Generally, courts will not scrutinize the business decisions of litigants. Concerns arise, however, when such decisions are improperly made for the purposes of abusing the judicial process. One business decision that has received attention in the context of patent law is the formation of anonymous shell companies.
Critics allege that these anonymous companies are frequently formed to hide the real parties in interest rather than for legitimate protection of personal or corporate assets. The company may be undercapitalized to avoid a fee-shifting award, may be hiding information about relevant witnesses or company principals, or may be trying to obstruct the efficient collection and analysis of patent licensing and enforcement activity.
Some efforts have been made by the judiciary to carefully monitor cases to prevent such abuses.
One recent example of judicial criticism of shell companies came out of the Eastern District of Texas. In Iris Connex v. Dell, the Court awarded attorney’s fees and imposed sanctions against an individual who brought a frivolous patent infringement suit through an empty shell company for the purpose of avoiding personal liability for such fees and sanctions. Iris Connex, LLC v. Dell, Inc., 235 F. Supp. 3d 826 (E.D. Tex. 2017). Following summary judgment in defendant Dell’s favor, Dell sought attorney’s fees pursuant to 35 U.S.C. § 285. Id. at 837. In light of “serious allegations” raised by Dell as to plaintiff Iris Connex’s true identity and the Court’s assumption that “there must be a real but hidden party in interest,” the Court took the unusual step of ordering targeted post-judgment discovery. Id. After the close of post-judgment discovery, the Court found that Iris Connex’s real party in interest, Brian Yates, “made an intentional decision to create and undercapitalize Iris Connex as an empty shell,” suggesting that Yates “intended to game the judicial system as part of a pattern of continuing conduct.” Id. at 851. According to the Court, the suit would have never been filed but for Yates’ “calculated assumption that he could insulate himself personally from the possible application of Section 285.” Id. at 846.
The Court explained that the purpose of Section 285 is to “deter frivolous claims and bad faith litigation,” along with “lawsuits that are simply exceptional in that they ‘stand out.’” Id. at 845. The Court further explained that “Congress enacted Section 285 to provide incentives to defend against frivolous infringement claims because doing so benefits the public.” Id. at 846. However, “[f]or such a deterrent to mean something it must reach the person or entities that cause or contribute materially to the exceptional nature of the case.” Id. at 845. In other words, “[t]he lack of deterrence caused by empty shell plaintiffs negates the incentive to vigorously defend against meritless claims when there are no practical means by which to recover costs.” Id. at 846.
Finding the case exceptional under Section 285 for, among other reasons, Yates’ abuse of the judicial system by setting up empty shell companies to shield himself from Section 285, the Court held Iris Connex and Yates jointly and severally liable for the Section 285 fees awarded to Dell. Id. at 846–55. The Court also imposed sanctions against Yates under its inherent authority, holding that “one cannot abuse the judicial process through the creation of shell entities to facilitate the assertion of otherwise meritless claims as part of a scheme to avoid the risks that Section 285 creates.” Id. at 860. In conclusion, the Court explained that this case was “the clearest example of an exceptional case,” and “if this case is not an exceptional case, then there are none.” Id. at 863.
Nevertheless, attempts have also been made in the Legislature to curtail these abuses by requiring the disclosure of a shell company’s real parties in interest. These laws tend to take an approach of requiring the disclosure of the real parties in interest of these companies.
In May 2013, the End Anonymous Patents Act was introduced in the House, which sought to amend 35 U.S.C. § 261, requiring “disclosure of the owner of the patent and any real party in interest in the patent” upon (i) the issuance of a patent, (ii) the payment of a patent’s maintenance fees, and (iii) the transfer of ownership of a patent. H.R. 2024, 113th Cong. § 2(e) (1st Sess. 2013). If an entity failed to comply with these disclosure requirements, damages in any infringement action on the patent could only be collected from the date on which requirement was met. Id. The Act was reintroduced in the House in May 2015 to no avail. H.R. 2370, 114th Cong. (1st Sess. 2015).
Recently, Senators Ron Wyden and Marco Rubio introduced the bipartisan Corporate Transparency Act of 2017. S. 1717, 115th Cong. (1st Sess. 2017). A corresponding bill was also introduced in the House with bipartisan sponsorship. H.R. 3089, 115th Cong. (1st Sess. 2017). The Act finds that nearly 2,000,000 corporations and limited liability companies are being formed each year and many states require that a person seeking to form such an entity provide less information “than is needed to obtain a bank account or driver’s license and typically does not name a single beneficial owner.” S. 1717. Because of these minimal formation requirements, such entities have been used to “commit crimes affecting interstate and international commerce such as terrorism, drug trafficking, money laundering, tax evasion, securities fraud, financial fraud, and acts of foreign corruption.” Id. Accordingly, the Act seeks to amend Title 31 of the United States Code, requiring that those who form corporations or limited liability companies in the United States disclose the beneficial owners of those entities, “in order to prevent wrongdoers from exploiting United States corporations and limited liability companies for criminal gain.” Id. The Act also seeks to assist law enforcement in detecting, preventing, and punishing terrorism, money laundering, and other misconduct involving such entities. Id.
Pursuant to the Act, disclosure of the beneficial owners requires disclosure of a natural person who, directly or indirectly, either (i) exercises substantial control over the entity or (ii) has a substantial interest in or receives substantial economic benefits from the assets of the entity. Such disclosures may be obtained by a civil summons or subpoena from a Federal agency. Id. at § 5333(d)(1). Those who provide false or fraudulent information or willfully fail to provide complete or updated information “shall be liable to the United States for a civil penalty of not more than $10,000” and may be fined under Title 18, imprisoned for up to three years, or both. Id. at § 5333(c). Although the Act is currently pending, it has been referred to committees in both the House and the Senate.
While the Corporate Transparency Act of 2017 was not drafted with the express intent of curtailing the improper use of anonymous shell companies by patent owners, the Act would undoubtedly have an impact on such entities by requiring the disclosure of their beneficial owners. If Congress enacts the Corporate Transparency Act of 2017, it may cause a litigant to think twice before bringing a frivolous patent infringement suit through an empty shell company.
The opinions expressed are those of the authors on the date noted above and do not necessarily reflect the views of Fish & Richardson P.C., any other of its lawyers, its clients, or any of its or their respective affiliates. This post is for general information purposes only and is not intended to be and should not be taken as legal advice. No attorney-client relationship is formed.
David Conrad is a Principal attorney in the Dallas office of Fish & Richardson. He provides legal services to clients in matters relating to business litigation, patent litigation, and trade secret litigation. Mr. Conrad’s clients benefit from his in-depth knowledge of...
Lance Wyatt is an Associate in the litigation group in Fish & Richardson’s Dallas office, focusing his practice on patent litigation. Lance was previously a Summer Associate of the firm. Prior to joining Fish, Lance served as a Judicial Law Clerk for the Honorable Kara F. Stoll of the U.S. Court of Appeals for the Federal Circuit, and the...