First published in the Solicitors Journal.
On 8 October 2021, His Honour Judge Hacon handed down his decision in Royalty Pharma Collection Trust v Boehringer Ingelheim GmbH  EWHC 2692 (Pat). The case included a claim by Royalty Pharma for underpayment of royalties by Boehringer under a patent licence and a counterclaim by Boehringer for overpayment of royalties under the same agreement.
The licence at the centre of the dispute was unusual in that it was governed by German law but provided for the courts of England and Wales to have jurisdiction over disputes. Issues of German law interpretation are beyond the scope of this article but the case nevertheless delivers an important lesson for practitioners on drafting and applying patent royalty clauses, irrespective of the governing law.
Royalty Pharma and Boehringer were party to a long-term patent licence under which Boehringer paid royalties on sales of its type 2 diabetes products containing the active ingredient linagliptin. The parties amended the royalty provisions in May 2015 and it was the effect of these 2015 amendments which were in dispute.
Since 2011, Boehringer had been paying royalties on worldwide sale of its type 2 diabetes product, including on sales made in countries where there were no licensed patents. This was despite the wording of the royalty clause which stated: “BI shall make royalty payments […] on Net Sales of Product in countries where a Valid Claim exists. […] For the avoidance of doubt, royalties will not be payable on Net Sales in a country where no Valid Claim exists.”
In May 2015, the royalty clause was amended to read: “BI shall make royalty payments […] on Net Sales of Product the development, manufacture, registration, use, import/export, marketing or offer to sell and/or sale of which, but for the Licence, would otherwise infringe a Valid Claim. […] For the avoidance of doubt royalties shall not be payable on Net Sales of Product the development, manufacture, registration, use, import/export, marketing or offer to sell and/or sale of which does not infringe a Valid Claim.”
Boehringer continued to pay royalties on worldwide sales of its type 2 diabetes products up to the third quarter of 2015.
Issues and decision in the case
One of the key issues in the case was the question of whether the 2015 amendment had changed the basis on which royalty payments were to fall due. By the time of closing, it was common ground that the original agreement did not require royalties to be paid on worldwide sales and that only sale of a product in a country with a subsisting licensed patent gave rise to an obligation to pay royalties; an act of manufacture did not. Under the original agreement, sales in countries where there was no licensed patent should not therefore have been included in Boehringer’s royalty calculation.
Royalty Pharma’s claims concerned the wording of the royalty provisions as amended in May 2015. Claiming an underpayment of royalties of around EUR 23 million, Royalty Pharma argued that from the May 2015 amendment, royalties were due on Boehringer’s manufacture of linagliptin in Germany (which infringed the licensed German designation of European Patent No. 1 084 705). On Royalty Pharma’s construction, Boehringer owed royalties on worldwide sales of all products manufactured in Germany. Importantly, all of the linagliptin in Boehringer’s products was manufactured in Germany. Whether EP 705 was infringed was also at issue in the case although this point is beyond the scope of this article.
Boehringer argued to the contrary; that the 2015 amendment did not change the events which triggered the payment of royalties and counterclaimed for an overpayment of royalties.
After considering the issues and applying German law principles of contractual interpretation, His Honour Judge Hacon held that the manufacture of linagliptin in Germany required payment of royalties under the amended licence. The royalties were to be paid by reference to Boehringer’s sales of products containing the linagliptin manufactured in Germany, irrespective of where those sales took place. Royalty Pharma therefore succeeded in its claim for underpayment of royalties under the amended agreement.
This decision delivers an important reminder for patent licensing practitioners to bear in mind when agreeing and drafting the basis on which patent royalties will be calculated.
Agreeing the basis on which royalties will be paid: Royalties under patent licences are typically calculated as a percentage of sales. However, which sales are counted is a commercial point with significant scope for negotiation and in practice, there is not one universally accepted approach.
Generally, licensees favour paying royalties only on sales of the product which infringe a licensed patent in the country of sale (regardless of the patent status in the country of manufacture). This approach can give a licensee more freedom to choose a manufacturing location and can mean that the licensee can avoid paying royalties (or pay a lower rate) on sales in countries where there is no licensed patent, even where there is a patent in the country of manufacture.
Licensors however, sometimes want to capture royalties on worldwide sales of products which are manufactured in a country where there is a licensed patent (as was the case in Royalty Pharma). Licensees often resist this approach, not only because of the potentially higher royalty burden but because from an administrative perspective it can be difficult to manage. It can require sophisticated tracking and record keeping systems, particularly where the licensee has manufacturing operations in multiple countries.
The extent to which the distinction between these approaches is meaningful will depend on a number of issues such as the geographical scope of the licensor’s patent portfolio, patent expiry dates, and the countries in which the licensee intends to manufacture and sell the licensed products. Often, these points are not clear at the time the parties enter into the licence and may only come into focus years later as patents begin to expire.
Ensure the licence agreement accurately reflects the deal and take care with amendments: A key part of a lawyer’s role is to ensure that provisions accurately reflect client’s instructions. Patent licence royalty provisions can be complex, often with multiple sub-clauses and relevant definitions which all need to work together. Practitioners should consider, for example, whether definitions of “Product”, “Net Sales”, “Valid Claim” and “Royalty Term” (or similar) are consistent when read in the context of the royalty provisions. Is it clear whether royalties are calculated on a country-by-country basis? Does the definition of “Royalty Term” also reflect this? This is just one of many points that should be considered. Similarly, when amending an existing agreement, it is crucial that the amendments are read in the context of the agreement as a whole to ensure that they do not introduce inconsistencies.
Ensure all stakeholders understand the basis on which royalties will be calculated: At the heart of this case seems to have been a fundamental misunderstanding by a licensee about the basis on which royalties should have been calculated. Even before the 2015 amendment, Boehringer had been miscalculating (and therefore overpaying) royalties by using worldwide sales figures. This highlights the importance of ensuring that everyone with responsibility for calculating royalty payments is familiar with the obligations under the relevant licence and that the agreement is not simply stored away, only to be looked at in the event of a dispute. When advising on complex documents, such as patent licences, it can be helpful for lawyers advising on the deal to prepare a contract summary, focusing on key points (such as royalty obligations), and including some “real world” worked examples.
As this case highlights, misunderstandings as to the effect of legal drafting (or even ignorance of the terms of an agreement) can lead to costly disputes. Patent licence royalty provisions are multifaceted and require careful structuring to adequately reflect the numerous legal and commercial issues at play (of which geographical basis for royalty payments is but one of many). Practitioners, therefore, have a crucial role to play in ensuring documents are drafted in clear terms; reflect agreed positions and that implications of complex drafting are well understood by our clients.