No-Challenge Clause in Settlement is Enforceable

Loops LLC v Maxill Inc 2020 ONSC 5438 Lederer J: Swinton, Penny, JJ revg 2020 ONSC 971 Templeton J

            2,577,109 / Toothbrush

This interlocutory motion concerns the enforceability of a “no-challenge” clause in a settlement agreement. It also indirectly raises the question of whether Canadian law should follow the decision of the US Supreme Court in Lear Inc v Adkins 395 US 653 (1969) and abolish the doctrine of “licensee estoppel,” which (more or less) prevents a licensee from challenging the validity of the licensed patent. At first instance Templeton J held that the no-challenge clause at issue was not enforceable (see here). In this appeal, Lederer J, for a unanimous panel of the Ontario Divisional Court, reversed, holding that a no-challenge clause in a settlement agreement is indeed enforceable according to its terms. At the same time, he left the door open to the possibility that Lear might be followed in a different context as part of the incremental evolution of the law; my sense is that he did not particularly favour such a development, but was simply concerned not to decide any more than was necessary to dispose of this motion.

In this post, I will summarize Lederer J’s decision. I agree entirely with his reasons, both in the substantive analysis and in his balanced approach to legal change. In two subsequent posts I will address issues that are raised by the decision, but which go beyond what was required by this appeal. My next post will review the Anglo-Canadian law and argue that there is no such thing as licensee estoppel; more precisely, “estoppel” is a very unhelpful label for a doctrine grounded entirely in contract law and not on any kind of equitable principle. In my third post I will argue that Lear is not sound as a matter of policy and should not be followed in any context, even as a part of a more incremental development of the law.

Facts

Loops and Maxill are in the toothbrush business. In 2012 Loops sued Maxill in Canada for infringement of Loops’ 109 patent. Two years later they reached a global settlement, which contained a “no-challenge” clause stating that Maxill would not “directly or indirectly assist any person attacking the validity” of either the Canadian 109 patent or the corresponding US Patent 8,448,285 [3]–[5], [ONSC 971/15]. Maxill then created another toothbrush to try to design around the 109 patent. In 2015 Loops sued Maxill in Canada over the new toothbrush, this time for breach of the Agreement [7], [ONSC 971/20]. In 2017 Loops also sued Maxill in the US, alleging the same new toothbrush infringed the US 285 patent [9]. Shortly thereafter, a US subsidiary of Maxill, Maxill (Ohio), brought an action seeking a declaratory order that the 285 patent was invalid [10]. The US actions were consolidated in Washington [11]. The result of the US consolidation is that Maxill itself was attacking the validity of the US patent, notwithstanding the no-challenge clause in the settlement agreement; under Lear, as interpreted in the US 9^th Circuit (which includes Washington), the no-challenge clause is unenforceable [ONSC 971/62]. Loops then brought this Canadian motion for an interlocutory injunction prohibiting Maxill from challenging the validity of the US 285 patent in the US litigation, on the basis that this was a breach of the no-challenge clause in the Agreement [ONSC 971/1]. In effect, Maxill is seeking a partial anti-suit injunction to enforce the no-challenge clause in the settlement agreement.

Because the injunction sought involved the enforcement of a restrictive covenant, this required Loops to make out a “strong prima facie case” on the merits [15]. In the decision under appeal, Templeton J held that Loops had failed to make out a strong prima facie case, for three reasons, the first two of which are largely peculiar to the case. The Divisional Court reversed on all points.

Issues peculiar to the case

First, Templeton J held that Maxill had not breached the settlement agreement because only Maxill (Ohio) was a party to the US action, not Maxill itself [ONSC 971/22, 28, 43]. Lederer J reversed, as Templeton J was simply mistaken in thinking that Maxill itself was not a party to the US litigation [21], [22]. In the US pleadings, Maxill itself alleged that the US patent was invalid [25]–[31].

Second, Templeton J’s interpretation of the no-challenge clause was wrong. She had adopted a very technical and restrictive interpretation, to the effect that because of a couple of missing words, the clause did not restrict Maxill’s own actions but only prevented it from assisting another in attacking the patent [40], [ONSC 971/44–56]. This was not a position advanced by either of the parties before Templeton J and on appeal, they agreed her interpretation was wrong [40]. In the Divisional Court, Maxill argued that the clause prevented Maxill from directly attacking the validity of Loops’ patents, but not from raising invalidity as a defense in a patent enforcement proceeding [37]. Lederer J rejected this argument, noting that it would render the clause “largely meaningless”; even if Maxill were prevented from bringing an impeachment / declaratory judgment action, it could achieve the same result by simply infringing and waiting for the Loops to sue.

On this issue, one simple point made by Lederer J is worth emphasizing:

From Loops’ perspective, the point of the arrangement was to ensure that if there was a breach, it would not be open to the Maxill interests to rely on the patents being invalid as part of their defence to any allegation of infringement.

Templeton J’s strained interpretation of the no-challenge clause was evidently driven by a hostility to such clauses. Lederer J, on the other hand, is concerned to interpret the agreement in a way that will give it practical business efficacy, as with any other contract.

Licensee estoppel

In light of his conclusions on the first two points, Lederer J concluded that there was a strong prima facie case that Maxill was in breach of the clear and unambiguous no-challenge clause in a binding contract [45]. The question then was whether the no-challenge clause was enforceable. In the context of an interlocutory injunction, this turns on whether it is reasonable in the public interest: [48]; Tank Lining Corp 1982 CanLII 2023 (ON CA). Templeton J had held that it was not, relying primarily on Lear Inc v Adkins, which abolished the doctrine of licensee estoppel in US law, and MCA Sign Co v Golden State Advert Co 444 F2d 425 (9th Cir, 1971), which extended Lear v Adkins to settlement agreements: [ONSC 971/57–71].

I’ll discuss Lear in more detail in a subsequent post, but in brief, in 1952 Lear hired Adkins to solve a “vexing problem” that Lear had encountered in developing an improved navigational system that was needed for the increasingly demanding requirements of the aviation industry. Adkins found a good solution. He applied for a patent, which was ultimately granted. At the same time Adkins granted Lear a licence to use the “patented or patentable” invention disclosed in the application. During prosecution of the patent Lear came to the conclusion that the patent was invalid. Lear then refused to pay and Adkins sued for royalties owing under the agreement. The Supreme Court of California held that Lear had not validly terminated the agreement; that it did continue to use the invention; and that Lear, as a licensee, was estopped from challenging the validity of the patent. Only the third point was at issue on appeal to the Supreme Court (the first two being a matter of state law). The Supreme Court abolished the doctrine of licensee estoppel, in light of “the important public interest in permitting full and free competition in the use of ideas which are in reality a part of the public domain” [53]. Lear is distinguishable from the case at hand in two respects. First, there was no express “no-challenge” clause in the contract between Lear and Adkins [54], and second, Lear concerned an action on the original licence agreement, and not in respect of a settlement agreement. However, in MCA Sign, the 9^th Circuit extended Lear to hold that an express no-challenge clause in a settlement agreement is unenforceable: [55]–[56].

Finding all this persuasive, Templeton J concluded [49], [ONSC 971/70]:

In a contract that includes a “No-challenge clause”, the price to pay by one party is access to a potentially valid legal position that has potential to affect the public at large. In my view, that price is simply too high if public trust and confidence in the administration of justice are to be maintained.

Lederer J noted that Templeton J did not rely on any evidence to support this conclusion, but only caselaw, and indeed, only US case law [51].

While Templeton J had not been provided with any binding Canadian authority on this issue [ONSC 971/61], Lederer J noted that in fact Lear had in fact twice been considered by Canadian courts, and twice rejected [58]–[61]. Moreover, there are many Canadian cases confirming the licensee estoppel principle [62]. (I’ll discuss this further in my next post, but for now I will simply say that I have reviewed all these cases, and more, and the Anglo-Canadian jurisprudence is entirely consistent on this point.)

Lederer J did not rule out the possibility that the law might develop in the direction suggested by Lear, perhaps in a case in which the no-challenge clause is found in the original licence agreement [64], or, I might add, in a case in which there is no “no-challenge” clause at all. But it is quite another matter to hold unenforceable a no-challenge clause that was part of a settlement signed to end litigation which explicitly addressed the validity of the applicable patents [64], [67], [70], [72]. The effect of Templeton J’s decision “is to overtake the process and foreclose evolution of the issue that the process, if followed, would typically direct” [64]. Indeed, the extension of Lear to settlement agreements in contentious even in US law, where Lear is directly binding. While MCA Sign represents the law in the 9^th Circuit, in Flex-Foot, Inc v CRP, Inc, 238 F3d 1362 (Fed Cir 2001) the Federal Circuit held to the contrary a no-challenge clause in a settlement agreement to be enforceable, notwithstanding Lear, and some other US jurisdictions have followed [68].

Finally, Lederer J held that the remaining branches of the test for an interlocutory injunction, namely irreparable harm and the balance of convenience, also favoured Maxill [74]–[80], and consequently he granted an order prohibiting the Maxill from challenging the validity of the US 285 either directly or indirectly [83]; that is, Maxill is prohibited from raising invalidity in the US infringement action.

Future developments?

In summary, Lear v Adkins abolished the doctrine of licensee estoppel in the context of a licence agreement which did not contain an express no-challenge clause. To adopt Lear even on similar facts would require overruling a substantial body of well-established Canadian law. There is another step to extend Lear to a licence that does have an express no-challenge clause, and another step again to extend it to a settlement agreement with an express no-challenge clause. The persuasive authority of Lear v Adkins, such as it might be, certainly does not warrant that kind of a leap.

Lederer J noted that in Asturiana (1979) 55 CPR(2d) 131 one of the cases that had rejected Lear, the judge had nonetheless “expressed some sympathy for that idea, noted that the Supreme Court of Canada had not yet ruled on the matter and recognized that the Court of Appeal might be inclined to a fresh look” [63]. Lederer J acknowledged that the law implied that the law can change through an evolutionary process [64]. His decision therefore did not close the door entirely on Lear v Adkins, but rather suggested that if the law is to change, it will do so incrementally, starting with a case where the argument against licensee estoppel is much stronger on the facts.

With that said, I do not read Lederer J’s decision as evincing much sympathy for such a development. For example, after holding unequivocally that a no-challenge clause in a settlement agreement should be enforced, he remarked that “Where the agreement is entered into at the outset of the relationship, without litigation, following Lear a no-challenge clause may be void, under U.S. law, due to concern for its impact on the free use of ideas in the public domain” [70]. Note the careful qualifications—the clause “may” be void “under U.S. law”—which I see as Lederer J taking care to avoid even an implicit endorsement of Lear. I wouldn’t read this as an implicit rejection of Lear either; as I see it, Lederer J was simply being careful not to express any opinion on a difficult issue that was not necessary to the disposition of the motion.