Brushing off an agreed restrictive covenant: Ontario Court on the enforcement of “No Challenge Clause” [Loops v. Maxill Inc., 2020 ONSC 971]

Hon’ble Justice L.C Templeton, in its judgment [Loops v Maxill Inc,2020 ONSC 971] dated 3rd February 2020 ruled that a party cannot be barred from raising the defense of patent invalidity despite of a prior promise of not to challenge it. Parties in the present case involved a subsidiary which was one of the reasons for such an outcome. However, there is no analysis in the judgment on the relationship between parent and the subsidiary corporation and the reasoning as to why the subsidiary corporation is excluded from the settlement obligations except that it’s a different legal entity. The case is already granted an appeal and will be heard by a 3 Judges bench of the Divisional Court of Ontario in September 2020. Let’s see what this case is all about.

The present post is divided into three parts, first part deals with the summary of the Loops v Maxill case, second part deals with the questions arising from the judgment and the third part deals with the relevant law in the United States.

Loops v Maxill: Facts, Reasoning & Summary ↑

Involved parties and patents are:

§  Maxill Canada (Canadian based parent company) and Maxill Inc. / Ohio (US based subsidiary company)

§  Loops LLC and Loops Flexibrush LLC (Delaware, US based corporations)

§  Patents Involved: CA 2577109:   ‘109 patent and its corresponding US patent US8448285:   ‘285 patent (Loops owned patents)

Facts & Timeline of the case:

Dec 2012: Loops started an action against Maxill Canada in the federal court of BC for the infringement of the ‘109 patent. 

April 2014: Maxill Canada accepted infringement and accepted to a “no challenge clause”, agreeing to the fact that it won’t attack the validity of the Loops Canadian patent and its corresponding worldwide patents (i.e. US ‘285 patent). A confidential settlement agreement and consent judgment were reached accordingly.

Meanwhile, Maxill Canada launched a toothbrush by designing around the ‘109 patent.

October 2015: Loops started an action against the Maxill Canada in ON SCJ for the breach of the settlement agreement.

Litigation across the Canadian border: In September 2017 Loops started an action in Utah against Maxill Ohio for the infringement of the corresponding US ‘285 patent. Maxill Ohio responded with an action in the state of Washington for a declaration of non-infringement and the invalidity of the ‘285 patent. Both actions were merged as the proceedings in Washington.

Loops sought a temporary injunction in ON SCJ against Maxill to prevent it from raising the invalidity defense in the US action based on the earlier settlement agreement.

When it comes to the temporary injunction, the court investigates several factors to see if the present factual situation justifies the grant or denial of the temporary injunction. Primarily the inquiry is to look into the following

a.) is there a serious issue to be tried;

b.) would the person applying for the injunction suffer irreparable harm if the injunction were not granted;

c.) and is the balance of convenience lies in favour of granting the temporary injunction or denying the temporary injunction.

The court further refers to the legal principles when the sought injunction involves the enforcement of a restrictive covenant. The court will consider a higher standard of a “strong prima facie case” rather than one of a “serious issue on the trial;” and the reasonableness of restrictive covenant in the interests of parties and the public.²

The restrictive covenant clause agreed between Loops and Maxill reads as:

“Maxill Canada and John Shaw, the President of Maxill Canada would not directly or indirectly assist any person attacking the validity of Canadian Patent No. 2, 577, 109 or any corresponding patents worldwide as set out in Schedule B attached to the Agreement. (Reference to ‘285 patent)”³

Court did not find the present case a strong prima facie one as Maxill Ohio was never a party to the settlement agreement. Also, the subsidiary status of Maxill Ohio kept it at bay from the proceedings for the breach of agreement. The court rejected the Loops argument that the parent Maxill aided the subsidiary Maxill in attacking the validity of the corresponding ‘285 patent and left this issue to be determined by the trial court. It is remarkably interesting to note the stance adopted by the ON SCJ on the interpretation of the restrictive covenant: 

The Interpretation adopted by the court	The Interpretation differentiated by the court
“a mere prohibition upon Maxill Canada and John Shaw from providing help to other person(s) who seek to attack the validity of the Loops’ US patent.”4	“a two-part undertaking by the party signing the agreement, namely, to not take any personal action in challenging the validity and to not assist others in challenging the validity.”5

Court adopted the position that Maxill Canada and John Shaw cannot assist a 3rd party in attacking the patent validity but they can attack the patent validity themselves. Wouldn’t it render moot the purpose of signing the settlement agreement in the first place?

Coming on to the reasonableness of the restrictive covenant clause, the Ontario court found the clause reasonable between the parties but unreasonable in the public interest. ONSCJ relied upon the following US authorities, Lear, Inc. v. Adkins, 395 U.S. 653 (1969), and Massillon-Cleveland-Akron Sign Co. v. Golden State Advert Co., 444 F. 2d 425 to conclude that no challenge clause is unreasonable in the public interest. Court did not find any related Canadian authority on this point. The competing interests considered by court in deciding the reasonableness of the no challenge clause are⁶

Contractual interests: licensor or purchaser cannot turn their back on the promises made in the contract.

Public Interest: patent law must allow full and free competition in the use of ideas in public domain; this goal cannot be achieved without asserting the patent invalidity.

Further, Hon’ble Justice Templeton observed that in a patent infringement proceeding, the validity of a patent is a fundamental issue, which is addressed before fact-finding of an alleged infringement⁷ and an invalid patent cannot be infringed.⁸ He further observed:

“If the Court failed to look at or was precluded from considering the legal foundation on which a complaint is based, surely the Court would fall into error notwithstanding the consent of the parties or the administration of justice would be brought into disrepute.”⁹

Hon’ble Justice Templeton points out that validity of a patent is the legal foundation on which patent infringement is claimed and notwithstanding the position of the parties, court cannot be barred from assessing the validity in an infringement suit, otherwise the court will be making an error in law or will bring the administration of justice in disrepute. The court found that there is a serious issue for trial, but the case is not prima facie one, which alone is enough to deny the temporary injunction.

Summary of the court’s reasoning behind the denial of temporary injunction ↑

• Maxill Ohio was not a party to the settlement agreement. Being a separate legal entity, it is not bound by the agreement and the no challenge clause.
• No challenge clause was interpreted simply as a prohibition in aiding others against asserting patent’s invalidity. The interpretation adopted by the court allowed Maxill to assert the invalidity itself.
• Public interest in the full and free use of the available ideas in the public domain outweighs the contractual interest between the parties.
• Assertion of the patent invalidity goes hand in hand with the claim of patent infringement because of its fundamental nature.
• Irreparable harm and balance of convenience also lies in the favor of Maxill because the clause bars from raising the defense against infringement and risks paying the damages for patent infringement where a patent may or may not be valid.¹⁰

Questioning the judgement ↑

Exclusion of the subsidiary company from settlement obligations

During settlement, Loops intended to prevent Maxill from asserting the validity of Canadian and its corresponding patents in the other jurisdictions. Exclusion of Maxill’s US operations i.e. US subsidiary is questionable?

If President Shaw is common to both entities, wouldn’t it impose a duty somehow on Maxill Ohio or can it be said that during settlement agreement he was representing only the interests of Maxill Canada and not its subsidiary in the United States? 

Whatever relationship subsidiary and parent company are having can be determined by looking at who is controlling the subsidiary in day-to-day operations, how it is controlled, from where it is controlled. There might be other factors included but I will leave the law related to corporations for another post. 

Interpretation of the no challenge clause ↑

The interpretation of “no challenge clause” adopted by the Hon’ble judge is questionable. The clause reads:

“Maxill Canada and John Shaw, the President of Maxill Canada would not directly or indirectly assist any person attacking the validity of Canadian Patent No. 2, 577, 109 or any corresponding patents worldwide as set out in Schedule B attached to the Agreement. (reference to ‘285 patent)”.

Wouldn’t ‘any person’ include Maxill Canada and John Shaw themselves, why Hon’ble judge concluded that, “the undertaking by Maxill itself has not been included. ¹¹

Conflicting public interests ↑

The third questionable point is how competing interests are weighed in the judgement. The settlement agreement is privy to the parties; anyone from the public is free to challenge the validity of the Loops patent. It is only Maxill, which is restrained. Until Loops receives a 3rd party challenge, Loops must be allowed to bear the fruits of the granted patent and the agreed settlement. There are a variety of public interests at stake like promoting innovation through grant of patents, public interest in coming to settlements, and their enforcement.

Wouldn’t settlement agreement be rendered moot by allowing Maxill to raise the invalidity defense? Maxill accepted the infringement of the Canadian patent and therefore the patent must be construed as deemed valid for the Maxill.

A lot depends upon the intention of the parties in reaching the settlement agreement, which is a factual matter, and beyond the scope of this post.

Corresponding law in the United States ↑

The third part of ththeis post refers to the relevant law in the United States. US caselaw shows that “no challenge clause” has been subject to litigation as a part of both settlement agreements and licensing agreements.

The position adopted by the US Courts in Lear Inc & Massillon has already been discussed above, which is the public interest in the full and free use of ideas outweighs the contractual interests related to estoppel or no challenge clause. 

Another interesting case is Kee Action Sports vs Shyang Huei (Docket No. 3:14-CV-071-HZ).

Kee Action sports discuss and differentiate the relevant federal circuit case laws on “no challenge clause.” Parties in Kee Action disputes upon whether the enforceability of no challenge clause is a matter of contract law or patent law and therefore which circuit law controls the assessment of no challenge clause? Court agrees that the issue involved in the enforcement of no challenge clause is intimately involved in the substance of enforcement of the patent right and therefore federal circuit law controls the issue.¹² Hon’ble Court distinguished it from Rates Tech¹³ where the same issue was considered to be one of a contractual nature and found it to be not governed by the federal circuit. The reason Rates Tech was different because parties entered into a license agreement with a no challenge clause before any litigation was even started. In Rates Tech, a 3rd party brought a declaration suit for patent invalidity and in response to that Rates Tech started a suit, claiming that party to license agreement provided information to the 3rd party which is in contravention of the no challenge clause. When infringement and invalidity proceedings began later, the district court held that no challenge clause is invalid and unenforceable based upon the Lears jurisprudence. Federal Circuit upheld the district court’s assessment. 

The key takeaway or point of distinction is to see whether the underlying suit has any disputed issue involving any patent.¹⁴ In Rates Tech, the breach of license agreement didn’t have an underlying patent dispute. The patent infringement and invalidity suit came later. The licensee never had an opportunity to discover evidence related to invalidity of patents and therefore the no challenge clause was invalid. However, “Once an accused infringer has challenged patent validity, has had an opportunity to conduct discovery on validity issues, and has elected to voluntarily dismiss the litigation with prejudice under a settlement agreement containing a clear and unambiguous undertaking not to challenge the validity and/or enforceability of the patent in suit, the accused infringer is contractually estopped from raising any such challenge in any subsequent proceeding.”¹⁵ Further, “Each case must be examined on its own facts in light of the agreement between the parties. In the context of settlement agreements, as with consent decrees, clear and unambiguous language barring the right to challenge patent validity in future infringement actions is sufficient, even if invalidity claims had not been previously at issue and had not been actually litigated.”¹⁶

Summarizing the legal points from the US Case-law ↑

Lear made the licensee estoppel clause invalid and unenforceable based on patent policy grounds that whatever is in the public domain must be allowed to use fully and freely. But Flex-Foot, Baseload Energy and Rates Tech made it clear that enforcement of no challenge clause is context-based, the language of the clause must be clear and unambiguous, and lastly, it is important to see if the clause is agreed to settle the litigation or the clause is agreed upon before any litigation.

The US case law gives a clearer picture than the one given by the Ontario Court. But there is more to come from Ontario Courts as the Divisional Court will be hearing the case soon. Maxill had a chance to discover and pursue patent invalidity but chose to settle. Considering Kee Action and underlying authorities the restrictive covenant should’ve been enforced.