Court Opinion

ID: 9464392
Source: CourtListenerOpinion
Date Created: 2023-08-04 23:31:44.635179+00
Date Added: 2024-06-11T17:38:35.820016
License: Public Domain

LUMBARD, Circuit Judge:
Warner-Jenkinson Company and H. Kohnstamm & Company, Inc. appeal from an August 13, 1976 judgment by Judge Frankel of the Southern District, who dismissed their action for invalidation of patents owned by Allied Chemical Corporation and ordered the payment to Allied of royalties which had been withheld pendente lite. Judge Frankel held that the appellants, who entered into a licensing agreement with the defendant as part of a settlement of earlier litigation, were thereby barred during the period when the agreement was not terminable by the licensees from seeking declaratory relief from royalty obligations on the basis of patent invalidity. We conclude that a nonterminable licensing agreement does not estop licensees from litigating validity and we reverse the judgment of the district court and remand for further proceedings.
All three parties are manufacturers of food coloring. Allied owns patents Nos. 3,519,617 and 3,640,733 issued in 1970 and 1972 for the chemical composition and production of a red food color known as Food, Drug & Cosmetics Red No. 40. Warner-Jenkinson and Kohnstamm are licensees of Allied who seek to challenge the validity of these patents.1
Until recently, another dye, Red No. 2, was the predominant red color additive in the food industry, and Red No. 40 was not widely used. However, in October 1971 the Food and Drug Administration announced it was considering the imminent delisting Red No. 2 for public health reasons. Since red is the dye most used in food coloring, and since Allied held a patent on Red No. 40, which is the only practicable alternative to Red No. 2, Warner-Jenkinson and Kohns-tamm each sought manufacturing licenses from Allied. Allied refused.
Thereupon appellants proceeded to manufacture Red No. 40 in defiance of Allied’s patent and in early 1972 instituted suit in the Southern District seeking a declaration of patent invalidity and damages for alleged unfair competition. Allied counterclaimed for infringement. After extensive discovery and pretrial briefing, trial was scheduled to commence before Judge William C. Conner on March 10, 1975. At this point FDA had still not delisted Red No. 2.
At the outset of trial, however, Judge Conner suggested that the parties try to settle the case. Judge Conner then con*186ducted a series of settlement conferences over the next two days, at the end of which the parties agreed in principle to settle on the basis of a $200,000 payment for past infringement and a royalty of 17½% of net sales for future manufacture, use, and sale of Red No. 40.
Details of the settlement were negotiated over the ensuing four months. At first, Allied asked for a consent judgment of patent validity, but this the plaintiffs rejected. The bargain ultimately struck by the parties included the following: (1) a “Stipulation and Order,” endorsed by Judge Conner on July 23, 1975, dismissing plaintiffs’ patent invalidity claims without prejudice, dismissing their unfair competition claims with prejudice, and dismissing defendant’s infringement claim without prejudice; and (2) a “Settlement Agreement” under which plaintiffs agreed to pay defendant $200,000 in exchange for releases from liability for any past infringement, plaintiffs agreed to release defendant from liability for any past unfair competition, and both sides agreed to enter into (3) “License Agreements” providing for 17½% royalties payable quarterly to the licensor Allied, allowing the licensor to terminate on 60 days notice in the event of non-payment of royalties by the licensee, and allowing the licensee to terminate on 60 days notice at any time after March 1, 1977. The settlement and license agreements were made effective as of March 1, 1975. It is not clear from the record whether Judge Conner had the agreements before him at the time he signed the stipulation and order, but it is clear that he was aware of their existence.
Royalty payments totalling approximately $500,000 were made by appellants over the first year of the agreement. However, on February 12, 1976 the FDA finally delisted Red No. 2. Since much heavier use of Red No. 40 therefore became necessary, appellants asked Allied to lower its 17½% royalty rate. Allied declined to be so generous.2 Kohnstamm'again brought suit in the Southern District to set aside Allied’s patent. They also sought a show causé order allowing them to deposit their royalty payments in escrow pendente lite, beginning with the quarterly payment due June 30.3 After briefing and argument, Judge Frankel dismissed plaintiffs’ complaint and ordered them to pay the June 30 royalties with interest. He granted plaintiffs’ request for leave to file a supersedeas bond for the June 30 royalties pending this appeal.
We first address the question of subject matter jurisdiction, which, although briefed in the district court, was not argued by the parties on appeal. The Declaratory Judgment Act, 28 U.S.C. § 2201, does not independently create federal jurisdiction. According to Skelly Oil Co. v. Phillips Petroleum Co., 339 U.S. 667, 671-72, 70 S.Ct. 876, 94 L.Ed. 1194 (1950), an action for declaratory judgment may be brought in federal court ordinarily only if there would exist a basis for federal jurisdiction in a coercive action between the two parties. See also Public Service Commission v. Wycoff Co., 344 U.S. 237, 248, 73 S.Ct. 236, 97 L.Ed. 291 (1952). If the plaintiffs were seeking a declaration simply of their right to assert patent invalidity as a defense to a contract action for royalties, which itself could not be brought in federal court, see e. g., Luckett v. Delpark, 270 U.S. 496, 502, 510, 46 S.Ct. 397, 70 L.Ed. 703 (1926); Arvin Industries, Inc. v. Berns Air King Corp., 7 Cir., 510 F.2d 1070 (1975); see generally Louisville & Nashville R. R. v. Mottley, 211 U.S. 149, 29 S.Ct. 42, 53 L.Ed. 126 (1908), one might conclude that no “arising-under” *187jurisdiction would be present. See Thiokol Chemical Corp. v. Burlington Indus., Inc., 448 F.2d 1328, 1330-31 (3d Cir. 1971), cert, denied, 404 U.S. 1019, 92 S.Ct. 684, 30 L.Ed.2d 668 (1972). See also Hanes Corp. v. Millard, 174 U.S.App.D.C. 253, 531 F.2d 585, 594-95 n. 8 (1976).
However, a second, and perhaps more important, reason why the plaintiffs want a declaration of patent invalidity is for its use as a defense in a patent infringement action. Under their licensing arrangement, nonpayment of royalties constitutes a material breach which gives the patentee the right to terminate the license prospectively. Thus, within a few months after the plaintiffs become liable for payment of royalties under contract law, they will also be subject to an action in federal court for an injunction and damages for infringement, see Luckett v. Delpark, supra, 270 U.S. at 510, 46 S.Ct. 397. At the present time the defendant has neither a state contract action nor a federal infringement action since the plaintiffs have not stopped paying royalties. One act on the part of the declaratory plaintiffs, nonpayment of royalties, will leave them vulnerable to federal as well as state claims by the declaratory defendants. Accordingly, plaintiffs’ action for declaratory judgment is raising a defense in anticipation of an impending federal action, and federal “arising under” jurisdiction is clearly present under Skelly Oil and Wycoff.4
The merits of this appeal are largely governed by Lear, Inc. v. Adkins, 395 U.S. 653, 89 S.Ct. 1902, 23 L.Ed.2d 610 (1969). There the Supreme Court rejected the principle of “licensee estoppel” and held that a patent licensee may assert patent invalidity as a defense to a contract action for nonpayment of royalties.
[T]he equities of the licensor do not weigh very heavily when they are balanced against the important public interest in permitting full and free competition in the use of ideas which are in reality a part of the public domain. Licensees may often be the only individuals with enough economic incentive to challenge the patentability of an inventor’s discovery. If they are muzzled, the public may continually be required to pay tribute to would-be monopolists without need or justification. We think it plain that the technical requirements of contract doctrine must give way before the demands of the public interest.
Id. at 670, 89 S.Ct. at 1911.
Addressing the question whether a patent licensee must actually withhold royalty payments before he can challenge validity, we conclude — as have most courts who have considered the issue — that such repudiation of the licensing agreement should not be precondition to suit. Compare PPG Industries, Inc. v. Westwood Chemical, Inc., 530 F.2d 700, 707 (6th Cir. 1976), cert, denied, 429 U.S. 824, 97 S.Ct. 76, 50 L.Ed.2d 86 (1976); American Sterilizer Co. v. Sybron Corp., 526 F.2d 542, 546 (3rd Cir. 1975); Milton Roy Co. v. Bausch & Lomb, Inc., 418 F.Supp. 975, 978-79 (D.Del. 1976); Dahlgren Manufacturing Co. v. Harris Corp., 399 F.Supp. 1253, 1256 (N.D.Tex. 1975), and Medtronic, Inc. v. American Optical Corp., 327 F.Supp. 1327, 1331 (D.Minn. 1971), with W. R. Grace & Co. v. Union Carbide Corp., 319 F.Supp. 307, 311 (S.D.N.Y.1970), and Thiokol Chemical Corp. v. Bur lington Industries Inc., 313 F.Supp. 253 (D.Del.1970), aff’d, 448 F.2d 1328 (3rd Cir. 1971), cert, denied, 404 U.S. 1019, 92 S.Ct. 684, 30 L.Ed.2d 668 (1972). Under most licensing arrangements, as in the present case, withholding of royalty payments constitutes a material breach of the contract. A licensee who wishes to continue using the patented element cannot withhold royalty payments without laying himself open to large potential liability for infringement and an injunction against all future use of the patented substance. If forced to make the hard choice, many licensees will choose the less perilous course, and the patents under which they are licensed will remain *188uncontested. Lear established that removing restraints on commerce caused by improperly-held patents should be .considered more important than enforcing promises between contracting parties. Thus, the seeming inequity of allowing a licensee to keep his license while he attacks the validity of the licensor’s patent is outweighed by the public interest in placing no impediment in the way of those in the best position to contest the validity of the underlying patent.
Moreover, we are not persuaded by appel-lee’s argument that enforcement of a royalties agreement should prevail where that agreement was part of a litigation settlement. There is certainly a public interest in the avoidance of litigation through the peaceful resolution of lawsuits. In the patent field, however, this interest is to be balanced against the public interest in having invalid patents cleared away through litigation. If encouragement of such litigation is important enough to justify allowing licensees to sue to invalidate patents, then it makes little sense for us to strain to preserve the termination of such litigation through a settlement. Of course, if a stipulated dismissal is with prejudice, see, e. g., Broadview Chemical Corp. v. Loctite Corp., 474 F.2d 1391, 1394-95 (2d Cir. 1973), if a settlement agreement contains an explicit prohibition on licensee suits during some future period, or if the payment of royalties is so ordered by a court as part of a settlement, see, e. g., Meetings & Expositions, Inc. v. Tandy Corp., 490 F.2d 714, 715-17 (2d Cir. 1974), a court may feel that effect should be given to such provisions. However, the Lear decision militates against reading such provisions into a settlement agreement. Although one court has suggested that settlement-agreement licensee estoppels might be imposed through an objective, case-by-case balancing of the interests, Aro Corp. v. Allied Witan Co., 531 F.2d 1368 (6th Cir. 1976), cert, denied, 429 U.S. 862, 97 S.Ct. 165, 50 L.Ed.2d 140 (1976), we are unwilling to leave parties at the mercy of what inevitably would be an imprecise and uncertain test.
The plaintiffs should not be barred from declaratory relief simply because the licensing agreement is not terminable by the licensee for two years. Such a provision in a patent licensing agreement serves a function analogous to that of a liquidated damages clause; it gives the patentee the option of claiming a fixed sum, royalties, instead of having to litigate regarding an indeterminate amount, damages for infringement. Thus, a two-year moratorium on litigation is not implicit in every two-year nontermination provision.5
The final issue on this appeal concerns plaintiffs’ proposal that they be allowed to pay their royalties into escrow, see Nebraska Engineering Corp. v. Shivvers, Civ. No. 7.6-221-1 (S.D. Iowa Oct. 1, 1976). We believe that if the plaintiffs wish to continue to invoke the protections of their licensing agreements, they should be required to continue paying their royalties to the defendant. Ultimately, all royalties paid after the filing of the complaint may have to be returned to the plaintiffs. Once the plaintiffs have proved patent invalidity, they would become entitled to withhold future royalties and to receive restitution of royalties paid pendente lite (with interest). See, e. g., Atlas Chemical Industries, Inc. v. Moraine Products, 509 F.2d 1, 4-7 (6th Cir. 1974). Thus the only question is who should have the use of the money during the interim. At present, plaintiffs already have the option of withholding royalties and thereby breaching the licensing agreement; of course, they would then run the risk of an injunction if they should lose on the merits. It would not be fair for the plaintiffs to be allowed simultaneously to reap all the benefits of the licensing agreement and to deprive the licensor of all his royalties. Patents are presumed to be valid, 35 U.S.C. § 282; until invalidity is prov*189en, the patentee should ordinarily be permitted to enjoy the fruits of his invention. The principal effect of an escrow arrangement would be to put undeserved pressure on the defendant. Therefore, in the absence of any indication that Allied might be judgment-proof at the end of the litigation, we conclude that it should not be deprived of its right to receive royalties in the interim.
Reversed and remanded.

. Warner-Jenkinson is a Missouri corporation ; Kohnstamm and Allied are New York corporations.

. Besides the parties to this case, there are approximately three other major manufacturers of food color in the United States. On March 15, 1976 one of these, the Hilton-Davis Chemical Company, obtained a license for Red No. 40 from Allied with a 17‘/2% royalty rate under an agreement nonterminable by the licensee for one year.

. Judge Frankel heard the application on June 25 and adjourned it until August 11 as an accommodation to both parties; until then, he ordered that plaintiffs could withhold their June 30 royalty payments without prejudicing their licenses.

. There is clearly a case and controversy here since the plaintiffs-licensees have an interest in proving patent invalidity and thereby escaping liability for royalties. The danger of collusive suits is no greater in this context than in any patent validity cases.

. In any event, there would be no bar to plaintiffs reinitiating their suit with respect to royalties accruing after March 1, 1977, the end of the two-year nontermination period. As we have indicated above, termination or breach of the licensing agreement would not be a precondition to plaintiffs’ suit after that time.