The Phantom Menace: Federal Circuit Upholds Judge Connolly’s Investigative Powers Evan After Dismissal

by Dennis Crouch

In Backertop Licensing LLC v. Canary Connect, Inc., the Federal Circuit addressed the scope of a district court’s inherent authority to investigate potential litigation misconduct. Chief Judge Connolly of the District of Delaware had initiated an inquiry into dozens of patent infringement cases filed by plaintiff LLCs associated with IP Edge, a patent monetization firm, and Mavexar, an affiliated consulting shop. The district court was concerned that the real parties in interest may have been concealed, that fictitious patent assignments were filed with the USPTO to shield those parties from liability, and that the plaintiff LLCs’ attorneys may have violated the Rules of Professional Conduct by taking direction from Mavexar without their formal-clients’ informed consent.

While I am not generally opposed to litigation finance, the Mavexar and IP Edge controversy highlights significant ethical concerns associated with the practice. Chief Judge Colm F. Connolly of the U.S. District Court for Delaware uncovered a scheme involving shell companies like Nimitz Technologies, Mellaconic IP, and Lamplight Licensing. These entities, ostensibly owned by individuals with little understanding of the patents or litigation process, were used to file numerous patent infringement lawsuits. The real control and financial benefit rested with IP Edge and its affiliate Mavexar. Ethical issues alleged included misrepresentation, lack of transparency in third-party litigation funding, violations of fiduciary duty, and potential unauthorized practice of law.

As part of this investigation, the district court ordered Lori LaPray, the legal owner of plaintiff Backertop Licensing LLC, to appear in person at a hearing in Delaware.  Ms. LaPray is apparently a paralegal at a law firm related to the litigation.  When Ms. LaPray refused to comply, the court held her in civil contempt, including an accumulating fine of $200 per day until she appears.  On appeal, Ms. LaPray argued that the order compelling her appearance exceeded the geographic limits on subpoenas under Federal Rule of Civil Procedure 45 and the general power of the courts.  The rule generally limits the geographic reach of subpoenas to within 100 miles of where the person resides, is employed, or regularly transacts business in person, or within the state where the person resides, is employed, or regularly transacts business in person if the person is a party or a party’s officer.  But LaPray is in Texas, nowhere near Delaware.

In its decision, the Federal Circuit affirmed the civil contempt, holding that the district court’s inherent powers were not constrained by Rule 45.  Although a district court’s exercise of its inherent powers cannot contradict an express limitation in a rule or statute, Rule 45 governs only subpoenas requested by parties or attorneys.  It does not expressly limit a court’s sua sponte orders to appear as part of an investigation into potential misconduct. The Federal Circuit rejected the argument that Rule 45’s requirements should apply simply because the district court’s order, like a subpoena, compelled a witness to testify.

At oral argument’s LaPray’s attorney argued more broadly that “a fundamental principle of our constitutional system is that in the absence of a statute or a minimum contacts, the Court may not compel the presence of someone who lives outside the Court’s geographic boundaries.”  However, it appears that this issue was not briefed until the reply brief and the court does not directly address these due process issues. At oral arguments, amicus counsel suggested that LaPray’s role as sole owner of an entity that filed lawsuits in Delaware would likely satisfy due process requirements under any standard.

Looking into the facts, the Federal Circuit found the order compelling Ms. LaPray’s appearance to be reasonable and so affirmed under an abuse-of-discretion standard. The district court required in-person testimony to assess Ms. LaPray’s credibility, which was particularly important given the concerns about potential misconduct and the apparent lack of communication between Ms. LaPray and Backertop’s counsel. See Dia v. Ashcroft, 353 F.3d 228 (3d Cir. 2003) (witness testimony important).  The Federal Circuit also emphasized the district court’s broad authority to investigate suspected attorney misconduct and fraud on the court. Compelling Ms. LaPray’s attendance was an appropriate means to investigate potential wrongdoing involving Backertop, a corporate party of which she was the sole representative. The court itself had already considered the burden on Ms. LaPray and expressed willingness to accommodate her specific scheduling conflicts.

In reaching its decision, the Federal Circuit rejected several of Ms. LaPray’s arguments. On point, the patentee had voluntarily dismissed the lawsuit, but the district court continued to move forward with the misconduct hearing. On appeal, the Federal Circuit affirmed that the district court retained jurisdiction to investigate potential misconduct even after the underlying patent infringement cases were voluntarily dismissed.  Quoting the district court: “It makes no sense that a party could deprive a court of its inherent powers simply by filing a notice (or stipulation) of dismissal.”

This case has significant implications for non-practicing entities and patent monetization firms like IP Edge. Judge Connelly is at the leading edge, but I expect that more courts will be willing to investigate the financing and ownership structures of NPEs when there is some suggestion that there is something being hidden.  Here though, the case is quite clear because the ‘formal’ client was apparently not being consulted by the attorneys — a seemingly clear violation of the rules of ethics.  The Federal Circuit’s decision affirms the broad authority of district courts to investigate potential litigation abuses and attorney misconduct in patent cases.  Although this is an NPE case, it is important IP attorneys to ensure that they are communicating with their client, and not simply the party-in-interest. This regularly comes-up in larger corporate shell situations.  Some attorneys may need to charge additional fees for this affirmative investigation requirement.

Another interesting aspect of the case is the court-appointed amicus curiae. After the defendants declined to participate in the appeal, the Federal Circuit appointed attorney W. David Maxwell and his colleagues at Hogan Lovells to present arguments in support of the district court’s position. The amicus brief appears to have been quite persuasive with the Federal Circuit’s opinion tracked the reasoning and arguments presented by the court-appointed amicus.