• Size of Entity Matters: Error in Classifying Self as "Small Entity" Jeopardizes Patent Rights
  • January 22, 2004 | Author: Michael A. Cicero
  • Law Firm: Womble Carlyle Sandridge & Rice - Atlanta Office
  • Introduction

    Those familiar with the defense of inequitable conduct in patent infringement cases know that it has conventionally arisen from accused conduct that occurred during the prosecution of the application that matured into the patent-in-suit. Recently, however, in Ulead Sys., Inc. v. Lex Computer & Mgt. Corp., 351 F.3d 1120 (Fed. Cir. 2003), the U.S. Court of Appeals for the Federal Circuit extended application of the inequitable conduct defense to conduct occurring after issuance of the patent, specifically to that case, the payment of patent maintenance fees. Patentees must therefore strive to be accurate in all post-issuance statements filed with the U.S. Patent and Trademark Office, lest an error now be exploited and characterized by a litigation opponent as inequitable conduct, a defense that, if successful, renders the patent-in-suit (and possibly related patents) unenforceable.


    An understanding of the significance and context of the Federal Circuit's decision in Ulead requires a basic understanding of the inequitable conduct defense, the nature of patent maintenance fees, and the definition of "small entity."

    Inequitable Conduct

    "Inequitable conduct includes affirmative misrepresentation of a material fact, failure to disclose material information, or submission of false material information, coupled with an intent to deceive."1 "Once a court concludes that inequitable conduct occurred, all the claims -- not just the particular claims to which the inequitable conduct is directly connected -- are unenforceable."2 Not only does such a finding render the patent-in-suit unenforceable, it also stands to render unenforceable any patents related to the patent-in-suit by way of having been continuing patent applications.3 A finding of inequitable conduct can lead to yet additional consequences; however, discussion of such other consequences is beyond the scope of this article. Suffice it to say, a finding of inequitable conduct carries severe ramifications.

    Analysis of an inequitable conduct defense proceeds as follows:

    Determination of inequitable conduct requires a two step analysis. First, the trial court must determine whether the withheld reference meets a threshold level of materiality. The trial court must then also determine whether the evidence shows a threshold level of intent to mislead the PTO. . . . Once the threshold levels of materiality and intent have been established, the trial court is required to weigh materiality and intent.4

    "In light of all the circumstances, the court must then determine whether the applicant's conduct is so culpable that the patent should be held unenforceable."5 The accused infringer bears the burden of establishing the threshold levels of both materiality and intent by clear and convincing evidence.6 Regarding the intent aspect of the analysis, "'[d]irect proof of wrongful intent is rarely available but may be inferred from clear and convincing evidence of the surrounding circumstances.'"7

    Patent Maintenance Fees

    "In 1980, Congress amended the patent laws to require for the first time the payment of periodic maintenance fees to maintain the life of a patent. Further amendments in 1982 imposed substantial increases in filing, processing, maintenance, and issue fees."8 Maintenance fees are due at 3½, 7½, and 11½ years from the date that the patent is issued.9 Failure to pay these fees when due may result in expiration of the patent.10

    What is a "Small Entity"?

    "Concerned that [the 1982 amendments] would be overly burdensome to individuals, non-profit organizations and smaller businesses, Congress provided a discount for small entities. Pursuant to its rulemaking authority . . ., the Patent and Trademark Office ('the PTO') adopted rules governing claims to small entity status."11 As the Federal Circuit explained:

    The PTO rules define a "small entity" as a small business concern, independent inventor, or non-profit organization. 37 C.F.R. § 1.9(f) (1993). "Small business concern" is defined in accordance with the definition established by the Small Business Administration ("SBA"). Id. at § 1.9(d). The applicable SBA regulation states as follows:

    a small business concern for purposes of paying reduced fees ... to the Patent and Trademark Office means any business concern (1) whose number of employees, including those of its affiliates, does not exceed 500 persons and (2) which has not assigned, granted, conveyed, or licensed, and is under no obligation under contract or law to assign, grant, convey or license, any rights in the invention to any person who could not be classified as an independent inventor if that person had made the invention, or to any concern which would not qualify as a small business concern or a nonprofit organization under this section.

    37 C.F.R. § 1.9(d) (quoting 13 C.F.R. § 121.12(a)) (emphases added).12

    In implementing a revision to the "small entity" regulation that became effective in 2001, the PTO cautioned that determining whether a patent applicant qualifies as a "small entity" involves more than just calculating the number of employees of the applicant/patentee or of an entity to whom patent rights have been assigned, granted, conveyed, or licensed. The applicant/patentee must also investigate whether it is properly classified as a "business concern" and who its "affiliates" are for purposes of the SBA regulations. It must also be sure to calculate the number of employees in accordance with the SBA regulations.13 "The assertion of small entity status . . . is not appropriate until such an investigation has been completed."14

    The PTO further emphasizes that the person making an assertion to small entity status "has a duty to investigate the circumstances surrounding entitlement to small entity status to the fullest extent," and that "[t]he Office has noted that any attempt to improperly establish status as a small entity will be viewed as a serious matter."15 A statement claiming small entity status carries a self-certification that, paraphrased loosely, the statement is true and that it is made with the knowledge that a willful false statement may jeopardize, among other things, the enforceability of the patent.16 If an applicant or patentee makes an improper attempt to claim small entity status with the intent to deceive, the PTO will regard that attempt as fraud on the PTO.17 This may expose the offending party to a variety of sanctions imposed by the PTO Commissioner, as well as to placing the enforceability of the patent in jeopardy.18

    To illustrate the differences in fees respectively paid by small entities and entities not qualifying as such (here termed "large entities" for convenience of reference), the most recent maintenance fees are set forth below.19 The differences are typical of most fees charged by the PTO, inasmuch as the fees owed by a small entity are frequently half of those owed by a large entity.

    First maintenance fee (due at the end of 3½ years):

    Small entity........ $455.00

    Large entity........ $891.00

    Second maintenance fee (due at the end of 7½ years):

    Small entity..... $1,045.00

    Large entity..... $2,090.00

    Third maintenance fee (due at the end of 11½ years):

    Small entity..... $1,610.00

    Large entity..... $3,220.00

    Facts in Ulead

    Lex Computer & Management Corp. ("Lex") owned a patent for which it paid three maintenance fees as a "small entity." When it paid the first maintenance fee, it properly qualified as a small entity. However, prior to payment of its second maintenance fee, Lex granted a non-exclusive license to Adobe Systems, Inc., a company with more than 500 employees, and also granted such licenses to at least two more large entities.20 When paying its third maintenance fee, Lex submitted a petition to the PTO stating that "small entity status for this patent has been checked and is still in effect."21

    In federal district court, Ulead Systems, Inc. ("Ulead") filed an action against Lex, seeking a declaratory judgment that Ulead did not infringe Lex's patent, and that the patent was invalid and unenforceable. Lex counterclaimed for infringement of its patent. Later, Ulead moved for summary judgment that Lex's patent was unenforceable and invalid and/or expired. Ulead asserted the following grounds: (1) Lex misrepresented its small entity status, and (2) the patent had expired "because Lex failed to pay the proper maintenance fee and did not pay the incorrect small entity fee in 'good faith' as required by the PTO regulation."22 Lex acknowledged that it was not entitled to claim small entity status at the time it paid its second and third maintenance fees.23

    Immediately after Ulead filed its motion in the district court, Lex petitioned the PTO to accept the balance of the deficiency owed on the maintenance fees. The PTO granted that petition and accepted payment. Nevertheless, the district court granted Ulead's motion on both grounds, and Lex appealed from that judgment.24

    The Federal Circuit's Rulings in Ulead

    The Federal Circuit began its analysis of Lex's appeal by reciting inequitable conductprinciples and by acknowledging that "[h]istorically issues of unenforceability have arisen in cases involving inequitable conduct occurring in the prosecution of patents."25 However, the Federal Circuit then announced:

    But, we see no reason why the doctrine should not extend into other contexts, like the present one, where the allegation is that inequitable conduct has occurred after the patent has issued and during the course of establishing and paying the appropriate maintenance fee. In this context, it is equally important that the PTO receive accurate information from those who practice before it.26

    The Federal Circuit then concluded that its law concerning standard inequitable conduct principles applied to the maintenance fee context, reasoning that the PTO rule on fraud did not conflict with the Federal Circuit's precedent.27 Turning then to the "materiality" prong of the standard inequitable conduct analysis, the Federal Circuit remarked: "[t]here is no serious question here as to materiality," and it then summarily concluded that Ulead established at least a threshold level of materiality because Lex's misrepresentation of its small entity status "was material to the PTO's acceptance of reduced maintenance fees, and thus, survival of the patent."28

    Concerning the "intent" prong of the analysis, however, the Federal Circuit found that Lex had established a triable issue of fact, and that therefore the district court's grant of summary judgment to Ulead was improper.29 Among the evidence submitted by Lex was a declaration from its patent attorney, attesting that "he did not directly represent Lex in acquiring any of its licenses and, as a result, was unaware that Lex had finalized license agreements with any companies having more than 500 employees."30

    Regarding Ulead's second ground for summary judgment (that the patent had expired for Lex's failure to pay the proper maintenance fee), the Federal Circuit reasoned: "the question here is whether Lex committed inequitable conduct by knowingly misrepresenting that it was entitled to have the error excused under [37 C.F.R.] section 1.28(c)."31 Stated in general terms:

    To be sure, if the patentee makes a request to correct incorrect payment of fees as a small entity knowing that it does not satisfy the good faith error standard of section 1.28(c), the patentee may be found to have engaged in inequitable conduct.32

    The Federal Circuit held that summary judgment on Ulead's "expiration" ground was likewise improper because Lex had established a triable issue of fact as to intent, on the underlying issue of whether it acted in bad faith in the first place when it asserted small entity status.33

    In view of its rulings concerning the impropriety of the summary judgment granted to Ulead, the Federal Circuit vacated the district court's judgment and remanded the case to that court for further consideration of, among other things, the issues of inequitable conduct and invalidity.34

    Judge Newman's Critique of the Majority's Rulings in Ulead

    Judge Pauline Newman dissented in part from the majority rulings of Ulead. Among Judge Newman's grounds of disagreement was her view that underpayment of maintenance fees was not intended by the PTO's regulations to be treated as an offense of the same magnitude as inequitable conduct committed during prosecution to obtain the patent grant.35 She also viewed a claim of inequitable conduct in the maintenance fee underpayment context to be without common sense, stating that it defies logic to contend that one would intentionally risk the loss of millions of dollars in patent royalties, only to save amounts such as $935.36

    Adapting to Changes Wrought by Ulead

    Regardless of whether the result in Ulead makes common sense, it must be recognized as the law unless and until it is overruled. Now that post-issuance dealings with the PTO will be scrutinized by litigation opponents for availability of an inequitable conduct defense, patentees need to take very seriously the PTO's admonitions surrounding the need to conduct a thorough investigation as to entitlement to claim "small entity" status, before the patentee makes that claim to the PTO. Failure to conduct such an investigation before making that claim may form the starting point of an inequitable conduct analysis.

    Additionally, any entity seeking to assert entitlement to small entity status should ensure that transactions involving the licensing, conveyance, granting, or assignment of patent rights be promptly reported to the patent attorney who is coordinating the payment of maintenance fees. Otherwise, that attorney may be in the position of the patent attorney in Ulead, who was uninformed of a change in the patentee's status. Also, direct communication with the patent attorney is obviously crucial if the patentee itself undergoes any change that might impact entitlement to small entity status, such as a hiring of new employees that may result in the total number of employees exceeding 500.

    As an alternative means of avoiding this pitfall altogether, the applicant/patentee ought to consider very seriously the option of refraining from claiming small entity status at all, even if it may be qualified to do so. As the PTO has recognized:

    It should be appreciated that the costs incurred in appropriately conducting the initial and subsequent investigations may outweigh the benefit of claiming small entity status. For some applicants it may be desirable to file as a large entity (by not filing a small entity statement and by submitting large entity fees) rather than undertaking the appropriate investigations which may be both difficult and time-consuming.37

    Given the devastating consequences that now may arise if a small entity statement is later found in litigation to have been incorrect, the option of simply bypassing the small entity procedures looks more attractive than ever before. While this option can certainly be seen as an unfair result, since it effectively deprives potentially qualified patentees from availing themselves of the very regulatory framework designed to help them, the burden of having to pay additional money as a large entity may pale in comparison to the risk of filing an incorrect small entity statement.

    1 Bd. of Educ. ex rel. Bd. of Trustees of Florida State Univ. v. Am. Bioscience, Inc., 333 F.3d 1330, 1343 (Fed. Cir. 2003).
    2 J.P. Stevens & Co. v. Lex Tex Ltd., 747 F.2d 1553, 1561 (Fed. Cir. 1984).
    3 Baxter Int'l v. McGaw, Inc., 149 F.3d 1321, 1331 (Fed. Cir. 1998).
    4 Baxter, 149 F.3d at 1327 (citations omitted).
    5 Florida State, 333 F.3d at 1343.
    6 Dayco Prods., Inc. v. Total Containment, Inc., 329 F.3d 1358, 1362 (Fed. Cir. 2003).
    7 Baxter, 149 F.3d at 1329 (citation omitted).
    8 Ulead, 351 F.3d at 1142.
    9 37 C.F.R. § 1.20(e), (f), & (g) (2003).
    10 37 C.F.R. § 1.362(g) (2003).
    11 Ulead, 351 F.3d at 1142.
    12 Ulead, 351 F.3d at 1142 (footnote omitted; italics in original case text).
    13 Definition of Small Entities and Establishing Status as a Small Entity to Permit Payment of Small Entity Fees, 65 Fed. Reg. 54,604, 54,612 (2000) (codified at 37 C.F.R. § 1.27 (2001)).
    14 Id.
    15 Id. at 54,613.
    16 Id.; 37 C.F.R. §§ 1.4(d)(2) & 10.18(b).
    17 37 C.F.R. § 1.27(h) (2001).
    18 See 37 C.F.R. § 10.18(c) (listing sanctions for statements made in violation of § 10.18(b)).
    19 37 C.F.R. § 1.20(e), (f), & (g) (2003). Note that these fees are subject to periodic increase by the PTO, so the patentee, prior to paying a maintenance fee, should always be sure to check the most recent version of these regulations.
    20 Ulead, 351 F.3d at 1142.
    21 Id. at 1143.
    22 Ulead, 351 F.3d at 1143.
    23 Id.
    24 Id. at 1143-44.
    25 Id. at 1144.
    26 Id.
    27 Id. at 1145-46 (citing predecessor to 37 C.F.R. § 1.27(h)(2) (2001), which provides: "Improperly, and with intent to deceive, establishing status as a small entity, or paying fees as a small entity, shall be considered as a fraud practiced or attempted upon the Office.").
    28 Ulead, 351 F.3d at 1146.
    29 Id. at 1148.
    30 Id.
    31 Id. at 1150.
    32 Id.
    33 Id.
    34 Id.
    35 Ulead, 351 F.3d at 1152 (Newman, J., dissenting in part and concurring in part).
    36 Id. at 1154.
    37 Definition of Small Entities and Establishing Status as a Small Entity to Permit Payment of Small Entity Fees, 65 Fed. Reg. 54,604, 54,613 (2000) (emphasis added).