E.I. du Pont de Nemours and Co., Inc. v. Shell Oil Co.

• Decision Date: 05 February 1985
• Citation: 498 A.2d 1108
• Parties: E.I. du PONT de NEMOURS AND COMPANY, INCORPORATED, Plaintiff Below, Appellant, v. SHELL OIL COMPANY, Defendant Below, Appellee. . Submitted:
• Court: Supreme Court of Delaware

Page 1108

498 A.2d 1108

227 U.S.P.Q. 233

E.I. du PONT de NEMOURS AND COMPANY, INCORPORATED, Plaintiff Below, Appellant, v. SHELL OIL COMPANY, Defendant Below, Appellee.

Supreme Court of Delaware.

Submitted: Feb. 5, 1985.

Decided: Aug. 21, 1985.

Richard L. Sutton (argued) and Jack B. Blumenfeld, Morris, Nichols, Arsht & Tunnell, Wilmington, for appellant.

E. Norman Veasey (argued), Allen M. Terrell, Jr., Stephen E. Herrmann, and John J. Schreppler, II, Richards, Layton & Finger, Wilmington, for appellee.

Before McNEILLY and HORSEY, JJ., O'HARA, BIFFERATO and TAYLOR, Judges, constituting the Court en Banc.

HORSEY, Justice:

This appeal requires us to determine the limits of a licensee's right to manufacture and sell a product under grant of a nonexclusive license without right to sublicense. The license agreement expressly prohibited the licensee from sublicensing. It did permit the licensee to make the patented product or to "have [it] made" and to sell the product. We here consider whether a nonexclusive license agreement entered into between E.I. duPont de Nemours and Company, Inc. ("DuPont") and Shell Oil Company ("Shell") in 1968 bars licensee Shell from carrying out a 1981 arrangement made between Shell and a wholly-owned subsidiary of Union Carbide Company, Inc., Union Carbide Agricultural Corporation, Inc. ("Carbide"). Under the arrangement, Carbide would manufacture the patented product for sale in a quantity to meet Carbide's requirements and Shell bound itself to sell the same quantity to Carbide.

Plaintiff DuPont appeals from the Court of Chancery's grant of a partial final declaratory judgment in favor of defendant Shell. That Court construed Shell's arrangement with Carbide as permissible under the "have made" language of DuPont's 1968 Patent License Agreement ("the License Agreement"), even in light of the License Agreement's prohibition against Shell's grant of a sublicense. We cannot agree with the Vice Chancellor's construction of the Agreement; and, for the reasons which follow, we reach the contrary conclusion. We conclude that Shell's contractual arrangements with Carbide constitute, in essence, a sublicense. Accordingly, we reverse the Court of Chancery's finding to the contrary and direct entry of partial judgment for DuPont.

I.

In the 1960's, both DuPont and overseas affiliates of Shell ¹ independently developed the insecticide, methomyl. DuPont and SIRM filed patent applications on methomyl in various jurisdictions throughout the world. By 1967, it was apparent that DuPont had obtained the dominant patent position for methomyl in the United States, while Shell had obtained such position in most of the commercially important countries overseas.

DuPont's interest in a potential Australian market prompted negotiations with Shell concerning a possible cross-licensing agreement. Negotiations continued through the fall of 1967, and in 1968, Shell and DuPont executed a Patent License Agreement with reciprocal provisions. Shell and its affiliates granted DuPont a license to commercially exploit methomyl in foreign countries where SIRM held the patents. The reciprocal provision, at the heart of this litigation, gave Shell equivalent rights with respect to the marketing of methomyl in the United States. It provided:

DuPont grants to Shell a nonexclusive license, without the right to sublicense, to become effective January 1, 1973, to make, have made, use and sell for use and resale METHOMYL and T-1642 [another chemical] and their formulations under the DU PONT PATENT RIGHTS.

Several years later during the 1970's, Carbide developed a product called Larvin, an insecticide which uses methomyl as an intermediate in its formulation. Therefore, in 1978, Carbide sought a ready supply of methomyl.

Carbide first requested a license to manufacture methomyl from Shell. Shell informed Carbide that it did not have the right to sublicense the manufacture of methomyl pursuant to its License Agreement with DuPont. Shell advised Carbide that only DuPont could grant a license for the domestic manufacture of methomyl.

As an alternative, Carbide investigated the possibility of buying from Shell quantities of methomyl sufficient to fill its needs. However, Carbide learned that the Shell plant, located near Denver, Colorado, did not have the necessary capacity to produce what Carbide required. In fact, the Denver plant had difficulty even in satisfying Shell's own needs for methomyl which it used to formulate another Shell product, Nudrin.

Shell then proposed the following arrangement: (1) Carbide would manufacture methomyl for Shell under the "have made" provision of its License Agreement with DuPont; and (2) exercising its right to "sell for use or resale," Shell would immediately sell the methomyl back to Carbide using a separate purchase and sale agreement. Carbide initially rejected the proposal.

Instead, Carbide approached DuPont directly seeking a license for the manufacture and use of methomyl. In addition to being able to make methomyl for its own use, Carbide saw another advantage to obtaining a license. Assuming a license were granted, Carbide anticipated tremendous economies of scale in the manufacture of methomyl at its plant, provided that it were also able to supply Shell with methomyl for its use and for sale to third parties.

Therefore, in May 1979, Carbide prepared two preliminary proposals. First, Carbide proposed that DuPont license Carbide to manufacture methomyl for its use in Larvin in return for Carbide's grant of a license to DuPont to sell Larvin. Second, believing that such license would be forthcoming, Carbide proposed to supply Shell with methomyl for sale to third parties.

DuPont rejected Carbide's proposal, because it had no interest in marketing Larvin. However, DuPont did offer to sell methomyl to Carbide at a favorable price for limited use in the formulation of Larvin. Carbide rejected this counteroffer.

Carbide then immediately contacted Shell about its earlier suggestion that Carbide manufacture methomyl for Shell and then buy it back from Shell. Shell and Carbide entered into a Methomyl Toll Conversion Agreement ² and a Methomyl Purchase and Sale Agreement. The Agreements were negotiated, drafted and executed simultaneously. Both Agreements cover the same period of time, terminating in 1988 when DuPont's methomyl patent expires. Moreover, termination of the Toll Conversion Agreement terminates the Purchase and Sale Agreement.

In essence, the Agreements provided that Carbide would produce methomyl for Shell's account, simultaneously buying back from Shell some or all of the methomyl Carbide manufactured. More specifically, the Agreements operated in tandem as follows:

Carbide was to construct a plant to manufacture 18 million pounds of methomyl per year. Carbide would then order from Shell the amount of methomyl it required. Shell would convey such information back to Carbide so that it could manufacture the required amounts. Carbide would send Shell a delivery schedule, with Shell relaying that information back to Carbide. Carbide would then place the methomyl in its own containers, simultaneously effectuating both delivery to Shell and redelivery to Carbide. Title was to remain in Shell until redelivery to Carbide. Carbide was to bear the risk of loss until delivery to Shell. Shell was obligated to sell to Carbide all of the methomyl which Carbide required both for use in making Larvin and for export sales. However, Shell was not obligated to sell unless Carbide performed its obligations under the Toll Conversion Agreement. Nor was Shell obligated to have any methomyl made in addition to that ordered by Carbide.

The drafters of these Agreements felt that the "have made" and "sale for use or resale" language of the DuPont License Agreement permitted the Toll Conversion and Purchase and Sale Agreements between Shell and Carbide. However, they were concerned by the License Agreement's express prohibition against sublicensing. Therefore, as the notes of one of Shell's lawyers reveal, counsel for Shell carefully structured the transaction so that, technically, it would not take the form of a license. Anticipating that DuPont would take legal action upon learning of the manufacture/sale-back arrangement, Shell's counsel noted:

To me it is essential that [the] transaction be structured to withstand scrutiny of a court. Must be a good faith exercise of our rights to "have made" and "sell back."

* * *

* * *

The use of a separate toll conversion agreement and sales agreement is not merely "cosmetic." Each agreement should be able to stand on its own, i.e., one agreement is between Shell and Carbide as toll manufacturer, and the other between Shell and Carbide as a customer for methomyl.

And, in response to Carbide's suggestion that Shell establish different conversion fees for the methomyl eventually sold back to Carbide, as opposed to that sold to Shell's other customers, counsel continued:

Can't justify different toll conversion schedules for product we would keep and that we would sell back to Carbide. Inconsistent with our basic position. Therefore, we are recalculating Carbide's toll conversion fees and sell back price so as to have only one toll conversion fee schedule but still keep same approximate dollar value as proposal made to us by [Carbide].

DuPont responded as predicted. It filed an action in the Court of Chancery for a declaratory judgment that the prohibition on sublicensing in the 1968 License Agreement barred the toll manufacture/sale-back arrangement between Shell and Carbide. In an unreported Letter Opinion, the Vice Chancellor found that such arrangement fell within the scope of Shell's collective rights: (a) to have methomyl made for Shell by a third-party manufacturer (Carbide); and (b) to sell methomyl to a third party (Carbide) for its own use or for resale. Therefore, the Vice Chancellor concluded that the Shell-Carbide...