January 2012: Complete Defense Victory for Micron at Multi-Billion Dollar Antitrust Trial
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After over six years of litigation and a three-month jury trial in San Francisco Superior Court, the firm obtained a complete defense verdict for Micron Technology, Inc., the last remaining U.S. manufacturer of dynamic random access memory (“DRAM”) chips, in a true “bet the company” antitrust case against Rambus Inc. Indeed, on the day of the verdict, Rambus’ stock sank 61% and Micron’s rose 23%.
In 2004, Rambus filed a complaint against Micron and other memory manufacturers alleging a conspiracy to boycott RDRAM, Rambus’ DRAM technology, in violation of the Cartwright Act, one of California’s antitrust laws; a conspiracy to monopolize the market for DRAM technologies in violation of the Cartwright Act; intentional interference with prospective economic advantage from Rambus’ relationship with Intel; and unfair competition under California’s Unfair Competition Law. Rambus alleged that Micron conspired with Hynix, Infineon, and Samsung to restrict the production of RDRAM, to raise the price of RDRAM, and to lower the price of DDR, defendants’ DRAM chips, in order to drive RDRAM from the market and to convince Intel to terminate its relationship with Rambus. Rambus argued, among other things, that defendants should be held liable, because Hynix and others had previously pled guilty to fixing the price of certain DRAM products. Rambus sought approximately $4 billion in compensatory damages, trebled to $12 billion under the Cartwright Act, as well as other relief.
At trial, Micron presented evidence that RDRAM failed as a mainstream memory as a result of its inherent deficiencies and Rambus’ flawed business practices, and not as a result of any conduct by defendants. At the conclusion of the trial, the jury rejected Rambus’ claims and awarded no damages.
This is the third case tried by the firm on behalf of Micron in Rambus’ ongoing litigation campaign against Micron and other memory manufacturers. It is also believed to be one of the largest antitrust cases tried to a jury verdict, and one of the biggest defense verdicts in terms of the stakes and impact on an industry.
January 2012: Patent Victory in Preliminary Injunction Proceeding in Germany
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The firm recently secured denial of a preliminary injunction against its client, Servona GmbH (“Servona”), a leading supplier of medical products in Germany. The plaintiff, Atos Medical AB (“Atos”), sought a preliminary injunction in the District Court of Munich based on the alleged infringement of two medical patents related to tracheostoma valves. Prior to Servona retaining Quinn, the Court had granted an ex parte preliminary injunction based on one of the two asserted patents.
The preliminary injunction prevented Servona from distributing and marketing its new product. German law, however, allows a defendant in such a case to appeal the Court’s decision. The appeal is before the same court, but is an inter partes proceeding, where both sides are permitted to file briefs and present oral argument. In its pre-hearing briefs, Servona attacked Atos’ overly- broad construction of certain claim terms as being unsupported by the plain language of the claims. Servona also presented noninfringement arguments that highlighted core differences between the accused device and the claimed invention. Servona also further explained how its products were fundamentally different from the patent’s claim even under Atos’ own theory. These arguments were supported by the results of tests produced on very short notice.
At the hearing, the Court made clear that it was reconsidering its prior holding and was leaning towards adopting the narrower claim construction. Only a few hours later, the Court reversed its prior decision, denied Atos’ requests for injunctions, and ordered Atos to pay Servona’s attorney fees.
November 2011: Seventh Circuit Victory for Ortho-McNeil
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The firm recently secured a major appellate win in the Seventh Circuit, which resoundingly reinstated an important arbitration victory that the firm had previously secured for Ortho-McNeil, a Johnson & Johnson subsidiary. In a published decision with great national significance for judicial review of arbitration awards, the court (per Easterbrook, J.) narrowed “manifest disregard of the law” almost to the vanishing point as a ground for arbitral vacatur. Some courts have treated this ground as a freestanding warrant to vacate arbitral awards for purported legal error. The Seventh Circuit flatly rejected any such approach as foreclosed by the Supreme Court’s decision in Hall Street v. Mattel, which held that the Federal Arbitration Act’s limited list of statutory grounds for vacatur is exclusive. The court held that an arbitration award may be vacated under such a rubric only if it orders a party to violate the rights of third parties (e.g., by ordering them to form a cartel and fix prices) and that—in finding for Ortho-McNeil in the underlying dispute—the arbitrators had not ordered any party to violate third-party rights. The court also found that the arbitrators had not exceeded their powers under FAA section 10(a)(4) because they had been faithful to the legal principles set forth in the parties’ arbitration agreement. The Seventh Circuit therefore reversed the district court’s partial vacatur of the award that had favored Ortho and remanded for full confirmation of the award.
November 2011: Appellate Victory in Landmark Iran Trade Embargo Prosecution
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The firm obtained a significant appellate victory in United States v. Banki, No. 10-3381-CR, in which The Second Circuit reversed or vacated the major counts of conviction for our client, Mahmoud Reza Banki.
After a fifteen-day jury trial in the Southern District of New York, Mr. Banki, a U.S. citizen who holds a Ph.D. from Princeton University, was convicted of violating the Iranian Transactions Regulations (ITR) (50 U.S.C. § 1705), operating an unlicensed money transmitting business (18 U.S.C. § 1960), conspiracy, and two counts of making materially false statements. The central allegation at trial was that Mr. Banki had violated the ITR and Section 1960 by receiving at least $3.4 million dollars from family members in Iran who sent the money through an informal money transfer system called a hawala. In a hawala, a person seeking to send funds out of one country transfers the funds to a broker in that country. Then the amount, less any fees, is disbursed in another country by a broker there who is coordinated with the originating broker. Mr. Banki’s prosecution is believed to be the first in the country in which the federal government has accused someone of violating the Iran trade embargo—which prohibits the export to Iran of goods or services—based on the individual’s receipt of family funds sent from Iran through a hawala. Quinn Emanuel was retained to represent Mr. Banki in the appeal of his conviction and sentence.
In a unanimous decision (authored by Judge Chin, who was joined by Judges Cabranes and Pooler), the Second Circuit reversed Mr. Banki’s conviction for violating the ITR, vacated his conviction for operating an unlicensed money transmitting business, and vacated his conviction for conspiring to violate both statutes. With respect to the ITR count, the Second Circuit said that the ITR had not given fair warning that non-commercial remittances, including family remittances, between the United States and Iran are prohibited. With respect to the money transmitting count, the Second Circuit held that the district court had erred in declining to instruct the jury that a “money transmitting business” must be a business (i.e., not a single transaction) that is conducted for a fee or profit. The Court’s decision to vacate the ITR and money transmitting counts led it to vacate the conspiracy conviction based on those substantive crimes. The money transmitting and conspiracy counts were remanded for possible new trial, under new instructions. The Second Circuit affirmed Mr. Banki’s conviction on two false statement counts.
This is a significant decision, particularly for the numerous immigrant communities in the United States that rely on informal money transfers, as it clarifies that the government may not premise a criminal prosecution for violation of the Iranian embargo on a non-commercial family remittance between the United States and Iran.
October 2011: Complete Victory on Appeal for Faulty Insurance Claim
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Following four years of litigation, the California Court of Appeal granted complete dismissal of a faulty claim brought by spinach packager Fresh Express against firm clients QBE Insurance Ltd. and Beazley Syndicate 2623/623 at Lloyd’s. Fresh Express filed suit after being denied coverage for the E. Coli spinach outbreak in 2007. Notwithstanding that its insurance policy was limited to self-initiated recalls arising from errors it caused, Fresh Express sought coverage for all losses associated with the market event of the E. Coli crisis. The trial court interpreted the policy favorably for Fresh Express, as covering any accidental contamination caused by any source so long as Fresh Express could point to an error that it made, regardless of its connection to the outbreak. However, following briefing and oral argument, the Court of Appeal reversed the trial court, remanded the case for full dismissal, and awarded appellate costs. It held that “[t]he trial court’s finding that the ‘Insured Event’ was ‘the E. coli outbreak’ is entirely inconsistent with the plain language of the policy.” This was a major victory for insurance carriers, who have well-founded concerns that coverage could be extended to market events that can affect an entire industry at once.
October 2011: Class Action Victory for Major Printer Manufacturer
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The firm recently obtained a significant victory for its client, a major printer manufacturer, in a consumer class action lawsuit. Although the class representatives initially alleged a wide variety of purportedly unfair consumer practices under California’s Unfair Competition Law and Consumer Legal Remedies Act, Quinn Emanuel whittled plaintiffs’ case down to claims based on only two theories. First, plaintiffs claimed that the printer manufacturer was liable based on an omission theory for failing to inform consumers that its products were somehow “less efficient” than other manufacturers’ printers. Quinn Emanuel successfully obtained a summary judgment ruling rejecting this novel theory. A subclass of plaintiffs alleged a second theory, based on a purportedly misleading description of a product feature. Shortly after obtaining summary judgment of the class claims, Quinn Emanuel defeated certification of the subclass.
October 2011: Securities Class Action Victory for Charles Schwab
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The firm recently obtained dismissals of two securities class actions against, Charles Schwab. The plaintiffs in both cases were investors in a mutual fund called the Schwab Total Bond Fund. They filed suit in the Northern District of California, alleging that Schwab invested too heavily in certain mortgage-backed securities (MBS). The percentage of the Fund’s investments in MBS peaked in 2008, just as the market for those securities started tanking. Plaintiffs’ firms swarmed in, and several lawsuits against Schwab mutual funds, including these two, soon followed.
In one case, the plaintiff made only a single claim under California’s Unfair Competition Law (“UCL”). After two rounds of briefing, Judge Koh dismissed the plaintiff’s prayer for relief, holding that because the plaintiff’s lost share value was not in Schwab’s possession, the plaintiff could not get UCL restitution. The plaintiff then gave up and dismissed her claim. In the other case, the plaintiff asserted a broad range of state-law claims, but following successive motions, Judge Koh dismissed each claim with prejudice.
October 2011: Patent Victory for Major LED Manufacturer
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The firm recently won summary judgment in the Eastern District of Virginia for Cree, Inc., a leading U.S. manufacturer of LEDs. The plaintiff, a failed semi-conductor technology company, sued Cree for infringement of two patents pertaining to high quality silicon carbide, a material often used in the manufacture of LEDs.
The Court’s “rocket docket” required the submission of summary judgment motions before a claim construction ruling issued and before the vast bulk of discovery was completed. Quinn Emanuel took advantage of the fast-paced schedule to conduct targeted discovery, and tailored its summary judgment motions to account for various potential claim constructions.
Quinn Emanuel argued that one patent would not be infringed, regardless of whether a broad or narrow construction was ordered. The plaintiff was unable to respond to the motion, merely arguing that it required more discovery. When the claim construction ruling was ordered, the plaintiff was forced to concede that Cree did not infringe, and the Court entered summary judgment of non-infringement.
The firm sought summary judgment as to the second patent under a narrow claim construction, arguing that Cree did not infringe. In the alternative, the firm argued that, under a broad claim construction, the patent was invalid over Cree’s own prior art, specifically “breakthrough” work performed by Cree’s engineers. Ultimately, the Court found that the patent was invalid in light of Cree’s prior art and entered summary judgment of invalidity as well.
September 2011: Arbitration Victory for Toshiba
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The firm recently won a complete victory for Toshiba Corporation in an AAA/ICDR arbitration in New York. Toshiba brought several claims against Coby Electronics Co., Ltd., a Chinese manufacturer of consumer DVD players, for breach of a patent license, and included claims for royalties due under the license agreement. The claims, with interest, totaled over $18 million. Additionally, Toshiba sought a declaration that the release for past patent infringement contained in the license was null and void.
Toshiba is the authorized licensor for the DVD6C Licensing Group (“DVD6C”). DVD6C licenses over 5,000 DVD patents on behalf of nine major companies (Hitachi, Mitsubishi Electric, Panasonic, Samsung, Sanyo, Sharp, Toshiba, Warner and JVC). In 2008, Toshiba entered into a license with Coby, which permitted Coby to practice the DVD6C members’ essential DVD patents and released it from claims of past patent infringement. But Coby only intermittently rendered royalty reports and failed to pay royalties on the sales it reported. In addition, Toshiba suspected that Coby was reporting only a fraction of the DVD players it was actually selling. Following an investigation into Coby’s export/import practices, the firm presented evidence that Coby had sold over ten times the number of DVD players it had reported to Toshiba.
In a 40-page decision, the arbitral tribunal awarded Toshiba $18.5 million in damages for breach of contract plus continuing interest at the rate of 2% per month until the award is paid in full. The tribunal also declared the release for past patent infringement null and void. And the tribunal found that Toshiba was the prevailing party, entitling it to recover all its reasonable attorneys’ fees and costs. Hence, Toshiba was accorded the full relief it sought on every claim it asserted in the arbitration.
The decision is significant in that it demonstrates that IP licenses may be enforced through arbitration against Chinese entities that fail to report accurately the sales of royalty-bearing products manufactured in China and sold worldwide. This is important because China is a signatory to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards.
September 2011: Preliminary Injunction Victory in Ninth Circuit
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The firm recently achieved another victory for Google in a long-running copyright infringement case brought by adult entertainment company Perfect 10. Seven years ago, Perfect 10 sued Google in the Central District of California for copyright infringement and other claims based on Google’s (1) linking to allegedly infringing copies of Perfect 10’s images through its core Web Search Service, and (2) display of thumbnail-sized copies of Perfect 10’s images through its Image Search service. Perfect 10 later added new claims related to Google’s Blogger web log hosting service. All told, the suit alleged over two million infringements of tens of thousands of claimed copyrighted works.
In 2009, Quinn Emanuel filed motions for summary judgment regarding Google’s entitlement to safe harbor under the Digital Millennium Copyright Act (17 U.S.C. § 512). While those motions were pending, Perfect 10 tried to leapfrog them by filing a motion for a preliminary injunction–its second in the case–seeking to shut down Google’s core business. Perfect 10’s motion was based on theories of direct, contributory and vicarious copyright infringement directed to Google’s Web Search, Image Search, web caching feature, and Blogger hosting service. Quinn Emanuel mounted a vigorous opposition, arguing that Perfect 10 was not likely to prevail on the merits and that Perfect 10 neither was entitled to a presumption of irreparable harm nor could demonstrate such harm.
The district court agreed and granted Google’s summary judgment motions with respect to the vast majority of the DMCA notices Perfect 10 had sent to Google. The court concluded that nearly all the notices failed to comply with the DMCA’s requirements in multiple respects, and that without adequate notice of copyright infringement under the DMCA, Google was entitled to safe harbor protection. The ruling disposed of well over 98 percent of Perfect 10’s expansive copyright infringement claims. The court also denied Perfect 10’s preliminary injunction motion on all counts.
Perfect 10 appealed both decisions to the Ninth Circuit, arguing that the ordinarily-unappealable order granting Google partial summary judgment of DMCA safe harbor was inextricably intertwined with the denial of its preliminary injunction motion. Quinn Emanuel vigorously defended both lower court victories. Earlier this month, the Ninth Circuit held that Perfect 10 was not entitled to a presumption of irreparable harm in connection with its preliminary injunction motion, and had not offered sufficient evidence demonstrating such harm. The Ninth Circuit also left Google’s DMCA summary judgment victory intact.
Importantly for copyright defendants, the decision reversed a long line of Ninth Circuit cases holding that copyright plaintiffs are entitled to a presumption of irreparable harm, finding those cases irreconcilable with the Supreme Court’s 2006 decision in eBay v.MercExchange. It also preserved the district court’s DMCA summary judgment order. As a result of this significant victory, Google has no damages exposure for approximately 2 million alleged infringements that Perfect 10 claimed with respect to Google’s Search and Blogger services. The decision also offers practical guidance to both copyright owners and internet service providers regarding the proper application of the DMCA and reinforces Ninth Circuit precedent confirming that the copyright owner–not the service provider–bears the burden to sufficiently identify alleged copyright infringements on the web.
August 2011: Second Circuit Severely Limits Reach of “Hot News” Misappropriation
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The Second Circuit Court of Appeals recently restricted the scope of “hot news” misappropriation claims, largely adopting arguments submitted by the firm in an amici brief on behalf of Google and Twitter. Barclays Capital Inc. v. TheFlyOnTheWall.com, Inc., --- F.3d ---, 2011 WL 2437554 (2d Cir. June 20, 2011).
Plaintiffs (“Firms”), financial services firms that provide “buy” and “sell” investment recommendations to clients, brought an action against defendant TheFlyOnTheWall.com (“Fly”), a website that collects and publishes investment firms’ financial recommendations. Alleging “hot news” misappropriation—an oft-criticized tort that prohibits, for a limited time, the use of time-sensitive facts gathered by a competitor—the Firms claimed that Fly misappropriated their recommendations by publishing them before the stock market opened, reducing the Firms’ incentive to create recommendations. After a bench trial, Judge Cote of the Southern District of New York ruled that Fly committed “hot news” misappropriation and enjoined it from publishing any of the Firms’ recommendations until several hours after the stock market opened. By enjoining Fly from publishing factual information, the ruling called into question the practices of Internet news aggregation services, thereby endangering the sharing of factual information online.
On appeal, the firm filed an amici brief on behalf of Google and Twitter supporting reversal. First, the firm argued that the tort of “hot news” misappropriation violated the Copyright Clause of the Constitution. Second, the firm argued that even if the tort were available, the circumstances in which it applies should be significantly narrowed to circumstances nearly identical to those in International News Service v. Associated Press, 248 U.S. 215 (1918) (“INS”). In INS, the Supreme Court held that a wire service could be prohibited from copying facts gathered and published by a direct competitor wire service. Third, the firm argued that the five-part test for “hot news” misappropriation articulated in National Basketball Association v. Motorola, Inc., 105 F.3d 841 (2d Cir. 1997) was flawed, incomplete, and did not account for the instantaneous nature of Internet communications.
Recognizing the implications of the district court’s ruling, the Second Circuit took the rare step of inviting several amici to participate in oral argument. Kathleen Sullivan argued on behalf of Google and Twitter, explaining that if the tort is ever available, it should only be recognized in circumstances nearly identical to those in INS.
On June 20, 2011, the Second Circuit unanimously reversed the district court’s ruling, holding that Fly did not commit “hot news” misappropriation. Bound by Motorola’s holding that the tort of “hot news” misappropriation is not preempted by federal law, the Second Circuit nonetheless severely cabined the scope of any potential “hot news” misappropriation claim. Specifically, it held that Motorola’s five-part test was dictum because it was based on a hypothetical “hot news” misappropriation claim rather than the facts before the Court. Although the Second Circuit did not offer a new test, it emphasized that because Fly collected and organized the Firms’ recommendations, it was not “free riding” on the Firms’ work; rather, “Fly is reporting financial news—factual information on Firm Recommendations—through a substantial organizational effort.” Barclays, 2011 WL 2437554, at *24. The Second Circuit recognized that Internet news aggregators do not compete with the authors of news articles and thus do not engage in wrongful misappropriation by collecting, organizing and publishing others’ news stories.
August 2011: Class Action Victory for Venture Capital Firm
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The firm successfully defended August Capital, a venture capital firm, against a class action suit brought by an undisclosed plaintiff in Washington state court. The complaint alleged RICO violations and a variety of related state law claims associated with the client’s one-time investment in a penny auction website, Swoopo.com, operated by defendant Entertainment Shopping, Inc. After removing the action to federal court, the firm moved to dismiss for lack of personal jurisdiction over August Capital, a California-based company with minimal Washington contacts. In the alternative, the firm sought dismissal for failure to state a claim upon which relief could be granted. Entertainment Shopping, Inc., moved to dismiss for failure to state a claim as well. The complaint contained few specific allegations concerning August Capital, but instead sought to hold it liable based solely on its status as a shareholder in Entertainment Shopping’s German parent.
While the motions were pending, Entertainment Shopping filed for Chapter 7 bankruptcy, automatically staying the case as to it. On May 23, 2011, the court dismissed the case against August Capital entirely, holding that plaintiff Doe had failed to plead facts sufficient to support the exercise of either general or specific jurisdiction and not only failed to meet the nationwide service of process requirements of RICO, but also relied an out-of-circuit test. The dismissal ends the case as to August Capital and, given the automatic stay in place as to Entertainment Shopping, the firm is optimistic that this marks the end of the litigation.
August 2011: Patent Victory for Wireless Router Manufacturers
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The firm recently won a complete defense victory in a patent case on behalf of four major players in the wireless network space: Cisco, Belkin, NETGEAR and D-Link. The defendants make wireless routers for home and small business use. The plaintiff had tried to sell internet access in South Carolina in the early 2000s. The Wall Street Journal wrote a favorable puff-piece about it in 2000, but the business did not succeed and the founders turned to enforcing a patent on a wireless router. The plaintiff brought suit in Florence, South Carolina, but the firm obtained transfer to Northern California, where three of our clients and various important prior artists were located.
Judge Claudia Wilken then set a schedule that did not permit a claim construction ruling until the eve of trial. The firm focused on developing a few key claim construction arguments that could resolve the case and developed a record to support the defenses of non-infringement and invalidity. Meanwhile other parties settled, rather than face the uncertainties of a combined claim construction and summary judgment ruling just weeks before jury selection.
Ultimately, the court agreed with the firm’s key claim construction and non-infringement arguments; it also granted summary judgment of invalidity, agreeing that the claims were rendered obvious in light of a pair of third-party prior art products.
August 2011: Summary Judgment Victory for Genentech
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The firm recently obtained summary judgment against Sanofi-Aventis Deutschland on behalf of Genentech. Sanofi filed a patent infringement suit in the Eastern District of Texas, alleging that that Genentech’s products were manufactured using a genetic sequence taken from a human cytomegalovirus known as an “enhancer” and, therefore, infringed Sanofi patents. Genentech moved unsuccessfully to transfer the litigation to the Northern District of California prompting the firm to seek mandamus from the Federal Circuit. In what has now become a seminal ruling in patent litigation, the Federal Circuit opined that the denial of transfer was a clear abuse of discretion and ordered that the case be transferred.
Following the completion of claim construction, the firm moved for summary judgment of non-infringement. The court agreed that Genentech’s products were non-infringing. Notably, the court denied Sanofi’s motions on anticipation, preserving Genentech’s declaratory relief claims that Sanofi’s patents are invalid.
August 2011: Appellate Victory for American Express
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The firm recently represented American Express Co. in a patent infringement action targeting its gift card products, in which plaintiff PrivaCash sought over $100 million in past damages and future royalties. The firm obtained a dismissal of codefendant American Express Incentive Services, LLC (“AEIS”) early in the case after proving that AEIS’s gift cards were distributed and sold in the business-to-business environment and therefore could not infringe plaintiff’s patent. The firm then sought and secured a favorable claim construction ruling for remaining defendant American Express, and shortly thereafter filed a motion for summary judgment of non-infringement. Approximately one month before trial, the Court granted American Express’s motion and entered summary judgment of non-infringement in favor of American Express. On August 11, 2011, after full briefing and oral argument, the Federal Circuit affirmed the District Court’s summary judgment of non-infringement in favor of American Express.
July 2011: Trial Victory for Major Brazilian Company
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The firm recently won a complete victory for its client, Companhia Siderurgica Nacional (“CSN”), following a jury trial in the United States District Court for the Southern District of New York. CSN, a large Brazilian steel company, sued its former Chief Financial Officer, Lauro Rezende for converting (1) the shares of a bearer-share company called International Investment Fund (“IIF”) that held assets valued at approximately $500 million dollars; (2) approximately $14.2 million in dividends paid on stock owned by IIF; and (3) $2.2 million dollars from IIF’s bank account in 2001. CSN also sought a declaration that it is the owner of IIF.
IIF was formed by CSN in 1999 to purchase stock in a Brazilian railroad company. When the railroad stock was first purchased by CSN in 1999, its financial value was quite low. Over the years, the value of its stock increased dramatically and the railroad began to pay millions in dividends to shareholders. Mr. Rezende was one of CSN’s most senior executives at the time. Seizing upon what he no doubt believed to be a golden opportunity, Mr. Rezende attempted to convert IIF from CSN by removing the original bearer share certificates that represented IIF’s capital stock from CSN’s vault. Upon discovering the theft, CSN immediately filed suit, and a subsequent internal investigation revealed that Mr. Rezende had also embezzled $2.2 million dollars from CSN in 2001.
Prior to trial, the firm moved for sanctions against Mr. Rezende for perpetrating an elaborate fraud on the Court in connection with a discovery-related matter. After extensive briefing and a two-day evidentiary hearing on CSN’s motion for sanctions, the Court found that Mr. Rezende had not only repeatedly perjured himself but also had fabricated and falsified numerous documents that he submitted to the Court as evidence. As a sanction, the Court ordered Rezende to pay more than $600,000 in attorneys’ fees to CSN and instructed the jury at trial that Rezende had previously been found to have lied under oath and fabricated documents in connection with this proceeding.
Quinn Emanuel’s trial strategy was two-fold: First, to meticulously present the mountain of evidence in CSN’s favor by putting on ten fact witnesses, many of whom were former CSN employees with no interest in the outcome of the litigation. Second, to destroy the credibility of Mr. Rezende. During a two-day cross examination, Quinn Emanuel did just that and impeached Mr. Rezende literally dozens of times until his credibility was in tatters. After deliberating for just three hours, the jury gave CSN a complete victory. The jury declared that CSN is the owner of IIF and all of its assets, and it found that Mr. Rezende had embezzled $2.2 million from IIF. The verdict brings CSN’s three-year dispute with Mr. Rezende to a conclusion and affirms that the approximately $500 million of assets at the center of the dispute belong to CSN. Following the verdict, the Court referred Mr. Rezende to the United States Attorney’s Office for the Southern District of New York for criminal prosecution.
July 2011: Appellate Patent Victory for Yahoo!
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The firm recently secured a complete reversal of a patent infringement judgment on behalf of Yahoo!. The case was tried to a jury in the Eastern District of Texas by another firm, resulting in an award of $12 million and an ongoing royalty of 23% on Yahoo!’s profitable IMVironments product.
The plaintiff had alleged infringement of a patent concerning the display of advertising in the background to electronic messages. After the jury found willful infringement, Yahoo! redesigned IMVironments attempting to avoid a prospective remedy. The district court nevertheless denied Yahoo!’s post-trial motions, enhanced the damages, held that the redesigned IMVironments willfully infringed, and awarded a 23% ongoing royalty. Yahoo! then turned to Quinn Emanuel.
On appeal, it persuaded the Federal Circuit that the district court had failed to resolve a fundamental claim construction dispute – whether each recited “logic” in the asserted claim had to be configured to operate on the same electronic message. Quinn Emanuel then persuaded the Federal Circuit that IMVironments did not infringe as a matter of law under the appropriate claim construction. The reversal secured Yahoo!’s ultimate victory in the company’s first patent infringement case litigated through trial in the Eastern District of Texas. Yahoo! may now continue to use its profitable IMVironments program free from any royalty. The complete judgment of non-infringement also allows Yahoo! the option to restore its pre-verdict design or continue using the post-verdict redesign.
July 2011: Appellate Patent Victory for Pharmaceutical Companies
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The firm recently won an affirmance from the Federal Circuit of a judgment as a matter of law in favor of the firm’s clients, Lundbeck, Inc. and Forest Laboratories, Inc. The plaintiff had brought claims seeking damages and ongoing royalties with respect to the antidepressant drugs CELEXA® and LEXAPRO®, which have over $2 billion in annual U.S. sales. After the Southern District of New York ruled that no reasonable jury could fail to find the asserted patent claim invalid due to obviousness, the Federal Circuit agreed decisively. It issued a Rule 36 affirmance three days after the appellate oral argument by Quinn Emanuel. The plaintiff’s damages and royalty claims were not only defeated but the possibility that an injunction might issue affecting CELEXA® or LEXAPRO® was eliminated.
July 2011: Chapter 11 Plan Confirmation Victory
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The firm recently obtained an order from the District Court for the Southern District of New York affirming FairPoint Communications chapter 11 plan. A federal bankruptcy court had earlier approved the plan, which included a critical third-party injunction, over the objection of Verizon Communications.
FairPoint was spun off from Verizon in a 2008 transaction that saddled FairPoint with an unserviceable debt load in excess of $2.5 billion. FairPoint filed for bankruptcy in late 2009. To reach a consensual plan of reorganization, FairPoint agreed to assign claims against Verizon arising out of the spin-off transaction to a litigation trust, but the assignment left FairPoint vulnerable to indemnification “claims over.” For that reason, FairPoint’s plan included a third-party injunction that precluded Verizon from asserting contribution or indemnification claims arising out of the assertion of the litigation trust claims against it.
Verizon objected to confirmation of the reorganization plan, arguing that the third-party injunction was not justified by “truly unusual circumstances,” as required under Second Circuit case law, and that the bankruptcy court lacked jurisdiction to enjoin the non-debtor claims. As FairPoint’s conflicts counsel, Quinn Emanuel convinced the court that the protection provided by the third-party injunction was essential to the debtor’s reorganization and in the best interest of the estate, and that the court had jurisdiction to authorize the injunction. The bankruptcy court then approved the injunction and confirmed FairPoint’s plan.
Verizon appealed the confirmation order, again challenging the bankruptcy court’s jurisdiction to authorize the injunction. The district court agreed with Quinn Emanuel that the Second Circuit would uphold the bankruptcy court’s jurisdiction. The court also agreed that the remainder of Verizon’s appeal was equitably moot due to the myriad transactions FairPoint and its creditors had already entered into in reliance on the confirmed plan.
July 2011: Appellate Genetic Testing Patent Victory
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The firm recently obtained a precedential opinion from a unanimous Federal Circuit panel affirming a judgment in favor of Associated Regional University Pathologists (“ARUP,” a reference laboratory at the University of Utah) and Bio-Rad Laboratories. The plaintiff had alleged infringement of two patents related to genetic testing for hemochromatosis, an iron disorder. The firm won a defense judgment in the district court that all asserted claims were invalid. Following oral argument, the Federal Circuit affirmed in all respects.
It adopted Quinn Emanuel’s argument that the first of plaintiff’s patents was invalid under the written description requirement of 35 USC § 112 because the inventor filed for a patent on a DNA mutation without knowing the actual DNA sequences. In essence, the inventor filed too early – more work needed to be done before the claimed invention was complete. The Court underscored that simply knowing roughly where a DNA mutation would be found in the genome is insufficient to claim a patentable invention.
The court also held that the second patent was also invalid because it was filed too late and was anticipated by prior art. Between the filing dates of the plaintiff’s two patents, another group of scientists had isolated the relevant gene and mutations and proposed genetic testing for hemochromatosis. The court found that their discovery anticipated the claims of second patent, not withstanding that they did not fully recognize the utility of the DNA mutations at the time.
June 2011: Technology Licensing Trial Victory in Delaware
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Quinn Emanuel obtained a remarkable victory on behalf of Nuance Communications, Inc. following a bench trial in Delaware Chancery Court. The plaintiff, Vianix, claimed over $30 million in unpaid royalties under a technology license agreement involving audio compression technology. The underlying contract, negotiated by an unrelated company later acquired by Nuance, was ambiguous. Accordingly, the parties had vastly different views of how royalties were to be calculated. Adding fuel to the fire, Vianix made extremely aggressive claims concerning the extent to which its technology was incorporated into Nuance products. Because of a fee-shifting provision, Nuance faced a considerable risk, in that owing to record-keeping errors, Nuance had underpaid royalties to at least some degree. Further, Vianix had secured an independent audit showing that Nuance owed several million dollars.
Quinn Emanuel quickly took the offensive. Digging deeply into the draft agreements and contemporaneous email messages, it established that virtually every aspect of the plaintiff’s contract interpretation had been specifically rejected during the negotiations, notwithstanding the lingering ambiguities in the text. It concurrently developed a deep understanding of the technology and products at issue so it could conclusively establish that the plaintiff’s technology was used only sparingly, and in very few Nuance products. Because some underpayment had occurred, Quinn Emanuel conservatively calculated what was owed, and had the client send the plaintiff a check in that amount.
During discovery, Quinn Emanuel obtained damaging admissions from the plaintiff’s witnesses concerning the underlying technology and highlighted the wide inconsistencies between the plaintiff’s interpretation of the contract and the evidence of the negotiations. In an unusual development, Quinn Emanuel learned that the plaintiff had secretly recorded its fake phone calls with Nuance employees during the life of the license agreement. The plaintiff thought that the recorded evidence would be its ace in the hole, but Quinn Emanuel instead used the recordings to support Nuance’s defense.
Following trial, and extensive post-trial briefing, the Court found for Nuance on almost every issue, awarding Vianix well under $1 million of the $30 million sought, and denying Vianix an award of attorneys’ fees.
June 2011: Another Summary Judgment Victory for Google Affirmed
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Quinn Emanuel had previously won summary judgment of non-infringement for Google and AOL in the Eastern District of Texas. In 2007, an Acacia plaintiff, represented by Dovel and Luner, filed suit against all major online search engines, including Google, AOL, Microsoft and Yahoo!, accusing their online advertising auction systems of infringing U.S. Patent No. 6,978,253. In particular, the plaintiff accused Google’s AdWords auction system, which is used by Google to sell advertising space on search results pages for Google.com and partner sites.
The alleged innovation of the ‘253 patent was to offer buyers the opportunity to pay a lower price for a product based on the buyer’s performance in a collateral “price determining activity” or “PDA.” For example, a buyer might obtain a discount on the purchase of a Mark McGwire rookie card based on his level of success in a “PDA” such as a trivia quiz or game. All defendants other than Google and AOL settled before the claim construction hearing. In September 2009, the court issued a claim construction order favorable to the defendants. Consistent with the defendants’ proposal, the court found that a PDA “is used to determine the price paid for the product or service and is not otherwise part of a sales transaction.” The defendants then moved for summary judgment of non-infringement arguing in part that there is no PDA in AdWords.
The case was then transferred to Judge Randall R. Rader of the Federal Circuit sitting by designation in the Eastern District of Texas. On March 18, 2010, Judge Rader issued an order granting summary judgment of non-infringement in favor of Google and AOL. He agreed that there is no PDA in AdWords. The plaintiff had argued that the advertiser’s creation and submission of ad text in AdWords is a PDA. However, the court found that the creation and submission of ad text is otherwise part of the AdWords sales transaction and, thus, cannot be a PDA under the court’s construction. The court explained that, in AdWords, the ad text defines the product itself. Additionally, the ad text may influence the selection process for the ad space awarded to the advertiser. The court further noted that the plaintiff’s arguments intended to “create an issue of fact” were “non-sequitors,” and concluded that “AdWords is not at all akin” to the patent.
In February 2011, the Federal Circuit affirmed the summary judgment of non-infringement, handing another appellate victory to Quinn Emanuel. This affirmance was per curium, and issued only two days after oral argument.
June 2011: Whoa! Sub-in Mid Trial—QE Wins Again
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After testifying on hostile direct examination in the plaintiff’s case for 1½ days, a widow defending against a claim of an alleged $18 million charitable pledge retained Quinn Emanuel to take over her defense. The firm immediately assumed the role of lead trial counsel.
The firm’s client was Dawn Arnall, the widow of founder and owner of Ameriquest Mortgage Company Roland Arnall. Mr. Arnall was a Holocaust survivor who emigrated to the United States and became a highly successful businessman and philanthropist. The plaintiff was Chabad of California, a well-known charity headed by Rabbi Baruch Schlomo Cunin. Chabad alleged that in 2004, Mr. Arnall pledged to donate between $18 million and $40 million, before fixing the amount at $18 million on the day in 2008 he was diagnosed with cancer. The only witness to the alleged pledge was Rabbi Cunin. At trial, Rabbi Cunin’s son testified that the Rabbi had told him in 2004—and again in 2008—about Mr. Arnall’s alleged pledges. Ms. Arnall and people associated with her testified that they never heard of any such pledge until Chabad alleged it following Mr. Arnall’s death.
Chabad had no documentary support for the alleged pledge but offered an explanation for why no such record was created. Quinn Emanuel cross-examined Rabbi Cunin demonstrating numerous inconsistencies and implausibilities in his testimony. The firm also offered Ms. Arnall’s testimony to demonstrate both the absence of any knowledge of the alleged pledge and the funding of a separate private charitable foundation with more than $32 million only a few months following the alleged 2004 pledge. Following four weeks of trial, including several days of closing argument by Quinn Emanuel, and then an extensive hearing on the court’s proposed statement of decision, the court issued a 69-page final Statement of Decision that Chabad had failed to prove any pledge whatsoever to Chabad.
June 2011: Real Estate Appellate Victory
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Quinn Emanuel recently won an expedited victory on appeal for Harry Mansdorf, a 90-year-old disabled World War II veteran, that secured recovery of real estate estimated to be worth up to $200 million, in which he and his brothers had invested their life savings.
Mr. Mansdorf was a decorated bomber pilot who lost the use of his right knee when he was shot down on a mission over Austria. After the war, Mr. Mansdorf and his three brothers founded an aviation business, which later played a key role in the space program. When the brothers sold the business in the late 1960s, they placed their money into a trust. Mr. Mansdorf’s older brother, Lee, used the trust funds to buy real estate in Southern California. Eventually, the trust assembled approximately 1300 acres of undeveloped beachfront property north of Malibu.
Two days after Lee’s death in 2003, Michele Giacomazza approached Mr. Mansdorf, claiming that he was Lee’s long-time partner and that Lee owed him $7 million. When Mr. Mansdorf refused to pay, Giacomazza said that he would make Mr. Mansdorf’s younger brother, who was bedridden with advanced Parkinson’s disease, “look like Lee” if Mr. Mandorf did not pay up. Using such threats of physical violence, bogus mechanics liens that tied up Mr. Mansdorf’s assets, fraud, and psychological manipulation, Giacomazza took control of Mr. Mansdorf’s life and induced him to sign over title to the Malibu properties and the Mansdorf family home.
This nightmare lasted for four years, until Giacomazza was hospitalized with heart problems and Mr. Mansdorf managed to break free. He then sued Giacomazza for elder abuse and sought to revoke the deeds transferring his home and the Malibu properties based upon undue influence. Mr. Mansdorf prevailed at trial and then retained Quinn Emanuel to protect his victory.
In light of Mr. Mansdorf’s age and health, Quinn Emanuel requested a calendar preference so that the appeal be heard as quickly as possible. On March 15, the California Court of Appeal held oral argument. Three days later, it issued an opinion adopting arguments in Quinn Emanuel’s brief, unanimously affirming the judgment in Mr. Mansdorf’s favor.
April 2011: Ninth Circuit Denies Petition for Review of Nuclear Regulatory Commission Ruling Regarding PG&E
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The firm recently obtained a complete victory for Pacific Gas and Electric Company (“PG&E”), persuading the Ninth Circuit Court of Appeals to deny a petition for review filed by the San Luis Obispo Mothers For Peace (“SLOMFP”) challenging five decisions made by the United States Nuclear Regulatory Commission. The decisions arose out of the Commission’s preparation of a supplemental Environmental Assessment (“EA Supplement”) concerning the construction, operation, and decommissioning of an independent spent fuel storage installation (“ISFSI”) designed to store temporarily spent nuclear fuel at PG&E’s Diablo Canyon Power Plant near San Luis Obispo, California. The Commission prepared the EA Supplement pursuant to a prior Ninth Circuit’s decision holding that the Commission had earlier erred when it ruled as a matter of law that it need not consider potential terrorist attacks in its review under the National Environmental Policy Act (“NEPA”). On remand, the Commission again concluded that there could be no significant environmental impact from PG&E’s activities, but refused to provide SLOMFP with access to classified and sensitive security-related information regarding potential terrorist attacks upon which the Commission relied to reach its conclusion.
In the Ninth Circuit, SLOMFP argued first that NEPA and/or the Atomic Energy Act (“AEA”) obligated the Commission to hold a closed hearing at which SLOMFP would have had access to classified, security-related information. SLOMFP contended that the Commission’s finding of no significant impact was unsupported because the Commission declined to consider the environmental impact of certain terrorist attack scenarios.
PG&E retained Quinn Emanuel to represent it as an intervenor in the Ninth Circuit, where it argued that neither statute required the Commission to hold a closed hearing, especially because its Commission had concluded that the risk the information would be disseminated outweighed heavily any limited benefit to access. PG&E further emphasized that the Commission was entitled to great deference when evaluating the appropriate procedures for handling classified and sensitive security information, conducting hearings, and performing a NEPA review. PG&E also defended the Commission’s finding of no significant environmental impact.
In a unanimous opinion, the Ninth Circuit upheld the Commission’s decision and denied the petition. In doing so, the Ninth Circuit held that neither NEPA nor the AEA required the Commission to hold a closed hearing at which the petitioner could have access to classified information, the Commission’s decision not to hold a closed hearing was not arbitrary or capricious, and the Commission’s environmental assessment was sufficient. Of particular significance, the Ninth Circuit’s NEPA holding extended the right of Federal agencies to restrict public access to documents recognized in Weinberger v. Catholic Action of Hawaii, 454 U.S. 139 (1981). In Weinberger, the Supreme Court held that security considerations may justify restricting public access to documents prepared in conjunction with a NEPA analysis if the object of the proposed project (there, the storage of nuclear weapons) is exempt from disclosure under FOIA. Although the PG&E project was part of the public record, the Ninth Circuit recognized that Weinberger’s “animating principles” supported the Commission’s decision to withhold access to the FOIA-exempt materials upon which the Commission relied. The other portions of the decision similarly awarded substantial discretion to the Commission in structuring its proceedings. The decision thus should give federal agencies comfort should they desire to curtail future NEPA proceedings in which classified or sensitive security information is at issue.
April 2011: Triple Success in Fraud Suits Against JPMorgan and Jefferson County, Alabama
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Acting on behalf of monoline insurers Syncora Guarantee Inc. and Assured Guaranty Municipal Corp., the firm recently defeated two motions to dismiss filed by defendant JPMorgan while prevailing on Syncora’s own motion to dismiss the counterclaims of yet another defendant, Jefferson County, Alabama. Those successes arose in a case alleging a massive bribery scheme and municipal corruption involving both Jefferson County and JPMorgan. Syncora and Assured sold insurance on several series of warrants issued by Jefferson County and underwritten by JPMorgan. However, Jefferson County and JPMorgan allegedly misrepresented the County’s financial condition, while also failing to disclose facts material to the insurance policies, including JPMorgan’s and the County’s bribery scheme.
In response to separate suits filed by Syncora and Assured, JPMorgan filed motions to dismiss. These motions were denied by the New York Supreme Court in their entirety on December 22, 2010. Jefferson County, a named defendant in the Syncora suit, did not move to dismiss, but instead counterclaimed against Syncora for over $100,000,000 dollars, alleging Syncora’s purported negligence, fraud and contractual breaches had caused the County to default on the warrants. The firm persuaded the court to grant Syncora’s motion to dismiss each of the County’s counterclaims while simultaneously denying JPMorgan’s motions to dismiss.
As a result of these back-to-back-to-back successes, Syncora’s and Assured’s cases against JPMorgan and Jefferson County will now go forward.
April 2011: Ninth Circuit Affirms Two Rulings Disposing of Claims Asserted Against Sequus Pharmaceuticals
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The firm recently obtained affirmance in the Ninth Circuit of two district court rulings disposing of claims asserted against Sequus Pharmaceuticals, Inc. Both appeals arose out of Infuturia Global Ltd.’s suits seeking $2.5 billion in damages from Sequus for intentional interference with supposed patent rights. Infuturia alleged that a non-party to the lawsuit had improperly assigned those patent rights to Sequus rather than to Infuturia.
Quinn Emanuel removed the case to the Northern District of California. When Infuturia sought remand, the firm argued that Sequus intended to rely on an Israeli arbitral award that had resolved a related dispute between Infuturia and assignor of the patent rights in connection with its affirmative defenses, and that the Convention on the Recognition and Enforcement of Foreign Arbitral Awards thus provided grounds for removal. The district court agreed and denied Infuturia’s motion. The court later dismissed Infuturia’s claims with prejudice under both Fed. R. Civ. 8 and 12(b)(7) for failure to name a necessary and indispensable party and 12(b)(6) grounds for failure to state a claim.
On February 7, 2011, in a published opinion, the Ninth Circuit unanimously affirmed the order denying Infuturia’s motion to remand. It adopted the firm’s argument that the removal provision of the Convention on the Recognition and Enforcement of Foreign Arbitral Awards should be construed broadly to encompass the dispute between Infuturia and Sequus. In an accompanying unpublished opinion, the Ninth Circuit also affirmed the dismissal of Infuturia’s claims with prejudice.
March 2011: Quinn Emanuel Wins Summary Judgment for Surety
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Quinn Emanuel, acting with co-counsel, recently obtained summary judgment on behalf of American Home Assurance Co. against a plaintiff seeking to recover in excess of $30 million for remediation work allegedly performed for of the New Jersey Meadowlands. The New Jersey Chancery Court (Bergen County) ruled that the bond in issue was not a payment bond insuring the payments to contractors after the original landowner, which had contracted with the plaintiff for the work to be performed, failed to make payment. Instead, the bond was for the sole benefit of the entity overseeing the remediation work, which had conveyed the land in question to the owner. The court held that the owner, now bankrupt, was solely responsible for payment of the plaintiff-contractor.
March 2011: Quinn Emanuel Wins Trial in Case Alleging that Malicious Conduct Contributed to Woman’s Death
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Quinn Emanuel obtained an exceptional victory following a bench trial in Los Angeles Superior Court on behalf of its clients, a bereaved family that lost a 24-year-old daughter owing to the negligent and malicious conduct of the defendant. The clients’ daughter suffered an accidental drug overdose while in the company of the defendant and other acquaintances. The defendant, who was a convicted felon with a warrant out for his arrest, prevented those present from calling 911 and summoning medical aid because he feared police involvement. After being left unconscious and without medical treatment for more than eight hours, the young woman died. The defendant contributed to the young woman’s death just two weeks after he had signed a written contract promising to cease all contact with her.
The young woman’s family brought claims for wrongful death, false imprisonment, and breach of contract. The judge found for the plaintiffs on all claims, noting that the court was deeply troubled by the defendant’s conduct and the course of events. The court also found that defendant acted with malice, justifying an award of punitive damages. The plaintiffs received the full amount of compensatory damages requested, totaling over $500,000, and the court will set a date to determine the appropriate punitive damages.
March 2011: Quinn Emanuel Clears the Path for FairPoint Communications to Emerge from Chapter 11
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In federal bankruptcy court in the Southern District of New York, the firm recently secured approval of a critical third-party injunction, clearing the way for FairPoint Communications, Inc. to emerge from chapter 11. After being spun-off from its parent, Verizon Communications, Inc., FairPoint entered bankruptcy in late 2009 with an unserviceable debt load in excess of $2.8 billion. In January 2011, FairPoint was set to emerge from bankruptcy with a restructured balance sheet negotiated by lead bankruptcy counsel, Paul, Hastings, Janofsky & Walker.
For the benefit of its creditors, FairPoint agreed to assign to a litigation trust certain claims against Verizon arising out of the spin-off transaction. But to protect reorganized FairPoint from any indemnification “claims over,” FairPoint’s plan included a third-party injunction that precluded Verizon from asserting any contribution or indemnification claims that could arise out of the assertion of the litigation trust claims against it. Verizon objected strenuously to this effective third-party release.
Controlling case law necessitated that FairPoint establish “truly unusual circumstances” making the injunction critical to the success of its reorganization. See In re Metromedia Fiber Network, Inc., 416 F.3d 136 (2d Cir. 2005). Quinn Emanuel argued that without the injunction, FairPoint would not agree to the assignment of claims to the litigation trust, and without the assignment, the creditors would not support FairPoint’s emergence from bankruptcy. The firm also illustrated the potential effect the to-be-enjoined claims could have on FairPoint’s estate, thus establishing that the court could fairly exercise jurisdiction to enjoin such claims.
The court adopted Quinn Emanuel’s argument, approved the injunction, and confirmed FairPoint’s plan, finding that the protection was “essential to the debtors’ reorganization and in the best interest of the estate.” FairPoint’s chapter 11 plan became effective January 24, 2011.
February 2011: Victory for Investment Fund
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The firm recently obtained a complete defense victory for a private investment fund created to manage real estate assets. The Central District of California dismissed with prejudice all claims asserted by the fund’s investors. Seventy of the 211 investors brought suit against the fund and its managers, asserting direct claims for securities fraud and derivative claims for breach of fiduciary duty. The plaintiffs’ securities fraud claims alleged misrepresentations regarding the fund’s business plan, the valuation of assets contributed to the fund by the managers, and the experience of the managers. The plaintiffs’ breach of fiduciary duty claim alleged mismanagement of the fund. The plaintiffs sought $13.8 million, in addition to punitive damages.
In an opinion adopting virtually all the arguments advanced by Quinn Emanuel, the district court dismissed all claims with prejudice. With respect to the securities fraud claims, it ruled that the plaintiffs had failed to allege (i) any materially false or misleading statement; (ii) facts raising a strong inference of any defendant’s scienter; (iii) each plaintiff’s reliance on any of the alleged misrepresentations, as required for direct claims by investors in a private offering; and (iv) loss causation. As to the breach of fiduciary duty claim, the court ruled that the fund’s operating agreement and applicable Delaware law precluded liability for any breaches of fiduciary duty other than those constituting bad faith or intentional wrongdoing to the substantial detriment of the fund, and that the plaintiffs had failed to allege conduct that demonstrated bad faith or intentional wrongdoing. The court dismissed the suit with prejudice because the plaintiffs had already amended their complaint twice and allowing them to do so again would be futile.
February 2011: $30 Million Verdict Upheld on Appeal
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On December 30, 2010, the California Court of Appeal handed the firm its final victory of 2010, affirming a $30 million jury verdict. Quinn Emanuel obtained the verdict in April 2008 after a two-week jury trial in Mono County, California. The firm sued the Town of Mammoth Lakes, located in Mono County, on behalf of Mammoth Lakes Land Acquisition, LLC, a group of real estate developers, for breach of a 1997 Development Agreement. Under the agreement, which was accepted by the Town pursuant to California’s Development Agreement Statute, our client agreed to improve the Mammoth Yosemite Airport in exchange for the right to develop a hotel/condominium complex on airport-owned land, including an option to purchase the land in 2027 at a very low price. After the developers completed the airport improvements at their own expense, the Town (in an attempt to circumvent its contractual obligations) requested and received from the Federal Aviation Administration a letter objecting that the purchase option violated assurances that the Town had made in accepting FAA grant money. The Town then informed the developers that it would not honor the purchase option unless the FAA’s objections were resolved. Because the Development Agreement did not contain any such condition, the developers sued the Town for anticipatory breach. The jury of Mono County residents rendered a $30 million verdict against the Town, the largest jury verdict in Mono County history.
On appeal, the Town contended that the developers’ only remedy was to petition for a writ of administrative mandate and thus the developers could not recover damages for breach of the Development Agreement. In addition, because the Development Agreement was adopted by legislation, the Town argued that the Agreement should be construed like a statute and the Town’s statements during negotiations concerning the scope of the provisions it asserted on appeal should be ignored.
The Third District Court of the California Court of Appeal heard the argument in mid-October. Before an opinion could be issued, one of the justices sitting on the panel retired. Because California requires that all three justices deciding a case attend oral argument, the case was reargued on December 20 with a new justice sitting on the panel. Ten days later, the Third Circuit issued a 66-page decision unanimously affirming the jury’s verdict.
It held that the Town had breached the Development Agreement and that the proper remedy for such a breach was damages, not administrative mandate. In addition, it held that aspects of a development agreement not dictated by development agreement statutes should be interpreted as ordinary contracts, according to the intent of the parties. The Court of Appeal also upheld the trial court’s approximately $2.36 million award of attorneys’ fees. With post-judgment interest and attorneys’ fees, the amount owed on the judgment is now approaching $40 million.
February 2011: Internet Music Streaming Victory
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Quinn Emanuel recently won summary judgment of non-infringement for RealNetworks and Rhapsody in the Southern District of Florida. Zamora Radio (a defunct company formerly known as Click Radio) sued all major online internet radio providers, including Rhapsody, Pandora, Last.FM, Yahoo! and CBS Radio. It sought $20 million in damages for defendants' alleged infringement of a patent on downloading songs in a predetermined order over the internet. After songs are downloaded and stored on a local computer, the user cannot alter the order in which the songs are played.
Zamora sought a claim construction to expand its patent to cover streaming internet radio systems, encompassing RealNetworks and Rhapsody’s products. Unlike Zamora’s patent, RealNetworks and Rhapsody stream music over the internet; nothing is stored. In March 2010, the court issued a claim construction order rejecting all of Zamora’s proposed constructions and adopting the constructions proposed by Quinn Emanuel’s clients. Quinn Emanuel then sought summary judgment on non-infringement based on at least five different constructions it obtained. In November 2010, the court issued an order granting summary judgment of non-infringement in favor of Quinn Emanuel’s clients on every ground requested in their motion—a complete defense victory.
February 2011: Preliminary Injunction Victory
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In the span of two months, Quinn Emanuel secured two important victories for MHR Fund Management, its founder, Dr. Mark Rachesky, and its affiliated funds arising from Carl Icahn’s hostile bid for Lions Gate Entertainment Corp. MHR is a longstanding significant investor in Lions Gate, and Dr. Rachesky is a member of Lions Gate’s board.
Icahn brought actions in New York and British Columbia arising out of transactions closed July 20, 2010 that allowed the company to exchange convertible notes held by Kornitzer Capital Management. These notes were later sold to MHR. On November 1, 2010, the Supreme Court of British Columbia rejected Icahn’s attempt to rescind the transactions or sterilize MHR’s votes under Canada’s shareholder oppression law.
In New York, Icahn claimed the challenged transactions violated a standstill agreement he had entered with the company, and that Dr. Rachesky and MHR had tortiously interfered with that agreement. On December 9, 2010, just days before Lions Gate’s annual general meeting at which Icahn was running a proxy contest, New York Supreme Court Justice James Yates denied Icahn’s request for a preliminary injunction to bar Rachesky’s fund, MHR, from voting 16 million shares of Lions Gate stock at the annual meeting.
Following that ruling, Icahn did not close his then-outstanding tender offer and his slate of directors was defeated in the proxy fight.
Good Faith Participation in Mediation: Recent Decisions in New York and California
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Introduction
In an effort to alleviate the growing congestion of court dockets around the country, judges increasingly require parties to engage in alternative dispute resolution, particularly mediation, prior to trial. Mediation is designed to be a confidential process lacking the formality and adversarial nature of court proceedings. However, participation in any court-ordered mediation is ultimately monitored by a judge. As a general rule, courts require parties to participate in mediation in good faith, and judges have the authority to sanction parties that fail to do so. The judge’s authority to impose sanctions for mediation conduct is grounded in the court’s inherent authority to regulate proceedings before it, and is further supported by local rules, Federal Rule of Civil Procedure 16(f) (requiring good faith participation) and statutes such as 28 U.S.C. § 1927 (prohibiting unreasonable or vexatious litigation). As in other areas of the law, however, “good faith” is not well defined.
This article examines some recent decisions by federal courts in New York and California enforcing the requirement of “good faith” participation in mediation. While it is well settled that a court may compel a party to mediate, it cannot compel a party to settle. Moreover, courts take care to protect the confidential nature of mediation proceedings. Accordingly, the requirement of “good faith” in mediation has clear limits. Federal courts in New York and California appear unwilling to probe into specific conduct at the mediation, in light of concerns over confidentiality and undue influence.
New York
Federal courts have broad authority to regulate participation in mediation under Federal Rule of Civil Procedure 16, 28 U.S.C. § 1927, and the inherent power of courts to regulate proceedings. In New York, some federal courts also codify in their local rules the requirement of good faith participation in mediation. The Western and Northern Districts have an explicit requirement that the parties participate in mediation in good faith. See, e.g., NDNY L.R. 83.11-5(c) (“Parties and counsel shall participate in good faith, without any time constraints, and put forth their best efforts toward settlement.”); WDNY ADR Plan 5.8(G) (“All parties and counsel shall participate in mediation in good faith. Failure to do so shall be sanctionable by the Court.”). The local rules for the Southern and Eastern Districts previously included an explicit requirement that the parties mediate in good faith, but that requirement was removed in the July 2011 update to the rules. See Local Civil Rule 83.8. Court-Annexed Mediation (Eastern District Only); Local Civil Rule 83.9. Alternative Dispute Resolution (Southern District Only). In practice, however, courts seem to apply the good faith requirement whether or not it is expressly included in local rules.
In March 2011, the Southern District of New York shed some light on the good faith requirement. See In re A.T. Reynolds & Sons, Inc., 452 B.R. 374 (S.D.N.Y. 2011). The A.T. Reynolds Court reversed an order of the Bankruptcy Court sanctioning Wells Fargo for failure to participate in mediation in good faith. In doing so, the Court rejected a subjective approach to good faith determinations. See id. at 376. The Bankruptcy Court had ordered the parties to participate in mediation. The mediator informed the Court that one of the parties, Wells Fargo, was participating in bad faith. Id. In particular, the mediator pointed to Wells Fargo’s demands to clarify the issues in dispute prior to mediation, and to know in advance the identity of party representatives that would be attending. The mediator also noted that the Wells Fargo representative apparently lacked authority to settle, and failed to engage in risk analysis regarding the available options. Id.
The Bankruptcy Court found that Wells Fargo was in violation of General Order M-390 of the United States Bankruptcy Court, Southern District of New York. In re A.T. Reynolds & Sons, Inc., 424 B.R. 76, 78 (Bankr. S.D.N.Y. 2010). That order provided that “the mediator shall report any willful failure to attend or to participate in good faith in the mediation process of conference. Such failure may result in the imposition of sanctions by the court.” Id. The mediator not only filed such a report, but testified at a hearing in front of the Bankruptcy Court regarding Wells Fargo’s behavior.
The Bankruptcy Court held that Wells Fargo violated the good faith requirement for three reasons. First, in the Court’s view, the representative sent by Wells Fargo lacked sufficient authority to settle the case. The Court noted that the representative had to make a phone call to move beyond a predetermined dollar amount, and was only prepared to discuss an inappropriately limited set of predetermined legal theories. Id. at 89. Second, while the Court acknowledged that parties are free to adopt a “no pay” position, he faulted Wells Fargo for “enter[ing] the mediation to assert the supremacy of its legal argument, and not to contemplate risk analysis.” Id. at 91. Finally, the Court found that Wells Fargo attempted to improperly control the mediation by demanding, prior to the mediation, that the discussion be limited to specific topics and that the identities of the representatives attending be disclosed in advance. Id. at 91-92. For these reasons, the Court found Wells Fargo in contempt of the Mediation Order. In re A.T. Reynolds & Sons, Inc., 424 B.R. 76, 95 (Bankr. S.D.N.Y. 2010). The judge ordered Wells Fargo to bear the costs of mediation.
On appeal, the District Court acknowledged the Bankruptcy Court’s power to sanction parties that fail to comply with its orders, but rejected that Court’s application of a subjective test of good faith. The District Court expressed concern about intruding into confidential dispute resolution, and declined to endorse the Bankruptcy Court’s subjective inquiry into the quality of Wells Fargo’s participation in the mediation. The Court was also concerned that admonishment of a party’s “no pay” position, or a requirement that a party engage in risk analysis, could run afoul of well-settled law that “a court cannot force a party to settle, nor may it invoke ‘pressure tactics’ designed to coerce a settlement.” In re A.T. Reynolds & Sons, Inc., 452 B.R. 374, 382 (S.D.N.Y. 2011). In the Court’s view, a party satisfies the good faith requirement if it attends mediation, provides pre-mediation memoranda and, when appropriate, produces organizational representatives with sufficient settlement authority. Id. at 384.
The District Court also addressed the Bankruptcy Court’s conclusion that Wells Fargo had failed to send a representative with sufficient settlement authority, and found that the lower court applied an “unworkable and overly stringent standard” in requiring “the ability to (1) settle this case for any amount, including an amount greater than the amount in controversy; (2) discuss any theory of legal liability; and (3) enter into undefined ‘creative solutions.’” Id. at 384. Instead, a party need only send “a person with authority to settle for the anticipated amount in controversy and who is prepared to negotiate all issues that can be reasonably expected to arise.” Id. The District Court also found no issue raising concerns with the mediator, pre-mediation, regarding both the scope and anticipated attendance of the mediation. Id.
The AT Reynolds District Court decision is consistent with prior decisions by other New York district courts finding violations of the duty to mediate in good faith, and imposing corresponding sanctions on a party. In all prior cases finding a violation, the courts identified an objective failure on the part of one party that amounted to an actual or constructive failure to appear at the mediation. For example, in Kerestan v. Merck & Co. Long Term Disability Plan, the court sanctioned the plaintiff $1,600 for failing to appear in person—not through counsel—at the settlement conference as ordered, “despite ample warning.” 2008 U.S. Dist. LEXIS 50166 (S.D.N.Y. July 2, 2008). The plaintiff’s failure to appear at the mediation meant plaintiff’s counsel had no authority to engage in settlement discussions, and the Court found sanctions were warranted. Id. In Outar v. Greno Indus., the plaintiff physically attended the mediation, but failed to participate in the proceedings, even after being requested to do so by his counsel. 2005 U.S. Dist. LEXIS 34657 (N.D.N.Y Sept. 27, 2005). While the plaintiff pled ignorance of the legal system when faced with the prospect of sanctions, the court found that his “clinging ignorance of the process, refusal to listen to more knowledgeable professionals, and his level of distrust are of his own doing.” Id. As such, his conduct amounted to abuse of the process and warranted sanctions. New York courts also take a dim view of attorneys who demonstrate a lack of respect for a scheduled mediation and fail to notify the mediator and other parties of changed circumstances.
In Fisher v. Smithkline Beecham Corp., the defendant filed a motion for summary judgment on the eve of mediation, while the plaintiffs and their counsel were en route to Buffalo, where the mediation would take place. 2008 U.S. Dist. LEXIS 76207, 20-21 (W.D.N.Y. Sept. 29, 2008). Once at the mediation, the defendant’s participation was limited to presenting plaintiff’s counsel with a copy of the motion that had been filed the previous evening. Id. at 18. The Court found the defendant’s failure to inform other parties of a motion that had clearly been contemplated well in advance of the mediation session, and had the predictable effect of hindering mediation efforts, caused the plaintiffs to unnecessarily incur expenses, was not in good faith, and warranted sanctions. Id. at 20-21.
California
Consistent with the District Court’s decision in AT Reynolds, and decisions by other New York district courts, federal courts in California generally look to objective criteria when determining whether a party’s participation in mediation was in good faith. What sets California apart is that each federal district court has adopted local rules setting forth objective guidelines to be followed by parties in mediation and settlement discussions. The local rule guidelines do not refer to a “good faith” requirement. Instead, the local rules generally require at least the following: submission of a written mediation statement; appearance by a party representative with full authority to settle the case; and appearance by lead trial counsel. See CD Cal Local Rule 16-15; ND Cal ADR Local Rule 6; ED Cal Local Rule 270, 271; SD Cal Local Rule 600.
In contrast to the court in AT Reynolds, and other courts in New York, courts in California have adopted a stringent view of the requirement that each party be represented at the mediation by someone with authority to settle the case. For example, courts in the Central and Eastern Districts have explicitly defined the term “full authority to settle” as meaning that “the individuals attending the mediation conference must be authorized to fully explore settlement options and to agree at that time to any settlement terms acceptable to the parties.” See e.g. Buenrostro v. Sahota, 2011 U.S. Dist. LEXIS 127313 (E.D. Cal. Nov. 2, 2011); Meyer v. Portfolio Recovery Assocs., LLC, 2011 U.S. Dist. LEXIS 53778 (S.D. Cal. May 18, 2011) And both Districts have approvingly cited cases from jurisdictions outside of California for the proposition that sending a representative with rigid limitations on their ability to settle a case may run afoul of the court’s requirements. See, e.g. Pittman v. Brinker Int’l., Inc., 216 F.R.D. 481, 485-86 (D. Ariz. 2003), amended on recon. in part, Pitman v. Brinker Int’l, Inc., 2003 U.S. Dist. LEXIS 26202, 2003 WL 23353478 (D. Ariz. 2003) (requiring that the individual with full authority to settle have “unfettered discretion and authority” to change the settlement position of the party, if appropriate.); Nick v. Morgan’s Foods, Inc., 270 F.3d 590, 596-97 (8th Cir. 2001) (an authorization to settle for a limited dollar amount or sum certain can be found not to comply with the requirement of full authority to settle). However, while California courts have expressed skepticism about representatives with authorization to settle for a limited amount, it is not clear that the courts would demand more than authority to settle up to the amount in controversy, as is required under AT Reynolds in New York.
Notwithstanding the local rules, California courts do not completely ignore the concept of “good faith” in mediation. See, e.g., Skylark Inv. Props., LLC v. Navigators Ins. Co., 2010 U.S. Dist. LEXIS 12834 (S.D. Cal. Feb. 11, 2010) (“General statements that a party will ‘negotiate in good faith’ is not a specific demand or offer contemplated by this Order. It is assumed that all parties will negotiate in good faith.”); Olam v. Congress Mortg. Co., 68 F. Supp. 2d 1110, 1116 (N.D. Cal. 1999) (noting that mediation participants are expected to participate in good faith, “but that ‘good faith participation’ does not mean that [a participant] would have to ‘cave in’ or agree to anything.”). However, the requirement of good faith by itself has not been applied in California to impose sanctions for mediation conduct; in all cases imposing sanctions, the determination was based on the objective criteria set forth by the local rules.
As noted in the commentary to Northern District of California ADR Local Rule 2-4, parties are encouraged to use the informal resolution procedure set forth in the ADR Local Rules, but under Zambrano v. City of Tustin, 885 F.2d 1473 (9th Cir. 1989), the district court may impose fee shifting sanctions for a violation of a local rule only on a finding of bad faith, willfulness, recklessness, or gross negligence. For example, such sanctions have been imposed for, at least in part, a failure to attend the mediation absent good cause. In Lial v. County of Stanislaus, the District Court found that an award of attorney’s fees was appropriate where the plaintiff offered what was, in the Court’s view, a disingenuous reason for cancelling a scheduled mediation. 2011 U.S. Dist. LEXIS 4435 (E.D. Cal. Jan. 11, 2011). After spending over 11 hours speaking with the mediator in advance of the scheduled mediation, the plaintiff cancelled the mediation on less than a week’s notice, allegedly because she did not have sufficient vacation time to attend. Id. The Court noted disapprovingly that the plaintiff took a vacation the day after the date the mediation was originally scheduled for. Id.
In contrast, although a party may be required to attend a mediation, good faith does not necessarily guarantee unfettered access by the mediator to the party. In EEOC v. ABM Industries Inc., the defendants brought a motion for sanctions against plaintiffs based on plaintiffs’ counsel’s refusal to allow the mediator direct access to the plaintiffs. 2010 U.S. Dist. LEXIS 24570, 3-4 (E.D. Cal. Mar. 3, 2010) (“ABM argues that they are entitled to sanctions because, in essence, ‘good faith’ mediation efforts required the mediator to be able to directly persuade the plaintiffs to the wisdom of the defendants’ position.”) EEOC countered that the plaintiffs were Spanish speakers, and that the mediator’s suggestion, given that the mediator did not speak Spanish, would have required counsel for plaintiffs to act as an interpreter and could easily give rise to confusion as to who was advocating a particular position. Id. The Court recognized that it had general authority under Federal Rule of Civil Procedure 16 (f) to impose sanctions for failure to obey a scheduling order, and under 28 U.S.C. § 1927 to sanction attorneys who act in bad faith, but declined to impose any sanctions.
As an initial matter, the district court in EEOC noted that this was not a mandatory mediation, and the parties appeared by agreement. But this does not appear to have affected the court’s analysis of what it means for a party to participate in good faith. In particular, the court criticized the defendant for failing to request direct access to the parties by the mediator before the ground rules for mediation were entered. The court also found that good faith efforts at mediation do not require attorneys to give up their role as counselor to their clients. In fact, “in the Court’s view a primary reason that people hire lawyers is so that they are not pressured into doing something that may not fully serve their interests. The plaintiffs were entitled to rely upon the advice of their counsel and the attorneys were duty-bound to zealously advocate for them.” Id. at 14-15.
The adoption by all California district courts of local rules codifying objective criteria to assess participation in mediation proceedings may be intended to ensure compliance with state laws, and state Supreme Court precedent, relating to the confidentiality of mediation proceedings and restrictions regarding the information that can be disclosed to the court. See, e.g., Benesch v. Green, 2009 U.S. Dist. LEXIS 117641, 11-12 (N.D. Cal. Dec. 17, 2009) (“The broad policy of mediation confidentiality contained in the statutes is strictly enforced and the California Supreme Court has refused to allow implied exceptions: ‘Where no express waiver of confidentiality exists, judicially crafted exceptions to mediation confidentiality are not appropriate.’”) (citing Foxgate Homeowners’ Assn. v. Bramalea California, Inc., 26 Cal. 4th 1, 15 (Cal. 2001)). Limited exceptions are recognized in each district’s local rules, but these generally relate to the ability to report failure to comply with an express local rule to the Magistrate overseeing the ADR program, not to the judge presiding over the case. See, e.g., ND Cal ADR Local Rule 6-12. See also CD Cal Local Rule 16-15.8 (“All settlement proceedings shall be confidential. No part of a settlement proceeding shall be reported, or otherwise recorded, without the consent of the parties, except for any memorialization of a settlement and the Clerk’s minutes of the proceeding”).
Conclusion
While courts continue to cite a duty to mediate in “good faith,” it is unclear what, if any, requirements that places on a party beyond the specific provisions set forth in a court order. When faced with a court-ordered mediation, participants should make sure that they are represented at least by counsel and someone with full authority to settle the matter. Any anticipated change in circumstances should be promptly notified to the mediator and to all parties, particularly if cancellation or postponement of the mediation may be necessary.
California Court Signals Potential In Pari Delicto Doctrine Split With New York
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The common law doctrine of in pari delicto bars recovery by plaintiffs who share culpability for wrongdoings alleged in a complaint. Subject to certain exceptions, a corporate plaintiff’s claims are barred by the in pari delicto doctrine where its employees or agents participated in the alleged wrongdoing. In pari delicto defenses may be asserted where corporate plaintiffs assert claims against third parties that conspired with the corporation’s former employees or agents to harm the corporation and its shareholders.
Different jurisdictions have applied the in pari delicto doctrine in a variety of different ways, and have crafted various exceptions to the general rule. For example, some jurisdictions recognize exceptions to the general rule that acts by a corporation’s agents are imputed to the corporation. Recent decisions from courts in New York and California illustrate divergent approaches regarding the “imputation exception” to the in pari delicto defense. The New York Court Appeals (the state’s highest court) has held that the in pari delicto doctrine may bar claims unless the wrongful acts of an employee are shown to have been beyond the scope of his authority and adverse to the plaintiff’s interests. On the other hand, a recent decision from San Francisco Superior Court appears to allow such claims where at least some of the corporation’s officers or directors were not complicit in the wrongful acts. This appears to contradict New York’s stringent interpretation of the doctrine. Thus, practically speaking, California may be more preferable than New York for plaintiffs where some, but not all, of the plaintiff’s officers or directors committed or were complicit in wrongdoing relating to the lawsuit, to the arguable benefit of the company. Several types of disputes may hinge on this forum choice, including actions against a company’s auditors or financiers, and many types of litigation springing from litigation trusts in bankruptcy.
New York: The In Pari Delicto Doctrine After Kirschner v. KPMG
In both California and New York, courts recognize the common law in pari delicto doctrine, which “dictates that when a participant in illegal, fraudulent, or inequitable conduct seeks to recover from another participant in that conduct, the parties are deemed in pari delicto, and the law will aid neither, but rather, will leave them where it finds them.” Casey v. U.S. Bank Nat’l Ass’n, 127 Cal. App. 4th 1138, 1143 n.1 (2005); see also Kirschner v. KPMG LLP, 15 N.Y.3d 446, 464 (2010) (“The doctrine of in pari delicto mandates that the courts will not intercede to resolve a dispute between two wrongdoers.”).
A recent high profile decision from New York, Kirschner v. KPMG LLP, affirmed dismissal of a bankruptcy trustee’s claims against the estate’s outside auditors on in pari delicto grounds. Kirschner dealt with the spectacular implosion of Refco, a leading provider of brokerage and clearing services, that declared bankruptcy when it was discovered that the company’s President and CEO covered up hundreds of millions of dollars in uncollectible debt for the better part of a decade. After the ensuing bankruptcy, the bankruptcy court appointed a Litigation Trustee, who brought suit in the U.S. District Court for the Southern District of New York on behalf of Refco’s estate against, among others, Refco’s outside auditors for their roles in the company’s years-long efforts to manipulate the company’s financial reporting and to hide the company’s debts from the public and regulators. Id. at 457-59.
The auditors moved to dismiss the lawsuit on several grounds, including in pari delicto. The Court granted this motion because, inter alia, the complaint was allegedly “saturated by allegations that Refco received substantial benefits from the [Refco] insiders’ alleged wrongdoing.” Kirschner v. Grant Thornton LLP, 2009 WL 1286326, at *6 (S.D.N.Y. Apr. 14, 2009). On appeal, the U.S. Court of Appeals for the Second Circuit certified a series of questions regarding the scope of the in pari delicto doctrine to the New York Court of Appeals, the state’s highest court.
In finding for the auditors on the Second Circuit’s certified questions, the New York Court of Appeals noted that acts of a corporation’s agents are traditionally imputed to the corporation itself. See Kirschner, 15 N.Y.3d at 465-66. Extending this precedent to the case at hand, the Kirschner Court found that actions taken to bolster a corporation’s healthy image should be imputed to the corporation and that there were no exceptions or public policies militating against this finding. Id. at 466-69, 474-77. Accordingly, the Court found that the Litigation Trustee, suing on behalf of Refco, was subject to the in pari delicto doctrine and could not sue Refco’s outside auditors for their part in its demise. Id. at 476-77.
California: The Apparent Rejection of Kirschner v. KPMG in Paron v. RKC
In a similar case, Paron Capital Management, LLC, et al. v. Rothstein, Kass & Company, P.C., et al., CGC-11-510203 (Cal. Sup. Ct. S.F. Cty.), a California court declined to apply the standard set forth in Kirschner. In Paron, two of the plaintiff hedge fund’s three partners, Peter McConnon and Timothy Lyons, hired Rothstein, Kass & Company (“RKC”) to audit the trading records of their third partner, James Crombie. Investors in Paron required such an audit before they agreed to invest money in the hedge fund. RKC validated Crombie’s trading records in November 2010 but, five months later, the National Futures Association (“NFA”) instigated a new audit of Paron that led McConnon and Lyons to discover that Crombie had provided them with falsified records. When McConnon and Lyons reported this information to the NFA and Paron’s clients, the fund experienced mounting withdrawals that led to its demise shortly thereafter. Paron, McConnon, and Lyons subsequently sued RKC and other parties in San Francisco Superior Court for the losses they sustained due to, among other things, the faulty audit of Crombie’s records. RKC moved to dismiss the plaintiffs’ complaint on in pari delicto grounds.
RKC’s motion to dismiss relied heavily on the reasoning in Kirschner and argued that Crombie’s fraud was properly imputed to Paron, which therefore barred the fund from suing RKC on in pari delicto grounds. Paron responded by pointing out that, “[u]nder California law, in pari delicto is never applied to innocent parties, and the doctrine would only be appropriate if ‘the complaint alleges that every decision maker in the company was involved in the misconduct.’” As the facts demonstrated—according to Paron—the plaintiffs were the victims of Crombie’s fraud, not its beneficiaries. Accordingly, in pari delicto did not apply.
The Court agreed with Paron’s analysis, denied RKC’s motion and reinstated claims that had previously been dismissed on in pari delicto grounds. Implicit in this decision was a holding that the complaint did not have to allege facts that “show that Crombie’s conduct was completely adverse to the company’s interest and outside the scope of authority,” which was the basis of the prior dismissal. Paron’s case thus proceeds in spite of New York’s Kirschner opinion.
Plaintiffs should be wary of relying too heavily on the Paron court’s decision for their forum selection analysis. At this stage, it is a trial court decision that may be subject to reversal on appeal. However, the decision is an encouraging sign for plaintiffs and may presage a split in how the in pari delicto doctrine is applied in New York and California.
January 2012: London Litigation Update
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Liquidator Ordered to Disclose Documents to Creditor for Use in Arbitration: In Sunwing Vacation Inc v. E-Clear (UK) plc [2011] EWHC 1544 (Ch), 3 June 2011, the U.K. High Court of Justice Chancery Division considered whether Section 155(1) of the 1986 Insolvency Act, which requires the disclosure of an insolvent company’s papers to its creditors, also required the disclosure of documents to a creditor for use in a separate arbitration against a third party. The applicants, Sunwing Vacations Inc. and Vacances Sunwing Inc. (collectively “Sunwing”) applied for an order against E-Clear (UK) plc (E-Clear), a company in voluntary liquidation of which they were creditors, and E-Clear’s liquidators for the disclosure of documents for use in arbitration proceedings in Germany. The German arbitration involved claims by Sunwing that relate to E-Clear’s debt to Sunwing.
Under Section 112(1) of the Insolvency Act 1986 (IA 1986), a creditor of a company in liquidation (but not being wound-up by a court) may request that a court exercise its power as if the company were being wound-up by the court. One such power is set forth in Section 155(1) IA 1986, which provides that a court “may, at any time after making a winding-up order, make such order for inspection of the company’s books and papers by its creditors and contributors as the court thinks just; and any books and papers in the company’s possession may be inspected by creditors and contributories accordingly, but not further or otherwise.” It has been held that the exercise of power under Section 155(1) must be for the purpose of the winding up a company (per Millett J in Re DPR Futures Ltd [1989] 1 WLR).
The main issue in Sunwing was whether the action sought by Sunwing under Section 155(1) was for the purpose of winding up E-Clear. The Court noted that, if Sunwing was successful in the German arbitration, it would reduce the recovery sought by Sunwing from the wind-up of E-Clear. The Court found that the exercise of power under section 155(1), i.e., disclosure of the documents, could benefit E-Clear and its creditors generally. As a result, the Court held that, the requested order was for the purposes of winding up.
This decision confirms that a creditor can apply for disclosure of an insolvent company’s papers for use in any proceedings where the creditor may obtain a benefit that reduces its claim in the insolvency.
Sovereign Immunity: Could an affiliate of a New York-based hedge fund seize Argentina’s assets in Britain using a $284 million U.S. court judgment it had against the South American nation? In NML Capital v Argentina, the U.K. Supreme Court held that the hedge fund was entitled to do so.
The claim arose out of New York law governing sovereign bonds issued by Argentina and bought, at a significant discount, by NML Capital in the early 2000s. When Argentina failed to pay the requisite interest on the bonds, NML Capital called an event of default and obtained a New York judgment against Argentina for over US$284 million. NML then sought to have the judgment recognized and enforced in England under the common law (there was no reciprocal enforcement legislation between the UK and the US). Argentina argued that it was a sovereign state and had immunity under the U.K. State Immunity Act 1978 (“SIA”), which grants general immunity to states unless specific exceptions apply. The U.K. Court of Appeal found in Argentina’s favor in February 2010.
Before the U.K. Supreme Court, NML Capital raised three points: first, that one of the exceptions in the SIA was that a state could not enjoy immunity for “a commercial transaction” it entered into; second, the Civil Judgments and Jurisdiction Act 1982 (“CJJA”) stated that foreign judgments against a sovereign state could not be enforceable unless two conditions were met: (a) the state would not be immune if English law applied (i.e., the SIA above); and (b) that the judgment satisfied enforceability criteria under English law; third, that under the terms of the bonds, Argentina had waived immunity and had submitted to the jurisdiction of the national courts for enforcement.
On the first issue, the Justices were split 3-2. While there was no dispute that the bonds would constitute a commercial transaction, the issue was whether proceedings to enforce judgments could be considered a “commercial transaction.” The majority were of the view that such proceedings fell into the category of “commercial transactions” because of Parliament’s intention at the time the legislation was drafted and market practice at the time in international capital markets. However, on the second issue, because all the Justices felt that NML could prevail on the CJJA to strip Argentina of its immunity. Lord Phillips, summarizing the effect of the CJJA on this particular case, stated: “State immunity cannot be raised as a bar to the recognition and enforcement of a foreign judgment if, under the principles of international law recognized in this jurisdiction, the state against whom the judgment was given was not entitled to immunity in respect of the claim.” Thus, if the state would not have enjoyed immunity under the claim, there is no reason why the judgment should not be recognized or enforced. On the third issue, the U.K. Supreme Court found that, on the specific terms of the bonds, Argentina’s submission to New York jurisdiction meant it had waived its right to object to jurisdiction for the purposes of subsequent enforcement proceedings.
Common Sense and Contract Interpretation: In Rainy Sky SA v. Kookmin Bank [2011] UKSC 50, The U.K. Supreme Court recently gave important guidance on the English courts’ approach to contractual interpretation. The fundamental rule under English law is that the purpose of contractual interpretation is to determine what the parties meant by the language they used. This is an objective enquiry – it involves ascertaining how a reasonable person, with all of the background knowledge available to the parties at the time of the contract, would construe the document.
The question in Rainy concerned the role played by considerations of “business common sense” in determining what the parties meant. Delivering the Supreme Court’s judgment, Lord Clarke said that “where the parties have used unambiguous language, the court must apply it.” Even if the result compelled by that language strikes the court as commercially absurd or unfair, English law takes the view that loyalty to the text of a commercial contract is the paramount principle of interpretation.
However, Lord Clarke said that where a clause in a contract was ambiguous (meaning it is capable of two or more meanings), it is appropriate for the court to apply the construction that is most consistent with, in the court’s view, commercial common sense. Accordingly, if there is contractual ambiguity, litigants can employ more creative arguments exploring the underlying commercial purpose of the transaction. Otherwise, if there is no contractual ambiguity, litigants in the English courts are invariably stuck with the words.
Lucasfilm v Ainsworth [2011] UKSC 39 (the ‘Stormtrooper Helmet’ case): England’s highest Court has held that Star Wars Stormtrooper helmets are not “sculptures,” much to the chagrin of Lucasfilm. In doing so, it also found that an action for copyright infringement based on activity outside the EU (in this case the United States) could be brought in England against someone residing in the United Kingdom over whom the English courts have personal jurisdiction.
There was no dispute that Mr. Ainsworth had infringed Lucasfilms’ U.S. copyrights in the United Kingdom by placing advertisements for his Star Wars Stormtrooper helmets in U.S. publications, operating a website in the United States, and sending his products to American customers from the United Kingdom. Default judgment for infringement of copyrights had been entered against Mr. Ainsworth in California, but he remained in the United Kingdom. The English Court therefore had to consider whether jurisdiction existed for an infringement action of an American copyright.
Previously, the Court of Appeal in England had held that European legislation requires English courts to hear copyright infringement actions against defendants over which they have jurisdiction, even if the infringement took place elsewhere in the European Union. However, until Lucasfilm, it was generally accepted that this principle did not extend beyond the European Union. Indeed this was the stance taken by the (lower) Court of Appeal in the case.
The Supreme Court, however, swept aside this view, ruling that the claim for infringement of a U.S. copyright in breach of U.S. copyright law is a claim over which the English courts can accept jurisdiction if there is jurisdiction over the defendant (in this case, he was domiciled in the United Kingdom). This is arguably the Supreme Court’s upholding of forum necessitatis considerations, allowing English courts to assert jurisdiction in instances where claimants would otherwise be bereft of a suitable forum in which to litigate. The Supreme Court emphasized that this applied to copyright infringement, not validity or registration issues, but the case nevertheless may have wide-ranging implications, and shows an increased willingness of the English Courts to consider U.S. copyright infringement claims.
January 2012: Japanese Litigation Update
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Japanese Record Labels Sue YouTube Downloader Site: The Recording Industry Association of Japan (RIAJ), an organization representing the Japanese music recording industry, issued a press release stating that 31 Japanese record labels filed a collective lawsuit on August 19th in Tokyo District Court against local firm MusicGate. According to the lawsuit, the defendant MusicGate operates an internet site called Tubefire that enables free downloads of music videos posted on YouTube. The labels are demanding 230 million Yen (around $3 million) in damages from MusicGate. RIAJ states that Tubefire attracts more than 2.2 million visitors a month, and that a huge volume of music video files have been illegally downloaded through the site. RIAJ claims that Tubefire replicated music video without permission of the copyright owners, which violated Japanese Copyright Law by infringing on the reproduction and distribution rights of the copyright owners. According to a RIAJ survey of Tubefire users, files protected by the labels’ copyrights were illegally replicated around 10,000 times a month. Based on the results, the labels calculated damages equal to the amount they would have earned if the music files were bought from official distributors. Although Tubefire has already ceased operations, several other websites still provide the same service. A RIAJ survey estimates that about 1.2 billion music files are illegally downloaded annually, while legitimately purchased music during 2010 amounted to about only 0.44 billion. At the first hearing, held on October 12th, MusicGate sought dismissal of the claims against it.
Canon Wins Ink Cartridge Patent Infringement Suit in the Japanese Supreme Court: Canon Inc. had sued six other ink cartridge makers claiming that their products, which are compatible with Canon-manufactured ink-jet printers infringe one of Canon’s patents. The defendant makers imported and sold allegedly infringing ink cartridges manufactured in Hong Kong. They were widely sold at lower prices than genuine Canon cartridges. The Intellectual Property High Court recognized that the defendants’ products had infringed the Canon patent and ordered the defendants to stop importing and selling those products. The defendants appealed, but the Japanese Supreme Court upheld the ruling of the High Court on September 29th. This case represents a major victory in the battle printer manufacturers have waged in recent years -- in Japan, the U.S. and Europe -- against the manufacturers of consumables made for use in their printers.
New Regulation Against Organized Crime Group Takes Effect in Tokyo: In October, the Tokyo Metropolitan Government introduced a new regulation against organized crime groups (commonly known as “Yakuza”). Although similar regulations had already taken effect in other prefectures, the enforcement in the capital city of Japan has a substantial impact. Yakuza was listed as one of four significant transnational criminal organizations in U.S. President Barack Obama’s July 25th executive order authorizing new sanctions against criminal cartels (the others are Los Zetas, Camorra and the Brothers’ Circle). The principal intent of this regulation is to weaken the economic power of members of such organizations (which are defined by the act as “gangsters”) by encouraging companies in their efforts to refrain from entering into contracts with them. Three important aspects of the regulation should be noted. First, whenever entering into a contract, companies must make their efforts to make sure the other party is not a “gangster” under the Act. In addition, companies are strongly encouraged to include contract clauses enabling them to cancel a contract if they find later find cause to believe that the other party qualifies as a “gangster” under the Act. Second, companies must not provide any “profits” to covered “gangsters.” Third, companies should watch for “gangsters by association”-- the act makes clear that a “gangster” includes those who have a “close relationship” with other “gangsters,” in addition to official members of organized crime groups.
It is not clear yet, however, how courts will interpret the term “profit” or what is a “close relationship” with gangsters. If companies are not able to determinations as to issues related to the regulation, consultation with police may be warranted.
January 2012: Trademark and Copyright Litigation Update
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Ninth Circuit Abandons “Internet Troika” For Assessing Trademark Infringement: In Network Automation v. Advanced Systems Concepts, 638 F.3d 1137 (9th Cir. 2011), the Ninth Circuit clarified that analysis of trademark infringement claims in the Internet context, as with other trademark infringement cases, must be tailored to fit the specific facts of each case. In so doing, the Ninth Circuit rejected the so-called “Internet troika” analysis, which focused on three and only three factors for Internet-related trademark infringement. In place of this abbreviated, plaintiff-friendly standard, Networks Automation requires a “flexible” approach when applying the traditional multi-factor Sleekcraft test for assessing likelihood of confusion – a far more defendant-friendly standard.
In Networks Automation, Advanced Systems Concepts, which sells software under the trademark ActiveBatch, sought an injunction against Network Automation, one of its competitors. Network Automation was bidding on keywords such as “ActiveBatch” in connection with advertising on search engines, including Google and Bing. A search for these keywords would deliver search results that included links to web pages for plaintiff’s ActiveBatch products, as well as defendant’s ads, which could also appear above or to the right of the search results.
The district court found that Advanced System Concepts proved a likelihood of confusion under the “Internet troika” factors: (1) the similarity of the marks; (2) the relatedness of the goods; and (3) the marketing channel used. The Ninth Circuit reversed. In so doing, it distinguished keyword advertising from the meta-tagging and banner advertising scenarios of Brookfield Communications, Inc. v. West Coast Entertainment Corp., 174 F.3d 1036, 1054 (9th Cir. 1999), and Playboy Enterprises, Inc. v. Netscape Communications Corp., 354 F.3d 1020, 1024 (9th Cir. 2004). The Ninth Circuit held that its analysis in Brookfield and Playboy was both due to the increasing “degree of consumer care” of online consumers since its earlier decisions, as well as the different appearance of the ads at issue in the present case. Network Automation’s advertisements were labeled as separate and distinct from natural search results; for example, they were delivered to different regions of the search results webpage and clearly identified the defendant in the advertised link. Squarely rejecting the “Internet troika” analysis, the Ninth Circuit found two of the three “troika” factors were particularly unlikely to favor a finding of confusion in the keyword advertising context. First, the “appearance of the advertisements and their surrounding context” on the screen did not support a confusion finding, given the nature of the search results page. Likewise, the “similarity of the marks” factor did not favor a confusion finding where the consumer was not confronted with two distinct trademarks, and instead received advertisements that clearly identified the defendant using the defendant’s own name. 638 F.3d at 1150-51, 1154. Additionally, it reasoned that “the shared use of a ubiquitous marketing channel does not shed much light on the likelihood of consumer confusion” given that “[t]oday, it would be the rare commercial retailer that did not advertise online.” Id. at 1151.
Other circuit courts also have rejected the “Internet troika” in the sponsored link context. Tiffany (NJ) Inc. v. eBay Inc., 600 F.3d 93 (2d Cir. 2010); College Network, Inc., v. Moore Educational Publishers, Inc., 378 Fed.Appx. 403, 2010 WL 1923763 (5th Cir. 2010).
Logos, Emblems, and Characters Given Trademark Protection Reprieve as Ninth Circuit Withdraws and Supersedes Earlier Controversial Aesthetic Functionality Decision: In our July 2011 Newsletter, we reported on an important and controversial trademark decision from the Ninth Circuit, Fleischer Studios, Inc. v. A.V.E.L.A., Inc., 636 F.3d 1115 (9th Cir. 2011), which affirmed the dismissal of copyright and trademark infringement claims related to the defendant’s licensing of the Betty Boop image on various products. As we reported in July, the Ninth Circuit reasoned that the defendant’s use of the Betty Boop image – “never designat[ing] the merchandise as ‘official’ [Fleischer] merchandise or otherwise affirmatively indicat[ing] sponsorship [by Fleischer]” 636 F.3d at 1124 – was not the kind of source-designating use as a trademark forbidden by the Lanham Trademark Act. Rather, the Ninth Circuit reasoned, the defendants merely employed the Betty Boop image as a “functional and aesthetic” characteristic of their licensed products: “Even a cursory examination, let alone a close one, of ‘the articles themselves, the defendant’s merchandising practices, and any evidence that consumers have actually inferred a connection between the defendant’s product and the trademark owner,’ reveal that A.V.E.L.A. is not using Betty Boop as a trademark, but instead as a functional product.” 636 F.3d at 1123.
On August 19th, the Ninth Circuit responded to the controversy its opinion created by taking the unusual step of simply withdrawing its February opinion and superseding it with a new opinion: Fleischer Studios, Inc. v. A.V.E.L.A., Inc., 654 F.3d 958 (9th Cir. 2011). The new opinion remands part of the plaintiff’s trademark cause of action, but abandons the prior analysis that the use of the Betty Boop image was aesthetically functional and that the Supreme Court’s decision in Dastar Corp. v. Twentieth Century Fox Film Corp., 539 U.S. 23 (2003) required dismissal under the Copyright Act. Indeed, the August opinion is entirely silent on the issue of aesthetic functionality.
The August opinion continues to express skepticism about Fleisher’s claims, finding again that it failed to present timely evidence of its trademark registration in the image of Betty Boop and refusing to take judicial notice of the registration. Fleischer, 654 F.3d at 966. It also reiterates that the “uncorroborated, and clearly self-interested testimony” of Fleischer’s CEO is insufficient to establish a triable issue regarding secondary meaning. Id. However, the new opinion held that remand was necessary because the previously dispositive fact that other entities held valid copyrights in Betty Boop is insufficient in and of itself to support a determination that Fleischer could not prove secondary meaning in the Betty Boop word trademark. Id. at 968.
The Case Against Arbitration: Do the Doubters Have a Point?
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Recently, the American Arbitration Association (AAA) obtained feedback from a number of its primary users throughout the United States that have traditionally used arbitration extensively as a dispute resolution mechanism. Although the AAA received many compliments and accolades, the results also reflected concerns about arbitration that have become more widespread. These can be distilled into three general perceptions: (1) arbitration is becoming more and more like ordinary litigation; (2) it is becoming as expensive as—if not more expensive than—litigation, in large part because of the high fees that arbitrators charge to conduct a case; and (3) in some circles, there is a lack of trust that arbitrators will be willing to make hard, albeit legally justified, decisions, particularly in complex cases. These results are also reflected in a recent survey concerning international arbitration, reported in the January 2011 edition of “Inside Counsel” magazine. Over 50% of in-house counsel interviewed in that survey said they have been “disappointed with arbitrator performance.”
Are these criticisms justified? To answer this question with any degree of accuracy requires some dissection of the factors at play in a complicated arbitration proceeding. As a starting point, one basic premise of arbitration does not seem to be in doubt, at either the international or the domestic level: for better or worse, arbitration remains a method of dispute resolution that carries with it more undefined and uncertain elements than litigation. The arbitration rules—in both international institutions (such as the ICC or the LCIA) and U.S. domestic institutions (such as AAA or JAMS)—have become somewhat more detailed over the years, but they are still purposely very general, allowing considerable flexibility for the tribunal to conduct the arbitration and for the parties to present their positions. The virtue of this somewhat loose structure is that it creates and defines the intended spirit of arbitration—a dispute resolution mechanism not bogged down by the formalities of litigation, which allows the parties and the tribunal to tailor the process in a fair and cost-efficient way, resulting in a reasoned award that, generally, will be more analytical and comprehensive than its judicial counterparts.
The major arbitral institutions of the United States and the world justifiably point to developments that have not only preserved but promoted this spirit of arbitration. Increased selectivity regarding the arbitrators who make up their resource pools, coupled with highly sophisticated training, continuingeducation, and multi-media publications addressing thorny issues, have produced proactive arbitrators who have implemented the spirit of arbitration in intelligent and often creative ways to resolve disputes. Likewise, arbitration practitioners who have tuned in to and kept abreast of this evolution have themselves embraced innovative, cost-efficient approaches to preparing and presenting an arbitration case.
So what has happened to change the mindset of a statistically significant sampling of sophisticated users of arbitration? Answers may lie in misdirected strategies that both parties and arbitrators might bring to an arbitration.
Problems Created by the Parties
Some problems with arbitration lie at the doorsteps of the parties themselves. As they become more familiar with the arbitration process, parties recognize that they can wield considerable power in shaping an arbitration proceeding to their liking, particularly when opposing parties can forge an agreement on some aspects of the arbitration process. As cases become more complex, with higher stakes, it is a natural reaction for a party to resort to the comfort of traditional litigation proceedings to try to increase the predictability of a favorable outcome, or at least to diminish the risks of failure. And there are opportunities to implement such an approach in virtually every phase of the arbitration process.
The Arbitration Pleadings
A “litigation-embracing” strategy can begin as early as the filing of the arbitration pleadings. Every set of international arbitration rules in the world—including those in the United States—is designed to make the initiation of an arbitration proceeding as easy as possible. There are no formal pleading rules, other than very general requirements that require parties to provide only the most basic information necessary to apprise the other side of the type of dispute that is being brought against them. To level the playing field, some rules do not even require the filing of a written response—by not doing so, the respondent simply will be deemed to have denied the allegations of the arbitration demand.
However, as arbitrations become more complex, a claimant tends to feel more compelled to obtain what it perceives will be an advantage by giving the arbitrators a detailed picture of the wrongs that have been committed against it. The tool of choice for doing so will often be an arbitration demand that contains as much detail as—and not uncommonly more detail than—would be set forth in a comparable litigation pleading. Not wanting to be outdone, the respondent typically will follow suit in its answer to the demand. There is nothing inherently wrong or wasteful about this approach. Many arbitration rules, both international and domestic, typically contain provisions that at some point down the line require the parties to specify in detail their claims and defenses, either as part of the terms of reference (ICC rules) or in the form of a detailed statement of claim or damages (AAA, ICDR rules).
The real trapdoor to the process is the tendency to lure the parties—particularly the respondent—into litigation – like pleading motions that clearly are designed to attack a claimant’s case before it ever gets out of the starting blocks, in the hope of at least raising suspicions in the minds of the arbitrators as to its true worth. Such motions often become very expensive and time-consuming endeavors.
Unfortunately, they are almost always unsuccessful. For example, many arbitrators would reject out of hand a motion to dismiss a claim or cause of action (à la Federal Rule of Civil Procedure 12(b)(6)), not only on the grounds that the arbitration rules neither reference nor contemplate such motions, but also because to allow such motions at such an early stage would deprive the opposing party of a fair opportunity to present its case and possibly lead to vacatur of the arbitration award on that basis. Courts have recognized that there is a legitimate, but narrowly-defined, place for motions to dismiss an arbitration: i.e., where the motion in effect serves as a summary judgment or dispositive motion to dispose of claims that are frivolous on their face or clearly beyond the scope of the arbitration panel’s jurisdiction under the parties’ arbitration agreement. Regrettably, motions to dismiss, motions to strike, and other motions directed against the arbitration pleadings are not always so focused. Like their litigation cousins, they attack the unartful articulation of a pleading, claiming, for example, that the demand fails to allege a claim with sufficient specificity. Such motions are doomed to failure before experienced arbitrators, who recognize that an initial demand or request for arbitration was never intended to be the platform for a battle on the highest and best articulation of a claim.
Discovery
Discovery is the area in which arguably the greatest opportunity for arbitration “abuse” arises.
Document production. There is no question that the exchange of relevant documents—particularly electronically stored information—is critical for a party to have a fair opportunity to present its case and for the arbitral tribunal to be able to render a decision that is rational and comprehensive. Arbitration rules almost universally try to achieve these objectives by providing procedures for document production, either in the form of a voluntary document exchange or authorization of formal document requests, or both.
Yet document production issues continue to increase arbitration costs, almost exponentially in some cases. Broad-based, unlimited litigation-style document requests, which are purposefully based on the very loose definition of potential relevance necessary to compel the production of documents in U.S. court proceedings, are prime contributors to this problem. They ignore the much narrower standard under most arbitration rules that the request: (i) must call for documents that are reasonably believed to exist, (ii) are not in the custody or possession of the requesting party, and (iii) are demonstrably relevant and material to the outcome of the case. Disregard of the more focused arbitration standard can, and frequently does, lead to extended discovery battles on the scope of document production that, regrettably and inappropriately, mirror those common to litigation.
Further, although electronic document exchange is critically important to arbitration (and in modern arbitration comprises the vast majority, if not all, of a party’s relevant documents), many parties struggle to agree on a procedure that will ensure comprehensive production of electronic information. Arbitration rules historically have not provided any guidance on this issue, because they were mostly created before electronically-stored information came into existence. Recently some arbitral institutions have corrected this by updating their rules to address electronic document production. But even the updated rules leave many of the critical details of production in the hands of the parties and the arbitrators. Thus, if parties are uncooperative in agreeing on a retrieval and production process—for strategic or other reasons—and if the arbitrators are uncomfortable with trying to forge a comprehensive process on their own, this produces a fertile ground for inefficient and expensive production procedures and the wasteful discovery battles that frequently accompany them.
Expert witnesses. Expert witness designations by the parties, combined with the exchange of reports, is also a mainstay of both international and domestic arbitration processes. The IBA Rules have a detailed procedure for designating expert witnesses and exchanging expert reports in international arbitrations (IBA Rules, Article 5). In U.S. domestic arbitrations, allowance of expert depositions is a common practice, based on the compelling rationale that a party should not be unduly surprised at the hearing by expert testimony of which the party may have no prior knowledge, or may not have the ability to address without seeing the expert report in advance and being able to retain its own expert to address the relevant opinions and assist in preparing cross-examination. These practices are almost universally perceived as a help, not a hindrance, to an efficient arbitration proceeding.
The problems with experts tend to arise from the parties’ attempts to overuse expert witnesses to render opinions outside the scope of what is appropriate or to present what at the end of the day is essentially cumulative expert testimony. Although this initially may seem to be a good strategy for shoring up a party’s position, in practice it more frequently leads to expensive and time-consuming motions regarding the qualifications of an expert or the propriety of expert testimony—most of which are unsuccessful—or to cumulative testimony that the arbitration tribunal simply ignores or possibly excludes altogether.
Depositions. A major concern with discovery or information exchange in arbitration lies in the area of depositions. In the international arena, the subject of depositions is generally irrelevant—there is almost a universal rejection among international tribunals of the distinctly American concept of depositions. Virtually no civil law jurisdictions recognize depositions, and some will either curtail or not even allow lawyer examination of a witness at the trial of a civil case. It is in U.S. domestic arbitrations that deposition practice can tend to run wild, incurring in the process very substantial expenses for all parties. Both the American Arbitration Association rules (particularly the Supplemental Procedures for Large Complex Cases) and the JAMS Rules contemplate the arbitration tribunal allowing some depositions to be taken, and it is becoming more common for the parties themselves to agree to at least a limited number of depositions in the arbitration clause of their contract.
However, as the stakes in a case increase, the natural tendency is for the parties to leave no stone unturned by deposing virtually every lay witness on an opposing party’s witness list, and then adding, for good measure, depositions of a number of “persons most knowledgeable” about some issues. Further, many parties will not hesitate in requesting depositions of non‑parties to the arbitration, despite rulings in many leading U.S. jurisdictions prohibiting the issuance of subpoenas for depositions of third parties in arbitration proceedings. Domestic arbitrators may, and usually do, make some attempt (most often in the preliminary conference) to limit the number of lay depositions each side may take. However, in complex matters, it is more and more the case that the parties themselves will try to circumvent any such attempts by agreeing in advance—or at the preliminary conference itself—to a high number of depositions. To many arbitrators, party agreement on such issues will trump any contrary, efficiency-driven ideas they may have.
Dispositive Motions
High-risk cases may also spawn dispositive motions, usually in the form of motions to dismiss or for summary judgment. This certainly can be a good thing and has been increasingly embraced by modern arbitration tribunals. The rationale is that if, in fact, a claim can be fairly disposed of through a motion procedure instead of a full hearing on the merits, the goals of arbitration are clearly promoted. Thus, in international proceedings, tribunals tend to be more amenable to deciding as a “preliminary issue” a question that potentially will either dispose of the case or narrow its scope significantly, such as a motion challenging the jurisdiction of the tribunal to decide a dispute or to award certain types of requested damages under the applicable contract provisions. Domestic arbitration panels—following cases such as the landmark California decision in Schlessinger v. Rosenfeld Meyer and Sussman, 40 Cal. App. 4th 1096 (2d Dist. 1995), which recognized the propriety of summary judgment in arbitration—will typically allow summary judgment motions but not until (as Rosenfeld advised) the responding party has had a fair opportunity to gather all evidence necessary to oppose the motion.
The problem with dispositive motions lies in the not uncommon maneuver of a party that, aware it has no real hope of winning a dispositive motion before the completion of discovery or maybe at all, nonetheless brings such a motion to “educate” and favorably influence the arbitrators before the hearing starts. This strategy can be extraordinarily expensive in complex cases. The soundness of such a strategy is questionable. Good arbitrators have both the desire and the ability to focus on the evidence and argument presented at the hearing and will tend to disregard factual presentations made in prior unsuccessful dispositive motions that may or may not turn out to be an accurate reflection of admitted evidence.
Interim Relief
The parties also can dramatically increase the cost of the arbitration by misusing their right to petition arbitrators for “interim relief.” Arbitration rules generally endow arbitrators with broad latitude to grant virtually any type of interim relief they consider appropriate, including injunctive relief, and even give the parties the option of taking requests for interim relief to a court. (See, e.g., ICC Rules, Article 23; AAA Commercial Rules R-34). This can lull the parties into thinking they will be able to persuade arbitrators to, in effect, end the case by granting prohibitory or even mandatory interim injunctive relief, which either gives the opposing party a clear picture of the likely outcome of the case or is so onerous that the other party will have no incentive to continue the arbitration. Aggressive requests such as these can easily become a profit center unto themselves in an arbitration—complete with extensive briefing, discovery, witness declarations and even live testimony to decide the interim issue. However, the end result of this strategy is seldom successful for the moving party. Good arbitrators tend to use their interim relief powers very cautiously, limiting relief to that necessary to preserve the status quo and to ensure fairness of the arbitration process—for example, by taking steps to preserve assets and/or prevent diminution of their value, or by requiring a party to post security for its share of the costs of the arbitration if there is a chance the party might not be able to pay at the end of the day. However, the same degree of caution is also used by arbitrators to avoid any prejudgment of the dispute on the merits prior to the hearing. This usually translates into denial of aggressive requests for injunctive relief under the judicial standard (reasonable probability of success on the merits, irreparable harm, and balance of equities). Thus, the considerable financial and legal resources a party can expend by trying to obtain punishing and perhaps dispositive interim relief may well go for naught.
Overpreparation for Arbitration Hearing
The parties’ resort to litigation-like practices to ease their apprehension about the outcome of an arbitration is perhaps most pronounced in preparation for the arbitration hearing. In complicated arbitrations, parties sometimes file extremely lengthy, comprehensive and fact-intensive pre-arbitration briefs—going far beyond those that would be filed (or allowed under rules on page limits) in litigation. Although pre-arbitration briefing is indisputably helpful to the arbitrator(s), a compendium of all the evidence and legal arguments is much more than is needed or useful on the eve of the hearing. The typical mindset of a good arbitrator in a complicated case is to reserve all judgment until the evidence is in, which essentially requires disregarding painstaking factual analyses in a pre-arbitration brief in favor of focusing on the evidence as presented at the hearing.
Pre‑hearing preparation also tends increasingly to be intertwined with litigation-style pre-trial motions, the primary culprit being motions in limine to preclude evidence from being admitted at the hearing. No rule of any recognized arbitration institution says anything about motions in limine, although some do articulate the power of the arbitrators to determine the admissibility of and exclude evidence where appropriate. (E.g., UNCITRAL Arbitration Rules, Article 27; ICDR International Dispute Resolution Procedures, Article 20; AAA Commercial Rule R-31). Such language may in essence be the springboard for such motions. But the overwhelming problem with motions in limine is that they often ignore the basic premise of arbitration that strict rules of evidence do not apply. Further, a refusal by the arbitrators to hear relevant evidence is one of the few grounds for vacatur of an award in both international and domestic arbitrations (e.g., 1958 New York Convention on the Enforcement of Foreign Arbitral Awards, Article V.1(b); Federal Arbitration Act, 9 U.S.C. Section 10(a)(3)), because it can be characterized as a party having been deprived of a fair opportunity to present its case. For these reasons, good arbitrators seldom grant motions in limine or similar exclusionary motions except in extreme cases, such as the protection of attorney-client privilege or to counter the attempt to bring in evidence or witnesses contrary to a stipulation of the parties or a prior order of the tribunal. Other evidentiary issues, however, can just as easily be handled when the evidence is presented during the hearing. The argument that motions in limine are preferable, because the arbitrators are unable to “unring the bell” in their minds once they hear the evidence, generally underestimates the high level of sophistication and experience of arbitrators overseeing a complex proceeding.
Problems Created by the Arbitrators
Despite all the tactics for arbitration abuse available to the parties, the main problem with runaway arbitrations in many cases may lie just as much—or more—with the arbitration tribunal itself. The fact is that where the parties try to venture beyond the relevant arbitration rules into new territory that promises to increase the time and expense of an arbitration proceeding dramatically, they can do nothing unless the arbitrators allow it. Yet many arbitrators—even at the highest levels—can be overly deferential to the parties as to how an arbitration should be conducted.
There are a number of possible explanations for this. The arbitrators may be overly sensitive to the premise that their jurisdiction derives from the agreement of the parties in the arbitration clause itself, and they may on that basis accept as gospel any procedure on which the parties both agree, or even one that one party requests and the other party does not oppose. Arbitrators also tend to be—and rightly so—keenly aware of possible grounds for vacatur of an arbitration award, which can be fairly summarized on both the international and domestic levels as events or actions that preclude a party from having a fair opportunity to present and have its case decided. To protect against vacatur on those grounds, arbitrators will sometimes step into the background, allow the parties to take a run at any number of the extraordinary procedures mentioned above, and make their views known only in the decisions on those procedures.
However, there unquestionably are a number of tools available to arbitrators— many of them referenced in the applicable arbitration rules—to help ensure that pre‑hearing procedures, and the hearing itself, will not be unduly drawn out and expensive without sacrificing the sacrosanct principle of a fair arbitral process. Proactive arbitrators will judiciously use motions to dismiss and motions of summary judgment as tools to resolve a matter when it is appropriate to do so, and in some circumstances may even properly suggest the possibility of such motions to the parties with regard to key issues. Likewise, a proactive arbitrator will not shy away from challenging the parties’ rationale for discovery if it seems excessive, and will work with the parties to customize a more streamlined discovery plan tailored to the legitimate pre-hearing need of the parties that at the same time conforms with the spirit of arbitration. In U.S. domestic arbitrations, rational limits can be set on deposition discovery, both in terms of number of deponents and time limits. The best arbitrators will extend their discovery responsibilities to the complexities of electronic information production, jumping into the trenches to help fashion a fair and efficient process that may creatively borrow guidelines from other arbitration rules not applicable to the case at hand or even from e-discovery developments in the judicial arena. Even in cases where dispositive motions might not be in order, a proactive arbitrator will invite the parties to identify, and perhaps even suggest themselves, possible issues that could narrow the focus of an arbitration dispute through a bifurcated hearing. Finally, proactive arbitrators can and do offer valuable guidance to the parties in advance—as early as the first preliminary hearing—for procedures to maximize the efficiency of the proceeding. Proper timing of dispositive motions can be determined, motions in limine can be rationally circumscribed, and page limits can be set on briefing, to name only a few possibilities. Arbitrators should also be favorably disposed to creative processes during the hearing that will increase efficiency while protecting fairness. For example, testimony from a third-party witness who is outside the arbitration’s subpoena power could be arranged effectively and cheaply (in today’s technology-driven world) by videoconference, in lieu of a protracted and possibly unsuccessful effort to force the witness to be deposed. In U.S. domestic arbitrations, the prudent use of depositions for the purpose of taking evidence from nonparty witnesses is also a possibility. The California Arbitration Act, for example, allows for such a procedure for a witness who cannot be compelled to attend the hearing, if “exceptional circumstances” make it desirable to do so “in the interests of justice and with due regard to the importance of presenting the testimony of witnesses orally at the hearing.” (Cal. Civ. Proc. Code §1283). Arbitrators, and parties, are also empowered to consider more extensive use of written witness statements in lieu of direct examination, which can shorten the hearing considerably. Witness statements are in fact the rule in international arbitration proceedings. U.S. domestic arbitration rules provide the same option to the parties and arbitrators. The AAA Commercial Rules (R-32(a)), for example, give the arbitrator the discretion to receive witness testimony by “declaration or affidavit.”
Arguably the single most effective tool to insure the efficiency of the hearing is the use of a time clock. Although some arbitrators are reluctant to impose this restriction out of concern that it may jeopardize the ability of the parties to present their cases fairly, the “time clock” procedure has never been a basis for vacatur of an arbitration award in any reported court decision—state or federal—in the United States. To the contrary, the procedure almost invariably plays out as an inverse function of Parkinson’s Law—the parties will make adjustments to do whatever they must to present their cases in the time allowed.
Arbitrator Distrust
It is quite clear that the driving factor for whether a party ends up trusting an arbitrator is not simply whether it won or lost its case—if this were so, any survey regarding arbitrator trust would probably always generate a distrust quotient of around 50%. The more rationale conclusion is that, regardless of the result, a party’s distrust of an arbitrator actually springs from the handling of the arbitration process. Great arbitrators will strive for a result where all parties to a dispute—winners and losers—come away with a respect for the arbitrator (and the process) because of (i) the fair and cost-efficient manner in which the pre-arbitration procedures, and especially the hearing itself, were conducted, and (ii) the high quality of the award, not so much because of what it gave to or took away from any party but because of the careful and complete analysis of evidence and legal arguments—addressing each substantive issue that the parties brought to the table and that gave rise to the relief awarded.
Adopting a proactive approach to achieving these objectives in an arbitration through, among other things, the procedures discussed above, is key to eliminating arbitrator distrust.
Conclusion
Unduly expensive and time-consuming arbitrations, with disappointing results, do not just happen randomly. They are invariably the creation of actions by the parties and/or inaction by the arbitrators, usually in some combination. Likewise, a successful arbitration—in terms of efficiency, cost and a fair and rational outcome—is the responsibility of all the participants. In the regrettable situation where an arbitration has morphed into expensive litigation by a different name, one cannot fairly point a finger at the inherent characteristics of arbitration, the arbitration rules or some amorphous concept. The more accurate attribution must rather be to the parties, their advocates, and even the arbitrators, who at the end of the day really have no one to blame for a cumbersome, costly and/or unfair arbitration process but themselves.
Federal Circuit Holds That the ITC Has Jurisdiction over Foreign Trade Secret Theft in Section 337 Investigations
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The U.S. Court of Appeals for the Federal Circuit recently affirmed the U.S. International Trade Commission (“ITC”)’s determination that it had jurisdiction to ban the importation of products made using processes protected by trade secrets, even where the misappropriation took place entirely outside of the United States. See TianRui Group Co. Ltd. v. Int’l Trade Comm’n, No. 2010-1395 (Fed. Cir. Oct. 11, 2011). In a split decision, the panel also ruled that the Commission should apply uniform federal law in Section 337 investigations when choice of law questions present themselves, such as in trade secret cases. The TianRui decision appears to open the door wider to complainants seeking a trade remedy against imported goods enriched by intellectual property theft abroad, provided that these complainants’ domestic industry is injured by the misappropriation.
The Foreign Misappropriation at Issue in TianRui and the Commission’s Determination
Amsted Industries, the Complainant in the underlying Section 337 investigation (Certain Cast Steel Railway Wheels, Certain Processes for Manufacturing or Relating to Same and Certain Products Containing Same, Inv. No. 337-TA-655), is an American corporation that manufactures cast steel railway wheels using a process protected by trade secrets. TianRui, the Respondent in the underlying Section 337 investigation, is a Chinese company that had unsuccessfully attempted to enter into a license agreement with Amsted to acquire a trade secret process for manufacturing railway wheels. Failing to obtain a license to Amsted’s trade secrets, TianRui hired nine former employees of an Amsted licensee in China. These nine employees knew of Amsted’s confidential manufacturing process and had signed confidentiality agreements agreeing to keep the process secret. Yet, shortly after these employees’ arrival at TianRui, TianRui began manufacturing cast steel railway wheels using Amsted’s secret process.
Amsted filed a complaint under Section 337 of the Tariff Act of 1930, as amended (19 U.S.C. § 1337). Applying Illinois state trade secret law, the ITC found after an evidentiary hearing that TianRui misappropriated more than 100 of Amsted’s trade secrets and injured Amsted’s domestic industry. The ITC issued an exclusion order banning the importation of TianRui’s cast steel railway wheels. TianRui appealed to the Federal Circuit, arguing that the ITC lacked jurisdiction over the alleged unfair act because Section 337 “cannot apply to extraterritorial conduct and therefore does not reach trade secret misappropriation that occurs outside the United States.”
While the appeal was pending, Taiwanese-based Richtek Technology Ltd. (represented by the authors) brought a Section 337 investigation against its Taiwanese competitor uPI Semicondutor and various uPI affiliates, customers and distributors based on patent infringement and trade secret misappropriation. See generally Certain DC-DC Controllers and Products Containing Same, Inv. No. 337-TA-698. Richtek alleged that its trade secrets were misappropriated abroad when Taiwanese executives and employees left Richtek and founded uPI. uPI argued that the ITC should apply Taiwan’s trade secret law, because the alleged theft occurred entirely in Taiwan. The ITC did not reach the choice of law issue, because the Respondents in the DC-DC Controllers investigation entered into settlement agreements or consent orders (the latter of which being a promise not to engage in the alleged act and import the products at issue made to the ITC by a Respondent). The DC-DC Controllers investigation remains active, pending a determination of whether uPI and Respondent Sapphire violated their consent orders, and may present the ITC with its first opportunity to apply the Federal Circuit’s guidance in TianRui in a trade secret-based Section 337 investigation.
The Statutory Basis for Trade Secret-Based Complaints Under Section 337
Although the vast majority of Section 337 investigations instituted by the ITC allege the infringement of a U.S. patent or trademark, Section 337(a)(1)(A) permits the ITC to investigate “[u]nfair methods of competition and unfair acts in the importation of articles . . . into the United States” if the unfair conduct results in injury to a domestic industry. 19 U.S.C. § 1337(a)(1)(A). The statute itself does not state explicitly that subsection (a)(1)(A) covers trade secret misappropriation, but this provision has historically supported the institution of trade secret-based Section 337 investigations.
The Federal Circuit’s Opinion: Extraterritorial Conduct, Federal Choice of Law
In a 2-1 decision reached by Judges Bryson, Schall, and Moore (dissenting), the court affirmed the ITC’s determination that it could issue an exclusion order—a remedial order directing U.S. Customs to block the importation of the products at issue—to remedy trade secret misappropriation that occurred entirely outside the United States. The court noted the general presumption that U.S. laws do not govern extraterritorial conduct but reasoned that Section 337 “is surely not a statute in which Congress had only domestic concerns in mind.” In this framework, the court further reasoned that “[t]he focus of Section 337 is on an inherently international transaction—importation.” The court noted that the extraterritorial conduct served only to “establish an element of a claim alleging a domestic injury and seeking a wholly domestic remedy.” The court cited the language in Section 337(a)(1)(A)(i)—which gives the ITC jurisdiction over conduct that could “destroy or substantially injure an industry in the United States” —and found that a foreign entity’s misappropriation of trade secrets abroad could cause such injury to a domestic industry in the United States. Notably, the court affirmed the ITC’s decision as to injury even though neither Amsted nor TianRui used the trade secret process at issue in the United States.
The court also held for the first time that a uniform federal law, rather than state law, governs trade secret-based Section 337 investigations. The court reasoned that federal law should govern Section 337 investigations because the statute is triggered by an act of federal concern: importation and cross-border trade, which is a “uniquely federal interest.” The court did not go so far as to define the federal law that would apply in a trade secret-based Section 337 investigation because it felt that TianRui’s misappropriation would have violated any state trade secrets law, but the court did note that nearly every state has adopted the Uniform Trade Secrets Act and the Restatement of Unfair Competition, and this seems likely to become the basis for a “federal” trade secrets law.
In a forceful dissent, Judge Moore wrote that the majority’s decision contravened the U.S. Supreme Court’s recent decision in Morrison v. Nat’l Australia Bank Ltd., 558 U.S. ___ (2010), which established a presumption against a U.S. law’s ability to control purely foreign conduct. Judge Moore criticized the majority’s opinion as too broad, writing that its “breadth . . . is staggering,” and opined that the majority’s decision would open the floodgates to permit Section 337 investigations into scores of instances of allegedly unfair conduct, such as low worker wages. Judge Moore also opined that Amsted would have better served the public interest by obtaining a U.S. process patent.
TianRui’s Impact: A New Weapon for Complainants
Complainants can now feel more comfortable bringing Section 337 actions to remedy trade secret misappropriation that occurred abroad, an unfortunately frequent occurrence. The Federal Circuit’s holding appears likely to lead to an increase in trade secret-based complaints filed by companies with manufacturing operations, particularly in developing countries with undeveloped domestic trade secret protection. It also seems likely that complainants will find shelter in the ITC that they would not find in U.S. district courts. Tempering this, however, is the need to establish that their industry in the United States has been injured by the foreign misappropriation.
November 2011: White Collar Update
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Food and Drug Regulators Step up Prosecution of Corporate Officers for Misconduct: U.S. regulatory authorities recently have made increasing use of a long dormant doctrine to prosecute business executives for their companies’ violations of the Food Drug and Cosmetic Act (“FDCA”). Under the “responsible corporate officer doctrine,” an officer may be held liable for a first-time misdemeanor or a subsequent felony based on misconduct within their corporation, even if the officer was not involved in or aware of the wrongdoing. Although the doctrine had been little-used since the 1970s, recent enforcement efforts reveal that regulators are now employing it with more frequency.
The responsible corporate officer doctrine was first articulated by the United States Supreme Court in the 1943 case of United States v. Dotterweich, 320 U.S. 277 (1943). In that case, the president and general manager of a company that packaged and shipped pharmaceuticals was found personally liable for his company’s violations of the FDCA. The Court explained that the FDCA placed “the burden of acting at hazard upon a person otherwise innocent but standing in responsible relation to a public danger.”
Three decades later, the Court affirmed and clarified this holding in the case of United States v. Park, 421 U.S. 658 (1975). In Park, the president of a national food chain was held personally liable under the FDCA for unsanitary conditions in a warehouse. The president appealed his conviction on grounds that the jury did not find he engaged in any wrongful action. The Court rejected this argument, and held the FDCA required responsible corporate employees “to implement measures that will insure that violations will not occur.” However, the Court allowed that “a claim that a defendant was ‘powerless’ to prevent or correct the violation” could be raised as a defense to charges against a responsible corporate officer.
After falling out of use in the early 1980s, this doctrine has recently returned to favor with regulators. For instance, in November 2010 four executives from Synthes, a medical device company, pleaded guilty to misdemeanor charges brought under the responsible corporate officer doctrine related to the promotion of unauthorized tests of a bone cement product on spinal surgery patients. The executives are currently awaiting sentencing. Likewise, in March 2011 Marc Hermelin, the former CEO of KV Pharmaceutical, pleaded guilty as a responsible corporate officer to two misdemeanor violations of the FDCA involving the improper manufacture and sale of oversized morphine tablets. Hermelin was sentenced to one month in jail, fined $1 million, and ordered to forfeit an additional $900,000.
The potential consequences for conviction under the reasonable corporate officer doctrine go beyond fines or jail time. The U.S. Department of Health and Human Services (“HHS”) can exclude executives from participating in federal health care programs for years based on such a conviction. For example, in 2007 three officers of the Purdue Frederick Company entered misdemeanor guilty pleas to charges that they had served as responsible corporate officers during a time when the company manufactured misbranded drugs in violation of the FDCA. As a result of the convictions, the Inspector General of HHS issued notices excluding the executives from participation in all federal health care programs for twelve years. The officers appealed, arguing that the exclusion penalty was not appropriate for convictions under the responsible corporate officer doctrine, since the convictions did not require any evidence of personal wrongdoing. Last year, the District Court for the District of Columbia rejected this argument and affirmed application of the exclusion penalty to responsible corporate officers. Friedman v. Sebelius, 755 F. Supp. 2d 98 (D.D.C. 2010).
Public comments by regulators indicate that we may be entering a new era of prosecutions under the responsible corporate officer doctrine. On August 5, 2011, the Office of the Inspector General of the HHS issued a statement affirming its commitment to sanctioning executives in charge of companies that engage in health care fraud, including “individuals who directly commit fraud as well as the executives in a position of responsibility at the time of the fraud.” In this type of regulatory environment, executives at food, drug, and health care companies must be proactive. The best defense against responsible corporate officer liability is the establishment of a robust compliance system to assure adherence to regulations at all levels of the corporation.
Does the Conviction of Galleon Founder on Insider Trading Signal an Increased Use of Wiretapping by Federal Investigators?: The recent conviction of New York hedge fund founder Raj Rajaratnam on fourteen counts of conspiracy and insider trading sent shockwaves through the financial industry. On October 13, 2011, Rajaratnam was sentenced to 132 months in prison—the longest prison sentence ever for insider trading. He had been widely regarded as one of Wall Street’s brightest stars. At the peak of his success, he managed $7 billion of investors’ funds and his personal fortune was estimated at $1.8 billion. In 2009, it all came tumbling down, as Rajaratnam and nearly two dozen associates, including senior executives at two Fortune 500 companies and lawyers at major firms, were arrested and charged with illegally trading stocks based on confidential information.
The centerpiece of the government’s investigation were the thousands of conversations between Rajaratnam and his associates that were recorded pursuant to court-authorized wiretaps. Prosecutors used only 45 of these recordings during Rajaratnam’s trial, but as one juror stated the recordings “pieced everything together.” Given the strength of this evidence, many were surprised to learn that this case marked the first time that the government had used wiretaps as part of an insider trading investigation.
Historically, the government has reserved the use of wiretaps for terrorism, organized crime and drug trafficking cases. Wiretaps are particularly well suited for these types of investigations because organized criminal groups are by nature tightly knit and rarely leave a paper trail. Thus, wiretaps are sometimes the only way to obtain incriminating evidence against the members of these groups.
In recent years, the government has stepped up its investigation of financial crimes. Indeed, the prosecution of financial fraud now ranks third in the Department of Justice’s list of priorities—below terrorism and violent crime. Rajaratnam’s conviction and the increased number of financial fraud investigations have caused hedge fund managers, analysts, and advisors to wonder to what extent even their legitimate calls were being recorded. Perhaps surprisingly, the answer is not very often. Despite the obvious probative value of wiretap recordings, there has not been a significant increase in their use in financial investigations. According to reports issued by the Administrative Office of the United States Courts, in 2009, 621 of the 663 federal wiretap intercepts were for narcotics offenses, a whopping 93.6%. In 2010, the number of federal wiretap intercepts nearly doubled, but narcotics offenses still accounted for 93.4% of all intercepts.
There are legal and practical reasons why the Rajaratnam investigation has not spurred a significant increase in wiretap investigations. In order to obtain a wiretap the government must show that traditional law enforcement techniques have proven unsuccessful and that the wiretap is a necessity. Unlike organized crime or drug cases, white collar cases can leave a paper trail that gives the government solid circumstantial evidence through which to prove its case. Moreover, the Wiretap Act (18 U.S.C. § 2510 et seq.) permits federal courts to authorize wiretap intercepts for only a limited number of criminal offenses. In the Rajaratnam investigation, the government obtained authorization to record Rajaratnam’s conversations by claiming that the wiretaps were necessary to investigate wire fraud (a predicate offense for wiretap authorization), but ultimately charged Rajaratnam with insider trading (which is not a predicate offense). Rajaratnam filed a motion to suppress arguing that the government’s reliance on the wire fraud statute was a subterfuge because the primary purpose of the wiretap was to investigate securities fraud. The trial court ultimately rejected Rajaratnam’s argument, but prosecutors may be reluctant to rely on the opinion of one district court to uphold future wiretap investigations of financial crimes.
Moreover the government must devote significant resources in order to conduct a wiretap investigation. Investigators cannot simply record all conversations that they overhear. Rather, they must take steps to minimize the recording of information that is not relevant to any criminal activity. Investigators are not allowed to record attorney-client privileged communications or any other privileged communications. The failure to follow these rules may result in suppression of wiretap evidence. Indeed, in a recent case growing out of the Galleon investigation, the trial judge criticized the agents for listening to “deeply personal and intimate calls” between the defendant and his wife.
In addition to those logistical issues, financial crimes do not typically lend themselves to wiretap investigations. Wiretaps are an invaluable tool for investigating ongoing crimes involving large groups of individuals. Securities fraud and other white-collar crimes do not often follow this model. Investigations of financial crimes are typically historical in nature, and often start after the fraudulent act or insider trading has already taken place.
Thus, although the Department of Justice has promised to increase its reliance on wiretaps in financial fraud and other white collar investigations, the available data suggests that that has not happened. When and if it does, defense counsel will still be able to rely on a number of potential defenses to challenge the legality of the interception.
China Implements New Laws in Foreign-Related Products Liability Cases
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In 2010, the People’s Republic of China (“PRC”) enacted two laws that together will substantially affect all civil litigation in China – and, in particular, product liability litigation regarding foreign entities. The Law of the Application of Law for Foreign-Related Civil Relations of the PRC (“the Choice of Law Statute”) covers almost all aspects of the application of law in foreign-related civil cases. The Tort Law of the PRC (“the Tort Law”) comprehensively governs tort liabilities. This article will focus on the provisions of these laws relevant to product liability disputes, particularly as they affect foreign entities.
The new laws will likely lead to increased litigation and compensation awarded to plaintiffs. Under the Choice of Law Statute, foreign law will be applied more widely, which could frequently be more favorable to plaintiffs. Under the new Tort Law, manufacturers and sellers now have substantive obligations to recall, implement remedial measures, and warn of potentially defective products. Punitive damages may now also be awarded for all kinds of product defects. Because the laws are so new, it is still unclear how Chinese courts will resolve legal issues arising from application of foreign law in actual cases.
New Choice of Law Rules in Foreign-Related Product Liability Cases
In China, product liability constitutes a distinct kind of tort liability. Previously, there was no special provision in Chinese law governing the choice of law in foreign-related product liability cases. The choice of law rules were the same as in ordinary tort liability cases, lex loci delictus, requiring the application of the law of the place in which the tort occurred. If damage occurred in China in a foreign-related product liability case, Chinese law generally governed.
The Choice of Law Statute now requires the application of the rule of lex loci domicilii in foreign-related product liability cases, thus making defendants subject to the law of their place of habitual residence. Although the law of the habitual residence of the plaintiff (foreign or Chinese) will ordinarily apply, the plaintiff may instead choose to apply the laws of the defendant’s main business place (i.e., the law of the manufacturer’s home country) or the laws of the location where the damage occurred (i.e., China) – unless the defendant has no relevant business operations at the habitual residence of the plaintiff, in which case only the latter two choices are available.
As a result of this reform, successful plaintiffs may now be awarded the same compensation as they would under the law of their state of habitual residence. That will likely be more than Chinese substantive law would permit. The damages awarded by Chinese courts are assessed conservatively to reflect necessary costs within China, which may well be less than the costs that injured parties would incur in their home states.
For example, if a Beijing hospital purchased defective medical equipment from a U.S. manufacturer, resulting in harm to patients from China, the U.S., Germany, and Cuba, the following outcomes could arise in suits against the manufacturer. The plaintiffs could choose to apply U.S. law (i.e., the tortfeasor’s principal place of business) or Chinese law (i.e., the law of the place where the injuries occurred). Alternatively, the plaintiffs could choose to allow lex loci domicilli to apply by default, in which case the laws of China, the U.S., Germany and Cuba would apply depending on each plaintiff’s nationality. That would, however, prejudice the plaintiffs domiciled in Cuba because U.S. companies have no relevant operations there. Thus, the Cuban plaintiffs would want to elect U.S. or Chinese law.
What will the consequences of the new choice of law rules be for multinational companies? Here, we discuss only a few briefly. But, in general there will be a lot of uncertainty as courts work through how to implement the new regime.
First, the choice of law may determine the elements of product liability and burden of proof issues – as to both the allocation of burdens and the required evidentiary showing – and might therefore be outcome determinative. Consider the potential difference in outcome if the plaintiff or the defendant bears the burden of proof for a required element, or if rules governing joint-and-several liability vary. Chinese law could be more favorable than foreign law. The provisions of the new Tort Law of the PRC shift the burden on many elements to the defendants, through the introduction of proactive duties. Yet, at the same time, foreign law on damages may be much more favorable. So, new flexibility in choice of law rules means increased strategic complexity.
Second, if the availability of foreign law proves attractive to plaintiffs, then foreign manufacturers will likely face more direct proceedings. The Tort Law maintains provisions of the former Product Quality Law of the PRC regarding liability for product liability claims, thus allowing plaintiffs to sue both manufacturers and sellers. Previously, for the sake of procedural convenience, Chinese plaintiffs preferred to sue local distributors or domestic manufacturers of foreign-trademarked goods. But targeting foreign manufacturers will likely become more attractive now, if doing so results in more generous damage awards. Pursuant to an interpretation of the Supreme People’s Court of 2002, any entity that allows a product to be labeled with its name, trademark, or distinguishable sign qualifies as a manufacturer in the context of product liability. While this “quasi-manufacturer” principle was developed under the previous Product Quality Law, it likely also applies to the new legal regime established by the Choice of Law Statute and Tort Law. Consequently, foreign manufacturers will likely face more direct product liability claims in China, and will be unable to confine litigation risk to their Chinese distributors and manufacturers.
Third, an important uncertainty concerns what legal issues will be subject to the plaintiff’s choice of law. Generally, courts apply lex fora (“law of the forum”) principles for procedural rules, which would require their application of Chinese rules. However, it is not always clear whether a particular rule is procedural or substantive. In the United States, for example, courts have sometimes interpreted the burden of proof requirements on elements as “procedural” rather than “substantive.”
Another open question concerns the application of discovery rules. China has no equivalent to U.S.-style discovery. Similarly, Chinese procedural rules also affect litigation timelines. The application of such procedural rules can have significant substantive consequences, potentially diminishing the extent to which the ability to apply foreign law will change Chinese product liability suits. The situation will remain uncertain and possibly vary from court to court until either the Supreme People’s Court or the legislators provide guidance on the extent to which lex fora should be applied to Chinese procedural law.
On the whole, the new choice of law regime will likely increase the cost and duration of the proceedings. As outlined here, courts will face complex new technical questions, as will multinational companies defending product liability suits. If foreign legal and scientific experts are used, additional costs for translation and travel will be incurred. Most of all, the application of foreign law will pose a significant challenge to Chinese lawyers, who typically lack education and expertise in foreign legal regimes.
Product Liability Under the New Tort Law
Once a court holds that Chinese law applies to a product liability case pursuant to the Choice of Law Statute, it will apply the new Tort Law. Most provisions regarding product liability in the Tort Law are derived from and remain consistent with the Product Quality Law promulgated in 1993 and revised in 2000. There are, however, four significant differences that apply to product liability suits.
First, the scope of liability includes the defective products themselves, which was not the case under the now-obsolete Product Quality Law. This eliminates the last vestiges of the civil law privity-of-contract principle, in which a party to a contract who suffered damage could recover only from the other party to the contract and not another party. The reform is intended to reduce the litigation burden on victims, who may now seek compensation for product losses in the same action as for other harms caused by the product defect.
However, this change raises new questions. For instance, if an injured party sues the manufacturer to recover compensation, should the manufacturer compensate the plaintiff at its direct wholesale price or at the ultimate retail price paid by the plaintiff? If the latter, could the manufacturer indemnify itself by suing the distributor? If there are multiple levels of distributors, against which should the manufacture pursue an action for indemnification? Multinational corporations facing these kinds of issues should closely monitor the attitudes expressed by jurists and legislators as actions are brought under the new Tort Law regime.
Second, the Tort Law extends the duty of manufacturers and sellers to recall all defective
products. Previous regulations applied to limited classes of products, such as automobiles, foods, medicines, and toys. The failure to recall products will result in tort liability if the defect causes harm. This change makes multinational manufactures responsible for tracking potential defects. Doing so will require new infrastructure and management practices, including additional oversight of distribution networks.
Third, the new Tort Law also imposes a duty to warn “after the product is put in circulation.” By contrast, under Article 41 of the Product Quality Law, producers were not held responsible if they could prove that the defect could not be found at the time of circulation due to scientific or technological reasons. This means that after first sale, even if there are technical obstacles that might prevent warning or recall of a defective product, the manufacturer or seller will nonetheless face tort liability for any harm that occurs. This removes a broad exception that manufacturers and sellers formerly used to avoid strict liability for product defects.
Fourth, and perhaps most controversially, the Tort Law allows for the award of punitive damages in product liability cases. Traditionally, Chinese courts have applied equitable principles in civil cases, making the recoverable compensation equal to the victim’s harm as measured by medical costs and lost income, for example, the award of punitive damages emerged in consumer fraud laws. Regulations imposing punitive damages have also been adopted for abuses in the sale of residential housing and food.
The Tort Law now extends the availability of punitive damages to all products, but important limitations remain. Article 47 requires that the manufacturer or seller know of the defect while continuing to manufacture or sell the product, and that the defect cause death or serious bodily harm. Even with these limitations, manufacturers and sellers will face more complaints seeking punitive compensation. They will have to take this into account in planning their public relations response to product liability lawsuits.
Conclusions and Next Steps
The new product liability provisions of the Conflict of Law Statute and Tort Law are part of an effort by Chinese authorities to stem the growing problem posed by large-scale and individual product defect-related incidents. These reforms represent an important legal component of China’s economic transformation. But, the adoption of novel principles, such as the choice of foreign law provisions, the expansion of duties imposed on manufacturers, and Western-style punitive awards, will inject new questions into the Chinese legal landscape.
Starting now, multinational companies should carefully monitor manufacturing and distribution systems to meet the duties of recall, warning and remedial measures. Companies will have to implement institutional procedures before any problems engender litigation, not only to avoid the consequences of litigation, but to comply with the Tort Law. Further, companies should determine in advance whether their Chinese counsel have the capability to address suits brought under foreign law, including the ability to understand differences between the foreign tort law and Chinese law, and perform tasks that may be new for them, such as selecting and training expert witnesses from abroad, conducting extensive legal translation work, and the like.
Finally, companies should encourage the counsel who represent them to engage in mock trials and other exercises to understand how the new laws may affect product liability claims and maintain close communications with legislators, jurists, and government agencies to help guide their implementation and refinement of those laws.
This article was authored by Liu Hong Huan, Liu Chi and Zhou Xi, attorneys from Jun He Law offices, and was published in original format in Asian Counsel Magazine, Vol. 8, Issue 10. Jun He is widely recognized as a leading full-service law firm in China, positioned to provide superior legal services in commercial transactions and disputes. For more information on the firm, please visit www.junhe.com.
Inducement of Patent Infringement: The Supreme Court Sets a New Standard for Proving Intent
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The Supreme Court’s recent decision in Global-Tech Appliances, Inc. v. SEB S.A., 131 S. Ct. 2060 (2011) establishes a new standard for proving intent to induce patent infringement. 35 U.S.C. § 271(b) provides that a defendant may be liable for “indirect infringement” if it actively induces another to infringe. Unlike direct infringement, which is a strict liability offense, indirect infringement requires a showing of intent.
For decades, the Federal Circuit was split over whether inducement merely requires that the defendant intend that a third-party perform the infringing acts, or whether the defendant must also intend that the induced acts infringe the asserted patent. Compare Hewlett-Packard Co. v. Bausch & Lomb Inc., 909 F.2d 1464, 1469 (Fed. Cir. 1990), with Manville Sales Corp. v. Paramount Sys., Inc., 917 F.2d 544, 553 (Fed. Cir. 1990). In DSU Med. Corp. v. JSM Co., Ltd., 471 F.3d 1293 (Fed. Cir. 2006) (en banc), the Federal Circuit resolved the split, holding that intent to induce requires that the defendant “knew or should have known that [its] actions would induce actual infringements.” In doing so, that “[t]he requirement that the alleged infringer knew or should have known his actions would induce actual infringement necessarily includes the requirement that he or she knew of the patent.” In DSU, the defendant had actual knowledge of the patent, so that element was plainly satisfied.
In SEB, the Federal Circuit squarely addressed the required standard for knowledge of the asserted patent. SEB S.A. v. Montgomery Ward & Co., Inc., 594 F.3d 1360 (Fed. Cir. 2010), aff’d on other grounds sub nom. Global-Tech Appliances, Inc. v. SEB S.A., 131 S. Ct. 2060 (2011). It held that the knowledge of the patent requirement is satisfied if the defendant acted with a “deliberate indifference to a known risk” that the asserted patent existed. It explained that “the standard of deliberate indifference of a known risk is not different from actual knowledge, but is a form of actual knowledge.”
In Global-Tech, the Supreme Court overturned the “deliberate indifference” standard, instead, holding that the required intent for inducement is actual knowledge or “willful blindness.” Significantly, the Supreme Court also considered more generally the intent standard for inducement. It remains to be seen how the new standard for intent will affect inducement claims given the unusual facts in Global-Tech.
Facts of the Case
SEB, a French manufacturer of consumer appliances, developed a popular T-Fal deep fryer. This fryer incorporated an innovative design that allowed the outer surface to remain cool while the fryer was in use. The design used inexpensive plastic to form the outer shell coupled with an air gap separating a heated cooking pan from the outer shell to insulate the shell from the pan. The novel design avoided the use of special, high-temperature plastics.
Global-Tech’s subsidiary Pentalpha, a Hong Kong-based manufacturer of consumer household goods, set out to commercialize a competing fryer. Pentalpha purchased a T-Fal fryer in Hong Kong that did not bear any U.S. patent markings, as it was not intended for the U.S. market. After copying everything but the cosmetic features of SEB’s T-Fal fryer, Pentalpha sought an opinion of counsel regarding freedom to operate, but did not inform its patent attorney that its fryer was nearly an exact copy of SEB’s T-Fal product. Pentalpha’s attorney did not locate any patent that appeared to be infringed by the product – not even SEB’s patent covering the T-Fal fryer design – and provided a right-to-use opinion to that effect.
Proceedings in the District Court
SEB subsequently sued Pentalpha for patent infringement, asserting two theories of liability: First, SEB claimed that Pentalpha had directly infringed SEB’s patent in violation of 35 U.S.C. § 271(a) by selling or offering to sell its deep fryers. Second, SEB claimed that Pentalpha had violated § 271(b) by actively inducing third parties to sell or to offer to sell Pentalpha’s deep fryers in the U.S. At trial, the jury found for SEB on both claims. The district court subsequently denied Pentalpha’s motion for JMOL, holding that there was sufficient evidence to find inducement even though Pentalpha did not actually know of SEB’s patent until it received notice of the lawsuit.
Federal Circuit Appeal
On appeal, Pentalpha argued that the jury’s verdict was not supported by the evidence because it did not know that SEB’s T-Fal fryer was patented or that there was a risk that such a patent existed. The Federal Circuit disagreed. Although it acknowledged the lack of direct evidence that Pentalpha was aware of SEB’s patent, Pentalpha’s pattern of behavior suggested that it had purposefully remained ignorant of the existence SEB’s patent. Pentalpha had chosen to reverse engineer a product purchased outside the U.S. that would not be marked with any U.S. patents and did not inform its attorney that it had copied SEB’s fryer. These facts, according to the Federal Circuit, demonstrated Pentalpha’s deliberate indifference to the risk that a patent covering the T-Fal product existed.
The Supreme Court granted certiorari to review: “Whether the legal standard for the state of mind element of a claim for actively inducing infringement under 35 U.S.C. § 271(b) is ‘deliberate indifference’ to a known risk that an infringement may occur, as the Court of Appeals for the Federal Circuit held, or ‘purposeful, culpable expression and conduct’ to encourage an infringement, as this Court taught in MGM Studios, Inc. v. Grokster, Ltd., 545 U.S. 913, 937 (2005).” Notably, the question under review was broadly directed to intent to induce, even though the appeal to the Federal Circuit had focused on Pentalpha’s knowledge of the asserted patent and did not explicitly address intent with respect to the inducement of infringing acts performed by a third-party.
The Supreme Court’s Decision
In an 8-1 decision on May 31, 2011, the Supreme Court affirmed the result below, but rejected the Federal Circuit’s “deliberate indifference” standard. Instead, the Supreme Court held that inducement of infringement requires actual knowledge or “willful blindness” that the induced conduct itself infringes.
The Court noted the common origin of both inducement and of contributory infringement, concluding that the same actual knowledge requirement applies to both. It further refined the actual knowledge requirement by analogy to criminal law, where courts have held that statutes requiring proof that a defendant acted willfully or knowingly may be satisfied – even though the defendant lacked actual knowledge – if the defendant “deliberately shield[ed] [himself] from clear evidence of critical facts that [were] strongly suggested by the circumstances.” By analogy, the Court explained that the actual knowledge of infringement requirement to prove inducement may be shown by “willful blindness,” which involves a two-part test: First, the defendant must subjectively believe that there is a high probability that a fact exists; second, the defendant must take deliberate actions to avoid learning of that fact. According to the Court, these requirements give willful blindness an “appropriately limited scope that surpasses recklessness and negligence.”
Although the Supreme Court rejected the Federal Circuit’s “deliberate indifference” standard, it nevertheless affirmed the judgment because the evidence was “plainly sufficient to support a finding of Pentalpha’s knowledge under the doctrine of willful blindness.”
October 2011: Appellate Litigation Update
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Overview of Intellectual Property Cases Before the Supreme Court in the October 2011 Term: In keeping with its recent trend, the Supreme Court has so far agreed to hear one copyright and several patent cases during the October 2011 Term.
Golan v. Holder, No. 10-545, was argued October 5, 2011, and addressed a copyright law issue. It concerns the constitutionality of Section 514 of the Uruguay Round Agreements Act (“URAA”). Congress enacted the URAA in 2004 to implement Article 18 of the Berne Convention for the Protection of Literary and Artistic Works, which requires that member countries afford the same copyright protection to foreign authors as they provide to their own authors. Because certain works by foreign authors had already entered the public domain in the United States by virtue of failures to comply with prior U.S. copyright formalities, lack of subject matter protection, or lack of national eligibility, Section 514 of the URAA restored the authors’ copyrights in those foreign works (with certain time-limited protections afforded to persons, called “reliance parties,” who were exploiting the foreign works in the United States). In other words, works that were in the public domain would now become subject to U.S. copyright protection.
A group of persons who have relied on public domain works for their livelihoods (including orchestra conductors, educators, performers, publishers, film archivists, and motion picture distributors) brought suit in the U.S. District Court for the District of Colorado, challenging Section 514 of the URAA as unconstitutional under the Copyright Clause of the U.S. Constitution, see U.S. Const., art. I, § 8, cl. 8 (granting Congress the power “[t]o promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries”), and the First Amendment. The district court ruled in favor of the government, and the Tenth Circuit affirmed in a 2007 decision as to the Copyright Clause and a 2010 decision as to the First Amendment. Among the governmental interests cited by the Tenth Circuit in rejecting the First Amendment challenge was that U.S. protection of foreign works is necessary to ensure that other countries extend the protection of their copyright laws to U.S. works.
The Supreme Court granted certiorari on both the Copyright Clause issue and the First Amendment issue. The case has attracted the attention of numerous amici curiae on both sides. A decision is expected by June 2012.
Caraco Pharm. Labs., Ltd. v. Novo Nordisk A/S, No. 10-844, scheduled for oral argument on December 5, 2011, involves the interpretation of the counterclaim provision of the Hatch-Waxman Act. The Hatch-Waxman Act, as described by the Federal Circuit, seeks to balance the goal of encouraging the development of new drugs and methods with the potentially conflicting goal of facilitating introduction of low-cost generic copies of those drugs and methods. The Act provides a streamlined approval process, known as an abbreviated new drug application (“ANDA”) for generic manufacturers, which allows the generic manufacturer to rely on the safety and efficacy studies of an already-approved drug upon a showing of bioequivalence between the approved drug and generic drugs. The ANDA process includes a certification by the generic manufacturer that the approved drug is not covered by a patent, the approved drug is covered by a patent that has expired or will expire, or, as relevant here, the patent is invalid or will not be infringed by the proposed generic drug. The last option, if invoked by the generic manufacturer, is deemed an act of patent infringement and allows the patent owner to file suit, and in turn allows the generic manufacturer to file a counterclaim challenging the accuracy of the “patent information” submitted to the FDA.
The scope of the counterclaim provision is at issue. Novo owns a patent that claims one of the three methods for using repaglinide to treat type 2 diabetes. Caraco, the generic manufacturer, submitted an ANDA asserting that Caraco was not seeking approval for the method claimed by Novo’s patent, and the FDA indicated that it would approve Caraco’s proposed drug label carving out the Novo method. Novo then asked the FDA to broaden Novo’s use code narrative for its patent so that it would no longer be specific to the one method claimed by Novo; that in turn led the FDA to change its initial position and reject Caraco’s carve-out label. Without the carve out, Caraco’s product would infringe Novo’s patent. Caraco counterclaimed, alleging that the new use code narrative was overbroad because it improperly suggested that Novo’s patent covered all three approved methods of using repaglinide to treat type 2 diabetes. The district court granted summary judgment in favor of Caraco on its counterclaim. A panel of the Federal Circuit reversed, over the dissent of Judge Dyk. The majority reasoned that the statute limits counterclaims to those alleging that the “patent does not claim … an approved method of using the drug.” The majority held that Novo’s method was “an approved method” and that the alleged overbreadth of the use code narrative was irrelevant. Judge Dyk argued that the majority’s approach left the generic manufacturer without a remedy and was contrary Congress’ purpose in ending the law.
Several amici curiae have filed briefs in support of Caraco, including the United States, Representative Henry Waxman, and the Generic Pharmaceutical Association.
Mayo Collaborative Servs. v. Prometheus Labs., Inc., No. 10-1150, scheduled for argument on December 7, 2011, was initially decided by the Federal Circuit in 2009. The Supreme Court then vacated that decision and remanded it to the Federal Circuit for further consideration in light of Bilski v. Kappos, 130 S. Ct. 3218 (2010). In Bilski, the Court held that the “machine-or-transformation” test is not the sole, definitive test for determining the patentability of a process under 35 U.S.C. § 101. (The machine-or-transformation test deems a process eligible for patent protection if it (1) is tied to a particular machine or apparatus; or (2) transforms a particular article into a different state or thing.) Instead, the Court resolved Bilski by resorting to the principle, established by its earlier decisions, that abstract ideas are not patentable. Mayo was re-decided by the Federal Circuit following the remand and is now back before the high court.
Prometheus is the exclusive licensee of patents that claim methods for determining the optimal dosage of thiopurine drugs used to treat autoimmune diseases. The claimed methods involve administering a drug to a patient and then determining the levels of the drug’s metabolites in the subject. The measured metabolite levels are then compared to pre-determined metabolite levels, allowing the level of drug to be corrected to minimize toxicity and maximize treatment efficiency in the particular patient. The patents were not directed to the drugs, or to any novel diagnostic test kit. Instead, Prometheus marketed a test that relied upon the levels of drug metabolites found in the human body. Mayo purchased that test for a time, but then announced that it would use its own test, which measured the same metabolites but looked to different benchmark levels to determine toxicity. Prometheus sued Mayo for patent infringement, and Mayo responded by arguing that the technology was not patentable under § 101 because the patents claimed natural phenomena involving the correlation between drug metabolite levels, on the one hand, and efficacy and toxicity, on the other.
The district court accepted Mayo’s argument and granted summary judgment that the patents were invalid. The Federal Circuit initially reversed, applying the machine-or-transformation test and finding that the administering-of-the-drug and determining-of-metabolite-levels steps were transformative and not merely data-gathering steps, and holding the claims did not wholly preempt the use of the recited correlations between metabolite levels and drug efficacy or toxicity. On remand after Bilski, the Federal Circuit adhered to its pre-Bilski decision, explaining this time that it would not rely solely on the machine-or-transformation test, but additionally on the fact that the claims at issue did not preempt every use of the natural correlations between drug metabolites and efficacy/toxicity, but rather utilize them in a series of specific steps that involve particular methods of treatment. The Federal Circuit also found transformation in that the administered drug is transformed by the human body into its metabolites; even though this is a natural phenomenon, it is preceded by the administration of a drug, which is not a natural phenomenon.
The United States has filed an amicus brief arguing that the Federal Circuit correctly held that the subject matter is patentable, but that the patents are likely invalid because they fail the novelty and nonobviousness requirements of 35 U.S.C. §§ 102 and 103. Quinn Emanuel has filed an amicus brief on behalf of two leading blood testing laboratories, ARUP and LabCorp, arguing that the subject matter is not patentable; specifically, Quinn Emanuel’s brief argues that the patents cross the line in patenting natural phenomena by asserting exclusive rights over the process of providing a medicine and observing the results – a biochemical reaction that occurs in the human body.
Kappos v. Hyatt, No. 10-1219, presents the questions (1) whether a plaintiff who files a civil action in federal district court against the Director of the United States Patent and Trademark Office (“PTO”) pursuant to 35 U.S.C. § 145 may introduce new evidence that could have been presented to the PTO; and (2) whether, if the plaintiff is allowed to introduce new evidence under Section 145, the district court may decide de novo the factual questions to which the evidence pertains, without giving deference to the PTO’s decision.
A patent applicant who is dissatisfied with a PTO decision may appeal the decision to the Federal Circuit or file an action in federal district court to determine whether the applicant “is entitled to receive a patent for his invention … as the facts in the case may appear.” 35 U.S.C. § 145. An en banc Federal Circuit majority concluded that there is no limitation on an applicant’s right to introduce new evidence in district court (apart from the evidentiary limitations applicable in all civil actions). The majority further held that the district court may consider whether the new evidence is inconsistent with any evidence or proceedings before the PTO in determining what weight to give it. The majority additionally held that if the applicant does not introduce new evidence that was not before the PTO, the district court should apply the Administrative Procedure Act’s deferential “substantial evidence” standard.
Judge Newman concurred as to the holding that an applicant may introduce new evidence in the district court, but dissented from the holding that if an applicant does not introduce new evidence, the “substantial evidence” standard of review applies. Instead, Judge Newman argued that the district court should decide the case de novo.
Judges Dyk and Gajarsa dissented, arguing that a Section 145 proceeding allows only for introduction of live testimony that was presented in written form in the PTO, not to any other introduction of new evidence. Further, the dissenters argued that the deferential “substantial evidence” standard applies in all Section 145 cases.
Intel Corp. and Verizon Communications Inc. have filed amicus briefs in support of petitioner, the Director of the PTO (who is represented by the Solicitor General’s Office); several amicus briefs in support of neither party, including one by the Intellectual Property Owners Association, have also been filed. The respondent’s brief is due October 31st with the amicus briefs supporting the respondent to follow shortly thereafter.
October 2011: Trial Update
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Five-Minute Limitation on Voir Dire Warrants Reversal in Criminal Case: The New York Court of Appeals overturned the conviction of a criminal defendant on the ground that the trial court improperly limited defense counsel to five minutes of questioning for each round of voir dire. Although the governing criminal procedure statute grants New York trial courts broad discretion to limit the scope of voir dire, the Court held that the courts’ discretion is not unlimited and that fixed time constraints on voir dire can in certain circumstances constitute reversible error.
The Court of Appeals did not establish any baseline requirement for the length of voir dire, reasoning that the appropriate allotment will vary with the circumstances. Acknowledging that New Yorka appellate courts had previously upheld time limits of ten and fifteen minutes, the Court ruled that five minutes was unreasonable in light of the facts and complexity of the case. In this regard, the Court emphasized that the defendant had been charged with four serious violent felonies and that the limited questioning revealed several areas of potential bias that defense counsel was unable to effectively probe. In particular, the victim was a popular DJ in the New York area and several potential jurors were aware of his celebrity. In addition, a number of potential jurors were themselves crime victims and the case involved sensitive issues of self-help, as the victim had pursued and constrained the defendant with considerable force prior to his apprehension by police. The Court ruled that the five-minute limitation on voir dire resulted in prejudice because it appeared, based on the uncontroverted contention of defense counsel, that a number of problematic jurors ultimately sat on the jury.
Two dissenting judges concluded that the defendant had not preserved a challenge to the voir dire time limit because counsel lodged only a generic objection in the trial court and failed to articulate why additional time was needed. The case is People v. Steward, 950 N.E.2d 480 (N.Y. 2011).
Non-Resident Cannot Be Compelled to Travel to California for Deposition: A California Court of Appeal ruled that non-residents cannot be ordered to appear in California for deposition. The court’s holding extends both to residents of other nations and to residents of states other than California.
The plaintiffs, who were injured in an Idaho car accident, noticed the depositions of five Toyota employees who lived in Japan. After the trial court ordered the production of the Japanese witnesses, Toyota obtained a writ of mandate from the appellate court vacating the order. The Court of Appeal relied on the California Code of Civil Procedure § 1989, which provides that a witness cannot be obligated “to attend as a witness before any court, judge, justice or any other officer, unless the witness is a resident within the state at the time of service.” Drawing on the legislative history and text of the provision, the court concluded that § 1989 covers not only trial witnesses, but also witnesses testifying at deposition. In so holding, the court rejected the reasoning of Glass v. Superior Court, 204 Cal. App. 3d 1048 (1988), which had reached the opposite conclusion. This split among the California appellate courts may well prompt the California Supreme Court to take the case on review.
Concurring Justice Klein invited the legislature to act. Agreeing that the statutory scheme precluded trial courts from ordering non-residents to appear for deposition in the state, Justice Klein reasoned that such a prohibition makes little sense in a global economy and grants non-resident corporations an unfair advantage over California corporations by shielding their personnel from extensive discovery. Justice Klein implored the legislature to revisit § 1989 “at the earliest opportunity.”
In a subsequent order modifying its opinion, the Court of Appeals clarified that its analysis was limited to depositions of natural persons and that it had expressed no view as to whether trial courts can compel the deposition of an individual testifying on behalf of a non-resident corporation. See Toyota Motor Corp. v. Super. Court, 197 Cal. App. 4th 1107 __ Cal. Rptr. 3d __, (2011).
October 2011: Internet Litigation Update
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Cloud-Based Music Storage Services Win DMCA Protection: On August 22, 2011, Judge William H. Pauley III of the Southern District of New York ruled that cloud-based music storage services are entitled to substantial protection under the Digital Millennium Copyright Act (“DMCA”). (Cloud computing offers computation, storage and other services that do not require end-user knowledge of how the system works, much like the use of electricity in one’s home does not require that a homeowner understand the electrical grid that supplies the electricity.)
Defendant MP3tunes created a system that allowed its users to search and download free MP3s from third-party sites. Its service allowed users to store downloaded music in private accounts and stream it on any device. At the same time, MP3tunes.com enforced policies prohibiting the use of its services by persons who had repeatedly downloaded music unlawfully and uploaded it to their accounts.
Notwithstanding that policy, the EMI Group brought suit because users of MP3tunes.com’s services were, predictably, downloading its music, which was not being offered for free. EMI sent “takedown notices” to MP3tunes.com under OCILLA (the “Online Copyright Infringement Liability Limitation Act”) and alleged that MP3tunes.com was liable for infringing the 472 songs that it failed to remove after receiving the notices. Under OCILLA, that was a given. Notably, though, EMI also sought to impose liability based on the unlawful downloading of files as to which it had never sent takedown notices. EMI alleged that 3,189 sound recordings, 562 musical compositions, and 328 images of album cover art had been infringed and that MP3tunes.com was liable because it was well aware that its services were being used for unlawful purposes.
Rejecting that argument, the court held that MP3tunes.com had no duty to search for instances of copyright infringement: “While a reasonable person might conclude after some investigation that the websites used by MP3tunes executives were not authorized to distribute EMI’s copyrighted works, the DMCA does not place the burden of investigation on the internet service provider.” The court further observed that “[i]f enabling a party to download infringing material was sufficient to create liability, then even search engines like Google or Yahoo! would be without DMCA protection.” Accordingly, MP3tunes.com was liable only for the pirated works it failed to remove after receiving takedown letters. See Capitol Records, Inc. v. MP3tunes, LLC, No. 07 Civ. 9931 (WHP), 2011 WL 366735, 2011 LEXIS 93351 (S.D.N.Y. Aug. 22, 2011).
Your Company’s Name (Not) Here?: When the Internet Corporation for Assigned Names and Numbers (“ICANN”) announced on June 19 that it would allow virtually any word or name to be registered as a top-level domain (“TLD”), many pundits predicted a digital gold rush. After all, why would a business want a www.ourproduct@xyzcorp.com Web site when it could instead have www.ourproducts.xyz? Moreover, wouldn’t it want to register “.xyz” as a TLD to prevent competitors or cyber squatters from doing so?
Many business are increasingly answering “no” to the above questions. Each applicant for a generic TLD must submit an application likely to take several hundred hours to complete, must pay a $185,000 evaluation fee, and can be required to pay a Registry Services Review Fee anticipated to cost an additional $50,000. If there are other applicants for the same or a substantially similar domain name, an applicant could become entangled in an expensive dispute resolution proceeding that could cost it both the TLD and most or all of the fees paid to ICANN. Moreover, winning the right to a new TLD has its own cost: successful applicants for the new TLDs will incur a minimum $25,000 annual fee to “operate” a registry for their TLDs, even if they do not use them. As a consequence, many well-known companies, including PepsiCo, Ikea, Wells Fargo, and Morgan Stanley, have chosen not to apply to register their names as TLDs.
October 2011: Class Action Update
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Class-Less Actions: Depending on which side of the class action divide you are on, 2011 has been either a very good year or a disaster. In April, and again in June, the United States Supreme Court issued decidedly pro-business decisions, cutting back on the availability of class actions to address large-scale consumer and employment practices.
In the first of the decisions, AT&T Mobility, LLC v. Concepcion, 131 S. Ct. 1740 (2011), a 5-4 Court decided that contracts of adhesion with arbitration clauses containing class action waivers are enforceable. Prior to Concepcion, trial courts frequently struck down such clauses as unconscionable, recognizing that class actions are necessary to remedy wide-spread consumer frauds or unfair business practices, because individual claims are almost always too small to motivate or justify individual action. California, for example, followed the Discover Bank rule, which held that class action waivers were not enforceable if they served as exculpatory clauses, letting companies off the hook for large schemes to defraud. Discover Bank v. Super. Court, 36 Cal. 4th 148 (2005). In Concepcion the Court held that Discover Bank was preempted by the Federal Arbitration Act.
Although upholding the arbitration clause at issue, Concepcion, did not close the door entirely to challenges to arbitration provisions based on unconscionability or other contract-formation defenses, such as fraud and duress. And some courts continue to find arbitration clauses unconscionable. See, e.g., Kanbar v. O’Melveny & Myers, 2011 U.S. Dist. LEXIS 79447 (N.D. Cal. July 21, 2011)(finding a law firm’s arbitration provision for employment disputes unconscionable because it was a one-sided, take-it-or-leave-it condition of employment, among other infirmities).
On the whole, lower courts are giving Concepcion an expansive reading, accepting the proposition that the threshold for unconscionability has been raised. See, e.g., Bellows v. Midland Credit Mgmt., Inc., 2011 U.S. Dist. LEXIS 48237 (S.D. Cal. May 4, 2011); Bernal v. Burnett, 2011 U.S. Dist. LEXIS 59829 (D. Colo. June 6, 2011); Day v. Persels & Assocs., 2011 U.S. Dist. LEXIS 49231 (M.D. Fla. May 8, 2011). And, even where an arbitration agreement contains unconscionable terms, some courts find that the objectionable provisions can be severed “blue pencilled,” allowing the arbitration to proceed. See, e.g., the unpublished opinion from California’s Fourth District Court of Appeal (Div. 3) in Mission Viejo Emergency Med. Assocs. v. Beta Healthcare Grp., (June 29, 2011).
Notwithstanding the broad reading of Concepcion, companies that wish to benefit from it need to give careful consideration to the arbitration clauses in their adhesion contracts. The AT&T clause approved by the Court was unusually consumer-friendly. Among other things, AT&T agreed to pay all arbitration costs for non-frivolous claims, conduct the arbitration in the consumer’s county of residence, and guarantee recovery of $7500 plus double attorneys’ fees if the consumer obtained more in the arbitration than AT&T had offered beforehand. How consumer friendly an arbitration clause needs to be under Concepcion awaits further development.
Within days of the decision, Senator Al Franken and two colleagues announced their intention to circumvent Concepcion through legislation known as the Arbitration Fairness Act. The bill, first introduced in 2009, was re-introduced within weeks following the decision in Concepcion, but is unlikely to advance this term.
The Court’s second class action blockbuster was Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 795 (2011), which decertified the largest employment discrimination class in history. The decision effectively closed the door to nationwide disparate-impact class actions and may have made it more difficult to certify other types of large class actions.
The plaintiffs’ theory was that the nation’s largest retailer had a strong corporate culture that permeated individual hiring and promotion decisions, thereby subjecting every female employee to a common discriminatory practice. The plaintiffs introduced statistical evidence of pay and promotion disparities and anecdotal evidence from 120 class members. An expert sociologist also opined that the corporate culture made it vulnerable to gender discrimination. The class was certified under Rule 23(b)(2), on the theory that the plaintiffs primarily sought injunctive relief and that their request for back pay awards was merely incidental.
A unanimous Court found that a (b)(2) class was not warranted because the individual back pay awards were not incidental relief and that it was not appropriate to try a random sample of cases, devise a formula, and extrapolate to the entire class. Instead, the case should have been brought as a (b)(3) class action, an approach plaintiffs clearly had avoided because of the more stringent requirements for predominance and superiority that such a large class likely could not meet.
In a second aspect of the decision, the Court, held 5-4 that the class did not meet the basic Rule 23(a) requirements for class certification because there was inadequate proof of commonality, which the Court defined not as the ability to raise myriad common questions, but as the ability to generate common answers. The majority were unable to discern a glue binding the challenged employment decisions together, such as a single discriminatory practice. The majority’s holding noted that the plaintiffs’ expert could not say what percent of employment decisions were affected by the strong corporate culture. The Court also concluded that anecdotes from the 120 class members did not represent a large enough percentage of the class to support commonality.
Because commonality was previously viewed as a relatively easy bar for plaintiffs to surmount, the Court’s discussion of commonality surely will change the way class certification motions are opposed and decided.
As the U.S. appears to be restricting the use of class actions, other nations continue to adopt them. Most recently, Mexico passed legislation permitting class actions in consumer, environmental, and antitrust actions. The legislation provides a very speedy procedure – five days to submit arguments against class treatment after the case is filed, and two weeks thereafter for the court to decide the issue.
Inequitable Conduct as a Defense to Patent Infringement in the Wake of Therasense: Defining “Materiality” and “Specific Intent”
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On May 25, 2011, the U.S. Court of Appeals for the Federal Circuit issued a landmark decision changing the standards for proving inequitable conduct as a defense to patent infringement. In Therasense, Inc. v. Becton, Dickinson & Co., the court held that to establish inequitable conduct an accused infringer must prove, first, that the patentee acted with specific intent to deceive or made a deliberate decision to withhold information from the United States Patent and Trademark Office (“PTO”); and, second, that “but for” the patentee’s misrepresentations or omissions, the PTO would not have issued the patent.
Therasense addressed a patent for disposable blood glucose test strips developed for the treatment of diabetes. The patentee sought to claim glucose strips that lacked a membrane on the electrode used for testing, over prior art stating that a membrane was “optionally, but preferably” included on the test strip. Because the patentee also owned the prior art, the Examiner required a declaration that the prior art had required a membrane. The patentee’s R&D director averred that a person of ordinary skill would understand the prior art’s use of “optionally, but preferably” language as requiring a membrane, and the Examiner allowed the claims. During the earlier prosecution of the European counterpart to the same prior art, the patentee had, however, submitted a declaration, from the same expert, stating that the prior art did not require a membrane. When the patentee asserted the patent against Becton, Dickinson & Co., the alleged infringer argued that it was unenforceable due to the patentee’s inequitable conduct by failing to disclose properly the prior art to the PTO.
History of Inequitable Conduct
Inequitable conduct is an equitable defense to patent infringement that, if proved, bars enforcement of a patent. The doctrine originated with Supreme Court cases that applied the common-law doctrine of unclean hands to dismiss patent infringement cases involving egregious misconduct by the patentee, including the suppression of evidence, perjury and the submission of false evidence to the PTO. Inequitable conduct gradually evolved to encompass misconduct broader than unclean hands, including the simple failure to disclose of information to the PTO. Inequitable conduct also acquired a powerful remedy: unenforceability of the entire patent rather than mere dismissal of the instant suit.
The Increase of Inequitable Conduct Claims
Federal courts have long required inequitable conduct claimants to show that the applicant misrepresented or omitted material information with the specific intent to deceive the PTO. Over time, the showing needed to establish the “materiality” and “specific intent” prongs of inequitable conduct weakened as courts promoted full disclosure to the PTO. Before Therasense, courts evaluated intent and materiality together on a “sliding scale,” that allowed a finding that a patent was unenforceable if the record contained a strong showing of materiality and a reduced showing of intent, or vice versa.
Whether caused by or coincidental to the evolution of the standard governing claims of inequitable conduct, the frequency of inequitable conduct defenses alleged in patent infringement cases has increased, leading to an expansion of discovery into pre-filing corporate practices, disqualification of prosecuting attorneys from the patentee’s litigation team, and, presumably, a lower probability of settlement. Inequitable conduct allegations “increase[d] the complexity, duration and cost of patent infringement litigation that [was] already notorious for its complexity and high cost” and frequently triggered antitrust and unfair competition claims, as well as additional litigation over the crime-fraud exception to attorney-client privilege.
The Therasense court concluded that then-current standards for proving inequitable conduct placed an undue strain not only on the judiciary, but also on the patent system as a whole. According to the court, patent applicants frequently disclosed too much prior art for the PTO to consider meaningfully, and failed to explain the significance of the prior art they disclosed, all out of fear that to do otherwise would risk an inequitable conduct claim. That risk was substantial because the remedy for inequitable conduct is the “atomic bomb of patent law.” Unlike validity defenses, which are specific to a particular claim, a finding of inequitable conduct regarding single claim renders the entire patent unenforceable and the problem cannot be solved by reissue.
Therasense Set New Standards for “Materiality” and “Intent”
To “redirect a doctrine that has been overused to the detriment of the public,” the Therasense court decided to “tighten the standards for finding both [the] intent and [the] materiality” required to prove inequitable conduct. Therasense eliminated the sliding scale, holding that “intent and materiality are separate requirements” that must be evaluated independently.
Under Therasense, the accused infringer must show intent by proving that the patentee acted with the specific intent to deceive the PTO. In cases involving nondisclosure of information, the accused infringer must show by clear and convincing evidence that the applicant made a deliberate decision to withhold known material prior art; it is insufficient that the applicant “should have known” of the materiality of the undisclosed prior art. The Therasense court conceded that, because direct evidence of deceptive intent is rare, “the district court may infer intent from indirect and circumstantial evidence” so long as the specific intent to deceive is “the most reasonable inference able to be drawn from the evidence.” In cases where multiple reasonable inferences can be drawn, a court cannot find intent to deceive. The party alleging inequitable conduct bears the burden to prove by clear and convincing evidence a threshold level of intent to deceive before the patentee need offer good faith explanation.
The Federal Circuit had previously attempted to reduce inequitable conduct claims by modifying only the intent prong of the analysis. See, e.g., Kingsdown Med. Consultants, Ltd. v. Hollister Inc., 863 F.2d 867, 876 (Fed. Cir. 1988). In Therasense, the court also adjusted the standard for materiality.
Therasense held that, to establish a claim of inequitable conduct, the accused infringer must show “but-for materiality.” When an applicant fails to disclose prior art, the prior art is “but-for” material if the PTO would not have approved the patent had it known of it. To determine patentability in this context, the court “should apply the preponderance of the evidence standard and give claims their broadest reasonable construction.”
The “but-for” test may be similar to a determination of invalidity. If a claim is invalidated based on a deliberately withheld reference, that reference would necessarily be material because invalidity “requires clear and convincing evidence,” a higher evidentiary burden than used in prosecution at the PTO. Even if a district court does not invalidate a claim based on a deliberately withheld reference, the reference may nevertheless qualify as material if it would have blocked the patent’s issuance under the PTO’s evidentiary standard.
Therasense adopted “but-for” materiality to ensure that inequitable conduct would be applied only when the “patentee’s misconduct resulted in the unfair benefit of receiving an unwarranted claim.” If the patent would have issued anyway, the patentee did not obtain an unfair advantage from the misconduct, and enforcement would not injure the public.
In adopting its new standard for materiality, Therasense expressly declined to use the PTO’s Rule 56 definition, which covers any information that “refutes or is inconsistent with” any position the applicant took regarding patentability. The court rejected that definition because “even if information would be rendered irrelevant in light of subsequent argument or explanation by the patentee, it could still be considered material.” Because Rule 56 encompasses anything “marginally relevant” to patentability, its low standard of materiality would “inevitably result in patent prosecutors continuing the existing practice of disclosing too much prior art of marginal relevance and patent litigators continuing to charge inequitable conduct in nearly every case as a litigation strategy.”
The Exception to “But-For” Materiality: Affirmative Egregious Acts
Although the but-for rule must generally be satisfied to satisfy the materiality prong of inequitable conduct under Therasense, the court recognized an exception for affirmative acts of “egregious misconduct.” In cases such as the filing of an unmistakably false affidavit, the misconduct is deemed material. The court’s exception incorporates elements of the early unclean hands cases decided by the Supreme Court. These cases addressed “deliberately planned and carefully executed schemes to defraud the PTO and the courts,” observing that “a patentee is unlikely to go to great lengths to deceive the PTO with a falsehood unless it believes that the falsehood will affect issuance of the patent.” Because the exception does not apply to mere nondisclosure of prior art references or the failure to disclose such references in an affidavit, claims of inequitable conduct based on such omissions still require proof of but-for materiality. By creating an exception to punish affirmative egregious acts without penalizing immaterial omissions, Therasense seeks to strike a balance between encouraging honesty before the PTO and preventing unfounded accusations of inequitable conduct that the Therasense majority believed have “plagued” courts and the U.S. patent system as a whole.
Practical Implications of Therasense
The Therasense court was closely divided, and what constitutes inequitable conduct may ultimately be decided by the Supreme Court. In the meantime, the heightened standard required to show “materiality” makes it more difficult for accused infringers to establish inequitable conduct as a defense to patent infringement. The Therasense dissent argued that the heightened standard is too restrictive, and makes inequitable conduct a redundancy because only invalid claims could be held unenforceable:
Under this court’s new rule, an applicant who conceals information with the intent to deceive the PTO will be free to enforce his patent unless it can be proved by clear and convincing evidence that the new patent would not have issued but for the fraud. Even though the majority justifies its new rule in part by asserting that it will improve the prosecution of patents before the PTO, I am convinced that the new rule is likely to have an adverse impact on the PTO and the public at large, a view that – significantly – is shared by the PTO itself.
It remains to be seen whether or not the heightened materiality standards announced by the Therasense majority will result in the adverse consequences predicted by the dissent. Even if the new materiality standard reduces the incentives to make a full initial disclosure to the PTO, the test will likely ease the burden on the patent system and courts created by “overdisclosure” to the PTO and the proliferation of inequitable conduct claims. In turn, the use of the new Therasense standard may allow the courts and the PTO to focus on the most egregious and potentially damaging cases of patent infringement, that were the most deserving of scrutiny in the first place.
New Trend Admitting Wiretap Evidence in Insider Trading Cases
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Until recently, the use of wiretap evidence was limited to the prosecution of crimes that are specifically enumerated in Title III of the Omnibus Crime Control and Safe Streets Act of 1968, codified at 18 U.S.C. 2510-2522. Such evidence has typically been admitted primarily in drug cartel, alien smuggling and organized crime cases, but until now it has not been used in securities fraud cases. The times have changed. In the last several months, federal courts have twice upheld the use of wiretap evidence in insider trading prosecutions. Defendants Raj Rajaratnam and other ex-Galleon Group traders were found guilty of securities fraud by juries that listened spellbound to damning evidence from wiretapped telephone calls. Although the use of wiretap evidence is still generally prohibited in insider trading and other cases not enumerated in Title III, these recent rulings suggest that the reliance on wiretap evidence may be allowed in any case in which the wiretap was authorized in the investigation of an enumerated crime, even if that crime is not itself prosecuted.
Wiretaps and Congressional Goals
Congress’ intent in passing Title III was to strike a balance between allowing wiretapping as an investigative tool and safeguarding the privacy of the general public and investigative targets. Wiretapping is one of the most invasive tools in law enforcement’s arsenal, and Title III reflects a strong Congressional desire to circumscribe its use. See, e.g., Berger v. New York, 388 U.S. 41, 63 (1967) (“Few threats to liberty exist which are greater than that posed by the use of eavesdropping devices.”); Gelbard v. United States, 408 U.S. 41, 48 (1972) (quoting S. Rep. No. 1097, 90th Cong., 2d Sess., 66 (1968)); U.S. Code Cong. & Admin. News, p. 2153 (“To assure the privacy of oral and wire communications, [T]itle III prohibits all wiretapping and electronic surveillance by persons other than duly authorized law enforcement officers engaged in the investigation or prevention of specified types of serious crimes, and only after authorization of a court order obtained after a showing and finding of probable cause.”) (emphasis added). Accordingly, Title III enumerates the only types of predicate offenses upon which law enforcement may rely in seeking authorization for a wiretap.
Title III requires government agents monitoring calls via wiretap to avoid listening to, or to “minimize” the interception of, calls that are not authorized for interception. See 18 U.S.C. § 2518(5). Title III also provides a suppression remedy for those unlawfully subjected to the interception of their wire or oral communications, but courts avoid applying the remedy harshly, see 18 U.S.C. § 2515 and Scott v. United States, 436 U.S. 128 (1978), instead employing a generous reasonableness analysis when determining whether or not to suppress wiretap evidence.
Expansion of Wiretap Use to Insider Trading Prosecutions
Securities fraud (insider trading) is not among the enumerated offenses. Nonetheless, in United States v. Rajaratnam, 2010 WL 4867402, *1 (S.D.N.Y. Nov. 24, 2010), Judge Richard Holwell held that evidence obtained from wiretaps was admissible at trial. He reasoned that because wire fraud is an authorized crime under Title III, and because the government used wiretaps to investigate a fraudulent insider trading scheme using interstate wires, the wiretap evidence was admissible at trial. Judge Holwell carefully avoided ruling that wiretaps are generally permissible in insider trading cases. Rather, he held that evidence of securities fraud discovered through a wiretap based on an authorized crime under Title III (wire fraud, in this case) was permissible. If securities fraud is committed without the use of a wire, Title III will preclude the use of wiretapping. Rajaratnam, at *6 n.8.
Even though Judge Holwell attempted to circumscribe the potential reach of Rajaratnam, his opinion may prove to be the gateway to broader usage of wiretapping in white-collar and other cases. In fact, his ruling was followed in another securities fraud case, U.S. v. Goffer. The defendants advanced two arguments against the admission of wiretapped conversations. First, they argued that Title III prohibited the use of wiretaps because securities fraud is not an enumerated predicate offense. Second, they contended that the government had to comply with Title III’s minimization requirement. Defendants’ Reply Memorandum in Further Support of their Joint Motion to Dismiss and Suppress, U.S. v. Goffer, No. 10-CR-0056 (RJS), ECF 115 (Dec. 17, 2010). The government had intercepted nearly 200 personal calls between one of the defendants, Craig Drimal, and his wife. Judge Richard Sullivan characterized the interception of martial communications as “disgraceful,” “egregious,” “an embarrassment generally,” and “inexcusable and disturbing,” especially because many intimate calls were monitored by agents long after they realized that the conversations did not relate to their investigation, with one six-minute call being monitored for at least four minutes. Goffer, Memorandum and Order, ECF 179 (Apr. 20, 2011).
Notwithstanding his distaste for the government’s conduct, however, Judge Sullivan did not suppress any relevant intercepted calls, either on the grounds of illegality, or as a sanction for the government’s misconduct. He summarily rejected the defendants’ arguments that the wiretapping was illegal due to the lack of an authorized predicate offense. And, notwithstanding the government’s voyeuristic intrusion into private calls, he found that, “on the whole, the wiretap was professionally conducted and generally well-executed.” Id. The wiretap evidence was subsequently introduced at trial.
Civil, as Well as Criminal, Cases to Be Affected
This innovative use of wiretap evidence may begin to change the legal landscape in certain civil cases, as well. The Securities Exchange Commission brought a civil action against Rajaratnam, parallel to his criminal prosecution. It sought to obtain wiretap evidence from Rajaratnam and his co-defendant, Danielle Chiesi, obtained in the criminal case and disclosed to Rajaratnam and his co-defendants. District Judge Jed Rakoff, presiding over the S.E.C. action, ruled that the S.E.C. was entitled to its production. S.E.C. v. Galleon Mgmt., LP, 683 F. Supp. 2d 316 (S.D.N.Y. 2010).
On appeal, the Second Circuit held that, “nothing in Title III bars the use of the fruits of authorized wiretaps obtained in the pursuit of investigations of suspected crimes that are listed in Title III in securities fraud or insider trading proceedings.” S.E.C. v. Rajaratnam, 622 F.3d 159, 173 (2d Cir. 2010). On remand, Judge Rakoff held that whatever privacy interests the defendants had were outweighed by the S.E.C.’s right of access to the wiretap intercepts, and therefore ordered Rajaratnam and Chiesi to disclose it. S.E.C. v. Galleon Mgmt., LP, 2011 WL 1770631 (S.D.N.Y. May 20, 2011).
In light of Goffer, Rajaratnam, and Fed. R. Evid. 403 as applied in the civil context, it seems likely that Judge Rakoff will permit the introduction of wiretap evidence.
The impact of his ruling may be felt even by those who are not the intended subjects of wiretaps. The New York Times has reported that the S.E.C. may file a federal enforcement proceeding against Rajat Gupta, the former managing director of McKinsey & Company and an alleged co-conspirator with Raj Rajaratnam. See Peter Henning, Focus on Insider Trading Becomes More Intense, DealBook (August 8, 2011, 3:50 pm), http://dealbook.nytimes.com/2011/08/08/focus-on-insider-trading-becomes-more-intense/. If it does so, it will almost certainly seek to admit wiretap evidence gleaned during the Rajaratnam investigation that allegedly reveals the nature of Gupta’s involvement in insider trading. Id. Assuming the S.E.C. files suit and satisfies the requirements of the “co-conspirator exception” to the hearsay rule, Gupta could find himself in a difficult position in court, defending himself against statements made by Rajaratnam during a wiretapped telephone call to which he was not a party. Id.
Implications for the Future
Rajaratnam could be interpreted as rendering admissible in any criminal proceeding wiretap evidence collected in the investigation of an authorized crime under Title III. Federal prosecutors pursuing insider trading cases have certainly taken notice of U.S. Attorney Preet Bharara’s success in prosecuting Wall Street insiders, and will seek to apply his innovative strategy. Bharara “took wiretaps for a test drive, and I’d say it was a resounding success,” opined Stephen Miller, a former federal prosecutor. See Larry Neumeister & Tom Hays, Wiretaps Key in Conviction of Ex-Hedge Fund Giant, ABC News (May 12, 2011), http://abcnews.go.com/US/wireStory?id=13585543.
Judge Rakoff has already permitted wiretap evidence to be used in prosecuting an insider-trading case against James Fleishman of Primary Global Research, LLC. Memorandum, United States v. Fleishman, No. 11-CR-32 (JSR), ECF 115 (Aug. 31, 2011). Fleishman had argued that there was insufficient probable cause for the wiretaps, which targeted 104 Primary Global telephone line users, because there was no showing that all 104 individuals had engaged in wrongdoing. See Andrew Longstreth, Expert-networking Defendant Challenges Wiretap, Reuters (Aug. 2, 2011, 9:25 am), http://www.reuters.com/article/2011/08/02/us-fleishman-wiretapidUSTRE77103T20110802. However, Fleishman declined to challenge the wiretaps’ validity on the grounds that insider trading is not an enumerated predicate offense under Title III.
Meanwhile, U.S. Attorney Bharara has made it clear his office will continue to prosecute insider trading cases based on wiretap evidence. When insider traders adopt “the methods of common criminals, such as the use of anonymous cell-phones, we have no choice but to treat them as such. To use tough tactics in these circumstances is not being heavy-handed; it is being even-handed,” Bharara stated in remarks to the New York City Bar last year. See Bruce Carton, SDNY’s Bharara Focuses on Insider Trading, Wiretaps, Compliance Week (Oct. 27, 2010) http://www.complianceweek.com/sdnys-bharara-focuses-on-insider-trading-wiretaps/article/191929/.
Insiders using non-public information should consider carefully a question Bharara has posed: “Today, tomorrow, next week, the week after, privileged Wall Street insiders who are considering breaking the law will have to ask themselves one important question: Is law enforcement listening?” United States Attorney Preet Bharara, Prepared Remarks for Press Announcement (October 16, 2009).
September 2011: Patent Litigation Update
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Knowledge Required For Induced Infringement, But It May Be Established Via Willful Blindness: In Global-Tech Appliances, Inc. v. SEB S.A., 131 S. Ct. 2060 (2011), the Supreme Court held that knowledge is the applicable standard for imposing liability under Section 271(b) of the Patent Act, which concisely provides that “[w]hoever actively induces infringement of a patent shall be liable as an infringer.” Of equal importance, it held that the willful blindness doctrine (developed in criminal cases) can be applied to establish knowledge in civil patent infringement cases.
Global-Tech reverse-engineered an SEB-patented deep fryer to make and market a competing deep fryer, but argued that it did not “actively” induce infringement because it was unaware of SEB’s patent and also had obtained a legal opinion that it had a right to use its product (albeit, without informing its attorney that Global-Tech had copied SEB’s commercially available fryer). SEB responded that Global-Tech’s re-engineering of the SEB fryer was sufficient to support a claim of active inducement.
The Supreme Court concluded unanimously that induced infringement under Section 271(b) requires knowledge that the induced acts constitute patent infringement. In doing so, the Court rejected the Federal Circuit’s holding that deliberate indifference to a known risk that a patent exists would constitute active inducement. It is now insufficient simply to show that the defendant knew there was a chance its activities could violate a patent, but paid no attention to the attendant risk.
Nevertheless, the Supreme Court affirmed the Federal Circuit’s judgment, holding that Global-Tech’s actions supported a finding of knowledge under the doctrine of willful blindness. Willful blindness requires a showing that: “(1) the defendant must subjectively believe that there is a high probability that a fact exists and (2) the defendant must take deliberate actions to avoid learning of that fact.” With implications that may reach far beyond the field of civil patent litigation, the Court’s opinion suggests that criminal statutes requiring proof of knowing or willful conduct are satisfied by proof of willful blindness under the Court’s articulated standard.
Patent Invalidity Defenses Must Always Be Proven By “Clear And Convincing Evidence”: In Microsoft Corp. v. i4i Ltd. Partnership, 131 S. Ct. 2238 (2011), the Supreme Court held that Section 282 of the Patent Act, which provides that “[a] patent shall be presumed valid,” requires that an invalidity defense be proven by clear and convincing evidence, even if the defense rests on evidence never considered by the PTO during the examination process.
Having failed at trial to prove patent invalidity under the contested clear and convincing standard, Microsoft argued that an infringement defendant need only prove invalidity by a preponderance of the evidence. In the alternative, Microsoft argued that a preponderance standard must at least apply if an invalidity defense is based on evidence that was not before the PTO, and questioned why deference should be given to the PTO with respect to evidence the PTO never considered.
The Supreme Court affirmed the Federal Circuit’s opinion, holding that clear and convincing evidence is the correct standard. The Court acknowledged that Section 282 does not expressly articulate a standard of proof, but concluded that because Judge Cardozo’s 1934 opinion in RCA adopted a clear and convincing standard, the Patent Act, enacted in 1952, implicitly incorporated that standard through the use of the phrase “presumed valid,” which had a settled common law meaning.
The Court also rejected Microsoft’s alternative argument, concluding that Congress would have made it expressly clear if Congress had intended that a lower standard be applied to evidence that was not before the PTO. The Court did, however, recognize that (i) a jury could consider that the PTO had no opportunity to evaluate specific evidence, (ii) such evidence could be weighed more heavily, and (iii) the party asserting invalidity might therefore more easily satisfy its burden under the clear and convincing evidence standard.
Federal Circuit Streamlines Rules for Contempt Proceedings for Designing Around an Injunction: In TiVo Inc. v. EchoStar Corp., 646 F.3d 869 (Fed. Cir. 2011), the Federal Circuit outlined new rules for contempt proceedings against a new or modified product when the original product has been barred by permanent injunction. The new rules effectively lower the burden for initiating such proceedings, but arguably raise the threshold required to establish the contempt itself.
After a jury found Echostar infringed TiVo’s DVR software patent, the district court entered a permanent injunction requiring in part that EchoStar disable certain infringing features for products placed with end users. TiVo later persuaded the district court to find EchoStar in contempt based on design-around activities it initiated as an alternative to the disabled features.
The Federal Circuit rejected Echostar’s argument that a finding of contempt is improper when a defendant has engaged in diligent and good faith efforts to avoid violating an injunction. In doing so, it overruled the two-part contempt inquiry established in KSM, which required that a district court first decide whether a contempt hearing is an “appropriate setting.” Doing so required that the redesigned product first be compared with the original to determine whether there was “more than a colorable difference” between them such that “substantial open issues with respect to infringement” existed. After that, the court was required to determine whether the redesigned product was also infringing. The Federal Circuit’s new test combines the two parts of the inquiry into one, leaving that appropriateness determination to the trial court’s sound discretion.
The new test also arguably increased the threshold for an actual finding of contempt by clarifying that the colorable difference consideration is not determined by simply judging whether the redesigned product continues to infringe, but rather by focusing on differences between the infringing features of the original product and the modified features of the newly accused product.
Finally, the majority held that a vagueness defense to contempt may be waived if not raised by the defendant at the first opportunity, suggesting that it might be wise to challenge ambiguities in an injunctive order when it is granted rather than within the context of a contempt proceeding.
Federal Circuit to Revisit “Control or Direction” Standard for Joint Infringement: On April 20, 2011, the Federal Circuit granted an en banc rehearing petition for Akamai Technologies, Inc. v. Limelight Networks, Inc., 629 F.3d 1311 (Fed. Cir. 2010), to address the following question: If separate entities each perform separate steps of a method claim, under what circumstances would that claim be directly infringed and to what extent would each of the parties be liable?
In Akamai, the defendant did not perform some steps of the plaintiff’s patented method itself, instead instructing its customers to perform those steps if they wanted to take advantage of the defendant’s services. Drawing on past Federal Circuit opinions in BMC Resources and Muniauction, which stated that joint infringement could be found only when one party was under the “control or direction” of the other party, the court held that “as a matter of Federal Circuit law … there can only be joint infringement when there is an agency relationship between the parties who perform the method steps or when one party is contractually obligated to the other to perform the step.”
Judge Newman’s dissent in McKesson Technologies, Inc. v. Epic Systems Corp., 98 U.S.P.Q.2d 1281 (Fed. Cir. 2011), a similar case involving patient/physician interactive Websites requiring the actions of both patients and physicians to perform all the steps in the patented method, attacked the decision in Akamai and related cases and pushed for an en banc hearing to resolve the conflicting precedents addressing joint infringement. She highlighted the conflicts by contrasting recent Federal Circuit cases applying the “single-entity rule” with older cases that analyzed such joint or contributory infringement under traditional tort theories (which required only participation, collaboration, or combined actions to find liability). Judge Newman also argued that the rule would withhold patent protection from technologically advanced methods that increasingly involve interaction between multiple entities.
Oral argument for the en banc rehearing is scheduled for November 18, 2011.
September 2011: Securities Litigation Update
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Supreme Court Redefines “Makers” of Untrue Statements as Those With Ultimate Authority: The Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 at 2302 (2011), in the final weeks of the 2010-2011 term, turned on the meaning of a single word. Securities and Exchange Commission (SEC) Rule 10b-5 states that it shall be unlawful for “any person . . . [t]o make any untrue statement of material fact . . . in connection with the purchase or sale of any security.” Securities Exchange Act, 15 U.S.C. § 78j(b) (1994). At issue was the scope of potential primary liability for actors involved in “mak[ing]” misleading statements under Rule 10b-5. The Court held that “[f]or purposes of Rule 10b-5, the maker of a statement is the person or entity with ultimate authority over the statement, including the content and whether and how to communicate it.” Id. This narrow definition of “make” has significance well beyond Janus because it impacts the extent to which a public company’s affiliates, officers, directors and outside professionals, including accountants, lawyers and investment advisers, may face liability under the federal securities laws for false or misleading statements issued by the company. After Janus, only the company itself faces primary liability under Rule 10b-5.
Background and Posture
Janus’ corporate structure was consequential to the outcome of the litigation. Janus Capital Group, Inc. (JCG), is a publicly traded asset management company and the sixteenth largest mutual fund complex in the United States, with more than four million mutual fund investors. Company Profile, Janus Capital Group, http://press.janus.com/company-profile.cfm (last visited July 26, 2011). Janus Capital Management LLC (JCM), JCG’s wholly owned subsidiary, serves as an investment adviser and administrator for the Janus mutual fund family. In this capacity, officers and employees of JCG and JCM participated in the preparation and dissemination of prospectuses issued by Janus Investment Fund (JIF), a separate legal entity with a separate board of trustees, and owned entirely by mutual fund investors. Although JIF was legally separate from JCM, the entities were closely related. For instance, each of JIF’s officers was also a JCM employee. Janus, 131 S. Ct. at 2302 (Breyer, J., dissenting).
The alleged misstatements giving rise to the litigation were exposed in September 2003 following an investigation by the New York Attorney General’s Office into “market timing,” which refers to the short-term, “in and out” trading in mutual-fund shares to, inter alia, exploit stale prices for stocks listed on foreign exchanges. New York v. Canary Capital Partners, (N.Y. Sup. Ct. Sept. 3, 2003). In prospectuses issued between 2001 and 2003, JIF represented that its policy was to discourage or prohibit market timing.
As a result of its investigation, however, the New York Attorney General filed a complaint against the Canary Capital Partners, LLC hedge fund, alleging that it had colluded in a market-timing scheme with JIF. See id. Ultimately Janus paid $225 million in 2004 to settle claims by regulators that it had failed to disclose the trading arrangements to long-term investors. See James Vicini & Ross Kerber, Top Court Rules for Janus in Securities Case, Reuters (June 13, 2011, 11:38 AM), http://www.reuters.com/article/2011/06/13/us-janus-lawsuit-court-idUSTRE75C3CC20110613. This disclosure caused investors to withdraw nearly $14 billion from various Janus funds. As a result, JCG’s stock price fell substantially.
First Derivative Traders, representing a class of stockholders in JCG, subsequently filed a private Rule 10b-5 securities class action in the District of Maryland. The district court dismissed the action, but the Court of Appeals for the Fourth Circuit reversed, holding that First Derivative had adequately pled its complaint. JCG and JCM then filed a petition for certiorari, which the Court granted.
Supreme Court Decision
In a 5-4 decision, the Supreme Court reversed the Fourth Circuit holding that the plaintiffs had failed to state a claim. Justice Thomas, joined by Chief Justice Roberts and Justices Scalia, Kennedy, and Alito, held that the “maker” of a misstatement under Rule 10b-5 is the person or entity with ultimate authority over the statement. According to the majority, this narrow view of primary liability followed directly from the Court’s holding in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. 511 U.S. 164 (1994), which held that Rule 10b-5’s private right of action excludes suits against aiders and abettors who contribute “substantial assistance” to the making of a statement but do not actually make it. An “expanded” right of action would undermine the distinction between “primary violators” and “aiders and abettors” by rendering the potential class of aiders and abettors practically non-existent.
The majority rejected the definition of “make” proposed by the United States, appearing as amicus. The government contended that “make” should properly be defined as “create,” allowing primary liability to extend to any person who provides misleading or false information that is later issued as a public statement. Janus, 131 S. Ct. at 2303 - 2304. The majority argued that this meaning was inconsistent with Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008), which rejected a private 10b-5 suit against companies involved in deceptive transactions, even when information about those transactions was subsequently incorporated into false public statements. In relying on Stoneridge, the majority refused to distinguish Janus on the basis of the “uniquely close relationship between a mutual fund and its investment advisor.” (Justice Thomas noted that he would “decline this invitation to disregard the corporate form.” Janus, 131 S. Ct. at *2304 - 2305.) Janus thus sets a bright-line rule limiting primary liability exclusively to the company or individual with “ultimate authority over the statement.” Id. at *13.
Applying its narrow definition of “make” to JCM, the majority held that JIF was the exclusive “maker” of the alleged misstatements in the prospectuses. Only JIF had the statutory obligation to file the prospectuses with the SEC, and notwithstanding that JCM may have been “substantially involved” in drafting the impugned sections of the prospectuses, their issuance remained “subject to the ultimate control” of JIF. Id. at *23. JCM acted only as a “speechwriter,” but, “[e]ven when a speechwriter drafts a speech, . . . it is the speaker who takes credit—or blame—for what is ultimately said.” Id. at *13-14.
Justice Breyer, in a dissent joined by Justices Ginsburg, Sotomayor, and Kagan, argued that “[n]either common English usage nor this Court’s earlier cases limit the scope of [the word ‘make’] to those with ‘ultimate authority’ over a statement’s content.” Id. at *26 (Breyer, J., dissenting). In the minority’s view, the bright-line rule articulated by the majority is willfully blind to the practical exercise of agency in the making of public statements. “Every day,” the minority noted, “hosts of corporate officials make statements with content that more senior officials or the board of directors have ‘ultimate authority’ to control. So do cabinet officials make statements about matters that the Constitution places within the ultimate authority of the President.” Id. at *27-28 (Breyer, J., dissenting). Accordingly, the minority suggested that the determination of a statement’s “maker”—and susceptibility to primary liability—ought to “depend[] upon the circumstances.” Id. at *26 (Breyer, J., dissenting). On the facts presented, the minority concluded that the facts alleged brought JCM within the scope of Rule 10b-5 because its “involvement in preparing and writing the relevant statements could hardly have been greater.” Id. at *44 (Breyer, J., dissenting).
Reflections and Impact
The decision has already been criticized by certain commentators, which ascribe it to the Court’s hostility to the implied private right of action under Rule 10b-5. In dissent, Justice Breyer envisioned that “guilty management” might make materially false statements, that “fools both board and public into believing they are true.” Janus, 131 S. Ct. at *2310 – 2311. Under the Janus bright-line rule, the manager would not be liable as a Rule 10b-5 primary violator because he did not “make” the statement. Neither could he be pursued by the SEC as an “aider and abettor” because there would be “no other primary violator [he] might have tried to ‘aid’ or ‘abet.’” (Under the Private Securities Litigation Reform Act of 1995, the SEC is authorized to prosecute “aiders and abettors” pursuant to section 10(b), but Congress did not provide a private cause of action against aiders and abettors). Professor Jeffrey Gordon has commented that “the decision exacerbates the problem of ‘agency capitalism’—the tendency of the managing agents to pursue their own objectives at the expense of the ultimate beneficiaries.” Gordon, supra note 23. In his view, the majority’s reasoning ignores one of the principal lessons of the financial crisis, which is that the “purported gatekeepers to the financial system—accountants, lawyers, credit rating agencies, underwriters—often pursued their immediate economic interests at the expense of their critical gate-keeping function.” Id.
Janus appears to foreclose the potential for primary 10b-5 liability for false statements on the part of outside professionals, such as accountants, attorneys and investment advisers, who assist companies in issuing SEC filings and public statements. Janus also seems to shield from primary liability officers of a company who are not themselves vested with “ultimate authority” to issue a public statement. The decision will likely encourage litigants to seek recourse through other avenues of liability for actors who participated in, but did not actually utter, false public statements. One avenue may be found in section 20(b) of the Securities Exchange Act of 1934, which provides for “control person” liability for a company, even when its board had no knowledge of the underlying fraud, if any of its agents had such knowledge. Another lies in state common law claims, such as fraud and aiding and abetting fraud, which remain unaffected by the Court’s restrictive statutory interpretation of Rule 10b-5.
September 2011: Entertainment Litigation Update
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Supreme Court Strikes Down Law Prohibiting Sale of Violent Video Games to Minors: The Supreme Court ended its term by striking down a California ban on violent video games. Brown v. Entertainment Merchants Ass’n, 564 U.S. __, 131 S. Ct. 2729 (June 27, 2011). The majority opinion reinforced that First Amendment protection does not depend on the medium of communication. Thus, video games are entitled to the same protection as Grimm’s Fairy Tales, and attempts to restrict their content will be subject to strict scrutiny.
California passed a law prohibiting the sale or rental of violent video games to minors. The law defined the restricted games as those “in which the range of options available to a player includes killing, maiming, dismembering, or sexually assaulting an image of a human being, if those acts are depicted” in a manner that is “patently offensive to prevailing standards in the community as to what is suitable for minors” and that “causes the game, as a whole, to lack serious literary, artistic, political, or scientific value for minors.” The definition blended two tests the Supreme Court had adopted in prior decisions, one adopting a restriction on obscene materials specific to minors (Ginsberg v. New York, 390 U.S. 629 (1968)), and the other governing obscenity generally and permitting the standard for restrictions on obscene material to be based on “community standards” (Miller v. California, 413 U.S. 15 (1973)). However, the California statute applied these standards to depictions of violence rather than depictions of nudity or sexually explicit conduct.
In striking down the law, the majority acknowledged that the government may adopt limits on materials available to minors that are more restrictive than the limits that may be applied to adults. However, it held that in doing so the government is limited to areas that traditionally have been the subject of restrictions on speech, such as obscene depictions of “sexual conduct.” Relying on United States v. Stevens, 559 U.S. ___, 130 S.Ct. 1577 (2010), in which it struck down a statute prohibiting violent “crush” videos, the Court held that “new categories of unprotected speech may not be added to the list by a legislature that concludes certain speech is too harmful to be tolerated.” The majority noted that there was no longstanding tradition in the U.S. of restricting children’s access to depictions of violence, citing examples of violent material in Grimm’s Fairy Tales and Homer’s The Odyssey. Thus, the restriction on violent video games was subject to “strict scrutiny,” the most demanding test imposed under constitutional law for the validity of restrictions on speech.
The Court concluded that California’s law failed to satisfy strict scrutiny because (i) California could not show a direct link between violent video games and harm to minors; (ii) the law was under-inclusive, singling out video-game providers and not addressing other providers, such as booksellers, cartoonists and movie producers; and (iii) the law provided only marginal benefits beyond those provided by existing, voluntary regulations undertaken by the industry.
The Hurt Locker: In March 2010, just days before The Hurt Locker won the Best Picture “Oscar” at the Academy Awards, Master Sgt. Jeffrey Sarver sued the producers, director and screenwriter, alleging that he was the source of the main character, title and other aspects of the film. Sgt. Sarver alleged claims for defamation, breach of contract, intentional infliction of emotional distress and misappropriation of his right of publicity.
The screenwriter, Mark Boal, was embedded with Sgt. Sarver’s unit in Iraq and spent a month profiling him for a Playboy Magazine story entitled “The Man in the Bomb Suit.” Sgt. Sarver alleged that Boal had no right to use his life in drafting the screenplay for The Hurt Locker. Although Boal acknowledged that his character bears some resemblance to Sgt. Sarver, he argues that because the film contains numerous creative elements, it merits protection under the First Amendment.
In deciding the defendants’ motion to dismiss District Judge Jacqueline Nguyen (recently nominated for appointment to the Ninth Circuit) recently issued a tentative ruling of significant consequence. She agreed that the defamation, breach of contract and intentional infliction of emotional distress claims should be dismissed, but her tentative ruling allowed Sgt. Sarver to pursue a claim for misappropriation of name and likeness.
Sarver argues that the remaining claim represents the “essence of this case.” Attorneys for the defendants argue that if Judge Nguyen maintains her tentative ruling, it would have a chilling effect on future films based on real world events. The ruling will be closely watched by industry insiders.
In Re NCAA Student-Athlete Name: Former NCAA football and basketball student-athletes have filed an antitrust lawsuit against Electronic Arts, Inc. (EA), the second largest U.S. video game publisher, and against the NCAA and the Collegiate Licensing Company (CLC). In Re NCAA Student-Athlete Name and Likeness Licensing Litigation, No. 09-1967, (N.D. Cal. 2009). The suit concerns EA’s “NCAA Football,” “NCAA Basketball” and “NCAA March Madness” video game franchises, which are distributed pursuant to license agreements with CLC, the NCAA and NCAA member institutions. The plaintiffs contend that the video games unlawfully use their images, likenesses and names by creating virtual football and basketball players that EA designed to resemble actual student-athletes. EA omits student-athletes’ names in the video games but the plaintiffs allege that EA, with the knowledge of the NCAA and CLC, designed the games to allow consumers to upload rosters created by third parties that supply their names.
The plaintiffs allege that the defendants have violated § 1 of the Sherman Act’s proscription on restraint of trade by participating in a (1) price-fixing conspiracy to set at zero dollars the price paid to the plaintiffs and putative class members to use their images, likenesses and names; and (2) “group/boycott/refusal to deal” conspiracy to use their images, likenesses and names.
Ruling on EA’s motion to dismiss, the court held on July 28th that the allegations were sufficient to state a claim for conspiracy to restrain trade. The court also found significant the plaintiffs’ allegations that, in addition to agreeing to abide by the NCAA’s rules prohibiting the compensation of current student-athletes, EA also agreed not to offer compensation to former student-athletes. Because NCAA rules do not prohibit former student-athletes from receiving compensation for use of their images, likenesses and names, the agreement exceeded the requirements of the NCAA's rules and policies and satisfied the requirement that the plaintiffs plead the existence of a price-fixing agreement. The litigation continues.
Section 1782 Discovery in Aid of Foreign Proceedings: A Powerful But Much Disputed Tool in International Litigation
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In enacting 28 U.S.C. § 1782, Congress created a mechanism for parties in foreign proceedings to obtain evidence from U.S. companies and residents. Recent contested Section 1782 applications have raised an array of legal questions, including whether it can be used in aid of a foreign arbitration, whether documents sought must be located in the judicial district, and whether the statute is applicable if the discovery contravenes the rules of the forum country.
Section 1782 Basics
Section 1782(a), entitled “Assistance to Foreign and International Tribunals and to Litigants before Such Tribunals,” provides, in relevant part:
The district court of the district in which a person resides or is found may order him to give his testimony or statement or to produce a document or other thing for use in a proceeding in a foreign or international tribunal, including criminal investigations conducted before formal accusation. The order may be pursuant to a letter rogatory issued, or request made, by a foreign or international tribunal or upon the application of any interested person and may direct that the testimony or statement be given, or the document or other thing be produced, before a person appointed by the court.
To invoke Section 1782, an applicant must meet three conditions:
(1) that the person from whom discovery is sought reside (or be found) in the district of the district court to which the application is made, (2) that the discovery be for use in a proceeding before a foreign tribunal, and (3) that the application be made by a foreign or international tribunal or “any interested person.”
In re Application of Esses, 101 F.3d 873, 875 (2d Cir. 1996) (per curiam).
In a 2004 decision, the United States Supreme Court clarified the scope of Section 1782 discovery, creating opportunity for its routine use by litigants in international disputes. Intel Corp. v. Advanced Micro Devices, Inc., 542 U.S. 241, 259-60 (2004). The Court rejected several proposed categorical limitations on federal courts’ authority to order discovery under Section 1782, instead setting forth considerations to govern district courts’ exercise of discretion. Those considerations include whether: (1) a foreign court could order the parties to produce the requested evidence; (2) the nature or character of the foreign tribunal and proceeding indicate that the foreign government may not be receptive to U.S. discovery; (3) it appears that the applicant may be attempting to circumvent foreign discovery limits; and (4) enforcing the statute would be “unduly intrusive or burdensome.” Intel, 541 U.S. at 264-65.
Despite the Supreme Court’s effort to provide guidance, disputes abound regarding the scope and applicability of Section 1782 discovery. Some of the more interesting issues are addressed below.
Can Section 1782 Be Used in Connection with a Foreign Arbitration?
Prior to Intel, it was unclear whether the phrase “foreign tribunal” was limited to court proceedings in other countries. Certain circuit courts had determined that foreign arbitrations did not constitute “foreign tribunals” and were thus outside the sweep of Section 1782. See, e.g., Republic of Kazakhstan v. Biederman Int’l, 168 F.3d 880, 883 (5th Cir. 1999); Nat’l Broad. Co. v. Bear Stearns & Co., 165 F.3d 184, 191 (2d Cir. 1999). In Intel, the Supreme Court cast doubt on that view. Although the specific holding concerned the European Commission’s antitrust enforcement capacity, a passage of the opinion reviewing Section 1782’s legislative history observed that “tribunal” was substituted in place of “judicial proceeding.”
Since then, several courts have held that arbitral tribunals are within the reach of Section 1782. See, e.g., In re Application of Chevron Corp., 709 F. Supp. 2d 283, 291 (S.D.N.Y. 2010) (aff’d on other grounds) (stating that “[t]he term ‘tribunal’... includes investigating magistrates, administrative and arbitral tribunals, and quasi-judicial agencies, as well as conventional civil, commercial, criminal, and administrative courts”) (emphasis in the original); Ukrnafta v. Carpatsky Petroleum Corp., No. 3:09 MC 265, 2009 WL 2877156 (D. Conn. Aug. 27, 2009) (finding arbitration proceeding was within purview of Section 1782); In re Application of Hallmark Capital Corp., 534 F. Supp. 2d 951, 954-55 (D. Minn. 2007) (granting application for discovery in Israeli arbitration). However, litigants continue to dispute whether private arbitrations fall within the scope of Intel. See, e.g., In re an Arbitration in London, England Between Norfolk Southern Corp., et al., 626 F. Supp. 2d 882 (N.D. Ill. 2009).
Can Documents Sought Be Outside the Judicial District?
Another area of significant dispute is whether a Section 1782 application can require the production of documents located outside the judicial district. One line of cases has held that it is irrelevant that the requested information is located elsewhere if person or entity subject to the Section 1782 application resides within the district. In re Application of Eli Lilly and Co., No. 3:09MC296, 2010 WL 2509133, at *4 (D. Conn. June 15, 2010) (granting petition in reliance and concluding that section 1782(a) does not require that the documents be found in the district); In re Hallmark Capital Corp., 534 F. Supp. 2d 951, 957 n.3 (D. Minn. 2007) (“[T]o the extent [local party from whom 1782 discovery was ordered] suggests that the only copies are located in Israel, any such fact would not relieve him of his obligation to produce them if they are nonetheless in his control.”) (emphasis in original); In re Application of Gemeinshcaftspraxis Dr. Med. Schottdorf, No. Civ. M19-88, 2006 WL 3844464, at *4 (S.D.N.Y. Dec. 29, 2006) (granting discovery of documents held by a German office of McKinsey because “McKinsey maintains its headquarters in New York, and thus is ‘found’ within this district”). Other courts, however, have taken the opposite view. See, e.g., In re Application of Godfrey, 526 F. Supp. 2d 417, 423 (S.D.N.Y. 2007); In re Microsoft Corp., 428 F. Supp. 2d 188, 194, n.5 (S.D.N.Y. 2006).
Would the Discovery Contravene the Discovery Rules of the Forum Country?
Section 1782 litigants often disagree whether the discovery would be admissible in the foreign tribunal. That is important because the Supreme Court held that Section 1782 relief should be granted if the requested discovery would be “of assistance” in the foreign proceeding. Intel, 542 U.S. at 265. As a general matter, if the information sought is relevant to the underlying foreign dispute, it is likely that the foreign court would be “receptive” to such evidence. See In re Servicio Pan Americano de Protection, 354 F. Supp. 2d 269, 274 (S.D.N.Y.2004) (granting discovery request under Section 1782, in part because “the discovery Pan Americano is seeking would be readily available and relevant to the litigation [in Venezuela]”). Courts have viewed a country’s status as a signatory to the Hague Evidence Convention as indicating that its courts would be receptive to Section 1782 discovery. See, e.g., In re Application of Imanagement Servs. Ltd., No. Civ.A. 05-2311, 2006 WL 547949 (D.N.J. Mar. 3, 2006) (noting that Russia and the United States are parties to the Hague Evidence Convention, which “supports a finding that the Russian court may be receptive to the evidence”).
Those seeking to avoid the application of Section 1782 invariably point to limitations of discovery and evidence in foreign proceedings and contend that the applicant is seeking to circumvent those restrictions. Faced with that argument, courts tend to restrict discovery only if the forum country has strict “proof-gathering restrictions,” which are defined as “substantive limits on the admissibility of discovered evidence.” See Pan Americano, 354 F. Supp. 2d at 275; In re Application of Kolomoisky, No. M.19-116, 2006 WL 2404332 (S.D.N.Y. Aug. 18, 2006) (no indication that applicant, in seeking discovery for Russian proceeding, was attempting to circumvent foreign proof-gathering restrictions or other policies); Imanagement, 2006 WL 547949 (no showing that discovery application sought to circumvent Russian proof-gathering restrictions). The Second Circuit has held that only “authoritative proof that a foreign tribunal would reject evidence obtained with the aid of Section 1782” warrants a decision to deny the use of the Act. See Esses, 101 F.3d at 876 (emphasis in the original). The rejection of such evidence must be “embodied in a forum country’s judicial, executive or legislative declarations that specifically address the use of evidence gathered under foreign procedures.” Euromepa S.A. v. R. Esmerian, Inc., 51 F.3d 1095, 1100 (2d Cir. 1995).
That a foreign tribunal has a more limited discovery regime is usually not a bar to Section 1782 discovery absent some abuse by the applicant. See Heraeus Kulzer GmbH v. Biomet, Inc., 633 F.2d 591, 594 (7th Cir. 2011). To the contrary, it may be a reason to grant it. See Pan Americano, 354 F. Supp. 2d at 274 (“[T]he apparent limitations of Venezuelan discovery rules suggest that the exercise of jurisdiction by this Court may be necessary to provide Pan Americano with the documents it seeks”). Likewise, limitations on the admissibility of evidence may not be cause to deny an otherwise valid Section 1782 application because there may be little harm in granting the discovery if the foreign tribunal retains the discretion later to determine whether to admit the discovered material in evidence. See Imanagement, 2006 WL 547949, at *3 (“Whether the foreign court will ultimately accept the evidence is beyond this Court’s ability to determine.”); In re Application of Grupo Qumma, No. M 8-85, 2005 WL 937486, at *3 (S.D.N.Y. Apr. 22, 2005) (“The Mexican court, rather than this Court, should decide whether the additional evidence is admissible, and it will be in a better position to do so if Qumma is permitted to conduct the requested discovery first”).
When the admissibility of particular discovery is in issue, courts tend to grant the discovery. See, e.g., Euromepa, 51 F.3d at 1101 (it is “far preferable for a district court to reconcile whatever misgivings it may have about the impact of its participation in the foreign litigation by issuing a closely tailored discovery order rather than by simply denying relief outright”); In re Imanagement Servc., Ltd., No. Misc. 05-89, 2005 WL 1959702 (E.D.N.Y. Aug. 16, 2005) (no “authoritative proof” that Russian court would reject any use of evidence gathered pursuant to Section 1782, and Russian court could protect itself from the effects of any unwanted discovery order by simply refusing to admit the evidence).
Conclusion
Following the Supreme Court’s Intel decision, lower courts continue to grapple with a number of legal issues regarding Section 1782. Given the proliferation of Section 1782 discovery applications in support of foreign disputes, we can expect to see further developments that will refine its scope.
Supreme Court Tightens Requirements for State Courts to Exercise Jurisdiction Over Foreign Corporations
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Recently, the Supreme Court addressed the standards for state courts asserting jurisdiction over foreign corporations. In Goodyear Dunlop Tires Operations, S.A. v. Brown, No. 10-76 (June 26, 2011) and J. McIntyre Mach., Ltd. v. Nicastro, No. 09-1343 (June 27, 2011), the Court held that North Carolina and New Jersey state courts had overstepped their authority by exercising jurisdiction over foreign corporations. Although neither opinion announced a new bright-line rule, they help clarify the conditions under which the assertion of jurisdiction is appropriate.
Traditional Jurisdictional Requirements
The broad principles informing jurisdictional analysis are well known and long established. The “outer boundaries” of a state’s jurisdictional authority to “hale a defendant before a court” are defined by the due process clause of the Fourth Amendment. Goodyear Dunlop Tires Operations, S.A. v. Brown, No 10-76, slip op., at 6 (June 26, 2011). Goodyear characterized the Court’s decision in Int’l Shoe Co. v. Wash., 326 U.S. 310, 316 (1945) as the “canonical opinion” defining those “outer boundaries”: jurisdiction is constitutional if the defendant has “minimum contacts [with the state] such that the…suit does not offend traditional notions of fair play and substantial justice.” Intl. Shoe at 316.
Jurisdiction can be either “general” or “specific” (also known as “limited” jurisdiction). General jurisdiction allows a court to assert jurisdiction over any activity, including those that occurred outside the state, and is proper when a defendant has significant “continuous and systematic” contacts within a state. Helicopteros Nacionales Colombia v. Hall, 466 U.S. 408 (1984). Specific jurisdiction allows a court to assert jurisdiction over a defendant for claims arising out of the defendant’s specific contacts within the state. Int’l Shoe, 326 U.S., at 317.
A “stream of commerce” analysis has been applied to the assertion of jurisdiction over a manufacturer whose products are intentionally distributed in a way that allows them to enter a particular state’s market. See World-Wide Volkswagen v. Woodson, 444 U.S. 286 (1980). Under that analysis, a state does not exceed its powers under the due process clause if it asserts personal jurisdiction over a corporation that delivers its products into the stream of commerce with the expectation that they will be purchased by consumers in the forum state. Id. at 567. However, the mere foreseeability of the entry of one’s product into a forum state is never enough to establish jurisdiction on its own. See Asahi Metal Indus. Co. v. Super. Ct., 480 U.S. 102, 111-12 (1987) (O’Conner, J., plurality opinion).
Factual Background
In Goodyear, the Supreme Court reviewed a North Carolina trial court’s assertion of jurisdiction over three foreign subsidiaries of the Goodyear Dunlop company. The subsidiaries were sued with the parent corporation over a bus accident in France that involved allegedly defective tires manufactured by the subsidiaries. Because the tires were manufactured and the injury occurred outside North Carolina, the state court asserted general jurisdiction over the defendants. Goodyear, slip op., at 3. Although the subsidiaries had “no place of business[,] . . . [did] not design, manufacture or advertise[,] . . . [did] not solicit business in . . . [nor] themselves sell or ship tires to North Carolina customers,” an appellate court upheld the assertion of jurisdiction because the subsidiaries’ products were placed “into the stream of interstate commerce without any limitation on the extent to which those tires could be sold in North Carolina.” Goodyear, slip op., at 4-5 (emphasis added).
It recognized that a “higher threshold” was necessary to assert general jurisdiction but found the subsidiaries’ activities met that threshold because: (a) the subsidiaries allowed their products to enter the stream of commerce without any “attempt to keep these tires from reaching the North Carolina market” and (b) the plaintiffs would experience hardship if they were forced to litigate outside the state. Id. at 5-6.
In McIntyre, a British manufacturer of shearing machines employed an independent corporation to sell and distribute its products in the U.S. and elsewhere. At most, four shearing machines were sold to U.S. customers. One injured a New Jersey man, who then sued the British manufacturer in New Jersey.
Unlike Goodyear, McIntyre involved a state court asserting specific jurisdiction over a foreign defendant. Even though McIntyre neither directly sold nor directly marketed its goods in New Jersey, the court, relying on the Asahi plurality opinion, found that it had specific jurisdiction over the company because, if a company “knows or reasonably should know that its products are distributed through a nationwide. . . system that might lead to those products being sold in any of the fifty states,” jurisdiction is proper in all of those fifty states, irrespective of defendant’s attempts, or lack thereof, to market to a particular state. Goodyear, slip op., at 1-2.
Clarifying the Standard
The Supreme Court unanimously reversed the state court in Goodyear. It held that the stream of commerce analysis “may bolster an affiliation germane to specific jurisdiction” but not to general jurisdiction. Goodyear, slip op., at 10-11 (emphasis in original). And, even in cases concerning specific jurisdiction, it held that the plaintiff must still demonstrate “some [additional] act by which the defendant purposefully avail[ed] itself of the privilege of conducting activities within the forum state, thus invoking the benefits and protections of its laws”. Id. at 7 (quoting Hanson v. Deckla, 357 U.S. 235, 253 (1958)).
The Court also found that the defendants’ “attenuated connections to the State [fell] far short of the ‘continuous and systematic general business contacts’ necessary” for general jurisdiction. Id. at 13 (quoting Helicopteros Nacionales de Colombia, 466 U.S. at 416). The Court was extremely skeptical of the North Carolina court’s view of general jurisdiction, which the Supreme Court argued would render “any manufacturer or seller of goods. . . amenable to suit, on any claim of relief, wherever its products are distributed,” in clear violation of the Court’s previous precedents in Helicopteros Nacionales de Colombia and Perkins. Id.
In McIntyre, the Supreme Court held that New Jersey lacked specific jurisdiction over the foreign corporation. Even though a majority of the Court agreed that the New Jersey Supreme Court’s standard for specific jurisdiction was incorrect, the Court did not agree on why the New Jersey court lacked jurisdiction. McIntyre, slip op., at 5, 11. In fact, the Court split 4-4-1 and issued a plurality opinion.
The plurality opinion rejected the trial court’s reliance on Justice Brennan’s plurality opinion in Asahi, declaring that: “Justice Brennan’s concurrence, advocating a rule based on . . . fairness and foreseeability, is inconsistent with the premises of lawful judicial power.” Id. at 8. Rather, the proper inquiry was whether the defendant “purposefully avails itself of the privilege of conducting activities within the forum State.” Id. (Kennedy, J., plurality op.).
However, in the case of a plurality opinion, the controlling opinion is the narrowest concurring opinion, rather than the plurality opinion itself. The controlling opinion, Justice Breyer’s concurrence, did not address the continued vitality of Asahi. Instead it confined itself to examining whether the contacts between New Jersey and McIntyre were of sufficient quality to justify the assertion of jurisdiction underthe Court’s existing precedent. Justice Breyer found that the “single, isolated sale” of the defendant’s products failed to meet those standards. He noted that “the relevant facts . . . show no regular course of sales . . . . [T]here is no something more, such as special state-related design, advertising . . . or anything else that would justify jurisdictional authority over the defendant.” Id. at 3 (Breyer, J. concurring op.).
In sum, while the two opinions do provide additional guidance to state courts examining the propriety of asserting jurisdiction over a foreign defendant, much is left in the dark. The Court’s inability to reach to a majority consensus in McIntyre leaves the continued vitality of Asahi an open question. However, under the plurality opinion expressed by Justice Kennedy, and possibly under the concurrence of Justice Breyer, foreign manufacturers appear to be able to insulate themselves from being haled into local courts.
August 2011: Insurance Litigation Update
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Claims Arising from Defective Drywall Are Excluded Under Most CGL Policies: During the housing boom in the mid-2000s, domestically manufactured drywall was in short supply, so hundreds of millions of pounds of drywall manufactured by a Chinese subsidiary of German manufacturer Knauf GIPS KG were imported into the United States and installed in homes, primarily in the Southeast. Consumers who bought homes containing Knauf’s drywall claim that a sulfur-containing gas released by the drywall has an unpleasant smell and causes damage to wiring and electrical appliances. Knauf and other foreign manufacturers have admitted that their drywall was defective, but they contest whether any court in the United States can force them to pay for the damages they caused, arguing that they are not subject to jurisdiction here. Homeowners have therefore resorted to suing the homebuilders, installers and distributors who purchased and resold Knauf’s defective products. Thousands of lawsuits seeking damages from those American companies and their insurers have been consolidated in a multi-district litigation before the Honorable Eldon Fallon in the Eastern District of Louisiana. In re Chinese Mfd. Drywall Prods. Liab. Litig., (MDL No. 2047) (E.D. La. 2010).
Insurance companies have claimed that the total pollution exclusion found in most comprehensive general liability policies excludes coverage for claims arising from defective drywall. A typical total pollution exclusion bars coverage for “bodily injury” or “property damage” that would not have occurred in whole or in part but for “the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of pollutants at any time.” Such exclusions may define “pollution” as an “emission, discharge, release or escape of pollutants into or upon land, the atmosphere or any watercourse or body of water provided that such emission, discharge, release or escape results in environmental damage.” The exclusion may also state that pollutants include “any solid, liquid gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste.”
State courts in Florida and many federal courts have agreed with the insurers that the drywall claims are excluded. A Virginia district court recently granted summary judgment to an insurer on a drywall-related claim, concluding that the sulfide gases released by the defective drywall “unambiguously qualify” as pollutants within the plain meaning of the pollution exclusion. Accordingly, the insurer had no duty to defend its insured in the underlying lawsuit. See Nationwide Mut. Ins. Co. v. Overlook, LLC, 4:10CV69, 2011 WL 1988396 (E.D. Va. May 13, 2011). See also Dragas Management Corp. v. The Hanover Insurance Co. No. 2:10-cv-00547 (E.D. Va. Aug. 8, 2011). Earlier federal court decisions also reached that result, finding that pollution exclusions are unambiguous, General Fid. Ins. Co. v. Foster, No. 9:09-cv-80743 (S.D. Fla. Mar. 24, 2011), and are not limited to “traditional environmental pollution,” Travco Ins. Co. v. Ward, 715 F. Supp. 2d 699 (E.D. Va. 2010). Both courts granted summary judgment in favor of the insurer.
The courts have almost uniformly found the pollution exclusions to be unambiguous, and have held that it is irrelevant that the fumes emitted by the Chinese drywall are not akin to traditional environmental pollutants. Several state courts in Florida, persuaded by the reasoning of General Fidelity and Travco, have recently reached the same conclusions. FCCI v. Gulfcoast Engineering, LLO., No. 10-CA-002862 (Fla. Cir. Ct. Aug. 8, 2011); FCCI Commercial Ins. Co. v. MDW Drywall, Inc., No. 10-CA-007389 NC (Fla. Cir. Ct. Jul. 6, 2011); FCCI Commercial Ins. Co. v. Ocean Const. Inc., No. 10-CA-2841 (Fla. Cir. Ct. June 6, 2011); FCCI Commercial Ins. Co. v. AL Bros., Inc., No. 10-CA-002840 (Fla. Cir. Ct. Apr. 19, 2011).
However, a court in Louisiana reached the opposite result, concluding that the pollution exclusion is inapplicable because the gases released by the defective drywall did not “cause environmental pollution by its presence in the Plaintiffs’ homes.” In re Chinese Mfd. Drywall Prods. Liab. Litig., 759 F. Supp. 2d 822 (E.D. La. 2010).
Several pending cases will also test the applicability of the pollution exclusion to Chinese drywall claims. Motions for summary judgment are pending in several cases in Florida district courts (see, e.g., Granite State Ins. Co. v. Am. Bldg. Materials, Inc., No. 8:10-cv-01542 (M.D. Fla. Apr. 27, 2011), Granite State Ins. Co. v. Probuild Holdings, Inc., No. 10-cv-60246-JEM (S.D. Fla. Jul. 6, 2010), Nat’l Union Fire Ins. Co. v. F. Vicino Drywall, Inc., No. 0:10-cv-60273-ASG (S.D. Fla. Jun. 21, 2010), Chartis Specialty Ins. Co. v. Banner Supply Co., No. 8:10-cv-00339-JSM-EAJ (M.D. Fla. Mar. 30, 2010), Amerisure Ins. Co. v. Albanese Popkin the Oaks Dev. Grp., L.P., 2010 WL 2321474 (S.D. Fla. Mar. 23, 2010)) testing the applicability of the pollution exclusion to underlying suits for damages arising from defective drywall.
These recent decisions from state and federal courts suggest that many American companies involved in the Chinese drywall mess are not insured, increasing the urgency to obtain jurisdiction over Knauf and the other Chinese manufacturers to obtain judgments to compensate victims for the damages their products have caused.
Quinn Emanuel is representing certain insurers in the Chinese drywall MDL proceedings.
August 2011: EU Litigation Update
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Software as Patentable Subject Matter in Germany - Recent Case Law of the German Federal Supreme Court: In a series of decisions starting in 2009 and culminating in the most recent decision of February 24, 2011, docket no. X ZR 121/09 – Webseitenanzeige, the German Federal Supreme Court (Bundesgerichtshof, BGH) outlined the requirements for software patents under German patent law. After a decision of the BGH’s Xa Senate in 2010 (GRUR 2010, 613 – Dynamische Dokumentengenerierung), in which the BGH declared a Siemens’ invention for the generation of structured documents with dynamic contents patentable (albeit without addressing its novelty or inventiveness), many commentators believed the BGH had dramatically lowered the barriers to software patentability in Germany. Some feared it would be sufficient to add language referring to a computer to a claim merely to fulfill the patentability requirements. The X Senate clarified the BGH’s position later in 2010 under Art. 52 EPC (BGH GRUR 2011, 125 – Wiedergabe topografischer Informationen) and in its latest decision on another Siemens patent under the corresponding German rules on patentable subject matter in § 1 paras. 1, 3 and 4 German Patent Code (Patentgesetz, PatG).
Under § 1 para. 1 PatG, only technical inventions are patentable subject matter. It is sufficient that only a part of an invention involves a technical aspect (Wiedergabe topografischer Informationen, para. 31). It is, for example, sufficient that steps of a method are performed by technical devices connected to each other by a network, like the typical steps of processing, storing, and transmitting data by such devices (BGH GRUR 2009, 479 – Steuerungseinrichtung für Untersuchungsmodalitäten), even if such devices are not mentioned in the claims provided that their use is obvious to a person skilled in the art (Webseitenanzeige, para. 16).
Section 1 para. 3 no. 3 PatG excludes, among other things, software for data processing equipment from the patentable subject matter. Therefore, while the first requirement is easily met, the BGH further demands that the technical aspect of the invention comprise instructions for solving a specific problem by technical means, e.g., the solution of a technical problem with the help of a programmed computer (Dynamische Dokumentengenerierung, para. 22).
The BGH’s latest decision provides that the requirement to solve a technical problem is met if (a) components of the devices are modified or are addressed in a fundamentally different way than before, (b) conditions outside the data processing equipment dictate the way the software is used to solve the problem, or (c) the software is designed to take the technical prerequisites of the data-processing equipment into account (Webseitenanzeige, paras. 21, 22).
The method claimed in the patent in dispute in Webseitenanzeige (display of websites) did not qualify. It comprised the following steps: (a) registering a user upon opening a start page, (b) registering information pages opened by the user directly or indirectly from the start page, and (c) creating a displayable description from which the order of the information pages opened by the user can be discerned. The claim would, for example, read on the use of cookies to track the sites visited by a user of a webpage, like the popular “bread crumb navigation.”
The technical aspect of this invention was merely a measure of data processing already known in the art and nothing in the invention went beyond that. Apart from incorporating methods already known in the art (using cookies, generating HTML structures), the patent specification did not disclose any specific method by which the data would be collected. The claimed invention merely relocated the method used from the client to the server. That, too, was known in the art.
In contrast, Dynamische Dokumentengenerierung, the BGH had been satisfied that the invention under scrutiny, a method for generating structured documents with dynamic content, was intended to solve a problem faced by servers that lacked the capacity to utilize script languages used in documents to assume sufficient technicality (e.g., because they were too weak to run a Java Virtual Machine). The solution was directed at designers of systems for data processing, not software engineers, thus placing the investigation outside the scope of § 1 para. 3 no. 3 PatG.
Because the patent in Webseitenanzeige lacked patentable subject matter, the BGH did not address novelty or inventive steps. However, the test for patentable subject matter in software inventions is not very strict. Its purpose is to filter out patent claims that offer no novel and inventive technical teaching. The effect of an at least partial software implementation on the assessment of the inventive step was addressed in Wiedergabe topografischer Informationen.
There, the technical aspects were limited to calculating the actual position of a car and to displaying topographical information corresponding to the car’s direction of travel. Because the technical aspects were part of the prior art, the BGH declared the claim not inventive. Even though the invention permitted the information to be displayed in an improved manner, the BGH concluded that those parts of the claim did not contribute to solving a technical problem and thus could not be considered in evaluating the invention’s inventiveness.
These series of decisions thus delineate the minimum requirements for patentable subject matter: there has to be a technical problem solved by technical means beyond what a person skilled in the art would do to implement the invention, such as collecting, processing, storing, or transmitting data. Even though the requirement can be satisfied easily, e.g., by catering to limitations of the data processing equipment used, only the technical aspects of the invention can be used to evaluate whether the invention is inventive. That inquiry will get much closer scrutiny from the courts.
August 2011: Media Update
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Poker Pro Files Suit in Wake of Online Poker Crackdown: In April 2011, in connection with a criminal indictment, federal prosecutors filed a civil complaint against the three online poker companies—Poker Stars, Full Tilt Poker, and Absolute Poker/Ultimate Bet—as well as various third-party payment processors, seeking approximately $3 billion in money laundering penalties and forfeiture of the websites’ domain names. See United States v. PokerStars, et al., 11 Civ. 2564 (LBS) (S.D.N.Y.). The complaint, filed in the Southern District of New York, alleges that the poker companies and payment processors disguised money received from U.S. poker players to deceive banks into processing billions of dollars of payments. The indictment and complaint resulted in the effective shutdown of those websites and left their U.S. customers wondering how to retrieve already-deposited funds.
By mid-May 2011, the poker companies reached an agreement with the U.S. government: they would be permitted to resume using their domain names to reimburse U.S. players’ funds and to allow players outside the United States to continue using the websites; in return, they agreed to shut down their “real money” poker services to U.S. customers while the actions were pending. The pace of reimbursement to U.S. players, however, has disappointed many, including professional poker players affiliated with the online poker companies implicated by the criminal and civil actions.
Professional poker player Phil Ivey recently filed suit against Tiltware, the parent company of Full Tilt Poker, in Nevada state court. See Ivey v. Tiltware, LLC, et al., A-11-642387-C (Dist. Ct. Clark Cty. Nev., June 1, 2011). Tiltware and Ivey allegedly entered into a 2004 agreement, where Tiltware agreed “to provide software and related support to Full Tilt Poker for the conduct of legal online poker” and Ivey agreed to endorse Full Tilt Poker with his name and likeness, and entered into a non-compete covenant. Ivey alleges, however, that Tiltware did not inform Ivey (i) of the activities alleged in the indictment; (ii) that the United States Attorney’s had given “repeated warnings and clear notice” that Tiltware’s conduct was illegal; or (iii) that Full Tilt Poker failed to maintain sufficient reserves to return the U.S. players’ funds. In addition, Ivey alleges that Full Tilt Poker’s failure to reimburse U.S. players has damaged his reputation. Ivey seeks, among other things, relief from the non-compete covenant and damages in excess of $150 million for the injury to his reputation – coincidentally the same amount Ivey alleges is still owed to U.S. users of Full Tilt Poker.
Best Practices for Defending Against Patent Trolls
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Today’s companies face a business reality rarely encountered by their predecessors: “patent trolls.” There is much debate over what constitutes a patent troll, but by most definitions, patent trolls are patent owners that do not make or sell patented inventions, and instead enforce their patents through infringement lawsuits to generate revenue in the form of license fees gained through settlements or jury awards. These companies, also sometimes less pejoratively referred to as “patent-holding companies” or “non-practicing entities” (NPEs), with business models centered on litigation rather than competition, are unsavory to many. But some “trolls” were once operating companies in their markets, and now seek to monetize their intellectual assets. Under any name, patent trolls have become a prominent fixture on today’s intellectual property landscape. While every case is unique, Quinn Emanuel’s extensive experience litigating against patent trolls has revealed effective defense strategies.
Proactively Responding to a Troll’s Initial Demand
Patent trolls often fire the first shot with a letter “inviting” a potentially infringing company to consider paying for a license. The opening salvo in any form should be taken seriously and responded to thoughtfully. Ignoring the letter is ill-advised, as a judge or jury will likely hear how the defendant was put on notice of its infringement, but couldn’t be bothered to respond. A better practice is to respond directly, affirming one’s respect for intellectual property rights and commitment to innovation, and requesting more information. Asking a troll to identify infringing products, to explain element-by-element why it believes there is an infringement, and to provide prior licenses to its patents will aid a defendant’s analysis and may provide some free discovery not otherwise available until litigation ensues. It may also buy some time to begin preparing one’s case. If the troll refuses to respond, this could give rise to an estoppel defense. In our experience, trolls who are not fully invested in their causes will simply go away when faced with a response that shows commitment to defending the case.
When a troll persists, companies accused of infringement should insist on entering a non-disclosure agreement to facilitate communication. Recent cases have suggested that, without extra protections, negotiations over settlement agreements may be discoverable in litigation, as evidence of a reasonable royalty. See ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860, 871-72 (Fed. Cir. 2010); Tyco Healthcare Group LP, et al. v. E-Z-EM, Inc., et al., Case No. 2:07-CV-262 (TJW) (E.D. Tex. March 2, 2010) (ordering discovery of settlement negotiations and holding that based on ResQNet, a privilege no longer protects settlement negotiations from discovery).
Making an early judgment call about whether the troll’s demands have merit and assessing the risk of litigation is crucial. At least three decision-makers, one who knows the technology, one who knows the sales and marketing of the accused products, and a lawyer, should review the demand letter and assess the strength of the accusations and their impact on the business if proven in court. A company’s lawyers should implement a “document hold” to preserve potential evidence and avoid the risk of sanctions for not doing so. Quickly preparing for litigation often helps facilitate an early and favorable resolution.
Knowing Your Enemy
Not all NPEs are created equal. Knowing your adversary, and its lawyers, is essential. Researching who the company is, how many patents they own and have licensed, whether they have any other assets or operations that may be vulnerable to counterclaims, how often they have taken their claims to trial, and what type of settlements they have worked out in the past all provides insight into resolving a case. A start-up NPE with only a few patents may be less willing to risk its limited resources in litigation. An experienced NPE with a large portfolio may be more willing to tolerate a measure of risk with the hope of obtaining a large award. Developing an effective strategy also depends on understanding an NPE’s business model. NPEs may target many defendants to accumulate many small license fees, seek larger fees from a smaller number of defendants, or look for a homerun by targeting just a handful of companies for multi-million dollar settlements or damages awards. The quality and track record of the NPE’s selected counsel, and whether they typically charge hourly or on contingency, may also reflect the investment the NPE is prepared to put into its case. Using discovery, once it begins, to uncover a troll’s prior licenses and settlements permits the prepared defendant to bargain for a better deal, or at least an equally favorable deal, compared to others. Knowing which routes an NPE usually follows is a useful guide in developing an opposition strategy.
Knowing Your Enemy’s Weapons
NPEs assert patents of varying strengths. Candidly reviewing each asserted patent and its applicability to a product or method accused of infringing obviously informs litigation strategy. Whether the patent at issue already has been tested – in litigation or other legal proceedings, like reexaminations before the Patent Office – may be an indicator of the strength of the case. If the NPE is asserting a patent for the first time, it may be willing to offer a better licensing deal to early licensees. And if the patent has not yet been tested in litigation and has not yet survived challenges to its validity, a vigorous attack on the patent itself in view of the prior art may expose new vulnerabilities.
Fighting on Your Own Turf (or at Least the Most Favorable Turf)
One of the most important influences on outcome is venue. Although plaintiffs generally select their preferred courts in which to file suit, companies accused of infringement usually have options to secure a more favorable forum. If an NPE has been threatening litigation but has not yet filed suit, an accused infringer may start the litigation and pick the battlefield by seeking a declaratory judgment (of non-infringement or invalidity) in a court of its choice, such as its home state or a locale where it enjoys name recognition and a positive reputation. NPEs often prefer forums with historically short times to trial, such as the Eastern District of Texas and the Eastern District of Virginia, although recent increases in time to trial in Texas may be changing the calculation. See PriceWaterhouseCoopers, A Closer Look: Patent Litigation Trends and the Increasing Impact of Nonpracticing Entities, 17 (2009). Speed is valuable to NPEs, and especially to counsel representing them on contingency, because it lessens legal fees and shortens the time to secure a settlement or verdict. The Eastern District of Texas is a popular venue choice for NPEs because of a perception that it is both friendly to plaintiffs and moves cases to trial quickly.
Even when an NPE has already filed suit in a preferred forum, the battle for venue is by no means over. A growing body of case law has made clear that if a defendant does not have significant ties to the venue, and another court is clearly better situated to try the case, transferring venue may be in order. Recent decisions from the Federal Circuit have eased the requirements for venue transfer and given defendants new ammunition when attempting their cases to more appropriate venues. The shift began with In re TS Tech USA Corp., 551 F.3d 1315 (Fed. Cir. 2008), in which the Federal Circuit reversed the denial of a transfer motion by a trial judge in the Eastern District of Texas. The Federal Circuit held that the trial court had erred in its weighing of the factors for and against transfer. Id. at 1320-21. The district court gave too much deference to the plaintiff’s choice of venue by treating it as a separate factor weighing against transfer and gave insufficient weight to the inconvenience to witnesses, ease of access to evidence, and the localized interests of the transferee venue. Id. The deference some trial courts had given plaintiffs’ choice of venue was further eroded the following year by In re Genentech, Inc., 566 F.3d 1338 (Fed. Cir. 2009), in which the Federal Circuit ordered transfer to the Northern District of California because many of the witnesses and much of the physical evidence was in California and none was in the Eastern District of Texas. Id. at 1344-46. These decisions have made it easier for some defendants to transfer cases out of the Eastern District of Texas – particularly where the evidence and witnesses are located elsewhere. See, e.g., In re Microsoft Corp., 630 F.3d 1361 (Fed. Cir. 2011) (granting transfer when Plaintiff’s presence in Texas was established solely for litigation).
Fighting with the Right Platoon
NPEs often name as many defendants in a case as possible to try and defeat potential venue transfer motions (by naming defendants located throughout the country and some in Texas) and to exploit potential conflicts in claim construction, non-infringement, discovery and other strategic issues. However, defendants can take advantage of being sued together in a number of ways. Most familiar, defendants can pool resources in a joint defense group and share fees and costs associated with common work, such as claim construction, invalidity, and discovery of the NPE. Defendants may also be able to achieve more favorable settlements as members of a group than they would otherwise obtain on their own.
It does not always make sense for defendants to stay together in a group, however. Another important strategic move can be to move to sever one’s case from other defendants who are uncooperative or have different interests, often in connection with a motion to transfer, or a motion to sever under Federal Rule of Civil Procedure 21. There is a current strand of thought in the Federal Circuit and elsewhere that multi-defendant patent cases are actually a violation of Federal Rule of Civil Procedure 20, which outlines what parties may be joined as defendants in a single action, and many companies view misjoinder motions as a way of gaining some control over large multi-defendant patent suits. Severing a case may also give an individual defendant greater control of strategy, can avoid conflicts, and may result in another defendant’s case being resolved first, providing a preview of litigation developments.
Counterattacks
It is a common misconception that typical trolls have no exposure to liability in the patent lawsuits they file. But patent litigation provides defendants with an opportunity to target an NPE’s most valuable assets, often only assets, its patents, by proving their invalidity or unenforceability. Focusing on ownership and assignment has also been an effective strategy for many defendants involved in litigation with patent trolls. Proving improper assignment through different entities, co-ownership of patents through divorce proceedings, or improperly identified inventors are some ways that defendants have turned the tables on patent trolls. Defendants also should pursue all available discovery that could uncover invalidating prior art or activity. Not just deposing the inventors, but also seeking evidence from them, their current or former employers, co-workers, and consultants, to name a few, may reveal helpful prior art or evidence of invalidating public disclosure or early sale of the patented inventions. Aggressive and creative discovery by the defense often exposes invalidity issues that trolls failed to anticipate before filing suit.
Defendants also should seize every opportunity to exploit behavior by an NPE that could subject it to counterclaims. For example, abusing the patent system or engaging in monopolistic practices may subject NPEs, even those that do not compete in the marketplace, to serious counterclaims. See, e.g., Senza-Gel Corp. v. Seiffhart, 803 F.2d 661, 667-68 (Fed. Cir. 1986) (finding patent misuse). And NPEs who are overly aggressive in their pre-litigation tactics and communications with potential infringers and their customers may find themselves subject to claims for wrongly interfering with business relationships. See, e.g., Enzo Life Sciences, Inc. v. Digene Corp., 295 F. Supp. 2d 424, 429-30 (D. Del. 2003). Thinking creatively, and outside the context of traditional patent defenses, can help the thoughtful defendant apply unexpected litigation pressures. Few NPEs are prepared to have their role as plaintiff reversed and take on the burden and expense of defending against counterclaims, which may provide valuable leverage.
Proceedings in the Patent Office
Initiating proceedings before the Patent Office to reexamine the validity of a plaintiff’s issued patent can be a valuable tool that impacts litigation. For example, some – but far from all – courts may be persuaded to stay their proceedings pending the outcome of a reexamination, providing a respite from the expense of litigation. The extra burden and risk to a plaintiff whose patent is being reexamined for validity may factor into a potential settlement. But reexaminations carry potential risks and should be used very carefully. If the Patent Office confirms in reexamination that the patent is valid, and the patent emerges from the proceedings unscathed, the NPE may well be in a stronger position than before the reexamination, its patent now battle-tested. With an ex parte reexamination, where a third party (often the defendant in litigation) initiates but does not participate in the reexamination, if the Patent Office does not narrow or invalidate the claims, the patent may appear more legitimate in litigation, especially since the NPE will most certainly have provided the Patent Office all of the prior art produced by the defendants in the lawsuit, “washing” that art in the eyes of the judge and jury. With an inter partes reexamination, where a third party initiates and also participates in the reexamination, the risks are even greater. Although the initiating party is allowed to participate in the inter partes proceeding, the cost for that participation is that the initiating party may be estopped in litigation from challenging patent claims on invalidity grounds that were or could have been raised in the course of an inter partes reexamination. In the end, a successful reexamination that invalidates or narrows a patent’s claims can be an effective way to weaken the position of an NPE, but the decision to file for reexamination depends on a careful consideration of the specific facts and circumstances surrounding the case, including whether a particular judge is likely to stay proceedings pending the reexamination.
Major Patent Case Milestones
Another important strategic decision involves when to request a claim construction hearing. An early interpretation of the patent’s claims is often advantageous to defendants because a positive defense construction (for example, a narrow construction that avoids infringement or a broad construction that supports an invalidity argument) may undercut an NPE’s theory of the case. At a minimum, the parties have more clarity as to the direction of the case once the meaning of disputed patent claim terms is resolved. Because the discovery burdens typically weigh far more heavily on defendants than plaintiffs in patent cases, having claim construction issues resolved early and before much discovery takes place can effect significant savings in costs and legal fees. Some courts, recognizing that claim construction can be case dispositive, may also stay fact discovery until claim construction is resolved.
Early summary judgment on non-infringement or invalidity can also save defense costs by bringing about a swifter resolution. Summary judgment also keeps the cases out of the hands of juries, where NPEs tend to have far higher success rates than they do at the summary judgment stage. See PriceWaterhouseCoopers, at 12.
Trial Themes
A clear and compelling trial theme is as important to winning a case against an NPE as any other. The contrast between NPEs who simply collect patents without contributing valuable products or technology to the marketplace, on one hand, and companies that through innovation and entrepreneurialism bring new products to market, on the other, often resonates with juries. On the other hand, NPEs often attempt to present themselves as the everyman “David” against “Goliath” corporations, and defendants in such cases are well served by personalizing their case with human interest stories about the individuals who independently created new technology now accused of infringement. Arriving at universal trial themes early in a case helps separate the important from the irrelevant throughout the litigation, and humanizes the story before a judge and jury, setting the framework for a winning defense.
Conclusion
Developing an effective defense against a troll requires understanding the themes common to NPE cases and tailoring the strategies to the specific characteristics of a particular adversary. Patent trolls or NPEs, a reality of today’s business climate, must be taken seriously and an informed and comprehensive litigation strategy can maximize the opportunity for a successful resolution.
July 2011: London Litigation Update
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CDO Misselling: In Cassa di Risparmio della Repubblicca di San Marino SpA (“CRSM”) v. Barclays Bank Ltd (“Barclays”), Case No: 08-757, High Court of Justice, Queen’s Bench Division, the court provided a clear summary of the legal principles that apply in CDO misselling claims, particularly if contractual disclaimer is at issue. Barclays sold CRSM four sets of AAA-rated, credit-linked notes (the “Notes”) in 2004/early 2005 having a total face value of €406 million. The Notes matured in 5 to 7 ½ years. In exchange for the principal value of the Notes, CRSM received a coupon for approximately Euribor + 0.95 %. CRSM’s central claim was that although Barclays had sold it the Notes on the basis of an AAA-rating that Barclays intended it to rely upon, and upon which it did rely, Barclays knew through internal modeling that the Notes had a probability of default equivalent to B-rated instruments. CRSM further alleged that Barclays deliberately structured the Notes to maximize its own profits.
Barclays’s expert witness testified that this practice – known as “credit ratings arbitrage” – was widespread in the structured finance sector during the boom. In many U.S. courts, the claimants have argued successfully that banks engaging in such practices acted fraudulently.
Nonetheless, the court agreed with Barclays that, on the facts, this aspect of CRSM’s claim “compared the incomparable.” Unlike the Notes’ credit rating, the court found that Barclays’s internal projection of the risks associated with the Notes was not concerned with default risk. Instead, its purpose was to derive a market price for the Notes to mark its books to market, hedge against the risks associated with the Notes, and calculate notional profits.
Barclays also argued that CRSM’s claims were defeated by the terms and conditions of the Notes and disclaimers in the deal documentation. However, the court made it clear that although contracting parties may agree that one party has not made any pre-contractual representations, or that any such representations will not be relied upon, very clear language will be necessary if a term is to be construed as having that effect.
The decision will be welcomed by banks as yet another case in which investors’ claims concerning complex financial products have been dismissed. That said, claimants will draw comfort from the court’s clarification that misrepresentation claims are contractually excluded only if the banks’ disclaimers are sufficiently precise. The key implication is that the stronger the evidence, the more difficult it will be for banks to rely on standard, widely worded disclaimers.
Commercial Contracts: Although disagreements concerning the meaning of contract documents are not new, they are becoming more common in complex debt restructuring cases. Under the “modern approach,” contractual interpretation requires a court to decide how a “reasonable person,” having all the background knowledge available to the parties, would have understood the words when the contract was made. According to Lord Neuberger, contractual interpretation is now an “iterative process” that requires “checking each of the rival meanings against other provisions of the document and investigating [their] commercial consequences.” So long as an argument for a particular interpretation can be made in good faith based on background material and commercial purpose, a party is legitimately entitled to raise that argument. The court will then be required to decide between the alternatives, even if the literal meaning of the contract is clear and unambiguous on its face.
Quinn Emanuel was recently involved in a case (European Directories (2010)) which shows how this approach is applied to distressed investments. In European Directories, the European Directories group borrowed money under a €1.5 billion senior facilities agreement in exchange for guarantees and security from various group companies. A restructuring was proposed pursuant to which the group’s holding company, DH7, would be placed into administration and DH7’s shares in its subsidiaries would be sold to a new company. To complete the restructuring, the administrators needed to transfer the subsidiaries’ liabilities. They also needed to release the guarantees and security granted by DH7 and its subsidiaries pursuant to using a “release on disposals” clause. Under a narrow construction, that clause permitted the administrators to release only DH7’s liabilities, not those of the subsidiaries. According to the High Court, the clause extended only to DH7; its purpose had to be determined from its wording, and its scope “should not be enlarged beyond the ambit of the clause itself” so as to apply to the subsidiaries by reference to a priori notions of commerciality. However, the Court of Appeal disagreed, holding that the clause had to be construed broadly and that the administrators’ powers extended to the subsidiaries as well. The Court of Appeals reasoned that because the commercial purpose of the clause was to maximize the value of the disposal, in circumstances where a clause was capable of two meanings and neither flouted business common sense, courts should adopt the more commercial construction.
July 2011: Bankruptcy Litigation Update
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Supreme Court Limits Bankruptcy Court Authority to Render Final Orders on State Law Counterclaims: The Supreme Court recently issued a decision resolving “two issues: (1) whether the Bankruptcy Court had the statutory authority under 28 U.S.C. § 157(b) to issue a final judgment on [a debtor’s counterclaim against a creditor]; and (2) if so, whether conferring such authority on the Bankruptcy Court is constitutional.” Stern v. Marshall, 131 S.C. 2594, 2600. Stern involves a dispute between Vickie Marshall (professionally known as Anna Nicole Smith) and Pierce Marshall regarding the disposition of the assets of J. Howard Marshall, Vickie’s husband and Pierce’s father.
During the pendency of this dispute, Vickie filed for chapter 11 bankruptcy protection. Pierce filed a proof of claim in Vickie’s chapter 11 case in respect of a pending litigation over defamation of character. Vickie responded by asserting a counterclaim for tortious interference with a gift she expected from J. Marshall. The Bankruptcy Court for the Central District of California subsequently entered judgment in Vickie’s favor. The District Court held that the Bankruptcy Court lacked authority to enter a final order, but ultimately affirmed the Bankruptcy Court’s holding. However, by the time the California District Court entered its order on appeal, a jury paneled in Texas State Court found for Pierce on his defamation claim. The Ninth Circuit ultimately held that because the Bankruptcy Court lacked authority to enter a final order, the Texas State Court judgment, as the first final judgment entered by a court of competent jurisdiction, controlled.
In discussing the Bankruptcy Court’s authority to enter a final order on the state law counterclaim, the Supreme Court first construed the scope of 28 U.S.C. § 157(b)(2)(c). The Supreme Court held that Congress had clearly provided that counterclaims against the debtor were “core” matters under section 157(b)(2)(c) and that such section evidenced Congress’s clear intent to provide the bankruptcy courts with authority to hear and enter final orders on such counterclaims. However, the Supreme Court held that while section 157(b)(2)(c) provided bankruptcy courts with statutory authority to enter final orders on such counterclaims, such authority violated Article III of the Constitution which vests the “judicial power of the United States” solely in judges with life tenure and salary protection.
The Supreme Court held that Article III of the Constitution limited the Article I bankruptcy courts’ authority to enter final judgments to those situations where: “the action at issue stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.” Id. at 2618 Ultimately, the Supreme Court held that the state common law tortious interference claim did not stem from the bankruptcy, as it was a claim arising under state common law, and was not integral to determining the allowance or disallowance of Pierce’s claims against Vickie’s estate. As such, the Court held that Article III of the Constitution prevented the bankruptcy court from entering a final order on the state law counterclaims.
Stern has sparked significant debate among litigants over its scope or whether it should be limited to its facts. The extent to which courts and litigants will use this opinion as a means to move adjudication of bankruptcy matters to final judgment from the United States Bankruptcy Courts to United States District Courts also remains to be seen.
Bankruptcy Court Holds That Transaction Regarding Closely Held Corporation Is Subject to Challenge as a Constructive Fraudulent Transfer Notwithstanding Safe Harbor Provisions: On April 21, 2011, the United States Bankruptcy Court for the Southern District of New York held that section 546(e) of the Bankruptcy Code, which protects certain transfers (in particular margin and settlement payments and transfers made under a securities contract between the debtor and a qualifying financial participant) from avoidance absent actual fraud, did not apply to transfers connected with a transaction regarding a closely-owned corporation.
In MacNenamin’s Grill, the debtor was a closely-held corporation owned by three equal shareholders. In 2007, the debtor entered into a stock purchase agreement with the shareholders to repurchase all outstanding stock. The stock sale was financed by a bank loan secured by the debtor’s assets. The debtor was unable to service the acquisition loan and filed for chapter 11 protection. The chapter 11 trustee subsequently commenced an action to avoid both the cash transfers to the shareholders and the bank loan and security interest as constructive fraudulent transfers. The shareholders and lender each argued that the transaction was protected by the section 546(e) safe harbors.
The Bankruptcy Court held that section 546(e) was inapplicable cash transfers to shareholders involving a small, private transaction, notwithstanding that they were settlement payments were made through a financial intermediary (i.e., a bank). The court noted that the policies underlying the statutory safe harbor provisions (i.e., the reduction of systemic risk and preservation of the financial markets) were not served by protecting the sale of three shareholders’ interests in a small business when the funds simply passed through a financial institution. The court adopted a five-part test to determine whether a transaction qualified for protection under the Bankruptcy Code safe harbor provisions:
(1) whether the transactions were long settled through actual transfers of consideration, so that a subsequent reversal of the trade could disrupt the securities industry, potentially creating a chain reaction that could cause the affected market to collapse;
(2) whether consideration was paid for the securities or property interest as part of the settlement of the transaction;
(3) whether the transfer of cash or securities effected contemplated the consummation of a securities transaction;
(4) whether the transfers were made to financial intermediaries involved in the national clearance and settlement system; and
(5) whether the transaction affected participants in the system of intermediaries and guaranties involved in the clearing and settlement process of public markets, thus creating the potential for adverse impact on the securities market if any of the guaranties were invoked.
The Bankruptcy Court found that the shareholders did not provide “any evidence that the avoidance of the transaction at issue involved any entity in its capacity as a participant in any securities market, or that the avoidance of the transactions at issue poses any danger to the functioning of the securities market.” As such, the court found that the section 546(e) safe harbor provisions did not apply.
The court further held that the Section 546(e) protections did not apply to the trustee’s action to avoid the underlying loan obligations. It noted that the reasons for holding the safe harbors inapplicable applied equally to the shareholders and lenders. It further held that Section 546(e) applies only to actions to avoid a “transfer of property of the debtor” and not to actions to avoid incurring an obligation of the debtor. Because the loan agreement constituted the incurrence of an obligation by the debtor, it was not protected by the statutory safe harbor. The case is Geltzer v. Mooney (In re MacNenamin’s Grill LTD), 09-8266 (Bankr. S.D.N.Y. April 21, 2011).
Second Circuit Rules that Chapter 11 “Gifting” Plan Violates Absolute Priority Rule: The Second Circuit recently held that a chapter 11 plan allowing a secured creditor to “gift” property to a junior class of stake holders, notwithstanding that a more senior class of unsecured creditors had not been paid in full, violated the Absolute Priority Rule of Bankruptcy Code section 1129. In re DBSD North America, Inc., 634 F.3d 79, 100 (2d Cir. 2011). In DBSD, the debtor sought confirmation of a chapter 11 plan to refinance the first lien debt, equitize the second lien debt (at less than par recovery), distribute new equity to holders of unsecured claims (providing a recovery estimated at less than 50% ), and distribute new shares and warrants to the existing equity holder. Sprint Nextel objected that the plan violated the Absolute Priority Rule, which provides that absent the agreement of all senior classes, junior creditors classes and interest holders may not receive distributions under a reorganization plan unless all senior classes are paid in full.
The Second Circuit reversed the bankruptcy court, holding that the distribution to existing equity holders, though labeled a “gift,” was nonetheless a distribution that failed to comply with Bankruptcy Code section 1129(b)(2)(B). In doing so, the Court distinguished the leading gifting case, In re SPM Manufacturing Corp., 984 F.2d 1305 (1st Cir. 1993), on the basis that SPM involved a chapter 7 case in which a secured creditor had already obtained relief from the automatic stay. It was therefore free to dispose of its recouped collateral as it saw fit because distribution was not made pursuant to a chapter 11 plan.
DBSD might make it more difficult to achieve consensus in complex chapter 11 cases by creating obstacles to allocating value to junior stakeholders. DBSD is also noteworthy in that it upheld a bankruptcy court ruling designating (i.e. disregarding) DISH Network’s vote on the basis that DISH voted against the plan not as a creditor seeking to maximize its return but as a competitor seeking to gain control of the debtor. Prior rulings had established that Bankruptcy Code section 1126(e) (authorizing the designation of votes) should be invoked sparingly, but the facts supported the designation of DISH’s vote.
July 2011: Trademark and Copyright Litigation Update
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Logos, Emblems, and Characters Find Trademark Protection Tenuous in Wake of Ninth Circuit Decision: On February 23, 2011, the Ninth Circuit affirmed the grant of summary judgment against Fleischer Studios, which claimed ownership and infringement of the Betty Boop character under both copyright and trademark theories. Fleischer Studios v. A.V.E.L.A., Inc., 636 F.3d 1115 (9th Cir. 2011). While the copyright ruling is unlikely to have a broad impact beyond this case, the trademark ruling substantially restricts the scope of trademark protection, especially as to copyrightable works of authorship.
Max Fleischer first developed the Betty Boop cartoon character in 1930. The plaintiff, Fleischer Studios, claimed ownership of the copyright to the Betty Boop character through a chain of assignments. The district court found that a break in the chain of title meant that Fleischer Studios did not own the character and had no standing to sue for infringement of it. The Ninth Circuit affirmed, disposing of Fleischer’s copyright infringement claim.
It is for the trademark infringement analysis, however, that Fleischer is most significant. There the court looked to two cases, neither cited by the parties, to conclude that “functional aesthetic” works, like the Betty Boop character, receive no trademark protection and that copyrightable works, like the character, likewise cannot receive trademark protection where the copyright is in the public domain. 636 F.3d at 1124-25 (citing Int’l Order of Job’s Daughters v. Lindeburg & Co., 633 F.2d 912 (9th Cir. 1980) and Dastar Corp. v. Twentieth Century Fox Film Corp., 539 U.S. 23 (2003)).
The “functional aesthetic” doctrine revived by the court distinguishes between the use of a plaintiff’s mark in a manner that causes consumer confusion as to “the maker, sponsor, or endorser of the product” and the use of a mark by its wearer to “publicly express her allegiance to [an] organization.” 636 F.3d at 1123. Only the former is actionable; the latter is permitted. As the Fleischer Studios court explained, Job’s Daughters held that where the defendant’s use of the plaintiff’s emblem (on jewelry) was a “prominent feature of each item so as to be visible to others when worn,” “never designated the merchandise as ‘official’ merchandise or otherwise affirmatively indicated sponsorship,” and “did not show a single instance in which a customer was misled about the origin, sponsorship, or endorsement [ ] nor that it received any complaints about [the challenged products]. there was no infringement.” 636 F.3d at 1124. The emblem was “functional[ly] aesthetic,” and unprotected from such alleged infringement. Job’s Daughters, 633 F.3d at 920. Applying the same analysis led the Fleischer Studios court to the same result: the images of Betty Boop, as used in the defendant’s dolls, t-shirts and handbags, were functionally aesthetic – the character was “a prominent feature of each item so as to be visible to others when worn,” and it was not used to indicate Fleischer’s sponsorship; it was “functional and aesthetic.” 636 F.3d at 1124-25.
The panel also applied the Supreme Court’s 2003 decision in Dastar. In that case, the Supreme Court held that where a copyright is in the public domain, a party may not assert a trademark infringement action against an alleged infringer if that action is essentially a substitute for a copyright infringement action. The Fleischer Studios court ruled, sua sponte, that this precluded a finding of trademark protection for Betty Boop since the plaintiff’s claim for copyright protection failed. To hold otherwise, the court reasoned, would allow trademark holders perpetual rights to exploit their creative works, which conflicts with the principles of copyright.
Ninth Circuit Limits Scope of Copyright Preemption: In our July 2010 Newsletter, we noted a significant new Ninth Circuit decision, Montz v. Pilgrim Films & Television, Inc., et al., 2010 WL 2197421 (9th Cir. June 3, 2010), which appeared to substantially enhance the force and effect of copyright preemption in the implied-in-fact contract context. In Montz, the plaintiffs sued a studio and others, claiming they had conceived and pitched the idea for a reality television series investigating paranormal activity with the assistance of high-tech equipment. The studio later aired a show, “Ghost Hunters,” allegedly based on plaintiffs’ pitch but without credit or compensation, leading to claims for copyright infringement, breach of implied-in-fact contract, and breach of confidence. The Ninth Circuit at first affirmed dismissal of the non-copyright causes of action, holding they were preempted by the Copyright Act, 17 U.S.C. § 301(a), et seq., because there was no “extra element” to distinguish those claims from the copyright infringement claim. As we reported last year, that was a significant addition to Ninth Circuit jurisprudence on copyright preemption, and limited the court’s prior decision in Grosso v. Miramax Film Corp., 383 F.3d 965 (9th Cir. 2004).
The Ninth Circuit then decided to rehear the matter en banc, and in May it reversed course, holding in a 7-4 decision that neither the breach of implied contract nor the breach of confidence claim was preempted. Montz v. Pilgrim Films & Television, Inc., 2011 WL 1663119 (9th Cir. May 4, 2011). The court reaffirmed, as it had ruled in Grosso, that a bilateral expectation of payment, at least in the context of an idea pitch, is an “extra element” that “transforms a claim from one asserting a right exclusively protected by federal copyright law, to a contractual claim that is not preempted by copyright law.” 2011 WL 1663,119 at *1. An implied agreement to “pay for use of the disclosed ideas” is, unlike the “monopoly protection of copyright law,” a “personal” relationship between the parties which yields the required extra element to avoid preemption. Id. at *4-5. Like “[c]ontract claims generally,” which survive preemption because they require proof of such an extra element, a claim for breach of an “implied agreement of payment for use of a concept” is not preempted. Id. at *4. Moreover, the breach of confidence claim “protects the duty of trust or confidential relationship between the parties, an extra element that makes it qualitatively different from a copyright claim.” Id. at *6.
The en banc Montz decision, which is of clear benefit to plaintiffs, imposes important limits on copyright preemption in the Ninth Circuit. The en banc court not only vacated the prior panel’s opinion, but, notably, also cited a longstanding Ninth Circuit precedent relied on by defendants urging preemption – Del Madera Props. v. Rhodes & Gardner, Inc., 820 F.2d 973 (9th Cir. 1986). Del Madera, discussed at length by the dissent in Montz, held a claim for unjust enrichment based on an implied promise to be preempted by copyright. Del Madera Properties v. Rhodes and Gardner, Inc., 820 F.2d 973, 977 (9th Cir. 1987) (“The foundation of Del Madera’s unjust enrichment claim is its contention that the defendants violated an implied promise, based on the parties’ relationship, not to use the Tentative Map and supporting documents. But an implied promise not to use or copy materials within the subject matter of copyright is equivalent to the protection provided by section 106 of the Copyright Act. Therefore, this portion of Del Madera’s unjust enrichment claim is also preempted.”). See Montz, 2011 WL 1663119 at *10 (dissent) (“a breach of a relationship of trust does not, by itself, transform the nature of an action”) (citing Del Madera). While it does not do so expressly, the majority’s opinion, which cites but does not follow this precedent, arguably overrules it.
State law causes of action for idea theft, which hearken back at least to Desny v. Wilder, 299 P.2d 257 (Cal. 1956), are alive and well in the Ninth Circuit following Montz. “Since an idea cannot be copyrighted, a concept for a film or television show cannot be protected by a copyright. 17 U.S.C. § 102. But the concept can still be stolen if the studio violates an implied contract to pay the writer for using it.” Montz, 2011 WL 1663119 at *3.
Transfers from the So-Called “Rocket Docket” May Reach Escape Velocity
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Patent infringement suits against national corporations can be brought in virtually any district court in the United States. See Elizabeth P. Offen-Brown, Forum Shopping and Venue Transfer in Patent Cases: Marshall’s Response to TS Tech and Genetech, 25 Berkeley Tech. L.J. 61, 66 (2010). The past decade saw a dramatic surge in the increase of patent infringement suits filed in the Eastern District of Texas. See id. at 70; Julie Creswell, So Small a Town, So Many Patent Suits, N.Y. Times (Sept. 24, 2006). The Eastern District’s popularity is generally attributed to plaintiff-friendly juries, large jury awards in patent infringement cases, and relatively short times to trial. Even though most cases filed in the Eastern District have little or no connection to that forum, defendants have typically had little success in transferring cases elsewhere. However, the Eastern District may be losing its status as a “rocket docket” known for speedy trials and judges hesitant to grant venue transfer motions. Over the past two years, the Federal Circuit has increasingly scrutinized denials of motions to transfer venue, making the Eastern District less attractive to forum-shopping plaintiffs. Also, time to trial has increased to over two years.
Motions to transfer venue in patent cases, like all federal civil cases, are governed by 28 U.S.C. § 1404(a), which permits transfer “[f]or the convenience of the parties and witnesses.” In the Fifth Circuit, a party seeking transfer must establish that the proposed venue is “clearly more convenient” than the plaintiff’s chosen venue. In re Volkswagen of America, Inc., 545 F.3d 304, 315 (5th Cir. 2008) (“Volkswagen II”) (en banc). The transfer analysis requires courts to consider a number of “public” and “private” interest factors, including, among others: (1) the relative ease of access to sources of proof; (2) the availability of compulsory process; (3) the cost of attendance for witnesses; and (4) the local interest in having localized interests decided at home. Id.
Putting the Brakes on Forum Shopping
The Federal Circuit’s crackdown on forum-shopping began with In re TS Tech USA Corp., 551 F.3d 1315 (Fed. Cir. 2008). The plaintiff, a Michigan-based corporation, filed a patent infringement suit in the Eastern District of Texas against TS Tech, an Ohio corporation, and related defendants. TS Tech moved to transfer the case to the Southern District of Ohio, asserting that it was a far more convenient forum because most of the physical and documentary evidence was located in Ohio, and the key witnesses lived in Ohio, Michigan, and Canada. It also argued that the case had no meaningful connection to the Eastern District of Texas because none of the parties were incorporated or had offices in Texas. The plaintiff opposed transfer, maintaining that venue was proper because some of the allegedly infringing products were sold there. The district court denied the motion, holding that: (1) TS Tech had failed to demonstrate that the inconvenience to the parties and witnesses clearly outweighed the deference to the plaintiff’s choice of forum, and (2) because some of the allegedly infringing products were sold in the Eastern District of Texas, its citizens had a “substantial interest” in having the case tried locally. Id. at 1318.
TS Tech filed a petition for a writ of mandamus. The Federal Circuit unanimously ruled in favor of TS Tech, holding that the district court had erred by treating the plaintiff’s choice of forum as a distinct factor in the § 1404(a) analysis. Id. at 1320. The moving party’s burden to show that the transferee venue is “clearly more convenient,” said the Federal Circuit, already incorporates the proper deference to the plaintiff’s choice of venue. Id. The district court had also erred by ignoring the Fifth Circuit’s 100-mile rule, which holds that when the distance between the existing venue and the transferee venue is more than 100 miles, “the factor of inconvenience to the witnesses increases in direct relationship to the additional distance to be traveled.” Id. Third, the district court had incorrectly treated the location of the physical and documentary evidence—all of which was far more conveniently located to Ohio—as a neutral factor in the analysis. Id. at 1321. Finally, it held that the mere fact that some of the allegedly infringing products were sold in the Eastern District did not create a meaningful connection to the venue. Rather, because the products were sold throughout the United States, the citizens of the Eastern District had no more interest in having the case tried locally than citizens of any other district. Id. The Federal Circuit therefore ordered the case transferred to the Southern District of Ohio.
The following year, the Federal Circuit decided a slightly more difficult case, In re Genetech, Inc., 566 F.3d 1338 (Fed. Cir. 2009). In contrast to TS Tech—in which the physical evidence and witnesses were all located in or close to the transfer venue—Genetech involved decentralized evidence, parties, and witnesses. The plaintiff, a German pharmaceutical firm, had filed a patent infringement suit in the Eastern District of Texas against two California defendants. The defendants sought to transfer the case to the Northern District of California, identifying at least ten witnesses who resided in that state. The plaintiff, who opposed the motion, indentified several witnesses in Europe, on the East Coast, and in Iowa. Most of the defendants’ physical evidence was located in California, while the plaintiff pointed to evidence located in Europe and Washington, D.C. It was undisputed that no witnesses or evidence were located in the Eastern District of Texas. The district court denied the motion, reasoning that it would be easier for the witnesses on the East Coast and in Europe to travel to Texas than to California, and easier for the plaintiff to transport its physical evidence from Europe to Texas. The district court also noted that one of the defendants had previously chosen to file an unrelated suit in the Eastern District of Texas, and therefore could hardly complain that the venue was now inconvenient. See id. at 1346.
On a petition for a writ of mandamus, the Federal Circuit rejected the district court’s reasoning that Texas’ “central” location in the middle of the country made the Eastern District a more convenient location than California. First, the witnesses from Europe, the East Coast, and Iowa would already be forced to travel a significant distance; it would be only slightly more inconvenient for them to travel the additional distance to California. Second, keeping the case in the Eastern District of Texas would impose a significant burden on the defendants to transport documents from California. Because the plaintiff already had to transport its evidence from Europe and Washington, D.C., bringing it to California rather than Texas could not pose a great additional burden. Third, there were a substantial number of witnesses who could be compelled to appear at trial in the Northern District of California through the court’s 100-mile subpoena power, but no witnesses were within the Eastern District’s subpoena power. Finally, because the case previously filed in the Eastern District involved a different set of parties, witnesses, and facts, the district court had erred by concluding that judicial economy weighed against transfer. The Federal Circuit ordered transfer to the Northern District of California.
Similarly, in In re Nintendo Co. Ltd., 589 F.3d 1194 (Fed. Cir. 2009), witnesses resided in Washington, Japan, Ohio, and New York, but not Texas; no evidence was located in Texas; and none of the parties were incorporated or had offices in the state. The Federal Circuit ordered that the suit be transferred to the Western District of Washington, instructing that when “witnesses and evidence are closer to the transferee venue, and there are few or no convenience factors favoring the venue chosen by plaintiff, the trial court should grant a motion to transfer.” Id. at 1198.
The Federal Circuit Rejects Plaintiffs’ Attempts to Prevent Transfer
In In re Hoffman-La Roche Inc., 587 F.3d 1333 (Fed. Cir. 2009), the Federal Circuit unanimously granted a writ of mandamus and ordered transfer of a patent infringement suit to North Carolina, where several key witnesses were located. Attempting to create a connection with the Eastern District of Texas, the California plaintiff had converted 75,000 pages of documents into electronic format and transferred them to its counsel’s Texas office. The Federal Circuit dismissed that as a thinly-veiled attempt to manipulate venue. Id. at 1336-37.
Similarly, in In re Zimmer Holdings, Inc., 609 F.3d 1378 (Fed. Cir. 2010), the Federal Circuit rejected the plaintiff’s claim that its business presence in the Eastern District weighed against transfer. The plaintiff, a Michigan corporation, had merely transferred files from its corporate headquarters in Michigan to recently-acquired Texas office space, which it shared with another of its counsel’s clients. The plaintiff had no employees in Texas and, in the view of the Federal Circuit was “attempting to game the system by artificially seeking to establish venue.” Id. at 1381. The Federal Circuit also rejected the district court’s finding that judicial economy would be served by keeping the suit in the Eastern District because the plaintiff had also sued another defendant in the district. According to the Federal Circuit, the overlap between the two cases was “negligible” and both were in the early stages of litigation. Id. at 1382. The court ordered transfer to the Northern District of Indiana, where the defendant’s principal place of business and at least eight witnesses were located.
Most recently, in In re Microsoft Corp., 630 F.3d 1361 (Fed. Cir. 2011), a plaintiff opened an office in Texas, moved documents there from the United Kingdom, and incorporated in Texas before filing suit in the Eastern District. The district court relied on these facts in denying a motion to transfer—a decision unanimously reversed by the Federal Circuit, on the basis that the plaintiff’s Texas office staffed no employees and was “recent, ephemeral, and an artifact of litigation [that] appeared to exist for no other purpose than to manipulate venue.” Id. at 1365. The Federal Circuit ordered transfer to the Western District of Washington, where the defendant’s principal place of business, all its witnesses, and all its relevant documents and evidence were located.
A Defendant’s Presence in Texas Does Not Preclude Transfer
In addition to rebutting attempts to establish a presence in the Eastern District to avoid transfer, the Federal Circuit has also recently rejected the argument that a defendant’s presence in the state is enough to tilt the scales against transfer. In In re Acer America Corp., 626 F.3d 1252 (Fed. Cir. 2010), a corporation headquartered in California brought suit in the Eastern District against 12 companies, 5 of which were also headquartered in California. Defendants sought transfer to the Northern District of California, but the district court denied the motion, largely because one defendant, Dell, Inc., was headquartered in the Northern District of Texas, approximately 300 miles from the court. The Federal Circuit unanimously granted a writ of mandamus, noting that all of the U.S.-based corporations except Dell, were headquartered in California, while none were located in the Eastern District. Further, significant numbers of witnesses were located in or near the Northern District of California, and therefore subject to that court’s subpoena power. Likewise, a significant portion of the evidence was located in California, but none was in the Eastern District of Texas. Finally, because a number of the companies alleged to have caused the harm, as well as the plaintiff, were all residents of the Northern District of California, the local interest factor strongly favored transfer.
Time to Trial in Eastern District Now Over Two Years
In addition to this increased likelihood of transfer, the Eastern District appears to be losing its status as a “rocket docket” where plaintiffs can be assured of a short time to trial. According to official statistics, the median time interval from filing to trial for civil cases in which trials were completed has now reached 24.2 months for the Eastern District. See Judicial Business of the United States Courts, Annual Report of the Director (2010) at Table C-10. Numerous district courts throughout the United States have shorter median times to trial. Id. While certain factors may continue to favor plaintiffs in the Eastern District, it should thus no longer be assumed that a speedy time to trial will be one of them.
Conclusion
The recent decisions of the Federal Circuit have made cases with little or no connection to the Eastern District of Texas far more susceptible to transfer. An article published last year noted that motions to transfer patent suits filed in the Eastern District have risen 270 percent since TS Tech. In addition, there is evidence that as the district’s popularity has risen, the time to trial has increased. These developments may diminish the district’s appeal to forum-shopping plaintiffs, but it remains to be seen whether the Eastern District’s popularity will disappear altogether.
Making Sense of Fraudulent Transfers, Intangible Benefits, and Lender Liability After TOUSA II
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In October 2009, Bankruptcy Judge John K. Olson of the United States Bankruptcy Court for the Southern District of Florida (the “Bankruptcy Court”), issued a controversial decision in In re TOUSA, Inc., ordering that the $403 million paid by TOUSA to settle litigation with certain lenders outside the Bankruptcy Code’s “preference” period be avoided and recovered for the benefit of certain of TOUSA’s subsidiaries’ estates as a fraudulent transfer and awarding prejudgment interest. On February 11, 2011, the district court reversed the Bankruptcy Court without remand, holding that Judge Olson’s decision was clearly erroneous. Given the complex facts and the alternative theories asserted by the plaintiff official committee of unsecured creditors, it is instructive for future stakeholders in large chapter 11 cases in which value-shifting is sought through the avoidance powers of the Bankruptcy Code to reflect on those decisions.
Factual Background
TOUSA and its subsidiaries designed, built, and marketed various sorts of residences. TOUSA was obligated on debt incurred to finance the so-called “Transeastern Joint Venture,” a very unsuccessful venture that TOUSA undertook in 2005. On July 31, 2007, TOUSA entered into a $500 million loan (the “New Loans”) with a group of new lenders (the “New Lenders”) to pay $421 million (the “Cash Transfer”) to holders of the Transeastern Joint Venture debt (the “Transeastern Lenders”) in satisfaction of their claims against TOUSA. Certain of TOUSA’s subsidiaries (the “Conveying Subsidiaries”) that were not previously liable to the Transeastern Lenders guaranteed and pledged their assets to secure the New Loans (the “Lien Transfer”). Six months later, on January 29, 2008, TOUSA and the Conveying Subsidiaries filed for chapter 11 protection.
The bankruptcy court held that the New Lenders’ claims and liens on the Conveying Subsidiaries’ assets and the Cash Transfer were fraudulent obligations of, and fraudulent transfers by, the Conveying Subsidiaries. The district court decision reversed the holding that the Cash Transfer was a fraudulent transfer by the Conveying Subsidiaries. Significantly, the opinion included findings that could impact separate appellate proceedings before the district court concerning the avoidance of the New Lenders’ claims and liens. The district court declared that the bankruptcy court had erred in concluding that: (1) the Transeastern Lenders were liable to the Conveying Subsidiaries as direct transferees of the Cash Transfer (the “Direct Transfer Holding”); and (2) pursuant to section 550(a)(1) of the Bankruptcy Code, the Transeastern Lenders were liable to the Conveying Subsidiaries as entities “for whose benefit” the Conveying Subsidiaries effectuated the Lien Transfer to the New Lenders (the “§550(a)(1) Holding”).
Dispositive Holdings
The district court rejected both premises on which the Bankruptcy Court’s Direct Transfer Holding was based. First, it held that the New Loan proceeds had never been the property of the Conveying Subsidiaries because they lacked any dominion or control over the use or disposition of the proceeds. Rather, the funds were clearly owned by TOUSA (the parent company), which had exclusive authority to control where such funds were transferred. Second, the court summarily rejected the Bankruptcy Court’s alternative basis, that the Transeastern Lenders had a property interest in the Cash Transfer because the New Loan proceeds were generated, in part, by the Conveying Subsidiaries’ agreement to be co-borrowers under the New Loans.
The district court also struck down the §#550(a)(1) Holding that the Transeastern Lenders were liable to the Conveying Subsidiaries as entities “for whose benefit” the Conveying Subsidiaries effectuated the Lien Transfer to the New Lenders, reasoning that the Lien Transfer facilitated the Cash Transfer. Citing Eleventh Circuit authority explaining that the “paradigm case of a benefit under [§ 550(a)(1)] is the benefit to a guarantor by the payment of the underlying debt of the debtor,” the district court found that the Transeastern Lenders could not be the entities for whose “benefit” the Lien Transfer was made to the New Lenders because the benefit received by the Transeastern Lenders—the Cash Transfer—was not the immediate and necessary consequence of the lien transfers. Rather, the Cash Transfer was a separate and distinct transfer.
Reasonably Equivalent Value
The district court could have reversed the Direct Transfer Holding and the §#550(a)(1) Holding based solely on the foregoing. Nonetheless, mindful that these issues would likely be appealed to the Eleventh Circuit and “for purposes of full analysis,” the district court chose to address whether the Conveying Subsidiaries received “reasonably equivalent value”—another Transeastern Lender defense to liability—in exchange for the Cash Transfer and the Lien Transfer. In doing so, it created the potential for inconsistent rulings because whether the New Loans and the Lien Transfer are avoidable by Conveying Subsidiaries is the subject of an appeal before District Judge Jordan.
Addressing the Direct Transfer Holding, the district court held that even if the Conveying Subsidiaries had a cognizable interest in the Cash Transfer, there was no fraudulent transfer liability because the Conveying Subsidiaries received reasonably equivalent value for the Cash Transfer. The court’s analysis is hard to reconcile with its other holdings. It did not focus on what the Conveying Subsidiaries received for the Cash Transfer; rather, the court focused solely on the property interest the Conveying Subsidiaries received for the Lien Transfer (i.e., the New Loan proceeds). In doing so, it therefore found value in the very property interest it held the Conveying Subsidiaries did not own.
Second, as a belt and suspenders holding to the §#550(a)(1) Holding, and notwithstading that that avoidance of the Lien Transfer was the central issue on appeal before Judge Jordan, the court addressed whether the Conveying Subsidiaries received reasonably equivalent value in exchange for the Lien Transfer. The court’s theory was that if the Lien Transfer could not be avoided, there could be no §#550(a)(1) liability because recovery under §#550(a)(1) requires avoidance as a prerequisite. Reversing the bankruptcy court’s holding that “value” must refer to an enforceable tangible or intangible article, the district court held that the Conveying Subsidiaries received indirect economic benefits constituting reasonably equivalent “value.” See Mellon Bank, N.A. v. Metro Communications, Inc., 945 F.2d 635 (3d Cir. 1991). The court found that such indirect benefits included avoiding the triggering of cross-guarantee obligations against the Conveying Subsidiaries and the concomitant disappearance of the Conveying Subsidiaries’ existing source of financing, and the resulting need to file for bankruptcy which, in turn, would raise major concerns regarding the whole enterprise’s ability to continue operating as a going concern. Notably, the district court found that those indirect benefits constituted reasonably equivalent value and reversed without remand for “quantification” of the benefit to the Conveying Subsidiaries and their unsecured creditors. The district court did not analyze whether the unsecured creditors really were better off being junior to more than $400 million of secured debt than they would have been had there been a mid-2007 bankruptcy filing. Unless the Eleventh Circuit agrees with the court’s §#550(a)(1) Holding, the failure to quantify in any fashion the indirect benefits purportedly received by the Conveying Subsidiaries may lead to reversal.
In sum, the court’s opinion appears well-reasoned concerning certain dispositive holdings. However, the alternative holdings addressing “reasonably equivalent value” may be subject to reversal, and may have created the potential for inconsistent rulings by Judge Jordan. The bar will be watching closely to see which of these issues Judge Jordan or the Eleventh Circuit chooses to address.
June 2011: Arbitration Update
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France Unveils New International Arbitration Statute: In January, France adopted a statute governing arbitration that took effect May 1, 2011. The statute is intended to maintain France’s role as a leading venue for international arbitration disputes.
Under the statute, the president of the Paris Court of First Instance is given the title of “support judge” and has the authority to support international arbitration proceedings in the event of procedural disputes. The support judge has jurisdiction when arbitration is in France or the parties have selected French procedural law. Remarkably, the support judge also has jurisdiction if one of the parties to the dispute is exposed to a risk of denial of justice, even if there is no link to France.
With respect to discovery, the new law allows parties to the arbitration to ask the support judge to order a third party to produce documents provided they first obtain permission from the tribunal. In addition, an arbitral tribunal can order the parties to produce documents subject to a penalty if they fail to comply. Another notable feature of the statute is that international arbitration clauses no longer need to be in writing, even if concluded before May 1.
The statute also changed the rule regarding suspension of the enforcement of international arbitration awards that are the subject of setting-aside proceedings in France. Under the statute, international arbitral awards are capable of enforcement in France while French proceedings to set aside the award are ongoing. An effort to set aside an award will stay enforcement only if the party seeking the stay demonstrates to the support judge that enforcement would be highly detrimental. The objective is to stop parties from initiating frivolous set-aside proceedings to delay enforcement of an arbitration award. Another provision allows the parties to waive their right to seek set aside. This provision does not, however, impact the parties’ right to appeal a court’s decision to enforce an award in France.
The law also addresses the availability of conservatory and provisional measures. It provides that once an arbitration tribunal is constituted, the tribunal has the ability to take conservatory or provisional measures. Before the tribunal is appointed, national courts have jurisdiction to order conservatory or provisional measures. These modifications to the law make France an even more attractive venue for parties engaging in international arbitration.
Motions to Vacate Arbitration Awards Are on the Uptick in U.S. Courts: The National Law Journal reports a sharp increase in the number of motions to vacate arbitration awards brought in state and federal courts. In 2010, state and federal courts issued 208 written decisions on motions to vacate arbitration awards. That was a 48% increase from 2005, when courts issued 141 decisions on motions to vacate arbitration awards. Although the increase is partially attributable to an increase in the number of arbitrations, the number of challenges are increasing at a faster rate than the number of additional arbitration proceedings.
Nevertheless, the success rate for motions to vacate remains low. The study concluded that only 13.9% of the motions decided in 2010 were successful. In 2005, 13.5% of the filed motions to vacate were successful and 16.8% of the motions to vacate filed in 2000 succeeded. This low rate of success is not surprising given the limited grounds for vacating arbitration awards under the Federal Arbitration Act and other applicable laws.
June 2011: Class Action Litigation Update
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Federal Courts Rein In California Supreme Court’s Tobacco II Decision: The California Supreme Court’s decision in In re Tobacco II Cases, 46 Cal. 4th 298 (2009), appeared to be grim news for companies defending consumer class actions under California’s Unfair Competition Law (“UCL”). The Court held that only the named plaintiffs, and not all absent class members, are required to show an “injury in fact” that resulted from the defendants’ conduct. The ruling appeared to gut a primary defense to certification in such cases: that individual issues of reliance, causation, and injury predominate over any common issues.
Many consumer class actions are now litigated in federal court under the Class Action Fairness Act, and an open question from Tobacco II was whether its relaxed standing approach conflicted with Article III’s requirement that federal court plaintiffs have suffered an injury in fact. The Eighth Circuit recently addressed the interplay of Article III and Tobacco II in Avritt v. Reliastar Life Ins., 615 F.3d 1023, 1034 (8th Cir. 2010). The Avritt plaintiffs were California residents who allegedly bought fixed deferred annuities based on a misleading rate-setting practice. They filed a class action that asserted, among other claims, violation of the UCL. The district court denied certification, finding that plaintiffs had failed to establish that common questions predominated over individual issues.
On appeal, the Eighth Circuit discussed the applicability of Tobacco II in federal courts, reasoning that “to the extent that Tobacco II holds that a single injured plaintiff may bring a class action on behalf of a group of individuals who may not have had a cause of action themselves, it is inconsistent with the doctrine of standing as applied by federal courts.” Although each class member is not required to submit evidence of personal standing, a class cannot be certified if it contains members who lack standing. As the Avritt court further stated, “[a] class must therefore be defined in such a way that anyone within it would have standing. Or, to put it another way, a named plaintiff cannot represent a class of persons who lack the ability to bring the suit themselves.” According to the Court of Appeals, the determination in Tobacco II that only the named plaintiffs asserting a representative UCL claim, and not all absent class members, are required to meet standing requirements “diverged from federal jurisdictional principles, which we are bound to follow.” The Eighth Circuit affirmed the district court’s denial of the plaintiffs’ class certification motion.
At least one California district court has followed Avritt’s analysis. See Webb v. Carter’s, Inc.,—F.R.D. —, 2011 WL 343961, at *6-9 (C.D. Cal. Feb. 3, 2011) (Feess, J.) (declaring that “Tobacco II does not persuade the Court that a class action can proceed even where class members lack Article III standing,” and denying certification of UCL, FAL, CLRA and fraud claims). Time will show whether other courts, including the Ninth Circuit, will ultimately agree with Avritt. Until this issue is definitively resolved, the ability of defendants to invoke Article III to countervail Tobacco II will provide a powerful incentive to remove consumer class actions to federal court when possible.
June 2011: White Collar Litigation Update
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SEC Exercises Expanded Power to Bring Administrative Enforcement Proceedings: The passage of the Dodd-Frank Act in July 2010 broadened the SEC’s power to bring administrative proceedings rather than civil actions in federal court for violations of securities laws. The SEC has now begun exercising that expanded power. Before Dodd-Frank, the SEC could bring administrative cases only against individuals and entities whom the SEC directly regulates, such as broker-dealers, brokerage firm executives, investment banks, mutual funds, and brokerage firms themselves. If the SEC wanted to challenge the conduct of public companies or officers or directors who did not fit within the above groups, it had to bring civil actions in federal court. Further, the SEC could not seek monetary remedies beyond disgorgement of illegal profits in administrative proceedings.
The Dodd-Frank Act expanded the SEC’s powers on several fronts. The SEC can now bring administrative proceedings against any public company and its officers or directors for violations of federal securities laws. Dodd-Frank also authorized the SEC to obtain substantial monetary penalties in addition to disgorgement in administrative proceedings. Further, Dodd-Frank expands the “collateral bar” remedy so that an individual may be barred not just from working in his specific job role again, but also from associating with any entity the SEC regulates. These expanded administrative powers are significant to SEC targets because, as described below, administrative proceedings give the SEC distinct procedural advantages not available to it in federal court proceedings. For example:
In federal court, a defendant has a right to a jury trial. An administrative proceeding is only decided by an administrative law judge, who, unlike a life-tenured and independent federal judge, is employed by the SEC itself. Administrative proceedings are subject to an accelerated schedule that excludes depositions and other forms of discovery that can take months or years in federal court.
• In federal court, a defendant has a right to a jury trial. An administrative proceeding is only decided by an administrative law judge, who, unlike a life-tenured and independent federal judge, is employed by the SEC itself. Administrative proceedings are subject to an accelerated schedule that excludes depositions and other forms of discovery that can take months or years in federal court.
• The Federal Rules of Evidence do not apply to administrative proceedings, potentially allowing the admission of hearsay and other evidence routinely barred in federal court.
• An appeal of the administrative law judge’s decision does not go directly to a federal appeals court. Rather, the appeal is first reviewed by the SEC Commissioners—the same Commissioners who directed that the administrative proceeding be filed. After that review, an appeal can be taken to a federal appeals court, but the decision of the Commissioners receives deference.
• After an administrative proceeding, the SEC may still file an action in federal court, and may rely on evidence obtained in the administrative proceeding.
The SEC’s expanded administrative powers may also help the Department of Justice in its prosecution of criminal securities fraud cases. Federal prosecutors and the SEC often find themselves investigating and prosecuting the same conduct in parallel proceedings. Because federal criminal proceedings do not afford defendants the same discovery tools as civil court actions, defendants charged in parallel civil and criminal securities fraud cases typically seek to use discovery from the civil court case to defend the criminal case. The government, in turn, usually seeks to stay the SEC proceeding pending resolution of the criminal action, but sometimes courts deny such requests. Because SEC rules permit stays of administrative proceedings, the SEC may resort to administrative proceedings to give the government a better chance of delaying such discovery.
The SEC recently flexed its expanded regulatory muscle by bringing administrative proceedings in parallel with the highly watched insider-trading criminal prosecution involving the hedge fund Galleon Group. Galleon was one of the world’s largest hedge fund management firms before the federal government criminally charged myriad Galleon employees, including billionaire co-founder Raj Rajaratnam, with insider trading in 2009.
The SEC’s parallel administrative proceeding involves Rajat Gupta, a former managing director of McKinsey & Co. and director at Goldman Sachs and Procter & Gamble. Gupta is accused of repeatedly passing on inside information to Rajaratnam, including information Gupta learned while serving at McKinsey and Goldman Sachs. In the pre-Dodd Frank world, the SEC would have had to bring a civil court action against Gupta to win civil penalties. The SEC has instead brought the administrative proceedings pursuant to the Dodd-Frank amendments.
Gupta is challenging the validity of the SEC’s action by seeking declaration from a federal court that the SEC can not apply the civil penalty provisions of Dodd-Frank against him. Although Gupta has raised issues concerning the retroactive application of the amendments, he also contends that using administrative proceedings against him would violate his rights to due process, because of the lack of equivalent federal court protections. The SEC has yet to respond to Gupta’s complaint.
Although the extent to which the SEC uses its expanded administrative proceeding powers remains to be seen, the procedural benefits that the SEC enjoys in administrative proceedings suggest that the power will not be used sparingly.
DOJ Fends Off Challenges to Concept that Employees of State-Owned Companies Fall Under FCPA: The DOJ and SEC show no signs of slowing in their aggressive stance towards possible FCPA violations. In the last few months, for example, both Kraft Foods and Las Vegas Sands Corporation received subpoenas indicating that they were being targeted under the FCPA. And the DOJ recently succeeded in persuading courts in two pending California cases that state-owned or state controlled enterprises can be “foreign officials” for the purposes of FCPA enforcement. On April 4, 2011, U.S. District Court Judge Matz in Los Angeles issued the first ruling on this issue in United States v. Noriega, holding that executives of state-owned corporations do count as foreign officials. The FCPA defines a “foreign official” as an “officer or employee of a foreign government or any department, agency, or instrumentality thereof.” Neither the statute nor the legislative history define “instrumentality,” “department,” or “agency.” Although past FCPA defendants have challenged claims that particular parties acted as foreign officials, the present cases appear to be the first to raise the purely legal question whether employees of state-owned companies are public officials under the FCPA.
In Noriega, Lindsey Manufacturing Company executives faced charges that they paid a state-owned Mexican electric utility to bribe government officials. In moving to dismiss, defendants challenged the definition of “foreign official,” arguing that the government’s theory has no basis in the text or history of the FCPA, and is contradicted by the plain meaning of the term “instrumentality” in the context of the “foreign official” definition (and the FCPA as a whole), the legislative history of the statute, and Congress’ intent in enacting it. The government contended that whether employees at state-controlled utility companies are foreign officials is “not a difficult question.” First, it argued that, under the Mexican Constitution, supplying electricity is exclusively a government function and public service. Second, it argued that “instrumentality” plainly includes state-owned entities, and that any other interpretation would leave a portion of the FCPA without effect and take the U.S. out of compliance with its OECD treaty obligations.
Judge Matz denied the motion to dismiss primarily based on the legislative history of the FCPA and on the ordinary definition of “instrumentality,” which is “serving as a means or agency.” He also noted that electricity is a government function in Mexico and that the utility company refers to itself on its website as a governmental agency. Trial in the Noreiga case began in late April 2011 and, on May 10, 2011, after only a day of deliberations, a Los Angeles jury found all defendants—that is executives of Lindsey Manufacturing company and the company itself—guilty of conspiracy to violate the FCPA. Lindsey Manufacturing is the first American company to be charged and convicted under the FCPA, but Assistant Attorney General Lanny Breuer definitively stated that “it will not be the last.”
In the second case raising the issue of whether employees of state-owned companies are foreign officials for purposes of the FCPA—United States v. Carson—former executives of valve manufacturer Control Components are charged in Santa Ana federal district court with bribing employees of state-owned companies in China, Malaysia, and the United Arab Emirates. The defendants moved to dismiss, arguing that employees of state-controlled companies are not foreign officials under the law and that the “government’s sweeping and aggressive interpretation is wrong as a matter of law.” They based their argument on the ordinary meaning of the term “instrumentality,” the “absurd results” that would result under the government’s definition, and the original legislative intent to prevent overseas bribery scandals from bringing down the foreign governments with whom our diplomats worked. On May 18, 2011, Judge Selna denied the motion, referencing the Lindsey case and stating that “state-owned companies may be considered ‘instrumentalities’ under the FCPA, but whether such companies qualify as ‘instrumentalities’ is a question of fact.” Judge Selna included a non-exhaustive list of factors to be considered, including the level of ownership or control, how the entity and its personnel are characterized by the foreign government, the entity’s purpose, its obligations and privileges under the foreign law including exclusivity or controlling power in its functional area, and the circumstances surrounding its creation.
It is unclear if other courts will follow Noreiga and Carson, especially in cases involving state-owned companies less entwined in quintessential government functions than, for example, the utility company in Noriega. The scope of the FCPA will be significantly narrowed if courts hold that it applies only to “true” government officials, thus exempting transactions with state-owned or state-controlled companies from its record-keeping and anti-bribery provisions. To some, this will be viewed as a leveling of the playing field because the U.S. has been the only major economic power to prohibit its companies from bribing foreign officials. To others, it will be seen as an end-run around a law that combats corruption.
Gucci America v. Guess?, Inc.: Cross-Border Privilege Dispute Resolved Applying “Touch Base” Test
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The recent trademark infringement decision Gucci America, Inc. v. Guess?, Inc., 271 F.R.D. 58 (S.D.N.Y. Sept. 23, 2010), solidified the adherence of courts in the Southern District of New York to the “touch base” doctrine, under which a court assesses whether to apply U.S. privilege law by asking whether the communications at issue related to legal proceedings in the U.S. or reflected advice concerning American law. In Gucci, Magistrate Judge James Cott, following a referral by Judge Shira A. Sheindlin, held that U.S. law governed a dispute over attorney-client privilege, notwithstanding that the communications at issue were made in Italy and involved an Italian in-house counsel. Importantly, the communications were made during investigations that led to parallel infringement actions against Guess in Italy and in the U.S. Gucci America, Inc. v. Guess?, Inc., 271 F.R.D. 58, 61-64 (S.D.N.Y. Sept. 23, 2010).
Gucci America asserted the privilege with respect to communications involving Vanni Volpi, an employee in the legal department of it’s Italian affiliate Guccio Gucci S.p.A. (“GG”). Volpi’s primary responsibility was to manage GG’s trademark protection and enforcement program worldwide. Prior to joining GG in July 2006, Volpi had served as an intellectual property specialist in the legal departments of Chanel and Louis Vuitton. Volpi did not, however, have a law degree, and was not a member of the Italian bar. In 2008, Volpi began to contact the legal departments of various Gucci affiliates worldwide, including Gucci America, to obtain information about Guess’s potentially infringing activities. At issue was whether the attorney-client privilege and work-product doctrine shielded from disclosure approximately 150 of Volpi’s communications arising from Volpi’s investigation of Guess’s activities.
Choice of Law Analysis
The court’s analysis of attorney-client privilege began with the proposition that pursuant to Rule 501 of the Federal Rules of Evidence, questions of privilege are “governed by the principles of common law” Gucci, 271 F.R.D. at 64 (citing Golden Trade S.r.L. v. Lee Apparel Co., 143 F.R.D. 514, 521 (S.D.N.Y. 1992) (holding that the communications between a non-party Italian corporation and its patent agents in Norway, Germany and Israel did not “touch base” with the U.S. because they “related to matters solely involving” foreign countries)). As the Gucci court observed “[t]he common law includes “choice of law questions” Id. (citing Astra Aktiebolag v. Andrx Pharm., Inc., 208 F.R.D. 92, 97 (S.D.N.Y. 2002) (applying U.S. law to communications between Swedish employees and American counsel, and between Swedish in-house counsel and Swedish employees related to the conduct of litigation in the U.S.)). The court then applied the “touch base” doctrine, Gucci, 27, F.R.D. at 64-65, under which “any communication touching base with the United States will be governed by the federal [privilege] rules....” Golden Trade 143 F.R.D. at 520.
The court did so because Volpi’s communications were directed at gathering information related to Guess’s activities in the U.S., and because his investigation contributed to the decision to commence parallel infringement suits against Guess in the U.S. and Italy.
In holding so, the court rejected Guess’s argument that it should apply Italian law according to Section 139 of the Restatement (Second) of Conflict of Laws, which provides that the country with the “most significant relationship” to the communications at issue should dictate the applicable privilege law. Restatement (Second) of Conflict of Laws § 139 (1989); see also VLT Corp. v. Unitrode Corp., 194 F.R.D. 8, 17-18 (D. Mass. 2000) (relying on the Restatement in applying the privilege laws of Japan and England, respectively, to communications in which each country had “the most compelling or predominant interest”). Guess argued that Italy had the “most significant relationship” because Volpi’s communications occurred in Italy, copies of Volpi’s communications were located in Italy, and all of Volpi’s communications occurred as part of his duties in GG’s legal department.
The court instead credited Gucci’s arguments that the motivation behind Volpi’s communications was protecting Gucci’s trademarks in the U.S., and that none of the legal advice rendered or requested involved Italian law. The court also found that litigating in the U.S., as well as Italy, was essential to Gucci’s overall litigation strategy because it would not be able to obtain injunctive relief in Italy. That Volpi worked in Italy and that the communications occurred there was relevant but not dispositive. Italy had some interest in the communications, but its interest was at best equal to the interest of the U.S. in applying its laws to communications concerning the conduct of an action pending in a U.S. court. Also significant to the outcome was that the U.S. litigation concerned the enforcement of trademarks registered in the U.S. Patent and Trademark Office—a right arising from of U.S. law.
Accordingly, the court reasoned that applying U.S. law would not offend principles of comity. Moreover, Italian law permitted only limited discovery in the first place, thus undercutting Guess’s argument that applying the broader U.S. privilege law would offend principles of comity.
Application of U.S. Law on Attorney-Client Privilege
Turning to the application of U.S. law, the court found that most of Volpi’s communications easily fell within the ambit of the attorney-client privilege. Citing United States v. Kovel, 296 F.2d 918 (2d Cir. 1961), the court noted that the privilege protected confidential communications made by agents of an attorney for the purpose of assisting the attorney’s representation of the client. In particular, factual investigations conducted by the agent of an attorney, such as “gathering statements from employees, clearly fall within the attorney-client rubric.” Gucci, 271 F.R.D. at 71 (quoting Lugosch v. Congel, 2006 WL 931687, at *14 (N.D.N.Y. Mar. 7, 2006). Under these precedents, all communications made while Volpi was helping to investigate Guess’s activities at the direction of a licensed attorney, Daniella Della Rosa, in preparation for litigation in the U.S. and Italy were privileged.
The only unprotected communications were those made when it appeared that Volpi was not acting as Della Rosa’s agent and was not under her supervision.
Communications Also Afforded Protection Under the Work-Product Doctrine
The court also held that the communications subject to the attorney-client privilege were also entitled to protection as work product. The court reasoned that the forum court’s rules always govern procedural matters, thus making the work-product doctrine applicable. That doctrine does not require that documents be prepared at the behest of counsel, but only that they be prepared “because of” the prospect of litigation. Gucci, 271 F.R.D. at 74 (citing United States v. Adlman, 134 F.3d 1194, 1202 (2d Cir. 1998)).
Practical Implications of Gucci
The “touch-base” doctrine applied in Gucci offers a more surefooted approach than the traditional balancing test applied in VLT Corp. v. Unitrode Corp., 194 F.R.D. 8, 15-16 (D. Mass. 2000). Under VLT’s traditional balancing test, courts considered “the subject matter at issue, the parties to the communication and whether those entities are parties to the lawsuit.” Gucci acknowledged VLT by noting that a “more than incidental connection with the United States” is required, but nonetheless applied the more “rigid” touch base doctrine that VLT attempted to avoid.
Gucci demonstrates the increasing importance of close coordination with lawyers in other countries concerning international disputes. It further underscores the importance of making sure that law-related work by non-attorneys is performed at the direction and under the supervision of an attorney. Further, any non-attorney work product created in anticipation of potential litigation in the U.S. should clearly indicate that purpose.
California Supreme Court Refuses to Create Exception to Mediation Privilege, Prohibiting Disclosure of Attorney Communications in Legal Malpractice Suits
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The California Supreme Court recently held in Cassel v. Superior Court, 51 Cal. 4th 113 (2011), that California’s statutory mediation privilege prevents the disclosure of private communications between an attorney and client made before or during a mediation, even in the context of a malpractice suit arising out of the attorney’s alleged conduct in connection with the mediation.
In Cassel, a client sued his former attorneys for malpractice, breach of fiduciary duty, fraud and breach of contract, alleging that they coerced him into settling during a mediation. Id. at 118. The trial court excluded all evidence of discussions between Cassel and his attorneys that took place before or during the mediation. Id. The court of appeal reversed, holding that the mediation privilege did not shield attorney-client communications from disclosure in a malpractice suit. It reasoned that, “the mediation confidentiality statutes are intended to prevent the damaging use against a mediation disputant of tactics employed, positions taken, or confidences exchanged in the mediation, not to protect attorneys from the malpractice claims of their own clients.” Id. (emphasis in original). The dissent objected that, “the majority had crafted an unwarranted judicial exception to the clear and absolute provisions of the mediation confidentiality statutes.” Id.
Although the Supreme Court acknowledged the policy concerns advanced by the court of appeal majority, it concluded that making an exception for attorney-client communications in malpractice actions would contravene the plain wording of the mediation privilege statutes. Id. at 118-19.
In particular, California Evidence Code section 1119 provides that:
a. No evidence of anything said or any admission made for the purpose of, in the course of, or pursuant to, a mediation or a mediation consultation is admissible or subject to discovery, and disclosure of the evidence shall not be compelled, in any arbitration, administrative adjudication, civil action, or other noncriminal proceeding in which, pursuant to law, testimony can be compelled to be given.
b. No writing, as defined in Section 250, that is prepared for the purpose of, in the course of, or pursuant to, a mediation or a mediation consultation, is admissible or subject to discovery, and disclosure of the writing shall not be compelled, in any arbitration, administrative adjudication, civil action, or other noncriminal proceeding in which, pursuant to law, testimony can be compelled to be given.
c. All communications, negotiations, or settlement discussions by and between participants in the course of a mediation or a mediation consultation shall remain confidential.
Although Cassel attracted much interest from the press, it was in line with prior Supreme Court decisions interpreting California’s mediation privilege statutes. The Supreme Court has consistently adhered to a literal reading of California’s broad mediation privilege, observing that, “We have repeatedly said that these confidentiality provisions are clear and absolute. Except in rare circumstances, they must be strictly applied and do not permit judicially crafted exceptions or limitations, even where competing public policies may be affected.” Cassel, 51 Cal. 4th at 118-19, citing Simmons v. Ghaderi, 44 Cal. 4th 570, 580 (2008) Fair v. Bakhtiari 40 Cal. 4th 189, 194 (2006); Rojas v. Superior Court 33 Cal. 4th 407, 415-16 (2004); Foxgate Homeowners’ Ass’n v. Bramalea California Inc., 26 Cal. 4th 1, 13-14 (2001).
In Foxgate, the Supreme Court held that the mediation privilege prevents a mediator from disclosing communications or conduct by any of the parties, even if that party thereby escapes sanctions for failing to participate in good faith. See 26 Cal. 4th at 17. In Rojas, the Supreme Court confirmed that the language of section 1119 forbids the disclosure of all writings “for the purpose of, in the course of, or pursuant to, a mediation,” excluding, only direct physical evidence introduced at or used during a mediation that is not a “writing.” See 33 Cal. 4th at 416. In Fair, the Supreme Court narrowly construed one of the enumerated exceptions to the mediation privilege concluding that the disclosure of a written settlement agreement reached during a mediation is permissible only if the agreement expressly states the parties intended to be bound by the document. See 40 Cal. 4th at 197. And, in Simmons, the Supreme Court rejected the argument that the judicial doctrines of equitable estoppel and implied waiver could provide an exception to the mediation privilege, thus allowing the disclosure of oral settlement agreements reached in mediation. See 44 Cal. 4th at 580.
Cassel is nonetheless noteworthy because, as one justice noted, “[t]his holding will effectively shield an attorney’s actions during mediation, including advising the client, from a malpractice action even if those actions are incompetent or even deceptive. Attorneys participating in mediation will not be held accountable for any incompetent or fraudulent actions during that mediation unless the actions are so extreme as to engender a criminal prosecution against the attorney. This is a high price to pay to preserve total confidentiality in the mediation process." Cassel, 51 Cal. 4th at 138 (J. Chin, concurring in the result). The interpretation of the mediation privilege reached in Cassel is so broad that it might prompt the legislature to carve out another exception to the California mediation privilege.
Internet Litigation Update
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Stored E-Mail Messages Entitled to Fourth Amendment Protection: The Sixth Circuit recently became the first appellate court to extend Fourth Amendment protection to stored e-mail messages. In United States v. Warshak, No. 08-3997, ___ F.3d __, 2010 WL 5071766 (6th Cir. Dec. 14, 2010), it held that when the government compels an Internet service provider (ISP) to disclose a user’s stored e-mail messages, the user’s reasonable expectation of privacy might be violated.
The facts underlying the decision were both simple and stark. Without either obtaining a warrant or giving notice to Steven Warshak, who was later convicted of charges related to his fraudulent business practices, the government seized 27,000 of his private e-mail messages. Some of them were highly damning and provided key evidence at his trial.
The Sixth Circuit found that an ISP “is the functional equivalent of a post office or a telephone company” and concluded that it defied common sense to deny e-mail messages lesser Fourth Amendment protection than letters and telephone calls enjoy. Without examining whether people in fact assume that their e-mail messages will remain private, the court held that the Fourth Amendment requires that e-mail messages be given “strong protection” lest the Fourth Amendment become an “ineffective guardian of private communication.”
In reaching that result, the court held that the ISP’s terms of service, which provided that the ISP could access users’ e-mail messages for some purposes, did not affect Internet users’ reasonable expectations of privacy. The court also held that such messages can be entitled to protection notwithstanding that ISPs are private businesses.
The above considerations notwithstanding, the Sixth Circuit declined to rule that ISPs’ “terms of service” agreements can never eliminate the reasonable expectation of privacy in stored e-mail messages. Instead, the court suggested that based on the level of review and inspection of stored communications engaged in by an ISP, it might still be possible to argue that an Internet user did not have a reasonable expectation of privacy in his or her stored communications in rare instances.
Purchase of Trademarked Term for Key Word Advertising Held Not Actionable: The District of Utah recently held that the purchase of a trademarked term for use as a key word advertising trigger on an Internet search engine was a use in commerce within the meaning of the federal Lanham Act. Nevertheless, the defendant was granted partial summary judgment because the plaintiff was unable to establish a likelihood of confusion.
The court concluded that a use that serves only to trigger advertising is nonetheless a “use” of a mark contemplated by the Lanham Act. “The Lanham Act does not require use and display of another’s mark for it to constitute ‘use in commerce,’” the court concluded. Even so, the plaintiff’s claim was held barred to the extent it relied on such uses of the plaintiff’s mark. The court reasoned that any “likelihood of confusion” analysis must determine whether consumers viewing a mark would make an improper mental association with the plaintiff or be confused as to the origin or sponsorship of the defendant’s goods or services. It then concluded that only a visible mark could generate such confusion.
In so holding, the court criticized the widely cited opinion in Brookfield Communications Inc. v. West Coast Entertainment Corp., 174 F.3d 1036 (9th Cir. 1999). In Brookfield, the Ninth Circuit concluded that the defendant improperly benefited from the goodwill associated with the plaintiff’s mark when Internet users were attracted to the defendant’s Web site through the use of an invisible metatag. The Utah court criticized Brookfield as reflecting a misunderstanding of the mechanics of search engines. It held that activities that cause competing products to appear in search results for a mark merely expand a consumer’s options but do not divert the consumer from one product to another. See 1-800 Contacts Inc. v. Lens.com Inc., No. 2:07-cv-00591-CW-DN (D. Utah Dec. 14, 2010).
Structured Finance Litigation Update
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Recent Court Decisions Clarify Enforceability of Setoff Provision in Structured Finance Transactions Following Counterparty Bankruptcy Filing: Contractual setoff and netting rights are among the more common protections bargained for in derivatives and structured finance transactions. In addition to the netting of gains and losses across multiple transactions after early termination under an International Swaps and Derivatives Association (“ISDA”) master agreement, counterparties may also contract for setoff of non-derivative obligations between the same counterparties against derivatives obligations (“cross-product netting”) and setoff of the obligations of one counterparty against obligations of affiliates of the other counterparty (“cross-affiliate netting”).
Of concern to any party is the enforceability of cross-affiliate and cross-product netting following its counterparty’s bankruptcy filing. Section 553 of title 11 of the United States Code (the “Bankruptcy Code”) governs setoff following the commencement of a bankruptcy case. Section 553 provides, in relevant part, that a bankruptcy filing “does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case.” 11 U.S.C. § 553(a).
Financial participants facing exposure as the result of a counterparty bankruptcy have argued that setoff should be permissible, even in the absence of mutuality, because their contracts create mutuality, even if mutuality may not have otherwise existed. Until recently, there had been very little case law discussing this “contractual exception” to mutuality. A pair of court decisions have recently construed the “mutuality” requirement of section 553 strictly and denied cross-affiliate and cross-product netting regardless of the language of the contract. The opinions held that parties cannot contract around provisions of the Bankruptcy Code, even in the context of a derivatives contract for which close-out netting is protected by statutory safe harbors.
Delaware District Court Affirms Decision Holding No Contractual Exception to Bankruptcy Code Mutuality: On April 30, 2010, the Delaware District Court affirmed a ruling by the Bankruptcy Court for the District of Delaware that disallowed the setoff of a creditors’ claims against a corporate debtor against claims that a subsidiary of the debtor owed to the creditor because such “triangular setoff” failed to satisfy the mutuality requirement of section 553 of the Bankruptcy Code.
In In re SemCrude, L.P., 428 B.R. 590 (D. Del. 2010), Chevron entered into futures contracts for the purchase or sale of oil with affiliated debtors SemCrude, SemFuel, and SemStream. The transactions resulted in Chevron owing money to SemCrude; however, SemFuel and SemStream each owed money to Chevron. Chevron argued that the automatic stay of Bankruptcy Code section 362 should be lifted to permit Chevron to offset its liability to SemCrude against the amounts owed by SemFuel and SemStream, contending that such setoff was permitted by Chevron’s agreements. The agreements had identical setoff provisions, which provided that, “in the event either party fails to make a timely payment of monies due and owing to the other party, or in the event either party fails to make timely delivery of product or crude oil due and owing to the other party, the other party may offset any deliveries or payments due under this or any other Agreement between the parties and their affiliates.”
The bankruptcy court denied stay relief, holding that even if “triangular setoff” is permissible under the parties’ agreements, there is no contractual exception to the mutuality requirements of the Bankruptcy Code. It noted that for the purposes of section 553, debts are “‘mutual’ only when ‘they are due to and from the same persons in the same capacity.’” In re SemCrude, L.P., 399 B.R. 388, 393 (Bankr. D. Del. 2009). The bankruptcy court the rejected Chevron’s argument regarding a contractual exception to mutuality, holding that “mutuality cannot be supplied by a multi-party agreement contemplating a triangular setoff.” Id. at 397.
The district court affirmed the bankruptcy court’s decision, holding that it was “not only consistent under the facts and applicable case law, but also consistent with general bankruptcy principles concerning the strict construction of mutuality against the party seeking setoff.” The case is In re SemCrude, L.P., 428 B.R. 590 (D. Del. 2010).
New York District Court Affirms That Pre-Petition Derivatives Claims Cannot Be Offset Against Post-Petition Deposits: On January 26, 2011, the Southern District of New York affirmed a bankruptcy court decision that the Bankruptcy Code derivatives safe harbor provisions do not create an exception to the section 553 mutuality requirements. See Swedbank AB v. Lehman Brothers Holdings Inc., 10 CV 4532 (S.D.N.Y. January 26, 2011).
Beginning in 1990, Congress had enacted revisions to the Bankruptcy Code creating “safe harbor” protections for counterparties facing risk on, among other things, obligations in respect of swap contracts that arose from a counterparty bankruptcy. Section 560 of the Bankruptcy Code permits a counterparty to “cause the liquidation, termination, or acceleration of one or more swap agreements” and to “offset or net out any termination values or payment amounts” arising thereunder. Section 561 of the Bankruptcy Code, enacted in 2005, provides similar protections to parties under master netting agreements.
Prior to its chapter 11 filing in 2008, Lehman Brothers Holdings Inc. (“LBHI”), through its UK branch, was a party to an ISDA Master Agreement with Swedbank AB. LBHI also guaranteed certain ISDA Master Agreements between Swedbank and LBHI affiliates. LBHI held a deposit account at Swedbank. Following LBHI’s chapter 11 petition, third parties deposited approximately $11.7 million into LBHI’s Swedbank account. Subsequently Swedbank informed LBHI that it intended to offset amounts owing to Swedbank under LBHI’s derivatives obligations (as either counterparty or guarantor) against amounts in the LBHI account, including the post-petition deposits. LBHI then filed a motion to enforce the automatic stay, arguing, among other things, that Swedbank was improperly attempting to offset pre-petition derivatives claims against post-petition deposits. In response, Swedbank acknowledged the lack of mutuality, but argued that sections 560 and 561 of the Bankruptcy Code preserved Swedbank’s right to setoff notwithstanding the lack of mutuality. The Bankruptcy Court granted LBHI’s motion holding that the safe harbor provisions did not create an exception to the section 553 mutuality requirements.
The district court affirmed, writing separately to discuss the interplay between section 553 of the Bankruptcy Code and the safe harbor provisions. The court explained that the mutuality requirement of section 553 had its genesis in pre-Bankruptcy Code law, and was a “fundamental principle” of bankruptcy law. The court explained that if Congress had intended to alter this fundamental principle, there would have been some discussion in the legislative history; because the legislative history was silent, the court concluded that Congress did not intend for the safe harbor provisions to affect section 553 mutuality. The court observed that, “there is not a single passage in the legislative history that specifically addresses whether the Safe Harbor Provisions were intended to be an exception to section 553 . . . . We think this silence is significant.” Slip Op. at 13.
The court further noted that the legislative history addressed three themes that focused narrowly on swap transactions, and that expanded setoff rights was not implicit in any of them. It concluded that Congress: (i) intended to permit swap counterparties to terminate swap transactions, but did not address the extension of this protection to the general commercial obligations of the counterparties; (ii) intended to prevent swap counterparties from being exposed to risk associated with short term market movements; and (iii) was motivated by fairness considerations and believed that counterparties should be permitted to terminate and net out swap transactions without fear of either violation of the automatic stay or challenge as an avoidable preference. The district court finally noted that the safe harbor provisions were not intended to create a “super-priority status” extending to all commercial transactions with the debtor.
Although Swedbank is not a “triangular setoff” case, it has implications for the contractual exception to mutuality argument that underlies triangular setoff. Like the SemCrude court, the Swedbank court rejected the notion of a contractual exception to mutuality requirements of the Bankruptcy Code. Instead, it held that such an exception would “run counter to the fundamental purposes of the bankruptcy law.” Swedbank is thus another instance of courts narrowly construing the mutuality requirements of Bankruptcy Code section 553.
The Swedbank decision is one of several in the Lehman Brothers’ bankruptcy proceedings that have narrowly construed setoff rights. In another example, the bankruptcy court held that Bank of America violated the automatic stay when it wrongfully offset collateral LBHI pledged for overdrafts against Bank of America’s Lehman derivatives exposure. In so holding, the court rejected, among other things, Bank of America’s argument that the setoff was protected by the derivatives safe harbors. A more detailed discussion of the case will follow in a future client alert.
Trial Practice Update
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Two recent decisions in MBIA Insurance Corp. v. Countrywide Home Loans , Inc., No. 602825/08 (N.Y. Sup. Ct. Dec. 22, 2010), one of the most closely-followed residential mortgage-backed securities (“RMBS”) cases in the country, involved significant trial-related issues. In the suit, MBIA alleges that Countrywide fraudulently induced it to insure $21 billion dollars’ worth of RMBS by falsely representing that Countrywide originated the loans in strict compliance with its underwriting standards and guidelines, when in fact it knowingly and routinely approved borrowers who could not afford to repay the loans, committed fraud in loan applications, or otherwise did not satisfy the basic risk criteria for prudent and responsible lending that it claimed to use.
First, Justice Eileen Bransten of the New York Supreme Court, ruled in limine that MBIA could use statistical sampling of the loan pools to prove its claims of fraud and breach of contract. In so doing, the court effectively freed the plaintiff from proving its case on a loan-by-loan basis. Doing so would have been impossible because more than 360,000 loans are at issue. The court instead approved a methodology allowing the plaintiff to sample 400 loans from each of 15 securitizations. The ruling granted MBIA a “powerful tool” for establishing its claims, allowing it to bypass the “costly and time consuming process” of proceeding on a loan-by-loan basis. See, John Carney, Bank of America Loses Key Battle in Mortgage Fraud Fight, CNBC, Dec. 23, 2010, http://www.cnbc.com/id/40794336. In granting MBIA’s motion, the court rejected the defendants’ contention that the motion was premature because discovery had not yet closed. It held that New York law permits parties to motion in limine “as their litigation strategy dictates.”
The court also concluded that statistical sampling meets the Frye test, the New York standard that imposes a higher threshold than Daubert for the admissibility of expert testimony. The court agreed that statistical sampling is not novel and observed that “[i]t is undisputed that the use of statistical sampling is generally accepted in the scientific community.” The court found that MBIA’s methodology of selecting a sample stratified by relevant criteria, was acceptable. Accordingly, the court held that, although challenges to MBIA’s methodology could be mounted at trial, there was no bar to the admissibility of the proof based on sampling, and it would be a jury question whether the proof was probative and sufficient to prove MBIA’s case.
In its subsequent January 28, 2011 decision, the court held that a party’s pre-litigation analysis can be protected by the work-product doctrine, attorney-client privilege, and New York’s trial-preparation privilege. At issue was whether MBIA had properly claimed privilege as to materials produced by non-testifying consultants it retained in anticipation of litigation to re-underwrite the mortgage loans underlying the securitizations. Doing so led MBIA to seek a contractual “put back” remedy before commencing suit, i.e., requesting that Countrywide repurchase approximately 4,689 loans that failed to comply with Countrywide’s representations and warranties. MBIA, through outside counsel, retained the consultants in early 2008 to work under its oversight. Once litigation commenced, Countrywide sought to discover the consultants’ work product.
Countrywide contended that the majority of documents neither sought nor reflected the advice of counsel and therefore were not protected by the attorney-client privilege. The materials also were not attorney work product, according to Countrywide, because they were not prepared by counsel and were not produced “solely” in anticipation of litigation, but also served its business purpose to determine whether the loans were originated in compliance with Countrywide’s underwriting guidelines and were serviced according to its servicing guidelines. Countrywide additionally argued that MBIA’s reference to the results of the consultants’ investigations in its complaint waived any trial preparation privilege.
The court rejected each of Countrywide’s arguments. It noted that notwithstanding New York’s policy favoring liberal discovery, “C.P.L.R. § 3101 establishes three categories of protected materials: privileged matter, absolutely immune from discovery (C.P.L.R. § 3101(b)); attorney work product, also absolutely immune (C.P.L.R. § 3101(c)); and trial preparation materials, which are subject to disclosure only on a showing of substantial need and undue hardship in obtaining the substantial equivalent of the materials by other means (CPLR § 3101(d)(2).”
The court held that because outside counsel hired and directed the consultants, and then used the results of their investigations to provide legal advice to MBIA, the consultants’ were acting as “agents” of counsel. Thus, communications between the consultants and outside counsel, as well as the consultants’ communications with MBIA employees, were privileged. Further, the document the consultants created were protected by the attorney work-product privilege because they were prepared “in furtherance of their respective investigations [and] were used by outside counsel to assist in analyzing and preparing advice upon MBIA’s legal remedies.”
Importantly, the court rejected Countrywide’s argument that the attorney work-product privilege applied only to materials created solely for purposes of litigation. Acknowledging that “[New York c]ase law has, at times, placed an emphasis on the term[s] ‘solely’ or ‘purely’ in finding against privilege protection and for disclosure based upon the purpose of the document,” the court nonetheless declared that the “proper test for whether documents are to be accorded protection [as work product] is not a didactic test as to whether the documents are created solely for purposes of litigation, but whether the documents were created primarily for the purpose of litigation.”
In ruling that the touchstone should be whether the documents were created primarily for the purpose of litigation, the court reasoned that: “finding that the work product of an investigation resulting in multiple avenues of legal recourse, including one other than litigation, is absolved of an otherwise applicable privilege is to force the investigating party into a modified Hobson’s choice of either litigating and retaining privilege (and therefore losing possible avenues of recourse) or pursuing all recourse and losing important attorney client and/or work product privileges.” The court also found that the due diligence conducted by MBIA prior to the filing of the complaint did not remove the documents from privilege. It noted that, as a policy matter, the privilege encourages parties to diligently examine their claims prior to approaching the court without fear that the documents will be discoverable.
Finally, the court ruled that the trial-preparation privilege also protected materials produced by MBIA’s consultants. Countrywide had failed to demonstrate a “substantial need” for the consultants’ documents that might overcome the privilege, because Countrywide had all the documents and facts necessary to defend itself. Equally unsuccessful was Countrywide’s argument that MBIA had somehow improperly used the consultants’ materials as a sword and a shield by referring to results of the consultants’ analysis in the complaint, while refusing to disclose the underlying work papers. In doing so, MBIA did not put the non-testifying consultants’ material “at issue” because it did not intend to prove its claims with that material.
Appellate Update
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Since Chief Justice John Roberts’ appointment in 2005, three more new justices have joined the United States Supreme Court—Justice Samuel Alito in 2006, Justice Sonia Sotomayor in 2009, and Justice Elena Kagan last year. While popular accounts often describe the justices as voting along predictable conservative or liberal lines, federal preemption is one important area in which such ideological lines often blur This Term there are four high-profile preemption cases, three of which already have been decided, that shed light on the direction of these justices and the Court on preemption.
The first preemption case decided this Term was Bruesewitz v. Wyeth, LLC, No. 09-152. This case addressed whether the National Childhood Vaccine Injury Act of 1986 (NCVIA), 42 U.S.C. § 300aa-22(b)(1), preempts state-law claims against vaccine manufacturers alleging design defects. (Disclosure: Quinn Emanuel successfully represented the vaccine manufacturers.) In the mid-1980s, vaccine manufacturers were facing hundreds of product-liability suits a year threatening them with damages many times their average sales. Several companies therefore stopped manufacturing vaccines, causing vaccine shortages. To encourage vaccine production, Congress enacted the NCVIA, which establishes a streamlined, no-fault compensation system. Parties dissatisfied with their recovery under this system may elect to reject the recovery and bring tort claims, but the Act preempts such claims “if the injury or death resulted from side effects that were unavoidable even though the vaccine was properly prepared and was accompanied by proper directions and warnings.” 42 U.S.C. § 300aa-22(b)(1).
In Bruesewitz, plaintiffs who rejected their administrative recovery asserted a design defect in the vaccine that allegedly harmed their daughter. In an opinion by Justice Scalia joined by Chief Justice Roberts and Justices Kennedy, Thomas, Breyer and Alito, the Justices agreed that the NCVIA’s express preemption clause was best read to preempt design defect claims in light of its language and the NCVIA’s overall structure and purpose, which would be undermined if manufacturers were subject to suits for design defects. Justice Sotomayor, joined by Justice Ginsburg, dissented.
The day after Bruesewitz issued, the Supreme Court decided Williamson v. Mazda Motor of America, No. 08-1314. In Williamson, the plaintiffs alleged that their son died in a car accident due to an auto manufacturer’s failure to install lap-and-shoulder belts in the rear aisle seat of its minivans. The manufacturer argued that the claim was preempted by a Federal Motor Vehicle Safety Standard allowing manufacturers to install either lap belts or lap-and-shoulder belts in rear aisle seats. Their argument was supported by Geier v. American Honda Motor Company, 529 U.S. 861 (2000), which held that a prior safety standard giving auto manufacturers discretion whether to install airbags preempted state tort claims challenging the failure to install airbags.
Nevertheless, the majority found no preemption. It reasoned that, unlike the earlier airbag regulations, the seatbelt regulations gave manufacturers a choice merely because the Department of Transportation was unsure about the cost effectiveness of lap-and-shoulder belts in rear aisle seats. Finding this concern would not be undermined by common-law suits claiming lap-and-shoulder belts should have been installed, the majority found no preemption.
Concurring, Justice Sotomayor wrote separately to emphasize that the mere fact that a federal regulation allows a choice between options does not automatically preempt state-law claims challenging the option chosen. There must, she stressed, be some regulatory objective that depends upon manufacturers having that choice. Justice Thomas also concurred, reiterating his opposition to implied preemption based on mere congressional purposes and objectives and invoking a savings clause the rest of the justices found inconclusive.
In the third preemption case the Court has decided this Term, AT&T v. Concepcion, 09-893, the Court upheld a challenge to a California Supreme Court decision holding an arbitration provision in a consumer contract unconscionable because it effectively bars class actions. A five-justice majority (Justice Scalia, joined by Roberts, Kennedy, Thomas and Alito) held the California decision preempted. Although the Federal Arbitration Act (FAA) contains an express preemption provision requiring states to enforce agreements to arbitrate unless they are invalid “upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. § 2, the majority did not find express preemption. Instead, it held the California decision preempted because the decision defeated the objectives underlying the express preemption provision by effectively requiring arbitration in consumer contracts, which the majority found inimical to the informal, streamlined arbitration procedures that the FAA seeks to protect. Reiterating his objections to purposes-and-objectives preemption, Justice Thomas reluctantly concurred, and Justices Breyer, Ginsburg, Sotomayor, and Kagan dissented.
In the one major preemption case still undecided, Chamber of Commerce v. Whiting, 09-115, an unusual coalition of the U.S. Chamber of Commerce and the ACLU sued to invalidate an Arizona law sanctioning employers for hiring unauthorized aliens. Although federal law expressly preempts state laws imposing sanctions for employing unauthorized aliens, see 8 U.S.C. § 1324a(h)(2), there is a savings clause for state licensing laws, which Arizona argues applies to its statute. The Arizona law also requires employers to participate in an E-Verification program which is voluntary under federal law. Chamber of Commerce was argued on December 8, 2010.
Although not too much should be read into the Bruesewitz, Williamson and AT&T cases since each preemption case involves specific statutory language, they do suggest, together with other recent preemption cases, that some patterns have emerged among the justices. One cohort (Chief Justice Roberts and Justices Scalia,Thomas and Alito) tends to favor federal preemption of state regulation or common-law tort suits where express preemption clauses permit as much; a smaller cohort (the same Justices minus Justice Thomas) tends to favor implied preemption of state law theories that conflict with federal purposes and objectives; and an emerging cohort (Justices Ginsburg and Sotomayor) appears to have stepped into retired Justice Stevens’ shoes in applying a strong presumption against federal preemption--leaving Justices Kennedy and Breyer as swing votes in preemption challenges. An important additional factor in preemption cases is the U.S. government’s litigation position, which prevailed in both Bruesewitz and Williamson. Chamber of Commerce will provide further insights on the evolution of the Roberts’ Court’s approach to preemption.
Converium Decision by Dutch Court Promotes European Venue for Binding Settlement of Mass Claims
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The Amsterdam Court of Appeal’s recent decision in Converium Holdings AG may signal the emergence of Dutch courts as a forum in which parties can settle cross-border mass claims, subject only to opt outs. In November 2010, that court held that it could declare binding a proposed settlement in a case in which 12,000 investors, only 200 of whom were from the Netherlands, alleged securities fraud on the part of Converium, a Swiss reinsurer with no securities listed on Netherlands-based exchanges. Scor Holdings AG (f/k/a Converium Holdings AG), Gerechtshof Amsterdam [HoF] [Amsterdam Court of Appeal], Amsterdam, 12 Nov. 2010 NJ—(Neth.) The decision notably expanded the jurisdiction the same court had exercised a year before in approving a settlement between Royal Dutch Shell and a class of non-U.S. investors who alleged that Shell had misstated its proven reserves. Shell Petroleum N.V./Dexia Bank Nederland N.V., Gerechtshof Amsterdam [HoF] [Amsterdam Court of Appeal], Amsterdam, 29 May 2009 NJ 506 (Neth.) (hereinafter “Shell Petroleum”).
The significance is that the Netherlands is the only European country that, like the United States, provides for the binding settlement of mass claims. Although Converium will be provisional pending a fairness hearing later this year, it will likely become final, thus making the settlement binding, at a minimum, in all EU member states, as well as Switzerland, Iceland, and Norway, under the Brussels I Regulation and the Lugano Convention.
The Amsterdam Court of Appeal appears to be acting consciously to create a forum for cross-border mass claims; it referenced limitations imposed, for example, by the U.S. Supreme Court in Morrison v. National Australia Bank Ltd., __U.S.__, 130 S. Ct. 2869 (2010), restricting the extra-U.S. application of Section 10(b) of the Securities Exchange Act. Id. at 2884 (holding that Section 10b-5 applies “[o]nly [to] transactions in securities listed on domestic exchanges, and domestic transactions in other securities”). Aggrieved shareholders already appear to have recognized Converium’s significance: A foundation representing a global consortium of shareholders filed a securities fraud class action on January 10, 2011, in the Utrecht Civil Court against Fortis—once the largest financial institution in Belgium and the Netherlands that collapsed in spectacular fashion following its ill-fated acquisition of ABN Amro. Moreover, in the Fortis case, shareholders are not presenting a proposed settlement, but rather are raising claims for adjudication.
Overview of Dutch Class Action System
Unique to European legal systems, Dutch law provides rudimentary elements of a class action system. The two most important provisions are the Dutch Act on the Collective Settlement of Mass Claims (Wet collectieve awkikkeling massaschade or “WCAM”) and Article 3-305a of the Dutch Civil Code, authorizing parties to bring collective actions.
WCAM, passed in 2005, allows parties to petition Dutch courts to declare a mass settlement binding on a class or classes of persons whose members suffered similar injury. See BW (Civil Code) Art. 9:907. Under WCAM, parties to a prior-negotiated settlement may petition the Amsterdam Court of Appeal—a court akin to a U.S. federal circuit court—to declare the agreement binding on a class whose members suffered similar damages. Parties to the settlement must include both those that inflicted the harm and will pay compensation and a foundation organized under Dutch law to represent the interests of the class and administer the settlement. Id. The court may reject a proposed settlement if the interests of the persons on behalf of whom the settlement was
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