No-Contest Clause in Pre-Litigation Settlement Unenforceable

In Natural Alternatives International, Inc. v. Allmax Nutrition, Inc., No. 16-cv-01764-H-AGS (S.D. Cal., June 26, 2017), the Southern District of California held that a clause barring a licensee from contesting the validity of a patent in a pre-litigation settlement or license agreement is unenforceable.

Plaintiff Natural Alternatives International owns patents on dietary supplements. Defendant Allmax sells dietary supplements that allegedly infringed Plaintiff’s patents. The parties entered into two license agreements, one in 2014 and one in 2016. Each agreement included a provision stating that Defendant would not contest the validity of Plaintiff’s patents. In the present litigation, Defendant offered an affirmative defense and counterclaim that the asserted patents were invalid. Plaintiff filed a Rule 12(c) motion for judgment on the pleadings, asserting that the 2014 and 2016 agreements prevent Defendant from contesting the validity of the patents.

Licensee Estoppel

The controlling case for licensee estoppel is Lear v. Adkins, where the Supreme Court held that a licensee of a patent is not estopped from challenging the validity of a licensed patent even if the license agreement includes a no-contest clause. However, the Federal Circuit held in Baseload Energy, Inc. v. Roberts that certain settlement agreements that include clauses preventing licensees from challenging the validity of an asserted patent are enforceable under Lear.

The scope of this “settlement agreement exception” to Lear is the primary question discussed by the Court. Particularly, Baseload involved a settlement agreement reached after litigation had occurred, while the present 2014 and 2016 agreements between Plaintiff and Defendant were drafted before any litigation on the asserted patents. Plaintiff argues that the 2016 agreement qualifies for the settlement agreement exception held in Baseload. Defendant argues that the settlement agreement exception only applies to post-litigation settlements.

Federal Circuit precedent governs whether an agreement bars a party from challenging the validity of a patent. However, the Court relied on a Second Circuit Court of Appeals case, Rates Tech. Inc. v. Speakeasy, Inc., as persuasive authority, which held that a no-contest clause contained in a pre-litigation settlement is unenforceable under Lear. The Court held that Baseload was narrowly focused on a post-litigation settlement agreement, and that the Federal Circuit has thus never considered whether a pre-litigation settlement qualified for the settlement agreement exception. The Court then could rely on Rates Tech., and held that the no-contest clauses in the 2014 and 2016 agreements were unenforceable, and Defendant could bring an affirmative defense of invalidity.

Lessons for Practice

Because the scope of the settlement agreement exception to licensee estoppel has been narrowed to post-litigation settlements, litigators should reconsider the use of no-contest clauses for patents in licenses and settlements. In at least the Second and Ninth Circuits, courts have narrowed the Federal Circuit’s holding in Baseload, and until the Federal Circuit revisits the settlement agreement exception (if ever), patentees should not rely on no-contest clauses to prevent invalidity challenges to asserted patents.

No-Contest Clause in Pre-Litigation Settlement Unenforceable

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