United States: Erroneous Small Entity Designation Can Jeopardize Patent Rights

A decision of the Court of Appeals for the Federal Circuit (CAFC) in Ulead Systems, Inc. v. Lex Computer Management Corp., 351 F.3d 1120 (Fed. Cir. December 9, 2003), highlights the importance of carefully determining whether a patent applicant or patentee is qualified for "small entity" status when paying fees to the U.S. Patent and Trademark Office (PTO).

The PTO rules define a "small entity" as an independent inventor, a non-profit organization, or a "small business concern." A "small business concern" is any business concern that, together with its affiliates, has no more than 500 employees and that has not assigned, granted, conveyed or licensed, and is not obligated to assign, grant, convey, or license, any rights in the invention to any person who could not be classified as an independent inventor or to any concern that would not qualify as a small business concern or a nonprofit organization. Being classified as a small entity entitles the patent applicant or patentee to pay 50% of the standard fees for application filing and maintenance charges.

In this case, the defendant Lex never had more than 20 employees and qualified as a small entity when it acquired the subject patent and paid the first maintenance fee at the reduced rate. However, Lex later granted at least 3 non-exclusive licenses to companies that each had more than 500 employees, after which Lex continued to pay the maintenance fees on the patent at the reduced small entity rates.

Ulead filed a declaratory judgment action in district court alleging that Lex's patent was unenforceable, invalid, and/or expired. Ulead claimed that the patent was unenforceable and/or invalid because of Lex's misrepresentation of its small entity status to the PTO, and that the patent had expired because Lex had failed to pay the correct maintenance fees and did not pay the incorrect small entity fee in "good faith" as required by PTO regulations. Lex acknowledged that it was not entitled to claim small entity status at the time it paid its second and third maintenance fees, and immediately petitioned the PTO to accept the balance of the deficiency owed on the maintenance fees. The PTO granted that petition and accepted payment. Lex then opposed Ulead's action on the grounds that it did not intend to mislead the PTO when it claimed small entity status, and that the patent was not expired because the PTO had properly excused its erroneous claim to small entity status and underpayment of fees.

The district court held that the patent was unenforceable because Lex had committed "inequitable conduct" in misrepresenting its small entity status and that it had intent to deceive the PTO. The district court also held that the patent had expired due to Lex's failure to pay the full maintenance fees. Lex appealed to the CAFC.

The CAFC began its analysis by reviewing the elements of inequitable conduct that renders a patent unenforceable. According to the court, inequitable conduct arises, "when there is evidence of affirmative misrepresentation of a material fact, failure to disclose material information, or submission of false material information, coupled with an intent to deceive." Although historically issues of unenforceability have arisen in cases involving inequitable conduct occurring during the prosecution of a patent, the Court saw "no reason why the doctrine should not extend into other contexts, like the present one, where the allegation is that inequitable conduct has occurred after the patent has issued and during the course of establishing and paying the appropriate maintenance fee."

The Court concluded that Lex's misrepresentation of its small entity status was material to the PTO's acceptance of reduced maintenance fees and, by extension, survival of the patent. The Court also found that although Lex admitted that it was not entitled to small entity status when it filed its affidavit of small entity status and paid reduced fees, these were innocent errors, that it was grossly negligent at worst, and that it did not have an intent to deceive the PTO.

With respect to Ulead's assertion that Lex's patent had expired for Lex's failure to pay the proper maintenance fee, the Court stated "the question here is whether Lex committed inequitable conduct by knowingly misrepresenting that it was entitled to have the error excused." The Court added that "if the patentee makes a request to correct incorrect payment of fees as a small entity knowing that it does not satisfy the good faith error standard ... the patentee may be found to have engaged in inequitable conduct." The Court concluded that the issue of whether Lex's patent was expired for failure to pay the proper maintenance fee should be resolved by the district court, especially on the issue of intent as it relates to whether Lex acted in bad faith when it initially asserted small entity status.

As the Ulead decision makes clear, if at any time small entity status is to be claimed, the patentee or patent applicant must first conduct a thorough investigation into whether claiming such status is appropriate. Failure to conduct such an investigation before making any claim for small entity status could form the basis of an inequitable conduct claim if the patent assets are challenged in court. In all cases (individual, nonprofit, or small business), the patentee or patent applicant must investigate whether there has been, or is an obligation to make, an assignment, grant, conveyance, or license of the patent assets in question to a person or entity that is not an individual, nonprofit, or small business as defined by the PTO.

Accordingly, a patentee or patent applicant should report to its patent attorney any transactions involving the licensing, conveyance, granting, or assignment of patent assets, so the attorney can take appropriate steps to review the transaction and determine if small entity status should be changed. Further, with respect to small business concerns, the patentee or applicant should thoroughly investigate all affiliate relationships, including investor relationships and obligations. Importantly, the issue of whether claiming small entity status is proper must be continuously reviewed and any change in status promptly disclosed to the PTO. If the applicant or patentee makes an improper attempt to claim small entity status with the intent to deceive, the PTO will regard that attempt as fraud, and expose the applicant or patentee to a variety of sanctions as well as placing the enforceability of the patent in jeopardy.