Supreme Court Update: Erica P. John Fund, Inc., v. Halliburton Co. (09-1403), General Dynamics Corp. v. United States (09-1298), Global-Tech Appliances, Inc. v. SEB S.A. (10-6) and Order List

June 13, 2011 Supreme Court Update

Greetings, Court fans!

Congratulations are in order for new Solicitor General Donald Verrilli. The former Deputy White House Counsel was confirmed by the Senate, 72-16, this past week. News outlets reported that Verrilli was quietly sworn in Thursday afternoon so that he could get to work, with a more formal ceremony to follow.

Now, back to our regularly scheduled program of cases. Today, we bring you a trio of decisions of interest across the business community: Erica P. John Fund, Inc. v. Halliburton Co. (09-1403), for public companies facing securities class actions; General Dynamics Corp. v. United States (09-1298), for defense contractors entering into contracts with the Government that may implicate state secrets; and Global-Tech Appliances, Inc. v. SEB S.A. (10-6), for patent holders (and alleged infringers).

In the closely-watched case of Erica P. John Fund, Inc. v. Halliburton Co. (09-1403), the Court held that plaintiffs need not prove loss causation to obtain class certification in securities fraud cases. Loss causation refers to the requirement in securities fraud cases that a defendant's deceptive conduct – as opposed to other factors, e.g., a market downturn – caused investors' claimed economic losses. There is no dispute that securities fraud plaintiffs must prove loss causation to prevail on the merits. But the Fifth Circuit – in contrast with the Second, Third, and Seventh – required plaintiffs to prove loss causation at the class certification stage. Following Fifth Circuit precedent, the District Court in this case refused to certify a class under Federal Rule of Civil Procedure 23(b)(3).

Led by the Chief, the Court swiftly and unanimously rejected the Fifth Circuit's approach. To certify a class under Rule 23(b)(3), a court must find that common questions of law or fact predominate over questions affecting individual class members. In securities fraud cases, whether common questions of law or fact predominate often turns on the element of reliance. Traditionally, a plaintiff alleging fraud must prove that he was aware of a statement that turned out to be false, and that he relied on that misrepresentation. Under Basic v. Levinson (1988), however, securities fraud plaintiffs need not submit individualized proof of reliance. Instead, they may invoke a rebuttable presumption of reliance based on the "fraud-on-the-market" theory; i.e., that misrepresentations disseminated into an efficient market are reflected in the market price transmitted to, and relied upon by, investors. To invoke the fraud-on-the-market presumption of reliance, plaintiffs must show that the misrepresentations were publicly known, that the stock traded in an efficient market, and that the relevant transaction took place between the time of the misrepresentation and when the truth was revealed. The Fifth Circuit would add another requirement to trigger the fraud-on-the-market presumption of reliance at the class certification stage: loss causation. The Court flatly rejected the Fifth Circuit's approach. Loss causation has no place in the analysis of reliance and predominance at the class certification stage: "The fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation has nothing to do with whether an investor relied on the misrepresentation in the first place, either directly or presumptively through the fraud-on-the market theory."

Interestingly, Halliburton conceded at oral argument before the Court that securities fraud plaintiffs should not be required to prove loss causation for class certification. Halliburton tried a different tack. It argued that the Fifth Circuit did not really mean "loss causation" when it said loss causation was required; instead, the Fifth Circuit was using "loss causation" as shorthand for "price impact," as in, plaintiffs must show that the alleged misrepresentations affected the market price in the first place. The Court rejected Halliburton's "wishful interpretation of the Court of Appeals' opinion." Loss causation is an established concept in securities law, and it does not refer to price impact. That being said, it will be interesting to see if Halliburton's price impact theory opens a new front in the securities class action wars. The Chief closed by noting that the Court was not addressing at this time "any other question about Basic, its presumption, or how or when it may be rebutted."

Our next case, General Dynamics Corp. v. United States (09-1298), involves a very large government contract gone very awry. In 1988, the Navy awarded petitioners General Dynamics and Boeing a $4.8 billion (yes, billion) contract to develop the A-12 stealth aircraft. Petitioners soon ran behind schedule and over budget, and the Navy terminated the contract for default in early 1991. By that point, petitioners had spent $3.88 billion on development, and the Government had paid only $2.68 billion in progress payments. Petitioners challenged the Navy's termination decision in the Court of Federal Claims, arguing that the Government's failure to share its "superior knowledge" about how to design stealth aircraft excused their default. Under Federal Circuit precedent, the Government has an obligation not to withhold its "superior knowledge" of difficult-to-discover information "vital" to contractual performance. During discovery on the superior knowledge argument, deposition witnesses inadvertently revealed military secrets. The Acting Secretary of the Air Force submitted a declaration to the Court of Federal Claims, warning that further discovery "would pose unacceptable risks of disclosure" of state secrets. The court thereafter terminated discovery relating to superior knowledge. After several more years in the courts, including a 6-week trial and three trips to the Federal Circuit, the petitioners were found to have defaulted.

The Court reversed, 9-0, in a measured – we might even say subdued – opinion by Justice Scalia. The Court did not question the Government's authority to invoke the state secrets privilege, or the Court of Federal Claim's decision to cut off further discovery on petitioners' "superior knowledge" defense. But the Court did not think it would be fair to impose liability on petitioners – who had a facially plausible superior knowledge defense – when the state secrets doctrine precluded them from proving the defense. Instead, the Court held that "where liability depends upon the validity of a plausible superior-knowledge defense, and when full litigation of that defense would ‘inevitably lead to disclosure of' state secrets . . . neither party can obtain judicial relief." Under the common law, when a court refuses to aid a contractual promisee on grounds of public policy, the court will leave both parties as it finds them – even though this may result in one of them retaining a benefit. Here, the Government wanted petitioners to return $1.35 billion in progress payments for unaccepted work. One of the petitioners, in turn, wanted the termination to be converted into a less Government-friendly termination for convenience, and to be awarded $1.2 billion in damages. The Court would instead "leave the parties where they are," producing "rough, very rough, equity." And although "neither side will be entirely happy" with their treatment in this case, the Court was confident that its decision would provide more predictability for future government contracts. The Court dismissed the Government's concern that contractors would raise frivolous superior-knowledge defenses to goad the Government into asserting the state-secrets privilege. The defense contractors likely to operate in the state-secrets field are repeat players, and therefore have "strong incentive to behave."

The Court achieved near-unanimity in our last case, Global-Tech Appliances, Inc. v. SEB S.A. (10-6), concerning an "innovative deep fryer" designed for home use. SEB developed and obtained a U.S. patent on its design in 1991. In 1997, a U.S. competitor of SEB asked Hong-Kong based petitioner Pentalpha Enterprises (a subsidiary of petitioner Global-Tech) to supply it with deep fryers meeting certain specifications. Pentalpha simply purchased an SEB fryer in Hong Kong and copied all but its cosmetic features. Pentalpha then began to supply SEB competitors with lower-cost fryers, undercutting SEB in the market. SEB sued Pentalpha for, inter alia, actively inducing others to infringe on SEB's patent by selling Pentalpha's fryers, in violation of 35 U.S.C. §271(b). Section 271(b) provides that "Whoever actively induces infringement of a patent shall be liable as an infringer." The jury found for SEB after a 5-day trial. Pentalpha sought to overturn the verdict on the ground that it did not actually know of SEB's patents. The District Court and Federal Circuit rejected that argument. The Federal Circuit held that deliberate indifference to a known risk that a patent exists is sufficient to establish inducement under §271(b).

The Court disagreed with the deliberate indifference standard, but affirmed on alternate grounds. Justice Alito wrote for all but Justice Kennedy. Acknowledging that there was "no definitive answer in the statutory text," the Court based its decision on precedent concerning an adjacent provision, §271(c). Prior to the enactment of the Patent Act of 1952, the case law imposed liability for "contributory infringement," i.e., aiding and abetting direct infringement by another party. The Patent Act of 1952 separated the concept of contributory infringement into two categories: §271(b) covered "actively induc[ing] infringement," while §271(c) covered selling a material component of a patented invention "knowing the same to be especially made or especially adapted for use in an infringement of such patent, and not a staple article or commodity of commerce suitable for substantial noninfringing use." In Aro Mfg. Co. v. Convertible Top Replacement Co. (1964), known as Aro II, a closely divided Court held that knowledge of the patent was needed under §271(c). Aro II's holding is such a fixture in the law that not even SEB asked the Court to overrule it. Given the common origin of §271(b) and (c), it would be "strange" to hold that knowledge was needed under §271(c) but not §271(b).

Pentalpha was hardly off the hook, however. Even if knowledge is required under §271(b), it may be satisfied by a showing of willful blindness. The rationale behind the willful blindness doctrine is that persons who "know enough to blind themselves" to direct proof of critical facts are just as culpable as those who have actual knowledge. The Court looked to the "long history of willful blindness" in the criminal context, and could "see no reason why the doctrine should not apply in civil lawsuits for induced patent infringement." Applying the doctrine in this case, the Court found that the jury could have easily found that Pentalpha (i) subjectively believed that there was a high probability that the fryer it copied was covered by a patent, and (ii) took deliberate actions to avoid learning of that fact. Specifically, Pentalpha's CEO John Sham (a very unfortunate name under these circumstances) was well aware that the SEB fryer Pentalpha bought to copy in Hong Kong would not have U.S. patent markings because it was made for an overseas market. And in seeking a right-to-use opinion letter from an attorney, Sham tellingly decided not to inform the attorney that Pentalpha had copied someone else's fryer. The Court therefore affirmed the judgment against Pentalpha on the alternate ground of willful blindness.

Justice Kennedy was the lone dissenter. In his view, the Court erred in permitting willful blindness to suffice for a showing of knowledge under §271(b). First, it is not at all clear that someone who is willfully blind is as culpable as someone who has actual knowledge. For example, what of the difference between a lawyer who avoids learning whether his client is lying when he testifies he was not the shooter, and a lawyer who knowingly suborns perjury? Second, the Court should not take the step of appearing to endorse the willful blindness doctrine for all criminal cases for the first time in a civil case, where it has received no briefing or argument from the criminal defense bar. In this case, Kennedy would have remanded to the Court of Appeals to determine in the first instance whether there was sufficient evidence, including circumstantial evidence, that Pentalpha had actual knowledge of SEB's patent.

We should also report that the Court has granted cert in the following cases:

Kurns v. Railroad Friction Products Corp. (10-879), which asks whether Congress intended the Federal Railroad Safety Act to preempt state law tort lawsuits.

Martinez v. Ryan (10-1001), presenting this question for review: "Whether a defendant in a state criminal case who is prohibited by state law from raising on direct appeal any claim of ineffective assistance of trial counsel, but who has a state-law right to raise such a claim in a first post conviction proceeding, has a federal constitutional right to effective assistance of first post-conviction counsel specifically with respect to his ineffective-assistance-of trial-counsel claim."

Barion v. New Hampshire (10-8974), which asks the Court to mull this issue: "When a witness in a criminal case identifies a suspect out-of-court, under suggestive circumstances which give rise to a substantial likelihood of later misidentification, due process requires the trial judge to determine whether the out-of court identification and any subsequent in-court identification are reliable before either may be admitted into evidence." Barion asks whether "the due process protections against unreliable identification evidence apply to all identifications made under suggestive circumstances . . . or only when the suggestive circumstances were orchestrated by the police."

Finally, the Court asked for the new SG's views on the cert petitions in the following cases:

Ryan v. Gonzales (10-930), which would ask whether the Ninth Circuit erred "when it held that 18 U.S.C. § 3599(a)(2) -- which provides that an indigent capital state inmate pursuing federal habeas relief ‘shall be entitled to the appointment of one or more attorneys' - impliedly entitles a death row inmate to stay the federal habeas proceedings he initiated if he is not competent to assist counsel?"

Farina v. Nokia, Inc. (10-1064), which would ask "whether state-law claims premised on cell phone companies' misrepresentations regarding the safety of their products are impliedly preempted because they frustrate the purposes" of the radio frequency radiation standard set by the Federal Communication Commission, which includes two further questions: (i) "Whether a regulation based on authority conferred by a statute that explicitly disclaims any implied preemptive effect can impliedly preempt state law on a ‘frustration of purpose' theory of preemption;" and (ii) "Whether an agency's [National Environmental Policy Act] regulation, which imposes no substantive requirements, may preempt substantive state health, safety, or consumer-protection laws."

With that, we'll sign off for now. As always, thanks for reading!

Kim and Jenny

From the Appellate and Complex Legal Issues Practice Group at Wiggin and Dana. For more information, contact Kim Rinehart or any other member of the Practice Group at 203-498-4400