Opinion ID: 403701
Heading Depth: 2
Heading Rank: 3

Heading: the parties' claims for royalties

Text: 17 Under the licensing agreement, Bristol Locknut agreed to pay SPS a royalty based on a percentage of the sales of Skidmore locknuts and locknuts manufactured by the Burt tool. In return, SPS agreed not to sue for patent infringement. 18 The original agreement was signed on December 11, 1970. Bristol Locknut started making royalty payments in 1971. It was purchased by Frank Klaus in late 1972 and sales were thereafter underreported and the royalties consequently underpaid. On January 28, 1977, Bristol Locknut wrote to SPS, explaining it was delaying payment of the fourth quarter 1976 royalties until it received copies of SPS's licensing agreements with other locknut manufacturers. Bristol Locknut never resumed payment of royalties, but soon thereafter filed this action, on March 22, 1977, for a declaratory judgment that both patents were invalid and not infringed. SPS's separate action for breach of contract and infringement of its patents and trademark was consolidated. Bristol Locknut sued for a return of all royalties it had paid, and SPS sued for the unpaid royalties that accrued during the two fiscal quarters before the action was filed. SPS also sued for the underpaid royalties Bristol Locknut was obligated to pay. The parties stipulated that the total amount of underreported and unpaid royalties that accrued to the date of filing totalled $69,396.43. 19 The district court left the parties as they were. It held that since both patents were invalid and the trademark not infringed, SPS was not entitled to any additional royalties. We assume the court concluded that the holding of invalidity terminated Bristol Locknut's obligation to pay any further royalties. The court also held that, under the rationale of Lear, Inc. v. Adkins, 395 U.S. 653, 89 S.Ct. 1902, 23 L.Ed.2d 610 (1969), and St. Regis Paper Co. v. Royal Industries, 552 F.2d 309 (9th Cir.), cert. denied, 434 U.S. 996, 98 S.Ct. 633, 54 L.Ed.2d 490 (1977), Bristol Locknut was not entitled to a reimbursement of royalties already paid. 20 We agree that Bristol Locknut was not entitled to a refund of royalties paid, but we reverse the holding that it owes no further royalties. Bristol Locknut is obligated to pay SPS the full amount of underreported royalties and the unpaid royalties which accrued before it challenged the patents' validity by bringing this action.
21 Bristol Locknut argues that it is entitled to a refund of royalties paid under an invalid, and therefore void patent. We reject the argument. 22 In St. Regis Paper Co. v. Royal Industries, 552 F.2d 309, 314 (9th Cir.), cert. denied, 434 U.S. 996, 98 S.Ct. 633, 54 L.Ed.2d 490 (1977), we held that a licensee was not entitled to a refund of royalties paid before it challenged the patent's validity. St. Regis involved the typical situation in which a license agreement was entered into after the patent was issued. After four years, the licensee stopped paying royalties. Nine months later, it filed an action contesting the patent's validity and sought a return of royalties paid under the agreement. We found that the federal policy in favor of the prompt and early adjudication of the validity of patents, as articulated in Lear, Inc. v. Adkins, 395 U.S. 653, 89 S.Ct. 1902, 23 L.Ed.2d 610 (1969), 5 overrode countervailing state laws: 23 (T)he possibility of a royalty refund might delay such a determination (of a patent's validity). The possibility of obtaining a refund of all royalties paid might induce a manufacturer to accept a license based on a patent of doubtful validity, derive the benefits of suppressed competition which the patent affords, and challenge validity only after the patent's expiration. The licensee would have a chance to regain all the royalties paid while having enjoyed the fruits of the license agreement. Therefore, if a refund were permitted, licensees who were only recently unmuzzled by Lear would again be silenced by economic self-interest rather than by state law. 24 St. Regis, 552 F.2d at 314. 25 Other circuits have also read Lear to deny a refund of royalties paid by a licensee. E.g., American Sterilizer Co. v. Sybron Corp., 614 F.2d 890 (3d Cir.), cert. denied, 449 U.S. 825, 101 S.Ct. 88, 66 L.Ed.2d 29 (1980); USM Corp. v. Standard Pressed Steel Co., 524 F.2d 1097 (7th Cir. 1975); PPG Industries, Inc. v. Westwood Chemical, Inc., 530 F.2d 700 (6th Cir.), cert. denied, 429 U.S. 824, 97 S.Ct. 76, 50 L.Ed.2d 86 (1976). 26 Bristol Locknut argues that it is entitled to a reimbursement of all royalties because the district court found both patents not infringed, as well as invalid. Unlike patent validity questions, infringement is a question of fact, not law. Bristol Locknut contends that since both parties were operating under a mutual mistake of fact, the licensing agreement should therefore be rescinded and all royalties returned. We understand but reject the argument. We affirm the holding of invalidity and need not review the finding of noninfringement, Schwinn Bicycle Co. v. Goodyear Tire & Rubber Co., 444 F.2d 295, 301 (9th Cir. 1970), since noninfringement here would not affect our holding that Bristol Locknut is not entitled to a reimbursement of royalties. Because an invalid patent cannot be infringed, Wham-O-Mfg. Co. v. Paradise Manufacturing Co., 327 F.2d 748, 751 (9th Cir. 1964), Bristol Locknut's logic would permit every licensee who successfully challenged the validity of a patent to demand a reimbursement of royalties because of the consequent noninfringement of that patent. Such a result would undermine the stated policies of Lear and St. Regis, and would also promote an injustice where, as here, both issues of invalidity and noninfringement rest on the same asserted technical defects in the patents. 6 27 Bristol Locknut's argument is novel and, under these facts, unpersuasive. Here, Bristol Locknut fully enjoyed the fruits of the license agreement. St. Regis, 552 F.2d at 314. We do not decide whether in a different situation involving a valid but not infringed patent, the argument would also fail. 28
29 A licensee remains obligated to pay all royalties under a licensing agreement which accrue until it takes an affirmative step that would prompt the early adjudication of the validity of the patent, such as filing an action contesting the patent's validity or notifying the licensor that the payments were being stopped because the patent was believed to be invalid. 7 PPG Industries, Inc. v. Westwood Chemical, Inc., 530 F.2d 700, 701 (6th Cir.), cert. denied, 429 U.S. 824, 97 S.Ct. 76, 50 L.Ed.2d 86 (1976); accord, American Sterilizer Co. v. Sybron Corp., 614 F.2d 890, 895-98 (3d Cir.), cert. denied, 449 U.S. 825, 101 S.Ct. 88, 66 L.Ed.2d 29 (1980) (the crucial date for terminating the obligation to pay royalties occurs when the licensee makes a prompt challenge to the patent, not necessarily when the action is filed); cf. St. Regis, 552 F.2d at 314 (a licensee is not entitled to the refund of royalties paid before it challenged the validity of the patent); Kraly v. National Distillers & Chemical Corp., 502 F.2d 1366, 1372 (7th Cir. 1974) (the obligation to pay royalties stopped when the licensee repudiated the license agreement by ceasing to represent that its product was licensed under the patent); see also USM Corp. v. Standard Pressed Steel Co., 524 F.2d 1097, 1099-100 (7th Cir. 1975). 30 Here, Bristol Locknut stopped paying royalties seven weeks before it filed suit. Because its letter to SPS did not prompt the early adjudication of the patents' validity, it remained obligated to pay royalties until it filed this declaratory judgment action to contest the patents' validity.
31 Before it ceased paying royalties because of doubts about the patents' validity, Bristol Locknut engaged in a deliberate and systematic underreporting of sales, thereby reducing the royalties paid to SPS. Bristol Locknut contends it has no obligation to pay royalties on the underreported sales that would otherwise be due if the patents were valid and not infringed. We reject the argument. To permit Bristol Locknut to retain the royalties it owed SPS would be inequitable and would undermine federal patent law policy. Bristol Locknut's contractual obligation to pay royalties terminated only after it ceased paying royalties and clearly notified SPS it was contesting the patents' validity. Just as the subsequent determination of the patents' invalidity did not affect Bristol Locknut's duty to pay royalties before it challenged the patents' validity, it does not affect the duty to pay the full amount of royalties owed under the contract. Cf. Ransburg Electro-Coating Corp. v. Spiller & Spiller, Inc., 489 F.2d 974, 978 (7th Cir. 1973) (an infringement settlement agreement was enforced even though the patent was later declared not infringed, since a contrary result would be inconsistent with the Lear policy favoring early challenges to patent validity). 32 A contrary result would also be inequitable. Here, Bristol Locknut received the full benefit of the licensing agreement despite the later adjudication of the patents' invalidity. Bristol Locknut was licensed to sell the locknuts without being sued by SPS for infringement. For six years Bristol Locknut enjoyed the benefits of the patent and developed a substantial business, economies of scale, and customer goodwill. It cannot avoid its contractual obligation by deliberately underreporting its sales. See Kraly v. National Distillers & Chemical Corp., 502 F.2d 1366, 1372 (7th Cir. 1974).