Two Federal Preemption Cases, One Consistent Outcome

Two recent decisions from the Fourth and Fifth Circuits—with similar outcomes—have contributed further guidance and consistency on the issue of federal preemption with respect to state law claims pertaining to conversion and computer fraud, as well as unfair competition. 

Both circuits explained that federal preemption, as it applies to federal intellectual property laws, is intended to maintain balance by preventing states from offering intellectual property protections that the federal Copyright or Patent Acts do not provide. Citing § 301 of the Copyright Act, both courts examined the facts of their respective cases under the Act’s two-pronged inquiry to determine when a state law claim is preempted. First, the work at issue must be within the scope of the subject matter of copyright. If it is, then a state-law claim is preempted if the rights granted thereunder are equivalent to those protected by federal copyright. 

OpenRisk v. MicroStrategy Services

The US Court of Appeals for the Fourth Circuit addressed the issue of whether the federal Copyright Act preempted a plaintiff’s state law claims arising from the copying and transfer of certain computer data. In finding such claims preempted, the Court affirmed the district court’s grant of summary judgment in favor of the defendant. OpenRisk, LLC v. MicroStrategy Services Corporation, Case Nos. 16-1852; -4906 (4th Cir., Nov. 13, 2017) (Harris, J).

OpenRisk, a startup company, contracted with MicroStrategy for cloud computing and hosting services in relation to OpenRisk’s data and programming. Shortly thereafter, OpenRisk faced insolvency, and three of OpenRisk’s principal officers resigned and started their own company, Spectant Group LLC. The next year, OpenRisk sued MicroStrategy in district court in Virginia, claiming conversion and computer fraud under state law based on allegations that MicroStrategy had copied and transferred OpenRisk’s data from the MicroStrategy cloud to a new cloud environment created for Spectant. After close of discovery, the district court granted MicroStrategy’s motion for summary judgment arguing that the federal Copyright Act preempted OpenRisk’s state law claims. OpenRisk appealed.

Starting with the two-prong preemption inquiry of § 301 of the Copyright Act, the court noted that there was no dispute as to the first prong since the materials in question (a computer program and associated data) fall within the subject matter of copyright. Thus, the case hinged on the second prong of the inquiry, i.e., whether the rights that OpenRisk wanted to protect under state law are “equivalent to the exclusive rights reserved to the owner of a copyright.” Finding that the unauthorized copying of a computer program falls squarely within the Copyright Act’s grant of exclusive rights to “reproduce” and “distribute” copies of a copyrighted work, the Court held that OpenRisk’s conversion and computer fraud claims were preempted.

The Court rejected OpenRisk’s arguments that the Virginia Computer Crimes Act upon which it based certain state law claims contains “extra elements” that save its case from preemption. The court explained that preemption may be avoided only when an extra element of a state law claim “changes the nature of the action so that it is qualitatively different from a copyright infringement claim.” Here, the Court found that the core of OpenRisk’s claim remains the unauthorized copying and transfer of its data, which is “equivalent to” a copyright infringement action and thus preempted.     

Motion Medical v. ThermoTek

Just one day after the Fourth Circuit’s OpenRisk decision, the US Court of Appeals for the Fifth Circuit granted judgment as a matter of law in favor of a defendant, finding the plaintiff’s unfair competition claim under Texas state law to be preempted by the federal Copyright and Patent Acts. Motion Medical Technologies, L.L.C., et al. v. ThermoTek, Incorporated, et al., Case No. 16-11381 (5th Cir., Nov. 14, 2017) (Higginson, J).  

ThermoTek, a medical device company, filed suit against its distributor, Mike Wilford, and his related companies in Texas state court for unfair competition after Wilford developed and sold a competing product for thermal and compression therapies that ThermoTek alleged was created with its proprietary information obtained by Wilford. Wilford removed the case to the Northern District of Texas, where a jury decided in favor of ThermoTek. Wilford then renewed a motion for judgment as a matter of law, arguing that federal copyright and patent law preempted ThermoTek’s state unfair-competition-by-misappropriation claim. The district court agreed and dismissed all claims in the matter.

On appeal, the Fifth Circuit examined whether Wilford waived the preemption argument by failing to plead the affirmative defense. The panel agreed with the district court findings (1) that Wilford raised the affirmative defense at a “pragmatically sufficient time” since the issue first arose at the summary judgment stage before discovery closed, which was nearly two years before trial, and (2) that ThermoTek was not prejudiced in its ability to respond.

Turning to the issue of whether federal copyright law preempted ThermoTek’s unfair-competition-by-misappropriation claim under Texas state law, the Fifth Circuit referred to the § 301 two-prong test. Regarding prong one, the Court quickly concluded that the misappropriated information, which included manuals, reports, billing information and other written documents, was “within the subject matter of copyright.” Moving on to prong two, the Court noted that it has “twice held that Texas’s unfair-competition-by-misappropriation tort does not afford protection qualitatively different from federal copyright law,” and thus affirmed the district court’s finding of copyright preemption.

On the question of patent preemption, the Fifth Circuit relied on the Supreme Court of the United States’ decision in Bonito Boats, since the issue of patent preemption with respect to the Texas unfair competition law was a novel question in the Fifth Circuit. Under Bonito Boats, the panel also affirmed the district court’s patent preemption ruling, explaining that to the extent a state law unfair competition claim seeks to protect functional aspects of ThermoTek’s products, that state law thereby offers patent-like protection that might otherwise be unavailable under federal law, and would likely “obstruct Congress’s goals.” 

Practice Note: As the circuits provide further detailed guidance on the issue of preemption, it is critical for parties on both sides of a matter to carefully examine state law claims to see if preemption can or should be addressed from an offensive or defensive position.