April 20, 2010

Companies That Reverse Engineer Products and Sell Overseas Should Get Solid Patent Opinion

In SEB S.A. v. Montgomery Ward, the Federal Circuit addressed two activities common in the medical device industry: obtaining and selling products outside of the U.S. and reverse engineering a competitor's product. The Federal Circuit's decision warns that global operations may support claims of U.S. patent infringement even when the accused infringing product is designed, manufactured, sold, and shipped from outside of the U.S. The decision also highlights why a company that reverse engineers a competitor's product should obtain a freedom-to-operate opinion from well-informed counsel.

Defendant Sells Product Reverse-Engineered Abroad to U.S. Companies; Jury Returns Verdict of Direct and Indirect Patent Infringement

In the SEB case, the defendant, Pentalpha, purchased in Hong Kong a product manufactured by the plaintiff and patent owner, SEB. Pentalpha proceeded to copy SEB's product and sell its own version to two U.S. companies. The product Pentalpha copied was not marked with any patent numbers, and Pentalpha did not know that SEB's U.S. patent covered the product. The sales contract between Pentalpha and the U.S. companies contained a clause that the product was sold "free-on-board"(FOB) in Hong Kong or mainland China, meaning that title to the product would pass to the U.S. companies at that location, outside of the U.S.

Shortly after it contracted to supply one of the U.S. companies, Pentalpha obtained a freedom-to-operate opinion from its patent attorney. The attorney searched for and analyzed patents in the area, but did not locate SEB's patent, and concluded that no patents covered Pentalpha's product. One reason the patent attorney did not find SEB's patent was Pentalpha's failure to inform its counsel that it had designed its product by copying SEB's product.

SEB sued Pentalpha for both direct infringement and actively inducing the infringement of its patents. A jury found that Pentalpha had directly infringed SEB's patent when it sold the infringing product to the two U.S. companies. The jury also found that Pentalpha had indirectly infringed SEB's patent when it failed to disclose to its opinion counsel that it designed the accused product by copying SEB's product—then sold the copied product to the two U.S. companies, knowing these companies would directly infringe by reselling the infringing product to consumers within the U.S.

Pentalpha appealed, arguing that it did not directly infringe SEB's patent because it sold its accused product outside of the U.S., and it could not actively induce the U.S. companies to infringe because it was not aware that SEB had a patent. In upholding the jury verdict on appeal on both issues, the Federal Circuit addressed the extra-territorial reach of U.S. patent rights, as well as the circumstances that can support liability for active inducement.

Selling Products Abroad May Constitute Direct Infringement of a U.S. Patent

Section 271(a) of the Patent Act places liability for direct infringement of a patent on anyone who "makes, uses, sells, offers to sell, . . . or imports into the United States" an infringing invention. Under section 271(a), only actions occurring "within the United States" can give rise to liability. A line of cases, however, including SEB, demonstrates that whether a particular act is deemed to have occurred in the U.S. for the purposes of section 271(a) liability is frequently not a straightforward analysis, and acts that include a substantial amount of extra-territorial conduct can be found to give rise to section 271(a) liability.

Site of Infringing Sale May Be Found to Be the Buyer or Seller's Location—Or Any Point In Between

In North American Philips v. American Vending Sales the Federal Circuit held that the sale of a patented product occurs not at the location where title transferred according to a contractual "free on board" clause but at the "familiar places of contracting and performance." Under this standard, an infringing sale can be sited at either the buyer or seller's location, or at any point in between where the goods traveled. Applying this rule, in Litecubes, LLC v. Northern Light Products, Inc., the Federal Circuit court found that a Canadian company had sold a device within the U.S. when it shipped products to a domestic buyer, even though title transferred in Canada.

Mere Knowledge That Product Sold Overseas Will Be Imported to U.S. Is Insufficient to Establish Liability

Conversely, the foreign manufacturer in MEMC Electric Materials, Inc. v. Mitsubishi Materials Silicon Corporation avoided liability for infringement of a U.S. patent by selling its products through an overseas intermediary, even though some aspects of the sale made it appear to have been directed towards the U.S. The foreign manufacturer in MEMC entered into a contract in a foreign country to sell its products to a foreign intermediary, which immediately sold the products to its U.S. counterpart. Even though the products were sold to the foreign intermediary, for convenience, they were delivered directly to the U.S. counterpart. The trial court dismissed the patent owner's claims that the accused infringer, Mitsubishi, directly infringed its patents by selling the infringing product or importing the infringing product into the U.S. because there was no proof that Mitsubishi's actions occurred within the borders of the U.S.

On appeal, the patent owner argued that, by shipping the product directly to the U.S., Mitsubishi sold the accused product within the U.S. The Federal Circuit rejected this argument, in effect refusing to adopt a "stream of commerce" theory for foreign sales. In particular, because the overseas intermediary controlled when a purchase order was submitted, managed shipping the product to the U.S., and paid the foreign seller, the sale was not domestic to the U.S., even though the seller knew that the product was bound for the U.S. Consequently, this case established that "[m]ere knowledge that a product sold overseas will ultimately be imported into the United States is insufficient to establish liability under § 271(a)."

SEB May Signal Shift Toward Totality of Circumstances Test to Determine Whether Sale Occurred in U.S.

In the SEB case, the Federal Circuit upheld a finding that Pentalpha's shipping of the infringing product to its U.S. customers constituted direct infringement by selling for purposes of section 271(a). Relying on Litecubes, the Federal Circuit rejected Pentalpha's argument that it did not sell products in the U.S. solely because the shipment was made FOB Hong Kong, although the FOB clause was relevant evidence of a foreign sale.

In addition, the court found that stamping a U.S. trademark on the label, designing its product with U.S. electrical fittings, and invoicing the sales for delivery to the U.S. demonstrated that Pentalpha intended to sell its products in the U.S. The Federal Circuit's analysis illustrates a continuing shift towards a totality of the circumstances test for determining whether a sale occurred in the U.S. for purposes of the patent laws. Such a shift could make it more difficult for foreign manufacturers to avoid liability for U.S. patent infringement simply by relying on the wording of purchase invoices and shipping contracts.

Flawed Patent Opinions May Not Guard Against Liability for Indirect Infringement

The patent laws place liability not only on a party who directly infringes a patent by making, using, selling, offering to sell, or importing a patented invention, but also on an entity that indirectly infringes a patent by contributing to or actively inducing another party to directly infringe.

Sitting en banc four years ago in DSU Medical Corp. v. JMS Co., the Federal Circuit addressed the legal standard for inducing infringement and held that "the plaintiff has the burden of showing that the alleged infringer's actions induced infringing acts and that he knew or should have known that his actions would induce actual infringements." In addition, "[t]he requirement that the alleged infringer knew or should have known his actions would induce actual infringement necessarily includes the requirement that he or she knew of the patent." Lastly, the accused inducer must "have an affirmative intent to cause direct infringement," in contrast to a general intent to cause the acts that constitute infringement. Thus, a claim for "inducement requires evidence of culpable conduct, directed to encouraging another's infringement, not merely that the inducer had knowledge of the infringer's activities." The DSU opinion, however, did not address the scope of the "knowledge of the patent" requirement. The SEB panel provided an explanation of this requirement.

Federal Circuit: Knowledge of a Patent Can Be Proved by ‘Deliberate Indifference'

In SEB, the defendant, Pentalpha, had no knowledge of the patent-at-issue before being served with the complaint, so it appeared that the plaintiff, SEB, could not make a prima facia case for active inducement based on Pentalpha's pre-suit actions. On appeal, the Federal Circuit ruled that the knowledge requirement for active inducement does not require that the accused infringer be aware of the patent. Instead, knowledge of a patent can be proved either by "actual knowledge" or inferred from a party's "deliberate indifference" to the existence of a patent. The Federal Circuit determined that Pentalpha acted with such indifference to SEB's patent because it did not tell the patent attorney who conducted a freedom to operate opinion that it had copied SEB's product.

The court noted that a "failure to inform one's counsel of copying would be highly suggestive of deliberate indifference in most circumstances." In addition, evidence that Pentalpha's management was well versed in U.S. patent law bolstered the conclusion that it was deliberately indifferent to the patent's existence. Pentalpha argued that it believed the SEB product was not patented because the SEB product was not marked with a U.S. patent number. The court rejected this exculpatory argument on the grounds that a product sold in Hong Kong would not be expected to be marked with a U.S. patent number. The court also noted that if the product had been marked, disregarding patent markings would likely have constituted deliberate indifference to the existence of a patent.

SEB Demonstrates Importance of Fully Informing Opinion Counsel

The SEB decision illustrates the importance of obtaining solid freedom-to-operate opinions. Generally, freedom-to-operate opinions are used in the pre-litigation context to determine whether a company is infringing a patent, but may also be asserted in litigation as exculpatory evidence against claims of active inducement or willful infringement. However, such legal opinions are only as good as the information provided to opinion counsel. Opinion counsel should be provided with a full picture of the company's activities surrounding its product, including any competitor's products, patents, or information used during the product design. While the exculpatory benefit of an opinion-of-counsel has not been fully resolved, the SEB case establishes that a fundamentally flawed opinion-of-counsel will not only fail to help an accused infringer defeat a claim of active inducement, it may constitute relevant evidence in support of such a claim.

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