Galbraith Laboratories, Inc. v. Nanochem Solutions Inc. et al

Filing 27

MEMORANDUM OPINION signed by Senior Judge Charles R. Simpson, III on 4/8/2016, re 15 Defendants' Partial Motion to Dismiss, and 22 Plaintiff's Motion for Leave to File a Sur-reply. The Court will enter an order in accordance with this Opinion.cc: Counsel (RLK)

UNITED STATES DISTRICT COURT
WESTERN DISTRICT OF KENTUCKY
AT LOUISVILLE
GALBRAITH LABORATORIES, INC.

PLAINTIFF
CIVIL ACTION NO. 3:15-CV-00553-CRS

v.
NANOCHEM SOLUTIONS INC., AND
FLEXIBLE SOLUTIONS INTERNATIONAL, INC.

DEFENDANTS

Memorandum Opinion
I.

Introduction

Galbraith Laboratories, Inc. (“Galbraith”) filed this lawsuit against Flexible Solutions
International, Inc. (“Flexible Solutions”) and Nanochem Solutions Inc. (“Nanochem”),
(collectively, the “Defendants”).
The Defendants move for partial dismissal of Galbraith’s claims under a recent Supreme
Court ruling. See Kimble v. Marvel Entm’t LLC, 135 S.Ct. 2401 (2015). Galbraith moves for
leave to file a sur-reply.
For the reasons below, the Court will grant the Defendants’ partial motion to dismiss.
The Court will grant Galbraith’s motion for leave to file a sur-reply.
II.

Legal standard

In evaluating a motion to dismiss for failure to state a claim, the Court determines
whether the complaint alleges “only enough facts to state a claim to relief that is plausible on its
face.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007). This Court assumes the veracity of
well-pleaded factual allegations. Ashcroft v. Iqbal, 556 U.S. 662, 679 (2009). The complaint
“does not need detailed factual allegations,” but a “formulaic recitation of the elements of a
cause of action will not do.” Twombly, 550 U.S. at 555.
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III.

The complaint

The Court assumes the veracity of the following well-pleaded factual allegations in
Galbraith’s complaint and attached documents:
In May 1992, Galbraith and Donlar Corporation (“Donlar”) entered into a Joint
Development Agreement (“JDA”) in which they “agreed to jointly develop agricultural products
containing polyaspartic acid,” Compl. ¶ 6, ECF No. 1. Donlar and Galbraith also established the
terms and conditions under which the companies would establish a joint venture company. Id.
Under the JDA, Galbraith and Donlar jointly owned a patent application that eventually became
U.S. Patent No. 5,350,735 (the “735 Patent”). Id.; see also, JDA (2)(C)(2)(b), ECF No. 8-1.
In June 1994, Galbraith and Donlar entered into the Technology Assignment Agreement
(“TAA”), which superseded the JDA. Compl. ¶¶ 7, 9; see also, TAA, ECF No. 8-2.1 Under the
“Grant of Rights” article of the TAA, Galbraith assigned Donlar its rights in
the subject matter disclosed in U.S. Patent Application Serial No. 07/972,375,
filed November 5, 1992, entitled Composition and Methods for Enhanced
Fertilizer Uptake by Plants, including worldwide patent rights in such subject
matter; and inventions and discoveries, whether patentable or not, that (1) use or
include polymers of polyaspartic acid, copolymers and compositions containing
polymers of polyaspartic acid, or polysuccinimide; and (2) were conceived during
the JDA by Galbraith or Donlar or both, as evidenced by written documents, and
Donlar hereby accepts such assignment.
TAA 1. U.S. Patent Application Serial No. 07/972,375 became the 735 Patent. See
Compl. ¶¶ 6, 8.2

The TAA says, “Effective as of the date of the JDA (May 8, 1992), the parties agree to
cancel the JDA [] in its entirety and release the other party from any further obligations under
that Agreement. Except as stated herein, neither party will assert any rights based on the JDA,
and all rights and obligations arising under the JDA are cancelled.” TAA 2.
2
Although Galbraith did not attach a copy of the 735 Patent to its complaint or the
supporting exhibits, the parties agree that Patent Application No. 07/972/375 became the 735
Patent. Defs.’ Mot. Partial Dism’l 2, ECF No. 15-1; Compl. ¶ 8.
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2

Under the “Compensation” article of the TAA, Donlar agreed to pay Galbraith
$300,000. TAA 2. Donlar agreed to secure this obligation with Patent 735 as collateral.
Id. at 2 – 4. Donlar agreed to convey 70,000 shares of stock to Galbraith. Id. at 5.
Donlar also agreed to pay Galbraith royalties on the sale of Licensed Products. The TAA
defined “Licensed Products” as
(1) any product covered by patents that issue on the above referenced patent
application (including continuation, continuation in part, and divisional
applications) and (2) any product sold in the agricultural market for agricultural
purposes that uses or includes polymers of polyaspartic acid, copolymers and
compositions containing polymers of polyaspartic acid, or polysuccinimide.
Id. Donlar’s obligation to pay royalties began after the earlier of sales equaling $5 million or
after 5 years, not to exceed $7.5 million. Compl. ¶ 9; TAA 5.
In 2004, Donlar filed for Chapter 11 bankruptcy. Compl. ¶ 10. The bankruptcy court
entered an order approving an Asset Purchase Agreement between Donlar and Flexible
Solutions. Id.; see also, In Re: Donlar Corp. Order, ECF No. 8-3. Under the Asset Purchase
Agreement, Donlar assigned and Flexible Solutions assumed the TAA. Compl. ¶ 10.
Nanochem, a wholly owned subsidiary of Flexible Solutions, made royalty payments
from 2004 until the first quarter of 2014. Id. ¶ 12. In June 2014, Nanochem requested Galbraith
refund the sum of $132,947.70 “based on the assertion that Defendants’ obligation to make
royalty payments pursuant to the TAA ceased upon expiration of the []735 Patent on November
5, 2012.” Id. ¶ 13.3 The parties agree that the 735 Patent expired on November 5, 2012. Defs.’
Mem. Supp. Mot. Dismiss 3; Pl.’s Resp. Opp. Mot. Dismiss 4, ECF No. 17.
IV.

The Defendants’ partial motion to dismiss

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Nanochem sued Galbraith in the U.S. District Court for the Northern District of Illinois
to recover the alleged overpayment of $132,947.70. Compl. ¶ 15. Galbraith filed this action six
months later seeking to recover additional royalties. Defs.’ Mem. Supp. Mot. Dismiss 3, ECF
No. 15-1. The U.S. District Court for the North District of Illinois dismissed that action. Defs.’
Mem. Supp. Mot. Ext. Time 2, ECF No. 14-1.
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The Defendants move for partial dismissal of Galbraith’s complaint, based on the
Supreme Court’s decisions in Kimble v. Marvel Entm’t, LLC, 135 S. Ct. 2401 (2015) and
Brulotte v. Thys Co., 379 U.S. 29 (1964).
In 1964, the Supreme Court held that “a patentee’s use of a royalty agreement that
projects beyond the expiration date of the patent is unlawful per se.” 379 U.S. at 32. The Court
reasoned, “A patent empowers the owner to exact royalties as high as he can negotiate with the
leverage of that monopoly. But to use that leverage to protect those royalty payments beyond the
life of the patent is analogous to an effort to enlarge the monopoly of the patent by tieing (sic)
the sale or use of the patented article to the purchase or use of unpatented ones.” Id. at 33.
In 2015, the Supreme Court revisited the rule in Brulotte. The Court declined to overrule
Brulotte, explaining: “The decision is simplicity itself to apply. A court need only ask whether a
licensing agreement provides royalties for post-expiration use of a patent. If not, no problem; if
so, no dice.” Kimble, 135 S.Ct. at 2411.
The Defendants argue that Brulotte and Kimble require dismissal of “all elements of
Counts I – V of the Complaint (DN1) to the extent that they relate to royalties accruing after
expiration of the []735 Patent, and seeks to completely dismiss Count VI which pertains only to
future royalties.” Defs.’ Mot. Partial Dism’l 1, ECF No. 15.
Galbraith argues that Brulotte and Kimble do not apply because the royalty payments in
the TAA are tied to non-patent rights. Galbraith relies on an exception to Brulotte highlighted in
Kimble: “post-expiration royalties are allowable so long as tied to a non-patent right—even when
closely related to a patent.” Kimble, 135 S. Ct. at 2408. As part of this “non-patent right”
argument, Galbraith argues that the “royalty payments at issue are compensation for cancelling

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Galbraith’s half-interest share in the joint venture company to be formed pursuant to the JDA.”
Pl.’s Resp. 8 (citing Compl. ¶ 9).
The Technology Assignment Agreement says:
2. COMPENSATION. ...
2.3 Royalties. Beginning upon the earlier of (i) five years following the
Effective Date of this Agreement or (ii) when sales of Licensed Products by
Donlar and its Licensees equals Five Million ($5,000,000) (the “Royalty Initiation
Date”), Donlar shall pay Galbraith a royalty on its sales of Licensed Products and
Licensing Revenue, as set forth in the table below. “Licensed Products” shall
mean (1) any products covered by patents that issue on the above referenced
patent application (including continuation, continuation in part, and divisional
applications) and (2) any product sold in the agricultural market for agricultural
purposes that uses or includes polymers of polyaspartic acid, copolymers and
compositions containing polymers of polyaspartic acid, or polysuccinimide.
“Licensing Revenue” shall mean all monies or other benefit derived by Donlar
from licensing unrelated third parties, to make, have made, use or sell Licensed
Products. ...

Royalty Rate on
Licensing Revenue
40%
30%
25%
20%

Royalty Rate on
Sales of
Licensed Products
4%
3%
2%
1%

Paid Until Cumulative
Royalties From Sales
and Licensing Equal
$2 million
$4 million
$6 million
$7 ½ million

At such time as the cumulative royalties paid by Donlar to Galbraith hereunder
equal Seven Million Five Hundred Thousand Dollars ($7,500,000), Donlar’s
royalty obligation shall terminate and no further royalties shall be due hereunder.
TAA 6 (emphasis added).
Although Galbraith argues that “it is clear that the royalty obligations of the TAA were
intentionally separated from the price assigned to the patent rights,” this argument is
unpersuasive. The TAA’s definition of “Licensed Products” explicitly says that Donlar will pay
Galbraith royalties for the sale of Licensed Products on “any products covered by patents that
issue on the above referenced patent application.” TAA 5. The “above referenced patent
application” is the U.S. Patent Application Serial No. 07/972,375, see TAA 1, which the parties
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agree became the 735 Patent. Compl. ¶ 6; Def.’s Mem. 2. Thus, the TAA’s royalties provision
obligated Donlar to pay Galbraith royalties for the sale of products covered by the 735 Patent.
Ultimately, the TAA intertwined Donlar’s obligation to pay royalties with Galbraith’s patent
rights, and the TAA did not intentionally separate royalties from patent rights.
Galbraith’s argument that the royalties were consideration for cancelling the JDA is
likewise unavailing. The TAA explicitly says that Donlar terminated the JDA by a letter
postmarked July 26, 1993, see TAA 2, almost one year before Galbraith and Donlar entered into
the TAA. TAA 1. Section 2.1 of the TAA “License Fees” begins with “As consideration for the
assignment set forth above,” which Galbraith relies on to argue that the $300,000 payment was
consideration for the patent licensing, and the royalties provisions served as consideration for
cancelling Galbraith’s half-interest share. See Pl.’s Resp. 8.
However, “License Fees” falls under the larger Article entitled “Compensation,”
indicating that the License Fees were part of Donlar’s larger obligation to convey 70,000 shares
of stock to Galbraith, pay Galbraith royalties for the sale of Licensed Products, report on its sale
of Licensed Products, pay any applicable minimum royalties, and submit to an audit by
Galbraith. See TAA 2 – 8. Galbraith’s argument artificially parses the “Compensation” article
of the TAA which included inter-related and mutually enforceable terms for payment of patent
licensing and cancelling Galbraith’s half-interest share.
Further, although the Court in Kimble said, “post-expiration royalties are allowable so
long as tied to a non-patent right,” Justice Kagan explained this exception in the next sentence of
the opinion: “That means, for example, that a license involving both a patent and a trade secret
can set a 5% royalty during the patent period (as compensation for the two combined) and a 4%
royalty afterward (as payment for the trade secret alone).” 135 S.Ct. at 2408. Here, the TAA has

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no provision differentiating the calculation of royalties during the patent period and a calculation
of royalties after the patent expired. See id. Additionally, as in Kimble, the TAA has no
expiration date for the payment of royalties. See id. at 2406 (“The parties set no end date for
royalties, apparently contemplating that they would continue for as long as kids want to imitate
Spider-Man (by doing whatever a spider can).”).
Finally, Galbraith’s argument that the royalty payments were not subject to patent
leverage is without merit. Galbraith points to the court of appeals opinion in Kimble:
“Accordingly, we join our sister circuits in holding that a so-called ‘hybrid’ licensing agreement
encompassing inseparable patent and non-patent rights is unenforceable beyond the expiration
date of the underlying patent, unless the agreement provides a discounted rate for the non-patent
rights or some other clear indication that the royalty at issue was in no way subject to patent
leverage.” Pl.’s Resp. 9 – 10 (quoting Kimble v. Marvel Enters. Inc., 727 F.3d 856, 857 (2013)).
Galbraith has made no showing that the TAA clearly indicated that the royalties were “in no way
subject to patent leverage.” Id.
The Court concludes that the TAA provides royalties for the post-expiration use of Patent
735. See Kimble, 135 S.Ct. at 2411. 4 Under Kimble and Brulotte, the post-expiration royalties
are unlawful per se. The Court will grant the Defendants’ partial motion to dismiss to the extent

4

The complaint identifies Donlar patents to which Galbraith shared an ownership interest
under the JDA as “including, without limitation, U.S. Patent Nos. 5,661,103; 5,854,177;
5,814,582; 5,861,356; 5,783,523; and 5,935,909.” Compl. ¶ 14. In its response, Galbraith
argues that this paragraph is sufficient to put the Defendants on notice that the TAA covers
additional patents with later expiration dates than Patent 735, including U.S. Patent Nos.
5,635,447 and 5,646,133. Pl.’s Resp. 13 – 14.
However, Galbraith admits that “a patent had not been applied for with respect to these
ideas by the time the TAA was entered into,” and that Patent ’477 and Patent ’133 were “not
specifically identified in the complaint.” Pl.’s Mem. 13. Galbraith makes no allegation that
Patent ’477 or Patent ’133 issued as a result of U.S. Patent Application Serial No. 07/972,375, or
that the royalties provision of the TAA otherwise applies to these later-issued patents.
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that Galbraith’s claims seek payment of royalties on an expired patent. The Court will dismiss
Count VI in full, as it seeks recovery for royalties on an expired patent.
V.

Galbraith’s motion for leave to file a sur-reply

Galbraith moved for leave to file a sur-reply. Pl.’s Mot. 1, ECF No. 22. The Defendants
opposed this motion. Defs.’ Resp. Opp. 1, ECF No. 24. Galbraith then filed a “Reply in Support
of Motion for Leave to File Sur-Reply to Defendants’ Reply in Support of Motion for Partial
Dismissal Under Rule 12(b)(6).” Pl.’s Reply 1, ECF No. 25.
Whether to grant leave to file a sur-reply is in within the Court’s discretion. Key v.
Shelby Cty., 551 F.App’x 262, 264 (6th Cir. 2014).
The Court will grant Galbraith’s motion for leave to file a sur-reply.
In its response brief, Galbraith requested that the Court grant leave to amend the
complaint to correct any deficiencies the Court may find. Pl.’s Mem. 14. Galbraith did not
move to amend, file a memorandum in support, or tender a proposed amended complaint for the
Court’s review. The Court will not consider Galbraith’s unsupported request at this time.
VI.

Conclusion

The Court will dismiss Counts I-V to the extent that those claims relate to royalties
accruing after expiration of the 735 Patent, with prejudice. The Court will dismiss Count VI,
with prejudice. The Court will grant Galbraith’s motion for leave to file a sur-reply. The Court
will enter an order in accordance with this opinion.

April 8, 2016

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