Tag: Sanctions

EU Sanctions And The International Oil And Gas Industry

Andrews Kurth

The international oil and gas industry is continuously tasked with adapting to an ever evolving sanction-regulated environment. The level of sanction activity and implementation in recent years has been unprecedented, partly as a result of the political events which gave rise to the Arab Spring and the opposition to Iran’s nuclear programme. The recent crisis in the Ukraine, and associated sanctions against Russia, have sparked further debate around the need for effective, targeted punitive measures and the consequences they may have for Europe.

This article considers the EU’s sanction regime, explores the effect it has on international oil and gas companies and addresses the short-comings of the EU’s decentralised system.

What are sanctions?

Sanctions are political policy instruments used to encourage jurisdictions acting in contravention of international law to adopt standards supported by the wider global community. They impose measures designed to cause damage to the targeted government, non-state entity or individual (“Target”) in order to force it to undertake, or prevent it from undertaking, certain behaviour. They may inhibit the Target from accessing foreign markets for trade or deny it from pursuing financial and other forms of commerce. The professed ultimate objective of a sanction is to preserve or restore global peace and security.

What is the source of EU sanctions?

The UN Security Council imposes sanctions through Security Council resolutions which are binding on the EU. The EU implements all sanctions imposed by the UN Security Council through legislation enacted by the European Council. The process typically results in a European Council regulation which has direct effect in EU member states’ separate legal systems, creating rights and obligations for those subject to them, and overrides national law. Additionally, the EU may decide to impose self-directed sanctions or restrictive measures which go further than a UN Security Council resolution in circumstances in which the EU deems such action to be necessary.

Why do EU sanctions affect international oil and gas companies?

Over the past two decades, the EU has engaged in an active use of restrictive measures in the form of economic and financial sanctions, embargoes and restrictions on admission to a country. Economic and financial sanctions typically take the form of asset-freeze measures which involve the use of funds and economic resources by Targets or persons acting for and on behalf of Targets, and the provision of funds and economic resources to designated Targets. Embargoes may prohibit trade in certain goods, and activities relating to such trade, with Targets (including the flow of arms and military equipment). Visa or travel bans can be imposed preventing certain persons from entering the EU or transit through the territory of EU member states. These sanction measures are part of the EU’s strategy to support the specific objectives of the Common Foreign and Security Policy.

At the time of writing, the EU has announced asset freezes and travel bans against around twenty individuals in Russia and the Ukraine. Companies conducting their business in the oil and gas sector should be particularly vigilant to ensure they act in compliance with EU sanctions, as Ukrainian and Russian entities and individuals who operate in this industry may increasingly become sanction targets.

US sanctions are questionable under international law because they apply extra-territorially to third state parties involved in business activities with the Target. Unlike the US, the EU has refrained from adopting legislation with extra-territorial effect. However, the EU’s recent sanctions against Iran displayed a greater resemblance to those levied by the US than had previously been the case. For example, sanctions were imposed prohibiting the provision of key resources to various parts of the Iranian oil and gas industry, as well as the provision of financial services to that sector. As a result of EU financial sanctions most, if not all, banks and other financial institutions have declined from conducting any business relations with the Iranian regime.

It is clear that EU sanctions are wide reaching and their scope has a significant impact on business activities. They will apply to international oil and gas companies in the following situations:

  • within EU territory, including its airspace;
  • on board of aircrafts or vessels under the jurisdiction of an EU member state;
  • to EU nationals, whether or not they are in the EU;
  • to companies and organisations incorporated under the law of a member state, whether or not they are in the EU (this captures branches of EU companies in non-EU countries); and
  • to any business done in whole or in part within the EU.

The corporate behaviour, performance and conduct of international companies are powerful channels through which the objectives of sanctions against Targets are achieved. Since an international oil and gas company has little option but to observe EU sanctions to the extent such company falls within the EU’s jurisdiction, these restrictive measures are likely to play a big part in a company’s commercial decision making processes.

Why are EU sanctions difficult to manage?

A principal reason why EU sanctions are difficult for international oil and gas companies based in various EU member states to manage largely stems from the fact that the European Union lacks a centralised licensing body. Instead, the responsibility for implementing and enforcing EU sanctions is delegated to the relevant competent authorities of the EU member states. The potential for variance and discrepancy is rife in a system where there are twenty-eight EU member states, each with their individual national resource constraints and self-centred policy objectives.

Typically, the competent authorities of EU member states are responsible for:

  • granting exemptions and licences;
  • establishing penalties for sanction violations;
  • coordinating with financial institutions; and
  • reporting upon the implementation of sanctions to the European Commission.

There have been calls for a central EU licensing body which would produce a single licensing and exemption policy for EU member states. Although EU guidelines on sanctions and best practices for the effective implementation of restrictive measures go some way to plug the gap, arguably a more comprehensive regime for implementing sanctions is required to provide a better level of certainty to international businesses operating in the realms of the EU.

Managing the risks

International oil and gas companies have always had to function in politically active climates. As sanctions initiated by multilateral organisations such as the UN and EU become more fashionable, so too does the exposure to political risk that these companies will face. Given the considerable levels of investment that can only be recouped over extended periods of time, and in accordance with pre-determined contractual apportionments, international oil and gas companies need to be able to recognise, assess and manage these political risks effectively.

Oil and gas companies can relieve the risks imposed on them by sanctions through political lobbying, taking pre-emptive measures and by reacting quickly to sanctions once they are implemented. Commercial negotiations will need to focus on the allocation of risk as a result of one party’s failure to perform or withdrawal from the contract on the grounds of applicable sanctions.

International oil and gas companies need to be proactive and consider both the legal solutions and pre-cure safeguards. Time and effort should be spent focusing on drafting and negotiating the relevant contractual documentation, following a careful risk assessment, instead of deferring to dispute resolution provisions. For instance, careful construction of force majeure provisions can allocate each party’s obligations in the circumstance where an event outside of a party’s control causes contractual performance to become impossible. Thus, whilst conventional force majeure clauses relating to physical events afford relief to an affected party from its liabilities under the contract, oil and gas companies should consider expanding such contractual provisions to cover sanctions and other restrictive measures imposed on them by the UN and EU.

To avoid falling foul of existing EU sanctions, oil and gas companies should also consider putting in place comprehensive compliance procedures and systems to implement applicable sanction regimes. Penalties for breach of sanctions can be severe; a person guilty of a sanction-related offence may be liable on conviction to imprisonment and/or a fine. Falling foul of sanctions also means that a transaction can immediately become unlawful.

Conclusion

In view of the economic significance of the EU, the application of economic financial sanctions can be a powerful tool. But like a chain is no stronger than its weakest link, the effectiveness and success of the EU’s sanction regime depends on all EU member states applying, implementing and enforcing EU sanctions in a consistent manner.

The current EU sanction regime warrants a fully integrated approach which would undoubtedly benefit its policy objectives and move some way to reducing the unduly high economic cost that international oil and gas companies face when operating their businesses in the EU.

In voicing the sentiments of Henry Kissinger: “No foreign policy – no matter how ingenious – has any chance of success if it is born in the minds of a few and carried in the hearts of none”, perhaps now, in the dawn of the recent events which have taken place in the EU’s backyard in the Ukraine and Russia, the EU should further global security measures by tightening its ranks and implementing a more centralised, and better monitored, sanction regime.

Article By:

Rebecca Downes
Of:
Andrews Kurth

Office of Foreign Assets Control Publishes New Syria and Ukraine Sanctions Regulations; Designates Russian Bank For its Involvement in Syrian Unrest

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The U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) recently published a final rule amending and reissuing in their entirety the Syrian Sanctions Regulations (“SSR”), 31 C.F.R. Part 542. The reissued SSR contain six new general licenses, including one that authorizes the provision by a U.S. person or from the United States of services ordinarily incident to the supply to Syria of non-U.S. food, medicine, and medical devices that are non-sensitive in nature.

In addition, OFAC last week issued new Ukraine-Related Sanctions Regulations to implement executive orders that the Administration issued in March 2014, and designated a Russian bank (Tempbank) and the Chairman of its Management Committee (Mikhail Georgievich Gagloev) for providing material support and services to the Government of Syria.

Background on Syrian Regulations

Syria has been the target of U.S. economic sanctions since it was designated as a state sponsor of terrorism in 1979. The SSR, which first went into effect in April 2005, constitute one of the primary regulatory regimes that implements these sanctions. (The Commerce Department’s Export Administration Regulations (“EAR”) also broadly prohibit, absent licensing, exports and reexports to Syria of most items, other than food and non-sensitive medicines, that are of U.S.-origin or that incorporate more than de minimis U.S.-origin content.) Since the original issuance of the SSR in 2005, the Bush and Obama Administrations have issued executive orders broadening the U.S. sanctions against Syria by imposing new blocking measures and other trade restrictions. OFAC also has issued a number of general licenses authorizing certain otherwise prohibited transactions. These developments had created a complex patchwork of authorities imposing sanctions on Syria. OFAC’s overhaul of the SSR combines many of these authorities into a single, unified, and up-to-date set of regulations.

Incorporated Executive Orders

The reissued SSR, which went into effect on May 2, 2014, incorporate asset-blocking measures and other trade restrictions imposed under six executive orders issued between 2006 and 2012. As a result, Section 542.201 of the SSR now requires the blocking of all property and interests in property of the Government of Syria (including its agencies, instrumentalities, and controlled entities) that are or hereafter come into the United States or the possession or control of a U.S. person, as well as such assets of Specially Designated Nationals (“SDNs”) sanctioned because they were determined to have undertaken activities specified in the executive orders. U.S. persons may not transfer, pay, export, withdraw, or otherwise deal in such blocked property. Consistent with OFAC guidance with respect to numerous sanctions programs, SSR § 542.411 clarifies that if a person whose assets are blocked under Section 542.201 owns, directly or indirectly, a 50 percent or greater interest in an entity, that entity’s assets are also blocked even if that entity is not added to the SDN List.

The SSR also now contain certain other trade restrictions originally imposed by

Executive Order 13582 (effective August 18, 2011), which we discussed in our e-alert of August 19, 2011. These restrictions prohibit:

  • U.S. persons, wherever located, from making new investments in Syria (§ 542.206) ;
  • The export, reexport, sale, or supply, directly or indirectly, by a U.S. person or from the United States of any services to Syria (§ 542.207);
  • The importation into the United States of Syrian-origin petroleum or petroleum products (§ 542.208);
  • U.S. persons from engaging in any transaction or dealing related to Syrian-origin petroleum or petroleum products (§ 542.209); and
  •  U.S. persons from approving, financing, facilitating, or guaranteeing a transaction by a foreign person that would be prohibited if performed by a U.S. person or within the United States (§ 542.210).

General LIcenses and Statements of Licensing Policy

In addition to incorporating prior executive orders, the reissued SSR incorporate (at Sections 542.509 through 542.520 and 542.523) a number of general licenses that were previously posted on OFAC’s website, and add six new general licenses and three new statements of licensing policy. The new general licenses authorize the following transactions:

  • With certain limitations, the receipt of payment of professional fees and reimbursement of incurred expenses for the provision of authorized legal services to or on behalf of the Government of Syria and other blocked parties (§ 542.508);
  • All transactions in the United States between U.S. persons and persons who have been granted certain categories of U.S. visas; services in connection with the filing of applications for such visas; and services provided by accredited U.S. graduate and undergraduate degree-granting institutions for the filing and processing of applications to enroll in the institutions, and the acceptance of payments for submitted applications to enroll and tuition from persons ordinarily resident in Syria (§ 542.521);
  • Otherwise prohibited transactions between blocked SDNs and employees, grantees, or contractors of the U.S. federal government that are for official government business (§ 542.522);
  • The following services provided in the United States to non-Syrian carriers transporting passengers or goods to or from Syria (but not the Government of Syria or blocked parties): bunkers and bunkering services, services supplied or performed in the course of emergency repairs, and services supplied or performed under circumstances which could not be anticipated prior to the carrier’s departure for the United States (§ 542.524);
  • The provision by a U.S. person or from the United States of services ordinarily incident to the supply to Syria of non-U.S.-origin food, medicine, and medical devices that would be classified EAR99 if subject to the EAR (§ 542.525); and
  • Certain services related to conferences, performances, exhibitions, or similar events in the United States or a third country attended by persons who are ordinarily resident in Syria, other than the Government of Syria or blocked parties (§ 542.526).

The new general license found at Section 542.525 is a particularly noteworthy development, as it eliminates an anomaly in the prior sanctions regime’s licensing requirements. Under the general license now found at Section 542.510, U.S. persons are authorized to be involved in and facilitate the supply to Syria of food, medicines and medical devices authorized for supply to Syria by the U.S. Commerce Department. However, because the Commerce Department regulations do not apply to exports to Syria of most non-U.S.-origin items that contain 10 percent or less U.S. content by value, U.S. persons were not permitted by the OFAC general license to facilitate the supply of such non-U.S.-origin items to Syria; rather, a specific OFAC license was required. The new general license authorizes the provision of services by a U.S. person or from the United States related to the export and reexport to Syria of non-U.S.-origin food, medicines, and medical devices that would be classified EAR99 if subject to the EAR.

In addition, three new statements of licensing policy contained in the SSR clarify that specific licenses may be issued by OFAC on a case-by-case basis authorizing: (1) certain transactions involving Syria’s telecommunications sector that are otherwise prohibited by the SSR, in order to enable private persons in Syria to better and more securely access the Internet (§ 542.527); (2) certain transactions involving Syria’s agricultural sector that are otherwise prohibited by the SSR, in order to strengthen that sector in light of Syria’s food “insecur[ity]” (§ 542.528); and (3) certain transactions that are otherwise prohibited by Sections 542.206 through 542.210 of the SSR, including new investment related to Syrian petroleum and petroleum products for the benefit of the National Coalition of Syrian Revolutionary and Opposition Forces (§ 542.529).

New Syria Related Designations

In addition to reissuing the SSR, on May 8, 2014, OFAC announced 10 new Syria-related designations. These designations included six Syrian government officials and two Syrian refineries. OFAC also designated a Russian Bank (Tempbank) and the Chairman of its Management Committee (Mikhail Georgievich Gagloev) pursuant to Executive Order 13582 for providing material support and services to the Government of Syria, including the Central Bank of Syria and SYTROL, Syria’s state oil marketing firm. The Treasury Department statement announcing the designations noted that Tempbank has provided millions of dollars and facilitated the provision of financial services to the Syrian regime, and that Mr. Gagloev personally travelled to Damascus to make deals with the Syrian regime on behalf of Tempbank.

As a result of these designations, U.S. persons are generally prohibited from engaging in any transactions or dealings with these parties, and the property and property interests of these parties that are or come into the United States or the possession or control of a U.S. person are blocked. Further, the sanctions apply to any entity in which any designated person owns a 50 percent or greater interest (regardless of whether such entity is itself designated).

Publication of Ukraine Related Sanction-Regulations

Also on May 8, OFAC issued new Ukraine-Related Sanctions Regulations at 31 C.F.R. Part 589 to implement executive orders issued in March 2014 (EOs 13660, 13661, and 13662, which were the subject of our prior e-alerts on March 6, 2014, March 18, 2014, and March 21, 2014).

The newly issued regulations, which were effective immediately, do not substantively change the scope of the Ukraine-related sanctions program, but do provide directions for management of blocked funds and property, definitions, interpretations, and limited general licenses. The general licenses authorize transactions such as certain transfers of property between blocked accounts in a U.S. financial institution, debits from blocked accounts by a U.S. financial institution for normal service charges, the provision of certain legal services, the receipt of certain payments for the provision of authorized legal services, and the provision of emergency medical services in the United States.

OFAC stated that these regulations were being published in abbreviated form, and that it intends to supplement them with a more comprehensive set of regulations, which may include additional definitions, interpretive guidance, general licenses, and statements of licensing policy.

Article by:

Peter Flanagan
Corrine Goldstein
Peter Lichtenbaum
Kimberly Strosnider
David Addis
Sarah Liebschutz
Of:
Covington & Burling LLP

 

New G-7 Sanctions Against Russia

McDermottLogo_2c_rgb

The United States, in coordination with other G-7 nations, announced on Monday, April 28new sanctions on individuals and entities with ties to the Russian government and President Putin.  The newly announced sanctions build on earlier rounds of U.S. sanctions imposed on March 6, March 17, March 20 and April 11.  The United States also tightened license restrictions for high technology exports to Russia.  In addition to the new U.S. sanctions, the European Union, Canada and Japan also announced new sanctions against Russian individuals and entities.

Reasons cited for the new sanctions were Russia’s failure to abide by commitments it made to de-escalate the crisis during an April 17 meeting in Geneva among Russia, Ukraine, the United States and the European Union (also known as the Geneva accord) and continued Russian-supported efforts to destabilize Eastern Ukraine.  According to an April 25 statement by the G-7 leaders, Russia has failed to take actions required by the Geneva accord and has continued to escalate tensions through its “increasingly concerning rhetoric” and “ongoing threatening military maneuvers on Ukraine’s border.”

New U.S. Sanctions and Export Restrictions

The new U.S. sanctions issued by the Office of Foreign Assets Control of the U.S. Department of the Treasury, target seven individuals and 17 entities, including banks, construction companies and transportation companies, with connections to the Russian government.  These sanctions, like those previously announced, freeze the assets subject to U.S. jurisdiction of all sanctioned individuals and bar those individuals from obtaining visas to enter the United States.  The sanctions also prohibit U.S. persons, including U.S. companies and their overseas branches and divisions, from transacting business with any sanctioned individuals or entities.

In addition, the Bureau of Industry and Security of the U.S. Department of Commerce announced that it added 13 of the newly sanctioned entities to its Entity List (comprised of parties that are prohibited from receiving some or all items subject to the U.S. Export Administration Regulations without a license), and that it will immediately begin denying pending applications for licenses to export or re-export “high technology” items to Russia or Crimea that may enhance Russia’s military capabilities.  Concurrently, the Directorate of Defense Trade Controls of the U.S. Department of State announced that it is placing a hold on all licenses for exports of defense articles and defense services to Russia.

New EU Sanctions

In coordination with the new U.S. sanctions, the new EU sanctions add 15 individuals with ties to the Russian government to the European Union’s existing list of sanctioned individuals.

Other New G-7 Sanctions

The two remaining G-7 member states also imposed new sanctions on Russian individuals this week:  Canada announced sanctions against two Russian banks and nine individuals, and Japan announced visa bans on 23 as-yet-unnamed individuals.

Companies with interests in Russia or Ukraine or doing business with Russian enterprises are advised to ensure appropriate measures are in place to comply with the sanctions, including careful screening of all parties to transactions.

Article By:

Jay L. Eizenstat
Andrea L. Hamilton
David J. Levine
Raymond Paretzky
David Henry
Of:
McDermott Will & Emery

United States Expands Sanctions in Response to Activities in Ukraine, Names First SDNs (Specially Designated Nationals)

DrinkerBiddle

 

Early March 18, 2014, President Obama signed an Executive Order (E.O.) expanding on E.O. 13660, which was issued on March 10, 2014.  In addition to naming specific persons subject to the restrictions of E.O. 13660, including former Ukrainian President Viktor Yanukovych, the new E.O. expands the sanctions previously announced in response to recent actions of the Government of the Russian Federation in Crimea to include any person who is determined to:

  • Be an official of the Government of the Russian Federation;
  • Operate in the arms or related materiel in the Russian Federation;
  • Be owned or controlled by, or to have acted or purported to act for or on behalf of, directly of indirectly:
    • a senior official of the Government of the Russian Federation; or
    • a person whose property and interests in property are blocked pursuant to this order; or
  • Have materially assisted, sponsored, or provided financial, material, or technological support for, or goods or services to or in support of:
    • a senior official of the Government of the Russian Federation; or
    • a person whose property and interests in property are blocked pursuant to this order.

Effective immediately, all property and interests in property that are in the control of U.S. persons (including foreign branches) will be blocked, and subject persons will be prohibited from entry to the United States.  The complete list of blocked persons is available here.

As the situation in Ukraine continues to unfold and sanctions are expanded, U.S. companies should be particularly cautious in screening transactions in the region and maintaining records.  In addition, companies with affiliates in the European Union should be mindful of changes to EU sanctions that could impact business in the region.

Article by:

Of:

Drinker Biddle & Reath LLP

Hitting Non-Practicin Entities Where It Hurts

Recently posted in the National Law Review an article by Robert A. Gutkin and Jeff C. Dodd of Andrews Kurth LLP about the Federal Circuit affirmed a district court award of substantial sanctions against a Non-Practicing Entity (NPE) that had a business model of suing numerous companies for nuisance value settlements. 

 

 

The Federal Circuit Affirms an Award of Substantial Sanctions Against a NPE with a Business Model of Bringing Litigation To Extract Quick Settlements

 

Eon-Net LP v. Flagstar Bancorp, No. 2009 – 1308 (Fed. Cir., July 29, 2011) (Judges Lourie, Mayer and O’Malley)

 

In a July 29 decision, the Federal Circuit affirmed a district court award of substantial sanctions against a Non-Practicing Entity (NPE) that had a business model of suing numerous companies for nuisance value settlements. As the Court succinctly stated:

 

The record supports the district court’s finding that Eon-Net acted in bad faith by exploiting the high cost to defend complex litigation to extract a nuisance value settlement from Flagstar. At the time that the district court made its exceptional case finding, Eon-Net and its related entities, Millennium and Glory, had filed over 100 lawsuits against a number of diverse defendants alleging infringement of one or more patents from the Patent Portfolio. Each complaint was followed by a “demand for a quick settlement at a price far lower than the cost of litigation, a demand to which most defendants apparently have agreed.” Slip Op at 22.

 

We think that this is a potentially important holding because the Federal Circuit approved an exceptional case for enhanced sanctions based on the business model adopted by some NPE’s—suit followed by quick settlement at lower-than-litigation cost. As we discuss below, the Eon-Net LP case represents the latest in a string of judicial opinions providing defendants with additional ammunition against NPE’s pursuing “objectively baseless” litigation. However, the threat of sanctions may also lead NPE’s to be more difficult in their settlement demands and willingness to offer quick and early settlements.

 

Background

 

The case at issue involved three document processing systems patents, U.S. Patent Nos. 6,683,697 (“the ‘697 Patent”), 7,075,673 (“the ‘673 Patent”), and 7,184,162 (“the ‘162 Patent”) (collectively “the Patents”) owned by Eon-Net LP, a patent holding company formed to enforce various patents. The Patents are part of a larger patent family (“the Patent Portfolio”) originating with a parent patent application filed in 1991. Between 1996 and 2001, Millennium L.P., an Eon-Net related company, filed four lawsuits asserting various claims of the Patent Portfolio. After 2001, Eon-Net hired new outside litigation counsel, and the number of patent cases filed on behalf of Eon-Net and its related entities skyrocketed. By the time the district court in the present matter had issued sanctions against Eon-Net, more than 100 lawsuits had been filed, almost all of which resulted in early settlements or dismissals.

 

Eon-Net sued Flagstar Bancorp in 2005, alleging infringement of the ‘697 patent. The district court entered summary judgment of noninfringement in favor of Flagstar, finding that Eon-Net failed to adequately investigate its claims prior to filing suit, and finding that the claims were baseless. The district court also assessed Rule 11 sanctions in the amount of $141,984.70 against Eon-Net and its attorney.

 

After the Federal Circuit vacated and remanded both the summary judgment and Rule 11 decisions in 2007, Eon-Net LP v. Flagstar Bancorp, 249 F. App’x 189 (Fed. Cir. 2007), Eon-Net pursued the case (even adding new claims for infringement). But after receiving an unfavorable Markman decision on claim construction, Eon-Net stipulated to noninfringement. The district court subsequently granted Flagstar’s motion for attorney fees under 35 U.S.C. §285, finding that Eon-Net pursued baseless claims; the lawsuit was brought for the improper purpose of seeking a nuisance value settlement; Eon-Net destroyed evidence; and, Eon-Net’s litigation tactics were improper. Upon invitation from the district court, Flagstar renewed its prior Rule 11 motion. The district court reinstated in full the $141,984.70 in attorneys fees and costs against Eon-Net and its attorney for violation of Rule 11. The district court also found the case to be exceptional under 35 U.S.C. §285, and awarded Flagstar $489,150.48 in attorneys fees and costs after Eon-Net continued to litigate the case after remand.

 

The Federal Circuit Decision

 

The Federal Circuit upheld the district court’s claim construction, and affirmed the judgment of noninfringement to which Eon-Net had stipulated.

 

In reviewing the district court’s finding of an exceptional case under 35 U.S.C. §285, the Federal Circuit stated:

 

Indeed, “[l]itigation misconduct and unprofessional behavior may suffice, by themselves, to make a case exceptional under § 285.” Absent litigation misconduct or misconduct in securing the patent, sanctions under § 285 may be imposed against the patentee only if both (1) the patentee brought the litigation in bad faith; and (2) the litigation is objectively baseless (citations omitted). Slip Op at 17.

 

Eon-Net failed to show that the district court’s findings regarding the accused litigation misconduct were clearly erroneous. Eon-Net also failed to overcome the finding that its infringement allegations could only be supported by baseless claim construction positions.

 

Certainly Eon-Net’s behavior during the course of the litigation was egregious, as the court described in detail.1 But that alone would not have warranted our Client Alert, for the behavior giving rise to sanctions in any given case is based on the particular facts of the case. What caught our eye was the Federal Circuit’s condemnation of the business model of filing litigation to obtain a quick return through settlement:

 

Eon-Net’s case against Flagstar had “indicia of extortion” because it was part of Eon-Net’s history of filing nearly identical patent infringement complaints against a plethora of diverse defendants, where Eon-Net followed each filing with a demand for a quick settlement at a price far lower than the cost to defend the litigation. Slip Op at 22.

Meritless cases like this one unnecessarily require the district court to engage in excessive claim construction analysis before it is able to see the lack of merit of the patentee’s infringement allegations…. Thus, those low settlement offers—less than ten percent of the cost that Flagstar expended to defend suit—effectively ensured that Eon-Net’s baseless infringement allegations remained unexposed, allowing Eon-Net to continue to collect additional nuisance value settlements. Slip Op at 23.

 

The Federal Circuit affirmed the finding that the case was exceptional under 35 U.S.C. §285, and was disturbed by the ability of an NPE, such as Eon-Net, to impose high costs on a company to defend against meritless claims, while at the same time the NPE faces little downside risk other than the loss of future licensing revenue.2

 

Potential Implications of Eon-Net LP

 

We stress that the Federal Circuit did not uphold sanctions merely because a NPE sought to enforce its patent rights. Rather, the Federal Circuit was clearly bothered by the ability of an NPE to exploit the “system” to extort nuisance value settlements while facing little downside risk.

 

Indeed, some NPE’s count on defendants to settle based on the inescapable fact that defense of even a suit on a bad patent is expensive. That cost is built into the architecture of patent litigation. As our colleague David Griffith chronicled in“Patents by the Numbers” in Andrews Kurth’s IP and Technology Developmentsthe median cost of defense in 2009 (as reported by AILPA) was $650,000 if less than one million was at risk, $2.5 million if $1 million to 25 million at risk – $2,500,000. In addition, the median time for an infringement case to get to trial was 2.5 years (2009 data from a report by PwC). While the rate of success was 38% in the 15 most active patent dockets (1995-2009) as reported by PwC (31% for NPE’s) if the patentee survives summary judgment motions and gets to a jury, its odds improve to a 75% win rate (according to the University of Houston Law Center’s patstats). Given these statistics, the temptation for any operating company faced with a lawsuit is to settle and move on with its business if the NPE’s offer of settlement is far less than the cost of defense. NPE’s count on that temptation.

 

The Federal Circuit stopped short of stating that business models like that of Eon-Net provide the sole basis for finding an exceptional case under 35 U.S.C. §285. However, the language of the decision does suggest that the business model may per se satisfy the “bad faith” element of the two part requirement for finding an exceptional case. This decision seems to be an attempt by the Court to try to level the playing field for patent litigation by increasing the downside risk for a NPE. Moreover, this case follows a string of other cases, including eBay (which held that irreparable harm would not be presumed in a preliminary injunction action even if infringement had been found) and MedImmune (which allows declaratory judgment actions to be brought under less stringent standards than the Federal Circuit had historically applied).

 

Just as importantly, we are seeing many other trends and techniques that defendants are starting to use to combat vexatious NPE litigation. Some defendants are finding success in obtaining venue transfers from courts thought to be more favorable to NPE litigation; others are using declaratory judgment actions; yet others are pursuing early summary judgments (by some accounts approximately 60% of patent cases are decided on summary judgment and patentee success at the summary judgment stage is only 12%).

 

Our firm also has had success strategically employing the re-examination to narrow or even eliminate patent claims from weak (or worse patents). Our success is consistent with some compelling statistics. Again our colleague David Griffith reported that the chances that PTO will grant an ex parte/inter partes reexamination application are greater than 90% (based on USPTO statistics as of March 2011). According to an AILPA 2009 report, the median cost of an ex parte reexamination was $10,000; for an inter-partes proceeding the median was $188,000. Moreover, according to USPTO statistics as of March 2011, in most cases claims were cancelled or modified:

 

ex parte reexamination (third party requested re-exam)

inter partes reexamination

All claims confirmed: 24%

All claims confirmed: 12%

All claims cancelled: 13%

All claims cancelled: 45%

Claims modified: 63%

Claims modified: 43%

 

The bottom line: defendants in NPE litigation should consider in the calculus of settlement not only litigation cost but also the trends and techniques favoring defendants over NPE’s, especially now that Eon-Net LP may encourage courts to shift the expenses of defense that NPE’s count on encouraging quick settlement—at least in the most abusive cases.

 

 

1. The court provided an extensive litany of Eon-Net’s sanctionable behavior throughout the course of the litigation, including: destroying relevant documents prior to the initiation of the lawsuit; flaunting the fact that as a patent enforcement company they did not believe they needed to have a document retention policy; refusing to participate in the claim construction process; lodging incomplete and misleading evidence with the court; submitting declarations contradicting deposition testimony; and, evidencing a general disdain and disrespect for the court process including statements made at a deposition by a party witnesses complaining that his deposition was “an inconvenience and a bother” and that he was “so sick of this stuff by now. I am so sick of this stuff, especially this haggling over stupidities and trivialities which is the name of the game in litigation.” Slip Op at 20.

 

2. The Federal Circuit also affirmed the Rule 11 sanctions, even though it was undisputed that Eon-Net’s counsel did examine portions of Flagstar’s website and reach a conclusion that it worked in a manner that infringed the ‘697 patent. “A reasonable pre-suit investigation, however, also requires counsel to perform an objective evaluation of the claim terms when reading those terms on the accused device.” Slip Op at 26. It was not clearly erroneous for the district court to conclude that Eon-Net’s claim construction position “borders on the illogical” and that “[t]he specification exposes the frivolity of Eon-Net’s claim construction position.” Id.

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