Alexsam, Inc. v. IDT Corporation

Accused Card Activation Systems Deemed to Infringe as Sanction for Discovery Violations

12-1063

May 20, 2013

Decision

Last Month at the Federal Circuit - June 2013

Judges: Dyk (author), Mayer (dissenting), Moore

[Appealed from: E.D. Tex., Magistrate Judge Everingham]

In Alexsam, Inc. v. IDT Corp., Nos. 12-1063, -1064 (Fed. Cir. May 20, 2013), the Federal Circuit affirmed that claims 57 and 58 of U.S. Patent No. 6,000,608 (“the ’608 patent”) are not invalid. The Court reversed the jury’s finding that IDT Corporation’s (“IDT”) Walgreens and EWI card activation systems infringed those claims, but affirmed that certain miscellaneous IDT systems infringed based on the district court’s discovery sanctions. On cross-appeal, the Court affirmed that IDT’s SafeNet systems did not infringe based on the license defense.

Claims 57 and 58 of the ’608 patent recite a system for activating multifunction cards, such as prepaid phone cards and electronic gift cards, using a point-of-sale (“POS”) terminal, such as a cash register or a free-standing credit card reader. IDT’s products include phone cards and prepaid gift cards that are sold through major retail chains such as Walgreens, as well as at smaller retailers. Alexsam, Inc. (“Alexsam”) owns the ’608 patent and sued IDT for infringement.

After the close of discovery, Alexsam moved for sanctions under Fed. R. Civ. P. 37, alleging that IDT violated its discovery obligations by failing to disclose information suggesting that miscellaneous IDT activation systems infringed Alexsam’s patents. The claims-at-issue require that the card’s number include a bank identification number (“BIN”), and IDT was late in disclosing that the cards associated with the miscellaneous systems carried a BIN. The district court granted Alexsam’s sanctions motion and instructed the jury at the close of trial that the miscellaneous systems infringed the asserted claims.

In addition, the district court held as a matter of law that DT’s Walgreens system did not infringe claim 58. The jury found that the Walgreens system infringed claim 57, that IDT’s EWI and SafeNet systems infringed both claims 57 and 58, and that neither claim was invalid. After trial, the district court granted IDT’s motion for judgment of noninfringement with respect to the SafeNet system, concluding it was licensed under an agreement between Alexsam and MasterCard. The SafeNet system sent activation data first to a bank computer and then to IDT by way of a network maintained by MasterCard. The district court reduced the jury’s award of reasonable royalties by subtracting royalties for the SafeNet system activations.

On appeal, IDT argued that Alexsam failed to present substantial evidence that the Walgreens and EWI systems included “an unmodified existing standard retail point-of-sale device,” as required by claims 57 and 58. The Federal Circuit noted that Alexsam’s witnesses testified that no modification of the terminals was required or necessary to activate IDT’s cards, but that they did not testify whether modifications had actually been made. The Court held therefore that it was error to deny JMOL of noninfringement as to the Walgreens and EWI systems.

The Federal Circuit then turned to the district court’s finding that the miscellaneous systems infringed. The Federal Circuit drew comparison to Chilcutt v. United States, in which the Fifth Circuit described a category of sanctions that are less severe than dismissing a claim or entering default judgment. Slip op. at 10-11 (citing Chilcutt, 4 F.3d 1313, 1319-20 (5th Cir. 2009)). For less severe sanctions, such as deeming certain facts established for purposes of litigation, the Fifth Circuit requires only that the sanction be just and fair, that it have a substantial relationship to the facts sought to be established by the discovery, and that it meet Rule 37’s goals of punishment and deterrence. The Federal Circuit determined that the discovery sanction imposed on IDT fell within the category of less severe sanctions because the district court deemed that the infringement facts of Alexsam’s case were established, while allowing IDT to present evidence of its affirmative defense of invalidity and requiring Alexsam to prove damages.

Factors indicating the sanction was just and fair include (1) whether the sanctioned party was warned of the impending sanctions; (2) whether the party made empty promises that it would comply with its discovery obligations; (3) whether the claim being pursued through discovery was not so frivolous that the use of discovery amounted to an abuse of judicial process; (4) whether the sanctioned party bore some degree of culpability; and (5) whether the court had previously sanctioned the same party. The Federal Circuit determined that all five factors supported the sanction.

Regarding the first factor, the Federal Circuit noted that IDT received ample warning because the district court informed it that sanctions of increased severity, up to and including striking IDT’s defenses, would result if IDT continued to fail to respond fully to interrogatories asking for identification of BINs. As to empty promises, the second factor, the Court determined that substantial evidence supported the district court’s finding that IDT misled Alexsam through incomplete discovery responses and false representations to the court concerning the extent to which it had disclosed an encoding scheme for assigning card numbers. Regarding the third factor, the Court held that Alexsam’s claims were not frivolous. With respect to culpability, the fourth factor, the Court noted that IDT offered no reason why it could not have examined the enclosing schemes of the late-disclosed cards earlier and determined that they included BINs. Regarding the final factor, the Court noted that IDT was previously sanctioned for incomplete response to the interrogatories.

The Federal Circuit next considered whether the sanction bore a substantial relationship to the facts sought to be established by the discovery. The Court noted that Alexsam sought to discover which cards bore BINs to establish which systems infringed its patents. The Court determined that the sanction deeming the concealed systems to infringe bore a substantial relationship to the attempted discovery because, as the district court found, IDT’s failure to timely produce the information severely prejudiced Alexsam’s preparations of its case for trial.

Finally, the Federal Circuit rejected IDT’s argument that Rule 37’s purposes would have been met by a lesser sanction such as an award of attorneys’ fees. The Court held the district court’s sanction was not an abuse of discretion, especially considering that earlier sanctions had not secured compliance. The Court therefore affirmed the judgment deeming the miscellaneous systems to infringe as a sanction for IDT’s discovery violations.

Next, the Federal Circuit considered Alexsam’s cross-appeal of the JMOL that the SafeNet system was sublicensed under the Alexsam-MasterCard agreement. The Court affirmed the district court’s finding that, under the plain terms of the agreement, any activation transaction covered by the patents-in-suit and taking place over the MasterCard network was automatically deemed sublicensed, regardless of whether MasterCard made royalty payments for the transactions.

Lastly, the Federal Circuit turned to the judgment that the ’608 patent is not invalid. The Court rejected IDT’s argument that the claims-in-suit were obvious in light of a second embodiment disclosed in a prior art reference because the Court had to presume that the jury resolved all factual disputes in favor of the prevailing party. The Court also rejected IDT’s alternative argument that the claims were obvious over a combination of that prior art and either of two other patents because IDT did not introduce expert testimony showing that a person having ordinary skill in the art would have been motivated to combine them. Rejecting IDT’s argument that expert testimony was not necessary, the Court noted that the technology in the case was complex and that expert testimony was required both to explain what the prior art references disclosed and to show a motivation to combine them. Accordingly, the Federal Circuit remanded for recalculation of damages in light of its reversal of the jury verdict regarding the Walgreens and EWI systems.

In dissent, Judge Mayer stated that the ’608 patent is invalid under 35 U.S.C. § 101 because it discloses no inventive concept. Judge Mayer related that before the application for the ’608 patent, retailers often installed dedicated activation terminals in their stores to activate gift and prepaid telephone cards. He stated that claims 57 and 58 of the ’608 patent disclose nothing more than an abstract idea for making a business run more efficiently by activating the cards using the POS terminals that were already present in retail locations for processing credit card transactions. Noting that the asserted claims have the potential to wield enormous preemptive power, Judge Mayer concluded that the ’608 patent did not disclose any technological advance sufficient to confer patent eligibility.

Summary authored by Hillary C. Matheson, Esq.