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By W. Samuel Niece
Thelen Reid Brown Raysman & Steiner LLP
Construction contracts issued by the federal government and many state transportation departments include "value engineering" or "cost reduction incentive" clauses. Under these, the contractor can suggest, after contract award, an alternative method of performing the work at a cost lower than the method specified in the contract. 1/ The incentive for the contractor is that cost savings are shared by the owner and the contractor. The contract price is decreased by only part of the savings, 2/ allowing the contractor to retain half or more of the cost savings on the contract under which the value engineering cost proposal (VECP) is submitted.3/
However, a contractor can lose potentially valuable patent rights by submitting a VECP, thereby: (1) creating a statutory bar to patentability of the VECP; or (2) giving the owner a license to practice or have practiced the technology embodied in the VECP.
The Statutory Bar
In the United States, an inventor loses the right to a patent on an otherwise patentable invention if he or she fails to file a patent application within one year after the invention is first "in public use or on sale in this country." 4/ Implementation of a VECP constitutes a "public use" that starts the one-year clock ticking. A year after this public use, the invention becomes unpatentable. 5/
Further, mere submission of the VECP may be construed as putting the technology "on sale" and thus commence the one-year period in which to apply for a patent. "Public" in 35 USC §102 (b) modifies "use" and not "on sale." 6/ Thus, even if the VECP is not accepted and the public owner holds the VECP in confidence under the trade secret exemption to the Freedom of Information Act 7/ or a comparable state law, the mere act of submitting the VECP may start the one-year statutory bar clock running. 8/ (Whether a rejected VECP actually starts the "on sale" clock running depends on whether the invention embodied in the VECP is "ready for patenting," 9/ an issue beyond the scope of this brief article.)
Thus, as soon as a contractor submits a VECP, it needs to evaluate whether the VECP incorporates patentable technology and, if so, promptly arrange for a patent application to be filed. The contractor cannot wait to see whether the technology contained in the VECP will be embraced by the industry. By the time that question is answered, it will be too late.
Creating a License in the Owner and Subsequent Contractors
Even if the contractor succeeds in obtaining a patent on its VECP, an owner is likely to use the VE idea on subsequent contracts awarded to other contractors. The question then becomes whether the owner and its subsequent contractors have a license to use the technology embodied in the VECP despite the patent and, if so, what payment, if any, is due to the VECP-generating contractor. The VE clauses do not provide clear answers to these questions, and there is little case law interpreting these clauses. At least one court has held that "the first contractor to propose a change based on a particular idea acquires no proprietary rights in the proposal that would allow him priority over a subsequent proposal based on the same idea." 10/
While the FAR VE clause for supply and service contracts 11/ provides for sharing "future contract savings" with the contractor submitting the VECP, the FAR construction VE clause 12/ contains no such provision.
The California Department of Transportation (CalTrans) clause provides:
| The Department expressly reserves the right to adopt a cost reduction proposal for general use on contracts administered by the Department when it determines that the proposal is suitable for application to other contracts. When an accepted cost reduction proposal is adopted for general use, only the Contractor who first submitted that proposal will be eligible for compensation pursuant to this section, and in that case, only as to those contracts awarded to that Contractor prior to submission of the accepted cost reduction proposal and as to which the cost reduction proposal is also submitted and accepted. Cost reduction proposals identical or similar to previously submitted proposals will be eligible for consideration and compensation under the provisions of this Section 5-1.14 if the identical or similar previously submitted proposals were not adopted for general application to other contracts administered by the Department. Subject to the provisions contained herein, the State or any other public agency shall have the right to use all or any part of any submitted cost reduction proposal without obligation or compensation of any kind to the Contractor. 13/ |
The Florida Department of Transportation (FDOT) VE clause provides:
 | Sharing Arrangements: If the Department approves a VECP, the Contractor may be entitled to share in both construction savings and collateral savings to the full extent provided for in this Subarticle. The Contractor shall receive 50% of the net reduction in cost of performance of the Contract due to an approved VCEP, except for innovative ideas.
For innovative ideas, as determined by the Engineer, the Contractor and the Department shall share the reduction in the cost of performance as follows:
| Accrued Net Savings | Contractor's Share % | Department's Share % |
| Less than $25,000 | 100 | 0 |
| $25,000 to $50,000 | 75 | 25 |
| Over $50,000 | 50 | 50 |
The Department will not consider an approved change that is identical or similar to a previously submitted VECP or an idea previously used by the Department as an innovative idea.
When collateral savings occur, the Department will provide the Contractor with 20% of the average annual net collateral savings.
Department's Future Rights in a VECP: In the event of acceptance of a VECP, the Contractor hereby grants to the Department all rights to use, duplicate or disclose, in whole or in part, in any manner and for any purpose whatsoever, and to have or to permit others to do so, royalty free and without fee, other costs or surcharge, data reasonably necessary to fully utilize such proposal on this and any other Department Contract. 14/ |
The State Contracting and Engineering Corporation Cases
In 1989, FDOT awarded State Paving Corp. a contract for construction of sound barrier walls. State Paving submitted a VECP under FDOT Standard Specifications §4-3.5, 15/ proposing a new sound wall design using a combination column and pile rather than a column bolted to a pile foundation. FDOT accepted the VECP and paid State Paving 50 percent of the cost savings. Meanwhile, State Paving applied for and was granted two patents on its combination column and pile: Patent No. 5,234,288 on the method (the 288 patent) and Patent No. 5,429,455 on the apparatus (the 455 patent). 16/
State Paving assigned its rights under the two patents to State Contracting and Engineering Corp.
When FDOT began using the VECP on subsequent sound barrier contracts, State Paving and State Contracting demanded royalties from the other contractors and additional payments from FDOT, based on the initial contract, for use of the VECP on subsequent contracts. When negotiations failed, State Paving and State Contracting brought suit in the U.S. District Court for the Southern District of Florida against the State of Florida and the other contractors for infringing the 288 and 455 patents and against the State of Florida for breaching the initial contract by not paying State Paving for use of the VECP on the subsequent contracts.
The U.S. District Court: (1) dismissed the patent infringement count against the State of Florida on grounds of sovereign immunity; (2) granted summary judgment in favor of the State of Florida on the ground that it had not breached the initial contract; and (3) granted summary judgment on the patent infringement count in favor of subsequent contractors on the ground that the initial contract created a license to practice the patents.
On appeal, the U.S. Court of Appeals for the Federal Circuit: (1) affirmed the State of Florida's sovereign immunity from suit for patent infringement; (2) affirmed the U.S. District Court's determination that the initial contract did not obligate FDOT to compensate State Paving for cost savings on subsequent contracts; but (3) reversed the U.S. District Court's finding that the initial contract created a license of patent rights to the subsequent contractors and remanded to the U.S. District Court. 17/
With regard to sovereign immunity, the Eleventh Amendment to the United States Constitution provides:
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The Judicial Power of the United States shall not be construed to extend to any suit in law or equity, commenced or prosecuted against one of the United States by Citizens of another State, or by Citizens or Subjects of any Foreign State.
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Although the Eleventh Amendment speaks of suits by citizens of another state, it has been construed to also bar suits in federal court by citizens of a state against their own state. 18/ And, the federal courts have exclusive jurisdiction over suits for patent infringement. 19/ Thus, states are immune from suits for patent infringement -- unless they consent. 20/ Accordingly, the Federal Circuit affirmed the District Court's dismissal of State Paving's infringement count against the State of Florida. 21/
Note, however, that the Eleventh Amendment does not bar suits against the federal government, and Congress has provided that the federal government can be sued for patent infringement. 22/ Also, the Eleventh Amendment bars suits against states and arms of states but does not bar suits against cities, which are municipal corporations rather than arms of the state. 23/
With regard to FDOT's contractual obligation to compensate State Paving for use of the VECP on subsequent contracts, the FDOT VECP provision then in effect stated:
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Sharing Arrangements: If a VECP is accepted by the Department, the Contractor is entitled to share in instant contract savings and collateral savings not as alternatives, but rather to the full extent provided for in this Subarticle. For the purposes of sharing under this Subarticle, the term "instant contract" shall not include any changes to or other modifications of this Contract, executed subsequent to the acceptance of this particular VECP, by which the Department increases the quantity of any item of work or adds any item of work. It shall however, include any extension of the instant contract through the exercise of an option (if any) provided under this Contract after acceptance of the VECP.
Except for innovative ideas the Contractor and Department shall each receive 50 percent of the net reduction in cost of performance of this Contract. For innovative ideas the reduction in the cost of performance shall be shared as follows:
| Accrued Net Savings | Contractor's Share % | Department's Share % |
| Less than $25,000 | 100 | 0 |
| $25,000 to $50,000 | 75 | 25 |
| Over $50,000 | 50 | 50 |
If a change is identical or similar to a previously submitted VECP or an idea previously utilized by the Department it will not be considered an innovative idea.
When collateral savings occur, the Contractor shall receive 20 percent of the average one year's net collateral savings.
The contractor shall not receive instant savings or collateral savings shares on optional work listed in this Contract, until the Department exercises its option to obtain that work.
Department's Future Rights to a VECP: In the event of acceptance of a VECP, the Contractor hereby grants to the Department all rights to use, duplicate or disclose, in whole or in part, in any manner and for any purpose whatsoever, and to have or to permit others to do so, data reasonably necessary to fully utilize such proposal on this and any other Department contract. 24/
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The Federal Circuit agreed with the U.S. District Court that because the subsequent contracts were not option work under the initial contract, FDOT was not contractually obligated to pay State Paving when it used State Paving's VECP on future contracts. 25/ The reference to "collateral cost savings" applies to reductions in operating costs, as opposed to construction costs, but does not extend to future contracts.
The current FDOT "Sharing Arrangements" provision (now at §3-9.7) deletes the term "instant contract" but still provides that the Contractor shall receive a share of the net reduction in the cost of Performance of "the Contract," which would appear to deny the VECP contractor a share of FDOT savings on subsequent contracts. In the current "Department's Future Rights to a VECP" provision, FDOT has added "royalty free and without fee, other costs or surcharge" between "permit others to do so" and "data," which appears to be an attempt to deny the VECP contractor royalties from subsequent contractors.
With regard to infringement by subsequent contractors, the Federal Circuit held that FDOT's acceptance of the VECP under the initial contract between FDOT and State Paving did not give subsequent contractors a license to practice the 288 or 455 patents. The Federal Circuit relied on the "Department's Future Rights to a VECP" subsection of the FDOT Standard Specifications in effect at the time: 26/
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In the event of acceptance of a VECP, the Contractor hereby grants to the Department all rights to use, duplicate or disclose, in whole or in part, in any manner and for any purpose whatsoever, and to have or to permit others to do so, data reasonably necessary to fully utilize such proposal on this and any other Department contract. [emphasis supplied by the Federal Circuit]
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In finding that this provision did not constitute a license to practice the patents, the Federal Circuit focused on the distinction between trade secret rights and patent rights. 27/ These are two distinct systems for protecting intellectual property, and an inventor can choose between them. 28/ According to the Federal Circuit:
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[The subsection entitled "Department's Future Rights to a VECP"] only conveyed rights to use "data" in future contracts, and did not in terms convey the right to manufacture the sound barriers using plaintiffs' design or use plaintiffs' manufacturing method. Most significantly the section did not explicitly convey any patent rights, require the contractor to surrender its rights to the technology, or bar the contractor from securing a patent on the invention. 29/
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By submitting a VECP, State Contracting conveyed rights in "data," i.e. disclosed the data such that it no longer was a trade secret, but in doing so, State Contracting did not license its patent rights. Indeed, disclosure of the data in the VECP is consistent with a decision to choose patent protection over trade secret protection.
On remand, a jury determined that the subsequent contractors had infringed the 288 and 455 patents and awarded royalties of $5,199,429 to State Contracting. The U.S. District Court denied the contractors' motion for a new trial. The U.S. District Court, however, refused to find the infringement willful. 30/ Finally, the U.S. District Court granted judgment as a matter of law in favor of State Contracting on the subsequent contractors' counterclaim of invalidity.
The subsequent contractors appealed, and State Contracting cross-appealed.
On appeal, the Federal Circuit: (1) affirmed the judgment of infringement; (2) affirmed the finding that the infringement was not willful; and (3) reversed the U.S. District Court's grant of judgment as a matter of law on validity and remanded for further proceedings on the issue of obviousness. 31/
Regarding willfulness, the Federal Circuit observed that while the subsequent contractors were mistaken in their contention that they had a license to practice the patents, "it was reasonable for the contractors to believe, based on the language of that agreement, that FDOT had a license to practice the VECP inventions." Accordingly, the infringement was not willful. 32/
In general, when a potential infringer has actual notice of another's patent, it has an affirmative duty to exercise care to determine whether it is in fact infringing, and this duty includes obtaining an opinion from competent patent counsel before initiating possibly infringing activity. 33/ In State Contracting II, State Contracting argued that the infringement was willful because the subsequent contractors failed to produce and rely on a written non-infringement opinion of counsel. The Federal Circuit rejected this argument, finding that "it was not unreasonable for the contractors to rely on FDOT's representation without seeking the advice of counsel to confirm the accuracy of that representation." 34/
With regard to damages, the Federal Circuit affirmed the award of $5,199,429 in royalties to State Contracting. 35/ Note, however, that State Contracting will collect nothing if the patents are invalidated for obviousness on remand. This probably is unlikely because an issued patent is presumed valid, and the burden of proving invalidity by clear and convincing evidence is on the party seeking to invalidate the patent. 36/
Lessons Learned
Although a bird in the hand often is worth two in the bush, a contractor with an idea on how to build a better mousetrap should stop and think before submitting the better mousetrap as a VECP. Such a submission can result in the loss of valuable patent rights.
The contractor needs to assess the potential market for its better mousetrap (which is largely a commercial determination) and then evaluate how much of that market it may be giving up by submission of a VECP (which is primarily a legal determination). In addition, the contractor needs to consider whether its better mousetrap may be patentable (not all VECPs are) and apply for a patent if the mousetrap meets the standards for patentability. 37/ Having a major customer such as the federal government, CalTrans or FDOT adopt a VECP can go a long way toward commercializing the better mousetrap, but it won't improve the contractor's bottom line if subsequent contractors can use the better mousetrap anywhere they want without paying royalties.
There are three potential routes to profit from a VECP beyond the contract under which the VECP is submitted: (1) by receiving a share of savings on subsequent contracts from the public owner; (2) by collecting patent royalties from the public owner for use of a patented VECP on subsequent contracts; or (3) by collecting patent royalties from the contractors on subsequent contracts incorporating a patented VECP.
The first route was closed off by the Federal Circuit in State Contracting I on the basis of the FDOT VECP clause. A similar result is likely under current FDOT, CalTrans and federal VECP clauses.
The Federal Circuit denied access to the second route in State Contracting I because of Florida's Eleventh Amendment immunity from suit for patent infringement. A similar result can be expected under any state contract, but the Eleventh Amendment does not immunize the federal government. Congress has provided for patent infringement actions against the federal government under 28 USC §1498, so an action against the federal government is theoretically possible. And, cities do not have Eleventh Amendment immunity.
With regard to the third route, the Federal Circuit held in State Contracting I that the FDOT VECP provision did not create a license for subsequent contractors to practice the VECP patent without paying royalties to the VECP patentee. FDOT since has added "royalty free and without fee, other costs or surcharge" language with the obvious intent to close off this route.
The CalTrans provision -- that it "shall have the right to use all or any part of any submitted cost reduction proposal without obligation or compensation of any kind to the Contractor" -- may be interpreted as denying the VECP contractor patent royalties from subsequent contractors and from CalTrans, but the precise meaning of this language remains an open question until some future court case.
The federal construction VECP clause 38/ is similar to the FDOT clause at issue in State
Contracting I. Under FAR Part 48 and §52.248-3, the federal government obtains rights in "data" while patents are addressed separately in FAR Part 27. Federal research and development contracts include a "patent rights clause" under which the federal government obtains a license to practice or have practiced on its behalf any invention made in the performance the work under the contract. 39/ Under such a provision, a subsequent federal contractor would have a license to practice the invention. Standard fixed-price, competitively-bid construction contracts, however, do not include such a patent rights clause. 40/ Accordingly, the federal government typically does not obtain rights in a patent developed as a VECP on a construction contract. Thus, the VECP-proposing contractor probably can collect royalties for use of a patented VECP on subsequent federal contracts. Note, however, that the means for enforcing such patent rights is by suit against the federal government in the U.S. Court of Federal Claims pursuant to 28 USC §1498 rather than in a U.S. District Court against the subsequent contractor under 35 USC §271. 41/
Wrap-Up
Not all VECPs are patentable. If an idea is not patentable, then the only way to profit from it is by a VECP, so submitting a VECP makes sense. However, if there is any chance that an idea may be patentable (a question which can best by answered by patent counsel), then the contractor needs to evaluate what patent rights it may be giving up by submitting a VECP. This question involves a careful review of the VECP and patent clauses in the particular contract (a question best answered by government contracts counsel).
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ENDNOTES
1/ See, e.g., Federal Acquisition Regulations (FAR) Part 48 and §52.248-3; California Department of Transportation (CalTrans) Standard Specifications §5-1.14; Florida Department of Transportation (FDOT) Standard Specifications §4-3.9.
2/ E.g., 45 percent on fixed-price federal construction contracts, 50 percent on CalTrans contracts and 50 percent on FDOT contracts.
3/ The "instant contract savings" in FAR-speak.
4/ 35 USC §102 (b); 2 Chisum on Patents §6.01.
5/ Root v. Third Ave. Ry. Co., 146 U.S. 210, 13 S.Ct. 100 (1892).
6/ Robbins Co. v. Lawrence Mfg. Co., 482 F.2d 432 (9th Cir. 1973).
7/ 5 USC §552 (b) (4).
8/ UMC Electronics v. United States, 816 F.2d 647 (Fed.Cir. 1987).
9/ Pfaff v. Wells Electronics Inc., 525 U.S. 55, 119 S.Ct. 304 (1998).
10/ Kirlin v. United States, 827 F.2d 1358 (Fed.Cir. 1987).
11/ FAR §52.248-1.
12/ FAR §52.248-3.
13/ CalTrans Standard Specification §5-1.14.
14/ FDOT Standard Specifications §§4-3.9.7 and 8.
15/ Now §4-3.9.
16/ The patents can be viewed at patft.uspto.gov/srchnum.htm or www.patentfetcher.com/Patent-etcher-Form.php.
17/ State Contracting and Engineering Corp. v. Florida, 258 F.3d 1329 (Fed.Cir. 2001) (State Contracting I).
18/ Port Authority Trans-Hudson Corp. v. Feeney, 459 U.S. 299, 110 S.Ct. 1868 (1990).
19/ 28 USC §1338 (a): "[T]he district courts shall have original jurisdiction of any civil action arising under any Act of Congress relating to patents.. Such jurisdiction shall be exclusive of the courts of the states."
20/ In 1992, Congress added subsection (h) to the infringement statute, 35 USC §271, purporting to remove the states' immunity from liability for patent infringement, but the U.S. Supreme Court held that Congress did not have the authority to abrogate the states' Eleventh Amendment immunity, so 35 USC §271 (h) is void. Florida Prepaid Postsecondary Education Expense Board v. College Savings Bank, 527 U.S. 627, 119 S.Ct. 2199 (1999).
21/ State Contracting I, 258 F.3d at 1337.
22/ But under 28 USC §1498 rather than 35 USC §271.
23/ Alden v. Maine, 527 U.S. 706, 119 S.Ct. 2240 (1999).
24/ FDOT Standard Specifications §§4-3.5.7 and 8 (1986)
25/ State Contracting I, 258 F.3d at 1338.
26/ Then at §4-3.5.8. Similar to current §4-3.9.8 but without the words "royalty free and without fee, other costs or surcharge."
27/ State Contracting I, 258 F.3d at 1339.
28/ Kewanee Oil Co. v. Bicron Corp., 416 U.S. 470, 94 S.Ct. 1879 (1974).
29/ State Contracting I, 258 F.3d at 1339-40.
30/ If infringement is willful, the court may increase damages by up to three times the compensatory damages assessed by the jury. 35 USC §284.
31/ State Contracting and Engineering Corp. v. Condotte America, Inc., 346 F.3d 1057 (2003) (State Contracting II).
32/ State Contracting II, 346 F.3d at 1064.
33/ Underwater Devices, Inc. v. Morrison-Knudsen Co., Inc., 717 F.2d 1380 (Fed. Cir. 1983).
34/ State Contracting II, 346 F.3d at 1065.
35/ State Contracting II, 346 F.3d at 1074.
36/ 35 USC §282; U.S. Surgical Corp. v. Ethicon, Inc., 103 F.3d 1554, 1563 (Fed.Cir. 1997).
37/ That it is novel (35 USC §101) and non-obvious (35 USC §103).
38/ FAR §52.248-3.
39/ FAR §§27.300, 27.302 (c), 52.227-11, 52.227-12.
40/ FAR §27.304-3 (b).
41/ FAR §27.201-1 (a). However, the subsequent contractor usually will defend the patent infringement action pursuant to the clause at FAR §52.227-4.
©2004 Thelen Reid Brown Raysman & Steiner LLP
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