A recent California appellate decision highlights a couple things that come up in licensing agreements, so this will be a two-part post about the opinion in City of Hope v. Genentech.
People often get frustrated by all the words that are in contracts and how nitpicky lawyers can be, and I often hear people joke that lawyers must get paid by the word. I admit that sometimes it looks just silly to see things repeated or to see long lists of what appear to be synonyms. This case is an example of why lawyers fret and fuss about the words.
This lawsuit is a long-running battle between City of Hope and Genentech and the opinion that came down was the California state appellate court's affirmation of the lower court’s findings against Genentech for about $500MM (approximately $300MM in compensatory damages and $200MM in punitive damages). The whole story begins way back in 1976 when the companies entered into a license agreement under which Genentech agreed to pay various royalties to COH for the latter’s patents (actually, at first it was trade secret and later become patents for that technology). I’ll try to briefly sum up the problem the parties had and illustrate why it sometimes pays to be precise ….
Back in 1976, scientists at COH met up with executives at Genentech regarding synthesized DNA fragment used to code for IGF, among other things, that the COH scientists had developed. City of Hope and Genentech eventually entered into a licensing agreement for the technology under which COH assigned the patent rights to the synthesized DNA to Genentech, and allowed Genentech to negotiate licenses for that technology with third parties. In return, Genentech was to pay certain royalties to COH.
Should be simple, eh? If only it were always so ….
A few of the key things in licensing agreements are: 1) what is being licensed, 2) what royalties or other payments are due, and 3) under what circumstances or conditions those payments are due. In other words, what is the royalty base?
In the agreement between COH and Genentech, there were several different provisions (at least 6 specifically mentioned in this opinion) that talked of different circumstances under which Genentech was to pay royalties to COH. COH’s lawsuit focused on one of these royalty payment provisions, Section 6.08, which said:
Should Genentech license [the technology to any third party, then Genentech] shall pay to City of Hope the same royalty City of Hope would have received had Genentech itself [done whatever the third party was going to do with the technology].
Sounds straight forward at first – if Genentech could have done “X” with the technology, but it licenses the ability to do “X” to a third party, then Genentech owes COH a percentage of whatever revenues it receives. But then you realize that you have to go back through the agreement and analyze what each of those individual circumstances are, and when the language of those other provisions contain conditions that don’t immediately make sense with regards to licensees, it becomes more complicated. Genentech had control over the licenses it entered into regarding the subject patents, and each of those license agreements set out what products the licensees could make with the licensed patent.
COH argued that Section 6.08 was meant to be a royalty on the licensing revenue received by Genentech from sales by a patent licensee of the products listed in its license even if the licensees themselves did not practice the patents in making that product. Genentech had paid COH royalties under Section 6.08 for some of the licenses, but not all of them, and COH sought its royalty for those other licenses. Also, Genentech had settled certain patent infringement suits, and has part of those settlements it had received money from the defendants and had given a license to the defendants for the subject patents. COH requested a royalty from that money (there was a provision in the agreement that provided a royalty to COH of settlement funds) and Genentech refused to pay it, so COH also sought its share of those funds in this lawsuit. COH looked more at what products are being licensed as the trigger for royalties
Genentech had a different interpretation of what that Section 6.08 was supposed to mean. Genentech had argued that they only needed to pay for licensing revenues for the patents using DNA synthesized by COH, and not for licenses using other DNA fragments to manufacture bovine growth factor, interferon and other hormones (in other words, they asserted that royalties were not due unless the patent was being used or the DNA fragments that COH developed were being used).
The jury agreed with COH and it awarded COH a little more than $300MM in compensatory damages and then another $200MM in punitive damages (saying, in essence, that Genentech knew the contract had a different meaning and was squirrelly in trying to get out of its obligations). Genentech appealed the jury award, saying that the interpretation of the agreement that the jury adopted (COH’s interpretation) was unreasonable.
Here is where parties run into problems when contracts are ambiguous and subject to different interpretations, each of which is reasonable. In cases where there is an ambiguous provision that needs extrinsic evidence (drafts of the agreement, letters between the parties, etc.) to resolve the ambiguity, the appellate court examines whether the interpretation that the court below came up with is reasonable and supported by substantial evidence. If the interpretation is not completely out of whack and it does have enough to support it, the court must uphold the trial court’s interpretation. Without repeating everything the California appellate court said, it dismissed Genentech’s contentions pretty quickly and found that, in looking at all the evidence, the jury’s interpretation was reasonable (and that Genentech’s interpretation actually made little logical sense), and upheld the award.
So, one of the things that I took from this case is that it really can pay to be as specific as you can be. Look carefully at your definitions of the technology and know-how being licensed. Look carefully at your definitions of "affiliate" and "licensee." If you want certain conditions to occur before paying the other party, say so. It’s not always to the parties’ advantage to be incredibly explicit and sometimes they want the provisions to be broader and vague; but, if you think you really want something to be a condition, negotiate it and spell it out. Don’t wait a couple decades (and an expensive lawsuit) later for a court to come in and have to decide what was meant. When it comes to showing only a "reasonable interpretation," that isn't a high hurdle and if you throw in some other bad facts (defendant is BigBio, plaintiff is non-profit medical research center, and defendant looked like it was trying to get around the contract her and there), your chances for winning diminish.
Some companies take it as a business strategy and a risk they’re willing to accept that the court won’t go their way, but just make sure you really consider all the consequences (including monstrous punitive damages) if the risk doesn’t pay off. Adding those few words may seem tedious, but can save a lot of resources in the end.
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