B-152389, DEC. 23, 1963

B-152389, DEC. 23, 1963

TO MR. MORTON A. RAUH:

FURTHER REFERENCE IS MADE TO YOUR LETTER DATED AUGUST 26, 1963, AND THE SUPPORTING PAPERS TRANSMITTED WITH YOUR LETTER OF SEPTEMBER 23, 1963, WHEREIN YOU REQUEST THAT WE REVIEW THE ADMINISTRATIVE ACTION TO DISALLOW CERTAIN ROYALTIES CLAIMED AS ITEMS OF COST UNDER COST REIMBURSEMENT CONTRACTS BETWEEN THE DEPARTMENT OF THE AIR FORCE AND THE SPERRY GYROSCOPE COMPANY, GREAT NECK, NEW YORK, TO WHOM YOU HAVE GRANTED LICENSES UNDER A NUMBER OF PATENTS OWNED BY YOUR COLLEGE COVERING FLUX VALVES.

YOU STATE IN YOUR LETTER THAT WRIGHT-PATTERSON AIR FORCE BASE, ONE OF SEVERAL GOVERNMENT AGENCIES TO WHOM SPERRY IS CURRENTLY SELLING FLUX VALVES, HAS DISALLOWED THE ROYALTIES PAYABLE TO YOU PURSUANT TO THE LICENSE AGREEMENTS, AND THAT VIEWS HAVE BEEN EXCHANGED BY CORRESPONDENCE BETWEEN SPERRY AND THE STAFF OF THE AIR FORCE LOGISTIC COMMAND OVER A PERIOD OF A YEAR WITHOUT RESOLVING THE ISSUE. YOU EXPRESS THE VIEW THAT TO JUDGE THE MERITS OF THE RESPECTIVE POSITIONS OF THE LICENSEE AND THE AIR FORCE WOULD BE PRESUMPTIOUS ON YOUR PART BUT YOUR LONG RELATIONSHIP WITH SPERRY AS LICENSEE INDICATES "THAT THEY HAVE NEVER TAKEN UNREASONABLE AND QUIXOTIC POSITIONS.' THEREFORE, YOU REQUEST THAT THE MATTER SHOULD BE REVIEWED BY US CITING OUR DECISION OF NOVEMBER 4, 1953, 33 COMP. GEN. 203, 99 USPQ 326, RELATIVE TO A SIMILAR CASE SUBMITTED BY THE SECRETARY OF THE ARMY.

THE AVAILABLE RECORD DISCLOSES THAT A ROYALTY PAYABLE BY SPERRY TO ANTIOCH COLLEGE PURSUANT TO A LICENSE AGREEMENT DATED NOVEMBER 15, 1940, AS SUPPLEMENTED OCTOBER 16, 1945, AND JULY 1, 1953, COVERING SEVERAL PATENTS OWNED BY ANTIOCH, HAS BEEN CLAIMED BY SPERRY AS AN ITEM OF COST FOR REIMBURSEMENT BY THE GOVERNMENT UNDER COST TYPE CONTRACTS WITH THE AIR FORCE COVERING THE PROCUREMENT OF CERTAIN SPERRY SPARE PARTS. THE PROPRIETY OF THE REIMBURSEMENT CLAIMED HAS BEEN QUESTIONED BY THE AIR FORCE LOGISTICS COMMAND, WRIGHT-PATTERSON AIR FORCE BASE, OHIO, AND THE MATTER HAS BEEN THE SUBJECT OF EXTENDED CORRESPONDENCE WITH SPERRY. THE PARTICULAR CONTRACTS INVOLVED ARE NO. AF 33/657/-8347, DATED JULY 13, 1962, NO. AF 33/657/-11506, DATED JUNE 26, 1963, AND NO. AF 33/657/-12616, CURRENTLY IN NEGOTIATION. CONTRACT AF 33/657-8347 CONTAINS AN EXPRESS ROYALTY RESERVATION CLAUSE, AS FOLLOWS:

"PART X--- ROYALTY RESERVATION CLAUSE

"IT IS UNDERSTOOD BY THE PARTIES HERETO THAT THE PRICES SET FORTH IN THIS CONTRACT FOR ITEMS 1.20 THROUGH 1.24 CONTAIN A FACTOR OF 5 PERCENT OF COST PLUS PROFIT FOR A ROYALTY PAYMENT ON PATENT NUMBERS 2476273, 2427654, AND 2410039. IT IS RECOGNIZED THAT SAID ROYALTY PAYMENTS ARE THE SUBJECT OF FURTHER NEGOTIATION BETWEEN CONTRACTOR AND THE GOVERNMENT. IT IS HEREBY AGREED THAT UPON COMPLETION OF SAID NEGOTIATIONS, THE UNIT AND TOTAL PRICES OF SAID ITEMS 1.20 THROUGH 1.24 SHALL BE REVISED TO REFLECT THE RESULTS OF SAID NEGOTIATIONS, AND THIS CONTRACT SHALL BE AMENDED TO INCORPORATE SAID REVISED PRICES.'

THE FOLLOWING PERTINENT PROVISIONS ARE INCLUDED IN CONTRACT AF 33/657- 11506 AND SIMILAR PROVISIONS WILL OR HAVE BEEN INCLUDED ALSO IN CONTRACT AF 33/657-12616:

"PART VI--- ROYALTY RESERVATION

"IT IS RECOGNIZED BY THE PARTIES THAT THE CONTRACTOR ASSERTS IT IS LICENSED UNDER A CERTAIN PATENT OR PATENTS. IT IS FURTHER RECOGNIZED BY THE PARTIES THAT THE CONTRACT PRICE OF ITEM 1.5 CALLED FOR BY THIS CONTRACT INCLUDES AN ELEMENT FOR THE PAYMENT OF ROYALTIES UNDER SAID PATENT OR PATENTS IN THE AMOUNT OF FIVE PERCENT (5 PERCENT) OF THE COST. UNLESS THE CONTRACTING OFFICER NOTIFIES THE CONTRACTOR TO THE CONTRARY IN WRITING WITHIN 120 DAYS FROM THE EXECUTION BY THE GOVERNMENT OF THIS CONTRACT, IT SHALL BE DEEMED THAT THE GOVERNMENT HAS NO OBJECTION TO THE AMOUNT OF ROYALTIES INCLUDED IN THE CONTRACT PRICE. IN THE EVENT THE GOVERNMENT OBJECTS TO THE ROYALTIES, FOR ANY REASON, THE CONTRACTING OFFICER SHALL, WITHIN THE SAID 120 DAYS, GIVE WRITTEN NOTIFICATION TO THE CONTRACTOR OF SUCH OBJECTION SETTING FORTH THE GROUNDS FOR THE OBJECTION. THE PARTIES AGREE TO NEGOTIATE FURTHER CONCERNING THE GOVERNMENT'S GROUNDS FOR ITS OBJECTIONS AS STATED IN ITS NOTIFICATION. UNTIL THE NEGOTIATIONS ARE COMPLETED OR PENDING A FINAL DECISION OF A DISPUTE THE GOVERNMENT RESERVES THE RIGHT TO WITHHOLD FROM FINAL PAYMENT UNDER THIS CONTRACT AN AMOUNT EQUAL TO THE AMOUNT OF SAID ROYALTIES AND THE CONTRACTOR SHALL SUBMIT NO INVOICE THEREFOR. THE FAILURE OF THE CONTRACTOR TO AGREE WITH THE CONTRACTING OFFICER CONCERNING THE PAYMENT OF THE ROYALTIES REFERRED TO HEREIN SHALL BE A DISPUTE WITH THE MEANING OF THE CLAUSE OF THIS CONTRACT ENTITLED "DISPUTE.'"

THE REFERENCED "DISPUTES" CLAUSE AND ITS USE ARE PRESCRIBED IN THE ARMED SERVICES PROCUREMENT REGULATION (ASPR), SECTIONS 7-103.12 AND 7 203.12, AND SPECIFIC REQUIREMENTS PERTAINING TO THE CONTRACTING OFFICER'S DECISION THEREUNDER ARE CONTAINED IN ASPR 1-314 PROVIDING, IN PART, AS FOLLOWS:

"1-314 CONTRACTING OFFICER'S DECISION UNDER THE DISPUTES CLAUSE.

"/A) WHEN A FINAL DECISION OF THE CONTRACTING OFFICER INVOLVES A DISPUTE THAT IS SUBJECT TO THE PROCEDURE OF A DISPUTES CLAUSE, OR WHEN THERE IS DOUBT AS TO WHETHER THE DECISION IS SUBJECT TO SUCH PROCEDURE, A PARAGRAPH SUBSTANTIALLY AS FOLLOWS SHALL BE INCLUDED IN SUCH DECISION:

" "THIS IS THE FINAL DECISION OF THE CONTRACTING OFFICER. DECISIONS ON DISPUTED QUESTIONS OF FACT AND ON OTHER QUESTIONS THAT ARE SUBJECT TO THE PROCEDURE OF THE DISPUTES CLAUSE MAY BE APPEALED IN ACCORDANCE WITH THE PROVISIONS OF THE DISPUTES CLAUSE. IF YOU DECIDE TO MAKE SUCH AN APPEAL FROM THIS DECISION, WRITTEN NOTICE THEREOF (IN TRIPLICATE) MUST BE MAILED OR OTHERWISE FURNISHED TO THE CONTRACTING OFFICER WITHIN THIRTY DAYS FROM THE DATE YOU RECEIVE THIS DECISION. SUCH NOTICE SHOULD INDICATE THAT AN APPEAL IS INTENDED AND SHOULD REFERENCE THIS DECISION AND IDENTIFY THE CONTRACT BY NUMBER. THE ARMED SERVICES BOARD OF CONTRACT APPEALS IS THE AUTHORIZED REPRESENTATIVE OF THE SECRETARY FOR HEARING AND DETERMINING SUCH DISPUTES. THE RULES OF THE ARMED SERVICES BOARD OF CONTRACT APPEALS ARE SET FORTH IN THE ARMED SERVICES PROCUREMENT REGULATION, APPENDIX A, PART 2.'"

BRIEFLY SUMMARIZED, THE POSITION TAKEN BY THE AIR FORCE AS SET FORTH IN A LETTER DATED JANUARY 30, 1963, TO SPERRY FROM THE AIR FORCE STAFF JUDGE ADVOCATE AND THE SUPPLEMENTAL CORRESPONDENCE, IS THAT THE PATENT CLAIMS RELIED UPON UNDER THE LICENSE WOULD IN EFFECT EXTEND THE MONOPOLY OF AN EXPIRED PATENT AND CANNOT BE READ ON THE PART NUMBERS CONCERNED; THAT IN THE ABSENCE OF SUCH PATENT COVERAGE SPERRY IS NOT OBLIGATED TO PAY THE ROYALTY PROVIDED BY THE LICENSE, AND THEREFORE SUCH ROYALTY PROPERLY MAY NOT BE REGARDED AS AN ITEM OF COST OF PERFORMING THE AIR FORCE CONTRACTS FOR FURNISHING THESE PARTS. THIS POSITION HAS BEEN REVIEWED BY THE OFFICE OF THE AIR FORCE GENERAL COUNSEL AND BY THE OFFICE OF THE AIR FORCE JUDGE ADVOCATE GENERAL WHO HAVE EXPRESSED CONCURRENCE THEREIN, AND THE AIR FORCE HAS ACCORDINGLY RECOMMENDED THAT YOUR PROTEST BE DENIED.

BY LETTER DATED MAY 3, 1963, SPERRY REFERRED TO OUR DECISION 33 COMP. GEN. 203, MENTIONED IN YOUR LETTER, AND URGED THE AIR FORCE LOGISTICS COMMAND, WRIGHT-PATTERSON AIR FORCE BASE, OHIO, TO RECONSIDER THIS MATTER AND TO ALLOW THE ROYALTY IN QUESTION AS A PROPER ITEM OF COST OR SUBMIT THE MATTER TO US FOR OPINION, STATING IN PART, AS FOLLOWS:

"SINCE YOUR LETTER OF APRIL 12, 1963, THIS COMPANY HAS BEEN REQUIRED TO DELETE THE ANTIOCH ROYALTY IN A BID IN ORDER TO HAVE ITS BID CONSIDERED. SPERRY IS, OF COURSE, LEGALLY OBLIGATED TO PAY THIS ROYALTY TO ANTIOCH COLLEGE EVEN THOUGH IT WAS PREVENTED FROM INCLUDING IT IN ITS BID BY THE CONTRACTING OFFICER. THIS SITUATION IS MOST UNFAIR AND IT SEEMS QUITE CLEAR FROM THE CITED DECISION OF THE COMPTROLLER GENERAL THAT IT IS THE GOVERNMENT'S POLICY TO ALLOW A ROYALTY AS AN ITEM OF COST WHICH THE CONTRACTOR IS LEGALLY OBLIGATED TO PAY. THIS IS PARTICULARLY TRUE SINCE YOUR ALLEGATION THAT CLAIM 9 DOES NOT READ ON THE PARTS PROCURED HAS NOT BEEN SUPPORTED IN ANY .'

IN OUR DECISION 33 COMP. GEN. 203 AN OPINION OF THE JUDGE ADVOCATE OF THE ARMY THAT A CERTAIN PATENT WAS INVALID, NOTWITHSTANDING THE STATUTORY PRESUMPTION OF VALIDITY UNDER 35 U.S.C. 282, HAD GIVEN RISE TO A QUESTION AS TO WHETHER IT WAS PROPER FOR THE CONTRACTING OFFICER TO CONSIDER CERTAIN ROYALTY PAYMENTS MADE BY THE CONTRACTOR PURSUANT TO A LICENSE COVERING THE USE OF A PATENTED ITEM IN DETERMINING THE ALLOWABLE ITEMS OF COST UNDER THE PRICE REDETERMINATION PROVISIONS OF THE CONTRACT. THE SECRETARY WAS ADVISED THAT IT PROPERLY COULD BE DETERMINED THAT PAYMENTS BY A CONTRACTOR OF LICENSE FEES OR ROYALTIES ON A PATENTED ARTICLE NECESSARILY USED IN THE PERFORMANCE OF HIS CONTRACT CONSTITUTE AN ALLOWABLE COST, SO LONG AS THE PATENT RIGHTS HAD NOT EXPIRED AND WERE OTHERWISE ENFORCEABLE. THE SECRETARY WAS ALSO ADVISED THAT IF DURING THE LIFE OF SUCH A CONTRACT, IT WAS JUDICIALLY DETERMINED THAT THE PATENT WAS INVALID, AS DISTINGUISHED FROM A DETERMINATION MADE BY AN EXECUTIVE OFFICIAL OR ADMINISTRATIVE AGENCY IN ACCORDANCE WITH THE RULE WELL SETTLED BY THE SUPREME COURT OF THE UNITED STATES THAT SUCH A DETERMINATION CAN BE EFFECTED ONLY BY APPROPRIATE COURT PROCEEDINGS, THE NECESSARY ACTION SHOULD BE TAKEN TO ASSURE THAT THE CONTRACTOR-LICENSEE WAS NOT GIVEN CREDIT FOR ROYALTY PAYMENTS NOT LEGALLY REQUIRED TO BE PAID TO THE PATENT OWNER; AND FURTHER, IT WAS SUGGESTED THAT IN THOSE CASES WHERE DOUBT MIGHT EXIST AS TO THE VALIDITY OF THE PATENT, CONTRACTS ENTERED INTO WITH LICENSEES UNDER SUCH A PATENT SHOULD CONTAIN A PROVISION RESTRICTING THE ALLOWANCE OF LICENSE FEES OR ROYALTIES AS COSTS TO THOSE WHICH THE CONTRACTOR-LICENSEE WAS LEGALLY OBLIGATED TO PAY THE PATENTEE.

IT SEEMS WELL SETTLED THAT NOTWITHSTANDING THE EXCLUSIVE REMEDY AFFORDED PATENT OWNERS BY THE PROVISIONS OF 28 U.S.C. 1498 FOR RECOVERY OF COMPENSATION FROM THE GOVERNMENT BY SUIT IN THE COURT OF CLAIMS FOR THE UNLICENSED USE OF AND MANUFACTURE BY OR FOR THE UNITED STATES OF PATENTED INVENTIONS, A MANUFACTURER LICENSED TO USE A PATENT REMAINS LIABLE FOR THE PAYMENT OF THE ROYALTY FIXED IN THE LICENSE, EVEN THOUGH THE ITEM IS MANUFACTURED FOR THE UNITED STATES. NEWPORT NEWS SHIPBUILDING AND DRYDOCK CO. V. ISHERWOOD (4TH C.A. 1925), 5 F.2D. 295, CERT.DEN. 269 U.S. 592, AND UNITED STATES V. YOUNGSTOWN SHEET AND TUBE CO. (6TH C.A. 1948), 171 F.2D. 103, 108. A LICENSEE OF A PATENT GENERALLY IS ESTOPPED TO CONTEST THE VALIDITY OF THE PATENT IN A PROCEEDING ON A CLAIM FOR ROYALTIES PAYABLE UNDER THE LICENSE, HOPE BASKET CO. V. PRODUCT ADVANCEMENT CORP. (6TH C.A. 1951), 187 F.2D. 1008, BUT UNDER CERTAIN CIRCUMSTANCES A LICENSEE IS NOT ESTOPPED FROM CONTESTING THE READABILITY OR THE SCOPE OF THE CLAIMS OF THE LICENSED PATENT. SCOTT PAPER CO. V. MARCALUS CO. (1945), 326 U.S. 249. AS WAS POINTED OUT BY MR. JUSTICE WHITE IN THE NOTE TO HIS CONCURRING OPINION IN THE RECENT CASE OF UNITED STATES V. SINGER MFG. CO., DECIDED JUNE 17, 1963, 374 U.S. 174, AT 200,

"IN THE "PATENT ESTOPPEL" CASES, THE COURT FOUND THAT PUBLIC POLICY FAVORS THE EXPOSURE OF INVALID PATENT MONOPOLIES BEFORE THE COURTS IN ORDER TO FREE THE PUBLIC FROM THEIR EFFECTS. THUS, A LICENSEE MAY NOT BE PREVENTED FROM ATTACKING THE VALIDITY OF HIS LICENSOR'S PATENT.'

IN THE INSTANT CASE, SPERRY HAS STEADFASTLY MAINTAINED THAT THE PATENT CLAIM IN QUESTION IS SOUND AND APPLICABLE; HAS ASSERTED THAT IT IS OBLIGATED UNDER THE LICENSE TO PAY THE ROYALTY AGREED UPON, AND HAS URGED THAT THIS ROYALTY IS AN ALLOWABLE ITEM OF COST UNDER THE CONTRACTS. BELIEVE YOU WILL RECOGNIZE, HOWEVER, THAT IN CONSIDERING ITEMS CLAIMED FOR REIMBURSEMENT AS COST UNDER GOVERNMENT CONTRACTS, IT IS THE DUTY AND RESPONSIBILITY OF THE CONTRACTING OFFICER TO WITHHOLD HIS APPROVAL OF ANY ITEM OF EXPENSE WHICH HE DETERMINES THE CONTRACTOR IS NOT LEGALLY OBLIGATED TO INCUR, AS SUCH EXPENSE REASONABLY MAY NOT BE REGARDED AS INCIDENT TO OR NECESSARY FOR THE PERFORMANCE OF THE CONTRACTS. CF. ASPR 9 -110 AND 9-111. FURTHERMORE, WITH PARTICULAR REFERENCE TO THE ALLOWANCE OF ROYALTIES, THE ROYALTY RESERVATION CLAUSE SET OUT ABOVE IN TWO OF THE CONTRACTS EXPRESSLY PROVIDES FOR NEGOTIATION OF THIS MATTER AND AN ADMINISTRATIVE PROCEDURE WHEREBY, UPON FAILURE TO AGREE, THE CONTRACTING OFFICER'S DECISION MAY BE APPEALED PURSUANT TO THE STANDARD "DISPUTES" CLAUSE INCORPORATED INTO THE CONTRACTS.

THE RULE IS WELL ESTABLISHED THAT WHERE A PARTICULAR PERSON IS DESIGNATED IN A CONTRACT TO ACT AS AN ARBITER OF DISPUTED QUESTIONS OF FACT ARISING THEREUNDER HIS DECISIONS ARE FINAL AND CONCLUSIVE ON THE PARTIES. SEE THE AUTHORITIES COLLECTED IN THE ANNOTATIONS 54 A.L.R. 1255, 110 A.L.R. 137, AND 137 A.L.R. 530. AND IN THIS CONNECTION, THE CONGRESS HAS ESTABLISHED A GENERAL POLICY PERTAINING TO THE REVIEW OF DECISIONS BY OFFICIALS UNDER GOVERNMENT CONTRACTS AS EVIDENCED BY THE PROVISIONS OF 41 U.S.C. 32-322, WHICH PROVIDE IN PART THAT "ANY SUCH DECISION SHALL BE FINAL AND CONCLUSIVE UNLESS THE SAME IS FRAUDULENT OR CAPRICIOUS OR ARBITRARY OR SO GROSSLY ERRONEOUS AS NECESSARILY TO IMPLY BAD FAITH, OR IS NOT SUPPORTED BY SUBSTANTIAL EVIDENCE.' IT HAS BEEN CONSISTENTLY HELD THAT AN AGREED ADMINISTRATIVE REMEDY MUST BE EXHAUSTED BEFORE RESORT TO THE COURTS. SEE UNITED STATES V. CALLAHAN WALKER CO., (1942), 317 U.S. 56; UNITED STATES V. BLAIR (1944), 321 U.S. 730; UNITED STATES V. BEUTTAS (1945), 324 U.S. 768; AND UNITED STATES V. CARLO BIANCHI, INC. (1963), 373 U.S. 709. CF. CONTINENTAL ILLINOIS NATIONAL BANK V. UNITED STATES (1952), 121 CT.CL. 203 AND ACORN DECORATING CORPORATION V. UNITED STATES (1959), 146 CT.CL. 394. THE ADMINISTRATIVE ACTION IN THIS CASE HAS GIVEN RISE TO A DISPUTE WHICH WE BELIEVE YOU WILL AGREE COMES WITHIN THE PURVIEW OF THE PROCEDURE PRESCRIBED BY THE CONTRACTS. THAT COMPLIANCE WITH THIS PROCEDURE IS MANDATORY UPON THE CONTRACTING PARTIES--- IN THIS CASE THE GOVERNMENT AS WELL AS SPERRY--- SEEMS BEYOND QUESTION. SEE THE AUTHORITIES CITED ABOVE. AND SINCE THE DISPUTE APPARENTLY HAS NOT BEEN CONSIDERED IN ACCORDANCE WITH THIS CONTRACT PROCEDURE IT MAY NOT BE REGARDED NOW AS A MATTER PROPERLY FOR DETERMINATION BY OUR OFFICE. CF. 37 COMP. GEN. 568 AND 38 ID. 749; ALSO B-150515, NOVEMBER 15, 1963.

YOU ARE ACCORDINGLY ADVISED THAT UNTIL THE ADMINISTRATIVE REMEDY AGREED UPON HAS BEEN EXHAUSTED WE WOULD NOT BE WARRANTED IN EXPRESSING AN OPINION ON THE MERITS OF THE POSITIONS TAKEN BY THE RESPECTIVE PARTIES.