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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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