Insurance companies have moved aggressively to limit liability coverage for intellectual property claims and have successfully challenged coverage under general liability policies for patent infringement.

Carriers were handed a win in 2003's Hameid v. National Union Fire Ins., 31 Cal.4th 16, for example, when the California Supreme Court unanimously agreed to limit "advertising" to only widespread dissemination to the public at large. Similarly, the International Organization for Standardization's Comprehensive General Liability forms have been modified to limit coverage of intellectual property offenses.

There is, however, an additional source of coverage in patent infringement litigation: shotgun counterclaims.

Shotgun counterclaims include causes of action from antitrust law, the Lanham Act and common law brought in response to the insured's patent infringement lawsuit. (The Lanham Act defines the scope of trademarks.)

The factual allegations of these counterclaims may trigger coverage under a CGL policy's personal injury and advertising injury coverage. Moreover, once the insurance carrier begins defending the counterclaims, the demarcation between the legal work needed to defend counterclaims and that needed to prosecute the insured's claim blurs, creating a source of funding for the insured's patent infringement suit.

CGL policies typically cover "malicious prosecution," but counterclaims in patent litigation rarely expressly state such a cause of action. These actions do, however, often contain allegations that the insured's efforts to protect its patent rights amount to "sham" litigation intended to monopolize the market.

A sub-species of this claim, a so-called "Walker Process" claim, alleges that the insured has attempted to enforce a patent procured through fraud on the U.S. Patent and Trademark Office. These allegations can appear in claims for monopolization under federal and state antitrust laws, interference with prospective economic advantage and abuse of process. Under California law, such allegations trigger a duty to defend.

In 1986, for example, in CNA Casualty of California v. Seaboard Surety, 176 Cal.App.3d 598, Seaboard and other carriers refused to participate with CNA in the defense of an antitrust suit that alleged that the insured, among other things, filed "false, frivolous and sham counterclaims in this action."

The First District Court of Appeal held that these allegations "raised at least the possibility of liability under the malicious prosecution coverage contained in the insurance policies." Coverage exists even without a cause of action for malicious prosecution, as insurance law has long prevented an insurer from "hiding behind the pleadings."

For example, in 1966, the California Supreme Court said in Gray v. Zurich Ins., 65 Cal.2d. 263, "In light of the likely overstatement of the complaint and of the plasticity of modern pleading, we should hardly designate the third party as the arbiter of the policy's coverage."

Furthermore, the counterclaimant need not allege that the "sham" litigation was already resolved against the insured in order to strictly satisfy the elements of a claim for malicious prosecution and trigger coverage. CNA v. Seaboard rejected this requirement, finding the potential for coverage existed because the insured's suit (the allegedly "sham litigation") could potentially be resolved against it.

Similarly, a judgment against the insured is not necessarily needed to meet the "finality" element for malicious prosecution; voluntary dismissal of a suit or of causes of action may satisfy the requirement if it evidences a resolution on the merits. In addition, the Ninth Circuit has held that allegations amounting to abuse of process (which does not require a final determination) trigger coverage under the malicious prosecution offense. See, for example, 1994's Lunsford v. American Guar. & Liab., 18 F.3d 653.

Defamation And Disparagement

Counterclaims to patent actions also often include allegations that 1) the insured made false statements in the trade press or in soliciting customers, 2) the counterclaimant infringed on the insured's patents or stole trade secrets, or 3) that its product does not work. The allegations may appear within antitrust or Lanham Act claims, as well as common law causes of action such as defamation, disparagement, trade libel or injurious falsehood. Such allegations also may trigger a duty to defend.

Policy language is important here: Some policies expressly cover both defamation and disparagement claims, but others purport to cover "libel, slander or defamation," but not "disparagement" or "trade libel." Carriers often use this language to argue that in this commercial context, the counterclaims sound in "disparagement," not "defamation," and therefore deny coverage.

The distinctions between "defamation" and "disparagement," or between "libel" and "trade libel," may not be obvious to a lawyer, much less the layperson who provides the standard for interpreting policy language. California courts are split as to whether a policy providing coverage for "libel, slander or defamation" also extends to disparagement claims. Here again, the specific factual allegations may be critical. False statements criticizing a business or its goods are defamatory if they explicitly or implicitly call into question the company's honesty, integrity or competence.

Defense Cost Issues

Even if your carrier agrees to defend under a reservation of rights, a ferocious battle over significant defense costs looms. Carriers employ a combination of tactics to limit their defense costs. They demand "panel counsel" rates under California Civil Code §2860. They attempt to allocate between defense of the counterclaims and prosecution of the insured's patent infringement claims. And they impose "billing guidelines." All of these objections to defense costs are subject to challenge.

§2860 allows a carrier to pay only the rates "actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended."

Carriers do not ordinarily defend patent infringement or antitrust lawsuits and may not be able to show that they retain attorneys for these kinds of suits "in the ordinary course of business." The insured, therefore, should insist that the carrier pay the actual rates being charged by defense counsel unless the carrier can prove — through evidence of specific cases and attorneys — that it has actually paid "panel counsel" for this kind of litigation.

Similarly, 1997's Buss v. Superior Court, 16 Cal.4th 35, requires a carrier to defend both covered and uncovered claims subject to the right of reimbursement as to defense costs related solely to the defense of uncovered claims. If the carrier must defend some of the counterclaims, it must defend all of them.

Carriers nonetheless may claim a right to allocate as to the prosecution of the insured's patent claims under Buss. But if the insured has filed a suit for patent infringement and the counterclaims allege that this and other infringement lawsuits are "sham" litigation, then the carrier's argument will likely fail.

The main defense to the sham litigation claim is, for example, for the insured to prove in its claim for patent infringement that the statements were true. Thus, there is no practical distinction between the work on the insured's infringement claim and the defense of the counterclaims. As such, it will prove impracticable to segregate the work in invoices, and a carrier's effort to do so after the fact will almost always result in arbitrary reductions in the amounts it reimburses.

The insured should also challenge the carrier's allocation efforts early and aggressively. Otherwise, the accumulation of allocated and unreimbursed fees and costs will give the carrier excessive and unfair leverage when it comes time to discuss settlement of the litigation and resolution of the coverage disputes.

Finally, billing guidelines can peck an insured to death. These may seek to limit staffing, avoid payment for certain tasks, such as meetings among attorneys, require task billing and deem certain work by paralegals and other non-attorney staff as unreimbursable "overhead."

While these are often presented as "mandatory" by the carrier, they are neither part of the policy nor within the policy's contractual obligations. Insureds should review such guidelines carefully at the outset and then negotiate a three-way arrangement with the carrier and defense counsel. In this manner, defense counsel's practices will match what the insurance carrier has agreed to pay.

Counterclaims in patent infringement suits, however denominated, can contain potentially covered allegations triggering a duty to defend. The insured should study the allegations carefully and seek advice from coverage counsel about tendering the defense of these counterclaims. In many cases, the carrier's defense obligations may result in the insured obtaining not only a defense to the counterclaims, but also funding for prosecution of the patent infringement suit. For the same reasons, a defendant in a patent infringement suit should carefully consider the facts it intends to allege in counterclaims and make an informed choice about whether it wants to trigger coverage for its opponent.

Dennis M. Cusack and Alexander E. Potente are attorneys in the insurance coverage practice group of Farella Braun & Martel. Farella Braun + Martel's Insurance Coverage Group represent policyholders in coverage disputes arising out of a wide variety of exposures, such as construction delay and defects claims, products liability litigation, securities fraud and other corporate directors' and officers' liabilities, errors and omissions claims, intellectual property disputes, employment litigation, environmental liabilities and disasters such as earthquakes and fires.

Farella Braun + Martel was founded in 1962 and maintains offices in San Francisco and St. Helena, California. The firm represents clients throughout the United States and abroad in sophisticated business transactions and high-stakes commercial, civil and criminal litigation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.