Zila, Inc. v. Tinnell

• Decision Date: 05 September 2007
• Docket Number: No. 05-15031.,No. 05-15087.,05-15031.,05-15087.
• Citation: 502 F.3d 1014
• Parties: ZILA, INC., a Delaware Corporation, Plaintiff-counter-defendant-Appellee, v. James E. TINNELL, Defendant-counter-claimant-Appellant. Zila, Inc., a Delaware Corporation, Plaintiff-counter-defendant-Appellant, v. James E. Tinnell, Defendant-counter-claimant-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

502 F.3d 1014

ZILA, INC., a Delaware Corporation, Plaintiff-counter-defendant-Appellee, v. James E. TINNELL, Defendant-counter-claimant-Appellant.

Zila, Inc., a Delaware Corporation, Plaintiff-counter-defendant-Appellant, v. James E. Tinnell, Defendant-counter-claimant-Appellee.

No. 05-15031.

No. 05-15087.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted December 8, 2006.

Filed September 5, 2007.

Larry C. Johns and John H. Pilkington, Las Vegas, NV, for the appellant.

Daniel P. Quigley, Raymond K. Ramella, Cohen Kennedy Dowd & Quigley, P.C., Phoenix, AZ, for the appellee.

Appeal from the United States District Court for the District of Nevada; Kent J. Dawson, District Judge, Presiding. D.C. Nos. CV-00-01345-KJD, CV-00-01345-KJD.

Before: D.W. NELSON, ROBERT E. COWEN,^* and MARSHA S. BERZON, Circuit Judges.

BERZON, Circuit Judge.

Appellant James Tinnell developed a liquid solution to treat lesions caused by the herpes virus. He applied for a patent on the treatment and acquired a defunct corporation, now named Zila, as a vehicle for marketing and selling the product, now called Zilactin. Tinnell subsequently entered an agreement with Zila that assigned all rights in his invention to the company in return for royalty payments and company stock. The royalty payments provided for in this contract are the subject of the present dispute.

The contract at issue is unambiguous as to the duration of the royalties, and the parties agree on their intent at the time it was formed. All the evidence is thus in accord with a single interpretation — that Tinnell would relinquish all rights to Zilactin, patent or otherwise, and, in return, receive in perpetuity a five percent royalty on Zila's sales of the invention. The difficulty in this case arises because Zila asserts, and the district court agreed, that the doctrine announced in Brulotte v. Thys, 379 U.S. 29, 85 S.Ct. 176, 13 L.Ed.2d 99 (1964), displaces, because of federal patent policy, the parties' intent and renders the royalty obligation unenforceable, either entirely or upon the expiration of the first patent that issued on Tinnell's invention. We confront, consequently, not simple questions of contract law but rather issues concerning the impact and bounds of Brulotte, in the context of an otherwise unremarkable case.

I.

Tinnell first developed his liquid solution to treat lesions caused by oral and genital herpes in 1976. He applied for a patent on the treatment the following year and soon thereafter acquired a defunct California corporation, which he renamed Zila, Inc.,¹ as a vehicle for marketing and selling the product. The product has been improved since it was developed in 1976 and is now sold under the brand name Zilactin.

On September 5, 1980, Tinnell and Zila entered into an agreement ("1980 Agreement") that began by noting that "Tinnell has invented a treatment composition for herpes virus infection, which is the subject of a patent application," and "Tinnell is desirous of assigning all of his right, title and interest in the application and invention, improvements thereon and Letters Patent thereon" for consideration including royalties and stock. The 1980 Agreement

assign[ed] all of [Tinnell's] right, title and interest in the [patent] application and invention, improvements thereon and Letters Patent thereon, when granted in the United States or foreign countries, to [Zila], including any present or future improvement whether the same being made by Tinnell or [Zila], and whether presently existing or made in the future, and as may be granted in the United States or any foreign country or otherwise, including each patent granted on any application which is a division, substitution or continuation of any of the applications specifically identified herein, and each reissue or extension of any of the same.

In return, and without any temporal or other limitation, the contract provided Tinnell with "a five percent (5%) royalty on gross sales of [Zila] of the invention," as well as company stock. Tinnell obligated himself to "cooperate with [Zila] to the extent that [Zila] may enjoy to the fullest extent the rights conveyed hereunder . . . ."

The officers who signed on behalf of Zila testified that when they executed the 1980 Agreement, it was not known whether any patents would issue on Tinnell's invention. According to their uncontested statements, the duration of Zila's obligation to pay Tinnell royalties was not related in any way to the patents that might or might not be obtained by the company as a result of his previously-filed patent application. Instead, the signatories understood the 1980 Agreement to provide Tinnell with a 5% royalty on gross sales of Zilactin for as long as the company sold his product.

Zila subsequently secured patents in the United States and Canada.² The first of these patents, U.S. Patent '934, was issued in August 1981. Zila also secured a continuation patent, '296, for the 1981 patent and, in December 1985, Canadian Patent '494. The primary improvement that transformed Tinnell's original solution into the present-day Zilactin was the addition of a thickener that made the product into a gel. The patent for the addition of this thickener was approved as U.S. Patent '158 in January 1992.

There is a dispute as to who invented the 1992 patent. In 1987, Zila filed a patent application which described an improvement to the original chemical compound and named Tinnell as the inventor. Because Zila's patent counsel erred in the technical description of the chemical compounds involved, however, the company withdrew the application. When the company resubmitted the application, it inexplicably named Edwin Pomerantz, Zila's regulatory specialist, as the inventor. The patent office subsequently issued the patent in 1992 to Zila, crediting Pomerantz rather than Tinnell with the invention.³

Zila's royalties to Tinnell grew exponentially from 1987 to 2000. In 1987, gross sales of Zilactin amounted to only $321,000, which pegged royalties at $6,426. By 2000, however, Zilactin had gross sales of over $8 million, and Zila owed Tinnell half a million dollars in royalties annually.

In July 2000, Zila's patent counsel advised the company to terminate Tinnell's royalties, on the grounds that, under Brulotte, Tinnell's right to royalties expired on August 1998, when the 1981 patent expired. Two months later, Zila stopped making royalty payments on all sales of Zilactin. Although the Canadian patent did not expire until December 2002, Zila justified its withholding of the Canadian royalties on the ground that it had overpaid Tinnell nearly a million dollars in American royalties over the previous two years.

Shortly after it stopped paying royalties, Zila filed a two-count complaint in federal court requesting a declaratory judgment that Tinnell's right to royalties under the 1980 Agreement ceased after August 25, 1998. The suit also sought reimbursement for the royalties paid to Tinnell for the two years after the 1981 patent expired. Tinnell filed a counter-claim for declaratory relief, contending that his entitlement to royalties under the Agreement did not terminate with the expiration of the 1981 patent but, instead, continued in perpetuity. He added counterclaims for breach of contract, fraud, and other state law claims.

After discovery, the parties made cross-motions for summary judgment on the over-arching question of whether royalties were owed after August 1998. Applying Brulotte, the district court held that the 1980 Agreement was "unlawful per se under federal patent law," because it "project[ed] beyond the expiration date of the patent." Accordingly, the district court granted summary judgment "to the extent that Zila requests declaratory relief from liability under the Agreement." The court explained that, "[s]ince the Agreement is unenforceable after the expiration of the patents on August 25, 1998, Zila cannot be forced to pay royalties after that date." Zila subsequently filed a further motion for summary judgment on its demand that Tinnell repay royalty payments from 1998 to 2000, arguing that the payments amounted to unjust enrichment. The district court denied summary judgment to Zila on this claim and, instead, dismissed it.

Tinnell did not sit idle after the district court's first order. He filed his own demand for entry of judgment, arguing that Zila owed him at least $56,753 in royalties for Canadian sales of Zilactin from August 2000, when he stopped receiving payments, until December 3, 2002, when the Canadian patent expired. Zila admitted to owing the money but claimed it was entitled to offset the amount against the American royalties it paid Tinnell from September 1998 through August 2000. The district court agreed with Zila's bottom line and went further: Tinnell had no rights to royalties in the United States or Canada, the district court held, because, although the 1980 Agreement "purports to require the payment of royalties based upon the Canadian patent, that agreement is unenforceable." The court noted that this result appeared inequitable but read Brulotte to require it.

On December 1, 2004 the parties stipulated to dismissal of Tinnell's outstanding counterclaim for breach of contact. The district court then declared all previous orders and the judgment ripe for appeal, and this timely appeal followed.

II.

We first consider Brulotte. The case involved various patents held by the Thys Company, which sold farmers a hoppicking machine for a flat sum but required them to purchase a license for the patents on the machines in order to use the product. Id. at 29, 85 S.Ct. 176. The license contract demanded that, in addition to the initial purchase price of the machines and onerous restrictions on their assignment or use, the farmers pay the larger of a $500 annual royalty or a set royalty rate tied to the amount of hops they harvested each year. Id. The last patent...