The California Supreme Court has overturned a $200 million punitive damage award against Genentech in the City of Hope National Medical Center case.  A copy of the opinion is attached.

The San Francisco Business Times reported on the ruling as follows:

Because of the court’s decision, Genentech (NYSE: DNA) will still pay out about $475 million in the second quarter of 2008, which includes $300 million in compensatory damages and interest since the original jury decision in 2002. . . . the removal of punitive damages will save Genentech about $315 million when interest is factored in.

The suit, filed in 1999, was over a 1976 research agreement in which Genentech paid royalties to the hospital. A first trial ended in a hung jury in October 2001. In a retrial verdict in 2002, South San Francisco-based Genentech was ordered to pay $300 million in royalties and $200 million in punitive damages.

The California court’s decision will likely be viewed with a sense of relief by the California business community, which was stunned by the 2005 damage award against Genentech for breach of contract..  It is highly unusual for punitive damages to be awarded in a breach of contract case, and of course, the concern was that this decision would set a new precedent.

Bloomberg.com reported on the history of the dispute between the parties:

The dispute between Genentech and City of Hope involves a research relationship more than 30 years ago. Doctors Arthur Riggs and Keiichi Itakura, who began working under contract with Genentech in 1976, produced human insulin two years later. The contract gave Genentech, then a fledgling company, the patents on the techniques used by Riggs and Itakura. In exchange, City of Hope was to receive a 2 percent royalty on sales of products that resulted from the patents. A dispute arose over the products covered by the contract.

City of Hope said it deserved royalties from 35 patent license agreements between Genentech and 22 other companies including Shering-Plough Corp. and American Home Products Corp. The center sued Genentech for breach of contract and fiduciary duty in 1999.

Genentech said in 2002 that it owed royalty payments to City of Hope only for sales of products made using DNA produced by the center and containing the patented technology from the sponsored research. The company said it paid City of Hope more than $300 million over 20 years.

A jury ruled against Genentech and awarded City of Hope compensatory damages and punitive damages. A state appeals court in Los Angeles upheld the jury’s verdict in 2004 and the California Supreme Court agreed to review the case in 2005.

What was the basis for today’s California Supreme Court ruling?  An excerpt from the opinion explains the Court’s decision as follows:

[W]e conclude that the trial court erred here in instructing the jury that a fiduciary relationship is necessarily created when a party, in return for royalties, entrusts a secret idea to another to develop, patent, and commercially develop.  Because fidicuary duties do not necessarily arise from this type of relationship, City of Hope’s only theory at trial for claiming a fiduciary relationship with Genentech was legally invalid, and therefore the judgment against Genentech is defective insofar as it is based on the jury’s finding that Genentech breached fiduciary duties owed to City of Hope. . . . .The only other ground for the jury’s imposition of liability against Genentech was the jury’s finding that Genentech had breached its contract with City of Hope.  Because punitive damages may not be awarded for breach of contract. . . .the award of punitive damages must be set aside.

The Recorder noted in an article that it ran last fall that the case between Genentech and City of Hope had been plagued by delays:

 Both parties [in the case] had fully briefed the case by December 2005, and 21 amicus curiae briefs had been filed and responded to by April 2006. Still, the court hasn’t set an oral argument date for City of Hope National Medical Center v. Genentech Inc., S129463.

Some court watchers are baffled by how long the case has languished. . . .Other than death penalty cases, which take years to process, only two out of 135 pending California Supreme Court cases — both criminal — have been awaiting oral argument longer than City of Hope.

Why were there so many delays in this case?  The Recorder offered some possible explanations:

Paul Utrecht, a partner in San Francisco’s Zacks Utrecht & Leadbetter who filed an amicus brief supporting Genentech for the Washington Legal Foundation, said the court’s justices could be proceeding cautiously because of the money involved. . . .Utrecht also said the legal issue — whether a breach of contract rises to despicable conduct that merits punitive damages — is so important that the court might be examining the case from all angles. . . . .It’s also possible the justices haven’t decided what to do with the case, and are still trading memos in the hopes that a tentative majority will emerge.

While Genentech cannot possibly be happy with the 2005 verdict and damage award, today’s ruling will at least take the some of the sting out of the verdict.  A $200 million reduction in damages is certainly not "chump change" and will surely help with the company’s bottom line. 

For the rest of us in California, today’s decision is similarly significant because it reaffirms that punitive damages cannot be awarded in contract cases–there must be a fiduciary relationship.  More importantly, for the biotech community (and even the high tech and medical device communities in California), we now have clarification from the California Supreme Court  that licensing relationships do not establish fiduciary relationships and therefore will not  incur punitive damages if they are breached.    

The Silicon Valley Chapter of Licensing Executives Society ("LES") recently sponsored an event in whch representatives from Stanford and the University of California ("UC") offered tips on licensing with the Stanford and UC systems.  Katharine Ku of Stanford University and Viviana Wolinsky of Lawrence Berkeley National Laboratory each gave an excellent presentation, outlining their respective university’s policies and procedures, as well as some of the issues of concern currently facing each organization.  Nader Mousavi of Wilmer Hale, which hosted the event, also participated.

What were some of the insights on their employers’ respective licensing programs that the two speakers shared?

Regarding the issue of exclusive licensing terms, Ku indicated that Stanford prefers fixed terms of exclusivity.  In contrast, Wolinsky indicated that UC is generally more willing than Stanford to agree to exclusive licenses that run for the full term of the patent.

On the issue of royalty rates, the speakers agreed that the range often runs from 3 to 6 % of net sales.  Wolinsky shared that the UC system is willing to consider royalty stacking, if this is brought up in the negotiations, and that UC may be willing to reduce the royalty rate on each license to half of what would otherwise be agreed to. 

On the issue of sublicensing, the speakers agreed that a royalty based on net sales from sublicensees is the current standard for UC and Stanford license agreements, replacing the once-common standard of a royalty based on sublicense income (which, in all honesty, I have never seen used in the licensing negotations I have been involved with).  The panel advised that in cases where sublicense income is used as the standard for the sublicensing royalty rate that the following should be excluded: research and development payments, equity, patent reimbursements, other research and development materials and equipment, and the fair market value of cross-licenses. 

The speakers highlighted an important distinction in how UC and Stanford prefer to handle patent prosecution in exclusive licenses.  The UC position is that the university controls all patent prosecution, whereas the preferred Stanford position is that the licensee controls all patent prosecution.  In both cases, the universities require that the exclusive licensee pays for the costs; however, UC prefers that the licensee reimburse UC for the patent prosecution costs, whereas Stanford prefers that the licensee pay the costs directly.

How do the universities deal with patent enforcement?

Ku indicated that Stanford’s default position is that Stanford has the right to enforce the patents, and that the licensee can step in if Stanford declines to enforce the patents.  Ku further stated that if the licensee enforces the patents, any damages recovered should cover costs first and then the balance should be treated as net sales/sublicense income. 

In contrast, Wolinsky stated that UC’s default position is the same as Stanford’s position, except that any damages recovered should go to the party bringing suit. 

Both Stanford and UC require university consent prior to any settlement, and provide the right to name the university as a party for standing.

How are Stanford and UC dealing with the recent MedImmune v. Genentech decision?

UC is taking the most unforgiving position on this issue.  According to Wolinsky, the position is that UC is drafting language into the license to state that if a licensee disputes the validity of a patent, the patent terminates.

In contrast, the Stanford position is a little more tolerant: Stanford is drafting language into the license to state that if a licensee disputes the validity of a patent, the licensee has to pay all costs.

Regarding other issues in the news, both Ku and Wolinsky indicated that the universities were very concerned about the prospect of patent reform, particularly with respect to the proposed changes to the "First to File" Rule.  Ku and Wolinsky also stated that both systems were now adding export control language to their NDAs as well as licenses.  Finally, with respect to sponsored research, Ku indicated that the Stanford policy is that the university is declining to set a royalty rate for inventions arising out of sponsored research, whereas Wolinsky indicated that UC continues to agree to a royalty rate range.

All in all, Ku and Wolinsky gave a very informative presentation on current licensing policies at their respective institutions.  After attending this presentation, however, I now find myself wanting to hear more from other universities on their current policies and procedures on licensing.  So, I am formally issuing an invitation into the blogosphere to any other universities who would like to share information to prospective licensees on their current licensing policies, procedures, and negotiating strategies: please share with us any insights on licensing at your schools, and this blog will gladly provide you a platform to publish that information to the biotech and licensing community.   I welcome your commentary. 

The Medimmune v. Genentech case has received extensive media coverage since the Supreme Court decision earlier this year, but if you still have questions about the case and its anticipated impact, you should check out the recap published on IP Frontline by attorney Dennis Fernandez and college student Brian Bensch.

In their article "The Impact of MedImmune v. Genentech," the authors describe the potential implications of MedImmune as follows:

The major implication of MedImmune is that potential and current licensees will find it incredibly easier to file a declaratory judgment action. . . . After MedImmune, licensees will be able to recklessly challenge contracts knowing that the worst possible consequence is that the contract is upheld. . . .

[T]he implications of MedImmune are already taking shape. Since the MedImmune ruling only four months ago, the Federal Circuit Court of Appeals has begun to clarify the impact of MedImmune by dropping the "reasonable apprehension" clause of its subject matter jurisdiction test in its decision in SanDisk Corporation v. STMicroelectronics, Inc. . . .

 [I]n its decision on March 26 of this year, the CAFC established a new test that "holds that "where a patentee asserts rights under a patent based on certain identified ongoing or planned activity of another party, and where that party contends that it has the right to engage in the accused activity without license," the party may bring a declaratory judgment action."

In the end, the authors conclude that the impact of the ruling will be as follows:

[T]he Supreme Court’s MedImmune decision weakened the stability of both future and current licensing agreements. While the federal circuit’s precedent had been rather unambiguous, the Supreme Court accepted the circularly reasoning and exaggerated risk claimed by MedImmune and allowed it to file for declaratory judgment relief against its licensor without first ending their licensing agreement. The decision gives a blank check to licensees to challenge their licensor on patent invalidity charges if they feel they have any chance at success.

As a licensing attorney looking at this case and the subsequent San Disk ruling, I can’t help but wonder if the impact of these decisions is really going to be as severe as legal commentators are predicting.  While certainly this line of cases enables licensees to challenge licenses more easily, I question whether this will really happen with the kind of frequency you might expect from the commentary.  Is it possible that they are looking at these cases from litigator’s perspective rather than considering the business realities that would often caution against souring an otherwise cordial business relationship?

The vast majority of licensing negotiations are not done at the end of a big stick, and that there are generally sound business reasons to maintain a good relationship with the other side of the negotiating table.  While it is true that these cases make it easier for licensees to challenge a licensing relationship, I question whether it will make good business sense for licensees to do so as frequently as it has been suggested they will do.  Will licensors really want to do deals with licensees who have challenged other licensing agreements with third parties?  Will licensors really want to develop relationships with licensees who have challenged  other licensing arrangements with prior licensors? 

In the end, I suspect that the application of these cases will depend largely on the realities of the business world.  I find it hard to believe that regularly challenging license agreements will ultimately prove to be a good business strategy as the dust settles on these decisions.  I anticipate that in the end declaratory judgments will be used a little more judiciously to challenge relationships that have already soured, in much the same way that litigation and the threat of litigation have been used prior to the MedImmune ruling.  When a relationship can be managed outside of the courtroom, I continue to believe that, despite the hype to the contrary, the average licensee is going to stick with negotiation and stay away from the courts.