Unambiguous Contract Language Extended Covenant Not To Sue to Downstream Users and Supported Broad Interpretation of “Patent Rights” Provision

By: Sasha Hoyt

Edited by Anthony Berlenbach, Cara Regan, and Brian Kacedon

Abstract: Industry competitors settled a patent infringement lawsuit. The patentee covenanted not to sue “or otherwise engage” the competitor or its affiliates in any proceeding related to infringement of certain US patents as well as foreign patents “related through priority claims.” After the competitor transferred its equipment to a third party operating in Canada, the patentee sued the third party to enforce its Canadian patent. The competitor intervened and brought its own separate lawsuit arguing that the covenant authorized the sale/lease of competitor’s own equipment and thus the patent exhaustion doctrine prohibited suit against downstream users. The district court concluded that the patentee’s covenant applied to competitor’s authorized downstream users by virtue of the patent exhaustion doctrine, and the jury found that the covenant covered the Canadian patent. The Tenth Circuit affirmed.

Background

Fuel Automation Station (“FAS”) and Energera are competing manufacturers of automated fuel delivery equipment. Energera holds Canadian and U.S. patents relating to its fuel delivery equipment, and several years ago, it asserted two U.S. patents against FAS. The parties settled and executed (1) mutual covenants not to sue and (2) a license disclaimer in which the parties agreed that the settlement agreement did not create a licensing relationship.

Energera’s covenant prohibited it from suing “or otherwise engag[ing] [FAS] “in any domestic or foreign legal or administrative proceeding, for or based on infringement of the [Patent Rights].” It applied to FAS’ related entities, such as subsidiaries and affiliates. The parties defined Energera’s “Patent Rights” to cover its U.S. patents, “any patent resulting from a continuation, continuation-in-part, or divisional related through priority claims to the [U.S. Patents]; and any foreign patent related through priority claims to the [U.S. Patents].” An attached press release confirmed that “both Parties are expressly permitted to manufacture, use, sell, lease, and license their respective mobile automated fuel distribution units utilized in the fracking industry.”

Less than a year later, FAS contracted with a third party “KVA” to operate FAS’s equipment in Canada. Energera responded by suing KVA. FAS then sued Energera, contending that Energera’s covenant covered downstream users of FAS’s equipment and thus the KVA suit was prohibited by both patent exhaustion and the parties’ agreement.

In the FAS suit, the Magistrate judge granted FAS’s motion for summary judgment regarding the scope of the covenant, concluding that it extended to downstream users. At trial, the jury found that the patent asserted by Energera was within the “Patent Rights” to which the covenant applied and ruled Energera had breached the covenant. Energera appealed.

The Energera Decision

Application of Energera’s Covenant to Downstream Users

Applying Colorado contract law and Supreme Court and Federal Circuit precedent regarding patent exhaustion, the court first considered the scope of the covenant and its applicability to downstream users.

Energera argued that the agreement unambiguously excluded downstream users from protection against patent infringement suits. Specifically, it argued that (1) the covenant’s language did not support protection for downstream users, (2) the license disclaimer prohibited protection for downstream users; and (3) the patent exhaustion doctrine should not have been applied. The Tenth Circuit disagreed on all counts.

The Tenth Circuit first determined that, in harmony, the language of the Covenant, license agreement, and accompanying press release did not expressly include or disclaim third party rights, and did support a broad interpretation of the Covenant to include downstream users. Based on common dictionary definitions of the word “engage,” the court found that Energera’s promise not to “otherwise engage” FAS or its associated entities “in any . . . proceeding[s]” related to the patent rights, reflected the parties’ intent to expand the Covenant to protect downstream use. The Press Release statement that “both Parties are expressly permitted to manufacture, use, sell, lease, and license their respective [equipment]” similarly demonstrated that the parties contemplated downstream use of equipment that could implicate patent rights.

Second, the court explained that the license disclaimer did not bar extension of the Covenant to downstream users. Indeed, the two provisions (the license disclaimer and Covenant) exist in harmony: Through the Covenant, Energera laid aside its rights to enforce its patents and thus exclude FAS (and affiliates) from committing otherwise infringing acts. The license disclaimer “merely acknowledge[d] what is legally correct”— that Energera did not grant FAS any affirmative rights in Energera’s patents.

Lastly, the court upheld the district court’s application of the patent exhaustion doctrine. The common law doctrine of patent exhaustion restricts a patent owner’s right to control downstream use of a patented item following its first lawful sale. Under Supreme Court and Federal Circuit precedent, an unconditional covenant not to sue an entity for patent infringement based on sales inherently extends the doctrine to downstream users of patented products. Because Energera’s Covenant was unconditional, the patent exhaustion doctrine automatically applied to extend the Covenant to FAS’s downstream users including KVA.

Scope of Patent Rights Provision

Next, the Tenth Circuit addressed whether the “Patent Rights” provision in the agreement was ambiguous. The provision covered foreign patents “related through priority claims to” specified U.S. patents. On appeal, Energera argued that this phrase operated as a “one-way street” and thus unambiguously excluded the Canadian patent asserted by Energera because it did not claim priority to one of the covered U.S. patents. Conversely, FAS asserted that priority relationships are a two-way street, and thus covered the asserted patent because the U.S. patents reached back to claim priority to that patent, establishing a defined familial relationship.

Considering patent law principles regarding priority, the plain, dictionary meaning of the word “related,” and rules of grammar, the Tenth Circuit agreed with FAS’s interpretation. The U.S. patents shared a familial relationship with the asserted patent, and the ordinary dictionary definition of “related” supported FAS’s view, as did the basic grammar of the clause. 

Strategy and Conclusion

Precision is paramount when drafting an agreement, especially with respect to terms that impact the agreement’s scope, a party’s rights after the agreement is executed, and what entities may be extended protections under the agreement (e.g., via a covenant not to sue). Parties may likewise benefit from contemplating future business activities and drafting covenants not to sue that explicitly include or exclude such activities.

Further Information

The Energera decision can be found here.

Editors and Authors

The editors and authors are attorneys at Finnegan, Henderson, Farabow, Garrett & Dunner, LLP.

This article is for informational purposes and does not constitute legal advice.

The views expressed do not necessarily reflect the views of LES or Finnegan.

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