Royalty payment clauses are generally enforceable, even if the related patent is no longer valid

Written on 11 Aug 2016

The Court of Justice of the European Union strengthens parties’ freedom to contract in Genentech v Hoechst, confirming that competition law does not prohibit a contractual royalty payment for the use of a technology that is no longer covered by a patent.

Background to the case

Genentech and Hoechst are in dispute over royalty payments under a licence agreement concerning one European and two US patents. Under the agreement, Genentech is permitted to use Hoechst’s technology in return for a 0.5% royalty fee on sales of any product incorporating the licensed technology. To date, Genentech has not made any royalty payments under the agreement. A French court ordered Genentech to pay royalties to Hoechst, despite the fact that the licensed European patent had been revoked. The question of whether this obligation violated EU competition law was referred to the CJEU for preliminary ruling.

The CJEU previously held in the 1989 Ottung case that an obligation to pay royalties even after a patent had expired would not violate EU competition law, provided that the licensee was entitled to terminate the agreement and discharge the royalty payment obligation. The CJEU also held that an obligation to pay royalties does not necessarily need to be connected to the existence of a patent, but rather may be founded in the commercial interest attributed to the possibility of exploitation granted by the licence agreement.

CJEU strengthens commercial considerations of the parties

In this latest decision, the CJEU confirmed that EU competition law does not prohibit the imposition of a royalty payment for the use of a technology that is no longer covered by a patent. In line with its Ottung decision, the CJEU found that this applies not only to cases in which the licence agreement obliges the licensee to pay royalties after the patent had expired (Ottung), but also to cases where the patent was invalidated.

This applies, however, on condition that:

  • the licence agreement between the parties is still valid; and
  • the licensee is free to terminate the agreement on reasonable notice.  

In particular the latter condition ensures that competition is not undermined by restricting the licensee’s freedom of action or by causing market foreclosure effects. The European judges put the commercial considerations of the parties at the fore when assessing licence agreements under competition law. Under the licence agreement between Genentech and Hoechst, Genentech should be allowed to use, for the duration of the licence agreement, the licensed technology without running the risk of patent litigation. This commercial consideration is independent of the underlying patent being valid, according to the European judges.

The Advocate General has already emphasised that Genentech’s obligation to pay royalties under the agreement was not conditional on the licensed technology being or remaining protected by patent, but on the mere use of the licensed technology.

Through its ‘once and for all’ approach, the CJEU has effectively stated that if a party wants a licence to terminate when the related patent is invalidated, it should say so in the licence agreement. Genentech’s approach by refusing to pay royalties after the patent was invalidated when it had previously agreed to do so, is not the same thing. Genentech was well equipped to assess the validity of the relevant patents prior to entering into the licence agreement and it is to be presumed that the royalty rate it agreed with Hoechst reflected Genentech’s belief in the potential invalidity of the patents. A subsequent unilateral decision not to pay even this level of royalty is still a breach of the agreement.

Impact on licence agreements

The CJEU’s decision clearly strengthens parties’ freedom to contract. At the same time it makes sure that contracts, once concluded, are fulfilled. The decision grants wide discretion to parties when structuring a royalty payment scheme. A longer payment period can allow for lower instalments, even if this means that the patent will expire before the agreement does. A licensee can also choose to completely eliminate the risk of patent litigation – irrespective of the validity of the patent. However, both cases are dependent on the licensee’s ability to terminate the agreement on reasonable notice.

Despite these allowances, competition law continues to play an important role when drafting licence agreements. The parties may choose between a variety of options with regard to royalty payments. However, competition law may still give rise to pitfalls in licence agreements; in particular, parties should carefully consider the competition law framework for limitations on the use of the licensee’s own technology, sales restrictions for the goods produced with the licensed technology, and the licensee’s ability to determine its own sales prices.

The CJEU’s judgments is also a statement that taking a licence involves making a choice and living with it. If a party does not intend to pay at all, it should invalidate the patent or agree that the licence terminates on revocation, not simply ‘beat down’ the price and then withhold payment.