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Special Feature -- Are Patent Trolls Facing A New Era of Litigation Penalties?

Wednesday, August 24, 2011

By Jack Scheter, Litigation Partner, Bromberg Sunstein Kann & Murphy LLP

Feared and loathed by most major companies and the general public, non-practicing entities (“NPEs”) that file patent infringement lawsuits are commonly referred to as “patent trolls” and are held up as illustrations of a broken patent system.

Whatever the merits of this characterization, NPEs have generally found refuge in the courts, where their "trollish" nature has largely been ignored and the law has held them to the same standards—and accorded them the same privileges—as any other patent litigant.

A recent Federal Circuit case, however, Eon-Net LP v. Flagstar Bancorp, may presage a new standard for assessing sanctions and awarding attorneys’ fees against unsuccessful NPEs and their lawyers.

Eon-Net is a Cayman Islands limited partnership formed by three inventors for the sole purpose of enforcing their patents. Eon-Net alleged that Flagstar’s website, which allowed its customers to submit loan applications and related information online using HTML forms, infringed Eon-Net’s patents. Those patents claim an “information processing system for inputting information from a document or file on a computer into at least one application program . . .”

Flagstar promptly sought summary judgment, arguing that its accused products were duly licensed. Flagstar also contended that Eon-Net’s lawyers should be sanctioned under Rule 11—a requirement that lawyers ask questions first, then shoot—for failing to vet their client’s baseless infringement claims.

Although Eon-Net successfully argued that Flagstar’s license covered only a subset of the accused products, the district court entered summary judgment of non-infringement. Without a hearing or any claim construction, the court concluded that the claims of the asserted patents were limited to the processing of hard copy documents, and that Flagstar’s HTML forms clearly fell outside the scope of the claims.

The court then assessed Rule 11 sanctions of $141,984 against Eon-Net’s counsel and his law firm, an amount equal to Flagstar’s attorneys’ fees.

On appeal, Eon-Net found a more sympathetic ear. The Federal Circuit held that it was error for the district court judge to find non-infringement without considering the parties’ claim construction arguments. The court also reversed the sanctions against Eon-Net’s lawyers, since that award was tied to the judge’s premature conclusion that Eon-Net’s patent claims did not cover online web applications.

The Federal Circuit noted that Eon-Net’s counsel had indisputably examined Flagstar’s website and, based on his experience, concluded that it infringed the asserted patents. In the same vein, the court pointed out that Eon-Net’s infringement position was not without some support in the specification of the asserted patents.

Unfortunately for Eon-Net, this victory would prove to be fleeting and costly.

On remand to the district court, the parties argued their claim construction positions, and the judge again found that no reasonable construction could support extending the scope of Eon-Net’s patents beyond the processing of information from hard-copy documents. The judge found that Eon-Net had engaged in litigation misconduct, and that Eon-Net’s infringement claims were objectively baseless and filed in bad faith.

Having thereby found the case to be “exceptional” under 35 U.S.C. § 285—a statute that effectively equates “exceptional” with “egregious”—the judge ordered Eon-Net to pay Flagstar $489,150 for expenses incurred litigating the case following remand. Not averse to piling on, the judge also reinstated the Rule 11 sanctions in the amount of $141,984 against Eon-Net’s lawyers.

Eon-Net appealed yet again. This time around, however, Eon-Net would find no succor with the Federal Circuit.

Instead, the court held that the specification of the patent “unequivocally compels the constructions adopted by the district court.” Although a “hard copy document” does not appear as a limitation in the claims themselves, the specification repeatedly defined “the invention” as a system for processing hard copy documents and included over 100 references to “hard copy documents.”

Dismissing the contrary portion of its prior order as dictum (that is, opinion that goes beyond the facts before the court and hence is not binding), the court rejected Eon-Net’s arguments that an ordinary meaning of “document or file,” including electronic or web-based documents or files, should be adopted.

Nor was the court persuaded that Eon-Net’s claim construction position was adopted by the PTO when it issued related patents to Eon-Net. These later patents were based on an identical specification but expressly claimed a system for processing information from a “file” or “document” that is not derived from “scanning a hard copy document.”

In upholding as well the award of attorneys’ fees and costs under § 285, the Federal Circuit could have based its decision solely on the numerous instances of litigation misconduct identified by the district court. These included Eon-Net’s destruction of relevant documents, failure to implement a document retention plan, failure to engage in claim construction in good faith, and an overall cavalier and disrespectful attitude toward the justice system.

Instead, the Federal Circuit went further, affirming the district court’s finding that Eon-Net had filed objectively baseless litigation in bad faith. Despite having pointed to possible support for Eon-Net’s claim construction position in its first appellate order, the court gave short shrift to Eon-Net’s argument that, even if its claim construction position was ultimately wrong, it was not baseless or frivolous. The court simply reiterated that its prior opinion was not binding and had left open the possibility that a proper claim construction analysis would reveal Eon-Net’s claim construction position to be without merit.

The court then focused on aspects of the litigation that are fairly typical when an NPE sues for infringement. It found support for the finding of bad faith based on what the district court referred to as “indicia of extortion,” namely the filing of over 100 nearly identical complaints against a diverse group of defendants, each followed by a demand for quick settlement at a price far lower than the cost to defend the litigation.

These low settlement offers led nearly all of Eon-Net’s targets to settle rather than litigate, effectively ensuring that Eon-Net’s baseless infringement allegations would remain unexposed and allowing Eon-Net to continue to collect additional nuisance-value settlements.

The court also emphasized the asymmetric nature of the case, noting that, as an NPE, Eon-Net had the capacity to impose disproportionate discovery costs on Flagstar. Eon-Net could impose these costs while simultaneously putting very little at risk itself since, as an entity not engaged in any real business activities, Eon-Net was immune to counterclaims for patent infringement, antitrust or unfair competition.

As for the re-imposition of the previously vacated Rule 11 sanctions, the Federal Circuit agreed with the district court that Eon-Net’s claims, predicated on an erroneous claim construction position, were legally baseless, and Eon-Net’s counsel’s pre-filing investigation was inadequate since it applied that same flawed claim construction to the accused Flagstar web pages.

To be sure, the decision in Eon-Net v. Flagstar was based on a highly specific set of facts. Still, the opinion suggests a new standard for assessing whether an unsuccessful patent infringement lawsuit filed by an NPE gives rise to Rule 11 sanctions or an award of attorneys’ fees and costs under 35 U.S.C. § 285.

The penalties imposed upon Eon-Net were predicated on a finding that its claim construction position was baseless. Yet, the Federal Circuit itself had previously suggested it had at least some support.

After all, whereas Eon-Net was content to rely on the plain and ordinary meaning of the claim terms, it was Flagstar that proffered a special definition of the claim terms “file or document” which would exclude electronic or web-based files or documents. While Eon-Net’s position did not carry the day, would it have been found to be frivolous if Eon-Net were not an NPE?

That a new standard may be emerging for sanctioning “patent trolls” is further supported by the “indicia of extortion” that both the district court and the Federal Circuit cited in concluding that Eon-Net filed its lawsuit in bad faith and for an improper purpose.

In practice, filing numerous lawsuits and demanding quick, low-cost settlements is a business model employed by scores of NPEs in order to sign up licensees, and almost every case brought by an NPE can be said to be asymmetric by its very nature. If these common characteristics of an NPE’s patent infringement suit can be deemed “indicia of extortion” and used to support a finding of bad faith and improper purpose, many unsuccessful NPE lawsuits will be found to be exceptional under 35 U.S.C. § 285.

If the Eon-Net decision proves to be the start of a trend, and not an outlier resulting from a set of egregious facts, NPEs may face a new patent litigation landscape much closer to a “loser pays” system. If so, general counsel may well be more willing to take a hard line the next time they are faced with a shakedown from a run-of-the-mill “patent troll.”

Copyright 2011, Sunstein Kann Murphy & Timbers LLP

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