9-0 Supreme Court Victory for Shell in Alien Tort Statute Case
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In what The New York Times has called “the most important business decision of the current term,” Quinn Emanuel obtained a landmark 9-0 victory for Shell Oil in the U.S. Supreme Court in Kiobel v. Royal Dutch Petroleum Co., 569 U.S. __, 133 S. Ct. 1659 (2013). All nine Justices agreed that the Alien Tort Statute (“ATS”) and federal common law do not extend to allegations by Nigerian nationals that English and Dutch subsidiaries of Shell supposedly aided and abetted the Nigerian government’s human rights violations on Nigerian soil.
The Court’s ruling is a significant development for corporations (whether U.S. or foreign) that operate in foreign countries. Plaintiffs’ lawyers have filed some 245 ATS cases since 1980 based on allegations of foreign conduct—imposing significant costs and negative publicity on the corporate defendants who increasingly became the targets of such suits. With the ruling in Kiobel, the Supreme Court has dramatically curtailed the reach of the ATS, holding that it extends only to claims that “touch and concern the territory of the United States … with sufficient force to displace the presumption against extraterritorial application.” Kiobel will enable corporate defendants to obtain dismissal of many ATS suits now pending and will discourage the filing of new ones.
The ruling in Kiobel was the result of a bold and creative litigation strategy. The Second Circuit had held that the case against Shell required dismissal on the ground that ATS liability does not extend to corporations as opposed to natural persons, and the Supreme Court granted certiorari initially to review that question. Upon being retained as Supreme Court counsel, Quinn Emanuel recognized that the Second Circuit’s decision, while correct, might be difficult for the Supreme Court to sustain given that it had recently decided in Citizens United that corporations enjoy the same rights as natural persons in the campaign finance context. Quinn Emanuel therefore argued for affirmance both on the corporate liability ground and also the alternative ground that the ATS does not apply extraterritorially to conduct within a foreign nation’s borders. After oral argument, the Court took the rare step of setting the case for reargument on that alternative ground, which the Court heard on the first day of the October 2012 Term. That alternative argument is now the law of the land.
The Road to Kiobel: A 1789 Statute Is Resurrected in the Lower Courts
The ATS provides: “The district courts shall have original jurisdiction of any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States.” 28 U.S.C. § 1350. The First Congress enacted the ATS as part of the Judiciary Act of 1789, in the wake of two incidents where foreign ambassadors or consuls suffered assaults on U.S. soil (one in Philadelphia, another in New York). The lack of recourse in federal courts for such incidents was viewed as an affront to foreign nations that might lead to international conflict or even war.
The ATS was invoked only three times before the Second Circuit’s 1980 decision in Filartiga v. Peña-Irala, 630 F.2d 876, which held that the ATS applied to a claim against a former Paraguayan official who had allegedly committed torture in Paraguay. Similar ATS cases followed, mostly alleging conduct on foreign soil. Because foreign governments are immune from suit, and individual perpetrators are often judgment-proof, plaintiffs’ lawyers increasingly named corporations as ATS defendants, alleging that they had aided and abetted human rights violations by foreign governments. While defendants obtained dismissal of many of these suits on personal jurisdiction, forum non conveniens and other grounds, it was commonly assumed that the ATS extended extraterritorially.
Sosa: The Supreme Court’s First Attempt to Limit the ATS
Almost a decade ago, the U.S. Supreme Court interpreted the ATS for the first time in Sosa v. Alvarez-Machain, 542 U.S. 692 (2004). The suit was filed against a Mexican individual defendant by a Mexican individual plaintiff who had allegedly been kidnapped and detained for one day on Mexican soil before being handed over to U.S. authorities. The Court observed that federal common law provides federal courts with authority to recognize certain causes of action as within ATS jurisdiction but held that such authority does not extend to “violations of any international law norm with less definite content and acceptance among civilized nations than the historical paradigms familiar when [the ATS] was enacted” (namely, assaults against ambassadors, violation of safe conducts, and piracy). The Court further held that such a cause of action should be recognized only sparingly, taking into account the “practical consequences of making that cause available.” Applying this standard, the Court concluded that a short-term detention of one day did not support a cause of action under the ATS. Sosa involved conduct on foreign soil, but the Court did not address the issue of extraterritorial application of U.S. law in its decision.
Post-Sosa ATS Litigation in the Lower Courts
Despite Sosa’s newly-announced “high bar” to ATS cases, the ATS continued to spawn substantial litigation. Corporations increasingly complained that such lawsuits effectively imposed an unwarranted tax on doing business abroad, and several foreign nations complained that such suits were usurping those nations’ ability to regulate conduct within their borders. Faced with these ongoing ATS suits, corporate defendants sought dismissal through various means, invoking the Sosa standard, lack of personal jurisdiction, strict standards for aiding and abetting liability under international law, and the doctrine of forum non conveniens. Lower courts often adopted one or more of these grounds for dismissal but typically only after many years of litigation that took a toll on defendants in the form of both litigation cost and incendiary headlines.
The Kiobel Case
In 2002, a group of Nigerian nationals by then residing in the United States filed suit against Nigerian, English and Dutch Shell entities (the Nigerian entity was later dismissed for lack of personal jurisdiction) for allegedly aiding and abetting the Nigerian government in violently suppressing demonstrations against the Nigerian Shell entity’s oil-development efforts in the Ogoni region of Nigeria. The plaintiffs alleged, among other offenses, that Shell had aided and abetted torture, crimes against humanity, and arbitrary arrest and detention—all claims that the district court allowed to proceed as sufficiently definite under Sosa.
On appeal, the Second Circuit held that the ATS does not apply to corporations—a novel ruling that no other circuit has yet adopted. Writing for the court, Judge Cabranes held that the “law of nations,” as that term is used in the ATS, does not recognize corporate (as opposed to individual) responsibility for the offenses alleged. International human rights tribunals, for example, have never tried corporations for human rights violations. Judge Leval concurred separately in the result, reasoning that the law of nations does apply to corporations but that any aiding-and-abetting liability under international law requires a mens rea of purpose not knowledge and that purpose had not been adequately alleged. A divided Second Circuit denied rehearing en banc.
The Supreme Court granted the plaintiffs’ petition for certiorari, and Shell retained Quinn Emanuel to handle proceedings in the Court. In the initial briefing, Quinn Emanuel defended the Second Circuit’s no-corporate-liability holding, which is strongly supported by all relevant international-law and federal-common-law precedent, but argued as well that either of two alternative grounds would justify affirmance: that the ATS does not extend extraterritorially to conduct on foreign soil, and that the ATS does not extend to aiding-and-abetting claims. The U.S. Solicitor General, as amicus curiae, joined the plaintiffs in urging the Court to reverse the Second Circuit on the corporate-responsibility issue and not to reach the alternative grounds.
The case was argued in February 2012 by Quinn Emanuel name partner and appellate practice chair Kathleen Sullivan (partner Sanford Weisburst led the firm’s efforts on the briefs). The Justices’ questions at the argument focused largely on the extraterritoriality issue, and five days after oral argument, the Court issued an unusual order setting the case for reargument on the question “whether and under what circumstances the [ATS] allows courts to recognize a cause of action for violations of the law of nations occurring within the territory of a sovereign other than the United States.”
The parties proceeded to brief that question over the summer. Because no court had ever dismissed an ATS case based on the presumption against extraterritorial application of U.S. law, briefing the new question on Shell’s behalf required sweeping original research. Fifty amicus briefs were filed in this second round, in addition to the 86 filed in the first round. The U.S. Solicitor General now moved over to Shell’s side of the case, filing an amicus curiae brief in support of affirming the judgment of dismissal in the case because it involved foreign plaintiffs, foreign defendants and foreign conduct—a position that was influenced by the fact that the United States had argued, in earlier amicus briefs in Sosa and other cases, that the ATS and its related cause of action do not extend to conduct on foreign soil. Ms. Sullivan reargued the case for Shell in October 2012.
The Kiobel Decision
On April 17, 2013, the Supreme Court issued a decision unanimously affirming the Second Circuit’s judgment and holding that the suit against Shell must be dismissed. Chief Justice Roberts (joined by Justices Scalia, Kennedy, Thomas and Alito) adopted Shell’s position, writing for the Court that the presumption against extraterritorial application of U.S. law applies to the ATS, and that neither the text, history nor purpose of the ATS overcame the presumption in this case because “all the relevant conduct took place outside the United States.” Justice Breyer (joined by Justices Ginsburg, Sotomayor and Kagan) concurred in the result but would have upheld the dismissal of the suit on other grounds.
The long-standing presumption against extraterritorial application of U.S. law rests on the notion that the political branches are better suited than the judiciary to trigger potential tension between U.S. and foreign nations, a principle the Court reaffirmed in 2010 in the federal securities-law context in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010). As in Morrison, the Court held in Kiobel that Congress had evinced no clear intent to override the presumption. The text of the ATS does not mention conduct abroad, and the historical purpose of the statute was to provide redress for injuries suffered on U.S. soil (and perhaps piracy on international waters where no sovereign exists), not conduct that occurs within the borders of a foreign sovereign. Chief Justice Roberts explained that the ATS and its related cause of action cannot apply unless the plaintiffs’ claims “touch and concern the territory of the United States … with sufficient force to displace the presumption against extraterritorial application,” and held that they could not do so in a case where all the alleged conduct took place in Nigeria.
Justice Kennedy joined Chief Justice Roberts’s opinion but added a one-paragraph concurring opinion noting that future cases “may require further elaboration and explanation of the presumption against extraterritoriality.” Justice Alito (joined by Justice Thomas) filed a concurring opinion elaborating that, for an ATS claim to “touch and concern the territory of the United States … with sufficient force” to overcome the presumption against extraterritorial application of U.S. law, it must be predicated upon “domestic conduct … sufficient to violate an international law norm that satisfies Sosa’s requirements of definiteness and acceptance among civilized nations.” In other words, it will not suffice if the plaintiff relies on a combination of domestic and foreign conduct to make out an international law violation.
Justice Breyer’s concurrence in the result disagreed with the majority’s reliance on the presumption against extraterritoriality, reasoning that the ATS expressly refers to foreign matters in mentioning “alien[s]” and “the law of nations.” Instead, Justice Breyer would consult a multi-factored analysis drawn from the Restatement (Third) of Foreign Relations Law, finding ATS jurisdiction appropriate “where (1) the alleged tort occurs on American soil, (2) the defendant is an American national, or (3) the defendant’s conduct substantially and adversely affects an important American national interest, and that includes a distinct interest in preventing the United States from becoming a safe harbor (free of civil as well as criminal liability) for a torturer or other common enemy of mankind.” Finding none of these factors satisfied, Justice Breyer agreed with the Court’s conclusion that the ATS does not extend to a case involving only foreign defendants and foreign conduct.
The ATS After Kiobel
Going forward, Kiobel eliminates ATS jurisdiction in virtually any “foreign cubed” case involving foreign plaintiffs, foreign defendants and alleged foreign conduct. But it also will likely rule out most ATS suits against “foreign squared” cases involving U.S. corporations, foreign plaintiffs and alleged foreign conduct. In relying on the presumption against extraterritorial application of U.S. law, Kiobel focuses on where the relevant conduct occurred, not on the nationality of the defendant. And Kiobel expressly rejected “mere corporate presence” in the United States as sufficient to trigger ATS jurisdiction. Thus, while plaintiffs may attempt in future cases to allege that relevant conduct took place within the United States, the mere fact that a defendant company is incorporated in the United States or maintains operations here will not be enough for an ATS claim to overcome the presumption against extraterritoriality. Moreover, few cases that center on conduct abroad will be able to satisfy Kiobel’s “touch and concern the territory of the United States … with sufficient force” standard—especially if the standard is applied, as Justice Alito suggests, to require that the U.S. conduct itself violate specific and definite international law norms, apart from any alleged foreign conduct.
Because Kiobel thus forecloses nearly all cases under the ATS that stem from conduct on foreign soil, plaintiffs will likely seek to bring such claims under theories other than the ATS. For example, plaintiffs may frame their claims as arising under the law of the foreign nation, international law, or state law; they may seek to pursue such claims in state court or, if alien diversity jurisdiction is available, in federal court. Faced with such cases, defendants will have to invoke different grounds for dismissal, such as personal jurisdiction and forum non conveniens. For example, in Palacios v. The Coca-Cola Company, 499 F. App’x 54 (2d Cir. 2012), plaintiffs filed purely state-law claims concerning conduct in Guatemala; Quinn Emanuel, representing The Coca-Cola Company, successfully obtained dismissal of the case from federal district court in favor of a Guatemalan forum, and the Second Circuit affirmed.
Thus, while some avenues may remain for plaintiffs to file suit in the United States arising from conduct abroad, plaintiffs no longer will be able to invoke the specter of a “law of nations” violation under the ATS and federal common law, with the considerable cost and negative publicity that such a claim tends to bring even when the suit is ultimately proven meritless. Quinn Emanuel is proud to have achieved this landmark result, and we stand ready to represent corporate defendants in future cases calling for strategic and sensitive responses to allegations of wrongdoing abroad.
Supreme Court Hears Bartlett, Will Resolve Liability Questions for “Design-Defect” of Generic Drugs
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In March, the U.S. Supreme Court held oral argument in Mutual Pharmaceutical Co. v. Bartlett, concerning whether design-defect claims against generic drug companies are preempted by federal law. Although the case addresses liability only for generic manufacturers, brand-name drug companies could also be affected by the ruling. If the Court holds that claims against generic companies are preempted, then brand-name companies would be the only defendants left standing. And, as the only viable defendants, plaintiffs’ lawyers could try to find new ways to hold brand-name companies liable, even for injuries caused by generic drugs.
Bartlett is a follow-up to the Court’s landmark ruling in PLIVA, Inc. v. Mensing, __U.S. __131 S. Ct. 2567 (2011), which also addressed federal preemption of claims against generic drug companies. In Mensing, the Court held, in a 5-4 decision, that products-liability claims based on labeling deficiencies were preempted by federal law. The Court noted that because federal law requires generic drug companies to use the same labels as brand-name manufacturers, it would be impossible for a defendant to comply with a judgment, based on a state-law claim, requiring it to change or enhance label warnings. “Thus, it was impossible for the Manufacturers to comply with both their state-law duty to change the label and their federal law duty to keep the label the same.” Id. at 2578.
Relying on Mensing, various courts have since dismissed state-law personal injury claims against generic drug companies. But, in Bartlett—the case now on appeal to the Supreme Court—the First Circuit distinguished Mensing and held that a particular type of state-law claim could survive federal preemption.
The plaintiff, Karen Bartlett, suffered from a rare side effect that caused severe burns over most of her body when she took a generic version of a drug called sulindac. She sued the drug’s manufacturer and prevailed at trial on strict-liability design-defect claim. The jury awarded her $21 million in damages.
The generic manufacturer appealed to the First Circuit. The First Circuit affirmed the judgment, holding that Mensing did not control the outcome because it applied only to failure-to-warn claims, not to the design-defect claim asserted by Ms. Bartlett. The First Circuit acknowledged that, just like the requirement that generic drug companies use the same label as the brand-name version of the drug, federal law requires them to design their generics to have precisely the same chemical composition as brand-name drugs. And, a successful design-defect claim would require the generic manufacturer to change the drug’s composition—prohibited by federal law.
Despite the apparent similarity to Mensing, the First Circuit held that the generic manufacturer could avoid the contradictory requirements of state and federal law by refraining from manufacturing the drug. The First Circuit recognized its holding conflicted with decisions of other courts, saying “this issue needs a decisive answer from the only court that can supply it.” The Supreme Court granted certiorari.
The Supreme Court held oral argument on March 19. Based on the Justices’ questions, it is difficult to predict what the Court will decide. But commentators have correctly suggested Ms. Bartlett’s attorneys face an uphill battle in persuading the five Justices in the majority in Mensing that Bartlett is distinguishable. The fact that a generic manufacturer could simply stop manufacturing a drug to avoid preemption does not distinguish the case from Mensing. The defendant there also could have stopped manufacturing the drug, yet the Supreme Court still held the state-law claim was preempted. Moreover, the vast majority of lower courts have held that claims just like Ms. Bartlett’s are preempted.
Whatever the outcome, the opinion in Bartlett will have implications for brand-name manufacturers. Should the Supreme Court rule that the design-defect claim is preempted, then it will have effectively protected generic drug manufacturers from all products liability claims. Such a holding would leave brand-name manufacturers as the only viable defendants in pharmaceutical products liability cases. A decision in Bartlett is expected in June.
May 2013: Sports Litigation Update
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Is “Redskins” a Disparaging Word or a Famous Mark That Honors Native Americans? A recent hearing before the Trademark Trial and Appeal Board of the United States Patent and Trademark Office provides guidance as to the interpretation, reach, and application of Section 2(a) of the Lanham Act, 15 U.S.C. § 1052(a). This section of the federal trademark statute prohibits the registration of marks that contain matter that “may disparage.”
Quinn Emanuel represented Pro-Football in a similar trademark-disparagement case, Suzan Shown Harjo et al. v. Pro-Football, Inc., brought in 1992 by seven Native Americans who petitioned the PTO for cancellation of the federal registrations of the trademark REDSKINS, owned by the Washington Redskins football team. Pro-Football persuaded the District Court that, among other things, the Petitioners’ claims were barred by laches, because they waited over 20 years before filing their cancellation request. On appeal, also handled by Quinn Emanuel, the D.C. Circuit asked the trial court to take briefing and rule upon whether one petitioner, Mateo Romero, who had not reached the age of majority until 1984, was also barred by laches.
The firm briefed this issue to the trial court, and nearly a year and a half later, Judge Kollar-Kotelly ruled Romero’s claims were barred by laches based on his 8-year delay in filing his petition for cancellation. The Court ruled that the 8-year delay resulted in both trial and economic prejudice, and that the length of the delay was comparable to other trademark cases where courts denied a claim based on laches. On appeal, the D.C. Circuit upheld Judge Kollar-Kotelly’s reasoning and affirmed Pro-Football’s laches defense. The Harjo Petitioners filed a petition for certiorari to the Supreme Court, which Quinn Emanuel opposed. On November 16, 2009, the Supreme Court denied the petition, concluding a high-profile dispute that had lasted for the better part of two decades.
After the Supreme Court denied that petition of certiorari, a younger group of Native Americans reactivated the case, now Amanda Blackhorse et al. v. Pro-Football, Inc., seeking to cancel the various registered Washington Redskins trademarks owned by Pro-Football. Quinn Emanuel represents Pro-Football in this identical Blackhorse case brought by the young Native Americans in an attempt to defeat a potential laches defense. Last year, after the parties submitted briefing to the Board as to their positions on the applicable law controlling the issues of the case, the Board issued a decision largely adopting Pro-Football’s legal positions and rejecting the Blackhorse Petitioners’ attempts to broaden the legal standard of trademark disparagement.
Most noteworthy in the Board’s decision is that the evidence must date from the years of registration 1967, 1974, 1978, and 1990; only the views of the referenced group—not the American public as a whole—are relevant; these views are determined by a “substantial composite” of Native Americans, which is not necessarily a majority; disparagement must be considered “in relation to the goods or services identified by the mark in the context of the marketplace”; and, finally, Petitioners need prove only that the marks were “capable” of disparaging, not that they actually were disparaging at the dates in question.
In addition, Quinn Emanuel convinced the Blackhorse Petitioners to agree to limit the record to the same evidence used in the earlier Harjo proceeding, thereby saving Pro-Football significant time, resources, and expenses that would have accompanied protracted discovery. Thus, the same trial evidence as in Harjo was submitted (trials before the Trademark Trial and Appeal Board take place via paper submissions), and final briefing was concluded last fall. The recent oral argument highlighted the legal standards at issue.
Ultimately, the Blackhorse case will test whether the TTAB will follow the direction of the District Court of the District of Columbia and find that there is not sufficient evidence of whether a substantial composite of Native Americans believed the term “Redskins,” as used in connection with the Washington Redskins football club, was disparaging to Native Americans at the times the majority of the trademarks were registered in the 1960s and 1970s.
May 2013: Insurance Litigation Update
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Insurer Prevails on Standards for Loss Causation. On April 2, 2013, the New York Supreme Court, Appellate Division, First Department issued its decision in MBIA Insurance Corp. v. Countrywide Home Loans et al., No. 602825/2008. The decision is significant for insurers, especially financial guaranty insurers, for two reasons. First, it confirms the long-standing insurance-law causation rule in New York, as codified in NY Insurance Law Sections 3105 and 3106. Under the statutory causation rule, a claim for fraudulent inducement of a policy or breaches of warranty in a policy permits an insurer to recover payments made on claims made under the policy, without resort to rescission, by showing that it would not have issued the policy absent the misrepresentations, or that the misrepresentations materially increased the insurer’s risk of loss. It is not necessary under this rule for the insurer further to show a direct causal link between the misrepresentations and the claims payments. Second, the First Department held, consistent with recent federal court decisions to the same effect, that an insurer need not show that breaches of representation and warranty caused a loan to default in order to obtain contractual repurchase of that loan.
MBIA brought suit in 2008, alleging that Countrywide fraudulently induced MBIA to insure residential mortgage-backed securitizations and that Countrywide breached certain representations and warranties in the transaction documents. On January 3, 2012, the NY Supreme Court (Bransten, J.) granted MBIA’s motion for partial summary judgment that it need not establish a causal connection between Countrywide’s alleged misrepresentations and MBIA’s claims payments under the policies issued to Countrywide.
The NY Supreme Court concluded that NY Insurance Law Sections 3105-3106, which enable insurers to avoid insurance contracts obtained on the basis of material misrepresentations and to defeat recovery under such contracts, informed MBIA’s fraud and breach of contract claims. More specifically, the court concluded that if MBIA could establish that Countrywide’s misrepresentations led MBIA to issue policies it otherwise would not have issued or that these misrepresentations materially increased its risk of loss under the policies, MBIA could succeed on both sets of claims. The NY Supreme Court rejected Countrywide’s contention that MBIA was required to prove that its claims payments were directly and proximately caused by Countrywide’s alleged misrepresentations to the exclusion of the so-called “mortgage meltdown.”
On appeal, the First Department affirmed these holdings. Because Sections 3105-3106 mention both “avoid[ing]” an insurance policy and “defeating recovery thereunder,” the First Department concluded that there was no basis to conclude that the statute could not facilitate the recovery of payments made pursuant to an insurance policy procured through misrepresentations, without resort to rescission. Although this decision involved residential mortgage-backed securities, it may have broader application to other contractual frameworks where an insurer issues a policy. Indeed, as the First Department noted, a New York court is “not required to ignore the insurer/insured nature of the relationship between the parties to the contract in favor of an across the board application of common law.”
The rationale for the insurance law causation rule is clear. As the Court of Appeals has repeatedly held, a fundamental principle of insurance law is that an insurer has the right to select the risks it insures. Moreover, if an insurer had to prove loss causation to obtain relief from policies it was induced to issue by fraud or breach of warranty, the law would incent insurance applicants to misrepresent facts relevant to the insured risk.
Similarly, the First Department agreed with MBIA that, based on the contractual language as confirmed by the insurance-law causation rule, MBIA need not show that loans that breached representations and warranties actually defaulted in order to obtain contractual repurchase of such loans. The First Department held that all MBIA must show is that the breaches materially and adversely affected its interests. This decision will also have broad application to all insurers asserting repurchase claims based on contractual provisions similar to the MBIA policies at issue.
May 2013: Germany Litigation Update
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Recent Developments in Determining Patentability of Claimed Software Inventions in Germany. In recent years, the German Federal Court—the appellate court for nullity (invalidity) proceedings in Germany —has begun addressing the scope of patentable subject matter for software patents claiming graphical user interface (“GUI”) related inventions. Given the high stakes involved in the recent smart phone patent wars, the threshold issue of patentable inventiveness for software patents could take center stage in many emerging patent disputes waged in Europe.
Article 52 of the European Patent Convention (“EPC”) is the controlling statutory law governing patentable subject matter. Under this Article “European patents shall be granted for any inventions, in all fields of technology, provided that they are new, involve an inventive step and are susceptible of industrial application” although under paragraphs 2(c) and 2(d) “schemes, rules and methods for performing mental acts, playing games or doing business.” Significantly, programs for computers; and presentations of information are excluded from protection.
In 2010, the German Federal Court addressed whether a software patent claiming a display of topographic information was valid. In German Federal Court - X ZR 47/07 – Wiedergabe topografischer Informationen [Display of topographic information], the patent-in-suit described a method of displaying topographic information relative to the position of a vehicle. In accordance with the practice of the Board of Appeal of the European Patent Office, the Court ruled that a subject matter could be regarded as a patentable invention under Article 52 EPC if at least one partial aspect of the teaching addresses a technical problem. In this regard, the exclusionary provisions of paragraphs 2(c) and (d) were considered to be only “coarse means” for identifying unpatentable subject matters that lack any technical relation.
The court next addressed the question of “inventive step” and, specifically, the proof required to establish sufficient technical relation to satisfy the inventive step test. With regard to the question of inventive step, the German court held that software-executable functions, such as displaying the actual position of a vehicle on a map or conditioning the height of the virtual point of view on the speed of a vehicle, failed to meet the technical solution threshold requirement for satisfying the inventive step test. Because the Court deemed the remaining features also not sufficiently inventive, the Court invalidated the patent-in-suit.
Subsequent decisions by the German Federal Court are in accord. For example, in “Webseitenanzeige” of 2011 (X ZR 121/09 – Webseitenanzeige [display of a website]), the Court decided that a computer-based method of favorably enhancing the dialogue between a user and a server—for example, by providing a specific design of the information displayed to the user—is not sufficiently technically related to satisfy the inventive step test.
The above mentioned decisions manifest the Court’s tendency to resolve the question of patentability of software and user interface related inventions substantially on the level of the inventive step test. This permits the Court to make a more flexible assessment of every single aspect of a teaching. The next years will show where the path taken by the German Federal Court will lead. Due to the ongoing Smart phone wars, several occasions could arise for the Court to further refine its case law on patents relating to software or means of displaying information in general.
May 2013: ITC Litigation Update
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Federal Circuit Addresses Licensing-Based Domestic Industry in Section 337 Investigations. In August 2012, the Federal Circuit issued an opinion in InterDigital Commc’ns v. Int’l Trade Comm’n, No. 2010-1093, reversing and remanding the International Trade Commission’s finding of no violation in Certain 3G Mobile Handsets and Components Thereof, Inv. No. 337-TA-613. In so doing, the Court also rejected an alternative ground for finding no violation that Complainant InterDigital failed to establish the existence of a domestic industry because section 337 does not permit a complainant to satisfy the “domestic industry” requirement based on licensing activities alone. The Court held that the requirement of 19 U.S.C. Section 1337(a)(3)(C) is satisfied if there is a domestic industry based on substantial investment in the exploitation of the asserted patent(s) where the exploitation is achieved by various means, including licensing.
Respondents filed a combined petition for rehearing en banc and panel rehearing with respect to the issue of whether InterDigital’s patent licensing activities satisfied the domestic industry requirement under 19 U.S.C. Sections 1337(a)(2) and 1337(a)(3). The Court denied Respondents’ request for rehearing en banc and issued a 2-1 decision also denying Respondents’ request for panel rehearing on January 10, 2013. The accompanying opinion, authored by Judge Bryson, relied on a mix of textual analysis and legislative history in rejecting Respondents’ and the dissent’s arguments and concluding that InterDigital satisfied the domestic industry requirement through its licensing activities.
Respondents’ petition did not challenge whether InterDigital’s licensing investments were substantial. Rather, Respondents argued that the panel and the Commission misinterpreted the phrases “relating to articles protected by the patent” and “with respect to the articles protected by the patent” in paragraphs 337(a)(2) and 337(a)(3). In particular, Respondents argued that these phrases mandated that any alleged licensing activity “must be tethered to a tangible good.”
In rejecting Respondents’ petition, the Court analyzed the text of the statute and the meaning of the phrase “with respect to articles protected by the patent” in paragraph 337(a)(3). The Court first explained that the requirements under paragraphs 337(a)(3)(A) and (B) were typically met by a showing that investments in plant, equipment, labor or capital are being expended in the production of articles protected by the patent. The Court noted that applying the same analysis to subparagraph (C) produces a parallel result consistent with the proper statutory construction such that “the engineering, research and development, or licensing activities must pertain to products that are covered by the patent that is being asserted.” According to the Court, this interpretation “accords with the common description of the domestic industry requirement as having two ‘prongs’: the ‘economic prong,’ which requires that there be an industry in the United States, and the ‘technical prong,’ which requires that the industry relate to articles protected by the patent.” The Court concluded that InterDigital satisfied the domestic industry requirement under paragraph 337(a)(3)(C) “because the patents in suit protect the technology that is, according to InterDigital’s theory of the case, found in the products that it has licensed and that it is attempting to exclude.”
Judge Newman, in a sharp dissent, wrote that the majority “depart[s] from the statutory text and purpose” and “continues to err” in its understanding of the statute. Offering a stricter interpretation of the domestic industry test by requiring domestic manufacturing, Judge Newman argued that the legislative record is clear that the 1988 amendments to section 337—which added subparagraph (a)(3)(C) —“were enacted to encourage and support domestic production of patented products.” Judge Newman further argued that the majority’s interpretation conflicts with the weight of the Court’s precedents, which require domestic production, or preparation to produce, articles protected by the patent.
On May 10, 2013, Respondents filed a petition for writ of certiorari with the U.S. Supreme Court of the United States on the issue of “whether the ‘domestic industry’ requirement of section 337 is satisfied by ‘licensing alone’ despite the absence of proof of ‘articles protected by the patent.’”
Customizing an International Arbitration Clause: Strategies for Success
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There is no question that international commercial arbitration is becoming, more and more, a preferred method of resolving large scale international business disputes. In crafting clauses that could lead to such arbitrations, parties may opt either to follow the rules of one of the major international arbitration institutions or to create their own ad hoc rules. In either case, there is great flexibility—even if the parties choose to follow the rules of an institution, those rules remain broad by design and continue to give considerable leeway to arbitrators. Left unchecked, this flexibility can create uncertainty and risk.
Carefully drafted customized arbitration provisions can effectively eliminate some of this uncertainty and, in the process, reduce costs and improve a party’s chances for a successful result. This article contains suggestions for terms to consider including in a customized international arbitration clause, from the basic—defining which disputes are covered—to the more complex, such as defining methods of calculating damages or how appeals can be pursued.
Defining Which Disputes Are Covered
Starting with the basics, it is worth considering whether to clarify which types of disputes are covered when drafting an international arbitration clause. Where there is ongoing litigation and the parties wish to arbitrate only discrete issues, those issues must be clearly identified. Similarly, where the parties believe certain types of disputes could arise that should not be arbitrated, these carve-outs should be made explicit to eliminate doubt. The parties might also want to specify time limits for filing an arbitration, and, to avoid undue delay in the arbitration itself, apply time limits for completion of the arbitration hearing that are tied directly to the jurisdiction of the arbitrators.
Defining the Relief Arbitrator(s) Can Provide
This is arguably the most important aspect of a customized arbitration clause. Questions and doubts concerning international arbitrations often center on the broad powers the arbitrators claim to have to award any relief, rationally related to the contract, that they consider fair—even if no party requested it. A customized arbitration clause can address these concerns in advance by defining and limiting the types of relief the arbitrators are empowered to grant. The parties may, for example, draft particular contract provisions that describe how damages are to be calculated when disputes arise, and define the scope of the arbitrators’ powers by reference to those clauses. The parties also may construct a somewhat arbitrary damages formulation, such as a clause that requires the arbitrators to adopt one of the damages calculations submitted by the parties. The arbitrators may be given power to issue only certain types of injunctive relief (although such an award will have to be enforced by a court) or even be limited to issuing findings of fact for the parties to use to calculate present or future damages on their own. The parties thus can be creative in negotiating damage parameters, but must do so in the arbitration clause itself or run the risk that unforeseen awards will be issued at arbitration.
Formulating a Special Appeal Process
It is a common complaint that the narrow appeal standard for an international arbitration usually ensures that any award issued at arbitration will be confirmed—not vacated—by the appropriate court. As a result, parties sometimes attempt to fashion their own appeal standard in a customized arbitration clause. This has produced mixed results. In the United States, the Supreme Court rejected a clause that attempted to make an arbitration award subject to the much broader appellate standard of an ordinary legal action in United States courts on the grounds that the appellate standard for arbitrations is within the exclusive province of the legislature. Hall Street Associates v. Mattel, 552 U.S. 576 (2008). Similarly, there is a serious question as to whether the parties could, by agreement, modify the vacatur provisions of a treaty such as the 1958 New York Convention on the Enforcement of Foreign Arbitral Awards (“New York Convention”) and still have the final result recognized by any signatory country.
In some circumstances, a customized arbitration clause may offer a viable solution to this problem by setting up an internal appeals procedure that runs its course before a final arbitration award is issued. There is precedent for this in the rules of the International Centre for Settlement of Investment Disputes (“ICSID”), which lay out such an internal appeals procedure. Still, caution must be taken. Although an internal appeals procedure avoids the potential problem of modifying established grounds for the vacatur of an award, such a procedure could run afoul of the rules of the administering institution. The rules of the International Chamber of Commerce (“ICC”) and the London Court of International Arbitration (“LCIA”) do not provide for any appeal of an arbitration award, and to the contrary expressly limit any review to the ICC or LCIA court’s approval of the award as to form. There is no precedent as to whether either court would defer this process pending an internal appeal set up by a customized arbitration clause, or consent to its administration by the assigned case administrator. Novel questions, such as choosing other arbitrators to handle the appeal, and requiring further advances of costs not contemplated by the existing cost structure of the institution, would have to be resolved in advance.
Ad hoc arbitrations, such as international arbitrations conducted under the United Nations Commission on International Trade Law (“UNCITRAL”) rules, are a different matter. Because these arbitrations are essentially self-administered, a customized appeals process in advance of the issuance of a final award does not present the same administrative complications as where the arbitration is administered by an institution.
Defining the Number of Arbitrators and Qualifications
Many international arbitrations deal with complex technical, financial or other issues as to which the arbitrators must have background knowledge in order to render a fair decision. But unless the arbitration clause sets forth the qualifications and experience that the arbitrators must have, there is no assurance that the chosen arbitrators will be so qualified. With a three-person tribunal in which each party appoints one arbitrator, the appointing party can assure that the arbitrator it appoints has the necessary qualifications—but setting forth the required qualifications and experience of arbitrators in a customized arbitration clause is the only way to assure that all the members of a tribunal will meet the desired standard. This is particularly important with regard to the appointment of the tribunal chair, or of a single arbitrator, by the chosen arbitral institution. Arbitrators for international arbitrations typically are chosen by case administrators, in accordance with the rules but with little input from the parties. If the arbitration clause itself identifies required qualifications, however, the institution will typically make a diligent effort to pick the right kind of arbitrators, and the parties may have a platform to communicate with the case administrator to assure that all arbitrator candidates meet the agreed standard. Of course, selecting the right kind of arbitrators often can be outcome determinative.
A customized clause also gives the parties the opportunity to choose the number of arbitrators. International arbitration rules typically provide for a default number of arbitrators, but this number may not be consistent with a party’s wishes. For example, a tribunal may provide more assurance of a mainstream, conservative decision, while a single arbitrator will likely allow for more expeditious scheduling of the arbitration hearing and other dates.
Specifying Rules for Document Exchange and Production
Document exchange and production is almost always the only “discovery” allowed in an international arbitration, so a party has to make it count. The most effective procedure is generally considered to be that set forth in the International Bar Association (“IBA”) Rules for the Taking of Evidence. Most arbitrators will suggest that the IBA Rules apply to the arbitration, but this does not always happen. It is not difficult to lay out effective guidelines for electronic document exchange and production in a customized arbitration clause, and it is prudent to memorialize the process. It is also important to clarify how relevant documents generated in other proceedings between the parties should be handled. For example, the parties may be involved in litigation that generated document production, but if there is a protective order for the litigation, the arbitrators may be reticent to allow such evidence absent the parties’ agreement. Here as well, a customized agreement can address in advance such avoidable doubts and uncertainties.
Expert Witness Clauses
Arbitrators invariably set forth a procedure for preparation and exchange of expert witness reports, and for taking expert testimony at the hearing, and the IBA Rules include detailed provisions regarding experts. Accordingly, it is not always essential to lay out these procedures in a customized arbitration clause. However, some details not covered by the rules, and possibly not within the contemplation of the arbitrators, deserve consideration: (i) a date in advance of the exchange of expert reports for experts to be identified and their CVs and a brief summary of the subject matter of their testimony provided; and (ii) a procedure to ensure the parties have input on any expert appointed by the tribunal.
Limits on the Ability to Craft Arbitration Clauses
There are relatively few limits on the customized arbitration provisions to which parties can agree. But there are some, and these must be considered when considering such clauses.
First, where the parties have chosen to conduct the arbitration under a particular set of arbitration rules, as opposed to an ad hoc arbitration proceeding, the rules themselves may contain certain procedures which, as a practical matter, are not subject to modification by a customized arbitration clause. Such rules may include, by way of example, the following:
1) Rules providing for supervision of the arbitration by an internal “court” or similar body. The ICC Rules (January 1, 2012) empower the ICC Court to oversee the arbitration in a number of ways, including (i) making a prima facie decision on jurisdiction (Article 6); (ii) making the final decision on any challenge of an arbitrator (Article 14); (iii) reviewing and approving the final form of the award (Article 33); (iv) determining the amount of advance deposits required of the parties to cover the arbitrator(s)’ fees and other costs of the arbitration (Article 36); and (v) extending time limits where necessary to ensure that the arbitrators, and the Court, can fulfill their responsibilities under the Rules (Articles 39, 30). The LCIA Rules also include clauses giving specific powers to the LCIA court, including (i) the power to appoint all arbitrators, and to make the final determination on any challenge to an arbitrator (Article 7,10); (ii) the power to override the parties’ agreed nominating process for the appointment of arbitrators; and (iii) the power to set and order the payment of advance deposits, to dismiss the arbitration if payments are not made by the parties as ordered, and to approve all costs assessed in the arbitration (Articles 15, 28). Where the parties had elected to have ICC or LCIA Rules govern their international dispute, it is questionable whether the ICC or LCIA courts would permit any material modification to their jurisdiction under the rules through a customized arbitration clause; and
2) Rules establishing the fundamental administrative structure to be applied to an arbitration. There are also other institutional rules so basic to the arbitration process that it is unlikely that an institution would accept any attempt by the parties to modify them. Such rules include, possibly among others: (i) the form and basic required content of a request for arbitration or answer thereto (e.g., ICC Articles 4 and 5; LCIA Articles 1 and 2); (ii) the requirement that each arbitrator be impartial and independent, and undertake procedures (such as the signing of a “statement of fairness” and continuous updates of disclosures) to assure that this requirement is met throughout the course of the arbitration (e.g., ICC Article 11; LCIA Article 5; ICSID Rule 6); (iii) the requirement that certain written procedures be followed (e.g., ICC Article 23 (Terms of Reference); ICSID Rule (memorials, countermemorials, and replies); (iv) the basic powers of the arbitrator(s) to decide their own jurisdiction and assess costs (e.g., ICC Articles 6, 14; LCIA Articles 23, 25, 28; ICSID Rule 41); (v) the format of the final award (e.g., ICC Article 31; ICSID Rule 47); (vi) the time period and grounds for seeking correction or supplementation of the award from the arbitrator(s) (e.g., ICC Article 35; LCIA Article 27; ICSID Rule 49); and (vii) the immunity of the arbitrator(s) or the arbitral court from liability (e.g., ICC Article 40; LCIA Article 31).
A second source of limits on customized arbitration provisions lies in the arbitration statutes of the jurisdiction. Many countries have arbitration statutes that should be referenced by the parties if the laws of that country would apply. Most of the arbitration procedures set forth in these statutes are subject to change by the parties’ agreement, but others, such as the standard for confirming or vacating an arbitration award, may not be. As noted, the United States Supreme Court has ruled that the parties cannot put into their arbitration clause a standard for vacating an award which is contrary to the narrow standard for vacatur set forth in the Federal Arbitration Act. Hall Street Associates, supra. Because the Federal Arbitration Act encompasses the vacatur standard of the New York Convention, this decision arguably prohibits vacatur provisions that differ from the New York Convention with respect to international arbitration awards as well. The laws of any jurisdiction that would apply to an international arbitration dispute should be checked closely for such judicially-imposed restraints on what the parties may include in a customized arbitration clause.
Finally, where a claim, and the relief for it, has been created entirely by statute, there may be a question as to whether a dispute arising under the statute is subject to arbitration even where the parties have agreed to arbitration. United States courts have recognized that actions determining certain real property rights—such as quiet title disputes and a dispute over the right of a landlord to evict a tenant (known as “unlawful detainer” actions)—are subject to strict statutory requirements and remedies that must be enforced in the courts. Such limitations will not necessarily impact the drafting of a customized arbitration clause, but wherever a claim is triggered exclusively by a statute care should be taken to ensure that there is no impediment under the applicable law to bringing the claim under the umbrella of the arbitration clause.
The rules of a game can often determine the outcome. In drafting provisions to cover international business disputes, those rules can, to a large extent, be fixed in advance. To avoid uncertainty and risk, parties may wish to negotiate such rules when crafting customized arbitration clauses in their agreements.
The First Amendment and Off-Label Promotion: United States v. Caronia
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For years, the U.S. Department of Justice has aggressively pursued and brought charges over “off-label promotions”—the promotion of drugs for uses that have not received FDA approval—by pharmaceutical manufacturers and their representatives. Suing under 21 U.S.C. §§ 331(a) and 352(f), the “misbranding” provisions of the Food, Drug and Cosmetic Act (“FDCA”), 21 U.S.C. § 301 et seq., the government has claimed that pharmaceutical manufacturers and their representatives may not engage in off-label marketing even though physicians are free to prescribe drugs for non-approved uses. The government has obtained massive settlements based on the threat of such charges, including an agreement last year by one company to pay a $500 million criminal fine and $198.5 million in forfeiture as part of a misdemeanor plea agreement for off-label marketing of the prescription drug Depakote. See Press Release, U.S. Department of Justice, Abbott Laboratories Sentenced for Misbranding Drug (Oct. 2, 2012) (available at http://www.justice.gov/opa/pr/2012/October/12-civ-1195.html).
A recent Second Circuit decision has the potential to change the landscape in such prosecutions. In United States v. Caronia, 703 F.3d 149 (2d Cir. December 3, 2012), a divided Second Circuit panel vacated the conviction of a pharmaceutical sales representative who had promoted off-label uses of Xyrem, a prescription drug manufactured by Orphan Medical, Inc. According to the Caronia majority, convicting the representative for off-label marketing that was not untruthful or misleading could impinge the representative’s First Amendment rights, requiring a narrow construction of the relevant statutes and regulations.
The government argued that Caronia’s alleged off-label promotional activities were unlawful based on Sections 331(a) and 352(f) of the FDCA and 21 C.F.R. §§ 201.5 and 201.128. The government argued that these sections, when read together, provide that a drug is misbranded if it is introduced into interstate commerce without adequate directions for use, that directions for use must be adequate for all intended uses of the drug, and that a drug’s intended use can be shown by oral or written statements by pharmaceutical manufacturers or their representatives. These statutes and regulations mean, according to the government, that “[a]n approved drug that is marketed for an unapproved use (whether in labeling or not) is misbranded because the labeling of such drug does not include ‘adequate directions for use.’” 703 F.3d at 155.
Caronia responded that the First Amendment prohibits a conviction based, as his was, solely on the truthful and non-misleading promotion of a drug, where the promoted use is not itself illegal and others, such as physicians, are permitted to engage in the same speech. Id. at 160. But according to the government, the First Amendment was of no concern because Caronia’s speech was not actually the basis of its prosecution instead, Caronia’s off-label promotional statements served merely the “evidentiary role” of providing evidence of the drug’s “intended use” under 21 C.F.R. § 201.128. See id. at 160.
The majority rejected this “evidentiary role” distinction in ruling that the government’s prosecution treated Caronia’s off-label promotional statements—his speech—as the crime of misbranding itself. Id. at 161. The government’s proscription of off-label promotion was presumptively invalid under Sorrell v. IMS Health, Inc., 131 S. Ct. 2653 (2011), which holds that a restriction on commercial speech that is content- and speaker-based is presumptively invalid. Further, the government failed two of the four Central Hudson factors that traditionally have been used to assess commercial speech. Id. at 166-68 (discussing Central Hudson Gas & Elec. Corp. v. Public Service Commission of New York, 447 U.S. 557, 566 (1980)). First, banning off-label promotion did not directly advance the government’s goal of reducing off-label drug use or the goal of preserving the FDA approval process because physicians are permitted to prescribe off-label. Second, the ban was not narrowly drawn as required under the fourth prong of Central Hudson because “[n]umerous, less speech-restrictive alternatives are available, as are non-criminal penalties.” Id. at 167. While the opinion thus suggests that prosecuting truthful, non-misleading, off-label promotions of a drug by a pharmaceutical representative would violate the First Amendment, the court ultimately avoided this “serious constitutional question” by ruling that the FDCA’s misbranding provisions cannot be interpreted to prohibit such promotions. Id. at 162.
Caronia appears to undermine the government’s ability to bring criminal charges based on off-label promotional conduct, and this potential impact was highlighted in a vigorous dissent by Judge Livingston, who attacked the majority for potentially unraveling the entire FDA drug approval process.
The FDA has announced that it will not appeal this decision to the Supreme Court, stating that it “does not believe that the Caronia decision will significantly affect the agency’s enforcement” of the FDCA’s misbranding provisions. Thomas M. Burton, FDA Won’t Appeal Free-Speech Marketing Decision, Wall St. J, Jan. 23, 2013. As of now Caronia is binding only in the Second Circuit, and it is difficult to predict whether other circuits will follow the majority’s or the dissent’s lead in future off-label promotion prosecutions.
April 2013: Bankruptcy and Restructuring Update
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Seventh Circuit Extends New Value Exception. In In re Castleton Plaza, L.P., No. 12-2639 (7th Cir. Feb. 14, 2013), the Seventh Circuit became the first Court of Appeals to address whether the new value exception to the absolute priority rule articulated in Bank of America Nat’l Trust & Savs. Ass’n v. 203 North LaSalle Street P’ship, 526 U.S. 434 (1999), extends to insiders, holding that (i) the wife of an equity holder qualified as an insider under the Bankruptcy Code and (ii) “plans giving insiders preferential access to investment opportunities in the reorganized debtor should be subject to the same opportunity for competition as plans in which existing claim-holders put up the new money.” Castleton, slip op. at *5.
In Castleton, George Broadbent (“George”) held a 98% direct and a 2% indirect equity interest in the debtor, Castleton Plaza, L.P. (“Castleton”). Id. at *2. Castleton was managed by The Broadbent Company, Inc. (“Broadbent”). Id. at *3. George’s wife, Mary Clare Broadbent (“Mary Clare”) owned a 100% equity interest in Broadbent and George served as its CEO, for which he received an annual salary of $500,000. Id. Castleton, which owed approximately $10 million to its only secured lender, EL-SNPR Notes Holding (“EL-SNPR”), filed its chapter 11 petition after failing to pay the balance due to EL-SNPR. Id. at *2.
Castleton proposed a plan of reorganization in which (i) it would pay $300,000 of the approximately $10 million owed to EL-SNPR, (ii) the remainder of the $10 million balance would be written down to $8.2 million, with the difference treated as unsecured, and (iii) the terms of the $8.2 million secured loan would be modified by, among other things, extending the term of payment for 30 years, deferring most payments until 2021 and reducing the interest rate. Id. at *3. Castleton’s proposed plan did not provide its creditors with any equity interest and, by excluding George from retaining any equity interest, appeared to accord with the absolute priority rule. Id. The plan did, however, provide that Mary Clare would receive 100% of the equity in the reorganized debtor in exchange for contributing $75,000. Id. EL-SNPR argued that the plan undervalued the debtor’s assets and the equity interest in the debtor was worth more than $75,000, and offered to pay $600,000 for the equity and to pay all creditors 100%, rather than the 15 cent recovery proposed by the Castleton plan. Id. at *4. Castleton rejected this plan, electing instead to accept Mary Clare’s offer, which had increased to $375,000. Id. The bankruptcy court rejected EL-SNPR’s argument that the debtor’s acceptance of Mary Clare’s offer should be conditioned on Mary Clare making the highest bid in an open competition, which led to the appeal and the Seventh Circuit’s certification of the case for direct appeal under 28 U.S.C. § 158(d)(2)(A). Id.
In its analysis, the Court noted that “[i]n 203 North LaSalle, the [Supreme] Court remarked on the danger that diverting assets to insiders can pose to the absolute priority rule.” Id. at *5. Applying the law to the facts before it, the Court reasoned that, though Mary Clare did not have a prior equity interest in the debtor, as a family member, she qualified as an insider under the definition in the Bankruptcy Code. Id. The Court noted that insiders are, in other contexts, such as in preference actions, equated with equity investors and that “there c[ould] be no doubt” that George would receive value, in the form of a continuation of his salary as CEO of the debtor’s manager and an increase in the family’s wealth, if Mary Clare were permitted to obtain equity in the debtor’s plan. Id. at *5-6. The Court also stated that in a situation where George had discretionary control over a trust and directed benefits to his spouse, such benefits would be viewed as income to George. Id. at *6 (noting that “[s]ince the exercise of a power of appointment is treated as income in tax law, it should be treated as income for the purpose of § 1129(b)(2)(B)(ii) too”).
The Court concluded that the absolute priority rule applied to Mary Clare, even though she did not hold a prior equity interest, because George had control over the plan on account of his equity holdings and would have received value as a result of those holdings under the proposed plan. Id. at *7. Competition, the Court concluded, could ensure that plans “offer creditors the best value” and is essential in situations like this to preventing the circumvention of the absolute priority rule and “the funneling of value from lenders to insiders.” Id. at *7.
April 2013: London Litigation Update
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Piercing the Corporate Veil: VTB Capital plc v. Nutritek International Corp and Others [2013] UKSC 5. In a recent case, the United Kingdom Supreme Court unanimously refused to pierce the corporate veil in order to treat an alleged controller of a company as a party to a contract entered into by that company. Accordingly, the claimant bank was unable to rely on a jurisdiction clause in the contract giving non-exclusive jurisdiction to the English courts.
VTB, a UK affiliate of the major Russian Vneshtorgbank group, lent $225 million to a Russian company, Russagroprom LLC (“RAP”), under a facility agreement (the “Agreement”). The stated purpose of the loan was to fund the acquisition by RAP of Russian dairy businesses from the defendant Nutritek, a British Virgin Islands (“BVI”) company. The parties to the agreement were VTB as lender, RAP as borrower, and two guarantors respectively incorporated in Cyprus and the BVI. The agreement was governed by English law and was subject to the non-exclusive jurisdiction of the English courts.
RAP defaulted on the loan, and VTB recovered less than $40 million by enforcing the security. Accordingly, VTB brought proceedings in England in which it alleged that it was induced to enter into the Agreement by fraudulent misrepresentations made by: (i) Nutritek; (ii) Mr. Konstantin Malofeev, Nutritek’s alleged controller; and (iii) two other BVI companies that were said to be jointly and severally liable for those misrepresentations. The key alleged misrepresentations concerned the nature of the transaction. In the Agreement, RAP and Nutritek were described as unrelated companies. The sale of the business was therefore represented to be an arm’s length transaction. According to VTB, however, both companies were under Mr. Malofeev’s control.
If established, the alleged misrepresentations would have enabled VTB to take jurisdiction in England under the jurisdiction clause in the Agreement, as opposed to being forced to rely on claims against the defendants in tort which, by virtue of prior decisions at first instance and on appeal, would have had to be brought in Russia.
The Supreme Court focused on whether the corporate veil could be pierced to make Mr. Malofeev a party to the contract. In answering that question, the Supreme Court noted that although there have been cases at first instance that have recognized the power to pierce the corporate veil in exceptional circumstances, the higher courts have not authoritatively ruled on whether and in what circumstances such a power can be exercised. To the extent that the courts can pierce the veil, however, the Court ruled that:
• VTB’s claim was an extension of the cases where the veil has been pierced previously. To allow that extension would be contrary to authority and principle.
• It would be wrong to treat Mr. Malofeev as a party to the Agreement as, on an objective view, (i) none of the parties intended to contract with Mr. Malofeev; (ii) Mr. Malofeev did not contract with those parties; and (iii) Mr. Malofeev did not lead any party to believe that he was liable under the Agreement.
• To the extent that VTB had claims in tort against Mr. Malofeev personally, those claims could be brought in Russia, and there was no basis for the Supreme Court to interfere with the lower courts’ decision that England was not the most appropriate forum for them.
The effect of this decision is to suggest that novel bases for the piercing of corporate veils will not be welcomed by the English Courts and that Claimants will be limited to the narrow grounds established in earlier lower Court cases.
Legal Advice Privilege: R (on the Application of Prudential plc and Another) v. Special Commissioner of Income Tax and Another [2013] UKSC 1. The Supreme Court has confirmed that legal advice privilege cannot be claimed in respect of confidential communications between accountants and their clients for the purpose of requesting or providing legal advice and that it can only be claimed where such communications are between solicitors, barristers or foreign lawyers (including in-house lawyers) and their client.
The case related to information notices issued by HMRC under the Taxes Management Act 1970 to Prudential, seeking documents relating to a marketed tax avoidance scheme, details of which had been disclosed to HMRC under the Tax Avoidance Schemes (Information) Regulations 2004. Prudential brought proceedings for judicial review, seeking to quash or limit the notices and arguing that the notices unlawfully required Prudential to disclose documents that were subject to legal advice privilege.
Prudential argued in the Supreme Court that legal advice privilege should be available for advice on tax law given by accountants because accountants provide the same services as qualified lawyers in the context of giving tax advice. In that context, Prudential suggested that the determining factor for the application of legal advice privilege should be the advisor’s function rather than the advisor’s status, and that it was not relevant whether or not they were a qualified lawyer.
The Supreme Court dismissed the appeal (by a majority of five to two) and followed the decision of both the High Court and the Court of Appeal, confirming the existing position of the law in relation to privilege. The Supreme Court concluded that legal advice privilege should not be extended beyond its current scope at common law and that any such extension was a matter for Parliament. Thus, it is now very clear that the court will not permit a party to claim legal advice privilege over communications unless they are with a qualified lawyer. What remains to be seen is whether bodies of professionals such as accountants will therefore seek to bring about a change in the law via the legislative process.
Good Faith in Contracts: Yam Seng Pte Ltd v. International Trade Corp [2013] EQHC 111 (QB). A recent High Court judgment has made a clear shift towards recognizing an implied duty of good faith and fair dealing in commercial contracts. This is a marked departure from the traditional hostility that English courts have shown towards such claims. Mr. Justice Leggatt noted that it was unlikely that “English law has reached the stage … where it is ready to recognize a requirement of good faith as a duty implied by law … into all commercial contracts.” Nevertheless, he had no difficulty in implying a duty of good faith and fair dealing in this case based on the presumed intention of the parties, following the established methodology of English law.
The Judge started from the approach of the Privy Council in Attorney General for Belize v. Belize Telecom Ltd [2009] 1 WLR 1988, in which the Privy Council held that the orthodox tests for an implied term should be analyzed as part of the exercise of contractual construction—what would the contract, read as a whole against the relevant background, reasonably be understood to mean? The judge held that the relevant background included not only the facts known to the parties but also shared values and norms of behavior. Many such norms were thought to be taken into account by contracting parties without being spelled out expressly, for example an implied obligation to act honestly. The judge thought it hard to envisage any contract that would not reasonably be understood as requiring honesty in its performance and held that there is “nothing novel or foreign to English law in recognizing an implied duty of good faith in the performance of contracts” and that, in refusing to recognize such an obligation of good faith, as English courts typically have done, England was “swimming against the tide.”
Whilst the case turns on its own facts, it is noteworthy for its positive attitude towards recognizing an implied duty of good faith and fair dealing in commercial contracts. As Leggatt J noted, “the traditional English hostility towards a doctrine of good faith in the performance of contracts, to the extent that it still persists, is misplaced.” This is good news for claimants, particularly in the financial services area, who may have found the English courts a difficult place to find a remedy in recent years.
April 2013: Trademark Litigation Update
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OSCAR Wins European Trademark Proceeding. On October 11, 2012, the Academy of Motion Picture Arts and Sciences won cancellation of an “Oscar Della Lirica” design mark from the Cancellation Division of the Office for Harmonization in the Internal Market (“OHIM”). The win is significant in that in Italy, where the offending mark was registered, the term “Oscar” can be used to refer to the Academy’s famous statuette or to any award of high distinction. Indeed, Italian dictionaries frequently provide both definitions for “Oscar.”
OHIM held that the defendant was both taking unfair advantage of, and engaging in activities detrimental to, the distinctive character of the Academy’s famous mark. OHIM rejected the defendant’s argument that its mark, consisting of the image of a statute of a winged woman holding a harp but labeled “Oscar Della Lirica” was actionably similar to the Academy’s one-word trademark.
The opinion declared broadly that the word “Oscar” indicates “in various languages of the European Union” the award annually conferred by the Academy. It further noted the “very high reputation” of the trademark throughout Europe and its world-wide reputation as a “symbol of quality and excellence in the field of the motion picture industry.” It added that the defendant’s mark “cannot have the same allure of the award ceremony in Los Angeles,” thus harming the “Oscar’s” reputation and commercial value.
The Cancellation Division thus ordered the registration of the defendant’s mark cancelled and awarded costs to the Academy. See Academy of Motion Picture Arts and Sciences v. Blanc Enterprise S.R.L., OHIM Ref. No. 5831C.
John B. Quinn, Managing Partner of Quinn Emanuel, is General Counsel of the Academy of Motion Picture Arts and Sciences.
Amazon Wins Summary Judgment in Internet Search Results Trademark Dispute. Continuing a trend away from rigid application of the Sleekcraft likelihood of confusion factors in the internet context, the Central District of California recently granted summary judgment for Amazon.com and Amazon Services LLC (collectively, “Amazon”) in a trademark infringement case relating to Amazon’s product search results. Multi Time Machine, Inc. v. Amazon.com Case No. 2:11-cv-09076-DDP-MAN, 2013 WL 638888 (C.D. Cal. Feb. 20, 2013). In considering whether Amazon’s search results pages for searches for “MTM Special Ops” watches infringed Multi Time Machine’s trademark where no MTM Special Ops watches were available from Amazon and only listings for competitor watches were displayed, the court applied the context-specific framework for evaluating competitors’ internet search advertising that the Ninth Circuit articulated in Network Automation, Inc. v. Advanced Systems Concepts, Inc., 638 F.3d 1137 (9th Cir. 2011). Focusing heavily on the context of search results and the clarity of labeling, the court concluded that “there is no likelihood of confusion in Amazon’s use of MTM’s trademarks in its search engine or display of search results.” 2013 WL 638888 *9.
Invoking Judge Berzon’s concurrence in Playboy Enterprises, Inc. v. Netscape Communications Corp., 354 F.3d 1020, 1035 (9th Cir. 2004), which posited a hypothetical about Macy’s display of its own Charter Club clothing near Calvin Klein merchandise and how that brick-and-mortar example may translate to the internet, the MTM court explained: “This case squarely presents the issue posed by Judge Berzon’s final question: If I search for one of MTM’s trademarks, such as ‘mtm special ops,’ is Amazon infringing when it presents me with a list of watches from MTM’s competitors?” 2013 WL 638888 *3. MTM argued that Amazon did infringe, analogizing Amazon’s display of competitor search results in response to search queries for MTM’s product to a restaurant serving glasses of Pepsi to customers who requested Coke, which the Ninth Circuit held to be unlawful passing off in Coca-Cola v. Overland, Inc., 692 F.2d 1250 (9th Cir. 1982). 2013 WL 638888 *4 n.4. But the court rejected MTM’s attempt to use the broad contours of that holding to exempt its claim from the likelihood of confusion standard. Id. The court reasoned that the more appropriate analogy was to “a consumer asking for a Coca-Cola and receiving a tray with unopened, labeled, authentic cans of Pepsi-Cola, RC Cola, Blue Sky Cola, Dr. Pepper, and Sprecher Root Beer, and a copy of Coca Kola: The Baddest Chick, by Nisa Santiago.” Id. The court explained that “[t]his is a substitution, but given the context it is not infringing because it is not likely to confuse.” Id. Evaluating the context of Amazon’s presentation of competitor’s products, the court likewise concluded that no confusion was likely.
The court determined that a number of Sleekcraft factors were not useful in its analysis. It concluded that the “proximity of the goods” factor could not favor the plaintiff even if the goods were in direct competition when, as here, the goods are presented as clearly marked options. Id. at * 5. Likewise, the “intent to confuse” factor was relevant “only insofar as it bolsters a finding that the use of the trademark serves to mislead consumers rather than truthfully inform them of their choice of products” (id. at *6 (quoting Network Automation, 638 F.3d at 1153))—a finding that “the clarity of labeling” (id. at *6) rebuts. In evaluating the “similarity of the marks” factor, the court similarly reasoned: “The issue is not whether the marks are identical but whether consumers are likely to be confused as to the source of the goods returned in the search results. Therefore, this factor is not independently relevant.” Id. And the court found the “marketing channels” factor wholly irrelevant. Id. (“The fact that Amazon and MTM are both selling watches on the Internet is too commonplace to affect the likelihood of confusion analysis.”). Based on the court’s reasoning, in any trademark infringement case involving clearly labeled search results, none of these factors is available to tip the scales toward a finding of infringement.
The court then evaluated the remaining Sleekcraft factors—strength of the mark, actual confusion, and degree of care and type of goods—in light of the record evidence. It concluded that they all favored Amazon, as did the critical inquiry of labeling and context. The court explained that while MTM’s expert testimony that Amazon’s search results are “ambiguous, misleading, and confusing,” did suggest “consumers may be confused about why they are receiving certain search results,” his study failed to test the relevant legal question of “whether users of Amazon are likely to be confused as to source.” Id. at *9.
Overall, the court’s analysis clarifies why confusion is unlikely in search results cases and sets a high bar for future plaintiffs to survive summary judgment.
April 2013: Life Sciences Litigation Update
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Will the Supreme Court Resolve Circuit Split on Settlement of ANDA Disputes? On March 25, 2013, the U.S. Supreme Court heard oral argument in Federal Trade Commission v. Actavis, Inc. (Docket No. 12-416). The Actavis case centers around the debate over the type of antitrust analysis that should apply to settlement agreements in patent litigation between branded and generic drug companies that include an element of consideration running from the brand to the generic (referred to by regulators and legislators alternatively as “reverse payment agreements” or “pay-for-delay agreements”). The Supreme Court agreed to hear the case after the development of a circuit split on the question.
A majority of the circuits addressing the issue (among them the Second, Eleventh and Federal) have adopted the so-called “scope of the patent test,” holding that “absent sham litigation or fraud in obtaining the patent, a reverse payment settlement is immune from antitrust attack so long as its anticompetitive effects fall within the scope of the exclusionary potential of the patent.” See, e.g., FTC v. Watson Pharmaceuticals, Inc., 677 F.3d 1298, 1312 (11th Cir. 2012). On the other hand, the Third Circuit has adopted the “quick look” rule of reason test advocated by the FTC. Under that rule, the court must apply a rebuttable presumption that “any payment from a patent holder to a generic patent challenger who agrees to delay entry into the market [is] prima facie evidence of an unreasonable restraint of trade.” In re: K-Dur Antitrust Litigation, 686 F.3d 197 (3d Cir. 2012). In adopting the “quick look” rule, the Third Circuit was highly critical of the rationale behind the “scope of the patent test,” arguing that it depends upon an “unrebuttable presumption of patent validity,” and that “courts must be mindful of the fact that ‘[a] patent, in the last analysis, simply represents a legal conclusion reached by the Patent Office.’”
At the recent oral argument in the Actavis case, the Supreme Court showed signs that neither test may be entirely appropriate, and that instead the district courts should have the flexibility to examine pay-for-delay agreements on a case-by-case basis. Justice Stephen Breyer asked whether the Court should simply instruct district judges to “pay attention to the [Justice] department when it says that these [agreements] . . . can be anticompetitive,” and then “ask the [drug companies] why [they’re] doing it.” Justices Antonin Scalia and Anthony Kennedy suggested that the key to the inquiry is the strength or weakness of the patent, calling this factor “the elephant in the room.” Justice Scalia also asked why the Court should overturn settled antitrust law “just to patch up a mistake that Hatch-Waxman made.”
Other justices focused on other factors, such as the burden of proof and the effect of these agreements on consumers. For example, Justice Sonia Sotomayor noted that “the burden of proving that the payment for services or the value given was too high” should be on the government, not the drug companies. And Justice Elena Kagan stated her opinion that “[i]t’s clear what’s going on here is that [the drug companies are] splitting monopoly profits, and the person who’s going to be injured are all the consumers out there.”
All in all, it’s difficult to predict how the Court will rule in this case, but what seems clear is that the majority of justices have concerns over the legitimacy of pay-for-delay deals but are unclear as to how best to approach the matter. One interesting point is that the Court is operating in this case with only eight justices after Justice Samuel Alito recused himself. There is the very real possibility that the Court could wind up splitting four to four. If that happens, the 11th Circuit ruling would stand, and the circuit split will remain. At that point, the controversy would likely turn back to Congress, where bills barring reverse payment settlements have been introduced, debated, and rejected over the last several years.
Common-Interest Doctrine—A Tool to Prevent Waiver of Attorney-Client Privilege in Intellectual Property Transactions
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It is easy to waive attorney-client privilege inadvertently while negotiating intellectual property (“IP”) transactions. For example, when an IP owner seeks to sell a patented product, potential buyers often ask for any opinions of counsel that concern the patent. The IP owner must decide whether or not to disclose the privileged opinions to the potential buyer. Such opinions might be essential to the deal itself. Many potential buyers request IP opinions in order to assess both the value and the strength of the seller’s IP portfolio. Without these opinions, a potential buyer might simply walk away from a deal—not knowing sufficient information to make an informed decision regarding the propriety of the transaction. However, while potentially essential to the transaction, such a disclosure of an opinion of counsel can waive the attorney-client privilege. This creates a tension between a need to disclose the opinions to further the business transaction and a need to maintain attorney-client privilege over the opinions of counsel.
As discussed below, if the disclosure of the privileged material is done carefully, it is possible to both disclose the privileged material to a potential business partner and maintain the attorney-client privilege. We first discuss a recent case where Quinn Emanuel successfully upheld the attorney-client privilege despite disclosure of opinions of counsel to several potential deal partners.
Quinn Emanuel Upholds Attorney-Client Privilege Under Common-Interest Doctrine
Quinn Emanuel recently encountered this issue in a case before Judge Stark in the District of Delaware. The firm’s client, in the course of due diligence preceding a potential business transaction, disclosed validity and freedom-to-operate opinions to a select set of potential buyers. In defending against a claim of waiver, Quinn Emanuel explained to Judge Stark that this was not a case where our client had voluntarily disclosed privileged information without concern for retaining its confidentiality. To the contrary, our client had been involved in discussions with a large number of potential suitors but disclosed the privileged information to only a few prospective buyers after they had conducted a series of negotiations and due diligence exchanges. In addition to being in a position where the deal was largely “locked up,” our client also had strict confidentiality agreements in place with each potential buyer. Moreover, the privileged documents were provided with an understanding that they were to be used to further the common legal interest both parties had in valid and enforceable patents should they choose to complete the transaction.
Perhaps most importantly, Quinn Emanuel argued the negative policy implications that would have followed if Judge Stark had found a waiver of the attorney-client privilege. After Quinn Emanuel argued that business transactions involving intellectual property would not occur absent such protection, Judge Stark frankly asked opposing counsel to explain the effects on negotiations if he were to rule against preserving our client’s privilege. Opposing counsel was largely speechless in its reply, and we summed it up quite readily—the negotiations simply would not occur. Heeding the caution of other courts, Judge Stark agreed with Quinn Emanuel’s position that waiver would chill similar business negotiations and upheld our client’s privilege under the common-interest doctrine.
Next, we provide an overview of the common-interest doctrine and discuss the factors that go into an analysis of whether the common-interest doctrine will prevent a waiver of the attorney-client privilege.
The Common-Interest Doctrine as Applied to Business Transactions
Courts focus on five factors in determining whether or not to uphold the privilege based on the common-interest doctrine. Those factors are: (1) the nature of the shared interest; (2) whether the privilege holder disclosed the information under an expectation of confidentiality; (3) whether the privilege holder and third party can reasonably anticipate joint litigation; (4) the stage of the diligence proceedings when the privileged information was disclosed; and (5) the policy considerations concerning the consequences that accompany waiver.
1. Nature of the Interest: The nature of the interest each party has during the due diligence and negotiations that surround a potential transaction is perhaps the most compelling factor in the common-interest analysis. As originally applied, the common-interest doctrine required that “the nature of the [parties’] interest be identical, not similar, and be legal, not solely commercial.” Libbey Glass, Inc. v. Oneida, Ltd., 197 F.R.D. 342, 348 (N.D. Ohio 1999). This principle has been relaxed in some jurisdictions—requiring only a “substantially identical” or “substantially similar” interest. See e.g., In re Teleglobe Commcn’s Corp., 493 F.3d 345, 365 (3d Cir. 2007); In re Regents of Univ. of California, 101 F.3d 1386, 1390 (Fed. Cir. 1996).
The motivating factor behind the relaxed standard derives from the acknowledgement by some courts that pre-deal diligence involving intellectual property will necessarily involve both a business and legal component. For example, parties arguing that disclosure of privileged advice during an IP transaction waived attorney-client privilege often rely upon the business component of the disclosure—that the disclosure was made to increase the value of the transaction or to entice the other party to complete the transaction. This might help contribute to closing the deal or aid in negotiating a purchase price that is more favorable to the seller. The privilege-holder seeking protection will vigorously fight to rebut this view because in jurisdictions that require the nature of the parties’ interest to be identical, the existence of the business component of the transaction will weigh in favor of a finding of waiver of the attorney-client privilege. Indeed, the privilege holder will most likely argue that the materials were disclosed solely in support of a “shared legal interest” between the buyer and seller in valid and enforceable patents.
Many courts have struggled with the issue of whether the parties to the negotiations have a “shared legal interest.” To address that issue, it is often necessary to make a prediction as to what would happen should the potential transaction come to a head. If the deal were to close, then both parties could potentially have concurrent rights in the intellectual property, i.e., in the case of a merger. Another possibility is that the seller of the intellectual property and the potential buyer could face joint litigation in the future if the products covered by the IP infringed another’s patent. The seller would face liability based on its rights before the sale, and the buyer based on its right subsequent the sale. See e.g., Hewlett-Packard Co. v. Bausch & Lomb, Inc., 115 F.R.D. 308, 310 (N.D. Cal 1987).
This leaves open the question of what happens when the seller extinguishes all its rights in its intellectual property portfolio upon completion of the business transaction. In such circumstances, some courts have still been inclined to uphold privilege assertions.
For example, in Fresenius Med. Care Holdings, Inc. v. Roxane Labs., Inc., No. 05-889, 2007 WL 895059, at *4 (S.D. Ohio Mar. 21, 2007), the district court held that the common-interest doctrine survived an asset purchase agreement where the seller disclosed privileged information to the buyer in connection with the sale of the asset.
Based on the case law, therefore, privileged information should only be disclosed in potential transactions when both parties have a common legal interest in obtaining, maintaining, protecting, and enforcing valid and enforceable patents.
2. Expectation of Confidentiality: Confidentiality is a key component in any privilege analysis. This issue often turns on whether a confidential disclosure agreement was in place before the privileged information was disclosed. If confidentiality is not maintained, courts have often found the privilege to be waived. In cases of due diligence associated with IP transactions, however, where parties voluntarily disclose privileged information, but do not intend to cause a waiver, courts have determined that they must investigate the “explicit or implicit undertaking by the recipient of the information to hold [the disclosed information] in confidence.” Hewlett-Packard, 115 F.R.D. at 311. This is not to say that the responsibility for protecting against waiver falls solely upon the potential buyer receiving the privileged information. The seller must take steps of its own to impress upon the potential buyer the confidential nature of the information. Id.
For example, in Hewlett-Packard, the court found that voluntary disclosure of privileged information did not vitiate the attorney-client privilege. In particular, the court found that Bausch & Lomb did everything it reasonably could to protect the confidentiality of the legal opinion it disclosed to GEC. Specifically, “[o]nly two copies of the [opinion] letter were transmitted to GEC; GEC was instructed that no further copies were to be made; both copies were returned to [B&L’s] counsel; and the letter was not disclosed to others.” Id. at 311. Indeed, leading cases denying application of the common-interest doctrine take care to specifically point out that the disclosing party did nothing to protect the alleged confidentiality of the disclosed privileged documents. See, e.g., Net2Phone, Inc. v. Ebay, Inc., No. 06-2469, 2008 WL 8183817, at *9 (D.N.J. June 26, 2008) (distinguishing Hewlett-Packard on the ground that the parties in that case were under a confidentiality agreement). Thus, a confidentiality agreement weighs in favor of common-interest applicability.
3. Anticipation of Litigation: There is considerable disagreement between courts regarding whether or not the common-interest doctrine applies when there is no anticipation of joint litigation in situations where legal and business interests are intertwined. For example, a more relaxed approach only considers whether there is some substantially identical legal interest accompanying an identical business interest, irrespective of whether or not the parties will embark on a joint litigation. See, e.g., In re Regents, 101 F.3d at 1390 (Fed. Cir. 1996) (the common interest doctrine “is not limited to joint litigation preparation efforts”); Fresenius Med., 2007 WL 895059, at *3 (S.D. Ohio Mar. 21, 2007) (“[T]he community of interest doctrine is not limited to joint litigation situations, but may also apply in connection with patent rights.”). On the other hand, some courts have expressly disclaimed the use of the common-interest doctrine as a shield to waiver of the attorney-client privilege when there is no anticipation of joint litigation. See e.g., Net2Phone, 2008 WL 8183817, at *7 (D.N.J. June 26, 2008) (no common-interest “where the third-party’s interest does not appear to be that of a potential co-defendant”); Nidec Corp. v. Victor Co. of Japan, 249 F.R.D. 575, 579-80 (N.D. Cal. 2007) (distinguishing Hewlett-Packard on the grounds that there was “a common legal interest because of anticipated joint litigation”).
4. Stage of Diligence: Where there is a potential business transaction, “the common interest doctrine protects privileged and work-product materials even if there is no ‘final’ agreement or if the parties do not ultimately unite in a deal.” Katz v. AT&T Corp., 191 F.R.D. 433, 437 (E.D. Pa. 2000). However, the common-interest doctrine will not likely be upheld if the privilege-holder freely conducts pre-deal discussions regarding its privileged materials with a host of potential suitors. The decision to disclose information, therefore, must be carefully made and only undertaken when a deal is nearing its final steps. See e.g., Morvil Tech., LLC v. Ablation Frontiers, Inc., No. 10-2088, 2012 WL 760603, at *3 (S.D. Cal. Mar. 8, 2012) (upholding the party’s privilege and noting that “both parties were committed to the transaction and working towards its successful completion”).
This factor is intertwined with the expectation of confidentiality. If a party freely discloses information to a large number of potential buyers early in the diligence process, the privilege-holder is likely to be viewed as not having taken adequate steps to protect the confidentiality of its materials. Accordingly, voluntary disclosure of privileged materials should be undertaken only near the completion of a transaction, when the parties are ready to move towards consummation.
5. Policy Considerations: There can be no doubt that opposing counsel has a great interest and desire in gaining access to an adversary’s privileged and confidential information, especially when it concerns IP that is the subject of an ongoing lawsuit. Application of the common-interest doctrine in the context of due diligence aids in deterring “the tendency of some lawyers, especially in intellectual property cases, to spend an inordinate amount of time attempting to gain an advantage in the litigation by making use of the adversary attorney’s words and opinions.” Hewlett-Packard, 115 F.R.D. at 311. As the court in Hewlett-Packard observed, it is important to keep the focus of the court’s infringement and invalidity analysis “on the real world, on the similarity of the products involved in the dispute and on the history of relevant inventions and commercial conduct.” Id. Freely granting waiver based on disclosures made in the course of negotiating IP transactions would undoubtedly invite the expenditure of time and judicial resources litigating collateral privilege issues.
Moreover, the common-interest doctrine serves to deter the chilling effects on potential business transactions that would occur if waiver were freely granted. See Hewlett-Packard, F.R.D. 115 at 311. Furthering this purpose, many courts find that “[u]nless it serves some significant interest courts should not create procedural doctrine that restricts communication between buyers and sellers, erects barriers to business deals, and increases the risk that prospective buyers will not have access to important information that could play key roles in assessing the value of the business or product they are considering buying.” See, e.g., id.; BriteSmile, Inc. v. Discus Dental Inc., No. 02-3220, 2004 WL 2271589, at *2 (N.D. Cal. Aug. 10, 2004).
Standard Essential Patents Come Under Scrutiny of the DOJ, FTC, and PTO
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Introduction
Increased public and regulatory attention has been recently given to litigation remedies available to standard essential patent (“SEP”) holders who have committed to offer patent licenses on fair, reasonable and non-discriminatory (“FRAND”) terms. In cases where SEP holders and technical standard implementers have been unable to agree on patent licensing terms, SEP holders have on occasion filed infringement suits, seeking remedies for infringement including injunctive relief.
Over the last several months, the Federal Trade Commission (“FTC”), and separately, in a joint policy statement, the U.S. Department of Justice, Antitrust Division (“DOJ”), and the U.S. Patent & Trademark Office (“USPTO”), provided their respective views on the remedies available to SEP holders. At present, it appears that these agencies are taking a nuanced market approach on this issue, avoiding per se rules on whether SEP holders are allowed to obtain injunctive relief on their patents. Both the FTC and DOJ/USPTO have focused on the circumstances surrounding the negotiations between the SEP holder and the accused infringer.
Standard Setting Organizations and Voluntary Consensus Standards
Technical standards are often developed by voluntary organizations commonly known as standard setting organizations (“SSOs”). SSOs publish technical standards which, if adopted widely, ensure interoperability between products and services offered by different businesses. For example, the popular 802.11 wireless standard, developed and published by the Institute of Electrical and Electronics Engineers (“IEEE”) and its member organizations, allows individuals to connect to WiFi hotspots, whether at home, work, a coffee shop, or even on an airplane. The individuals and organizations that are involved in collaborative standard setting environments frequently own patents that cover the standard at issue, known as SEPs. By definition, practice of SEPs is technically necessary in order to comply with the requirements of a standard. Defendants in SEP infringement suits have contended via counterclaims that SEP holders, by way of their involvement in the standards, are subject to a commitment to license any essential patents on FRAND terms.
Increased media and regulatory attention has been given to cases where companies have been unable to successfully negotiate the terms of a SEP portfolio license prior to litigation initiated either before the International Trade Commission (ITC), federal district court or both. SEP portfolio holders have filed actions both in the district court and before the ITC, seeking damages and/or injunctive relief. Implementers, in turn, have sought declaratory judgments from courts that the terms of the licenses sought by the SEP holders have not been FRAND. The FTC, DOJ, and USPTO have recently provided some insight on their respective policy positions related to the propriety of obtaining injunctive relief on SEPs in such cases.
FTC Addresses SEPs and Injunctive Relief
In November 2012, as part of its investigation of the proposed acquisition of SPX Services Solutions by Robert Bosch GmbH, the FTC issued for public comment a Complaint and Order against Bosch. As part of its Statement related to the Decision and Order, the FTC stated that it would be inconsistent with FRAND licensing commitments for an SEP holder to “seek[] injunctions against willing licensees of . . . SEPs.” Statement of the Federal Trade Commission, In the Matter of Robert Bosch GmbH, at 1, FTC File Number 121-0081 (Nov. 26, 2012). The FTC added that the pursuit of injunctive relief on SEPs “can also lead to excessive royalties that can be passed along to consumers in the form of higher prices.” Id. at 2. Even still, the FTC appears to have adopted a circumstance-specific approach to its policy on injunctive relief, clarifying its position that the SEP holder should still be entitled to obtain injunctive relief against unwilling licensees. See id.
In the context of In the Matter of Google Inc., FTC File No. 121-0120, the FTC again offered insight into its current position on the availability of injunctive relief to SEP holders who have made FRAND commitments. The FTC took the position that the threat of injunctive relief on SEP patents can potentially impair competition and increase consumer prices. However, the FTC limited its position as applying only to “willing licensees” and “any company that wants to license” SEPs. Statement of the Federal Trade Commission, In the Matter of Google Inc., at 1, FTC file No. 121-0120 (Jan. 3, 2013). As part of the proposed consent order with Google, the FTC provided a procedural framework and conditions under which Google-subsidiary Motorola Mobility would be permitted to obtain injunctive relief on SEPs subject to a FRAND commitment.
DOJ and PTO Issue Rare Joint Policy Statement
Separately, on January 8, 2013, the DOJ and USPTO issued a joint policy statement regarding the availability of remedies, particularly injunctive relief, for patents subject to a FRAND commitment (“DOJ/PTO Policy Statement”).
The DOJ and USPTO “recognize[d] that the right of a patent holder to exclude others from practicing patented inventions is fundamental.” DOJ/PTO Policy Statement, at 2. The DOJ and USPTO also acknowledged that voluntary consensus standard setting “promot[es] efficient resource allocation and production by facilitating interoperability among complementary products.” Id. at 3. However, the DOJ and USPTO noted that there may be instances where an injunction or exclusion order on SEPs may harm competition, be inconsistent with a FRAND commitment, and/or not satisfy the equitable factors set forth in eBay Inc. v. MercExchange, L.L.C., 547 U.S. 388 (2006). The DOJ/PTO Policy Statement identified certain circumstances under which injunctive relief may be appropriate:
[I]f a putative licensee refuses to pay what has been determined to be a F/RAND royalty, or refuses to engage in a negotiation to determine F/RAND terms, an exclusion order could be appropriate. Such a refusal could take the form of a constructive refusal to negotiate, such as by insisting on terms clearly outside the bounds of what could reasonably be considered to be F/RAND terms in an attempt to evade the putative licensee’s obligation to fairly compensate the patent holder.
Id. at 7.
The DOJ/PTO Policy Statement addresses the policy considerations that can impact injunctive
relief in actions against unwilling licensees as well as circumstances that may constitute an unwillingness to take a license on FRAND terms. It does not make reference to any particular SEP holder or FRAND commitment.
Conclusion
Standard essential patents and FRAND commitments continue to be the subject of intense public debate and regulatory interest. While it remains to be seen how the recent investigations and policy statements by the DOJ, FTC, and USPTO will impact future patent litigation, it appears that these agencies are focused on determining whether and to what extent the potential licensee is willing to take a license on FRAND terms and avoiding categorical (or “per se”) rules on the availability of injunctive relief. While the grant of injunctive relief (as in any other patent case) is not an automatic remedy in federal district court under current precedent, the DOJ, FTC, and USPTO have expressed policies regarding injunctive relief in SEP cases subject to FRAND commitments that require inquiry into the circumstances of negotiations between the litigants to determine whether the parties are willing licensors and licensees respectively.
March 2013: White Collar Litigation Update
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Second Circuit Declines to Apply Short-Swing Profit Rule to Transactions Involving Different Types of Stock. In a case of first impression, Gibbons v. Malone, No. 11–3620–cv, 2013 WL 57844 (2d Cir. Jan. 7, 2013), the Second Circuit held that an insider’s purchase and sale of different stock types in the same company does not trigger liability under Section 16(b) of the Securities Exchange Act of 1934. Specifically, the court held transactions involving separately traded, nonconvertible stocks with different voting rights fall outside the purview of Section 16(b).
Congress enacted Section 16(b) of the Securities Exchange Act, more commonly known as the “short-swing profit rule,” for the disgorgement of profits obtained by insiders who use their nonpublic knowledge when trading in a company’s securities. The statute allows for the issuing company to recover an insider’s profits from any paired purchase and sale or sale and purchase of any equity security occurring within less than a six-month period.
At issue in Gibbons was whether the profits obtained from sales and purchases of different types of stock by the defendant, John Malone, a director and shareholder of Discovery Communications, Inc., were recoverable by plaintiff shareholder Michael Gibbons under Section 16(b). Over the course of about two weeks in December 2008, Malone had made nine sales of Discovery’s “Series C” stock totaling 953,506 shares and ten purchases of Discovery’s “Series A” stock totaling 632,700 shares. Gibbons v. Malone, 2013 WL 57844, at *1. Discovery’s Series A and C stock are different equity securities, separately registered and traded on the NASDAQ stock exchange, and not convertible into each other. In addition, the Series A stock comes with voting rights while the Series C stock does not.
Alleging that Malone realized illicit profits of at least $313,573 from his sales of Series C stock and purchases of Series A stock, Gibbons brought a derivative suit seeking disgorgement of Malone’s profits under Section 16(b). Id. The United States District Court for the Southern District of New York dismissed Gibbons’ complaint for failure to state a Section 16(b) claim, finding that the statute’s use of the singular term “any equity security” undermined the plaintiff’s theory which “requires the purchase and sale of any equity securities, rather than of one equity security,” while the statute prohibits a paired purchase and sale or sale and purchase of only the latter, not the former. Gibbons v. Malone, 801 F.Supp.2d 243, 247 (S.D.N.Y. 2011).
On appeal, the Second Circuit upheld the District Court’s dismissal, finding that Malone’s sales of Series C stock and purchases of Series A stock are not within the scope of Section 16(b). Gibbons v. Malone, 2013 WL 57844, at *2. First, the court found that Malone’s sales and purchases failed to form the requisite “pair” of securities transactions constituting the “type of insider activity that Section 16(b) was designed to prevent.” Id. at *3. In particular, upon examining the statutory text, the court determined that “Congress’s use of the singular term ‘any equity security’ supports an inference that transactions involving different equity securities cannot be ‘paired’ under § 16(b).” Id. Because the statutory terms “purchase and sale” and “sale and purchase” are both directed at the same singular object – i.e., the same equity security—Malone’s purchase and sale of different equity securities fell outside of the scope of the statute.
Second, while the Second Circuit noted that “§ 16(b) could apply to transactions where the securities at issue are not meaningfully distinguishable,” this was not the case here where the difference in voting rights readily distinguishes Series A stock from Series C stock, rendering the two securities “distinct not merely in name but also in substance.” Id. at *4. Accordingly, the court concluded, “[a]n insider could easily prefer one over the other for reasons not related to short-swing profits.” Id.
Third, the court refused to apply the principle of “economic equivalence” to the stocks at issue, reasoning that the principle had “developed in the context of fixed-ratio convertible instruments, particularly with respect to whether exercising conversion rights is a ‘purchase’ or ‘sale within the meaning of § 16(b).” Id. In this case, “two nonconvertible securities” such as Discovery’s Series A and Series C stocks, “whose prices fluctuate relative to one another,” are not “economically equivalent” and therefore do not fall under the scope of § 16(b) on this basis. Id. at *5.
Finally, the Second Circuit refused to find liability based on the plaintiff’s request “to enter uncharted territory by holding that the two securities are sufficiently ‘similar’ to be paired under § 16(b).” Id. Acknowledging that such a broad interpretation might be plausible, the court nevertheless determined that a “substantial similarity” standard would be at odds with both the plain text and fundamental purpose of the statute. The court noted that the “statutory text appears to require sameness, not similarity.” Moreover, citing the Supreme Court, the Second Circuit explained that Congress intended § 16(b) to establish “mechanical requirements” through “a relatively arbitrary rule capable of easy administration,” as opposed to one that “reach[es] every transaction in which an investor actually relies on inside information.” Id. Accordingly, the court concluded that § 16(b) was designed to establish rules that can be mechanically applied as opposed to standards that must be assessed on a case-by-case basis.
The Second Circuit’s affirmation in Gibbons establishes that § 16(b) liability does not extend to unpaired transactions involving the trading of different types of stock in the same company that are “meaningfully distinguishable” or that are “distinct not merely in name but also in substance.” Id. at *4. Absent further guidance from the Securities and Exchange Commission (“SEC”), we can expect that the Second Circuit will not venture into “unchartered territory” beyond the plain meaning of the statutory text, but instead will adhere to the “strict form of liability” offered by Section 16(b)’s “‘prophylactic’ remedy of disgorgement.”
March 2013: Appellate Update—The Appellate Timetable
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When faced with the prospect of an appeal, the most common question asked by clients, no matter whether they won or lost below, is “how long is the appeal going to take?” The most current data available from the Administrative Office of the United States Courts shows that the median time it takes in the United States Courts of Appeals to resolve an appeal is eleven months from the filing of the notice of appeal to final disposition. That simple figure, however, masks a number of differences between the regional circuits.
The Ninth Circuit, which has by far the largest docket of any of the circuits, has a median decision time from notice of appeal to disposition of nearly eighteen months. But the relationship between docket size and time to decide a case does not hold for all of the circuits. For example, the Sixth Circuit, which has just over a third of the docket size as the Ninth, has a median time of more than fifteen months to issue a disposition. The Second Circuit has a median decision time of just over a year, while the D.C. Circuit is a couple of months faster, having a median disposition time of approximately ten months. The Eighth Circuit is the fastest, with a median disposition time of under seven months.
Clients are often concerned more specifically in two sub-periods of the appellate process, the time from conclusion of briefing to oral argument, and the time from oral argument to final disposition. Again, there are differences between the circuits. For example, given the Sixth and Ninth Circuits take nine and eight months, respectively, to hold oral argument after receiving the final brief, while the median time from conclusion of briefing to oral argument in both the Second and D.C. Circuits is less than three months.
Interestingly, some of the circuits that are slower to hold oral argument after the conclusion of briefing are quicker in issuing a decision after holding oral argument. For example, while it may take the Ninth Circuit a median time of eight months to schedule oral argument, it takes only a month and a half (the third fastest in the country) to issue a decision. The Second Circuit, already speedy in scheduling oral argument following the conclusion of briefing, leads the circuits in the time between oral argument and decision, with a median rate of just a half month. It is important to note, however, that this median rate includes cases disposed of by summary order and cases disposed of by published decision; whereas the former often occurs within weeks of oral argument, the latter can take several months.
Data on the Federal Circuit is somewhat more sparse than data for the other circuits, but it suggests that the Federal Circuit’s median disposition time is in line with many of the other circuits, at just under ten months. This median time varies, however, depending upon the type of appeal. While an appeal from a district court takes nearly twelve months, an appeal from the International Trade Commission (ITC) takes over sixteen. Indeed, ITC cases have traditionally been among the slowest of cases at the Federal Circuit, suggesting that both the complexity and form of ITC cases causes the Federal Circuit to take its time disposing of such appeals.
Cases before the Supreme Court of the United States operate on an entirely different schedule. Although the certiorari-petition and merits-briefing phases of a Supreme Court case often can span two Terms, the Supreme Court almost always decides all cases argued in a given Term (which begins the first Monday in October) before the Court’s summer recess, which usually begins on the first day of July. With few exceptions, this tradition results in a firm deadline for the Court to issue all decisions from cases argued that Term by June 30. And while the Court normally takes, on average, slightly over three months from oral argument to issue a decision, that time varies directly on where a case appears in a Term. Thus, if a case is heard early in a Term, such as in October, it takes the Court nearly four months to issue a decision, whereas if a case is heard late in the Term, such as April, the Court’s average time to issue a decision is under two months. The data reveals that litigants who have their cases argued in October are also the parties who are most likely to have waited the longest, in contrast to those parties who have their cases argued in April.
The above figures for the circuits are, importantly, only median figures, and it is worth noting that several circuits provide the opportunity for litigants to request expedited treatment of their appeal. The local rules of many Circuits, including the Second, Ninth, and D.C. Circuits, allow parties to file formal motions to expedite an appeal, though these rules require a showing of some form of irreparable harm to justify such a motion.
March 2013: Russia Litigation Update
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Jurisdictional conflicts between courts of different countries are an unavoidable consequence of developed global trade. This has led to an increase in multi-national forum shopping. Some Russian courts however, view the adjudication of Russian-related disputes in foreign courts as a direct threat to Russian state sovereignty.
Background. Recently, there has been a large increase in litigation between Russian businessmen in foreign jurisdictions. For example, between 2008 and 2012, the number of Russia-related cases litigated or arbitrated in London tripled. These include a high profile dispute in the London High Court between Russian ex-business partners Boris Berezovsky and Roman Abramovich. Russian President, Vladimir Putin, commented on this lawsuit, stating that Messrs. Berezovsky and Abramovich should have met in a Russian court instead. “That would be more honest—for them and for our country,” Mr. Putin said. “The money was made and stolen here—let them divvy it up here too.” President Putin’s comment reflects a growing sentiment that Russian-related disputes should be adjudicated in Russian, not in foreign jurisdictions.
In May 2012, more than 2,000 representatives from 51 countries took part in the 2nd Saint Petersburg International Legal Forum to discuss issues concerning global legal policy in the 21st century. This supposed threat to Russian state sovereignty by court decisions and arbitration awards rendered in other countries was a central issue in the discussions. Anton Ivanov, the Chairman of the Russian Federation Supreme Commercial Court, delivered a noteworthy speech openly criticizing foreign litigation and arbitration proceedings involving Russian parties and assets.
Key Points of Mr. Ivanov’s Speech. Mr. Ivanov stated that Russia must protect its citizens and companies from being unfairly prejudiced in foreign judicial systems. Mr. Ivanov addressed the issue of “dragging” a dispute from one jurisdiction to another, particularly where the parties use allegedly far-fetched pretexts to establish jurisdiction in the desired court.
As specific examples, Mr. Ivanov cited an injunction issued by the High Court in London in favor of BNP Paribas S.A. against the Basel Group company, Russian Machines, in support of LCIA arbitration (BNP Paribas SA v. Open Joint Stock Company Russian Machines and another [2011] EWHC 308 (Comm)) and a damages award granted under the Germany-USSR BIT in a Stockholm arbitration, subsequently enforced in Germany, and resulting in the seizure of real estate previously used by the KGB. Mr. Ivanov said these cases exemplify violations of basic human rights and freedoms, particularly the right to have a dispute considered by a competent court. He added that they breach the principle of legal certainty and also encroach on sovereign immunity.
Mr. Ivanov made proposals to prevent forum shopping for Russian-related disputes by “guarantee[ing] its citizens and entities protection from the unfair competition of foreign jurisdictions.” These proposals include giving Russian judges the right to set aside foreign judgments and arbitration awards if they feel that Russian parties are unfairly prejudiced in any way, taking punitive measures against those who interfere with Russian interests abroad, and in extreme cases, denying entry into Russia and freezing assets of foreigners involved in rendering unlawful judgments. Mr. Ivanov’s proposals are designed to create a disincentive for foreign courts to hear Russian-related cases. The sanctions are designed to create a disincentive for international law firms with offices in Russia to bring disputes to foreign courts because punitive sanctions—such as possible assets confiscation—would apply to them directly, the Chairman added. Russian Prime-Minister, Dmitry Medvedev, speaking at the same forum endorsed Mr. Ivanov’s suggestions, describing them as “civilized means of resolving issues”.
Reflection. It is yet unclear how Mr. Ivanov’s proposals will affect Russian legislation and commercial courts’ practice. One might expect that more claims in Russian-related disputes would be brought in Russian courts and that Russian courts will issue anti-suit injunctions against parties pursuing foreign litigations or arbitrations. It is worrisome that Russian courts appear intent on issuing legislation to prevent anyone from litigating Russian-related disputes outside the boundaries of Russia.
This is not a new issue. Russia has long struggled with the sentiment that forum shopping through international arbitrations was competing with the Russian court system. More than ten years ago, the Russian courts addressed the question of whether it was necessary to recognize arbitration agreements. At an educational program for judges, a Supreme Commercial Court judge urged that all disputes be litigated in Russian courts regardless of arbitration clauses. Some judges formed an “anti-arbitration” party, however, it was unable to change the law and state courts took a more reasonable approach to international arbitration and awards.
Mr. Ivanov’s proposals appear to be a troubling resurgence of the “anti-arbitration” sentiment. There are established procedures in place to resolve conflict between the sovereign interests of diverse jurisdictions and to counter attempts to initiate proceedings in improper jurisdictions. These procedures have existed for decades and are sufficient to prevent the alleged evils raised by Mr. Ivanov.
March 2013: Class Action Litigation Update
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Defeating Nationwide Class Actions: Mind Your Burden or Get Burned. Last year, the Ninth Circuit issued a decision that many interpreted as a death-knell for multistate consumer class actions. In Mazza v. American Honda Motor Co., the Ninth Circuit decertified a class of automobile buyers in a false advertising lawsuit, based in part on the finding that differences in state laws precluded certification of a nationwide class.
The underlying Mazza suit alleged that Honda violated California law by disseminating advertisements that misrepresented the Collision Mitigating Braking System sold with certain Acura automobiles by concealing information about the limitations of that system. The district court certified a nationwide consumer class, concluding that California law could apply to all class members because Honda had failed to show how differences in the various states’ laws were material, that other states had an interest in applying their own laws, or how those interests were implicated. The district court further concluded that California, which was the forum state and the headquarters of Honda’s U.S. operations, had sufficient contacts to the claims to ensure application of California law would not be arbitrary or unfair to nonresident class members.
On appeal, the Ninth Circuit reversed. Pointing to varying scienter and reliance requirements, the court held that such differences “are not trivial or wholly immaterial,” because these elements “will spell the difference between the success and failure of the claim.” The Ninth Circuit further held that the district court failed to consider adequately the interests of other states in having their consumer protection laws applied to claims brought on behalf of their residents, and erroneously concluded that California’s interests in having its law applied outweighed the interests of states with different consumer protection laws.
Following Mazza, it initially appeared that the decision precluded nationwide consumer classes as a matter of law. For example, in Kowalsky v. Hewlett-Packard Co., a purported nationwide class involving the marketing of allegedly defective printers, the court denied certification of a nationwide class, concluding that “Mazza controls and forecloses the certification of the proposed nationwide class.” Other district courts reached similar conclusions.
However, one district court recently issued a sobering reminder that Mazza did not establish a per se rule, and that the defendant still retains the burden to show that application of a single state’s law would be inappropriate under the governing choice-of-law rules. Specifically, a Central District of California court ruled in In re POM Wonderful LLC Marketing and Sales Practices Litigation, that a nationwide class was appropriate because the defendant had failed to demonstrate potentially outcome-determinative differences among the various states’ consumer protection laws.
The plaintiffs in POM Wonderful alleged that Pom misleadingly claimed that its juice products provide certain health-related benefits. Relying on Mazza, the defendant argued that California law could not apply to consumers nationwide. It supported this contention with a chart that summarized each state’s consumer protection laws, including elements such as scienter, reliance and limitations periods, as well as remedies and defenses. The POM Wonderful court found this showing insufficient, and distinguished Mazza because the defendant there had “met its burden to demonstrate material differences in state law and show that other states’ interests outweighed California’s.” In contrast, the district court held that “nowhere does Pom apply the facts of this case to those laws or attempt to demonstrate, beyond citation to Mazza, that a true conflict exists,” and thus failed to carry its burden with respect to California’s choice-of-law analysis.
Thus, POM Wonderful illustrates the important lesson that Mazza did not banish multistate classes as a matter of law. Rather, to benefit from Mazza, a defendant must adequately explain why the particular claims at issue are inappropriate for nationwide treatment under governing choice-of-law principles.
Caveat Emptor: Emerging Issues for Buyers of Bankruptcy Claims
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In a large Chapter 11 bankruptcy case, claims against the debtor are actively traded in the secondary markets. A debtor’s original creditors may lack the liquidity to wait for uncertain payment at the end of the bankruptcy case (which could be years from the commencement date) and are often inclined to promptly “cash out” by selling their positions, even at a discount. Purchasers of claims, usually hedge funds and other seasoned participants in the bankruptcy process, are rewarded if the ultimate recovery on the transferred claims is greater than the purchase price. Moreover, the acquisitions of claims can, if purchased in sufficient quantities, give the buyer a meaningful voice in the strategic direction of the underlying Chapter 11 case.
These investments, however, are not without legal risk. A number of recent judicial decisions addressed (i) whether a taint that could render a claim worthless in the hands of the original creditor continues to travel to a buyer and (ii) the circumstances under which a court may disregard the votes of a claim purchaser in connection with the balloting on the debtor’s plan of reorganization.
Does a Taint Travel to a Buyer?
Section 502(d) of the Bankruptcy Code prohibits distributions by the estate on account of “any claim of any entity” that has failed to return a voidable transfer to the estate. 11 U.S.C. § 502(d). The United States Bankruptcy Court for the Southern District of New York considered the “statutory reference [in section 502(d) applicable] ... to any claim.” Enron Corp. v. Avenue Special Situations Fund II, LP (In re Enron Corp.) (“Enron I”), 340 B.R. 180, 194 (Bankr. S.D.N.Y. 2006). “[T]he transfer of a claim subject to section 502(d) disallowance in the hands of the transferor remains subject to disallowance in the hands of a transferee. A claim in the hands of a transferee, either as an initial transferee or subsequent transferee, remains subject to a section 502(d) disallowance defense, just as if such claim was still held by the transferor. The claim and the section 502(d) disallowance defense are linked, and such relationship is not severed by a transfer.” Id. at 183-84.
On appeal, the United States District Court for the Southern District of New York took the opposing position, finding instead that “[t]he plain language of section 502(d) focuses on the claimant as opposed to the claim and leads to the inexorable conclusion that the disallowance is a personal disability of a claimant not an attribute of the claim.” Enron Corp. v. Springfield Assocs., LLC (In re Enron Corp.) (“Enron II”), 379 B.R. 425, 443 (S.D.N.Y. 2007). The District Court also drew a distinction between “sale” and “assignment” of claims, noting that “[a]n assignment is a contractual transfer of a right, interest, or claim from one person to another. The word ‘assignment’ is not synonymous with ‘sale,’ although each is a type of transfer …. ” Id. at 435-36. From there, the District Court deduced that
[T]he outcome of this case depends on whether the principle that an assignee has no greater rights than its assignor applies to equitable subordination and disallowance. That issue raises a threshold question of law[:]… are equitable subordination [and disallowance] … attributes of a claim or are they personal disabilities of particular claimants. If they are attributes of the claim, they will travel with the claim regardless of the method of transfer, whereas if they are personal disabilities, their application to transferees depends on whether the transfer was by way of a sale or assignment . . . . [E]quitable subordination and disallowance are both personal disabilities that do not inhere in the claim. Thus, unless there was a pure assignment (or other basis for the transferee to step in the shoes of the transferor), as opposed to a sale of the claim, the claim in the hands of the transferee is not subject to equitable subordination or disallowance based solely on the conduct of the transferor.”
Id. at 439. See also id. at 436-37 (suggesting “holder in due course” status may provide assignee with defense).
In In re KB Toys, Inc., 470 B.R. 331 (Bankr. D. Del. 2012), the United States Bankruptcy Court for the District of Delaware considered whether a claim would still be subject to disallowance upon its purchase by a third party which does not have an obligation to return a voidable transfer. The KB Toys court ultimately sided with the New York Bankruptcy Court’s decision in Enron I (i.e., not the decision of the United States District Court for the Southern District of New York in Enron II), concluding that the bar imposed by section 502(d) follows a claim to its new owner. Id. at 343.
KB Toys and its affiliates filed Chapter 11 petitions in 2004 and liquidated substantially all of their assets under court supervision. The plan established a litigation trust to, among other things, prosecute avoidance actions on behalf of the estate. The trust commenced preference lawsuits against a host of targets, including parties set forth in the debtor’s Statement of Financial Affairs (the “SOFA”) as having received payments during the 90-day preference window that preceded the bankruptcy filing. However, at least nine defendants, which were trade creditors of the debtor, had sold their claims to an investor (the “Investor”) and defaulted on the trust’s preference actions. Invoking section 502(d), the trust eventually sought to disallow each of the Investor’s claims where the trust had a corresponding judgment against the original trade creditor. Id. at 332-34.
The Investor argued that the plain language of section 502(d) linked disallowance to the claimant, such that only claims that are still in the hands of the entity that received, but did not return, a voidable transfer at the time of distribution by the estate, would be subject to the section 502(d) bar. In response, the trust contended that the statute disallowed any claim originally held by the voidable transfer recipient, even if that claim had been transferred to an “innocent” third party. Id. at 335.
The KB Toys court did not dwell on the plain meaning of section 502(d). It instead focused on section 57(g) of the Bankruptcy Act of 1898, the predecessor to section 502(d). In the view of the KB Toys court, section 57(g) clearly stated that disallowance followed claims by identifying “the claims of creditors” which had made voidable transfers and mandating disallowance unless the creditors returned the voidable transfers. Id. at 335-36. The KB Toys court also examined case-law that interpreted section 57(g). Those cases generally held that assignees and sureties could collect payment only if the original claimant could as well. Id. at 336-37.
The KB Toys court analyzed section 502(d) from the vantage point of the estate as opposed to that of the affected creditor. The court read the statute as giving the estate an affirmative defense to an otherwise valid claim, and held this defense cannot be rendered moot by a transfer of the claim from one creditor to another. Id. at 338. The transferring of a claim merely substitutes one party for another and does not confer any right upon the transferee that was not originally available to the transferor. Id. at 339. According to the KB Toys court, the long-standing Congressional policy goal of preventing the recipient of a voidable transfer from collecting a distribution unless the recipient returns the voidable transfer, as articulated in both section 57(g) and section 502(d), would be seriously undermined if such creditor could circumvent the statutory restriction by simply selling a tainted claim, and thereby cleanse it. Id. In a footnote, the KB Toys court arguably limited the scope of its decision by observing that it was making “no determination about whether the same result should ensue in circumstances involving other types of transferred claims [other than trade claims]. It seems the drafters of the Bankruptcy Code also recognized when public markets might be effected.” Id. at 342 n.14.
As part of its legal analysis, the KB Toys court declined to adopt the sale vs. assignment distinction espoused by the Enron II court. According to the KB Toys court, as had been recognized by numerous commentators, these two terms are not easily distinguishable and are not defined in the Bankruptcy Code. Id. at 340-41. The KB Toys court also dismissed the argument that its ruling could unleash chaos in the distressed debt markets, describing that possibility as a “hobgoblin without a house to haunt” because buyers of claims are highly sophisticated entities capable of performing due diligence and are presumed to appreciate the risk that a purchased claim may be disallowed in whole or in part by a bankruptcy court. Id. at 341-42.
The KB Toys court further observed that the SOFA put the Investor on notice of the potential disallowance of the claims it bought. Id. at 342. In addition, the presence of indemnity provisions in four of the nine sales contracts in the event the claims acquired were disallowed demonstrated that the Investor understood the risk of disallowance and knew how to bargain with the sellers of claims for contractual protection against prospective disallowance. Id. The court would not force the estate to be the Investor’s insurer where the Investor elected not to obtain indemnification from a seller. Finally, the KB Toys court rejected the Investor’s argument that their purchases were made in “good faith,” finding that the “good faith” defense was not applicable where the purchaser knew that the claims being purchased could be disallowed as part of the bankruptcy process. Id. at 343.
The Second Circuit declined in Longacre Master Fund Ltd. v. ATS Automation Tooling Systems, Inc., No. 11–3413–cv, 2012 WL 4040176 (2d Cir. September 14, 2012), an opportunity to definitely determine whether the bar to payment set forth in section 502(d) travels to a new owner of the claim. In its decision, the court sustained broad contractual remedies granted to a purchaser/assignee (the “Purchaser”) against the seller/assignor (the “Seller”) in a claim transfer agreement (the “Agreement”). Id. at *2-*3.
Under the Agreement, the Seller agreed to transfer to the Purchaser claims against Delphi Automotive Services, LLC (“Delphi”), a Chapter 11 debtor (the “Claim”). The Agreement required the Seller to repurchase the Claim with interest if (1) “all or any part of the Claim is . . .objected to, disallowed, . . . in whole or in part, in the Case for any reason whatsoever,” or (2) the Purchaser received notice of a possible impairment against the Claim, and such possible impairment was not fully resolved within 180 days. The Agreement also contained a representation (the “Representation”) that “to the best of [the Seller]’s knowledge, the Claim is not subject to any defense, claim or right of setoff, reduction, impairment, avoidance, disallowance, subordination or preference action. . . .” Id. at *2.
Delphi sued the Seller following the execution of the Agreement, alleging that the Seller had received approximately $17.3 million in preferential transfers from Delphi within the 90 days before bankruptcy and that such amounts were avoidable under the Bankruptcy Code. Invoking section 502(d) of the Bankruptcy Code, Delphi also filed an objection to the Claim. Delphi and the Seller eventually reached a global settlement and the objection to the Claim was withdrawn. Id. at *1. However, the withdrawal occurred more than 180 days after the filing of the objection. Id. at *2.
The Purchaser commenced an action seeking a determination that the Seller was obligated to pay it over $800,000 in interest because (i) Delphi’s objection was an impairment of the Claim under the Agreement and (ii) the Seller breached the Representation. Id. The United States District Court for the Southern District of New York ruled against the Purchaser, holding that Delphi’s objection to the Claim did not constitute under the Agreement an impairment. In the District Court’s view, the objection to the Claim merely “preserved the Debtor’s right to object ” and did not constitute a formal objection under section 502(d). Longacre Master Fund, Ltd. v. ATS Automation Tooling Sys. Inc., 456 B.R. 633, 640 (S.D.N.Y. 2011). After the withdrawal of the objection, “no vehicle exist[ed] through which such an objection could be raised, filed, or formally commenced in the future.” Id.
The District Court further observed that the language of the Agreement evidenced a sale, not an assignment, of the Claim. Relying upon the distinction drawn between sales and assignments by the Enron II court, the District Court observed that “no section 502(d) objection (even if one were to have been made) would have constituted an Impairment in the first instance.” Id.
On appeal, the Second Circuit vacated the District Court’s decision. It determined that the objection filed by Delphi against the Claim constituted an Impairment and a Possible Impairment as those terms were defined under the Agreement because:
Delphi stated that it was “objecting to” the claim, and the Bankruptcy Court issued an order stating that the “Objection” was preserved. These steps are all that the purchase agreement requires in order to trigger [the Seller]’s obligations under Paragraphs 7 and 16. These paragraphs do not exclude objections intended to be withdrawn after the resolution
of some other pending issue. Thus, even if the objection was in effect only a reservation of rights rather than an objection they intended to pursue immediately, it still constituted an objection under the purchase agreement. And the parties had good reason to draft the contract in this way, because the pendency of the objection limited [the Purchaser]’s ability to transfer or obtain payment on the claim.
2012 WL 4040176 at *2.
The Second Circuit also addressed the sale vs. assignment distinction in the context of the alleged breach of the Representation. The District Court had dismissed that claim based on the Purchaser’s concession that the transaction was a sale, which would have, in the District Court’s view and consistent with Enron II, “negat[ed] the possibility that the claim could be impaired by a preference action.” Id. at *3. But the Second Circuit observed that the Seller “had no reason at the time of the transfer to anticipate [the Purchaser]’s litigating position that the transfer was a ‘sale’ rather than an ‘assignment.’” Id. Moreover, the Agreement repeatedly referenced the transaction as an “assignment.” Id. The Second Circuit ruled that because “language in the agreement strongly suggests that it was an assignment, we conclude that [the Purchaser] has shown a material issue of fact as to [the Seller]’s knowledge of a possible preference action and related objection.” Id.
The Acquisition of Claims Does Not Ensure the Unfettered Right to Vote Them
Holders of claims or interests that are impaired by a plan (and that are slated to receive a distribution) are eligible to cast a vote on that plan. This is one of the most important statutory rights a creditor has in a Chapter 11 case. However, section 1126(e) of the Bankruptcy Code empowers a court to designate, i.e., disregard, the votes of “any entity whose acceptance of rejection of such plan was not in good faith.” The Bankruptcy Code provides no guidance as to how good faith should be defined, but the purpose of section 1126(e) is to deter a creditor from extracting an undue or inequitable advantage for itself in the Chapter 11 process.
In In re DBSD North America, Inc., 634 F.3d 79 (2d Cir. 2011), the Second Circuit affirmed the decision of the bankruptcy court to designate the votes of DISH Network Corporation (“DISH”). DISH was an indirect competitor of the debtor and a part-owner of a direct competitor of the debtor. DISH was not a pre-existing creditor of the debtor. The bad faith finding appeared to stem from the purchase by DISH of an entire class of claims at par after the debtor had proposed their plan and while solicitation for the plan’s acceptance was ongoing. Id. at 87. DISH had a keen interest in acquiring DBSD’s spectrum rights. Id. The court found that the purpose of the purchase of the claims was not to obtain maximum recovery on the debt, but to “obtain a blocking position” to defeat the debtor’s plan and to propose its own competing plan. Id. at 104. DISH ultimately voted against confirmation and DBSD moved to designate DISH’s votes under the theory that DISH did not vote in good faith. Id. at 87. In its opinion, the Second Circuit held that votes are subject to designation if creditors attempt to receive “more than the ratable equivalent of their proportionate part of the bankruptcy assets,” or act with an “ulterior motive,” that is, with “an interest other than interest as a creditor.” Id. at 102.
The Second Circuit zeroed in on DISH’s motives. DISH was a competitor of the debtor and decided to purchase a blocking position in a class of claims after a plan had been proposed with the intention of “us[ing] [its] status as a creditor to provide advantages over proposing a plan as an outsider, or making a traditional bid for the company or its assets.” Id. at 104. “In effect, DISH purchased the claims as votes it could use as levers to bend the bankruptcy process toward its own strategic objective of acquiring DBSD’s spectrum rights, not towards protecting its claim.” Id.
The Second Circuit emphasized that its decision imposed “no categorical prohibition on purchasing claims with acquisitive or other strategic intentions.” Id. at 105. Moreover, the court also noted that it was not addressing the situation where a preexisting creditor voted with strategic intentions. The court specifically noted two situations in which designation would generally be inappropriate. First, trade creditors could vote in such a way that would allow them to continue doing business with the reorganized debtor. Id. at 102. Second, a fully secured creditor could vote to seek liquidation to allow its funds to be invested more favorably elsewhere. Id.
Three post-DBSD decisions vividly illustrate that the concept of bad faith for purposes of section 1126(e) is a dynamic one that requires an examination of the totality of the circumstances, and not just a single set of factors.
In In re Circus & Eldorado Joint Venture, No. 12-51156, (Bankr. D. Nev. Sept. 20, 2012), the United States Bankruptcy Court for the District of Nevada designated the plan votes of a noteholder after finding that the noteholder acted in bad faith when it lobbied other creditors to vote against the debtor’s plan by filing a motion to terminate exclusivity. That motion critiqued the purported defects of the debtor’s plan of reorganization and described in detail the noteholder’s alternative plan structure. The court was troubled by the failure of the noteholder to (i) obtain court approval to disseminate information pertaining to its prospective competing plan during the debtor’s exclusive solicitation period and (ii) notice its own motion for hearing. Accordingly, the court concluded that the noteholder’s true intention in filing the exclusivity termination motion was to acquire operating ownership of the debtor. That conduct fell squarely within the range of “bad faith” conduct that required designation of the noteholder’s plan votes.
In In re Windmill Durango Office LLC, 473 B.R. 762, 767 (9th Cir. B.A.P. 2012), Beal Bank was the only secured creditor of the debtor. The debtor solicited votes on a “cramdown” plan that provided for the repayment of Beal Bank’s claim over time. It was evident that Beal Bank would vote to reject the plan, while the only two remaining holders of unsecured claims had voted to accept the plan. The plan would be confirmable with the support of these creditors. Attempting to preclude confirmation, Beal Bank bought one of the two unsecured claims for about 82 percent of its face value, or $1,250. Beal Bank then sought, pursuant to Bankruptcy Rule 3018(a), to withdraw the vote that had been cast on account of the unsecured creditor’s claim and submit a substitute ballot rejecting the plan. If the motion was successful, the debtor’s plan would not have been confirmable. Id. at 769-770. The bankruptcy court denied the bank’s motion to change the vote. The bankruptcy court held that a new creditor could only change its vote upon a showing of “cause” and it was not appropriate for creditors “to wait ‘til the plans [were] balloted and then decide what claims [they were] going to buy” and that Beal Bank’s attempt to change its vote so as to block confirmation was improperly motivated and “did the [bankruptcy] process violence.” Id. at 770.
On appeal, the Bankruptcy Appellate Panel affirmed the bankruptcy court’s denial of Beal Bank’s motion. The appellate panel specifically noted its decision was a “close” one and limited its ruling to the issue of whether the bankruptcy court had “abuse[d] its discretion.” Id. at 777.
At least one case expressly refused to designate the votes of a competitor of the debtor pursuant to section 1126(e). In In re Trikeenan Tileworks, Inc., 2011 WL 2898955 at *3, *7 (Bankr. D.N.H. July 14, 2011), the debtor’s competitor purchased a claim. By virtue of that purchase, the competitor obtained standing and proposed a plan that would (i) restructure the debtor’s secured debt, (ii) provide a meaningful recovery to unsecured creditors, and (iii) invest additional capital
into the reorganized debtor. The court found that the competitor “intend[ed] to maintain the [debtor] as viable entities that w[ould] create a going concern value for creditors.” Id. at *7. The court noted the amount of the purchased debt was small and the competitor’s alternative plan enjoyed significant creditor support. Id. In declining to designate the votes of the competitor, the court explained that:
Being a competitor who proposes a competing plan to take over the debtor does not equal bad faith per se. To the contrary, the Supreme Court has noted that lifting exclusivity to propose a competing plan opens the door for other parties to bid for the equity of the company . . . . There is no requirement that a competing plan must be friendly to the existing management or ownership of a debtor.
Id. (citing Bank of America v. 203 N. LaSalle St. P’ship, 526 U.S. 434, 457-58 (1999)).
Conclusion
“Claims trading markets are as old as our nation.” KB Toys, 470 B.R. at 341. The importance of these markets to the Chapter 11 process has grown by leaps and bounds in recent years. However, as discussed herein, market participants need to be mindful of the potential legal risk. Whether the bar to payment set forth in section 502(d) travels with a new owner of the claim is an unsettled question of law. As a result, it behooves potential buyers of bankruptcy claims to conduct due diligence by at least reviewing the SOFA filed by a debtor and to, whenever possible, obtain indemnification protection from the seller. In a development that could strengthen the hand of buyers of bankruptcy claims, the Longacre Master Fund court broadly read a contractual indemnification clause to require the seller to take back the claim upon an objection to the claim by the estate. And given that court’s oblique reliance on the sale vs. assignment distinction in which a defense to payment of a claim in bankruptcy travels with the claim to an assignee, but not to a purchaser, a claim buyer should, at least for a bankruptcy case in New York, document a transfer agreement as a purchase agreement, rather than as an assignment.
It is also clear that while good faith under section 1126(e) is not synonymous with selfless disinterest, see, e.g., In re Figter Ltd., 118 F.3d 635, 639 (9th Cir. 1997), buyers of claims who are competitors of the debtor are vulnerable to losing their voting right, especially if they are not pre-petition creditors and their goal in purchasing claims is to carry out a hostile takeover of a debtor or to use the assets of the debtor for their own benefit.
February 2013: Entertainment Litigation Update
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Second Circuit Steers Away from Strict Copyright Protection in the Photography Arena. According to well-known photographer Janine Gordon, rival photographer Ryan McGinley copied more than 150 of Ms. Gordon’s contemporary images in a series of advertising campaigns in violation of copyright law. The U.S. District Court for the Southern District of New York disagreed. See Gordon v. McGinley, et al., 2012 U.S. App. LEXIS 23273, *2-4 (2d Cir. Nov. 13, 2012). Ms. Gordon has established herself as a major photographer in the art world, with exhibitions at prominent venues, including the Whitney and Hammer museums. Mr. McGinley also has received critical and commercial acclaim in recent years, particularly with respect to a series of advertising campaigns for fellow defendant Levi Strauss. According to Ms. Gordon, the images used in Mr. McGinley’s Levi Strauss campaigns, and exhibited at various defendant galleries, were substantially similar to her copyrighted photographs. Ms. Gordon pointed to examples such as an arm gesture at a right angle in one photograph, and a naked, tattooed body laying at a similar angle in another. Mr. McGinley countered by stressing the differences between his and Gordon’s photographs—such as the use of different colors, clothing and physical appearances. The District Court agreed with Mr. McGinley, finding that there was no substantial similarity as a matter of law because the differences in the works outweighed the similarities. Accordingly, it granted Mr. McGinley’s motion to dismiss. The Second Circuit concurred, holding after a de novo review that the District Court’s dismissal of Ms. Gordon’s federal copyright claims was proper.
The Gordon ruling has special resonance within the arts community, where artists must calibrate new works based on the degree to which those works can contain or reflect content from other artists’ works. The Second Circuit has now indicated a willingness not only to protect visual artists from copyright claims regarding tangentially similar works, but also to dispose of such claims at an early stage in the litigation process.
February 2013: Trial Practice Update
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Court Rules Jury Voir Dire Must Be Public. The Second Circuit recently reversed a criminal conviction because the public had been excluded from the courtroom during jury selection. In the case of United States v. Gupta, the courtroom deputy had asked the defendant’s brother and girlfriend to leave the courtroom because there were insufficient seats for them in the gallery along with the jury venire of 70 people. The deputy informed the two that they would be welcome back in the courtroom after jury selection was complete. The defense did not lodge an objection. Voir dire was uneventful, and the defendant’s brother and girlfriend watched the balance of the trial. Mr. Gupta was convicted of immigration fraud and sentenced to more than four years in prison.
After the trial, Mr. Gupta objected to the exclusion of his brother and girlfriend. The Court of Appeals, following the Supreme Court decisions in Waller v. Georgia, 467 U.S. 39 (1984) and Pressley v. Georgia, 558 U.S. 209 (2010) held that a courtroom cannot be closed simply to accommodate a large panel of prospective jurors, nor can a courtroom be closed to protect the panel from contact with the public. The court also rejected the Government’s argument that the closure was trivial because voir dire was not contentious. The court wrote that “it is the openness of the proceeding itself, regardless of what actually transpires,” that imparts public confidence in our system of justice.
The Court of Appeals also rejected the Government’s argument that Mr. Gupta forfeited his challenge to the courtroom closure by not raising it contemporaneously with the exclusion of his brother and girlfriend. The court rejected this argument for two reasons: first, the evidence was not clear that Mr. Gupta had been aware of the exclusion at the time. Second, the record was clear that Mr. Gupta’s trial counsel was unaware of the exclusion of the brother and girlfriend. The court refused to find waiver if counsel was ignorant of the basis for the need to object. The Second Circuit therefore vacated Mr. Gupta’s conviction and sentence. Regardless of courtroom space, criminal trials in the federal courts must remain open to the public.
Deprivation of Rebuttal Summation Leads to Reversal. In Wagner v. County of Maricopa, decided late last year, the Ninth Circuit reversed a civil case after trial because the judge refused to allow the plaintiff to do a rebuttal summation. The plaintiff in Wagner sued the county after an inmate died in custody. The case proceeded to trial in the District of Arizona. After the plaintiff delivered its principal summation, which lasted an hour, the trial court informed the plaintiff that there would be no rebuttal summation despite the practice in the District of Arizona for the plaintiff to speak last. The county delivered its summation and then the jury returned a defense verdict. The Ninth Circuit held that while a court may manage a trial in its discretion, the trial court cannot deprive a plaintiff of a rebuttal summation without notice. One dissenting judge noted that a party is only entitled to principal closing argument, and no rule requires that a plaintiff be given the opportunity for a rebuttal summation. But that view did not carry the day, and the rest of the Ninth Circuit rejected the county’s motion for rehearing en banc. So the rule in the federal courts of the Ninth Circuit is that a plaintiff cannot be deprived of a rebuttal summation without notice.
February 2013: Japan Litigation Update
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Japanese Court’s Ruling Limits Scope of Contributory Infringement in Pharmaceutical Patents. The Osaka District Court recently addressed the application of the Japanese counterpart to “contributory infringement” in the pharmaceutical context. Specifically, in Takeda Pharmaceutical Company Limited v. Sawai Pharmaceutical Co., Ltd., et al, the court assessed whether infringement of a pharmaceutical patent could be found where the alleged infringer sells only a non-patented medicine that can then be combined with another product to infringe the patent.
Takeda, which produces a product named ACTOS that treats Type 2 Diabetes, owns patents covering a product that combines the ACTOS treatment with other medicine(s). The defendant companies manufacture and sell generic products akin to ACTOS that may be used with other oral anti-diabetic products. Takeda sought a provisional injunction and damages against the defendants under Article 101, Item 2 of the Patent Act. Analogous to contributory infringement in the United States under 35 USC § 271(c), Article 101 covers infringement where the accused infringer makes a product that is knowingly used with another component or product that together fall within the scope of the patent claims, and where the accused infringer’s contribution is indispensable to the resolution of the problem of the invention.
The Osaka District Court rejected the contributory infringement theories on numerous grounds. The court first held that the defendants’ generic products are independent medical products themselves and are not intended to be used with other products or medicines, even if they ultimately are used as such. The court specifically rejected Takeda’s argument that the doctor’s prescriptions, which prescribed that the generic be used with other medicines, constituted producing a product to be used with another. The court further found that giving a patient those medicines together, such as when they are given in the same bag under a common prescription, cannot constitute production of an infringing product. The court similarly found that a patient’s active ingestion of the defendants’ medicines with other medicines did not constitute production of an infringing product. Accordingly, the court held that the generic medicines could not be liable for infringement pursuant to Article 101, item 2 even when their medication was combined with other medication so as to fall within the scope of the claims.
Takeda appealed the decision by the Osaka District Court to the Intellectual Property High Court.
Criminalization of Illegal Music and Video Downloads. The Revised Japanese Copyright Act that criminalizes illegal downloads of music and video files came into effect on October 1, 2012. The revised act now imposes penalties of up to two years in prison and fines of up to two million yen (around $25,000) on those who illegally download infringing files. To institute criminal prosecution, the copyright title holder must file a complaint.
Before the amendment, although prohibited, downloading files that infringed copyrights was not criminalized—only uploading infringing files was considered a crime. As a result, before the amendment, the only recourse for a copyright title holder against an infringing downloader was a civil suit seeking damages. Time will tell how this criminal penalty will be enforced in practice.
February 2013: Libor Litigation Update
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UBS and Barclays Acknowledge Making False Libor Submissions. Investigations into misconduct at UBS and Barclays have revealed pervasive corruption of the London Interbank Offered Rate (“Libor”), which provides a benchmark for more than $350 trillion in financial instruments. The British Bankers’ Association (“BBA”) calculates Libor in several currencies and maturities based on banks’ reported borrowing costs in the London interbank lending market. This reliance on self-reporting makes Libor vulnerable to manipulation if banks misreport their true cost of borrowing. With numerous government probes ongoing, regulators are expected to ensnare more global banks and uncover new evidence of Libor manipulation that will influence already-filed and potential litigation.
UBS became the second bank to admit to Libor-related wrongdoing late last year, when it agreed to pay $1.5 billion to resolve investigations by U.S., British, and Swiss authorities. The UBS settlement—following the $453 million fine imposed on Barclays in June—includes a rare admission of criminal wrongdoing by UBS’s Japanese subsidiary. The Justice Department is also pursuing wire fraud charges and antitrust violations against two Tokyo-based UBS traders accused of conspiring to manipulate Yen Libor.
Regulators have identified three main categories of Libor-related wrongdoing at UBS and Barclays.
First, both banks systematically suppressed their Libor submissions in an effort to protect their reputations during the global financial crisis. Managers at UBS and Barclays directed their respective submissions desks to adjust their USD Libor and other submissions downward to avoid being perceived as a high outlier relative to other panel banks.
Second, traders manipulated their own banks’ rate submissions in order to benefit their trading positions. In Barclays’ case, traders in New York, London, and Europe sought to influence the bank’s USD Libor and Euro Interbank Offered Rate (“Euribor”) submissions. The allegations against UBS focus on traders in Tokyo, London, and Zurich, and relate primarily to the bank’s Yen Libor, Sterling Libor, and Swiss Franc Libor submissions.
Third, some of this trader-driven misconduct involved coordination with other banks. The most damaging revelations concern UBS’s Japanese subsidiary, where traders colluded with interdealer brokers and other panel banks to manipulate Yen Libor. This scheme reportedly involved traders at Citigroup, Deutsche Bank, HSBC, JPMorgan, and other institutions. The Barclays probe also found that traders colluded with peers at other banks to manipulate USD Libor and Euribor submissions.
More revelations are certainly forthcoming. Royal Bank of Scotland (“RBS”) is widely expected to be the next panel bank to reach a settlement with authorities, who have reportedly unearthed evidence of improper USD and Yen Libor submissions. Many other banks are under investigation or are facing litigation, including JPMorgan, Bank of America, and Citibank. These probes will likely lead to further acknowledgements of misconduct.
Quantifying Crisis-Era Libor Suppression. UBS and Barclays have both admitted to systematically understating their Libor submissions beginning in 2007, and it is now clear that Libor was abnormally low during the same period. By late 2007, emerging discrepancies between Libor and comparable interest rates attracted the attention of officials at the Federal Reserve Bank of New York. Concerns about the reliability of Libor spilled into public view in April 2008, when the Wall Street Journal published articles questioning whether banks’ submissions accurately reflected their borrowing costs. A Citigroup analyst estimated at the time that Libor “may understate actual interbank lending costs by 20-30 bps.” In addition, submissions by Citigroup, Bank of America, and JPMorgan Chase often clustered, suspiciously, around the lowest rate that could be submitted without being discarded as an outlier.
A growing body of statistical research has attempted to quantify the degree of Libor distortion during the crisis period. According to one study comparing Libor submissions with comparable funding transactions, Libor understated banks’ borrowing costs by 10 basis points between August 2007 and March 2008, and by up to 30 basis points for the remainder of the year. The Federal Housing Finance Agency and other investors have estimated much larger spreads, finding that Libor diverged from comparable Federal Reserve Eurodollar Deposit rates by as much as 300 basis points at the peak of the financial crisis. This misreporting could have damaged large investors by substantially reducing the interest paid on Libor-indexed financial products.
The Existing Litigation Does Not Cover Potential Investments and Causes of Action. Investors have filed numerous actions based on rate-setting misconduct at panel banks, including an individual investor claim by Charles Schwab and a number of class actions. All of the current Libor cases are part of the multi-district litigation before Judge Naomi Buchwald in the Southern District of New York: In re: Libor-Based Financial Instruments Antitrust Litigation, No. 1:11-md-02262-NRB. The class cases have been consolidated into two main actions, the “direct purchaser” case and the “over-the-counter” action. Judge Buchwald recently imposed a stay on any action that is not the subject of pending motions to dismiss filed in June 2012.
The current class complaints assert antitrust violations, unjust enrichment claims, and violations of the Commodity Exchange Act on behalf of investors who purchased or held Libor-linked assets. Members of these classes may receive the benefit of American Pipe tolling, but the existing actions only cover a small subset of potential investments and causes of action. For example, the main class actions do not assert securities fraud, RICO, or common-law fraud claims, which may prove to be the most viable causes of action. The statutes of limitations on these claims are generally not tolled by the class actions and they continue to run. For claims brought under the Securities Exchange Act of 1934, which are governed by a five-year statute of repose, this means that claims relating to investments made in late 2007 are already barred, with more claims being barred daily.
The primary hurdle facing antitrust claims is pleading an agreement among the panel banks. Government investigations have unearthed evidence of collusion among individual traders seeking favorable rate submissions, and the consistency of the banks’ Libor submissions (especially their departure from historical norms) suggests that the banks may have been acting in concert. But neither the Barclays nor the UBS settlement has produced any direct evidence of a high-level agreement between the banks systematically to suppress Libor. Thus, while the current facts may be sufficient to overcome a motion to dismiss under the Twombly plausibility standard, the antitrust claims may face tougher scrutiny at the summary judgment stage.
For this reason and others, investors considering opt-out suits should not limit themselves to antitrust claims, but rather should consider claims that do not require proof of collusion among the panel banks. For example, RICO claims do not require an industry-wide conspiracy, and carry potential treble damages. Claims brought under the 1934 Act likewise do not require a conspiracy, although such claims are only available for investors who purchased Libor-linked “securities” (not loans, swaps, or other non-security instruments).
Notably, RICO and 1934 Act claims are likely mutually exclusive because securities fraud cannot be a predicate act for a federal RICO claim. Whether to allege securities fraud or RICO will depend largely on the makeup of the particular investor’s portfolio. Investors asserting fraud-based claims will have strong arguments that the Libor panel banks committed fraud when they offered instruments whose returns were benchmarked to Libor, without disclosing that Libor was being manipulated.
Common-law fraud claims have a number of advantages that will make them particularly attractive to opt-out claimants. For instance, common-law fraud: (1) does not require a conspiracy among the panel banks; (2) can be brought with respect to all types of Libor-based financial instruments; (3) should not be subject to the heightened standards of the PSLRA; and (4) depending on the jurisdiction, may have longer statute of limitations than other claims.
The Libor scandal is almost certain to grow. Due to the potential size of the banks’ fraud, and the fast-approaching expiration of the statute of limitations for certain causes of action not included as part of the class actions, investors should perform a detailed analysis of their portfolios as soon as possible. Only those investors who have analyzed their portfolios in advance will be well positioned to respond to any changes in this fast-unfolding scandal.
Shifting the Growing Costs of E-Discovery
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Since the arrival of e-discovery in the mid-1990s, the cost of collecting, copying, reviewing, sorting, processing and producing electronically stored information (“ESI”) has grown exponentially. In 2007, for example, litigants spent nearly $2.79 billion dollars on e-discovery, a 43% increase from the amount spent just a year earlier. See George Socha & Tom Gelbmann, A Look At The 2008 Socha-Gelbman Survey, Law Tech. News, Aug. 11, 2008. In a more recent case study of Fortune 500 companies, the RAND Institute found that the median total cost for ESI production among participants reached the astounding sum of $1.8 million dollars per case. See Nicholas Pace & Laura Zakaras, Rand Institute for Civil Justice, Where the Money Goes: Understanding Litigant Expenditures for Producing Electronic Discovery, 28 (2012). Given the sheer volume of email and other electronic documents stored in the cloud and on company servers, hard drives, and handheld devices that are potentially responsive to discovery requests, these e-discovery costs will only continue to rise in 2013 and beyond.
In an effort to defray these costs, prevailing litigants can seek reimbursement of certain e-discovery expenses as taxable costs under Federal Rule of Civil Procedure 54(d)(1) and 28 U.S.C. § 1920(4). Litigants seeking to tax e-discovery costs have done so with varying degrees of success. See, e.g., Race Tires Am., Inc. v. Hoosier Racing Tire Corp., 674 F.3d 158, 159, 162 (3rd Cir. 2012) (taxing $30,000 (or 8%) of requested e-discovery costs for copying related tasks); Fells v. Virginia Dept. of Transp., 605 F. Supp. 2d 740 (E.D. Pa. 2011) (refusing to tax any costs associated with the processing of electronic records because the techniques were not technically “photocopying or scanning”); Lockheed Martin Idaho Technologies Co. v. Lockheed Martin Adv. Envtl. Sys., Inc., 2006 WL 2095876, at *2 (D. Idaho July 27, 2006) (taxing $4.6 million (or 100%) of requested e-discovery costs for a document review database). Recent decisions like these and others, while not entirely consistent, provide guidance for litigation counsel hoping to shift at least a portion of the ever-rising e-discovery costs and expenses to an opposing party.
Statutory Support of Shifting Costs
Rule 54(d)(1) allows a prevailing party to recover certain costs and expenses incurred during litigation from the opposing party. “Unless a federal statute, these rules, or a court order provides otherwise, costs—other than attorney’s fees—should be allowed to the prevailing party.” Fed. R. Civ. P. 54(d)(1). Under this Rule, if a substantiated bill of costs is sent to the court clerk, there is a presumption that recovery is proper; however, courts still have discretion to reduce any award. Id.; see also Plantronics Inc. v. Aliph, Inc., 2012 WL 5269667, at *2 (N.D. Cal. Oct. 23, 2012). The losing party then has the burden of overcoming the presumption by affirmatively showing that the prevailing party is not entitled to costs.
However, the term “costs” is not defined under Rule 54. Instead, the universe of taxable costs is defined by 28 U.S.C. § 1920. See Taniguchi v. Kan Pac. Saipan, Ltd., 132 S. Ct. 1997, 2001-02 (2012) (rejecting the proposition that “the discretion granted by Rule 54(d) is a separate source of power to tax costs and expenses not enumerated in § 1920.”) Taxable costs under § 1920 include, inter alia, “[f]ees for exemplification and the costs of making copies of any materials where the copies are necessarily obtained for use in the case.” 28 U.S.C. § 1920(4). Even among courts that have taxed e-discovery costs, however, there is a lack of uniformity on how or whether to treat individual e-discovery costs as taxable under §1920(4), with some courts taxing all e-discovery costs and some courts refusing to tax anything more than a minute fraction.
The Impact of Race Tires
The Third Circuit is the first, and arguably only, appellate court to directly address the propriety and scope of taxing e-discovery costs under §1920(4). In Race Tires, the Third Circuit was confronted with a bill of costs that contained over $365,000 of e-discovery charges related to the collection, processing, TIFF conversion, OCR, and production of approximately 600,000 pages of electronic documents. Race Tires Am., Inc., 674 F.3d at 159, 162.
Prior to the Circuit’s review, the district court had accepted the defendant’s bill of costs, viewing the work as “the electronic equivalent of exemplification and copying.” Id. at 163. The district court found that the “expertise” needed to “retrieve and prepare” the electronic information for discovery (an expertise “not normally” possessed by lawyers) was an “indispensable part of the discovery process” and thus taxable under §1920(4). Id. Disagreeing, the Third Circuit vacated the opinion and ordered the district court to tax a mere 8% of the requested costs. Id. at 171.
In reaching its decision, the Third Circuit first analyzed whether the e-discovery costs fell under the “exemplification” allowance contained in § 1920(4). Noting that its sister courts had split on the scope of the exemplification allowance, the Third Circuit ultimately decided it was unnecessary to decide how broadly the allowance extended since none of the work at issue was for “illustrative evidence or the authentication of public records,” it could not qualify as “exemplification” under any interpretation. Id. at 166.
The Race Tires court next reviewed the bill of costs to determine if any of the e-discovery work could be considered “making copies.” Id. The court held that only the scanning of hard copy documents, the conversion of native files to TIFF, and the transfer of VHS tapes to DVD were costs that were properly taxable under §1920(4). Id. at 171. In addition, the court explicitly disagreed with prior district court opinions that held all types of e-discovery services are taxable due to their “indispensable,” “highly technical,” and/or “cost-saving” nature. Id. at 168. The court criticized this approach as being completely “untethered from the statutory mooring” of §1920. Compare id. at 169 with CBT Flint Partners LLC v. Return Path, 676 F. Supp. 2d 1376, 1381 (Fed. Cir. 2009) (vacated on other grounds) (e-discovery vendor’s “highly technical” services are the “21st century equivalent of making copies”) (citing Cargill Inc. v. Progressive Dairy Solutions, Inc., 2008 WL 5135826, at *6 (E.D. Cal. Dec. 8, 2008)).
As §1920(4) did not provide for the taxation of “all steps” necessary to make a copy in the pre-digital era, the Third Circuit held that it cannot be used to tax the cost of all the services that proceed the making of an electronic copy, such as “gathering, preserving, processing, searching, culling, and extracting ESI.” Race Tires Am., Inc., 674 F.3d at 169-70. Fundamentally, to be taxable under §1920(4), the Race Tires court held that costs must be incurred for the “physical preparation and duplication of documents.” Id. (citations omitted).
Moreover, e-discovery costs are not taxable simply because the activities leading up to the making of copies are performed by third party consultants with “technical expertise.” Id. at 169. The Race Tires court held that neither the degree of expertise necessary to perform the work nor the identity of the party performing the work is a factor that can be gleaned from the text of § 1920(4). Id. In fact, Race Tires noted that the Ninth Circuit Romero rule has long limited these types of costs as not taxable under § 1920(4). See Romero v. City of Pomona, 883 F.2d 1418, 1427-28 (9th Cir. 1989), overruled on other grounds, (holding that § 1920(4) did not extend to the “intellectual effort” involved in the production of documents, only the physical preparation and duplication of documents).
The Romero rule has been interpreted by district courts to bar taxation of e-discovery costs. For example, in Oracle v. Google, Google attempted to seek remuneration for almost $3 million in e-discovery charges. Oracle Am., Inc. v. Google Inc., 2012 WL 3822129, at *3 (N.D. Cal. Sept. 4, 2012). The court refused Google’s requested e-discovery costs in their entirety because the costs were for “organizing, searching, and analyzing [of] discovery documents” and such “intellectual effort” costs were non-taxable under Romero. Id; see also, Gabriel Techs. Corp. v. Qualcomm Inc., 2010 WL 3718848, at *10-11 (September 20, 2010) (denying motion for a bond to tax $1.5 million in e-discovery consultant fees because the work was intellectual effort and not “the physical preparation and duplication of documents”); Computer Cache Coherency Corp. v. Intel Corp., 2009 WL 5114002, at *4 (N.D. Cal Dec. 18, 2009) (awarding less than 50% of requested e-discovery costs because OCR and metadata extraction costs were not “physical preparation and duplication of documents”).
The State of the Race Post-Race Tires
While the Third Circuit found it “imperative to provide definitive guidance to the district courts in [the Third] Circuit on the question of the extent to which electronic discovery expenses are taxable,” Race Tires, 674 F.3d at 160, the majority of district court decisions in other circuits have also tended to follow the rule announced by Race Tires. At the time of print, five district courts, from several circuits, have declined to tax large portions of e-discovery costs based on the analysis articulated in Race Tires. For example, the court in El Camino Resources, Ltd. V. Huntington Nat’l Bank noted that while there were diverging views on the appropriateness of taxing e-discovery costs, the “well-reasoned” approach of Race Tires had convinced it of the impropriety of adopting an expansive approach. El Camino Resources, Ltd. V. Huntington Nat’l Bank, 2012 WL 4808741, at *5-7 (W.D. Mich. May 3, 2012) (taxing only $2,000 of $84,000 in requested e-discovery costs).
Similarly, the courts in Johnson v. Allstate and Country Vitner v. Gallo Winery followed the “persuasive” and “helpful” Race Tires decision when they limited taxable e-discovery costs to the “making of copies” and ruled against taxing the pre-production processing costs of other e-discovery services such as the “creat[ion] of litigation database[s], processing of ESI, [and] extraction of metadata.” Johnston v. Allstate, 2012 WL 4936598, at *6 (S.D. Ill. Oct. 16, 2012) (denying $122,000 worth of e-discovery costs as non-taxable “gathering, preserving, processing, searching, culling and extracting [of] ESI”); Country Vitner v. Gallo Winery, 2012 WL 3202677, at *2-3 (E.D. N.C. Aug. 3, 2012) (denying $111,000 worth of e-discovery costs and only awarding $218.59 for the “tasks that involve copying [such as] the conversion of native files to TIFF and PDF formats and the transfer of files onto CDs.”).
On the opposite end of the spectrum, at least one district court has refused to follow the rationale articulated by the Third Circuit. In In re Online DVD Rental Antitrust Litig., a Ninth Circuit Northern District of California court allowed nearly $700,000 of e-discovery costs to be taxed to the losing party. In re Online DVD Rental Antitrust Litig., 2012 WL 1414111 (N.D. Cal. April 20, 2012). The court reasoned that, in the absence of controlling Ninth Circuit precedent, a broad approach to cost shifting was appropriate under the facts of the case Id. at *1. Notably, the court failed to mention the Ninth Circuit’s Romero rule against awarding “intellectual effort” costs in its brief two-page decision.
By contrast, another, more recent, Northern District of California district court followed the measured Race Tires and Romero analysis in taxing only $20,000 out of $200,000 of in-house e-discovery costs; limiting taxable costs to those associated with TIFF conversion; OCR; CD, DVD, and HD duplication. Plantronics Inc., 2012 WL 5269667, at *17-18. This decision is also instructive on “best practices” litigants should follow under Race Tires and Romero that are most likely to result in a successful motion to tax e-discovery costs. First, litigants should prepare detailed, itemized lists of the costs sought to be taxed as “[n]othing about… Rule 54(d)’s presumption excuses a prevailing party from itemizing its costs with enough detail to establish that each expense is taxable under section 1920.” Id. at 5 (citing Oracle America, Inc., 2012 WL 3822129, at *3). Second, litigants must be careful to avoid line-item descriptions that read like “intellectual effort” to a court, or they risk those costs being denied under the Romero rule. Id. at 21. Another pitfall is to avoid producing documents in a costlier, alternative format, especially if that format was not requested by the other side as it provides a basis for the court to deny costs. Id. at 23. Above all, litigants must remember that when it comes to e-discovery cost-shifting, greed is not good. Submitting a bill of costs with inflated costs, bad-faith accounting, or purposefully vague descriptions will result in “diminished award[s] and sometimes result in denying of taxable costs altogether.” Id. at 3 (quoting Jansen v. Packaging Corp. of Am., 898 F. Supp. 625, 629 (N.D. Ill. 1995).
The Supreme Court May Eventually Limit Section 1920(4) Similar to Race Tires
The Supreme Court chose not to accept certiorari in Race Tires so there is no definitive precedent on the taxability of e-discovery costs outside of the Third Circuit. However, in early 2012, the Supreme Court ruled on the scope of the category of taxable costs under §1920(6) (“compensation of interpreters”) in a decision that is instructive on how the Supreme Court might interpret the scope of taxable e-discovery costs under §1920(4).
Holding that the term “interpreter” could not be stretched to include non-oral translation, the Supreme Court articulated a relatively circumscribed approach to the recovery of litigation costs under § 1920. Taniguchi, 132 S. Ct. at 2005. The Court explained that taxable costs are of “narrow scope” and are “limited to relatively minor, incidental expenses.” Id. at 2006. Ultimately, the Court remanded the case to the Ninth Circuit with instructions to refuse to tax costs for the written translation of documents.
While Taniguchi was limited to costs associated with translation of documents, it appears that the thrust of Taniguchi, combined with the Court’s decision not to accept certiorari in Race Tires, may indicate that the Court is not sympathetic to arguments that § 1920(4) should be used to allow a party to shift the entirety of the costs associate with e-discovery.
Conclusion
Race Tires and subsequent cases provide mixed results for corporate litigants. On the one hand, Race Tires protects unsuccessful litigants (at least in the Third Circuit) from being saddled post-judgment with their opponents’ e-discovery costs that can run into the millions of dollars. On the other hand, Race Tires and courts following it pose the serious risk that successful litigants will still be on the hook for vast sums of money for e-discovery, even when the underlying litigation lacks merit. Ironically, the only true protection may come from the same source as the problem itself: technology. If companies can more fully automate the early stages of ESI processing and e-discovery, this issue may yet resolve itself.
Aesthetic Functionality and the Use of “Color Marks” in the Fashion Industry
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For more than a century, courts have grappled with whether to extend the protections of trademark laws to colors. In 1995, however, the Supreme Court recognized that both the “language . . . and the basic underlying principles” of the Trademark Act of 1946, 15 U.S.C. §§ 1051-1127 (Lanham Act), “would seem to include color within the universe of things that can qualify as a trademark.” Qualitex Co. v. Jacobson Prods. Co., 514 U.S. 159, 162 (1995) (“We cannot find in the basic objectives of trademark law any obvious theoretical objection to the use of color alone as a trademark, where that color has attained ‘secondary meaning’ and therefore identifies and distinguishes a particular brand (and thus indicates its ‘source’).”).
Holding that “color alone, at least sometimes, can meet the basic legal requirements for use as a trademark,” id. at 166, the Qualitex court acknowledged, however, that in some circumstances, “to permit one, or a few, producers to use colors as trademarks will ‘deplete’ the supply of usable colors to the point where a competitor’s inability to find a suitable color will put that competitor at a significant disadvantage. Id. at 168. In such circumstances, the competitor’s use of a color mark may be subject to a defense of “aesthetic” functionality:
When a color serves as a mark, normally alternative colors will likely be available for similar use by others. . . . Moreover, if that is not so – if a “color depletion” or “color scarcity” problem does arise – the trademark doctrine of “functionality” normally would seem available to prevent the anticompetitive consequences . . . .”
Id. (citations omitted). The Qualitex court anticipated that such “aesthetic” functionality concerns would cause courts evaluating the validity of color marks to “examine whether the use [of a color or range of colors] as a mark would permit one competitor (or a group) to interfere with legitimate competition through actual or potential exclusive use of an important product ingredient [i.e., all usable colors],” and that such examination would, “ordinarily, . . . prevent the anticompetitive consequences of . . . ‘color depletion.’” Id. at 170.
The Second Circuit recently analyzed that aesthetic functionality defense to a single-color trademark in Christian Louboutin S.A. v. Yves Saint Laurent America Holding, Inc., 2012 WL 3832285 (2d Cir. 2012). At issue was a dispute between two European fashion houses over the right to color the “outsole” of women’s shoes red. In 2008, the plaintiff, French shoe designer Christian Louboutin, registered a mark consisting of “a lacquered red sole on footwear” (the “Red Sole Mark”). Since Louboutin began designing shoes in the early 1990s, he had featured red outsoles to contrast with the colors of other parts of the shoes. The district court concluded that, through Louboutin’s marketing efforts, the “flash of a red sole” had become “instantly” recognizable as “Louboutin’s handiwork.” Id. at *2 (citing district court).
In 2011, the fashion company founded by the late Yves Saint Laurent (“YSL”) designed a line of “monochrome” ladies shoes of various colors, including red shoes that “featured the same color on the entire shoe, so that the red version is all red, including a red insole, heel, upper, and outsole.” Id. After YSL rejected Louboutin’s demand that it remove its monochrome red shoes from the market, Louboutin sued and sought a preliminary injunction. YSL opposed in part on the ground that the Red Sole Mark was invalid as aesthetically functional.
Relying on Qualitex, the district court concluded that a “color is protectable as a trademark only if it ‘acts as a symbol that distinguishes a firm’s goods and identifies their source, without serving any other significant function.’” Id. at *3 (quoting district court). Noting the supposedly “unique characteristics and needs – the creativity, aesthetics, taste, and seasonal change – that define production of articles of fashion,” the district court held that single-color marks are inherently “functional” in the fashion industry, and on that basis denied Louboutin’s requested injunction. Id.
On review, the Second Circuit recognized the Qualitex court’s concerns about the potential anti-competitive consequences of single-color marks and discussed at length the “aesthetic functionality” defense to a trademark infringement claim. In addition to the traditional “functionality” defense, which asks whether a product feature like color is “‘functional’ in a utilitarian sense,” id. at *8, aesthetic functionality goes a step further in considering whether a design feature has a “significant effect on competition.” Id. After analyzing various formulations of the aesthetic functionality tests that it and other circuit courts have applied, the Second Circuit held that “a mark is aesthetically functional, and therefore ineligible for protection under the Lanham Act, where protection of the mark significantly undermines competitors’ ability to compete in the relevant market.” Id. at *10.
Having decided on the standard for evaluating aesthetic functionality, the Second Circuit turned to the district court’s “per se rule of functionality for color marks in the fashion industry.” Id. The court profits opinions, and after conducting an eight-day evidentiary hearing, the judge excluded the expert’s testimony because it was speculative and lacked any reliable basis.
The Court of Appeal reversed, ruling that any challenges to the expert’s reasoning were for the jury to resolve, but Quinn Emanuel successfully petitioned the California Supreme Court, which grants review in less than 1.5% of civil, to review case. Arguing in the California Supreme Court only two days after being before the U.S. Supreme Court, Kathleen Sullivan, the head of the firm’s appellate group, persuaded the California Supreme Court to overturn the Court of Appeal and rule for USC in a unanimous 7-0 decision.
In addition to protecting USC against $1.18 billion in lost profits, the California Supreme Court’s decision in Sargon Enterprises v. USC establishes that California trial courts have a duty to exclude speculative and unreliable expert testimony. Using language similar to Daubert, the Court held that trial judges have a “gatekeeping” responsibility, which requires them to exclude expert testimony that is based on invalid or unreliable reasoning. This now clearly established responsibility will enable businesses litigating in California courts to exclude speculative and unreliable expert testimony. Also, by bringing California practice more in line with federal practice, the Sargon decision removes a significant incentive for forum-shopping in complex business cases.
The Sargon decision also establishes another principle that may have a wide ranging impact on business litigation. It is well settled that new businesses seeking lost profits bear a heavy burden because they have no track record of profitability. Small businesses such as Sargon frequently claim that they would have grown into much larger companies absent some tort or breach of contact but that they should not be subject to the standard for new businesses because they already were earning some small profit. The Sargon decision makes clear that claims that a small business would grow into a much larger entity are subject to the same burden of proof. This ruling will change the dynamic in cases in which start-ups and other small companies seek large lost profit awards based on growth that they alleged that they would achieve. Moreover, because of California’s leading role in the high-tech industry involving so many start-ups, this aspect of the Sargon decision is likely to influence decisions in other jurisdictions.
January 2013: Patent Litigation Update
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European Parliament Approves European Unitary Patent and Unified Patent Court: On December 11, 2012, the European Parliament approved a new patent system that, once fully implemented, would create both an optional Unitary Patent and a Unified Patent Court to handle litigation of all European patents. Ideally, the Unitary Patent option should streamline the process for obtaining patent protection in the 25 participating EU member states, and will reduce the associated fees and translation expenses.
Once the set of EU regulations are in effect (which could be as early as 2014), patentees will have the option to request that a new European patent granted by the European Patent Office be given unitary effect across all 25 participating EU member states. Applications for a Unitary Patent must be filed in English, German or French, and no other human translations will be required (automated “machine” translations may be submitted). Unitary Patents will coexist with national patents and also classical European patents that will still be available to obtain patent protection in non-participating states, including Spain, Italy, Switzerland, Turkey, Norway and Iceland.
The Agreement on a Unified Patent Court, once ratified by at least 13 EU member states including France, Germany and the United Kingdom, will create a Unified Patent Court with exclusive jurisdiction over the litigation of all European patents, including over actions for infringement, revocation, or injunctions. The Unified Patent Court will include a specialized Court of Appeal located in Luxembourg, and a set of specialized trial courts of first instance. The central division of the trial courts will be located in at least Paris, Munich and London, while local divisions will be located in one venue of each of the member states (some member states will share on venue, regional divisions) with the exception of Germany, which will have at least 3 local divisions (Düsseldorf, Mannheim and Munch, possibly Hamburg). Each trial court will be overseen by an internationally composed panel of judges and each division of the trial court will grant pan-EU relief for all of the member states (or for all of the designated contracting states of a European patent, which can extend beyond the EU). The Plaintiff can decide to file in any local division where there is an infringing activity in the member state that hosts that local division.
Gross Negligence Insufficient to Establish Deceptive Intent for Inequitable Conduct: The Federal Circuit recently clarified the level of deceptive intent required for inequitable conduct in Outside the Box Innovations, LLC v. Travel Caddy, Inc., No. 2009-1171 (Fed. Cir. Sept. 21, 2012). The Court held that gross negligence is insufficient to establish clear and convincing evidence of the deceptive intent required for inequitable conduct.
Recognizing that inequitable conduct requires evidence of the omission or misrepresentation of material information in dealings with the PTO, and also clear and convincing evidence of specific intent to deceive the PTO, the trial court found two patents unenforceable due to inequitable conduct arising out of the patentee’s failure to disclose to the PTO the existence of litigation involving the parent patent during the prosecution of its progeny. In so holding, the trial court rejected the patentee’s argument that any material omission regarding the litigation was the result of oversight, error or negligence, not deceptive intent.
On appeal, the Federal Circuit overruled the trial court, holding that “[n]egligence, however, even gross negligence, is not sufficient to establish deceptive intent.” Building on the Court’s prior holding in Therasense, Inc. v. Becton, Dickinson & Co., 649 F.3d 1276 (Fed. Cir. 2011) (en banc), this latest decision further raises the bar for proving inequitable conduct, confirming not only the need for clear and convincing evidence of the patentee’s specific intent to deceive, but also rejecting the notion that the requisite deceptive intent can be inferred from merely the patentee’s gross negligence.
Federal Circuit Eases Requirements for Proving Inducement Involving Joint Infringement: In a 6-5 en banc decision involving the cases of Akamai Tech. v. Limelight Networks and McKesson Technologies, Inc. v. Epic Systems Corp., the Federal Circuit has apparently loosened the standard for proving liability under the doctrine of induced infringement.
Under the Court’s prior decision in BMC Resources, Inc. v. Paymentech, L.P., 498 F.3d 1373 (Fed. Cir. 2007), proof of induced infringement of method claims required a single, direct infringer who performed all of the steps of the method claim. Neither of the cases before the Court in Akamai and McKesson included such a direct infringer. In Akamai, the defendant performed some of the steps of the claimed method and induced others to perform the remaining steps. In McKesson, the defendant induced multiple parties to “collectively perform” all the steps of the claimed method, i.e., no single party performed all of the required steps for direct infringement. Both defendants prevailed at the trial court level because there was no single, direct infringer.
However, upon reconsideration, the en banc Federal Circuit expressly overruled the requirement in BMC Resources of a single entity who performs all the claimed steps of the patent. As stated in the Akamai opinion (emphasis in original):
Requiring proof that there has been direct infringement as a predicate for induced infringement is not the same as requiring proof that a single party would be liable as a direct infringer. If a party has knowingly induced others to commit the acts necessary to infringe the plaintiff’s patent and those others commit those acts, there is no reason to immunize the inducer from liability for indirect infringement simply because the parties have structured their conduct so that no single defendant has committed all the acts necessary to give rise to liability for direct infringement.
In the view of a majority of Federal Circuit judges, a party who induces several others to infringe collectively, or a party who performs some steps of the claimed method and induces others to perform the remaining steps, “has had precisely the same impact on the patentee as a party who induces the same infringement by a single direct infringer.”
Going forward, plaintiffs may find it slightly easier to prove inducement even in the absence of a single direct infringer. All of the steps of the claimed method still need to be performed, but it is no longer necessary to show that a “single entity” performed them. Nevertheless, this ruling may have a minimal impact on the number of cases finding induced infringement because such a determination still requires that the accused infringer to have knowingly induced the infringement. Additionally, the Court also limited its opinion to infringement of method claims, thereby potentially further reducing its impact on the existing patent landscape.
January 2013: Securities Litigation Update
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Viability of Core Operations Doctrine Still Unsettled in Second Circuit: Securities fraud plaintiffs continue to attempt to plead scienter by invoking the “core operations” doctrine, which imputes to key company officers and directors knowledge of facts relating to the company’s “core” businesses. In the Second Circuit, the doctrine originates from Cosmas v. Hassett, 886 F.2d 8 (2d Cir. 1989), in which a company announced that sales to China would constitute a significant revenue source for the company, despite Chinese regulations preventing exactly those sales. The Second Circuit imputed knowledge of the regulations to the defendant directors, given that “the restrictions apparently eliminated a potentially significant source of income for the company.” Id. at 13.
The Second Circuit has not determined, however, what if any of this doctrine survived the passage of the PSLRA. See Frederick v. Mechel OAO, 2012 WL 1193724, at *2 (2d Cir. Apr. 11, 2012) (“Cosmas was decided prior to the enactment of the PSLRA, and we have not yet expressly addressed whether, and in what form, the ‘core operations’ doctrine survives as a viable theory of scienter.”). Nonetheless, New Orleans Employees Retirement Sys. v. Celestica, Inc., 2011 WL 6823204 (2d Cir. Dec. 29, 2011), decided late last year, explained in a footnote that “allegations of a company’s core operations . . . can provide supplemental support for allegations of scienter, even if they cannot establish scienter independently.” Id. at *2, n.3 (emphasis added). But the Court declined to address core-operations allegations because plaintiff had otherwise pleaded sufficiently that the CEO and CFO knowingly made false statements concerning the company’s inventory. Id. at *2. See also City of Pontiac Gen’l Employees’ Retirement System v. Lockheed Martin Corp., 2012 WL 2866425 (S.D.N.Y. July 13, 2012) (interpreting Celestica to suggest that the Second Circuit “endorsed the idea behind the core operations doctrine as enhancing, if not independently supporting, an inference of scienter.”).
Recent cases indicate that courts in the Southern District of New York may impute knowledge of the company’s financial statements to key officers and/or directors. In In re Longtop Financial Technologies Ltd. Securities Litigation, 2012 WL 2512280 (S.D.N.Y. June 29, 2012) (SHS), for instance, Judge Scheindlin found it appropriate to impute to the defendant CFO knowledge of “information [that] was available to [defendant] that would have made him aware of the falsity of the financial statements (which he signed) and his own oral and written statements.” Id. at *11. The allegations there related to specific filings or press releases, signed by the CFO, that contained false statements or were based upon false information. Id. at *4.
In Dobina v. Weatherford Int’l Ltd., 2012 WL 545148 (S.D.N.Y. Nov. 7, 2012), the Court explained that the doctrine imputes knowledge of a company’s false financial statements to senior officers “who should have known of facts relating to the core operations of their company that would have led them to the realization that the company’s financial statements were false when issued.” (quoting In re Atlas Worldwide Holdings, Inc. Secs. Litig., 324 F. Supp. 2d 474, 490 (SDNY 2004)). The Court also noted, however, that the doctrine’s post-PSLRA survival is an “open question,” id. at *11, and even assumed that the “tax rates” at issue were sufficiently important to the company’s financials to constitute “core operations.” Id. But the Court nonetheless declined to determine the doctrine’s viability, since a simple mistake in the company’s financials was the most plausible inference. See also Ho v. Duoyuan Global Water, Inc., 2012 WL 3647043, at *18 (S.D.N.Y. Aug. 24, 2012) (imputing knowledge of company’s financials to CEO and CFO, particularly where revenue and net income in an SEC filing was reported to be one-hundred times greater than what was reported in an SAIC filing).
Given the frequency with which securities class action plaintiffs rely on the core operations doctrine, courts will have ample future opportunities to consider the question of whether the doctrine survives the passage of the PSLRA which established a heightened pleading requirement for scienter. Even if so, the precise contours of the doctrine remain to be defined.
January 2013: European Litigation Update
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The European Court of Justice (ECJ) on European Supplementary Protection Certificate (SPC) for Further Medical Uses: With a remarkable ruling from July 2012 (Neurim Pharmaceuticals, C-130/11), the European Court of Justice (ECJ) substantiated its interpretation of the granting conditions for the European Supplementary Protection Certificate (SPC) for medicinal products by extending the scope of protection to usage patents. This judgment further liberalizes the SPC system and subsequently will stimulate investments of pharmaceutical or biotech companies researching on new medical uses of earlier marketed products.
General Background on the SPC: Subject to European regulations complemented by national legislation, e.g. by section 16a of the German Patent Act, the SPC generally allows for supplementary protection of patents for products depending on regulatory licensing. The SPC provides a maximum of an additional five years of protection to compensate the patent owner for the loss of time for effective use due to the period that elapses between the filing of an application for a patent for a new product and the authorization to place the product on the market. Within European legislation, the lack of effective protection has been considered to penalize research, potentially leading to a relocation of research centers situated in the Member States to countries that offer greater protection. In view of the purpose of promoting protection for research, the SPC so far has been introduced by European regulations for medicinal products and for plant protection products such as herbicides and insecticides. By virtue of the direct effect of European regulations, the granting conditions are thereby governed by European Law, being subject to the jurisdiction of the European Court of Justice (ECJ).
The Neurim Case: In the recent decision Neurim Pharmaceuticals, the ECJ inter alia had to substantiate its interpretation of Regulation (EC) No 469/2009 concerning the SPC for medicinal products. The referring UK court first and foremost was seeking clarification on the requirement pursuant to Article 3(d) of the Regulation that the marketing authorization referred to in the SPC application has to be the first authorization to market as a medicinal product.
The case concerned Neurim’s discovery that appropriate formulations of the natural hormone melatonin could be used as a medicine for insomnia. Based on a patent protecting a medical product for human use called “Circadin”, Neurim applied for a grant of an SPC. This application was rejected by the UK Intellectual Property Office as being contrary to Article 3(d) of the Regulation, since an earlier marketing authorization already had been granted for a medical use of melatonin with respect to regulating the seasonal breeding activity of sheep under the mark “Regulin”.
ECJ Ruling: The Court followed the opinion of the Advocate General and decided that the mere existence of an earlier marketing authorization obtained for a veterinary medicinal product does not preclude the grant of a SPC for a different application of the same product for which marketing authorization has been granted, provided that the application is within the limits of the protection conferred by the basic patent relied upon for the purposes of the application for the SPC. Furthermore, Article 13 (1), defining the duration of the SPC, equally must be interpreted as meaning that it refers to the marketing authorization of a product that comes within the limits of the protection conferred by the basic patent relied upon for the purposes of the SPC application.
The reasoning is formal and logical, as it is not only based on the wording and context of the Regulation, but also on its protective purpose, as the introduction of SPC was meant to foster research within the Member States, by preventing a relocation of research centers due to a lack of adequate protection. In these premises, the decision rightly broadens the application range of SPCs by including usage patents for new medical developments of earlier known medicinal products in the scope of supplementary protection.
Multi-Defendant Joinder Under the America Invents Act: Much Ado About Nothing?
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In September 2011, Congress passed the Leahy-Smith America Invents Act (“AIA”), which implemented a number of changes to the U.S. patent system. Notably, Congress took aim at a proliferation of patent infringement suits strategically directed to multiple unrelated defendants. In many of these cases, often the only fact common to the various defendants was that they were being sued for infringing the plaintiff’s patent. Prior to the passage of the AIA, joinder issues in patent infringement suits had been governed by Rule 20 of the Federal Rules of Civil Procedure, and a minority of jurisdictions (primarily, the Eastern District of Texas) had followed an interpretation of Rule 20 that allowed plaintiffs to successfully maintain multidefendant patent suits involving many unrelated defendants.
Section 299 of the AIA modified the standard for joinder in patent infringement suits. While actions filed prior to the AIA’s effective date remain governed by Rule 20, infringement suits filed after the AIA’s effective date are subject to the higher joinder standard provided by Section 299 of the AIA, codified at 35 U.S.C. § 299 (“Section 299”). Whereas previously some courts (again, primarily in the Eastern District of Texas) had blessed multidefendant patent suits where there were few or no common questions of fact amongst the defendants, Section 299 permits joinder only where the claims against the defendants arise out of “the same transaction, occurrence, or series of transactions, or occurrences relating to the making, using, importing into the United States, offering for sale, or selling of the same accused product or process” and “questions of fact common to all defendants or counterclaim defendants will arise in the action.” 35 U.S.C. § 299(a)(1)-(2) (emphasis added). Now, absent waiver, accused infringers may not be joined together “based solely on allegations that they each have infringed the patent or patents in suit.” Id. § 299(a)(2).
The AIA’s joinder provision marked a significant response to non-practicing entities, who had been the most conspicuous and prolific of plaintiffs filing the multidefendant suits targeted by Section 299. The legislative history makes it clear that non-practicing entities were, in fact, in the crosshairs. But while the Federal Circuit has not yet taken the opportunity to interpret the law, recent developments in the district courts suggest that Section 299 is not shaping up to be the panacea that Congress intended.
The Indefatigable MyMail Precedent
Prior to passage of the AIA, district courts typically applied Rule 20 of the Federal Rules of Civil Procedure to determine when permissive joinder was appropriate in a patent infringement suit. Rule 20 allows plaintiffs to join defendants if “(a) any right to relief is asserted against them jointly, severally, or in the alternative with respect to or arising out of the same transaction occurrence, or series of transactions or occurrences; and . . . (b) any question of law or fact common to all defendants will arise in the action.” Fed. R. Civ. P. 20 (emphasis added). Rule 20 appears to be, however, virtually identical to the patent-specific joinder requirements in Section 299. Indeed, commentators have observed that the plain language interpretation of Rule 20 is “substantively identical to the conditions set forth in section 299.” Chandran B. Iyer & Ryan M. Corbett, Joinder Limitations in the America Invents Act: Big Change?, ABA Intell. Prop. Lit. Comm., February 20, 2012, available at http://apps.americanbar.org/litigation/committees/intellectual/articles/winter2012-joinder-limitationsamerica-invents-act.html.
Query, then, why draft and pass Section 299? The legislative history reveals a surprisingly simple answer: some courts, principally in the patent-heavy Eastern District of Texas, were applying an alternative interpretation of Rule 20 that originated in MyMail, Ltd. v. AOL, Inc., 223 F.R.D. 455 (E.D. Tex. 2004) (Davis, J.). See 157 Cong. Rec. S5429 (daily ed. Sept. 8, 2011) (statement of Sen. Kyl) (observing that Section 299 “effectively codifies current law as it has been applied everywhere outside of the Eastern District of Texas”); see also Tracie L. Bryant, The America Invents Act: Slaying Trolls, Limiting Joinder, 25 Harv. J. L. & Tech. 673, 687-88 (2012) (collecting and discussing citations to Section 299’s legislative history).
In MyMail, the plaintiff sued eight parties for infringement of a patented method and apparatus for accessing a computer network by a roaming user. Some of the defendants moved to sever and transfer the claims against them, and argued that the claims against them failed to meet the “same transaction or occurrence” test of Rule 20. The court denied the motion, reasoning that the “same transaction or occurrence” test of Rule 20 was met as long as “there is some nucleus of operative facts or law.” MyMail, 223 F.R.D. at 456 (emphasis added). And because the same patent was asserted against all defendants, the court continued, joinder was appropriate because the plaintiff’s claims against the defendants involved the “legal question as to the. . . [asserted] patent’s scope.” Id. In effect, MyMail opened the door to the joinder of unrelated defendants where the claims shared only legal questions like claim construction and patent validity.
The MyMail interpretation of Rule 20 was faithfully followed by other courts in the Eastern District of Texas, a fact assiduously noted in the House Report on the AIA: “Section 299 legislatively abrogates the construction of Rule 20(a) [enumerated in five cases out of the Eastern District of Texas].” H. R. Rep. No. 112-98, at 55 n. 61.
Predictably, patent infringement defendants sued in the Eastern District of Texas chaffed under the MyMail rule. The MyMail rule often pitted non-practicing entities against a multitude of unrelated defendants, who found themselves burdened with problems that were, as one practitioner described, “anything but trivial.” Charles Gorenstein, America Invents Act Exercises “Con-Troll” Over Patent Litigation, Sept. 19, 2011, IPWatchdog.com, available at http://www.ipwatchdog.com/2011/09/19/con-troll-over-patent-litigation/id=19279.
For example, motions to transfer were often unsuccessful because the forced joinder of often disparate defendants amalgamated equally disparate concerns about efficiency and convenience, which in turn ensured that no other individual venue would likely be particularly convenient for all the parties. Id. Moreover, cooperation between codefendants was hampered by the fact that defendants often had “different accused products, differing business interests, and a host of other personal factors,” and were in fact sometimes direct business competitors who were (understandably) reluctant to share confidential information to coordinate a common defense. Id. And not least were the court-imposed constraints on the discovery phase, which sometimes limited depositions, discovery requests, and other motions practice such that defendants found themselves unable to adequately defend their individual interests. Id.
As Congress pointed out in drafting Section 299, supra, practically every other federal court in the country had rejected the MyMail rule. For example, one court observed that the MyMail rule in effect collapsed the two-element conjunctive test of Rule 20 into a mutated rule that required only common questions of law to permit joinder. Rudd v. Lux Prods. Corp. Emerson Climate Technologies Braeburn Sys., LLC, 2011 WL 148052, at *2 (N.D. Ill. Jan. 12, 2011) (agreeing that the MyMail rule “eviscerates the same transaction or occurrence requirement [of Rule 20] and makes it indistinguishable from the requirement that there be a common question of law or fact”). But because the Eastern District of Texas handled one of the heaviest patent dockets in the country, the MyMail rule wielded a disproportionately powerful effect on American patent litigation that persisted until Congress enacted the AIA.
Section 299: An Effective Weapon Against Trolls, or a Minor Adjustment to the Law?
Now that more than a year has passed since the AIA’s effective date, a handful of district courts have had the opportunity to analyze the heightened joinder standard in Section 299. If Congress’s goal was truly to adjust the balance of litigation bargaining power between patent trolls and their victims, the results appear mixed.
Unsurprisingly, plaintiffs have generally complied with the express requirements of Section 299. In the immediate aftermath of the AIA, many non-practicing entities “began to conform their practices: Instead of instituting one massive multidefendant infringement action, they would institute a multitude of separate but nearly identical patent infringement complaints against unrelated entities in the same court.” Macedo et al., AIA’s Impact On Multidefendant Patent Litigation: Part 2, Oct. 26, 2012, Law360.com, available at http://www.law360.com/ip/articles/387458/aia-s-impact-on-multidefendant-patent-litigation-part-2. And in cases involving unrelated patent infringement defendants, courts have applied Section 299 to sever improperly joined parties. For example, in Digitech Image Technologies, LLC v. Agfaphoto Holding GmbH, 2012 WL 4513805, at *1 (C.D. Cal. Oct. 1, 2012), a non-practicing entity sued 45 defendants for infringement of a patent teaching a device profile for use in a digital image processing system. Id. The defendants included retailers and manufacturers of various accused digital cameras. A single defendant brought a motion to sever for improper joinder under Section 299. Id. In response, plaintiff Digitech proffered arguments for joinder that the court deemed “creative” but ultimately rejected as meritless because the Digitech “essentially joined all Defendants in the known universe that make, import, sell, or offer to sell digital cameras that fall within the purview of the [asserted patent].” The court not only granted the movant’s motion to sever, it elected to sever and dismiss every other named defendant except for the first named defendant. Id.
Courts in the Eastern District of Texas have also evidently begun to apply Section 299 with some rigor. In Norman IP Holdings, LLC v. Lexmark Int’l, Inc., 2012 WL 3307942 (E.D. Tex. Aug. 10, 2012) (Davis, J.), the court dealt with a motion to sever defendants joined to the case after the AIA’s effective date. The complaint had been duly filed the day before the AIA came into effect, and had named two defendants as accused infringers. Over the next few months, plaintiff Norman IP Holdings subsequently added 23 additional defendants. Id. at *1. On motions to sever and transfer under Section 299 by 13 of the newly added defendants, the Norman court granted severance after acknowledging that “unrelated defendants in this case were improperly joined and should either be dismissed from the case or severed into their own cases.” Id. at *3. See also Phoenix Licensing, LLC v. Aetna, Inc., 2012 WL 3472973, at *2 (E.D. Tex. Aug. 15, 2012) (Gilstrap, J.) (determining one defendant improperly joined under Section 299 because only commonality between codefendants was “allegations of patent infringement”).
Pretrial Consolidation Under Federal Rule of Civil Procedure 42
Although courts appear to have faithfully followed the letter of the law in Section 299, it is a murkier question whether they have followed the spirit. While Section 299 clearly forbids one trial for codefendants who do not meet the heightened joinder standard, it does not speak to any phases of litigation other than trial. In Norman, the court severed the pertinent defendants into separate cases, but immediately ruled all “newly severed actions consolidated with the original filed case as to all issues, except venue, through pretrial only.” Norman, 2012 WL 3307942, at *4. Consolidation (under Fed. R. Civ. P. 42) was appropriate, the court reasoned, because separate discovery proceedings would “wast[e] judicial resources by requiring common issues to be addressed individually for each case.” Id.
Other courts in the Eastern District of Texas and in other jurisdictions have followed suit to consolidate separate actions involving unrelated defendants for pretrial proceedings. See, e.g., SoftView LLC v. Apple Inc., 2012 WL 3061027, at *11 (D. Del. Jul. 26, 2012) (consolidating newly-severed cases for all pre-trial purposes); C.R. Bard, Inc. v. Med. Components, Inc., 2012 WL 3060105, at *1-*2 (D. Utah Jul. 25, 2012) (same, and concluding that pre-trial consolidation is not “violative of the spirit of the AIA”); Rotatable Tech. LLC v. Nokia Inc., No. 2:12-cv-265 (E.D. Tex. filed May 1, 2012), ECF No. 60 (consolidating cases for pretrial purposes); Roy-G-Biv Corp. v. Abb Ltd., No. 6:11-cv-00622 (E.D. Tex. filed Nov. 15, 2011), ECF No. 51 (same).
Moreover, seeking pretrial centralization by the Multidistrict Litigation panel remains a viable option for plaintiffs who want to consolidate pretrial litigation against disparate defendants. See In re: Bear Creek Technologies, Inc., MDL 2344, 858 F. Supp. 2d 1375, 1377-78 (J.P.M.L. May 2, 2012) (concluding that Section 299 does not prohibit MDL coordination or consolidation for pretrial purposes).
At bottom, the federal courts’ “early run of pretrial consolidations suggests that pretrial life under the AIA for purposes of joinder may closely resemble the pretrial state of affairs before the AIA.” Macedo et al., supra. Under the current state of the law, patent plaintiffs (non-practicing entities and otherwise) should retain much of the tactical and strategic advantage that they held when they forced multiple unrelated defendants to jointly coordinate litigation, provided courts continue to follow the trend in consolidating pretrial litigation. Such a result seems problematic, and some observers have commented that consolidation may be an “end run” around Congressional purpose by, among other things, “reliev[ing] patent plaintiffs of the many financial impediments that Congress sought to impose on them.” Maya M. Eckstein et al., The (Unintended) Consequences of the AIA Joinder Provision § IV.D.i, AIPLA Spring Meeting, Austin, Tex., May 10-12, 2012, available at http://www.aipla.org/learningcenter/library/papers/SM/2012_Spring/Documents/2012SM-Materials/Eckstein_Paper.pdf.
The Road Ahead
To date, none of the patent cases filed under the AIA have reached trial. The courts have seen an uptick in “serially file[d] multiple single-defendant (or defendant group) cases involving the same underlying patents.” Norman, 2012 WL 3307942, at *4. Despite this fact, plaintiffs appear to have been reasonably successful in consolidating multiple cases for pretrial purposes. And open questions remain: for example, does pretrial consolidation circumvent Congress’s purpose and violate the spirit of Section 299? How should courts apply claim construction term limits to consolidated claim construction, where different defendants seek to construe completely different terms in different ways? If one defendant wins a summary judgment motion on non-infringement or other issues, how will it affect the other consolidated defendants? As the post-AIA suits proceed, the courts will certainly find opportunities to answer.
The English Court of Appeal Decision in Toshiba Carrier May Lead to More Private Antitrust Actions in England
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Introduction
A recent decision by the English Court of Appeal may lead to more private antitrust actions in England. This decision confirms that English courts have broad jurisdiction to maintain antitrust actions against UK defendants who are not addressees of European Commission (EC) cartel decisions. It also confirms that such UK defendants can be “anchor defendants” that establish jurisdiction over non-UK defendants who are associated with cartels.
The Use of “Anchor Defendants” in Antitrust Actions
In Europe, private antitrust claims are often brought against a defendant who was an addressee of an EC cartel decision. These “follow on” claims generally must be brought in the country where the defendant is domiciled. However, when multiple defendants are addressees of the EC cartel decision, claims may be brought in any country where one of the defendants is domiciled so long as the claims are sufficiently connected.
English courts have gone even further and established jurisdiction when private antitrust claims were brought against UK-domiciled subsidiaries of companies who were addressees of the EC’s cartel decision, even though the UK-domiciled subsidiaries were not subject to the EC decision. These UK-domiciled subsidiaries are often referred to as “anchor defendants.”
Toshiba Carrier Expands the Use of Anchor Defendants
The European Commission Action: In December 2003, the EC found three companies violated Article 81(1) of the EC Treaty for participating in a price-fixing and market-sharing cartel in the industrial copper tubes sector. The Commission found the three non-UK companies—Outokumpu Oyj of Finland, Wieland-Werke AG of Germany, and the KM Europa Metal group (KME Group) of Germany—liable for operating a secret cartel between May 1988 and March 2001 in the copper tube market. The three companies appealed the EC’s decision and their appeals were dismissed in May 2009.
The “Follow On” Action: In December 2009, Toshiba Carrier UK Limited and various associated companies (the claimants) brought a damages action before the High Court in England. These companies each bought substantial quantities of copper tubes, or goods incorporating such tubes, during the period of the cartel. They sought damages resulting from the infringements established in the EC’s decision.
The damages action was brought against three companies domiciled in the UK, including KME Yorkshire Limited, who were not named in the EC’s decision (the UK Defendants). The damages action was also brought against several companies who were the addressees of the EC’s decision but who were not domiciled in the UK (the non-UK Defendants). The UK Defendants sought orders striking out the claim against them on the ground that there was no reasonable ground for bringing it or alternatively summarily dismissing the claim on the ground that no claimant had a real prospect of succeeding on the claim against them.
In October 2011, the High Court denied the UK Defendants’ requests. The High Court found that the claimants’ pleadings sufficiently alleged that each of the UK Defendants was part of the undertaking and engaged in the same economic activity as the non-UK Defendants. The High Court also found that the pleadings sufficiently alleged that the activity undertaken by the non-UK Defendants infringed Article 101 of the TFEU and the UK Defendants implemented the unlawful arrangements. The non-UK Defendants also sought an order declaring that the courts of England and Wales did not have jurisdiction to try the claims against them, but that too was dismissed. The defendants appealed this decision to the Court of Appeal.
The Court of Appeal Decision: In September 2012, the English Court of Appeal affirmed the High Court’s decision. KME Yorkshire Ltd and others v. Toshiba Carrier UK Ltd and others [2012] EWCA Civ 1190. The Court of Appeal found that the claimants’ pleadings sufficiently alleged that the UK-domiciled subsidiary had participated in, and implemented, the cartel arrangements, with knowledge of the cartel agreement.
The main issue before the Court of Appeal was whether the High Court should have dismissed the action against the only remaining UK Defendant, KME Yorkshire Limited (KME UK). If the claim against KME UK was not dismissed, the parties agreed that the High Court would have jurisdiction over the non-UK defendants.
KME UK argued that an essential element of conduct that infringes Article 101 is a meeting of minds or concurrence of wills between rival parties to conduct themselves on the market in a specific way that gives rise to an unlawful agreement. On this basis, implementation of an unlawful anti-competitive agreement reached between others is not enough, even if the implementation is with knowledge of the agreement. KME UK claimed that the claimants’ pleadings did not contain an allegation against KME UK of that essential element.
The Court of Appeal did not accept KME UK’s arguments. The court noted that well-established case law holds that “concerted practices” which fall short of a complete agreement can constitute infringement of Article 101. Case 48-69 ICI v. Commission [1972] ECR 619. Further, even indirect and isolated instances of contact between competitors may be sufficient to infringe Article 101, if their object is to promote artificial conditions of competition in the market. Case C-49/92 P Commission v. Anic Partecipazioni SpA. [1999] ECR I-4125. The court also found that acts of implementation alone were capable of amounting to concerted practices where they are carried out pursuant to an anti-competitive agreement made between others and with knowledge of that agreement.
Under this legal backdrop, the Court of Appeal found that it was “perfectly clear” that the claimants’ allegations provided sufficient grounds for a cause of action against KME UK for infringement of Article 101 and a corresponding breach of statutory duty. The court also found that there were clear allegations of unlawful conduct by KME UK, including that it refrained from selling or offering certain products to customers to allow other members of the cartel to secure the business and/or that it exchanged confidential information with competitors in order to monitor and implement the cartel arrangements. These allegations presupposed knowledge of, and an intention to implement, the cartel agreement and concerted practices described in the Commission’s decision. They also amounted to a stand-alone claim for conducting concerted practices contrary to Article 101.
The Court of Appeal was also satisfied that KME UK’s knowledge was sufficiently pleaded to constitute a valid allegation of infringement of Article 101 by KME UK. In the particular circumstances of the present case, these allegations were sufficient to survive the defendants’ application to dismiss the claim and for summary judgment. The Court of Appeal also noted that anti-competitive cartels are by their very nature “shrouded in secrecy,” and therefore it is difficult until after disclosure to assess the strength of an allegation that a defendant was a party to or aware of anti-competitive conduct by members of the same corporate group.
Conclusion
This decision is a significant development likely to expand the ability of claimants to bring actions against UK defendants—as “anchor defendants”—and against non-UK defendants (addressees of cartel decisions) in the High Court. The Court of Appeal’s willingness to allow the Toshiba Carrier action to proceed will provide antitrust claimants with a higher degree of confidence that their claims will survive an early application to strike out or summary judgment and therefore encourage the filing of more private antitrust damages actions in England.
December 2012: Sports Litigation Update
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District Court Finds Appearance of Logo in Documentaries and Stadium Displays, but Not Video Games, to Be Fair Uses: A recent decision by Judge Marvin J. Garbis in the District Court of Maryland has provided further guidance as to when the use of an athletic team’s copyrighted logo may or may not be a fair use under the Copyright Act. Judge Garbis’s opinion confirms that the use of a team’s copyrighted logo for the purpose of offering commentary, criticism, or documentation of historical facts likely will be fair uses, while the use of a logo for its “nostalgia value” may not be sufficient.
When the Baltimore Ravens first moved to Baltimore in 1996, they adopted an inaugural logo (the “‘Flying B’ Logo”), used by the team for its 1996-1998 seasons. After the 1996 season completed, Frederick E. Bouchat filed a lawsuit alleging that the “Flying B” Logo infringed his own copyrighted drawing and seeking damages in the form of a percentage of profits of all merchandise sold bearing the logo. A jury found that the “Flying B” Logo infringed Bouchat’s drawing, but awarded Bouchat zero damages. In 2008, Bouchat filed another lawsuit, claiming that the NFL’s sales of Ravens highlight films from the 1996-1998 seasons (which necessarily included images of the “Flying B” Logo on the uniforms and the field) infringed his copyright. In a 2-1 decision, the Fourth Circuit found that the use of the logo in team highlight films was not a fair use because, in part, “[t]he simple act of filming the game in which the copyrighted work was displayed did not ‘add[] something new’ to the logo.” Bouchat v. Baltimore Ravens Ltd. P’ship, 619 F.3d 301, 309 (4th Cir. 2010) (quoting Campbell v. Acuff-Rose Music, Inc., 510 U.S. 569, 579 (1994)). However, in the same decision, the Fourth Circuit unanimously concluded that the use of the logo in a photographic display in the headquarters of the Ravens’ corporate office was fair because, in part, “[t]hese depictions of the logo are consistent with the fair use display of copyrighted material in a museum,” which “‘adds something new’ to its original purpose as a symbol identifying the Ravens.” Id. at 314 (quoting Campbell, 510 U.S. at 579).
In 2011 and 2012, Bouchat filed three more lawsuits: (1) one against the Ravens organization for its display of historical photographic displays in M&T Stadium (the Ravens’ home stadium) that included the “Flying B” Logo; (2) one against various NFL entities for its use of the “Flying B” Logo in its NFL Network documentary series Top Ten and Sound FX; and (3)
one against Electronic Arts for its use of the “Flying B” logo as one of many “throwback” uniform options in a series of Madden NFL video games. See Bouchat v. Baltimore Ravens Ltd. P’ship, 12-cv-1905 (D. Md.), Bouchat v. NFL Enterprises LLC, 12-cv-1495 (D. Md.); Bouchat v. NFL Properties LLC, 11-cv-2878 (D. Md.). The defendants in these three lawsuits filed motions for summary judgment, contending that all of the uses of the “Flying B” Logo at issue were fair uses under the Copyright Act, 17 U.S.C. § 107.
In an omnibus decision, Judge Garbis found that the use of the “Flying B” Logo in the Stadium photographs and in NFL Network programming were fair uses, while the use of the logo in EA’s Madden NFL games was not fair. See Bouchat v. NFL Enterprises LLC, 12-cv-1495, Doc. No. 33 (Decision Re: Fair Use Issues) (D. Md. Nov. 19, 2012). As to the Stadium historical displays, the Court found that the use of the “Flying B” Logo was transformative because, just as was the case with the display in the Ravens’ headquarters, it was used not for its expressive content, but rather for its factual content—i.e., “to represent the inaugural season and the team’s first draft picks.” Id. at 19 (quoting Bouchat, 619 F.3d at 314). As to the use of the “Flying B” Logo in the NFL Network documentaries, the Court determined that the logo was used “selectively as necessary to portray ‘history’ in biographical and comparative presentations,” and that the uses were “substantially transformative” because they “add[ed] something new by representing factual content, documenting and commenting on historical events, or functioning as a biography or career retrospective.” Id. at 25-26. The Court found that the transformative nature of the use of the logo in the Stadium displays and the documentaries offset any potential harm to the market for Bouchat’s drawing. Id. at 21, 27.
However, for the Madden NFL games, the Court found that the “Flying B” Logo was being used in the same manner as the Ravens used it in 1996-1998: as a symbol identifying the Ravens. Thus, according to the Court, the use of the logo in the games was not transformative. Further, the Court held that use of the “Flying B” Logo for “nostalgia value” did not render such a use transformative. Id. at 31. Finally, the Court noted that football teams play official games in throwback uniforms and that some NFL teams offer for sale replicas of throwback uniforms, evidencing the existence of a potential market to exploit the nostalgia value of past logos. Id. at 33-34. Weighing all four fair-use factors, the Court concluded that the use of the “Flying B” Logo in the Madden NFL games was not fair. Id. at 35.
While fair use is inherently a case-by-case inquiry, Judge Garbis’s decision demonstrates the centrality of the “transformative” inquiry in fair use determinations. If a work is used to communicate factual content or comment on historical events, it will likely be a transformative use and be adjudged a fair one. However, a work used only to communicate “nostalgia,” without anything more, may not be seen as a fair use. Nostalgic uses, like other uses, must add “something new” to the original in order to communicate a historical or other perspective, rather than simply evoke emotion already embedded in the copyrighted work, in order to be adjudged fair.
Quinn Emanuel represented defendants NFL Enterprises LLC, NFL Network Services, Inc. & NFL Productions LLC d/b/a NFL Films in Bouchat v. NFL Enterprises LLC, MJG-12-1495 (D. Md.); Baltimore Ravens Limited Partnership in Bouchat v. Baltimore Ravens Limited Partnership, MJG-12-1905 (D. Md.); and NFL Properties LLC in Bouchat v. NFL Properties LLC, 11-cv-2878 (D. Md.).
December 2012: Insurance Litigation Update
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Exhaustion Means Exhaustion: Courts Require Complete Exhaustion for Excess Coverage: The idea behind excess insurance is easy to understand—an excess policy provides additional coverage above the limits of the underlying, or primary policy. While excess policies generally require primary coverage to be fully exhausted before any claim can be made, insureds and third-party claimants often attempt to access excess coverage prematurely, either through settlements with primary (or lower-tier excess) carriers, or through other creative strategies. In 2012, courts have continued to reject those strategies as disregarding the plain language of the excess policies, finding the requirement of underlying exhaustion to be a condition precedent to coverage.
In Goodyear Tire & Rubber Co. v. Nat’l Union Fire Insurance Company of Pittsburgh, PA, 694 F.3d 781 (6th Cir. 2012), the Sixth Circuit held that Goodyear’s excess insurer (Federal) did not owe Goodyear any coverage under an excess policy because the primary insurer (National Union) had settled for less than its full limits—even though the total loss was greater than the full amount of the underlying limits. Goodyear incurred $30 million in costs it claimed were covered, and had a $15 million policy from National Union and a $10 million policy from Federal, with a single, $5 million deductible. Id. Although National Union disputed that the losses were covered, it settled for $10 million. Id. The district court granted summary judgment to Federal, and the Sixth Circuit affirmed on the plain language of the policy that provided “[c]overage hereunder shall attach only after [National Union] shall have paid in legal currency the full amount of the Underlying Limit.” Id. The Sixth Circuit refused to accept any “public policy favoring settlement” as abrogating the policy language, id. at 783, having already noted its view that the appeal was “the latest in a series of recent cases in which one corporation asks us to disregard the plain terms of its insurance agreement with another corporation.” Id. at 782.
Likewise in JP Morgan Chase & Co. v. Indian Harbor Ins. Co., 98 A.D. 3d 18 (1st Dep’t 2012), New York’s Appellate Division, 1st Department (applying Illinois law), held that where the insured had a multi-layer excess insurance structure, the carriers in the higher layers had no duty to indemnify the insured because of the mechanics of the insured’s settlement with other, lower layer carriers. Finding a condition precedent to payment similar to the one in Goodyear, the First Department held that no liability could attach to the fourth excess policy because the third excess layer carrier “did not admit liability when it settled with plaintiff” and in fact had also settled an unrelated claim made by the same insured against another insurer affiliated with the third excess layer carrier, with no allocation to the specific claim at issue. Id. at 20-21. Since the insured could not demonstrate that the underlying insurers had “duly admitted liability and [had] paid the full amount of their respective liability,” it could not recover. Id. Making similar findings for higher-tier carriers, the First Department expressly rejected the notion that a lower layer policy can be deemed exhausted if the insured is willing to absorb the difference in settlement. Id. at 22-23.
Lastly, in Preferred Construction, Inc., v. Illinois Nat. Ins. Co, No. 11-4339-cv, 2012 WL 3735056 (2d. Cir. Aug. 30, 2012), the Second Circuit held that an excess carrier could not be called to defend an insured where the primary carrier’s policy had not exhausted, even though the underlying claim only sought “any recovery that [the underlying plaintiff] may obtain in excess of the primary policy limits.” In Preferred Construction, the excess policy contained a requirement that it did not attach until “the total applicable limits of Scheduled Underlying Insurance have been exhausted.” Id. at *2. The Second Circuit rejected plaintiff’s argument that the policy was triggered because the “complaint seeks only damages above the ‘applicable limits’ of the underlying coverage” as “miss[ing] the mark, however, because even if … the claim is one for damages above the ‘applicable limits,’ exhaustion is still a condition precedent to triggering [the excess policy], and that condition has not been met.” Id. at *3.
December 2012: ITC Update
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ITC Proposes Modifications to E-Discovery Practices in Section 337 Investigations: This fall, the U.S. International Trade Commission (Commission) proposed changes to its rules governing discovery in Section 337 investigations. The main thrust of these proposed changes is to place limitations on discovery of electronically stored information (e-discovery) “to increase the efficiency” of Section 337 investigations. See 77 Fed. Reg. 60953-56 (Oct. 5, 2012). The current rules lack many of the limitations found in district court litigation regarding e-discovery, which has made discovery in Section 337 investigations unnecessarily broad and expensive—particularly when paired with the Commission Administrative Law Judges’ historically permissive attitude toward broad discovery. The Commission proposed the changes, in part, in response to comments made by practitioners at an event in July 2011. In presenting these proposed changes, the Commission considered the e-discovery standards of a variety of district courts, a model e-discovery order prepared by the Federal Circuit Advisory Council, as well as ground rules issued by the Commission’s ALJs, and the Federal Rules of Civil Procedure.
The proposed changes relate to Commission Rule 210.27, which contains general provisions governing discovery. Proposed subsection (c) is similar to Federal Rule of Civil Procedure 26(b)(2)(B) and allows a party to refuse production of electronic documents and information from sources that are not reasonably accessible. If a party can show that the requested documents and/or information is not reasonably accessible because of undue burden or cost, the presiding ALJ then determines whether the requesting party has shown good cause for the production of the requested materials. If the requesting party does not meet this burden, the ALJ can deny the discovery request or specify conditions for the discovery. New subsection (c) specifically provides the ALJ with the option of conditioning requiring the requesting party to pay for costs associated with the discovery of information from sources that are not reasonably accessible. By allowing for cost shifting, the Commission is attempting to address the current status quo where parties to Section 337 proceedings may be required to produce millions of documents even though few are actually allowed into the evidentiary record.
Proposed subsection (d) requires the ALJ to impose limitations if he determines that: “the discovery sought is duplicative or can be obtained from a less burdensome source; the party seeking discovery has had ample opportunity to obtain the information; or the burden of the proposed discovery outweighs its likely benefit.” 77 Fed. Reg. 60954. This proposed rule is similar to Federal Rule of Civil Procedure 26(b)(2)(C). Unlike the Federal Rules of Civil Procedure, however, subsection (d) requires the ALJ to limit discovery when the party from whom discovery is sought has stipulated to facts or waived the legal position to which the discovery pertains—which occurs frequently in Section 337 proceedings. Additionally, this proposed addition requires the ALJ to consider the importance of the discovery requested to resolving issues decided by the Commission.
Proposed subsection (e) clarifies questions of waiver pertaining to privileged information and attorney work product. It also sets forth uniform procedures for privilege logs, an area that is currently governed by the ground rules of the presiding ALJ in each investigation. Subsection (e) also attempts to clear up the uncertainty surrounding the consequences of disclosure of privileged or work product documents by setting forth clear procedures for dealing with such disclosures, similar to the procedure set forth in Federal Rule of Civil Procedure 26(b)(5). It also sets forth specific deadlines for resolving privilege disputes in line with the rapid pace of Section 337 investigations. Commission ALJs currently vary in their treatment of waiver, even when the parties privately agree to a claw-back agreement.
The Commission issued its Notice of Proposed Rulemaking on October 5, 2012, and will accept public comments on the revisions through December 4, 2012. The rules will not become effective until after the Commission has an opportunity to review public comments and publishes final amendments to the rules at least thirty days prior to their effective date.
Predictive Coding Comes of Age
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So-called “predictive coding”—using a small number of manually-coded documents to analyze and predict appropriate coding for a much larger set of documents —has become a hot topic in e-discovery. This past year brought the first reported judicial decisions explicitly authorizing the practice. 2012 also saw some of the first disputes concerning the appropriate methodologies for this technique.
In coming years, the use of predictive coding will continue to grow as litigants seek to limit discovery costs. Judges may also continue to endorse the practice, even incorporating it into model e-discovery orders. But early adopters should proceed with caution; the practice is likely to generate many disputes as acceptable methodologies and best practices are established.
The Evolution of Computer-Assisted Document Review
As companies have moved away from paper file systems and toward electronically stored information (ESI), the number of documents that must be collected and reviewed in civil litigation has skyrocketed. A number of technologies have been used to handle this explosion in discoverable information. Predictive coding is the latest technical evolution for reviewing and producing large data sets.
Manual Review: Not long ago, manual, linear, “eyes-on-the-page” analysis was the predominant method of document review. The process started with collecting documents that were potentially responsive to formal requests for production. The data collections, especially in complex civil litigation, often contained millions of pages. A small army of junior associates, contract attorneys, and even paralegals would then mobilize to manually review the documents for responsiveness, privilege, and confidentiality.
Although many still consider manual review to be the “gold standard,” it is rife with performance and quality shortcomings. Analysts estimate that when operating at a maximum review speed of about 100 documents per hour, a decision on relevance, responsiveness, privilege, or confidentiality would need to be made in an average of 36 seconds. See Nicholas M. Pace and Laura Zakaras, Where the Money Goes; Understanding Litigant Expenditures for Producing Electronic Discovery (RAND Corporation 2012) (hereafter “Pace & Zakaras”). As a result, the document review in a large case could take thousands of man-hours. This significant expenditure of time and money does not come with a guarantee of accuracy; studies suggest that up to 95% of reviewer disagreement is the result of human error and not simply close questions of relevance. See Maura R. Grossman & Gordon v. Cormack, Inconsistent Assessment of Responsiveness in E-Discovery: Difference of Opinion or Human Error? 9 (ICAIL 2011 / DESI IV: Workshop on Setting Standards for Searching Elec. Stored Info. in Discovery, Research Paper).
Keyword Search: Keyword searching is a rudimentary form of computer assistance that narrows the scope and number of documents for further manual review. In a typical keyword search, the producing party runs a set of keywords against emails and other electronic documents to identify a smaller set of documents to be manually reviewed for responsiveness. Typically, multiple keywords and Boolean relationships among them can be utilized. Keyword searching offers performance improvements over manual searching, and is highly common in modern e-discovery. Courts have explicitly endorsed the practice and have even incorporated keyword restrictions and search terms into model orders for e-discovery. See, e.g., Federal Circuit’s Model E-Discovery Order for Patent Cases, available online at www.cafc.uscourts.gov/images/stories/announcements/Ediscovery_Model_Order.pdf (proposing that email productions occur using “five search terms per custodian”).
Yet keyword searching is also rife with shortcomings. Keyword searches are frequently overinclusive and underinclusive; search terms fail to capture many relevant documents, while simultaneously generating many false positives. When search terms turn out to be more common than expected in a document set, keyword searching will return a high number of documents that contain the keyword but have no possible relevance to the case—forcing the producing party to use expensive manual review to find truly relevant documents. A poorly chosen keyword often returns more “junk” than responsive documents. For that reason, great care must be taken by the producing party to identify appropriate keywords, often with the assistance of the document custodians themselves. Creativity must be employed to ensure that common synonyms, misspellings, acronyms, and abbreviations are included and keywords likely to generate false positives are excluded.
Predictive Coding: Predictive coding is the latest evolution of computer-assisted document searching. As with manual and keyword searching, the process begins by collecting a corpus of potentially responsive documents from the client. Next, attorneys review a small set of randomly selected documents to identify a “seed set” of documents that are clearly fitting, or not fitting, the desired document categories. Then, the predictive coding software uses the “seed” documents to create a template to use when screening new documents. Some systems produce a simple yes/no, while others assign a score (for example, on a 0 to 100 basis) relating to responsiveness or privilege. Attorneys then audit the identified documents to validate their relevance, responsiveness, or privilege. The computer uses the attorneys’ audit results to modify its search algorithm. The search algorithm is repeatedly audited and rerun until the system’s predictions and the reviewer’s audits sufficiently coincide. Typically, the senior lawyer (or team) needs to review only a few thousand documents to train the computer, at which point the system has learned enough to make confident predictions on a much larger data set—relevance of millions of documents.
Once a predictive model is generated, there are several ways the review might proceed. In the context of a review for relevance and responsiveness, one option might be to assume that all documents with scores above a particular threshold can be classified safely as responsive, while all those with scores below a particular threshold can be safely classified as not responsive. Only those documents with scores in the middle would require eyes-on review. Another option would be to perform eyes-on review of only those documents exceeding a particular score in order to confirm the application’s decisions, while dropping the remainder from all further work. Foregoing all manual review altogether is also a possibility, though likely not advisable, given the potential for unexpected error. As these examples illustrate, the umbrella term “predictive coding” can be used to describe a number of different ways that predictions are used and applied. The individuals supervising the review must pick appropriate cut-off points and use their best judgment as to whether and how humans will review and refine codes that are automatically applied.
Used carefully, predictive coding has the potential to offer significant performance and cost benefits, without compromising accuracy. Litigants are already touting the cost-saving potential; some defendants have claimed predictive coding would reduce time for production and review from ten man-years to less than two man-weeks, and would cost roughly 1% of the cost of human review. See Global Aerospace, Inc. v. Landow Aviation, 2012 WL 1431215 (Cir. Ct. Loudoun Cty. Va. 2012). As to accuracy, predictive coding has not been shown to be any less accurate than traditional manual review. (Pace & Zakaras, pp. 61-66.) Some studies suggest that predictive coding identifies at least as many documents of interest as traditional eyes-on review, with about the same level of inconsistency, and may in fact offer more accurate review for responsiveness than most manual reviews. (Pace & Zakaras, p. xviii) Actual cost savings will depend on a number of factors, including the size of the document set, challenges to the predictive coding methodology, and the document review methodology against which predictive coding is compared—but used in the right circumstances, the cost-saving potential of predictive coding is obvious.
Recent Decisions
While keyword searching has been the most frequently used choice of computer-assisted document review and searching, a small handful of recent cases have considered the use of predictive coding. As courts become more familiar with the practice, some are explicitly endorsing and recommending the practice.
Global Aerospace may be the first case actually ordering the use of predictive coding. Global Aerospace, Inc. v. Landow Aviation, 2012 WL 1431215 (Cir. Ct. Loudoun Cty. Va. 2012). The defendants argued that, with more than 2 million documents to review, it would take reviewers more than 20,000 hours to perform the task—10 man-years of billable time. 2012 Global Aerospace, Inc. v. Landow Aviation, 2012 WL 1419842 (Va. Cir. Ct. April 9, 2012). But with predictive coding, it would take less than two weeks at a cost of roughly 1/100 that of manual, human-review. Id. Having heard arguments, the Court ordered that Defendants could proceed with the use of predictive coding for processing and production of ESI. Global Aerospace, Inc. v. Landow Aviation, 2012 WL 1431215 (Va. Cir. Ct. April 23, 2012).
Global Aerospace stopped short of an unqualified approval of predictive coding. For example, predictive coding cannot work effectively if a representative corpus is not used for the initial training. The Global Aerospace court noted that the receiving party was free to challenge the completeness of the contents of the production and the manner in which predictive coding was used for new documents. Id.
In Moore v. Publicis, perhaps the most significant judicial decision on predictive coding to date, the Southern District of New York (Magistrate Judge Peck) held that “computer-assisted review is an acceptable way to search for relevant ESI in appropriate cases.” Moore v. Publicis Groupe, 2012 U.S. Dist. LEXIS 23350, 2012 WL 607412 (S.D.N.Y. 2012). The Court reasoned that computer-assisted review complied with the doctrine of proportionality of Federal Rule of Civil Procedure 26(b)(2)(C), and that predictive coding was an acceptable form of computer-assisted review. Id. at *12 (“…computer-assisted review is an available tool and should be seriously considered for use in large-data-volume cases where it may save the producing party (or both parties) significant amounts of legal fees in document review.”)
As courts have endorsed the voluntary use of predictive coding, parties have also sought to compel their adversaries to use the technique. In Kleen Products, Defendants sought to use keyword search-term processing, in which they had already invested much time and effort; but Plaintiffs moved to compel the use of predictive coding, arguing that keyword search methods were inadequate and flawed. Kleen Products, LLC v. Packaging Corp. of America, No. 10-C5711, Dkt. 412 (N.D. Ill. Sept. 28, 2012). The Court held evidentiary hearings in February and March 2012, during which it urged the parties to reach a compromise—for example, adopting Defendants’ keyword-based approach, but refining or supplementing terms and review procedures to meet Plaintiffs’ concerns. Ultimately, the parties reached agreement before a ruling on the motion to compel was reached. But Kleen illustrates that disputes over keyword search-terms may extend far beyond the sufficiency of specific terms going forward. Parties may challenge the notion of keyword searching itself—perhaps using the availability of predictive coding as leverage to obtain significant concessions on proposed keywords.
A recent case management order in In re: Actos provides further insight into the predictive coding processes that parties are likely to agree to and courts to sanction. In re: Actos (Pioglitazone) Products Liability Litigation, MDL No. 6:11-md-2299, Dkt. 1539 (W.D. La. July 27, 2012). The agreed-upon order in Actos allows each side to nominate three reviewers to work collaboratively to code the seed set of documents. The extremely detailed protocol contains numerous levels of sampling and review, as well as meet-and-confer check points throughout the procedure, including regarding the relevance threshold that would trigger manual review by the producing party.
Predictive Coding Done with Care
Litigants interested in utilizing predictive coding should keep several principles from these cases in mind. First and foremost, the producing party should attempt to gain the receiving party’s consent to use of predictive coding. The greater transparency offered into the procedure, the less likely that the receiving party will successfully move to compel an alternative document production methodology later in the case. An agreement regarding the basic methodology and the custodians from whom documents will be collected is recommended. Moreover, using jointly-appointed reviewers for the document training set may ease concerns with the process.
Second, the producing party should negotiate a “claw-back provision” that will allow recovery of documents that are improperly produced as a result of the predictive coding methodology. These could include documents that are irrelevant, privileged, or that should be, but were not, marked as confidential under a protective order. Such a provision is especially important if any portion of the documents marked responsive by the predictive coding methodology will not be manually reviewed.
Third, great care should be taken in preparing the initial “seed set” of documents that will be used to program the predictive coding algorithm. If the producing party does not actually involve the receiving party in the selection of the seed set, the producing party should be prepared to disclose the entire seed set to the receiving party and the court, which may raise work-product protection concerns. It is also important that the persons reviewing the initial seed set have a strong grasp of the issues in the case. Because of the importance of the initial seed set, it is critical that persons reviewing the seed set make accurate decisions; any errors in the seed set will become systemic throughout the larger review.
Fourth, the producing party should consider whether it is appropriate to use different seed sets for different custodians. For example, in a patent case, responsive documents that are held by an engineer may look very different than responsive documents held by an employee in the marketing or finance departments.
Fifth, the producing party should work closely with its e-vendor to ensure that the methodology is statistically justifiable. This includes ensuring that the documents from which the seed set is drawn is random, that the seed set is sufficiently large, and that the confidence interval and confidence level are either agreed upon between the parties or statistically justifiable.
Potential Stumbling Blocks and Pitfalls of Predictive Coding
Litigants planning to use predictive coding should be aware of potential pitfalls that could render the practice either more costly or inappropriate than manual review or keyword-driven review. For example, predictive coding may be inappropriate in a case that does not involve a sufficiently large body of documents. If the receiving party is dissatisfied with the results of the predictive coding, the producing party may face a motion to compel a more traditional document review methodology—thereby eliminating any cost savings. The danger of such a motion is especially high now, when predictive coding is in its earliest stages and best practices have not yet been developed. Where the corpus of documents contains highly sensitive information, a full manual review of any documents automatically selected for production may also be required to reduce the likelihood of damaging disclosure. This may entail significantly greater expense than keyword-driven reviews. Finally, predictive coding is not presently suitable for files that are not primarily text-based, such as video or audio files, necessitating the continued manual review of those materials.
Conclusion
As the amount of electronically stored information held by companies continues to grow at an exponential pace, widespread dissatisfaction with traditional manual and keyword review will likely lead to even greater use of predictive coding in 2013. This transition will offer cost savings for some, and headaches for others. As predictive coding grows, so too will litigation concerning predictive coding’s appropriate use and methodology. But the potential for significant cost savings is undeniable for large-scale reviews. Cost-conscious litigants in document-intensive cases would be wise to consider predictive coding as one tool to reign in growing e-discovery costs.
November 2012: Copyright Litigation Update
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European Court Holds Computer Programming Languages and Functionality Unprotectable: The European Court of Justice in Luxembourg recently held in SAS Institute Inc. v. World Programming Ltd., No. C-406/10 (May 2, 2012) that under the laws of the European Union, the functionality of computer programs and computer programming languages is not subject to copyright protection. SAS developed a scripting language and application for its Base SAS database program to extract data. Using commercially available SAS products, the defendant developed software capable of running scripts written in that language. The Court of Justice held that this was not copyright infringement: the European software copyright directive excludes from protection “ideas and principles which underlie any element of a computer program, including those which underlie its interfaces,” and Defendant’s effort to replicate the functionality of a computer program or the use of a programming language, did not infringe a form of protected expression.
This decision has received international attention, reflecting widespread desire for harmonization of copyright laws for protection of computer software. For example, in Oracle America, Inc. v. Google Inc., No. C 10-03561 WHA (N.D. Cal. May 31, 2012), the Northern District of California asked the parties to brief the European Court of Justice’s SAS Institute decision before ruling that the structure, sequence and organization of a Java Application Programming Interface (“API”) were not subject to copyright protection. After Oracle acquired Sun Microsystems, which owned Java-related copyrights and patents, Oracle sued Google alleging patent and copyright infringement by the Android platform. In ruling for Google, Judge Alsup held that as long as “the specific code used to implement a method is different, anyone is free under the Copyright Act to write his or her own code to carry out exactly the same function or specification of any methods used in the Java API.” Further, it was irrelevant that Google had not chosen to use different method header lines and class names: “copyright protection never extends to names or short phrases as a matter of law.” Finally, the Court expressed its view that when the principles underlying patent law and copyright law clash, the patent laws should prevail; thus, even if the structure, sequence and organization of the API were the product of creative endeavor—and arguably entitled to copyright protection—providing copyright protection to these allegedly patented APIs would defeat the 20-year limitation on patent claims.
November 2012: Bankruptcy Litigation Update
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Jefferson County Section 928 Decision: In a matter of first impression and potential importance in the municipal bond market, the Bankruptcy Court for the Northern District of Alabama held in Bank of New York Mellon v. Jefferson County, Alabama, 474 B.R. 725, 763-64 (Bankr. N.D. Ala. 2012), that where a trust indenture provides sufficient funding for operating expenses, the “minimal standard” of “necessary operating expenses” imposed by Bankruptcy Code section 928(b) is inapplicable. Section 928(b) provides that “[a]ny [ ] lien on special revenues, other than municipal betterment assessments, derived from a project or system shall be subject to the necessary operating expenses of such project or system, as the case may be.” 11 U.S.C. § 928(b). The Bankruptcy Court rejected Jefferson County’s contention that section 928(b) overrode the provisions of the parties’ trust indenture and permitted it to characterize depreciation, amortization, capital expenditures, reserves for any of the same, or reserves for professional fees and expenses, as operating expenses that it could deduct prior to funding debt service. The Bankruptcy Court agreed with the plaintiffs that “a pledge of special revenues [is] unaffected unless it is at odds with the policies incorporated in 928.” Id. at 756. It found that “unbridled inclusion of costs that under generally accepted accounting principles are capitalized, whether in the context of a gross revenue or a net revenue pledge, is capable of undoing what the 1988 Amendments were designed to [achieve],” i.e., the post-petition preservation of special revenue liens, protecting the benefits of parties’ bargains, and ensuring continued municipal access to capital markets. Id. at 760-61. Finally, the Bankruptcy Court concluded that the parties’ “mutual exercise of business judgment ... incorporated into a special revenue financing transaction [ ] should not be second guessed in a municipal bankruptcy absent clear evidence of an unreasonable exercise or that it is a certainty that 928(b) is not met. In other words, for pledges that are not gross revenues, a court should defer to the agreed pledge and distributive design representing the business judgments of the parties that is expressed in the contract between them.” Id. at 763.
CIT Section 510(b) Decision: The Second Circuit recently held that mandatory subordination under section 510(b) of the Bankruptcy Code must be interpreted narrowly in accordance with its underlying purpose. In re CIT Group Inc., 2012 WL 3854887, at *2 (2d Cir. Sept. 6, 2012). The underlying Bankruptcy Court (In re CIT Group Inc., 460 B.R. 633 (Bankr. S.D.N.Y. 2011)) had clarified the scope of section 510(b), which requires the subordination of a claim “arising from rescission of a purchase or sale of a security of the debtor or of an affiliate of the debtor, [or] for damages arising from the purchase or sale of such a security . . . .” The debtor and its former parent, in connection with the debtor’s pre-petition initial public offering, had entered into a tax sharing agreement whereby the debtor agreed to pay its former parent any tax benefits resulting from the debtor’s use of certain net operating losses (the “NOLs”). The Bankruptcy Court rejected the debtor’s attempt to subordinate the former parent’s claim, which arose from the debtor’s rejection of the tax sharing agreement, concluding that Congress had enacted section 510(b) to prevent equity claims in bankruptcy from being disguised as higher-priority creditor claims. The court reasoned that subordination is appropriate only if the claimant “‘(1) took on the risk and return expectations of a shareholder, rather than a creditor, or (2) seeks to recover a contribution to the equity pool presumably relied upon by creditors in deciding whether to extend credit to the debtor.’” Id. at 638 (citation omitted). Tax sharing agreements generally create only contractual debtor-creditor relationships. Even though the debtor’s ability to use the NOLs depends upon its future revenues, the former parent does not have an interest in the debtor’s future equity value, and thus has no expectation of sharing in the debtor’s profits without limitation. Thus, the court concluded, and the Second Circuit has now affirmed, subordination is not warranted.
Sentinel Fraudulent Transfer Decision: In In re Sentinel Management Group, the Seventh Circuit affirmed that a debtor’s repayment of debt owed to creditors with funds taken from the debtor’s own customers’ accounts was not made with an intent to hinder, delay, or defraud the customers (who became creditors of the debtor by virtue of this comingling of funds) and thus was not an intentional fraudulent conveyance under section 548(a)(1)(A) of the Bankruptcy Code. 689 F.3d 855, 861-64 (7th Cir. 2012). The Sentinel Court explained that “fraudulent conveyance law exists for very different purposes that does not include attempts to choose among creditors as contrasted with restitution and preferences.” Id. at 862-63. Based on this principle, the Court held that the debtor’s “preference of one of set of creditors . . . to another . . . is properly reserved for [the plaintiff]’s preferential transfer claims[.]” Id. at 863. The Court further stated that “a debtor’s ‘genuine belief that’ he could repay all his debts if only he could ‘weather a financial storm’ won’t ‘clothe him with a privilege to build up obstructions’ against his creditors . . . but that does not mean that actions taken to survive a financial storm require a legal finding that the debtor intended to hinder, delay, or defraud[.]” Id. (quoting Shapiro v. Wilgus, 287 U.S. 348, 354 (1932)).
November 2012: Class Action Litigation Update
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Defending False Advertising Claims: If you thought a false advertising lawsuit based on ads that cats “like” or “choose” one brand of kitty litter over another was going too far, you were not alone. Judge Samuel Conti of the Northern District of California recently dismissed that aspect of a class action against Clorox, pointing out what seems perfectly obvious: that no reasonable consumer could be deceived by depictions of cats appearing to “choose” one litter box over another and that such statements are “puffery.” See In re Clorox Consumer Litigation, 12-00280, 2012 WL 3642263 (N. D. Cal. Aug. 24, 2012). It is still safe to show our furry friends engaging in human-like behavior without fear of being sued by someone who thinks it should be taken literally.
The Clorox case, which moves forward on other claims, is one of the scores of new false advertising lawsuits that have become the suit du jour in the class action world. Every label, print, internet, and TV ad is being carefully scrutinized for any transgression from 100% accuracy, no matter how obvious it is that the license taken with a claim is poetic. Even where the plaintiffs concede product ingredient levels and nutritional information are accurately disclosed on the label, they have still launched class actions—and gotten past the pleading stage—by contending consumers should not be expected to read labels provided for their benefit. Indeed, because consumer protection claims are broad in their coverage and claims of violations are fact-intensive, it is difficult to dismiss even seemingly frivolous cases with an early motion. But there are defenses that have had some measure of success and merit considering in the proper case.
First, if the claim is pled generally in a Federal Court complaint, it may be possible to argue it should be considered a fraud claim, subject to Fed. R. Civ. P. 9(b), requiring plaintiff to plead the “who, what, when, where, and how” of the charged misconduct. Federal Courts have required state-law consumer claims to be pled with particularity, including the commonly-asserted trio in California of the Unfair Competition Law (UCL), the Consumer Legal Remedies Act (CLRA), and the False Advertising Law (FAL). See Yumul v. Smart Balance, Inc., 733 F. Supp. 2d 1117, 1122 (C.D. Cal. 2010). This rule will rarely lead to dismissal with prejudice, but it is always worthwhile to know from the start what specific facts plaintiffs believe support their claim.
Second, and potentially more powerful, is a preemption defense, particularly for claims involving federally-regulated labels. This could include FDA-regulated packaging for foods and nonalcoholic beverages, see, e.g., Chacanaca v. Quaker Oats Co., 752 F. Supp. 2d 1111, 1116 (N.D. Cal. 2010), as well as USDA-regulated labeling of meat, poultry, and liquid egg products. For example, The 2012 Nutrition Labeling and Educational Act (“NLEA”), 104 Stat. 2353, 21 U.S.C. §§ 341, et. seq. (2012), requires certain nutritional and ingredient information to be disclosed on the labels of nearly all FDA-regulated food items. Peviani v. Hostess Brands, Inc., 750 F. Supp. 2d 1111, 1118 (C.D. Cal. 2010). The Act expressly prohibits States from imposing “any requirement respecting any claim of the type described in section 343(r)(l) of this title made in the label or labeling of food that is not identical to the requirement of Section 343(r) of this title.” 21 U.S.C. §§ 343-1(a); see also Yumul v. Smart Balance, Inc., No. 10-00927, 2011 WL 1045555 (C.D. Cal. Mar. 14, 2011) (finding more restrictive “no cholesterol” labels required by California law preempted by the NLEA); Chacanaca, 752 F. Supp. 2d at 1116-17 (finding consumers’ action to prohibit “0 grams trans fat” labeling preempted by NLEA).
In California, in particular, many UCL/FAL/CLRA claims against food and drink manufacturers have been held preempted by federal labeling requirements under the NLEA when plaintiffs seek to impose a burden on food manufacturers that is not identical to what the NLEA requires. See Charles Hairston v. South Beach Beverage Co., Inc., No. 12-1429, 2012 WL 1893818 (C.D. Cal. May 18, 2012) (finding preemption of claim that it was improper to refer to fruits in describing flavors when beverage did not contain actual fruit or fruit juice).
Identifying specific provisions of the NLEA or FDA rules will increase the odds of succeeding on a preemption defense. For instance, in Lam v. General Mills, Inc., No. 11-5056, 2012 WL 1656731 (N.D. Cal. May 10, 2012), plaintiffs argued that packaging of Fruit Roll-Ups misled consumers into thinking they were healthy. The packaging contained statements such as “fruit flavored snack” and “strawberry natural flavored,” although the side panel had an accurate list of ingredients. Defendants presented a specific rule that permitted a producer to label a product as “natural strawberry flavored” even if that product contained no strawberries. The District Court held the claim was preempted. See also Carrea v. Dreyer’s Grand Ice Cream, Inc.¸ 475 F. App’x 113 (9th Cir. Apr. 5, 2012) (claim “0g Trans Fat” statement on drumstick’s packaging misled consumers into believing Dreyer’s ice cream was healthy were preempted by NELA rules on nutritional labeling).
Despite these cases, there is little help for claims against an advertiser who contends that a product is “all natural.” The FDA has not defined what is “natural,” and as a result, such claims are not preempted. See e.g., Wright v. Gen. Mills, Inc., No. 08-cv-1532, 2009 WL 3247148 (S.D. Cal. Sept. 30, 2009) (rejecting preemption defense to an assertion that a granola bar containing high fructose corn syrup is misleadingly labeled “all natural”); Astiana v. Ben & Jerry’s Homemade, Inc., No. 10-4387, 2011 WL 2111796 (N.D. Cal. May 26, 2011) (claim that ice cream containing alkalized cocoa was improperly labeled “all natural” not preempted).
If pleading defenses fail and a class is certified, under most consumer protection statutes, the challenged advertising claim will be judged from the perspective of the “reasonable consumer.” Even where common sense compels success under this standard, the litigation costs required to obtain that result in a class action can be significant. Whether courts like the Clorox court will become more active in shutting down suits that defy common sense at the pleadings stage remains unclear.
November 2012: Appellate Litigation Update
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Quinn Emanuel Opens Supreme Court’s October 2012 Term: On Monday, October 1, 2012, the Supreme Court reconvened for its first oral arguments after the summer recess. Quinn Emanuel’s Kathleen Sullivan argued in the very first case of the new Term, Kiobel v. Royal Dutch Petroleum Co., No. 10-1491, on behalf of the respondents, the Dutch and English corporations Royal Dutch Petroleum Company and Shell Transport and Trading Company (collectively, “Shell”). This is the second time the case was argued, after the Court took the unusual step of ordering re-argument after Shell’s argument last Term.
At issue is the scope of the Alien Tort Statute (“ATS”), 28 U.S.C. § 1350, which the First Congress enacted in 1789. The Act was motivated by concern that international law violations, like assaults on foreign ambassadors on U.S. soil, required redress in the nation’s nascent Federal Courts lest State-Court indifference to such violations lead to international conflict. The ATS accordingly provides: “The district courts shall have original jurisdiction of any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States.”
The ATS was rarely invoked until 1980, when the U.S. Court of Appeals for the Second Circuit gave it new life in Filartiga v. Pena-Irala, 630 F.2d 876 (2d Cir. 1980). Filartiga allowed an ATS suit alleging that a former Paraguayan government official had tortured the plaintiff in Paraguay in violation of international human rights norms. Filartiga opened the door to numerous other ATS cases for conduct on foreign soil—including many naming corporations as defendants.
In 2004, in Sosa v. Alvarez-Machain, 542 U.S. 692 (2004), the Supreme Court kept the door open for such ATS actions, if only just ajar. Sosa held that, while the ATS provides only jurisdiction, federal common law provides a cause of action for offenses against the law of nations so long as they have no “less definite content and acceptance among civilized nations than the historical paradigms familiar when [the ATS] was enacted”—namely, violation of safe conducts, infringement of the rights of ambassadors, and piracy. Id. at 732. Sosa imposed a second screen on ATS actions as well, requiring that Federal Courts exercise their “judgment about the practical consequences of making [a new ATS] cause available to litigants in the federal courts.” Id. at 732-33.
Kiobel raises the question whether an ATS suit may proceed against a foreign corporation for alleged conduct aiding and abetting a foreign government on foreign soil. It involves a suit by Nigerian citizens alleging that Shell aided and abetted human rights violations in Nigeria by a prior Nigerian government. In 2010, the Second Circuit, in a divided opinion, held that international law does not recognize liability for corporations (as opposed to natural persons) for the violations alleged, and thus dismissed the case. The Supreme Court granted review in October 2011, and Shell retained Quinn Emanuel to represent it in the Court.
The Court granted review on the question whether international law holds a corporation (as opposed to a natural person) responsible for the violations alleged. Shell argued that it does not, but also argued, in the alternative, that the ATS and federal common law do not apply at all to conduct within the territory of a foreign sovereign. During oral argument on February 28, 2012, several Justices posed questions concerning that extraterritoriality issue, asking what the case had to do with the United States. The following week, the Court issued an unusual order asking the parties to prepare briefs on that issue over the summer and setting the case for re-argument this Term.
Kiobel in its two rounds has attracted over 85 amicus briefs from the U.S. and international business communities, human rights organizations, and governments, including the United States, which argued on the first Monday in October, in support of Shell, that the ATS cannot apply to a “foreign-cubed” action involving foreign conduct by a foreign corporation alleged to have aided and abetted a foreign government. Numerous other corporations and groups filed amicus briefs agreeing with Shell that the ATS equally cannot apply to “foreign-squared” actions against U.S. corporations alleged to have aided and abetted foreign government conduct on foreign soil. A decision is expected by June 2013.
November 2012: London Litigation Update
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State Immunity: In SerVaas Incorporated v. Rafidain Bank and others [2012] 3 WLR 545, the UK Supreme Court considered the scope of a state’s immunity from execution of a judgment and provided helpful guidance in relation to the “commercial purpose” exception provided for in section 13(4) of the State Immunity Act 1978 (“the Act”).
SerVaas sought enforcement of a judgment by applying for a Third Party Debt Order in relation to dividends payable to Iraq by Rafidain under a Scheme of Arrangement. Iraq resisted this on the grounds that the money due to the state was immune from execution by virtue of section 13(4) of the Act as the funds were not property “for the time being in use or intended for use for commercial purposes”. The application was dismissed at first instance and an appeal by SerVaas was also dismissed by the Court of Appeal. Undeterred, SerVaas then mounted a further appeal to the Supreme Court.
The Supreme Court unanimously dismissed the appeal and confirmed that the nature of the property against which execution was sought was irrelevant to the “commercial purpose” analysis. Parliament did not intend a retrospective analysis of all the circumstances which gave rise to the property, but an assessment of the use to which the state had chosen to put the property. Unhelpfully for SerVaas, a certificate was signed by the Iraqi Ambassador in London stating the dividend payments would not be used for any commercial purpose. The Supreme Court noted that this certificate created a presumption that SerVaas had no real prospect of rebutting.
This decision demonstrates the considerable limitations of the “commercial purpose” exception. This development may create challenges in enforcing judgments against states in the United Kingdom and, therefore, any party contracting with a state should carefully consider insisting upon an express waiver of immunity from execution when drafting contractual dispute resolution clauses.
Determining a Debtor’s COMI: Should a German national (B) who owed a German Bank (the Bank) more than €3 million be allowed to take advantage of England’s debtor-friendly bankruptcy regime to erase his liabilities to the bank? This was what the Court had to decide in Sparkasse Hilden Ratingen Velbert v. Benk and another [2012] EWHC 2432. B, who had been declared bankrupt in England, owed the Bank more than €3 million. The bankruptcy had run its course and B had been discharged, erasing his liabilities to the Bank. The Bank argued that the English Court should not have made the bankruptcy order because B’s COMI had been in Germany at all relevant times and that his presence in England was only temporary. For the Bank to succeed, they had to establish that B’s COMI was not in England at the time the petition was presented.
The Court held that B’s COMI was in Germany at the time the second petition was presented and when the bankruptcy order was made. It found that B was habitually resident in Germany but only lived in England temporarily. Habitual residence did not require presence at any particular time, only habit: B’s professional domicile was in Germany. B was a notary in Germany at all material times and even though he was suspended from practice at the time of the second petition, he had lodged numerous appeals in Germany to resume his practice. This Court found that this showed B’s motive to resume professional activities in Germany once discharged and his purported job in England as a professional sports photographer was mere “window dressing”. The Court also found that B’s only economic activity since relocating to England (i.e. the appeals he had lodged to revive his notary practice) took place in Germany which also pointed to a German COMI. B’s partner, E, on whom he was dependent, financed B through her German bank accounts and maintained a German residence despite B’s tenancy agreement in Birmingham, England being in their joint names. E’s residence was deemed to be in Germany, and the Court found that the mutual emotional dependence of B and E as a couple made it unrealistic that they would have separate COMIs.
Most of B’s creditors were also located in Germany and B had not taken steps to inform them of his change in COMI. The Court held that even though the creditors would have known of his change of COMI by way of an earlier unsuccessful bankruptcy petition, this was insufficient to establish a change in COMI. The Court noted that a debtor should not normally need to notify his creditors of a change in COMI, but he should not hide his COMI from them either. B’s subjective intent was also a factor in the Court’s decision. The judge found that his evidence as a witness pointed to his presence in England as a short-term arrangement. B’s ultimate objective was to return to Germany free of his debt and resume his practice as a notary. Lastly, the fact that he had been untruthful in the past and openly used a company which advertised services aimed at helping German debtors relocate to England to work around German bankruptcy law, showed that he had made no real effort to settle in England.
Countries such as Ireland and Germany have much stricter bankruptcy laws than England, and debtors often try to establish England as their COMI to take advantage of the more relaxed laws there. While this decision does not affect the requirements for the establishment of COMI, it certainly shows the English Court’s sympathy for the anti-forum-shopping arguments which creditors frequently raise against their debtors when seeking to set aside English Bankruptcy petitions.
Causation in Financial Services Cases: Section 150 of the UK’s Financial Services and Markets Act creates a cause of action for private persons who have suffered loss as a result of a financial institution’s breach of a rule contained in the FSA’s Conduct of Business Sourcebook (COBS). Case law (e.g. Camerata v. Credit Suisse [2012] PNLR 15) had suggested that where a breach of COBS led a Claimant to make an investment they would not have made but for the breach, but Claimant went on to suffer loss as a result of unforeseeable market events (e.g. the collapse of Lehman Bros), then such loss was not recoverable under section 150. In Rubenstein v. HSBC [2012] EWCA 1184, the Court of Appeal departed from that principle. Rix LJ held that “It was the bank’s duty to protect Mr Rubenstein from exposure to market forces when he made clear that he wanted an investment which was without any risk (and when the bank told him that his investment was the same as a cash deposit)... [A] bank must reasonably contemplate that, if it misleads its client as to the nature of its recommended investment, and thereby puts its client into an investment which is unsuitable for him, when it could just as easily have recommended something more suitable which would have avoided the loss in question, then it may well be liable for that loss.” This approach recognizes that the tort created by section 150 is intended to protect investors, and that questions of causation and foreseeability must be understood in that context. This is a welcome development in an area of the law where English claimants have historically faced severe challenges in holding financial institutions to account for their wrongdoing.
Pleading Extraterritorial Claims in New York in Light of Global Re v. Equitas
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Courts have long grappled with how to apply state and federal laws to disputes that arise entirely outside U.S. borders, sometimes concluding that such laws should not be applied extraterritorially at all. Earlier this year, the New York Court of Appeals weighed in on this issue in an antitrust case, Global Reinsurance Corp. v. Equitas Ltd. et al., 969 N.E.2d 187 (N.Y. 2012) (“Global Re”), holding that New York law did not extend to an alleged antitrust violation involving foreign defendants and a foreign conspiracy. The case itself turned on the Court’s interpretation of the Donnelly Act, New York’s antitrust statute; but litigants may try to extend the decision to cases involving non-antitrust claims, such as securities violations and various business torts. Whether or not those efforts are successful, Global Re highlights the potential problems that can arise when state-law claims based on international conduct are asserted. Maintaining these types of claims requires careful pleading, particularly in the wake of Global Re. Litigants contemplating claims based on foreign transactions should consider the full range of available options—including not only litigation, but aggressive arbitration—a strategy the Global Re plaintiff was ultimately forced to employ.
The Global Re Decision
Global Re arose out of a retrocessionary reinsurance dispute. Retrocessionary reinsurance is global reinsurance that covers a variety of risks, including so-called “non-life” coverages for environmental, catastrophic, and asbestos-related exposures. By the early 1990s, it was clear that a number of reinsurers had issued “non-life” retrocessionary policies without appreciating the long-term liabilities that these policies could cover (e.g., significant losses from asbestos liability). As claims began to mount, some reinsurers concluded that their exposure under these policies could outstrip reserves. Global Re, 969 N.E.2d at 189.
One such group was Lloyd’s of London, a London-based insurance market comprised of competing underwriters. Lloyd’s members concluded they could not stem rising “non-life” liabilities without concerted action; if underwriters individually imposed difficult hurdles on “non-life” claims, those underwriters could no longer compete for new business against other companies that were not imposing these same hurdles. Id. Lloyd’s members therefore created a new entity, Equitas—the defendant in the Global Re case—to assume obligations under existing “non-life” retrocessional reinsurance policies. Equitas was given free rein to handle claims arising under these policies. It immediately took a “hard-nosed” approach aimed at limiting exposure, including burdensome documentation requirements that led to the denial of many claims. Id. at 189-90.
Plaintiff Global Reinsurance Corporation (“Global Re”) was the U.S. branch of a German reinsurance company that had purchased retrocessional coverage through Lloyd’s. Global Re believed Equitas’ new claim resolution procedures caused denials on claims that would have been approved by individual Lloyd’s members. Because Equitas’ procedures were only possible due to the elimination of competition among other retrocessional reinsurers in the Lloyd’s marketplace, Global Re’s New York branch filed Donnelly Act claims in New York court, alleging that the merger of individual reinsurers into Equitas suppressed competition in the retrocessional reinsurance market. The complaint alleged that while individual participants in the Lloyd’s marketplace were once “disposed to settle claims expeditiously and fairly” because they “competed with each other for new business and were thus anxious to curry favor” with potential customers, Equitas eliminated “any competitive disincentive to the adoption of sharp claims management practices.” Id. at 190-91.
The trial court dismissed the Donnelly Act claim, concluding the complaint failed to adequately allege market power. The Appellate Division reversed and reinstated, finding market power had been adequately alleged, and that Defendants’ other argument for dismissal—that a London-based conspiracy to restrain trade was not actionable under the Donnelly Act even if market power was adequately alleged—also did not warrant dismissal. Id. at 191-92.
The Court of Appeals reversed. The Court concluded that market power was not adequately alleged in the complaint; for example, coverage available from Lloyd’s participants could presumably be obtained on competitive terms elsewhere after Equitas was formed. Thus, no Donnelly Act claim was adequately alleged. Id. at 194.
But the Court’s analysis did not end there. The Court then proceeded to address a much broader question: whether, if market power had been adequately alleged, the Donnelly Act could ever extend to a claim for injury inflicted by a foreign defendant, caused by a foreign conspiracy, whose impacts were felt in New York only because a participant in the worldwide market happened to be located in New York. On that question, the Court held the complaint failed to set out a sufficient case for applying the Donnelly Act:
Injury so afflicted, attributable primarily to foreign, government approved transactions having no particular New York orientation and occasioning injury here only by reason of the circumstance that plaintiff’s purchasing branch happens to be situated here, is not redressable under New York State’s antitrust statute.
Id.
In reaching that conclusion, the Court noted the presumption against applying New York statutes extraterritorially, observing that this presumption is especially strong where corresponding federal law was expressly limited so as not to apply extraterritorially: “The established presumption is, of course, against the extraterritorial operation of New York law, and we do not see how it could be overcome in a situation where the analogue federal claim would be barred by congressional enactment.” Id. The Court acknowledged, however, that extraterritorial application of the Donnelly Act might be warranted in some circumstances:
For a Donnelly Act claim to reach a purely extraterritorial conspiracy, there would, we think, have to be a very close nexus between the conspiracy and injury to competition in this state. That additional element is not discernable form the pleadings before us.
Id. at 196. Plaintiff failed to establish any nexus to New York, much less a “very close nexus”: it did not allege injury to competition in New York, focusing instead on constrained competition in a London-based market (Lloyd’s) that allegedly caused worldwide injuries—not injuries with any particular and special connection to New York. Id. Thus, the court concluded that even if market power had been adequately alleged, and even if a Sherman Act claim had been stated, no Donnelly Act claim was possible based on the complaint.
The Potential Impact of Global Re on New York Litigants
In the wake of the Global Re decision, commentators have suggested that defense counsel might use Global Re to limit the territorial reach of New York law generally. Global Re specifically held only that antitrust plaintiffs cannot avoid the Sherman Act’s territorial limitations by bringing claims under the Donnelly Act, but some commentators suggest that defendants should argue that claims of any sort under New York law are barred by Global Re when they would apply New York law extraterritorially.
Those sorts of arguments seem likely in securities-related litigation, where federal claims arising out of foreign conduct have been limited in recent years. The Supreme Court’s decision in Morrison v. National Australia Bank, 130 S.Ct. 2869 (2010), limited claims under Section 10(b) of the Securities Exchange Act and Rule 10b-5 to those involving securities listed on American exchanges or securities purchased or sold in the United States. Morrison dismissed so-called “F-cubed” claims that involved (1) foreign investors, (2) a foreign defendant, and (3) a foreign securities transaction. The Court broadly rejected the “F-cubed” claims under federal law, on the rationale that extraterritorial application of federal laws should not be presumed absent an express congressional statement to that effect:
It is a “longstanding principle of American law ‘that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States.’” … Thus, “unless there is the affirmative intention of the Congress clearly expressed” to give a statute extraterritorial effect, “we must presume it is primarily concerned with domestic conditions.” … When a statute gives no clear indication of an extraterritorial application, it has none.
Morrison, 130 S.Ct. at 2877-78 (citations omitted).
In the wake of Morrison, plaintiffs in securities-related cases used state statutory and common-law claims to address injuries where no federal causes of action existed. In Terra Sec. ASA Konkursbo v. Citigroup, Inc., 740 F. Supp. 2d 441 (S.D.N.Y. 2010), for example, the court dismissed foreign plaintiffs’ federal securities law claims against Citigroup under Morrison because the transactions at issue took place on a foreign exchange. Id. at 447. But the court denied a motion to dismiss plaintiffs’ common-law fraud claims, finding that plaintiffs adequately alleged reliance and causation. Id. at 454-55.
Before Global Re, efforts to use state law as a substitute for federal securities laws were on the rise. Those efforts received a boost from a recent New York Court of Appeals decision, Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management Inc., 962 N.E.2d 765 (N.Y. Dec. 20, 2011), which held that the Martin Act (a New York securities fraud and enforcement statute) does not preempt claims under New York common law in securities-related cases. Plaintiff Assured Guaranty sued J.P. Morgan for breach of fiduciary duty, gross negligence, and breach of contract based on mismanagement of a portfolio that was insured by Assured Guaranty. J.P. Morgan moved to dismiss, arguing that plaintiff’s claims were preempted by the Martin Act because they involved allegations of securities and investment fraud that were the exclusive purview of the New York Attorney General under the Martin Act. The Court rejected that argument, finding nothing in the legislative history of the Martin Act expressly indicating that it was meant to preempt common-law claims by civil plaintiffs. Id. at *6 -7. This decision rebuffed a line of cases finding common-law claims preempted under New York law. See, e.g., Horvath v. Banco Comercial Portuges, S.A., 2011 WL 666410, at *7-8 (S.D.N.Y. Feb. 15, 2011) (in case involving foreign transaction, dismissing federal securities claims under Morrison and also dismissing common-law claims for aiding and abetting and negligent misrepresentation as precluded by the Martin Act).
In future suits involving foreign transactions, defendants may try to use Global Re to stem the tide of state-law claims authorized by Assured. Defendants are likely to argue that even where New York common law claims are not preempted by the Martin Act, they are precluded by Global Re if they would apply New York law extraterritorially and regulate international conduct.
Plaintiffs may face similar arguments based on Global Re when bringing claims under New York’s Organized Crime Control Act (“OCCA”), the state analogue to the federal Racketeer Influenced and Corrupt Organizations (“RICO”) Act. In recent years, some courts have refused to apply RICO to conduct occurring entirely abroad, citing Morrison as a general limitation on extraterritorial application of federal law. See, e.g., Cedeño v. Castillo, No. 10-cv-3861, 2012 WL 205960, at *37 (2d Cir. Jan. 25, 2012). Defendants may similarly argue that cases barred by territorial limits on RICO should not be authorized under OCCA.
Indeed, defendants may try to use Global Re to limit the scope of nearly any state-law action involving foreign acts, including claims relating to intellectual property rights. For example, a New York fashion designer recently sued Japanese companies in New York for merchandise sales in Japan that allegedly violated the designer’s trademarks and trade dress rights. The suit involved claims under the Lanham Act, claims under the New York General Business Law, and claims for common-law trade dress infringement, all arising out of these foreign sales. Defendants moved to dismiss the Lanham Act claims based on Morrison, and similarly cited Global Re to argue for a general presumption against extraterritorial application of New York law. See Jill Stuart (Asia) LLC v. Sanei Int’l Co., Ltd., 2012 WL 3601203 (S.D.N.Y. June 1, 2012). Similar arguments could be made in essentially any substantive area of law where New York plaintiffs seek to recover for wrongs committed abroad.
Avoiding the Pitfalls of Global Re Going Forward
Defendants’ efforts to convert Global Re into a general prohibition on state-law claims may be legally misguided. Global Re involved the extraterritorial scope of a New York statute—not claims under New York common law. The authority cited by the Court of Appeals for a presumption against the extraterritorial application of that statute was a treatise on New York statutory law—McKinney’s Consolidated Law of NY, Book 1, Statutes § 149—which states that “every statute in general terms is construed as having no extraterritorial effect” (emphasis added). Global Re’s emphasis on legislative history and congressional intent regarding territorial scope does not speak common law claims. Plaintiffs seeking to recover losses stemming from foreign transactions may argue that common-law claims simply are not implicated by the statutory presumptions discussed in Global Re or Morrison.
Moreover, plaintiffs can and should anticipate Global Re-style arguments in future cases involving foreign transactions, and avoid the pleading pitfalls that ensnared the Global Re plaintiff. In Global Re, the Court’s opinion repeatedly emphasized that the complaint alleged “a purely extraterritorial conspiracy,” where “[t]he only harm to competition alleged is within a particular London reinsurance marketplace” and that “only incidentally affected commerce in this country” through “transactions having no particular New York orientation and occasioning injury here only by reason of the circumstance that plaintiff’s purchasing branch happens to be located [in New York].” Global Re, 969 N.E.2d at 194-95 (emphases added).
To head off Global Re arguments, Plaintiffs should make efforts to avoid pleading purely foreign transactions with local injuries that are incidental. For example, to the extent possible, plaintiffs should set forth some acts underlying the transaction that occurred in or were specifically directed at New York—such as pre-transaction correspondence directed to New York, meetings in New York, and the like. Plaintiffs should also highlight the predictability of injuries suffered in New York—for example, identifying evidence that defendants actually knew New York residents would be harmed by their conduct. With careful analysis and thorough pre-filing investigations, plaintiffs may be able to satisfy the “very close nexus” standard Global Re articulated.
Arbitration the Answer?
Whatever the impact of Global Re on state-law claims, the outcome of that case highlights another issue: as New York courts, federal courts, or other courts restrict the availability of litigation to redress harms from foreign transactions, international arbitration will become increasingly important. For example, after Global Re’s claims under New York law were all dismissed, Global Re’s only hope of recovery was arbitration—specifically, an international arbitration proceeding against underwriters, seeking damages for alleged abuses under insurance treaties. Id. at 194 (noting plaintiffs were “pursuing contract claims against Lloyd’s underwriters in arbitration based on the same claims handling practices presently alleged”). Plaintiffs in future cases involving foreign defendants and foreign transactions need to carefully consider their opportunities for arbitration, and aggressively pursue arbitral awards as part of their global litigation strategy. A litigation-only approach would have left Global Re without avenues for recovery after its state-law claims were dismissed. Plaintiffs considering whether to assert U.S. claims in future cases involving foreign transactions should not overlook the importance of instituting arbitrations, and making forceful efforts to maximize recoveries in those arbitrations.
Contingency Fees in England After April 2013
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Beginning in April 2013, lawyers in England will be permitted to recover fees from the damages awarded to their clients. This type of contingency fee agreement was formerly prohibited in the UK, but a comprehensive review of civil litigation costs in 2009 prompted the recent passage of the Legal Aid, Sentencing and Punishment of Offenders Act 2012, which will permit damages-based fee agreements when the first part of the Act comes into force, which is expected in April 2013. Many details concerning these agreements will be contained in regulations that are still being developed. Nonetheless, it is clear that the introduction of damage-based fee agreements will shake up the way litigation is conducted in the UK.
Although contingency fees were long barred in the UK, one sort of contingency fee arrangement, success fees, has been a feature of the UK litigation environment for the past two decades. Success fees entitle lawyers to an increase in fees, capped at 100%, in the event of a successful outcome. Success fees are said to encourage the prosecution of meritorious claims which lack funding and provide lawyers with incentives to win cases without emphasising the size of the resulting award.
In 2000, successful claimants were allowed for the first time to recover from defendants, not just their usual fees, but also success fees as well as any premiums for after-the-event insurance, which protects litigants against costs that may be imposed upon them in unsuccessful litigation. Although in England successful parties traditionally have been able to recover legal fees from the losing party in most cases, the recovery of success fees and insurance premiums significantly increased the costs burden for unsuccessful parties. Moreover, this burden was asymmetric because unsuccessful claimants could often insulate themselves from large costs bills by taking out after-the-event insurance and entering into success fee arrangements based on an initial reduced fee.
Commentators criticized the disparate cost burdens created by shifting the costs of contingency fees and after-the-event insurance. These concerns, along with the growing interest in enabling greater access to justice, led to a significant review of civil litigation costs in England. As a result, the Master of the Rolls, the second most senior judge on the Court of Appeal of England and Wales, mandated his colleague, Lord Justice Jackson, with reviewing civil litigation costs. Lord Justice Jackson issued a report in December 2009. In the forward to that report, Lord Justice Jackson commented, “In some areas of civil litigation costs are disproportionate and impede access to justice. I therefore propose a coherent package of interlocking reforms, designed to control costs and promote access to justice.” Accordingly, Lord Justice Jackson recommended permitting barristers and solicitors in England to enter into damages-based contingency fee agreements, but prohibiting shifting the costs of after-the-event insurance premiums and success fees. These reforms were adopted in the Legal Aid, Sentencing and Punishment of Offenders Act 2012 and will progressively come into effect, with contingency fees expected to be effective in April 2013.
If the United States’ experience with contingency fees is any guide, these reforms will bring significant benefits. It is more likely that impecunious claimants with meritorious, high-value claims will be able to find representation. It is also expected that barristers and solicitors will become more creative with their costs structures and will depart more and more from simple time-sheet billing. In addition, clients may begin to expect creativity from their legal counsel in structuring fee deals to deliver commensurate value.
On the other hand, the retention of the English practice of awarding legal fees to the prevailing party is likely to prevent many of the speculative claims experienced in the U.S. The “no win, no fee” concept utilized in the United States won’t apply in England because, regardless of whether a matter is conducted under a contingency fee arrangement, in England the unsuccessful party normally bears the reasonable costs of the successful party’s legal fees and disbursements. Moreover, because of the reforms contained in the recent legislation, defendants will not be induced to settle by the threat of contingency fees because insofar as the contingency fee payable to a solicitor exceeds what would be chargeable under a normal fee arrangement, the successful party must bear that cost.
Numerous questions concerning the new damages-based contingency fee arrangements remain open. Many are being addressed by the regulations on which the Civil Justice Council (“CJC”) is advising. For example, the CJC has recommended that there should be no maximum cap set for contingency fee agreements in general commercial litigation. (There would be caps, however, in litigation concerning certain areas such as employment law and personal injury.)
The CJC is also considering whether lawyers should themselves be made subject to adverse costs awards as third party funders may be in some circumstances. In third party funding arrangements, an investor finances all or part of a client’s legal costs and expenses in exchange for an agreed share of any recovery. Under current law, third party funders may be held directly liable for adverse cost awards, but lawyers are immune from such awards. The CJC has recommended retaining both practices. However, some commentators have suggested that, if lawyers are not liable for adverse cost awards in circumstances when third party funders are, litigation funders may buy into or set up law firms in order to avoid adverse costs liability.
Even after the regulations are issued, questions will remain concerning contingency fee arrangements. One issue will be the impact of the common law doctrines of maintenance and champerty. Maintenance is the act of supporting litigation in which a party has no legitimate interest, while champerty is maintaining a party on the basis that the funder will be rewarded upon a successful outcome. The Criminal Law Act 1967 abolished both the crimes and torts of maintenance and champerty. Nevertheless, the common law rules against maintenance and champerty remain, and therefore a contingency fee agreement that violates those rules may be held contrary to public policy and unenforceable. Case law suggests that a funding arrangement amounts to maintenance or champerty if it permits an unjustifiable intrusion into the running of the case or disproportionate control or profit, or creates a clear tendency to corrupt justice.
While the coming regulations and existing common law doctrines such as champerty and maintenance will place some restrictions on the new damages-based contingency fees, there undoubtedly will be much room for creative new fee arrangements, which lawyers and clients alike should explore.
October 2012: White Collar Litigation Update
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Second Circuit Clarifies “Substantial Assistance” Standard for Aiding and Abetting Liability in SEC Enforcement Actions: Section 20(e) of the Securities Exchange Act of 1934 allows the SEC, but not private litigants, to bring civil actions against aiders and abettors of securities fraud. Under this section, the SEC may bring an enforcement action against “any person that knowingly provides substantial assistance” to a primary violator of the securities laws. On August 8, 2012, in SEC. v. Apuzzo, 689 F.3d 204 (2d Cir. 2012), the Second Circuit lowered the bar necessary to state a claim for aiding and abetting. Noting that prior case law may have been unclear, the Second Circuit rejected the argument that the SEC is required to plead or prove that an aider and abettor proximately caused the primary securities law violation. Instead, relying on a 75-year-old decision by Judge Learned Hand, the Court stated that once the government proves that a primary violation occurred and that the defendant had knowledge of it, the government need only prove that the defendant associated himself with the fraudulent scheme and sought to make it succeed. This relaxed standard will make it easier for the SEC to pursue enforcement actions against individuals who assist others in committing securities violations.
Joseph Apuzzo was the Chief Financial Officer of Terex Corporation, a manufacturer of mining equipment. The government alleged that, with Apuzzo’s assistance, United Rentals, Inc., one of the largest equipment rental companies in the world, and its Chief Financial Officer, Michael Nolan, carried out two fraudulent sales-leaseback transactions designed to allow United Rentals to recognize revenue prematurely and inflate the profit generated from sales. As part of this scheme, United Rentals sold used equipment to General Electric Credit Corporation (“GECC”) and leased the property back for a short period of time. In order to secure GECC’s participation in the sales-leaseback, United Rentals convinced Terex to agree to resell the equipment for GECC at the end of the lease period and to guarantee that GECC would receive no less than 96% of the purchase price that GECC paid United Rentals to acquire the equipment. To obtain Terex’s agreement, United Rentals secretly promised to indemnify Terex for any losses that Terex sustained and to make substantial equipment purchases from Terex in the future. Pursuant to Generally Accepted Accounting Principles, United Rentals could immediately recognize the revenue generated by the sale of equipment to GECC if it could demonstrate, among other things, that the risks and rewards of ownership had been fully transferred to GECC. However, because it had secretly agreed to indemnify Terex for any losses that Terex incurred, that requirement was not met, and therefore United Rentals could not properly record the revenue from the sales. The government alleged that Apuzzo knew that if the indemnification payments were disclosed, United Rentals would not be able to recognize the revenue. The government also claimed that Apuzzo executed various agreements and approved false invoices to conceal the indemnification payments.
For a defendant to be liable as an aider and abettor in a civil enforcement action, the SEC must prove: “(1) the existence of a securities law violation by the primary (as opposed to the aiding and abetting) party; (2) ‘knowledge’ of this violation on the part of the aider and abettor; and (3) ‘substantial assistance’ by the aider and abettor in the achievement of the primary violation.” SEC v. DiBella, 587 F.3d 553, 566 (2d Cir. 2009) (quoting Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d 57, 62 (2d Cir. 1985)). Relying on Bloor, the District Court found that although the complaint plausibly alleged that Apuzzo had actual knowledge of the primary violation, it did not adequately allege “substantial assistance” because the government did not allege that Apuzzo proximately caused the harm on which the primary violation was predicated. Specifically, the Court held that “the complaint contains factual allegations which taken as true support a conclusion that there was a ‘but for’ causal relationship between Apuzzo’s conduct and the primary violation, but do not support a conclusion that Apuzzo’s conduct proximately caused the primary violation.” SEC v. Apuzzo, 758 F. Supp. 2d 136, 148 (D. Conn 2010). Concluding that proximate causation was required to satisfy the “substantial assistance” component of aider and abettor liability, the District Court granted Apuzzo’s motion to dismiss.
The Second Circuit reversed and clarified the standard for determining the substantial assistance prong for aider and abettor liability. Relying on criminal case law for guidance, the Court reasoned that the conduct of an aider and abettor that was sufficient to impose criminal liability would also be sufficient to impose civil liability in an enforcement action. The Court then noted that in Peoni, Judge Hand set forth the classic formula for aider and abettor liability in criminal cases by stating that the government—in addition to proving that the primary violation occurred and that the defendant had knowledge of it—must prove “that he in some sort associate[d] himself with the venture, that [the defendant] participate[d] in it as in something that he wishe[d] to bring about, [and] that he [sought] by his action to make it succeed.” Apuzzo, 689 F.3d at 206. (quoting Peoni, 100 F.2d at 402.)
The Second Circuit concluded that this was likely the clearest definition possible and then rejected Apuzzo’s argument that substantial assistance should, instead, be defined as proximate cause. The Court determined that that argument ignored the difference between an SEC enforcement action and a private suit for damages. “Proximate cause” is the language of private tort actions; it derives from the need of a private plaintiff, seeking compensation, to show that his injury was proximately caused by the defendants’ actions. But, in an enforcement action, civil or criminal, there is no requirement that the government prove injury, because the purpose of such actions is deterrence, not compensation. Id. at 213.
Applying this new standard, the Second Circuit concluded that the complaint alleged that Apuzzo provided substantial assistance in carrying out the fraud because he negotiated the details of both transactions, extracted agreements for Terex, and signed inflated invoices to further the fraud. The Court thus reversed the District Court’s order and remanded the case for trial.
Because only the SEC may bring civil claims for aiding and abetting securities law violations, this decision will not affect private litigants. However, it will likely increase the number of enforcement actions brought against individuals who assist others in transactions designed to make financial statements seem more attractive. The SEC has long relied on theories of secondary liability to enforce the federal securities laws. In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which confirmed that knowing or reckless behavior can form the basis for liability for securities fraud. The Second Circuit’s decision in Apuzzo continues this recent trend in easing the SEC’s burden in secondary liability cases.
NLRB Prohibits Employers from Requesting that Employees Keep Silent About Internal Investigations: The National Labor Relations Board (the “Board”) recently issued a surprising decision that has important ramifications for internal investigations conducted by employers. In Banner Health System d/b/a Banner Estrella Medical Center, 358 N.L.R.B. No. 93 (July 30, 2012), the Board found unlawful the common practice by employers of requesting that an employee witness in an investigation not discuss the matter with other employees pending the completion of the investigation. Although the verbal instruction—which the employer provided to all employees involved in an investigation—was not accompanied by any threat of disciplinary consequences for its violation, the Board held that the request constituted an impermissible restraint on employees’ right to engage in protected concerted action under Section 7 of the National Labor Relations Act. As such, the Board issued an order requiring the employer to cease and desist from “[m]aintaining or enforcing the rule that employees may not discuss with each other ongoing investigations of employee misconduct” and to post a notice stating the same. Banner Health System, 358 NLRB No. 93 (Slip Opinion at 3).
The underlying investigation involved an employee who alleged that his negative performance review was in retaliation for his refusal to follow his supervisor’s improper instructions. In interviewing the employee, a human resources manager utilized a standard interview form wherein the employee was given the following verbal instruction:
This is a confidential interview and I will keep our discussion confidential except as required by law, or [Company] policy or as necessary to conduct this investigation. I ask you not to discuss this with your coworkers while the investigation is going on, for this reason: when people are talking it is difficult to do a fair investigation and separate facts from rumor.
A copy of the form was not provided to the employee.
For reasons apart from this instruction and not relevant to this note, the employee subsequently filed a claim with the NLRB alleging that Banner Health System committed certain violations of Section 8(a)(1) of the National Labor Relations Act, which prohibits employers from interfering, restraining, or coercing employees’ enjoyment of their Section 7 rights. The Board issued a complaint and notice which was subsequently amended to address the verbal confidentiality instruction.
Following a hearing on the complaint, the Administrative Law Judge upheld the verbal confidentiality instruction, finding that the employer had a “legitimate business reason for making this suggestion.” Id. at 6 (emphasis added). Specifically, the hearing judge recognized that the purpose of the “suggestion” was “to protect the integrity of the investigation.” Id.
On appeal, the Board reversed in a 2-1 decision. The Board found that the employer’s “blanket” (rather than case-by-case) approach of instructing all employee witnesses in an investigation to maintain confidentiality was an impermissible restraint on the employees’ Section 7 rights. The Board explained that an employer’s “generalized concern with protecting the integrity of its investigations is insufficient to outweigh employees’ Section 7 rights” to engage in concerted action for mutual aid and protection. Id. at 2.
Moreover, it was of no consequence to the Board that the instruction was merely a request. Nor did it matter that the request was not accompanied by an express threat of discipline for violation of the request. In the Board’s view, “[h]owever characterized, [the instruction], viewed in context, had a reasonable tendency to coerce employees, and so constituted an unlawful restraint....” Id.
In reaching this decision, the Board announced that, for a confidentiality instruction to be valid, an employer must first assess whether the instruction is necessary given the circumstances of the specific situation. In making that determination, the employer should consider the following non-exhaustive factors:
(1) “[W]hether in any give[n] investigation witnesses need[] protection”;
(2) Whether “evidence [is] in danger of being destroyed”;
(3) Whether “testimony [is] in danger of being fabricated”;
(4) Whether “there [is] a need to prevent a cover up.”
Employers conducting internal investigations of complaints and alleged misconduct have routinely issued confidentiality instructions for purposes of preserving the integrity of the investigation. Pursuant to this ruling—which applies to both union and non-union workplaces—such confidentiality instructions violate Section 8(a)(1) unless the instruction is narrowly tailored to the specific situation.
A strict interpretation of the Board’s decision would prove difficult to implement. Oftentimes, an understanding of the facts necessary to fully contemplate the considerations listed by the Board is impossible without at least some investigation. By the time that sufficient facts have been gathered to support a confidentiality instruction, the investigation may have already been tainted by behavior that would have been prevented by the earlier issuance of an instruction. The Board, however, would have no reason to promulgate an unworkable rule. This suggests that the Board, though uncomfortable with blanket confidentiality restrictions, views instructions appropriate so long as grounded in a reasonable basis that is specific to the matter under investigation. In other words, employers should utilize confidentiality instructions only after identifying specific concerns that make such an instruction appropriate.
With this understanding in mind, employers should revisit their internal policies and procedures governing (and agreements applicable to) internal investigations. Policies and procedures should be updated if necessary to implement a formal company policy regarding the issuance of confidentiality instructions. The policy should specifically address each of the four considerations identified above and require the individual undertaking the investigation to specifically list the facts at issue that justify the instruction prior to issuing the instruction. This record should be maintained in the event of subsequent litigation.
October 2012: International Arbitration Litigation Update
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In recent years, a hotly contested issue in international arbitration practice has been the extent to which parties to foreign seated arbitrations can employ 28 U.S.C. § 1782 to obtain discovery in the U.S. for use in the arbitration. In a decision of potentially great significance, the U.S. Court of Appeals for the Eleventh Circuit recently held that a party engaged in a private foreign arbitration may employ Section 1782 to obtain discovery in the U.S. The decision creates a split with the Fifth and Second Circuits, which had both previously precluded discovery in aid of private foreign arbitrations, allowing it only in the service of foreign state-sponsored adjudicatory proceedings. The Eleventh Circuit’s decision heralds potentially significant opportunities for parties to obtain discovery in aid of foreign commercial arbitrations, while exposing those within the Eleventh Circuit’s jurisdiction to potentially enlarged discovery burdens, even as non-parties to foreign arbitral proceedings.
The Section 1782 Discovery Mechanism: Section 1782 is a powerful tool for Federal Court assistance in gathering evidence for use in foreign proceedings. Under the Section, a U.S. court may grant discovery where: (a) the person from whom the discovery is sought is found in the Court’s district; (b) the application is made by a foreign or international tribunal or “any interested person”; and (c) the evidence is for use in a proceeding before a “foreign or international tribunal.” Although the Section’s language is relatively clear, controversy has long persisted over (i) whether Congress intended the term “tribunal” to include arbitral panels, and, if so, (ii) whether that definition is broad enough to encompass both governmental or state-sponsored arbitral panels (such as those established under NAFTA or the World Bank’s International Convention for the Settlement of Investment Disputes (ICSID)) as well as arbitration panels presiding over private commercial cases.
The U.S. Supreme Court’s 2004 decision in Intel Corp. v. Advanced Micro Devices, Inc., 542 U.S. 241 (2004), suggested that a private arbitral tribunal may fall within the scope of Section 1782, but the Court did not decide the issue. Before the Intel decision, both the Second and Fifth Circuits held that Section 1782 does not permit discovery assistance to foreign private commercial arbitration tribunals. See Republic of Kazakhstan v. Biedermann Int’l, 168 F.3d 880 (5th Cir. 1999); Broadcasting Co. v. Bear Stearns & Co., 165 F.3d 184, 191 (2d Cir. 1999). District Courts reviewing the issue since the Intel decision have divided on the question.
The Eleventh Circuit’s Decision: Splitting with the Second and Fifth Circuits, the Eleventh Circuit recently held that a party engaged in a private foreign arbitration can rely on 28 U.S.C. § 1782 to obtain discovery from persons or companies located in the U.S. for use in that arbitration. Consorcio Ecuatoriano de Telecomunicaciones S.A. v. JAS Forwarding (USA), Inc., 685 F.3d 987 (11th Cir. 2012). The case concerned a foreign shipping contract billing dispute between wireless communications operator, Consorcio Ecuatoriano de Telecomunicaciones S.A. (“CONECEL”) and an air freight carrier, Jet Air Service Equador S.A. (“JASE”). JASE commenced arbitration proceedings against CONECEL in Ecuador. Thereafter, CONECEL filed an ex parte application in the U.S. District Court for the Southern District of Florida pursuant to 28 U.S.C. § 1782 to obtain discovery from JASE’s U.S. counterpart, JAS Forwarding (USA), Inc. The District Court granted the application and denied JASE’s subsequent motion to quash.
In affirming the District Court’s order, the Eleventh Circuit, relying heavily on the Intel decision, held that the arbitral tribunal before which the dispute was pending was a “foreign tribunal” for purposes of Section 1782. It reasoned that the statutory requirements for judicial assistance were met here because: (i) the arbitral panel acted as a first-instance decisionmaker; (ii) it permitted the gathering and submission of evidence; (iii) it would resolve the dispute; (iv) it would issue a binding order; and (v) its order would be subject to judicial review. Section 1782, according to the panel, “requires nothing more.” Id. at 990. The Eleventh Circuit distinguished the contrary holdings of the Second and Fifth Circuits as being at odds with the broader and more functional definition of a “tribunal” posited in Intel.
Impact of Decision and the Path Forward: Although the CONESCO decision is binding only within the Eleventh Circuit, its impact is nevertheless likely to be significant. It provides a potent tool—essentially opening up the panoply of discovery devices under the Federal Rules of Civil Procedure—to parties to foreign arbitral proceedings who may wish to obtain discovery within the Eleventh Circuit’s jurisdiction (Alabama, Florida and Georgia), whether or not they are parties to those proceedings. Indeed, one of the hallmarks of Section 1782 discovery is that it does not inquire whether such discovery would be available in the foreign proceedings. Thus, it is possible for parties to obtain far broader discovery through Section 1782 than would normally be authorized in the arbitration itself.
It is yet to be seen whether other Courts will adopt the Eleventh Circuit’s position. It seems likely though that this question will at some point return to the Supreme Court. The Eleventh Circuit’s split with the Fifth and Second Circuits is arguably not yet ripe for review, because both of those Circuit’s decisions disallowing Section 1782 discovery in aid of foreign private arbitral tribunals pre-dated the Supreme Court’s 2004 Intel decision. However, future published decisions confirming those earlier holdings could well provide a basis for the Supreme Court to again weigh in. In the meantime, for better or worse, the courts in the Eleventh Circuit may well become a magnet for discovery applications in aid of foreign arbitrations.
Other International Arbitration Practice News: In other news, the United States District Court for the District of Columbia recently cited favorably to an article published by New York international arbitration associate, Lucas Bento, in the Berkeley Journal of International Law. Mr. Bento’s article, Toward an International Law of Piracy Sui Generis: How the Dual Nature of Maritime Piracy Law Enables Piracy to Flourish, 29 Berkeley J. Int’l L. 399, 418 (2011), examines international law and jurisprudence on maritime piracy. It is quoted twice in the D.C. Court’s opinion in United States v. Ali Mohamed Ali, No. 11-0106, 2012 WL 2870263 (D.D.C., July 13, 2012).
Court Quashes Summons of Indictment in Economic Espionage Act Prosecution Against Quinn Emanuel Chinese Client
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Last month, Quinn Emanuel won an important victory for its clients the Pangang Group and three of its subsidiaries in a closely watched criminal prosecution brought under the Economic Espionage Act (EEA). Pangang is one of the largest manufacturers of steel, titanium, and vanadium products in China. The government alleged that the Pangang defendants are state-owned companies controlled by a special government agency of the PRC and that Pangang had violated the EEA by misappropriating titanium dioxide (TiO2) production technology from E.I. du Pont de Nemours & Company (DuPont). On July 23, 2012, a United States District Court quashed the service of the summons, which may have ended the criminal prosecution, by ruling that the government had failed to properly serve the Pangang defendants under Rule 4 of the Federal Rules of Criminal Procedure. On August 16, 2012, the government indicated that it is exploring alternative methods to effect service. The next status conference is scheduled for October 11, 2012.
The Defendants
The firm’s clients are Pangang Group Co. Ltd. and its subsidiaries Pangang Group Steel Vanadium & Titanium Company, Ltd., Pangang Group Titanium Industry, Ltd., and Pangang Group International Economic & Trading Company, which manufacture and market steel, titanium, and vanadium products. Other defendants include several individuals and a corporate defendant associated with one of the individuals, Walter Liew. One individual pled guilty and awaits sentencing. All other defendants who were served await trial.
Indictment
The criminal prosecution arises out of a civil suit filed by DuPont against an individual named Walter Liew, his company, and one of his employees, for allegedly misappropriating trade secret materials that provided detailed specifications for DuPont’s chloride-route TiO2 process.
On July 27, 2011, the government filed a criminal complaint charging Mr. Liew and his wife with witness tampering in the civil case and lying to federal investigators. A grand jury indicted the Liews on those and other charges on August 23, 2011.
The government then filed a superseding indictment against additional defendants, including our clients, and with expanded charges. The Pangang defendants were indicted under the EEA for an alleged conspiracy to commit economic espionage, conspiracy to commit theft of trade secrets, and attempted economic espionage. The indictment alleges that the defendants conspired to steal trade secrets regarding DuPont’s process for manufacturing TiO2, a white pigment commonly used in paint, plastics, and paper. The indictment also alleges that DuPont has the largest share of the $12 billion global titanium dioxide market and that the Chinese government had identified the development of TiO2 production as a scientific and economic priority.
The Economic Espionage Act
The EEA criminalizes two types of trade secret misappropriation: “economic espionage,” as defined by 18 U.S.C. § 1831, and “theft of trade secrets,” as defined by 18 U.S.C. § 1832. These offenses share three elements: (1) misappropriation of information; (2) with knowledge or belief that the information is a trade secret; and (3) that the information is, in fact, a trade secret. Only section 1831 requires a nexus with a foreign government, punishing those who steal trade secrets “intending or knowing that the offense will benefit any foreign government, foreign instrumentality, or foreign agent.” 18 U.S.C. §1831(a).
Penalties under the EEA can be severe. Section 1831 and 1832 violations can result in up to 15 and 10 years in prison, respectively, and the statute carries a range of fines up to $15,000,000. Depending on the nature of the offense, those fines can be substantially increased given that the EEA is subject to the alternative fines provision of 18 U.S.C. § 3571(d), under which a defendant “may be fined . . . the greater of twice the gross gain or twice the gross loss” caused by the unlawful conduct. Violators are also subject to the provisions of the Mandatory Victim’s Restitution Act.
Although the law was passed in 1996, economic espionage prosecutions were rare until very recently. The DOJ is now investigating and prosecuting economic espionage cases on an unprecedented scale and two bills are pending before Congress seeking to amend the EEA to provide for enhanced penalties and broader civil remedies. Significantly, this is the first case in which the government charged an alleged foreign instrumentality directly rather than an individual who was allegedly trying to benefit the foreign government. The outcome will likely have an important impact on enforcement and amendment efforts.
Quinn Emanuel’s Motion to Quash
Pre-indictment, the government asked the General Manager of Pan America, a separate U.S. company and subsidiary of two of the defendants, to accept a letter to Pangang Group’s chairman and legal representative. The General Manager refused. His counsel advised the government that neither he nor Pan America were authorized to accept service for the Pangang defendants. The government nonetheless delivered the summons to serve the indictment to Pan America’s office manager on February 9, 2012. The government also sent copies of those four summons via certified mail to Pan America’s office in New Jersey.
The Pangang defendants moved to quash service of the summons on the basis that the government failed to comply with the service requirements of Federal Rule of Criminal Procedure 4(c). Rule 4(c) has both a delivery and a mailing requirement: a summons may be served “on an organization by delivering a copy to an officer, to a managing or general agent, or to another agent appointed or legally authorized to receive service of process” and the summons must be mailed “to the organization’s last known address within the district or to its principal place of business elsewhere in the United States.” The Pangang defendants argued that neither requirement was met in this case. The government argued that it complied with both requirements because Pan America is the general agent and the principal place of business in the United States for the Pangang defendants. It argued alternatively that Pan America is each of the Pangang defendants’ alter ego.
The court heard argument on the motion to quash over two days before taking the matter under submission. On July 23, 2012, the judge issued his opinion.
Prior Precedent
The jurisdictional conundrum that this case poses is rare. Normally, service is straightforward in the criminal context because defendants are either individuals who are arrested and brought into the court’s jurisdiction or corporate defendants with a U.S. presence that enables the government to comply with the Rule 4 requirements. Unlike the civil rules, the criminal rules have no provision for foreign service — the only way to serve corporate criminal defendants without a U.S. presence is to demonstrate alter ego. It is therefore not surprising that the government rarely attempts to serve summons on non-defendants in criminal cases.
As noted by the court, although the “interplay between personal jurisdiction, sufficiency of service, agency, and alter-ego has been addressed frequently in civil cases . . . there appear to be only four criminal cases” on this issue. In all four of those cases, service of criminal process on an affiliate or subsidiary was found sufficient as to a foreign defendant only where there were compelling facts supporting an alter-ego finding. See United States v. Johnson Matthey PLC, 2007 WL 2254676, *1 (D. Utah Feb. 26, 2007) (granting motion to quash); United States v. Alfred L. Wolff GmbH, 2011 WL 4471383 (N.D. Ill. Sept. 26, 2011) (granting motion to quash and refusing to endorse the notion that an alter ego analysis even applies to Rule 4 compliance); United States v. Chitron Electronics Co., Ltd., 668 F. Supp. 2d 298, 300 (D. Mass. 2009) (denying motion to quash where the U.S. subsidiary was a “mere conduit” for the Chinese parent); United States v. The Public Warehousing Company, 2011 WL 1126333, *1-2 (N.D. Ga. Mar. 28, 2011) (denying motion to quash based on twelve-factor test adopted from civil context to determine if the subsidiary was the alter ego of the parent). Those four decisions, along with the Pangang opinion, demonstrate that whether the government can pierce the veil to disregard the corporate form and separateness of the corporate entities is “heavily fact-specific.” See Public Warehousing, 2011 WL 1126333 at *6.
The Delivery Requirement
To satisfy the delivery requirement, the government had to show that it had served a summons on the Pangang defendants’ managing or general agent. In the Ninth Circuit, an agency relationship exists if (1) the domestic subsidiary functions as the parent’s representative “in that it performs services that are sufficiently important to the foreign corporation that if it did not have a representative to perform them, the corporation’s own officials would undertake to perform substantially similar services,” and (2) the foreign defendant exercises a measure of control over the domestic subsidiary. The government must show an independent agency relationship between each particular defendant — a general agency theory as to the defendants as a group will not suffice.
For three of the defendants, the court held that the government did not establish that Pan America acted as their agent. As to the fourth defendant, the court found that Pan America did act as its agent and the government had therefore met its burden to show it satisfied the delivery requirement. That did not end the inquiry, however, because the government also had to comply with the mailing requirement.
The Mailing Requirement
To satisfy the mailing requirement, the government must show that it mailed the summons to the organization’s last known address within the district or to its principal place of business elsewhere in the U.S. Here, the government argued that it complied with the mailing requirement by mailing a copy of each of the summons to Pan America as the defendants’ general agent. However, the court found that even if Pan America was a general agent, the mailing requirement must be mailed to the organization’s principal place of business, not to an individual officer, director or general agent. The court also rejected the government’s argument that actual notice is sufficient.
The court held that “the only way for the government to show that it has complied with the mailing requirement is to show that Pan America is the alter-ego of a particular Pangang defendant,” and that the government had failed to do so in this case. Pan America observes basic corporate formalities, keeps its own separate records, retains profits for its own purposes, and has many other indicia of corporate separateness.
Alternative Means of Service
After holding that the government had failed to serve the defendants under Rule 4, the court inquired whether there were alternative means of service. The U.S. and the PRC have a Mutual Legal Assistance Agreement (MLAA) regarding assistance in criminal cases. However, the MLAA gives the requested party discretion whether or not to effect service: “[T]he Requested Party shall not be obligated to effect service of a document which requires a person to appear as the accused.” MLAA, Art. 8, para. 1.
In this case, the U.S. government initially represented that it believed that the PRC would not agree to effect service on the Pangang defendants, and that it would therefore be futile to attempt service by way of the MLAA. However, on August 16, the government indicated that it was exploring alternative means of effectuating service, including under the MLAA.
Ramifications of the Court’s Ruling
At oral argument, the government told the Court that its ruling would effectively end the EEA case against Quinn Emanuel’s clients. In an August 16, 2012 joint status statement, the government said it is exploring alternative methods of effectuating service, including under the MLAA. The next status conference is scheduled for October 11, 2012.
The Pangang opinion will undoubtedly make it more difficult for the U.S. government to serve foreign corporations. This is especially significant because the federal government has recently been redoubling its efforts to combat the theft of trade secrets. For instance, the DOJ and FBI reported last year that they have “increased their investigations and prosecutions of corporate and state-sponsored trade secret theft,” and promised that “[t]this focus will continue.” 2010 U.S. Intellectual Property Enforcement Coordinator, Annual Report on Intellectual Property Enforcement, at 4 (Feb .2011), available at http://www.cybercrime.gov/ipecreport2010.pdf. In fact, in announcing the Pangang case, the United States Attorney for the Northern District of California proclaimed that “fighting economic espionage and trade secret theft is one of the top priorities of this Office and we will aggressively pursue anyone, anywhere, who attempts to steal valuable information from the United States.” DOJ Press Release, U.S. and Chinese Defendants Charged with Economic Espionage and Theft of Trade Secrets in Connection with Conspiracy to Sell Trade Secrets to Chinese Companies (Feb. 8, 2012), http://www.justice.gov/opa/pr/2012/February/120nsd-180.html. The precise effect of this case on the government’s ability to live up to that promise remains to be seen. In some cases, service could still be achieved through the mutual legal assistance treaties that the U.S. has with various countries, but, as we saw in this case, those governments may not always interpret the treaties to allow for or require service. Further, many countries have no such agreements with the U.S. at all.
The government has also shown an increased focus on and willingness to prosecute cross-border crimes and foreign corporations more generally. A prime example of this is in the realm of intellectual property and trade secrets, which is ever increasingly an international affair. A specific and significant example of this is the attempted prosecution of file sharing platform Megaupload, another Quinn Emanuel client. On January 5, 2012, the government indicted Megaupload, its founder Kim Dotcom, and six other individuals for alleged copyright infringement in one of “the largest criminal copyright cases ever brought by the United States.” The government seized Megaupload’s domain and assets and forced it to shut down, but to date has not served a summons on any of its officers or agents. Megaupload is a foreign entity with no U.S. agents, offices, or subsidiaries. Like the Pangang defendants, Megaupload specially appeared for the limited purpose of asking the court to dismiss the indictment for lack of personal jurisdiction. Its motion stated that the “Federal Rules do not contemplate service of a criminal summons on a wholly foreign corporation without an agent or offices in the United States.” See United States v. Kim Dotcom, et al., case number 1:12-cr-00003-LO, in the U.S. District Court for the Eastern District of Virginia.
The Pangang case firmly establishes that Rule 4 does not allow for service on foreign corporations without a U.S. presence, regardless of alleged actual notice. The only exception is where the foreign corporation has a U.S. alter ego, in which case it is no longer a truly foreign entity.
The case is United States v. Liew et al., case number 3:11-cr-00573, in the U.S. District Court for the Northern District of California.
Analysis: The Federal Circuit’s Transocean Decision on Offer-To-Sell Infringement
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Offer-to-sell liability under U.S. patent laws has not historically been a topic of much discussion among patent litigators. See 35 U.S.C. § 271(a) (“…whoever without authority makes, uses, offers to sell, or sells any patented invention, within the United States, …, infringes the patent.”). Perhaps this is because reasonable royalty damages are difficult if not impossible to measure in the offer context (what would one pay in a hypothetical negotiation for a license to offer an infringing device for sale but not actually sell it). Recently, however, practitioners and academics alike have taken notice of offer-to-sell liability, particularly in light of the 2010 decision, Transocean Offshore Deepwater Drilling, Inc. v. Maersk Contractors USA, Inc., 617 F.3d 1286 (Fed. Cir.). Of particular interest is to what extent does “offer-to-sell” infringement extend the reach of U.S. patent law to conduct or persons outside the U.S.?
In Transocean, the offer was to construct and deliver a massive, floating oil drilling rig for use in the U.S. Gulf of Mexico. The terms of the offer were made and communicated outside the U.S., and the resulting contract provided that the oil rig could be modified prior to delivery to avoid patent infringement (which is precisely what happened). The Federal Circuit held that the offer to sell an infringing oil rig was sufficient to warrant a finding of patent infringement because the location of the “contemplated” sale was within the U.S. Id. at 1308.
Nearly a century ago, Judge Learned Hand held — under the then-existing patent laws — that it was not an infringement “for the defendant to take away from the plaintiff a contract calling for a door covered by the patent, and later to change the structure so that it did not infringe.” Van Kannel Revolving Door Co. v. Revolving Door & Fixture Co., 293 F. 261, 262 (S.D.N.Y. 1920). Interestingly, this is precisely the type of conduct found to infringe in the Transocean decision under the subsequently enacted “offer to sell” provision of the U.S. patent law. Curiously, however, under today’s version of § 271(a) as interpreted by the Federal Circuit in Transocean, the conduct described by Judge Hand is an infringement only if the location of the contemplated sale is within the U.S. According to the Transocean decision, offer-to-sell infringement is defeated when the contemplated sale is outside the U.S. See, e.g., Ion, Inc. v. Sercel, Inc., 2010 WL 3768110 (E.D. Tex.). In this situation, the “offeror” may actually follow through with its promise made to a U.S. customer to supply an infringing article and still avoid liability, provided it makes and then delivers the article outside the U.S.
The drilling rig ultimately delivered in the Transocean case was not infringing, having been modified before delivery. Thus, under the precedent set by the case, liability for offer-to-sell infringement does not require that an infringing article ultimately be delivered. By analogy, in the hypothetical scenario where the offeror makes an offer to a U.S. customer to supply an infringing article but intends to make and deliver it abroad, the device ultimately delivered is likewise not infringing (because one is not liable for direct infringement for making and selling an otherwise infringing article if it is done outside the U.S.). It is difficult to reconcile why this scenario would not trigger liability whereas liability is triggered when the offeror offers a patented article for sale but either (i) never delivers it or (ii) pulls a bait-and-switch of the type Judge Hand described back in 1920 and that actually occurred in the Transocean decision.
In Transocean, the U.S. Court of Appeals for the Federal Circuit held that “the location of the contemplated sale controls whether there is an offer to sell within the United States.” 617 F.3d at 1309. This holding means that a foreign manufacturer can engage in promotional activities within the U.S. (including by direct solicitation) and present offers to sell an infringing article to a U.S. company — yet still avoid liability so long as the ultimate delivery and performance take place abroad. This is because, under the Transocean decision, the location of the advertising and solicitation activities is apparently deemed irrelevant, the court having opted instead for a bright-line rule that bases the existence of offer-to-sell liability solely on the location of the contemplated sale.
In reaching its decision, the Federal Circuit noted that an offer to sell under § 271(a) is to be analyzed using traditional contract principles. Oddly, however, the “offer for sale” analysis in the Transocean decision lacks any discussion of traditional contract principles. Id. at 1308. Had the Federal Circuit actually considered traditional contact principles, the outcome may have been different, because traditional contract principles dictate that place of performance is not a necessary term for forming a valid offer sufficient to create the power of acceptance in another. For instance, the Uniform Commercial Code provides that “[a]n agreement for sale which is otherwise sufficiently definite […] to be a contract is not made invalid by the fact that it leaves particulars of performance to be specified by one of the parties.” U.C.C. 2-311(1). In fact, § 2-311 makes specific reference to details of shipment: “Unless otherwise agreed, […] specifications or arrangements relating to shipment are at the seller’s option.” Id. at 2-311(2). Thus, the Transocean decision would appear to detract from traditional notions of contract law by relying nearly exclusively on the place of performance in determining whether offer-to-sell infringement has occurred even though “place of performance” is not a term that is required to be stated for an offer to be valid and capable of acceptance.
Some Practical Thoughts on How to Determine the Place an Offer Is Made
The U.S. patent laws regulate conduct rather than the goods themselves (i.e., in personam vs. in rem). Infringement liability is therefore directed to “activities” performed by or at the direction of human beings (selling, making, using, offering, importing). Thus, it is the infringing offeror’s conduct that is to be regulated. And in view of the presumption against extraterritorial application of the U.S. patent laws (see Microsoft Corp. v. AT&T Corp., 550 U.S. 437 (2007)), for there to be offer-to-sell infringement, the act of “offering” an infringing item for sale should take place within the U.S. Under this construct, the physical location of the offeror would determine whether the “offer to sell” is made within the U.S. Accordingly, if an offer is made to sell an infringing article by a sales agent physically present in the U.S.—whether made to customers located outside or inside the U.S.—it is an infringement. On the other hand, if an offer is made to sell an infringing article by a sales agent not physically present in the U.S.—whether to customers located inside or outside the U.S.—it is not an infringement.
The case of in-person offers is straightforward: the offer is made in the place where the offeror communicates the offer to the offeree, wherever that may be. In the case of a telephone offer, the analysis is not as easy: the offer could be deemed made either (i) at the place where the offeror is located and makes the offer or (ii) at the place where the offeree is located and receives the offer. But, under the construct that the intent of the patent law is to regulate the infringer’s “conduct,” the answer would be the place where the offeror is located, as it is the offeror’s conduct that is to be regulated in this situation. Similarly, in the context of an e-commerce transaction, the rule would be that the location of the person/entity responsible for sending the electronic communication (i.e., the person/entity legally bound by acceptance of the offer) should control. In this manner, the patent law is properly drawn to the location of the infringing conduct rather than the location (or contemplated location) of the infringing article.
While not a perfect fit for all circumstances, by looking to where the offeror is located, this approach focuses more directly on the “conduct” that is to be regulated within the U.S. borders than does the Transocean approach. Transocean’s focus on the location of the ultimate sale seems to overlook that it is the act of “offering” that is to be regulated under the statute, not the physical delivery or possession of the sold good (which is already regulated under the “import” and “use” infringement provisions). In addition, as an independent basis for liability, an “offer for sale” should not be dependent in any way on an actual sale—whether consummated or merely contemplated—and therefore the place of performance or delivery should not dictate whether the offer is infringing. In Transocean, all of the infringing offeror’s conduct took place in Europe, yet infringement was still found to exist. Such a result is difficult to square with the presumption that U.S. patent laws should not regulate extraterritorial conduct.
September 2012: Trial Update
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Second Circuit Allows Jurors to Take Their Work Home: Every trial lawyer envies the jury at the end of trial day as the judge admonishes the jurors not to talk about the case or do any outside work, just as the lawyers are setting out to prepare for the next day’s proceedings. But in a surprising twist, the Second Circuit Court of Appeals recently approved jury homework in United States v. Esso, the jury was allowed to take home copies of the indictment to study at their leisure.
In Esso, jurors in a criminal mortgage fraud trial requested to leave a bit early from the first day of deliberations. To speed the proceedings, they asked that each juror be allowed to take a copy of the indictment home with them so they could read it on their own. The judge allowed them to do so over the defendant’s objections. The judge warned the jury neither to discuss the indictment nor to do any independent research on the case. And the judge reiterated that the indictment is just an accusation and is not evidence.
The Second Circuit, in a case of first impression, held that allowing homework did not deprive the defendant of a fair trial. The court reasoned that having the indictment at home is similar to thinking about the case while at home. The court also relied on precedent from a few jurisdictions that have allowed jurors to take home jury instructions during deliberations. The court put special emphasis on the fact that trial judges are afforded broad discretion in trial management techniques, especially when the techniques are intended to save time. The court cautioned that the risk of a juror discussing the case with a loved one or doing independent research was greater if the indictment was sent home with them. But, since there was no evidence that the jury disregarded the “clear, uncomplicated” warnings to the contrary, the practice was allowed.
Defense Lawyer’s Decision During Voir Dire Waives Challenge to Lying Juror: A defendant in the Southern District of New York recently lost the chance for a new trial because his lawyer had suspicions that a juror was engaged in misconduct but did not pursue them until after the verdict.
United States v. Daugerdas was a three-month tax shelter fraud trial that resulted in the conviction of four of the five defendants. After the convictions, a juror sent a letter of congratulations to the prosecutor who then shared the letter with all defense counsel. Counsel for David Parse, who had had suspicions about the juror during voir dire and during the trial, then fully investigated the juror. Counsel discovered that the juror lied during voir dire so she could become a juror. She lied about where she lived, her and her husband’s criminal history, her educational background, and the civil cases that she was a party to. And she did not disclose that she was a disbarred attorney.
The district court held a hearing where the juror admitted to concocting an entire persona to make herself more “marketable” as a prospective juror. The juror also showed great bias against defense counsel, lamenting about their professional successes compared to her own and declaring that “‘most attorneys’ are ‘career criminals.’” The judge held that the juror’s misconduct entitled three of the convicted defendants to a new trial.
But the district court found that Parse was not entitled to a new trial because he waived his sixth amendment right to an impartial jury. During voir dire Parse’s defense counsel knew by doing a Google search that there was a disbarred attorney with the same name as the prospective juror. Defense counsel discounted the possibility that the two were the same person based on the juror’s answers during voir dire. Later in the trial, the juror sent a note to the judge asking about a legal standard, which prompted defense counsel to do more research into the juror’s background, including obtaining a Westlaw report. There were more similarities between the juror and the disbarred attorney, causing counsel to remark during an email exchange with a colleague: “Jesus, I do think that’s her.” The judge found this, among other things, as evidence of defense counsel’s actual knowledge of the juror’s true identity. The court alternatively found waiver because the defense counsel’s decision not to follow up on the evidence showed a “glaring lack of reasonable diligence.”
September 2012: Internet Litigation Update
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Internet Retransmission of Television Broadcasts Approved: Judge Alison Nathan of the Southern District of New York ruled on July 11, 2012, that the Internet retransmission of over-the-air television signals is not copyright infringement. American Broadcasting Companies sought to prohibit Aereo, Inc. from providing its users with free access to television programs captured at their instruction by Aereo’s antennas and maintained on its hard disks. In denying ABC’s application for preliminary injunction, Judge Nathan ruled that there is no “public performance” of the works Aereo records and, hence, no copyright infringement. Aereo characterized its system as “allowing users to rent a remotely located antenna, DVR, and Slimbox-equivalent device, . . . to access content they could receive for free and in the same manner merely by installing the same equipment at home.” The court acknowledged that if Aereo did allow the public to access freely the recorded programs, it would be engaging in a “public performance” of copyrighted works and would be liable for infringement. The court also acknowledged that under Cartoon Network LP v. CSE Holdings, Inc., 536 F.3d 121 (2d Cir. 2008), the mere transmission of a performance is itself a “performance” for infringement purposes. However, Aereo’s users could only access programming that they, themselves, had selected, meaning that they merely enjoyed “a service that could also be accomplished by using any standard DVR or VCR.” Accordingly, Aereo’s service was held not infringing. The case is American Broadcasting Companies v. Aereo, Inc., 12 Civ. 1543 (AJN) (S.D.N.Y. July 11, 2012).
Employer that Provided Internet Connectivity Held Subject to Suit: Internet service providers (“ISPs”) generally enjoy an absolute immunity with respect to content provided by others if they play no role in gathering or editing that content. The narrow exceptions concern federal criminal liability and intellectual property infringement. When those concerns were not implicated, the courts have for many years interpreted Section 230 of the Communications Decency Act of 1996, 47 U.S.C. § 230, broadly and have used it to protect ISPs that refused to take down even clearly libelous materials. However, the sense of comfort that an ISP need not concern itself with the content of materials posted by others has recently been called into question by an Illinois appeals court, which held that an employer could be found liable for failing to take down an employee’s threats made to a third party. The court concluded that irrespective of Section 230, the employer could be found liable for negligent supervision because its duty to supervise its employees “is distinct from any conduct like editing, monitoring or removing offensive content published on the Internet.” The case is Lansing v. Southwest Airlines Co., 212 Ill. App. (1st) 101164 (Ill. Ct. App. June 8, 2012).
September 2012: Russia Litigation Update
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Overview: Dispute resolution through international arbitration is rapidly developing in Russia, although not quite at the pace set by the leading international arbitration centers of Europe, such as London, Paris, and Stockholm. All the basic pieces are in place: the Russian Federation is a party to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, the 1961 European Convention on International Commercial Arbitration, and even the seldom used 1972 Moscow Convention on the Settlement by Arbitration of Civil Law Disputes Arising from Relations of Economic, Scientific and Technical Cooperation. In July of 1993, Russia adopted its own law “On International Commercial Arbitration” (“ICA”), which essentially mirrors the UNCITRAL model law.
These are certainly positive developments, but hurdles must still be cleared on the path to Russia’s full acceptance of international arbitration as a global dispute resolution mechanism. Court, decisions, and even statements of high-ranking Russian officials, reflect a cautious—and in some cases an internally controversial—attitude towards arbitration of which practitioners and clients should be aware.
Arbitrability: Significant developments have occurred on the subject of which disputes are arbitrable in the first instance. Generally, Russian law recognizes that all commercial and other civil law disputes (with limited exceptions) may be arbitrated; however, public law cases, such as bankruptcy and tax matters, remain within the exclusive province of the courts. However, recent court decisions have sent a disturbing message on arbitrability. In 2011, the Constitutional Court in ZAO Kalinka Stockmann v. Smolensky Pasazh, issued a decree clarifying that only domestic arbitral tribunals could resolve real estate disputes. And earlier this year, a three-judge panel of the Supreme Arbitrazh Court in the Maximov v. NLMK confirmed that the lower courts had correctly set aside an award of the International Commercial Arbitration Court at the RF Chamber of Commerce and Industry (“ICAC”) on the basis that a dispute arising out of non-payment under a sale-purchase agreement of shares in a Russian company, as well as other corporate disputes, could not be resolved by arbitration; worse, the decision includes a pronouncement that corporate disputes in general are not arbitrable in Russia. Both cases are disturbing from an international arbitration perspective: although the real estate decision would generally be applicable to real property in Russia, it certainly is possible that a foreign party could be involved in such a dispute (for example, in a real estate development deal with international investors). The same is obviously true regarding disputes between corporations—indeed, the vast majority of international arbitration disputes today are between corporations, partnerships, or similar legal entities.
Public Policy: Russian courts also seem to have adopted unique grounds for vacating awards on the grounds of public policy. The New York Convention of course recognizes a violation of “public policy” as grounds for refusing to enforce an international arbitration award. But case law around the world has interpreted this clause very narrowly, limiting it to behavior that offends fundamental principles of morality (see e.g., Parsons & Whittemore Overseas Co. v. Societe Generale de L’Industrie du Papier (“RAKTA”), 508 F.2d 969, 973 (2d Cir. 1974). As such, vacatur petitions on grounds of “public policy” under the Convention are seldom made and even more rarely granted.
Russia is falling into line with this reasoning, but the road has not been easy, as demonstrated in the remarkable case of Stena RoRo v. Baltiisky Zavod, —decided September 13, 2010—by the Supreme Arbitrazh Court. In Stena RoRo, the Court annulled the lower courts’ decisions that refused recognition and enforcement of an international arbitration award issued under the arbitration rules of the Swedish Chamber of Commerce based on a “public policy” rationale that was defined not in terms of morally reprehensible conduct but as an award that would lead to bankruptcy of Baltiisky Zavod (a strategic Russian enterprise), thereby jeopardizing the interests of Russia in violation of public policy. However, in righting the Russian “public policy” ship, the Supreme Court did somewhat more than it had to, holding that the question of the validity of the contracts had been considered by the arbitral tribunal and could not be reconsidered at the enforcement stage by the state court. Obviously, this holding raises its own controversy—i.e., whether Russia will allow courts to entertain any vacatur petition, either under the New York Convention or Russian law, which seeks to reexamine the validity of contract decided by the arbitral tribunal, even if the facts fit under one or more of the recognized grounds for vacatur.
Interim Measures: In line with virtually all sets of international arbitration rules, Russian law provides for the possibility of granting interim measures in support of a pending arbitration in situations where the court believes that a failure to do so could render the enforcement of the award impossible, substantially complicate enforcement, or cause the applicant to incur substantial damage. Happily, recent court decisions on this issue are much more mainstream, granting interim measures in support of international arbitration and, in one case, an attachment of assets. See Edimax Limited v. Shalva Chigirinsky (2010) (Russian Arbitrazh court granted interim measures to support Enka v. KMKI Dobrininskiy (2011) (court issued pre-award attachment of land lease rights over a state-owned land plot in support of a pending ICC construction arbitration).
Impartiality of Arbitrators: In 2010, the RF Chamber of Commerce and Industry adopted Rules on Impartiality and Independence of Arbitrators (“Rules”) based on, inter alia, the IBA Guidelines on Conflicts of Interest in International Arbitration. While the court practice on application of the Rules has yet to be established, the Rules have already become a ground for setting aside an ICAC award (Ruling of Supreme Arbitrazh Court of 30 January 2012 in Maximov v. NLMK). However, the Court once again seems to have overshot the mark. Specifically, the Court found that the failure by the arbitrators to disclose that they were employees of the same education and scientific institutions as experts who provided legal opinions to the tribunal cast doubt on the impartiality of the arbitrators sufficient to vacate the award, which is as aggressive a position on arbitrator bias as that taken by any court.
Mediation: In addition to arbitration, another positive signal of the overall development of alternative dispute resolution mechanisms in Russia is the January 1, 2011 adoption of the set of rules aimed at regulating mediation. It includes the Federal Law “On Alternative Procedure of Dispute Settlement with Participation of Mediator (Mediation Procedure)” and a separate set of amendments to the Russian procedural laws designed to incorporate mediation into the already existing procedures. It is promising that the law covers a broad range of disputes—civil, labor (except for collective employment disputes), and family law, except when such disputes affect public interests or the rights and legitimate interests of third parties that are not participants in the mediation.
All told, the Russian Federation is getting there. Movement toward fully embracing international arbitration appears to clearly be on the horizon—perhaps the fairly immediate horizon—but parties may not be able to take full comfort from an arm’s length negotiated international arbitration clause until court decisions on arbitration issues become more predictable.
September 2012: Securities Litigation Update
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Materiality and Class Certification in Securities Fraud Litigation: Are plaintiffs in securities fraud class actions required to prove materiality at the class certification stage? In cases where plaintiffs rely on the “fraud on the market” theory to plead reliance, the Second, Third, and Fifth Circuits have all suggested that the answer may be yes, creating a major potential obstacle for class action plaintiffs. The Seventh and Ninth Circuits, however, have held that class action plaintiffs need not prove materiality at the class certification stage. The Supreme Court recently granted certiorari to the latest circuit court decision to address this question in an apparent effort to resolve this split among the circuits. Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 660 F.3d 1170 (9th Cir. 2011), cert. granted, 80 U.S.L.W. 3519 (U.S. Jun. 11, 2012) (No. 11-1085). In addition to resolving this split of authority, the Supreme Court’s impending decision could help further define the contours of the fraud on the market theory for the first time in nearly twenty-five years and affect the number of securities fraud class actions filed in the future.
In 2011, the Supreme Court handed down two decisions that sent mixed signals to courts addressing class certification in securities class actions, Erica P. John Fund Inc. v. Halliburton Co., 131 S. Ct. 2179 (2011) and Wal-Mart Stores v. Dukes, 131 S. Ct. 2541 (2011). In Dukes, the Court reaffirmed a position expressed in General Telephone Co. of the Southwest v. Falcon, 457 U.S. 147 (1982), that courts must engage in a “rigorous analysis” to determine if Rule 23(b)(3)’s threshold issues like numerosity and commonality have been satisfied. The Court explained that such analysis may likely “overlap with the merits of the plaintiff’s underlying claim,” and that this overlap simply “cannot be helped” since the class certification inquiry “generally involves considerations that are enmeshed in the factual and legal issues comprising the plaintiff’s cause of action.” Dukes, 131 S. Ct. at 2551-52. In contrast, just weeks before Dukes, the Halliburton Court ruled that class action plaintiffs do not need to prove up the merits of loss causation in order to obtain class certification. As a result, courts applying Rule 23(b)(3) in the wake of Halliburton and Dukes have grappled with the questions of which elements must be subjected to merits-based scrutiny to determine class certification, and what level of scrutiny should be applied.
Further complicating this issue is application of the “fraud on the market” theory in securities class actions. Nearly twenty-five years ago, the Supreme Court in Basic v. Levinson, 485 U.S. 224 (1988), endorsed the “fraud on the market” theory, making it easier for plaintiffs in securities fraud class actions to establish commonality on the issue of reliance. The fraud on the market theory creates a rebuttable presumption of reliance on false statements once they become public. According to the theory, when a party “makes a false [or true] statement that adds to the supply of available information, that news passes to each investor through the price of the stock.” Schleicher v. Wendt, 618 F.3d 679, 682 (7th Cir. 2010). The presumption can be invoked even if the investor never saw the misstatements at issue because the theory’s premise is that the misstatements are built into the market price itself. To obtain class certification, virtually all courts since Basic have agreed that class action plaintiffs may be required to do more than plead the conditions necessary for a fraud on the market—such as an efficient market—they may be required to show some proof of it.
Materiality, like an efficiently operating market, could be viewed as a necessary precondition for establishing a case of fraud on the market. This seems to be the basis for the approach taken by the Second, Third, and Fifth Circuits. In support of their position, those courts cite a footnote from the Supreme Court’s Basic decision, which appears to include materiality as one of the elements required for the fraud on the market presumption:
The Court of Appeals held that in order to invoke the presumption, a plaintiff must allege and prove: (1) that the defendant made public misrepresentations; (2) that the misrepresentations were material; (3) that the shares were traded on an efficient market; (4) that the misrepresentations would induce a reasonable, relying investor to misjudge the value of the shares; and (5) that the plaintiff traded the shares between the time the misrepresentations were made and the time the truth was revealed. 485 U.S. at 248 n.27 (emphasis added).
Based on this language, the Second Circuit requires plaintiffs to make “some showing”—beyond the allegations of the complaint—of the elements triggering the Basic presumption, including materiality. In re Salomon Analyst Metromedia Litigation, 544 F.3d 474, 484 (2d Cir. 2008). The Fifth Circuit’s requirement is even more rigorous: “[T]he plaintiff may recover under the fraud on the market theory if he can prove that the defendant’s [alleged fraud] materially affected the market price of the security.” Oscar Private Equity Investments v. Allegiance Telecom Inc., 487 F.3d 261, 265 (5th Cir. 2007). The Third Circuit’s rule permits defendants to rebut the fraud on the market presumption during class certification by affirmatively showing that alleged misrepresentations were immaterial. In re DVI, Inc. Sec. Litig., 639 F.3d 623 (3d Cir. 2011).
The Seventh and Ninth Circuits, however, hold that materiality need not be proven for class certification. Instead, materiality, like loss causation, must only be plausibly alleged at the class certification stage, and its adjudication on the merits must await trial. In defense of this approach, the Seventh Circuit has explained that “certification is largely independent of the merits, and a certified class can go down in flames.” Schleicher, 618 F.3d at 685. In a similar vein, the Ninth Circuit has held that materiality “is a merits issue that abides the trial or motion for summary judgment.” Amgen, 660 F.3d at 1172. The Seventh and Ninth Circuits contend that Basic’s footnote 27 demonstrates only that the decision under review in Basic deemed materiality an essential precondition, not that the Supreme Court adopted that precondition. The Ninth Circuit also notes that more recent formulations of the fraud on the market presumption contained in Halliburton and Dukes do not mention materiality as a precondition. Amgen, 660 F.3d at 1176.
Amgen presents the Court with its first chance in almost a quarter of a century to revisit and refine the fraud on the market theory and to indicate, more specifically, whether materiality is a precondition that must be proven to obtain class certification. If the Court does hold that materiality is an element that must be proven to sustain the presumption of reliance under a fraud on the market theory, the number and viability of class action securities fraud cases would certainly be diminished, as this would be difficult for many class plaintiffs to establish. Either way, Amgen is a decision that should be carefully watched.
Raising the Stakes in International Arbitration
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International arbitration of high-value disputes involving claims of $100 million to over $1 billion is on the rise. The largest international arbitration institutions are consistently reporting year-on-year growth in the number and size of disputes they administer, and have been doing so for several years. For example, 2011 saw the highest number of investment arbitrations ever filed. See United Nations Conference on Trade and Development (UNCTAD), Latest Developments in Investor-State Dispute Settlement (2011). According to the American Lawyer’s Arbitration Scorecard 2011, between 2009 and early 2011, there were 113 known pending international arbitrations where the amount in dispute was $1 billion or more. See Michael D. Goldhaber, 2011 Arbitration Scorecard: High Stakes, The American Lawyer (July 1, 2011) at 1 [hereinafter 2011 Arbitration Scorecard]. The true figure is probably higher due to the confidentiality of many of these large arbitrations. The Global Arbitration Review (“GAR”), a leading publication in the field, reported that its measure of the total value of international arbitration claims and counterclaims that reached the merits stage jumped over 100% this year, from $96 billion a year ago to $206 billion this year. See Sebastian Perry, The GAR 30 Unveiled, GAR News (March 12, 2012), available at www.globalarbitrationreview.com/news/article/30389/the-gar-30-unveiled/. There is no sign of this upward trend slowing down.
Why International Arbitration?
International arbitration has become the preferred means of resolving cross-border business disputes. Anecdotal and empirical evidence suggest that the bigger the amount in dispute, the more likely it is that the dispute will be referred to international arbitration. See Queen Mary, Univ. of London & PricewatehouseCoopers, International Arbitration: Corporate Attitudes and Practices 2008, available at www.pwc.co.uk/forensic-services/publications/international-arbitration-2008.jhtml [hereinafter Corporate Attitudes and Practices]. There are a number of important reasons for this phenomenon. First, and perhaps foremost, businesses involved in multi-million and multi-billion dollar cross-border deals do not, generally speaking, feel comfortable leaving dispute resolution in the hands of local courts or local arbitration centers. They want to maximize the chances of having objective, neutral decision-makers resolve any disputes that may arise. Second, the parties can designate arbitral proceedings as confidential, which allows the parties to resolve their disputes outside of the public eye. Third, the parties are able to select the persons who will be deciding their dispute, based on, among other criteria, those persons’ particular industry- and sector-specific expertise. Fourth, the flexibility of the procedure is appealing, as the parties can participate in designing the main aspects of their dispute resolution process. Fifth, the decisions of international arbitral tribunals are generally subject to limited review, either on appeal or in annulment proceedings. Sixth, arbitral awards are generally more easily enforceable as compared with foreign court judgments. The 1958 United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“New York Convention”) and the 1965 Convention on the Settlement of Investment Disputes Between States and Nationals of Other States (“ICSID Convention”), ratified by 146 and 148 countries respectively, provide efficient and effective procedures for enforcing foreign arbitral awards in most countries of the world. In contrast, the 1971 Convention on the Recognition and Enforcement of Foreign Judgments in Civil and Commercial Matters has only 5 Contracting States, leaving foreign court judgment-holders at the mercy of local court procedures all over the world. These are but a few of the compelling reasons why international arbitration has become the gold standard for resolving international business disputes.
The 2008 study International Arbitration: Corporate Attitudes and Practices by the School of International Arbitration at Queen Mary, University of London—the most recent survey of corporate attitudes towards international arbitration—concluded that major corporations overwhelmingly prefer to arbitrate international disputes. This study offers insight into why international arbitration is a preferred method of dispute resolution for many large corporations involved in high stakes disputes:
• Of the companies polled, 88% have used arbitration. Certain industries, such as insurance, energy, oil and gas, and shipping rely on international arbitration as a default resolution mechanism.
• Of the in-house counsel polled, 86% said they were satisfied with international arbitration. Corporate counsel saw the enforceability of arbitral awards, the flexibility of the procedure, and the depth of expertise of the arbitrators as the major advantages to arbitration.
• In the vast majority of cases (up to 90% according to interviews with corporate counsel), the non-prevailing party voluntarily complies with the arbitral award. In cases of non-compliance, most companies are able to enforce arbitral awards within one year and usually recover more than 75% of the value of the award.
See Corporate Attitudes and Practices at 2–4.
The recent trend of high-value international arbitration should give companies that are not using international arbitration reason to reexamine the dispute resolution procedures they include in their high-value cross-border agreements.
Why Such an Increase in Billion-Dollar Disputes?
The increase in the size and volume of international arbitrations is correlated to the flow of foreign investment into emerging economies. In recent decades, a large influx of foreign investment poured into emerging economies in several areas, including India, Asia, Latin America, Eastern Europe, and Africa. As The American Lawyer put it, recent high-value arbitrations involve disputes ranging from “the Almaty Monorail and Bosphorus tunnel projects to Mongolian gold mines, Uruguayan cigarettes, and Zimbabwean farms seized by the thugs of Robert Mugabe.” See 2011 Arbitration Scorecard at 1. These areas are rich in natural resources, but also often susceptible to economic and political instability, which in turn tends to generate business disputes. For the reasons noted above, international arbitration is a critical risk mitigation tool for companies as they do more business abroad in emerging economies, because it provides foreign investors a more level and manageable dispute resolution playing field in the event of a dispute.
We may also be witnessing a trend in high-value arbitrations sprouting interrelated cases and follow-on claims in multiple fora, thereby increasing the total overall aggregate value of the dispute. The incidence of parallel contract and investment arbitrations, as well as parallel U.S. and foreign litigation, seems to be increasing. For example, in a long-running dispute with Venezuela, ExxonMobil lodged claims where the amount in controversy (including counterclaims) reached upwards of $20 billion in parallel commercial and investment arbitrations under the rules of the International Chamber of Commerce (ICC) and International Centre for the Settlement of Investment Disputes (ICSID). ExxonMobil recently won a $907.6 million award before the ICC tribunal (subject to discounting), while the ICSID proceeding remains pending. See Mobil Cerro Negro Ltd. v. PDVSA Cerro Negro S.A., Final Award, ICC Case No. 15415/JRF, Dec. 11, 2011; Mobil Corp. and Others v. Bolivarian Republic of Venezuela (ICSID Case No. ARB/07/27).
The recent wave of high-value arbitrations may also be explained in light of regional economic crises. These include the spread of resource nationalism in Russia and Latin America, and the economic upheavals of debt-ridden Europe, where E.U. member states have implemented austerity measures with severe repercussions for foreign investors. Some of the largest arbitrations that were active in 2009 and 2010 centered on gas pricing regulation in Europe. Indeed, as of January 2011, oil and gas cases accounted for more than a third of the billion-dollar arbitrations and eight out of eleven awards of $350 million or more. See 2011 Arbitration Scorecard at 1.
Case Studies of Multi-Billion Dollar Arbitrations: 2009-2011
Between 2009 and early 2011, the largest arbitrations generally concerned disputes in the energy (mostly oil and gas), mining, and high-tech sectors. For example, in the largest reported arbitration to date, the majority shareholders of the defunct Yukos Oil Company sued Russia for over $100 billion in an UNCITRAL arbitration at the Permanent Court of Arbitration in The Hague, and survived jurisdictional challenges. See Yukos Universal Ltd. v. Russian Fed’n, Interim Award on Jurisdiction and Admissibility, PCA Case No. AA 227 (Nov. 30, 2009); Catherine Belton, Yukos Owners Win Ruling, Financial Times (Dec. 1, 2009). The claimants argue that Russia forced Yukos into bankruptcy by inflating tax claims in a politically-motivated attack on former CEO Mikhail Khodorkovsky.
Separately, ConocoPhillips brought a claim against Venezuela for up to $30 billion alleging breaches of its treaty obligations for its expropriation of a joint-venture project to produce crude oil from the Orinoco Belt. See ConocoPhillips Co. and Others v. Bolivarian Republic of Venezuela (ICSID Case No. ARB/07/30). The hearing on the merits took place in May-June 2010 and the parties are awaiting the tribunal’s final award.
In another example, U.S. and Danish companies Anadarko Petroleum and Maersk Oil sought $10 billion from the Algerian state-owned oil company Sonatrach over its “windfall-profits” tax in parallel proceedings in ad hoc UNCITRAL and ICSID arbitrations. See Mærsk Olie, Algeriet A/S v. People’s Democratic Republic of Algeria (ICSID Case No. ARB/09/14). In a positive resolution to this long-running dispute, the parties agreed to settle the arbitrations in March of this year in exchange for concessions on both sides, including large shipments of crude oil worth $1.8 billion to Anadarko and an additional $920 million in crude to Maersk. See Kyriaki Karadelis, Anadarko and Maersk Settle with Sonatrach, GAR News (Mar. 15, 2012), available at http://www.globalarbitrationreview.com/news/article/30402/anadarko-maersk-settle-sonatrach/. The parties also agreed to continue their profit-sharing agreements under revised terms, ultimately restoring their business relationship.
These are just a few examples of the high-stakes arbitrations that topped the charts between 2009 and early 2011.
2012 and Beyond
The trend toward high-value international arbitration disputes has continued in 2012. In May, an ICC tribunal awarded Dow Chemical Co. $2.16 billion plus costs and interest from Petrochemical Industries Company of Kuwait. See Sebastian Perry, Dow Wins US$2 Billion Over Cancelled Kuwaiti Venture, GAR News (May 24, 2012), available at www.globalarbitrationreview.com/news/article/30567/dow-wins-us2-billion-cancelled-kuwaiti-venture/. Dow Chemical filed the claims based on the cancellation of a planned joint venture to create the world’s biggest polyethylene manufacturer (“K-Dow”) after the plan was thwarted by parliamentary opposition.
The first half of 2012 has also seen billion-dollar settlements in international arbitrations. In January, the Canadian mining company First Quantum Minerals Ltd. settled multi-party ICSID and ICC disputes with the Democratic Republic of the Congo and the Eurasian Natural Resources Corp. (ENRC) over the government’s cancellation of First Quantum’s mining permits and nationalization of the mines for $1.25 billion. See First Quantum Closes Congo Claims Agreement with ENRC, Reuters (Mar. 2, 2012), available at www.reuters.com/article/2012/03/02/firstquantumminerals-idUSL4E8E26B420120302. A few weeks later, two American oilfield services companies, William Cos Inc. and Exterran Holdings, settled their ICSID claim against Venezuela stemming from the nationalization of their natural gas compression facilities for $420 million, slightly over one-third of the $1.2 billion they had claimed in damages. See Marianna Parraga, Venezuela to Pay $420 million to Williams and Exterran, Reuters (Mar. 24, 2012), available at www.reuters.com/article/2012/03/24/us-venezuela-oil-nationalizations-idUSBRE82N0BW20120324.
Full or even partial victory in high-value international arbitration can never be guaranteed, however, and there are recent examples of large claims being defeated before arbitration tribunals. A mutually-appointed sole arbitrator dismissed Thailand’s state-owned CAT Telecom PCL’s $735 million claim against rival Total Access Communication PCL for concession fees it claimed to be owed. The sole arbitrator found that Total Access Communication was legally entitled to subtract the fees to pay an excise tax. See Phisanu Phromchanya, Total Access Communication PCL: Arbitrator Dismisses CAT Telecom’s THB23 Billion Claim against Total Access, Dow Jones Newswire (June 7, 2012), available at www.totaltele.com/view.aspx?ID=474133. A few days later, on June 5th, an ICSID tribunal dismissed for lack of jurisdiction an estimated $1.2 billion-dollar case brought by Kazakh oil company Caratube against Kazakhstan. The ICSID tribunal found that a U.S. national who owned 92% of the Kazakh-company-claimant lacked a sufficient nexus to the company to allow it to invoke the protections of the U.S.-Kazakhstan bilateral investment treaty. See Caratube Int’l Oil Co. LLP v. Republic of Kazakhstan (ICSID Case No. ARB/08/12); Kyriaki Karadelis, Caratube Claim Dismissed for Lack of ‘Foreign Control,’ GAR News (June 14, 2012), available at www.globalarbitrationreview.com/news/article/30613/caratube-claim-dismissedlack-foreign-control/.
Other high-value arbitrations are moving full steam ahead in 2012. At least eight new arbitrations have been publicly announced this year in which the claim value exceeds $1 billion. A number of these claims arise in the energy and telecom sectors. For instance, Norwegian telecom operator Telenor gave notice to the Indian government in March that it would file an international arbitration claim seeking nearly $14 billion in damages unless the government promised to reverse the revocation of its mobile licenses or provide adequate compensation for its expropriated investment. See Telenor Seeks Arbitration, Claims Damages of $14 Billion from Govt in 2G Case, The Times of India (Mar. 27, 2012), available at timesofindia.indiatimes.com/business/india-business/Telenor-seeks-arbitration-claims-damages-of-14bn-from-govt-in-2G-case/articleshow/12420404.cms. German utility company Vattenfall Europe AG filed a request with ICSID in June seeking $18.7 billion in damages from Germany due to the government’s decision to exit nuclear power and shut down Vattenfall’s reactors. See Vattenfall AB and Others v. Federal Republic of Germany (ICSID Case No. ARB/12/12); Vattenfall Launches Second Claim Against Germany, GAR News (June 25, 2012), available at www.globalarbitrationreview.com/news/article/30634/vattenfall-launches-second-claim-against-germany/. Similarly, in June of this year it was reported that the southern German state of Baden-Württemberg filed a €2 billion ICC claim over its purchase of a stake in German utility Energie Baden-Württemberg (EnBW) from French power company EDF. See EDF faces ICC claim over German power company purchase, GAR News (June 6, 2012), available at www.globalarbitrationreview.com/news/article/30593/edf-faces-icc-claim-german-power-company-purchase/. And in July, Reliance Power Ltd. filed for arbitration against eleven state distribution companies claiming $3.14 billion in damages in connection with a delayed 4000-MW power project in southern Indonesia, after changes in export rules by Indonesia raised prices of coal and made the project nonviable. See Sanjeev Choudhary, India’s Reliance Power Seeks Arbitration Against Distribution Cos, Reuters (July 2, 2012), available at www.reuters.com/article/2012/07/02/reliancepower-arbitration-idUSWNAS994920120702.
This phenomenon is not going away. While some commentators question whether international arbitration is a better alternative to other forms of dispute resolution, the fact remains that many parties involved in significant cross-border deals and investments rely on, and prefer, international arbitration to resolve their controversies.
Federal Circuit Establishes New Rule for Proving Willful Infringement: Bard Peripheral Vascular, Inc. v. W.L. Gore & Associates, Inc.
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In a decision with significant implications for patent cases involving willful infringement, the Federal Circuit recently held that the threshold determination of objective recklessness under the Seagate standard for willful infringement is a question of law to be decided by the trial court and subject to de novo review. Bard Peripheral Vascular, Inc. v. W.L. Gore & Assocs., Inc., 682 F.3d 1003, 1006-07 (Fed. Cir. 2012). While the ultimate determination of willful infringement had long been considered a question of fact to be decided by the fact finder and subject to the clearly erroneous standard of review, the Federal Circuit had not previously addressed the standards that apply to the threshold determination of objective recklessness. Id. at 1006.
Under the patent laws, if a patentee is able to prove that its patent was willfully infringed, it is entitled to enhanced damages, up to three times compensatory damages. Id. at 1005. In Seagate, the Federal Circuit, sitting en banc, overruled its prior standard for willful infringement, which was “more akin to negligence” than recklessness. In re Seagate Tech., LLC, 497 F.3d 1360, 1371 (Fed. Cir. 2007) (en banc). The court set forth a new two-pronged standard for proving willful infringement. Id. First, the patentee must prove by clear and convincing evidence that the alleged infringer acted despite “an objectively high likelihood that its actions constituted infringement of a valid patent.” Id. Second, the patentee must then prove that this objectively high risk was “either known or so obvious that it should have been known” to the alleged infringer. Id. Subsequently, the Federal Circuit ruled that the first prong of this standard is generally not met where the alleged infringer relies on a reasonable defense. Spine Solutions, Inc. v. Medtronic Sofamor Danek USA, Inc., 620 F.3d 1305, 1319 (Fed. Cir. 2010).
The Federal Circuit’s recent decision in Bard v. Gore was the latest development in a long-running patent suit. On March 28, 2003, Bard filed suit against Gore in the District of Arizona, alleging infringement of U.S. Patent No. 6,436,135. Bard Peripheral Vascular, Inc. v. W.L. Gore & Assocs., Inc., 670 F.3d 1171, 1177 (Fed. Cir. 2012). The technology at issue involved prosthetic vascular grafts that are fabricated from highly-expanded polytetrafluoroethylene, and that are used to bypass or replace blood vessels to assure adequate and balanced blood flow to particular body parts. Id. at 1175.
Following a 17-day trial, on December 11, 2007, the jury found that the ’135 patent was valid and willfully infringed by Gore. Id. at 1177. The jury awarded Bard lost profits of over $102 million and reasonable royalties of over $83 million. Id. at 1178. Based on the jury’s finding of willful infringement, the court awarded Bard enhanced damages of over $371 million, two times the compensatory damages awarded by the jury. Id. The court also awarded Bard attorneys’ fees and non-taxable costs of $19 million and an ongoing royalty with a range of rates between 12.5% and 20% for Gore’s various types of infringing grafts. Id. At the end of the case, the court described it as “the most complicated case this court has presided over.” Id.
On appeal, the Federal Circuit initially affirmed the judgment of validity and willful infringement, as well as the district court’s award of enhanced damages, attorneys’ fees and costs, and an ongoing royalty. Id. at 1193. Gore timely filed a petition for rehearing and rehearing en banc. Bard, 2012 WL 2149495, at 1005. On June 14, 2012, the Federal Circuit granted the petition for rehearing en banc and returned the case to the original panel for reconsideration of the standard of review for willful infringement. Id.
In an opinion authored by Judge Garza and joined by Judge Linn, the panel revisited this issue. Id. As an initial matter, the court reviewed Supreme Court and Federal Circuit precedent and recognized that the simple statement that the ultimate determination of willful infringement is a question of fact oversimplifies the issue. Id. at 1006. For example, in an earlier opinion, the Federal Circuit had recognized that the issue is more complex, and held that the threshold determination whether an alleged infringer relied on a reasonable defense is a matter for the jury when the resolution of the defense is a question of fact, but that determination is a matter for the trial court when the resolution of the defense is a question of law. Id. While the second prong of the Seagate test, like the ultimate determination of willful infringement, may have been a question of fact, the issue in Bard was whether the determination of the first prong is a question of law, a question of fact, or a mixed question of law and fact. Id. That threshold question would determine which judicial actor would decide the issue at the trial court level, and what standard of review would apply to that determination on appeal.
Recognizing that the characterization of an issue as one of these types of questions is sometimes a matter of allocation and administration, as much as a matter of analysis, the Federal Circuit concluded that the trial court was better positioned than the jury to make the threshold determination of objective recklessness, including whether the alleged infringer relied on a reasonable defense. Id. The Federal Circuit therefore held that the threshold determination is a question of law, which is decided by the judge and subject to de novo review. Id. at 1006-07. The Federal Circuit noted that its holding was consistent with similar holdings in parallel areas of law, including Federal Circuit precedent on the standard for proving objectively baseless claims for purposes of obtaining enhanced damages and attorneys’ fees, and Supreme Court precedent on the standard for proving objectively baseless litigation for purposes of establishing the “sham litigation” exception to antitrust immunity for bringing patent and other lawsuits. Id. at 1007-08.
With respect to the application of this new rule, the Federal Circuit explained that where the threshold determination of objective recklessness is dependent on purely legal questions such as claim construction, the determination should be made by the trial court. Id. at 1007-08. The Federal Circuit further explained that where the threshold determination is based on fact questions such as anticipation or on legal questions dependent on underlying fact questions such as obviousness, the ultimate determination should still be made by the court, although the underlying fact questions may be sent to the jury. Id.
In light of its clarification of the proper procedure for determining willful infringement, the Federal Circuit vacated the trial court’s prior ruling and remanded the case for further proceedings consistent with the Federal Circuit’s opinion. Id. at 1008-09. The trial court was directed to determine whether the defenses relied upon by Gore were reasonable. Id. at 1008. In her separate opinion, Judge Newman concurred with the decision to vacate the prior determination, but dissented from the decision to remand the case on the ground that it was apparent from the record that the finding of willful infringement was not supportable. Id. at 1009.
The Federal Circuit’s decision in Bard raises a number of interesting questions. First, what effect will the decision have on the likelihood of proving willful infringement by shifting the decision maker from the jury to the judge and the standard of review from clearly erroneous to de novo? The decision may increase the consistency and predictability of willful infringement determinations, to the extent that the Federal Circuit will now review every determination de novo. The decision may also heighten the difficulty of proving willful infringement, to the extent a judge may apply the clear and convincing evidence standard more strictly than a jury. Second, what procedure will the courts use to make the threshold determination of objective recklessness? In a case where the threshold determination is dependent on underlying questions of law, such as the reasonableness of a defense based on claim construction, a court could make its determination of objective recklessness at a pre-trial hearing similar to a Markman hearing. In contrast, in a case where the threshold determination is dependent on underlying questions of fact, such as the reasonableness of a defense based on anticipation or obviousness, a court could wait to make its determination of objective reasonableness until after a jury determines the underlying questions of fact. The answers to these questions and the implications of this decision will become more evident once the lower courts have had the opportunity to develop a sufficient record in applying this new rule.
August 2012: Patent Litigation Update
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In re: Blaise Laurent Mouttet: The Federal Circuit recently loosened the rules regarding obviousness in In re: Blaise Laurent Mouttet, No. 2011-1451 (Fed. Cir. June 26, 2012). In affirming a Patent Office rejection of inventor Blaise Laurent Mouttet’s crossbar arithmetic processor invention, the Court held that prior art references do not necessarily teach away from a proposed design merely because they suggest the use of a preferred embodiment over a disclosed, but non-selected, alternative.
Mouttet submitted patent application No. 11/395,232, entitled “Crossbar Arithmetic Processor,” on April 3, 2006. It discloses a programmable arithmetic unit capable of performing addition, subtraction, and division using nanoscale materials in a “crossbar array”—a grid of microscopic conductive wires in which the wire junctions are bridged using a thin film or molecular component. By controlling the voltages applied to individual wires, each junction can be programmed to be in a high or low resistance state, allowing the grid to store data in binary form that a post-processing unit can output as numerical values.
The U.S. Patent Office rejected Mouttet’s claims as unpatentable over a prior publication and four prior art patents, including U.S Patent No. 5,249,144 issued to Falk. The Falk ’144 patent disclosed a device for performing arithmetic and logic operations. In the Patent Office’s estimation, Falk disclosed all of the elements of Mouttet’s invention, except that Falk’s crossbar array used intersecting optical channels instead of electronic circuitry. In Falk, the intensity of light at each intersection along the crossbar’s optical paths represented particular logic states used to perform the arithmetic processes. Because Mouttet’s claims required use of wires in the array, the Patent Office combined the teachings of Falk with those of an article by Das, which taught a nanoscale crossbar array of electrical wires with molecular switches.
On appeal, Mouttet argued that Falk taught away from Mouttet’s claimed invention, relying on a passage in Falk stating that optical devices are preferred to electronic devices because optical devices possess “interconnect possibilities that do not exist with electronic hardware.” Under U.S. patent law, “teaching away” from the claimed invention can preclude a finding that the reference renders the claimed invention obvious. As the Supreme Court explained in KSR International Co. v. Teleflex, Inc., 550 U.S. 398, 416 (2007), “when the prior art teaches away from combining certain known elements, discovery of a successful means of combining them is more likely to be nonobvious.” On March 29, 2011, the Patent Office’s Board of Patent Appeals and Interferences rejected Mouttet’s argument and affirmed the examiner’s rejection, agreeing that an electrical engineer with several years of experience would have recognized that combining the teachings of the prior art references would yield Mouttet’s claimed circuit.
On appeal, the Federal Circuit affirmed the finding that Mouttet’s invention was obvious in light of Falk and the other prior art. The court stated that the mere disclosure of alternative designs in a prior art reference does not teach away from a non-preferred alternative. Falk noted certain advantages to using optical devices in his design, but did not go as far as to suggest that using wires instead of optical channels would destroy the operability of the circuit as a programmable arithmetic unit. The Court further explained that “just because better alternatives exist in the prior art does not mean that an inferior combination is inapt for obviousness purposes.” In particular, the Court held that even if Falk suggested that electrical circuits are inferior to optical circuits for some purposes, Mouttet failed to cite any reference showing that Falk’s claimed invention would be unlikely to work using electrical circuitry.
Following this decision, it may be more difficult for applicants (or litigants) to show that a prior art reference disclosing multiple alternatives teaches away from the claimed invention, even in those instances where the reference expressly states that some alternatives are inferior to the preferred embodiment. When trying to oppose an obviousness rejection on the basis that a reference “teaches away” from the claimed invention, it will be important for applicants to establish that the reference does more than merely state a preference for a non-anticipating embodiment over a potentially anticipating, alternative. Applicants should emphasize that the reference affirmatively discourages using the non-preferred embodiment, or that the reference teaches that the non-preferred embodiment would be unlikely to work.
August 2012: Entertainment Litigation Update
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Quirk v. Sony Pictures: On July 5, 2012, a federal court in California denied Sony Pictures’s motion to dismiss writer Joe Quirk’s beach of implied contract claim relating to the upcoming film, Premium Rush. Quirk v. Sony Pictures Entm’t Inc., No. C 11-3773 RS (N.D. Cal. July 5, 2012). Quirk alleged that Premium Rush is derived from his 1998 novel, Ultimate Rush, and that Sony breached an implied contract to compensate him for the use of his material. Although the court noted that Quirk’s theory of liability stretches California’s law of idea theft to its “breaking point” (id. at 6), Quirk’s claim was found to meet the low “facially plausible” standard required to survive a motion to dismiss.
Notably, Quirk failed to allege that Sony received a copy of Ultimate Rush directly from him or his agents. Instead, Quirk theorized that a copy of his novel “passed through one or more routes between those to whom his agent directly submitted the novel” and Sony. This distinction is important because, while there is significant precedent for implied contract claims when an author submits a literary work directly to a producer on the implied condition that the producer will pay if it uses the work, see, e.g., Desny v. Wilder, 46 Cal. 2d 715 (1956), there is no previous authority to support such an implied contract without direct contact.
The court explicitly stated that its decision to deny the motion was a “close call” and it applied an extremely fact-specific analysis. Nonetheless, the fact that Quirk’s claims were allowed to proceed may impact the landscape of implied contract and idea theft cases in California.
FCC v. CBS: Eight years after the 2004 Super Bowl’s infamous halftime “wardrobe malfunction,” the legal battle between the FCC and CBS has finally concluded. In response to the musical halftime performance, which included 9/16ths of a second of nudity broadcast to 90 million viewers, the FCC fined CBS $550,000—the largest fine ever levied against a broadcaster. On June 29, 2012, the Supreme Court declined to hear an appeal from the Third Circuit’s decision reversing the fine, thereby making the Third Circuit’s ruling the final word.
In CBS Corp. v. FCC, 663 F.3d 122, 151 (3d Cir. 2011), the Third Circuit held that the FCC’s fine was arbitrary and capricious, relying on the FCC’s previous treatment of “fleeting words”:
[T]he balance of the evidence weighs heavily against the FCC’s contention that its restrained enforcement policy for fleeting material extended only to fleeting words and not to fleeting images. As detailed, the Commission’s entire regulatory scheme treated broadcasted images and words interchangeably for purposes of determining indecency. Therefore, it follows that the Commission’s exception for fleeting material under that regulatory scheme likewise treated images and words alike.
Although the Supreme Court denied certiorari, Chief Justice Roberts issued a concurrence indicating that future FCC fines may not be treated in the same way because the FCC has clarified its rules on fleeting images and words since the 2004 Super Bowl:
[T]he FCC no longer adheres to the fleeting expletive policy. It is now clear that the brevity of an indecent broadcast—be it word or image—cannot immunize it from FCC censure. See, e.g., In re Young Broadcasting of San Francisco, Inc., 19 FCC Rcd. 1751 (2004) (censuring a broadcast despite the “fleeting” nature of the nudity involved). Any future “wardrobe malfunctions” will not be protected on the ground relied on by the court below.
Federal Commc’ns Comm’n v. CBS Corp., 567 U.S. __ (2012) (Roberts, C. J., concurring).
Dish Network v. ABC: On July 9, 2012, a federal district court in New York dismissed Dish Network’s copyright and contract claims against Twentieth Century Fox and its copyright claims against CBS and NBC, based on improper venue. Dish Network, LLC v. ABC, No. 12 Civ. 4155 (LTS) (S.D.N.Y. July 9, 2012). Dish’s claims stem from its “Auto Hop” feature, also known as an “ad zapper,” which allows Dish subscribers to skip over commercials on programs saved to their DVRs. Venue had been at issue in the case since Dish filed a lawsuit in New York the same day that Fox and other television networks filed in California.
The court ruled these claims would best be litigated in California. Rejecting Dish’s argument that it had won the race to the courthouse, the court found that Dish’s New York lawsuit “was motivated by a fear of imminent legal action by the networks and was, thus, improperly anticipatory.” Dish had filed suit in New York on May 24, just hours before the television networks filed suit in Los Angeles and less than 24 hours after a Hollywood Reporter article “conveyed the unmistakable impression that a legal showdown was inevitable.”
However, the court allowed Dish’s contract claims against CBS and NBC to remain in New York because those networks have yet to assert contract claims in California. In addition, because ABC has not yet filed suit against Dish, Dish’s claims against ABC will remain in New York for the time being.
August 2012: ITC Litigation Update
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Federal Circuit Recants Criticism of Commission’s “No Position” Rule: In an unusual turnabout, the Federal Circuit withdrew six pages of its precedential opinion in General Electric Co. v. International Trade Commission, 670 F.3d 1206 (Fed. Cir. Feb. 29, 2012), which had criticized the Commission’s practice of taking “no position” on fully-litigated issues. General Elec. Co. v. International Trade Comm’n, No. 2010-1223, 2012 WL 2626908 (Fed. Cir. July 6, 2012). The Court’s July 6 order granted the Commission’s petition for panel rehearing for the limited purpose of withdrawing Part III of its February 29 opinion and to make clear that the panel was not offering any decision as to the questions raised therein. In dissent, Judge Newman noted that the court’s decision to withdraw Part III “ratifies the Commission’s authority to negate the finality of [ ] final decisions, thereby forestalling judicial review and impeding expeditious resolution of ITC proceedings, as required by statute and as the Commission represents to the public.”
The court’s February 29 decision and subsequent dissenting opinion by Judge Newman highlight the tension between the Commission’s statutory charge to adjudicate section 337 investigations as expeditiously as practicable and its practice of allowing piecemeal and prolonged appeals. Pursuant to 19 U.S.C. § 1337(c), any person adversely affected by a final determination of the Commission may appeal such determination to the Federal Circuit. What constitutes a “final determination” subject to appeal, however, is defined by the Commission’s rules and governing precedent. Under Commission Rule 210.42, an unreviewed initial determination issued by an administrative law judge becomes a final determination and is automatically appealable. If the Commission chooses to review an initial determination, Commission Rule 210.45 permits the Commission to affirm, reverse, modify, set aside, or remand for further proceedings, in whole or in part. This rule also permits the Commission to take no position on specific issues or portions of the initial determination. Prior to its February 29 decision, in Beloit Corp. v. Valmet Oy and other cases, the Federal Circuit had consistently held that where the Commission takes no position on a particular issue, that issue is not appealable. See, e.g., Beloit Corp. v. Valmet Oy, 742 F.2d 1421 (Fed. Cir. 1984).
In the investigation underlying the Court’s decision in General Electric, the ALJ found a violation based on Mitsubishi’s infringement of General Electric’s ’039 and ’221 patents. Although he also found that Mitsubishi infringed General Electric’s ’985 patent, the ALJ concluded there was no violation as to that patent due to a lack of domestic industry. The Commission noticed review of all aspects of the initial determination except for the issue of importation and the ALJ’s finding on the intent element of inequitable conduct. On review, the Commission determined that the ’039 and ’221 patents were not invalid but were not infringed, and that the domestic industry requirement was not met for any of the three patents. The Commission took no position on any other issues.
General Electric appealed the Commission’s final determination to the Federal Circuit. The court held that issues related to the ’039 patent were moot in light of the patent’s expiration, affirmed the Commission’s finding of non-infringement as to the ’221 patent, and reversed the Commission’s determination of no domestic industry for the ’985 patent. Because the Commission had taken no position with respect to infringement and validity of the ’985 patent, however, the Federal Circuit remanded for further proceedings. In Part III of the opinion, the court criticized the Commission’s practice of taking no position on certain issues, stating that “[t]he consequences of this practice are illustrated in this case, for all contested issues concerning the ’985 patent were investigated by the Commission, tried to the ALJ, decided by Initial Determination, yet nearly all were held unavailable for judicial review.” General Elec., 670 F.3d at 1220. The court’s February 29 opinion also clarified that, going forward, fully-litigated issues would be appealable even where the Commission took no position on them pursuant to Commission Rule 210.45. The court distinguished its holding in Beloit as addressing only the situation where the party prevailing before the Commission sought judicial review of issues that the Commission had not reached, and as not addressing the situation at hand where the party losing before the Commission sought judicial review. The court further explained that the “legislative purpose of expedited ITC resolution of unfair competition issues requires attention, in accord with statute and regulation, that issues decided by initial determination and not substantively reviewed by the full Commission are deemed determinations of the Commission . . . and entitled to appeal . . . .” Id. at 1220–21.
The Commission petitioned for panel rehearing and rehearing en banc. The Federal Circuit granted the Commission’s petition for panel rehearing for the limited purpose of withdrawing Part III of the Court’s February 29 opinion. A revised opinion, with Part III removed, was issued on July 6. In a dissenting opinion accompanying the court’s order on rehearing, Judge Newman expressed her view that the court’s decision to withdraw Part III ratifies the Commission’s authority to negate the finality of its decisions, which will only result in further delay, cost, and burden to the parties, the Commission, and the Court, and is contrary to the purposes of section 337. General Elec., 2012 WL 2626908, at *1. She further noted that the Commission’s practice of taking no position on contested issues “is in conspicuous tension with the statutes, regulations, and with unambiguous precedent.” Id. at *3. Judge Newman concluded her dissent by urging that rather than “simply ratifying this aberrant procedure and accepting its consequences, at a minimum the court should take the case en banc and obtain input from the communities that Section 337 is designed to serve,” so as to resolve the lingering question whether judicial review is available for issues reviewed by the Commission, but upon which the Commission takes no position. Id. at *6.
It is unclear whether the Federal Circuit will use this case as a vehicle to reconcile the apparent incongruity between the statutory language of section 337, the Commission’s rules, and the court’s own precedent. Until it does, however, it appears that the Commission may continue to take no position on certain issues under review, and that those issues are not appealable to the Federal Circuit.
When in Rome...(U.S. Law Still Applies): Lessons of Wal-Mart, News Corp., and the Foreign Corrupt Practices Act
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The old DC adage, never do anything you wouldn’t want to see reported on the front page of the New York Times, must have taken on a very personal meaning to the senior management and directors of Wal-Mart and News Corp. Both companies have become targets of criminal investigations of possible violations of the Foreign Corrupt Practices Act (FCPA), 15 U.S.C. § 78dd-1 et seq., only to see the allegations of misconduct splashed across the front pages of the Old Gray Lady. The FCPA, which prohibits U.S. companies and even foreign companies with substantial ties to the U.S. from bribing foreign government officials to win or keep business overseas, has been around since the late 1970’s but was only sparingly invoked until about a decade ago, when the U.S. Department of Justice (DoJ) and the Securities & Exchange Commission (SEC) dusted off the statute and began bringing major cases against multinationals for alleged wrongdoing around the globe. For the DoJ and the SEC, enforcement of the FCPA has been a huge success, leading to billions of dollars in fines against companies and stiff jail terms for executives who orchestrated bribery schemes.
News stories this past April broke allegations that executives at Wal-Mart de Mexico, the largest foreign subsidiary of US-based Wal-Mart Stores, Inc., bribed Mexican officials to secure construction permits. In a similar vein, News Corp., already reeling from the hacking scandal that last year toppled the company’s U.K.-based tabloid, News of the World, came under criminal investigation, the DoJ announced, based on bribes allegedly paid to U.K. police and military in exchange for tips.
Press coverage of the Wal-Mart and News Corp. episodes has focused less on the bribery allegations themselves than on the initial steps senior management and board directors took to investigate internally upon first learning of the allegations. In both instances, the early investigation, and senior management and the board’s roles in them, has come under withering criticism from many corners, with some going so far as to suggest perceived deficiencies in the early investigations may be grounds for charges of obstruction of justice.
In the face of this external scrutiny, companies should focus on how they conduct their internal investigations. Although diligent internal investigation will not necessarily inoculate a company from liability under the FCPA, it can help reduce the likelihood of an actual prosecution and mitigate any penalties. Conversely, a fumbled internal inquiry can significantly raise the risk to the company and its executives and board members. In Wal-Mart’s case, for instance, the New York Times reported that a former executive of Wal-Mart de Mexico advised Wal-Mart’s US management in 2005 that executives at the subsidiary had been systematically bribing Mexican officials to win construction permits in Mexico. Also according to the New York Times, the ensuing internal investigation turned up suspect payments in excess of $24 million and indications of concealment, but abruptly ceased without meaningful follow up or disclosure to the authorities. Then, some years later, in December 2011, Wal-Mart notified the Justice Department that it was conducting an internal investigation of possible FCPA violations by Wal-Mart de Mexico. The New York Times suggested that this notification to the DoJ was prompted by the Times approaching Wal-Mart about the allegations. When the company disclosed its ongoing inquiries in its SEC filings, its shares took a serious hit.
The allegations against Wal-Mart may very well prove unfounded and the company and the people caught up in the controversy are not only entitled to the presumption of innocence but deserve the public’s reservation of judgment—after all, it would not be the first time that salacious allegations of misconduct in the press turn out to be little more than a mix of rumor, conjecture, and misstatements. Whatever the truth of the current reports concerning Wal-Mart or future reports about other companies, the reality is that companies have a very limited window in which to investigate properly, rectify, and self-report possible violations of the FCPA before risks and penalties escalate.
Of course, Wal-Mart and News Corp. are but two of countless companies facing potential FCPA exposure. The DoJ and the SEC now have units specially dedicated to FCPA cases and the Justice Department is getting more investigative support from the Federal Bureau of Investigation. Last year, FCPA enforcement actions reached 48, the second-highest level in the 34-year history of the Act, down from an unprecedented 74 actions in 2010.
Several business groups, including the US Chamber of Commerce, are rightly questioning whether the FCPA is too vague in certain respects and too unforgiving in others. These groups are seeking greater guidance from the DoJ and the SEC to help companies comply and get credit for self-disclosures, and they have even asked Congress to intervene. One idea is to codify into law credit for prompt discovery, internal investigation, and disclosure to the authorities. The DoJ and the SEC tell companies that they will receive credit for thorough internal investigations and prompt and accurate self-disclosures. Nonetheless, it is not unusual for companies to question what benefit they have actually received when law enforcement chooses to impose a harsh fine and threaten jail time for executives in the wake of a self-report. Codifying the benefits of self-disclosure—rather than leaving them purely to the discretion of prosecutors—would help encourage companies to detect and report problems they find, secure in the knowledge that they will receive appropriate credit from law enforcement for doing the right thing.
Unless and until Congress acts, companies should be organizing their legislative strategies even while implementing internal protocols and, if issues arise, conducting thorough, professional internal investigations that will help mitigate their risk in the meantime.
Waiting for Superman: The Ninth Circuit Finally Weighs in on the Selective Waiver Doctrine
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On April 17, 2012, the U.S. Court of Appeals for the Ninth Circuit held in In re Pacific Pictures Corporation, that “a party waives attorney-client privilege forever by voluntarily producing privileged documents to the federal government.” 2012 WL 1293534 at *1 (9th Cir. 2012). In doing so, the Ninth Circuit joined the majority of other circuits in rejecting the selective waiver of attorney-client privilege.
History of Selective Waiver
The theory of selective waiver provides that a party’s voluntary disclosure of privileged materials to the government does not necessarily waive the privilege in civil litigation. The purpose of the rule is to encourage voluntary cooperation with government investigations.
The theory was first adopted by the Eighth Circuit in Diversified Industries Inc. v. Meredith, 572 F.2d 596 (8th Cir. 1978) (en banc). Since then, however, every other circuit to consider the theory has rejected it. See In re Qwest Commc’ns Int’l, 450 F.3d 1179, 1197 (10th Cir.2006); Burden–Meeks v. Welch, 319 F.3d 897, 899 (7th Cir. 2003); In re Columbia/HCA Healthcare Corp. Billing Practices Litig., 293 F.3d 289, 295 (6th Cir. 2002); United States v. Mass. Inst. of Tech., 129 F.3d 681, 686 (1st Cir. 1997); Genentech, Inc. v. United States Int’l Trade Comm’n, 122 F.3d 1409, 1416–18 (Fed.Cir. 1997); In re Steinhardt Partners, L.P., 9 F.3d 230, 236 (2d Cir. 1993); Westinghouse Elec. Corp. v. Republic of Philippines, 951 F.2d 1414, 1425 (3d Cir. 1991); In re Martin Marietta Corp., 856 F.2d 619, 623–24 (4th Cir.1988); Permian Corp. v. United States, 665 F.2d 1214, 1221 (D.C.Cir. 1981). Before In re Pacific, the Ninth Circuit twice deferred judgment on the issue, leaving it an open question as to whether the court would accept a theory of selective waiver. See United States v. Bergonzi, 403 F.3d 1048, 1050 (9th Cir. 2005) (per curiam); Bittaker v. Woodford, 331 F.3d 715, 720 n. 5 (9th Cir. 2003) (en banc).
Truth, Justice, and the American Way
In the 1930s, Jerome Siegel and Joe Shuster created Superman and ceded the intellectual property rights to D.C. Comics. Since Superman’s first appearance in 1938, the creators and their heirs have been fighting with D.C. Comics over royalties. Around 2000, attorney and Hollywood producer Marc Toberoff approached the heirs with an offer to manage the preexisting litigation and to arrange for a new Superman film to be produced. Toberoff hired lawyer David Michaels to assist with the business, but Michaels worked for only three months before absconding with copies of documents from the creators’ files. After a failed attempt to extort business from the heirs with the documents, he sent them anonymously to executives at D.C. Comics along with a timeline outlining in detail Toberoff’s alleged plan to capture Superman for himself. Since then, the parties have been battling over what to do with those documents. D.C. Comics entrusted the documents to an outside attorney and sought to obtain them through discovery in the ongoing lawsuits over Superman. Toberoff resisted those efforts. In 2007, a magistrate judge ordered some of the documents, including the timeline, turned over to D.C. Comics. A few months later, Toberoff finally reported the incident to the FBI, and in December 2008 he produced some of the documents.
In 2010, D.C. Comics filed this lawsuit claiming that Toberoff interfered with D.C. Comics’ contractual relationships with the heirs. Michaels’ timeline was incorporated into the complaint. Toberoff asked the U.S. Attorney’s Office to investigate Michaels, and it issued a grand jury subpoena for the documents, promising that if Toberoff voluntarily complied with the subpoena the government would “not provide the . . . documents . . . to non-governmental third parties except as may be required by law or court order.” Toberoff voluntarily complied with the subpoena and turned the documents over without redaction or objection.
D.C. Comics immediately requested all of the documents disclosed to the U.S. Attorney, claiming that the disclosure waived all privilege. The magistrate agreed, reasoning that voluntary disclosure of privileged materials breaches confidentiality and is inconsistent with the theory behind privilege. The district court denied review and petitioners sought Ninth Circuit review through a writ of mandamus.
The Ninth Circuit Rejects Selective Waiver
In rejecting the theory of selective waiver, the Ninth Circuit held that producing documents to the government constituted a voluntary waiver of attorney-client privilege for all purposes -- even though the documents had been subpoenaed -- because the heirs produced them without redaction or objection. It reasoned that voluntary disclosure of the documents was inconsistent with promoting full and frank attorney-client communications, regardless of whether the disclosure was to the government or a private party. The court stated that “to unmoor a privilege from its underlying justification . . . would at least be failing to construe the privilege narrowly, . . . [a]nd more likely, would be creating an entirely new privilege.” In re Pacific Pictures Corp., 2012 WL 1293534 at *4. The court also noted that, since Diversified, there have been multiple legislative attempts to adopt the doctrine of selective waiver, yet most have failed: “Congress has declined broadly to adopt a new privilege to protect disclosures of attorney-client privileged materials to the government, we will not do so here.” Id.
The fact that the heirs were victims (of having their documents stolen) did not warrant different treatment because “if it is unnecessary to adopt a theory of selective waiver to encourage potential defendants to cooperate with the government. It is even less necessary to do so to encourage victims to report crimes to the government,” Id. at *5. It was similarly unpersuaded that, because Toberoff was a victim of the crime, petitioners were entitled to the common interest exception to waiver because “a shared desire to see the same outcome . . . is insufficient to bring a communication . . . within this exception.” Id. at *6. Further, voluntary disclosure could not be cured by a post hoc confidentiality agreement such as the letter obtained in this case from the U.S. Attorney’s Office. Thus, the Court found that the interest in encouraging cooperation with the government is outweighed by the interest in upholding the purpose of the attorney-client privilege.
July 2012: Insurance Litigation Update
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Supreme Court To Address Whether Statutory Injury Creates Article III Standing: In Edwards v. First American Financial Corp., No. 10-708, the United States Supreme Court will decide an important question of Article III standing that will have broad-reaching impact on many industries, including the insurance and reinsurance industries. The Court will decide whether a plaintiff that alleges the violation of a statutory right, but no damage resulting from that violation, has standing to bring a case.
In Edwards, the plaintiff brought suit against her title insurer, claiming that the insurer had violated the Real Estate Settlement Procedures Act of 1974 (RESPA). RESPA prohibits kickbacks by certain entities that provide services related to real estate transactions. The plaintiff complained that her title insurer had paid kickbacks to title insurance agencies in exchange for referrals of business. However, she conceded that the alleged kickback had no effect whatsoever on the insurance she received or the price she paid.
The title insurer moved to dismiss, claiming Edwards suffered no injury sufficient to confer Article III standing. The district court denied the motion, and the Ninth Circuit affirmed finding that there was no requirement that a plaintiff allege any injury to assert a claim under RESPA. The Ninth Circuit concluded that RESPA gives plaintiffs a statutory right, the violation of which provides standing to maintain a cause of action. The Ninth Circuit’s decision was consistent with prior decisions of the Sixth and Third Circuits, which had also found that plaintiffs had standing under RESPA regardless of whether they could allege that they suffered overcharge or other injury.
The Supreme Court granted certiorari. Twenty years ago in Lujan v. Defenders of Wildlife, 504 U.S. 555 (1992), Justice Scalia wrote that “injury in fact” was an element of the “irreducible constitutional minimum” of Article III standing. In Edwards, the Court must resolve the distinction (as noted by Chief Justice Roberts at oral argument) between an “injury-in-fact” (such as an overcharge) and an “injury-in-law” The case was argued on November 28, 2011 and remains sub judice.
The Supreme Court’s decision in Edwards could have a significant impact on a wide range of commercial litigation. For insurers and reinsurers, the case will bear directly on a scourge of RESPA class action lawsuits pending against mortgage insurers in federal courts in California, Pennsylvania, and New York. In those cases, plaintiffs claim that reinsurance agreements between mortgage insurers and reinsurers that are affiliated with a lending bank constitute an illegal kickback under RESPA, despite the fact that these plaintiffs paid the “filed rate” for their insurance policy and thus suffered no monetary injury. Edwards also will have impact beyond the insurance and reinsurance industry. Notably, Facebook, LinkedIn, Yahoo, and Zynga have filed an amicus brief in the case addressing whether a broad ruling in Edwards will expose them to damages under statutes like the Wiretap Act, the Electronic Communications Privacy Act, and the Stored Communications Act.
Quinn Emanuel represents a mortgage insurer involved in several reinsurance related lawsuits alleging violations of RESPA.
July 2012: Sports Litigation Update
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District Courts Divided over Use of Football Players in Video Games: Recent disputes involving Electronic Arts (EA) have divided district courts in the Third and Ninth Circuits over whether the First Amendment insulates designers of video games from lawsuits when they use an athlete’s likeness without permission and, if so, under what law.
This line of decisions began in 2009 in the Central District of California, where Jim Brown, a retired professional football player, filed an action claiming that EA violated the Lanham Act by wrongfully misappropriating his name, identity, and likeness when it included him as a player in the video game Madden NFL without his consent. Brown v. Electronic Arts, Inc., No. 09-CV-1598, Doc. No. 43 (Order), at 3 (C.D.Cal. Sept. 23, 2009). While the game did not use Brown’s name or jersey number, he alleged that the character in the video game had “nearly identical” statistics to his own and thus created a false endorsement. Id. at 3. The Court disagreed, holding that Madden NFL was an “expressive work” protected from his federal false endorsement claim. Id. at 6, 7. Because Madden NFL manifested enough creativity to be deemed an “expressive work,” it triggered the two-pronged test established by Rogers v. Grimaldi: (1) that the relevance of the defendant’s use of the plaintiff’s likeness is relevant to the work; and (2) that the use does not explicitly mislead consumers. Rogers v. Grimaldi, 875 F.2d 994 (2d Cir. 1989). The Court concluded that use of Brown’s likeness was not irrelevant to the game’s content, and that EA’s use of his likeness (if his “likeness” was used at all)—in the form of an anonymous, mis-numbered video game character—could not be understood by the public as an “explicit attempt” to signify Brown’s endorsement of the game. Brown, No. 09-CV-1598, Doc. No. 43 (Order), at 6-8.
Less than five months later, in addressing a state-law claim, a court in the Northern District of California came to an arguably different outcome. In Keller v. Electronic Arts, Inc., plaintiff Samuel Keller, a former college quarterback, alleged that EA’s depiction of a football player in its game NCAA Football used his and other college players’ likenesses without compensation, violating California’s right of publicity law. Keller v. Electronic Arts, Inc., No. C 09-1967 CW, 2010 WL 530108, at *1-3 (N.D. Cal. Feb. 8, 2010). While EA claimed that its use was protected by the First Amendment, the Court disagreed, holding that EA’s use was “not sufficiently transformative” to implicate First Amendment protection. Id. at *3-5. The Court reasoned that, rather than depicting the player “in a different form,” EA represented him as “what he was: the starting quarterback for Arizona State University” in a setting “identical to where the public” would have found him during his collegiate career—that is, on a football field. Id. at *5.
Finally, one year later, a court in the District of New Jersey reached the opposite conclusion. In Hart v. Electronic Arts, Inc., a former college football player brought a claim under New Jersey’s right of publicity law for using his likeness in NCAA Football—the same video game addressed in Keller. Hart v. Electronic Arts, Inc., 808 F. Supp. 2d 757, 760-61 (D.N.J. 2011). The Court held that EA’s use of Hart’s likeness was sufficiently transformative to warrant First Amendment protection. Id. at 784 . In so holding, the Court asserted that Keller ignored one of the key components of NCAA Football: that “the virtual image” representing the football player could be altered by the user in “various formulations.” Id. at 786-87. The Court found “this aspect of the game significant because it suggests that the goal of the game is not for the user to ‘be’ the player,” but instead to be a “starting point for the game playing experience.” Id. at 787. The Court concluded that players’ images in NCAA Football is “one of the raw materials from which an original work is synthesized, [and] the depiction or imitation of the celebrity is [not] the very sum and substance of the work in question,” id. (citations and quotation marks omitted), rendering its use transformative, and thus protected by the First Amendment. While the Rogers test typically is applied to Lanham Act claims, the Court nonetheless suggested that it may also apply to right-of-publicity claims, and stated that NCAA Football would be protected under the two-prong Rogers test if the Court were to apply it. Id. at 793.
This trio of cases reflects significant confusion in case law over the use of athletes in video games—specifically, whether (1) the proper standard is the two-pronged Rogers test or the “transformative use” test and (2) when the use of an athlete’s likeness satisfies those tests. While all three cases are currently on appeal, their outcomes will likely have implications for the design of future video games bearing an athlete’s likeness.
July 2012: European Litigation Update
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European Patent System Is in for Fundamental Changes: Adopting the European Patent Convention (EPC) and establishing the European Patent Office (EPO) – thereby allowing for a single application for a “European patent” (which is more precisely a bundle of national patents which are independent from each other) – was a major step towards harmonizing patent law in Europe. Yet, the EPC leaves infringement law and proceedings predominantly to its member states. In practice this means that a patent may be infringed in one jurisdiction by for example selling an infringing device whereas it may be held not infringed in another jurisdiction by selling the identical infringing device.
Stakeholders from Europe and abroad have come to terms with the European patent system. Nevertheless, the European patent system is soon to undergo a fundamental change. The European Union (EU) is aiming to adopt a regulation on unitary patent protection as well as an agreement on a unified patent court. In other words, the European unitary patent is just around the corner.
Decision making in the EU can be rather slow and painful. For more than ten years several drafts of agreements and regulations have been circulated, discussed, amended, and finally dropped. At that point the most promising plans on the creation of a European patent court was finally sunk by the Court of Justice for the European Union (CJEU) in March 2011. But then again, decision making in the EU can be rather swift. Since the decision of the CJEU, EU bodies have been deliberating on a proposal for a unitary patent system in Europe. It plans to adopt the latest proposal in mid-2012. This (at least by European standards) extremely fast process has been criticized widely, particularly for its lack of transparency.
Under the proposal, the unitary patent would be an optional adjunct to traditional national and European patents. The unitary patent would have – rather than the traditional national and European (bundle) patents – unitary effect in its member states. The unitary patent would be enforced by a unified patent court system. The unitary patent court would, among other things, include a Court of First Instance and a Court of Appeals. The Court of First Instance would be composed of a central division, as well as local and regional divisions in the contracting states.
Several points remain in controversy. Besides the typical European language issues, the seat of the central division is one of the main issues. Several member states have thrown their hat in the ring, amongst them Germany, the United Kingdom, and France. At present it appears that the central division will be located in Paris with branches in London and Munich. Furthermore, the composition of the courts will be complicated since proportional representation has to be dealt with. Another point of concern is whether or not to include substantive patent law as opposed to merely procedural patent law in the regulation. Critics argue that the judges at the CJEU are not sufficiently qualified to rule on substantive patent law issues. Indeed, for now the pendulum seems to be swinging in favor of deleting the provisions regarding substantive patent law.
Since several public and non-public drafts are circulating at the moment and the decision making process is indeed not very transparent, it is hard to make reliable statements about how the court will be implemented. An update will follow as soon as a decision has been reached by the competent bodies. It will likely take several years until the new European patent system will be established and the first cases will be litigated in front of the unitary patent court.
July 2012: Japan Litigation Update
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The IP High Court Addresses Trademark Infringement Liability of Internet Shopping Websites: In Perfetti Van Melle S. p.A v. Rakuten Co., Ltd., the Intellectual Property (IP) High Court in Tokyo addressed the issue of whether Rakuten, who organizes a website in which numerous independent stores and dealers can sell goods on the Rakuten website (called an “internet mall” in Japanese), could be liable for trademark infringement committed by those stores. Although the court dismissed the suit and found the defendant Rakuten not liable, the court recognized that an internet mall can be liable in certain circumstances.
The plaintiff Perfetti Van Melle is an Italian entity that holds trademarks to “Chupa Chups,” a famous candy. The defendant, Rakuten, operates the biggest internet mall in Japan, called “Rakuten Ichiba.” The plaintiff claimed that several shops using the Rakuten website were committing trademark infringement by selling items such as mugs, caps and baby bibs that incorporated the “Chupa Chups” trademark. The plaintiff sued Rakuten seeking an injunction and damages under the Japanese trademark law and unfair competition law. Rakuten argued that it was not liable because it was merely the administrator of the website, and not the shop that directly sold the products accused of trademark infringement.
The IP High Court held that the threshold test for finding the administrator of an internet mall liable depends on whether the administrator receives commissions from the shops, has power or control over the shops, and knows or should have known of the existence of trademark infringement by the shops. If the test is satisfied, then the administrator can be held liable for damages and be subject to an injunction for the infringement unless the administrator removes the infringing products from the website within a reasonable time period. Applying this test to the case, the court concluded that Rakuten was not liable because Rakuten had removed the infringing products within a reasonable time after learning of the infringement.
The decision of the IP High Court leaves unclear when an administrator “should have known” of the infringement or what it means to remove the infringing goods “within a reasonable time.” Nevertheless, website administrators may now have to investigate if goods sold on the internet mall are infringing trademarks and remove them if they are costs.
Japanese SESC Accelerates Its Enforcement Activities: The SESC, the Japanese version of the SEC, has stepped up its investigations of insider trading allegations related to public stock offerings of Japanese companies. Recently, there have been instances where stock prices have fallen immediately before offerings were publicly announced. Critics have argued that this pattern suggests that some traders are getting information about offerings from securities companies before the public announcement of the offerings. Using this information, the traders sell the issuing company’s stock at a higher price in anticipation of a stock price drop due to the increase in capital, which leads to the stock price drop prior to the public announcement of the offering. Seeking to address potential insider trading, the SESC has opened a number of investigations.
On March 21 and May 29, 2012, the SESC recommended the Japanese Financial Services Agency issue an administrative monetary penalty order against Sumitomo Mitsui Trust Bank, Ltd. for insider trading in relation to the 2010 public share offerings held by Mizuho Financial Group Co., Ltd. and Inpex Co., Ltd., respectively. In addition, on June 8, the SESC recommended an administrative monetary penalty order against First New York Securities L.L.C., a New York based broker-dealer, for insider trading in relation to the 2010 public offering by Tokyo Electric Power Co., Ltd. The charges alleged the use of confidential information of the public offering to sell the issuing companies’ stock immediately before the public announcement of the offering. In each case, the employees providing the alleged information tips were from Nomura Securities Co., Ltd., a leading Japanese securities company and the underwriter in each instance. After the press release of the First New York case, Nomura officially admitted that they had tipped off traders to the confidential information.
In furtherance of its efforts to combat insider trading, the SESC also established in August 2011 an international trading investigation section that mainly handles overseas transactions, sometimes cooperating with the SEC.
Development on Introduction of a New Japanese Class Action System: Current Japanese laws provide no system comparable to the class action system in the United States. If a group of people suffers harm arising from a single cause of action and seeks to recover damages, all of the members of the group are required to either file individual suits or to jointly file a lawsuit. To improve consumer protection, the Japanese government is now in the process of drafting and passing legislation to introduce a new class action-like system. The Japanese government issued a summary of the proposal and is currently preparing the draft bill.
Although the details of the system might be changed when the bill is ultimately implemented, as it stands now, the new system would only allow a qualified organization (called a Specified Qualified Consumer Organization) to file an action on behalf of a class.
The proposed class action-like system consists of two stages. In the first stage, the qualified organization brings the lawsuit. A court conducts fact finding and makes a decision on issues which are common to all consumers who suffered harm. If a court finds that the defendant is liable for damages, the plaintiff organization gives notice to each individual consumer to join. At this point, the second stage commences with the involvement of the individual consumers to determine damages. Even if the plaintiff organization does not succeed in the first stage, consumers can still bring their own action.
Because plaintiffs are limited to the qualified organizations and consumers who actively participate in the procedure, the impact of this new system may be quite limited in comparison to the U.S. class action system. Nevertheless, the number of consumer damage cases in Japan will likely increase considerably.
Implications of Statute of Limitations Rulings in Mortgage-Backed Securities Cases
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The financial crisis of 2007 and 2008 led to catastrophic losses for investors in residential mortgage-backed securities (“RMBS”). In the wake of the crisis, numerous suits were filed by investors and insurers against Wall Street banks. Plaintiffs allege that the banks issued loans to homeowners, packaged loans into securities, and sold them to investors—or induced plaintiffs to insure the securities—pursuant to offering materials that misrepresented the loans’ characteristics. The volume of these cases, all filed over the past few years, involving a similar set of background facts and a relatively new and complex type of security, created a series of decisions that have moved and clarified the law of statute of limitations. The holdings are not just relevant to the flood of RMBS cases currently facing the courts, but for all parties interested in bringing, or defending, securities and fraud-related claims.
Is “Inquiry Notice” Even the Standard Anymore?
A recent line of cases has suggested that the traditional “inquiry notice” standard for claims brought under the Securities Act of 1933 no longer applies. Rather, courts have adopted the more plaintiff-friendly standard of whether an investor could have actually amassed sufficient facts to survive a motion to dismiss.
The shift began with the Supreme Court’s decision in Merck & Co. v. Reynolds, 130 S. Ct. 1784 (2010). In Merck, the Supreme Court established a new test for measuring the statute of limitations for claims under the Securities Exchange Act of 1934. The 1934 Act’s two-year limitations period was traditionally measured by the “inquiry notice” standard, but Merck rejected it, holding that the limitations period does not begin to run until “a reasonably diligent plaintiff would have discovered ‘the facts constituting the violation,’ including scienter—irrespective of whether the actual plaintiff undertook a reasonably diligent investigation.” Id. at 1798. “Inquiry notice” does not trigger the statute of limitations, the Court held, because even a diligent investigation may not feasibly lead to “facts constituting the violation.” Id. at 1788. The Supreme Court thus confirmed that the proper focus is not on when the investigation should have begun, but rather must be on when a reasonable investigation would have borne sufficient fruit.
In City of Pontiac General Employees’ Retirement System v. MBIA Inc., 637 F.3d 169, 175 (2d Cir. 2011), the Second Circuit addressed the question of what is ‘sufficient’ fruit. The Second Circuit concluded that, under Merck, the 1934 Act’s statute of limitations does not begin to run until a plaintiff could plead sufficient facts to survive a motion to dismiss: A “fact is not deemed ‘discovered’ until a reasonably diligent plaintiff would have sufficient information about that fact to adequately plead it in a complaint.” As the Second Circuit explained: “Since the purpose is to prevent stale claims, it would make no sense for a statute of limitations to begin to run before the plaintiff even has a claim…. [I]n the limitations context, it makes sense to link the standard for ‘discovering’ the facts of a violation to the plaintiff’s ability to make out or plead that violation.” Lower courts have since applied the Merck and City of Pontiac standard to 1934 Act cases. See, e.g., S.E.C. v. Wyly, 788 F. Supp. 2d 92 (S.D.N.Y. 2011); Space Coast Credit Union v. Barclays Capital, Inc., No. 11-cv-2802 (S.D.N.Y. Mar. 20, 2012).
The question nonetheless remained: Was the abrogation of the “inquiry notice” standard driven by some peculiarity of the 1934 Act’s text? The numerous RMBS cases that were brought in the wake of the financial crisis provided the opportunity for many courts to address that question. RMBS defendants have argued that investors were on “inquiry notice” of their claims in 2007 and 2008, due to general news reporting about a shifting economy, loosened underwriting guidelines in the industry, and similar materials. One way plaintiffs have pushed back is to argue that defendants’ motions are focused on the entirely wrong standard—and many courts have agreed. For instance, the court in In re Bear Stearns Mortgage Pass-Through Certificates Litigation sided with “the majority of judges in this district” in holding that there was “no principled basis for cabining Merck’s holding” to 1934 Act’s claims. No. 08-cv-8093, 2012 WL 1076216, at *12 (S.D.N.Y. Mar. 30, 2012). As such, “Defendants’ focus on inquiry notice is misplaced. The operative question is no longer when a reasonable plaintiff would have known that she had a likely cause of action and inquired further. Rather, the question is whether a plaintiff could have pled ’33 Act claims with sufficient particularity to survive a 12(b)(6) motion . . . .” Id. at 13. Most recently, the Southern District sided with the Federal Housing Finance Agency in applying Merck to FHFA’s 1933 Act claims. Federal Housing Fin. Agency v. UBS Am., Inc., 11-cv-5201 (S.D.N.Y. May 4, 2012), Order at 22-24. See also In re Wachovia Equity Sec. Litig., 753 F. Supp. 2d 326, 371 n. 39 (S.D.N.Y. 2011) (applying Merck to 1933 Act claims); In re Direxion Shares ETF Trust, No. 09-cv-8011, 2012 WL 717967, at *2 fn. 3 (S.D.N.Y. Mar. 6, 2012) (same); Plumbers’ & Pipefitters’ Local No. 562 Supp’l Plan & Trust v. J.P. Morgan Acceptance Corp. I, No. 08-cv-1713, 2012 WL 601448, at *10 (E.D.N.Y. Feb. 23, 2012) (same).
While the concept of “inquiry notice” now appears all but dead in federal securities claims, courts have reached mixed results in extending Merck to state law claims. A federal court in Ohio recently applied Merck to Ohio’s blue sky law, drawing a comparison between the statutory language of the 1934 Act and the Ohio law, which requires knowledge of “facts” related to defendants’ wrongdoing. In re Nat’l Century Fin. Enter., Inc., 755 F.Supp.2d 857, 869-72 (S.D. Ohio 2010). But a Texas appellate court declined to apply Merck to the Texas Securities Act, “[i]n light of the differences in the language of the statutes’ limitations provisions,” particularly because intent is not at issue in the Texas statute. Allen v. Devon Energy Holdings, L.L.C. No. 01–09–00643–CV, 2012 WL 880623, *26 fn. 62 (Tex. App. Mar. 9, 2012). An Indiana appellate court likewise declined to apply Merck to the Indiana Uniform Securities Act, finding that Merck is not controlling and distinguishable on its facts, because plaintiffs were on notice of defendant’s wrongdoing “all along.” Paddock v. Maikranz, No. 82A05–1010–CT–6362011 WL 3849439, *4 fn. 6 (Ind. App. Aug. 31, 2011).
How Specific Must Information Be to Start the Clock?
Other courts dealing with RMBS cases have not felt the need to reach the Merck question. In so doing, they have established another clear statute-of-limitations trend: that, at the pleading stage at least, general information about the industry in question is insufficient to show the statute of limitations began with respect to the plaintiff’s particular securities.
Defendants in RMBS cases typically cite newspaper articles, filed complaints, and other public sources in arguing that plaintiffs were on notice of their claims outside of the limitations period. Plaintiffs push back, arguing that none of that information relates to their specific securities, and much of it does not even have to do with the specific defendants at issue. Courts have almost uniformly sided with plaintiffs, rejecting the sufficiency of materials untethered to the specific securities at issue. See, e.g., Mass. Mut. Life Ins. Co. v. Residential Funding Co., LLC, No. 11-cv-30035, 2012 WL 479106, *10-*11 (D. Mass. Feb. 14, 2012) (public information “did not directly relate to the misrepresentations and omissions alleged”); N.J. Carpenters Vacation Fund v. Royal Bank of Scotland Grp., 720 F. Supp. 2d 254, 267 (S.D.N.Y. 2010) (“Although defendants point to a number of publicly-available documents generally related to the weakening and outright disregard for underwriting guidelines by subprime originators, this information alone does not ‘relate directly’ to the [offerings] specifically at issue.”); In re Wells Fargo Mortgage-Backed Cert. Litig., 712 F. Supp. 2d 958, 967 (N.D. Cal. 2010) (whether press coverage was sufficient to put a reasonable investor on notice of its claims was a factual question not appropriate for resolution on a motion to dismiss).
For example, in Plumbers’ & Pipefitters v. J.P. Morgan, the court concluded:
[N]one of the newspaper articles proffered by defendants “refer to the offerings, the Certificates, or tie the originators to securities offered by the defendants. Of the stories that do refer to an originator, most describe the high rate of default experienced by subprime mortgages . . . . This information would put a potential plaintiff on notice merely that their mortgage-backed securities were likely to decline in value. But, default on subprime loans could be caused by any number of broad economic factors . . . . Even if this were enough to cause a reasonable investor to investigate, it would not establish that their offering documents contained material misstatements and omissions.
2012 WL 601448, at *11.
Courts that have dismissed RMBS claims as being untimely have done so where there were security-specific—or, at least, highly defendant-specific—facts publicly available. For instance, in In re Morgan Stanley Mortgage Pass-Through Certification Litigation, the securities had been downgraded twenty times prior to the relevant cutoff of May 2008. 2010 WL 3239430, at *8 (S.D.N.Y. 2010). And in Boilermakers National Annuity Trust Fund v. WaMu Mortgage Pass-Through Certificates, Series AR1, the trigger for finding that the period there had begun by August 2008 was a class-action complaint, filed against common defendants, that focused “almost exclusively” on the exact same offering materials being sued on in the later action. 748 F. Supp. 2d 1246, 1258 (W.D. Wash. 2010).
Similarly, the court’s analysis in Stichting Pensioenfonds ABP v. Countrywide Financial Corporation turned heavily on facts made public by multiple, defendant-specific, overlapping cases that had been filed before the 2008 limitations cutoff. 802 F. Supp. 2d 1125, 1136-37 (C.D. Cal. 2011). Indeed, while the court in Stichting found claims were time-barred as of February 2008, the same court denied a motion to dismiss other claims where the cutoff period was December 2007, noting that “the period between December 27, 2007 and February 14, 2008 was an important time in the Countrywide saga.” Allstate Ins. Co. v. Countrywide Financial Corp., No. 11-cv-05236, 2011 WL 5067128 (C.D. Cal. Nov. 21, 2011), at *14.
The RMBS cases dismissing claims as being untimely are thus the exceptions that prove the rule, that securities claims are only untimely if investors knew of the facts as to their specific investments.
How to Apply American Pipe
Another way that RMBS cases have shined a light on important statute of limitations questions—even if, here, it has not yet brought clarity to the issue—is in their repeated assessment of how to apply American Pipe.
In recent years, institutional investors have argued that the one-year statute of limitations and three-year statute of repose under the Securities Act of 1933 can be tolled by prior class actions that name overlapping securities. Tolling has the potential to extend the limitations periods for such claims by several years. Plaintiffs rely on the tolling rule announced in American Pipe & Construction Co. v. Utah, 414 U.S. 538, 554 (1974), that “the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action.” If potential class members’ claims were not tolled, the Supreme Court held, they would be induced to file placeholder complaints and motions, which would undermine the “efficiency and economy” of class actions. Id. at 553.
One question that courts have grappled with is whether American Pipe can toll statutes of repose. In Footbridge Limited Trust v. Countrywide Financial Corp., 770 F. Supp. 2d 618, 624-27 (S.D.N.Y. 2011), Judge Castel of the Southern District of New York concluded that the three-year statute of repose is “absolute” and not subject to tolling, although he noted extensive case law to the contrary and conceded that “many of the policy considerations present in American Pipe would support tolling of a statute of repose.” Judge Kaplan of the Southern District followed the Footbridge decision in In re Lehman Bros. Sec. & ERISA Litig., 800 F.Supp.2d 477, 481-83 (S.D.N.Y. 2011), but likewise acknowledged that “most courts that have addressed this issue have concluded that American Pipe does apply to toll statutes of repose” and that his holding “is in tension with the policies animating the American Pipe decision.” Id. at 482-83. Other courts have since rejected the reasoning of Footbridge and In re Lehman, finding that the statute of repose can be tolled under American Pipe. See, e.g., Maine State Ret. Sys. v. Countrywide Fin. Corp., 722 F.Supp.2d 1157, 1166 (C.D. Cal. 2010); In re Bear Stearns, 2012 WL 1076216, at *16; Plumbers’ & Pipefitters’ Local No. 562 Supplemental Plan & Trust v. J.P. Morgan Acceptance Corp. I, No. 08-cv-1713, 2011 WL 6182090, at *4-*5 (E.D.N.Y. Dec. 13, 2011); Int’l Fund Mgmt. S.A. v. Citigroup Inc., No. 09-cv-8755, 2011 WL 4529640, at *5-*8 (S.D.N.Y. Sept. 30, 2011).
Another question that has repeatedly come up is whether class members can rely on American Pipe even if the named plaintiffs are later found to have lacked standing to bring the claims. The Third and Eleventh Circuits addressed the issue in the non-RMBS context, both finding that the principles of American Pipe—that the initial suit put defendants on notice of their claims, and creating ambiguity will result in an unnecessary flood of protective suits—require the doctrine’s application even if the named plaintiff is later found to lack standing. See Haas v. Pittsburgh National Bank, 526 F.2d 1083, 1086 (3d Cir. 1975); Griffin v. Singletary, 17 F.3d 356, 356 (11th Cir. 1994). Many RMBS courts have followed such rulings, applying American Pipe even if the relied-on class action was later narrowed due to a lack of standing. See, e.g., In re Morgan Stanley Mortg. Pass-Through Certificates Litig., 810 F. Supp. 2d 650, 669-70 (S.D.N.Y. Sept. 15, 2011) (“In cases where the law on standing was anything less than crystal clear, potential class members would be taking a tremendous risk by delaying intervention.”); Genesee County Emp.’ Ret. Sys. v. Thornburg Mortg. Secs. Trust 2006-3, 2011 WL 5840482, *61-*64 (D. N.M. Nov. 12, 2011) (“putative class members should not have to predict how the Court would decide the standing issues” but instead should be able to rely on filed class actions). Other courts have reached the opposite conclusion, fearing that recognizing such a rule would invite abuse by the class-action bar. See Stichting Pensioenfonds ABP v. Countrywide Fin. Corp., 802 F. Supp. 2d 1125, 1131 (C.D. Cal. 2011), appeal docketed, No. 11-56642 (9th Cir. Sept. 22, 2011).
The Statute of Limitations in Repurchase Claims
Most RMBS lawsuits allege fraud arising from misrepresentations in offering materials, but a subset allege breach of contract arising from the failure to repurchase non-compliant loans—so-called “putback” litigation. The contracts that govern RMBS trusts allow the trustee or other parties to the contracts to demand that the seller, sponsor, or other responsible party cure or repurchase defective loans in the RMBS trust. Investors arguably cannot make such a demand directly, but if they meet specific contractual requirements, they can direct the trustee to obtain the loan files, then analyze the files to identify breaches of representations and warranties, and then direct the trustee to demand the repurchase of defective loans.
The issue in these cases is whether the statute of limitations begins to run when the defendant refuses a repurchase request or when the alleged underlying misrepresentations were made. In Securitized Mortgage Trust 1997-2 v. Daiwa Fin. Corp., No. 02 Civ. 3232, 2003 WL 548868, *2 (S.D.N.Y. Feb. 25, 2003), an early mortgage-backed securities case, the court found that the defendant’s “false warranties and representations breached the contract at its inception,” as alleged in the complaint, and therefore the statute began to run when the contract was made (i.e. the closing date). The court rejected the argument that the statute of limitations only began to run later, when a demand was made, because the plaintiff could have made its demand earlier. Id. More recently, a Washington court applying New York law found that the failure to repurchase cannot constitute an independent breach for limitations purposes and, where two related breaches are alleged, the limitations period begins to run from the first breach. Lehman Bros. Holdings, Inc. v. Evergreen Moneysource Mortg. Co., 793 F.Supp.2d 1189, 1193-94 (W.D. Wash. 2011).
These holdings notwithstanding, plaintiffs can and will argue, with much force, that the failure to repurchase is a separate breach of contract, independent of the underlying breaches of representations and warranties. If the breaches are separate, the statute of limitations for the failure to repurchase should begin to run only when a repurchase demand is made and refused. Some RMBS offerings also include accrual provisions which provide that claims do not accrue until a repurchase demand is made and refused, but such provisions are still untested in the courts. RMBS lawsuits arising from repurchase claims are a small but growing area of RMBS litigation, and the courts’ rulings on the applicable statute of limitations will continue to develop.
Summary of the Implications of Recent RMBS Case Law
The Supreme Court’s decision in Merck, and the decisions that have followed it, have far-reaching implications for securities claims. Most of the decisions raise defendants’ burden for dismissal on a motion to dismiss—either by applying Merck even to 1933 Act claims, stressing the importance of security-specific information, or both. Given the principles of fairness to plaintiffs, who arguably should not have their clocks begin before they could even successfully bring a claim, is a universal concern, we may soon see courts re-assessing the application of “inquiry notice” standards even to common-law claims (though the courts have thus far split on whether Merck should govern state blue sky limitations periods).
The RMBS cases have also raised important questions regarding the application of American Pipe. Unless and until such questions as its applicability to the statute of repose and whether investors are protected are finally settled, one can expect prudent investors to file protective “opt-out” suits unless the named plaintiffs’ standing is beyond dispute. Though such would undermine the efficiency purposes of class-action litigation, that is the unfortunate side effect of those minority rulings that have read American Pipe narrowly.
June 2012: Bankruptcy & Restructuring Update
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In re Lancelot Investors Fund, L.P.: A bankruptcy judge in Illinois recently determined that the Bankruptcy Code’s “safe harbor” provisions (11 U.S.C. § 546(e), (g)) apply to payments made to innocent investors who unwittingly put money into a “Ponzi” scheme. In In re Lancelot Investors Fund, L.P., No. 08-B-28225, slip op. (Bankr. N.D. Ill. Mar. 1, 2012), the debtor was a hedge fund that purportedly used investors’ money to invest in the sale of electronics. In fact, as with typical Ponzi schemes, early investors were merely being repaid with the money received from later investors. In Lancelot, the question was whether ‘early’ investors who had been ‘repaid’ pre-petition had to return those funds to the trustee for the benefit of the overall estate (i.e., the other Ponzi victims). The Bankruptcy Court held the ‘early’ investors could keep the funds received from their exercise of redemption rights, as long as such transfers otherwise met the facial requirements of the safe harbor provisions. The Court held that the safe harbor provisions applied because the plain meaning of the safe harbor provisions protected transfers that were themselves legitimate, even if they were the end result of a larger fraudulent scheme.
Statek Corporation v. Development Specialists, Inc., Plan Administrator for Coudert Brothers LLP: The Second Circuit recently shed light on how bankruptcy courts should apply choice-of-law rules to state law claims. In Statek Corporation v. Development Specialists, Inc., Plan Administrator for Coudert Brothers LLP (In re Coudert Brothers LLP), No. 10-2723-bk (2d Cir. February 28, 2012), a former client of Coudert Brothers filed a pre-bankruptcy malpractice suit in Connecticut state court. The action was stayed when Coudert Brothers filed for bankruptcy in New York. The malpractice plaintiff then perfected its claim in bankruptcy, but the plan administrator moved to disallow it. The bankruptcy court disallowed the claim, finding that New York law applied and that the claim was time-barred under the New York statute of limitations. The district court affirmed, but the Second Circuit reversed, holding that a bankruptcy court should look to the choice of law rules of the state where the underlying prepetition complaint was filed, not the choice-of-law rules of the state in which the bankruptcy court sits.
June 2012: London Litigation Update
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The Enforceability of “Best Endeavours” Clauses: Clauses requiring parties to use ‘best’ or ‘reasonable’ endeavours are common place in commercial contracts. They make sense to parties at the time of contracting, where typically there is goodwill and a belief that the parties will operate under such clauses in the spirit of good faith. Frequently, however, that goodwill does not last and a dispute emerges. In this context, courts have had to wrestle with the meaning of these somewhat uncertain obligations.
In Jet2.com v. Blackpool Airport Limited [2012] EWCA Civ 417, the Court of Appeal considered a contract between Jet2.com (“Jet2”), a low cost airline that operates between various United Kingdom and European destinations, and Blackpool Airport Limited (“BAL”), which owns and operates a commercial airport on the outskirts of Blackpool, England. In 2005, Jet2 and BAL executed a letter agreement setting out the terms on which Jet2 would operate from Blackpool Airport over the course of the following 15 years. Clause 1 of the letter agreement provided that “Jet2 and BAL will cooperate together and use their best endeavours to promote Jet2’s low cost services from Blackpool Airport and BAL will use all reasonable endeavours to provide a cost base that will facilitate Jet2’s low cost pricing.”
The dispute concerned Blackpool Airport’s operating hours. Although the airport’s normal operating hours were 7:00 am to 9:00 pm, Jet2 regularly operated flights outside of those hours for the first four years of the contract. However, in October 2010, in order to reduce its costs, BAL notified Jet2 that Blackpool Airport would not accept departures or arrivals scheduled outside normal operating hours. In response, Jet2 brought proceedings against BAL on the grounds that clause 1 of the letter agreement obliged BAL to accept aircraft movements outside of normal hours. The High Court ruled in Jet2’s favour, and BAL appealed.
All three judges on the Court of Appeals agreed that being able to ascertain the object of a best endeavours clause is critical in deciding whether the contractual commitment is sufficiently definite to be legally enforceable. The majority ruled that, in the circumstances, BAL’s actions amounted to a breach of contract, because the wording “best endeavours to promote Jet2’s low-cost services” was sufficiently certain so as to include keeping the airport open to accommodate flights outside normal hours ([31 and 71]). However, given the uncertainty about future events, the majority was not prepared to issue a broad declaration that BAL could never refuse aircraft movements ([33]).
Relevant to Their Lordships’ decisions were the following propositions: (a) An obligation to use best endeavours is not unenforceable merely because it requires a party to act contrary to its commercial interests. Rather, the extent to which parties can have regard to their own financial interests will very much depend on the nature and terms of the contract in question, which in BAL’s case included incurring costs to facilitate Jet2’s use of the airport ([32]). (b) The claimant had produced considerable evidence as to the object of the clause, namely promoting low-cost airline services, which included that low-cost airlines relied on obtaining maximum use of their aircraft by operating schedules under which plane movements occur early in the morning and late at night ([17]). (c) There was criteria by which it was possible to assess whether best endeavours could be, and had been, used, specifically, that BAL had allowed Jet2 to use the airport outside of normal hours since the beginning of the contract, and had changed that stance suddenly and without a justifiable explanation ([72]).
For completeness, Lewison LJ dissented because His Lordship considered that, on the facts of the case, there was insufficient clarity as to the object of clause 1 and because such clarity as there was in the case could only be gained by ignoring the usual rules of contract interpretation as to the relevance of background facts and the admissibility of parties’ subsequent conduct ([57 – 62]).
UK Supreme Court Rules on Lehman Client Money Case: In In the matter of Lehman Brothers International (Europe) (In Administration) and In the matter of the Insolvency Act 1986 [2012] UKSC 6, the Supreme Court considered another case in the long running fallout from the collapse of Lehman Brothers. The case concerned “client money” received and held by Lehman Brothers International (Europe) (“LBIE”) on behalf of its clients in relation to particular investments, which was then pooled together with other funds in mixed accounts.
The Supreme Court held unanimously that the relevant rules in chapter 7 of the Clients’ Assets Sourcebook (“CASS”) issued by the Financial Services Authority (“FSA”) under the Financial Services and Markets Act 2000, create statutory trusts for clients’ money held by firms. Those statutory trusts arise at the time financial institutions receive client money, rather than when client money is segregated from the other monies that firms might hold ([62-63 and 182-183].
A majority of the Supreme Court (Lords Clarke, Dyson and Collins) also ruled that: (1) The rate at which each client participates in a notional client money pool is determined by the amount of client money that should have been segregated at the date of a pooling event ([159]): it is not necessary for client money to have already been segregated prior to a pooling event in order for it to be considered part of a notional client pool ([160]). (2) The primary pooling arrangements prescribed in the CASS apply to in house accounts, such that, if a firm becomes insolvent, client money in those accounts should be distributed in accordance with the FSA rules ([167]). Again, it is not necessary for client money to be held in segregated accounts in order for the distribution rules to apply ([166]).
An important consideration for the Lords in the majority was that the client money rules are intended to protect all the clients’ money received prior to a pooling event, and the distribution rules are intended to protect all clients’ money following a pooling event. Accordingly, where there is a choice of interpretations for those FSA rules, the courts should adopt the one that affords a high degree of protection for all clients ([147]). Ruling that clients’ monies must be segregated before clients can participate in a notional client money pools would be contrary to that policy, as would excluding identifiable client money in house accounts from the regime.
Disclosure of Spouses’ Emails: In McKillen v Misland (Cyprus) Investments Ltd & Otrs [2012] EWHC 866 (Ch), the High Court dealt with the novel question of whether a party can be compelled to disclose emails sent or received by that party’s spouse at his or her request.
The claimant in the case applied for order that the wife of one of the defendants disclose emails that she had sent or received for the defendant, who did not use email himself. The claimant argued that the emails were within the defendant’s control because: (a) the email accounts were jointly held by the defendant and his wife; and (b) in sending and receiving the emails, the defendant’s wife was acting as an agent for the defendant, such that he could now request that she provide him with copies of them for the purposes of disclosure.
The High Court rejected the first ground on the facts ([9]). As to the second ground, David Richards J was not convinced that, when a person sends or receives emails for his or her spouse, it gives rise to an agency relationship with a continuing obligation to provide copies, at a later date, of the emails sent or received from that account ([18]). His Lordship considered that requests to send emails are fairly commonplace between husbands, wives, partners, friends and work colleagues, and that, in the absence of any express agreement, those people would be surprised if they were under a continuing obligation ([19]). Given that the defendant’s wife had only sent approximately 40 emails at the request of her husband over an 18 month period, an agency relationship should not be implied ([20]). Accordingly, the application for further disclosure was dismissed. The Judge left open the possibility that a spouse could be an agent in these circumstances, but indicated that the facts would need to disclose a clear course of dealing to this effect ([20]).
Libellous Tweets on Twitter: In Cairns v Modi [2012] EWHC 756 (QB), the High Court considered a libel action by Chris Cairns, a former captain of the New Zealand cricket team, against Lalit Modi, the former Chairman and Commissioner of the Indian Premier Cricket League. It was the first case before English Courts that concerned alleged libellous “Tweets.”
On 5 January 2010, Modi “Tweeted” that Cairns had been removed from the Indian Premier League auction list (from which teams purchase players) because of his (alleged) past record of match fixing. On the same day, Modi suggested to an online cricket magazine, Cricinfo, that there were strong grounds to suspect that Cairns was guilty of (alleged) match fixing. Cricinfo published briefly an article on its website in which Modi’s suggestion was repeated.
Cairns brought proceedings, and the High Court ruled in his favour, noting that Modi “singularly failed to provide any reliable evidence that Cairns was involved in match fixing, or even that there were strong grounds for suspicion that he was” ([118]).
Two rulings in the case will be relevant to future libel claims involving social media:
(1) Although Modi did not publish the “Tweet” from England, Bean J ruled that the case was properly before the English courts. Bean J’s reasoning was that Cairns had previously lived in England; by the time of the proceeding, Modi was living in England; and a trial in India would have involved very long delays ([3]). (2) Damages should not be reduced to trivial amounts simply because publication was limited. The Court found that only about 65 followers of Modi’s Twitter account would have viewed the “Tweet,” and only about 1000 people would have viewed Cricinfo’s online article. However, Bean J referred to longstanding authority to the effect that the “real” damage of libellous statements cannot be ascertained because it is impossible to track the scandal and to know what quarters the “poison” may reach. Bean J was of the view that “this remains true in the 21st century, except that nowadays the poison tends to spread far more rapidly” ([123]).
June 2012: Copyright Litigation Update
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Supreme Court Confirms U.S. Copyright Protection for Foreign Works Previously in Public Domain: On January 18, 2012, a 6-2 majority of the U.S. Supreme Court affirmed the constitutionality of the Uruguay Round Agreements Act (URAA), granting copyright protection to certain foreign works that had previously been in the public domain in the U.S. In so doing, the Supreme Court affirmed the Tenth Circuit’s decision in Golan v. Holder, 609 F.3d 1076 (10th Cir. 2010).
In this case, a group of orchestra conductors, musicians, publishers and others brought an action challenging the URAA on the grounds that Article I, § 8, Cl. 8 of the Constitution (the “Copyright Clause”), together with the First Amendment, restricted the ability of Congress to grant copyright protection to works that had previously been in the public domain. Codified at 17 U.S.C. § 104A and 109(a), the URAA extends copyright protection to works that obtained copyright protection in their countries of origin, but had no such protection in the United States for one of three reasons: (i) an absence of copyright relations between the country of origin and the United States at the time of publication; (ii) the lack of protection for sound recordings fixed before 1972; and (iii) a failure to comply with statutory formalities peculiar to the Copyright Act in the U.S. The petitioners contended that the URAA violated the “limited Times” language of the Copyright Clause because it extended protection to existing public domain works rather than incentivizing the creation of new works, an argument rejected by the Court.
Writing for the majority, Justice Ginsburg noted that the Court’s decision in Eldred v. Ashcroft, 537 U.S. 186 (2003)—a decision that had confirmed the ability of Congress to extend the term of copyright for preexisting works—foreclosed the petitioners’ “limited Times” challenge: “The Copyright Clause does not demand that each copyright provision, examined discretely, operate to induce new works … the Clause ‘empowers Congress to determine the intellectual property regimes that, overall, in that body’s judgment, will serve the ends of the Clause.’” Golan v. Holder, 132 S.Ct. 873, 888 (2012). The majority found the petitioners’ First Amendment argument similarly unavailing: “[s]ome restriction on expression is the inherent and intended effect of every grant of copyright,” and “[n]othing in the historical record, congressional practice, or our own jurisprudence warrants exceptional First Amendment solicitude for copyrighted works that were once in the public domain.” Id. at 889-90. Justice Breyer, joined by Justice Alito, dissented from the majority’s opinion, stating that the URAA’s effect of removing material from the public domain meant that “the Copyright Clause, interpreted in the light of the First Amendment, does not authorize Congress to enact this statute.” Id. at 912.
The dissent notwithstanding, the majority opinion confirms the broad scope of Congressional power to define the boundaries of copyright protection.
Ninth Circuit Affirms Strength of DMCA Safe Harbor Provisions: On December 20, 2011, the Ninth Circuit affirmed a district court grant of summary judgment to an operator of a publicly accessible website enabling users to share digital videos with other users. The Court’s opinion in UMG Recordings, Inc. v. Shelter Capital Partners LLC, 667 F.3d 1022 (9th Cir. 2011) confirms the strength of the safe harbor provisions of the Digital Millennium Copyright Act (“DMCA”), codified at 17 U.S.C. § 512(c), for internet service providers faced with allegations of copyright infringement by publishers and artists.
In this case, despite efforts by the website operator to prevent copyright infringement on its system, some of its users were able to download unauthorized videos containing music for which the plaintiff owned the copyright. In September of 2007, the plaintiff publisher brought suit against both the website owner and three of its investors, alleging direct, vicarious and contributory copyright infringement, as well as inducement of copyright infringement. The district court granted summary judgment in favor of the defendants on the basis of the DMCA’s safe harbor provision. The safe harbor protects service providers who (i) control systems or networks on which copyrighted material is posted without their actual knowledge; (ii) do not receive a financial benefit directly attributable to the infringing activity; and (iii) take down such material upon notice from the copyright owner.
The Ninth Circuit affirmed, noting first that facilitating access to content, if done at the direction of a user, falls within the ambit of the “storage” language of the safe harbor: “We hold that the language and structure of the statute, as well as the legislative intent that motivated its enactment, clarify that [the safe harbor] encompasses the access-facilitating processes that automatically occur when a user uploads a video [].” UMG Recordings, 667 F.3d at 1031. The Court noted that the defendants’ system, allowing user-submitted content to be processed and recast in a readily accessible format, satisfied the safe harbor requirement that the content submission be “user-directed.” Id. at 1035. The Court also noted that general knowledge that one’s services could be used to share infringing material is insufficient to meet the “actual knowledge” standard of the DMCA safe harbor: According to the Court: “[m]erely hosing a category of copyrightable content, such as music videos, with the general knowledge that one’s services could be used to share infringing material, is insufficient to meet the actual knowledge requirement under [the DMCA safe harbor].” Id. at 1038, 1042. As to the investor defendants, the Court held they were not liable for secondary copyright infringement because there was no allegation that they “agreed to work in concert” to induce the alleged infringement in question—the mere funding of the plaintiffs’ enterprise is not enough to support secondary liability. Id. at 1047.
By affirming the district court grant of summary judgment on the copyright infringement claims, the Ninth Circuit re-affirmed the broad scope of the safe harbor protections of the DMCA for digital service providers and their investors.
Second Circuit Adopts Ninth Circuit Reasoning Regarding “Actual Knowledge” for DMCA Safe Harbor Provisions: In a related development, on April 5, 2012, the Second Circuit issued its opinion in Viacom Intern., Inc. v. YouTube, Inc., Nos. 10-3270-cv and 10-3342-cv, 2012 WL 1150851 (2d Cir. Apr. 5, 2012). In that case, the Court was presented with a question similar to the one tackled by the Ninth Circuit in UMG Recordings v. Shelter Capital Partners LLC, 667 F.3d 1022 (9th Cir. 2011)—namely, what level of specificity is required of a service provider’s knowledge of infringement before its conduct falls outside the safe harbor provisions of the DMCA. Rejecting the plaintiff’s contention that objective knowledge of “facts and circumstances” is enough to meet the “actual knowledge” standard of 17 U.S.C. § 512(c), the Court adopted the reasoning of the Ninth Circuit in holding that the statute requires “[a]ctual knowledge or awareness of facts or circumstances that indicate specific and identifiable instances of infringement [to] disqualify a service provider from the safe harbor.” Viacom Intern., Inc. at *7. According to the Second Circuit, subjective knowledge of facts and circumstances of the specific infringement is required by the actual knowledge standard. Id. at *6. In adopting the reasoning of the Ninth Circuit on this point and confirming the necessity of subjective knowledge in order to remove a service provider from the benefits of the DMCA safe harbor provisions, the Second Circuit has further confirmed the strength of these provisions for digital service providers.
Ninth Circuit Reverses Summary Judgment for Major Apparel Retailer; Holds That Erroneous Inclusion of Published Works in Unpublished Collection Does Not Invalidate Copyright Registration: On April 9, 2012, the Ninth Circuit Court of Appeals handed down its ruling in the copyright case of L.A. Printex, Industries, Inc. v. Aeropostale, Inc., No. 10-56187, 2012 WL 1150273 (9th Cir. Apr. 9, 2012). The plaintiffs (copyright owners of a small floral design) alleged that a major apparel retailer and manufacturer infringed their copyright by using the design on shirts bearing the apparel retailer’s trademark. The district court granted the apparel retailer’s motion for summary judgment, but the Ninth Circuit reversed. On the question of access, the Ninth Circuit held that the plaintiffs had raised a genuine issue of material fact by presenting evidence that they had sold more than 50,000 yards of fabric bearing the copyrighted design to fabric converters, many in the Los Angeles area—the same location of the defendant who had provided the design to the major apparel retailer. This was enough to avoid summary judgment on the question of access: “A reasonable jury could find that [the copyrighted design] was widely disseminated in the Los Angeles-area fabric industry, and hence that there was a ‘reasonable possibility’ that Defendants had an opportunity to view and copy L.A. Printex’s design.”
The Ninth Circuit also took issue with the district court’s view that the differences between the copyrighted work and the apparel retailer’s shirts were enough to grant summary judgment for the defendant. According to the Court: “[a] copyright defendant need not copy a plaintiff’s work in its entirety to infringe that work. It is enough that the defendant appropriated a substantial portion of the plaintiff’s work.” L.A. Printex at *7. The Court also rejected defendants’ contention that an error in the plaintiffs’ copyright registration precluded the suit. Although 17 U.S.C. § 411(b)(1) provides that the knowing inclusion of inaccurate information in a copyright registration can render the certificate incapable of supporting an infringement action, the Ninth Circuit disagreed that the inaccuracy in this case met this standard of invalidity. The Court noted, “[t]here is no evidence that L.A. Printex knew that the two designs had been published at the time it submitted its application for copyright registration,” and that the Copyright Office’s issuance of a certificate of supplementary registration when the plaintiffs noticed the error and corrected the registration “shows that the error was not one that ‘if known, would have caused the Register of Copyrights to refuse registration.’” L.A. Printex at *9.
This decision emphasizes both the difficulty that copyright defendants face in winning on summary judgment and the reluctance of federal courts to invalidate copyright registrations.
The Supreme Court Confronts Controversies Overseas, But Will Congress Have the Final Word?
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The proper role of US courts in policing conduct abroad is commanding the Supreme Court’s attention and may soon command that of Congress. Since 1789, the Alien Torts Claims Act (“ATCA”) has long conferred jurisdiction upon federal courts to entertain suits “by an alien” for an alleged tort “committed in violation of the law of nations or a treaty of the United States.” Beginning around 1980, the ATCA became a focal point of controversy as non-US citizens increasingly asserted ATCA claims in federal courts arising from alleged wrongs committed outside the United States. Seldom has the Supreme Court weighed in about that controversy. It is now positioned to do so, however, in what could be a landmark decision.
In February, the Supreme Court heard oral argument in Kiobel v. Royal Dutch Petroleum Co. on the question whether corporations (as opposed to individuals) can be liable under the ATCA for alleged wrongdoing committed in foreign countries against foreign nationals. Arguing on the side of the defendant was Kathleen Sullivan, a name partner at Quinn Emanuel Urquhart & Sullivan, LLP, former Dean of Stanford Law School, and renowned appellate advocate and constitutional scholar. Less than a week after hearing the argument, the Supreme Court issued an extraordinary order setting re-argument for next term. The Supreme Court moved beyond the exposure faced specifically by corporations and asked the parties to address a broader question: “Whether and under what circumstances the [ATCA] allows courts to recognize a cause of action for violations of the laws of nations occurring within the territory of a sovereign other than the United States.” Thus, the Supreme Court will now consider the fundamental question whether US courts should be sitting in judgment of alleged violations of international law committed in other countries.
The Court last ordered re-argument in this fashion three years ago, in Citizens United v. FEC. That case yielded a blockbuster ruling favoring corporations’ first-amendment rights in the face of campaign-finance restrictions. It remains to be seen whether Kiobel will yield a ruling of similar significance.
Looking Around the Corner. Wherever the Supreme Court comes down, there will be winners and losers. If the Court limits ATCA lawsuits, supporters of opening up the US legal system to foreign plaintiffs will go to Congress to amend the statute to provide for more expansive jurisdiction. Opponents will attempt to counter those efforts. Should the Supreme Court instead permit ATCA lawsuits for foreign torts, opponents of such suits might well ask Congress to limit the law’s application to overseas torts, with corresponding resistance mounted by supporters of expansive jurisdiction. Either way, the debate is unlikely to end with the Supreme Court’s decision, and Congress may have the final word.
The Cuts Are Coming, Payments May Not Be: How Defense Contractors Can Prepare
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Government contractors are facing a year of unprecedented uncertainty. Three things contribute to this: (1) reduced funding requested by the Pentagon; (2) the prospect of sequestration (the automatic cuts triggered when a congressional committee could not agree on deficit reduction); and (3) the prospect that the government will hit the debt ceiling late this year. This article discusses each of the three and suggests some proactive steps that defense contractors can take to protect themselves.
The Pentagon’s Lower Budget Request. In February, the Pentagon unveiled a 2013 budget plan that would cut $487 billion in spending over the next decade by trimming approximately 100,000 ground troops, purchasing fewer ships and cutting back on air defense. For 2013, the Pentagon has asked for a base budget of $525 billion—down from $531 billion approved last year and the first reduction that the Pentagon has requested since 9/11. Only $108 billion of the total 2013 budget will be available for procurement of weapon systems, including guns, ships and jet fighters, down from $120 billion in 2012. As of the date of this writing, President Obama has announced that he would veto the House’s 2013 defense spending bill in its current form.
The Impact of Sequestration on Defense Spending. Although the Pentagon’s proposed 2013 budget takes into account spending caps mandated by the Budget Control Act, it does not address the additional $492 billion in defense cuts over nine years that will go into effect on January 2, 2013. Because the Joint Select Committee on Deficit Reduction did not agree on a comprehensive spending-reduction package, the Department of Defense and its agencies, like other parts of the government, are facing across-the-board, automatic and indiscriminate cuts, known as “the sequester.” These cuts, which are estimated to be in the magnitude of 15 percent at the Program, Project and Activities level, will touch almost all discretionary defense programs and contracts. In late April, the Chairman of the House Armed Services Committee announced a plan that would eliminate the sequester and set the base defense budget at $554 billion—roughly $8 billion above the cap set by the Budget Control Act. While efforts to eliminate the sequester are gaining momentum on Capitol Hill, it is unclear whether those efforts will succeed.
The Debt Ceiling. There is—once again—a very real possibility that the government will reach the debt ceiling before year-end and potentially default on its obligations to contractors. It is, of course, impossible to predict when the government will hit the debt ceiling. Treasury Secretary Timothy Geithner recently reiterated his position that lawmakers will have until the end of 2012 to decide whether to raise the debt ceiling. It is possible, however, that the government will hit the debt ceiling in early-November 2012 if tax receipts fall short, economic growth continues to languish, and spending continues to outpace receipts. If the debt ceiling is not raised and the government is unable to pay its bills or, more likely, is forced to prioritize which bills it does pay, it may require contractors to continue performing. The government will likely take the position that, unless and until its failure to pay amounts to a material breach, contractors are obligated to continue contract performance and must attempt to recoup payments for their performance after-the-fact.
Given the present reality of reduced spending and fiscal uncertainty, defense contractors can take steps now to prepare for whatever lies ahead.
- Classify existing contracts. Determine the nature of the work being performed and how existing contracts are funded. Contracts that support an essential government function are less likely to be impacted negatively by a potential default than are contracts funded with multi-year or revolving appropriations. Additionally, the sequester should not apply to contracts for which funds have been obligated prior to January 2, 2013.
- Confirm the status of existing contracts. Review the statement of work, period of performance and funding level of existing contracts. If the performance period is about to end and the company has an option to extend, ensure that the contracting officer exercises the option prior to continuing performance. Performing after expiration of a contract, in excess of contract requirements or above the appropriated funding level, is risky and may not be compensated.
- Anticipate a Reduction in Spending. For contracts that are coming up for renewal, have unexercised options or will be bid for as part of the 2013 budget, determine the impact of a 15-percent reduction in funding. Be prepared to renegotiate, taking this reduced spending level into account and take the lead on suggesting ways to implement the cut.
- Submit ripe requests for equitable adjustment. Given funding uncertainties and the likelihood that the Department of Defense will put off executing new contracts, efforts should be undertaken to increase cash reserves. Getting paid for outstanding requests for equitable adjustment on existing contracts is an excellent way to do that.
- Collect interest penalties. Review the status of progress payments on existing contracts and redouble efforts to submit timely progress payment requests going forward. Pursuant to the Prompt Payment Act, 31 U.S.C. § 3901 et seq., federal agencies are required to pay their bills on time and to pay interest penalties when payments are late. Collecting interest penalties for late payments will improve liquidity. Moreover, it is critical to submit, on time, progress payment requests when they come due. Interest penalties accrue only if a request for payment has been submitted.
- Track expenses. Develop procedures to track expenses associated with government-caused delays and terminations, including creating separate charge items. In the event of default or as a means to reduce spending, contracting officers may (depending on the terms of the contract) descope, issue stop work orders, order production breaks, suspend work, delay performance, or terminate contracts in whole or in part. The government generally must compensate contractors for the impact of such actions, but may avoid doing so if the impact on the contractor is not adequately documented.
- Cure defects. Cure defects in existing contracts and, if appropriate, respond to show-cause notices. Contracting officers faced with slashed budgets may see terminating underperforming contractors for default as an easy way to save money. Contractors should eliminate every possible ground for default termination.
- Review subcontractor agreements. Understand obligations to pay any subcontractor, and, correspondingly, entitlements to demand performance from that subcontractor. A prime contractor’s obligation to pay a subcontractor depends on the terms of the agreement, as does the subcontractor’s obligation to continue performance if it is not paid. Newly executed subcontracts should include a “payment-when-paid” clause that makes payment to the subcontractor contingent on the prime contractor’s receipt of payment from the government.
- Develop a communication protocol. While effective communication is always the touchstone of successful contract administration, constant communication with the contracting officer, the contracting officer’s technical representative, subcontractors and employees is vital during this period of uncertainty. Developing an effective communication plan will ensure that complete and accurate information is obtained from the government and is properly disseminated to subcontractors and employees.
Will the FDIC’s Claims Against Directors and Officers of Failed Banks for Simple Negligence Yield to the Protections of the Business-Judgment Rule?
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Federal legislation has yet to specify the extent to which state law may protect directors and officers of failed banks against claims of simple negligence by FDIC, and Congress may soon be urged to step in. For now, directors of banks can breathe a modest sigh of relief. Earlier this year, the Federal District Court for the Northern District of Georgia ruled that directors of banks that failed during the 2008 economic collapse cannot be liable to the FDIC for simple negligence in a case when the directors qualify for protection under a state’s business-judgment rule.
Whenever a bank insured by the FDIC fails, the FDIC will cover the bank’s depository losses while retaining authority to sue those it deems responsible for causing the bank to fail. Integrity Bank of Alpharetta, Georgia had losses of over $70 million and failed. The FDIC, in its capacity as receiver of the failed Integrity Bank, brought a professional-liability lawsuit against a number of the bank’s former officers and inside and outside directors.
Such actions by the FDIC are nothing new. Since 2009, the FDIC has authorized over 460 lawsuits and formally filed 27 complaints in federal district courts. Some of the larger bank failures, including those of IndyMac and Washington Mutual, have been followed by professional liability lawsuits, yet many of the largest bank failures have not been. If history is any guide, bank directors and officers may face professional liability complaints or settlement agreements in the coming years.
The district court’s recent order in the case against Integrity Bank and its directors and officers should offer some comfort. Almost all of the 27 complaints the FDIC has filed since 2009 accuse the directors and officers of simple negligence, gross negligence, and breach of fiduciary duties. In many states, including Georgia, however, the business-judgment rule protects against claims for simple negligence. To qualify for protection under the business-judgment rule, as recited by the Georgia court (quoting the Georgia statute), a director or officer must have “discharge[d] the duties of their respective positions in good faith and with that diligence, care, and skill which ordinarily prudent men would exercise under similar circumstances in like positions.” Given the contours of that protection, the district court determined that the FDIC’s “claims for ordinary negligence and breach of fiduciary duty based upon ordinary negligence fail to state a claim upon which relief can be granted.”
It follows from the ruling that, to hold Integrity Bank’s former directors liable, the FDIC would have to prove they were grossly negligent. For instance, the Georgia court referred to instances where a defendant has “engage[d] in fraud, bad faith, or an abuse of discretion” as instances that would extend beyond simple negligence and outside “the ambit of the protections of the business judgment rule.” Gross negligence is more difficult to prove than simple negligence.
Notwithstanding the court’s decision with respect to Integrity Bank and its former directors, the FDIC is persisting in its efforts to hold directors liable for simple negligence. The FDIC is seeking reconsideration of the court’s ruling and indicated that it may appeal to the U.S. Court of Appeals for the Eleventh Circuit. Following the Integrity Bank order, the agency also filed two more complaints in Georgia against directors and offices of failed Georgia banks. Both allege claims for simple negligence.
The business-judgment rule has yet to be tested outside of Georgia as a defense against a claim of simple negligence by FDIC. Thus, there is cause for doubt and room for argument. Officers and directors of failed banks should monitor how courts handle the FDIC’s simple-negligence claims against former directors and officers who invoke the business-judgment rule in their defense. Beyond that, officers and directors may ask Congress to pass legislation that federalizes the business-judgement defense for bank officers and directors. On the flip side, if the Georgia district court’s ruling starts a trend, then the FDIC may seek expanded authority from Congress to hold officers and directors liable for simple negligence.
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