Seventh Circuit: Policyholder Is Entitled to Independent Counsel at Insurer’s Expense Where Excess Judgment Is Likely

Illinois courts have long held that a policyholder is entitled to retain independent counsel at the insurance company’s expense whenever there is a conflict between the interests of the insurance company and those of the policyholder. Such a conflict typically arises where the insurer reserves its right to deny coverage and insurer-retained defense counsel would have an opportunity to shift facts in a way that takes the underlying litigation outside the scope of policy coverage.  American Family Mut. Ins. Co. v. W.H. McNaughton Builders, Inc., 363 Ill. App. 3d 505, 843 N.E. 2d 492 (2006).  For example, where the underlying complaint alleges both negligent conduct (covered) and intentional conduct (not covered), insurer-retained defense counsel could provide a strong defense to the negligent-act allegations and a less vigorous defense to the intentional-act allegations, potentially resulting in the suit’s not being covered.

For the first time, an appellate court, applying Illinois law, has held that a conflict of interest also arises between the insurer and the policyholder when it becomes clear to the insurer that a judgment against the policyholder in excess of policy limits is a “nontrivial probability.”  In R.C. Wegman Construction Co. v. Admiral Insurance Co., 629 F. 3d 724 (7th Cir. 2011), a worker at a construction site managed by the policyholder was seriously injured in a fall and sued the policyholder. The policyholder tendered its defense to its liability insurer under a policy that had a $1 million limit.  The insurer accepted the defense and retained counsel to defend the policyholder. The worker’s suit proceeded to trial, and a judgment in excess of $2 million was entered against the policyholder.

The policyholder sued its insurer, alleging that the insurer was liable for the entire judgment due to its failure to inform the policyholder of the likelihood of an excess judgment.  The policyholder alleged that, had it known of the likelihood of an excess judgment, it would have retained independent counsel to defend it in the underlying suit, notified its excess insurer and possibly settled the suit prior to trial.  The policyholder alleged that its excess insurer denied coverage based on late notice, leaving the policyholder liable for the excess judgment.

The court found that the likelihood of an excess judgment gave rise to a conflict of interest because, due to the policy-limit cap on the insurer’s liability, it had less incentive to settle than the policyholder.  As such, the court held that the insurer had an obligation to notify the policyholder of the probability of an excess judgment, disclose the resulting conflict of interest and afford the policyholder the option “of hiring a new lawyer, one whose loyalty will be exclusively to him.”  By failing to do so, the insurer breached its fiduciary duty to the policyholder.

The Wegman decision is significant for policyholders in that it provides a strong basis for asserting a right to retain independent counsel at the insurer’s expense where an excess judgment is a real possibility.  The Wegman decision is also significant for insurers because it dictates that insurers must notify a policyholder where an excess judgment is a possibility and afford the option of hiring independent counsel at the insurer’s expense.  Where the insurer fails to do so, it may find itself liable for an excess judgment against the policyholder.

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Yahoo! Expands Policy on Maintaining User Data

Search company Yahoo! has announced its intention to extend user data for 18 months to meet the needs of its clients. Currently, the data is only retained for 90 days before it is made anonymous. This change is expected to take place sometime this summer.

Will this enable litigants to extract data from Yahoo! when a lawsuit arises?  Probably not.  Yahoo! will maintain all user search data for an indefinite period of time.  However, under the new policy, Yahoo! will anonymize that data after 18 months.  This means that all identifying particulars will be removed from the users’ data upon the expiration of the 18 month period.

Finding specific user data prior to the end of 18 months will be the equivalent of finding the proverbial needle in a haystack assuming it is possible at all.  Thus, subpoenas to Yahoo! (or any search provider) are usually not the recommended course of action as they are rarely worth the effort.  Rather, the better route is usually to access the target user’s computer directly which in turn requires prompt litigation hold letters and other established procedures.

Turning a Blind Eye to Critical Facts leads to Induced Infringement Under 35 U.S.C. § 271(b)

A person who actively induces another person to infringe a patent is liable as an infringer. 35 U.S.C. §271(b).  On Tuesday, May 31, 2011, the United States Supreme Court held that “willful blindness” to the existence of a patent can be sufficient evidence of knowledge of the patent to support a finding of induced infringement. Global-Tech Appliances, Inc. v. SEB S.A., 563 U.S. ___ (2011). The Court rejected a more lenient standard adopted by the Federal Circuit — deliberate indifference to a known risk that a patent exists. Nonetheless, the Supreme Court affirmed the Federal Circuit’s judgment by applying its new standard. Justice Alito wrote the majority opinion from which Justice Kennedy dissented.

Summary of the Case

SEB S.A. (“SEB”) is a French manufacturer of home appliances. It owns a patent that relates to deep fryers. Sunbeam Products, Inc. (“Sunbeam”) is a competitor of SEB in the United States.  Pentalpha Enterprises, Ltd. is a Hong Kong manufacturer of home appliance and a wholly-owed subsidiary of Global-Tech Appliances, Inc. (collectively “Pentalpha”). Slip op. at 2–3.

Pentalpha developed a deep fryer for Sunbeam by copying all but the cosmetic features of a SEB deep fryer it purchased in Hong Kong. The SEB deep fryer had no U.S. patent markings because it was made for sale in a foreign market.  Before selling the deep fryers to Sunbeam, Pentalpha retained an attorney to conduct a right-to-use study of the deep fryer it had developed for Sunbeam. Pentalpha refrained, however, from telling its attorney that it had copied SEB’s deep fryer to develop its deep fryer. Slip op. at 2.

After conducting a search that failed to locate the SEB patent, the attorney issued his opinion that the deep fryer developed by Pentalpha did not infringe any of the patents that he had found.  Pentalpha immediately began selling its deep fryer. Slip op. at 2.

SEB sued Pentalpha for patent infringement alleging direct infringement under section 271(a) and induced infringement under section 271(b) by actively inducing Sunbeam and other retailers to sell Pentalpha’s deep fryer in violation of SEB’s patent rights. Slip op. at 3. After trial, the jury returned a verdict of direct infringement under section 271(a) and induced infringement under section 271(b) and found that Pentalpha’s infringement was willful. The district court entered judgment against Pentalpha. Slip op. at 3.

On appeal, Pentalpha argued the judgment of induced infringement had to be reversed because there was no direct evidence that Pentalpha knew of the SEB patent before it received notice of the Sunbeam lawsuit. The Federal Circuit held that section 271(b) requires that the patentee “’show that the accused infringer knew or should have known that his actions would induce actual infringement’ and that this showing requires proof that the accused infringer knew of the patent.”  Slip op. at 3. The Federal Circuit found, however, sufficient evidence to support a finding that “’Pentalpha deliberately disregarded a known risk that SEB had a . . . patent.’”  Id.  According to the Federal Circuit, such disregard “’is not different from actual knowledge, but is a form of actual knowledge.’”  Id.

Section 271(b) Requires Knowledge of the Patent that is Infringed

In 1952, Congress codified the principles of contributory infringement that had been part of the case law for about 80 years. See 35 U.S.C. § 271(b) & (c). Section 271(b) addresses conduct where a person actively induces infringement of a patent. 35 U.S.C. § 271(b). Section 271(c) addresses conduct where a person sells a component that is not itself patented, but may enable another party to make or use a patented machine. Neither the language of section 271(b) nor the pre-1952 cases provided an affirmative answer to the first question before the Court- is knowledge of the patent required to find induced infringement under section 271(b).

The Court found the answer in Aro Mfg. Co. v. Convertible Top Replacement Co. 377 U.S. 476 (1964). In Aro, the Supreme Court considered the issue of contributory infringement under section 271(c). A majority in Aro concluded that knowledge of the patent was needed to violate section 271(c).  Id. at 8–9 (citing Aro, 277 U.S. at 488 n.8; id. at 415 (White, J., concurring); id. at 524–27 (Black, J., dissenting)). Since section 271(b) and (c) both were aspects of contributory infringement, the Court unanimously concluded that knowledge of the patent was likewise needed to find inducement in violation of section 271(b). Id.; Dissenting op. at 1.

The Court Adopts the Doctrine of Willful Blindness From Criminal Law to Find Knowledge of the Patent Infringed Under Section 271(b)

Lacking direct evidence that Pentalpha knew of the patent, the Court had to address whether the evidence was nonetheless sufficient to support a finding of knowledge. The Court rejected the standard applied by the Federal Circuit for two reasons. “First, it permits a finding of knowledge when there is merely a ‘known risk’ that the induced acts are infringing.” Slip op. at 14. “Second, in demanding only ‘deliberate indifference’ to that risk, the Federal Circuit’s test does not require active efforts by an inducer to avoid knowing about the infringing nature of the activities.”  Id. Instead, the Court applied the doctrine of willful blindness, which had been widely adopted by federal courts in the area of criminal law, to support a finding of knowledge. Slip op. at 10–11.

The doctrine of willful blindness has two basic requirements: (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.  The Court explained that these requirements “give willful blindness an appropriately limited scope that surpasses recklessness and negligence.” Id. Neither recklessness, i.e., merely knowing of a substantial and unjustified risk of such wrongdoing, nor negligence, i.e., should have know of a similar risk, but in fact did not, will suffice to prove that the accused infringer had knowledge of the patent. Accordingly, “a willfully blind defendant is one who takes deliberate actions to avoid confirming a high probability of wrongdoing and who can almost be said to have actually known the critical facts.” Id.

Although the Court rejected the test applied by the Federal Circuit, it affirmed the judgment of the Federal Circuit “because the evidence in this case was plainly sufficient to support a finding of Pentalpha’s knowledge under the doctrine of willful blindness.” Slip op. at 10.

Conclusion

The affirmance in Global-Tech Appliance shows that in many cases, the result will be the same under the willful blindness test adopted by the Court as under the now rejected deliberate indifference test. Nonetheless, at the margin, proving inducement has been made more difficult where actual knowledge cannot be established.

U.S. Supreme Court Rules Arbitration Clauses May Waive Class Action Rights

The Supreme Court of the United States ruled on April 27, 2011, that state laws and court decisions that prohibit arbitration clauses from containing class action waivers are preempted by the Federal Arbitration Act, and that such clauses are not necessarily unconscionable.

The Supreme Court of the United States recently handed down a decision in AT&T Mobility LLC v. Concepcion, 562 U.S. ___ (2011), which will have a major impact on the enforceability of class action waivers in arbitration clauses.  The court held that the Federal Arbitration Act (FAA) preempts state statutory and decisional authority that treats arbitral class action waivers as unconscionable, as a matter of law.  The Supreme Court also specifically disapproved of a California Supreme Court decision that had held that class action waivers in consumer contracts were unconscionable, and thus unenforceable.  The AT&T decision could provide a road map for companies desiring to avoid consumer class action claims.

Section 2 of the FAA makes agreements to arbitrate “valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”  9 U.S.C. §2.  The California decision had held that class action waivers are, as a matter of law, unconscionable in consumer contracts of adhesion involving small amounts at issue.  Based on its finding that unconscionability may provide grounds to revoke any contract, the California court found the FAA did not prohibit it from refusing to enforce an arbitral class action waiver.

In AT&T, the Supreme Court held that this rule interferes with the clear intent of the FAA to promote arbitration, noting “[t]he ‘principal purpose’ of the FAA is to ‘ensur[e] that private arbitration agreements are enforced according to their terms.’”  AT&T slip op., at 9–10 (quoting Volt Information Sciences, Inc. v. Board of Trustees of Leland Stanford Junior Univ., 489 U.S. 468, 478 (1989)).  The court found that the California rule would disallow enforcement of any arbitration agreement that included a class action waiver in a consumer contract.  While the California court reasoned that its rule should only apply to adhesion contracts, the Supreme Court noted that “the times in which consumer contracts were anything other than adhesive are long past.”  AT&T slip op., at 12.  The Supreme Court also noted that the other requirements for the California rule to be applied—that the case involve small dollar amounts and involve schemes to cheat consumers—were too flexible and would only require basic allegations to be made to defeat the terms of an arbitration agreement.  The Supreme Court held that when a state law would impair the purpose of the FAA to the extent that the California rule would, the FAA must preempt the conflicting state law.

Importantly, the Supreme Court did not rule that all arbitral class action waivers are enforceable.  Rather, the Supreme Court held only that arbitral class action waivers are not, in and of themselves, unconscionable.  Courts still must evaluate the particular arbitration agreement at issue on a case-by-case basis to determine whether the terms are fair.  The arbitration agreement at issue in the AT&T decision, however, provides an example of an arbitration agreement that courts have held to be fair and enforceable.  The highlights of that arbitration agreement include the following:

  • Venue in the county where the consumer resides
  • Consumer election to have the arbitration be in-person, telephonic or decided based on written submissions
  • AT&T agreed to pay all costs for nonfrivolous claims
  • Arbitrators had the power to award any form of individual relief, including issuing injunctions and presumably awarding punitive damages
  • AT&T waived any right to seek reimbursement of its fees and costs
  • In the event that a consumer received an award greater than AT&T’s last written settlement offer, AT&T was to pay a $7,500 minimum recovery and double the amount of the consumer’s attorney’s fees

In finding AT&T’s terms fair, the Supreme Court relied on the District Court’s finding that consumers “were better off under their arbitration agreement with AT&T than they would have been as participants in a class action, which ‘could take months, if not years, and which may merely yield an opportunity to submit a claim for recovery of a small percentage of a few dollars.’”

Businesses at risk for consumer class actions should consider whether the cost of a generous arbitration provision like AT&T’s may outweigh the risk of consumer class actions.  The key to this analysis is the difference between the number of consumers who are likely to pursue individual claims to their conclusion and the likelihood that a plaintiff’s attorney will assert claims on behalf of a large number of consumers without their active participation.