POWER OF INTELLIGENCE

Insight Center: Publications

Court Clarifies Discharge of Judgments for Willful Intellectual Property Infringement Through Bankruptcy

Corporate Restructuring and Bankruptcy Update

Author: Michael H. Reed

6/02/2009

This article first appeared in the May 26, 2009 edition of The Legal Intelligencer. It is reprinted here with permission.

An intellectual property (IP) rights owner who seeks to enforce his/her rights against an infringer must consider a potential risk that has nothing to do with the subject matter of the IP: whether the infringer/debtor may discharge a money judgment for willful infringement in bankruptcy proceedings. IP owners will have a much better chance at protecting their judgments from being discharged in bankruptcy if they begin their infringement actions with a plan to ensure that they obtain the factual and legal findings necessary to satisfy the standard required for a debt to not be discharged in bankruptcy.

‘Willful and Malicious Injury’ Under the Bankruptcy Code

Section 523(a)(6) of the Bankruptcy Code provides that an individual debtor may not discharge a debt "for willful and malicious injury by the debtor to another entity or to the property of another entity." To determine whether a debtor may discharge a particular debt under that section, bankruptcy courts analyze two separate and distinct issues: "willfulness" and "maliciousness." A "willful" injury under § 523(a)(6) is a "deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury." Kawaahau v Geiger, 523 U.S. 57 (1998). In order for an injury to be deemed "malicious," a four-part test must be met. There must be: (1) a wrongful act, (2) done intentionally, (3) which necessarily causes injury, and (4) is done without just cause or excuse.

If the IP owner cannot establish both prongs of the foregoing test and the infringer/debtor is otherwise eligible for a discharge, the infringer will be able to discharge its liability on the infringement judgment through bankruptcy. This result would leave an IP owner with no means of enforcing the judgment. By contrast, a finding that the infringement debt is not dischargeable in bankruptcy will leave the IP owner with its judgment intact.

Unfortunately for IP owners, the two-part standard utilized by bankruptcy courts to establish dischargeability under § 523(a)(6) does not mirror the standards required for establishing willful patent, copyright or trademark infringement. Thus, the factual findings and legal determinations underlying the infringement judgment do not satisfy the requirements under the bankruptcy standard. As a result, if the infringer/debtor seeks bankruptcy protection, the IP owner could find its hard-earned judgment for willful infringement significantly devalued, maybe even rendered valueless.

Judgments for Willful Infringement of Copyrights

A copyright owner will be able to secure enhanced damages if the court finds that the infringement was "willful." Under the Copyright Act, willfulness can be found in cases where the defendant’s conduct was intentional or reckless. The willfulness standard under the Copyright Act does not require a separate finding of "maliciousness," nor does it actually require a "willful" act by the infringer, as that term is understood under the Bankruptcy Code. Indeed, willfulness under the Copyright Act can be based upon acts that are "merely" reckless. Therefore, a finding of willful infringement under the Copyright Act will not necessarily provide a basis for establishing either the "willful" or "malicious" prong of the test under the Bankruptcy Code.

In re Barboza

A recent decision of the Court of Appeals for Ninth Circuit highlights the potential difficulties facing IP owners as creditors seeking to prevent their infringement judgments from being discharged by the infringer/debtor in a bankruptcy case.

In In re Barboza, 545 F. 3d. 702 (9th Cir. 2009), the Ninth Circuit reversed an order of the Bankruptcy Appellate Panel that had affirmed a bankruptcy court’s holding that a judgment for a willful copyright infringement was nondischargeable under the Bankruptcy Code. The debtors operated a business for the duplication, distribution and sale of Spanish-language films. The debtors purchased a large quantity of videotapes of the films from Million Dollar Video Corp. The plaintiff, which held an exclusive right to manufacture, sell and distribute the films, sent the debtors a notice of its rights. The debtors nevertheless continued to sell the existing copies of the films, made an additional 500 copies and began selling them as well. The plaintiff sued the debtors for copyright infringement in a federal district court in California (the district court action).

After a jury trial on the merits, the jury in the district court action was instructed that, under the standard for willful copyright infringement, the plaintiff was only required to prove by a preponderance of the evidence that the defendants knew they were infringing the plaintiff’s copyrights or acted with a reckless disregard as to whether they were doing so. The jury returned a verdict of willful copyright infringement, but the jury made no specific finding as to the basis for its finding of willful copyright infringement.

Based on the verdict, the jury awarded statutory damages of $75,000 per film. The judgment for the plaintiff in the district court action, including legal fees, was approximately $893,000. The result was everything that the plaintiff had wished for, but the plaintiff soon discovered that saving its judgment from discharge in bankruptcy would prove to be just as difficult as winning the judgment in the first place.

In an attempt not to pay the judgment, the debtors filed for Chapter 7 bankruptcy in the U.S. Bankruptcy Court for the Southern District of California. In response, the plaintiff filed a complaint with the bankruptcy court seeking a determination that the judgment could not be discharged under § 523(a)(6) of the Code based on the judgment entered in the district court action. The plaintiff moved for summary judgment that the debt was not dischargeable because of the finding in the district court action that the infringement was willful. The bankruptcy court agreed, finding that because the evidence clearly showed that the defendants knew of the plaintiff’s rights, the copyright infringement was a willful injury under § 523(a)(6) of the Bankruptcy Code.

After the Bankruptcy Appellate Panel affirmed, the defendants appealed to the Ninth Circuit, which reversed. The Ninth Circuit began its analysis by noting that the Supreme Court had specifically limited the standard for finding "willfulness" in dischargeability litigation involving personal injury claims. See Geiger, 523 U.S. at 60-61 (1998) (holding that debts resulting from recklessly or negligently inflicted injuries are not sufficient to be considered "willful" injuries under § 523(a)(6)). The Ninth Circuit also found that the standard for "willfulness" under § 523(a)(6) of the Bankruptcy Code requires a "deliberate" or "intentional" injury. After analyzing the facts of the Barboza case, the Ninth Circuit held that summary judgment was not proper because the bankruptcy court had no way to determine whether the jury had found the willful infringement based on a reckless disregard or a knowing violation of the copyright.

In particular, the Ninth Circuit held that since the debtors had introduced evidence that the films had actually been ordered, duplicated and distributed by a disgruntled relative of theirs, not by the debtors, the jury could have based its willful infringement verdict on recklessness. Based on this material issue of fact alone, the Ninth Circuit determined that a remand was required.

The Ninth Circuit also found that the bankruptcy court erred when it failed to separately examine whether the copyright infringement was "malicious" under § 523(a)(6). The appeals court further held that the bankruptcy appellate panel erred when it based its finding of malice completely on the conclusion that the debtors’ actions were willful. According to the Ninth Circuit, the malicious injury requirement must be decided separately from the willful injury requirement.

Thus, the viability of the plaintiff’s judgment for willful copyright infringement remained in doubt and the plaintiff would have to continue to incur expenses to preserve the judgment.

Applicability to Judgments for Willful Infringement of Trademarks and Patents

The potential for an IP owner to face challenges similar to that faced by the plaintiff in Barboza is the same in patent and trademark infringement cases.

In In re Seagate Technology, LLC, the Federal Circuit, sitting en banc, clarified that in patent cases:

[T]o establish willful infringement, a patentee must show by clear and convincing evidence that the infringer acted despite an objectively high likelihood that its action constituted infringement of a valid patent... The state of mind of the accused infringer is not relevant to this objective inquiry. If this threshold objective standard is satisfied, the patentee must also demonstrate that this objectively-defined risk (determined by the record developed in the infringement proceeding) was either known or so obvious that it should have been known to the accused infringer.

In re Seagate Technology, LLC, 497 F.3d 1360, 1371 (Fed. Cir. 2007). Thus, in patent cases, much like in the copyright context, willfulness can be based upon intentional behavior or recklessness. Id. at 1370 ("The term willful is not unique to patent law, and it has a well-established meaning in the civil context. For instance, our sister circuits have employed a recklessness standard for enhancing statutory damages for copyright infringement. ... Although the statute does not define willful, it has consistently been defined as including reckless behavior.") In addition, the patent willfulness analysis does not specifically refer to or require a specific finding of maliciousness.

Similarly, a trademark owner may obtain a finding of willful trademark infringement in cases of recklessness or gross negligence. See e.g. N.A.S. Import, Corp. v. Chenson Enters., Inc., 968 F.2d 250, 252 (2d Cir. 1992) (an infringement may be willful if the defendant "had knowledge that its actions constitute an infringement"). Actual knowledge is not required, and constructive knowledge will suffice. Thus, knowledge need not be proven directly, but may be inferred from the defendant’s conduct.

Pepper Points

As Barboza demonstrates, judgments based on claims for willful copyright infringement are not necessarily non-dischargeable in bankruptcy. Instead, the facts and holdings surrounding settlement or trial of the claims may determine whether a judgment is non-dischargeable. Counsel involved in any IP dispute should pay heed to Barboza, and consider the ability to enforce a settlement or judgment in a subsequent bankruptcy case.

IP owners and their counsel should take steps from the beginning of the dispute to protect themselves. When pleading a cause of action for willful infringement, the complaint should include sufficient factual allegations to satisfy the Bankruptcy Code as well as the particular willfulness standard at issue. The prayer for relief in the complaint should also specifically request that the court make the necessary findings and legal holdings in order to support both the willfulness and maliciousness prongs of the non-dischargeability standard. The allegations and relief sought in the complaint become even more important when the judgment ultimately obtained is a default judgment.

In addition to carefully drafting the initial pleadings, counsel for an IP owner should ensure that the non-dischargeability standard requirements are met throughout the course of the litigation. For example, counsel should include the requisite factual findings and legal holdings in any documents used to resolve a dispute pursuant to the terms of a settlement agreement. Also, when presenting evidence and crafting jury instructions in willful infringement cases, an IP owner should consider introducing sufficient evidence and including additional jury instructions to satisfy the Bankruptcy Code’s definitions of "willful" and "malicious." The evidence presented and subsequent jury instructions would address willfulness under the trademark, copyright, and patent statutes, and separately address "willful and malicious injury" under the requirements of the Bankruptcy Code.

Addressing requirements necessary to support a finding that the infringement was "willful" and "malicious" under the Bankruptcy Code from the very beginning of the dispute may eliminate the risk that a judgment for willful infringement will be discharged through bankruptcy. If these issues are not addressed from the outset and considered throughout the proceeding, an IP owner risks losing its infringement judgment or, at the very least, being required to relitigate the issues in the bankruptcy court in order to obtain the necessary findings of willfulness and maliciousness.

Michael H. Reed and J. Anthony Lovensheimer

The material in this publication is based on laws, court decisions, administrative rulings and congressional materials, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.