Co-authored by Mr Robert L. Bronston and Mr Andrew H. Schapiro.

The Supreme Court granted certiorari in one case of potential interest to the business community. Amicus briefs in support of the petitioners are due on Thursday, August 8, 2002, and amicus briefs in support of the respondent are due on Monday, September 9, 2002. We also report on a recent decision of the Supreme Court that may have significance for our clients and friends.

Bankruptcy - Dischargeability of Debt - Fraud Claims Resolved By Settlement. Section 523(a)(2)(A) of the Bankruptcy Code provides that "[a] discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt * * * for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by * * * false pretenses, a false representation, or actual fraud." 11 U.S.C. § 523(a)(2)(A). The Supreme Court granted certiorari in Archer v. Warner, No. 01-1418, to determine whether a debt that is otherwise nondischargeable in bankruptcy under Section 523(a)(2) becomes dischargeable if the parties enter into a settlement agreement resolving the amount of the debt.

Elliott and Carol Archer sued Leonard and Arlene Warner in North Carolina state court alleging fraud in connection with their purchase of the Warners' business. On the eve of trial, the Archers agreed to release their claims against the Warners in exchange for a $200,000 cash payment and a secured promissory note for $100,000, payable in two installments over a year. The Warners defaulted on the first payment under the promissory note, prompting the Archers to sue in state court to recover the outstanding debt. While that action was pending, the Warners filed in bankruptcy court an action seeking relief under Chapter 13 of the Bankruptcy Code. Their case was later converted to a Chapter 7 case.

The Archers filed in the bankruptcy court an adversary proceeding seeking a declaration that the debt on the promissory note was for money owed on account of fraud and therefore was nondischargeable under Section 523(a)(2)(A). Arlene Warner contested dischargeability. The bankruptcy court concluded that the settlement agreement effected a "novation" so that the debt Arlene Warner owed to the Archers was no longer a debt owed on account of fraud, but instead a debt due on a contract. The district court affirmed, agreeing with the bankruptcy court that the settlement agreement and release created a contract debt that was dischargeable in bankruptcy, regardless of the nature of the underlying debt.

A divided panel of the Fourth Circuit affirmed. 283 F.3d 230 (2002). The court first noted that the circuits are divided on the issue of whether a debt resulting from a settlement of claims involving alleged fraud is dischargeable in bankruptcy. The D.C. and Eleventh Circuits have held that a bankruptcy court should look behind the settlement agreement to determine whether the underlying obligation is derived from the alleged fraudulent conduct. See United States v. Spicer, 57 F.3d 1152, 1155-1156 (D.C. Cir. 1995); Greenberg v. Schools, 711 F.2d 152, 156 (11th Cir. 1983). The Seventh and Ninth Circuits, in contrast, have held that a settlement agreement and release that resolves a debt that is otherwise nondischargeable because it was obtained by fraud creates a new contract debt that is dischargeable in bankruptcy. See In re Fischer, 116 F.3d 388, 390 (9th Cir. 1997) [link 2] [link 3] [link 4]; In re West, 22 F.3d 775, 777-778 (7th Cir. 1994). The panel majority, like the bankruptcy and district courts, aligned itself with the Seventh and Ninth Circuits and adopted the "novation theory," holding that the settlement agreement and the associated release extinguished the Archers' claim of nondischargeability under Section 523(a). 283 F.3d at 236-237. The dissenting judge concluded, however, that this approach was inconsistent with Congress's intent that certain debts should be nondischargeable in bankruptcy. Id. at 239-240 (Traxler, J., dissenting).

This case is of interest to all businesses. If the Fourth Circuit's position is sustained, defendants who settle certain fraud claims will be able to seek bankruptcy protection from any debts resulting from those settlements. The possibility that settlement obligations will be discharged in bankruptcy may discourage settlements in such cases, increasing the costs to both plaintiffs and defendants of resolving their disputes.

Any questions about this case should be directed to Miriam Nemetz (202-263-3253) or Robert Bronston (202-263-3244) in our Washington office or Andrew Schapiro (212-506-2672) in our New York office.


From time to time, we report on Supreme Court decisions that may have particular significance for our clients and friends. We call your attention to the June 3 decision in Holmes Group, Inc. v. Vornado Air Circulation Systems, Inc., 122 S. Ct. 1889 (June 3, 2002), because it removes a substantial class of patent law claims from the appellate jurisdiction of the Federal Circuit ("CAFC"). We also would like to share with you some ideas that Mayer, Brown, Rowe & Maw is developing for a legislative response.

In Holmes, the Court was faced with the question whether the CAFC may assert appellate jurisdiction over a case in which the plaintiff did not plead a claim under the patent laws, but the defendant asserted a compulsory counterclaim of patent infringement. The CAFC's patent law jurisdiction is keyed to that of the district courts, and turns on whether the action is one "arising under" federal patent law. Whether an action "arises under" patent law in a district court depends, in turn, on the facts and claims as they appear in the plaintiff's well-pleaded complaint (the "well-pleaded-complaint rule"). The Court took the view that to find CAFC jurisdiction over a case simply because a patent-law counterclaim is involved would expand the well-pleaded complaint rule into a "well-pleaded-complaint-or-counterclaim rule." Accordingly, the Court held that the CAFC lacks jurisdiction over such cases. Although acknowledging that the Federal Circuit was created to promote uniformity in patent law decision, the Court observed that its task is not "to determine what would further Congress's goal of ensuring patent law uniformity, but to determine what the words of the statute must be fairly understood to mean." 122 S. Ct. at 1895.

The adverse consequences of this decision on patent law are clear. Permitting the various regional courts of appeals to decide patent-law counterclaims not only will erode the uniformity of patent law, but also is likely to impair the quality of patent jurisprudence as non-expert appellate judges sporadically decide patent cases. The decision also may have an impact in areas that tend to intersect with patent law. For example, whenever a defendant-patentee in an antitrust case must assert an infringement counterclaim, the case will be reviewed by one of the regional circuits with a less finely tuned appreciation for the characteristics and policies of the patent system.

Because the Court has spoken, only Congress can give the CAFC exclusive jurisdiction over all patent appeals. Mayer, Brown has been considering appropriate legislative remedies to do just that. Working with Professor Herbert Hovenkamp of the University of Iowa College of Law, we have identified two potential "fixes" that merit serious consideration. The first would provide the CAFC with jurisdiction over a case involving a patent-law counterclaim, provided that the counterclaim has already been adjudicated on the merits by a district court - an approach embraced by Justice Ginsburg in her concurring opinion in Holmes. See 122 S. Ct. at 1898. The second approach would provide the CAFC with jurisdiction over any claim, including counterclaims, "arising under" federal patent-law. If you would like to support this effort, please contact Steve Shapiro at (312) 701-7327, Mark Gitenstein at (202) 263-3218, or Donald Falk at (650) 331-2030.

Copyright © 2007, Mayer, Brown, Rowe & Maw LLP. and/or Mayer Brown International LLP. This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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