IP Law Daily Contract dispute did not trigger federal question simply because it involved patent licensing
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Friday, September 20, 2019

Contract dispute did not trigger federal question simply because it involved patent licensing

By Robert B. Barnett Jr., J.D.

To be substantial enough to constitute a federal question, the breach of contract claim must be one in which allowing the state courts to resolve the case would potentially undermine the development of a uniform body of patent law.

A claim by Inspired Development Group alleging that KidsEmbrace breached a licensing contract involving a patent for child safety seats in the shape of comic book characters did not constitute a claim "arising under" patent laws, the U.S. Court of Appeals for the Federal Circuit has ruled. As a result, the federal courts had no federal question jurisdiction over the dispute. To rule otherwise, the court said, would allow a party to create a federal jurisdictional hook to avoid state court by doing little more than pleading an infringement (Inspired Development Group v. Inspired Products Group, LLC, September 18, 2019, Prost, S.).

Background. Inspired Development held several patents for child safety car seats as assignee. The first design patent issued as U.S. Design Patent No. D524,559, which incorporated a representation of Batman into the car seat. The Inspired Development owner then formed a second company called Inspired Products Group, which operated as KidsEmbrace, to manufacture and sell the car seat. Inspired Development granted KidsEmbrace an exclusive license to use the designs to develop car seats. Whether KidsEmbrace ever used a patented design is a matter of dispute. After the owner was removed as KidsEmbrace CEO, the company began questioning the value of licensing the patents. In the end, it terminated the license agreement. Inspired Development, however, believed that it was still owed unpaid royalties and other monies.

Inspired Development sued KidsEmbrace in 2016 in Florida federal court, alleging breach of contract and various equitable remedies, including unjust enrichment. KidsEmbrace counterclaimed for breach of contract, fraud, and other state law claims. Federal jurisdiction was based on diversity. The court granted summary judgment to KidsEmbrace on all claims other than breach of contract, which was later settled. After losing on summary judgment, Inspired Development appealed to the Eleventh Circuit.

The Eleventh Circuit, however, raised questions about the existence of diversity, wondering what a full list of all members of the limited liability company would reveal. In the absence of such a list, the Eleventh Circuit remanded for a determination of the diversity question. On remand, it turned out, after looking at the full list of LLC members, that diversity did not exist. KidsEmbrace then argued that the court had federal question jurisdiction because the original claims arose under federal patent law and that its counterclaims, which had since been voluntarily dismissed, also provided a basis for jurisdiction. Inspired Development opposed the effort to keep the case in federal court. The federal court, however, accepted KidsEmbrace’s argument, and it ruled that federal question jurisdiction existed. On appeal again, this time the Eleventh Circuit transferred the case to the Federal Circuit for a determination whether the federal court had jurisdiction because the claim arose out of patent law.

Subject matter jurisdiction. A case may arise out of federal law in two ways. First, it arises out of federal law the most common way, where federal law is the cause of action asserted. Second, it arises through a limited means identified by the Supreme Court as involving a "special and small category" of state law claims that are deemed to be a federal issue. The Federal Circuit concluded that this case did not fall into the first category. All claims and counterclaims were clearly based only on state law. Thus, if this case were to "arise out of" federal law, it could do so only as part of the second category.

Special category. Cases that might fit in the second category are analyzed using the four-part test established in Gunn v. Minton, 568 U.S. 251 (2013). KidsEmbrace argued that the unjust enrichment claim was really nothing more than a thinly disguised patent infringement claim. As a result, the court analyzed the unjust enrichment claim under the Gunn test. The four-part test provides that a state law claim will be deemed a "federal issue" if a federal issue is (1) necessarily raised, (2) actually disputed, (3) substantial and (4) capable of resolution in federal court without disrupting the federal-state balance.

As to whether a federal issue was "necessarily raised," the court said that a patent law issue will be necessarily raised only if it is a necessary element of a well-pleaded claim. No patent law issue was raised on the face of the unjust enrichment claim. Inspired Development could, however, potentially raise a patent infringement question by arguing that KidsEmbrace accepted and retained a benefit at Inspired Development’s expense by using the patent in a manufactured car seat. It could also claim a residual benefit from the exclusive license even if no infringement occurred. Thus, it is possible that federal issue could be necessarily raised.

As for the second element, whether the claim is actually disputed, the allegations do appear to indicate that the matter is disputed. KidsEmbrace has denied that it manufactured on sold any products within the scope of the patents in an infringing way. Thus, arguably, KidsEmbrace could satisfy the second test.

The third requirement asks whether the claim raises a substantial federal question. On this count, the claim utterly fails, the court said. To be substantial, it is not enough that the federal issue be significant to the particular parties. The issue will always be significant to the particular parties. Rather, the question is whether allowing the state courts to resolve the case would undermine the development of a uniform body of patent law. First, the patent infringement issue in this case is not dispositive of whether Inspired Development is entitled to relief. Even if Inspired Development cannot show infringement, it can still prevail on the unjust enrichment claim. Second, a state court’s resolution of the issue will not control numerous other cases. The risk of conflict from state courts under these facts is remote. State courts cannot invalidate patents. Also, a state court’s determination that a patent is valid has no precedential effect on a federal court. In addition, this case presents no novel question of patent law that could impact other cases. Third, the government has no direct interest in this private contract dispute. As a result, the facts of this case fail the third part of the test.

The fourth part of the test asks whether the federal-state balance would be upset. The court rejected the idea that any breach of contract claim or related equitable claim, such as unjust enrichment, involving a patent license agreement must "arise under" the patent laws. If such a rule were adopted, the federal-state balance would be thrown out of whack because many state law claims would be swept into federal court. A plaintiff, therefore, or any other party, could create a "federal jurisdictional hook" to avoid state court by doing little more than pleading an infringement. As a result, KidsEmbrace also failed the fourth test.

Having failed the Gunn test, the unjust enrichment claim did not qualify for the special second category. Consequently, this breach of contract lawsuit involving a dispute between two private parties raised no federal questions.

The court, therefore, vacated the lower court’s ruling and remanded for further proceedings.

This case is No. 2018-1616.

Attorneys: Steven L. Brannock (Brannock & Humphries) for Inspired Development Group, LLC and Florida Ltd. Liability Co. Thomas A. Dye (Cozen O'Connor P.C.) for Inspired Products Group, LLC and California Ltd. Liability Co., d/b/a KidsEmbrace, LLC.

Companies: Inspired Development Group, LLC; Florida Ltd. Liability Co.; Inspired Products Group, LLC; California Ltd. Liability Co., d/b/a KidsEmbrace, LLC

MainStory: TopStory Patent FedCirNews

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