Industrial Promotion Co. v. Versa Products, Inc. ( 1991 )

SULLIVAN, J.

Versa Products, Inc. (Versa), a licensee, appeals from a judgment following a trial to the court awarding Industrial Promotion Company (IPC), the licensor, 4.4% of the net sales of ladders manufactured by Versa, and 3.5% of the net sales of ladders purchased and resold by Versa from February 22, 1989, until August 5, 1992. This award was based on the language of a contract between these two parties. However, products subject to the contract were patented and these patents expired February 22,1989. The conflict between the contract expiration date, August 5, 1992, and the patent expiration date, February 22, 1989, is the center of this dispute.

The contract at issue is a hybrid agreement providing for royalties under a patent and a "know-how" or trade secret license.² The contract was entered into by IPC and Versa on August 5,1983, and specified a term of nine years, ending August 5, 1992. The three patents involved under this hybrid agreement expired February 22,1989. The basic issue in the trial court and on appeal is whether the continuing royalty obligations of the hybrid license agreement remain enforceable after the expiration of the licensed patents.³ The determination of this issue turns on whether state law or federal patent law is applied. The trial court found state contract law applied and enforced the terms of the contract. We disagree and hold that federal patent law supersedes state contract law in a hybrid license contract affecting U.S. patent rights.

The trial court, by enforcing the terms of the contract until August 5, 1992, effectively extended the patent license agreement beyond the terms of the patent. This extension occurs because the contract contains no allocation of royalties between the patents and the know-how license. The hybrid agreement between the parties in relevant part follows.

EXCLUSIVE PATENT LICENSE AGREEMENT

RECITALS:⁴

WHEREAS, Sacóme International is the owner of letters patent of the United States numbers 3,643,292; 3,849,834, and 3,879,146 for an automatically interlockable hinge fitting, lockable hinge joint and joint respectively issued on February 22, 1972, November 26, 1974, and April 22, 1975, respectively to Otto Mayer, Plauderhausen, West Germany (hereinafter referred to as the "Invention"); and

WHEREAS, IPC has represented to Versa that it has the exclusive rights to these patents for the United States of America, Canada, and Mexico; and

WHEREAS, IPC is willing to grant to Versa the exclusive right to manufacture, use, market, and sell the products using the patented items as integral parts, thereof; and

WHEREAS, Sacóme International agrees to countersign and fully guarantee any and all agreements or obligations of IPC as contained in this Agreement.

NOW, THEREFORE, for and in consideration of the premises and mutual covenants herein contained, the parties hereto intending to be legally bound hereby, agree as follows:

3. (a) Sacóme International hereby grants to Versa the right to manufacture Sacóme International's standard related catalog items. Sacóme International agrees to furnish confidential technical information, data, drawings, and the specifications needed to manufacture Sacóme International's standard related catalog items. Sacóme International further agrees to provide the same data to manufacture the hinges after a minimum of One Million hinges have been bought by Versa should Versa, at its sole discretion, thereafter decide to manufacture the hinges.

(b) Any change, improvement, redesigning or alteration of the patented items covered by this Agreement and manufacturing knowhow shall be exchanged between all parties of this Agreement including Sacóme International and its assigns, and is included in the exclusive license granted hereunder.

5. (a) The term of this Agreement shall be for nine (9) years from the date hereof.

If the royalties were allocated between the patents and the know-how, the patent royalties would expire with the patents on February 22, 1989, and the know-how license royalties would expire under the contract on August 5,1992. Because the contract fails to allocate and because the contract royalties cannot be split, the contract is subject to the superseding relevant federal patent law, making the hybrid license agreement unenforceable beyond the expiration date of the patents. Pitney Bowes, 701 F.2d at 1372-73; see also Brulotte v. Thys Co., 379 U.S. 29 (1964).

IPC argues and the trial court agreed that Brulotte is distinguishable and that the controlling case is Aronson v. Quick-Point Pencil Co., 440 U.S. 257 (1979). Aronson is not controlling in this case. While it is true that the Supreme Court in Aronson held that federal patent law does not preempt state trade secret law, the facts in Aronson have one fatal flaw — no patent was ever issued for the product. However, even if we chose to apply Aronson, the outcome would be the same — all royalties terminate when the patent period ends. The contract in Aronson provided for two different percentage royalties, one under the patent and another if a patent did not issue. Citing Brulotte, the Eighth Circuit Court of Appeals observed that had a patent issued, the entire royalty obligation would have ceased at the completion of the seventeen-year patent term, notwithstanding the terms of the agreement. Quick-Point Pencil Co. v. Aronson, 567 F.2d 757, 762 (8th Cir. 1977). Although the Supreme Court reversed the Eighth Circuit, its holding limited the application of state trade secret law to situations where a patent did not issue. The Court specifically noted the Eighth Circuit's Brulotte-based conclusion, Aronson 440 U.S. at 261, and at a later point in its decision agreed that if a patent had issued, all royalty obligations would have ceased after seventeen years. Id. at 263-65.

IPC misconstrues as controlling both Aronson and another case, Kewanee Oil Co. v. Bicron Corp., 416 U.S. 470 (1974). While it is true that both of these cases support the enforcement of state trade secret law against claims of federal preemption, IPC's reliance is flawed for two reasons. As noted, no patent ever issued in Aronson and in Kewanee, no patent was ever applied for. Second and more importantly, this is not a preemption issue but rather a supremacy conflict. "When a patent issues [as in this case], the potential exists for direct conflict between federal patent law and state trade secret law. When such a conflict occurs, the question is no longer one of federal preemption; it is instead one of federal supremacy."

Pitney Bowes, 701 F.2d at 1372 and n.12. Footnote 12 in Pitney Bowes states:

This does not mean that parties cannot agree to license both trade secrets and patent rights on patents actually issued. As the Court in Kewanee noted, the purposes of patent protection and trade secret protection usually are entirely different, and the enforcement of trade secrets need not necessarily undermine federal patent policy. See 416 U.S. 479-93, 94 S.Ct. at 1885-1892. But if and when their purposes conflict directly, federal supremacy requires that federal patent law determine the rights under the agreement.

Pitney Bowes does not contend that all hybrid agreements providing for post-patent-expiration payments necessarily raise a direct conflict with federal patent laws. Instead, it argues that the defect in the Vertical Collator Agreement is its failure to allocate payments between trade secrets and patent rights. Citing Veltman v. Norton Simon, Inc., 425 F.Supp. 774, 776 (S.D.N.Y. 1977), it suggests that, had the parties to the agreement undertaken such an allocation, reduced payments for trade secrets after the patents expired might not have directly conflicted with federal patent law and therefore might have been permissible. The district court seems to have adopted this view. See 517 F.Supp. at 61 & n.19, 63. See also Modrey v. American Gage & Machine Co., 339 F.Supp. 1213, 1217-18 (S.D.N.Y. 1972) (agreement providing for reduced royalties of 3% after patent expires does not violate Brulotte). In light of our conclusion infra that the Vertical Collator Agreement violates federal patent law, and the fact that there is no allocation in the agreement, we need not decide whether allocation — or some other provision — would have rendered it enforceable. Indeed, the Supreme Court has never addressed the question whether a hybrid agreement in which patents issue can ever survive the expiration of the patents. The court in Brulotte, however, applied a per se rule to agreements containing the same terms before and after the patent expires because it was "unable to conjecture what the bargaining position of the parties might have been" had no patent been involved. 379 U.S. at 32, 85 S.Ct. at 179. The implication of this language is that, if a patent owner can prove that he did not use his patent monopoly leverage to exact reduced post-expiration trade secret payments, then there would be no direct conflict with federal law and the agreement would be enforced.

Id. at 1372-73.

We agree with the analysis set forth in this footnote from Pitney Bowes. As in Brulotte, we have no way to determine what would have happened between these parties if no patents were involved. IPC argues that because Versa's counsel drafted the agreement and Versa was well-advised throughout the negotiations, Versa was in an equal bargaining position and not subject to the patent monopoly leverage, an underlying concern with hybrid agreements. This argument is not supported by evidence in the record. First, since the patents were in existence at the time the agreement was entered into, there is no conclusive way to determine if patent monopoly leverage was a factor. Second, because there is no distinction and no reduction or any change in patent royalties as distinguished from compensation for know-how, the contract rights cannot be distinguished from the patent rights, and under federal patent law, the agreement is per se invalid. See Brulotte, 379 U.S. at 32. To be innocent of patent misuse or even the perception of misuse, the agreement must clearly distinguish between payments for trade secrets and patent royalties. Id.; see also Meehan v. PPG Indus., Inc., 802 F.2d 881, 885 (7th Cir. 1986). Without the allocation of royalties, this contract is an unlawful extension of patent monopoly. This failure to allocate is fatal to the recovery of royalties after the expiration of the patents.

By the Court. — Judgment reversed and cause remanded.

2 Interchangeability of trade secrets and know-how was recognized in Pitney Bowes, Inc. v. Mestre, 701 F.2d 1365, 1367 n.4 (11th Cir. 1983).

3 The royalty obligations due under the agreement prior to the expiration of the patents are not at issue.

4 Recital 3(b) is the "know-how" portion of the agreement.