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Orthopedic Systems, Inc v. Allen Schlein

December 29, 2011


Trial Court: Alameda County Superior Court Trial Judge: Hon. Robert B. Freedman (Alameda County Super. Ct. No. RG05210781)

The opinion of the court was delivered by: Reardon, J.


(Alameda County Super. Ct. No. RG05210781)

The instant appeals involve the contract and tort claims of an orthopedic surgeon who had an agreement with an orthopedic products company regarding the creation and sale of a medical device that bore the surgeon's name. After paying royalties to the surgeon for more than a decade, the company renounced its obligations to pay anything further for the medical device even though it still sold a version of the product bearing the surgeon's name.

Orthopedic Systems, Inc. (OSI) and Allen Schlein, M.D., entered into an agreement in which OSI acknowledged receipt of a medical device called the "Schlein Shoulder Positioner," and obligated itself to pay Dr. Schlein royalties on sales of the resulting product. After OSI stopped paying the royalties, Dr. Schlein threatened to sue for breach of contract, prompting OSI to file an action seeking a declaration of rights under the agreement. Dr. Schlein cross-complained for breach of contract, conversion, and commercial misappropriation of his name among other things. The jury found in favor of Dr. Schlein on his contract claim and awarded $616,043 in damages. The jury also awarded Dr. Schlein $750 in statutory damages for his misappropriation claim, and found that OSI earned $1,220,000 in profits attributable to the use of Dr. Schlein's name. The trial court, however, did not include the profits in the judgment.

Dr. Schlein appeals, challenging the exclusion of the profits from the judgment. OSI appeals the judgment, the denial of its judgment notwithstanding the verdict, and the postjudgment award of attorney fees.

We modify the judgment and otherwise affirm.


A. Facts*fn2

1. OSI's Product Development

OSI was formed by Robert Moore, an experienced chiropractor, and his family in 1977 to develop, manufacture and sell orthopedic devices. Prior to forming OSI, Moore had invented several products to help his patients. In early 1980, Moore hired Steven Lamb to head up the engineering department at OSI.

Moore attended orthopedic trade shows and conferences, where he encouraged physicians to bring ideas and concepts to OSI in exchange for a royalty, telling them "If you have a problem, let me know, I will then try to develop a product or [way] of solving that [problem] to make your life easier and [to do] a better job for the patient and then we will pay you a royalty of five percent on that."

Moore worked closely with the physicians who brought their problems to OSI, discussing possible improvements and modifications. The product would then "evolve from that interface or interaction."

In lieu of legal formalities, Moore offered the physicians a "handshake agreement," whereby OSI would pay a royalty to the physician for as long as OSI sold the product. Nothing other than Moore's word was required; he said OSI "would pay and [it] did." Moreover, there was never any requirement that a physician participate in the modification of a product in order to continue to receive the royalties.

2. OSI's Initial Collaboration with Dr. Schlein

Dr. Schlein, an experienced orthopedic surgeon and inventor, met Moore in the early 1980's at a medical conference. Dr. Schlein and Moore started working together shortly thereafter on a cast padding product that Dr. Schlein was already manufacturing through subcontractors. Moore agreed to distribute the product without any formal written agreement.

In 1986 or 1987, Dr. Schlein brought OSI another product called the "Dynafix," which was a plastic external fixator for wrist fractures. Moore agreed to manufacture the product and sell it, and agreed to pay Dr. Schlein a royalty for as long as OSI continued to sell the product. There was no formal written agreement between OSI and Dr. Schlein when OSI initially agreed to sell the Dynafix.

3. Genesis of the Schlein Shoulder Positioner

In the mid-1980's, as arthroscopic surgery became a popular alternative to traditional surgery, Dr. Schlein found it difficult to perform arthroscopic shoulder surgery with a patient lying on the operating table.*fn3 Then, in or about 1988, Dr. Schlein attended a meeting on arthroscopic surgery where another surgeon described performing shoulder surgery with a "beach chair" that elevated the patient into a seated position.

Dr. Schlein thought the beach chair concept was a good one, and he went home and started to think about how he could create something like it. Although Dr. Schlein thought he could make one, he was having trouble creating a locking or "gatch" mechanism to support the backrest.*fn4

When Dr. Schlein told Moore about his difficulty in crafting a mechanism to lock the device, Moore sent him one of OSI's radiolucent tilt tables. Dr. Schlein took the table apart and extracted the gatch mechanism. He bought some plastic and went home to make the back piece of the positioner. Dr. Schlein enlisted the help of a plastic prototype maker, who helped make the head piece. Dr. Schlein then combined all of the parts and tested the device in surgery.

Dr. Schlein then sent the prototype of the positioner to Moore. After multiple discussions regarding the device, Dr. Schlein and Moore decided to work together on manufacturing it for sale through OSI. Dr. Schlein and Moore also discussed the development of a disposable pad set or "patient care kit" to be used with the shoulder positioner that would provide cushioning for the patients.

Starting in or about 1989, Dr. Schlein and Moore worked collaboratively on the shoulder positioner. Dr. Schlein understood that his agreement with OSI would be the same as it was with the Dynafix--OSI would manufacture and sell the positioner and Dr. Schlein would receive a royalty for as long as OSI sold the product. Moore had the same understanding about the arrangement. Indeed, in a handwritten note dated December 28, 1990, Moore noted that for the shoulder positioner "Schlein gets 5% royalty Disp Pad Set." Dr. Schlein was not required to work on any subsequent modifications of the product in order to receive the agreed upon royalties.

4. Sale of OSI

In or about March 1989, Moore and his family began to contemplate the sale of OSI. To that end, Moore engaged the services of a company that would assist in finding a purchaser for OSI. Once the prospective purchasers were found, Moore was required to document all of OSI's royalty agreements. As such, Moore drafted a form agreement to document the verbal handshake agreements he had with the physicians who sold products through OSI.

In early 1992, Dr. Schlein received a one-page agreement from Moore regarding the Schlein Shoulder Positioner (1992 Agreement), which provided as follows:

"[OSI] of Hayward, CA has received a product improvement idea from Dr. Allen Schlein. It is called the Schlein Shoulder Positioner.

"[OSI] will manufacture (or have manufactured) the device and will market the device.

"In return, [OSI] will pay a royalty of 5% of the list price less discounts to the Adam David Schlein trust fund.

"It is understood that a disposable pad set is being investigated. Should OSI determine that a disposable set is desirable and markets the pad set, a 5% royalty on the list price less discounts will apply.

"The royalties will be paid the 30th day of the month following the calendar quarter.

"Dr. Schlein, or his representatives shall have any reasonable opportunity to audit the sales of the device at his expense, should he so desire.

"The device has been assigned a product number for sales and accounting purposes. The pad set will also be assigned a product [number]."*fn5

Dr. Schlein signed the agreement on January 10, 1992, and returned it to Moore.*fn6 Dr. Schlein had nothing to do with the drafting of the 1992 Agreement. Dr. Schlein had no recollection of having any conversations with Moore either before or after he signed the written agreement.

In 1992, Moore and his family sold OSI to Marc Abramowitz and Allan Epstein. A portion of the sales agreement prepared by Moore and OSI expressly disclosed that as to the shoulder positioner, as well as other products, "[r]oyalties are payable for as long as OSI sells the product."

5. Subsequent Sale of OSI

In 1995, Abramowitz and Epstein sold 51 percent of OSI's stock to Mizuho Ikakogyo Co., Ltd. In the stock purchase agreement, OSI represented that "[p]ursuant to a letter agreement dated January 10, 1992, Dr. Allen Schlein licenses OSI the Schlein Shoulder Positioner."

Following subsequent litigation and Mizuho's eventual acquisition of the remaining 49 percent of OSI's stock, Abramowitz and Epstein agreed to refrain from making any competing products and from undermining the value of OSI. The Schlein Shoulder Positioner was expressly identified as one of the products in the non-competition agreement due to its economic value to OSI.

6. OSI Modifications to the Schlein Shoulder Positioner

Until 1999, OSI marketed and sold the shoulder positioner under the name "Schlein Shoulder Positioner" or "Schlein Shoulder Positioner SSP 1000." In marketing brochures and in the instruction guide, OSI stated: "The manufacturer thanks Allen P. Schlein, M.D. for his assistance in the development of the OSI Schlein Shoulder Positioner SSP-1000."

In 1999, OSI modified parts of the backrest and added a chin strap that had been designed and patented by Lamb. OSI also changed the name of the device to the "Schlein II Universal Shoulder Positioner" and changed the product number to 5338.

OSI also modified the text of its brochures to state "[OSI] thanks [Allen] P. Schlein, M.D., for his assistance in the development of the OSI Schlein II Universal Shoulder Positioner." OSI continued to pay Dr. Schlein for the sales of the Schlein II Universal Shoulder Positioner and the patient care kits.

In 2001, OSI changed the name of the device to the "Schlein Ultra" and changed the product number from 5338 to 5358. In the marketing brochures and user guide, OSI thanked Dr. Schlein for his "assistance in the development of the OSI Schlein Ultra™ Shoulder Positioner."

OSI did not inform Dr. Schlein that it was changing the product number. OSI continued to pay Dr. Schlein royalties for the sales of the Schlein Ultra Shoulder Positioner and the patient care kits.

7. OSI Trademarks Dr. Schlein's Name

In 2001, OSI applied to trademark the name "Schlein Ultra" to the shoulder positioner. The application was approved by Lamb, who at that time was OSI's chief operating officer. Lamb also signed a declaration attesting to OSI's alleged ownership of the name "Schlein Ultra."

Lamb filed the trademark application because competitors were using Dr. Schlein's name on competing shoulder positioners and/or patient care kits. However, prior to filing the application, neither Lamb nor anyone else at OSI asked Dr. Schlein for his authority to trademark his name to the positioner.

The trademark registration was issued to OSI on September 21, 2004.

8. OSI Stops Paying Royalties to Dr. Schlein

On January 21, 2005, Lamb sent a letter to Dr. Schlein, remitting his royalty check for the fourth quarter of 2004 and advising him as follows: "As you know, OSI has paid you [a] royalty on the shoulder positioner according to the agreement signed by Bob Moore since January 1991. In light of the fact that there is no patent protection on the product and this product is in a very competitive market, it has become economically unfeasible to continue this program. It is our standard practice to pay royalties on unpatented products at a rate of 2.5% for no more than ten years. In this case, we are nearing the end of the 14th year and we have generously paid you a 5% royalty. In light of our long relationship, I am proposing that we continue this royalty at 2.5% of [the] sales for 2 more calendar quarters (i.e., through June 30, 2005) after which the royalty will be discontinued."

Prior to sending the letter to Dr. Schlein, Lamb did not do anything to determine whether it was economically feasible to continue the royalty program. Indeed, OSI's records indicated steady sales of the positioner and pad sets from 2000 through 2005.

9. OSI Continues to Sell Shoulder Positioner Using Dr. Schlein's Name

Although OSI tendered the last royalty payment to Dr. Schlein in January 2005, at least until July 29, 2005, OSI continued to market and sell the shoulder positioner and pad sets using Dr. Schlein's name.

During the period January 1, 2005 to July 31, 2005, OSI's total revenues on sales of the shoulder positioner and pad sets were $2,033,333.*fn7 Dr. Schlein's economic expert opined that the profit OSI earned on the forgoing sales was $1,220,000, using a 60 percent profit margin; this amount did not include royalties that were due to Dr. Schlein for that period, which was equal to 5 percent of $2,033,333 or $101,667.

OSI eventually changed the name of the shoulder positioner to the "Ultra Shoulder [P]ositioning [D]evice." In all respects, there was no difference between the Schlein Ultra Shoulder Positioner and the Ultra Shoulder Positioning Device.

B. Pretrial Proceedings

OSI filed a complaint against Dr. Schlein in May 2005, seeking declaratory relief, reformation of contract, and unjust enrichment. OSI alleged that it had no further obligation to Dr. Schlein under the 1992 Agreement, assuming it ever had one. To the extent the agreement was ever enforceable, it was terminable at the will of either party and that OSI had "effectively terminated" the agreement. OSI also claimed the agreement was void or voidable for lack of consideration.

Dr. Schlein answered the complaint and filed a cross-complaint against OSI, seeking damages for breach of contract and conversion. Dr. Schlein also asserted a claim for declaratory relief, seeking a determination that the 1992 Agreement required OSI to continue paying royalties for the sales of the shoulder positioner and pad sets. His amended cross-complaint alleged that OSI had violated Civil Code*fn8 section 3344, by using his name in conjunction with its marketing and sales of the shoulder positioner and pad set. In support of this claim, Dr. Schlein alleged that he gave OSI permission to use his name to market the Schlein Shoulder Positioner on the condition that OSI satisfied its obligations under the 1992 Agreement.

C. Trial

A jury trial commenced on March 20, 2008. Throughout the trial, evidence was presented regarding the difference between damages and profits. Also, during argument, counsel for both parties discussed the difference between an award of damages and an award of profits.

The court instructed the jury as to the differences between contract and tort damages. The court also instructed the jury with CACI No. 361, explaining that Dr. Schlein could not be awarded duplicative damages: "Dr. Schlein has made claims against [OSI] for breach of contract, conversion and misappropriation. . . . [I]f you decide, by way of example, that Dr. Schlein is entitled to recover royalties on one of his claims, he cannot recover those same royalties on another claim but may, if you so decide, recover non-royalty damages on other claims where permitted."

The jury was also instructed with CACI No. 1821 regarding damages under section 3344, and advised that the "specific items of damages" claimed by Dr. Schlein were harm to reputation and loss of standing in the community and the commercial value of his name. CACI No. 1821 further instructed the jury that: "In addition, Dr. Schlein may recover any profits that [OSI] received from the use of Dr. Schlein's name." In establishing the amount of profits, the jury was instructed to "[d]etermine the gross, or total, revenue that [OSI] received" from the use of Dr. Schlein's name; to "[d]etermine the expenses that [OSI] had in obtaining the gross revenue"; and to [d]educt [OSI's] expenses from the gross revenue." The jury was also instructed that Dr. Schlein was required to prove the amount of gross revenue and OSI was required to prove the amount of the expenses.

D. Special Verdict and Judgment

The jury returned a special verdict finding, among other things, that:

(1) Dr. Schlein and OSI entered into a contract that required OSI to pay royalties Dr. Schlein "for the sale of any shoulder ...

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