IP Law Daily, PATENT—5th Cir.: Federal courts lacked jurisdiction over patent settlement fraud inducement counterclaim, other lower court rulings remanded, (May 15, 2023)

By Linda Panszczyk, J.D.

"Expert testimony" by one party's founder, was inadmissible because he was a layperson, and it may have infected the jury's verdict as to the claim involving breach of the settlement.

In a patent infringement matter regarding technology in oil and natural gas extraction, which had been settled but where discord between the parties re-emerged in later litigation resulting in additional appeals of various court holdings both before and after a trial over a 2011 settlement agreement, the U.S. Court of Appeals for the Fifth Circuit held that it lacked jurisdiction over Defendant—Appellant/Cross-Appellee Auto-Dril’s counterclaim for being fraudulently induced into entering the Settlement Agreement. For the remaining issues, the court reversed the rulings of the district court and remanded for further proceedings consistent with this opinion. Specifically, the Fifth Circuit reversed the ruling granting summary judgment for Plaintiff—Appellee/Cross-Appellant NOV on Auto-Dril’s claim for breach of the Settlement Agreement and it also reversed the dismissal of NOV’s claim for breach of the Settlement Agreement. The appellate court also remanded NOV’s judgment as a matter of law (JMOL) motion for reconsideration. In light of the court's evidentiary holding as to whether the district court improperly allowed Auto-Dril’s founder to provide expert testimony during trial, even though he was testifying as a lay witness, the Fifth Circuit instructed the district court to consider how its admission of this inadmissible testimony may have infected the jury’s verdict on NOV’s claim for breach of the Settlement Agreement when reevaluating NOV’s JMOL motion (National Oilwell Varco, L.P. v. Auto-Dril, Inc., May 12, 2023, King, R.).

Background. In 2004, Varco, L.P. (“Varco”), an oil and gas drilling company, purchased the assets of another drilling company, including U.S. Patent No. 5,474,142 (the “’142 Patent”). The ’142 Patent covers technology that automatically controls a drill bit to be used in oil and natural gas extraction based on drilling fluid pressure. In March 2005, following the asset sale, Varco’s parent company, Varco International, Inc., and a competitor, National Oilwell, Inc., completed a merger to form National Oilwell Varco, Inc. It was understood that Varco, as Varco International, Inc.’s operating company, would transfer its assets to the newly formed entity’s operating company: Plaintiff-Appellee/Cross-Appellant National Oilwell Varco, L.P. (“NOV”).

In 2009, NOV filed an action in the United States District Court for the Eastern District of Texas alleging that Defendant-Appellant/CrossAppellee Auto-Dril, Inc. (Auto-Dril) infringed the ’142 Patent (the Underlying Action). In November 2011, Auto-Dril and NOV entered into a confidential settlement agreement that was intended to end their litigation over the ’142 Patent (the Settlement Agreement). Under the terms of the Settlement Agreement, among other things, Auto-Dril was granted a license to the ’142 Patent in exchange for a licensing fee of $900,000 to be paid in 16 quarterly installments of $62,412.05. In the final judgment dismissing the action, the district court retained jurisdiction over the Settlement Agreement “in the event of a dispute concerning that agreement, to interpret and enforce the agreement, if necessary.

In March 2015, Auto-Dril sued NOV for infringing U.S. Patent No. 6,994,172 (the ’172 Patent), which claims a system for more precise weight-on-bit measurement and control that achieves a better balance between the goals of increasing drilling speed and reducing damage to drilling components, in the United States District Court for the Western District of Texas in Waco (the Waco Action). Later that month, NOV filed a separate action against Auto-Dril in the Eastern District of Texas in Texarkana for breach of the Settlement Agreement (the Texarkana Action). Specifically, NOV asserted that it had been released from claims relating to the ’172 Patent under the Settlement Agreement, that it had not infringed the ’172 Patent, and that the ’172 Patent was otherwise invalid, among other claims. In May 2015, Auto-Dril amended its complaint in the Waco Action and included a new count for fraud, alleging that NOV either knew or recklessly represented that it owned the ’142 Patent throughout the Underlying Action when it in fact did not own that patent.

In January 2016, the court in the Waco Action granted a motion to transfer venue to the Southern District of Texas in Houston (the Houston Action). In February 2016, NOV and Auto-Dril filed a motion in the Texarkana Action stating that they had agreed to resolve claims relating to the 2011 Settlement Agreement in this Court and resolve infringement/validity claims regarding the ’172 Patent in the Southern District of Texas. The parties thus moved the court to (1) permit NOV to file an amended complaint that only included contract claims and (2) provide Auto-Dril two weeks to answer the amended complaint, at which time it would need to assert any claims under the Settlement Agreement. The court in the Texarkana Action granted the motion. NOV subsequently amended its complaint in the Texarkana Action in accordance with its motion and the court’s implementing order. In March 2016, Auto-Dril filed its answer and counterclaimed, asserting the same claim for fraud that it brought in the Waco Action and a claim for breach of the Settlement Agreement as well. In June 2016, NOV again amended its complaint to include an additional breach-of-contract claim, alleging that Auto-Dril failed to make the remaining four payments under the Settlement Agreement. NOV now asserts that Auto-Dril failed to remit only the final three payments in accordance with testimony elicited at trial.

In April 2021, as trial approached in the Texarkana Action, the district court in that case granted summary judgment for NOV on Auto-Dril’s breach-of-contract counterclaim, reasoning that Auto-Dril failed to produce evidence of damages. A jury trial was held later that month and the jury ultimately found that Auto-Dril did not fail to comply with the Settlement Agreement; NOV committed fraud against Auto-Dril; and Auto-Dril “should have discovered the fraud in the exercise of reasonable diligence by October 21, 2011. The jury awarded Auto-Dril $5,000,000 in compensatory damages for the fraud. NOV then moved for entry of judgment on the verdict and for judgment as a matter of law (JMOL), while Auto-Dril moved for entry of judgment on the jury’s fraud and damages findings.

The district court ultimately granted NOV’s motions with respect to Auto-Dril’s fraud claim, denied the remaining motions, and dismissed NOV’s breach-of-contract claim with prejudice. First, in ruling on the fraud claim, the court reasoned that the jury found that Auto-Dril should have discovered NOV’s fraud by October 21, 2011, because that was the date on which Auto-Dril filed a motion to dismiss in the Underlying Action alleging that NOV did not own the ’142 Patent. Because Auto-Dril entered into the Settlement Agreement in November 2011, the court ruled that a fraud could not have arisen out of an agreement signed weeks later. The court also noted that had it not granted JMOL in NOV’s favor on Auto-Dril’s fraud claim, it would have entered a take-nothing judgment because the fraud claim was otherwise barred under Texas’s four-year statute of limitations. Second, the court exercised its inherent authority to dismiss NOV’s claim for breach of the Settlement Agreement due to the jury’s fraud finding. Specifically, the court held that NOV’s repeated assertions that it owned the ’142 Patent in the Underlying Action amounted to a fraud on the court and an abuse of the judicial process. The court would not allow NOV to maintain its breach-of-contract claim because, although Auto-Dril’s owner admitted to not making the last three payments required under the Settlement Agreement, the jury nonetheless found that Auto-Dril had not breached the Agreement.

Here, both parties appeal the district court’s rulings in the Texarkana Action. After the appeals had been filed, NOV filed a motion to dismiss both appeals for lack of subject matter jurisdiction, making similar arguments to those that it presented in the Texarkana Action. That motion has been carried with the case.

Jurisdictional challenges. NOV asserted that federal subject matter jurisdiction is lacking over this entire action and also contended that Auto-Dril’s fraud claim is outside the bounds of federal jurisdiction. First, NOV argues that the district court’s holding that NOV did not own the ’142 Patent retroactively stripped the court in the Underlying Action of jurisdiction. NOV thus contends that the court never possessed jurisdiction over this case because the court in the Underlying Action lacked the authority to retain jurisdiction in the first instance.

A federal court dismissing an action pursuant to Federal Rule of Civil Procedure 41(a)(2) may retain jurisdiction over the enforcement of a settlement agreement relating to that dismissal. Here, in its order dismissing the Underlying Action pursuant to Rule 41(a)(2), the court retained its jurisdiction over the Settlement Agreement, which permitted the court to later enforce that agreement through its ancillary jurisdiction. But according to NOV, the court’s ancillary jurisdiction was abrogated when it held that NOV never owned the ’142 Patent, as this was the only basis for NOV’s standing in the Underlying Action. Consequently, NOV contends that the court in the Underlying Action never had the authority to retain jurisdiction over the Settlement Agreement, and that court’s order retaining jurisdiction cannot presently serve as the jurisdictional anchor for the court in the Texarkana Action.

According to the Fifth Circuit, however, NOV is now precluded from collaterally attacking the Underlying Action. Under the doctrine of issue preclusion, a prior judgment foreclosed successive litigation of an issue of fact or law actually litigated and resolved in a valid court determination essential to the prior judgment. The Underlying Action was dismissed via a final order, and NOV was afforded the opportunity to litigate the issue of subject matter jurisdiction throughout the Underlying Action.

Alternatively, NOV argues that the Fifth Circuit's 2022 decision in Vikas WSP, Ltd. v. Economy Mud Products Co., barred the district court in the Texarkana Action from considering Auto-Dril’s fraud claim because that claim fell outside of the court’s retained jurisdiction. According to the Fifth Circuit, the fraud claim in Vikas is similar to Auto-Dril’s fraud claim in this case. Both claims contend that a counterparty to a settlement agreement fraudulently induced the party asserting its fraud claim into entering said settlement agreement. Accordingly, Auto-Dril’s fraud claim is a tort claim falling outside the scope of the district court’s retained jurisdiction.

The appellate court here found Auto-Dril’s attempt to distinguish Vikas was unavailing. Auto-Dril argued that the language the district court used to retain jurisdiction over the Settlement Agreement in this case is broader than the language used by the district court in Vikas. Without citation to authority, Auto-Dril asserted that the power to “interpret” the Settlement Agreement provided the district court with jurisdiction over tort claims requiring a court’s interpretation of that agreement. Auto-Dril provided no analysis regarding its non-obvious reading of the court’s implementing order. A less strained reading of the court’s order in the case is that the two words “interpret” and “enforce” work together so that a court may interpret the Settlement Agreement to aid in the enforcement of that agreement. However, the Fifth Circuit indicated that Auto-Dril ascribes too much meaning to the word “interpret.” To accept Auto-Dril’s reading would allow a single inexplicit word to “stretch retained jurisdiction too far.” Therefore, the Fifth Circuit held, the district court lacked the requisite subject matter jurisdiction to consider Auto-Dril’s fraud claim.

Remaining non-mooted issues. The court's jurisdictional holding above leaves one non-mooted issue that Auto-Dril raises on appeal, namely whether the district court erred in granting summary judgment for NOV on Auto-Dril’s counterclaim for breach of the Settlement Agreement. According to the Fifth Circuit, two issues affecting the parties’ bargain, and whether Auto-Dril suffered damages, remain unresolved: (1) whether they would have agreed to the terms of the Settlement Agreement knowing that NOV did not own the ’142 Patent and (2) whether Varco is a party to the Settlement Agreement. Due to the unresolved ambiguity and lingering counterfactual uncertainty, the Fifth Circuit is unconvinced that there was no genuine dispute of material fact that Auto-Dril was not entitled to damages at summary judgment. This was the sole basis for the district court’s dismissal of Auto-Dril’s counterclaim for breach of the Settlement Agreement. Accordingly, the Fifth Circuit remanded Auto-Dril’s counterclaim to the district court.

The Fifth Circuit then turned to the remaining issues raised by NOV, beginning with NOV’s argument that the district court erred when it dismissed NOV’s claim for breach of the Settlement Agreement under its inherent authority.

Here, NOV’s conduct did not rise to the level of a fraud on the court. Specifically, there is not clear and convincing evidence that NOV was cognizant that it did not own the ’142 Patent while it was litigating the Underlying Action. In sanctioning NOV, the district court stated that, in front of the court, NOV accused Auto-Dril of infringing a patent that NOV had no right to assert, referring to the Underlying Action. The court also relied on the jury’s finding that NOV’s conduct rose to the level of fraud. But the court’s jury instructions state a more lenient standard for fraud than the standard required for a fraud on the court, noted the Fifth Circuit, as to the requisite intent and the unlawful conduct that is bound with such intent. Also, there was no evidence that NOV’s assertions regarding its ownership of the ’142 Patent in the Underlying Action amounted to an unconscionable plan or scheme designed to improperly influence the court in its decision. The district court also provided no explanation as to how NOV abused the judicial process. Furthermore, NOV’s untrue assertions in the Underlying Action were devoid of the intent required to show bad faith or willful abuse of the judicial process. That NOV committed a fraud on the court or otherwise abused the judicial process cannot be substantiated by clear and convincing evidence. Accordingly, the district court erred in invoking its inherent authority to dismiss NOV’s claim for breach of the Settlement Agreement. Because it first dismissed NOV’s claim for breach of the Settlement Agreement before addressing the merits, the district court never ruled on NOV’s JMOL motion. Therefore, on remand, the district court should consider the merits of NOV’s motion.

Testimony of Auto-Dril's founder. NOV also contends that the district court improperly allowed James Ray, Auto-Dril’s founder, to provide expert testimony during trial, even though he was testifying as a lay witness. Ray testified that he believed he could stop remitting licensing fees for the ’142 Patent because he was fraudulently induced into entering the Settlement Agreement.

NOV argued that Ray’s testimony included legal conclusions on multiple occasions and the appellate court found that, in the context of Ray’s testimony, these statements cannot be interpreted as anything other than legal conclusions. Even if they were admitted in order to demonstrate why Ray decided to cease paying the licensing fees, that would have no bearing on whether Auto-Dril had breached the Settlement Agreement and constituted irrelevant testimony. The Fifth Circuit thus concluded that the district court abused its discretion in admitting the above testimony.

Auto-Dril admits that it failed to make the final three licensing-fee payments under the Settlement Agreement. Furthermore, it is not apparent that the other evidence introduced at trial supports a finding that Auto-Dril did not breach the Settlement Agreement. Therefore, while reconsidering NOV’s JMOL motion on remand, the district court should consider how Ray’s inadmissible testimony may have infected the jury’s verdict on NOV’s claim for breach of the Settlement Agreement.

Dissenting opinion. Chief Judge Priscilla Richman dissented, indicating that she would hold, as a matter of law, that Varco was bound by the Settlement Agreement and that Auto-Dril received all that it bargained for under the Settlement Agreement—the right to use the ’142 patent without complaint from NOV or Varco. Despite receiving all that it bargained for, Auto-Dril failed to make the final three installment payments, thereby breaching the Settlement Agreement. She indicated that she would affirm the district court’s dismissal of Auto-Dril’s breach-of-contract claim and remand NOV’s breach-of-contract claim for the district court to determine the damages owed by Auto-Dril.

The Case is No. 21-40648.

Attorneys: John Wesley Raley (John Raley & Associates, P.L.L.C.) for National Oilwell Varco, L.P. James Lawton Reed, Jr. (Gray Reed & McGraw, L.L.P.) for Auto-Dril, Inc.

Companies: National Oilwell Varco, L.P.; Auto-Dril, Inc.

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