July 9, 2003.
RECOMMENDATION OF UNITED STATES MAGISTRATE JUDGE
In this action, Plaintiff Static Control Components, Inc. ("SCC") has alleged claims against Defendants Lexmark International, Inc. ("Lexmark") and Dallas Semiconductor Corporation ("Dallas") for civil conspiracy; antitrust violations under the Sherman Act; false advertising, product libel, and unfair competition under the Lanham Act; and violations of North Carolina's unfair and deceptive trade practices statute. SCC has also requested a declaratory judgment of invalidity and non-infringement of Dallas's patents. Pending before the court is Lexmark's [pleading #11] motion to dismiss SCC's claims or, alternatively, to transfer the action to the Eastern District of Kentucky, where a copyright infringement claim by Lexmark against SCC is pending. Lexmark has filed the motion to dismiss or transfer on the theory that SCC's claims are Rule 13(a) compulsory counterclaims to Lexmark's claims against SCC in the Kentucky action. See FED. R. Civ. P. 13(a). Defendant Dallas joins in Lexmark's motion to dismiss or transfer to the extent that the motion seeks dismissal or transfer of the entire action. See "Statement of Partial Joinder in Lexmark's Motion to Dismiss or Transfer" [pleading # 18]. Lexmark has also filed a motion to disqualify the law firm of Moore Van Allen, PLLC, from representing SCC in this action [pleading #13]. Since there has been no consent, the court must deal with the motions by way of a recommended disposition.
The disqualification motion is based on Lexmark's allegations that, when agreeing to assist Lexmark with several patent applications in 1999 (not related to this case), Moore Van Allen failed to disclose to Lexmark that the law firm had previously filed, on SCC's behalf, a declaratory judgment action against Lexmark in this court and that the declaratory judgment action was pending. Lexmark also alleges that Moore Van Allen intentionally discontinued its representation of Lexmark in the patent work so that the firm could represent SCC in this action. Lexmark contends that Moore Van Allen's conduct violates North Carolina's Rules of Professional Responsibility. See N.C. RULES OF PROF'L RESPONSIBILITY R. 1.7.
For the reasons discussed herein, it is recommended that this action be dismissed without prejudice so that SCC may bring its claims as counterclaims in the pending action by Lexmark against SCC in the Eastern District of Kentucky. It is further recommended that, upon dismissal of this action, the court deny as moot Lexmark's motion to disqualify the Moore Van Allen law firm.
BACKGROUND I. Toner Cartridges and Remanufacturing
A toner cartridge is a device that is inserted within a computer laser printer and contains the toner necessary for the printer to print. A toner cartridge's components are depleted during the normal operation of a printer, but many toner cartridges have a usable life beyond the initial toner load. If the cartridges are repaired and/or overhauled and if new toner is added the cartridges can be reused. The process of repairing and/or overhauling used toner cartridges is known as "remanufacturing." Remanufactured toner cartridges cost significantly less than new toner cartridges.
Defendant Lexmark is a Delaware corporation with its principal place of business in Lexington, Kentucky. Lexmark is a worldwide developer, manufacturer, and supplier of, inter alia, laser printers and toner cartridges. Lexmark is known in the computer printer industry as an original equipment manufacturer, or an "OEM." Lexmark and other OEMs such as Hewlett-Packard and Canon earn a significant portion of their profits through their "aftermarket" sales — that is, sales of their printer replacement parts including toner cartridges. Third-party remanufacturing companies compete with OEMs for aftermarket product sales of remanufactured and new toner cartridges.
The background facts are summarized in part from the factual findings made by the federal district court in Kentucky in its order granting Lexmark's motion for a preliminary injunction against SCC. See Lexmark Int'l, Inc. v. Static Control Components, Inc., 253 F. Supp.2d 943, 946 (E.D. Ky. 2003).
Lexmark sells a variety of printer models. Lexmark designs its printer models so that only a Lexmark-brand toner cartridge will work in a Lexmark printer. Thus, for a Lexmark printer to function it must either contain a new Lexmark toner cartridge or a remanufactured Lexmark toner cartridge. See First Amended Complaint ¶ 30. Owners of Lexmark printers can only buy toner cartridges directly from Lexmark, from a Lexmark reseller, or from a third-party remanufacturer. Thus, every toner cartridge sale by a third-party remanufacturer is a sale lost by Lexmark.
II. Activities Leading up to Lexmark's Copyright Infringement and DMCA Claims Against SCC in Federal District Court in Kentucky A. Lexmark's "Prebate" Program
In 1997, Lexmark announced a "Prebate" program in conjunction with the sale of certain Lexmark printers known as the "T-series" printers, which include (but are not limited to) Lexmark's T520/522 and T620/622 laser printers. Under the Prebate program, a customer who buys a T-series printer may purchase a "Prebate" toner cartridge for an upfront discounted price (the "Prebate"). In exchange for receiving a discounted price on the Prebate cartridge, the customer agrees to use the Prebate toner cartridge only once and to return the used cartridge to Lexmark for remanufacturing and recycling (as opposed to sending the used cartridge to a third-party remanufacturer and then reusing the remanufactured cartridge in a T-series printer). The Prebate agreement between Lexmark and the customer is in the form of a shrink-wrap agreement placed across the top of every Prebate toner cartridge box. The Prebate agreement states as follows:
RETURN EMPTY CARTRIDGE TO LEXMARK FOR REMANUFACTURING AND RECYCLING. Please read before opening. Opening this package or using the patented cartridge inside confirms your acceptance of the following license/agreement. This all-new cartridge is sold at a special price subject to a restriction that it may be used only once. Following this initial use, you agree to return the empty cartridge only to Lexmark for remanufacturing and recycling. If you don't accept these terms, return the unopened package to your point of purchase. A regular price cartridge without these terms is available.Lexmark Int'l, Inc., 253 F. Supp.2d at 947 n. 1. As the Prebate agreement explains, customers who do not want to participate in the Prebate program may instead buy a "regular" Lexmark toner cartridge at a non-discounted price. The regular toner cartridges do not contain the "use and return" conditions that accompany the Prebate cartridges.
As stated previously, customers can purchase regular Lexmark toner cartridges directly from Lexmark or from a Lexmark reseller.
When Lexmark initially began its Prebate program in 1997, Lexmark had no way to enforce the Prebate agreement between customers and Lexmark. In other words, Lexmark could not prevent customers who had bought the Prebate cartridges at a discounted price (in exchange for the customers' agreement to return the used cartridges to Lexmark) from sending their used Prebate cartridges to a third party for remanufacturing and then reusing the cartridges in the T-series printers. At some point, Lexmark came to believe that SCC and third-party remanufacturers were encouraging customers who had bought the Prebate cartridges not to abide by the Lexmark Prebate agreement and to send the used Lexmark Prebate cartridges to third-party remanufacturers. By letter dated November 24, 1998, Lexmark's corporate counsel informed SCC that Lexmark had learned that SCC had been encouraging Lexmark customers not to abide by the Prebate agreement. See Letter from Kunz to London of 11/24/98, at 1 (attached in the record as Ex. I-6 to SCC's Br. Opp'n Lexmark's Mot. Disqualify the Law Firm of Moore Van Allen, PLLC [pleading #20]). Lexmark's counsel warned SCC that SCC was interfering with the Prebate agreement between Lexmark and its customers. Counsel further stated in the letter that Lexmark was aware that SCC had been sending remanufacturers a legal opinion written by a legal expert in which the expert opined that remanufacturers had the legal right to retrieve used Prebate cartridges from landfills and remanufacture them for reuse in Lexmark printers. Lexmark's counsel warned SCC that third-party remanufacturers of the Lexmark Prebate cartridges "would be willful patent infringers" and suggested that SCC take "corrective action immediately."
On December 8, 1998, SCC filed a declaratory judgment action against Lexmark in this court, requesting that the court declare that SCC's dissemination of the legal expert's opinion did not constitute inducement of infringement or contributory infringement of Lexmark's purported patent rights and that remanufacturers have the legal right to retrieve and remanufacture abandoned Lexmark cartridges recovered from landfills. On June 7, 1999, this court dismissed SCC's declaratory judgment action without prejudice due to SCC's failure to serve Lexmark within 120 days of the filing of the Complaint. See Order (attached in the record as Ex. I-7 to SCC's Br. Opp'n Lexmark's Mot. Disqualify the Law Firm of Moore Van Allen, PLLC [pleading #20]).
B. The New Microchips In the Prebate Toner Cartridges for Lexmark's T520/522 and T620/622 laser printers
Sometime after Lexmark sent SCC the letter advising SCC to stop encouraging Lexmark customers to have their used Prebate cartridges remanufactured, Lexmark began installing a new kind of microchip into the Prebate toner cartridges for its T520/522 and T620/622 laser printers. The microchips are manufactured and supplied by Defendant Dallas, a Texas corporation with its principal place of business in Dallas, Texas. Dallas owns the patents on the microchips. See Dallas Answer ¶ 166. The microchips for the T520/522 and T620/622 laser printers contain two computer programs known as the "Toner Loading" and "Printer Engine" programs, which control and monitor various printer and toner cartridge operations for the T520/522 and T620/622 laser printers. See Lexmark Complaint ¶¶ 23, 24 (Kentucky action) (attached in the record as Ex. I-9 to SCC's Br. Opp'n Lexmark's Mot. Disqualify the Law Firm of Moore Van Allen, PLLC [pleading #20]). Lexmark uses a technological measure, or authentication sequence, to prevent unauthorized access to its Toner Loading and Printer Engine programs in the T520/522 and T620/622 laser printers. Lexmark Complaint ¶ 27 (Kentucky action). In general, the authentication sequence requires a "secret handshake" between the printer and toner cartridge to enable printer functionality. Unless the "secret handshake" takes place successfully, the printer will not recognize the toner cartridge. See Lexmark Complaint ¶ 28 (Kentucky action). In other words, the microchips tell the printer how much ink is left in the cartridge. When the chip indicates there's no more ink, the printer stops until a new cartridge with a new chip is inserted. The practical effect for third-party remanufacturers — and truly the heart of this litigation — has been that, with the introduction of the microchips' authentication sequence in the Lexmark T520/522 and T620/622 laser printers, Prebate toner cartridges remanufactured by third-party remanufacturers would no longer work in the T520/522 and T620/622 laser printers. C. Static Control's "Smartek" chips
According to SCC, it first learned about the new Lexmark microchips around May 2001. See SCC's Br. Opp'n Lexmark's Mot. Prelim. Inj. at 2 (Kentucky action) (attached in the record as Ex. A-3 to Lexmark's Br. Supp. Mot. Dismiss or Transfer [pleading #12]).
Lexmark's regular toner cartridges also contain microchips that use a technological measure, but the technological measure does not prevent the regular cartridges from being remanufactured by a third party and then reused in Lexmark printers.
Plaintiff SCC is a North Carolina corporation with its principal place of business in Sanford, North Carolina. SCC manufactures and sells, inter alia, replacement toner cartridge supplies to third-party remanufacturers that compete with Lexmark for toner cartridge sales. In response to Lexmark's installation of the new toner cartridge microchips for the T520/522 and T620/622 laser printers, SCC created and began selling to third-party remanufacturers its own toner cartridge replacement microchips called "Smartek" chips. In designing the Smartek chips, SCC made an identical copy of Lexmark's Toner Loading program. The Smartek chips mimic the authentication sequence or "secret handshake" used by the Lexmark Prebate cartridge microchips, therefore "tricking" the Lexmark T520/522 and T620/622 laser printers into accepting Lexmark Prebate cartridges that have been remanufactured by third-party remanufacturers. Thus, the Smartek microchip enables third-party remanufacturing of Prebate cartridges for use in Lexmark's T520/522 and T620/622 laser printers. See Lexmark Complaint ¶ 34 (Kentucky action).
SCC sells one Smartek microchip for use with Lexmark's T520/522 toner cartridges and another Smartek microchip for use with Lexmark's T620/622 toner cartridges. Lexmark Int'l, Inc., 253 F. Supp.2d at 955.
III. The Litigation Between SCC, Lexmark, and Dallas
SCC unveiled its Smartek chip at a trade show in October 2002. See SCC's Br. Opp'n Lexmark's Mot. Prelim. Inj. at 4 (Kentucky action) (attached in the record as Ex. A-3 to Def. Lexmark's Br. Supp. Mot. Dismiss or Transfer [pleading #12]). On October 29, 2002, Lexmark applied for and subsequently obtained copyright registrations for its Toner Loading program, and on December 6, 2002, Lexmark applied for and subsequently obtained a copyright registration for its Printer Engine program. Id. On December 6, 2002, SCC filed a declaratory judgment action against Defendant Dallas in this court. In the declaratory judgment action, SCC requested a judgment of non-infringement of Dallas's patents on the microchips at issue. On December 30, 2002, Lexmark filed a Complaint against SCC in United States District Court for the Eastern District of Kentucky, requesting injunctive relief for copyright violations arising under the Copyright Act, 17 U.S.C. § 101 et seq., and for violations of the Digital Millennium Copyright Act ("DMCA"), 17 U.S.C. § 1201 et seq. In the Kentucky action, Lexmark has alleged that SCC committed traditional copyright infringement by copying the Toner Loading Program used in Lexmark's T520/522 and T620/622 laser printers. Lexmark has also alleged that SCC violated section 1201 of the DMCA, which generally makes it unlawful to circumvent technology that restricts access to copyright-protected materials.
The DMCA was adopted after heavy lobbying by the entertainment industry in response to widespread, unauthorized copying of music and movies via the internet, and the Act generally prevents unauthorized copying of music and movies. See 144 CONG.REC. S4435-04, 4439 (1998), available at 1998 WL 222890 ("The bill addresses the problems caused when copyrighted works are disseminated through the Internet and other electronic transmissions without the authority of the copyright owner.") (statement of Sen. Leahy). Sections 1201(a)(2)(A), (B), and (C) of the Act specifically provide:
(2) No person shall manufacture, import, offer to the public, provide, or otherwise traffic in any technology, product, service, device, component, or part thereof, that —
(A) is primarily designed or produced for the purpose of circumventing a technological measure that effectively controls access to a work protected under this title;
(B) has only limited commercially significant purpose or use other than to circumvent a technological measure that effectively controls access to a work protected under this title; or
(C) is marketed by that person or another acting in concert with that person with that person's knowledge for use in circumventing a technological measure that effectively controls access to a work protected under this title.
In the Kentucky action, Lexmark alleges that SCC's Smartek chip violates section 1201 because the Smartek chip mimics the authentication sequence used by Lexmark chips and unlawfully tricks the T520/522 and T620/622 laser printers into accepting a remanufactured cartridge, thus "circumventing" the "technological measures" that control Lexmark's copyrighted Toner Loading and the Printer Engine programs.
On February 27, 2003, after an evidentiary hearing, the federal court in Kentucky issued a written order granting Lexmark's motion for a preliminary injunction against SCC. Lexmark Int'l, Inc., 253 F. Supp.2d at 946. The court found that Lexmark showed it was likely to prevail on both the traditional copyright infringement claim and the DMCA claim. Id. at 974. The court also found that SCC had produced no evidence of copyright misuse by Lexmark. The court barred SCC from "making, selling, distributing, offering for sale or otherwise trafficking in the `SMARTEK' microchips for the Lexmark 520/522 and 620/622 toner cartridges, until further order from [the] court." Id.
The Kentucky action is pending, with a scheduled trial date of May 2004. See Scheduling Order (Kentucky action) (attached in the record as Ex. D. to SCC's Br. Opp'n Lexmark's Mot. Dismiss or Transfer ([pleading #19]).
The next day, on February 28, 2003, SCC filed in this court a "First Amended Complaint" in the action against Dallas. In the First Amended Complaint, SCC added Lexmark as a defendant and alleged additional claims against both Lexmark and Dallas for civil conspiracy; antitrust violations under the Sherman Act; false advertising, product libel, and unfair competition under the Lanham Act; and various violations of North Carolina's unfair and deceptive trade practices statute. The First Amended Complaint alleges, inter alia, that SCC's lawsuit against Dallas and Lexmark is based on:
illegal conduct arising from Defendants' anti-competitive acts affecting the markets for remanufactured toner cartridges used on certain Lexmark printer model lines, for components used to remanufacture toner cartridges used on the same Lexmark printer model lines, and for microchips used in toner cartridges for the same Lexmark printer model lines.
First Amended Complaint ¶ 1. SCC specifically alleges that Dallas and Lexmark designed the microchips at issue solely to lock out competitors' products from use in Lexmark's T520/522 and T620/622 laser printers.
Lexmark has now filed a motion to dismiss the action or, alternatively, to transfer the action to Kentucky, arguing that SCC's claims are compulsory counterclaims to Lexmark's claims against SCC in the Kentucky action. See FED. R. Civ. P. 13(a); 28 U.S.C. § 1404. In response to SCC's request for declaratory judgment of patent non-infringement, Dallas has counterclaimed for patent infringement of Dallas's patents on the microchips at issue (Patent Nos. 5,210,846 and 5,398,396).
Lexmark contends that, under Rule 13(a) of the Federal Rules of Civil Procedure, SCC was required to bring the claims alleged in this action as compulsory counterclaims to Lexmark's claims against SCC in the Kentucky action. Rule 13(a), which addresses compulsory counterclaims, provides:
A pleading shall state as a counterclaim any claim which at the time of serving the pleading the pleader has against any opposing party, if it arises out of the transaction or occurrence that is the subject matter of the opposing party's claim and does not require for its adjudication the presence of third parties of whom the court cannot acquire jurisdiction.
FED. R. Civ. P. 13(a). The compulsory counterclaim rule serves to make efficient use of limited judicial resources by avoiding multiple suits arising out of the same basic facts. Painter v. Harvey, 863 F.2d 329, 333 (4th Cir. 1988). In keeping with the rationale behind the rule, courts have construed Rule 13(a) generally to mean that if a defendant has a claim against a plaintiff that arises out of the transaction or occurrence that is the subject matter of the plaintiff's claim against the defendant, the defendant must assert the claim as a counterclaim or it is forever barred. See, e.g., Dow Chem. Co. v. Metlon Corp., 281 F.2d 292, 297 (4th Cir. 1960). Courts differ in their approach to determining whether a party's claim arises out of the transaction or occurrence that is the subject matter of the opposing party's claim. In discussing compulsory counterclaims, the United States Supreme Court has made clear, however, that the fact that the parties' claims "are not precisely identical, or that the counterclaim embraces additional allegations . . . does not matter." Moore v. New York Cotton Exch., 270 U.S. 593, 610 (1926). This circuit's court of appeals has held that Rule 13(a) should be given a broad realistic interpretation to avoid a multiplicity of suits, and the court has implemented the following four-factor test for determining whether a claim is a compulsory counterclaim under Rule 13(a): (1) Are the issues of fact and law raised by the claim and the counterclaim largely the same?; (2) Would res judicata bar a subsequent suit on the claim absent the compulsory counterclaim rule?; (3) Will substantially the same evidence support or refute the defendant's claim as well as the plaintiff's counterclaim?; and (4) Does any logical relation exist between the claim and the counterclaim? Painter, 863 F.2d at 331 (discussing Sue Sam Mfg. Co. v. B-L-S Constr. Co., 538 F.2d 1048, 1051-52 (4th Cir. 1976)). A court need not answer all four questions in the affirmative for the counterclaim to be compulsory. Id. The 4-part inquiry is to be used rather as a guideline, not as a litmus, with evidentiary similarity as the underlying thread. Id.
Although Moore was decided before promulgation of the Federal Rules of Civil Procedure, the "transaction or occurrence" language in Rule 13(a) substantially mirrors the Moore Court's definition of a compulsory counterclaim as one "`arising out of the transaction which is the subject matter of the suit,' [and which] must be pleaded." 270 U.S. at 609 (quoting Equity Rule 30); see also FED. R. Civ. P. 13 advisory committee's note ("This is substantially [former] Equity Rule 30[.]").
The Painter court stressed that examining only whether the claims required the "same evidence" was too narrow a definition of a single transaction or occurrence, stating that "[a] counterclaim may still arise from the same `transaction or occurrence', as a logically related claim even though the evidence needed to prove the opposing claims may be quite different." Id. at 332; see also Hospital Bldg. Co. v. Trustees of Rex Hosp., 86 F.R.D. 694, 696 (E.D.N.C. 1980); 6 CHARLES ALAN WRIGHT, ARTHUR R. MILLER, MARY KAY KANE, FEDERAL PRACTICE AND PROCEDURE § 1410 (2nd ed. 1990). Thus, the Painter court considered the 4-part inquiry as the more appropriate way to determine whether claims arise out of the same transaction or occurrence.
Here, at least three parts of the 4-part inquiry can be answered in the affirmative. First, the issues of fact and law are largely the same, and the claims rely on substantially the same evidence. In the Kentucky lawsuit, Lexmark has accused SCC of violating traditional copyright law and the DMCA by illegally copying Lexmark's copyrighted Toner Loading program and by placing the program onto the Smartek chips, thus enabling the Smartek chips to disarm the "technological controls" that prevent use of unauthorized toner cartridges in the Lexmark's T520/522 and T620/622 laser printers. In this action, SCC accuses Lexmark and its microchip supplier Dallas of creating the copyrighted "technological controls" not as a way to protect Lexmark's copyrights but, instead, as an attempt to monopolize the markets for toner cartridges and microchips used in Lexmark printers. SCC accuses Lexmark and Dallas of engaging in "anticompetitive" conduct-including conspiring to "retrain trade, including refusals to deal with Plaintiff and competitors" and by conspiring "to monopolize the relevant markets." See Amended Complaint at ¶ 26. SCC further alleges that Defendants have threatened intellectual property infringement litigation against cartridge component suppliers who might contemplate offering replacement microchips for the Lexmark Prebate cartridges and that Defendants have falsely warned customers that (1) the Prebate agreements prohibit the remanufacturing of the Prebate toner cartridges and that (2) SCC's Smartek chips illegally infringe on Defendants' intellectual property. First Amended Complaint ¶¶ 56-58, 109.
SCC argues that its claims against Lexmark and Dallas in this action extend much more broadly than the copyright infringement claims in the Kentucky action. This court does not agree. It is true that SCC does allege some anti-competitive conduct that may extend beyond copyright infringement issues-including the allegation that Defendants conspired to monopolize the relevant markets by threatening intellectual property litigation against customers and third-party remanufacturers who refused to comply with the Prebate agreement. Nevertheless, most of the factual allegations in the First Amended Complaint are based on Lexmark and Dallas's creation of the microchips containing the copyrighted toner loading programs for the T520/522 and T620/622 laser printers. Indeed, Dallas's primary relevance in the lawsuit pertains to its patented microchips containing the Toner Loading and Printer Engine programs. In other words, SCC's theory of a conspiracy between Lexmark and Dallas to engage in antitrust violations is borne primarily out of the creation of the microchips at issue in this case and in the Kentucky action, not out of Dallas's alleged threats to third-party manufacturers regarding the Prebate agreement between Lexmark and its customers.
Second, Lexmark's claims against SCC in the Kentucky action and SCC's claims against Lexmark in this action are logically related. See, e.g., Service Training, Inc. v. Data Gen. Corp., 963 F.2d 680 (4th Cir. 1992). Indeed, in opposing Lexmark's motion for a preliminary injunction in the Kentucky action, SCC presented substantially the same arguments it now presents to support its claims against Lexmark and Dallas. For instance, in asserting its copyright misuse defense in the Kentucky action, SCC argued that Lexmark had engaged in technological efforts to retain the market for printer toner cartridges against competition from toner cartridge remanufacturers. See SCC's Br. Opp'n Lexmark's Mot. Prelim. Inj. at 2, 4, 5, 21, 26, 29 (Kentucky action) (attached in the record as Ex. A-3 to Lexmark's Br. Sui Mot. Dismiss or Transfer [pleading #12]). Furthermore, in its "Proposed Findings" in the Kentucky action, SCC requested the court to find that "Lexmark's efforts extend its copyrights so as to control the aftermarket for remanufactured ton cartridges amounts to misuse of copyright and bars any claim of infringement u after such misuse is purged." SCC's "[Proposed] Findings of Fact and Conclusions of Law" at 49 (attached in the record as Ex. A-4 to Lexmark's Br. Supp. IV Dismiss or Transfer [pleading #12]). In its order granting a preliminary injunction against SCC in the Kentucky action, the court discussed SCC's copyright misuse arguments and rejected them:
In the Kentucky action, SCC argued in its brief opposing the preliminary injunction motion that Lexmark:
long has engaged in a campaign to stifle legitimate competition from toner cartridge manufacturers. . . . Lexmark, by placing a small microchip in toner cartridges for its laser printers, has been attempting to thwart remanufacturers' ability to compete. . . . . Finally, permitting Lexmark to use either copyright law or the DMCA to stifle competition in markets for noncopyrighted goods . . . would unintentionally sanction copyright misuse. . . . . The consequences of such misuse would offend established economic policies by reducing competition, promoting monopolization, and . . . increasing prices to the consumer . . . Lexmark's true and only purpose is to exclude competition from third party remanufacturers. [T]he Complaint in this action is only part of a long, mostly unsuccessful effort by Lexmark to secure a market intoner cartridges to itself and to preclude any and all competitors from that market. . . . Even were they able to meet demand, a sole supplier without price competition has the ability to artificially raise prices to the consumer, in contravention of the anti-trust laws and public policies. . . . .See Lexmark's Reply Br. Supp. Mot. Dismiss or Transfer, at 4.
In the instant case, other than merely accuse Lexmark's Prebate program as being anticompetitive, SCC presents no factual or legal basis for there being an antitrust violation by Lexmark. SCC's misuse defense is based on the mere allegation that Lexmark is "using copyright to secure an exclusive right or limited monopoly not expressly granted by copyright law." Contrary to SCC's allegation, however, Lexmark is not seeking to improperly extend its copyright monopoly.Lexmark Int'l, Inc., 253 F. Supp.2d at 966.
SCC argues that in the Kentucky action SCC premised the copyright misuse defense on the theory that Lexmark illegally extended its monopoly beyond the scope of its copyright in violation of public policies underlying the copyright laws, rather than on the theory that Lexmark committed violations of antitrust law, as SCC has alleged in this case. SCC contends, therefore, that SCC's claims against Lexmark in this action are neither logically related to nor share substantially the same issues of fact and law as the claims in the Kentucky action. This argument is specious. The 4-part inquiry for compulsory counterclaims promotes substance over form, with efficient use of limited judicial resources as the overriding concern. It is quite clear — after examining the pleadings in both cases — that a logical relation exists between Lexmark's claims against SCC in the Kentucky action and SCC's claims against Lexmark and Dallas in this action and furthermore that substantially the same evidence will support or refute either party's claims. Lexmark's "Prebate" program, Lexmark's technology and intellectual property, SCC's replication of that technology by creating its Smartek chips, and the legal consequences are the central questions in both lawsuits. Indeed, SCC's own statements support the conclusion that the claims in the Kentucky action and in this action are logically related. In the first sentence of SCC's brief opposing Lexmark's motion for a preliminary injunction in the Kentucky action, SCC argued:
In the order granting the preliminary injunction, the court in the Kentucky action noted that to establish the defense of copyright misuse in a copyright infringement action a defendant can show either (1) that the plaintiff violated the antitrust laws or (2) that the plaintiff illegally extended its monopoly beyond the scope of the copyright or violated the public policies underlying the copyright laws. Lexmark Int'l, Inc., 253 F. Supp.2d at 966. See also Service Training, Inc., 963 F.2d at 690 (stating that misuse of one's copyright "need not be a violation of antitrust law in order to comprise an equitable defense to an infringement action") (quoting Lasercomb Am., Inc. v. Reynolds, 911 F.2d 970, 978 (4th Cir. 1990)). Copyright misuse is an affirmative defense and bars a culpable plaintiff from prevailing on an action for infringement of the misused copyright. Lasercomb Am., Inc., 911 F.2d at 972.
"Holding counterclaims compulsory avoids the burden of multiple trials with their corresponding duplication of evidence and their drain on limited judicial resources." Painter, 863 F.2d at 332 (citing Southern Constr. Co. v. Pickard, 371 U.S. 57, 60 (1962)).
This case is about neither copyright infringement nor the Digital Millennium Copyright Act. The complaint and motion for preliminary injunction are but the latest efforts by plaintiff Lexmark International, Inc. ("Lexmark") to stifle lawful competition by makers and sellers of remanufactured recycled toner cartridges. As Lexmark concedes, the purpose of the "handshake" chip technology at issue in this case is not to protect a copyrighted work but, in truth, `To prevent unauthorized toner cartridges from being used with Lexmark's T520/522 and T620/622 laser printers.' Thus, the Lexmark technology, indeed this lawsuit, are intended not to control access to copyrighted works, but to defeat access to the toner cartridge aftermarket by Lexmark's competitors, and compel consumers to purchase only Lexmark cartridges.
SCC's Br. Opp'n Lexmark's Mot. Prelim. Inj., Introd. at i (attached in the record as Ex. A-3 to Lexmark's Br. Supp. Mot. Dismiss or Transfer [pleading #12]) (first emphasis added, second emphasis in original) (citation omitted).
In sum, the facts in this case easily satisfy at least three parts in this circuit's 4-part inquiry for compulsory counterclaims. To what extent adjudication of the claims would serve as "res judicata" is not as clear. In any event, failure to satisfy the res judicata part of the 4-part inquiry will not prevent a finding that a claim is compulsory. As this circuit's court of appeals has observed, "[i]f the limits of the compulsory counterclaim are no broader than res judicata, then Fed.R.Civ.P. 13(a) would be superfluous." Painter, 863 F.2d at 333; Banner Indus. of New York v. Sansom, 830 F. Supp. 325, 328 n. 4 (S.D. W. Va. 1993) (discussing the 4-part inquiry).
Courts in other jurisdictions have routinely found copyright misuse and antitrust claims to be compulsory counterclaims to previously filed copyright infringement claims. For instance, in Grumman Systems Support Corp. v. Data General. Corp., Data General owned a copyright for a computer program called ADEX. 125 F.R.D. 160 (N.D. Cal. 1988). Grumman, a competitor, allegedly copied ADEX without authorization. Data General sued Grumman in a federal court in Massachusetts for copyright infringement. Grumman moved to dismiss. The day after the Massachusetts federal court denied Grumman's motion to dismiss, Grumman sued Data General in a federal court in California, alleging anti-trust violations. The federal court in California dismissed the action, holding that Grumman's antitrust claims against Data General were compulsory counterclaims in the Massachusetts action under Rule 13(a). See also Harley-Davidson Motor Co. v. Chrome Specialties, Inc., 173 F.R.D. 250 (E.D. Wis. 1997) (where the antitrust claims by a motorcycle parts manufacturer against a motorcycle manufacturer were compulsory counterclaims to the manufacturer's previously filed trademark infringement action); Grupke v. Linda Lori Sportswear, Inc., 174 F.R.D. 15 (E.D.N.Y. 1997) (where t-shirt designers sued a competitor for copyright infringement, trademark infringement, and unfair competition, the competitor's counterclaim for unfair competition was compulsory where it was based on an allegation that the t-shirt designers had used the lawsuit competitively to inform customers of the alleged infringement); Rohm Haas Co. v. Brotech Corp., 770 F. Supp. 928 (Del. 1991) (where the plaintiff's antitrust claims were compulsory counterclaims to the defendant's previously filed patent infringement claim).
Here, as in Grumman, a significant factual and legal overlap exists between the parties' claims in the two separate lawsuits. Furthermore, the fact that the litigants and the claims are not exactly the same does not prevent the court from finding that SCC's claims against Lexmark are compulsory counterclaims in the Kentucky action. Neither additional defendants nor different legal claims will preclude a claim from being a compulsory counterclaim, provided that the two cases share substantial evidence such that litigating the parties' claims separately would drain limited judicial resources. See, e.g., Shmuel Shmueli, Bashe, Inc. v. Lowenfeld, 68 F. Supp.2d 161 (E.D.N.Y. 1999) (where the later suit included additional litigants); Howard v. Klynveld Peat Marwick Goerdeler, 977 F. Supp. 654 (S.D.N.Y. 1997) (same).
In its brief opposing the motion to dismiss, SCC relies heavily on Mead Data Central, Inc. v. West Publishing Co., in which a federal court held that a party's antitrust claims filed in Ohio were not compulsory counterclaims to previously filed copyright infringement claims against the party in Minnesota. 679 F. Supp. 1455, 1461 (S.D. Ohio 1987). The Mead court found little or no overlapping evidence between the two cases, concluding that the Ohio antitrust claims involved issues that extended far beyond the subject matter of the Minnesota copyright issues, including claims of monopolization through predatory pricing and anti-competitive acquisition policies. Id. at 1461. According to SCC, this case is similar to Mead because the claims extend much more broadly than the copyright infringement claim in the Kentucky action. The court has already rejected this argument. Furthermore, as the Grumman court observed in its own discussion of Mead, the Mead court placed significant emphasis on the dissimilarity of the legal issues instead of on the factual overlaps between the claims. 125 F.R.D. at 163.
Like the court in Mead, SCC here focuses too much on the alleged dissimilarity of its legal claims rather than on the similarity of evidentiary issues and whether the claims are logically related. For instance, SCC argues in its brief that "Lexmark's allegations concerning Prebate, printer competition, and Static Control's replacement chips have no relevance for Lexmark's claims under the DMCA." Even if there is no "copyright defense" or antitrust defense to the DMCA, however, the factual and evidentiary underpinnings of the parties' claims, rather than the claims' legal dissimilarities, are more properly the focus of Rule 13(a) analysis. See Painter, 863 F.2d at 332-33. In sum, the court finds that SCC's claims in this action are compulsory counterclaims to Lexmark's claims in the Kentucky action.
Rule 13(a) does not set forth the proper procedure for when a party files a subsequent action that should have been brought as a counterclaim in a previously filed action. This circuit's court of appeals has held, however, that "[a]s a principle of sound judicial administration, the first suit should have priority, absent the showing of balance of convenience in favor of the second action." Ellicott Mach. Corp. v. Modern Welding Co., 502 F.2d 178, 180 n. 2 (4th Cir. 1974) (quoting Remington Prods. Corp. v. American Aerovap, Inc., 192 F.2d 872, 873 (2nd Cir. 1951)). Thus, in such a case it is appropriate for the court to dismiss the second-filed action without prejudice so that the party may bring the claim as a counterclaim in the first-filed action. R.J. Reynolds Tobacco Co. v. Star Scientific, Inc., 169 F. Supp.2d 452 (M.D.N.C. 2001) (stating that the "first filed" rule generally governs the determination of which suit shall proceed); see also Great Lakes Rubber Corp. v. Herbert Cooper Co., 286 F.2d 631, 633 (3rd Cir. 1961) (explaining that "[w]hen multiple claims involve many of the same factual issues, or the same factual and legal issues, or where they are offshoots of the same basic controversy between the parties, fairness and considerations of convenience and economy require that the counterclaimant" maintain his cause of action in the original action, otherwise it will "be barred if asserted separately, subsequently").
Here, Lexmark first brought its copyright infringement and DMCA claims against SCC in federal district court in Kentucky, and SCC has not made a sufficient showing that North Carolina is the more convenient forum for SCC to litigate its claims against Lexmark. Thus, it is recommended that the court dismiss this action without prejudice. SCC must assert its claims against Lexmark as counterclaims in the Kentucky action or be forever barred from bringing the claims.
SCC does not argue that its claims against Lexmark were "first filed" by virtue of filing the declaratory judgment action against Dallas on December 6, 2002. Indeed, the circumstances in this case do not warrant a finding that the claims against Lexmark "relate back" to SCC's filing of the declaratory judgment against Dallas for purposes of the "first-filed" rule. See FED. R. Civ. P. Rule 15(c)(3) (addressing amendments that change the party or the name of the party against whom claims are asserted); Nelson v. Adams USA, Inc., 529 U.S. 460, 467 n. 1 (2000) (stating that relation back under Rule 1 5(c)(3) only applies in cases involving "a mistake concerning the identity of the proper party"); see also Abovepeer, Inc. v. Recording Indus. Ass'n of Am., 166 F. Supp.2d 655, 658 (N.D.N.Y. 2001) (stating that the amendment of the complaint to add copyright holders as defendants did not relate back so as to give the case priority over actions filed by the copyright holders in another federal district court).
Based on the foregoing, IT IS RECOMMENDED that the motion to dismiss SCC's claim be granted without prejudice so that SCC may bring the claims against Dallas and Lexmark as counterclaims in the Kentucky action. It is FURTHER RECOMMENDED that the motion to disqualify the law firm of Moore Van Allen be denied as moot upon dismissal of this action.