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System Operations Inc. v. Scientific Games Development Corp.

filed as amended may 24 1977: May 3, 1977.



Rosenn and Hunter, Circuit Judges, and Daniel J. Snyder, Jr., District Judge.*fn*

Author: Rosenn

ROSENN, Circuit Judge

The genesis of this litigation is the calculating appeal of state governments to the gambling instincts of their respective constituents as an important tool to raise operating revenues. This growing phenomenon in state government*fn1 has fanned a blazing competition between the parties in this proceeding for state and municipal contracts in the lucrative and fast-growing "instant lottery" ticket market. This action is an outgrowth of that heated rivalry.


System Operations, Inc., a 76 percent owned subsidiary of plaintiff Mathematica, Inc., a New Jersey corporation, is engaged in the designing, marketing, and implementing of public lotteries. Both plaintiff corporations ("System") maintain their principal places of business in New Jersey. Defendant Scientific Games Development Corp. ("Scientific") a Michigan corporation, competes with System in public lottery consulting, designing, and marketing and often works jointly with defendant Dittler Brothers, Inc., ("Dittler"), a specialty printer, in designing lottery tickets. Both defendant corporations maintain their principal places of business in Georgia.

In an instant lottery, unlike the more traditional weekly or monthly lottery, each ticket is a pre-determined winner or loser. The determinative numbers, letters, or symbols on each ticket are concealed from view by a coating of gold leaf or other opaque material which can be rubbed off by the purchaser of the ticket, thereby instantaneously providing such person with the good, or more often, sad results.

The key to a successful instant lottery is in the coating process. The ticket coating must resist all attempts to see through it or around it with special equipment: if the hidden numbers can be read without leaving visible evidence that the ticket has been disturbed, the lottery is doomed to failure; unscrupulous dealers will cull out the winning tickets and sell only the losers to unsuspecting members of the public. As the number of winners among the public declines, confidence in the game diminishes; ticket sales fall off. The end result is a degenerating lottery with less revenue for the sponsoring state or city.

In the instant lottery business, a ticket is said to be "broken" if a feasible means of reading the hidden numbers has been discovered; a ticket is "non-breakable" or "secure" if such reading is impossible. Ticket security is the paramount concern of instant lottery directors. Allegations that a ticket has been broken or is insecure can threaten the success of a lottery and must be taken seriously.

System instituted an action in the United States District Court for the District of New Jersey charging Scientific and Dittler with antitrust violations, seeking a declaratory judgment that certain patents held by the defendants are invalid, and alleging that the defendants have engaged in a widespread campaign to falsely disparage the security of System's lottery ticket and to interfere with its contractual relations with various lottery commissions around the country. On this common law cause of action, System requested both damages and permanent injunctive relief, and applied to the district court for an immediate preliminary injunction against further disparagement of its instant lottery ticket and further interference with its contractual relations. The district court entered an order granting the preliminary injunction and it is that order which we are called upon to review.*fn1a Although the district court's subject matter jurisdiction is based on federal questions of antitrust and patent law under 28 U.S.C. §§ 1337, 1338, 2201, and 2202 (1970), it had pendent jurisdiction over the plaintiffs' state law claims of product disparagement and interference with contract. This court has jurisdiction under 28 U.S.C. § 1292(a)(1) (1970) to review the order granting the preliminary injunction.

In its complaint, System alleges that Scientific and Dittler falsely and maliciously disparaged the security of System's instant lottery ticket to lottery officials in the states of Delaware, Illinois, Michigan, New Jersey, and in the city of Omaha, Nebraska. Although further proceedings in this case may well deal with instances of alleged disparagement in all these states, in the hearing on the motion for the preliminary injunction the district court, with the consent of the parties, focused exclusively on the defendants' activities in Delaware and Omaha. The court found that in both these areas, Dr. Koza, the chairman of the board of directors of Scientific, made numerous statements to lottery officials that the System ticket was easily broken, that it had been deemed insecure by police of several states, and that dealers were breaking the tickets and "ripping off" the public. But the court found no evidence that Dittler engaged in such activities. In spite of Scientific's alleged campaign of disparagement, System managed to retain the Delaware contract previously awarded to it while competition for the Omaha contract became moot upon the cancellation for other reasons of the Omaha game.

Finding that the parties "were almost constantly negotiating or bidding on contracts" in many states, the district court entered the following order:

Ordered that defendant Scientific Games Development Corporation, its officers, agents, employees and any other persons acting in concert with the above, be and are hereby enjoined from making, uttering or publishing false and disparaging statements, whether direct or indirect, regarding plaintiffs' instant lottery tickets, this to include statements that plaintiffs' instant lottery tickets are not secure or can be "broken"; statements relating to rumors of ticket selling agents taking advantage of the alleged insecurity of plaintiffs' instant lottery tickets; and other similar statements or innuendo regarding the security of plaintiffs' instant lottery tickets; and

It is further ORDERED that there being no sufficient showing of impropriety on the part of defendant Dittler Brothers, Inc., said defendant not be specifically enjoined from any activity except insofar as its officers, agents and employees may be said to be acting as an agent for or in concert with defendant Scientific Games Development Corporation, as set forth above.*fn2

Scientific and Dittler appeal from this order. Because we conclude that the preliminary injunction cannot be sustained under the applicable New Jersey law and also because the district court failed to require plaintiffs to post a security bond, we reverse the order of the district court and remand the case for further proceedings.


The threshold issue which confronts us is the choice of law. The issue is knotty, for the allegedly disparaging statements of which System complains were published in New Jersey, Delaware, Nebraska, Michigan, and Illinois by a company headquartered in Georgia concerning products of companies with principal places of business in New Jersey. The problem is made more complex by the broad scope of the preliminary relief granted: the injunction restricts the conduct of the defendants not only in the foregoing states but also in every state in the Union in which they might compete for future lottery contracts. In addition, System seeks both damages for disparaging communications which were allegedly published in these states and a permanent injunction against all future disparagement regardless of the state in which it occurs.

In skirting the choice-of-law problem and basing its decision in part on case law from jurisdictions some of which have no apparent relationship to this case,*fn3 the district court violated the command of Klaxon v. Stentor Elec. Mfg. Co., 313 U.S. 487, 85 L. Ed. 1477, 61 S. Ct. 1020 (1941), that a federal district court adjudicating a state law issue must apply the law of the forum state, including that state's choice of law rules. See Suchomajcz v. Hummel Chemical Co., 524 F.2d 19 (3d Cir. 1975). Although Klaxon was a diversity jurisdiction case, the same principle holds true with respect to pendent jurisdiction claims. See UMW v. Gibbs, 383 U.S. 715, 726, 86 S. Ct. 1130, 16 L. Ed. 2d 218 (1966); Mintz v. Allen, 254 F. Supp. 1012 (S.D. N.Y. 1966). Since the present cause of action for product disparagement is indeed based on state, not federal, law, the district court's selection of applicable rules of product disparagement law should have been governed by the choice-of-law principles of the forum state, New Jersey. See Henry v. Richardson-Merrell, Inc., 508 F.2d 28 (3d Cir. 1975). The district court having failed to follow this course, it becomes our obligation to distill from those New Jersey choice-of-law principles a rule by which we can select the applicable body of product disparagement law.*fn4

As we recognized in Henry, supra, New Jersey courts have abandoned the traditional lex loci delicti approach to choice of law problems in tort cases in favor of the more flexible governmental interest analysis. See, e.g., Rose v. Port of New York Authority, 61 N.J. 129, 293 A.2d 371 (1972); Mellk v. Sarahson, 49 N.J. 226, 229 A.2d 625 (1967); Breslin v. Liberty Mutual Ins. Co., 125 N.J. Super. 320, 310 A.2d 527 (1973). Although most of the modern New Jersey decisions dealing with the choice of applicable rules of tort law have come in personal injury cases, a recent New Jersey defamation case suggests that governmental interest analysis also will be used in that context. See Barres v. Holt, Rinehart & Winston, Inc., 131 N.J. Super. 371, 330 A.2d 38 (1974), aff'd 141 N.J. Super. 563, 359 A.2d 501 (1976). Bearing in mind the close relationship between defamation and disparagement, see, e.g., Restatement (Second) of Conflicts of Law § 151 (1973), we are convinced that New Jersey courts would also resolve the choice-of-law problem in a product disparagement case by identifying and weighing the interest of each state in having its own product disparagement law applied.

The first step in assessing a state's interest in having its law applied to a particular issue is to understand the policy considerations which underlie the law in question. That is readily done in the present case, for we may assume that any state's product disparagement law represents a considered balance between protection of the good reputation of products from unfounded attack on the one hand and encouragement of free and robust debate on matters of public interest (including the relative merits of products offered for sale to the public) on the other.*fn5 By adjusting the rules relating to damages, malice, proof of falsity, and privilege, each state is able to determine for itself just where that delicate balance will be struck. Each state's law of product disparagement thus embodies policy considerations regarding interests in property, the right to free speech, and, probably, principles of business ethics as well.

Since Nebraska is one of the states in which System complains its tickets were disparaged, application of Nebraska law would presumably further that state's policy judgment as to how protection of reputation and encouragement of free speech are to be balanced when disparagement is published within its borders. It would appear, therefore, that Nebraska has a legitimate and substantial interest in having its law applied and, by the same reasoning, that Delaware, Illinois, New Jersey, and Michigan each have a substantial interest in having their respective laws of product disparagement applied. On the other hand, Georgia's interest cannot be ignored: as the principal place of business of both defendants, Georgia can legitimately claim that application of its law would further its policies pertaining to Georgia's economic well-being and how companies doing business in Georgia comport themselves in competition. Both plaintiff corporations, however, maintain their principal places of business in New Jersey and application of New Jersey law would further New Jersey economic and social policies affecting the operations of New Jersey companies. In addition, each state in which the parties might engage in future competition has an important interest in having the preliminary injunction under appeal (as well as any permanent injunction which might hereafter be awarded) conform with that state's policies. Given the facts of this case, therefore, we believe a New Jersey court would be hard pressed to single out any one state as having the most significant interest in having its law applied.

The Restatement (Second) of Conflicts of Law (1972) would offer some guidance to a New Jersey court were it faced with this seemingly insoluble problem. Section 151 provides that "The choice-of-law rules involving injurious falsehood*fn6 are the same as those involving defamation." The two related Restatement rules involving defamation are section 149 pertaining to defamatory communications published in one state at a time and section 150 applying to defamatory communications published simultaneously in two or more states ("aggregate communications"). The basic rule is that except in the case of aggregate communications, "the local law of the state where the publication occurs determines the rights and liabilities of the parties." Restatement (Second) of Conflicts of Law § 149 (1973). In the case of aggregate communications, section 150(1) provides that "the local law of the state which, with respect to the particular issue, has the most significant relationship" applies. Section 150(3) contains a clarification very pertinent to the issue here under discussion:

When a corporation . . . claims that it has been defamed by an aggregate communication, the state of most significant relationship will usually be the state where the corporation . . . had its principal place of business at the ...

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