Court Opinion

ID: 2996986
Source: CourtListenerOpinion
Date Created: 2015-09-24 19:32:53.5332+00
Date Added: 2024-06-11T12:11:22.423827
License: Public Domain

In the
 United States Court of Appeals
               For the Seventh Circuit
                          ____________

Nos. 03-1683, 03-1825, 03-2405
XCO INTERNATIONAL INC.,
                               Plaintiff-Appellant/Cross-Appellee,
                                 v.

PACIFIC SCIENTIFIC COMPANY,
                             Defendant-Appellee/Cross-Appellant.

                          ____________
            Appeals from the United States District Court
        for the Northern District of Illinois, Eastern Division.
               No. 01 CV 6851—John W. Darrah, Judge.
                          ____________
      ARGUED DECEMBER 3, 2003—DECIDED MAY 24, 2004
                          ____________

  Before FLAUM, Chief Judge, and POSNER and WILLIAMS,
Circuit Judges.
  POSNER, Circuit Judge. The appeal in this diversity breach
of contract suit governed mainly by Illinois law presents
issues involving the enforceability of a liquidated damages
clause (found by the district judge to be a penalty), contract
interpretation, patent law, and sanctions for making friv-
olous claims.
2                             Nos. 03-1683, 03-1825, 03-2405

   The plaintiff, XCO, owned U.S. and foreign (mainly
European) patents on heat-sensitive cables. In 1991 it as-
signed the patents to the defendant, PacSci, which wanted
to use them in making products for fire control and related
uses. PacSci agreed to pay XCO $725,000 down, plus
$100,000 or 5 percent of PacSci’s sales of products utilizing
the patented technology—whichever amount was greater—
annually from 1995 through 2000; after that it would pay 5
percent of annual sales until the patents expired. As part of
the deal, PacSci licensed the patents that it had just bought
back to XCO for use in making heat-sensitive cables for
lining refractory process vessels (used for processing
petroleum products), which was the core of XCO’s business,
its principal market being in Europe. As the consideration
for this license XCO agreed to pay PacSci $100,000 plus
royalties on sales of the cables for the licensed use. The
parties further agreed that PacSci would be “responsible for
all expenses of any kind relating to” the patent rights that it
was buying, including the fees charged by European patent
authorities to maintain patents in effect. The U.S. Patent and
Trademark Office charges patent-maintenance fees for U.S.
patents, but payment of those fees is not in issue.
   The agreement was to continue until the last of the patents
expired in 2003. Beginning in 1993, however, just two years
after the agreement had been signed, PacSci stopped paying
maintenance fees on those patents that it wasn’t using. It
took the position that notwithstanding the “responsibility”
clause of the contract, it could pick and choose which
patents to keep alive. As a result, by 1998 a number of the
patents had lapsed. XCO declared a breach that year and
terminated the contract, as it was entitled to do (without
liability) if in fact PacSci had committed a breach. A provi-
sion in a section of the contract captioned “Breach and
Liquidated Damages” states that in the event of such a
termination all money owed XCO by PacSci, “including
Nos. 03-1683, 03-1825, 03-2405                               3

such amounts which constitute overdue, delinquent or
otherwise unpaid amounts . . . plus one hundred thousand
dollars ($100,000) per year from and including the year of
such termination to and including the year of the last to
expire of the patent rights, shall then constitute liquidated
damages under this Agreement.” Another provision, also in
the “Breach and Liquidated Damages” section, states that if
XCO breaks the contract, PacSci will have no further
obligations except to pay XCO any amounts that came due
before the breach; in other words, from the date of a breach
by XCO forward, PacSci would have a royalty-free license.
So damages were specified for a breach by either party.
   Because XCO terminated the contract in 1998 and the last
patent expired in 2003, and because the $100,000 in liqui-
dated damages was due in both the year in which the con-
tract was terminated and the year in which the last patent
expired, as well as in all the intermediate years, the clause,
if valid, entitles XCO to $600,000 in damages. The district
judge held that it is a penalty clause, hence invalid. He ruled
so on summary judgment, while rejecting PacSci’s interpre-
tation of the “responsibility” clause. He found, in other
words, that PacSci had broken the contract; but since XCO
did not attempt to prove its actual damages, instead seeking
only liquidated damages, XCO got no relief for the breach.
   There is also a counterclaim. Beginning in 1998 XCO had
begun manufacturing a somewhat different kind of heat-
sensitive cable, for which it has applied for a patent. PacSci
counterclaimed for royalties on XCO’s sales of the new
cable, citing a clause in the contract which states that PacSci
is purchasing not only the patents listed in the contract but
also “all purchasing, manufacturing, marketing, sales and
installation information and materials including know-how,
drawings, sketches, plans, designs, specifications, data,
methods, processes, techniques, inventions or discoveries
4                              Nos. 03-1683, 03-1825, 03-2405

whether patentable or not which relate in any way to the Products
covered by the Patent Rights” (emphasis added). Another
clause, however, provides that if “any such additional
proprietary subject matter is first conceived and/or reduced
to practice by or on behalf of [XCO] during the term of this
Agreement, then title thereto shall vest in and remain
[XCO’s] exclusive property.” The district judge rejected the
counterclaim, and PacSci has appealed that ruling. But the
judge also rejected XCO’s request for sanctions for the filing
of the counterclaim; XCO had argued that the counterclaim
was frivolous and in addition that PacSci was trying to
inject into the case an issue of patent law—namely whether
XCO’s new patent (if issued) would infringe patents that it
had assigned to PacSci— without complying with the
standards laid down by the Federal Circuit for proving
infringement. XCO claims to have incurred nearly $400,000
in legal fees and other expenses to defend against the
counterclaim.
   XCO’s appeal challenges the district judge’s denial of its
motion for sanctions as well as his refusal to enforce the
liquidated damages clause. In defending the latter ruling
PacSci not only embraces the judge’s penalty-clause deter-
mination but also argues that letting the patents lapse was
not a breach of contract after all.
   When damages for breach of contract would be difficult
for a court to determine after the breach occurs, it makes
sense for the parties to specify in the contract itself what the
damages for a breach shall be; this reduces uncertainty and
litigation costs and economizes on judicial resources as well.
Indeed, even if damages wouldn’t be difficult to determine
after the fact, it is hard to see why the parties shouldn’t be
allowed to substitute their own ex ante determination for
the ex post determination of a court. Damages would be just
another contract provision that parties would be permitted
to negotiate under the general rubric of freedom of contract.
Nos. 03-1683, 03-1825, 03-2405                               5

One could even think of a liquidated damages clause as a
partial settlement, as in cases in which damages are stipu-
lated and trial confined to liability issues. And of course
settlements are favored.
   Yet it is a rule of the common law of contracts, in Illinois
as elsewhere, that unless the parties’ ex ante estimate of
damages is reasonable, their liquidated damages provision
is unenforceable as a penalty intended to “force” perfor-
mance. Bauer v. Sawyer, 134 N.E.2d 329, 333 (Ill. 1956);
Checkers Eight Ltd. Partnership v. Hawkins, 241 F.3d 558, 561-
62 (7th Cir. 2001) (Illinois law); Lake River Corp. v.
Carborundum Co., 769 F.2d 1284, 1289-90 (7th Cir. 1985)
(same); Med+Plus Neck & Back Pain Center, S.C. v. Noffsinger,
726 N.E.2d 687, 693 (Ill. App. 2000); see also Truck Rent-A-
Center, Inc. v. Puritan Farms 2nd, Inc., 361 N.E.2d 1015, 1017-
19 (N.Y. 1977). The reason for the rule is mysterious; it is
one of the abiding mysteries of the common law. At least in
a case such as this, where both parties are substantial com-
mercial enterprises (ironically, it is the larger firm, PacSci,
that is crying “penalty clause”), and where damages are
liquidated for breach by either party, making an inference
of fraud or duress implausible, it is difficult to see why the
law should take an interest in whether the estimate of harm
underlying the liquidation of damages is reasonable. Courts
don’t review the other provisions of contracts for reason-
ableness; why this one?
  It is true that if there is a very stiff penalty for breach,
parties will be discouraged from committing “efficient”
breaches, that is, breaches that confer a greater benefit on
the contract breaker than on the victim of the breach, in
which event breach plus compensation for the victim pro-
duces a net gain with no losers and should be encouraged.
(This is a reason why injunctions are not routinely granted
in contract cases—why, in other words, the party who
6                             Nos. 03-1683, 03-1825, 03-2405

breaks his contract is usually allowed to walk away from it,
provided only that he compensates the other party for the
cost of the breach to that party.) But against this consider-
ation must be set the worthwhile effect of a penalty as a
signal that the party subject to it is likely to perform his
contract promise. This makes him a more attractive contract
partner, since if he doesn’t perform he will be punished
severely. His willingness to assume that risk signals his
confidence that he will be able to perform and thus avoid
the penalty. It makes him a credible person to do business
with, and thus promotes commerce.
  Granted, the case for a contractual specification of dam-
ages is stronger the more difficult it is to estimate damages
and so the greater the expense to the parties and the ju-
diciary, and hence to society, of determining the plaintiff’s
damages by the clumsy and costly methods of litigation.
That presumably is why the enforceability of liquidated
damages clauses depends on the difficulty of estimating,
when the contract is signed, what the damages will be if the
contract is broken. Yet in such cases the plaintiff will often
be able to obtain injunctive relief instead of damages, on the
ground that his damages remedy is inadequate, that being
the standard criterion for injunctive relief; and an injunction
often has a punitive effect because the cost to the defendant
of complying with it will often exceed the harm to the
plaintiff from the enjoined conduct. The fact that injunctions
are sometimes granted in contract cases shows, therefore,
that “punishment” is not wholly alien to contractual
remedies. At a minimum one might suppose penalty clauses
tolerable to the extent that the penalty portion approxi-
mated the costs in attorneys’ fees and other expenses of
proving damages for breach of contract.
  The explanation for the rule against penalty clauses may
be purely historical—and “it is revolting to have no better
Nos. 03-1683, 03-1825, 03-2405                                7

reason for a rule of law than that so it was laid down in the
time of Henry IV.” O. W. Holmes, “The Path of the Law,” 10
Harv. L. Rev. 457, 469 (1897). The slow pace at which the
common law changes makes it inevitable that some com-
mon law rules will be vestigial, even fossilized. When a
person comes into court seeking relief, the court naturally is
inclined to ask why it should get involved in the matter. The
court is busy, its resources limited. It wants to see some
potential benefit from judicial intervention before it will lift
a finger. The rules of contract law have remote origins,
predating the era of freedom of contract and the ideology of
free markets. Thus, when parties to contracts first sought
damages for breach in cases in which the contract when
broken had still been executory, courts declined to oblige;
they couldn’t see what harm had been done when the victim
of the breach hadn’t yet paid anything or begun to perform.
Flureau v. Thornhill, 96 Eng. Rep. 635 (C.P. 1776); Basiliko v.
Pargo Corp., 532 A.2d 1346, 1348-49 (D.C. 1987); 3 E. Allan
Farnsworth, Farnsworth on Contracts § 12.8, p. 192 (3d ed.
2004); Morton J. Horwitz, “The Historical Foundations of
Modern Contract Law,” 87 Harv. L. Rev. 917 (1974). They
were not moved by the fact that the parties, presumably
rational, had thought it in their mutual interest to be able to
enter into an enforceable executory contract.
  Similarly—though here the historical record is murkier
because there was an early period in which penal bonds
were enforced, 3 Farnsworth, supra, § 12.18, pp. 302-04;
Horwitz, supra, 87 Harv. L. Rev. at 936-37; William H. Loyd,
“Penalties and Forfeitures,” 29 Harv. L. Rev. 117 (1915)—
courts have had difficulty seeing what benefit would be
conferred by awarding in effect punitive damages for
breach of contract. Because liability for breach is strict
(though the strictness is somewhat ameliorated by such
defenses as impossibility and frustration), contract breakers
8                             Nos. 03-1683, 03-1825, 03-2405

often are innocent in a moral sense. Breach of contract is not
a tort, so should not be punished—or so the reasoning goes.
  The rule against penalty clauses, though it lingers, has
come to seem rather an anachronism, especially in cases in
which commercial enterprises are on both sides of the con-
tract. As we noted in Operating Engineers Local 139 Health
Benefit Fund v. Gustafson Construction Corp., 258 F.3d 645,
655 (7th Cir. 2001), “it is easy to assign nonexploitive rea-
sons for contractual penalties and hard to give convincing
reasons why in the absence of fraud or unconscionability
consenting adults that are, moreover, substantial organi-
zations rather than mere consumers should be prohibited
from agreeing to such provisions.” See also Lawyers Title Ins.
Corp. v. Dearborn Title Corp., 118 F.3d 1157, 1160-61 (7th
Cir. 1997); Lake River Corp. v. Carborundum Co., supra, 769
F.2d at 1288-89. The rule hangs on, but is chastened by an
emerging presumption against interpreting liquidated dam-
ages clauses as penalty clauses. MetLife Capital Financial
Corp. v. Washington Ave. Associates L.P., 732 A.2d 493, 499-
500 (N.J. 1999); Circle B Enterprises, Inc. v. Steinke, 584
N.W.2d 97, 101 (N.D. 1998); Wallace Real Estate Investments,
Inc. v. Groves, 881 P.2d 1010, 1013-14 (Wash. 1994); Rohlin
Construction Co. v. City of Hinton, 476 N.W.2d 78, 79-
80 (Iowa 1991); Pierce v. B & C Electric, Inc., 432 N.E.2d 964,
966 (Ill. App. 1982); 24 Richard A. Lord, Williston on Con-
tracts, § 65:13 (4th ed. 2004); cf. Penske Truck Leasing Co. v.
Chemetco, Inc., 725 N.E.2d 13, 20 (Ill. App. 2000); Pav-Saver
Corp. v. Vasso Corp., 493 N.E.2d 423, 427-28 (Ill. App. 1986);
but cf. Checkers Eight Ltd. Partnership v. Hawkins, supra, 241
F.3d at 563 (Illinois law).
  Whatever the strength and contours of the rule in Illinois
today, PacSci is wholly in error in arguing that a liquidated
damages clause is invalid unless it recites, or extrinsic evi-
dence shows, that the parties determined that, yes, it really
Nos. 03-1683, 03-1825, 03-2405                                  9

would be difficult to determine damages for breach after the
breach occurred. No case in Illinois or anywhere else so
holds or implies, and the rejection of the argument is
implicit in the numerous cases that hold such clauses valid
which do not contain such recitals, even when there is no
extrinsic evidence to fill the gap. See, e.g., First National Bank
v. Atlantic Tele-Network Co., 946 F.2d 516, 518, 521-22 (7th
Cir. 1991); Penske Truck Leasing Co. v. Chemetco, Inc., supra,
725 N.E.2d at 18-20; In re Graham Square, Inc., 126 F.3d 823,
828-30 (6th Cir. 1997). PacSci has tried to reverse the burden
of proof, which, as in the case of other affirmative defenses,
rests on the party resisting enforcement of a liquidated
damages clause to show that the agreed-upon damages are
clearly disproportionate to a reasonable estimate of the
actual damages likely to be caused by a breach. E.g., Weiss
v. United States Fidelity & Guaranty Co., 132 N.E. 749, 751 (Ill.
1921); Pace Communications, Inc. v. Moonlight Design, Inc., 31
F.3d 587, 594 (7th Cir. 1994); First National Bank v. Atlantic
Tele-Network Co., supra, 946 F.2d at 521-22; Pav-Saver Corp. v.
Vasso Corp., supra, 493 N.E.2d at 427; Honey Dew Associates,
Inc. v. M & K Food Corp., 241 F.3d 23, 26-27 (1st Cir. 2001);
Joseph F. Sanson Investment Co. v. 268 Ltd., 795 P.2d 493,
497 (Nev. 1990).
  The burden of proving the invalidity of the liquidated
damages clause in the contract with XCO thus remained on
PacSci and it is apparent from the nature of the breach of
contract—failing to pay patent-maintenance fees, as a pre-
dictable result of which the patents lapsed—that PacSci
failed to carry it. And breach it was; PacSci’s argument that
because it was made “responsible” for the fees it could
decide not to pay them—an interpretation that deprives the
“responsibility” clause of all force, as well as wreaking
semantic havoc (“responsibility” signifies duty, not
right)—does not merit discussion.
10                             Nos. 03-1683, 03-1825, 03-2405

   The premature lapse of XCO’s European patents exposed
XCO to competition that the patents, had they remained
valid, might well have prevented—or might not have. That
would be a costly and uncertain issue for a court to resolve.
About all the court could say would be that given the scale
of XCO’s operations, $100,000 a year from the breach to the
termination of the last patent was not an outlandish esti-
mate of the damages that XCO might sustain as a result of
PacSci’s allowing the patents to lapse. This case thus
illustrates how a liquidated damages clause can spare the
parties and the court the anxiety and expense of protracted
and uncertain remedy proceedings. Cf. First National Bank
v. Atlantic Tele-Network Co., supra, 946 F.2d at 521-22; JKC
Holding Co. LLC v. Washington Sports Ventures, Inc., 264 F.3d
459, 468 (4th Cir. 2001); Farmers Export Co. v. M/V Georgis
Prois, Etc., 799 F.2d 159, 164-65 (5th Cir. 1986).
  The element common to most liquidated damages clauses
that get struck down as penalty clauses is that they specify
the same damages regardless of the severity of the breach.
Checkers Eight Ltd. Partnership v. Hawkins, supra, 241 F.3d at
562; Lake River Corp. v. Carborundum Co., supra, 769 F.2d at
1290; M.I.G. Investments, Inc. v. Marsala, 414 N.E.2d 1381,
1386 (Ill. App. 1981); Kalenka v. Taylor, 896 P.2d 222, 228-
29 (Alaska 1995). One can see the problem: if a contract
provides that breaches of different gravity shall be sanc-
tioned with equal severity, it is highly likely that the sanc-
tion specified for the mildest breach is a penalty (that, or the
sanctions for all the other possible breaches must be inade-
quate). That would have been the case here if instead of
fixing the damages at $100,000 per year, the damages clause
had recited for example that in the event of breach PacSci
must pay XCO $500,000, period. Then if PacSci failed to pay
only the maintenance fee due six months before the last
patent expired, it would owe the same damages that it
would owe had it never paid any of the maintenance fees
Nos. 03-1683, 03-1825, 03-2405                                11

and as a result all of XCO’s patents had lapsed within a year
after the contract was signed. That isn’t how the clause
works. Instead, by proportioning damages to the remaining
life of the patents, it sanctions PacSci more heavily the
longer the life that remained to them when PacSci allowed
them to lapse. American National Bank & Trust Co. v. Regional
Transportation Authority, 125 F.3d 420, 439-40 (7th Cir. 1997);
Penske Truck Leasing Co. v. Chemetco, Inc., supra, 725 N.E.2d
at 19-20; Builder’s Concrete Co. v. Fred Faubel & Sons, Inc., 373
N.E.2d 863, 869 (Ill. App. 1978); Information Systems &
Networks Corp. v. City of Kansas City, 147 F.3d 711, 715 (8th
Cir. 1998).
   Yet the proportionality of the damages specification high-
lights by way of contrast the only halfway decent argument
that PacSci has against the validity of the liquidated dam-
ages clause. This is that the clause fails to differentiate
between different kinds of breach, some more serious than
others, as distinct from different degrees of seriousness
within a given kind. Suppose the breach had taken the form
of PacSci’s failing not to keep the patents in force but to
make a royalty payment of $1,000 when it was due. The
liquidated damages clause read literally would require
PacSci not only to pay the $1,000 but to pay $100,000 on top
of it for each year from the breach to the expiration of the
last patent. That would be pretty outlandish—depending on
the date of breach it could cost PacSci more than $1 million
though it had harmed XCO to the tune of $1,000 at
most—but it is an argument not for invalidating the clause
but for interpreting it reasonably. It is apparent from the
reference in the clause to the date of expiration of the last
patent that the $100,000 a year damages provision is
intended only for the case in which a breach by PacSci
endangers the patents. It is not intended for other breaches,
such as failure to pay agreed-upon amounts.
12                             Nos. 03-1683, 03-1825, 03-2405

  Even if the clause were read literally, and as a result
would be deemed a penalty if invoked in a case in which the
breach consisted merely of a failure to pay royalties or other
amounts due under the contract to XCO, the proper judicial
remedy would be to reform the clause to limit it to those
breaches, such as the one that occurred in this case, for
which it constituted a reasonable specification of damages.
There would be no reason to invalidate the clause in its
entirety. See United Air Lines, Inc. v. Austin Travel Corp., 867
F.2d 737, 741 (2d Cir. 1989); American Multi-Cinema, Inc. v.
Southroads, L.L.C., 119 F. Supp. 2d 1190, 1205-07 (D. Kan.
2000); 24 Williston on Contracts, supra, § 65:18.
  We turn to PacSci’s counterclaim and the connected issue
of sanctions for its filing. The district judge was correct to
reject the counterclaim. It is true that the first proprietary-
rights clause that we quoted early in this opinion is ex-
tremely broad, but it is qualified by the subsequent clause
that entitles XCO to obtain and retain new proprietary
matter, including new patents, as distinct from the patents
transferred by the agreement and the associated know-how
to enable PacSci to practice those patents as well as such
associated inventions as would enable PacSci to obtain the
maximum benefit from the patents that it was buying. Not
only is the contract reasonably clear when the two provi-
sions are read together, but XCO, which is an inventor
rather than a producer (it contracts out production), would
be unlikely to agree to give up all its future inventions for
the entire 12-year life of the contract, however remotely
related they were to the subject matter of the transferred
patents. Cf. Ingersoll-Rand Co. v. Ciavatta, 542 A.2d 879, 887,
895-96 (N.J. 1988); Dispatch Automation, Inc. v. Richards, 280
F.3d 1116, 1117-19 (7th Cir. 2002); New Britain Machinery
Co. v. Yeo, 358 F.2d 397, 405 (6th Cir. 1966). That would
pretty much put XCO out of business, as it would have no
incentive to be inventing for the benefit of PacSci without
Nos. 03-1683, 03-1825, 03-2405                               13

being compensated. There is no indication that XCO was
intending to commit corporate suicide. Contract interpreta-
tions that produce commercially unreasonable results are
disfavored, not as a matter of policy but simply because
they are implausible to impute to the parties. FutureSource
LLC v. Reuters Ltd., 312 F.3d 281, 284-85 (7th Cir. 2002); Level
3 Communications, Inc. v. Federal Ins. Co., 168 F.3d 956,
958 (7th Cir. 1999); Outlet Embroidery Co. v. Derwent Mills,
172 N.E. 462, 463 (N.Y. 1930) (Cardozo, C.J.); McMahon v.
Chicago Mercantile Exchange, 582 N.E.2d 1313, 1320 (Ill. App.
1991).
  This principle of interpretation must be used cautiously
because there is always a danger that what seems commer-
cially unreasonable to a court did not seem so to the parties.
PacSci might have tried to show that the consideration it
gave XCO for the patents was so generous in relation to the
scale, profitability, and prospects of XCO’s business that it
must surely have covered future inventions. PacSci pre-
sented no such evidence.
   But what if XCO, seeking to defeat PacSci’s contract
rights, sought a patent on a “new” invention that wasn’t
really new—that duplicated and thus infringed one or more
of the patents that it had sold PacSci—and claimed the right
to sell, use, or license the new invention? The patent would
not be granted, or if granted would be invalidated by a
court; and just the attempt to patent such an invention
would violate the requirement of good-faith dealing that
Illinois law reads into every contract. Cramer v. Insurance
Exchange Agency, 675 N.E.2d 897, 902-03 (Ill. 1996); Wolf v.
Federal Republic of Germany, 95 F.3d 536, 543 (7th Cir. 1996)
(Illinois law); Beraha v. Baxter Health Care Corp., 956 F.2d
1436, 1443-45 (7th Cir. 1992) (same).
  Under the patent doctrine of equivalents, a subsequent
inventor cannot escape a finding of infringement by point-
14                             Nos. 03-1683, 03-1825, 03-2405

ing to immaterial variations between his invention and an
already patented one. Warner-Jenkinson Co. v. Hilton Davis
Chemical Co., 520 U.S. 17 (1997); Riles v. Shell Exploration &
Production Co., 298 F.3d 1302, 1309-11 (Fed. Cir. 2002). Thus
in International Nickel Co. v. Ford Motor Co., 166 F. Supp. 551,
563-65 (S.D.N.Y. 1958), the plaintiff had a patent on “nodu-
lar iron,” an alloy that was .04 percent magnesium. Ford
began making its own version of nodular iron, which
differed from the plaintiff’s only in containing half as much
magnesium. The court held that Ford had infringed the
plaintiff’s patent; Ford’s variant was “equivalent” to the
patented product. XCO, however, points out that the
components, proportions, production methods, and so forth
specified in its new patent application differ from those in
the patents assigned to PacSci, yet PacSci made no effort to
show that the differences were immaterial and thus that
XCO was seeking to circumvent its transfer of the old in-
ventions to PacSci.
   We note parenthetically that if PacSci were challenging in
a complaint for breach of contract the validity of an issued
patent, this appeal would have to go to the Federal Circuit
rather than to this court. 28 U.S.C. §§ 1295(a)(1), 1338(a);
U.S. Valves, Inc. v. Dray, 212 F.3d 1368, 1372 (Fed. Cir. 2000);
U.S. Valves, Inc. v. Dray, 190 F.3d 811, 813-14 (7th Cir. 1999).
But a challenge to the validity of a patent made in a counter-
claim instead of a complaint is not within the Federal
Circuit’s exclusive jurisdiction, Holmes Group, Inc. v. Vornado
Air Circulation Systems, Inc., 535 U.S. 826, 829-32 (2002)—and
anyway the new XCO patent hasn’t, as far as we can tell,
been issued yet, and it may never be. PacSci rightly insists
that it is not challenging the validity of any patent (though
it confuses the issue horribly by referring to “claims con-
struction” in its reply brief, which is patent talk, though
PacSci apparently meant to refer rather to the “claims”
made in its counterclaim); it is only contending that the
Nos. 03-1683, 03-1825, 03-2405                               15

contract requires that if any patent issues it must be as-
signed to PacSci and that the filing of the patent application
shows bad faith on XCO’s part. The first argument misreads
the proprietary-rights clauses (if the invention sought to be
patented is a genuine improvement, it belongs to XCO, and
if it’s not, it’s not patentable), and the second founders on
PacSci’s failure to prove that the new invention steps on the
toes of any of the transferred patents.
  The counterclaim is thin, to say the least; it borders on the
frivolous. But it does not quite cross the line—or so at least
the district judge was entitled to conclude without being
thought to have abused his discretion. The proprietary-
rights language in the contract is not entirely clear, and
PacSci had at least some ground for suspicion that the de-
velopment of the new product was intended to circumvent
the assignment of the old patents to it. PacSci failed to
substantiate its theory, so it lost, but that does not mean that
the theory and claim were frivolous.
  The theory underlying the counterclaim has a bearing on
the issue of the validity of the liquidated damages clause,
and so we return to that issue briefly. After PacSci allowed
XCO’s European patents to lapse, a European company
called Thermocoax started selling a product that competed
with XCO’s refractory-vessel cables (the major market for
which, we said, is European), and as a result XCO’s reve-
nues plummeted by hundreds of thousands of dollars a
year. XCO used this episode to argue that the liquidated
damages clause was valid even if the clause didn’t estimate
damages reasonably at the time the contract was made,
because it estimated them reasonably at the time of breach,
and the trend in contract law is—very sensibly, as it seems
to us—to allow a showing of ex post reasonableness to save
the clause. Restatement (Second) of Contracts § 356(1) (1981);
3 Farnsworth, supra, § 12.18, pp. 309-10; Lawyers Title Ins.
16                            Nos. 03-1683, 03-1825, 03-2405

Corp. v. Dearborn Title Corp., supra, 118 F.3d at 1161-62
(Illinois law); Yockey v. Horn, 880 F.2d 945, 951-54 (7th Cir.
1989) (same); Pav-Saver Corp. v. Vasso Corp., supra, 493
N.E.2d at 427. PacSci counters that since by the time
Thermocoax entered the European market XCO was selling
the product that is the subject of its new patent application,
the lapse of its old patents could not have harmed it. But
that doesn’t follow, since we are told nothing about
Thermocoax’s product. And although the filing of a patent
application provides some protection, at least under U.S.
law, 35 U.S.C. § 154(d); 1 John Gladstone Mills III, Donald
C. Reiley III & Robert C. Highley, Patent Law Fundamentals
§ 1:38 (2d ed. 2004), the protection evaporates if the patent
is not granted. For all we know, Thermocoax’s product
would have infringed one of the old patents that had,
however, by this time lapsed through PacSci’s breach of
contract, opening the way for Thermocoax to enter the
market and clobber XCO.
  We conclude that XCO is entitled to its liquidated dam-
ages but not to sanctions and that the rejection of PacSci’s
counterclaim must stand. The judgment is affirmed in part
and reversed in part and the case is remanded to the district
court for the entry of a new judgment consistent with this
opinion.
Nos. 03-1683, 03-1825, 03-2405                            17

A true Copy:
       Teste:

                         _____________________________
                          Clerk of the United States Court of
                            Appeals for the Seventh Circuit

                   USCA-02-C-0072—5-24-04
18   Nos. 03-1683, 03-1825, 03-2405