Supreme Court: Bayh-Dole Act Does Not Eclipse Inventor’s Rights

On June 6, 2011, the United States Supreme Court ruled that the Small Business Patent Procedures Act of 1980 (a/k/a the Bayh-Dole Act)1 does not displace the centuries-old maxim that “rights in an invention belong to the inventor.” Board of Trustees of the Leland Stanford Junior Univ. v. Roche Molecular Sys(opens in a new window)., 563 U.S. —, 2011 WL 2175210, at *4 (June 6, 2011). “Although much in intellectual property law has changed in the 220 years since the first Patent Act, the basic idea that inventors have the right to patent their inventions has not.” Id. at *6. “[U]nless there is an agreement to the contrary, an employer does not have rights to an invention which is the original conception of the employee alone.” Id. at *7. This rings true even when the Federal Government is footing the bill.

In 1985, scientists at Cetus Corp. developed a revolutionary method that allows billions of copies of DNA sequences to be made from a small initial blood sample. This technique became known as the polymerase chain reaction or PCR. In 1988, Dr. Mark Holodniy, a professor at Stanford University, sought to work with Cetus to use the PCR method in an effort to develop a method for quantifying HIV levels in patient blood samples. As a condition of accessing Cetus’ facilities and methodology, Holodniy signed a Visitor’s Confidentiality Agreement (“VCA”), which stated that Holodniy “will assign and do[es] hereby assign” to Cetus his “right, title and interest in each of the ideas, inventions and improvements” made “as a consequence of [his] access” to Cetus.

Upon returning to Stanford, Holodniy disclosed his new method of quantifying HIV to Stanford and Stanford filed a series of patent applications. In 1991, Roche Molecular Systems acquired Cetus’s PCR-related assets, including the rights Cetus obtained through the VCA signed by Holdoniy. Roche subsequently developed and commercialized the procedure. Standford then filed suit against Roche contending that Roche’s HIV test kits infringed Stanford’s patents. In response, Roche claimed that it was a co-owner of Holdoniy’s inventions based on Holdoniy’s assignment of rights in the VCA, while Stanford argued that it had superior rights to Holodniy’s inventions under the Bayh-Dole Act. The District Court agreed with Stanford, finding that although “the VCA effectively assigned any rights that Holodniy had in the patented invention to Cetus, . . . Holodniy had no interest to assign” because of the operation of the Bayh-Dole Act. Id. at *5 (internal quotation marks and citation omitted). The Court of Appeals for the Federal Circuit, however, disagreed. The court determined (1) that the Bayh-Dole Act “does not automatically void ab initio the inventors’ rights in the government-funded inventions and (2) that Holodniy’s assignment to Roche, with the “hereby assigns” language, trumped the one he made earlier to Stanford’s because Stanford’s assignment stated that Holodniy “agree[d] to assign” to Stanford his “right, title and interest in” inventions resulting from his employment at Stanford. Id. at *1, *6 (internal quotation marks and citation omitted). Stanford appealed, arguing that the Bayh-Dole Act gave Stanford superior rights.

In affirming the Federal Circuit, Chief Justice Roberts concluded that “[t]he Bayh-Dole Act does not confer title to federally funded inventions on contractors or authorize contractors to unilaterally take title to those inventions; it simply assures contractors that they may keep title to whatever it is they already have.” Id. at *9. That is, the Act “serves to clarify the order of priority of rights between the Federal Government and a federal contractor in a federally funded invention that already belongs to the contractor. Nothing more.” Id. Simply put, absent an express written agreement to the contrary, an inventor’s rights to an invention reign supreme over an employer’s interest, even when the invention is financed by the Federal Government.2

This holding poses particular challenges for universities and other educational institutions, which often receive federal funding leading to patentable inventions. Such institutions cannot assume that ownership rights are certain by virtue of receiving federal funding. Thus, these institutions must “enter into agreements with their employees requiring the assignment to the university of rights in inventions” to ensure their ownership stake. Id. at *11.

In addition, the Supreme Court’s decision exposes a vulnerability in the Bayh-Dole Act that enables organizations to avoid the Act’s “marching orders” by ensuring that federally funded inventions remain assigned to their individual inventors. Indeed, as Justice Roberts makes clear, inventions only fall within the scope of the Bayh-Dole Act if federally funded and effectively assigned to the contracting organization. It is now up to Congress to patch this loophole by amending the Act to expressly vest title in federally funded inventions in the contracting organizations.

For now, however, this decision acts as a guidepost and warning to all employers to ensure that those involved in the inventive process have signed written agreements specifying employer rights with respect to each invention. Moreover, it underscores the importance of a company meticulously requesting visitors to execute confidentiality agreements in which the visitor assigns all rights, title and interest to inventions made as a result of the access provided by the company. Without such agreements, organizations risk being able to ensure their own rights, which in turn threatens their future ability to license or transfer their rights to third parties. Accordingly, all organizations (but especially federal contractors) should undertake the following protective measures:

  1. Inventory all inventions arising out of past and present research and development projects;
  2. Identify all employees and independent contactors involved in inventive processes relating such inventions;
  3. Ensure that all employees and independent contractors involved in the inventive processes have signed written agreements specifying the employer’s rights to any related inventions; and
  4. Keep track of all confidentiality agreements executed by employees seeking to gain access to third party facilities.

This list may also prove beneficial when conducting due diligence of an acquisition target, a potential licensing deal, or technology transfer opportunity.

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.

Federal Circuit Significantly Restricts the Doctrine of Inequitable Conduct in Therasense v. Becton Dickenson

On May 25, 2011, the U.S. Court of Appeals for the Federal Circuit issued an en banc decision in Therasense v. Becton Dickenson, No. 2008-1511 (Fed. Cir., May 25, 2011), outlining a heightened standard for inequitable conduct in patent infringement cases, requiring a finding of both specific intent to deceive and a “but-for” materiality.

The doctrine of inequitable conduct is a defense to patent infringement that, if proved, bars enforcement of the patent. In making its decision, the Federal Circuit noted that the doctrine evolved from three early U.S. Supreme Court Cases, which involved particularly egregious misconduct, including perjury, the manufacture of false evidence, and the suppression of evidence, to a broader scope of misconduct including the mere nondisclosure of information to the PTO. In addition, the doctrine evolved from a mere dismissal of the suit, to the unenforceability of the entire patent and its continuations and divisionals. In order to prove inequitable conduct, the accused infringer must prove intent and materiality by clear and convincing evidence. If the infringer meets this burden, the court must then weigh the equities to determine whether the applicant’s conduct before the PTO warrants rendering the entire patent unenforceable. The Federal Circuit noted that the standards for materiality have fluctuated over time, and the standard has been weakened by placing intent and materiality on a sliding scale, thus both conflating and diluting the standards at the same time. As a result, inequitable conduct has become a significant litigation strategy, increasing the complexity, duration, and cost of patent litigation. According to the Federal Circuit, one study estimated that eighty percent of patent infringement cases included allegations of inequitable conduct. This has plagued the courts and the whole patent system.

In this en banc decision, the Federal Circuit adopted a much more restrictive test for inequitable conduct. With regard to intent, an accused infringer must now prove that the patentee acted with specific intent to deceive the PTO. For example, the accused infringer must prove by clear and convincing evidence that:

(1) the applicant knew of the reference,

(2) knew that it was material to the prosecution of the application, and

(3) made a deliberate decision to withhold it.

With regard to materiality, the Federal Circuit adopted a “but-for” standard, e.g. but-for the non-disclosure of the reference, the patent would not have issued.This is a much more restrictive standard than the prior standard and even the patent office’s own standard under Rule 56. In fact, the Federal Circuit said specifically that they do not adopt the PTO’s definition of materiality under Rule 56.

The Therasense decision has strictly limited the usefulness of the inequitable conduct doctrine as a defense to patent infringement. It is likely that this decision will help to simplify patent infringement cases and may lead to more patents being upheld and infringed.

U.S. Supreme Court Establishes State-of-Mind Requirement for Inducing Infringement Liability

Today, the U.S. Supreme Court issued its decision in Global-Tech Appliances, Inc., et al. v. SEB S.A., No. 10-6 (2011), holding that to prove inducing infringement under 35 U.S.C. § 271(b) a plaintiff must prove that the infringer had knowledge that “the induced acts constitute patent infringement.” The Court also held that this knowledge requirement can be satisfied by evidence of “willful blindness.”

Morgan Lewis represented SEB in this case.

On the facts of the case, SEB had developed an innovative method to produce household deep fryers and received a U.S. patent for this invention. A foreign competitor, Global-Tech Appliances, purchased one of SEB’s fryers in Hong Kong where it would not have patent markings, reverse-engineered SEB’s fryer, and then copied the SEB fryer’s unique technology. Global-Tech hired a patent attorney to conduct a patent search, but deliberately chose not to tell that attorney that its fryer was a copy of another company’s commercially successful fryer. The attorney did not locate SEB’s patent in its patent search. Global-Tech then sold its fryers to U.S. companies to sell within the United States. SEB sued Global-Tech for patent infringement and inducing infringement, and the jury found for SEB on all counts.

On appeal, Global-Tech challenged the finding on inducing infringement liability due to a lack of evidence of its actual knowledge of SEB’s patent. Section 271(b) provides that “[w]hoever actively induces infringement of a patent shall be liable as an infringer.” Over the last two decades, the Federal Circuit has offered various formulations of what mental-state requirement must be proven to establish liability under § 271(b). On appeal in this case, the Federal Circuit held that the mental-state requirement could be satisfied by evidence of “deliberate indifference of a known risk that a patent exists” and that Global-Tech’s actions constituted such deliberate indifference.

The Supreme Court rejected the Federal Circuit’s analysis but nonetheless affirmed the judgment. The Court held that inducing infringement liability under § 271(b) requires evidence that the infringer had knowledge that “the induced acts constitute patent infringement.” Adopting the argument advanced by SEB, the Court held that this knowledge requirement could be satisfied by evidence of “willful blindness.” After analyzing the record, the Court held that the judgment for SEB could be affirmed based on the evidence of Global-Tech’s willful blindness. The Court focused on Global-Tech’s decision to purchase the fryer to reverse-engineer it overseas (where it would not have U.S. patent markings) and then to deliberately withhold from its attorney the basic information that its fryer was a copy of SEB’s fryer.

This decision clears up an issue of long-standing confusion in the Federal Circuit as to the mental-state requirement of § 271(b). The Court’s explication of the standard should be welcome news to both innovators and holders of patents. The decision prevents frivolous claims of inducing infringement by requiring proof of knowledge of infringement. At the same time, it allows companies to protect their intellectual property rights against those companies that willfully blind themselves to a lawful patent in order to copy a commercially successful product. Corporations hiring attorneys to conduct patent searches should be sure to disclose to their attorneys any products copied or relied upon in developing a new technology.

Football Dataco Ltd v Sportradar GmbH: Copyright and Database Right Infringement and Jurisdiction

Allowing Sportradar’s appeal in part, the Court of  Appeal of  England and Wales has ruled that Dataco’s copyright claim in  relation to a database of football statistics failed because what  was allegedly copied was “mere data”, not the database itself.   Lord Justice Jacob, however, dismissed Sportradar’s appeal on  jurisdiction over database right infringement claims insofar as  they were based on allegations that Sportradar were joint  tortfeasors with its UK customers.  Further and most  significantly, on the question of primary infringement by  Sportradar of Dataco’s database rights, Jacob LJ has decided to  refer the reutilisation issue to the Court of Justice of the  European Union (CJEU).


Dataco creates and exploits data relating to football matches in  the English and Scottish leagues.  Sportradar provides live  scores, results and other statistics relating to football and other  sports, including UK football matches, to the public  via the  internet.  A number of Sportradar’s customers provide betting  services for and aimed at the UK market.  In Football Dataco  Ltd and others v Sportradar GmbH and another [2010] EWHC  2911 (Ch) Dataco argued that Sportradar copies data from  Dataco.

Sportradar denied copying and commenced proceedings against  Dataco in Germany, seeking declarations that its activities did  not infringe Dataco’s rights.  Sportradar contended that the  English proceedings did not disclose a “good arguable case”  against the company and so the German court is the court first  seised with the dispute.


Copyright Claim

Jacob LJ accepted Sportradar’s submission that the data alleged  to have been copied (goals, goal scorers, etc.,) were matters of  fact that were precluded from copyright protection  as mere  “contents” of a database.  It followed, therefore, that when the  proceedings started, the English court was not seised of a claim  in copyright to the necessary standard.

Database Right:  Joint Tortfeasorship 

The issue here was not subsistence of database rights but  whether Dataco’s claim identified properly any cause of action  justiciable in the English courts.    Jacob LJ agreed with Dataco’s submissions, finding  that the  English courts were first seised of the dispute insofar as  Dataco’s claim alleged that Sportradar was joint tortfeasor with  businesses in the United Kingdom over which the court had  jurisdiction.  If Dataco was right about copying, it was arguable  clearly that Sportradar and its customers were acting in concert  to enable access in the United Kingdom to the copied data.

Database Right:  Primary Infringement

On the question of primary infringement, Jacob LJ decided to  refer to the CJEU questions on the meaning of “reutilisation”  under Article 7.2 of the Database Directive (96/9/EC).   Dataco’s claim of primary infringement by Sportradar turned  on the definition of infringement in the Directive, which  includes transmission.

Transmission over the internet, in Dataco’s submission,  involves both the acts of hosting the website and also the act of  the user in accessing it.  Sportradar’s case is that acts of  transmission occur only in the place from where the data  emanates.  Jacob LJ decided that “this very important and  difficult question” should be referredto the CJEU.


Dataco’s claim that Sportradar is directly liable for breach of  database right is now stayed pending the outcome of the  reference to the CJEU, whilst its claim in joint tortfeasorship,  which is not dependent on the questions asked, is allowed to  proceed.  Given the far reaching consequences of a  decision  that transmission can “occur” where the user accesses the  information, the CJEU’s view is eagerly anticipated.

Software Compilation Not A Trade Secret Under State Law

The U.S. Court of Appeals for the Fourth Circuit vacated and remanded a grant of summary judgment to Defendants on Plaintiff’s claims for misappropriation of trade secrets and breach of contract against defendant Sentia Group and several former employees of the plaintiff.  Decision Insights, Inc. v. Sentia Group, Inc et al., Case No. 09-2300, (4th Cir., March 15, 2011) (per curiam).

Decision Insights offers software used as an analytical tool in preparing negotiation strategies.   In 2006, Decision Insights filed suit against a group of former employees alleging that they improperly used the plaintiff’s propriety source code and breached non-disclosure agreements in forming Sentia Group, a competing software company.   Decision Insights also alleged that the defendants used materials containing the plaintiff’s trade secrets, such as marketing and research reports, client information and information contained in its software user manual.

To qualify as a trade secret under Virginia law, information must possess independent economic value, not be generally known or readily ascertainable by proper means and   be subject to reasonable efforts to maintain secrecy.

The district court granted summary judgment for the defendants, holding that Decision Insights failed to establish that its software qualified as a trade secret, because the plaintiffs did not show that the software was not generally known or ascertainable.   The district court also dismissed the plaintiff’s trade secret claims towards the additional, non-software materials, finding that because the plaintiff’s claims failed towards its source code, the plaintiff’s other claims also failed.

On appeal, the 4th Circuit determined that the deposition testimony and testimony of Plaintiffs’ expert witnesses created sufficient issues of fact to merit consideration by a jury and on that basis vacated and remanded the summary judgment determination.   One of the plaintiff’s expert witnesses, a co-author of the original source code at issue, opined that certain elements of the source code had never been published, supporting a finding that the plaintiff’s source code qualified as a trade secret.   A second expert witness, also a co-author of the source code, testified that portions of the source code and its sequence had been purposefully kept confidential.

Further, the 4th Circuit determined that the district court improperly granted summary judgment without considering the other two elements required for trade secret protection – whether the plaintiff’s source code possessed independent economic value and whether Decision Insights engaged in reasonable efforts to maintain secrecy.   Further, the 4th Circuit directed the district court to consider the plaintiff’s trade secret claims towards non-source code materials independently from the trade secret claim concerning the plaintiff’s source code.

You Cannot “Game” the Appellate System by Filing a “Protective” Cross-Appeal

Believing that an appellee’s cross-appeal following a favorable judgment was nothing more than an attempt to get the upper hand in the appeal, the U.S. Court of Appeals for the Federal Circuit granted a motion to dismiss a cross-appeal, finding the cross-appeal improper because, if successful, it would not expand the scope of the judgment in appellee’s favor.  Aventis Pharma S.A. v. Hospira, Inc., Case No. 11-1047 (Fed. Cir., Mar. 24, 2011) (Moore, J.).

In separate actions, Aventis Pharma sued Hospira and Apotex for infringement of patents relating to drugs used to treat certain types of cancers.  The cases were consolidated and the district court ruled in favor of the defendants, finding that all the asserted claims were invalid for obviousness and unenforceable due to inequitable conduct.  The district court, however, rejected Apotex’s assertion that some of the claims were invalid for double-patenting.

After Aventis appealed, Apotex filed a “protective” cross-appeal, allegedly aimed at preserving its right to challenge the district court’s double-patenting ruling should the Federal Circuit reverse the invalidity and unenforceability rulings. Subsequently, Aventis asked Apotex to withdraw the cross-appeal. After Apotex refused, Aventis moved to dismiss the cross-appeal.

The Federal Circuit granted Aventis’ motion.  The Court noted that “[a] cross-appeal may only be filed ‘when a party seeks to enlarge its own rights under the judgment or to lessen the rights of its adversary under the judgment,’” The Court noted that parties should not be permitted “to game the system by filing a cross-appeal to obtain the final word: this is neither fair to the appellant nor an efficient use of the appellate process.”

The Federal Circuit rejected Apotex’s argument that Federal Circuit policy is in conflict with other circuits, characterizing other circuits’ allowance for conditional cross-appeals “as a means to raise additional arguments which do not expand the scope of the judgment.” The Federal Circuit noted it offers the same opportunity, albeit in a different form, by “requir[ing] parties to raise such arguments in their primary briefing.”

The court explained that under its precedent “as a general matter … a finding of invalidity means there is ‘no basis for a cross-appeal’ of non-infringement or additional claims of invalidity.”  The Federal Circuit acknowledged that the court has not sua sponte struck every improperly filed cross-appeal, but found that “[t]his infrequent leniency is not an invitation to flaunt our practice and precedent, and the improper use of a cross-appeal directly contrary to our precedent may meet with sanctions.”

Practice Note:    At the Federal circuit, an invalidity decision in a lower court leaves no room for the successful defendant to file a contingent cross-appeal as to infringement or other validity issues.

Claim Construction: Too Much Structure Will Spoil the Brew

In affirming-in-part grants of summary judgment on non-infringement by two separate district courts, the U.S. Court of Appeals for the Federal Circuit reiterated the role of a district court in claim construction is to give meaning to the limitations actually contained in the claims, “not to redefine claim recitations or to read limitations into the claims.”  American Piledriving Equip., Inc. v. Geoquip, Inc., Case Nos. 10-1283, -1314 (Fed. Cir., Mar. 21, 2011) (Linn, J.).

American Piledriving filed suit against Geoquip in the Eastern District of Virginia and separately against Bay Machinery in the Northern District of California alleging that each infringed its patent by selling piledrivers manufactured by Hydraulic Power Systems.   The patent in issue relates to counterweights for “vibratory” piledrivers, which rely on vibrations to drive piles into the ground.   The representative claim recites, inter alia, a limitation requiring “counterweights having a cylindrical gear portion and an eccentric weight portion integral with said cylindrical gear portion, said eccentric weight portion having at least one insert-receiving area formed therein.”

A Markman hearing was held in each case and each of district courts consistently construed the term “integral” to mean “formed or cast of one piece.”

The district courts diverged, however, on their construction of “eccentric weight portion” and “insert-receiving area.”   The California district court construed “eccentric weight portion” to mean “the bottom portion of the counterweight, which extends forward from the front face of the gear portion, containing more weight than the top portion due to its larger mass, including at least one insert receiving area formed therein to receive at least one solid tungsten rod.”   The Virginia district court construed the same term to mean “that portion of the counterweight that extends either forward or rearward from the front or back face of the gear portion such that it shifts the center of gravity radially outward from the gear’s rotational axis.”

With regard to the term “insert-receiving area,” the Virginia district court construed that term to mean “a bore located, at least in part, within the eccentric weight portion that is shaped to hold securely a solid insert member,” whereas the California district court construed the same claim language to mean “a bore formed in the eccentric weight portion of the counterweight, which extends fully through the gear portion and fully through the eccentric weight portion of the counterweight capable of receiving a solid tungsten rod.”

In both the California and Virginia actions, the defendants moved for, and the district courts granted, summary judgment of non-infringement.   The summary judgment grants were based on each court’s constructions of the disputed phrases “integral,” “insert-receiving area” and “eccentric weight portion.”   American Piledriving appealed.

On appeal, American Piledriving argued that the district courts misconstrued these three terms.   The Federal Circuit affirmed the Virginia court’s construction of each of these claim terms, as well as the California court’s construction of “integral” (which was identical to that of the Virginia court).

In upholding the Virginia constructions, the Federal Circuit found that the California constructions imported unnecessary limitations into the construction of “eccentric weight portion” and “insert-receiving area.”   In its analysis, the Court reviewed the claims, the specification and the file history as it related to each of these terms.   With regard to both “eccentric weight portion” and “insert-receiving area,” the Court found that there was no support in the intrinsic evidence for the additional structural limitations imported by the California district court.

The Federal Circuit affirmed both of the district court’s grants of summary judgment of non-infringement with regard to the accused products.

Does Family Exclusion Preclude Coverage? Insurance Coverage Law Update: Wendy M. Day v. Allstate

On April 29, 2011, the Wisconsin Supreme Court issued a decision in Wendy M. Day v. Allstate Indemnity Co., et al., 2011 WI 24 (“Day”) in which the court held that Allstate failed to demonstrate that the family exclusion contained in a homeowner’s policy unambiguously precluded coverage.

In Day, 8-year-old Emma Day drowned as a result of having a seizure while taking a bath at the home of her father, Clinton Day, and her stepmother, Holly Day. Emma’s mother, Wendy Day, filed suit against Holly alleging that Holly was negligent for leaving Emma unattended in the bathtub. Holly tendered her defense to Allstate, which had issued a homeowner’s policy listing Clinton and Holly as the named insureds. The policy included coverage for family liability. However, the policy contained a family exclusion which read in part:

“We do not cover bodily injury to an insured person … whenever any benefit of this coverage would accrue directly or indirectly to an insured person.”

After a series of stipulations, the only remaining claims were the survival action advanced on behalf of Emma’s estate and Wendy’s claim for wrongful death. Allstate sought a declaration that the family exclusion precluded coverage for both claims. The circuit court denied Allstate’s motion. The court of appeals reversed, reasoning that both claims were excluded from coverage because Clinton, an insured, was entitled to half of any recovery on either claim. The Wisconsin Supreme Court reviewed the court of appeals decision on the wrongful death claim.

The Wisconsin Supreme Court noted that the family exclusion would apply if any benefit of coverage would accrue directly or indirectly to an insured person. Allstate asserted that Holly would benefit by her contractual right to defense and indemnification and, therefore, a “benefit of coverage” “would accrue directly or indirectly to an insured person.” The court rejected Allstate’s assertion, finding that such an expansive interpretation of “benefit” would render the family exclusion meaningless because in every case where there is an initial grant of coverage, a “benefit” would accrue to the insured.

Having determined that Allstate failed to demonstrate the term “benefit” unambiguously includes the right to defense and indemnification, the court next examined whether any insurance proceeds will accrue directly or indirectly to an insured person as a result of Allstate’s coverage of Wendy’s claim. Allstate asserted that because half of the wrongful death claim belongs to Clinton, any insurance proceeds Wendy recovers for Emma’s wrongful death must be split between Wendy and Clinton. The court found that Allstate’s position was based on the mistaken assumption that because Clinton has a right to make a claim under the wrongful death statute – and because his claim would be consolidated with Wendy’s claim – Clinton will have an entitlement to a portion of any insurance proceeds Wendy recovers. The court held that each beneficiary’s recovery for wrongful death may be independent from the recovery of any other beneficiary. Thus, although Clinton has a right to bring a claim for Emma’s wrongful death, a judgment in favor of Wendy does not entitle Clinton to any ownership of her recovery. If Clinton were to remain a party in the action, he would have to prove his own loss (any loss sustained by Clinton would be a “benefit” and, thus, not recoverable under the Allstate homeowner’s policy).

Justice Ziegler issued a dissenting opinion. Justice Prosser and Justice Gableman joined the dissent.

“Innocent” Criminals: Criminal Copyright Infringement, Willfulness and Fair Use


On November 17, 2010, Gawker Media LLC published on its popular blog, Gawker, excerpts of Sarah Palin’s unreleased book America By Heart: Reflections on Family, Faith and Flag.[1]  In response to the release, Palin tweeted, “Isn’t that illegal?”[2]  Defending itself, Gawker mockingly wrote to Palin in a post titled Sarah Palin is Mad at Us for Leaking Pages From Her Book, telling her to “take a moment to familiarize yourself with the law.  . . . Or skip the totally boring reading and call one of your lawyers.  They’ll walk you through it” and attached pages on the copyright law’s fair use doctrine.[3]  After Gawker refused to remove the excerpts from its blog, Palin’s publisher, HarperCollins, filed suit against Gawker and obtained a preliminary injunction on November 20, 2010.[4]  By November 23, 2010, Gawker agreed to keep the material off its website for good and settled the suit with HarperCollins.[5]  Ignoring the underlying political and ideological tension between Gawker and Palin,[6] this incident highlights a very important issue: the complex and commonly misunderstood fair use doctrine.

The fair use doctrine has been a large source of legal uncertainty and, as a result, has led many civil copyright infringement suits to settle out of court.[7]  While it might be desirable that civil suits are settled out of court for judicial efficiency, the doctrine’s uncertainty poses a problem when fair use is used as an affirmative defense against criminal charges of copyright infringement under 17 U.S.C. § 506.[8]  In order to convict an individual of criminal infringement, the individual must have willfully infringed a copyright (1) for commercial or financial gain; (2) reproducing or distributing copies with a total retail value over $1000; or (3) making an unpublished work publicly available on a computer.[9]  The fair use doctrine states that there are certain uses, subject to a four factor balance test, where an individual can use or copy a copyrighted work without infringing.[10]  The fair use defense would then argue that either (1) the use was not infringing because it was a fair use; or (2) the individual did not willfully infringe because he or she believed the use was a fair use.

A problem arises when an individual believes in good faith his or her copying is a fair use but does not pass the factor test and is actually infringing.  Depending on the courts interpretation of “willfully,” this good faith, but mistaken belief, can be the difference between conviction and freedom.  As illustrated in the Gawker-Palin example, even sophisticated parties, who presumptively have personal legal counsel, misinterpret the bounds of the fair use doctrine.  If sophisticated individuals find difficulty in the nuances of the doctrine, what can be expected of the unsophisticated individual?  Since the mens rea of willfully is attached to a section 506(a) charge, barring a bad faith fair use defense, will a fair use defense always absolve a defendant?

This article will look at the fair use doctrine as an affirmative defense against the criminal charge of copyright infringement under section 506(a) and whether it serves as a suitable defense within the statute, or whether the statute needs to be revised to avoid the problems created by the fair use doctrine.  Part II will give a brief background of section 506(a) for a charge of criminal copyright infringement and analyze the case law defining “willfulness” generally and its application to the mens rea of section 506(a).  Part III will review the fair use doctrine and the issues created when fair use is used as a defense.  Part IV will briefly examine certain policy considerations in relation to criminal copyright infringement.  Finally, this article will conclude that the fair use doctrine is too vague of a doctrine to be an effective defense and may reduce section 506(a) to a “toothless” statute.[11]  As a result, the statute should be amended by increasing the monetary criminal trigger from $1,000 to at least $25,000 and the term “willfully” needs to be defined in accordance with the majority view.


Criminal copyright infringement is codified under 17 U.S.C. § 506(a) and the punishment guidelines is under 18 U.S.C. § 2319.[12]  Under section 506(a), criminal copyright infringement is anyone who willfully infringes a copyright (1) for commercial or financial gain; (2) reproducing or distributing copies with a total retail value over $1000; or (3) making an unpublished work publicly available on a computer if that person knew the work was intended for commercial distribution.[13]  To prove willful infringement, evidence of reproduction or distribution of a copyright work will not be sufficient.[14] The government has the burden to prove all four elements which are: (1) a valid copyright; (2) infringement of that copyright; (3) willfulness; and (4) one of the qualifying violations of section 506(a)(1)(A)-(C).[15]  The first two elements are the same that must be shown in a civil infringement case.[16]  The difference between civil and criminal infringement is the addition of the third and fourth element.

Unlike civil infringement, which is a strict liability offense, criminal infringement requires that the government prove the individual acted willfully.    However, the definition of “willfulness” has been left up to the courts’ interpretation since Congress failed to define it.[17]  Unfortunately, “willfulness” has long been a thorn in court’s side when used in the context of criminal law.[18]  It was not until United States v. Moran[19]that the court was confronted with interpreting the vague term’s meaning under section 506(a).

In Moran, Moran was a full-time police officer and owner of a “mom and pop” video rental store.[20]  Moran made a practice of purchasing legal videos, making a single duplicate of the original, renting the copy, and keeping the original to “insure” the video from theft or damage.[21]  Moran testified that he believed his actions were legal.[22]  He argued that “the word ‘willful’ implies the kind of specific intent . . . which is to say, a voluntary, intentional violation of a known legal duty.”[23]  The government argued that willful only meant “an intent to copy and not to infringe.”[24]  In coming to its decision, the court looked to a prior Supreme Court case dealing with the term “willfully” in a criminal statute.

In Cheek v. United States,[25] Cheek was charged with willfully failing to file federal income taxes and willfully attempting to evade his taxes.[26]  Cheek claimed that he believed the tax code was unconstitutional and therefore believed he did not have to pay taxes.[27]  The court held that while the “general rule that ignorance of the law or a mistake of law is no defense to criminal prosecution,” an exception is made when the term “willfully” is used in complex criminal statutes.[28]  Due to the complexity of the tax code, “willfulness . . . simply means a voluntary, intentional violation of a known legal duty.”[29]  The government then has the burden to prove that the defendant knew of the duty and voluntarily and intentionally violated it.[30]  Therefore, “a good faith belief that one is not violating the law negates willfulness, whether or not the claimed belief or misunderstanding is objectively reasonable.”[31]

Using the reasoning of Cheek, the Moran court was persuaded that “willfully” carried the same meaning under 17 U.S.C. § 506(a) and was similarly exempt from the presumption that ignorance of the law or mistake of the law is no defense.[32]  Accordingly, the court held that Moran’s lack of sophistication, in addition to the totality of the circumstances, negated the willfulness requirement.[33] However, it should be noted, the lack of willfulness does not eliminate civil liability for copyright infringement.[34]

The holding in Moran has since become the majority view, while the minority view interprets “willfully” as only the intent to copy.[35]  These two views are drastically different; from who carries the burden of proof to the consequence facing an individual who believed his use was protected by fair use.  Unlike the clear complexity of the tax code, the fair use doctrine appears straight-forward but is deceptively complex.[36]  Faced with this complexity, the statute should be amended to define “willfully” in accordance with the majority view and create consistency throughout the courts.

The outcomes of a fair use balancing test can be unpredictable and creates uncertainty in its application.[37]  Applying the minor’s view, “innocent” infringers face the possibility of being labeled criminals.  By adopting the majority’s definition of “willfully”, prosecution will have the burden of showing that an individual has the mens rea warranting criminal punishment.  Additionally, by codifying the majority’s definition, there will be minimal disruption to current law.


Section 107 of the Copyright Act allows for the use of a copyrighted work for limited purposes such as “criticism, comment, news reporting, teaching . . ., scholarship, or research.”[38]  Whether that use is eligible for the fair use defense depends on the court’s evaluation of four factors set forth in section 107.[39] These four factors are: (1) the purpose and character of the use (i.e. whether such use is of a commercial nature or for nonprofit purposes); (2) the nature of the copyright (i.e. whether the work is fact based or creative); (3) the amount and substantiality of the portion used in relation to the copyrighted work as a whole; and (4) the effect of the use upon the potential market for or value of the copyrighted work.[40]  While the courts have held that all the factors must be examined and weighed together, the fourth factor has been given the most weight.[41]

This first factor of the fair use doctrine is usually split into two separate questions.  The first question asks whether the use is “transformative,” meaning, whether it “supersede[s] the objects’ of the original creation.”[42]  The second question asks whether the use is “commercial.”[43]  Since “transformative” and “commercial” are general terms and are susceptible to various interpretations, the first factor can be confusing.  In Sony Corp. of America v. Universal City Studios,[44]the court acknowledged that time-shifting[45] was an acceptable “private, noncommercial” transformative use “in the home”.[46]  However, when compared to BMG Music v. Gonzalez,[47]which held that Gonzalez’s music downloading on a try-before-you-buy basis was a commercial use, the line between commercial and noncommercial, especially for private, personal use, becomes hazy.  Both seem like private, noncommercial uses in the home for personal use, but Gonzalez’s actions supplant her actually purchasing music.[48]  This creates a fine distinction that the unsophisticated individual could misunderstand.  What exactly is commercial if personal use can be both commercial and noncommercial?  Is loading potentially infringing content on YouTube or a similar streaming website commercial if the user does not have a financial interest in the website?[49]

If an individual posts a clip to his blog or YouTube of a scene from his favorite TV show, saying just that, he could believe he is protected by the fair use doctrine.  He believes the use is noncommercial because he’s not receiving any money from it and he is only using a small portion of the show.  He could believe that he’s making commentary on the piece by saying it is his favorite piece.  Finally, since he is not making any money from posting the video, he does not believe he has any effect on the copyrighted work’s market.  Within a 180 day period it is very possible that the video is viewed well over 100,000 times.  The $1000 or even the $2500 threshold under section 506(a) could easily be attained.

It is feasible that a court could find fair use under these facts or slightly different facts because of the variables of the balancing test.[50]  One commentator likened the fair use balancing test to “balancing a dinner plate on the pointy end of a nail.”[51]  Since each evaluation of fair use is fact specific, and all the factors vary in weight depending on those facts, the outcomes are sometimes unpredictable.  As such, the unpredictability of fair use seems to breed fertile ground for an individual to make a good faith mistake in evaluating his or her actions.

Depending on the district an individual is in, and the interpretation of “willfulness” observed, this mistake can be the difference between walking away a free man or going away a felon.  If the court is within the majority, an individual can theoretically always negate “willfully,” absent evidence that the individual’s belief was not in good faith.  “If a person can claim ‘fair use’ and escape criminal penalties, then the law has no teeth since alleged infringers will invariably assert this defense.”[52]  Alternatively, if the court is within the minority, an individual will not be allowed a mistake defense and will only avoid conviction if the fair use analysis is successful.  These two outcomes are polar opposites; one is too lenient while the other is too severe.


Is the infringement of $1000 worth of copyrighted material worth labeling that individual a felon or criminal, even if he did not believe his actions were illegal?[53]  “Felon is a word that should be reserved for individuals committing crimes that damage a victim beyond repair through civil means.”[54] Civil remedies are more suitable in such a case. Incarceration for up to three years for the infringement of $2500 worth of copyrighted material[55] is excessive when civil remedies are available to recover those damages.  If the basis of enacting criminal laws are for “deterring future crimes, stigmatizing offenders, expressing community values, extracting retribution, reforming the offender, and so on,”[56]what are the “retributive function[s] . . . these statutes convey?”[57]  If the offender does not know his actions are illegal, the statute does not achieve these goals.  Furthermore, public opinion does not believe the punishment fits the crime in such low level infringement, as evidenced by the outcry over a Twilight fan’s arrest for taping a birthday party during a viewing of the film “New Moon.”[58]

Additionally, the cost attributed to the enforcement and incarceration of such an offender is far too high.  Beyond the cost of prosecution, the costs of incarcerating the offender far exceeds the low infringing $2500 threshold.  Based on California’s 2008-2009 Annual Costs to Incarcerate an Inmate in Prison, the average cost per inmate per year is about $47,000.[59]  Theoretically, for a three year sentence, the government would be paying over $140,000 of taxpayer money to incarcerate a non-violent criminal for a $2500 infringement.  Additionally, the non-violent criminal would now be exposed to the dangers and violence inherent in prison.[60]


While these low threshold cases with fair use issues are typically not prosecuted,[61]charges are still filed.[62]  The statute has the ability to make criminals out of people that do not know their actions are illegal or believe that they are legal.  By raising the threshold of section 506(a)(1)(B) to at least $25,000, the statute would be better able to avoid prosecution of “innocent” infringers.  The other subsections of 506 would still allow for punishment of individuals selling infringing materials for personal financial gain and individuals distributing unpublished material prior to commercial releases (i.e. leaking music albums, movies, or books).  With these two other options available, raising the threshold would not make prosecution any more difficult.

Finally, “willfully” needs to be defined in the statute in accordance with the majority view.  One action should not be more or less culpable depending on the circuit where it is committed.  By defining “willfully” in the statute, all circuits would be in conformity and there would be no discrepancies between courts. Furthermore, if the purpose of the criminal copyright infringement statute is to educate, prevent, and deter, the public needs to know what is and what is not criminal.  For that reason, the definition of “willfully” is necessary to educate and assist in deterring future criminal infringement.

Hyatt v. Kappos: A New Standard for the Admissibility of Evidence in a Section 145 Action


When the Board of Patent Appeals & Interferences (the “Board”) of the United States Patent and Trademark Office (“PTO”) rejects a patent application, the applicant has two avenues available. He can appeal the decision to the United States Court of Appeals for the Federal Circuit. In that case, the record on appeal is the record from the PTO. New issues cannot be raised, and new evidence cannot be introduced. Alternatively, the applicant can file a civil action under Section 145 of the Patent Code in the U.S. District Court for the District of Columbia. As with an appeal, new issues cannot be raised. However, unlike an appeal, evidence not presented to the PTO can be introduced. In Hyatt v. Kappos, 625 F.3d 1320 (Fed. Cir. 2010), the en banc Federal Circuit recently held that there is no limitation in a Section 145 proceeding on the introduction of new evidence at the District Court level apart from limitations imposed by the Federal Rules of Evidence and the Federal Rules of Civil Procedure. Having twice had the time period extended, the PTO has until April 7, 2011, to seek certiorari.


The Board confirmed the examiner’s rejection of 79 of the 117 claims in Hyatt’s patent application on the grounds that they failed to satisfy Section 112’s written description requirement. In the District Court, the PTO moved for summary judgment upholding the Board’s decision. In opposing the motion for summary judgment, Hyatt filed his declaration to provide additional support to refute the written description rejections. In granting the PTO’s motion, the Court refused to admit the declaration, holding that Hyatt had been negligent in not providing it to the PTO. Without new evidence, the Court employed the deferential “substantial evidence” standard and upheld the Board’s decision.

This decision was appealed to the Federal Circuit. On August 11, 2009, a divided panel issued its decision affirming the District Court’s exclusion of the declaration and the grant of summary judgment. This opinion was subsequently vacated. The en banc Court reversed the District Court’s decision. In the en banc decision, Judge Moore wrote the majority opinion, which was joined in by six other judges on the admissibility issue.

The En Banc Decision

After a lengthy review of the legislative history of the statute and prior statutes going back 200 years, the Court held that :

“35 U.S.C. § 145 imposes no limitation on applicant’s right to introduce new evidence before the District Court, apart from the evidentiary limitations applicable to all civil actions contained in the Federal Rules of Evidence and Federal Rules of Civil Procedure.” Id. at 1323.

The Court’s extensive review of the legislative history led it to conclude that Congress intended Section 145 to be a new “civil action in which an applicant would be free to introduce new evidence.”  Id. at 1327. Having determined that Section 145 did not impose any limitation on the evidence that could be presented in a Section 145 proceeding, the Court held that when new evidence was provided, review by the District Court would be de novo. If new evidence were not provided on an issue, substantial evidence would be the standard. In neither circumstance, was the patent applicant entitled to raise new issues in the proceedings. The Court indicated that its decision was supported not only by the legislative history, but Supreme Court precedent.

The Impact of the En Banc Decision

Although only about 30 Section 145 proceedings are filed in a year, the lack of limitation on the admissibility of evidence, coupled with de novo review for issues that rely on new evidence, indicate that the number of these actions will increase.

A patent applicant should pay particularly close attention during patent prosecution to make sure that all necessary legal issues have been raised.  New issues cannot be raised in Court, but new evidence can be presented on all issues. This includes live fact and expert testimony. Further, the pendency of a Section 145 proceeding will not shorten the patent term. Thus, for commercially important patent applications, a patent applicant should consider bypassing continuation practice and instead file a Section 145 proceeding to present a strong factual record to a new fact finder who will conduct a de novo review and decide the case without a jury.

NLRB Determines that “Preemptive” Firing Violates Federal Labor Law

The recent National Labor Relations Board decision of Parexel International addresses the definition of “protected activity” under federal labor law for which subsequent employer retaliation is unlawful. The case appears to stretch the boundaries quite a bit since the Board held in this decision that federal labor law protections apply to employees who think about engaging in a protected activity and does not require that they actually do so.

The case involved an investigation by the Company’s Human Resource Consultant regarding employee rumors and dissatisfaction about alleged disparate pay. As part of the investigation, the HR consultant was advised by an employee that she had not yet discussed or complained to other employees about the issue, but was concerned about it.  Several days later, the employee was fired.

The employee filed a charge under the National Labor Relations Act and, after the hearing, the Administrative Law Judge agreed that the termination was part of a “preemptive strike” to nip the rumors of disparate pay in the bud. However, the judge determined that since the charging party/employee had not yet engaged in concerted activity, the charge should be dismissed.

The National Labor Relations Board, on review, reversed, and ordered reinstatement of the discharged employee. According to the Board, the absence of “protected concerted activity” was not dispositive since a termination designed to nip such activity in the bud is violative of employee rights under the Act.

Just as the definition of protected conduct which could give rise to claims of retaliation has expanded in the areas of EEOC and wage and hour cases, we now see the expansion of this protection under NLRA. Thus, the employer inquiry prior to any bona fide termination, must include not only whether the employee has engaged in protected concerted activity, but whether the employee is thinking of engaging in that activity. No wonder Human Resource personnel lose their hair and develop facial tics at a young age.

Sixth Circuit Reverses Dismissal of a Shareholder Derivative Action Based Upon the Lack of Independence of the Special Litigation Committee

In Booth Family Trust v. Jefferies, No. 09-3443, 2011 WL 1237583 (6th Cir. Apr. 5, 2011), the United States Court of Appeals for the Sixth Circuitreversed the district court dismissal of a shareholder derivative action, holding that the special litigation committee (“SLC”) of the board of directors, which recommended the dismissal, was not sufficiently independent of management.  The Court reached its decision despite the fact that one of the two members of the SLC recused himself from considering claims against the defendant Robert S. Singer (“Singer”), CEO of Abercrombie & Fitch Co. (“Abercrombie”), with whom the SLC member had a personal relationship. In fact, the Court held that the SLC member’s recusal constituted an admission that he, and thus the SLC as a whole, lacked independence. This decision, which applies Delaware law, reinforces the high standard of independence imposed on members of SLCs.

Plaintiffs were shareholders of Abercrombie. They filed a shareholder derivative suit against certain of Abercrombie’s officers and directors based upon allegations that they caused Abercrombie to make misleading public statements regarding the company’s business model of selling products with low manufacturing costs at high retail prices, resulting in a high per-unit margin. Plaintiffs alleged that while defendants were making the misleading statements, Abercrombie was amassing a large surplus of inventory such that the company would have to dramatically mark down its merchandise to clear out its inventory. The complaint alleges that insiders, including Singer, were aware that share prices would soon fall and sold a large number of their personally held shares on insider information.

In response to the allegations, Abercrombie’s board of directors created a SLC eventually composed of two board members, Allen Tuttle and Lauren Brisky. The SLC retained the law firm of Cahill Gordon & Reindel LLP, which took the lead in what would be a sixteen month investigation. Cahill did the bulk of the work in interviewing witnesses and reviewing documents and records, advised the two SLC members on the progress and results of the investigation, and made recommendations on how to proceed. When it came time to consider potential claims against Singer, Tuttle recused himself due to his prior personal and business relationship with Singer. Ultimately, the SLC produced a 144-page report which detailed its investigation and recommended to Abercrombie to seek a dismissal of the case on the ground that pursuing the claims would not be in the best interests of Abercrombie’s shareholders. The United States District Court for the Southern District of Ohio granted Abercrombie’s motion to dismiss, finding that the SLC was independent, proceeded in good faith and had a reasonable basis for its conclusions. Plaintiffs appealed.

Under the standard set out in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981), a court must determine whether the SLC is independent, and whether it acted in good faith and had a reasonable basis for seeking the dismissal.  If the court makes these findings, it then has the option to apply its own business judgment to determine whether to dismiss the derivative action.

In Booth, the Sixth Circuit began by noting that other courts have not clearly articulated the standard of review to be applied to a lower court’s decision granting a motion to dismiss a derivative action based on the recommendations of an SLC. The Court found that the de novo review standard applies with respect to the first prong of the Zapata inquiry as to whether the SLC was independent, carried out the investigation in good faith, and had a reasonable basis supporting its conclusions. It also, however, left open the possibility that a more deferential review standard may apply to a lower court’s application of its own business judgment under the optional second prong in the Zapata test.

The Court then turned to the merits. It reversed the district court’s decision to grant the motion to dismiss. It based its reversal upon a finding that SLC member Tuttle was not independent. Because Tuttle lacked independence, the SLC also was not independent. The Court pointed to the fact that Tuttle had recused himself from considering allegations against Singer, a named defendant and central player in the shareholders’ allegations. “[B]ecause Tuttle … recused himself from considering claims against Singer,” the Court held “he effectively admitted he was not independent.” The Court also considered evidence that Tuttle and Singer had previously worked together, that Singer had spearheaded the effort to add Tuttle as a board member, and that Tuttle was planning on vacationing with Singer and his wife. Additionally, the Court noted that the claims against defendants were “not individual in nature.” In other words, Tuttle could not conclude that any claims against any other defendants had merit without implicitly concluding that those against Singer had merit. Abercrombie also did not establish that Tuttle’s recusal was effective. Moreover by recusing himself, Tuttle had impermissibly altered the Board’s resolution creating a two-member committee by creating a de facto one person committee led by Brisky. The Court did not rule on Brisky’s independence.

Under Delaware law, SLC’s are not presumed to be independent, and the SLC must prove its independence “beyond reproach.” The Court concluded by finding that, “Tuttle’s decision to recuse himself from considering claims against Singer, and Singer’s central role in the alleged wrongdoing, cast serious doubt on Tuttle’s objectivity as to the claims as a whole … where Abercrombie had the opportunity to work with competent counsel and cherry pick who would serve on its special litigation committee, it cannot now rely on the recommendation of a special litigation committee with such dubious independence.”

This decision confirms that Delaware corporations seeking to employ an SLC to investigate the allegations underlying a derivative lawsuit must take great care to ensure that the individuals it nominates to form the committee have no potentially material independence issues, including close personal relationships, with the defendants. At least according to the Sixth Circuit, recusal by a committee member will not automatically cure a potential independence issue. Because the precise contours of independence are highly fact specific and have not been delineated, a board seeking to establish an SLC should take great care to ensure independence of committee members at the outset of the committee’s work.

EEOC Sues HD Dimension Corp. To Enforce Conciliation Agreement

Tech Company Failed to Comply With Terms Settling Race and Age Bias Charge, Federal Agency Says

NEWARK, N.J. – A Newark, N.J., information technology training and service company violated a settlement agreement stemming from an age and race discrimination charge when it failed to complete payments that were a condition of the agreement, the U.S. Equal Employment Opportunity Commission (EEOC) charged in a lawsuit announced today.

According to the EEOC, HD Dimension Corp. entered into a conciliation agreement to resolve a discrimination charge and agreed to pay $32,500 to an applicant who, the EEOC found, had been discriminated against because of her age and race. The agreement also required various injunctive provisions including training for HD Dimension employees and management and training for third-party companies who did recruitment for HD Dimension. From October 2009 through February 2010, the company made monthly payments toward satisfying the conciliation agreement, but stopped after paying only $17,500 of the agreed-upon $32,500. HD Dimension never complied with any of the injunctive relief.

The EEOC filed suit in U.S. District Court for the District of New Jersey to enforce the agreement after HD Dimension failed to make any payments for 12 months. The EEOC filed suit after first attempting to reach a pre-litigation settlement through its conciliation process.

The conduct alleged in the original discrimination charge violates Title VII of the Civil Rights Act of 1964, which prohibits employment discrimination based on race, color, religion, sex (including sexual harassment or pregnancy) or national origin and protects employees who complain about such offenses from retaliation. The alleged conduct also violates the Age Discrimination in Employment Act (ADEA), which prohibits discrimination in the workplace based on age.

“When the EEOC enters into conciliation agreements with companies, the process does not end there,” said Charles F. Coleman, Jr., a trial attorney in the EEOC’s New York office. “We continue to monitor these agreements to ensure that they are carried out and, in this case, it was not, so we had to take forthright action.”

Judy Keenan, the EEOC’s acting regional attorney in the New York office, said, “The EEOC will absolutely enforce the conciliation agreements it reaches, even if that means filing a lawsuit. The objective of this suit is to obtain full relief under the conciliation agreement and place others on notice that the EEOC will not tolerate this behavior.”

Seventh Circuit Expands on Illinois Law Regarding Insurer’s Duty to Provide Independent Counsel Due to Conflict of Interest

When insurers defend their insureds in liability actions, they have long had to be careful to protect the interests of the insured while still protecting their own interests.  Illinois courts have addressed two scenarios where the conflicting interests of the insured and the insurer are particularly difficult to reconcile:

(1) where the insurer’s coverage defenses create an incentive for the insurer to defend the case in a way that would maximize the insurer’s potential to prevail on its coverage defenses, even though that might create more exposure to the insured; and

(2) where the verdict potential of the case substantially exceeds the insurer’s policy limit, so that the insurer might be inclined to try the case rather than settle it within its limit in the hope that it will obtain a defense verdict and therefore pay nothing rather than paying all or most of its limit to settle the claim.

Illinois courts have adopted two different approaches to reconciling these potential conflicts.  For the first situation, Illinois courts have ruled that when the insurer’s coverage defenses create a conflict of interest with the insured, the insurer must give the insured the right to retain counsel of its own choosing, to be paid for by the insurer.  E.g.Maryland Cas. Co. v.  Peppers, 64 Ill.2d 187, 193, 355 N.E.2d 24, 28 (1976);Illinois Masonic Medical Center v. Turegum Ins. Co., 168 Ill.App.3d 158, 163, 522 N.E.2d 611, 613 (1st Dist. 1988). In the case where the verdict potential exceeds the policy limits, insurers generally maintain control over the defense of the case, but if the insurer acts in bad faith by unreasonably failing to settle the claim within its limit, the insurer will be liable for the full amount of the verdict or judgment entered against the insured, even though it exceeds the policy limits.  E.g.Haddick v. Valor Insurance, 198 Ill.2d 409, 763 N.E.2d 299 (2001); O’Neill v. Gallant Ins. Co., 329 Ill. App. 3d 1166, 769 N.E.2d 100 (5th Dist. 2002).

Despite the clear demarcation between these two lines of cases, the Seventh Circuit Court of Appeals recently ruled that under Illinois law, an insured is entitled to independent counsel whenever there is a substantial likelihood that the verdict in the case will exceed the insurer’s policy limit.  R.G. Wegman Constr. Co. v. Admiral Ins. Co., 2011 U.S. App. LEXIS 679 (7th Cir. Jan. 14, 2011).  In Wegman, Admiral issued a policy to Wegman with limits of $1 million.  A worker at one of Wegman’s construction sites was injured on the job, and sued Wegman.  Admiral defended the case through trial and a judgment was entered against Wegman for $2 million, $1 million in excess of Admiral’s limits.   The court acknowledged that when the case was first assigned to defense counsel, neither Admiral nor Wegman had any reason to believe the case would exceed the policy limit. However, according to the court, when the plaintiff was deposed and revealed the extent of his injuries, Admiral learned that a judgment or settlement could well exceed its $1 million limit.  The court stated that this “likelihood created a conflict of interest by throwing the interests of Admiral and Wegman out of alignment.”  The court went on to state that when such a conflict of interest exists, the insurer’s duty of good faith requires that it notify the insured. The court acknowledged that this usually occurs when the insurer denies coverage, but considered the principle to be the same when the conflict arises from the relationship between the policy limit and the insured’s potential liability.

The court carried this further by concluding that once notified of the conflict, the insured has the option to hire a new lawyer, whose loyalty will be exclusively to the insured, to be paid for by the insurer.  According to the court, the new lawyer “would have tried to negotiate a settlement with [the plaintiff] that would not exceed the policy limit; and if the settlement was reasonable given the risk of an excess judgment, Admiral would be obligated to pay.”

Much of the court’s opinion seems to have been supported by the fact that the insurer not only failed to notify the insured of a conflict of interest, it failed to notify the insured that the judgment was likely to exceed the policy limits.  As a result, the insured did not notify its excess carrier, so the excess verdict was not covered by excess coverage.  Nevertheless, the import of the court’s decision cannot be overemphasized. If followed by Illinois state courts, it creates a right of independent counsel whenever there is a substantial likelihood of an excess verdict.  Moreover, the court’s ruling that the independent counsel can negotiate a settlement, apparently without the insurer’s consent, which the insurer will have to pay if reasonable, takes control of the insurer’s funds and right to settle away from the insurer and gives it to the insured, in violation of the terms of the policy which give the power to settle to the insurer.

The decision in Wegman raises the question of why the court considered it necessary to mix up the concept of conflict of interest created by coverage defenses with the problems created by the potential for an excess verdict.  Illinois insureds have long had a remedy for an insurer which gambles with the insured’s money in the face of a potential excess verdict: an action against the insurer for bad faith failure to settle.  This protection has adequately protected the insured’s rights by ensuring that the insurer will consider the insured’s interests in avoiding an excess verdict at least equal with its own rights.  However, the conflict of interest standard does not fit this situation.  In a case presenting excess exposure, both the insured and the insurer have an interest in a strong defense that will result in a verdict of non-liability or a low settlement.  There is no need for independent counsel. Nor is there any need to take away the insurer’s control of settlement, when the insurer’s obligations to the insured mandate that it consider the insured’s interests at least equally with its own when faced with a potential excess verdict.

No previous Illinois state court case has gone as far as the court did in Wegman.  However, as long as Wegman stands without being challenged by an Illinois appellate court, insurers must be aware of the risk they face if they fail to appoint independent counsel when there is a substantial risk of an excess judgment.  At the same time, insureds concerned about excess judgments should seek to have the insurer appoint an independent counsel to represent them and potentially settle the claim.  Insureds must be cautious though, since a decision to settle without the agreement of the insurer could backfire if future courts do not follow Wegman.

In Florida Zoning Case Participant’s Right to Cross-Examine Witnesses Denied

If you own a parcel of property and intend to develop it, it is highly likely that you will find yourself at a hearing before a governmental entity at some point to deal with issues that will invariably arise relating to that property. For example, if the development you envision for your property does not comport with the preexisting zoning on the property, you may have to go to the city or county commission and request that the property be rezoned. Depending on the neighborhood surrounding the property and what you propose to develop, this request could garner significant opposition from certain members of the community, which could dramatically alter the landscape of the hearing. The Fifth District Court of Appeal, which governs Orange and Seminole County, among others, recently handed down a decision, however, that lessens the potential for such opposition to derail the hearing.

In Carillon Community Residential Association, et al. v. Seminole County, Florida, et al., certain members of the community challenged the county commission’s refusal to allow them to cross-examine witnesses during a rezoning hearing. The community members contended that such refusal denied them of their right to due process because they could be adversely impacted if the rezoning application was granted. In deciding whether the community members were deprived of their right to due process – which is the principle that requires that proceedings be fundamentally fair – the Court initially noted that hearings before governmental agencies such as a county commission are “quasi-judicial.” As such, they are not controlled by the strict rules of evidence and procedure that govern traditional lawsuits. Despite this less stringent atmosphere, however, the principles of due process still require that quasi-judicial proceedings be “essentially fair.”

In further examining what exactly due process requires in the context of quasi-judicial proceedings, the Fifth DCA recognized that it was important to distinguish between the actual parties to the hearing, which would include the applicant and the government agency, and those who were merely participating in the hearing, such as the members of the community. The Court recognized that due process required that “parties” to quasijudicial proceedings have the right to present evidence, cross-examine witnesses and generally be informed of all the facts that form the basis of the government action.

The Court then examined what due process rights “participants” have in quasi-judicial proceedings. The Court held that depending on the type of proceeding involved and the nature of the interest that will be affected, “participants” are entitled to some measure of due process. The Court held, though, that “participants” are not entitled to cross-examine witnesses. In making this finding, the Court explicitly rejected the community members’ claim that due process requires that adjoining landowners have the right to cross-examine witnesses during a rezoning hearing. It observed that allowing all participants the right to cross-examine witnesses in this context could create “a cumbersome, unwieldy procedural nightmare for local government bodies.” In fact, it could be the classic “zoo!”

By finding that only “parties” have the due process right to cross-examine witnesses during “quasi-judicial” hearings, the Fifth DCA has significantly lessened the potential for a hearing before a governmental entity to turn into a circus, which will benefit both the owner/developer of the property and the local government tasked with making the decision.