiation and your expectation was that no binding agreement would exist until a final agreement was signed. Your negotiation must be handled properly, and your term sheet must have the right language in it, if you are to minimize this risk. Note, though, that not just term sheets but also agreement drafts and any negotiation process carry similar risks. Parties are not necessarily increasing this kind of risk by using a term sheet.

Even if you are careful in how you craft the language of a term sheet, a term sheet can still become a binding, enforceable contract and/or significant liability can accrue if your actual conduct under the term sheet is sloppy or improper. As one common pitfall, one or both parties may start performing under the putative license too soon. Overconfident that the final agreement will be placed, a party may ship supplies to the other party. One party might make royalty payments, and the other accepts those payments. Both parties might start development. One party might start the transfer of know how, which the other accepts. Even with the most non-binding term sheet language ever crafted, this kind of partial performance by both parties creates a high risk that a contract is in place whose terms are very much unclear. You may wish to walk away from a negotiation without liability or obligation in these circumstances, but your wish may not be granted.

Perhaps it is surprising that partial performance under a term sheet forges obligations and liabilities. But it should come as no surprise that misconduct under a term sheet can lead to significant liability. For instance, those who pirate information received in confidence while doing due diligence under a term sheet should expect to pay the consequences. Ditto if you make fraudulent misrepresentations or other malfeasance or nonfeasance.

Fortunately, some strategies can significantly reduce the risk that your term sheet, negotiations, and agreement drafts will haunt you with obligations and liabilities according to your worst nightmares:

• Use a nondisclosure agreement to cover negotiations that is customized to include express language that the proposed agreement terms are non-binding and that only a fully signed, final agreement will bind the parties.
• Recognize that the term sheet setting will involve some terms that are intended to be binding and then very clearly distinguish between binding and non-binding aspects. These are examples of terms that may be intended to be binding: identifying the parties, establishing confidentiality, excluding third party beneficiaries, prohibiting assignment of the term sheet, setting up a period of exclusive dealing, defining the expiration of the term sheet, making sure the proposed terms of the license are nonbonding until a final deal is signed, setting up a period of due diligence, etc.
• Consider partitioning binding and non-binding terms into separate documents. For instance, binding terms can be placed in a nondisclosure agreement to be signed by both parties, with the non-binding, proposed joint development terms in an attachment.
• Expressly state that either party may withdraw from the negotiation at any time, including up to and until a final agreement is signed, without the acts of early performance or withdrawal triggering any obligation or liability to the other. Malfeasance or nonfeasance should be excluded, understanding that withdrawal per se is neither of these.
• Specify a choice of law and venue applicable to construing the binding and non-binding aspects of the term sheet. The risks of term sheets are governed in large part by state law. Because state laws differ, it makes sense to specify the law that supports the strategies you are practicing.
• Recognize that the initially proposed, non-binding license terms will be modified as the negotiation proceeds. The term sheet should expressly state that none of these modifications are to be binding. Many disclaimers against being bound address only the original proposal and do not encompass future evolutions. In the absence of a suitable disclaimer, these future evolutions can be deemed to be binding depending upon the course of dealing between the parties.
• Refer to the non-binding terms as “proposed” or similar.
• Leave out key details, addressing these aspects at a conceptual level. For example, propose that a royalty will be paid, but don’t specify the amount. The amount can be left for negotiation.
• Avoid statements that the final agreement is intended to memorialize the understanding in the term sheet.
• Avoid performing until after the agreement is signed.
• Be aware that many states will imply a duty to negotiate in good faith under a term sheet. Fail to satisfy this duty and you may incur liability for this malfeasance. Don’t enter a term sheet unless you have a good faith intent to negotiate.

The more of these strategies that you practice, the more that you reduce your risk. However, we are not presently aware of any case that sets forth a bright line between binding and non-binding term sheets. There is no formula, if followed, that guarantees that your term sheet will be non-binding. Most of the case law arrives at decisions based upon the totality of circumstances, not by black letter rules. Not only term sheet language, but also party conduct comes into play. This means that term sheet danger can only be reduced, not eliminated.42

1 U.S. Const., Art. I, Section 8, Clause 8.
2 The rewards to be earned by patent owners should not be “excessive.” See Quanta Computer Inc. v. LG Electronics Inc., 553 US 617, 128 S. Ct. 2109, 86 USPQ2d 1673, 1678 (2008) (patent owners not entitled to reap “private fortunes”).
3 Conceptually, repair v. reconstruction is a subset of implied license law.
4 108 USPQ 1648 (Fed. Cir. 2013).
5 Patent exhaustion as an affirmative defense to infringement was greatly revitalized by Quanta Computer, Inc., v. LG Electronics, Inc., 553 U.S. 617 (2008). There, a patent owner licensed a manufacturer to produce and sell special electronic components that, when combined with other, more standard components in a personal computer, performed patented methods during use of the computer. The patent owner attempted to assert that downstream purchasers of the licensee’s components were licensed to practice the patented methods only if all computer components used to perform the patented methods were purchased from the licensee. Under this theory, if a downstream purchaser combined a component purchased from the licensee with other components purchased from third parties, using the resulting combination would infringe the patent owner’s method patents. The U.S. Supreme Court nixed LG Electronics’ theory and business model. The Supreme Court first determined that method claims could be exhausted and then expounded a two-part test to assess when method claims are exhausted. Exhaustion occurs upon the authorized sale of an item that substantially embodies the method if that item (1) has no reasonable non-infringing use and (2) includes “all inventive aspects” of the claimed method.
6 Exactly what might constitute a legitimate time-of-sale restriction on a consumer good is an open issue.
7 The concurrence argued that this aspect of the majority opinion constitutes dicta, so it remains to be seen whether this aspect of exhaustion law will take hold or not.
8 108 USPQ2d 1757 (Fed. Cir. 2013).
9 Intent is a new part of exhaustion jurisprudence after Lifescan. Previously, the Federal Circuit indicated that intent with respect to downstream customers is relevant to implied license, but not to exhaustion. Transcore LP v. Electronic Transaction Consultants, 563 F.3d 1271, 90 USPQ2d 1372 (Fed. Cir. 2009).
10 Compare this dicta to the Keurig discussion, supra. In Keurig, the same court at nearly the same point in time applied a different, harsher exhaustion rule, and Keurig patents on the beverage cartridges did not prevent exhaustion of Keurig’s patent rights.
11 See also Monsanto Co. v. Scruggs, 459 F.3d 1328, 79 USPQ2d 1813 (Fed. Cir. 2006) (without an actual sale, there can be no exhaustion, and second generation seeds were never sold by the patent owner); Monsanto Co. v. McFarling, 302 F.3d 1291, 64 USPQ2d 1161 (Fed. Cir. 2002).
12 See also Jazz Photo Corp. v. ITC, 264 F.3d 1094, 59 USPQ2d 1907 (Fed. Cir. 2001).
13 See, e.g., Nimmer & Dodd, Modern Licensing Law, §§4:2-4:3 (2007).
14 750 F.2d 903, 925, 223 USPQ 982, 998 (Fed. Cir. 1984).
15 803 F.2d 684, 231 USPQ 474 (Fed. Cir. 1984).
16 Even though the decision refers to the corners as “special,” they were special in terms of their shape but not their patented status.
17 329 F.3d 1343, 66 USPQ2d 1675 (Fed. Cir. 2003).
18 PAG never sold F plates. Thus, any M plate sold by PAG, presumably at a price that was better than M plates sold by Anton/Bauer, was used only in combination with F plates obtained from Anton/Bauer.
19 See footnote 3, 66 USPQ2d at 1680.
20 Met-Coil involved implied licenses under method claims triggered by a sale of equipment used to practice that method.
21 In contrast to the appropriateness of post-sale restrictions in an implied license analysis, post-sale restrictions are quite ineffective at negating exhaustion, a separate legal theory. Also, intent with respect to downstream customers is relevant to implied license, but had not been relevant to exhaustion per Transcore LP v. Electronic Transaction Consultants, 563 F.3d 1271, 90 USPQ2d 1372 (Fed. Cir. 2009). However, the Lifescan decision, discussed above, announced that intent is now relevant to exhaustion.
22 See also Jacobs v. Nintendo of America, Inc., 370 F.3d 1097, 71 USPQ2d 1055 (Fed. Cir. 2004) (the scope of an implied license derived from an express grant clause cannot be construed to render the express grant meaningless, however).
23 But see Jazz Photo Corp. v. ITC, 264 F.3d 1094, 59 USPQ2d 1907 (Fed. Cir. 2001)(repair, not reconstruction, occurred even with extensive refurbishment of totally spent, single use cameras).
24 United States v. Univis Lens Co., 316 U.S. 241, 53 USPQ 404 (1942) is a good example. That case involved an enforcement action against an allegedly overzealous patent owner who overextended patent rights to fix prices.
25 93 USPQ2d 1361 (7th Cir. 2010).
26 59 USPQ2d 1532 (Fed. Cir. 2001).
27 75 USPQ2d 1225 (1st Cir. 2005).
28 45 USPQ2d 1545 (Fed. Cir. 1998).
29 The AIA changed U.S. patent priority determinations from first-to-invent to first-to-file. Interferences resolved priority under the pre-AIA system, which still applies to applications/patents having priority dates prior to the crossover date. Priority battles involve proving corroborated conceptions and reductions to practice to establish who was the first to invent. Priority is irrelevant under the AIA where patents are awarded to the first-to-file.
30 Conception and reduction to practice remain relevant in other contexts, too, including (a) government contracts where subject invention rights depend upon when an invention is conceived or reduced to practice; (b) shop rights to prove that conception or reduction to practice involved using employer resources; and (c) derivation proceedings to prove that one party derived an invention from another; etc. Using conception and reduction to practice principles to prove priority may be obsolete as to patent rights subject to the AIA, but those principles are far from obsolete in contexts other than priority battles.
31 73 USPQ2d 1609 (Fed. Cir. 2004).
32 88 USPQ2d 1481 (Fed. Cir. 2008).
33 See also Israel Bio-Engineering Project v. Amgen, Inc., 81 USPQ2d 1558 (Fed. Cir. 2007) (ownership subject to agreement when some claims developed within contract and others were not).
34 Oddzon Products Inc. v. Just Toys Inc., 43 USPQ2d 1641 (Fed. Cir. 1997).
35 Oral agreements are not eligible for the JRA safe harbor under this pre-AIA law. This contrasts to 35 USC § 262, where oral agreements qualify as an “agreement to the contrary” that may restrict independent action by joint patent owners.
36 76 USPQ2d 1616 (Fed. Cir. 2005).
37 For example, a supply agreement might be attached to a joint research agreement as an exhibit.
38 Such a grant “only contemplates that ‘resultant products’ could potentially be sold[.]” In re Kollar, 62 USPQ2d 1425 (Fed. Cir. 2002).
39 The judicial temperance is strongly evidenced by Illinois Tool Works v. Independent Ink Inc., 547 US 28 (2006), which eliminated any presumption that existence of a patent conferred market power. Prior to that case, market power in tying cases was presumed when a patent was at play. The case held that market power always must be proved.
40 Other courts for decades have shared this hostility to clauses that improperly suppress competitive development and technology. See, e.g., Tampa Electric Co. v. Nashville Coal Co., 365 U.S. 320 (1961) (evaluating legality of exclusive dealing under section 1 of the Sherman Act and section 3 of the Clayton Act); Beltone Electronics Corp., 100 F.T.C. 68 (1982) (evaluating legality of exclusive dealing under section 5 of the Federal Trade Commission Act); see also, U.S. v. General Electric, 80 USPQ 195 (D.N.J. 1949); Kobe, Inc. v. Dempsey Pump Co. 89 USPQ 54 (N.D. Okla. 1951), aff’d on other grounds, 94USPQ 43 (10th Cir. 1952).
41 Sometimes complexity cannot be avoided; other times, undue complexity is an artifact of incomplete thinking. Before committing to a complex agreement structure, spend additional analysis time to see if the same business goals can be achieved with a simpler structure. Often, simplification is possible. Any simplification is desirable, as the drafting, negotiation, administration, operation, and enforcement of the agreement will be eased. If you have a choice between simple and complex to achieve the same goal, simple simply is better.
42 For additional information, please see Ballard and Lively, “Should You Sue Over A Term Sheet?”, The Practical Litigator, pages 43-56 (July 2007), available online at http://www.cadwalader.com/assets/article/070107BallardLivelyPracticalLitigator.pdf. See also Fairbrook Leasing, Inc. v. Mesaba Aviation, Inc. 408 F.3d 460 (8th Cir. 2005).