Prohibitions on patent validity challenges are unenforceable even in patent settlement agreements

Imagine if you will a not uncommon scenario: ABC Corporation accuses XYZ Inc. of infringing ABC's patents. After some investigation, XYZ's lawyers determine that the likelihood of successfully defending an infringement lawsuit that ABC may bring against XYZ is low, and that the patents in question appear valid. As a consequence, the parties enter into an agreement settling their dispute, in which XYZ agrees to pay a one-time fee to ABC  in exchange for ABC's promise to never sue XYZ for patent infringement. As part of this settlement, XYZ agrees that it will never challenge the validity of the patents in question or assist any other party to do so.

A few years later, XYZ is acquired by a competitor to ABC, Newco Inc. Newco, flush with cash and eager to challenge XYZ's market power, decides that XYZ's patents are an impediment to Newco's plans for global domination. Newco files a lawsuit in federal court seeking a declaration that the ABC patents are invalid.

Naturally, ABC files a motion to dismiss the suit, based on the settlement agreement signed between ABC and XYZ. Newco inherited the agreement and is now forbidden from challenging the validity of the patents in question, ABC asserts.

Seems rather straightforward - XYZ promised in a signed writing, in an arms-length negotiation between well-represented parties of equal bargaining power, never to challenge ABC's patents or assist others to do so. This promise was an integral part of a settlement agreement intended to fully and finally resolve the dispute between the two companies. Case closed, correct?

Actually, no.

In a recent decision of the United States Court of Appeals for the Second Circuit, Rates Technology Inc. v. Speakeasy Inc. (July 10, 2012) (covering New York, Connecticut, and Vermont), the court held, under essentially identical facts, that a prohibition on challenging patent validity in a pre-litigation settlement agreement is unenforceable. Resting its decision on a 1960s era US Supreme Court decision, Lear Inc. v. Adkins (1969), the Second Circuit reasoned that public policy favors permitting parties in this situation, who are often best-situated to challenge patent validity, to be free to bring challenges to patents in order to promote full and free competition in the use of ideas. In the court's own words:

While we recognize the important policy interests favoring the settlement of litigation may support a different rule with respect to no-challenge clauses in settlements entered into after the initiation of litigation, ... and we are conscious of the great costs that can be associated with patent litigation, we believe that enforcing no-challenge clauses in pre-litigation settlements would significantly undermine the “public interest in discovering invalid patents” .... We therefore hold that covenants barring future challenges to a patent's validity entered into prior to litigation are unenforceable, regardless of whether the agreements containing such covenants are styled as settlement agreements or simply as license agreements.

(citations omitted).

This rule, by the way, is the same in the Ninth Circuit by virtue of Massillon–Cleveland–Akron Sign Co. v. Golden State Adver. Co. (1971), cited with favor in the Speakeasy decision. The rule therefore applies in California and all of the other western states (unless overturned by the US Supreme Court).

The Lear decision and its progeny, typified by decisions like Speakeasy, are instructive to counsel who routinely advise their clients in patent infringement scenarios. A party seeking to minimize its exposure to future challenges to its patents should be forewarned that a no-challenge clause in a pre-litigation settlement or license agreement will not be enforceable, and therefore such party would be well-advised to adjust its monetary demands accordingly.

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