Royalties and Marvel Entertainment

Sometimes funny little cases that don’t make the news contain interesting lessons if we take the time to think about them.  One such case decided by the Supreme Court this last June is Kimble v. Marvel Entertainment which takes up the question of whether patent licenses can be written to keep royalties flowing even after the patent has expired.

Imagine you are a small company needing access to expensive patented technology.  The patent will expire in five years and the cost of a five-year license is a million dollars.  Well, ideally you’d pay $200,000 a year for five years to use the technology, but what if you don’t have the cash?  What if you are a struggling start-up and cannot come up with a million dollars so quickly?  Well, you might want to suggest a payment plan that takes more time to pay off, just as homeowners do when they finance a house for 30 years instead of 5.  The start-up company and the technology owner might rationally agree to stretch out payments over a longer period than five years as a financing mechanism.  One way to do this would be for the start-up to pay a small amount up front and then agree to pay a reasonable royalty every year for the use of the technology.

Does such an agreement sound nefarious?  Well, in 1964 the Supreme Court in Brulotte v. Thys held that royalty agreements that exceed a patent’s term length are per se illegal and unenforceable.  Economists have been howling about the case ever since.

Well, the Supreme Court was asked to reconsider Brulotte last June in a case involving a patent license on a Spiderman toy that was written to exceed the length of the toy’s patent.  We economists in-the-know predicted the Court would reverse the silly rule in Brulotte, especially since the case presents an added reason to enforce such agreements.

In Kimble v. Marvel Entertainment, the patentee is actually the little guy, an independent inventor licensing to a multi-billion-dollar media group.  Marvel paid Kimble a fixed sum up front and then agreed to pay a 3% yearly royalty on sales of the toy with no fixed end date.  Now, why would Marvel engineer such a deal when it certainly has the cash to pay for the entire value of the invention from day one?  Well, think about . . . how can anyone really know the present value of the invention?  How many toys will be sold?  Will it be a flop or a hit?  With most patents you have extreme valuation problems before you actually try to make and sell a product.  Of course, one way to rationally deal with this uncertainty is to enter into a long-term royalty agreement rather than an outright sale.  That way, the risks of success or failure are shared between the parties over time.

Sound reasonable?  Well, unfortunately for Mr. Kimble, a lawyer at Marvel ran across the old Brulotte case and argued that Marvel did not have to honor the royalty agreement once the patent expired.  The case made its way to the Supreme Court with economists cheering all way for the Court to throw water on the old wicked witch of Brulotte v. Thys.

But funny thing happened.  The Court acknowledged the uniform economic condemnation of Brulotte, if not its silliness, but refused to overrule the case.  Legal economists were especially shocked because the reasoing in Brulotte itself was so odd.  There is nothing in the patent law, for example, about how long royalty agreements can run, and it’s always seemed a very shaky case.

Nonetheless, the Court held firm and told Marvel that it can stop paying Mr. Kimble when the patent expires.  Stare decisis, it said, the doctrine embodying the force of legal precedent, means that the Court should only reverse itself in extraordinary circumstances.

How come?  Well, stare decisis is also a way for the Court to paint itself as an institution bound by existing law, not an institution that is authorized to search for the best policy.  Stare decisis assures institutional integrity and the image of objective decision-making, something the Court badly needs to communicate after Citizens United (which inflamed liberals by holding that corporations have First Amendment rights) and Obergfell (which inflamed conservatives by establishing marriage equality).

Our funny little patent case may in fact be a little piece in a larger story about how the Court intends to rebuild its image as a legal institution.