Executive Summary: Two Court of Appeals decisions involving patents owned by Rambus Inc. (NASDAQ:RMBS) relating to computer memory chips are expected in early 2011. I predict Rambus will win the appeals and get an instant noticeable boost in its stock.
When is something “reasonably foreseeable”? The answer to that question could cause one company to gain or lose $1B worth of market cap at some point in the next couple months. Let me explain.
Parties involved in litigation are not allowed to destroy any documents, emails, or other materials that could possibly be relevant to the case. Doing so is considered “spoliation” of evidence and is a big big no-no. If a party commits spoliation, the judge can impose a penalty that is appropriate given the level of bad faith by the spoliator and the prejudice caused to the other party. If the spoliation is grievous enough, a court can grant outright victory in the case to the other party. This is called the “death penalty,” because it literally kills the spoliator's case.
The duty to not destroy relevant documents can arise well before a lawsuit begins if involvement in the lawsuit was “reasonably foreseeable.” So, for example, if you plan to sue someone in the future, the litigation is “reasonably foreseeable” to you, and, thus, you have a duty as of right now to not destroy any documents that could be relevant to the lawsuit you intend to file. The same duty may not be placed on your adversary, yet, because he/she may not know that you're planning to sue them, and thus the litigation isn’t yet “reasonably foreseeable” to them. Determining when litigation is “reasonably foreseeable” is not that easy. As we'll see, different judges can – and do – disagree.
RAMBUS' ACCUSED SPOLIATION
Rambus Inc. is a company that designs, develops and licenses chip interface technologies and architectures. One of its biggest claimed successes is the dynamic random access memory (DRAM) architecture for memory chips that are “implemented in hundreds of millions of consumer, computing and networking products from leading electronics companies including Cisco (NASDAQ:CSCO), Dell (NASDAQ:DELL), Hitachi (HIT), HP (NYSE:HPQ), Intel (NASDAQ:INTC), Panasonic (PC), SiS, Sony (NYSE:SNE), Texas Instruments (NYSE:TXN), and Toshiba (OTCPK:TOSBF).” RMBS' business is largely based on asserting patents over its technology through licensing efforts and, when those fail, litigation. As another Seeking Alpha contributor wrote last summer, Rambus is one of “3 Stocks With Potentially Lucrative Patents."
Rambus is currently involved in a number of patent cases. Two are currently on appeal and pit Rambus against Micron Technology, Inc. (NASDAQ: MU) and Hynix Semiconductor Inc. (Public, SEO:000660) in suits originally filed in August 2000 (yes, they're more than 10 years old, which is a sign of how long and protracted these fights can be). Rambus admitted in the lawsuits that it destroyed a substantial number of relevant documents in 1998 and 1999. This led both Micron and Hynix to argue that Rambus had spoliated evidence and that, as a result, Rambus’ patents should be held unenforceable (i.e. given “the death penalty”).
CONFLICTING DISTRICT COURT DECISIONS
The Hynix court in California found that the litigation was not “reasonably foreseeable” to Rambus until late 1999, when Rambus sought out and retained litigation counsel. As such, the documents destroyed in 1998 and 1999 were destroyed before the duty of preservation arose. The Micron court in Delaware found the complete opposite, that the litigation was “reasonably foreseeable” to Rambus by at least December 1998, when Rambus’ VP of Intellectual Property wrote a memorandum outlining a potential litigation strategy. As a result, the Micron court held that all of the documents destroyed in 1999 constituted impermissible spoliation and sanctioned Rambus with the death penalty by declaring Rambus' patents unenforceable. Hynix asked the California court to reconsider its decision on the issue in light of the Micron/Delaware court's decision, but the California judge in the Hynix case maintained his original finding that Rambus had done nothing wrong. Putting it bluntly, the California judge acknowledged that, “The Delaware court’s decision on spoliation differs from this court’s as to both factual and legal conclusions.”
APPEALS COURT REVIEW
Hynix appealed the decision of the California court in favor of Rambus, and Rambus appealed the decision of the Delaware court in favor of Micron. There is only one Court of Appeals for patent cases, so both appeals ended up there. Realizing that the two cases were filed at about the same time and based on virtually identical facts and legal issues, the Court of Appeals combined the two for purposes of appellate review. That means the same judges were assigned to both cases and that they were both heard for oral argument at the same time.
The two appeals were originally argued to a panel of three judges on April 5, 2010. One of the judges assigned to the case retired in May, but the Court didn't issue its opinions by then. On June 9, 2010, the Court issued an order scheduling a re-argument of the cases on October 6. The cases were also assigned to a new group of five judges, one of which was a member of the original three-judge panel. The October 6, 2010, argument was described by Bloomberg as, “Rambus Defends Document Policy in Hynix, Micron Appeal Redux,” and Reuters reported that “Two judges seem skeptical of Rambus arguments."
After reviewing the matter, I believe Rambus will win both appeals. There are several reasons for this, and I won't bore you with all the details, but here are at least a couple of the considerations that led me to this conclusion.
First, both cases were filed by the opposing party in an attempt to challenge Rambus’ patents before Rambus sued them. This makes the argument that the lawsuits were “reasonably foreseeable'” to Rambus a little more specious, because it wasn't Rambus that actually filed the suits.
Second, when Rambus destroyed some of the documents here, many of the patents in the suits had not even yet been issued. It seems quite attenuated to me to say that litigation is foreseeable for a patent holder who hasn't yet even received the patents, because you can't file a patent infringement lawsuit unless and until you actually have a patent.
Third, even if Rambus did commit spoliation, for the Delaware court to hold the patents unenforceable is a very draconian penalty, one that should only result if there was substantial bad faith by Rambus and prejudice to the opposing party. I don't see either of those proven here, as there's no evidence that Rambus purposeful tried to hide evidence and neither Micron nor Hynix has pointed to any specific issue on which the missing documents will make it harder for them to win their case. So, at worst, even if the Court of Appeals believes Rambus did destroy documents improperly, I think they will say instituting the death penalty was too harsh. In the Micron case, the judge could implement a lesser penalty, but the California judge cannot, because Hynix made an all-or-nothing spoliation motion.
Fourth, if the Court of Appeals were to rule Rambus had acted improperly here, such would have a substantial effect on all other patent holders that could be quite devastating. Setting the precedent that destroying documents more than 18 months before a lawsuit is filed against you constitutes your own spoliation of evidence punishable by the death penalty would cause a lot of risk and concern and burden for patent holders. Pharmaceutical companies, who could be argued to only get patents in order to sue potential generics, could be argued to be spoliators if they ever destroyed any documents. This is simply, in my mind, unreasonable.
Further, the retroactive application of the holding (because it would apply to acts of document destruction that occurred prior to the Court of Appeals setting this precedent) would also punish patent holders who had previously thought they were abiding by the law and doing the right thing. The law of spoliation isn't supposed to punish people with good intentions. It's meant to punish people who purposefully try to hide evidence from the courts. I don't believe there's any legitimate evidence that Rambus was the latter. In fact, they hired a very well respect lawyer to advise them on the issue of document destruction and followed his advice. For the Court of Appeals to now rule that lawyer's advice was wrong would be very disruptive and send a great chill through the legal community.
As for the timing of the decisions, because the cases were argued in October 2010, I expect the Court of Appeals to issue its opinions in the two appeals within the next few months. It is likely, but not for certain, that both appeals will be decided at the same time. It's also possible that the Court of Appeals could maintain a split decision in the cases, by upholding both trial court decisions. This is because trial court judges are given wide discretion on some issues, and so long as a judge isn't outside his or her discretion, then the Court of Appeals won't reverse the decision, even if another judge would not use their discretion in the same way. I think this is unlikely to happen in this case, however, because there seems to me to have been clear errors of law committed by the Delaware court that merit reversal. But it's possible that Rambus could win the Hynix appeal and lose the Micron appeal.
It's also possible that Rambus could lose both appeals, as I could be completely wrong about my expectation of the outcome. The law is inherently subjective and unpredictable, so please don't ever think anything is for certain, especially cases like this that are so contentious and where there are strong arguments on all sides. Rambus did destroy a large number of documents here even when it conceded litigation was being contemplated, so those facts could support the Court of Appeals in ruling against Rambus and upholding the Delaware court's refusal to enforce their patents.
POSSIBLE EFFECT ON RMBS
As discussed above, these cases were actually argued before the Court of Appeals twice, once on April 5, 2010, and again on October 6, 2010. RMBS didn't move on either day of oral argument, although one source wrote on October 6 that “Traders Hedging Bets in Rambus as Put Volume Surges."
But, on June 9, 2010, when the Court announced the cases were going to be re-argued, RMBS instantly dropped 17% on 18X volume. As you can see from the chart below, this reset RMBS' trending line, which had been hovering around $23 for the first half of 2010 and then hovered around $19 for the later half of the year. If you look at the chart, you can see the clear step down that took place in early June.
This made absolutely no sense to me, because there wasn't a substantive reason for the re-hearing that should have made anyone feel more or less confident in their position on the outcome. What this signaled to me was that any news related to these cases will greatly affect the stock price. This is confirmed by looking at what happened back in January, when Samsung (OTC:SSNLF) and RMBS settled their patent dispute with Samsung agreeing to pay Rambus as much as $900 million over five years. RMBS jumped about 14% on substantially higher volume then, and I expect it will move upward when these cases with Micron and Hynix get resolved as well. I'm no genius, though, as in 2008, fellow Seeking Alpha contributor Eric J. Savitz reported that, “Rambus Soars On Potential for Huge Settlement in Hynix Case.”
If my expectation of what the Court of Appeals will do is wrong, which is absolutely possible, given the inherent subjectivity of the law and specifically the meaning of the phrase “reasonably foreseeable,” then I'd expect Rambus to suffer a big loss in share value, because a Court of Appeals ruling upholding the Delaware court's “death penalty” for Rambus' patents in the case with Micron could set precedent that renders those same Rambus patents unenforceable against any other party.
Disclosure: I am long RMBS. Also have both call and put options on RMBS.