Go Forth And Infringe No More?: Dischargeability In Bankruptcy And Willful Patent Infringement

Sunday, June 1, 2008 - 01:00

Intentional patent infringement has always been, at best, a problematic business model. Intentional infringers presumably have more frequent resort to the bankruptcy courts than other entrepreneurs, particularly smaller operators with the misfortune to get caught. Even where a corporate entity is employed, the small operator has an inherently higher risk of having the corporate veil pierced or of having direct involvement and thus liability for this business tort. The Patent Act provides for treble and punitive damages, and even attorneys' fees in "exceptional cases." One might expect that the dischargeability of a judgment debt for intentional patent infringement in a personal bankruptcy would be well-traveled ground. Yet, there exists a surprising lack of case law on this bread-and-butter issue.

First, some basics. Under the pre-1976 Bankruptcy Act, patent infringement, like other torts,1was not dischargeable. The Code reversed this rule. It is now understood that a debt for damages for garden-variety patent infringement with no showing of intentional infringement is discharged under the Bankruptcy Code upon a final order or confirmation of a plan.2The debtor "is assumed to be poor but honest," and there is a presumption that a debt is dischargeable unless the party objecting sustains the burden of showing otherwise.3

The general concept of a "fresh start" following bankruptcy requires a discharge of the debtor's pre-petition debts.4An individual's non-dischargeable debts are carved out from this general rule, however, by 11 U.S.C. § 523, which sets forth twenty-one classes of non-dischargeable debts, ranging from unpaid taxes,5to child support,6to debts for death or personal injury from drunken driving.7Individuals undergoing reorganization under chapter 138and individual chapter 7 debtors are made subject to the exceptions to discharge of section 523(a),9and, even if they were not, also must beware of becoming the alter ego successor to the liability of a liquidated corporation or partnership.10Chapter 11 incorporates the section 523(a) exceptions to discharge only against individual debtors.11 Thus, corporate entities and partnerships reorganized under chapter 11 will be discharged from a judgment debt for willful patent infringement.12

The few courts that have considered whether willful patent infringement is dischargeable look to 523(a)(6), which excepts from discharge a debt for "willful and malicious injury by the debtor to another entity or the property of another entity." The elements are conjunctive - the debtor must have been both willful and malicious or the debt is dischargeable. As the Ninth Circuit wrote in In re Markowitz ,13"[t]he absence of one creates a dischargeable debt." Markowitz relied heavily on Kawaauhau v. Geiger ,14in which the Supreme Court held that non-dischargeability under § 523(a)(6) requires "a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury."15 Geiger noted that "willful and malicious" in 523(a)(6) suggests intentional torts rather than negligence or recklessness, and that intentional torts generally require that the actor intend "the consequences of an act," not simply, "the act itself."16

Geiger was a medical malpractice case and the judgment was held dischargeable. The Supreme Court cited as a contrasting example McIntyre v. Kavanaugh, 17denying discharge to a broker who sold certain stock certificates held by his firm as security for a debt. McIntyre found that the debtor had "deprive[d] another of his property forever by deliberately disposing of it without semblance of authority."18 Geiger interpreted this to mean that "the act constituted an intentional injury to property of another, bringing it within the discharge exception."19 Geiger also rests on the language of the statute - that "[t]he word "willful" in (a)(6) modifies the word "injury[.]" This and Geiger 's focus on the "intentional injury to property" in the stockbroker's defalcation in McIntyre suggest that the Code will not permit discharge of a debt for misappropriation of a property right, with knowledge of the owner's superior right.

Bankruptcy Judge Stern in the District of New Jersey very recently tackled the problem in In re Benun .20The debtor was liable for patent infringement for refurbishing disposable cameras. During the litigation the legal landscape changed, through interlocutory decisions and a change in the first sale defense announced by the Federal Circuit. The court boiled the precedents down to a rule of willful injury that required a subjective intent to injure and defined malice as lack of justification or excuse.21Importantly, Judge Stern noted that willfulness in Section 523(a)(6) is a more stringent standard than willfulness in the Patent Act.22Some of the infringement in Benum was held dischargeable and some was not, and the case and Judge Stern's excellent discussion are worth study.

Two cases from the Sixth Circuit have applied Geiger 's construction of the willful and malicious elements of 523(a)(6) to find patent infringement to be non-dischargeable. In In re Trantham , the 6th Circuit Bankruptcy Appeal Panel found that "the Debtor carried out his plan to appropriate Monsanto's technology without any intention of paying Monsanto for it."23To make a bad matter worse, Trantham attempted to conceal his efforts. "In effect, Trantham was planning to permanently deprive Monsanto of its property (its license fees) without the semblance of authority (the license agreement) to use the patent technology."24In In re Wood , the bankruptcy court held that where the infringer has acted with subjective willfulness in infringing the patent and with malicious intent to deprive the patent owner of license fees, it will fall within the willful and malicious exception to discharge of 11 U.S.C. § 523(a)(6).25

Room remains for a contrary argument, however, and not only because of the dearth of authority. Obviously, the Supreme Court was not considering intentional patent infringement in either Geiger or McIntyre . Patent infringement injures the patent owner's property rights in a manner different from that of the broker's sale of his customer's stock in McIntyre . The infringed patent owner is not necessarily "deprive[d]of his property forever."26The patent owner is only deprived of a portion of it, typically as measured by a reasonable royalty for the extent of the infringement.

The two elements of section (a)(6) do not read naturally on all intentional patent infringement. As noted, the statute requires that the injury be both "willful and malicious."27The plain meaning of "willful" gathers both the elements of knowledge of the patent owner's superior right and the decision to profit by violation of that right. But this would include any intentional patent infringement. If all intentional patent infringement is non-dischargeable under the "willful" prong of the statute, no content is left for the word "malicious" in section 523(a)(6). It also makes an uncomfortable fit with the apparent thrust of 523(a)(6) as a whole that only especially bad-faith deprivations of property will not be subject to discharge.

The accused infringer has grounds to distinguish Trantham and Woods. Significantly, the facts of both cases suggest an extra element. In Trantham there was concealment of the infringement. In re Woods criticized the Trantham panel's assumption that the infringer must have known of harm to the patentee, but found subjective knowledge of harm on the facts before it and added a requirement that the infringer's knowledge of the harm to the plaintiff be proved in the individual case. Woods can be read to give substance to the malice element by requiring proof of subjective knowledge of the patent and of the patentee's intent to exploit it before the infringement will qualify as a non-dischargeable debt, but it may have merged the willful and malicious prongs.

Section 523(a)(6) requires an injury to property, and one can argue that infringement does not "injure" the patent. The patent survives, the invention retains its value and the remedy is a monetary payment that makes the owner whole. The tort can be analogized to a trespass on land - the right to exclude may temporarily be abrogated, but it is not clear that the property has been "injured."

The problem is more acute if one accepts that non-dischargeability is limited only to specially reprehensible or socially undesirable wrongs. Where the patent owner is commercially exploiting the statutory monopoly, the right misappropriated by the infringer can be restored with a damage award equal to a reasonable license fee and an injunction against further illicit competition. Where a patent owner has chosen not to develop the invention commercially and seeks to block others from doing so, an infringer might argue that it is actually conferring social good, promoting "the Progress of Science and useful Arts,"28as the intellectual property laws intend. While it is certainly within the rights of a patent owner to mothball an invention, the infringer of such a patent hardly fits with the deadbeat parents and drunk drivers singled out in the other subsections of section 523(a) for non-dischargeability.

The Ninth Circuit BAP in In re Albarran 29made short work of these concerns in the context of willful copyright infringement, finding that an award of statutory damages under the Copyright Act created a non-dischargeable debt under the Bankruptcy Code. Under the Copyright Act, statutory damages may be awarded in lieu of any evidence of actual damage to the copyright owner. The Albarran panel reasoned that "[i]nfringement is a codified injury to an intangible property interest which Congress has protected . The damages are awarded for such injury even though they may not constitute actual loss."30 Albarran ended further rumination on the nature of "injury" under section 523(a)(6), writing "intentional copyright infringement is a categorically harmful activity and thus is an 'injury,' as that term is used in § 523(a)(6)."31 Abarran took a similarly categorical approach on willfulness, holding that "the only remaining proof required" was that the infringer was aware of the copyright.32Malice did not apparently form a discrete element for non-dischargeability and Albarran may be inconsistent with Markowitz 33on that ground.

There is plenty of work left for the courts to do in this area. The opinions that exist leave questions as well as answer them. With other types of intellectual property, the courts have not hesitated to come down on the side of non-dischargeability. A bankruptcy court in the Central District of California has ruled that a pre-petition judgment for cybersquatting in violation of the Lanham Act is not dischargeable because it constituted a malicious and willful injury to the plaintiff's marks.34Whether there are meaningful distinctions between these cases and patent cases remains to be explored. Until this work is substantially more advanced, intentional infringers and aggrieved patent owners will have arguments to make on both sides of the issue.

1See Carbice Corp. v. Am. Patents Dev. Corp., 283 U.S. 27, 33 (1931) ("Infringement, whether direct or contributory, is essentially a tort, and implies invasion of some right of the patentee.").

2E.g., Mickowski v. Visi-Trak Worldwide, LLC, 321 F. Supp. 2d 885 (N.D. Ohio 2004); see 11 U.S.C. § 1141.

3In re Albarran, 347 B.R. 369 (9th Cir. BAP 2006)(citing Brown v. Felsen, 442 U.S. 127, 128-29 (1979)).

4See H.R. Rep. No. 595 95th Cong., 1st Sess. 384 (1977).

5 § 523(a)(1).

6 § 523(a)(5).

7 § 523(a)(9).

8 Prior to the Bankruptcy Abuse Prevention and Consumer Protection Act, several of section 523(a)'s exceptions from discharge did not apply in chapter 13. Now, for cases filed after October 17, 2005, all of the section 523(a) exceptions apply and individuals under chapter 13 will not be discharged for debts that come under one of these exceptions.

9 11 U.S.C. § 727(b).

10NLRB v. Goodman, 873 F.2d 598 (2d Cir. 1989).

11 11 U.S.C. § 1141(d)(2).

12 11 U.S.C. § 1141(d)(1).

13 190 F.3d 455, 465 (6th Cir. 1999).

14 523 U.S. 57, 61 (1998).

15 523 U.S. at 61.

16Id. at 61-62 (citing Restatement (Second) of Torts § 8A cmt. a (1964)).

17 242 U.S. 138 (1916).

18Id. at 141.

19Geiger , 523 U.S. at 63.

20 2008 WL 583891 (Bankr. D.N.J. Feb. 29, 2008).

21Id. at *28.

22Id. at *7.

23 304 B.R. 298, 308 (6th Cir. B.A.P. 2004).

24Id.

25 309 B.R. 745 (Bkr. W.D. Tenn. 2004).

26McIntyre, 242 U.S. at 141.

27Markowitz, 190 F.3d at 465 (quoted supra) (emphasis added).

28 U.S. Const. Art. 1, sec. 8, para. 8.

29 347 B.R. 369 (9th Cir. BAP 2006).

30Id. at 384.

31Id. at 383.

32Id. at 385 .

33 190 F.3d at 465.

34In re Wright, 355 B.R. 192 (Bankr. C.D. Cal. 2006).

E. Evans Wohlforth, Jr. is Of Counsel at Gibbons P.C., Newark, New Jersey. Mr. Wohlforth concentrates his practice on federal litigation.

Please email the author at ewohlforth@gibbonslaw.com with questions about this article.