Judges: Newman (concurring-in-part and dissenting-in-part), Schall (author), Dyk

[Appealed from E.D. Tex., Judge Davis]

In ClearValue, Inc. v. Waggett, Nos. 07-1487, 08-1176 (Fed. Cir. Mar. 24, 2009), the Federal Circuit affirmed the district court’s decision to impose sanctions on appellants and affirmed the district court’s award of attorneys’ fees under Fed. R. Civ. P. 26 and 37 as to appellants, but reversed the sanction as to their attorney. The Federal Circuit also reversed the district court’s order striking appellants’ pleadings under Rule 37 and the court’s inherent powers. In addition, the Court reversed the district court’s entries of judgment in favor of appellees and appellees’ counterclaims, reversed the district court’s award of attorney’s fees and costs under the court’s inherent powers and under 35 U.S.C. § 285, and reversed the award of costs under 28 U.S.C. § 1920. The case was remanded for further proceedings.

The patent-at-issue, U.S. Patent No. 6,120,690 (“the ’690 patent”), relates to a process for clarifying wastewaters by using aluminum salts and/or aluminum polymers and newly formulated high molecular weight quaternized polymers. In particular, the patent claims required a “high molecular weight di-allyl di-methyl ammonium chloride (DADMAC) having a molecular weight of at least approximately 1,000,000.” Slip op. at 4 (emphasis omitted).

ClearValue, Inc. (“ClearValue”) and Richard Alan Haase (the sole inventor of the ’690 patent) filed suit against Pearl River Polymers, Inc. (“Pearl River”) and others for infringement and misappropriation of trade secrets. A critical issue in the case was whether Pearl River’s DADMACs had molecular weights over one million and thus fell within the scope of the claims of the ’690 patent. The district court issued a discovery order requiring the parties to provide all documents and reports that had been provided to or reviewed by the expert in anticipation of litigation.

During discovery, Pearl River requested that ClearValue and Haase provide the results of any molecular weight testing they had conducted on Pearl River’s DADMAC products. ClearValue and Haase objected to the discovery requests on various grounds and did not produce any documents relating to testing. During the jury trial, however, it became evident that ClearValue and Haase had in fact performed tests on Pearl River’s products. Two different tests revealed that samples of Pearl River’s products had molecular weights substantially below the one million limitation of the ’690 patent. None of the test results were produced to Pearl River.

The district court held a sanctions hearing and considered testimony from Haase, Jim Stoll (ClearValue’s expert), and Gordon Waggett (ClearValue’s attorney). At the hearing, the district court examined additional e-mails relating to the testing of the accused products. Both Haase and Stoll attempted to explain the failure to provide the test results, claiming they believed the tests were irrelevant because they were performed only to determine if an additive had caused a water treatment plant in Arkansas to malfunction. Attorney Waggett also claimed he had “a total disconnect” with respect to the testing, he was sorry for not producing the test results, and he now appreciated that he was obviously wrong. The district court found itself confronted with “an extremely troubling matter” as the withheld test results were relevant to a critical issue in the case and were withheld for over a year and a half. The district court imposed the “ultimate sanction” of striking ClearValue and Haase’s pleadings, entering judgment for appellees, and imposing monetary sanctions against ClearValue, Haase, and Waggett, jointly and severally, in the amount of $2,717,098.34.

The Federal Circuit first considered the district courts imposition of sanctions under Rules 26 and 37, and affirmed its finding of sanctionable conduct. The Federal Circuit noted that Rule 26 imposes on parties an affirmative obligation to disclose in discovery information “considered by testifying experts” and that Rule 37 gives a court authority to impose sanctions if a party fails to make a disclosure required by Rule 26(a). ClearValue, Haase, and Waggett argued that the decision to withhold the test results was not sanctionable because the results were not considered by expert Stoll in forming his opinions, and therefore neither Rule 26 nor the discovery order compelled disclosure of the testing. Specifically, they argued that Stoll had not been designated as an expert for purposes of infringement liability at the time of the testing and that Stoll had forgotten about the tests before giving his opinion. Since the results were not considered by expert Stoll, appellants reasoned that they must have been privileged and were properly withheld. Applying Fifth Circuit law, the Federal Circuit rejected these arguments, noting that there was more than ample support for the finding that appellants engaged in unjustified and sanctionable conduct. Furthermore, the district court did not err in finding the failure to disclose was not “harmless.”

The Federal Circuit next considered the district court’s award of attorney’s fees under Rule 37 and found no abuse of discretion in the award as to ClearValue and Haase. Appellees submitted affidavits as to the reasonableness of the attorney’s fees they incurred. Although the relatively sparse monthly breakdown of fees by attorney and claim were on the “lower end of the spectrum as to acceptable documentation,” the affidavits were nonetheless sufficient under Fifth Circuit precedent. Id. at 24.

The Federal Circuit did find, however, that the district court abused its discretion by imposing joint and several liability on Waggett under Rule 37. Specifically, the district court erred by failing to consider that Waggett did not have the ability to pay when it fashioned the sanction against him as required by the Fifth Circuit. Since the monetary award of $121,107.38 was four times Waggett’s reported annual net income, the district court found Waggett did not have the ability to pay and reversed the award of joint and several liability.

Next, the Federal Circuit held that the district court abused its discretion in striking ClearValue and Haase’s pleadings and entering judgment in favor of appellees. The Federal Circuit acknowledged that Rule 37 allows a court to strike pleadings and dismiss an action in whole or in part for discovery violations, but that the Fifth Circuit considers dismissal as a “remedy of last resort” and a “draconian” measure. Id. at 28. The Federal Circuit compared ClearValue, Haase, and Waggett’s discovery misconduct with the misconduct in two Fifth Circuit cases, where the sanction of dismissal was reversed. The Federal Circuit stated that although ClearValue, Haase, and Waggett’s discovery misconduct was sanctionable, it was less egregious than discovery violations in those cases and therefore did not warrant the sanction of dismissal.

The Federal Circuit then addressed the district court’s reliance on its inherent powers in striking ClearValue and Haase’s pleadings, entering judgment against appellants, and awarding additional attorney’s fees and costs. The Federal Circuit agreed with appellants that the district court should only resort to its inherent powers when “an applicable rule or statute cannot fulfill the purpose of the sanctioning authority.” Id. at 31. The Federal Circuit explained that appellants’ misconduct was a discovery violation that was properly addressed under Rule 37. Thus, the district court abused its discretion by resorting to its inherent powers to impose sanctions on appellants.

Lastly, the Federal Circuit reversed the district court’s award of attorney’s fees under 35 U.S.C. § 285 and its award of costs under 28 U.S.C. § 1920. Both § 285 and § 1920 have a “prevailing party” requirement. Because the Federal Circuit reversed the district court’s striking of ClearValue and Haase’s pleadings and its entries of judgment in favor of appellees, the appellees were no longer a prevailing party and not entitled to the awards.

In a separate opinion, Judge Newman concurred-in-part and dissented-in-part. Judge Newman agreed that the district court abused its discretion in failing to consider Waggett’s ability to pay when fashioning the sanction against him, but disagreed that Waggett should be exonerated based solely on his inability to pay. Specifically, Judge Newman explained that Waggett’s plea of hardship was raised in the context of the district court’s award of $2,717,098, but the Federal Circuit reduced the total award to $121,107, less than one twentieth of the original amount. Judge Newman dissented from the panel’s exoneration of the attorney from the monetary consequences of his admittedly improper actions and recommended that the matter be remanded to the district court.