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Settlement Traps for the UnwaryOrange County Bar Association

Intellectual Property/Technology Law

August 21, 2006

Steve ComerJae Hong Lee, MD, MPH

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3 Cases — 3 Lessons

• Have you settled?Exigent Tech., Inc. v. Atrana Solutions, Inc.,

442 F.3d 1301 (Fed. Cir. Mar. 22, 2006)

• What future claims are barred after a settlement?Pactiv Corp. v. Dow Chemical,

449 F.3d 1227 (Fed. Cir. June 5, 2006)

• May a settling manufacturer later seek to protect customers threatened with suit?

Microchip Technology v. The Chamberlain Group,441 F.3d 936 (Fed. Cir. Mar. 15, 2006)

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Exigent Tech., Inc. v. Atrana Solutions, Inc.

Have you settled?

U.S. Patent No. 6,651,885

“A multi-function transaction processing system ….”

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Exigent Tech.: Background

• March 2, 2004: Exigent files suit against Atrana alleging infringement of the ‘885 patent.

• September 24, 2004: Atrana files a motion for summary judgment on the issues of infringement, invalidity, and unenforceability.

• District Court granted Exigent two extensions of time.

• October 26, 2004: Exigent, with new counsel, filed a Rule 56(f)motion for another extension of time. Exigent did not file a substantive response to Atrana’s summary judgment motion.

• November 3, 2004: District Court denies Exigent’s Rule 56(f) motion.

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Exigent Tech.:Agreement in Principle Term Sheet

• November 10, 2004: Exigent and Atrana attended a mandated mediation session, where they signed an Agreement in Principle Term Sheet.

• Exigent agreed to license the patented system to Atrana in exchange for royalty payments.

• Agreed to dismiss the case under terms to be determined.

• Exigent and Atrana agreed that “this Agreement will not affect any deadlines set by the Court.”

• The Term Sheet contemplated that the parties would proceed to negotiate and sign a formal agreement.

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Exigent Tech.:Agreement in Principle Term Sheet

• The Agreement in Principle Term Sheet stated:

“The parties agree to negotiate additional terms ordinarily in licensing agreements of this sort in good faith to within five business days execute a formal Settlement Agreement embodying these Principles and forward it to the Mediator for filing with the Court, failing which the mediator will report animpasse.”

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Exigent Tech.:The Plot Twist

• Also on November 10, 2004: On the same day the Agreement in Principle Term Sheet was signed, the District Court granted Atrana’s motion for summary judgment with respect to non-infringement, declining to address the issues of invalidity and unenforceability.

• District Court denied all pending motions as moot.

• November 18, 2004: Exigent files a motion asking the District Court to vacate its summary judgment decision and to enforce the alleged settlement agreement as reflected in the Term Sheet.

• November 22, 2004: Mediator reports an impasse with respect to a final settlement agreement “per a telephone call from Defendant’s counsel.”

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Exigent Tech.:District Court’s “Final Order”

• March 10, 2005: District Court entered a “final order” of dismissal.

• March 15, 2005: Exigent filed a motion for clarification of the final order, arguing that the District Court could not issue a final order because the Court had not decided its motion to vacate summary judgment and enforce the alleged settlement agreement.

• Exigent appealed to the Federal Circuit.

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Exigent Tech.:The Federal Circuit’s Decision

• Federal Circuit affirmed the grant of summary judgment of noninfringement.

• Federal Circuit reversed the order denying as “moot” Exigent’smotion to enforce the settlement agreement, stating that if the agreement was enforceable, it rendered moot the entry of final judgment.

• Federal Circuit suggested that if the “essential terms” had been agreed upon by the parties, the Term Sheet was an enforceable agreement.

• Remanded to the District Court for further proceedings.

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Exigent Tech.: Lessons• This can happen to you.• Keep the court informed:

--Notify the court of any ongoing settlement or mediation discussions.

--Notify the court immediately once any agreement is reached.--Some courts will have the parties put an agreement on the

record.• Basic contract law:

--Make clear, in the text, when precisely an agreement becomes enforceable (a contract).

--Consider including in the Term Sheet that the agreement isnot enforceable until a formal settlement is executed.

--Contingency clause: settlement value decreases for loser and increases for winner of a summary judgment motion.

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Pactiv Corp. v. Dow Chem. Co.

What Future Claims Are Barred After A Settlement?

U.S. Patent No. 5,424,016

“A method for providing accelerated release of a blowing agent from an

extruded plastic foam….”

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Pactiv v. Dow: Background• In 1995, Dow sued Pactiv for infringement of two patents, and Pactiv

counterclaimed for invalidity and unenforceability.

• Parties reached a number of Settlement and License agreements (collectively, the “1998 Agreement”) that included a dismissal of the claims and counterclaims with prejudice.

• Under the 1998 Agreement, Pactiv agreed to pay royalties to Dow on the two patents.

• In late 2002, Pactiv stopped paying royalties, claiming the patents were invalid.

• December 30, 2003: Pactiv filed for declaratory judgment alleging noninfringement, invalidity, and unenforceability.

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Pactiv v. Dow: District Court

• Dow moved for dismissal under FRCP 12(b)(6), arguing that Pactiv’ssuit was barred by res judicata (claim preclusion).

• The parties agreed that Pactiv’s suit was barred unless:

1. the 1998 Agreement reserved Pactiv’s right to challenge the patents in the future; or

2. Pactiv had been denied a full and fair opportunity to litigate the invalidity and unenforceability claims.

• District Court granted Dow’s 12(b)(6) motion and dismissed Pactiv’ssuit, concluding that res judicata applied and that the plain language of the 1998 Agreement did not expressly reserve future litigation rights.

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Pactiv v. Dow: Federal Circuit Analysis/Holding

• Federal Circuit affirmed (Michel, Bryson, Dyk).

• General rule: claim preclusion bars the relitigation of a claim that was, or could have been raised, in a prior action between the parties that was adjudicated on the merits.

• Dismissal with prejudice is an adjudication on the merits for claim preclusion purposes.

• Exception: parties can expressly reserve the right to relitigate a claim as part of an agreement, and therefore avoid claim preclusion.

• However, Federal Circuit holds that did not happen here.

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Pactiv v. Dow: Federal Circuit Analysis/Holding

• Federal Circuit states that Pactiv had the legal standard backwards:

“The question is not whether the 1998 Agreement precluded Pactiv from future litigation; the question is whether the 1998 Agreement expressly permitted Pactiv to participate in future litigation.” (emphasis added)

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Pactiv v. Dow: The 1998 Agreement

• No express reservation of rights to relitigate invalidity and unenforceability claims:

“[Pactiv’s] obligation to pay royalty ... will terminate if: (1) the particular Dow Patent or claim is found invalid through any final judicial or administrative proceeding ... [or] (3) the Dow Patent or claim is found to be unenforceable through any final judicialor administrative proceeding.

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Pactiv v. Dow: The 1998 Agreement

• Express release of Dow from all claims “relating to” the patents:

“[Pactiv] ... does hereby release each and every Dow Released Party from ... any and all claims ... relating to those Dow Patents ....”

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Pactiv v. Dow: Lessons

• There is no default reservation of rights with respect to future claims that might be barred by res judicata.

• Must expressly reserve any right to litigate a claim within the “four corners” of the agreement.

• Dismiss your counterclaims without prejudice?

• Don’t have mutual releases?

• Pay attention to basic principles in contract drafting.

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Microchip Technology v. The Chamberlain Group

May a settling manufacturer later seek to protect its

customers threatened with suit?

U.S. Patent No. 4,750,118

“A garage door operator for a garage door ....”

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Microchip v. Chamberlain: First Case

• Microchip makes chips and software for garage-door openers that “learn” the opening code. Chamberlain makes openers.

• In an earlier case, Microchip sued Chamberlain for infringement.The parties settled. Chamberlain received a license to the Microchip patents and granted a covenant not to sue Microchip for infringement of Chamberlain’s patents:

“Under no circumstance shall the foregoing release be construed as a release of Microchip, its present Affiliates or any customersthereof with respect to claims relating to [Chamberlain's patents]. The foregoing sentence notwithstanding, [Chamberlain] hereby agrees that it will not bring suit against Microchip or Microchip's current Affiliates involving any of the CGI Patents.”

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• In the years following the settlement agreement, Chamberlain sued one of Microchip’s customers for infringement, and threatened others.

• Microchip filed an action for declaratory relief of invalidity, unenforceability, noninfringement, and patent exhaustion.

• Microchip argued that the settlement agreement was a license, and that under doctrine of patent exhaustion Chamberlain could not sue the customers.

Microchip v. Chamberlain: Second Case

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Microchip v. Chamberlain: District Court

• Chamberlain moved to dismiss for lack of jurisdiction.

• The District Court held that there was jurisdiction under the Declaratory Judgment Act.

• The District Court reasoned that although Microchip was not threatened with suit, Chamberlain’s suits against Microchip’s customers had the practical effect that Microchip could not sell its chips without subjecting its customers to risk of suit.

• The District Court concluded that Microchip had a reasonable apprehension that its customers would be sued for infringement.

• Microchip’s motions for summary judgment of invalidity granted.

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Microchip v. Chamberlain: Federal Circuit

• Federal Circuit reversed (Lourie, Rader, Linn).

• Two-part test to determine whether there is an actual case or controversy:

• Reasonable apprehension of infringement suit if it continues activity, and

• Present activity that could constitute infringement (or concrete steps toward such activity)

• Microchip had no apprehension of suit, because of the covenant not to sue.

• Microchip’s economic interest in clarifying the rights of its customers does not create an apprehension of suit. No cause of action could be brought against Microchip.

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Microchip v. Chamberlain: Federal Circuit

• Indemnity agreement suffices?

• “Nor has Microchip established a legal relationship between it and a customer that had a legal interest adverse to Chamberlain,such as the existence of an indemnity agreement between Microchip and its customer.”

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Microchip v. Chamberlain: Federal Circuit

• Liability for inducing infringement suffices?• Arrowhead Industrial Water v. Ecolochem, 846 F.2d 731 (Fed.

Cir. 1988).• Arrowhead provided customers with all the steps of allegedly

infringing water-treatment process. • Arrowhead was potentially inducing infringement and had

indemnified its customers. Thus, patentee could have brought infringement suit against Arrowhead.

• No indication that Microchip would be liable for inducing or contributing to infringement (it had a covenant not to sue).

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Microchip v. Chamberlain: Lessons

• State in settlement agreement that customers are released.

• Example: “Immunity. The rights and license granted to Licensee . . . shall inure to the benefit of, and includes an immunity from suit against, any direct or indirect distributor, reseller, customer or other user of Licensed Products manufactured or sold by or for Licensee, any Affiliate and/or any sublicensee . . . .”

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Microchip v. Chamberlain: Lessons

• Consider whether to limit the scope of a covenant not to sue so that it does not preclude a suit as to customers.

• Note: everything else being equal, the alleged infringer would normally want as broad a covenant as possible.

• But here, the broad covenant blocked Microchip from protecting its customers.

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3 Lessons -- Summary

• Exigent: Keep the court informed of any settlement discussions and express clearly within the text of the agreement precisely when the agreement becomes enforceable.

• Pactiv: Dismissal of counterclaims with prejudice bars future challenges to invalidity. Any right you want preserved after a settlement agreement should be expressly reserved within the “four corners” of the agreement.

• Microchip: Consider all parties you want to protect through a settlement agreement, especially your customers, and expressly protect them in the agreement.

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Resources for Patent Settlement Agreements

• Involve a licensing lawyer early

• Exemplars

• Treatises and form books on licensing