Permanence Corp. v. Kennametal, Inc.

• Decision Date: 19 July 1990
• Docket Number: No. 89-1872,89-1872
• Citation: 908 F.2d 98
• Parties: PERMANENCE CORPORATION, Plaintiff-Appellant, v. KENNAMETAL, INC., Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 98

908 F.2d 98

15 U.S.P.Q.2d 1550

PERMANENCE CORPORATION, Plaintiff-Appellant, v. KENNAMETAL, INC., Defendant-Appellee.

No. 89-1872.

United States Court of Appeals Sixth Circuit.

Argued June 5, 1990.

Decided July 19, 1990.

Robert H. Golden, Armand D. Kunz, Golden & Kunz, Southfield, Mich., Ronald C. Winiemko (argued), Rochester, Mich., for plaintiff-appellant.

Ernie L. Brooks (argued), Brooks & Kushman, Southfield, Mich., for defendant-appellee.

Before KRUPANSKY and MILBURN, Circuit Judges, and CONTIE, Senior Circuit Judge.

CONTIE, Senior Circuit Judge.

Plaintiff-appellant, Permanence Corp., appeals the district court's grant of summary judgment to defendant-appellee, Kennametal, Inc., holding that defendant did not have an implied best efforts obligation in the contract between Permanence and Kennametal. 725 F.Supp. 907. For the following reasons, we affirm.

I.

Permanence is a closely-held Michigan corporation, which was formed by its president and majority shareholder Charles S. Baum in 1969 for the purpose of developing and exploiting certain processes developed by Baum. In the 1970s Permanence conducted research and manufactured products in the tungsten carbide field. On May 24, 1977, Permanence obtained U.S. Patent No. 4,024,902 (hereinafter "Patent 902") for a process to form an alloy by incorporating tungsten carbide into a steel matrix. The patent was entitled "metal sintered tungsten carbide composites and method of forming the same."

On December 8, 1977, plaintiff executed a non-exclusive license agreement for the use of Patent 902 to Masco Corp., a Detroit corporation. The agreement included a plan of reorganization and plan of merger between Masco and Permanence, an employment agreement concerning Baum, and an agreement not to compete concerning Baum. The agreement also contained a clause providing for its termination. The patented process was not developed by Masco and Masco chose to terminate the agreement pursuant to the contract clause, but retained its non-exclusive license to use Patent 902.

On September 19, 1979, Permanence sued Masco, claiming that Masco failed to fulfill an implied obligation to use best efforts to exploit the patent. The Michigan trial court found that Masco had no implied obligation to use best efforts as the contract for the non-exclusive right to use the patent was adequately supported by consideration in the form of the employment contract given by Masco to Mr. Baum. The Michigan Court of Appeals affirmed. Permanence Corp. v. Masco Corp., No. 65585, Slip Op. at 4 (Mich.Ct.App. Oct. 4, 1983).

On February 8, 1979, Permanence executed a written agreement with defendant Kennametal, a publicly traded corporation specializing in the manufacture of tools, tooling systems, and supplies for the metal working industry. Kennametal's principal office is in Latrobe, Pennsylvania.

In the contract between the parties, Permanence granted Kennametal the non-exclusive right to the licensed patents (existing Patent 902 and patents that would issue from applications owned by Permanence) ¹ for a period of 24 months subject to the non-exclusive license previously granted to Masco Corp. for Patent 902. For the non-exclusive license, Kennametal agreed to pay Permanence a consideration of a $150,000 fee and a royalty rate of 2 3/4% on the net sales price of products made by Kennametal using processes that fell under valid claims of the licensed patents. Advance royalties of $100,000 were to be paid upon the signing of the agreement for the non-exclusive license.

The agreement also provided that Kennametal would have the option to obtain the exclusive license to the patents, subject to the non-exclusive license previously granted to Masco, exercisable within 24 months from the date of the agreement. If after 24 months, the option was not exercised, Kennametal agreed to pay a royalty rate of 3 1/2% except on products sold by Kennametal in direct competition with products manufactured under Masco's non-exclusive license. The royalty rate for competing products was 2%.

Kennametal agreed to pay Permanence a second $150,000 fee and a second $100,000 in advance royalties upon the exercise of the option for an exclusive license. Under the exclusive agreement, the royalty rate was 3 1/2% with the exception of a 2% rate on products sold in direct competition with Masco products manufactured under its non-exclusive license.

On February 8, 1979, the parties signed the agreement and a $150,000 up-front fee and an advance payment of royalties in the amount of $100,000 was paid to Permanence for the non-exclusive right to the patents. On February 5, 1981, Kennametal exercised its option and paid an additional $250,000 for the grant of the exclusive agency--$150,000 for the exercise of the option and a second $100,000 in advance royalties.

Seven years later on April 18, 1988, Permanence filed a one-count complaint alleging that Kennametal had breached the contract by not fulfilling an obligation to use best efforts to exploit the patents. As there was no express "best efforts" provision in the contract, plaintiff argued that the grant of an exclusive agency imposes on the licensee (Kennametal) an implied duty to use best efforts to exploit. On February 1, 1989, Kennametal moved for summary judgment, arguing that it had spent $500,000 for the use of the patented technology of Permanence and that a best efforts obligation had specifically been negotiated out of the agreement.

On May 18, 1989, the district court granted defendant's motion for summary judgment, holding that no obligation on defendant's part to use its best efforts to exploit the patents could be implied in the parties' contract. Plaintiff timely filed this appeal.

II.

The sole issue before this court on appeal is whether the district court erred in its order granting summary judgment that as a matter of law an implied best efforts obligation did not arise in the contract between the parties. When an appeals court reviews the grant of summary judgment below, the district court's legal conclusions are reviewed de novo. Pinney Dock and Transport Co. v. Penn Cent. Corp., 838 F.2d 1445, 1472 (6th Cir.), cert. denied, 488 U.S. 880, 109 S.Ct. 196, 102 L.Ed.2d 166 (1988). Federal district courts sitting in diversity cases must apply the law of the appropriate state as declared by the legislature or highest court of the state. Erie R.R. Co. v. Tomkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188 (1938). In the present case the contract at issue states that the agreement is to be interpreted under the law of Pennsylvania and the parties are therefore agreed that Pennsylvania law applies.

Plaintiff's legal theory that the court will imply a duty on the part of an exclusive licensee to use "best efforts" ² to bring profits and revenues into existence finds its ultimate support in the landmark opinion of Judge Cardozo, Wood v. Lucy, Lady Duff-Gordon, 222 N.Y. 88, 118 N.E. 214 (1917). There, the defendant, a fashion designer, gave the plaintiff the exclusive privilege of marketing defendant's designs. The court implied an obligation to exploit the design, although there was not an express obligation to do so in the contract, because defendant's sole revenue from the grant of the exclusive agency was to be derived from plaintiff's sale of clothes designed by defendant, and defendant was thus at plaintiff's mercy. 118 N.E. at 215. In subsequent cases, an obligation to employ best efforts has generally been implied in contracts in which the only consideration for a grant of property lies in payment of royalties. Post Mach. Co., Inc. v. Tanges, 705 F.Supp. 55, 58 (D.N.H.1989).

In Maxwell v. Schaefer, 381 Pa. 13, 112 A.2d 69 (1955), the Pennsylvania Supreme Court stated that since plaintiff's profits for granting the exclusive contract depended entirely on the volume of sales defendant was able to create for the product, "it may fairly be inferred that all parties to the agreement fully intended and expected [defendant] to devote reasonable effort to the promotion of [the product]." Id. 112 A.2d at 72, citing Wood v. Lucy, Lady Duff-Gordon, 222 N.Y. at 90-91, 118 N.E. 214. Thus, under Pennsylvania law an obligation to use "best efforts" will be implied in a contract granting an exclusive agency if the plaintiff depends for its consideration solely upon sales of the licensed product.

In cases such as Wood and Maxwell, courts have found it necessary to imply a covenant to employ best efforts as a matter of law because otherwise the contract at issue would lack mutuality of obligation and be inequitable. Eastern Elec., Inc. v. Seeburg Corp., 427 F.2d 23, 25 (2nd Cir.1970); Kardios Systems Corp. v. Perkin-Elmer Corp., 645 F.Supp. 506, 509 (D.Md.1986). It would be inherently "unfair to place the productiveness of the licensed property solely within the control of the licensee, thereby putting the licensor at his mercy, without imposing [a reciprocal] obligation upon the licensee." Vacuum Concrete Corp. v. American Mach. & Foundry Co., 321 F.Supp. 771, 773 (S.D.N.Y.1971).

The issue before this court is thus whether an implied covenant to use best efforts is necessary to establish mutuality of obligation in the present case. The existence of a best efforts obligation should not be lightly inferred since "such an obligation subjects the licensee to significant litigation exposure and deprives him of the fundamental power of determining for himself the reasonableness of his marketing efforts." Kardios Systems Corp., 645 F.Supp. at 509. Where it is unnecessary to imply such an obligation in order to give effect to the terms of the contract, the obligation will not be implied. Willis Bros., Inc. v. Ocean Scallops, Inc., 356 F.Supp. 1151, 1155 (E.D.N.C.1972).

In making the determination of whether a covenant to use best efforts should be implied as a matter of law, this court must focus its attention on the terms of the written contract...