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Supreme Court says Royalties under US Patents Not Taxable

Patent Law / Employees Invention / Reasonable Remuneration

Patent Law, Section 35 / Conflicts Law / Civil Code

Tokyo High Court, Case Hei 14(ne) No. 6451, Decided January 29, 2004

1. Defendant shall pay to Plaintiff the amount of 128,106,300 yen (approx. US$ 1.1 mil.) and the interest accruing from August 8, 1998 to the date of payment.
2. Other claims of Plaintiff are rejected.
3. Other claims of Defendant are rejected.
4. Plaintiff shall bear two third of the court fees and Defendant bears the rest.

Plaintiff was an employee of Hitachi Ltd., the Defendant, which is a major electronic company in Japan. During his employment, he invented hundreds of inventions relating to light pickup units for compact discs, some of which were granted patents in and outside of Japan. Among other patents, Plaintiff's inventions #1, #2 and #3 (subject inventions) contributed to the licensing revenue of the Defendant.
After his retirement, the Plaintiff brought suit before the Tokyo District Court claiming the payment by the Defendant of reasonable remuneration for, among others, the subject inventions. The Plaintiff asserted that the patents granted on the subject inventions were licensed to many companies and resulted in a huge amount of royalty income to the Defendant. His claim was subject to Section 35, Paragraph (3) of the Patent Law, which reads:
" (3) The employee, etc. shall have the right to a reasonable remuneration when he has enabled the right to obtain a patent or the patent right with respect to an employee's invention to pass to the employer, etc. or has given the employer, etc. an exclusive right to such invention in accordance with the contract, service regulations or other stipulations."
In its decision of November 29, 2002, the Tokyo District Court ordered the Defendant to pay the amount of approx. 35,000,000 yen (approx. US$318,200) as remuneration under Section 35(3). In determining the amount, the court considered as a basis for calculation the royalty payment received from the individual licensees of the Defendant. However, the court did not include the foreign patents based on the subject inventions as the basis for calculation in view of different jurisdiction. The court explained that the Japanese Patent Law could not be applicable to foreign counterpart patents under the doctrine of territoriality.
In its argument before the district court, the Plaintiff attempted to persuade that profits obtained from Defendant's own business exploiting and utilizing the subject inventions should be included as a basis for calculation in addition to the license revenue. However, the court dismissed this argument based on the procedural reason that the claim on this specific point was filed unreasonably belatedly.
With regard to the interpretation of Section 35, Paragraphs 3 and 4, the district court followed the precedent of the Olympus case in which the district court regarded the nature of this statutory provision as being preemptive against contractual settings between the parties. The district court made it clear that despite the provision of an internal program for the treatment of inventions and remuneration therefor, an inventor is entitled to claim additional payments by its employer for its invention whenever the invention is an employee's invention and whenever he/she reasonably recognizes that the payment so far made under the internal program was insufficient.
Both parties appealed the district court's decision to the Tokyo High Court. On appeal, the High Court upheld the reasons elaborated on by the district court, except for the issues and the reasons as follows.

1) Section 35 vs. Internal Program
The provisions of Section 35 assume that the ownership of an employee invention belongs to the inventor of the employee invention. Based on that assumption, law assures that the right to obtain a patent for an employee invention can be assigned to an employer. Such assurance can be lawfully made under a prior contractual arrangement between the employer and the inventor. At the same time, the law intends to protect the interest of the inventor by requiring the employer to pay reasonable remuneration in return to assignment. The Court articulated the situation where such payment can be justified as follows.
Even if a companyfs program for invention and remuneration has provisions to set forth a specific amount of remuneration to be paid by the employer to the inventor, the inventor is entitled to claim additional payments as reasonable remuneration under Section 35, Paragraph 3, when and if the inventor recognizes that the amount in the companyfs program was in shortage of the amount which ought to be reasonable in view of Section 35, Paragraph 4.

2) Nature of Section 35 of the Patent Law
The lower court ruled that Section 35 of the Japanese Patent Law did not extend to the foreign counterparts because of the principle of territoriality. However, the High Court did not support this interpretation by the lower court.

" An agreement to assign an employee invention from the inventor to the employer was made in Japan. The parties did not explicitly express their intent as to which law was applicable to the execution and validation of the agreement. However, there was implied intent between the parties that allowed a presumption that the applicable law was Japanese law. Subject to Article 7, Paragraph 1 of the Horei (Statutory Conflicts Law), governing law applicable to the agreement setting forth the likely assignment of the right to obtain patents, not only domestically but also overseas, should be construed as Japanese law. Given the absence of the partiesf explicit intent of applicable law, Article 7, Paragraph 2 of the Horei sets a basis for determining Japanese law as governing law in this case.
" The application of Japanese law to this case can be sustained even if the applicability of Article 7 of the Horei is denied. In absent of statutory provisions, the rule of reason can be applied. The rule of reason suggests an application of conflicts law which is most likely to affect employment relationships between the employer and the inventor. The rule of reason would support the choice of Japanese law in view of the fact that the employment agreement was made by and between a Japanese corporate entity and a Japanese citizen.

"Section 35 of the Patent Law has a superseding and preemptive nature (kyoko hoki). It aims at adjusting interests of the employee and its employer relating to their employment contact. While it is codified in the Patent Law, provisions embrace character and effect of labor law. Taking this nature of Section 35, a reasonable remuneration under this section shall be uniformly governed under the law of the country where the employee and its employer live. Reasonable remuneration should not be subject to the law of the country where a relevant foreign patent exists."

3) Value of the Subject Invention #1
The invention #1 relates to a light pickup unit. The Plaintiff received from the Defendant a special award for this invention during his employment. This award was very special and given to a limited number of inventions which had been recognized extremely outstanding under the companyfs reward program. The award ratio was 0.006% (6 out of 10,000 for the past 20 years). This invention was filed for patent in many countries and in fact patents were granted thereto. During licensing negotiations, many to-be licensees acknowledged that the subject invention was unavoidable, which witnessed the value and strength of the subject invention.
The High Court analyzed the contribution ratio in connection with each package license. For example, in the agreement with NV Philips, contribution was rated as 22% for the agreement made in 1983 while it jumped to 40% for the 1986 agreement and the 1991 agreement. The Court concluded that contribution of the subject invention to the profits which the Defendant had received from Philips amounted to 98,800,000 yen. Likewise, the Court calculated the Defendantf profits under the subject invention and the Plaintifffs contribution ratio for individual agreements with other companies.

4) Amount of Reasonable Remuneration
a) Defendantfs Profits Received from the licensees
There were 16 licensees to which a package license was granted including the patent on the subject invention #1 was licensed. Royalty revenue from each licensee was calculated individually, totaling 579,745,000 yen (approx. US$5,270,410).
The inventorfs contribution to this revenue was set as 20%. His share of contribution among the co-inventors was determined to be 70%. Therefore, the amount of reasonable remuneration arising from the package license was calculated from the following equation:
579,745,000 yen x 0.2 x 0.7 = 81,164,300 yen
b) Defendantfs Profits Received from Cross-Licensee
The High Court found that the package cross license with Sony resulted in the royalty income of 600 million yen. Applying the contribution factors of 20% for the inventor and 70% for the co-inventors, the amount of reasonable remuneration in connection with the package cross license with Sony was calculated according to the following equation:
600,000,000 yen x 0.2 x 0.7 = 84,000,000 yen
c) Total
To sum up, the amount of reasonable remuneration was:
81,164,300 yen + 84,000,000 yen = 165,164,300 yen
The amount of reasonable remuneration for the subject invention #1 was 165,164,300 yen. The amount of 2,318,000 yen was already paid to the Plaintiff in accordance with the internal program.
Thus, the amount to be additionally paid is 162,846,300 yen (US$1,480,421).

This decision is interesting in two aspects. First, the Appeal Court attempted to elaborate on the rationale to extend the effect of Section 35 to counterpart patents in foreign countries. This inevitably called for arguments on the issue of governing law. Second, the Court attempted to set a basis for the calculations of Defendant's profits from cross-licensees, with adjusting factors.
Extension of the Japanese Patent Law, Section 35 to foreign counterparts apparently increased the amount of profits which the Defendant received. This increase results in the increase of reasonable remuneration since several international companies such as Sony and Philips were major licensees in this case. However, the first aspect does not necessarily match with the second aspect. For example, while the Appeal Court increased the amount of award to 84,000K yen from 30,000K yen for the profits from Sony, the Court did not agree with the amount of 40,000K yen which the district court found as profits from Philips. The reason for this cancellation is not necessarily clear from the decision. The Appeal Court simply stated that there were no evidences to show the basis for calculation. However, this statement does not explain the fact that the "offset payment" in the amount of US$250,000. was made by Philips to Hitachi and evidence was submitted to the court to prove the payment.
Valuation of company's profits from cross-license arrangements is difficult. Such difficulty increases when off-set deal was made under package cross-licensing. Given difficulties of figuring out specific amounts, it may not appropriate to vary the benchmark for different cross-licensees in the same case. But the High Court applied different measures in this case.
The Court's decision created uncertainties which will be embarrassing industry people as to the profit calculation under cross license arrangements in particular.

This decision was delivered on January 29, 2004, one day before the Tokyo District Court delivered the long-waited decision in the case of Nakamura Shuji vs. Nichia Chemical Co. in which a 20 billion yen claim was awarded as reasonable remuneration under Section 35(3). On February 24, 2004, the Tokyo District awarded to a former high ranked engineer a 190 million yen award in the case of Ajinomoto's artificial sweetener.
Nine digit figure awards by courts are no longer surprising in Japan as statutory reasonable remuneration to employee inventors.

(By Jinzo Fujino, published in AIPPI Journal, March 2004)

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