oversight

Need to Improve Reviews of Royalty Charges Included in Air Force Contracts

Published by the Government Accountability Office on 1977-08-16.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                         DOCUMENT BESUMF

03242 -   A2293430'
Need to Improve Reviews of Royalty Charges Included in Air Force
Contracts. PSAD-77-153; B-133386. August 16, 1977. 7 pp +
enclosure (9 pp.).

Report to Secretary, Department of the Air Force; by Richard W.
Gutmann, Director, Procurement and Systems Acquisition Div.
Issue Area: Federal Procurement of Goods and Services (1900);
    Federal Procurement of Goods and Services: Reasonableness of
    Prices Under Negotiated Contracts and Subcontracts (1904).
Contact: Procurement and Systems Acquisition Div.
Budget Function: National Defense: Department of Defense -
    Procurement   Contracts (058),.
Organization Concerned: Department of the Air Force:
    Wright-Patterson AWB, OH; Patent and Trademark Office.
Congressional Relevance: House Committee on Armed Services;
    Senate Committee on Armed Services.

         The Armed Services Procurement Regulation permits a
dea.nsp contractor to include in his proposed contract price
ro ilties he must pay a patent owner. Te contracting officer
must submit the information about royalties received from the
contractor to a patent office for advice on the propriety of the
royalties. Findingqs/Conclusions: A review of patent royalty
files indicated a general lack of documentation necessary to
determine he propriety of royalties approved. About 40 of
files xamined did not contain documents showing that the Patent
Division: (1) determined if the Government had rights to the
patent; (2) obtai.ied engi.neers' comments; or (3) reviewed
engineering drawings. The Patent Division recommended approval
of about $106,000 under nine license agreements for which there
was no evidence that the patents covered items procured. There
were several instances in which royalty approvals were
questionable. Contracting officers were not familiar with
general guidelines for processing royalty requests, nd some Air
Force contracts included royalty charges without identification
by the contractor. A review of four cases showed that
conflicting opinions on the propriety of royalty approvals went
unresolved for several years. Failure to obtain and review
necessary information on royalty requests can lead to improper
contract payments. Recommendations: Procedures should be
established to assure that necessary documentation is obtained,
revewed, and maintained to support royalty approval action.
Such procedures could involve requiring a statement or
certification from the contractor regarding the amount of
royalties included in a price proposal and the use of a
checklist by the contracting officer. Steps should be taken to
reevaluate those cases identified where royalties may have been
improperly approved and, if appropriate, take measures to
recover improper payments. (Author/TW)
                 UNITED STATES GENEAL ACOUNTNG OFFICE
 p~J     ~*/t~3WAYHINGTON, D.C 25




       B-133386                              AUG16 W7a


       The Honorable
LI     The Secretary of the Air Force
       Dear Mr. Secretary:

            Thne General Accounting Office reviewed the procedures
       followed for approving patent royalty charges included in
       Air Force contracts awarded by the Air Force Logistics
       Command and other procuring activities at right-Patterson
       Air Force Base. Our review of patent royalty files ndi-
       cated a general lack of documentation necessary to determine
       the propriety of royalties approved. In several instances,
       questionable approvals were made.

            we reviewed studies made by Air Force eadquarters on
       four longstanding royalty cases to determine the propriety
       of royalties approved. These cases were referred to us by
       Congressman Clarence J. Brown. Based on our review of these
       cases, we believe royalties may have been improperly approved
       in three of the four cases.

            We are recommending that you requirt procurement and
       legal review activities to establish procedures to assure
       that necessary documentation is obtained, reviewed, and
       maintained to support royalty approval actions. Further,
       we recommend that steps be taken to reevaluate those
       cases identified where royalties may have been improperly
       approved and, if appropriate, take measures to recover
       any related improper payments.
       SCOPE OF REVIEW

            We interviewed officials and reviewed documents at
       the Office of tne Staff Judge Advocate, Patent and Data
       Division (Patent Division), Wright-Patterson Air Force
       Base, and contacted officials at Air Force Headquarters,
       Air Force Logistics Command, Air Force Systems Command,
       and te Aeronautical Systems Division.



                                            PSAv-77-153
B-133386


ASPR REQUIREMENTS AND AIR FORCE
REGULATIONS CONCi;R;ING ROYALTIES

      The Armed Services Procurement Regulation (ASPR) permits
a defense contractor to include in his proposed contract price
royalties he or any of hs subcontractors must pay a patent
owner for use of a patent. For negotiated contracts which will
exceed $100,000, and which will include over $250 in royalties,
the ASPR reqiies the contractor to eparately identify the
amount of royalties in his price proposal and furnish
details concerning the royalties to the contracting officer.
The contracting officer is to submit the informaticn received
from the contractor to the appropriate patent office for
advice on the propriety of the royalties before the contract
is awarded. The contracting officer may deviate from the
Patent and Data Division's advi    with the onsent of the head
of the procurement activity.

     When reviewing the propriety of royalties, an Air Force
supplement to the ASPR requires that the Patent Division

     -- obtain and review the applicable patent and
        the engineering drawings and consult the
        project engineer concerning the items being
        procured to ensure that the patent covers
        the items;

     -- obtai n the license agreement to verify that
        it requires royalty payments and that the
        rate is reasonable; and

     -- ensure that the Government does not have a
        royalty-free license to use the patent (the
        Government may be entitled to ryalty-free
        use if the invent'on was first conceived and
        reduced to practice under a pior Government
        contract).
     Th~e contracting officer is to use his best effort to
obtain the necessary documents for the Patent Division's review.
If the contracting officer is unable to obtain the information,
the Patent Division is to obtain it. When the Patent Division
receives the information, it must reach a conclusion concerning
the propriety ad reasonableness of the royalty charges
and transmit its recommendation to the contracting officer.




                             2
B-133386


LACK OF DOCUMENTATION IN FILES

     In 1975 and 1976, the Patent Division received 79 royalty
requests and recommended that 68 requests be approved. Many
of these approvals were multiple requests under 28 separate
license agreements. These approved royalties totaled about
$356,000.

     We reviewed the Patent Division's files containing the 28
license agreements and found many of the files to be
incomplete. The chart below summarizes our analysis of the
contents of the file;.

                Analysis of 28 Files Containing
               Requests Recommended For Approval


           Required data                   Number of files
                                           containing data

Patent                                             24
License agreement                                  23
Engineering drawings                               11
Project engineers' comments                        11
Determination of Government's rights               12

     About 40 percent of the files did not contain documents
showing that the Patent Division (1) determined if the Govern-
ment had rights to the patent, i2' obtained engineers' comments,
or (3) reviewed engineering drawings of the patented items.
Only three of the files contained the entire complement of
required data.

     We found that the Patent Division rcommended approval
of about $106,000 under nine separate license agreements for
which there is no eviJence in the files that the patents
cover the items procured.

     By examining the data in the files, plus additional
information we obtained, we also found several instances
in which royalty approvals were questionable.  For example,
the Patent Division

     -- recommended the wrong royalty rates because it
        apparently did not review the license agreement
        or know the terms of the contract;




                             3
B-133386

     -- recommended approval of royalties based
        on the rise of a patent that had expired;
     -- recommended approval of royalties without
        knowing whether license agreements had
        expired; and
     -- recommended approval of royalties even
        though chardes were for technical assistance
        and the amortization of development costs
        rather than patents.
     These cascz were identified and discussed with Patent
Division officials at the close of ur.review.
CONTRACTING OFFICERS DO NOT ALWAYS OBTAIN
AND SUBIIT REQUIRED DATA TO THE DVIS:ON
     We found that contracting officers were not familiar
with the general guidelines for processing royalty requests
which are contained in the ASPR and were unaware of any
responsibility to obtain more information than was volun-
teered by the contractor. Contracting officers stated they
have no way of determining whether royalties will be paid
unless the contractor identified them in the proposal. Even
though the contractor may identify the royalties in his
proposal, the contracting officer may not always obtain
and forward the required information to the Patent Division
in a timely manner.
     Our analysis of selected Air Force contracts showed
that royalty charges have been included i contract prices
without identification by the contractor, and that royalty
charges have been included in contract prices but not iderti-
fied until after negotiations were complete. For example,
about $24,000 in royalties were included in contracts for
sensors used in the F-15 air inlet controller but were not
reported to the contracting officer. Additional ryalties
for the sensors totaling about $116,000 were reported
to the contracting officer and the Patent Division after
negotiations had Deen completed.
     In 1974, the Air Force Audit Agency reported to the
Commander of the Aeronautical Systems Division that con-
tracting officers failed to obtain and forward complete
information concerning royalties to the Patent Division.



                           4
B-133386


As a result, the Aeronautical Systems Division office responsible
for procurement issued a memorandum to procurement personnel
emphasizing the need to follow the established procedures of
the Air Force supplement to ASPR. The Air Force Audit Agency
has not conducted a followup review.

     In early 1977, contracting officers and officials respon-
sible for procurement policy at the Aeronautical Systems Division,
Wright-Patterson Air Force ase, told us that the Air Force has
not established internal controls to ensure that contractors
properly identify royalties in proposals to the Government.

REVIEW OF FOUR LONGSTANDING
ROYALTY CASES

     During our study, Congressman Clarence J. Brown referred
information to us where it was alleged that the Air Force had
approved about $5.9 million in royalties over a number of years
without legal support.

     A review of the files on these four cases showed that Air
Force attorneys, contractors, and patent owners expressed con-
flicting opinions on the propriety of the royalty approvals.
These differences went unresolved for everal years.
     We did not attempt to resolve the differences of opinion.
In 1975, the Patent Division requested Air Force Headquarters
to study one of the four cases. We requested studies of the
three remaining cases to resolve specific issues which were
still open.

     In Case 1, royalties have been paid over a 20-year
period without determining if the components were patented.
In Case 2, steps were not taken to recover improper royalty
payments identified. In Case 3, royalties may have been
approved after the license agreement expired.  There were no
problems with Case 4. Overal, we believe that royalties of
about $349,000 may have been improperly approved.  Details
on each case are contained in enclosure I.

AGENCY COMMENTS AND
OUR EVALUATION

     The Patent Division officials commented that our draft
report accurately portrayed the handling of royalty payments
under Air Force contracts. They agreed that there appears to
be a lack of communication between their division and the


                              5
B-133386

contracting officer on the approval of royalty payments. They
also ointed out that the contracting officer has the final
responsibility for determiiaing action to be taken on their
recommendations.
     The Director of Procurement and Manufacturing, Aeronau-
tical Systems Division, commented that it would be difficult,
if not impossible, to establish further internal controls to
assure that contractors identify royalties in the contract's
cost breakdown. He felt that sufficient local internal con-
trols existed for identifying applicable royalty charges.
CONCLUSIONS
     Failure to obtain and fully review the necessary infor-
mation on royalty requests can lead to improper -contract
payments. Several license agreements were rought to our
attention under which the Air Force had paid royalties for
up t    20 years without obtaining the necessary information
to determine the propriety of royaltes. Unless the Air
Force obtains and fully reviews the necessary data and re-
solves pertinent questions efore contracts are awarded,
similar problem3 may arise regarding the propriety of
royalties.
     Since contractors do not always identify royalties when
appropriate, there is uncertainty as to the total amount of
royalties the Patent Division should aave reviewed in 1975
and 1976, although $356,000 in royalties were identified and
paid in these years. Also, lack of contro and incomplete
reviews may result in unidentified royalties, improperly
approved royalties and/or disagreements which could take years
and considerable expense to resolve.
RECOMMENDATIO':S

       we recommend that you require the procurement and legal
review activities discussed in this report to establish proce-
dures tc assure that necessary documentation is obtained,
reviewed, and maintained to support royalty approval action.
Such procedures could involve requiring a statement or certi-
fication from the contractor regarding the amount of rryalties
included in a price proposal and the use of a checklist by
the contracting officer to remind him of the documentation
needed to support royalty charges. Also, the reviewing patent
official could have a list of the things he would need to
support a royalty approval.



                           6
B-133386

     With regard to the cases identified where royalties may
have been improperly approved, we recommend that the Patent
Division reevaluate its actions on those cases mentioned on
pages 3 and 4, and if appropriate, recover those royalties
improperly paid.
     Regarding the four longstanding cases in which royalties
of about $349,000 may have been improperly approved, we have
made specific recommendations on each case in the enclosure
to this report.
     We are sending copies of this letter to the Secretary o'
Defense, the Director, Office of Management and Budget, Bouse
and Senate Committees on Armed Services, and Appropriations,
House Committee on Government Operations, Senate Committee on
Governmental Affairs, and Congressman Clarence J. Brown.
     With regard to these recommendations, as you know, section
236 of the Legislative Reorganization Act of 1970 requires the
head of a Federal agency to submit a written statement on actions
taken on our recommendations to the ouse Committee on Government
Operations, and the Senate Conimittee on Governmental Affairs
not later than 60 days after the ate of the report and to the
House and Senate Committees on Appropriations with the agency's
first request for appropriations made more than 60 days after
the date of the report.

                                     Sincerely yours,



                                     R. W. Gutmann
                                     Directo:
Enclosure




                          7
ENCLOSURE                                          ENCLOSURE


               DETAILS ON FOUR LONGSTANDING
                      ROYALTY CASES


     The following describes the specific issues of the four
cases, the results of studies performed by Air Force Beadquar-
ters (Headquarters), and our conclusions and recommendations.

CASE 1 - ROYALTIES PAID FOR
SWITCHES IN AIRCRAFT NGINES

     The main issue in this case involved whether or not the
components were actually patented. The royalties applied
to switches used in certain aircraft engines. The payments
were made to patent owners who were affiliated with the
manufacturer of the patented items (elf-royalties).

     The first request for royalties, according to the
Patent Division's files, was dated March 1956 and totaled
about $5,400.   The Patent Division recommended approval.
The switches were supplied to the prime contractor b a sub-
contractor who was licensed to produce them by the patent
owners in 1951.   From 1955 through 1976, about $277,000 in
royalties were recommended for approval. During this period
the Patent Division's advice to the contracting officer was
not consistent, as it recommended approval of some requests,
recommended disapproval of some and consented to others
provided that a royalty reservation clause was placed in
the contracts.   The clause enabled the Government to with-
hold final payment in an amount equal to reported royalties
until they were found to be proper.

     In 1962, the Patent Division recommended that the con-
tracting officer disallow the royalties for the switches
because the royalty rate of 7.5 percent seemed too high,
the royalties appeared to be self-royalties, and the rate
was applied to the entire cost of the switches instead of
the patented components. The contracting officer notified
the contractor that the royalties would be disapproved and
the contractor appealed to the Armed Services Board of Con.-
tract Appeals.  In 1964, the Air Force and the contractor
stipulated tefore the Board to a 5-percent royalty rate on
the entire switch. Because of this stipulation, the Air
Force was to receive a refund of royalties amounting to
about $21,800.
ENCLOSURE                                          ENCLOSURE

     Again in 1969 and 1970, a Patent Division patent
attorney opposed the royalty payments because he con-
sidered them to be self-royalties and to be improperly
computed on the entire switch rather than on the com-
ponents. He also questioned whether the patents even
covered the components. From 1970 to 1976, these issues
continued to surface. We requested Headquarters to re-
solve the issues involved.
Beadgarters study
     The resulting eadqua-ters' study concluded that
the Govelnment's legal position would be tenuous if it
attempted to isallow royalt:y costs on the basis of
self-royalties. Ta study indicated that self-royaltis
are not always improper but must be evaluated on the facts
of each case. Also, the s, .- royalty issue in this case
was discussed and resolved during negotiations leading
to the settlement of the appeal in 1964.
     With respect to payment of roy.lties on the entire
switch, Headquarters stated they were reasonable because
there is no "proper" royalty base or rate for the use of
a patented item. A patent owne~ may fix any convenient
base he desres and obtain royalties as high as he can
nrgotiate.

     Beadquarters could not determine from the available
engineering drawings and other file materials if the
patents covered the switch components.
Conclusions and recommendations
     The files related to this case did not contain suffi-
cient information to resolve the issue. Beadquarters did
not conclude that the royalty payments were proper or that
they should bave been approved because it could not deter-
mine if the components were patented. Therefore, we believe
the Air Force has approved $277,000 in royalties over a
20-year period without documenting the legal basis of its
actions.
     We recommend that the Patent Division approve no
further royalties under the license agreements until it
is determined that the items are covered by the patents.
If the Patent Division cannot satisfy itself, we recom-
mend that the procuring activity take whatever action is
available to recover royalties previously paid.


                             9
ENCLOSURE                                           ENCLOSURE


CASE 2 - ROYALTIES PAID FOR JET ENGINE
AFTERBURNING ACTUATOR ASSEMBLIES

     The issue in this case involved a question of whether
the patents cited the requests for royalty approval cover-
ed actuator assemblies used in 79 engines purchased by
the Air Force. The engine contractor purchased the actua-
tor assemblies from a subcontractor who was licensed by
the patent owner to manufacture the assemblies. Each engine
has four actuators with pistons connected by a flexible
shaft.  The pistons position the flaps of the engine's
afterburner nozzle and their movement is synchronized by
the shaft.

     From 1961 through September   1970, the requests for
royalties generally cited patent number 2,657,539, which
expired November 3, 1970. The Patent Division did not
request copies of engineering drawings until 1968 and
determined in early 1969 that the assemblies were covered
by the patent. After November 3, 1970, the Patent Divi-
sion reviewed seven requests. Five of the requests cited
another patent--number 2,606,450--as the basis of the
royalty charge; one cited the expired patent, and one
did not cite any patents.
     The Patent Division recommended that the request
which cited the expired patent be disapproved. For the
other six requests tctaling $39,334, the Patent Division
did not determine if the new patent covered the actuator
assembly, but recommended that the royalties be allowed
provided a royalty reservation clause was placed in the
contract. The clause permitted the Government to recover
the royalties if they were found to be improper. Through
1973, the Patent Division recommended approval of about
$510,000 in royalties for actuator assemblies used in
jet engines.
     In October 1974, a Patent Division attorney ques-
tioned the propriety of the royalties that were paid on
patent 2,657,539 through September 1970. In his opinion,
the flexible shaft or cable used to connect the actuator
pistons was not covered by the patent claims since the
description of the invention identified the connector as
a solid shaft. He recommended the prime contractor make
an independent investigation regarding patent coverage.
There were no documents in the file which showed that the
investigation was made or that the Air Force took any
further action.


                          10
ENCLOSURE                                       ENCLOSURE

Headquarters study

      In September 1975, the Patent Division requested Air
Force Headquarters to review this royalty case and deter-
mine whether the actuator assemblies were covered by the
patents. Concerning the question of whether the flexible
shaft was covered by patent 2,657,539, Headquarters con-
cluded in its study, dated November 1976r that the patent
covered the actuator assembly as it was used between
September 1961 and November 3, 1970. Headquarters noted
that in engineering terms the word "shaft" may be defined
as camshaf, drive shaft and flexible shaft, Also, the
Headquarters' report indicated the courts have held that
(1) a pent claim is not avoided by use of a different
material than that identified in the description section
to the patent, and (2) the limits of a patent claim may
be interpreted to include equivalent mechanisms that
substantially perform the same function in the same way
to produce the same results.

     With respect to the use of patent 2,806,450 after
November 1970, Headquarters concluded that none of the
actuator assemblies were covered by any of the patent
claims. In December 1976, the Patent Division sent a
letter to the Aeronautical Systems Division contract-
ing officer recommending that royalty payments after
November 3, 1970, be considered for recoupment. As of
May 9, 1977, no action had been taken to recover the
royalty payments.

Conclusions and recommendations

     The Air Force did not document the basis for its
approvals of requests submitted between 1961 and
September 1970. From November 19, 1970, to April 19,
1973, six requests for royalties were recommended for
approval by the Patent Division without a determination
that the assemblies were covered by the patent. Rather,
the Patent Division recommended that the royalties
be allowed, provided that a royalty reservation clause
was included in the contracts.    Not until late 1976,
about 6 years after the initial request for royalty
approval citing the new patent, did the Air Force
establish a position that the $39,334 n royalties
allowed were improper. These improper payments could
have been avoided had the Air Force documented the
basis of its royalty approials and conducted complete
reviews of the propriety and reasonableness of the
royalties before or shortly after contract awards.


                           11
ENCLOSURE                                     ENCLOSURF

     We recommend that the Commander of the Aeronautical
Systems Division promptly take whatever action is available
to recover these royalties paid since November 19, 1970,
which have been determined to be improper.
CASE 3 - ROYALTIES PAID FOR PARTS
OF TE TF-41 ENGINE

     The issue in this case is whether the Air Force should
pay royalties when the contractor manufactures some of the
parts and combines them with other parts supplied by the
patent owner to fabricate a patented device.
     In August 1966, the Air Force entered into a contract
with a domestic corporation to develop and produce the
TF-41 jet engine. The TF-41 engine was a modification
of a jet engine previously developed by a foreign company.
A license agreement, effective July 15, 1966, established
a variable royalty rate for use of patents and technical
data. The royalty rate was 4 percent on te first 500
engines and decreased to 1 percent for engines in excess
of 5,000.   The Patent Division recommended approval of
royalties at the licensed rates in November 1966 and May
1969. Through December 1976, the Air Force approved
over $5 million for use of the foreign company's patents
and for technical data.

      In June 1970, the Patent Division reanalyzed the
royalty charges. The Patent Division found that the
foreign company held five United States patents being
used in the manufacture of the jet engines for which
royalties were being charged. The domestic corporation
made all of the components for the device cove:ed by
one of the patents. Under the four other patents, the
domestic corporation made some of the parts and combined
them with others supplied by the licensor to fabricate
the patented devices. For example, one of the four
patents covered a valve which contained five separate
parts. The domestic corporation made the manifold and
valve assemblies and combined them with a bearing housing,
valve actuator and shaft housing assembly supplied by
the foreign company to fabricate the patented valve.
The Patent Division was unable to identify court cases
which covered a similar situation and was unsure if
royalties should e paid for the use of the four
patents.




                          12
ENCLOSURE                                         ENCLOSURE


     Since the royalty rate included in the license agreement
was intended to cover both the use of patents and technical
data, the Patent Division recommended approval of 7 percent
of the rate as attributable to patent royalties. The remain-
ing 93 percent would cover technical data and assistance,
which is under the purview of the contracting office.

     The contracting officer included as royalties in contract
prices the total rate specified in the license agreement
because

     -- the Air Force wanted the complete transfer of
        all technical data necessary to manufacture
        the engine and to design corrective parts when
        needed; and

     -- it was essential to retain the assistance of the
        foreign company and to maintain its capability
        so that it could support the jet engine in
        service.

     In early 1973, a Patent Division attorney continued
to question the legal basis for paying royalties on the
TF-41 engine and believed that the royalty rate was pro-
bably too high.   e recommended that a complete review
of the royalties be conducted. Later in 1973, at the
request of the Air Force Logistics Command Staff Judge
Advocate, another Patent Division attorney made a study
of this case file and recommended that the Patent
Division continue to recommend approval of the royalties.
He also recommended approval of royalties computed under
the method established in June 1970--7 percent of the
licensed royalty rate for royalties, 93 percent of the
rate for technical data and assistance. The contracting
officer continued to include the total licensed royalty
rate in the contract prices.

Headquarters study

     In a March 1977 analysis conducted at our request,
Headquarters noted that the five patents covered only cer-
tain components of the engine. Under one of the patents,
the domestic contractor made all of the parts and assembled
them into the patented device.  For the four remaining
patents, the domestic contractor made some of the parts
and combined them with others purchased from the patent
owner to make the patented devices. The study noted that



                         13
ENCLOSURE                                           ENCLOSURE

'ourts have eld that the sale of a component part of a
patented device does not imply that the seller has given
the buyer a license to use the entire device. Head-
quarters concluded that the domestic contractor was not
entitled to free use of the patented devices just because
components were procured from the patent owner and, con-
sequently, that the royalties were legally proper.
     Headquarters also noted that the license agreement
of July 15, 1966, was to expire on July 15, 1976, subject
to an extension for an additional 5-year period. We
found that about $33,000 in royalties (based on 7 percent
of the rate) was approved from August 5, 1976, through
December 14, 1976, although the Patent Division's file
did not indicate that the agreement had been extended.
Conclusions and recommendations
     Headquarters stated that patent royalties paid by
the contractor were legally proper. In 1970, the Patent
Division adjusted the method of computing royalties under
the contracts because the licensed royalty rate included
charges for technical data. The contracting officer
continued to approve royalties at the licensed rate to
obtain complete transferral of all necessary technical
data and to maintain the assistance of the foreign com-
pany even though they were not technically royalties.
From August through December 1976, however, the Patent
Division recommended royalties for approval totaling
about $33,000 without documenting that the license
agreement had been extended.
     Before the Air Force approves additional royalty
requests under this license agreement, we recommend
that the Patent Division determine whether the license
agreement has been extended. If the agreement has not
been extended, we recommend that the Patent Division
take whatever action is available to recover the royal-
ties approved since July 1976.
CASE 4 - ROYALTIES PAID FOR MONOCULARS

     The license agreement in this case involves 15
United States patents, of which only 2 were claimed
to apply to the monoculars being procured. The issues
concern the limits of patent coverage and validity
of one of the patents.



                         14
 ENCLOSURE                                           ENCLOSURE

     A request for royalty approval under the license agreement
dated January 1971 was for a 5-percent royalty on 100 monoc.,-
lars. The request totaled about $20,000 and was based on the
use of ona patent. The contracting officer notified the Patent
Division that the patented parts made up only 22 percent of
the price of the items. Based on this advice, the Patent
sion recommended to the contracting officer that royalties Divi-
be limited to 5 percent on 22 percent of the unit price.
      The contractor later revised his price proposal because
the costs of purchased parts, engineering labor and subcon-
tracted parts had increased. The contractor submitted revised
royalty information increasing the royalties to about $21,000.
Royalty charges in this report were based on the patent cited
previously and on one additional patent. The Patent Division
informed the contracting officer that the additional patent
had errors in its language which made it invalid and that it
did not cover the items being procured. Again, the Patent
Division recommended to the contracting officer that royalties
be limited to 5 percent on 22 percent of the monocular unit
price.
     A Patent Division attorney discussed this case with
Headquarters who told the Patent Division that if requested
in writing, it would state that the second patent was valid
and that the royalties should be approved. Based on this
conversation, the Patent Division recommended that the re-
quest for about $2,.000 be approved. Because of allegations
that the royalties were approved improperly, we requested
Headquarters to study the royalties paid in this case.
Headquarters study
     Headquarters concluded that the patent which allegedly
contained errors was valid, and that royalties paid on the
price of the entire monocular were proper.
     A patent contains two sections: one describing
what the invention is and another containing a series of
claims which specify what the invention ds.    According
to Beadquarters, one of the claims of the patent incorrectly
described a physics principle and, therefore, contained
errors in its language. The eadquarters' report indicated
that court decisions, however, consistently hold
errors in a claim do not make it invalid when the that the
                                                   intended
meaning is apparent from the description of the invention.
The study indicated that the patent was valid because the
inventor identified what he meant to claim in his descrip-
tion of the device.


                          15
ENCLOSURE                                      ENCLOSURE


     Beadquarters also maintained that it was immaterial
what portion of the monoculars was covered by the claims
of the two patents cited in the requests for royalty
approval.  As long as some portion was covered, a reason-
able royalty could be negotiated on the cost of all or
any portion of the monocular.  If the file documents were
correct, Headquarters stated that the monoculars contained
the patented parts identified in one of the patents, a-
the royalty payments on the price of the entire item were
reasonable and proper.

Conclusions

     The Patent Division recommended approval of the
royalty requests in 1971, based on advice from Bead-
quarters, and established the Air l'orce position that
the royalties were proper.  In its March 1977 study,
Beadqutrters concluded that th~ patents involved
in this case were valid and that the royalties were
reasonable and proper.  Therefore, we are making no
recommendation.




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