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Patent Unenforceable Because Company’s Founder and President Was “Substantively Involved” with Application and Incurred Duty of Candor to PTO

April 27, 2010
Cook, Elliot C.

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Last Month at the Federal Circuit - May 2010

Judges: Mayer, Linn (concurring-in-part and dissenting-in-part), Prost (author)

[Appealed from: E.D. Tex., Judge Ward]

In Avid Identification Systems, Inc. v. Crystal Import Corp., Nos. 09-1216, -1254 (Fed. Cir. Apr. 27, 2010), the Federal Circuit determined sua sponte that it had jurisdiction over the appealed issue of unenforceability due to inequitable conduct, and affirmed the district court’s finding of unenforceability.

Avid Identification Systems, Inc. (“Avid”) is a small, closely held company that designs and markets biocompatible radio-frequency identification chips for implantation in animals, which function to locate lost animals.  Avid’s founder and president, Dr. Hannis Stoddard, hired at least three engineers, Dr. Polish, Dr. Malm, and Mr. Beigel, to develop a chip and reader system in which the reader could read both unencrypted chips currently on the market as well as encrypted chips that Avid produced.

Dr. Stoddard demonstrated some of Avid’s technology at a U.S. Livestock Committee trade show around April 1990.  Four months later, Avid filed the application that matured into U.S. Patent No. 5,235,326 (“the ’326 patent”), which was directed to a multi-mode radio-frequency identification system for reading encoded biocompatible chips.  The inventors named on the application were Drs. Polish and Malm, and Mr. Beigel.

Avid sued Datamars SA and its subsidiary Crystal Import Corporation (collectively “Datamars”) in 2004, alleging infringement of the ’326 patent, as well as unfair competition and false advertising claims.  The jury found the ’326 patent willfully infringed and not invalid, found in favor of Avid on the unfair competition and false advertising claims, and awarded Avid $26,981 on the patent infringement claim.  Following the trial, the district court granted Datamars’s motion for unenforceability based on inequitable conduct, finding that Dr. Stoddard’s trade show demonstration was material prior art under 35 U.S.C. § 102(b).  The district court held that Dr. Stoddard owed a duty of candor to the PTO and violated that duty by withholding information concerning the trade show demonstration from the PTO with deceptive intent.  After the ruling on inequitable conduct, the parties entered into a settlement agreement involving the dismissal of all claims other than those related to the ’326 patent.  Datamars also agreed not to contest the standing, jurisdiction, mootness, or case and controversy of the inequitable conduct decision on appeal to the Federal Circuit, and agreed to pay the $26,981 damages award to Avid if Avid prevailed on the issue of inequitable conduct on appeal.

The Federal Circuit first considered, sua sponte, whether it had jurisdiction to decide the issue of unenforceability.  The Court noted that Datamars’s agreement not to dispute standing, jurisdiction, mootness, and case or controversy on appeal did not thereby give Avid standing or give the Court jurisdiction.  But a live controversy did exist, the Court held, because Datamars remained free under the settlement agreement to oppose the appeal on the merits, even though Datamars declined to submit an appeal brief.  Further, Datamars’s agreement not to contest the procedural appropriateness of the appeal did not release the Court from its legal obligation to determine procedural appropriateness sua sponte.  In response to an argument by amicus participant Allflex USA, Inc. that the $26,981 Avid could recover on appeal was merely a nominal amount, the Court found that the $26,981 was not a token or arbitrary sum introduced for the purpose of manufacturing a controversy, given that it represented the entirety of the jury award for patent infringement.  Consequently, the Federal Circuit held that it had jurisdiction to decide the issue of inequitable conduct.

The Court next turned to the issue of inequitable conduct.  According to Avid, the district court’s finding that Dr. Stoddard’s trade show demonstration was material prior art was clearly erroneous, because the demonstration related to a precursor product that did not contain all of the elements of the ’326 patent claims.  In fact, Avid noted, the jury found the ’326 patent valid despite evidence of the demonstration.  The Federal Circuit rejected this argument because it confused the concepts of “material” and “invalidating.”  “We have often held that a reasonable examiner may find a particular piece of information important to a determination of patentability, even if that piece of information does not actually invalidate the patent.”  Slip op. at 8.  The Federal Circuit concluded that the district court’s finding of materiality was not clearly erroneous because the precursor product, while not invalidating, reflected the closest prior art, and thus was highly material to patentability.

Avid next argued that Dr. Stoddard was not bound by 37 C.F.R. § 1.56 (“Rule 56”), which imposes on inventors, attorneys or agents, and individuals “substantively involved in the preparation or prosecution of the application,” a duty of candor to the PTO.  See 37 C.F.R. § 1.56(c).  The Federal Circuit recognized that its previous decisions had not determined the meaning of substantive involvement in the preparation or prosecution of an application.  Citing MPEP § 2001.01, the Court stated:  “We read ‘substantively involved’ to mean that the involvement relates to the content of the application or decisions related thereto, and that the involvement is not wholly administrative or secretarial in nature.”  Slip op. at 10.

The Federal Circuit then considered the district court’s findings that supported the conclusion that Dr. Stoddard was bound by Rule 56, including the nature of his position as president and founder of Avid, that Avid is a closely held company, that Stoddard hired the inventors to reduce his encrypted chip concept to practice, that Stoddard was involved in all aspects of the company’s operation, from marketing and sales to research and development, and that Stoddard was a recipient of two communications from an inventor of the ’326 patent concerning a related European application.  Further, the Federal Circuit noted that the district court found that “Dr. Stoddard’s testimony at trial was not credible, his memory of facts was suspiciously selective, and he refused to acknowledge certain incontrovertible events.”  Id. at 13.

Given these findings of fact, the Federal Circuit found that the district court’s duty of candor analysis was not clearly erroneous and was reinforced by the Court’s own review of the entire record and relevant case law, including Bruno Independent Living Aids, Inc. v. Acorn Mobility Services Ltd., 394 F.3d 1348 (Fed. Cir. 2005).  Specifically, the Court noted that Dr. Stoddard was personally responsible for the disputed prior art demonstrations, he was in contact with at least one of the inventors during the preparation of the ’326 patent application regarding patent-related matters and was advised by that inventor to check with a patent attorney before disclosing information about Avid’s technology to the public, he signed a small-entity status affidavit shortly before the application was filed, and the functionality of the system described in the ’326 patent was his idea.  Accordingly, the Court affirmed the district court’s finding of unenforceability due to inequitable conduct.

In a separate opinion, Judge Linn concurred with the majority’s opinion insofar as it found that a live controversy between the parties existed on the issue of unenforceability, and that Dr. Stoddard’s trade show demonstration was material prior art.  But Judge Linn dissented with respect to the majority’s holding that Dr. Stoddard was bound by 37 C.F.R. § 1.56(c)(3).  According to Judge Linn, “Because one cannot assess whether information is ‘material to patentability’ without knowledge of the technical details or legal merits of an application, it should be self-evident that when Rule 56(c)(3) talks about persons who are ‘substantively involved’ it is referring to those persons who are both (1) engaged in the preparation or prosecution of an application and (2) sufficiently apprised of the technical details or legal merits of the application as to be able to assess the materiality of any information they may know or discover as the application is prepared or prosecuted.”  Linn Dissent at 3-4.  Judge Linn clarified that the “knowledge” requirement he believed should apply was distinct from the knowledge component of the materiality inquiry.  Rather, Judge Linn read the word “substantive[]” as limiting the set of individuals who have a duty to disclose to those who possess a specific understanding of the substance of the application.  Judge Linn further disagreed with the majority that the evidence of record supported a finding that Dr. Stoddard was substantively involved in the preparation or prosecution of the ’326 patent application.  Consequently, Judge Linn would have reversed the finding that the ’326 patent was unenforceable due to inequitable conduct.


Summary authored by Elliot C. Cook, Esq.