Print PDF

Dismissal with Prejudice Based on Covenant Not to Sue Does Not Divest District Court of Jurisdiction to Hear Attorney Fees Claim Under 35 U.S.C. § 285

November 21, 2006

Decision icon Decision

Last Month at the Federal Circuit - December 2006

Judges: Schall, Linn (author), Dyk

[Appealed from: N.D. Iowa, Judge Jarvey]

In Highway Equipment Co. v. FECO, Ltd., Nos. 05-1547, -1578 (Fed. Cir. Nov. 21, 2006), the Federal Circuit held that the district court properly retained subject matter jurisdiction over FECO, Ltd.’s (“FECO”) attorney fees claim and affirmed the district court’s denial of the motion. In addition, the Federal Circuit ruled that the district court did not have jurisdiction to rule on FECO’s claim of wrongful termination of dealership and vacated the district court’s grant of SJ to Highway Equipment Company, Inc. (“Highway Equipment”) on that issue, remanding the case with instructions to dismiss the claim.

In 1996, FECO and Highway Equipment, both manufacturers of agricultural equipment, entered into a dealership agreement in which Highway Equipment authorized FECO to sell its adjustable spreader (a machine that applies fertilizer to fields). Almost six years later, in December 2002, Highway Equipment, without good cause or prior written notice as required by the governing state law (Iowa Code § 322F (“322F”)), terminated the dealershipagreement with FECO. Three months later, FECO began manufacturing an adjustable spreader. The next February, the patent for Highway Equipment’s adjustable spreader issued as U.S. Patent No. 6,517,281 (“the ’281 patent”), and four months later Highway Equipment sued FECO and its president (collectively “FECO”), and the manufacturing company, Doyle Equipment Manufacturing Company (“Doyle”), for infringement of the ’281 patent. In response, FECO (1) asserted affirmative defenses based on inequitable conduct and inventorship, (2) counterclaimed for DJ of noninfringement and invalidity, (3) counterclaimed for tortious interference with a prospective business relationship, (4) sought damages pursuant to 322F for wrongful termination of the dealership agreement, and (5) sought attorney fees and costs.

Initially, the district court issued an interlocutory order granting Highway Equipment’s motion for partial SJ on FECO’s counterclaim for wrongful termination of the dealership agreement. The district court found that no violation of the relevant statute had occurred.

The day before the pretrial conference, both Highway Equipment and defendant Doyle filed stipulations and motions for dismissal with prejudice of all claims against each other. The next day, Highway Equipment filed a “Declaration and Covenant Not to Sue” (“covenant”), which stated that it “unconditionally and irrevocably” covenants not to assert any claim of patent infringement against FECO under the ’281 patent for any current or prior FECO product. The same day, based on these stipulations, the district court entered a dismissal with prejudice as to the claims between Doyle and Highway Equipment. Left now without an infringement controversy, the district court canceled the jury trial.

FECO then filed a motion for attorney fees pursuant to 35 U.S.C. § 285, based on alleged litigation misconduct and inequitable conduct during prosecution of the ’281 patent. Highway Equipment opposed the motion, arguing that because of the covenant, the court did not have subject matter jurisdiction to hear the motion, and alternatively, because FECO had not obtained a disposition on the merits, there was not a prevailing party for purposes of 35 U.S.C. § 285. FECO filed a motion requesting the district court dismiss the infringement claim with prejudice, arguing that the covenant alone did not relieve all future threat of litigation. Although the district court sided with FECO and dismissed the entire action under Fed. R. Civ. P. 41(a)(2), it decided that it nevertheless retained jurisdiction to hear the claim for attorney fees. And after an evidentiary hearing, the district court entered final judgment, dismissing the claims and counterclaims with
prejudice, and denying FECO attorney fees.

FECO appealed both the grant of SJ as to the wrongful termination of dealership claim and the denial of its motion for attorney fees. Highway Equipment cross-appealed the district court’s ruling that it retained subject matter jurisdiction over the motion for attorney fees.

As a threshold issue, the Federal Circuit first assessed whether Federal Circuit law or Eighth Circuit law should apply to determine “what effect a dismissal with prejudice has on the legal requirements under 35 U.S.C. § 285.” Slip op. at 7. Citing the policy interests of uniformity, clarity, and consensus, the Court decided that Federal Circuit law was appropriate because Federal Circuit law “governs the substantive interpretation of 35 U.S.C. § 285, which is unique to patent law.” Id. (citation omitted).

Applying Federal Circuit law, the Court held that the district court had correctly retained subject matter jurisdiction over the attorney fees claim after dismissal with prejudice. The Court disagreed with Highway Equipment that the preverdict covenant divested the district court of jurisdiction over the fee request, instead distinguishing the disposition of the request for attorney fees under 35 U.S.C. § 285 from the patent-related counterclaims, over which the district court may not have retained jurisdiction. The Federal Circuit also rejected Highway Equipment’s alternative argument that the district court erred in hearing the attorney fees claim because FECO cannot be properly characterized as a prevailing party. The Court explained that other similar fee shifting statutes have been consistently interpreted by theSupreme Court to “prohibit an award of fees to the plaintiff unless the court awards relief on the merits, either through a judgment on the merits or through a settlement agreement enforced through a consent decree.” Id. at 9 (citing Buckhannon Bd. & Care Home, Inc. v. W. Va. Dep’t of Health & Human Res., 532 U.S. 598 (2001)). “[T]he critical focus is not on the defendant’s voluntary change in conduct, but rather whether there is a ‘judicially sanctioned change in the legal relationship of the parties.’” Id.

Applying the requirements of Buckhannon, the Federal Circuit held that the dismissal with prejudice did have “the necessary judicial imprimatur to constitute a judicially sanctioned change in the legal relationship of the parties.” Id. at 13. Noting that the district court had exercised its discretion in dismissing the patent claims with prejudice, the Court found that FECO was a prevailing party for purposes of 35 U.S.C. § 285. In distinguishing precedent cited by Highway Equipment, the Court stated that “the voluntary filing of the covenant in this case was designed to be judicially enforceable and was the basis for the court’s order dismissing the claims with prejudice. The covenant was not simply an extrajudicial promise made by one party to another outside the context of litigation.” Id. at 11-12. In addition, the Court added that its ruling is consistent with precedent holding the defendant the prevailing party for purposes of costs pursuant to Rule 54 where the plaintiff voluntarily dismissed its case with prejudice, stating that there is no reason to define the term “prevailing party” differently in the context of attorney fees pursuant to 35 U.S.C. § 285. Thus, the Court concluded that “the dismissal with prejudice, based on the covenant and granted pursuant to the district court’s discretion under Rule 41(a)(2), has the necessary judicial imprimatur to constitute a judicially sanctioned change in the legal relationship of the parties, such that the district court properly could entertain FECO’s fee claim under 35 U.S.C. § 285.” Id. at 13.

After holding that the district court did have jurisdiction to hear the fee claim, the Federal Circuit went on to find no error in the district court’s denial of FECO’s attorney fees. The Federal Circuit addressed FECO’s two arguments. First, FECO alleged that Highway Equipment engaged in inequitable conduct during prosecution of the ’281 patent by failing to name an alleged inventor and failing to disclose material prior art. The district court based its decision on factual findings that Highway Equipment had investigated the prior art at issue and could not determine how the prior art device operated, and that the alleged coinventor had indicated at the time of filing that he should not be named as an inventor. The Federal Circuit held that there was no clear error in the district court’s determination that FECO had failed to prove, by clear and convincing evidence, that Highway Equipment had intended to deceive the PTO. Second, with regard to alleged litigation misconduct by Highway Equipment, the Court initially dismissed two of FECO’s allegations as irrelevant (Highway Equipment’s failure to honor its statutory obligation under 322F) or as waived for failure to argue the issue before the district court (Highway Equipment’s filing the covenant on the “eve of trial”). As to the remaining four instances of misconduct alleged by FECO, including improper or untimely disclosure of expert reports and exhibits and evasive witness testimony, the Federal Circuit refused to second guess the district court, holding that the district court’s determination was not clearly erroneous. Therefore, the Federal Circuit affirmed the district court’s judgment of denial of attorney fees.

As to the claim of wrongful termination of dealership, the Federal Circuit held that the district court did err in exercising supplemental jurisdiction over the counterclaim. The Court explained that because Highway Equipment and FECO do not qualify for diversity jurisdiction and did not plead the 322F claim as a diversity claim or otherwise independently subject to federal jurisdiction, the district court would not have jurisdiction unless the 322F claim was joined with a sufficiently related federal claim. The Federal Circuit concluded that the 322F wrongful termination claim was not sufficiently related to the patent claims to support jurisdiction because the claims do not derive from a common nucleus of operative fact. The Court explained that the two sets of claims involved different instrumentalities, acts, and products, as well as different governing laws. Whereas the facts alleged in the 322F claim involved a contract and a Highway Equipment product, the facts alleged in the patent claims involved a patent (issued after the contract was terminated) and a FECO product (manufactured after the contract was terminated). Therefore, the Court determined that the district court did not have jurisdiction to hear the 322F claim, vacated the district court’s judgment, and remanded the case with instructions to dismiss the claim for lack of