Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-azd-2_05-cv-01520/USCOURTS-azd-2_05-cv-01520-1/pdf.json

Nature of Suit Code: 830
Nature of Suit: Patent
Cause of Action: 15:1125 Trademark Infringement (Lanham Act)

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WO

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF ARIZONA

Farnam Companies, Inc., 

Plaintiff, 

vs.

Stabar Enterprises, Inc., 

Defendant. 

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No. CV 05-1520-PHX-NVW

ORDER

The court has considered Stabar's Partial Motion To Dismiss Or, In The Alternative,

For Summary Judgment Regarding Counts 3-7 (doc. # 39) ("Stabar Motion"), Statement Of

Facts In Support Of Stabar's Partial Motion To Dismiss Or, In The Alternative, For Summary

Judgment Regarding Counts 3-7 (doc. # 38) ("Stabar SOF" and "Stabar SOF Ex."), Farnam's

Response To Stabar's Partial Motion To Dismiss Or, In The Alternative, For Summary

Judgment Regarding Counts 3-7 And Farnam's Cross-Motion For Summary Judgment (doc.

# 59) ("Farnam Response" or "Farnam Motion" as appropriate), Farnam's Controverting And

Separate Statement Of Facts In Support Of Farnam's Response To Stabar's Motion To

Dismiss Or, In The Alternative, Motion For Summary Judgment And Farnam's Cross Motion

For Summary Judgment (doc. # 60) ("Farnam CSOF" and "Farnam SOF" as appropriate),

Exhibit List To Farnam's Controverting And Separate Statement Of Facts In Support Of

Farnam's Response To Stabar's Motion To Dismiss Or, In The Alternative, Motion For

Summary Judgment And Farnam's Cross-Motion For Summary Judgment (doc. # 62)

Case 2:05-cv-01520-NVW Document 79 Filed 12/08/05 Page 1 of 19
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("Farnam SOF Ex." or "Farnam CSOF Ex."), and Defendants' Response To Plaintiffs' CrossMotion For Summary Judgment And Reply In Support Of Their Partial Motion To Dismiss

Or, In The Alternative, For Summary Judgment Regarding Counts 3-7 (doc. # 69) ("Stabar

Reply" or "Stabar Response" as appropriate), Supplemental Statement Of Facts In Support

Of Defendants' Response To Plaintiffs' Cross-Motion For Summary Judgment And Reply

In Support Of Their Partial Motion To Dismiss Or, In The Alternative, For Summary

Judgment Regarding Counts 3-7 (doc. # 67-1) ("Stabar SSOF") and exhibits thereto (doc. #

67-2 through 67-13) ("Stabar SSOF Ex."), and Farnam's Reply In Support Of Its CrossMotion For Summary Judgment Re Counts 3-7 (doc. # 77).

Farnam Companies, Inc. ("Farnam") brought this action against Stabar Enterprises,

Inc. ("Stabar") after this court denied Farnam's untimely motion to amend its complaint in

a parallel action by Farnam against Stabar. (Case # 03-CV-0503-NVW, doc. # 114.) Stabar

now moves to dismiss for failure to state a claim or alternatively for summary judgment as

to Counts 4-7 of Farnam's Complaint, which allege unfair competition, fraud, negligent

misrepresentation and innocent misrepresentation, and as to Count 3, which seeks a

declaratory judgment that Farnam did not breach the parties' license agreement. Farnam

cross-moves for summary judgment in its favor on the same five counts.

I. Background

The following background is set forth in the Complaint.

Barbara Allen and her husband Stacy Allen formed Stabar, a corporation which

markets, distributes and outsources the manufacture of nutritional supplements for pets.

(Complaint at ¶ 6; Farnam Response at 3.) The parties, for the purpose of this motion, have

treated the Allens and Stabar interchangeably. Stabar's principle products, the "Shed-Stop"

line, are supplements designed to prevent pet shedding. (Complaint at ¶ 6.) The secret

formula for Shed-Stop was invented 300 years ago by Barbara Allen's ancestors and was

passed down to Barbara in the 1980s. (Complaint at ¶¶ 14-17.) The Allens formed Stabar

in 1994 as a vehicle to bring this ancient formula to market. (Complaint at ¶ 18.)

Case 2:05-cv-01520-NVW Document 79 Filed 12/08/05 Page 2 of 19
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Barbara Allen submitted a patent application for Shed-Stop in 1998 and at the same

time assigned her rights in the application to Stabar. (Complaint at ¶¶ 25-26.) In the

application Barbara Allen did not disclose the formula, even though she knew she had a duty

to do so. (Complaint at ¶¶ 27, 30-31.) Nor did Barbara Allen disclose that at the time, ShedStop had been on sale for over 2.5 years. (Complaint at ¶ 28.) Barbara Allen swore to the

Patent Office that she was the "original, first and sole inventor" of the Shed-Stop formula.

(Complaint at ¶ 29.) 

In 1999, Farnam entered negotiations with Stabar to license the rights to Stabar's

products and Shed-Stop in particular. (Complaint at ¶ 41.) During negotiations Barbara

Allen and Stabar made various representations to Farnam about the patent. Barbara Allen

and Stabar told Farnam that Stabar had just been granted a patent on the Shed-Stop formula

and that "one cease and desist letter from Stabar's patent attorney should close the

competition down." (Complaint at ¶¶ 42, 46.) Stabar also submitted to Farnam a business

plan indicating that "Stabar's patent application for the Shed-Stop formula was recently

approved by the U.S. Patent Office" and that "the value of this patent in providing licensing

opportunities and protecting against knock-offs can hardly be overstated." (Complaint at ¶

44.) 

At no time during the negotiations did Stabar or Barbara Allen disclose that Barbara

Allen was not the inventor of Shed-Stop, that the formula was on sale for over 2.5 years

before Barbara Allen had filed the patent application, that the Shed-Stop patent did not

disclose the best mode of making Shed-Stop, or that Barbara Allen had failed to tell the

Patent Office these facts. (Complaint at ¶ 61.) The parties entered a license agreement

("License Agreement") at the close of these negotiations on March 17, 2000, in which

Farnam paid $500,000 in license acquisition fees and $500,000 in prepaid royalties, thereby

obtaining inter alia the exclusive right to practice Stabar's patent. (Complaint at ¶ 52.) 

Pursuant to the license's termination clause, Stabar terminated the License Agreement

on November 24, 2002, allegedly for prior breaches of the agreement by Farnam.

(Complaint at ¶¶ 65-66.) Farnam thereafter brought suit, which was removed to federal court

Case 2:05-cv-01520-NVW Document 79 Filed 12/08/05 Page 3 of 19
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on March 13, 2003. (Complaint at ¶ 71; 03-CV-0503-NVW.) After discovery, Farnam filed

a Motion To Amend Its Complaint on February 15, 2005, seeking to add claims of patent

invalidity and unenforceability, fraud and misrepresentation, and other claims. (Complaint

at ¶ 73.) The court denied the motion to amend and Farnam filed this new action asserting

some of those same claims. (Complaint at ¶¶ 73-74.)

The court previously awarded Farnam a final and enforceable summary judgment on

its claim that Stabar's patent was invalid, without opposition from Stabar. (doc. # 48.) The

court issued a declaratory judgment that Stabar's patent is invalid (1) under 35 U.S.C. § 112

for failing to disclose what the named inventor considered the best mode for making the

claimed invention and (2) under 35 U.S.C. § 102(b) because the product was on sale more

than one year before the application was filed. (doc. # 61.)

II. Legal Standard

The court may not dismiss a complaint for failure to state a claim "unless it appears

beyond doubt that the plaintiff can prove no set of facts in support of his claims which would

entitle him to relief." Barnett v. Centoni, 31 F.3d 813, 816 (9th Cir. 1994). "Dismissal can

be based on the lack of a cognizable legal theory or the absence of sufficient facts alleged

under a cognizable legal theory." Balistreri v. Pacifica Police Dept., 901 F.2d 696, 699 (9th

Cir. 1988). When analyzing a complaint for failure to state a claim, all factual allegations

are taken as true and construed in the light most favorable to the nonmoving party. See Iolab

Corp. v. Seaboard Sur. Co., 15 F.3d 1500, 1504 (9th Cir. 1994). The court must assume that

all general allegations "embrace whatever specific facts might be necessary to support them."

Peloza v. Capistrano Unified Sch. Dist., 37 F.3d 517, 521 (9th Cir. 1994). The court does

not need to assume, however, that the plaintiff can prove facts different from those alleged

in the complaint. See Associated Gen. Contractors of Cal. v. Cal. State Council of

Carpenters, 459 U.S. 519, 526 (1983). 

With regard to the parties' motions for summary judgment, the moving party bears the

initial burden of informing the court of the basis for its motion, and identifying those portions

of the pleadings, depositions, answers to interrogatories, and admissions on file, together

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with the affidavits, if any, which it believes demonstrate the absence of any genuine issue of

material fact. See Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986). Where the moving

party has met its initial burden with a properly supported motion, the party opposing the

motion “may not rest upon the mere allegations or denials of his pleading, but . . . must set

forth specific facts showing that there is a genuine issue for trial.” Anderson, 477 U.S. at

248. Summary judgment is appropriate against a party who “fails to make a showing

sufficient to establish the existence of an element essential to that party’s case, and on which

that party will bear the burden of proof at trial.” Id. at 322. See also Citadel Holding Corp.

v. Roven, 26 F.3d 960, 964 (9th Cir. 1994). Although the initial burden is on the movant to

show the absence of a genuine issue of material fact, this burden may be discharged by

indicating to the court that there is an absence of evidence to support the nonmoving party’s

claims. See Singletary v. Pennsylvania Dep’t of Corr., 266 F.3d 186, 193 n.2 (3d Cir. 2001).

Before the court are Stabar's motion to dismiss the Complaint or, in the alternative,

for summary judgment, as well as Farnam's motion for summary judgment. 

III. Rule Precluding Post-Hoc Recoupment Of Royalties

Stabar moves to dismiss Counts 4-7 on the ground that these claims are barred by the

rule against recoupment of royalties paid under a license. The general rule is that a patent

licensee may not recoup those royalties paid under the license before the licensee

affirmatively declares the patent invalid or otherwise seeks a determination of the patent's

invalidity. Bristol Locknut Co. v. SPS Techs., Inc., 677 F.2d 1277, 1283 (9th Cir. 1982);

Rite-Nail Packaging Corp. v. Berryfast, Inc., 706 F.2d 933, 936 (9th Cir. 1983). The rule is

based on the federal "policies favoring early adjudication of patent validity and

encouragement of the use of the patent system by protecting the security of royalty income."

Transitron Elec. Corp. v. Huges Aircraft Co., 649 F.2d 871, 874 (1st Cir. 1981). The rule

is subject to an exception which Stabar contends applies in this case. "The exception occurs

when a patent holder has induced the licensee to enter into the license agreement through

fraud; in such event, the licensee is entitled to restitution of his royalty payments."

Transitron, 649 F.2d at 874. As described by the court in Transitron, 

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The fraud exception does no violence to the policies [behind the

rule against recoupment]. It does not unduly burden a patent

holder's reasonable expectations since fraud, if ever alleged,

would have to be proven by clear and convincing evidence, and

the patent holder would have to be proven not merely careless

but to have intended to deceive. An honest patentee, therefore,

will have little to fear, while a dishonest patentee can scarcely

complain if later stripped of ill-gotten gains.

Id. at 875 (internal citations omitted). The fraud, moreover, must involve nothing less than

knowing and deliberate conduct and must have been perpetrated against the licensee, not

merely against the Patent Office. Id. at 876. 

The Complaint alleges that Stabar and Barbara Allen knew the patent was invalid and

unenforceable while negotiating the License Agreement with Farnam. (Complaint at ¶ 104.)

Intending for Farnam to rely upon the representations, Stabar submitted to Farnam a business

plan indicating that "Stabar's patent application for the Shed-Stop formula was recently

approved by the U.S. Patent Office" and that "the value of this patent in providing licensing

opportunities and protecting against knock-offs can hardly be overstated." (Complaint at ¶¶

44, 105.) The Complaint also alleges that Stabar represented to Farnam that the patent was

valid, while knowing otherwise. (Complaint at ¶¶ 102, 104.) 

In this court's order of May 17, 2005, in case # 03-CV-503 denying Farnam's motion

to amend, this court noted its skepticism about treating a patent licensor's failure to disclose

its patent's invalidity as fraudulent inducement of a license agreement, such that the licensee

could recoup royalties paid before asserting the patent's invalidity. (03-CV-503, doc. # 114

at 3.) However, this court did not rest its ruling denying amendment on that skepticism. (03-

CV-503, doc. # 114 at 4.)

Upon closer examination of Farnam's principal case, Ampex Corp. v. Memorex Corp.,

1980 U.S. Dist. LEXIS 12068, C-74-2349 at *12 (N.D. Cal. Feb. 1, 1980), this court

concludes that it is in fact an example of recoupment for fraud in the inducement. There the

patent licensee investigated potential patent invalidity, and the patentee withheld the

information from which the invalidity would have been discovered. Perhaps the allegations

of this case that Stabar knew its patent was invalid fall short of that kind of concealment; but

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the similarity between Ampex and this case is too great for this court to undertake to resolve

the sufficiency of that similarity unless necessary to rule on these motions.

Because Stabar is entitled to a stay and alternatively summary judgment on other

grounds, the court need not decide whether Farnam has sufficiently stated a claim for

recoupment.

IV. Waiver By Failing To Bring Claims In The 2003 Suit

Stabar alleges that Farnam has waived its claims by failing to bring them as

compulsory counterclaims in the original 2003 suit between these parties as required by Rule

13(a), Fed. R. Civ. P. (Stabar Motion at 8-9.) Farnam responds that Stabar's prior counsel,

Mr. Lucia, waived Stabar's Rule 13 rights at oral argument on April 1, 2005. (Farnam

Response at 9.) It is undisputed that Mr. Lucia waived at least some of Stabar's rights under

Rule 13(a) on that date; the only issue is the scope of that waiver.

A. Factual Context

The April, 2005 oral argument related to Farnam's Motion To Amend the Complaint

in the 2003 case between these parties. Farnam moved to incorporate eight additional counts

into its complaint, including fraud and invalidity of the patent. (See 03-CV-0503, doc. #

114.) Stabar opposed the amendment, given the extention of discovery that would inevitably

result from amending (see, e.g., Stabar SSOF Ex. 2 at 62:12-16), but sought in the alternative

to be allowed itself to amend its countercomplaint against Farnam to add a Lanham Act

claim. (Id. at 47:10-15.) 

The relevant exchange began as follows. Mr. Lucia argued that the 2003 case was

basically a contract case that would not be affected by a declaration of patent invalidity and

that the court should deny Farnam's motion to amend as well as Stabar's own motion in the

alternative to amend. During the discussion allegedly constituting a waiver, both the court

and Mr. Lucia referred only to a single patent invalidity claim, as opposed to various claims:

MR. LUCIA: . . . . But what I'm saying is, now that they have

moved to amend past the deadline, what we're saying is well, if

you are going to get to amend, we should get to amend also.

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THE COURT: If they -- if I open the door for them you want to

walk through as well.

MR. LUCIA: That's correct. But what I really expect is that

because we're both way beyond, by more than a year, the

deadline to amend, you should deny both motions. And -- I

mean, this case is complicated enough already. To add to it the

validity of the patent, more expert testimony, no possibility of

trying to dispose of this claim by April 22, it just means the trial

is going to get even more complicated and probably be

postponed. 

THE COURT: If I deny their motion to amend and the patent

invalidity is not adjudicated in this case, and we go to judgment

here in due course, you will not be contending that there is any

claim or issue of preclusion that would preclude them from

bringing such a claim in a separate action, will you?

MR. LUCIA: That's right. I mean I don't know if the period of

limitations might run, but even if that's the case.

(Stabar SSOF Ex. 2 at 47:10-48:5 (emphasis added).) The court spoke then with Farnam's

counsel on the issue, and Farnam's counsel mentioned a potential fraud claim. (Id. at 49:15-

50:1.) Nevertheless, the court and Mr. Lucia continued to speak only in terms of a single

claim for patent invalidity:

THE COURT: . . . But let me ask you, Mr. Lucia, if I did decide

to grant their motion, how much additional discovery would

fairly be needed and how much time to do it.

MR. LUCIA: It's going to take re-deposing everyone.

THE COURT: Well, that doesn't sound right to me. It sounds to

me like you would need to go into those specific facts they have

articulated that go to their grounds of invalidity. And that

would have to do with when they first commercially used this,

whether it was more than a year before their application. They

seem to be rather discrete facts. . . .

. . . .

MR. LUCIA: . . . But if we're going to add in this claim, we're

going to have to go another three or four months of discovery

and then have dispositive motions at the end of the summer and

then try the case well into next year. And the better way to

solve this would be to stay on schedule in this case, and if they

want to sue us to declare the patent invalid, they can do that at

some point in the future and have that on its own schedule.

(Id. at 61:24-63:10 (emphasis added).) Thereafter Mr. Lucia made his only arguably

ambiguous statement: "But there's nothing wrong with both sides filing these amendments

as new lawsuits and we'll have a different lawsuit." (Id. at 66:13-15.) The court then

explicitly discussed the Rule 13 waiver situation with Mr. Lucia, who affirmed Stabar's

waiver:

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THE COURT: Well, there is [a problem] – it does seem to me

that if these grounds for invalidity would be lawful defenses to

your action on the licensing agreement, then it is clearly

encompassed within the transaction or occurrence that is the

subject of this lawsuit. And unless you waive it, and perhaps

you already have, a separate action would be barred by an a

adjudication in this case.

Now, the rules of merger and bar can be waived. And the

answers you gave to my earlier question probably are a waiver.

But for your waiver, it sounds like that is a defense to this

action. If they are right about the law, and as I told you I will go

read those cases today. All right.

Anything further?

MR. LUCIA: No. I don't see why they can't bring a lawsuit to

declare the patent illegal, because that has not been an issue in

this case since we dismissed our infringement case.

THE COURT: Okay.

MR. LUCIA: The Lanham Act, that hasn't been part of this case

at all until we now moved to amend. So if it's not granted to be

added to this case there's no reason why we can't sue for it

separately. 

(Id. at 66:16-67:12 (emphasis added).) Only later in the discussion did Farnam's counsel

bring up the fraud claim:

MR. CLAUSEN: . . . With, respectfully, with that, there is also

a claim of fraudulent inducement, which would require

additional discovery as to the reliance upon and the materiality

of the patent at issue here.

THE COURT: Indeed. I have overlooked that one.

MR. CLAUSEN: I didn't think it was expressed at this point.

THE COURT: That claim is that the fraudulent inducement was

the representation that there was a patent for the Stop-Shed.

MS. CATALFIO: Your Honor, if I may answer.

. . . 

THE COURT: All right. Well, as I said, I'm going to take this

under advisement. I will look at those cases. . . .

(Id. at 69:12-70:15 (emphasis added).)

B. Waiver Analysis

"[A] waiver is a voluntary and intentional relinquishment of a known right, or such

conduct as warrants an inference of the relinquishment of such right." Guarantee Title &

Trust Co. v. Babbitt Bros. Trading Co., 47 Ariz. 47, 53, 53 P.2d 734, 736 (1936); Kontrick

v. Ryan, 540 U.S. 443, 458 (2004) ("[W]aiver is the intentional relinquishment or

abandonment of a known right." (internal quotations and citations omitted)). The

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circumstances do not support a finding that Stabar knowingly or intentionally relinquished

its rights under Rule 13 with respect to claims other than for declaration of patent invalidity.

Mr. Lucia only spoke of a single claim of patent invalidity, as opposed to plural

"claims," which might include fraud, unfair competition or negligent misrepresentation.

After the waiver discussion with the court, Mr. Lucia was very precise in explaining exactly

what rights Stabar was waiving, clarifying that the waiver was for a patent invalidity case.

At that point the discussion had been curtailed by the court, yet Mr. Lucia conscientiously

ensured that the record related his clarified intentions. 

The court itself also spoke only of a single "claim," buttressing Mr. Lucia's

understanding about the scope of the discussion despite Farnam's references to the fraud

claim. The court even went so far as to clarify to Mr. Lucia that the amount of additional

discovery the claim would add in the 2003 suit would be limited to depositions related to

Farnam's specific grounds of patent invalidity, as opposed to Stabar having to re-depose

everybody. Later, the court demonstrated that Mr. Lucia's understanding about the scope of

the waiver was accurate, noting that the court had only considered during the waiver

discussions a patent invalidity claim and not the parallel fraud claim. Most tellingly,

Farnam's counsel concurred that the discussion up to that point – which included Mr. Lucia's

waiver – had not dealt with the fraud claim.

In light of the foregoing, the single ambiguous statement made by Mr. Lucia can only

be reasonably read to refer to the claim of patent invalidity. The court therefore concludes

that Stabar did not waive its Rule 13 rights to these other claims.

C. Application Of Rule 13

Having determined that Mr. Lucia did not waive Stabar's Rule 13 rights as to the other

claims, the court must decide the effect of Rule 13 in these circumstances. While there is

variation among courts as to the proper disposition under such circumstances, see Robin

Cheryl Miller, J.D., Annotation, Effect of Filing as Separate Federal Action Claim That

Would Be Compulsory Counterclaim in Pending Federal Action, 81 A.L.R. Fed. 240 (1987);

W. R. Habeeb, Annotation, Failure to Assert Matter as Counterclaim as Precluding

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Assertion Thereof in Subsequent Action, Under Federal Rules or Similar State Rules or

Statutes, 22 A.L.R.2d 621 (1952), Farnam has not disputed Stabar's assertion that absent

waiver, Rule 13 is a bar to these claims. Some authority supports dismissal as the proper

disposition. See United States v. Eastport Steamship Corp., 255 F.2d 795, 802 (2d Cir. 1958)

(holding that Rule 17(a) of the Court of Claims, which is modeled after Rule 13(a), allows

for dismissal of claims in a second suit that should have been brought as compulsory

counterclaims in the first suit, even though the first suit had not yet come to judgment);

Republic Telcom Corp. v. Telemetrics Communications, Inc., 634 F. Supp. 767, 768 (D.

Minn. 1986) ("The general rule is that when an action before a court involves a claim that

should be a compulsory counterclaim in another pending federal suit the court should stay

its own proceedings or dismiss the claim." (emphasis added) (internal quotations omitted)).

A more conservative approach is to stay the claims in the second suit that should have been

brought in the first. See Republic Telecom, 634 F. Supp. at 768 (staying claims in the second

action); Donnkenny, Inc. v. Nadler, 544 F. Supp. 166, 170 (S.D.N.Y. 1982) (same); White

Motor Corp. v. Int'l Union, 365 F. Supp. 314, 317 (S.D.N.Y. 1973) (same); Republic

Precious Metals, Inc. v. Republic Precious Metals Corp., 575 F. Supp. 1256, 1259 (D. Minn.

1984) (same); see also Seattle Totems Hockey Club v. Nat'l Hockey League, 652 F.2d 852,

856 (9th Cir. 1981) (upholding injunction against prosecution of claim in foreign court that

should have been brought as compulsory counterclaim in then-pending suit). The court

concludes that a stay of later-filed claims that are compulsory counterclaims in an earlierfiled action is the appropriate course of action. 

Farnam's Count 3 will be stayed to await a final judgment in the 2003 action. Staying

Count 3 under Rule 13 will inevitably subject Count 3 to merger and bar upon a final

judgment in the 2003 case, likely to be entered in January 2006. Where a plaintiff's motion

to amend the complaint to add claims is denied for dilatoriness, res judicata from the first

case to judgment, if otherwise applicable, will bar such claims when brought in a subsequent

suit. Mpoyo v. Litton Electro-Optical Sys., No. 04-15047 (9th Cir. Dec. 5, 2005). 

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The statute of limitations issues raised in these motions have some similarity to the

timeliness considerations bearing upon this court's denial of Farnam's motion to amend to

bring these claims in the earlier case and its denial of Farnam's later motion to consolidate

the two cases. This court has reconsidered on its own initiative both those rulings in light of

the study it has given to the statute of limitations issues raised in these motions. That further

study leaves this court convinced that the earlier rulings were correct and need not be

changed.

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Counts 5, 6 and 7 would otherwise be stayed for the same reason. However, since the

parties have fully briefed summary judgment arguments with respect to statutes of limitations

on those counts and that defense is dispositive on the merits, the court will decide that

motion. 

The Lanham Act claim in Count 4 would not be stayed by Rule 13, as it is not

necessarily part of the same transaction or occurrence as the claims in the 2003 action. See

Fed. R. Civ. P. 13(a). The Complaint alleges that "Stabar made, and continues to make . .

. misrepresentations to gain competitive advantage over its competitors which now includes

Farnam." (Complaint at ¶ 97.) The claim is one for continuing conduct after the contractual

transaction comprising the 2003 case. 

V. Statute Of Limitations

 Stabar alternatively argues that it is entitled to summary judgment on Farnam's claims

for fraud, negligent misrepresentation, innocent misrepresentation, and unfair trade practices

as barred by statutes of limitations.1

 (Stabar Motion at 11.) 

A. Fraud

The statute of limitations for fraud in Arizona is three years. A.R.S. § 12-543; Estate

of Kirshenbaum v. Kirschenbaum, 164 Ariz. 435, 437, 793 P.2d 1102, 1104 (App. 1989).

A cause of action generally accrues under Arizona law according to the "discovery rule,"

meaning when "the plaintiff knows or with reasonable diligence should know the facts

underlying the cause." Doe v. Roe, 191 Ariz. 313, 322, 955 P.2d 951, 960 (1998). Section

12-543 explicitly mandates that "[f]or relief on the ground of fraud or mistake, [the] cause

of action shall not be deemed to have accrued until the discovery by the aggrieved party of

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the facts constituting the fraud or mistake." A.R.S. § 12-543(3). Despite this narrowing

language, accrual of fraud claims are treated under the same rubric as accrual of other causes

of action. The "statute of limitations, A.R.S. § 12-543, has been interpreted to begin running

when the defrauded party discovers or with reasonable diligence could have discovered the

fraud." Mister Donut of Am. v. Harris, 150 Ariz. 321, 323, 723 P.2d 670, 672 (1986)

(citations omitted); accord Richards v. Powercraft Homes, Inc., 139 Ariz. 264, 265, 678 P.2d

449, 450 (App. 1983) (citations omitted), modified on other grounds, 139 Ariz. 242, 678 P.2d

427 (1984). "The statute commences to run only after one has knowledge of facts sufficient

to make a reasonably prudent person suspicious of fraud, thus putting him on inquiry."

Coronado Dev. Corp. v. Superior Ct., 139 Ariz. 350, 352, 678 P.2d 535, 537 (App. 1984)

(citing Nat'l Auto. & Cas. Ins. Co. v. Payne, 67 Cal.Rptr. 784, 261 Cal.App.2d 403 (1968)).

"As such, it may begin to run before a person has actual knowledge of the fraud or even all

the underlying details of the alleged fraud." Mister Donut, 150 Ariz. at 323, 723 P.2d at 672

(citations omitted).

The parties dispute when Farnam was placed on inquiry notice so as to accrue

Farnam's claim of fraudulent inducement. Stabar alleges that Farnam was on inquiry notice

as of the parties' 1999-2000 negotiations because Farnam was informed at that time of facts

suggesting the patent was invalid. Farnam responds that it had no reason to suspect fraud

until Barbara Allen's 2005 testimony, which allegedly provided new information triggering

Farnam's suspicions.

Under Arizona law, inquiry notice for fraud claims generally arises upon apprehension

of facts materially adverse to the potential claimant's interest. See, e.g., Guerin v. Amer.

Smelting & Refining Co., 28 Ariz. 160, 171, 236 P. 684, 687 (1925) (holding that a

defendant's statement to claimant that claimant could not legally own as a non-American any

part of the property claimant had inherited "should have been a notice and warning to [the

claimant] to investigate the situation" and that therefore the fraud claim against the defendant

had accrued). Inquiry notice for contractual fraud claims, more specifically, arises when a

claimant obtains knowledge of facts suggesting that the defendant has acted or is acting in

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a way materially inconsistent with the claimant's contractual expectations. See Rhoads v.

Harvey Publ'ns., Inc., 145 Ariz. 142, 147, 700 P.2d 840, 845 (App. 1984); Richards, 139

Ariz. at 265, 678 P.2d at 450; Hadra v. Herman Blum Consulting, 632 F.2d 1242, 1247 (5th

Cir. 1980). In Richards, for example, fraud claims brought by the purchasers of houses

against the builder accrued when the purchasers obtained knowledge that the houses were

seriously defective. Richards, 139 Ariz. at 265, 678 P.2d at 450. Like Farnam, the Richards

purchasers had filed a complaint but alleged that they did not discover the facts on which

their fraud claims were based until a later hearing. Id. at 266, 451. The court held that the

purchasers' knowledge of the building defects had placed them on inquiry notice. Id. at 266,

451. The builder's failure to fulfill the purchasers' contractual expectations accrued the

purchasers' claims for fraud. 

Similar are Rhoads and Hadra. In Rhoads, a cartoonist sued his publishing company

alleging that the company had fraudulently deprived him of the copyrights to his drawings.

The court held that contractual language printed on the cartoonist's paychecks, which

indicated inter alia that the paychecks were payment for the cartoonist's copyrights, placed

the cartoonist on inquiry notice "about his rights" and thus accrued his fraud claim. Rhoads,

145 Ariz. at 147, 700 P.2d at 845. If the cartoonist believed that he had retained the

copyrights upon entering his employment contract, the contractual language on his paychecks

indicating contrariwise was materially inconsistent with his expectations and accrued his

fraud claim. 

Hadra, cited by the Arizona Court of Appeals in Rhoads, 145 Ariz. at 147, 700 P.2d

at 845, is also demonstrative. In Hadra, the defendant purchaser of an engineering

consulting firm brought a counterclaim against the seller for fraudulent inducement into the

contract. The court held that in the year after the sale, the purchaser's awareness that the

seller's projections "did not seem to be correct" and that "the firm was not generating as much

money as expected" accrued the purchaser's fraudulent inducement claim. Hadra, 632 F.2d

at 1247. Because such knowledge "should have been enough to cause a reasonably prudent

person to inquire further," the clock had starting ticking. Id.

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Here, within three weeks of entering the License Agreement, the parties were in open

and heated debate about their respective rights arising from that contract. (See Case # 05-

CV-0503.) Farnam describes in its pleadings in the 2003 case how Stabar did not provide

Farnam with what Farnam had bargained for and expected from the License Agreement.

(Id.) Specifically, Stabar refused to disclose the Shed-Stop formula, an integral part of

Farnam's expectation under the agreement and, Farnam contends, an absolute prerequisite

for Farnam to fully benefit from the contract. (Id.) Moreover, Farnam allegedly discovered

to its chagrin that many of the Original Products were merely conceptual and that Farnam

would be required to expend significant sums in bringing the products to market. (Id.)

Informed of such departures from what Farnam expected to receive under the License

Agreement, any reasonable person in Farnam's position would have at that time inquired

about his or her rights under the agreement. 

Richards, Rhoads, and Hadra support this conclusion. Like the defective houses

provided by the builder in Richards, here the transferred product was materially "defective."

According to Farnam, because the patent did not disclose the precise Shed-Stop formula, it

was basically worthless. Just as the Richards purchasers' knowledge of the houses' defects

was sufficient such that "a reasonable person would be put on notice that he might have a

claim against the builder," Richards, 139 Ariz. at 265, 678 P.2d at 450, Farnam's knowledge

about the uselessness of the acquired patent rights put Farnam on notice that it might have

a claim against Stabar. Like the cartoonist in Rhoads, moreover, Farnam knew that Stabar

was viewing Farnam's rights under the contract differently than Farnam viewed them.

Knowledge of the underlying different understanding about disclosure of the formula accrued

Farnam's claim for fraud, just as knowledge of the underlying different understanding about

ownership of the copyrights accrued the Rhoads cartoonist's fraud claim. Finally, the

evidence of broken expectations was more clear here than in Hadra. The patent's

worthlessness was more acutely disappointing than the Hadra claimant's vague realization

that the seller's projections "did not seem to be correct" and that "the firm was not generating

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as much money as expected." Farnam was placed on inquiry notice within weeks after the

execution of the License Agreement. 

 The potential unfairness of belated claims of fraudulent inducement is discussed in

Guerin:

Parties cannot, by their seclusion from the means of information,

claim exemption from the laws that control human affairs, and

set up a right to open up all transactions of the past. The world

must move on, and those who claim an interest in persons and

things must be charged with the knowledge of their status and

condition, and of the vicissitudes to which they are subject.

Guerin, 28 Ariz. at 173, 236 P. at 688. Farnam pursued the benefits of the License

Agreement and the exclusive license of Stabar's patent for two years, investing significantly

more money under the License Agreement during the second year than the first. (See Case

# 05-CV-0503.) Farnam was throughout that time in possession of the patent, which Farnam

only recently argues is facially and obviously invalid. (Id.) As suggested by Guerin, Farnam

should "be charged with knowledge of the status and condition" of that patent and of the

"vicissitudes to which" the patent "is subject," especially given that Farnam is a sophisticated

party in the business of licensing intellectual property. Farnam cannot "claim an exemption

from the laws that control human affairs," even if ascertaining those laws may require

Farnam's contacting of an attorney. See Guerin, 28 Ariz. at 172, 236 P. at 687 (holding that

plaintiff's fraud claim had accrued because "[a] letter to an attorney in Tucson any time after

April, 1914, would have doubtless brought to her information of what was being done [with

her property]"). 

B. Negligent Misrepresentation, Innocent Misrepresentation, And Lanham

Act Claims

Farnam has addressed the statutes of limitations issue for the claims of negligent

misrepresentation, innocent misrepresentation, fraud and violation of the Lanham Act

without distinguishing among them. Farnam does not suggest that the negligent

misrepresentation or innocent misrepresentation claims accrued at a different time than the

fraud claim and provides no separate authority or rationale for denying Stabar's motion as to

these other claims. As Farnam also does not contest Stabar's calculation of the limitations

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periods for these other claims, the court alternatively grants Stabar's motion with respect to

Farnam's negligent misrepresentation and innocent misrepresentation claims. See Texaco

Inc. v. Hasbrouck, 496 U.S. 543, 571 n.30 (1990).

With respect to Farnam's Lanham Act claim, the Complaint alleges that Stabar

"continues to make" misrepresentations. (Complaint at ¶ 97.) Such a continuing violation

would not be barred, at least as to damages within the statute of limitations. 

VI. The Lanham Act Claim (Count IV)

Stabar moves to dismiss Count IV of the Complaint for failure to state a claim. That

Count alleges that Stabar violated § 43(a) of the Lanham Act, 15 U.S.C. § 1125(a), which

reads:

§ 1125. False designations of origin and false

descriptions forbidden

(a) Civil action.

(1) Any person who, on or in connection with any goods

or services . . . uses in commerce any word, term, name, symbol,

or device, or any combination thereof, or any false designation

of origin, false or misleading description of fact, or false or

misleading representation of fact, which--

 . . . (B) in commercial advertising or promotion,

misrepresents the nature, characteristics, qualities, or geographic

origin of his or her or another person's goods, services, or

commercial activities,

shall be liable in a civil action by any person who believes that

he or she is or is likely to be damaged by such act. 

15 U.S.C. § 1125(a). 

The Federal Circuit has read in a bad faith requirement for § 43(a) Lanham Act claims

against patentees. "[B]efore a patentee may be held liable under § 43(a) for marketplace

activity in support of its patent . . . the marketplace activity must have been undertaken in bad

faith." Zenith Elecs. Corp. v. Exzec, Inc., 182 F.3d 1340, 1353 (Fed. Cir. 1999). The

additional requirement is the result of the interaction of federal patent law and the Lanham

Act; patent owners' conditional privilege to make good faith statements in support of their

patents protects even untrue statements, which would otherwise create liability under the

Lanham Act. See id. 

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Farnam alleges that Stabar falsely represented that Stabar's Shed-Stop products were

“subject to a valid U.S. patent” and that Stabar knew its patent was invalid. (Complaint at

¶¶ 93 and 94.) Nevertheless, the Complaint does not sufficiently allege that Stabar made a

"false or misleading" statement of fact as required by the Lanham Act. Patents are

presumptively valid under the law. 35 U.S.C. § 282. Even where a court determines that a

patent was obtained through inequitable conduct such as fraud on the Patent Office, the

patent is not technically invalidated. Zenith, 182 F.3d at 1349. Stabar's statements that its

Shed-Stop formula was the subject of a valid U.S. patent were therefore technically true and

did not violate the Lanham Act. This is the precise holding of IMCS, Inc. v. D.P. Technology

Corp., 264 F. Supp. 2d 193, 197 (D.Pa. 2003). In that case the defendant alleged in

counterclaim that the plaintiff had intentionally failed to disclose relevant prior art to the

Patent Office, making plaintiff's patent invalid and unenforceable, but then advertised that

its software was protected by the patent, knowing that the patent was invalid. Id. at 195. The

court held that until a determination of patent invalidity is made, patents are considered valid

and enforceable, and therefore the counterclaim did not allege false or misleading statements

as required by 15 U.S.C. § 1125(a)(1). Farnam alleges nothing more in this case.

 The application of what is false or misleading may be different between the fraud-onthe-market theory of a § 43(a) Lanham Act claim and a fraudulent inducement claim in direct

negotiations. IMCS reflects the view, and this court agrees, that there is no meaningful

difference for advertising purposes between describing a product as patented and describing

it as validly patented, and either verbalization is insufficient for § 43(a). The difference in

words may or may not matter in the context of a specific patent licensing negotiation. 

VII. Farnam's Motion For Summary Judgment

The foregoing determinations on Stabar's Motion effectively dispose of Farnam's

motion for summary judgment. Farnam's motion for summary judgment on Counts 3-7 is

therefore denied. 

IT IS THEREFORE ORDERED that Stabar's Partial Motion To Dismiss Or, In The

Alternative, For Summary Judgment Regarding Counts 3-7 (doc. # 39) is granted in part.

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Counts 5, 6, and 7 are dismissed on the merits under the statutes of limitations. Count 4 is

dismissed with prejudice for failure to state a claim upon which relief can be granted. Count

3 is stayed under Rule 13(a), Fed. R. Civ. P., pending final judgment in Case No. 03-0503-

PHX-NVW. 

IT IS FURTHER ORDERED that Farnam's motion for summary judgment (doc. # 59)

is denied. 

DATED this 8th day of December, 2005.

 

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