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Sales Authorized Under a License Do Not Become Unauthorized or Infringing Sales Just Because a Licensee Subsequently Delays Royalty Payments Due Under That License

10-1489
September 30, 2011

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Last Month at the Federal Circuit - October 2011

Judges: Dyk (author), Moore, O’Malley

[Appealed from: N.D. Cal., Judge Wilken]

In Powertech Technology Inc. v. Tessera, Inc., No. 10-1489 (Fed. Cir. Sept. 30, 2011), the Federal Circuit reversed the district court’s dismissal of Powertech Technology Inc.’s (“PTI”) DJ action for lack of subject matter jurisdiction, finding that an Article III controversy did in fact exist between the parties.

PTI is a Taiwanese subcontracting company that packages semiconductor chips for various customers in the semiconductor industry. PTI’s customers send bare chips to PTI, and PTI encapsulates them in protective materials before returning the packaged chips to the customers. PTI’s customers then incorporate the prepackaged chips into downstream electronic products for marketing, selling, and importing worldwide, including in the United States. As the packager of the chips, PTI appears to be the only party in the supply chain that allegedly practices the method claims in Tessera, Inc.’s (“Tessera”) U.S. Patent No. 5,663,106 (“the ’106 patent”). The ’106 patent is directed to methods for preventing the contamination of exposed chip terminals during encapsulation. The claimed process requires a protective barrier that protects the terminals of the chip from coming in contact with the encapsulant when it is injected into the encapsulation area through a fill hole.

Tessera licenses its technology to more than sixty semiconductor companies through agreements called Tessera Compliant Chip Licenses (“TCC Licenses”). Tessera and PTI entered into such an agreement in 2003, under which PTI agreed to pay running royalties in return for a license under the ’106 patent (and other patents) to assemble, use, or sell certain “TCC Licensed Products.” PTI claims that it has complied with all its obligations under the license agreement, including the obligation to pay royalties on a postsale quarterly basis.

The current action stems partly from Tessera’s allegations in two earlier suits, one before the ITC and one in the Eastern District of Texas (“the Texas action”). In the ITC action, Tessera sought relief under Section 337 of the Tariff Act of 1930, 19 U.S.C. § 1337, alleging infringement of the ’106 patent and three other patents by eighteen defendants through the importation and sale of certain semiconductor chips. In the Texas action, filed on the same day as the ITC action, Tessera asserted infringement of the same patents, accusing the same defendants and products. The Texas action was stayed pending the final outcome of the ITC proceedings. The accused products in the ITC and Texas actions were semiconductor chips that came in two formats: a first group consisting of so-called “wBGA” chips and a second group consisting of so-called “µBGA” chips. PTI is licensed by Tessera to manufacture both wBGA and µBGA chips. Though PTI was not a named party in either the ITC or Texas action, it maintains that some of the accused companies were customers who directly or indirectly purchased their wBGA and µBGA chips from PTI.

In the ITC proceedings, the ALJ ruled that the ’106 patent was not invalid and not infringed by the accused wBGA and µBGA products. The ALJ also determined that Tessera’s patent rights were exhausted with respect to all accused products sold by Tessera’s licensees, including PTI. In its Final Determination, the ITC affirmed the ALJ’s determination that the wBGA products did not infringe, but held that the µBGA products did infringe. The ITC did not, however, issue an exclusion order under Section 337 with respect to the µBGA products because it determined that Elpida Memory, Inc. (“Elpida”), one of the accused companies that were customers who directly or indirectly purchased the wBGA and µBGA chips from PTI, was the only importer of µBGA chips and that all of Elpida’s µBGA chips were purchased from licensed vendors, including PTI. The ITC action culminated in the Federal Circuit’s recent decision in Tessera, Inc. v. International Trade Commission, 646 F.3d 1357, 1361 (Fed. Cir. 2011), in which the Court affirmed the ITC’s finding that there was no Section 337 violation. The Court held that (1) the ’106 patent was not invalid as anticipated by three prior art references; (2) the accused wBGA products did not infringe the ’106 patent; and (3) although Elpida did not dispute that the µBGA chips infringed the ’106 patent, Elpida was nonetheless protected by a valid patent exhaustion defense, having purchased all of its products from licensed subcontractors, including PTI. The Court ultimately remanded the case to the ITC.

While the ITC action was underway, PTI made royalty payments to Tessera for the wBGA products “under protest” because PTI believed that the wBGA products did not infringe the ’106 patent and that the ’106 patent was invalid, and royalties were therefore not owed. Soon after, PTI filed its DJ action, asserting two separate claims for relief. First, PTI sought a declaration that the wBGA products did not infringe the ’106 patent. Second, PTI sought a declaration that the ’106 patent was invalid based on prior art raised in a pending reexamination of the ’106 patent before the PTO. In response, Tessera moved to dismiss for lack of subject matter jurisdiction, which the district court granted. The district court held that PTI’s products could not have been at issue in the ITC action because PTI’s products were all manufactured pursuant to a license with Tessera, which explicitly excluded licensed products from its enforcement actions. Additionally, the district court concluded that there was no actual controversy arising from the license agreement because the license agreement itself required PTI to pay royalties whether or not its products were covered by the ’106 patent. Finally, the district court sua sponte held that, even if there were an actual controversy, the court would have declined to hear the case because judicial efficiency favored hearing the DJ action along with the pending Texas action.

On appeal, the Federal Circuit reviewed the district court’s dismissal for lack of subject matter jurisdiction de novo. PTI alleged that two controversies existed in creating DJ jurisdiction. First, PTI alleged that Tessera’s allegations against its customers in the ITC and Texas actions created a controversy as to whether its wBGA and µBGA chips infringed the ’106 patent, either because the chips were not within the scope of the claims (the wBGA chips) or because the ’106 patent was invalid (the wBGA and µBGA chips). PTI further argued that Tessera’s pending claims of infringement in the ITC and Texas proceedings created a sufficient controversy because they directly implicated PTI’s products and customers. Tessera, however, maintained that there was no controversy because all of PTI’s products were “properly licensed” and categorically excluded from the enforcement of the ’106 patent in the ITC and Texas actions.

The Federal Circuit found Tessera’s position in the DJ action inconsistent with its arguments in the ITC action. There, Tessera maintained that products were only licensed and noninfringed if royalty payments were current. Because some licensees, including PTI, had allegedly underpaid their royalties or had paid them late, Tessera asserted that those sales were “unlicensed” and did not trigger exhaustion of its patent rights. These allegations created a controversy as to whether certain sales of PTI’s products were unlicensed and infringing. The Court explained that, although the outcome of the ITC action will not have preclusive effect on either the district court in Texas or the district court in this case, both courts are bound by stare decisis to abide by any legal precedents established by the Court in its previous Tessera decision, where it held that sales authorized under a license do not become unauthorized or infringing sales because a licensee subsequently delays royalty payments due under that license. The Federal Circuit therefore rejected Tessera’s theory that previously licensed products would become unlicensed when a licensee’s royalty payments lapsed. Because neither party disputed that PTI’s wBGA and µBGA products were covered by the license agreement, to the extent Tessera’s claims against PTI’s customers arose from the same set of facts addressed in Tessera, the Court vacated the dismissal on jurisdictional grounds and remanded with instructions to apply the Court’s decision in Tessera.

PTI also contended that a controversy existed as to PTI’s continued obligation to pay royalties for the sales of its wBGA and µBGA chips under the license agreement with Tessera. In particular, PTI argued that the terms of the license agreement did not require it to pay royalties for the wBGA chips if those chips did not infringe or for the wBGA and µBGA chips if the ’106 patent was invalid. In response, Tessera argued that royalty payments were due even if the products did not infringe the ’106 patent and regardless of the ’106 patent’s validity. Tessera maintained that there could be no Article III controversy as long as PTI complied with all the terms of the license agreement, including the payment of royalties.

The Court held that it need not decide whether PTI or Tessera is correct as to this issue because the issue of contract interpretation is a merits issue, not appropriate to a decision on a motion to dismiss under Rule 12(b)(1). The Court simply held that the dispute as to whether the license agreement requires royalty payments to be tied to valid patent coverage is sufficient to support DJ jurisdiction, leaving the merits-based arguments to the district court to consider on remand.

The Federal Circuit also addressed the propriety of the district court’s alternative ground for dismissal. The district court sua sponte held that, even if PTI had established an actual controversy, the district court would nonetheless dismiss the case because the interests of judicial efficiency could favor hearing PTI’s DJ action along with the pending Texas action. PTI argued that the district court abused its discretion by ignoring the forum selection clause in the license agreement. The Court found that since the forum selection clause in PTI’s license agreement employed language to mandate jurisdiction in California, it was clear that the district court erred in failing to enforce the forum selection clause. Nothing suggested that a Texas court would confer any additional conveniences with respect to the availability of evidence or potential witnesses, nor had Tessera provided adequate cause to override PTI’s choice of forum. The Court therefore held that it was an abuse of discretion for the district court to refuse jurisdiction over the action.

Summary authored by Ruby Jain Natnithithadha, Esq.