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Lessons from a failed patent-license agreement

There are several lessons for contract drafters and business people in this week’s Federal Circuit opinion in XY, LLC v. Trans Ova Genetics, L.C., No. 2016-2054 (Fed. Cir. May 23, 2018). The case in the trial court was No. 13-cv-0876 (D. Colo. Apr. 8, 2016) (decision on post-trial motions), where both a patent owner and its licensee were held liable to pay significant damages because each side had breached the license agreement between them.

The facts

The defendant, Trans Ova, performs cattle-embryo transfer and in-vitro fertilization for cows. Trans Ova formerly bought chromosome-sorted bull semen from a vendor, Inguran, LLC (Inguran), which sorted semen using a patented process that it had licensed from patent owner XY.

But Trans Ova became dissatisfied with the sorted semen it bought from Inguran. So, Trans Ova approached patent owner XY about acquiring its own license to use the patented chromosome-sorting method, so that Trans Ova could sort bull semen on its own and stop buying it from Inguran. XY and Trans Ova entered into a five-year license agreement in April 2004.

Then in November 2007, Inguran acquired XY — and shortly thereafter, XY sent Trans Ova a letter that purported to terminate the license agreement, on grounds that Trans Ova had allegedly breached the license agreement.  Trans Ova disagreed that it had breached the license agreement and asserted that XY could not properly terminate the agreement. This went on for several years, with Trans Ova continuing to send royalty payments and XY refusing to cash the checks, until finally XY filed suit in March 2012.

The license agreement was subject to automatic renewal in April 2009 — unless, among other things, Trans Ova was in material breach of the license agreement.

At trial, the jury concluded that XY, in sending its 2007 notice of termination, had breached the implied obligation of good faith and fair dealing.

But the jury also concluded that, at the scheduled time for auto-renewal, Trans Ova had indeed been in material breach; consequently, the agreement was not auto-renewed, and Trans Ova’s subsequent use of the technology infringed XY’s patent rights.

Lesson 1: Don’t commit to doing things
you might not remember to do

One of Trans Ova’s breaches of the license agreement arose from an improve­ments grant-back provision. That provision required Trans Ova (i) to notify XY if Trans Ova made any improvements to the patented process, and (ii) to assign ownership of those improvements to XY.

At trial, XY put on evidence that Trans Ova’s employees had indeed developed new techniques and had not notified XY nor assigned ownership of the new techniques to XY. According to the trial court, the jury could reasonably have concluded that the Trans Ova’s failure constituted a material breach. See the trial court post-trial opinion at 8.

But here’s a question:  When Trans Ova’s people developed the new tech­niques, did it even occur to them that they were supposed to tell the patent owner, XY? The trial- and appellate courts’ opinions don’t say. It’s a good guess that those employees were clueless about their company’s grant-back obligation.

The lesson here: When the other side asks you to take on a contract obligation for circumstances that might or might not ever arise—

Consider setting up some kind of prompting system, for example, periodic training and/or recurring calendar reminders — but that might increase your costs, which in turn might have to be taken into account in negotiating the economics; and

Consider asking to revise the circumstantial obligation so that it only kicks in when so requested by the other side, so that you won’t be in breach if the circumstances arise but you don’t think to do what’s required.

Lesson 2: Get it in writing!

Trans Ova’s other breach of the license agreement was underpayment of royalties for years — the trial court said that this was due to Trans Ova’s erroneous belief that the the license agreement had been modified after an oral agreement with patent owner XY’s CEO. See the trial court post-trial opinion at 8. (The trial court said that Trans Ova made the oral agreement with a Dr. Mervyn Jacobson; in an earlier denial of a summary-judgment motion, the trial court identified Dr. Jacobson as XY’s chairman and CEO.)

The lesson here: When amending a contract to reduce your obligations, get it in writing!  Here, at a minimum the licensee, Trans Ova could have could have sent the patent owner XY’s CEO an email confirming the oral agreement to reduce the royalty rate; if the CEO hadn’t timely objected to the email confirmation, then Trans Ova would have been in a much stronger position.

Lesson 3: Be careful with material-breach exceptions to automatic renewal

The XY license agreement provided that the the agreement would auto­mat­ic­al­ly renew for an additional five-year period “provided that the Licensee is not in material breach.”  Trial court post-trial opinion at 9 (cleaned up).  Importantly, the provision did not require the patent owner, XY, to give notice of breach to the licensee, Trans Ova, nor did it give Trans Ova the right to cure the breach. The trial court “reject[ed] Trans Ova’s argument that the lack of prior notice necessarily means that the Agreement must have automatically renewed.” Id.

The lesson here: When negotiating an automatic-renewal provision, if there’s going to be an exception for material breach, then consider having the pro­vis­ion not kick in unless some prerequisites are met — for example:—

This Agreement will not be automatically renewed, however, if all of the following are true at the time when this Agreement would expire if not automatically renewed:

(1) (i) the Licensor gave the Licensee notice of the breach, or (ii) it is clearly shown, with reasonable corroboration, that one or more persons in the Licensee’s relevant manage­ment structure was aware, not merely that the Licensee had committed acts later found to constitute a material breach, but that the acts in fact constituted a material breach; and

(2) the Licensee had an opportunity to cure the breach, of the duration specified in this Agreement for termination for breach; but

(3) the breach remains uncured.

This would give the licensee at least some protection from ambush non-renewals.

CAUTION: Consider whether the term used should be automatic renewal or automatic extension, because the difference could be significant, as discussed here.

Lesson 4: Don’t score an own-goal when terminating for alleged breach

The licensee, Trans Ova, wasn’t the only one held liable for breach of contract. The jury found that the patent owner, XY, was also liable for breach of the implied covenant of good faith and fair dealing. The reason:  XY terminated the license agreement, allegedly for material breach by Trans Ova, in the same month that XY was acquired by Inguran — which, of course, was the vendor of chromosome-sorted semen that Trans Ova had previously jilted to take up with XY. See trial court’s post-trial opinion at 7.

The lesson here: When terminating a contract for (what you think is) a breach by the other side, make sure you’re right — otherwise you might be the one in breach.

(For other examples of own-goal termination, see, e.g.,  Southland Metals, Inc. v. Amerian Castings, LLC, 800 F.3d 452 (8th Cir. 2015); Automated Solutions Corp. v. Paragon Data Sys., Inc., 2006 Ohio 3492, 167 Ohio App.3d 685 (2006) (affirming judgment after bench trial).)

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A case from Mississippi’s supreme court reminds us that it can be dangerous for service providers and customers to agree orally to changes in the scope of work:

¶3. Yates Construction, LLC, and D.W. Caldwell, Inc., entered into a construction sub-contract for the roof installation on a residential dormitory at Auburn University in Auburn, Alabama. …

Early on, Caldwell employees identified structural issues with the building …. [A]fter some discussion about the repairs needed, Caldwell agreed to repair the building prior to installing the roof.

Rather than amending the existing subcontract or creating a new contract for the repair expenses, Yates urged Caldwell to bill against “unperformed work” for those costs related to the extra work completed.

Although the arrangement was unconventional, Caldwell orally agreed to the billing scheme, requiring that it be paid weekly, on a “cost plus overhead and profit basis.”

¶4. When Caldwell completed both the repairs and the roof installation, it had yet to receive total payment for the structural repairs. The companies disputed the scope and expense of these repairs and quickly negotiated their way to an impasse.

Thereafter, Caldwell filed a claim against Yates for causing delay and increased costs by failing to pay for work performed, which was in breach of the agreements between the parties.

D. W. Caldwell, Inc., v. W.G. Yates & Sons Constr. Co., No. 2017-CA-00116-SCT (Miss. May 10, 2018) (reversing trial court’s modification of arbitration award) (emphasis and extra paragraphing added).

Business lesson:  Put something in writing about what’s expected.

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(Here’s an email I just sent to my students:)  The last micro-essay question on the final exam had to do with whether a lawyer should sign a contract on behalf of a client. Recall that in class I noted that if a contract were to go sideways, the lawyer’s signature on the document would create an opening for people within the client to point fingers at the lawyer. Well, that seems to have happened to the general counsel of Novartis, which entered into a consulting contract with Michael Cohen, the personal lawyer for now-President Trump:

Novartis’s top lawyer is to retire from the company over payments made by the pharmaceutical giant to President Trump’s personal lawyer Michael D. Cohen, the Swiss drug maker said on Wednesday.

In a statement, Novartis said that Felix R. Ehrat, the group general counsel, would be replaced by Shannon Thyme Klinger, who is currently the company’s top ethics officer, at the beginning of June. Mr. Ehrat was stepping down “in the context of discussions surrounding Novartis’s former agreement with Essential Consultants, owned by Michael Cohen,” the pharmaceutical company said.

“Although the contract was legally in order, it was an error,” Mr. Ehrat said. “As a cosignatory with our former C.E.O., I take personal responsibility to bring the public debate on this matter to an end.”

Prashant S. Rao and Katie Thomas, Novartis’s Top Lawyer is Out Amid Furor Over Payments to Michael Cohen (NYTimes.com May 16, 2018) (emphasis added).

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Just published in the ABA Dispute Resolution Section’s E-News: my article “EVALOA [evaluation plus last-offer arbitration]: A better way to facilitate settlements in arbitration.”

Here’s the TL;DR (too long; didn’t read):

  • Non-binding mediation, in which a mediator tries to help litigants to reach a settlement agreement, is expensive; it can often be ineffectual if one party or another won’t budge far from its position.
  • Another approach (assuming the parties so agree) is to stick with binding arbitration — but early in the case, have the arbitrator carefully give the parties her tentative, provisional views about the case, based on whatever information the parties have provided.  (This is like early neutral evaluation and mini-trials.)  That alone can help encourage implacably-stubborn parties to reconsider their views.
  • If the arbitrator’s early views don’t result in settlement, then the parties can agree to do “baseball” arbitration, in which:
    • Each party submits one or more proposed outcomes of the case;
    • The arbitrator’s sole power is to pick the party proposal that is the closest to how the arbitrator herself would decide the case.  This gives each party a powerful motivation to be reasonable, because otherwise the arbitrator might pick the other side’s proposal.  (That’s why baseball arbitration has an excellent track record of getting baseball teams and players to settle salary disputes.)
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Contract drafters should keep an unpleasant possibility in the back of their minds:  Courts in different jurisdictions might define a particular term in dif­fer­ent ways, leading to different results.  That happened in an Eleventh Circuit case, Winn-Dixie Stores, Inc. v. DolGenCorp, LLC, No. 15-12990 (11th Cir. Jan. 31, 2018), after remand from 746 F.3d 1008 (11th Cir. 2014).

Grocery-store chain Winn-Dixie leases store space in shopping centers; as an anchor tenant, it has a certain amount of bargaining power to get the lease terms it wants. The Winn-Dixie lease form in suit contains a restrictive cov­en­ant that forbids the landlord from letting other tenants sell more than a spe­ci­fied amount of “groceries” within a certain distance of the Winn-Dixie store. Under local law, that cov­en­ant apparently ran with the land and thus was binding even on subsequent tenants. Winn-Dixie sued Dollar General and others for violating the restrictive covenant. See 746 F.3d at 1016-17, part I.

Dollar General defended (in part) with the assertion that the term groceries, as used in the restrictive covenant, was ambiguous, and therefore by law the restrictive covenant was unenforceable.  In an earlier appeal in the case, the Eleventh Circuit rejected Dollar General’s ambiguity defense for stores in Florida:  The court held that the term groceries was not ambiguous for Florida stores because, in a still-earlier Winn-Dixie case, a Florida court had adopted a definition of groceries; thus, said the Eleventh Circuit, the term was not ambiguous — at least not within Florida. See 746 F.3d at 1022-24.

The Eleventh Circuit’s prior ruling applied only to stores in Florida; the appeals court remanded the case to the district court with instructions to make ad­ditional findings as to whether Alabama courts would consider groceries to be ambiguous — and on remand, the district court held that the term was indeed ambiguous in Alabama; the Eleventh Circuit affirmed. See slip op. at part IV.

Thus, in the context of the Winn-Dixie lease form:

  • In Florida, the term groceries is unambiguous, and so Winn-Dixie can stop competitors from selling groceries too close to Winn-Dixie stores in that state.
  • But just across the state line in Alabama, the term groceries is am­big­uous; consequently, a Winn-Dixie competitor can lease space in the same Ala­bama shopping center as a Winn-Dixie store and is free to sell how­ever much it pleases in the way of “groceries.”

Drafting lesson: If an important term in your contract might be interpreted differently in different jurisdictions, consider including a definition for that term.

 

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