Supreme Court Update: Wellness International Network, Ltd. v. Shariff (13-935); Commil USA, LLC v. Cisco Systems, Inc. (13-896) and Kellogg Brown & Root Services, Inc. v. United States ex rel Carter (12-1497)

May 31, 2015 Supreme Court Update

Greetings, Court fans!

This past week the Court released important decisions in the areas of bankruptcy law (Wellness International Network, Ltd v. Shariff (13-935), patent law (Commil USA, LLC v. Cisco Systems, Inc. (13-896), and the False Claims Act (Kellogg Brown & Root Services, Inc. v. United States ex rel Carter (12-1497). Let's get right to it.

The rapper 50 Cent was not the only force making waves in the world of bankruptcy law this week. The Supreme Court also weighed in with a hefty decision on the jurisdiction of the country's bankruptcy courts. In Wellness Int'l Network, Ltd. v. Sharif (No. 13-935), the Court dialed back some earlier decisions limiting the authority of bankruptcy judges and held that, where the parties knowingly and voluntarily consent to adjudication by a bankruptcy judge, Article III of the Constitution is not offended by the bankruptcy judge's deciding matters ordinarily entitled to an Article III adjudication.

Article III provides that "[t]he judicial Power of the United States, shall be vested in one supreme Court, and in such inferior Courts as the Congress may from time to time ordain and establish." In addition to district and circuit courts, Congress has—through the Bankruptcy Act of 1978—established bankruptcy courts, which are empowered to "hear and determine" core bankruptcy proceedings, and also to submit proposed findings of fact and conclusions of law to district judges in "non-core" proceedings. The judges of these courts, however, are not entitled to the Article III protections of life tenure and irreducible pay. For this reason, in a series of cases culminating in Stern v. Marshall (2011), the Court has held that it violates Article III for certain claims, now called "Stern claims," to be adjudicated by a bankruptcy judge. Last term, in Executive Benefits Insurance Agency v. Arkison (2014), the Court held that Article III is not offended by a preliminary ruling by a bankruptcy judge so long as a district judge subsequently enters judgment after de novo review. Sharif concerned whether Article III is also satisfied if the parties consent to judgment by a bankruptcy judge.

When Richard Sharif declared Chapter 7 bankruptcy in 2009, one of his creditors, Wellness International, filed an adversary complaint against him in the Bankruptcy Court, objecting to the discharge of his debts because he had concealed assets by claiming they belonged to a trust, which Wellness alleged was an alter ego. In his answer, Sharif conceded that the adversary proceeding was a "core proceeding" and requested that the Bankruptcy Court enter judgment in his favor. Ultimately, as a sanction for repeated discovery violations, the Bankruptcy Court entered judgment against Sharif, including a declaration that the trust was his alter ego and therefore its assets were the assets of the bankruptcy estate. Sharif appealed to the District Court, but before he filed his opening brief, the Supreme Court decided Stern, in which it held that Article III prevents bankruptcy courts from entering final judgment on claims (like Wellness's declaratory judgment claim) that seek only to "augment" the bankruptcy estate. The District Court affirmed the Bankruptcy Court's judgment, but the Seventh Circuit reversed, holding that the Bankruptcy Court's order violated Stern and that the Bankruptcy Court lacked constitutional authority to enter a final judgment on the declaratory-judgment count.

The Court reversed right back, in a 6-3 decision authored by Justice Sotomayor, which turned primarily on her pragmatic observation that "it is no exaggeration to say that without the distinguished service of [bankruptcy judges], the work of the federal justice system would grind nearly to a halt." As Sotomayor noted, the right to adjudication before an Article III judge is personal and therefore subject to waiver in most cases. Where Article III's "structural interests" relating to the separation of powers are implicated, parties cannot cure the constitutional defect by consent. However, the practice of allowing Bankruptcy Courts to decide "Stern claims" on consent would not, practically speaking, "impermissibly threaten the institutional integrity of the Judicial Branch." District Courts retain great control over bankruptcy judges, who "serve as judicial officers of the United States district court" and may be removed at any time for cause. Bankruptcy courts decide matters only upon referral from the district court and possess no separate authority to decide Article III claims. "So long as [bankruptcy] judges are subject to control by the Article III courts, their work poses no threat to the separation of powers." Moreover, in this case, unlike in Stern itself, there was no doubt that both parties consented to the resolution of the declaratory judgment count by the bankruptcy court. Sotomayor concluded that reading Stern to prevent bankruptcy judges from deciding issues on consent would seriously disrupt the bankruptcy system and could significantly harm the efficiency of the federal judiciary as a whole. That would be inconsistent with Stern majority's insistence that Stern would "not change all that much" about the division of labor between district and bankruptcy courts. Having concluded that a Stern objection can be adjudicated by a bankruptcy court on consent, and that such consent need not be express, the Court remanded for consideration of whether Sharif had evinced the requisite knowing and voluntary consent through his actions.

Justice Alito joined the majority opinion in part, analogizing the consent of parties to have a bankruptcy judge decide Stern claims to the consent of parties to arbitration. "No one believes that an arbitrator exercises ‘[t]he judicial Power of the United States' in an ordinary, run-of-the mill arbitration. And whatever differences there may be between an arbitrator's ‘decision' and a bankruptcy court's ‘judgment,' those differences would seem to fall within the Court's previous rejection of ‘formalistic and unbending rules.'" He differed with the majority, however, in that he felt there was no need to reach the question whether consent may be implied, since Sharif had waived any argument that he had not consented to the bankruptcy court's adjudication of the claim.

The Chief Justice authored the principal dissent, joined by Justice Scalia and, in part, by Justice Thomas. But even the dissenters would not have ruled in Sharif's favor in this particular case. As the Chief put it, the declaratory judgment claim at issue here clearly "stems from the bankruptcy itself" and therefore, even under the Court's prior, restrictive precedent, "Article III poses no barrier to such a decision." In other words, this wasn't really a Stern claim to begin with. Roberts lamented that the majority nevertheless went further to decide "whether private parties may consent to an Article III violation." In this respect, the dissenters rejected the majority's view that pragmatic considerations can justify an Article III violation that implicates structural concerns regarding the separation of powers.

Justice Thomas authored a separate dissent, emphasizing that the majority's view that few "structural interests" are implicated by consent to the adjudication of Stern claims is beside the point: "It matters not whether we think the particular violation threatens the structure of our Government. Our duty is to enforce the Constitution as written, not as revised by private consent, innocuous or otherwise." Therefore, to the extent a bankruptcy court's adjudication of a Stern claim really violates Article III, it doesn't matter whether the parties consent to it; the constitutional separation of powers is nevertheless offended. The more difficult question, Thomas argued, was whether it violates Article III in the first place for a bankruptcy court to adjudicate a Stern claim with the consent of the parties. Not quite answering his own question, Thomas suggested that Stern claims might be constitutionally adjudicated by bankruptcy courts to the extent they resemble "public rights," rather than "private rights," as public rights have traditionally been amenable to adjudication by non-Article III courts. Although many or most Stern claims will involve private rights, Thomas theorized that party consent "may have the effect of lifting [the] ‘private rights' bar, much in the way that waiver lifts the bar imposed by the right to a jury trial." Ultimately, Thomas concluded that whether parties may consent to bankruptcy court adjudication of Stern claims is in fact a much more difficult question than either the majority or principal dissent had engaged; he therefore would have resolved the case on the narrow grounds the Chief recommended—namely, concluding that the claim at issue in this case was not a Stern claim to begin with.

Moving from bankruptcy law to patent law, a majority of the Court again took the pragmatic view in deciding Commil USA v. Cisco Systems (13-896), holding that a defendant's good-faith belief that a patent is invalid is not a defense to liability for inducing patent infringement.

Commil sued Cisco, alleging that Cisco directly infringed one of its patents by manufacturing and selling certain networking equipment and induced others to infringe the patent by selling its infringing equipment for them to use. To defend against the inducement claim, Cisco sought to introduce evidence that it had a good-faith belief that Commil's patent was invalid, and thus it did not knowingly induce infringement. The district court precluded this evidence as irrelevant, and charged the jury that Cisco was liable for inducement if it knew or "should have known" that the induced acts constituted infringement. The jury returned a verdict for Commil on its inducement claim and on its direct infringement claim.

While Cisco's appeal was pending, the Supreme Court decided Global-Tech Appliances v. SEB S.A. (2011), which held that a plaintiff prosecuting an inducement claim must show that the defendant both knew of the allegedly infringed patent and knew that the acts it allegedly induced infringed the patent. (Thus, if the defendant was aware of the patent but believed its own product fell outside of patent's scope, an inducement claim could not succeed.) Relying on Global-Tech, the Federal Circuit vacated the jury's verdict for Commil and remanded for a new trial. The Federal Circuit reasoned that the district court erred in charging the jury that it could rule for Commil if Cisco "should have known" the acts infringed – as opposed to requiring actual knowledge. In addition, the Federal Circuit concluded that because only a valid patent can be infringed, if the defendant genuinely believes that a patent is invalid, the defendant cannot "know" that the induced acts constitute patent infringement. The District Court thus erred in excluding evidence of Cisco's good faith belief that the patent was invalid.

The Supreme Court reversed, 6-3. Writing for the majority, Justice Kennedy first rejected the argument advanced by Commil and the U.S. as amicus that Global-Tech required a plaintiff to demonstrate only that the defendant knew of the existence of the patent and not that the defendant knew that the induced acts constitute infringement. Both the majority (save Thomas) and dissent agreed that the latter requirement was central to the outcome of Global-Tech. Thus, to be liable for induced infringement, the defendant must know that acts induced would infringe the patent's claims. But the majority nevertheless agreed with Commil that even though a defendant must know that the induced acts constitute infringement, a good-faith belief in the invalidity of a patent is not a defense to a claim for inducement. The majority noted that infringement and validity have long been treated as separate issues in patent law, with different burdens, presumptions, and evidence pertaining to each. Chief among them, patents have a strong presumption of validity, which the defendant can only rebut with clear and convincing evidence. If belief of invalidity were a defense to inducing infringement, the force of this presumption would be greatly reduced because the defendant could avoid liability without offering clear and convincing evidence of invalidity. Moreover, someone who believes a patent is invalid already has several mechanisms to secure rulings to that effect, including via petitioning the Patent and Trademark Office or by filing a declaratory judgment action or raising invalidity as an affirmative defense to infringement. Given these distinctions between validity and infringement, the majority concluded that a good faith belief in patent invalidity is not a defense to inducing infringement.

Recognizing that its ruling would potentially expose businesses to greater risks from patent suits, the Court took a moment to call out "patent trolls" (entities that own patents not to innovate or make use of inventions but to litigate sometimes frivolous patent lawsuits in an effort to exact licensing fees). The Court noted that there was no issue of frivolousness here, but that lower courts "have the authority and responsibility to ensure frivolous cases are dissuaded," suggesting that Rule 11 can be used to sanction attorneys bringing such suits which impose "‘a harmful tax on innovation.'"

Justice Scalia, joined by the Chief, dissented in a short opinion. He agreed with the straightforward reasoning of the Federal Circuit: Since only valid patents confer exclusive rights, one can only infringe a valid patent. "To talk of infringing an invalid patent is to talk nonsense." And if, as Global-Tech held, a defendant must know both of the existence of the patent and that the induced acts constitute infringement, a defendant cannot "know" that the induced acts constitute infringement if the defendant believes in good faith that the patent is invalid.

Finally, the Court's unanimous decision in Kellogg Brown & Root Services, Inc. v. United States ex rel Carter (12-1497) handed a mixed result to False Claims Act ("FCA") litigants. Led by Justice Alito, the Court tackled two hotly debated issues: (1) whether the Wartime Suspension of Limitations Act ("WSLA") applies to toll the statute of limitations for civil qui tam suits under the FCA; and (2) whether the first-to-file bar forever precludes a later-filed action or only bars subsequent suits while it remains pending.

Analyzing the text and history of the WSLA, the Court first concluded that it only tolls the limitations period for bringing criminal charges and does not apply to civil whistleblower suits under the FCA. The precursors to the current WSLA were passed in connection with the First and Second World Wars and were explicitly limited to offenses "now indictable under any existing statutes." There is thus no debate that these versions applied only to criminal charges and not civil suits. In 1944, Congress amended the WSLA to make it prospectively applicable to future wartime frauds (rather than being tied to a certain point in time), but continued to discuss these frauds in terms of "offenses." In doing so, Congress removed the phrase "now indictable under existing statutes." While respondent argued that the removal of this language signaled an intent to expand the scope of the WSLA to include civil frauds, the Court found it more likely that Congress's intent was simply to ensure that the WSLA covered any future criminal fraud statutes, rather than be limited to those existing at the time the law was enacted. The fact that the WSLA continued to speak in terms of "offenses" – a term generally used to convey crimes – and that Congress chose to codify the WSLA in Chapter 18 (which covers criminal laws and procedures) was enough to convince the Court that the WSLA does not cover civil fraud suits. This is a significant ruling, particularly in an era of a "war on terror," which does not appear to have any end in sight. Qui tam litigants had been arguing that the limitation period on FCA suits was thus tolled virtually indefinitely. The Court's ruling now puts a kibosh on these arguments and provides some added certainty for those dealing with the government.

However, the Court's decision was not a clean win for the FCA defense bar. In the second part of the Court's opinion, the Court considered the scope of the first-to-file bar, which provides that "[w]hen a person brings an action . . . no person other than the Government may intervene or bring a related action based on the facts underlying the pending action." Many courts had concluded that this provision bars any successive qui tam suits once an initial suit has been filed, even if the original suit is ultimately dismissed. The Court didn't tarry long on this issue. While recognizing that allowing repetitive suits on the same issues could raise policy problems, it concluded that "pending" means "pending." Therefore, the first-to-file bar only precludes a second suit while a prior suit remains pending. The Court did not address whether claim preclusion principles will protect defendants if the prior suit has been decided on the merits (or settled). Shrugging its shoulders, the Court stated: "The False Claims Act's qui tam provisions present many interpretive challenges, and it is beyond our ability in this case to make them operate together smoothly likely a finely tuned machine."

The Court also added two criminal cases to its docket for next Term:

Foster v. Humphrey (14-8349), which asks: "Did the Georgia courts err in failing to recognize race discrimination under Batson in the extraordinary circumstances of this death penalty case?"

Lockhart v. United States (14-8358), on "[w]hether § 2252(b)(2)'s mandatory minimum sentence is triggered by a prior conviction under a state law relating to ‘aggravated sexual abuse' or ‘sexual abuse,' even though the conviction did not ‘involv[e] a minor or ward'"?

Tomorrow's the first day of June, so we'll be back in you inboxes soon . . .