A Risk of Moonlighting

by Dennis Crouch

Despite California’s policies limiting non-compete agreements, the law still lays an implicit powerful fiduciary duty on employees. The (proposed) Restatement (Third) of Employment Law indicates that competition by current managerial employees violates the duty of loyalty but that a manager has the right to “prepare to compete.”  One question that arises from the facts of the case below is whether an employee who obtains patents on-the-side in preparation to compete is somehow violating his fiduciary duty.

Robert Kulakowski v. Verimatrix, Inc. (Cal. Appellate Ct. 2014) Decision Text

Back in 2000, Kulakowski helped to found Verimatrix – acting as the company’s chief technology officer (CTO) and directing product development. The company makes video encryption security systems known as Conditional Access Systems or CAS.

In his last year with the company, Kulakowski began working on side projects. As part of that process, he was able to modify his IP and non-compete agreement with Verimatrix to clarify that he did not need to disclose to Verimatrix any inventions “conceived, reduced to practiced or developed by [Kulakowski] in [his] own time; without using the Company’s equipment, facilities, or trade secret information; and which is not the result of work performed by me for the Company.”  Meanwhile, Kulakowski founded a new company (Secure TV) in May 2010 also operating in the CAS market but then expressly denied to his Verimatrix boss that the new company was in the CAS market.  In September 2010 Kulakowski left Verimatrix and then filed a patent application known as Dynamic Obfuscation Processing.

This case arose when Kulakowski filed a declaratory judgment action in California state court asking for a ruling that Verimatrix held no right to title or interest in the new patents.

Following a bench trial, the lower court ruled in favor of Verimatrix — holding (1) that declaratory relief is not called for at this time because the patent applications are pending and may still be amended; and, alternatively, (2) that Kulakowski’s claim for equitable relief should fail because of his unclean hands based upon his breach of fiduciary and contractual duties owed to the company while he was still employed.

Seeing some of the logic of the lower court, Kulakowski accepted that the DJ action was not ripe appeal. However, he appealed the unclean portion of the opinion — arguing particularly that the lower court’s DJ decision was effectively jurisdictional with the consequence that the court lacked jurisdiction to then decide the unclean hands defense.  That conclusion follows from the notion that a court who lacks subject matter jurisdiction has no power to make any findings on the merits of a proceeding.

On appeal, the California appellate court rejected Kulakowski’s arguments and affirmed  the lower court ruling.  Here, the appellate court found that the lower court’s first ruling on the DJ action for practical reasons, not for jurisdictional reasons.

If a court decides for practical reasons it is not necessary or proper to grant declaratory relief, there is no jurisdictional prohibition to the court making alternate findings based on the evidence before it.

The case may be revived once the patents issue or a more concrete dispute arises at that point the court will need to address whether the unclean hands decision here has a preclusive effect.  The appellate court expressly refused to “offer any opinion on the extent to which the court’s alternative findings are binding on either party under res judicata or collateral estoppel doctrines.”

Cancer Research Technology v. Barr Laboratories: Prosecution Laches and Inequitable Conduct

By Jason Rantanen

Cancer Research Technology Ltd. v. Barr Laboratories, Inc. (Fed. Cir. 2010)
Panel: Newman, Lourie (author), Prost (dissenting)

Although overshadowed by the en banc Federal Circuit arguments in TheraSense v. Becton Dickinson this morning, Cancer Research Technology v. Barr Laboratories may provide a preview of what the opinions in TheraSense could look like – although it doesn't necessarily indicate which view of inequitable conduct will ultimately prevail.  In Cancer Research, Judges Lourie and Newman reversed a district court finding of prosecution laches and inequitable conduct, while dissenting Judge Prost would have reached the opposite result.

The patent at issue (the '291 patent) involved a set of thirteen tetrazine derivatives that the original 1982 specification identified as possessing anticancer activities based on animal studies.  During the first nine years of prosecution, the examiner repeatedly rejected the claims due to lack of utility; rather than file a response to the office actions, the applicant instead filed continuation after continuation.  In 1991, Cancer Research obtained ownership of the patent application and shortly thereafter responded to the examiner's arguments.  The patent issued in 1993 and expires in 2014. 

Following Cancer Research's clinical testing, the FDA approved one of the compounds covered by the '291 patent (marketed as TEMODAR) for the treatment of one type of cancer in 1999 and a second in 2005.  In 2007, Barr Laboratories filed an Abbreviated New Drug Application ("ANDA") for a generic form of TEMODAR.  Cancer Research sued Barr for infringement four months later.  During the district court proceedings, the parties stipulated to validity and infringement and, after a bench trial, the court found that the patent was unenforceable due to prosecution laches and inequitable conduct. 

Prosecution Laches
Given the nearly ten-year delay before any meaningful response to the examiner's rejection was filed, Barr contended that the patent was unenforceable due to prosecution laches.  The district agreed, concluding that the delay in prosecution was unreasonable and unexplained.

On appeal, the majority reversed the finding of prosecution laches, holding that the doctrine requires not just unreasonable delay, but also a showing of prejudice.  The majority further held that "to establish prejudice, an accused infringer must show evidence of intervening rights, i.e., that either the accused infringer or others invested in, worked on, or used the claimed technology during the period of delay."  (Slip Op. at 9).  Here, there was no evidence of intervening rights during the prosecution period, such as evidence showing that someone other than the patent holder attempted to develop the claimed compounds.  Even Barr itself waited until 2007 – four years later than required – before filing its ANDA.  The majority also noted that there was no public harm: in the absence of the patent, Cancer Research likely would not have been incentivized to develop TEMODAR at all. 

Writing in dissent, Judge Prost rejected the notion that prosecution laches requires prejudice, let alone intervening rights; rather, under her reading of the precedent such a requirement is not part of the laches determination.  Furthermore, in her opinion, both Barr and the public were harmed by Barr's inability to market a generic version of TEMODOR.

Comment: I'm unconvinced by Judge Prost's argument on this point.  If she is correct, then the '291 patent was never enforceable – be it in 2007, when Barr filed its ANDA, or 1993, when it issued.  Yet without an enforceable patent, Cancer Research would never have developed TEMODOR, let alone engaged in the expensive Phase III clinical studies necessary to demonstrate its safety and efficacy.  Thus, the "harm" to the public would been greater in the absence of the '291 patent, not less.

Inequitable Conduct
The majority also rejected the district court's finding of inequitable conduct, while the dissent reached the opposite conclusion.  Both opinions focused on the subject of intent to deceive. 

The inequitable conduct issue in this case revolved around an extensive series of articles by an inventor on the '291 patent that presented data from post-application clinical trials of the claimed compounds.  These articles included conclusions indicating that some of the claimed compounds demonstrated high toxicity and low anticancer activity, which the district court found to be highly material to the patent claims because it directly contradicted statements in the '291 patent regarding the compounds' utility in treating cancers, as well as the patentability of a broadly written claim.

The majority, following the "intent cannot be inferred from materiality" line of thought, concluded that the district court's only basis for finding intent was its determination that the withheld articles were highly material.  "Because the district court did not rely on any other evidence to support its finding of deceptive intent beyond that used to find the withheld data material, the court in effect relied solely on its materiality finding to infer intent to deceive."  Slip Op. at 17.  The majority also concluded that the inference of deceptive drawn by the district court about the inventor's publication of data was not the only reasonable inference; rather, the broad publication of this data in multiple articles is inconsistent with an inference of intent to deceive.  Thus, an equally reasonable inference is that the inventor did not appreciate the potential importance of the published data to the patentability of the patent claims.

Judge Prost, again writing in dissent, would have affirmed the district court's determinations.  In contrast to the majority, which required independent evidence of intent, her view of inequitable conduct is that it does not require separate evidentiary bases for materiality and intent; rather it is appropriate to cite to the same evidence for materiality and intent.  Furthermore, here there was additional evidence of intent in the form of the district court's credibility findings, "which are virtually unreviewable by this court."  Thus, under her approach to intent in inequitable conduct, "[w]e should not draw inference that the district court has already excluded based on its own credibility findings."

Comment: The majority and dissent's views on intent can be partially reconciled under the position that, although an intent to deceive may be partially based on evidence of materiality, materiality cannot be the sole basis for the finding of intent to deceive.  Here, in the majority's opinion, the finding of materiality was the sole basis for the intent to deceive determination, because the only additional factor – the credibility determination – was based on an erroneous inference.  On the other hand, in the dissent's view credibility determinations are unreviewable and are sufficient to provide the "beyond the materiality" support for an intent to deceive finding.

Constitutional Inventors, First-Possession, and the Confusion of Bayh-Dole

Property law courses generally begin with the concept of first-possession as an originator of property rights. In patent law, the first-possession principle leads to a rule that potential patent rights are owned by the inventors unless and until they are assigned to another entity. See Crown Die & Tool Co. v. Nye Tool & Machine Works, 261 U.S. 24, 35-37 (1923). The legal basis for inventor rights is derived from constitutional principles that give Congress power to enact patent laws that grant exclusive rights "to inventors." US Constitution, Article I, § 8, cl. 8.

In Stanford v. Roche, Both Stanford and the US Government argue that that the Bayh-Dole Act of 1980 alters this original formula in the special case where an invention was either "conceived or first actually reduced to practice" with the use of US federal funding received by a university, non-profit, or small business. In that situation, the Bayh-Dole Act suggests that the funded-entity, the "contractor", automatically holds patent rights with a right to "elect to retain title to any subject invention." 35 U.S.C. § 202(a). If the contractor decides not to retain title, then, the funding federal agency "may receive title" or "may … grant requests for retention of rights by the inventor." 35 U.S.C. § 202(d). The Bayh-Dole Act includes a comparative-law clause making its provisions superior to those found in any other Act. "This chapter shall take precedence over any other Act which would require a disposition of rights in subject inventions of small business firms or nonprofit organizations contractors in a manner that is inconsistent with this chapter."

The Bayh-Dole language is somewhat confusing when examined through a first-possession framework. Namely, the statute indicates that the university might "retain title" and also that inventors can request "retention of rights." It is unclear from these provisions whether it is the university or the inventor that first holds rights. The US Constitution helps break this seeming conflict by focusing on inventors as the original recipient of rights. With this Constitutional backstop, there is no way that the university can be the original rights-holder. Rather, that designation must remain with the inventors.

This result may be important for the Stanford v. Roche case that was recently granted a writ of certiorari. Under a Constitutionally limited Bayh-Dole Act, Stanford cannot automatically claim first-possession rights to every invention & first reduction-to-practice that was materially supported by federal funding obtained by Stanford. At most, the Bayh-Dole law requires a transfer of rights from the inventor to the university. In the property framework, the question then focuses on the timing of the Bayh-Dole transfer (is it immediate or does it only occur upon the university's election of rights?) and on its impact on a prior transfer of patent rights to a third party.

Supreme Court to hear Bayh-Dole Patent Ownership Dispute: Stanford v. Roche

Bd. of Trustees of Leland Stanford Jr. University v. Roche Molecular Systems, 09-1159 (Supreme Court 2010)

The Supreme Court has granted Stanford's petition for a writ of certiorari in Stanford v. Roche on an issue of patent ownership. Although the case may turn on federal patent law statutes, it looks substantially like derivative title issues considered in the law of property. The rule of derivative title generally bars a property owner from transferring rights greater than his own. One exception to the rule of derivative title is that, in certain situations, a bona fide purchaser can take title free of prior claims to the property.

The patents in this case involve methods for using PCR techniques to measure HIV concentration in blood plasma. Stanford scientists first created the invention while subject to a contractual duty to assign any inventions to Stanford. After agreeing to assign rights, but prior to the invention, one of the inventors (Holodniy) assigned his rights in his future inventions to Cetus (who later became Roche). Rather than a promise-to-assign, the assignment to Roche was an actual assignment of future inventions. Thus, on the contracts, Holodniy first promised-to-assign rights to Stanford but first actually-assigned rights to Cetus. Stanford later filed for patent protection and then demanded a royalty from Roche. The Federal Circuit held that Roche could not be liable for infringement because it held ownership rights based on the Holodniy assignment.

On appeal to the Supreme Court, Stanford has argued that its receipt of federal funding for the research somehow results in a superior claim to title. Stanford framed the question as follows:

Whether a federal contractor university's statutory right under the Bayh-Dole Act, 35 U.S.C. §§ 200-212, in inventions arising from federally funded research can be terminated unilaterally by an individual inventor through a separate agreement purporting to assign the inventor's rights to a third party.

The US Department of Justice filed a brief supporting the petition and argues that the Bayh-Dole Act does indeed establish a "framework for determining ownership interests in federally funded inventions." The Government brief argues that the Bayh-Dole Act flips the normal statutory rule that patent rights first vest with the inventor. Instead, in their view, by virtue of receiving federal funding, the university or federal contractor automatically receives title to the invention and then may "elect" to not "retain title." Under that interpretation of the law, Stanford retains full title because it received federal funding for the research and elected to pursue patent protection. The Government frames the question as follows:

Whether an inventor who is employed by a [federal] contractor that elects to retain rights in an invention may defeat the contractor's right to retain title under the Bayh-Dole Act by contractually assigning his putative rights in the invention to a third party.

The Federal Circuit rejected these questions – holding instead that the Bayh-Dole Act was not designed to automatically void contractual transfers made by an inventor simply because the research received federal funded.

In addition to the Government Brief, additional petitions-stage briefs were filed by a number of universities and university-controlled organizations that all supported the petition.

Comment: The cause of Stanford's plight is the University's failure to negotiate a tight assignment agreement with its researchers and scientists. If it has not done so yet, Stanford could fix the issue by forcing its students and employees to agree to a new assignment agreement. Thus, this particular issue is solved by contract law. A real ongoing question that the Supreme Court should focus-on with this decision involves the rights of third-party inventors who are not under any contractual duty to assign rights to a university or federal contractor. Does that third party retain rights when the University can show that the invention process was at last partially federally funded. This issue arises in collaborative projects where the work of a subset of inventors receives federal funding.

Successor Company Holds Patents Assigned to Predecessor Company (Even if Assigned after Predecessor Dissolved)

Tri-Star Electronics Int'l. v. Preci-Dip Durtal SA (Fed. Cir. 2010)

Mr. Kerek (from Ohio) invented the claimed “socket contact” while an employee of Tri-Star and he duly executed an assignment of his rights to to Tri-Star.  The year prior to the invention, Tri-Star (OHIO) had merged and become Tri-Star (CALIFORNIA).  However, Kerek's assignment clearly stated that the assignment of rights was to Tri-Star (OHIO) — even though that Ohio company no longer existed. Later, Tri-Star (CALIFORNIA) merged and became Tri-Star (DELAWARE).

Here, the accused infringer has challenged whether Tri-Star (DELAWARE) has standing as owner of the patent rights.  The Federal Circuit accepted this interlocutory appeal and held that Tri-Star (DELAWARE) is the owner of the patent rights.  

In making its decision, the Federal Circuit found two points of law important:

First, contract law attempts to satisfy the mutual intent of the parties, and here, it was clear that the employee had intended to transfer rights to his employer as required by the employment contract.

Second, even after a merger, a predecessor company continues to exist under Ohio law for the purposes of allowing its property to vest.

Based on these two points, the Federal Circuit held that the stated transfer to the merged Tri-Star (OHIO) equated to a transfer to its successor Tri-Star (CALIFORNIA). The later transfer to Tri-Star (DELAWARE) was not disputed.

* * * * *

I have no problem with the Federal Circuit's statements regarding Ohio law — it is correct as far as I know. However, I do have some concern with the ongoing fallacy that there is no Federal law or policy controlling the transfer of patent rights. On point, there is a Federal Law requiring that patent assignments be done “in writing.” 35 U.S.C. 261. Based on that statute, the court should have considered how the supposed transfer from Kerek to Tri-Star (CALIFORNIA) fits within that statutory requirement. In addition, we have seen an increasing number of companies playing games with the patent recordation system by using shell corporations and by mis-recording assignment records. Here, for instance, the assignment record showed ownership by Tri-Star (CALIFORNIA) despite the documentation in the underlying assignment.  Those concerns are important — especially if we believe that the public properly has an interest in knowing the identity of patent owners.