Tuesday, January 5, 2021

There Is No Such Thing as Licensee Estoppel

Loops LLC v Maxill Inc 2020 ONSC 5438 Lederer J: Swinton, Penny, JJ revg 2020 ONSC 971 Templeton J

            2,577,109 / Toothbrush

In Lear Inc v Adkins 395 US 653 (1969) the US Supreme Court abolished the doctrine of “licensee estoppel,” which (more or less) prevents a licensee from challenging the validity of the licensed patent. Monday’s post summarized the decision of Lederer J for the Ontario Divisional Court holding that a “no-challenge” clause in a settlement agreement is enforceable, Lear v Adkins notwithstanding. In this post I will argue that there is really no such thing as licensee estoppel in Canadian law. More precisely, the rule at issue is simply based on contract law and it is not helpful to characterize it as based on an estoppel.

First, what exactly is the rule? The precise nature of the licensee estoppel rule was not at issue in this case, as the question was only whether the express no-challenge clause was enforceable. Lederer J at [61] did quote from Asturiana (1979) 55 CPR(2d) 131 (Ont HCJ) referring to the consistent Anglo-Canadian authority “that a licensee is not permitted to dispute the validity of the patents.” This is not exactly right because there are many circumstances in which a licensee is permitted to dispute validity. It is more accurate to say that a licensee cannot raise invalidity of the patent as a defence to an action for payment of royalties owing under a licence agreement, except in the case of fraud, unless the agreement contains an express covenant as to validity of the patent. (Asturiana was an action for payment of royalties, so the quoted statement is correct in that context.)

Now, in some respects the rule is very strict. In particular, the licensee cannot raise invalidity as a defence to an action for payment of royalties even when the patent has actually been held invalid in other proceedings: Mills v Carson (1893) 10 RPC 9 (CA); African Gold Recovery Co Ltd (1897) 14 RPC 660 cited with approval in Anderson v EJ Shepard Ltd (1930), 66 OLR 105 (CA) [20]; Duryea v Kaufman (1910), 21 OLR 165 (OHCJ) [23] (in obiter).

On the other hand, it is subject to a major exception. While a licensee cannot raise invalidity as a defence to an action for payment of royalties under the licence, a licensee, even a current licensee, may always raise invalidity as a defence to an action for infringement: this was in fact the holding in Duryea v Kaufman, the leading case that firmly established licensee estoppel in Canadian law with a thorough review of the English cases; see also Bayer AG v Apotex Inc (1995) 60 CPR(3d) 58 (OGD) 73 (“a licensee will not be estopped from alleging that the patent is invalid if the action brought against it is for infringement of the patent”) aff’d (1998) 82 CPR (3d) 526 (Ont CA) 532-33; Fuel Economy v Murray (1930) 47 RPC 346 (Ch) at 353 (“an estoppel cannot arise in an action for infringement”) aff’d 358 (CA). So, for example, a current licensee may argue invalidity if the patentee alleges the licensee has infringed by carrying out activities outside the scope of the licence, whether by falling outside of the permitted uses (Apotex v Tanabe (1994) 59 CPR(3d) 38 (OGD) 49; Bayer AG v Apotex Inc) or outside the geographic scope of the licence (Fuel Economy v Murray). A defendant claiming a right by licence may plead invalidity in the alternative: Duryea [35], [41]-[42]. A former licensee whose licence has come to an end by revocation, lapse of time, or any other method, may raise invalidity as a defence to an action for infringement in the same manner as if it had never had a licence: Duryea [35]; Crossley v Dixon (1863), 10 HLC 293, 308. Conversely, a former licensee may not raise invalidity as a defence in an action for unpaid royalties owing under the agreement that was formerly in effect: Crossley v Dixon (1863), 10 HLC 293, 308; Philco Products Ltd v Thermionics Ltd [1943] SCR 396, 419.

Now, while this rule is commonly referred to as an estoppel, it is not based on any recognized form of estoppel. Indeed, in every case I have found in which a recognized estoppel has been argued, it has been rejected: see Curtiss-Wright Corporation v Canada [1968] 1 ExCR 519 (rejecting estoppel in pais and promissory estoppel); Cropper v Smith (1884), 1 RPC 81 (CA) (rejecting arguments based on estoppel of record, estoppel by deed and estoppel in pais) aff’d on this point (1885) 10 AC 249 (HL) at 259. In Clark v Adie (No 2) (1877), 2 AC 423, 435-36 (HL) Lord Blackburn drew a loose analogy with the position of a tenant of lands who is his estopped from denying his lessor’s title so long as the lease remains in force, and the tenant has not been evicted from the land, he is estopped from denying that his lessor had a title to that land. However, Lord Kenyon in Hayne v Maltby (1789) 100 ER 665 at 666, rejected the analogy.

This should perhaps not be very surprising. Generally speaking, an estoppel is an equitable doctrine that supplements contract law by giving effect to some representation that is not supported by consideration, such as in promissory estoppel when a representation by one party to an agreement leads the other party to suppose that the agreement will not be strictly enforced, even though no consideration may have been given for the forebearance: John Burrows Ltd [1968] SCR 607 at 614-16; Curtiss-Wright Corporation v Canada [1968] 1 ExCR 519 at 530; and see generally John D McCamus, The Law of Contracts, (2005), Ch 8. It is sometimes said that the licensee estoppel arises “from the fact of the relationship itself,” (Fox on Patents 3rd ed Vol I, 618; Fox 4th at 320) but this is clearly not true; a licensee may raise invalidity as a defence if there is an express guarantee that the patent is valid, notwithstanding that the nature of the relationship is otherwise the same. In any event, it is very difficult to see how the act of entering into an agreement could in itself give rise to an estoppel making it inequitable to insist on the terms of the agreement.

In Lear the US Supreme Court at 656 explained that

The theory underlying this doctrine is that a licensee should not be permitted to enjoy the benefit afforded by the agreement while simultaneously urging that the patent which forms the basis of the agreement is void.

Perhaps this was the theory in US law, but it cannot be the explanation for the Anglo-Canadian rule; it is perfectly clear, as discussed above, that when sued for infringement a current licensee may indeed enjoy the benefit of the licence agreement while simultaneously urging that the patent is void.

So, we have a bit of a puzzle. Licensee estoppel is an estoppel that is not related to any other estoppel, that does not prevent either party from relying on the strict terms of the contract, and that operates only in respect of a claim brought on the contract. In short, it looks a great deal like a contract doctrine.

And indeed it is. The basis for the “estoppel” doctrine is really very simple. A licensee cannot raise invalidity as a defence to an action for unpaid royalties under a licence because the validity of the patent is normally immaterial to the obligation to pay under the contract. This has nothing to do with estoppel; it is purely a matter of contract. The licensee is contractually obliged to pay and unless otherwise provided in the contract, that obligation is not contingent on the validity of the contract. The “estoppel” such as it is, does not arise from the relationship between the parties, it arises from the terms of the contract. See Aidan Robertson, “Is the Licensee Estoppel Rule Still Good Law? Was It Ever?” 10 EIPR 373 (1991) making much the same point.

This explains what might otherwise be counter-intuitive aspects of the doctrine. It is why the actual invalidity of the patent, established in different proceedings, has not afforded a defence. It is not because the courts have buried their heads in the sand, like ostriches, resolutely ignoring the fact of invalidity; rather, the courts have in effect said, “Yes, we know the patent is invalid, but that doesn’t affect your obligations under the contract.” That is why fraud is an exception; contracts induced by fraud are not enforceable as a matter of general contract law doctrine. That is why an express provision is an exception; it is no exception at all, as the question is simply a matter of interpreting the contract, and an express term will always trump an implied term. That is why a licensee in good standing can always raise invalidity as a defence to an infringement action; invalidity is always material to the licensee’s obligation to pay damages for infringement, even when it is not material to the licensee’s obligation to pay royalties. That is why licensee estoppel is not related to any other established form of estoppel: it is not an estoppel, but purely a matter of contract. When an allegation of invalidity by the licensee is struck, it is simply on the basis of the procedural rule that allegations that can have no effect on the outcome of the case should be struck as a waste of judicial resources.

The more interesting question is why, as a matter of contract law, the obligation to pay royalties does not turn on the validity of the patent (unless of course, the agreement itself so provides). The answer is most clearly articulated in the early cases, decided before the matter was settled simply by reference to authority. It follows from two principles. First, a warranty or guarantee of validity will not normally be implied into a licence agreement; absent express language or special circumstances, either a licence or assignment is presumed to be transferring only such rights as the letters patent conferred upon the patentee: Electric Fireproofing Co of Canada v Electric Fireproofing Co (1910) 43 SCR 182 at 184-85 (Davies J), 189-90 (per Duff J), 195 (Anglin J) (assignment); Vermilyea v Canniff (1886), 12 OR 164 (OntHCJ), 169 (licence); Duryea (1910), 21 OLR 165 [10]-[14] (reviewing the cases); Anderson v EJ Shepard Ltd (1930), 66 OLR 105 (Ont CA) [19] (licence); Rymland v Regal Bedding Co Ltd (1966), 51 CPR 137 (Man CA) 141 (licence). This is because the validity of the patent turns on objective considerations—the early cases dealt primarily with anticipation by a third party publication—and not on information peculiarly within the knowledge of the patentee, and therefore the licensee is generally as well placed as the patentee to assess the validity of the patent: Hall v Conder (1857) 140 ER 318, 327; Taylor v Hare (1805) 127 ER 461, 462; Lawes v Purser (1856) 119 ER 1110, 1112; Vermilyea v Canniff (1886), 12 OR 164 (OntHCJ), 169; Rymland v Regal Bedding Co Ltd (1966), 51 CPR 137 (Man CA) 141. As the exception that proves the rule, if the patentee had actual knowledge of invalidity, this would likely constitute fraud that would enable the licensee to raise invalidity even in an action for payment under the contract: see Lawes v Purser (1856) 119 ER 1110, 1112. Moreover, this is not a strict rule as such; it is simply the usual outcome of interpreting the contract in light of the fact that the licensee is normally in as good a position to assess validity as the licensor. Thus the most accurate statement of the law is that “Courts are not prepared to readily extend the meaning of doubtful words so as to convert them into an express warranty of the validity of a patent”: Rymland 141.

Second, invalidity of the patent does not normally constitute complete failure of consideration, as even an invalid patent may effectively confer the benefit of exclusivity until such time as it is challenged: Vermilyea v Canniff at 169; Lawes v Purser (1856) 119 ER 1110, 1112; Taylor v Hare (1805) 127 ER 461, 462. So, in the early English case of Taylor v Hare, the licensee had practised the invention for 6 years before discovering prior art said to anticipate, and sought on that basis to recover all the royalties that had been paid to date. The court rejected the action, with Heath J stating at 462 “It might as well be said, that if a man lease land, and the lessee pay rent, and afterwards be evicted, that he shall recover back the rent, though he has taken the fruits of the land.” A licence agreement may also involve a transfer of know-how or confidential information, or more than one patent, so that it would be unwarranted to read in a provision absolving the licensee of the obligation to pay on the basis of the invalidity of one patent. Consequently, even when there is language in the agreement relating to the validity of the patent, the courts will not interpret it as absolving the licensee of the obligation to pay royalties (unless it is expressly to that effect); it is more likely to be interpreted as a warranty, breach of which might be the basis for a counter-claim in damages: see eg Hall v Conder (1857) 140 ER 318, 323; Gillard v Watson (1924) 26 OWN 77 (OCA).

In summary, there is no rule of licensee estoppel, because there is no rule and it is not an estoppel. While a licensee cannot normally raise invalidity as a defence to an action for payment of royalties, this is simply because the obligation to pay royalties under the licence is not normally conditional on validity.

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