Federal Circuit Declines to Establish a "Settlement Negotiation Privilege"

[authors: Jeanne M. Gills, Barry L. Grossman]

Draft License Agreements and Communications Regarding License Negotiations May Be Produced in Discovery

On April 9, 2012, the Court of Appeals for the Federal Circuit gave alleged patent infringers a potentially powerful new discovery tool to help establish what is, or is not, a reasonable royalty based on prior patent licenses. In In re MSTG, Misc. Docket No. 996, Fed. Cir., April 9, 2012, the court held that “settlement negotiations related to reasonable royalties and damage calculations are not protected by a settlement negotiation privilege” and that a “district court did not clearly abuse its discretion in ordering production of the settlement negotiation documents.” This decision is an extension of the Federal Circuit’s 2010 decision in ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860 (Fed. Cir. 2010), which opened the door to discovery of license agreements entered into to settle litigation.

The issue of whether settlement negotiations are privileged and thus protected from discovery was a matter of first impression before the Federal Circuit and one on which circuit courts and district courts are split. However, in MSTG, the Federal Circuit specifically declined to fashion a new “settlement negotiation privilege” in patent cases that would prevent discovery of litigation settlement negotiations related to reasonable royalties and damages. Alleged infringers may now discover draft license agreements and communications regarding license negotiations between the patent owner/licensor and third parties. The decision represents a recent trend in expanding the scope of damages related discovery and may impact the manner in which settlement negotiations are conducted in the future, as well as the amount of information available to accused infringers particularly in litigation involving non-practicing entities (NPEs) where there tends to be a larger number of prior licenses.

Background

The MSTG decision arose from a petition for writ of mandamus based on an order of the U.S. District Court for the Northern District of Illinois wherein plaintiff MSTG, Inc. was compelled to produce documents related to license negotiation discussions between MSTG and six other companies, including previous defendants to the lawsuit. The petition asked the Federal Circuit to decide, as a matter of first impression, whether such communications related to reasonable royalties and damages are protected from discovery based on a settlement negotiation privilege, and second, whether on the facts of this case the district court clearly abused its discretion by ordering their production.

The district court first denied discovery of the settlement negotiations because the settlement agreements had already been produced and the defendant had not shown a need for discovery as to the underlying settlement negotiations. However, after MSTG’s expert offered his opinion regarding a reasonable royalty for the alleged infringement, the district court reconsidered and ordered production of the negotiation documents because they might contain information showing that the grounds MSTG’s expert relied on to reach his conclusion were erroneous. Also prompting the district court to permit the discovery was the fact that MSTG’s damages expert relied on the testimony of an MSTG executive regarding MSTG’s “business reasons” for entering into the license agreements. Under these circumstances, the district court held it would be unfair for MSTG to then shield those reasons from further examination.

The Federal Circuit Decision

In analyzing the district court’s rulings, the Federal Circuit first considered Supreme Court precedent on whether a new settlement negotiation privilege should be recognized under Federal Rule of Evidence 501. The court concluded that none of the factors supported creation of a new privilege here, where: the failure to recognize such a privilege did not “frustrate the purposes” of any state legislation; U.S. Congress had never recognized such a privilege; the privilege was not among the list of evidentiary privileges recommended by the Advisory Committee of the Judicial Conference in its proposed Federal Rules of Evidence; recognition of the privilege is not needed to foster settlement; the privilege would be subject to too many exceptions rendering it ineffective; and there were other effective discovery methods to limit the scope of discovery.

Likewise, the Federal Circuit stated that it was not an abuse of discretion for the district court to compel the discovery: “As a matter of fairness MSTG cannot at one and the same time have its expert rely on information about the settlement negotiations and deny discovery as to those same negotiations.” However, while the Federal Circuit held that settlement negotiation documents and information may be discoverable, the court specifically noted that they “have not yet decided the extent to which evidence of settlement negotiations would be admissible under Rule 408.”

E.D. Texas District Court Likewise Compels Discovery of Draft Licenses and Negotiation Documents

A district court in Texas may have anticipated the Federal Circuit’s MSTG decision since it said much the same thing last week in Charles E. Hill & Associates, Inc. v. ABT Electronics, Inc., 2-09-cv-00313 (E.D. Tex. April 4, 2012, Order) (Gilstrap, J.). There, the court granted the defendant’s motion to compel the production of draft license agreements and communications regarding license negotiations between the plaintiff and third parties entered into to resolve past claims under the asserted patents. While it noted that production of such agreements was the “exception and not the rule,” and it reserved judgment on the probative value of the information, the alleged infringer was, nonetheless, permitted to discover this information.

Interestingly the court further noted that where the plaintiff’s business is to litigate and license and does not openly compete with defendants in the marketplace, the settlement communications will be a valid consideration in determining whether the settlement agreements themselves accurately reflect the patents’ value.

Conclusion

MSTG appears to be an extension of the Federal Circuit’s prior holding in ResQNet.com where the court observed “that the most reliable license in this record arose out of litigation.” There, the court vacated the district court’s reasonable royalty damages determination and remanded the case so that the district court would have the opportunity to reconsider the reasonable royalty calculation and the events and facts that occurred in litigation settlements.

Accordingly, with the door now open to seek discovery of license negotiations and agreements entered into to settle litigation, this expands the scope of damages related discovery and may ultimately affect how future settlement negotiations are conducted and the information exchanged between settling parties. Further, such discovery requests appear to particularly relevant and discoverable against patent owners/licensors whose sole or primary business is litigating and licensing patented technology.

The recent In re MSTG case can be found online.