More Color on the Star Scientific versus Reynolds Legal Battles

star-scientific-reynolds-battleWe recommended a short on CIGX early this week and wanted to provide some more color on the battles between Star and Reynolds — a dispute which has been dragging on now for a decade.

It’s important to note the risks involved here, which if ruled in favor of Star could lead to a subtantial settlement of some sort or in fact a potential licensing deal.   Here we provide a bit of a backstory on the case, and our opinion of what could potentially happen moving forward.

If you are short, it is crucial that you understand the risks regarding this case.

As a background, Star’s CEO Jonnie Williams was awarded patents (’401 and ’649) in 2001 and 2002 for a tobacco curing process which creates a ‘controlled environment’ that controls various measures key to the reduction of hazardous chemicals (or TSNA’s) in the tobacco curing processs.  From ’98 thru ’01, Star had agreements with Brown and Williamson to cure low TSNA tobacco using the Williams method. RJR eventually acquired Brown and Williamson, and ultimately terminated the agreement with Star.

David Peele, a researcher for RJR filed a patent in 1999 which was issued in 2004. The Peele method claims a method of reducting TSNA formation by by using a “heating source that is not a direct fire heating source” and also provides a method of retrofitting direct-fire flue curing barns. In 2000, RJR required every farmer in its chain to retrofit their barns–utilizing the Peele method.

On May 23, 2001, Star filed a complaint against RJR alleging infringement. After a bench trial in 2007, the district court ruled that RJR had not infringed–and that the Star patents were invalid. On appeal in 2008, the court reversed the previous finding regarding the patents and ruled that they were indeed valid. Whereas the district court had ruled that the Williams patents were indefinite, the appeal court found that Williams mention of “anaerobic condition’ was not indefinite. The court also reversed the district court’s judgment that RJR had not infringed on the patents.

The twists and turns continued as the battle proceeded to district court for a hearing on the infringement. The trial lasted 20 days, featuring 24 witnesses and over 4000 pages of transcript. In June of 2009, it was found that RJR’s curing process was not infringing and that the Peele method did not infringe on the Williams patents.

Then in August of 2011, the appeals court reversed the district court’s finding that the Williams patents were invalid.   The court noted that “a person of skill in the art of tobacco curing would posses adquate understanding to manipulate these variables to create a controlled environment”.    Translation–the court believed that Williams’ patents were not ambiguous –as Reynolds argued and indeed not indefinite.   The court however affirmed the non-infringement ruling of the district court.

Now as we mentioned in our short recommendation write-up,  RJR has now appealed the patent ruling and has petitioned for Supreme Court ruling against Star’s patents. 

I’ve read through all the court documents, read over the patents and even spoke to a patent attorney to get a take on the case.   Here’s what one respected lawyer told me:

“At the moment I would not give favorable odds to cert grant. The case did not garner the kind of attention before the CAFC the typically precedes cert grants, the indefiniteness issue is a little awkwardly-presented in the case, and RJR has been an overly-aggressive/optimistic litigator with Star. This feels like another such last-ditch effort. Wait and see how many (if any) amici file briefs for cert and later if the court asks for the Solicitor’s views. These would be better indicators.”

Meaning basically that there is little chance of RJR’s petition being heard—-unless RJR has a littany of other parties (Altria, etc) piling on and helping plead the case.

So, if it doesn’t get heard, then Star is likely going after RJR again, for infringement–years 2002–2009.    And now, since the patents have been deemed to be valid, it makes me pause and wonder if the verdict could maybe be different this time around.

The judge has also ordered mediation for the two parties, which will likely come at some point in the summer.   Shortzilla spoke to the head of Investor Relations at Reynolds to get his take.    He noted that while RJR has agreed to mediation,  his company believes that they have nothing to settle here.   Mediation does not mean a settlement.    I asked about future curing years and the potential for Star to come after for infringement again.  His response: “Nothing has changed.  We didn’t violate the patents”.

Surely a biased opinion, but since this battle has been going on for such a long time now,  I wonder if Reynolds might potentially cave and try and avoid another costly, draw out infringement case.

The risk is obvious, and while a lot of at it first glance appeared to be minor due to all of the pumping on the boards–I take pause and think that there could actually be more value than I had initially anticipated with these patents.    The noise makes it tough to assess the situation, but after examining the cases a bit further, I have turned slightly more optimistic. 

It’s rare that I recommend jumping out of a position only a few days after providing our initial thesis, but that’s what I’m doing now.    We’ll cover our short here today for a loss of a few pennies, while putting it at the top of our watch list.    The court case(s) will likely drag on for years now, but any potential news of a settlement would propel the shares much higher.    We still think the rest of the business is nearly worthless and with only a few quarters of cash left on the books,  Star might just in fact push Reynolds for some sort of settlement money.   And for Reynolds it might just be easier to pay Star just to go away.  

If you have the guts, and want to stick it out, we commend your valor, and wish you luck on the trade.   For now, we shall step away and spend our time on more fruitful ideas.