A federal trial judge in San Francisco has provided food for thought for patent licensors and licensees. Litigation arose from a 2002 patent license agreement between Novartis Vaccines and Diagnostics Inc. as licensor and Abbvie Inc. as licensee. The patents pertained to treatments for hepatitis C.

The license agreement required the payment of royalties on products that would, but for the license, infringe a “Valid Claim” of the licensed patents. “Valid Claim” was defined, as it usually is, to include any claim in a licensed patent or patent application that has not been found by a court or governmental agency to be invalid. The license agreement also contained an arbitration provision that applied to any disputes “that relate to either party’s rights and/or obligations” under the license agreement.

Ten years later, the US Supreme Court issued a series of opinions that reinforced and expanded older rulings that laws of nature, natural phenomena and abstract ideas fall outside the scope of patent-eligible discoveries. None of these cases involved the patents licensed to Abbvie or technologies related to hepatitis C.

Abbvie decided that it no longer should pay royalties on the hepatitis C patents because, in its view, the recent Supreme Court cases rendered the patents invalid. In suing for a declaratory judgment, it was following in the wake of others who had convinced the Supreme Court that licensees could challenge patents that they had licensed even if the license agreement said they couldn’t.

Two Supreme Court precedents loom over this case. In Lear v. Adkins (1969), reversing an earlier decision, the court held that a licensee could challenge the validity of a patent without terminating the license agreement. The Lear opinion sets contract law at odds with a federal policy promoting free competition as enshrined in the Sherman Act. The court declared:

Surely the equities of the licensor do not weigh very heavily when they are balanced against the important public interest in permitting full and free competition in the use of ideas which are in reality a part of the public domain. Licensees may often be the only individuals with enough economic incentive to challenge the patentability of an inventor’s discovery. . . . We think it plain that the technical requirements of contract doctrine must give way before the demands of the public interest in the typical situation involving the negotiation of a license after a patent has issued.

Lear thus suggests that the licensee’s challenge to the patent is justified not by contract but by the public interest in having bad patents challenged.

However, in Medimmune Inc. v. Genentech Inc. (2007) the court focused on the constitutional requirement that a “case or controversy” exist before a federal court can assert jurisdiction. In that case the patent licensee sought a declaratory judgment of invalidity without terminating the license. The licensor argued that there was no case or controversy with the license still in effect, and that the federal courts therefore lacked jurisdiction to issue a declaratory judgment. The Supreme Court characterized the dispute as rooted in the license agreement, not one based upon a public policy favoring the scrutiny of patents, and concluded that a controversy existed as to whether the licensee should be paying royalties under it.

Abbvie’s complaint seeking a declaratory judgment of invalidity cited no provisions of its license with Novartis, only that the license existed. Instead, it explained why the licensed patents should be deemed invalid in light of the recent Supreme Court cases mentioned above that invalidated patents that merely recite laws of nature or describe naturally occurring molecules. According to Abbvie, Novartis’s patents did no more than that.

Novartis’s reply included a request that the matter be resolved by arbitration. In doing so, Novartis characterized Abbvie’s complaint as one involving the meaning of “Valid Claim”, a matter of contract interpretation that, according to Novartis, was subject to the arbitration clause of the license just like any other contract dispute.

Abbvie resisted this request with two arguments. First, it said that the definition of “Valid Claim”, invoking as it does the notion that a court must have held the claim to be invalid, constituted an exception to the arbitration provision. How can a court ever get to the question, Abbvie seemed to ask, if it must be arbitrated? Given that conundrum, Abbvie argued that the definition of Valid Claim must be interpreted as constituting an exception to the arbitration clause.

Abbvie’s second argument drew on Lear’s public policy concerns. The public has an interest, said Abbvie, in having courts decide the validity of patents so that the market can be cleared of invalid monopolistic claims.

Abbvie cited Abbott Laboratories v. Mathilda and Terence Kennedy Institute in which Abbott pressed the same arguments. The federal district court in New York refused to submit the question to arbitration. In doing so, Judge Paul Crotty suggested that the definition of “Valid Claim” created an exception to the arbitration provision, relying on Lear v. Adkins and the public policy favoring patent challenges.

Abbvie was not so fortunate in the Northern District of California. Judge Edward Chen expressed sympathy for Abbvie’s public policy argument, but ruled that Novartis had provided a reasonable interpretation of the license agreement in support of its request for arbitration and that, under California law (which governed the license agreement), if a contract is ambiguous, the federal presumption of arbitrability prevails. He directed that the question of whether the claims of the licensed patents were “valid” should be arbitrated.

Regardless of the eventual outcome of the case, its progress to date provides lessons for those engaging in license transactions. First, by including an arbitration provision in a patent license, the parties create the possibility that a licensee may successfully challenge a patent but never create a public record that the patent is invalid. This could be a win for the licensor, who could continue to enforce the patent against third parties in the hopes of a better outcome. This would not be possible if a court were to have found the patent to be invalid.

Second, Abbvie ended up arguing that the recent Supreme Court cases trimming the scope of patent eligibility effectively meant that Novartis’s hepatitis C patents are invalid, thus taking the claims outside of the definition of “Valid Claim.” This is a surprising argument. A natural reading of the customary definition of “Valid Claim” suggests that a claim is to be deemed valid unless it has specifically been contested in litigation (or a USPTO proceeding) and found to be invalid. Abbvie’s argument opens up the possibility that other licensees will make similar arguments, claiming that litigation unrelated to the patents at hand has rendered them invalid.

In light of this case, licensors might want to insist upon arbitration provisions with language that clearly states that the question of whether a claim is valid is to be arbitrated. Licensors should also consider making sure that the definition of “Valid Claim” does not allow for an argument that a judicial invalidation of patents unrelated to those being licensed can be viewed as a court ruling that the claims of the licensed patent are invalid.

Conversely, licensees might want to resist arbitration clauses because the possibility of a court ruling of invalidity will give the licensee additional leverage in the event of a dispute. And while licensees might want to consider tinkering with the definition of “Valid Claim” to ensure that litigation involving other patents might be viewed as invalidating the licensed patent, most licensors will likely reject any such effort.

Abbvie v. Novartis floated the interesting question of whether a licensee’s patent challenge is essentially a contract dispute or whether the contract is only a basis for providing standing to sue on the public policy question of whether the patent is valid. Judge Chen’s ruling suggests the former; Judge Crotty suggested the latter. It may be a long time before this question is resolved. In the meantime, licensors and licensees should consider the language of their license agreements in light of this uncertainty.

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