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Failure to Raise Patent Invalidity Defenses in Contract Dispute Bars Claims in Subsequent Lawsuit

January 18, 2013

By: Brian T. Moriarty and Christopher K. Albert

Hamilton Brook Smith Reynolds Alert

  • Even in a licensing dispute, challenges to patent validity should be raised or they may be waived.
  • Litigants must carefully consider all possible defenses and counterclaims in contested IP matters.

In Cummins, Inc. v. TAS Distrib. Co., Inc., the Federal Circuit held that declaratory judgment claims alleging patent invalidity and unenforceability were barred under the doctrine of res judicata in view of prior litigation between the parties regarding the performance and royalties due under a patent license agreement.  By failing to raise patent invalidity and unenforceability as defenses in the prior dispute, which focused on the extent of patent royalties, Cummins waived its right to assert them later.  In defending a breach of contract claim where a patent license forms part of the subject matter for the contract, litigants must consider asserting patent-based defenses and counterclaims or risk having them forever barred.
The parties to this case had a history of litigation.  TAS patented diesel engine technology and entered into a Master License Agreement with Cummins that included a patent license.  TAS filed a declaratory judgment action ("TAS I") alleging that Cummins breached the Master Agreement by failing to make "all reasonable efforts" to market and sell TAS technology.  At its core, the parties disputed the extent of royalties and Cummins' continued obligations under the Master Agreement.
After TAS initiated a second contract dispute ("TAS II"), again alleging that Cummins had not paid sufficient royalties, Cummins deposed the inventor on the TAS patents and obtained evidence of sales of the invention prior to the patent critical date that had not been disclosed to the U.S. Patent and Trademark Office.  The district court denied Cummins' leave to amend its answer on the ground that "the claims should have and could have been brought in TAS I."

Cummins then brought an action ("TAS III") seeking several patent- and contract-based remedies, including: dismissing TAS II; declaring the patents invalid; declaring the Master Agreement void for patent misuse; declaring that TAS engaged in patent misuse by improperly enforcing its patents; declaring the patent unenforceable due to inequitable conduct; and rescinding the Master Agreement entirely.  The district court held that these claims were barred by the doctrine of res judicata, and an appeal to the Federal Circuit ensued.
Under Illinois state law, the applicable law in this instance, res judicata, or claim preclusion, "extends to what was actually decided in the first action, as well as those matters that could have been decided in that suit."  Applying the "transactional test" for res judicata, "separate claims [are] considered the same cause of action for purposes of res judicata if they arise from a single group of operative facts, regardless of whether they assert different theories of relief."  Although the Federal Circuit applied Illinois state law, it relied on the Restatement (Second) of Judgments, which is of general applicability throughout the United States.
On the key issue of whether TAS I and TAS III arise from the "same operative facts," the Federal Circuit affirmed the district court's ruling that "the validity of the Master Agreement was, though implicitly, an operative fact in TAS I and that Cummins could have contested, either as a defense or counterclaim, the validity of the Master Agreement and the patents that it asserts under the agreement in TAS I.  If successful, Cummins' claims would have defeated TAS's suit in TAS I."  In other words, "[t]he onus was on Cummins under Illinois state law to raise the defenses at that time or forfeit their use at a later time."  The Federal Circuit was also careful to point out that an "equitable exception" to res judicata did not apply because some evidence suggested that Cummins should have known about the potentially invalidating sales prior to TAS I, and thus Cummins had a duty of due diligence in investigating the potential defense.

We encourage you to fully consider all possible defenses and counterclaims in every litigation matter, particularly IP issues in litigating any aspect of a licensing agreement.  This case is a warning that choosing to restrict the scope of a litigation, even with good reason, may constrain your ability to vigorously litigate future lawsuits.

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