Do You Have a Licence to Sue?

It is very common to establish a corporate structure including two or more entities, in which one entity holds the assets of the business, while another entity acts as the operating or trading company.  I am not a corporate lawyer or a financial advisor, so I do not propose to go into the pros and cons of such arrangements in general.  The only important point to make for the purpose of this article is that ‘assets’ generally include intangible assets, and that intangible assets include patents.

This raises the issue of authorisation: if one entity owns a patent, and a different entity exploits the patented technology, then the operating entity must be licensed by the holding entity.  It may be that the two entities are companies with common ownership and/or directorship, in which case the terms of the licence may not be set out fully (or perhaps even at all) in writing.  It is not uncommon for an operating company to carry on business without any formal written licence agreement with its related holding company, with the effect that an ongoing royalty-free licence to exploit the patent rights would usually be implied from the circumstances.

There are all sorts of reasons why this is an undesirable situation.  For example, a formal licence agreement can set out in detail what happens to the licence in the event that the operating company is sold or becomes insolvent.  An implied licence, or verbal agreement, will never be sufficiently clear to address such situations without ambiguity.

However, I am concerned here with one very specific issue that arises under the Australian Patents Act 1990.  Section 120 of the Act provides that ‘infringement proceedings may be started … by the patentee or an exclusive licensee.’  Thus, if the operating company is not an exclusive licensee it will not have standing to sue for infringement.  An exclusive licence is one which grants to the licensee a right to exploit the patented invention to the exclusion of all others, including the patentee.  By comparison, a licence limited to a single licensee where at least some rights are retained by the patentee is known as a sole licence, while a non-exclusive licence leaves the patentee free to grant further licences to other parties.

In the case of the holding/operating company structure, the operating company is likely to be the entity suffering damage as a result of infringing activities, and with the funds to take action.  Thus an inability to do so on its own behalf may place it at a disadvantage.

This issue arose recently in a series of decisions issued by Justice Middleton in the Federal Court of Australia, Damorgold Pty Ltd v JAI Products Pty Ltd [2014] FCA 150, Damorgold Pty Ltd v JAI Products Pty Ltd (No 2) [2014] FCA 377 and Damorgold Pty Ltd v JAI Products Pty Ltd (No 3) [2014] FCA 651.  It is the third of these judgments that relates specifically to the issue of standing.  Despite what might be described as some degree of informality in past licensing arrangements, Justice Middleton was prepared to find that Damorgold’s operating company, Vertilux Corporation Pty Ltd, had been, at all relevant times, an exclusive licensee of the patent at issue.

Background – Oral Agreements

Damorgold is the owner of Australian patent no. 760547 for ‘a blind control mechanism’.  Vertilux is an operating company associated with Damorgold.  Ross Lava is the CEO and one of the two directors of both companies, and has held those positions since, respectively, 1 July 1991 and 28 June 1996.

Vertilux and Damorgold sued JAI Products Pty Ltd for infringement of the patent back in February 2011.  JAI cross-claimed for revocation of the patent, alleging that it was invalid on various grounds.  In the first of his three decisions in the matter, Justice Middleton found that a number of claims of the patent were, indeed, invalid.  However, he also found that two of the valid claims were infringed by JAI.  In short, Vertilux and Damorgold were successful in their infringement action.

Despite their long operation together, there was no written licence agreement between Damorgold and Vertilux until 9 July 2010.  The written document, provided to the court in evidence, records and confirms the terms of an oral licence granted by Damorgold to Vertilux, which was purported to have existed since at least 1 January 2006.

It does not appear to have been in dispute that some form of oral agreement had existed, however JAI contended that Vertilux’s licence could not have been exclusive, because there was a pre-existing licence given to an entity called Acmeda, in or about the years 2000 to 2004, which was never terminated.  This ‘licence’ was described by Mr Lava as an ‘authority’ to sell products, and also appears not to have been formalised in writing.

The Outcome – Exclusive Licence Found!

In the event, based on cross-examination of Mr Lava, Justice Middleton found that an exclusive licence had, in fact, been granted by Damorgold to Vertilux at some (indeterminate) time prior to 2006 and, indeed, prior to the grant of any relevant licence to Acmeda.  He concluded that what had, in fact, happened (albeit informally, based on the common control of Damorgold and Vertilux) was that Vertilux had granted a sub-licence to Acmeda, with the consent of Damorgold, as was its right under the terms of its exclusive licence.

Conclusion – The Lesson from Damorgold

Some people might regard Damorgold and Vertilux as being somewhat fortunate, although with the only witness to relevant events being Mr Lava, the controlling mind behind both companies, it might have been difficult for Justice Middleton to reach a different conclusion.  Also, since the intention behind the Damorgold/Vertilux structure is pretty clear, this is no doubt also a fair and reasonable outcome.

But time, energy and money have been expended on court proceedings that would have been unnecessary had Damorgold and Vertilux simply prepared and executed a suitable exclusive licence agreement in writing at the outset.  Such details, however, are too often not at the front of people’s minds when establishing a new venture.

So, if you have a business structure in which IP assets are held by an entity that is different from the one which exploits the IP, you might want to check that all of your paperwork is in order.  And if you are starting out on such a venture, make sure you obtain appropriate advice on IP licensing arrangements.  Taking care of these details may seem like an unnecessary distraction – and expense – when there are bigger matters requiring attention, but can save a great deal of trouble and expense down the track.

Tags: Australia, Licensing, Litigation