A recent decision by the Seventh Circuit Court of Appeals in a patent license dispute, Zimmer Biomet Holdings, Inc. v. Insall, 2024 U.S. App. LEXIS 17064 (7th Cir. July 12, 2024), nicely illustrates the extremely limited scope of review of arbitration decisions by the courts, under which an arbitrator award can be based on misapplication of the law, yet survive judicial scrutiny.
The arbitration in Zimmer involved a patent license that was originally agreed to in 1991, by which a Mr. Insall licensed to Zimmer the rights to his (future) patents relating to knee replacement technology. The royalty payments to Mr. Insall under the original version of the license agreement were based on sales of "knee systems," and they were to be paid until the last of Insall's patents expired. Id. at 3. In 1998, the parties amended the license by agreeing to change the basis of payments to any sales of devices marketed as part of Zimmer's "NexGen Knee" product line. Further, the contractual royalty obligation no longer ended on the date of expiration of Insall's patents. Id. at 3-4. However, when the last of Insall's patents expired in 2018, Zimmer stopped paying royalties, on the ground that the agreement violated the doctrine, set forth in the Supreme Court case Brulotte v. Thys Co., 379 U.S. 29 (1964), that a licensor of a patent cannot collect royalties on the patent after it expires.
In Brulotte, the Supreme Court held that "a patentee's use of a royalty agreement that projects beyond the expiration date of the patent is unlawful per se." Id. at 32. While a patent "empowers the owner to exact royalties as high as he can negotiate with the leverage of that monopoly," it is improper, according to the Court, "to use that leverage to project these royalty payments beyond the life of the patent." Id. at 33. It is "an assertion of monopoly power in the post-expiration period when . . . the patent has entered the public domain." Id.
However, that reasoning is clearly flawed. There is no such thing as post-expiration monopoly power. As explained by Judge Posner in Scheiber v. Dolby Labs., Inc., 293 F.3d 1014 (7th Cir. 2002), any leverage used to "extract" an obligation to pay post-expiration royalties is due solely to a current threat of a patent infringement lawsuit, at a time when the patent has not yet expired:
"When the patent term ends, the exclusive right to make, use or sell the licensed invention also ends. Because the invention is available to the world, the license in fact ceases to have value. Presumably, licensees know this when they enter into a licensing agreement. If the licensing agreement calls for royalty payments beyond the patent term, the parties base those payments on the licensees' assessment of the value of the license during the patent period." Id. at 1017 (citation omitted).
In 2015, the Supreme Court seemed poised to overrule Brulotte, having granted certiorari in Kimble v. Marvel Entertainment, LLC, on the question presented of "[w]hether this Court should overrule Brulotte v. Thys Co., 379 U.S. 29 (1964)." The petition for certiorari characterized Brulotte as "the most widely criticized of this Court's intellectual property and competition law decisions. Three panels of the courts of appeals (including the panel below), the Justice Department, the Federal Trade Commission, and virtually every treatise and article in the field have called on this Court to reconsider Brulotte …." Yet, surprisingly, the Court upheld Brulotte. Kimble v. Marvel Entertainment, LLC, 576 U.S. 446 (2015). The court said that the doctrine from that case could be overturned by Congress through an amendment to the patent statutes. The court, however, chose not to disturb Brulotte on its own, based on stare decisis. Id. at 455-56. "Respecting stare decisis means sticking to some wrong decisions." Id. at 455.
Brulotte thus survives, although mainly as a trap for the unwary, since it is easily circumvented through creative drafting of an agreement. As the court in Kimble noted, parties who wish to stretch out the period for payment for royalties in exchange for a lower royalty rate "can often find ways around Brulotte, enabling them to achieve those same ends." Id. at 456. The court cited Zenith Radio Corp. v. Hazeltine Research, 395 U.S. 100 (1969), which upheld a license that extended royalty payments beyond the expiration date, since the payments were expressly based on pre-expiration use. Under Zenith, then, amortizing all or part of a lump-sum payment due for a license over a period of years that exceeds the term of the patent does not violate the Brulotte rule (even though conceptually the patent owner's use of the leverage created by the patent in that situation is no different than what occurred in Brulotte).
Other exceptions further blunt the effect of Brulotte. It is common practice to license patents in a package or a bundle, with a single royalty rate applying to licensed sales, even though the patents in the bundle may have different expiration dates, and even though the rate does not diminish as each of those patents expires. Courts have generally found that practice to be acceptable under Brulotte. Hull v. Brunswick Corp., 704 F.2d 1195, 1202-03 (10th Cir. 1983). Courts also recognize an exception to Brulotte for "hybrid" agreements, allowing royalty payments to continue post-expiration where a license conveys both patent and non-patent rights, such as trade secrets. Kimble, 576 U.S. at 454.
Nevertheless, in Zimmer, the licensee argued that none of the myriad exceptions to Brulotte applied, so that by law its royalty obligations had to end when the last of Insall's patents expired. The arbitration panel rejected the argument, concluding that, under the 1998 amendment to the license agreement, royalty payments became "untied" to "Insall's patents, products, or technology." 2024 U.S. App. LEXIS 17064 at 13. Zimmer asked the district court to vacate the arbitration award. The district court did not, and Zimmer appealed the district court's opinion to the Seventh Circuit.
Zimmer argued persuasively on appeal that the arbitration panel misinterpreted Brulotte and Kimble. In the 1998 amendment to their license agreement, "the parties changed how the royalties were paid," but "never changed why they were paid in the first place." Id. at 14. Companies are not in the habit of sending royalty payments to people without a reason, and here, Zimmer argued, Insall had no leverage in 1998 to get Zimmer to agree to pay him post-expiration royalties other than through his exclusive rights under his patents. Thus, the post-expiration royalties were not "tied to a non-patent right," Kimble, 576 U.S. at 454, as required to avoid the Brulotte doctrine.
The Seventh Circuit, though, did not disturb the arbitrators' decision. Its opinion relied on the principle that courts' review of arbitration is highly restricted. It is well-established that merely demonstrating that the arbitrator arrived at a bad decision is not a valid basis to overturn an arbitrator's work. The four statutory grounds for vacating an award under the Federal Arbitration Act all focus on some form of misconduct: "the award was procured by corruption, fraud, or undue means"; "evident partiality or corruption in the arbitrators"; "the arbitrators were guilty of misconduct in refusing to postpone the hearing . . . or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced"; or "the arbitrators exceeded their powers." 9 U.S.C. § 10(a)(1) through (a)(4). In short, "[s]ection 10(a) has been understood to reflect a congressional focus on procedural protections rather than ensuring the correct outcome." Zimmer, 2024 U.S. App. LEXIS 17064 at 7.
While there is also a narrow exception allowing a court to vacate a decision that is in violation of "some explicit public policy," id. at 8, in Zimmer the arbitration panel duly recognized the law as stated in Brulotte and, at worst, misinterpreted it, which the court said is not a violation of public policy but rather simply one of the risks when one agrees to arbitration as an alternative to the judicial system.
It may be fitting somehow that in Zimmer the licensee's attempt to rely on Brulotte, whose holding survived only because the Supreme Court must accept "some wrong decisions" under the doctrine of stare decisis, was thwarted by the standard of judicial review in arbitration, where the goal is not to "ensur[e] the correct outcome." More generally, the case highlights how clients should be aware of the "coin flip" aspect of arbitration, i.e., that agreeing to arbitration means agreeing to a process where, absent misconduct, there is almost no recourse to reverse an unfavorable decision.
