Inclusion of a “covenant not to challenge” clause in a patent license agreement has until recently been seen by licensors as crucial to protecting the validity and value of their rights. Without it, nothing prevents a licensee from attempting to avoid or bypass the cost and restrictions of a license by invalidating the underlying patent or assisting a third party to do so.

However, a September 17, 2015 decision by the Patent Trial and Appeal Board (PTAB) has reduced a “covenant not to challenge” clause to mere words on paper, and fails to deter licensees from seeking a review of the licensed patent under the America Invents Act (AIA).

Background

In 2006, two data storage solutions providers—Dot Hill Systems Corp. and Crossroads Systems, Inc. – sought to bring to an end the litigation between the two parties by entering into a settlement and license agreement under which Crossroads licensed to Dot Hill certain patents concerning virtual storage networks.

The agreement included a “covenant not to challenge” clause which read, in part:

4.4 No Challenges . For as long as the License remains in effect, Dot Hill agrees that it will not challenge … the validity or enforceability of any patent … If this License is terminated for any reason … Dot Hill expressly reserves the right to challenge the validity or enforceability of any of the patents …

“Covenant Not to Challenge” clauses are common in patent licenses, including licenses that are part of post-litigation settlements.

The clause provides that a licensee may not challenge the license in court or an administrative proceeding, and can also provide that the licensee cannot assist others in doing so.

It should be noted that a “covenant not to challenge” clause is seen as a benefit bargained for under a license agreement and constitutes part of the consideration obtained by the licensor for the license. The intended effect of such a clause is to allow the licensor to make an estoppel argument in the event that licensee does challenge the patent, in spite of its agreement not to do so.

Due to the fact that the agreement at issue preceded the adoption of the AIA, the “no challenge” clause did not expressly refer to its applying to an administrative action, such as an inter partes hearing at the PTAB. However, it is likely that the intention of both parties in any “covenant not to challenge” clause, including the one in the Crossroads settlement, would be to extend the covenant not to challenge clause to other forums in which the patents may be challenged.

[PTAB-1]

The Petition and the Ruling

In 2013 the settlement and license agreement between Crossroads and Dot Hill deteriorated into a royalty dispute and litigation continued concerning Dot Hill’s alleged infringement of the Crossroads’ patents at issue.

Early in 2015, Dot Hill petitioned the PTAB to initiate an inter partes review (IPR) of the patents licensed under the agreement. Crossroads filed a preliminary response to Dot Hill’s petition, arguing that Dot Hill was contractually estopped from challenging the validity of the patents pursuant to the “no challenge” clause.

Dot Hill then replied to Crossroads’ preliminary response, arguing that if the US Congress intended the PTAB to consider contractual estoppel, 35 U.S.C. § 311 (providing for limitations on the PTAB’s jurisdiction to hear patent reviews) would have been worded differently.

Dot Hill also noted that the “no challenge” clause, which was conditioned on the license remaining in effect, ceased to be in effect under its terms since the license had partially terminated due to the royalty disputes.

The PTAB accepted Dot Hill’s first argument and chose not to opine on the second and no mention was made whether the PTAB would have considered the “no challenge” clause had it been in effect under its own terms and the license agreement or whether a specific reference to an inter partes review at the PTAB in the “no challenge” clause may have lent more weight to Crossroads’ contractual estoppel argument..

Interestingly, the PTAB made no mention as to the merits of the “no challenge” clause itself. It should be noted that even the U.S. Supreme Court has not been consistent in its determination on whether to uphold a “covenant not to challenge” clause. Prior to Lear, Inc. v. Adkins, the licensee estoppel doctrine prevented a patent licensee from challenging the validity of the licensed patent. However, in Lear, the Supreme Court rejected the patent licensee estoppel doctrine holding that a licensee that repudiates the patent license agreement has the right to challenge the validity of any licensed patent, generally rendering strict “no-challenge” clauses unenforceable (395 U.S. 653 [1969]). Later cases held that Lear requires the licensee to stop paying royalties before it can challenge a licensed patent’s validity (see Gen-Probe Inc. v. Vysis, Inc., 359 F.3d 1376, 1382 [Fed. Cir. 2001]). However, in MedImmune, Inc. v. Genetech Inc., the Supreme Court overturned this rule and held that even if the licensee does not repudiate the license agreement, it has standing to challenge any licensed patent’s validity while continuing to operate under the patent license agreement ( 549 U.S. 118 [2007] ).

In our blog, entitled When Can a Licensee Challenge the Validity of a Patent? And How Can Licenses Be Drafted to Discourage Disputes?, we discuss how to draft a license to discourage a licensee from challenging the very patents that it is licensing. Measures including allowing the licensor to terminate the license, doubling royalty rates, requiring the licensee to pay the licensor’s legal costs incurred in any challenge, and establishing liquidated damages to be paid to the licensor, can all be included to deter the licensee from breaching the very “covenant not to challenge” clause to which it originally agreed.

The PTAB found that:

Patent Owner cited no explicit statute or rule that would compel us to deny institution of inter partes review because of contractual estoppel alone.

The PTAB thus concluded that without an express grant from Congress, it did not have the authority to recognize contractual estoppel as a bar to an inter partes review. However, in the Dot Hill case, the PTAB also concluded that it largely didn’t matter whether it needed to decline review based on contractual estoppel because the inter partes review was properly before them and, as such, the licensor would still have to defend the claims in these proceedings. Therefore, any prejudice towards the licensor because of the proceeding did not outweigh the prejudice of the licensee of losing its opportunity to challenge the claims of the patent and the PTAB exercised its discretion to proceed with the IPR.

The PTAB thereby allowed the challenge to go forward.

The Takeaway

It is important to note that under 35 U.S.C. § 314, the PTAB’s decision whether or not to institute the IPR is final and non-appealable. However, it is not clear whether there is a second instance to review questions of law per se and in particular, whether the PTAB is in fact subject to contractual or equitable estoppel.

On one hand, it is a well-established principle of administrative law that administrative decisions, especially those that implicate the discretionary powers of an agency, cannot be appealed until there has been a final decision on the matter and even then, review is limited. On the other hand, administrative law provides that questions of law and an agency’s interpretation thereof, are reviewable by a court.

It would seem that the question of whether Congress in fact intended to exclude contractual estoppel as a bar to PTAB review is a question of law—and one that should be permitted to be reviewed by a federal court.

Nevertheless, while we may be able to distinguish Dot Hill on its facts, the question remains as to whether “covenants not to challenge” and in particular, ones that expressly reference IPRs, will be respected by the PTAB.

A well-written license or settlement agreement should be able to remove or greatly reduce the risk of costly disputes and litigation concerning the subject of the agreement. However, if the PTAB decision stands, the uncertainty to patent licensors of their ability to mitigate the risk of continued patent infringement and challenges could lead to more costly licensing or settlement deals, hurting licensors and licensees alike.

Additionally, as Crossroads mentioned in its preliminary response to Dot Hill’s petition, the legislative intent behind the AIA was to make infringement litigation cheaper and more efficient, not to encourage litigation by parties to a settlement agreement, itself a cheaper alternative to litigation.

On basic public policy grounds, a provision in a contract between private parties should largely be upheld. The whole point of a “no challenge” clause is to close the door for further review and litigation and it makes little sense that the PTAB interprets its discretion to allow one of those parties to get around such a clause by claiming that it cannot entertain arguments of contractual estoppel as a bar to review. In fact, the harm suffered by the licensor cannot be remedied after the fact. By simply granting the review (whether or not the patent survives) the PTAB forces the licensor into a situation where it must defend the patent against a party that had already agreed not to invoke such a challenge.

Conclusion

There is significant risk of damage to a patent licensor from a post-license IPR challenge, whether or not a “covenant no to challenge” is enforceable. Given the costs involved and the possibility that unrelated license agreements may also be invalidated or terminated as a result of an IPR, there is need for clarification. Many licensors would find it useful for a court of higher instance to opine on whether the decision to institute an IPR in the presence of a “covenant not to challenge” is appealable as a matter of judicial review of an administrative decision.