First published in LES Insights

Agreements transferring ownership of intellectual property typically address whether the seller will retain any right to use the transferred intellectual property. Generally, if the seller desires to retain such a right it will take the form of an explicit license or reservation in the agreement. One might assume then that the absence of such a license would be similar to a prohibition on the future use of such intellectual property. But as illustrated by a recent Federal Circuit case, the absence of such a license may not always be the same as an express contractual promise not to continue using the transferred intellectual property.

In Energy Recovery, Inc. v. Hauge,1 the Federal Circuit reversed the district court's decision that found the defendant in contempt of an earlier court order related to a settlement agreement between the parties. The Federal Circuit held that the district court abused its discretion when it held that the defendant's use of plaintiff's manufacturing processes violated provisions of an earlier court order transferring intellectual-property rights from the defendant to the  plaintiff.

Background

In 2001, Mr. Hauge and Energy Recovery, Inc. ("ERI") settled a dispute on the ownership of IP rights related to "pressure exchangers"—energy-recovery devices used in reverse osmosis. The agreement, adopted in a 2001 court order, obligated Mr. Hauge to transfer ownership in several U.S. patents and patent applications, and "all other intellectual property and other rights relating to pressure exchanger technology" predating the agreement (and the 2001 order) to ERI. The agreement also included a noncompete clause prohibiting Mr. Hauge from making or selling pressure exchangers for two years from the agreement's date.

After the noncompete clause expired, Mr. Hauge filed a provisional application for a pressure exchanger, an application that later issued as a patent. Through his newly formed company, Isobaric Strategies, Inc., Mr. Hauge offered to involve ERI in a project related to "pressure exchanger technology." ERI declined the offer. Soon after, Mr. Hauge hired two former ERI employees to set up Isobarix's manufacturing facility and began selling a pressure exchanger (the "XPR pressure exchanger") based on his new patent.

ERI filed a Motion for Order to Show Cause, accusing Mr. Hauge of violating the 2001 order by using ERI's proprietary technology in manufacturing the XPR pressure exchanger. After a hearing, the court issued a contempt order, finding that Mr. Hauge had violated the 2001 order, enjoining him and Isobarix from manufacturing and selling pressure exchangers, and awarding ERI attorneys' fees. The court reasoned that allowing Mr. Hauge to "develop new products using the very technology he assigned to ERI solely because those new inventions post-date the Agreement would render the Settlement Agreement and its assignment of ownership rights useless."

The Energy Recovery Decision

On appeal, the Federal Circuit, applying Fourth Circuit law on contempt proceedings, noted that a district court's decision on a civil-contempt motion is reviewed for abuse of discretion. The Court further explained that a finding of civil contempt requires, among other things, clear and convincing evidence "that the alleged contemnor by its conduct violated the terms of the decree, and had knowledge (at least constructive knowledge) of such violations."

At issue in this case, the Court stated, was whether Mr. Hauge's conduct violated any terms of the 2001 court order. According to ERI, Mr. Hauge's conduct violated the clause of the agreement relating to the transfer of "all other intellectual property and other rights relating to pressure exchanger technology predating" the 2001 order. The Federal Circuit disagreed, finding that Mr. Hauge's manufacture of the XPR pressure exchanger did not conflict with the 2001 order's requirement to transfer all intellectual property and other rights predating that order. Although Mr. Hauge's use of ERI's manufacturing processes "may be in violation of patent laws or state trade secret laws," the Court reasoned, the use was "not in violation of any unequivocal command in the 2001 order." Here, the district court had determined that a patent-infringement analysis was unnecessary "because it was Mr. Hauge's use of ERI's allegedly proprietary manufacturing processes that was problematic, not the patented pressure exchanger technology."

Although Mr. Hauge's hiring of two ERI employees might constitute trade-secret misappropriation, the Court held, the conduct did not violate any provision of the 2001 order. Explaining that "the resultant decree embodies as much of those opposing purposes as the respective parties have the bargaining power and skill to achieve," the Court concluded that "the scope of a consent decree must be discerned within its four corners, and not by reference to what might satisfy the purposes of one of the parties to it."

Strategy and Conclusion

The Energy Recovery decision illustrates that the challenges of drafting a settlement agreement (and any related court order) that unequivocally reflect the parties' goals. It also demonstrates that if a purchaser of intellectual property wants to contractually prohibit the seller from using certain technology, it can be helpful to include an express promise to that effect in the agreement. Otherwise, the remedies available for unauthorized use of the technology after the date of transfer may be limited to those under the intellectual property laws.