Kimble v. Marvel Enterprises: Supreme Court Clarifies Intellectual Property Contracts in Spider Man Dispute
If you weren’t careful in drafting that patent royalty or licensing agreement, the Supreme Court just confirmed the intrinsic value of your cash flow stream is a lot smaller than you thought following its refusal to overturn an older decision from the 1960s.
That is particularly important for this community because intellectual property is a major source of passive income for several of the people who read this blog. It certainly played a crucial role in Aaron and my early years when we relied disproportionately on it and what we refer to as a form of synthetic equity. The legal, tax, and regulatory frameworks for patents, trademarks, copyrights, royalties, and other streams of cash is particularly important to investors who operate in this arena as seemingly small clarifications or modification in payout structures can mean the difference between lifetime financial independence and bitterness as a bigger, better capitalized rival enriched itself further on your work without adequate or fair remuneration.
In case you missed it, here’s what happened. Following the Horne v. Department of Agriculture decision, which was a major win for personal property right against government confiscation without compensation, the Supreme Court released its decision in a dispute involving Spider Man. The case: Kimble v. Marvel Enterprises. To save time, permit me to quote the summation of facts from the Supreme Court majority opinion, penned by Justice Kagan:
In 1990, petitioner Stephen Kimble obtained a patent on a toy that allows children (and young-at-heart adults) to role-play as “a spider person” by shooting webs—really, pressurized foam string—“from the palm of [the] hand.” U. S. Patent No. 5,072,856, Abstract (filed May 25, 1990). Respondent Marvel Entertainment, LLC (Marvel) makes and markets products featuring Spider-Man, among other comic-book characters. Seeking to sell or license his patent, Kimble met with the president of Marvel’s corporate predecessor to discuss his idea for web-slinging fun. Soon afterward, but without remunerating Kimble, that company began marketing the “Web Blaster”—a toy that, like Kimble’s patented invention, enables would-be action heroes to mimic Spider-Man through the use of a polyester glove and a canister of foam.
Kimble sued Marvel in 1997 alleging, among other things, patent infringement. The parties ultimately settled that litigation. Their agreement provided that Marvel would purchase Kimble’s patent in exchange for a lump sum (of about a half-million dollars) and a 3% royalty on Marvel’s future sales of the Web Blaster and similar products. The parties set no end date for royalties, apparently contemplating that they would continue for as long as kids want to imitate Spider-Man (by doing whatever a spider can).
And then Marvel stumbled across Brulotte, the case at the heart of this dispute. In negotiating the settlement, neither side was aware of Brulotte. But Marvel must have been pleased to learn of it. Brulotte had read the patent laws to prevent a patentee from receiving royalties for sales made after his patent’s expiration. See 379 U. S., at 32. So the decision’s effect was to sunset the settlement’s royalty clause.2 On making that discovery, Marvel sought a declaratory judgment in federal district court confirming that the company could cease paying royalties come 2010—the end of Kimble’s patent term. The court approved that relief, holding that Brulotte made “the royalty provision . . . unenforceable after the expiration of the Kimble patent.” 692 F. Supp. 2d 1156, 1161 (Ariz. 2010).
1 Petitioner Robert Grabb later acquired an interest in the patent. For simplicity, we refer only to Kimble.
2 In Brulotte, the patent holder retained ownership of the patent while licensing customers to use the patented article in exchange for royalty payments. See 379 U. S., at 29–30. By contrast, Kimble sold his whole patent to obtain royalties. But no one here disputes that Brulotte covers a transaction structured in that alternative way.
The Brulotte decision mentioned was Brulotte v. Thys Co., a case the Supreme Court decided on November 16th, 1964. The court, at that time, ruled:
The Constitution by Art. I, § 8 authorizes Congress to secure “for limited times” to inventors “the exclusive right” to their discoveries. Congress exercised that power by 35 U.S.C. § 154, which provides in part as follows:
“Every patent shall contain a short title of the invention and a grant to the patentee, his heirs or assigns, for the term of seventeen years, of the right to exclude others from making, using, or selling the invention throughout the United States, referring to the specification for the particulars thereof. . . . ”
The right to make, the right to sell, and the right to use “may be granted or conferred separately by the patentee.” Adams v. Burke, 17 Wall. 453, 84 U. S. 456. But these rights become public property once the 17-year period expires. See Singer Mfg. Co. v. June Mfg. Co., 163 U. S. 169, 163 U. S. 185; Kellogg Co. v. National Biscuit Co., 305 U. S. 111, 305 U. S. 118. As stated by Chief Justice Stone, speaking for the Court in Scott Paper Co. v. Marcalus Mfg. Co., 326 U. S. 249, 326 U. S. 256:
“. . . any attempted reservation or continuation in the patentee or those claiming under him of the patent monopoly, after the patent expires, whatever the legal device employed, runs counter to the policy and purpose of the patent laws.”
In light of those considerations, we conclude that a patentee’s use of a royalty agreement that projects beyond the expiration date of the patent is unlawful per se. If that device were available to patentees, the free market visualized for the post-expiration period would be subject to monopoly influences that have no proper place there.
The theory behind this philosophy, and the reasons the founders put restrictions on intellectual property, is easy to understand. Imagine if this were not the case and inventions never made it into the public domain! One example: Every light bulb manufacturer in the world would still need to pay royalties to the heirs of, or corporate successor to, Thomas Edison! More likely, the patent holder wouldn’t allow others to manufacture at all, but charge substantially inflated prices for light bulbs as they now had a monopoly on what has become a basic necessity. (It’s actually a bit more complex but you get the idea. Those of you who are interested in corporate conspiracies, look into the light bulb trusts that were setup around the world, giving early control to certain cartel members in certain geographic areas; cartel members who were held to planned obsolescence standards to make sure the products weren’t too reliable.) Stoves, bookcases, chairs … concepts that we inherited as a sort of shared intellectual toolbox from our ancestors would result in payments going to some sort of aristocracy as each and every new invention created a never-ending right to sue someone who might, purposely or accidentally, infringe upon something you happened to register with a government agency first. It would be an economic, social, and political nightmare. The trick is to strike a balance between permitting a long enough artificial monopoly that content and idea creators are compensated fairly, and short enough that the work makes it into the hands of everyone, who can improvise, build upon, modify, and improve it.
Inherent in this framework is the notion that you cannot license or sell what you do not own. The moment a patent enters the public domain, it belongs to everyone. To demonstrate the concept, imagine you tried to license the rights to fairy tale Hansel and Gretel. One of your family members agrees to pay you $100,000 a year. The IRS isn’t going to let it happen. They’re going to say the $14,000 per annum gift tax exclusion was exceeded by $86,000; that the transaction was a disguised gift because no exchange occurred so the differential needs to either be applied to the lifetime exclusion the “buyer”, in this case, has remaining in his or her estate, or a gift tax paid at present. It’s not a particularly difficult concept. The Brulotte court essentially clarified this, saying you can’t pay royalties to someone on property he, she, or it doesn’t own, meaning royalty agreements extending beyond patent expiration can’t exist. They are an impossibility as a matter of law.
What Kimble Was Hoping to Accomplish in the Marvel Case
What, then, were the people rooting for Kimble hoping to achieve? The goal was a full-out Lawrence v. Texas declaration as it pertained to Bowers v. Hardwick in the now-famous smack-down of a particularly bad past Supreme Court decision in which the majority declared, “Bowers was not correct when it was decided, and it is not correct today. It ought not to remain binding precedent. Bowers v. Hardwick should be and now is overruled.”; for the court to say, “We screwed up badly back in the 1960s, which economic history has subsequently shown, so we’re going to fix the mistake now.” Kimble believed that a private contract, entered into by the parties involved of their own free will for their mutual benefit, calling for a perpetual 3% royalty share to the creator in exchange for selling the then-valid and in force patent, was constitutional.
There were also matters of basic fairness. One can argue that the expectation of a perpetual payment was a core part of the valuation of the contract itself, without which he never would have agreed to give up the patent and in exchange for which Marvel benefited by having years of exclusivity, establishing dominance. There are economic arguments. For example, many products which might be manufactured on a test-market basis, which turn out to be huge hits, are only possible due to royalty sharing arrangements as no sane manufacturer would dump large up-front cash payments for unproven goods and services. If you own a toy company, you might agree to give a person a bit of cash plus a cut of sales for some new board game, but you’d never pay him millions of dollars before the first unit was sold as you might be lucky to sell five hundred copies. This risk-reward split is good for society. More products go to market. Companies, entrepreneurs, and investors can gamble on more ideas to see what gets consumer acceptance. If the product becomes a mainstay, the inventor gets a never-ending stream of checks alongside the manufacturer, who can’t just cut them off and keep all of the profits itself once some magic date has been crossed.
The decision was 5-4. The majority disagreed with Kimble, saying that even if it was unfair, it was not going to invalidate Brulotte for the sake of adhering to stare decisis; deferring to legal precedent for the sake of consistency, clarity, and stability. The court said that the arguments very well could be convincing, right even, but that it was the job of the legislature, not the courts, to change the patent laws to reflect those beliefs; to explicitly state that royalty streams negotiated at the time of valid patents could extend beyond patent expiration.
Justice Alito, who wrote the dissent, wasn’t having any of it. He thought the whole thing was nonsense, the court’s prior decision so glaringly bad that it needed to be overturned, and the idea that private parties couldn’t negotiate royalty agreements among themselves based on their own interpretation of the relevant market factors, even if it meant paying for something beyond the period at which it had entered the public domain, idiotic, saying:
The Court employs stare decisis, normally a tool of restraint, to reaffirm a clear case of judicial overreach. Our decision in Brulotte v. Thys Co., 379 U. S. 29 (1964), held that parties cannot enter into a patent licensing agreement that provides for royalty payments to continue after the term of the patent expires. That decision was not based on anything that can plausibly be regarded as an interpretation of the terms of the Patent Act. It was based instead on an economic theory—and one that has been debunked. The decision interferes with the ability of parties to negotiate licensing agreements that reflect the true value of a patent, and it disrupts contractual expectations. Stare decisis does not require us to retain this baseless and damaging precedent.
The Patent Act provides that a patent grants certain exclusive rights to the patentee and “his heirs or assigns” for a term of 20 years. 35 U. S. C. §§154(a)(1) and (2). The Act says nothing whatsoever about post-expiration royalties. In Brulotte, however, the Court held that such royalties are per se unlawful. The Court made little pretense of finding support for this holding in the language of the Act. Instead, the Court reasoned that allowing post-expiration royalties would subject “the free market visualized for the post-expiration period . . . to monopoly influences that have no proper place there.” 379 U. S., at 32–33. Invoking antitrust concepts, the decision suggested that such arrangements are “an effort to enlarge the monopoly of the patent by t[y]ing the sale or use of the patented article to the purchase or use of unpatented ones.” Id., at 33.
Whatever the merits of this economic argument, it does not represent a serious attempt to interpret the Patent Act. A licensing agreement that provides for the payment of royalties after a patent’s term expires does not enlarge the patentee’s monopoly or extend the term of the patent. It simply gives the licensor a contractual right. Thus, nothing in the text of the Act even arguably forbids licensing agreements that provide for post-expiration royalties.
Brulotte was thus a bald act of policymaking. It was not simply a case of incorrect statutory interpretation. It was not really statutory interpretation at all.
My Thoughts on Kimble v. Marvel Enterprises
I am so incredibly torn on this particular case for a number of reasons. This would not have been an easy decision for me were I on the court because I’m not even sure how I feel about intellectual property restrictions in general, let alone the proper interpretation of them in a constitutional framework. As someone who benefits tremendously from IP over the years, both directly and indirectly, my own incentives as a content creator and someone who invests in content creators makes me think they’re good things. On the other hand, a rich public domain has long been considered a fundamental human right to some degree; that you cannot own ideas as we all benefit from having them out there, accessible to us and we must, at some point, draw a line beyond which we say, “No. You can go no further.” Sure, it sucks for Kimble but 1.) He arguably should have known the law at the time he entered into a legal contract pertaining to it, 2.) It’s not like he’s going to live in poverty as he’s been paid more than $6,000,000 on top of the upfront roughly $500,000 he got at the start of the deal, and 3.) there’s a broader public policy issue at play, far beyond justice in this individual case.
For example, many, if not most, of Disney’s own hits were based on folk stories. The billions of dollars being made from Elsa and Anna dolls, DVDs, downloads, soundtrack sales, toys, backpacks, bedspreads, costumes, wigs, and more were inspired by The Snow Queen, a story originally titled Snedronningen and penned by Hans Christian Andersen in 1844-1845 after his romantic advances were rejected by a cold-hearted opera singer. Walt Disney has been dead for generations. At what point does his work, like Andersen’s, belong to everyone? How long should it be until Mickey Mouse is treated like The Snow Queen or The Little Mermaid? It’s an interesting problem with trillions of dollars in aggregate and cumulative economic activity at stake.
And where it gets really tricky? Software. The situation in technology at the moment (really for the past decade or two) is absurd. Major corporations, backed by cash from IPOs, private equity funds, and retained profits from existing operations, gobble up multi-billion dollar patent portfolios just to have some mechanism to sue any and every upstart that threatens their business; a terrible outcome for civilization that kills innovation, hurting us all. Of course, the legislature would be perfectly free to change the rules for software in isolation given the rapidity with which the industry changes (e.g., software patents could only last for 60 months or something). That may not be such a bad idea.
I just don’t know. My gut sides with Alito and the dissenters. If someone wants to willingly enter into a contract, they should be able to do it, even if it means they bear a legacy cost beyond which their competitors would bear in exchange for having the first rights to market. I also think the technical side of it matters, too, even though in a just society it probably shouldn’t. In the majority opinion, they think there is no real economic distinction from Brulotte, where the patent was licensed, and Kimble, where the patent was sold. I’m not sure I agree. Kimble gave up ownership of the patent, transferring it to Marvel in exchange for compensation. That compensation included a contract right to a perpetual royalty on anything they manufactured using the technology listed in that patent. Whether the patent remained in force or not is not particularly consequential as Kimble now has no ownership in the patent at all, but, instead, holds a contract in which Marvel promises to give him a cut of sales. The economic outcomes might be similar but I see them as two fundamentally different things.
On the other hand, the founders, particularly as it pertains to things like copyrights and patents, placed a high enough value on public domain entry they thought it was worth mentioning in the constitution itself along with the right to bear arms, the right to control the currency, and the mechanism of calling a constitutional convention. Congress can fix this. Congress can clarify this. Let them do it.
The one thing of which I am certain has to do with the financial side of it: If you hold a patent, and want to negotiate a royalty contract, account for an end termination date in your valuation. The cash flows cannot be valued as a perpetuity. This means you’re going to have to substantially increase the upfront payment component, or the percentage royalty rate itself, which very well might kills deals you otherwise could have made. The court just reiterated that a major negotiation tool remains out of your toolbox, even if both parties agree to it in a free market transaction.
The more I think about it, though, the more I’m convinced you could setup a new LLC through which the activity itself was conducted, with non-dilutable equity interests given to both parties, then have a minimum purchase quota and exclusive right to manufacturer certain products somehow signed between the acquirer and the patent owner that achieved the same economic ends but would stand up to the decision; a sort of technical loophole akin to how I’m convinced you could get past the FAFSA rules for extended family members using silent trust funds. I need spend time working through it because I feel like the answer is right there, just out reach, slightly lit in the dark.
I encourage you to read the decision yourself [PDF] to come up with your own opinion about what should be done given the facts. This is a tricky, tricky thing. The whole issue leaves me feeling dissatisfied because it’s not a matter of right and wrong, it’s a matter of weighing priorities and benefits for different parties.