Seventh Circuit Court of Appeals Issues Ruling Which Affirms Rights in an Exclusive License to Joint Intellectual Property

I just spent about five hours on the phone with multiple clients over the last few weeks explaining to them the ins and outs of exclusively licensing joint intellectual property, so I was pleased to see the decision of the Seventh Circuit Court of Appeals in the Wisconsin Alumni Research Foundation v. Xenon Pharmaceuticals, Appeal No. 08-1351 (7th Cir. 2010), which affirmed the licensor's rights in an exclusive license to joint intellectual property.

In this case, as in my various clients' cases, the parties had entered into a collaboration in which they agreed to jointly pursue research. The agreement provided Xenon an exclusive option to license any resulting technology, which again is often typical in collaboration agreements, particularly with universities. The parties filed a joint patent application deriving from the provisional application that the Wisconsin Alumni Research Foundation ("WARF") filed before the collaboration began. Xenon exercised its option to exclusively license the technology, which gave Xenon the exclusive right to make, use and sell patented products under the joint patent application within the field of human healthcare. In exchange, Xenon agreed to pay the Foundation a percentage of any product sales, royalties or sublicense fees it received.

Xenon then went on to sign a license agreement with NovartisPharma AG ("Novartis"), which gave Novartis a license to the technology covered by the same joint patent application it had exclusive licensed from WARF. WARF demanded sublicensing royalty fees under the terms of the exclusive license, which Xenon refused, claiming it had the right to license its interest in the joint patent application. WARF sued Xenon, claiming that it had breached the terms of the exclusive license. The district court judge held in favor of WARF, ruling that Xenon breached the exclusive license agreement by granting a sublicense to Novartis without notifying WARF or conforming the sublicense to the terms of the exclusive license agreement. The judge held that Xenon owed WARF license fees, and that given Xenon's breach, WARF had the right to terminate the exclusive license.

At the same time the district court judge ruled in Xenon's favor on several issues:

• He dismissed as moot the Foundation's claim that Xenon breached its duty of good faith by failing to abide by the terms of the license agreement.
• He held that the Foundation had not given Xenon proper notice or opportunity to cure before invoking its right to terminate the exclusive license agreement.
• It denied the Foundation's claims to a compound that had been discovered by a University researcher who had entered into a consulting agreement with Xenon.

In a subsequent ruling, the court vacated its earlier decision regarding the WARF's right to terminate the license agreement. The case went to a jury on the damages issue and the jury awarded $1 million, which was later reduced by the court to $300,000.00.

So, that's the background.  The Seventh Circuit ruled exactly as I would have expected, and agreed that Xenon breached its exclusive license by granting a sublicense on the joint patent without paying WARF's  sublicense fees.  The Seventh Circuit also agreed that the breach triggered WARF's right to terminate the agreement.  The Seventh Circuit also found that WARF owned the compound in dispute as well.

What did the Seventh Circuit find compelling here?

First, the terms of the exclusive license on the joint patent contemplated sublicenses and said that they were permitted upon the payment of a royalty sublicense fee but specifically prohibited assignments without consent. So, even though Xenon before the agreement had the right to commercialize the patent independently of WARF, it gave up that right when it entered into the exclusive license. The Novartis license provided that Xenon would grant Novartis an exclusive license to all Xenon technology in the field of human and animal healthcare, which effectively was a sublicense to Xenon's exclusive rights in the joint patent.

Second, the terms of the license require that Xenon was to pay WARF

(1) a royalty for direct sales by Xenon, which would be earned on the date that the product was sold, the date the invoice was sent on the sale of the product, or the date the product was transferred to a third party for promotional reasons, whichever came first; and

(2) "a percentage of any license fees, milestones, and royalty payments received by Xenon as consideration for the sublicense granted. . . .the percentage shall remain fixed at a rate of ten percent (10%) for years (1) and two (2) of this Agreement and seven and one-half percent (7.5%) thereafter until this agreement was terminated."

In the second possibility, Xenon tried to argue that because the clause began with "for all Products sold by Xenon sublicensees" that it didn't owe Novartis any money until such time that Novartis brought products to market at sold them. However, the court dismissed that interpretation, saying that in both the direct sales and sublicensing possibilities, the paragraphs began with "for all products sold" and that this phrase was just intended to distinguish direct commercialization from when a sublicensee commercialized the technology, and in the latter case, any compensation received triggered a payment obligation on Xenon's part to WARF.

Third, on the damages issue, the Seventh Circuit found that the evidence was sufficient to sustain a damages award and that the issue of damages was not beyond the understanding of a lay juror and did not require the use of expert testimony.

Fourth, the Seventh Circuit dismissed the argument that because the agreement had a 90 day notice and opportunity to cure a material breach clause, that WARF's decision to file suit during that 90 day period meant that it could not terminate the agreement for material breach until the court found Xenon in breach. The Seventh Circuit found that the ability to terminate the license was completely separate from the right to sue for breach of the contract, and that WARF had the right to sue after giving notice and had the right to terminate for breach after the 90 day period had lapsed.

Fifth, on the compound issue, the researcher assigned his rights to the compounds to the Foundation, and the fact that his work was conducted in part under the sponsorship did not change the ownership of the rights in the compounds.

All in all, this decision is a clear affirmation of the licensor's rights in an exclusive license to jointly owned intellectual property. Parties looking to collaborate on the development of intellectual property and who have questions about how this all works from a practical perspective should look to this case as a reference.

At the same time, I think this case provides some good lessons to potential collaborators. You need to be very precise about what remains joint intellectual property and what will potentially be exclusively licensed intellectual property. If you do not intend to exclusively license all of the joint intellectual property, the agreement needs to be clear on this and it needs to be clear on what rights the parties jointly retain after the exclusive license is entered into.

You also need to be clear on what triggers payments to the licensor--in this case, the dispute was in part over a clause "on all sales of products". The compensation language was obviously imprecise enough to provide fodder for a dispute. The parties clearly could have made a better choice on words.

As I have stressed to my clients, it is very important to think through all of the issues in a collaboration before you just draft and sign the agreement. This case is a good example of why that is so important.