From the Hill—States Go After Patent Trolls—How Far Can They Go?

Vol. 6 No. 6

By

Hayden W. Gregory is legislative consultant for the ABA Section of Intellectual Property Law in Washington, D.C.

In the May/June issue, this column continued its series of discussions concerning efforts to develop legal mechanisms and strategies to combat abusive practices in patent infringement enforcement by so-called patent “trolls,” also known as “non-practicing entities” (NPEs) and “patent assertion entities” (PAEs). The discussion then focused on the utilization of “bad faith demand letters” by PAEs as a technique to extract or extort unjustified settlements from parties alleged to be infringing a patent.

We are all familiar with “demand letters,” a short hand term for a legitimate technique whereby a patent owner formally notifies another party of its alleged infringement as a precursor to filing a suit and as invitation to discuss settlement. Less well-known, but growing more familiar every day, is the concept of “bad faith” demand letters. Enforcement agencies and legislative proposals to combat these practices vary somewhat in their definitions of this terminology, but common identifying features tend to include the sending of multiple—sometimes hundreds or thousands—identical letters to targeted small businesses whose commerce is unrelated to patents, with little or no previous investigation to establish that infringement is occurring and that the target is engaged in the infringement. Information provided in the letter is usually insufficient to allow the recipient to identify the infringing product and the patent claims alleged to be infringed, and how the target is committing infringement. The target is offered to take a license at a modest rate that is identified as far less than the cost of defending a suit, and advised that a suit is certain if settlement is not reached by a date certain. In fact PAEs rarely file suit if the target has not responded, and false representation to this effect is typically another identifying component in enforcement policies or legislative proposals targeted on “bad faith” demand letters.

As noted in our May/June column, states are becoming increasingly and aggressively involved in combatting bad faith demand letters that target businesses in the respective states. Such state involvement in patent matters is somewhat unusual, since patent law is subject to exclusive federal jurisdiction. 28 U.S.C. § 1338 provides that federal district courts “shall have original jurisdiction of any civil action arising under any Act of Congress relating to patents, plant variety protection, copyrights, and trademarks,” and that “such jurisdiction shall be exclusive of the courts of the states in patent, plant variety protection and copyright cases.”

The extension of exclusive jurisdiction to federal courts does not close the door to state participation in patent matters, since section 1338 provides that federal jurisdiction extends only to “any civil action arising under any Act of Congress.” State laws such as those enacted to combat consumer fraud do not “arise under” federal statutes, and thus are not immobilized by section 1338. However, enforcement of state laws relating to patents can also be limited by federal preemption. As applied in matters relating to patents, the doctrine of federal preemption is less well-defined than the jurisdictional statement in section 1338, but potentially more far-reaching and limiting on state action.

Recently, states have been aggressively engaged in two areas of activity relating to abusive enforcement practices by PAEs. Both have exactly the same objectives, deterring and sanctioning the communication of bad faith demand letters within the state in question.

States’ First Line of Attack: State Consumer Protection Suits

A year ago, state attorneys general began to attack PAEs by filing suit in state court under a state consumer protection law or similar law concerning consumer fraud or unfair trade practices. Vermont was the first state to confront a PAE in this manner, when in May 2013, Attorney General William H. Sorrell filed suit under Vermont’s Consumer Protection Act (VCPA) in Washington (VT) Superior Court against MPHJ Technology Investments, a Delaware limited liability corporation that lists its place of business as the address of another LLC, Registered Agents Legal Services LLC, MPHJ’s registered agent in Delaware.

MPJH removed the suit to federal district court, asserting that federal “arising under” jurisdiction exists because Vermont’s suit presents issues concerning the validity, infringement, and enforcement of the patents cited in the demand letters. The Vermont Attorney General moved to remand the case back to state court, asserting that the consumer fraud claims under the VCPA are based solely on state law, and the success of the suit does not depend on the invalidity or infringement of the MPHJ patents.

On April 14, 2014, U.S. District Court Judge William K. Sessions III granted Vermont’s motion to remand the case back to state court on grounds that the federal court lacked federal question jurisdiction. Acknowledging that federal patent jurisdiction is exclusive, Judge Sessions began his analysis by noting that the Supreme Court has recognized that: “[t]he Federal courts have exclusive jurisdiction of all cases arising under the patent laws, but not of all questions in which a patent may be the subject-matter of the controversy.”1 Sessions noted that federal jurisdiction by reason of “arising under” patent laws of the United States can be established in two ways, the first of which occurs when federal patent law created the cause of action in question. The judge ruled that was not the case with Vermont’s suit under its Consumer Protection Act, where consumer fraud was alleged based on the communication of bad faith demand letters and did not require adjudication of the validity or infringement of the MPHJ patents.

Judge Sessions identified a second basis recognized by the Supreme Court as establishing “arising under” jurisdiction to be a showing that “the plaintiff’s right to relief necessarily depends on resolution of a substantial question of federal patent law, in that patent law is a necessary element of one of the well-pleaded claims.”2

MPHJ argued that federal jurisdiction arose because sending the letters was permitted by federal patent law and by the First Amendment. However, these issues arise as defenses, and it is well-established that anticipated federal defenses are not components of a well-pleaded complaint, and thus cannot form the basis of federal jurisdiction. Judge Sessions distinguished cases in which a state claim necessarily raised issues of federal patent law, as in Hunter Douglas, Inc. v. Harmonic Design, Inc., 153 F.3d 1318, 1329 (Fed. Cir. 1998), where a state law claim of “injurious falsehood” was based on the defendant’s assertion of exclusive patent rights and required the plaintiff to establish the falsity of the assertion. Similarly, in Broder v. Cablevision Sys.Corp., 418 F.3d 187 (2d Cir. 2005), a state law claim for deceptive trade practices based on violation of a federal uniform rate provision necessarily raised issues of federal law and established federal jurisdiction.

State Statutes Specifically Directed to Bad Faith Demand Letters: A Second Line of Attack on PAEs

About the same time that states began suing PAEs for bad faith demand letters under their consumer protection laws, they also began enacting patent-specific state statutes directed at and designed to curb practices involving bad faith demand letters. At least a dozen states have enacted such legislation, and others have the matter under consideration. The primary objective of these legislative initiatives appears to be the same as those of the suits under consumer protection laws: to deter PAEs from sending bad faith demand letters. However, examination of the statutory mechanisms being established and analysis thereof in the context of recent jurisprudence concerning federal “arising under” and preemption jurisdiction suggest that these statutory schemes may be more vulnerable to attack on jurisdictional grounds than state action to achieve the same results through suits under state consumer protection laws.

As it has in anti-troll litigation, Vermont has taken the lead on the legislative front, being the first to enact a patent-specific law directed to bad faith demand letters, and that law is serving as the model for several other states as they move on the legislative front.

While targeted to the same conduct associated with bad faith demand letters, enforcement action authorized under the Vermont statute (9 V.S.A. chapter 120) is considerably broader than under the state’s consumer protection law. In addition to enforcement by the attorney general, a private cause of action is established, which may be brought by “a target of conduct involving assertions of patent infringement, or a person aggrieved by a violation of this chapter or by a violation of rules adopted under this chapter.”

“Target” is defined broadly to include any “Vermont person” who has received a demand letter or other communication accusing the person of patent infringement, and any person whose customers have received such a communication. “Target” also includes any Vermont person “against whom a lawsuit has been filed alleging patent infringement.” Since a suit for patent infringement is a matter of exclusive federal jurisdiction, the Vermont law seems to provide for state intervention against bad faith infringement demands in federal litigation. Remedies available to a person aggrieved by a violation of the Vermont statute include equitable relief, damages, reasonable attorney fees, and “exemplary damages” of $50,000 or three times actual damages and costs, whichever is greater.

The Vermont statute also provides for the imposition of a bonding requirement upon the establishment of “a reasonable likelihood that a person has made a bad faith assertion of patent infringement,” with the amount of the bond set to equal “the target’s cost to litigate the claim and amounts likely to be recovered” if the suit by the target is ultimately successful.

The Vermont attorney general successfully opposed removal to federal court of his MPHJ suit by arguing that the single objective of the suit was consumer protection from harassment and extortion through the communication of bad faith demand letters. This objective is stated in the statutory findings in chapter 160 that articulate the objectives of the statute, but the objectives are also stated more broadly to include “to facilitate the efficient and prompt resolution of patent infringement claims,” (not just bad faith claims) to “build Vermont’s economy,” and “attracting and nurturing small and medium sized internet technology (‘IT’) and other knowledge based companies.”

To its credit, the Vermont legislature included in its findings a number of recitations recognizing the exclusivity of federal patent law and disclaimers of intent to conflict with federal patent law or to “interfere with legitimate patent enforcement actions.” However, if the state law in fact conflicts with federal patent law, lack of intent will not excuse that conflict.

Gunn v. Minton: When Can a Patent Issue Trigger Federal Jurisdiction of a State Cause of Action?

In its October 2012 term, the Supreme Court decided Gunn v. Minton, a decision with potentially great significance for the jurisprudence of federal jurisdiction in patent cases and the federal-state jurisdictional interface in such cases, including in litigation growing out of state action against PAEs.

In the run-up to the decision in Gunn, patent owner Minton lost an infringement suit in federal district court when his patent was invalidated on grounds of the “on-sale” bar to patenting. He then moved for reconsideration claiming that he was testing the invention and therefore fell within the “experimental use” exception to the on-sale bar. When that motion was denied and the denial affirmed on appeal, Minton sued his lawyer Gunn in state court for malpractice for failure to raise the experimental use defense earlier in the proceedings. At the conclusion of the state judicial proceedings, the Texas Supreme Court held that the suit belonged in federal court because the success of the malpractice case depended on the outcome of “a substantial federal issue,” namely the applicability of the experimental use exception to the on-sale bar.

Chief Justice Roberts’s opinion for a unanimous Court begins with a recitation of the general rule that a case “arises under” federal law only when federal law creates the cause of action. However, the Court goes on to note and expound on a “special and small category of cases in which federal “arising under” jurisdictional still lies, even when the claim in question has its origins in state law. The Chief Justice characterized this exception as an “unruly doctrine,” the unruliness of which apparently prompted the Court a decade earlier to synthesize the doctrine in a more coherent statement. As synthesized in Grable & Sons Metal Products, Inc. v Darue Engineering & Manufacturing, 545 U.S. 308, and described by the Chief Justice in Gunn, “federal jurisdiction over a state law claim will lie if a federal issue is: (1) necessarily raised, (2) actually disputed, (3) substantial, and (4) capable of resolution in federal court without disrupting the federal-state balance approved by Congress.”

Real property owned by Grable was seized and sold by the Internal Revenue Service for a federal tax delinquency. Grable brought a quiet title action in state court, claimed that the IRS had not complied with notice requirements in the Internal Revenue Code before seizing and selling the property. In affirming the decision below upholding removal to federal court, the Supreme Court found substantiality in the need for the prompt collection of delinquent federal taxes and, to that end, for a clear meaning of federal tax law.

In applying the doctrine of Grable in Gunn, the Court acknowledged that the state malpractice action does meet the first two requirements of the four-part test. Since the success of the malpractice suit is dependent on the applicability of the experimental use exception, a federal issue is “necessarily raised” and “actually disputed.” The Gunn Court found that, unlike in Grable, the federal issue was not substantial. The Court ruled that the Texas Supreme Court had erred in focusing on the importance of the issue to the parties, and that “[t]he substantiality inquiry under Grable looks instead to the importance of the issue to the federal system as a whole.” Applying this principle to the facts in Gunn, the Court had little difficulty deciding that the federal issue was not significant, in that a ruling on “the backward-looking nature” of the malpractice claim in the case-within-a-case would have little effect on the on-going federal patent system.

The Court also addressed the issue of federal preemption by declaring that allowing state courts to resolve the patent law issues in question in Gunn will not undermine “the development of a uniform body of [patent] law,” quoting from Bonito Boats, Inc. v. Thunder Craft Boats, Inc., 489 U. S. 141, 162 (1989), a seminal decision on federal preemption of patent law.

State Action Against PAEs: To What Extent Can It Survive Supreme Court “Arising Under” and Federal Preemption Jurisprudence?

Vermont Attorney General Sorrell’s carefully crafted suit against PAE MPHJ resulted in a well-reasoned decision of U.S. District Judge Sessions that the case properly belonged in state court. While this result is by no means certain to be repeated when the issues involved are reviewed by higher courts, narrowly fashioned actions against bad faith demand letters under state consumer protection laws appear to have a good chance of survival.

As states expand the range, reach, and remedies against PAEs by legislative enactment, new and more difficult jurisdictional issues are created. In fact, the simple fact of additional states joining the playing field with legislation, even identical or similar legislation, increases the potential for conflict with federal patent law. This is true because it is the significance of the patent-related issue to the system, not to the parties, that is critical. This is true in both determining the substantially of a patent issue to the resolution of an action brought under state law—a key factor in “arising under” federal jurisdiction under Gunn v. Minton—and to determining the separate question whether federal patent law preemptively precludes application of conflicting state law.

As noted in the discussion above of the Vermont law, these patent-specific state laws seem to authorize counter measure against PAEs that go well beyond actions authorized under state consumer protection laws. This includes additional purposes (such as “attracting and nurturing small and medium sized internet technology (IT) and other knowledge based companies” and “to facilitate the efficient and prompt resolution of patent infringement claims”), and authorizing additional parties to bring an action against PAEs, including a private cause of action by any “Vermont person” injured by the PAE conduct.

The statute seems to suggest that authority to act against a PAE is not limited to a bad faith demand letter sent in advance of filing a federal patent infringement suit, but would also extend to any communication of a bad faith assertion of patent infringement, including in a federal patent infringement suit. A “target” aggrieved by a violation of the law is defined to include any Vermont person who has been threatened with suit or “against whom a lawsuit has been filed alleging patent infringement.” Since a patent infringement suit can be brought only in federal court, this seems to authorize a state suit by a target against a PAE who has filed suit in federal court. Remedies available to a successful target include injunction, damages (including punitive damages), and reasonable attorney’s fees. Further indication of likely impact on federal patent litigation is a bonding provision, under which an alleged offender can be ordered to post a bond that includes costs to the target “to litigate the claim,” which apparently includes the cost to the target of defending in a federal infringement action.

Conflict with the federal system is the primary test to determine if a state law is preempted by federal patent law, and the above-cited provisions are among those in the Vermont statute that raise concerns.

The flurry of activity in state legislatures regarding PAE patent infringement enforcement parallels similar efforts in Congress, and it is interesting to consider the impact of these concurrent efforts on issues of jurisdiction and preemption. For example, amendments have been proposed in the Senate that recognize systemic problems caused by bad faith demand letters and propose federal responses. It may be argued that these parallel measures show that federal and state lawmakers share a common goal and reflect complementary and not conflicting approaches. However, there are a number of problems with this line of argument. As the Supreme Court ruled in the 2012 Arizona immigration decision, Arizona v. United States, 567 U.S. ___ , when Congress by statute occupies an entire field of law, even complementary state regulation is precluded. Without regard to content, the very existence of a parallel state system represents conflict with the federal system. Furthermore, actual conflict in parallel systems is all but inevitable. For example, S. 1720, the leading Senate PAE bill, calls for enforcement against bad faith demand letters by the Federal Trade Commission as an unfair or deceptive act or practice under the FTC Act. State action, including private causes of action based on the same bad faith allegation of patent infringement, seems to present an irreconcilable conflict with the federal system. This creates not just a conflict with the federal system, but a systemic conflict. Indeed, with an ever-growing number of states enacting their own statutory schemes, multiple systemic conflicts may be emerging.

The Chairman of the Senate Judiciary Committee has recently suspended action on PAE legislation, citing fundamental disagreements among stakeholders and senators on key provisions that to date have been irreconcilable. What are the jurisprudential ramifications should Congress pass no new legislation? It may be tempting for advocates of state action to suggest that congressional inaction represents a decision against federal occupancy of the field, leaving it free for states to move in. However, Supreme Court cases such as Bonito Boats and Sears Roebuck v. Stiffel, 376 U.S. 224, inform us that where federal patent law denies protection, states may not step in and provide patent-like protection under state laws. In fact, the failure of Congress to date to enact PAE legislation is due in large part to its inability to agree on the need to respond to PAE abuses with additional requirements and restrictions for enforcement against patent infringement, such as additional disclosure requirements, mandatory or presumptive payment of the prevailing party’s attorney fees by the losing party, and highly detailed content requirements for demand letters. It is not unreasonable to argue that congressional failure to enact these measures represents a decision that they do not belong in the patent system, either directly in federal law or indirectly through state law.

It may be that these patent-related state laws will suffer a better fate than the above discussion of the precedents suggests. Although these statutes cast a much broader enforcement net than Vermont’s consumer protection action that so far has survived, it could be that in application of the new laws, states’ attempted grasp does not exceed the successful reach of Vermont in MPHJ. It could also be that federal appellate courts will look less critically on state tinkering with patent enforcement mechanisms than on state efforts to extend patent law to subject matter not protectable under federal law.

State attorneys general seem to be producing good results in pursuing PAEs under traditional state consumer protection laws. In addition to Vermont’s experience, both New York and Minnesota have reached favorable settlements in actions against MPHJ in which MPHJ has agreed to severely curtail its shady practices involving demand letters. The Minnesota agreement requires advance submission and consent of the AG before such letters may be sent. These enforcement actions under state “Mini-FTC” Acts are not immune from challenge on jurisdictional grounds, but they are certainly less vulnerable than the patent-specific full service anti-troll state laws that are a hot topic on multi-state and model state law agendas. State attorneys general might be wise to do a costs/risks/benefit analysis in directing their resources and strategies in the commendable effort to protect their citizens from unscrupulous enforcement efforts of patent trolls.

Endnotes

1. New Marshall Engine Co. v. Marshall Engine Co., 223 U.S. 473, 478 (1912).

2. Citing Christianson v. Colt Indus. Operating Corp., 486 U.S. 800, 809 (1988).

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