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REUBEN H. DONNELLEY CORP. v. MARK I MKTG. CORP.

July 28, 1995

THE REUBEN H. DONNELLEY CORPORATION, Plaintiff, against MARK I MARKETING CORPORATION, MARK I MARKETING CORPORATION OF AMERICA, and WALLACE EDWARDS, Defendants.

William C. Conner, Sr. United States District Judge


The opinion of the court was delivered by: WILLIAM C. CONNER

CONNER, SENIOR D.J.:

 Plaintiff Reuben H. Donnelley Corporation ("RHD") brings this action against defendants Mark I Marketing Corporation ("Mark I"), Mark I Marketing Corporation of America ("Mark I-A"), and Wallace Edwards for a declaration that it is not infringing United States patent no. 4,554,241, that the patent is invalid, that it is not in violation of a licensing agreement (the "Agreement") between it and Mark I-A, that it does not owe defendants any royalties under the Agreement, and for the return of certain royalties paid to defendants under the Agreement. In their answer, defendants counterclaim for an accounting under the Agreement, for fraud and breach of contract, and for an injunction against plaintiff's use of a process covered by the Agreement. Plaintiff has moved under Fed. R. Civ. P. 12(b)(6) to dismiss all but defendants' counterclaim for an accounting for failing to state claims on which relief can be granted. For the reasons stated below, we grant plaintiff's motion in part, but allow defendants thirty days from the date of this opinion and order to amend their counterclaims to overcome the pleading inadequacies discussed below.

 BACKGROUND

 A widely used method of color printing, known as the four-color process, utilizes four different colors of transparent ink (Cyan, Magenta, Yellow, and Black) superimposed on each other, to produce a full-color image. In the 1970s, Defendant Wallace Edwards developed a process utilizing two colors of opaque ink layered on colored paper to produce a full-color or near full-color image. Because the two-color process, entitled Markolor, requires less ink than the four-color process, it can be used on thinner paper and is ideal for use in printing telephone yellow page advertisements.

 Defendant Edwards applied for and received a Canadian patent covering the Markolor process, No. 1,168,508 ("the '508 patent"), on June 5, 1984, and a related United States patent, No. 4,554,241 ("the '241 patent"), on November 19, 1985. Edwards then assigned all rights to the '241 patent to Mark I.

 Prior to receiving the '241 patent, on October 25, 1984 Mark I-A, an affiliate of Mark I, entered into a licensing agreement (the "Agreement") with RHD, granting it a fifteen-year renewable exclusive license to promote and market the Markolor process embodied in the '508 patent and other then pending or future acquired patents. In exchange, RHD agreed to pay a flat licensing fee in addition to a portion of its revenue from sub-licensing the use of the process. RHD also covenanted to "use its best efforts to reasonably promote sales of the [Markolor] Process so that the benefits to be derived by RHD and [Mark I-A were] maximized." That agreement was amended in 1987 and again in 1990; the later amendment narrowing RHD's exclusivity to the United States and Great Britain and adjusting the fees paid by RHD to Mark I-A.

 Subsequently, RHD began using and marketing a printing process allegedly not covered under the terms of the Agreement (the "Four Color Process"). Mark I and Mark I-A, contending that the so-called Four Color Process was indistinguishable from the Markolor process covered by the Agreement, the '508 patent, and the '241 patent, repeatedly demanded that RHD pay royalties for its use and promotion of the process. In response, RHD filed this suit against Mark I, Mark I-A, and Edwards seeking a declaration that its use of the Four Color Process does not infringe the '241 patent, that the '241 patent is invalid, that it is not in breach of the Agreement, and that it does not owe Mark I-A royalties for using and promoting the Four Color Process. In addition, RHD seeks the return of certain royalties mistakenly paid under the Agreement.

 The defendants have counterclaimed for an accounting pursuant to the Agreement, for breach of contract for RHD's failure to pay royalties for using the Markolor process, for breach of contract for RHD's failure to use its best efforts to promote sales of the Markolor process to others, for fraud based on RHD's concealment of its use of the Markolor process, and for an injunction against RHD's ongoing and future use of the Markolor process. In addition to seeking compensatory damages, defendants seek punitive damages for plaintiff's bad faith and fraud, and attorneys fees pursuant to 35 U.S.C. § 285 in light of the alleged frivolity of RHD's declaratory judgment suit.

 Prior to answering defendants' counterclaims, plaintiff filed the instant motion to dismiss defendants' second through fifth counterclaims under Rule 12(b)(6), Fed. R. Civ. P., for failing to state claims on which relief can be granted. In response, contending that no case or controversy exists concerning the '241 patent, defendants cross-moved to dismiss plaintiff's patent infringement and validity declaratory judgment claims. Defendants having voluntarily withdrawn their cross-motion, we must now decide the legal viability of defendants' second through fifth counterclaims as pled. We address each of plaintiff's arguments in the order presented to the Court.

 A. FRAUD

 The parties have proceeded on the assumption that New York law controls defendants' common law claims, including their fraud cause of action. Because the parties to the Agreement, RHD and Mark I-A, have their principal places of business in New York, the alleged wrongful conduct apparently took place in New York, and the Agreement, out of which the instant dispute arises, contains a New York choice of law provision, we do likewise.

 To maintain an action for fraud under New York law, a plaintiff must allege "(1) that [the defendant] made a misrepresentation (2) as to a material fact (3) which was false (4) and known to be false by [the defendant] (5) that was made for the purpose of inducing [the plaintiff] to rely on it (6) that [the plaintiff] rightfully did so rely (7) in ignorance of its falsity (8) to his injury." Cohen v. Koenig, 25 F.3d 1168, 1172 (2d Cir. 1994) (quoting Murray v. Xerox Corp., 811 F.2d 118, 121 (2d Cir. 1987)). However, when the alleged fraud is not separate and distinct from a failure to perform under a contract, the claim is treated as one sounding in contract rather than tort. Trusthouse Forte (Garden City) Management v. Garden City Hotel, Inc., 106 A.D.2d 271, 272, 483 N.Y.S.2d 216, 218 (N.Y. App. Div. 1984); Vista Co. v. Columbia Pictures Indus. Inc., 725 F. Supp. 1286, 1294 (S.D.N.Y. 199); Airlines Reporting Corp. v. Aero Voyagers, Inc., 721 F. Supp. 579, 582 (S.D.N.Y. 1989).

 Plaintiff first asserts that defendants' purported fraud counterclaim is actually a breach of contract claim, and must be dismissed under New York law. Because defendants allege only that plaintiff's fraudulent scheme consisted of concealing its use of the Markolor process from Mark I-A to avoid paying royalties under the Agreement, conduct also constituting a breach of contract, plaintiff argues that "the only fraud charged relates to a breach of contract" ...


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