One of your better clients asks you to draft contracts to cover the sale of two of the machines he manufactures:  (1) selling a first machine and licensing the patented technology that it uses; and (2) selling a second machine and licensing the technology, for which a patent application has been filed, that it uses.  He tells you he wants you, not the overpaid patent lawyer, to help him.  After concluding this is a simple contract, covered by state contract law, you agree to do it.  You have just unknowingly entered a minefield in which the mines have been placed by the Queen of Hearts from Alice in Wonderland.

Not realizing the danger, however, you start by drafting a contract reflecting the agreement of your client and the buyer covering the first machine.  The machine is to sell for a flat fee, and the patented technology is to be licensed for a uniform usage fee for each of ten years even though only five years is left on the term of the patent.

Unfortunately for you, the Supreme Court in Brulotte v. Thys Co. 379 US 29 (1964), on very similar facts, held that provisions of a license that allow royalties to be collected that accrued after the patent expired are unenforceable.  While the rationale of Brulotte is not crystal clear, it appears to be based on federal patent policy involving the impropriety of using state contract law to extend a patent’s term and the encouragement of free use and competition in items not patented.

The Court refused to construe the agreement before it as an installment plan sale or lease of the machines in question with an indeterminate payment based on usage, which arrangement would have been acceptable.  Thus, revising your draft to provide for payment of royalties based on usage for five years, the remaining term of the patent, and for a payment of the purchase price of the machine over ten years also based on usage could “pass muster.”  This may be the classic distinction without a difference.

The Second Machine

In any event, you draft a contract concerning the sale of the second machine that is similar to the draft contract for the sale of the first machine.  It provides for the sale of the second machine for a flat fee.  It then provides for the license of the technology on which no patent has issued but a patent application has been filed, as follows:  royalties of 10 % of the sales of items manufactured by the machine unless the patent does not issue in five years, at which time the royalties will decrease to 5 %.

A logical response to this draft contract is that, based on Brulotte, it is unenforceable because it provides for a royalty not after a patent expires but after any chance of one issuing expires.  However, as Justice Holmes noted “the life of the law is not logic alone.”  The Supreme Court in Aronson v. Quick Point Pencil Co., 440 US 257 (1979), upheld a similar contract, noting that it was traditionally the domain of state law and that the parties contracted with full awareness of the pending the patent application and the fact it might be rejected.  The court distinguished Brulotte on the grounds that there the monopoly granted by a patent was used as leverage to negotiate but that in Aronson the reduced royalty was not negotiated with the leverage of a patent but with the knowledge that a patent might not issue at all.

Paul C. Remus is Chair of the Patent Group of Devine, Millimet & Branch.  He may be reached at premus@devinemillimet.com and is pleased to answer questions about IP issues, jogging or rowing.

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