Arbitrating the Patent Case Part XXII: Attacks on the Award

In earlier articles in this series we followed arbitration involving patent matters from drafting the arbitration clause through the award, motions to “reconsider” the award and, finally a motion to confirm the award.  We now arrive at attacks on the award.

The standard that applies to review of an arbitration award is much more rigorous than appellate review of a trial court judgment.  The whole point of arbitration is to have a quick, relatively inexpensive, final determination of the parties’ dispute.  The Federal Arbitration Act (“FAA”) and most state arbitration acts recognize that.  Because the FAA typically pre-empts state arbitration acts for transactions in interstate commerce – which will almost certainly include your patent arbitration – we will focus on the FAA.

Before we do, however, note that under the rules of most arbitral bodies, you can build in an arbitration appeal.  The newer AAA commercial rules, for example, allow the parties to agree to review of an award by a panel of arbitrators, acting much like an appellate court. But, as a practical matter, you must build that into your arbitration clause if you want an appeal. Nobody is ever going to agree to an appeal after they have won.  We’ll take a look at arbitration appeals in a later article.

Timing

Let’s begin with a timing issue.  You will recall from the last article that a party has one year to seek confirmation of an award.  9 U.S.C. § 9.  A motion to vacate, modify or correct an award must be brought within three months after the award is filed or delivered.  § 12.  So what happens if a party moves to immediately confirm the award?  Does the party wanting to vacate or change the award still get three months, so a confirmed award can later be undone and a judgment on it vacated?

I haven’t seen this be much of a problem as a practical matter. The party seeking to vacate the award usually does so in response to an application to confirm it, so the issue doesn’t arise.  I did once have a state court, applying rules almost identical to the FAA, postpone the hearing on a motion to confirm the award until over 90 days after the award to make sure the other party had a chance to move to vacate the award before it was confirmed.

Grounds for vacating awards

The FAA has only a few specific grounds for vacating the award.  They are:

(1)   where the award was procured by corruption, fraud, or undue means;

(2)   where there was evident partiality or corruption in the arbitrators, or either of them;

(3)   where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced; or

(4)   where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.

9 U.S. C. § 10. Note first that none of these grounds are that the arbitrator improperly applied the law or that the findings of fact have no support.  To quote the Eighth Circuit, so long as “the arbitrator is even arguably construing or applying the contract and acting within the scope of his authority,” the award must be confirmed.  Gas Aggregation Svcs., Inc. v. Howard Avista Energy, LLC, 319 F.3d 1060 (8th Cir. 2003).

Evident partiality

“Evident partiality” can be a ground for attacking an award in the right case.   For example, in a Second Circuit case, an award was vacated under the evident partiality standard where an arbitrator had reason to believe a conflict of interest might exist, but chose to ignore it and instead erected a “Chinese wall” in his company.  If he had investigated, he would have learned that his company had a significant contract in place with one of the parties.  But he disclosed neither that he had decided not to investigate further nor that he had erected the wall.  The award was vacated.  Applied Industrial Materials Corp. v. Ovalar Makine Ticaret Ve Sanayi, A.S., 492 F.3d 132 (2d Cir. 2007).

The cases tend to be quite fact specific, so a party considering this ground will need to review all applicable cases in the jurisdiction and the specific facts of the case.

Of course, there is always the danger that a party will learn of a failure to disclose a relationship and keep it under wraps until they see whether or not they won.  Courts don’t like that type of gamesmanship.  The Fifth Circuit held that a party seeking to vacate an arbitration award based on an arbitrator’s evident partiality must object during the arbitration proceedings. Failure to do so results in waiver of its right to object.  Dealer Computer Services, Inc. v. Michael Motor Co., Inc., 11-20053, 2012 WL 3317809 (5th Cir. Aug. 14, 2012).

The district court found that rule that an objection must be made during the proceedings “paradoxical [because] if the arbitrator completely failed to disclose a potential conflict, the objecting party could not know about it in order to object.” But the Fifth Circuit noted that the arbitrator had at least generally disclosed that she had been in an earlier arbitration involving one of the parties.  That was found to be sufficient to provide notice to the objecting party. The Fifth Circuit upheld the award.

Because many courts are willing to define “evident partiality” to include unrevealed relationships with a party, this is one of the more promising grounds for vacating an award.  That law – and the ethical rules – keep diligent arbitrators making disclosures of just about anything that could cause their neutrality to be questioned.

Refusal to hear evidence

This ground seems to be at the heart of some arbitrators’ apparently limitless patience in hearing evidence of dubious value.  Arbitrators often simply take evidence “for whatever relevance it may have, if any,” to be determined later so as not to be accused of refusing to hear evidence.  Still, this ground is not as promising for getting an award overturned as one might suppose.

First, a party would have to show the evidence is “pertinent or material” not just that the arbitrator refused to consider all the evidence proffered.   Second, in AAA Commercial arbitrations, for example, the parties have agreed to the AAA rules which specifically give the arbitrator the power to “determine the admissibility, relevance, and materiality of the evidence offered and may exclude evidence deemed by the arbitrator to be cumulative or irrelevant.”  Rule 34(b).  Given that the parties typically will have agreed to these rules, the arbitrator would have to have fairly blatantly abused this authority for it to become a real issue.

But his ground has recently been applied in a fairly high profile case to vacate an award.  In National Football League Management Council v. National Football League Players Association, No. 15 Civ. 5916 (S.D.N.Y. Sept. 3, 2015), the district court vacated the arbitration award of the NFL Commissioner suspending quarterback Tom Brady for four games over the “inflategate” controversy.  In so doing, he noted that Brady’s counsel had sought to call for examination Jeff Pash, an announced co-lead investigator of the allegations against Brady.  Instead, the Commissioner, serving as arbitrator, refused to compel his examination, finding it would be cumulative of other evidence already submitted.

The court found denial of an opportunity the examine Mr. Pash was fundamentally unfair and violated the FAA.  While recognizing an arbitrator has authority to exclude cumulative evidence, the court found he could not simply do so ipse dixit without indicating “in what respects it would be cumulative.”  The decision is on appeal.

Exceeding authority

Another ground that could be promising in the right case would be an arbitrator exceeding authority.  The arbitrator derives all power from the parties’ contract, so only issues the parties have given the arbitrator power to arbitrate may be decided.  Of course, the parties may expand this authority by actually arbitrating issues before the arbitrator beyond these agreed.  And note that, if the parties’ contract incorporates AAA or other rules, the arbitrator’s power will include those given in the rules unless the parties contract otherwise.

As pointed out earlier in this series, parties will not want to get too elaborate about what is or is not to be arbitrated so that the arbitrator’s authority is unclear.  Otherwise the award will be subject to attack on this ground.

This ground may also be raised to attack a late award.  Many rules or arbitration clauses require that an award be made within a certain amount of time, often 90 days.  Some late awards have been vacated because the arbitrator was without power after the time for issuing the award had run.

There is room for gamesmanship here, with parties complaining about a late award only after it is issued and they lost.  Some state arbitration statutes specifically require that an attack on a late award be made before it is issued.  The FAA does not, but that doesn’t mean the award will be vacated automatically if it is late.  Still, it is best to avoid all this by getting the award issued on time.

Other statutory grounds

The FAA’s other grounds for vacation are fairly esoteric and will not come up very often.  Hopefully, you have vetted your arbitrator or arbitrators during the selection process so they are unlikely to engage in misconduct or write incomprehensible awards.

There are other grounds for attacking awards that have been raised and considered over the years, which we will take up in the next article.

 

Arbitrating the Patent Case Part IX: Statutory provisions

In earlier articles in this series we looked at patent disputes most suitable for arbitration, choice of arbitrator, arbitration clauses to use and avoid, the prehearing conference, discovery, and prehearing matters such as claim construction and summary judgment.  Before we continue on, let’s stop to explore the statutes that specifically provide for arbitration of patent disputes:  35 U.S.C. §§135 and 294.  I’ve received a question on patent statutes and arbitration, so there is no time like the present to address the matter.

Derivation proceedings.  Section 135 is straightforward.  It allows parties to a derivation proceeding to submit their contest to an arbitrator.  A derivation proceeding is used to determined whether the first-to-file inventor was the true inventor or whether he or she derived the invention from another.

If the parties determine to arbitrate the matter instead of submit it to the Patent Office, they are to give the Director of the Patent Office notice of the arbitration award – which is the arbitration term for a decision or order. The award is then binding on the parties.  The arbitration award is not enforceable until notice is given to the Director.  The award is noted as part of the patent’s prosecution record.  The Director may still determine the patentability of the invention claimed in the patent.

This makes sense. The arbitration will bind the parties.  But the patentability of the invention goes to the public interest in having only valid patents in existence.  That is not something the parties should be able determine for others in a private arbitration.  It remains the Director’s responsibility.

Contracts involving patent rights.  Section 294 allows arbitration of any contractual dispute relating to patent validity or infringement. This would most typically relate to patent license agreements, although it is not limited to that.  The parties can provide for arbitration either in the contract itself or later agree to it in writing. Section 294(a) says such a provision is “valid, irrevocable, and enforceable, except for any grounds that exist at law or in equity for revocation of a contract.”   Those grounds are very narrow.

According to House Report 97-542 (1982), this provision was enacted, in part, in response to cases such as Beckman Instruments, Inc. v. Technical Developments Corp., 433 F.2d 55 (7th Cir. 1965).  The Beckman court found that patent issues were “inappropriate for arbitration proceedings and should be decided by a court of law, given the great public interest in challenging invalid patents.”  Congress decided allowing arbitration was in the public interest to save time, money and burden on the courts.

The arbitration is governed by the Federal Arbitration Act.  The arbitrator must consider defenses under 35 U.S.C. § 282.  These include  (1) non-infringement, (2) invalidity, (2) unenforceability,  (3) failure to comply with 35 U.S.C. §112 – including, for example, failure to meet the written description, definiteness, enablement, and other requirements of section 112, and (4) failure to comply with any requirement of 35 U.S.C. § 251, which among other things prohibits broadening the scope of re-issued patents.

Significantly, section 294(c) provides that the arbitration award binds the parties, but no one else.  This may have some benefit for the patent holder, but that is not clear.  Consider a case where the licensee successfully defends by proving the licensed patent is invalid   Recall that in  Lear v. Atkins, 295 U.S. 653 (1969), the Supreme Court held that, in light of “the strong federal policy favoring the full and free use of ideas in the public domain,” licensees are not required not to pay patent royalties if they establish the licensed patent is invalid.

But does an invalidity finding bind the patent holder when it later sues someone else on the patent or seeks royalty payments from a different licensee of the patent?  The issue is unclear.  In fact, section 294(c) says the arbitration binds parties, and the patent holder is a party.  So one might think that a later accused infringer could make use of the arbitration decision to invalidate the patent.  After all, in Blonder-Tongue Laboratories, Inc. v. University of Illinois Foundation, 402 U.S. 313, (1971), the Supreme Court held that, where a patent has been declared invalid in a proceeding in which the patent holder “ has had a full and fair chance to litigate the validity of his patent,” the patent holder is collaterally estopped from re-litigating the patent’s validity.

But one might suppose there must be some reason Congress made it clear that the arbitration decision only binds parties to the arbitration. An arbitrator’s finding the patent is valid wouldn’t bind a third part in later proceedings anyway, so why does the statute specifically say third parties aren’t bound?  Maybe the idea was just to make it clear that the drafters understood that.

Or perhaps the idea was to meet the concern that validity issues implicate the public interest so much, as recognized by Lear and later cases, that an arbitration is not the way to determine them except as between the parties who agreed to arbitrate.  Just as the issue of validity was specifically carved out from derivation arbitrations under section 135, noted above, perhaps Congress meant to carve it out so that only within the arbitration itself would the validity decision be of any effect.

But that isn’t what the literal language of the statute says. After all, if a patent holder is satisfied to submit the issue of validity of a patent to arbitration and loses, the only interest at stake is the holder’s interest in having a patent monopoly.  The public’s interest in eliminating invalid patents is not disserved.

And if the arbitration decision is to have no effect on the patent’s validity in other proceedings, why does section 294(d) of the statute require that one of the parties inform the Director of the arbitration award on pain of the award otherwise being unenforceable?  In fact, the award is also entered publicly in the patent’s prosecution record.  One might assume that making the award of record is necessary to give the award preclusive effect.  But perhaps the idea is only to give a later licensee notice that a validity challenge has been successful even though it isn’t binding in subsequent proceedings.

Unfortunately, there appear to be no decided cases on the matter, so we are left to wonder.

Practical considerations.  A few observations can be made about all this as a practical matter. First, whether or not the arbitration has a collateral estoppel effect or not provides no real disincentive to a licensor to include an arbitration clause.  Collateral estoppel would surely apply if the licensor chose to litigate instead of arbitrate, unless it could show it did not have a full and fair opportunity to present its case.  Thus, arbitration provides no disadvantage over court in this regard.

Second, a licensor worried about the matter could suggest a provision in the arbitration clause that the award would simply say what if anything was owed in royalties without specifying the reasons.   Thus, no specific finding of validity would be required.  To be sure, the arbitrator is required to consider an invalidity defense, as noted above.  But that probably doesn’t mean the arbitrator has to include a specific finding on it in the award. Without a specific finding, no collateral estoppel effect is likely.

Third, the licensor still has an argument that section 294(c) should be read to eliminate the effect of an invalidity finding concerning a third party, as noted above.  This is no sure thing, but the issue could be decided in the licensor’s favor.

Finally, it seems unlikely the licensee will be concerned about whether a third party could or could not raise invalidity as a defense against its former licensor.  So long as the licensee is found not to have to pay royalties because the patent is invalid, whether or not its competitors have to pay is of little concern to the licensee. In fact, if its competitors have to pay and the licensee doesn’t, it will enjoy a competitive advantage.

Similar questions could arise concerning infringement findings in an arbitration.  Section 294 requires that the award be provided to the Director, which would include an infringement determination.  Again, a finding that the products at issue infringe the licensed patent would not be binding on a party in a later proceeding that was not a party to the arbitration.  A finding of non-infringement is much less likely to bind the licensor in subsequent disputes than a finding of invalidity.  The requirements of collateral estoppel may well not be met under the facts of the second case because different issues are being presented, depending on the products involved and the like.  And section 294(c) may foreclose use of a non-infringement finding in a later dispute involving a different licensee.  But it may not, as discussed above in the context of an invalidity finding.

Thus, arbitration remains a viable way to settle contractual disputes involving patents.  While it would be better if the statute was clearer on the precise effect arbitration determinations have in later proceedings, it is a benefit that there is a statute with the express purpose of allowing arbitration of patent disputes.

Next up. In the next article, we will proceed through the next stages in the process of arbitrating patent disputes, focusing on the use of experts.