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Enforcing “no-challenge” clauses: no brushing off an agreed contractual term

Canada Publication December 4, 2020

A recent decision from the Ontario Divisional Court, Loops L.L.C. v. Maxill Inc., setting aside an order from the Ontario Superior Court of Justice,1 has confirmed the enforceability of “no-challenge” clauses in Canada in patent settlements, filling a void in recent Canadian jurisprudence on the validity of such clauses.  

“No-challenge” clauses are restrictive covenants that bind one party to an agreement not to challenge the validity of the other party’s intellectual property rights. They’re commonly used in patent settlements (prohibiting the alleged infringer from later challenging the validity of the patent), trademark coexistence agreements (prohibiting each party from challenging the validity of the other’s trademark registrations), and intellectual property license agreements (prohibiting the licensee from challenging the validity of the rights being licensed). In the context of patents, these types of clauses have been held unenforceable in certain circumstances in jurisdictions such as the United States, making this decision a welcome clarification for parties contracting under Canadian law.


Background 

The parties, who are both in the business of designing, manufacturing and distributing inter alia toothbrushes, had settled a patent infringement dispute whereby Maxill’s Supermaxx toothbrush was alleged to infringe Loops’ registered Canadian patent. The confidential settlement agreement between the parties contained, among other things, a “no-challenge” clause stating that Maxill and its president “would not directly or indirectly assist any person attacking the validity of” certain intellectual property, including Loops’ corresponding US patent.  

Following settlement, Maxill created and began to distribute another toothbrush as a “design-around” of Loops’ patent. In response, Loops commenced an action in Utah for infringement of its US patent, and an action in Ontario to enforce its settlement agreement with Maxill. As part of its defence in the US action, Maxill attacked Loops’ US patent as being invalid. 

Loops sought an interlocutory injunction from the Ontario Superior Court of Justice to bar Maxill from asserting invalidity of the US patent before the US courts based on the “no-challenge” clause in the settlement agreement. The court declined to grant an injunction, applying the three-part RJR-MacDonald test of (i) a strong prima facie case; (ii) irreparable harm; and (iii) balance of convenience. 

In determining that there was no strong prima facie case establishing breach of the “no-challenge” clause, the court relied on English and American jurisprudence to conclude that such clauses were unenforceable in Canada.  

The Superior Court expressed concern that such clauses precluded a potentially valid defence for the personal profit or protection of one party. The court concluded that precluding access to a potentially valid legal position was “too high” a price to pay if public trust and confidence in the administration of justice are to be maintained, regardless of the contracting parties’ intentions. Accordingly, the court held that “no-challenge” clauses are not reasonable in the public interest and are therefore unenforceable. 

The Divisional Court decision 

On appeal, the Divisional Court set aside the order of the motions judge and granted an interim and interlocutory injunction prohibiting Maxill from challenging the validity of Loops’ US patent either directly or indirectly.  

Strong prima facie case 

Returning to first principles of contractual interpretation, the court held that the restriction against attacking the validity of the US patent found in the “no-challenge” clause was clear and unambiguous. By asserting that Loops’ US patent is invalid, Maxill was in breach of the “no challenge” clause, which on its face established a strong prima facie case to support an injunction. 

The court noted that evidence that the “no-challenge” clause is not reasonable in the public interest could still overcome such a strong prima facie case, observing that there can be limits to the power to contract where the public is harmed. However, it found that no evidence whatsoever had been adduced to show that the public would be harmed, or that such clauses are a threat to public trust and confidence in the administration of justice.  It noted that agreeing in a contract to preclude the subsequent use of a defence otherwise available does not prove harm to the public simply because it will result in personal gain or protection of one party. Indeed, as these authors note, that is the essence of many settlement agreements.  

The court also addressed the English and American case law cited by the motions judge in significant depth. It concluded that US jurisprudence itself is split, particularly as between enforcement of “no-challenge” clauses in patent litigation settlements, as opposed to licensing arrangements.  

Perhaps more importantly, the court concluded there was no need to rely on foreign law. Instead, it affirmed the prior Canadian jurisprudence confirming the application of the related licensee estoppel principle in Canada, which is a broader form of “no-challenge” prohibition. 

Irreparable harm and balance of convenience 

Finally, the court considered irreparable harm and balance of convenience, which it noted were interrelated. 

In an important development, the court concluded that Loops would suffer irreparable harm if an injunction was not granted. The court reasoned that Loops’ inability to hold Maxill to its bargain and prohibit Maxill from attacking the validity of the US patent would fundamentally change the nature of the US case. That harm is one that, once the proceeding is complete, cannot be recovered in damages and is for that reason irreparable.

Similarly, the court found the balance of convenience lay with Loops, in particular because if the US patent was rendered invalid despite a valid “no challenge” clause it would be extremely difficult to rectify the situation. 

Takeaway 

This decision establishes a clear and fresh precedent for the enforceability of “no-challenge” clauses in Canada, confirming that courts are likely to enforce “no-challenge” clauses where they are clear and unambiguous. Such clauses are crucial for patent and intellectual property holders to protect the validity and value of their rights. In light of the increasingly competitive global landscape, sophisticated parties negotiating at arm’s length will be held to their bargain and courts in Canada will give effect to the intentions of the parties as clearly expressed in the contract, even if settlement is reached on a global basis.  

This approach allows parties to negotiate terms based on the strength and value of corresponding global patents, and accordingly, allows freedom of contract to resolve what otherwise might be a global dispute.

Were this not the case, patent holders would be put to the unenviable position of accepting the risk of a future validity challenge in foreign jurisdictions, despite a mutual desire for settlement. Such a position would deter patent holders from entering into settlement agreements, running contrary to the strong jurisprudential policy in favour of settling litigation.   

While this decision was made in the context of a settlement agreement from a patent infringement action, it is likely to have broader implications regarding the enforceability of these types of restrictive covenants generally and with other intellectual property rights. 

The authors wish to thank articling student Melissa Wells for her help in preparing this legal update.


Footnotes

1   Loops v. Maxill Inc., 2020 ONSC 971.



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