Opinion
Case No. 95-10504-AM, Adversary Proceeding No. 95-1060
July 17, 1995
Carlos M. Recio, Esquire, Judith A. Hoggan, Esquire, Keck, Mahin Gate, Washington, DC, Of counsel for defendant and counter-plaintiff Robert L. Fullerton
John G. Milliken, Esquire, Venable, Baetjer and Howard, LLP, McLean, VA, Of Counsel for intervenor ZipNut Virginia, Inc.
Joseph F. Manson, III, Esquire, Lagenberg Manson, P.C., Fairfax, VA, Of Counsel for plaintiffs and counter-defendants ZipNut, Inc. et at.
MEMORANDUM OPINION
This matter was heard in open court on June 26, 1995, on the motion of the defendant to dismiss or abstain and on the objection thereto filed by ZipNut Virginia, Inc. d/b/a Thread Technology, Inc. ("Thread Technology"), which has been allowed to intervene as a plaintiff. At the conclusion of the hearing, the matter was taken under advisement. For the reasons set forth in this Memorandum Opinion, the court concludes that abstention is appropriate and that the complaint and counter-complaint should be dismissed without prejudice.
Statement of Facts
While the underlying causes of action are hotly contested, the facts relevant to the present motion are not in dispute. Plaintiff ZipNut, Inc. ("the debtor"), is a Nevada corporation which moved its corporate office and manufacturing operations to Chantilly, Virginia, in 1992. It filed a voluntary petition under chapter 11 of the Bankruptcy Code in this court on February 9, 1995. ZipNut's business was the manufacture and sale of couplings and nuts based on an invention by Robert L. Fullerton ("Fullerton") known as the "ZipNut," a quick-acting threaded nut or coupling that can be pushed on and then engage and hold as a regular nut or coupling. Among the assets listed in the debtor's schedules were three United States patents, four United States Trademark registrations, three United States patent applications, ten foreign patent applications, and a "Master Exclusive License of all designs, trade secrets, patents, trademarks related to Zipnut Technology."
Fifteen days after the chapter 11 petition was filed, the debtor and two affiliates, First Phoenix, Inc. ("First Phoenix") and Crescent Products Corp. ("Crescent"), commenced the present adversary proceeding against Fullerton, who resides in Nevada and is the debtor's majority shareholder, seeking a declaratory judgement that the plaintiffs, rather than Fullerton, own the patent rights to the ZipNut. The complaint further seeks a declaratory judgment that, based on an asserted breach of a "master license" and of a Nevada state court consent order, Fullerton has no further royalty rights in the ZipNut. Fullerton has filed an answer denying that the plaintiffs are entitled to the relief sought and a counter-claim for declaratory judgment that he is the exclusive owner of the ZipNut patents and patent applications and that any rights he had previously granted to the plaintiffs were of no further force and effect.
The complaint asserts, and the answer denies, that First Phoenix and Crescent are wholly-owned subsidiaries of the debtor. For the purposes of the present motion, it does not matter whether First Phoenix and Crescent are subsidiaries or merely affiliates of the debtor.
At the time the chapter 11 petition was filed, the debtor was still in business, manufacturing and filling orders for ZipNut products. Although the debtor was able to obtain a partial cash infusion from some of its existing debenture holders, the funds were ultimately not sufficient to sustain the company's operations, and it has ceased to conduct business. Orders have been entered by this court allowing the debenture holders, a pre-petition lender, and the assignee of a pre-petition lender to foreclose their security interests in the debtor's equipment and license rights. Thread Technology claims to be the assignee of two such security interests. The debtor, having no funds to prosecute the present adversary proceeding, was, after notice to all creditors, permitted to abandon its interest in the present litigation, and this court on June 26, 1995, granted the motion of Thread Technology to intervene to protect its interest as lien holder in the underlying patents.
Although the claimed security interests extend also to the ZipNut patents and patent applications, relief has not been granted to foreclose against the patent rights, as distinguished from the debtor's rights under the claimed exclusive master license.
Prior to the chapter 11 filing, there had been extensive litigation in the Nevada state courts involving Fullerton and the debtor. The course of that litigation is fully set forth in the opinion of the Supreme Court of Nevada in Fullerton v. Second Judicial District Court, 892 P.2d 935 (Nev. 1995), which was decided subsequent to the chapter 11 filing, and need not be repeated at length. Briefly, in 1991 the State of Nevada brought a securities fraud action against the debtor, First Phoenix, Crescent, and Fullerton based on the sale of unregistered shares of stock in First Phoenix. After a receiver was appointed for the assets of all the defendants, a consent order was entered on October 24, 1991, by the Second Judicial District Court of the State of Nevada that provided, among other terms, for the merger of First Phoenix and Crescent into the debtor and for the licensing of Fullerton's patent rights to the debtor in exchange for a five percent royalty. As part of the order, the debtor (but not Fullerton) was released from receivership in order to carry out the reorganization. In 1993, Fullerton moved to terminate the receivership as to him. That motion was denied. The trial court's decision was sustained on appeal by the Nevada Supreme Court in an order of March 31, 1994, which explained "that the purpose of the continued receivership was to maintain control of Fullerton's patent rights until a licensing agreement was executed and to control the [ZipNut, Inc.] voting shares owned by . . . Fullerton until [ZipNut, Inc.] was `up and running well.'" 892 P.2d. at 937.
The consent order does not state the terms of the license. The essential terms are set forth in a subsequent order of February 21, 1992, which decreed as follows:
4. The Court having found that Mr. Fullerton and Crescent have given to Zip Nut an exclusive license of all patents, patent applications an [sic] foreign right [sic] in consideration of a five percent (5%) royalty, Zip Nut is hereby authorized to exercise that license in its manufacturing, marketing and sales.
The order directed the parties, since they had not agreed on "the remaining terms" of the license, "to attempt to reach agreement." Such agreement was never reached. By amended order dated April 13, 1994, the trial court determined that a provision in one of its prior orders prohibiting the sublicensure or disposition of the patent did not bar the debtor from encumbering the license in order to raise operating capital. Most recently, the Nevada trial court, by amended order dated December 28, 1994, determined that
ZipNut, Inc. has the authority under the exclusive license granted in February 1992 by this Court to grant its affiliates, or joint venture partners * * * the right to manufacture, market and sell specific ZipNut products
as long as Fullerton received his 5 percent royalty. The order further decreed "that the only outstanding issues unresolved are in regards to the final terms of the licensure agreement which shall be adjudicated by this Court hereinafter."
Subsequently, the receiver asked the Nevada trial court to approve a $2 million investment in the debtor by a company called Space Vest. Three of the conditions of the Space Vest investment were that Fullerton's shares be redeemed by the debtor; that his patent rights be assigned to the debtor in exchange for a cash payment of approximately $77,000 and a three percent royalty on future ZipNut sales; and that he waive all claims against the debtor. On May 17, 1994, the Nevada trial court approved the investment and ordered Fullerton to transfer his shares of stock and any "patents, patents pending, trademarks, copyrights, designs and other intellectual property . . . related to the Zip Nut invention" to the debtor and to waive any claims they had against the debtor. Fullerton applied to the Nevada Supreme Court for a writ of prohibition. That court issued a stay and, ultimately, a decision which concluded that under Nevada receivership law the trial court lacked authority to order Fullerton to sell his shares and patent rights and, therefore, "acted in excess of its jurisdiction." 892 P.2d at 942. Accordingly, the Nevada Supreme Court directed that a writ of prohibition issue precluding the trial court from enforcing the May 17, 1994 order.
Conclusions of Law
This court has jurisdiction over this adversary proceeding under 28 U.S.C. § 1334 and 157(a) and the general order of reference entered by the United States District Court for the Eastern District of Virginia on August 15, 1984. The complaint asserts, and the answer admits, that this is a "core" proceeding within the meaning of 28 U.S.C. § 157(b). However, the court is of the opinion that this is not a core proceeding but rather a proceeding "related to" the debtor's chapter 11 case. The distinction is important, because under 28 U.S.C. § 157(c), although a bankruptcy judge may hear both core and non-core matters, he or she may enter final judgments and orders only in core proceedings. In non-core "related" proceedings, the bankruptcy judge may enter final judgments or orders only where all parties consent to the bankruptcy judge so acting; otherwise the bankruptcy judge submits proposed findings of fact and conclusions of law to the district court. In this case, Fullerton orally consented on the record at the hearing on June 26, 1995, to the entry of final judgments and orders by this court; and Thread Technology, by letter to the court subsequent to the hearing, likewise consented. Accordingly, this court has authority to enter a final judgment or order, subject to the right of any party to appeal to the United States District Court under 28 U.S.C. § 158(a).
A proceeding is "related to" a bankruptcy case "if the outcome could in some way alter the parties' rights in bankruptcy or affect administration of the estate." Lux v. Spotswood Construction Loans, 176 B.R. 416, 418 (E.D.Va. 1994). See, Pacor, Inc. v. Higgins, 743 F.2d 984, 994 (3rd Cir. 1984) (a matter is "related to" a bankruptcy case if "the outcome of that proceeding could conceivably have any effect on the estate being administered" or if it "could alter the debtor's rights, liabilities, options, or freedom of action.") These include "causes of action owned by the debtor that became property of the estate under section 541." 1, King, Collier on Bankruptcy ¶ 3.01[c][iv], p. 3-28 (15th ed.).
Fullerton has advanced two principal theories under which this court should abstain: respect for state court proceedings under the rule of Younger v. Harris, 401 U.S. 37, 91 S.Ct. 746, 27 L.Ed.2d 669 (1971), and permissive abstention under 28 U.S.C. § 1334(c)(1). Because the latter is dispositive, it will be addressed first.
Under 11 U.S.C. § 1334(b), the district courts of the United States have original but not exclusive jurisdiction of "all civil proceedings arising under title 11, or arising in or related to cases under title 11" (emphasis added). Although the bankruptcy jurisdictional grant is both pervasive, and in most cases paramount, because it is not exclusive, other state and federal courts are not deprived of jurisdiction they otherwise possess over matters to which bankruptcy jurisdiction extends. Under 11 U.S.C. § 1334(c)(1), the district court — and by extension, this court, in view of the reference under 28 U.S.C. § 157(a) and the parties' consent to the entry of final judgments and orders by this court — may choose, "in the interest of justice, or in the interest of comity with State courts or respect for State law," to abstain from hearing a particular proceeding.
Although 28 U.S.C. § 1334(d) grants the district court in which a bankruptcy case is pending exclusive jurisdiction over property of the debtor's estate, this provision has never been thought to deprive other courts of jurisdiction over disputes about such property if the bankruptcy court chooses to abstain. See, e.g., Cournoyer v. Town of Lincoln, 790 F.2d 971, 974 (1st Cir. 1986); In re White, 851 F.2d 170 (6th Cir. 1988).
At the outset, the court is not unconscious of the irony inherent in Fullerton — who at all times has vigorously contested the right of the Nevada courts to exercise control over his patent rights — asserting in this case that the Nevada receivership proceedings are the proper forum in which to resolve ownership of those rights. As noted above, he has been partially successful in attacking the scope of the Nevada trial court's jurisdiction, in that the Nevada Supreme Court, while refusing to dissolve the receivership which was intended in part "to maintain control of Fullerton's patent rights," nevertheless held that the trial court had gone too far in ordering him to surrender those rights.
While the Nevada Supreme Court decision clearly raises a question of just how much control the trial court has over the patent rights in the context of a securities fraud receivership action, by the same token, it does not oust the trial court of all jurisdiction or imply that the trial court would not have the power to construe or enforce the consent order of October 24, 1991. It is Fullerton's alleged breach of that consent order and the resulting master license which is urged by the plaintiffs in the present action as the basis for terminating his royalty rights. Although ownership rights to the patents and patent applications, and royalty rights under the consent order, are not currently the direct subject of litigation in the Nevada receivership, they at least fall within the broad outer perimeter of matters that the state court may have to resolve in order to fashion a remedy for the First Phoenix shareholders whom Fullerton allegedly defrauded. Even if the Nevada courts were to hold that the precise claims asserted by the complaint in this case would have to be raised by an independent action rather than in the receivership proceedings, the Nevada courts would nevertheless appear to be in a superior position to this court to construe, and to determine the appropriate remedy for breach of, the state court consent order.
Additionally, at the present time the causes of action raised in the complaint have only the most tenuous relationship to the pending bankruptcy case. While relief from stay has been granted only with respect to the debtor's "exclusive master license" to exploit the ZipNut patents and not with respect to the patents and patent applications themselves, the debtor's patent rights are the subject of liens claimed by the debenture holders and two secured creditors in the case. Because of a lack of cash, the debtor in possession is not in a position to exploit the patents or pursue the applications, and, therefore, whatever may be the theoretical value of the patents and patent applications, they have no presently realizeable value to the debtor or to the estate. Additionally, the debtor in possession, asserting that it was without funds to pursue its claims against Fullerton, was permitted to abandon them under § 541 of the Bankruptcy Code, which permits a trustee — and by extension under § 1107 of the Bankruptcy Code, a debtor in possession — to abandon property that is burdensome or of no consequential value. While abandoning the litigation asserting ownership of the patent rights may not be the same as abandoning the patents and patent applications themselves, there is little difference from a practical point of view. With the debtor itself out of business, and with all of its manufacturing assets, inventory, and the master license in the hands of its secured creditors, there is little or no likelihood of benefit to the bankruptcy estate that could result from this litigation.
Moreover, there appears to be no independent basis of federal jurisdiction. First, diversity of citizenship does not exist under 28 U.S.C. § 1332. Since Strawbridge v. Curtiss, 7 U.S. (3 Cranch) 267, 2 L.Ed 435 (1806), diversity jurisdiction has required that every plaintiff be of diverse citizenship from every defendant. 1 Moore's Federal Practice ¶ 071 [5.-2], p. 739 (2nd ed.) Additionally, a corporation is treated as "a citizen of any State by which it has been incorporated and of the state where it has its principal place of business." 28 U.S.C. § 1332(c). Fullerton, as noted above, is a citizen of Nevada. ZipNut and First Phoenix are both Nevada corporations, even though ZipNut had a principal place of business in Virginia at the time the complaint was filed. Since at least two of the plaintiffs are citizens, by their place of incorporation, of the same state as the defendant, the requisite diversity does not exist. See, e.g., McLaughlin v. Arco Polymers, Inc., 721 F.2d 426 (3rd Cir. 1983) (No diversity jurisdiction where individual plaintiff a citizen of Pennsylvania and defendant corporations incorporated in Pennsylvania, even though corporations' principal place of business was in California).
Additionally, although Thread Technology repeatedly attempts to characterize the complaint as raising issues of Federal law — thereby providing a basis for federal jurisdiction either under 28 U.S.C. § 1331 or 28 U.S.C. § 1338(a) — a review of the complaint does not support such an assertion. The complaint, although pleaded in a single count, essentially sets forth two claims for relief: first, that because of Fullerton's inequitable conduct and his fiduciary position vis-a-vis the investors in First Phoenix, Crescent, and the debtor, the ZipNut patent rights belong to those corporations; and second, that because of Fullerton's breach of the state court consent order, he is not entitled to any royalties from the patents. Nowhere in the complaint is there a reference to any "laws of the United States" or "Act of Congress" other than those related to bankruptcy jurisdiction. Simply because patents are creatures of federal statute does not make every cause of action involving a patent an action "arising under" the patent laws of the United States. As one commentator notes, summarizing the extensive case law that has developed:
"The district courts shall have original jurisdiction of all civil actions arising under the Constitution, laws or treaties of the United States."
"The district courts shall have original jurisdiction of any civil action arising under any Act of Congress relating to patents. . . ."
Suits to enforce a patent, whether or not literally asserted as infringement claims, arise under federal law. Generally, a declaratory judgment suit to decide whether a patent is valid or infringed arises under federal law. * * * Actions to resolve patent ownership do not usually arise under federal law. For example, a claim for shop rights is a state law claim. * * * A declaratory judgment action for reversion of title to patent rights does not arise under federal law, nor does a suit for specific performance of a contract to assign a patent. A claim to determine whether a contract is a patent assignment or how to interpret an assignment is a state court claim.
Ted D. Lee and Ann Livingston, "The Road Less Traveled: State Court Resolution of Patent, Trademark or Copyright Disputes," 19 St. Mary's Law Journal 703, 708-709 (1988) (citations omitted.) Here the pleaded cause of action is most closely analogous to a claim for shop rights and for breach of an agreement to grant an exclusive license of a patent; it does not attack, or seek to affirm, the validity of the underlying patents, to prohibit or seek damages for their infringement, or to obtain a declaration of noninfringement. Accordingly, the claims raised do not "arise under" federal law but rather are in all essential respects state law claims. Mead Corp. v. United States, 652 F.2d 1050 (D.C. Cir. 1981) (District Court lacked subject matter jurisdiction over suit for declaratory judgment that Department of Defense, and not another company, was rightful owner of patent rights in ink jet printer;) Poles, Inc. v. Estate of Beeker, 475 F. Supp. 23 (E.D.Pa. 1979) (no federal jurisdiction over declaratory judgement action to avoid license obligations); Lion Mfg. Corp. v. Chicago Flexible Shaft Co., 106 F.2d 930 (7th Cir. 1939) (Employer's alleged equitable ownership of employee's patent invokes no federal court jurisdiction).
The court concludes, therefore, that in view of the fact that the Nevada trial court retains receivership control over Fullerton's patent rights; that a major portion of the complaint seeks to determine the proper remedy for the alleged violation of a consent order entered by that court; that the debtor in possession has abandoned its interest in this litigation and the action is being pursued by an intervenor; and that federal jurisdiction does not exist independently of the jurisdiction conferred by 28 U.S.C. § 1334 for proceedings "related to" a bankruptcy case, the "interests of justice" favor abstention in favor of resolving the claims in the state court. In view of the decision reached, it is not necessary to consider whether abstention would separately be required under Younger v. Harris, supra.
Thread Technology, which is a Virginia corporation, may-an issue this court need not and does not decide — have standing to assert the claims by an independent action solely in its own name, in which case diversity jurisdiction might exist. Whether the Eastern District of Virginia would be the appropriate venue is doubtful, however, as the pleadings do not set forth any contacts by Fullerton with Virginia, and it seems likely that such an action would have to be brought in Nevada even if filed in Federal court.
An order will be entered dismissing the complaint and counter-complaint without prejudice.