SUMMARY: In Inspired Dev. Grp. v. Inspired Prods. Grp., No. 2018-1616, 2019 U.S. App. LEXIS 27989 (Fed. Cir. Sep. 18, 2019), the United States Court of Appeals for the Federal Circuit explained that claims related to patent license agreements are not necessarily viable in federal court.  Although federal courts generally have exclusive jurisdiction over patent matters, when patent issues such as infringement or validity are embedded in state law claims, those patent issues may not be enough to create federal jurisdiction.  The Federal Circuit determined federal jurisdiction was not appropriate in this case and therefore reversed the district court and remanded the case for dismissal.

The Federal Circuit recently held that a dispute over a patent licensing agreement did not “arise under” federal law and therefore federal question subject matter jurisdiction did not exist. Inspired Dev. Grp. v. Inspired Prods. Grp., No. 2018-1616, 2019 U.S. App. LEXIS 27989 (Fed. Cir. Sep. 18, 2019).

Inspired Development Group, LLC (“Inspired Development”) is the assignee of several patents for children’s car seat designs in the shape of cartoon and comic book characters, including U.S. Design Patent No. D524,559, directed to a car seat featuring a representation of Batman®. Id. at *1-2.  Inspired Development entered into an Exclusive Patent Licensing Agreement (the “Agreement”) with Inspired Products Group, LLC, d/b/a KidsEmbrace, LLC (“KidsEmbrace”), whereby KidsEmbrace would have the right to manufacture and sell the car seats in exchange for paying royalties to Inspired Development. Id. at *2.

U.S. D524,559, FIG. 1

Subsequent to the Agreement, KidsEmbrace sought additional investment from a third company and both Inspired Development and KidsEmbrace executed a Binding Letter of Agreement (the “Binding Letter”) to obtain that investment. Id. at *2-3.  Under the Binding Letter, Inspired Development was required to transfer the patent rights to KidsEmbrace in exchange for a minimum royalty payment if KidsEmbrace was acquired. Id. at *3.

KidsEmbrace unilaterally terminated the Agreement shortly after the Binding Letter was executed. Id.  Believing that it was owed various payments under the Agreement and the Binding Letter, Inspired Development filed suit in federal court, relying on diversity to establish subject matter jurisdiction. Id. at *3-4.  Inspired Development asserted causes of action for breach of contract under state law as to both the Agreement and the Binding Letter, and state law equitable claims for unjust enrichment and promissory estoppel. Id.  KidsEmbrace responded with various counterclaims founded in state law, also relying on diversity for subject matter jurisdiction. Id. at *4.

KidsEmbrace ultimately prevailed on all counts in the district court and Inspired Development appealed. Id. at *4-5.  The appellate court issued a “Jurisdictional Question,” remanded back to the district court, requiring the parties to identify all the members of each limited liability company and list the citizenship of each member in order to properly establish subject matter jurisdiction via diversity. Id. at *5-6.  In response, the parties reviewed their membership and determined that diversity of citizenship was not present. Id. at *5-6.

KidsEmbrace argued that federal subject matter jurisdiction nevertheless existed because the case presented a federal question. Id. at 6.  Because the state law breach of contract and equitable claims potentially raised validity and infringement issues as to the subject patents, KidsEmbrace characterized those claims as “arising under” federal patent law instead of state law. Id.  On remand, the district court accepted KidsEmbrace’s arguments, and the case returned to the appellate court for review of the jurisdictional issue and was transferred to the Federal Circuit. Id. at *7.

A case will “arise under” federal law in two ways. Id. at *8.  The first way is if federal law creates the cause of action asserted. Id.  Failing that, the case may fit into a “special and small category” of cases that nonetheless arise under federal law. Id. (citing Gunn v. Minton, 568 U.S. 251, 258 (2013)).

The court determined that because the claims and counter-claims between the parties were all based in state law, federal law did not create the causes of action. Id. at *9-10.  Thus, the court turned to the four-part Gunn test, and considered whether a federal issue was “(1) ‘necessarily raised,’ (2) ‘actually disputed,’ (3) ‘substantial,’ and (4) ‘capable of resolution in federal court without disrupting the federal-state balance approved by Congress.’” Id. at *10 (citing Gunn, 568 U.S. at 258).

KidsEmbrace based its argument in favor of federal subject matter jurisdiction largely on the unjust enrichment cause of action, contending that it was, in reality, a thinly disguised patent infringement claim. Id. at *9.  Accordingly, the court focused on whether the state law claim for unjust enrichment satisfied all four parts of the Gunn test. Id. at *10-11.

On the first element, the court determined that a patent law issue was not necessarily raised by the unjust enrichment claim. Id. at *11.  To prevail on the claim for unjust enrichment, Inspired Development would have to show that it conferred a benefit on KidsEmbrace. Id.  One way to establish a benefit would have been to show that one or more licensed patents covered the car seats manufactured and sold by KidsEmbrace. Id. at *12.  However, that was not the only way Inspired Development could show a benefit to KidsEmbrace. Id.  For example, if infringement is possible but not clearly established, a licensee benefits from a license by avoiding uncertainty and litigation. Id. at *12-13.  Also, as an exclusive licensee, KidsEmbrace benefitted by ensuring that no competitor could make or sell products covered by the patents at issue. Id. at *13.  Thus, where the unjust enrichment claim could have been established without proving that KidsEmbrace actually practiced the licensed patents, patent infringement was not a “necessary element.” Id.

The second element of the Gunn test was satisfied. Id. at *13-14.   KidsEmbrace denied that it manufactured or sold products within the scope of the patents, thus, the issue of infringement was “actually disputed.” Id.

In order for a federal issue to be “substantial” under the third element of the Gunn test, the federal issue must be important to the federal system as a whole, not just to the parties in the present suit. Id. at *14.  A substantial federal issue may exist if (a) a pure issue of federal law is dispositive, (b) the resolution of the issue will control numerous other cases, or (c) the federal government has a direct interest in vindicating its own administrative action in a federal forum. Id. at *15 (internal citations omitted).  The court found none of the three factors favored a substantial issue of federal patent law. Id.

The first factor weighed against substantiality because Inspired Development could establish unjust enrichment without showing KidsEmbrace’s products actually infringed and because the federal issue was at most only one of several elements needed. Id.  As to the second factor, a state court’s resolution of the claims would not control “numerous other cases,” because a state court cannot invalidate patents and a state court’s decision would not be precedential in a district court. Id. at *16-19.  The third factor also weighed against a substantial federal issue since the federal government has no direct interest in a fact-specific contract dispute between private parties. Id. at *26.

Lastly, the fourth element of the Gunn test went against finding a federal question because exercising federal jurisdiction would disrupt the federal-state balance. Id. at *27.  The court characterized the embedded patent issues as “run-of-the-mill” questions of infringement and invalidity, such that finding a federal question would open the door to a federal jurisdictional hook in almost any case involving a state law claim. Id. at *28.

Accordingly, the Federal Circuit found that the district court lacked subject matter jurisdiction, and as such, the district court’s judgment was vacated and the case was remanded for dismissal. Id. at *32.

TAKEAWAY:  Both parties appeared to expect or desire the case to be heard in federal court at least at some point in the process, where the plaintiff originally filed the suit in federal court and, after jurisdictional questions arose on appeal, the defendant argued in favor of the federal courts retaining jurisdiction over the case.  Nevertheless, federal jurisdiction did not exist.  Thus, parties should be aware that cases involving only state law causes of action may be viable only in state court even when patent issues are implicated.  Therefore, forum selection clauses may be of value in patent license agreements so that the case is heard in a favorable state when a controversy arising from the agreement does not create a federal question.