When Merger Clauses Don't Merge

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Last week, a divided panel of the Federal Circuit extinguished Molon Motor and Coil Corporation’s hopes of going forward with a patent infringement suit against its electric motor industry competitor Nidec Motor Corporation. The majority’s affirmation of the lower court order and the dissenting opinion can be read here, but, briefly, the majority agreed with the lower court’s decision on summary judgment that the covenant not to sue in an earlier agreement was not extinguished by the latter license agreement. 

The origins of the dispute go back over a decade. In 2004, Molon sued Nidec’s predecessor Merkle-Korff for patent infringement of U.S. Patent No. 6,054,785. When Merkle-Korff counterclaimed for declaratory judgment of noninfringement, invalidity, and unenforceability of two other Molon patents (U.S. Patent No. 6,465,915 and U.S. Patent No. 6,617,726), Molon provided Merkle-Korff with a covenant not to sue for the ʼ915 and ʼ726 patents. The entirety of the covenant, referred to here as the 2006 Covenant, reads as follows:

Molon hereby forever covenants not to sue Merkle-Korff for patent infringement (whether direct, contributory, or by inducement thereof) under either the ’915 patent or the ’726 patent with respect to any and all products previously or presently made, used or sold by Merkle-Korff in the United States. This covenant extends directly to Merkle-Korff as well as any individual or entity to which Merkle-Korff previously or presently supplies products by way of the manufacture and/or sale thereof in the United States.

With Merkle-Korff’s counterclaims related to the ʼ915 and ʼ726 patents dismissed, only the ʼ785 patent remained at issue in the litigation. Molon and Merkle-Korff ultimately resolved the dispute with a settlement and license agreement (the 2007 Agreement) where Merkle-Korff obtained an exclusive license, in a limited market (defined in the agreement as the Kinetek Exclusive Market), to the ʼ785 patent, in addition to the ʼ915 and ʼ726 patents and other U.S. and foreign patents and patent applications. 

Years later in 2016, Molon filed a patent infringement suit against Nidec in the Northern District of Illinois for practicing the ʼ915 patent outside the Kinetek Exclusive Market. Nidec filed an early partial summary judgment motion, arguing that, by filing suit against Nidec, Molon violated the terms of the 2006 Covenant since the accused products were covered by the agreement. Molon countered that a merger clause in the 2007 Agreement, which said that all prior agreements “concerning the subject matter hereof, are merged herein and shall be of no further force or effect,” revoked or extinguished the 2006 Covenant. The lower court rejected Molon’s counterargument, holding that there were substantive differences between the agreements, and granted Nidec’s motion with respect to the ʼ915 patent. 

On appeal, the Federal Circuit panel engaged in a de novo review of the 2006 Covenant and 2007 Agreement under Illinois contract law. The majority focused on the differences between the 2006 Covenant and the 2007 Agreement, namely the number of patents, the types of license, and the right to sue in the two agreements, to determine whether the “subject matter” of the two agreements was the same. More specifically, in determining the subject matter in the two agreements differed, the majority explained that the subject matter of the 2006 Covenant is a one-paragraph, unilateral covenant not to sue on the ʼ915 and ʼ726 patents, whereas the 2007 Agreement is a lengthier, bilateral contract for an exclusive license of more than just the ʼ915 and ʼ726 patents. Unlike the 2006 Covenant, which was essentially a non-exclusive license to only two patents in the U.S. for previous and current products, the 2007 Agreement included a globally exclusive license to 12 patents for current and future products, albeit in a limited market, and an additional right to sue third parties for infringement should Molon decline to do so. In short, the majority did not agree with Molon’s position that the 2006 Covenant and the 2007 Agreement covered the same subject matter, i.e., the right to practice the ʼ915 patent, stating that “we find no legal support for the sweeping proposition that an overlapping patent is sufficient to render two agreements the same subject matter.” In addition, the majority rejected Molon’s argument that the mere existence of the merger clause in the 2007 Agreement demonstrates the parties’ “intent to…override all other agreements.” As a result, the majority concluded that the merger clause in the 2007 Agreement did not function to extinguish the rights from Molon to Nidec in the 2006 Covenant and, thus Molon did not have the right to sue Nidec for infringement of the ʼ915 patent. 

In his dissenting opinion, Judge Reyna opined that this case “should have been straightforward” since both the 2006 Covenant and the 2007 Agreement were “licenses” that “relate to the same subject matter — the right to practice the ’915 patent” and, thus, the merger clause “which wiped away all prior covenants with the same subject matter, wiped away the 2006 Covenant.” In his view, the majority’s holding improperly rewrites the 2007 Agreement, allowing Nidec to practice the ʼ915 patent outside of the limited market defined therein and giving Nidec a windfall. He noted that, while the majority recognized that the right to practice the ʼ915 patent is common to both agreements, it applied an unduly heightened standard for merger when it found that the absence of any reference to the 2006 Covenant in the 2007 Agreement indicated that Nidec did not intend for the 2006 Covenant to be revoked. 

What are the lessons here? First, to establish whether a merger or integration clause affects the rights in an earlier or separate agreement, the actual language of the agreements themselves and how that language conveys the substantive rights and obligations exchanged between the parties is key to determining the subject matter of each agreement. If forced to interpret an integration clause that purportedly nullifies all prior agreements, the court will look at factors, such as type of license, scope of market, number of patents, types of products, and enforcement rights, to determine whether the agreements in question are directed to the same subject matter. 

Second, while hindsight is certainly 20/20, this opinion highlights the importance of careful and intentional drafting of agreements during settlement and otherwise. In fact, during oral argument of the appeal, the panel mentioned several times that this issue would not have even come before them if the 2007 Agreement specifically dealt with the rights in the 2006 Covenant. Despite the fact that there is no legal requirement to explicitly list prior agreements in a merger clause, the court here was forced to determine whether the fairly standard merger clause in the 2007 Agreement acted as an implicit revocation of the 2006 Covenant. If the parties truly intended to revoke the 2006 Covenant, why take the risk and leave it to future contract interpretation? Indeed, a party may be exposed to unnecessary risk when a merger clause is considered boilerplate and not given much, if any, thought during drafting, reviewing, and negotiating the terms of an agreement. In this vein, foresight does not always have to be legally blind.