A tangled web – innovation, IP and patent trolls

Intellectual property law has for centuries formed the basis of a system designed to protect invention and promote innovation. But a rise in abusive, oftentimes frivolous, litigation is prompting a rethink of patent law – with the United States front and centre as potential reform looms.

There is no substitute for a good idea

In its most broad sense, that sentiment has been the foundation for intellectual property protections dating back as far as the Ancient Greeks. While not codified in law, the premise held was that by awarding effective monopolies to novel ideas, new concepts and developments could be shared with the world without fear of duplication. That concept evolved over centuries, as the relative protections afforded by intellectual property legislation developed into what we now know as modern patent law.

But in the United States in particular, the centuries-old system designed to protect ideas and spur innovation is under threat. The rise to prominence in recent years of patent assertion entities, colloquially known as patent trolls, has prompted calls from lawmakers across the country – from Congress and the Senate, all the way up to the White House – to initiate reform with an aim of bringing a halt to their activities.

‘The way that I think about patent trolls is as people or companies that are using patents in an offensive manner, instead of using patents to protect ideas, create new products or contribute to the development of ideas,’ says Michal Rosenn, general counsel at Kickstarter.

In essence, patent trolls use the intellectual property they control as fiscal weapons against inventors, innovators and producers who they deem to be infringing on their rights. Generally, the patents themselves are acquired en masse, with overly-broad, dormant or non-novel patents purchased from small-time inventors, down on their luck companies or as excess collateral following mergers and acquisitions, with zero intent of utilising the intellectual property for any purpose other than in court.

‘Their primary business is litigation – it’s lawsuits and deriving profit from lawsuits around patents or threatened lawsuits,’ explains Rosenn.

‘Many of these entities file lawsuits against small and medium-sized businesses, targeting a settlement just under what it would cost for litigation’, adds Congressman Bob Goodlatte, chairman of the United States House Committee on the Judiciary.

The effect of patent trolls is palpable. Since 1980, the number of patent lawsuits filed in the United States has increased more than six-fold, with a direct financial impact estimated to be in the tens of billions of dollars on an annual basis, with totals as high as $60 billion bandied about. Perhaps even more concerning, that figure fails to account for the indirect cost to firms and national innovation, with spooked investors and venture capitalists curtailing their outlays and an overall decline in research and development efforts attributed to the activities of patent trolls.

‘Abusive patent litigation is a drag on the economy. This problem impacts businesses and industries of all types and the jobs of the people who work for them, from the tech sector to the hospitality industry and even grocery stores. Everyone from independent inventors, to start-ups, to mid and large sized businesses face this constant threat,’ says Goodlatte.

It’s not reinventing the wheel

Despite the term ‘patent troll’ not being coined until 1994, by then Intel assistant general counsel Peter Detkin (ironically a founder of Intellectual Ventures, arguably the world’s most prominent and powerful patent troll, who declined comment as part of this feature) the tactics employed are far from novel.

‘The economic history of invention is full of people who invent, perhaps even to the point of producing prototypes, but who have never been in the business of manufacturing,’ explains Stephen Haber, professor in the School of Humanities and Sciences at Stanford University, and a senior fellow at public policy think tank the Hoover Institution.

‘This is something which dates back and has been employed as a tactic for deriving income from inventions since the 19th century. That was another period of disruptive technology, based on small innovators and now we’re faced with a similar phenomenon. Back then, they were referred to as patent sharks and were derided, the only difference now is what we call them.’

In the 19th century, similar to the contemporary climate with software developers and technology entrepreneurs in particular, small-time inventors were largely the norm. Back then, inventors directly exploiting the patents they held were in the firm minority, with transfer of intellectual property rights to producers and manufacturers the most common way to derive income from developments.

‘Among the most famous of those who would today be referred to as a patent troll is Charles Goodyear, who invented the vulcanisation process for rubber, but had no interest in actually producing or marketing products based on his invention,’ says Haber.

Instead, what Goodyear and a number of his well-known contemporaries did – including the likes of famous innovators such as Thomas Edison and even Abraham Lincoln – was license the technology they had developed (and patented) to firms with both the ability and desire to commercialise the inventions.

But like we see today, it wasn’t the transfer of technology which caused issues back in the 19th century. Rather, it was a specific subset of those who acquired the intellectual property and used it as a basis for offensive litigation. In the 19th century, it was farmers and the railroads which were hit the hardest, losing huge sums of money for inventions as innocuous and vague as barbed wire – with both groups eventually banding their individual members together in order to take on the patent sharks collectively.

In essence, patent trolls use the intellectual property they control as fiscal weapons.

Favourable court judgments and structural economic changes (chiefly a shift away from small-time inventors to corporate-led research and development) largely mitigated the issue of patent sharks for much of the 20th century. But a comparable contemporary economic situation, with the increasing prominence of small businesses and entrepreneurs driving innovation – particularly in the technology space, has brought the issue back to the fore – albeit this time with a new name.

‘Patent trolls have become an ever-increasing problem in recent years because it has become an effective and profitable business model. The turning point I believe, when it became recognised as a potentially extremely profitable business model, was when the barcode patent litigation took place,’ explains Kenneth Grady, former general counsel at Wolverine World Wide and KB Toys.

The barcode patent litigation was an equal parts extended and infamous series of litigation brought about by the estate of Norman Woodland, a Manhattan Project scientist who came up with the idea for barcodes long before the technology to make the idea viable was invented. With the advent of affordable lasers in the 1970s, barcode technology became economically feasible and Woodland subsequently took out a number of additional patents related to the idea throughout the 1980s and 1990s. The subsequent court cases generated close to an estimated USD$1 billion in settlements before the patent was declared invalid in 2005.

‘In more recent years, the technology sector in particular has given rise to all sorts of patent troll activity. This has become a mess which is very difficult to sort out, because of the volume of patents being filed and granted – many of which are very broad – alongside the explosion in the importance of apps and software, it’s created a very fertile environment for going after anybody and everybody with patents – no matter how tenuous the claim,’ says Grady.

A broken system

‘Everyone is very well aware of how inefficient and expensive the legal system is when it comes to litigating suits generally, but even more so around intellectual property. Patent lawsuits are particularly tedious, expensive and they require a lot of costly things like expert discovery, so the costs can be tremendous,’ says Rosenn.

That the system for dealing with intellectual property disputes is so costly and time-consuming is what gives rise to the activities of patent trolls. A 2012 Congressional survey showed that when cases brought by patent trolls played out in their entirety through the courts, 92% of the time they were defeated. Yet the vast majority of patent trolls have no intention of taking things that far.

‘The strategy is to target a settlement just under what it would cost for litigation, knowing that these businesses will want to avoid costly litigation and probably pay up,’ explains Goodlatte.

image of bike patent in spider web

‘We started off with an industry that was grounded more in law and fact, but as time went on it became easier as the model developed on the plaintiff’s side and as such, defendants were willing to play the game of paying some amount to make the lawsuit go away and remove the liability. It become a case of recognising that the payment, while you as a defendant hated it, still was less than the risk plus payment required to prove that you’re right,’ adds Grady.

‘The cost is what has really made this such a lucrative business, because you may feel as the defendant that you’re absolutely comfortable in your knowledge that you did not infringe on a valid patent. But the expense to go through and prove that simple statement is phenomenal. The patent trolls are very aware of the costs of litigation involved and so the model had been set that you as a patent troll would bring your case, but your demand to get a license would always be beneath what the cost of just proving you’re right as a defendant would be. The bottom line is that you can spend millions of dollars to prove you’re right or you could pay the troll less than that and this all goes away.’

While a significant proportion of companies when threatened by patent trolls are inclined to settle, for Michal Rosenn and Kickstarter, that wasn’t an option. Instead, they took the trolls head on – making it clear that their intention was to litigate and not settle.

‘From a philosophical and moral perspective it was a very easy decision, it’s one that we’d been taking from the start,’ explains Rosenn.

‘Two of the trolls that sued us ended up just withdrawing their suits without us paying anything when we made clear that we wanted to litigate – that we were not going to submit to their demands and we were prepared to take the issue to court and defend our rights. I think that sort of proves perfectly the point that they are not interested in really litigating the merits of the claims that they’re bringing, they’re really interested in getting a payout by threatening litigation.’

During his time with Wolverine World Wide, Kenneth Grady said they faced a similar decision, when a vague and overbearing patent was used as the basis for a frivolous lawsuit they were forced to defend.

‘We had been challenged because we had an online e-commerce business and there were patent owners who claimed that they owned the idea to essentially shopping online,’ explains Grady.

Wolverine World Wide was one of a number of major companies with an online presence that was threatened with similar litigation, including Newegg and Overstock – who eventually succeeded in defending the claim – albeit through an arduous and protracted process. For Goodlatte, the experiences of Rosenn and Grady speak to the heart of the issue which patent trolls present.

‘The tens of billions of dollars spent on settlements and litigation expenses associated with abusive patent suits represent truly wasted capital – capital that could have been used to create new jobs, fund research and development, and create new innovations and technologies,’ says Goodlatte.

A necessary evil?

But while patent trolls are near universally derided for their activities, Stephen Haber asserts that the research he and his colleagues are carrying out paints a very different picture, with patent trolls playing a valuable role in the innovation ecosystem and their negative impact being heavily overstated.

‘Patent trolls are always presented as if they are having a huge impact on the innovation ecosystem of the United States and there is not a shred of evidence that is true. Firstly, that would assume that all patent assertion activity is a pure tax on innovation. It leaves out whatever percentage of that activity is actually benefitting the innovation ecosystem by providing returns to inventors,’ says Haber.

‘We need to work on reforms to discourage frivolous patent litigation’.

Haber was highly critical of the numbers cited by Goodlatte and other politicians, attacking their accuracy and the failure to release their datasets for external scrutiny. He says that the research he and his team are in the process of finishing will be published online for dissemination to the public, as well as in a peer-reviewed journal so that their validity can be confirmed.

‘Bob Goodlatte can make up any numbers he wants, but as near as my colleagues and I have been able to estimate it, the total revenues of patent trolls in the US plus the litigation costs they generate are going to be in the area of $6 billion per year.’

With an economic impact of only $6 billion, if he is correct, Haber insists that the negative costs associated with frivolous patent claims will pale in comparison to the positive impact they have within the innovation ecosystem – particularly for small inventors and businesses.

‘The fundamental problem at root here is that you have very large companies doing the implementation of patents and a lot of much smaller companies doing technology development. That imbalance in size and resources has promoted the development of specialised intermediaries – which are now commonly referred to as patent trolls,’ says Haber.

‘These have arisen because of circumstance. Many of the inventors or developers are too small to effectively negotiate with large manufacturers who choose to infringe the patent rather than negotiate a license. In Silicon Valley, this is cynically referred to as efficient infringement.’

Haber says this is where he sees patent trolls adding value, by using their more significant resource base to provide an avenue for patent holders to derive the income that they rightfully deserve from players generally unwilling to pay – effectively playing patent infringers at their own game.

‘The goal of these large manufacturers is to simply bleed the small inventor dry in court. That’s why patent assertion portfolios are disproportionally based on patents that were initially taken out by small companies and individual inventors,’ says Haber.

‘In order for a patent assertion entity to have any patents to assert in the first place, someone has to sell them those patents – some inventive person or company that decided they would earn more by selling their patents than asserting it or licensing it themselves. That suggests that patent trolls, at least for some class of inventors, are an intermediary much like any other intermediary in the market. If they could have licensed their patents directly to implementing companies, they would have.’

But for Michal Rosenn, that was an overly simplistic way of looking at things and failed to reflect the realities of the misery which patent trolls cause for companies of all sizes and the harm they inflict upon innovators.

‘Academically, Haber’s theory is certainly an interesting proposition, but I think that when you apply it to the real world and you look at the actual consequences of what sort of value is derived – it is not derived in a vacuum. That value is derived by extracting value from people and companies and members of our economy who would otherwise be able to contribute in immense ways. But their contribution is being stymied and in some cases completely destroyed by the actions of these patent trolls,’ says Rosenn.

Likewise, Goodlatte recognised that for a subset of intellectual property creators, licensing their inventions out to patent assertion entities could represent the most productive way to generate value from their inventions – but in the wider sense, their activities were largely harmful.

‘The patent assertion model can be a legitimate way for small inventors with good patents to monetise their inventions. However, within that universe there are a specific subset of entities – which often times gobble up weak or poorly-granted patents, and proceed to send blanket demand letters or file numerous patent infringement lawsuits against American businesses with the hopes of securing a quick payday,’ says Goodlatte.

Reform at the ready

For Goodlatte, the solution is straightforward – reform to the patent system is an absolute necessity to ensure that American innovation is insulated from what he sees as the detrimental impact caused by patent trolls.

‘The patent system was never intended to be a playground for overly aggressive trial lawyers and frivolous claims. We need to work on reforms to discourage frivolous patent litigation and keep US patent laws up to date,’ says Goodlatte.

Patent trolls have been an issue he has worked strongly on since 2013, with Goodlatte introducing and sponsoring the proposed Innovation Act presently before Congress – the key elements of which are broken down by Goodlatte on the following page.

Congressman Bob Goodlatte’s patent policy prescription

Congressman Bob Goodlatte is the representative for the Sixth Congressional District of Virginia in the United States House of Representatives, a post he has held since 1993. A former lawyer, in the 113th Congress, Goodlatte was elected to serve as the Chair of the House Judiciary Committee, a function he has been a member of since arriving in Congress. He has previously held leadership positions on sub-committees focused on intellectual property and is a sponsor of the proposed Innovation Act, presently making its way through Congress, which aims to implement major reforms to patent law, the key elements of which he breaks down for GC below.

Targets abusive patent litigation: the bill targets abusive patent litigation behaviour and not specific entities, with the goal of preventing individuals from taking advantage of gaps in the system to engage in litigation extortion. It does not attempt to eliminate valid patent litigation.

Protects the patent system: this legislation does not diminish or devalue patent rights in any way.

Increases transparency: this legislation requires greater transparency in patent litigation and requires parties to explain exactly why they are suing a business or individual. Requiring parties to do a bit of due diligence up front before filing an infringement suit is just plain common sense. It not only reduces litigation expenses, but saves the court’s time and resources. Greater transparency and information is a good thing and it makes our patent system stronger.

Prevents extortion: the legislation prevents any one party in a patent lawsuit from unilaterally racking up extreme litigation costs for another party in an attempt to force a dubious settlement.

Provides greater clarity: the legislation provides for more clarity surrounding initial discovery, case management, joinder and the common law doctrine of customer stays. The bill works hand-in-hand with the procedures and practices of the Judicial Conference and the courts.

Small business education: the bill provides for small business education and outreach by the US Patent and Trademark Office.

Places reasonable limits on venue in patent cases: restores Congress’ intent that patent infringement suits only be brought in judicial districts that have some reasonable connection to the dispute. Since 1897, Congress has regulated the venue in which patent actions may be brought. These limits protect parties against the burden and inconvenience of litigating patent lawsuits in districts that are remote from any of the underlying events in the case. In 1990 the US Court of Appeals for the Federal Circuit ‘reinterpreted’ that statute in a way that robbed it of all effect. The Innovation Act corrects the Federal Circuit’s error, and restores the congressional purpose of placing some reasonable limits on the venue where a patent action may be brought.

A key tenet of Goodlatte’s proposed legislation is fee-shifting, wherein losing parties in patent legislation cases would be responsible for the victor’s legal fees – a similar system to that which is used in Europe and has been cited as a primary reason why this form of litigation is less frequently seen there compared with the United States.

‘One of the ideas involved is fee-shifting and transferring those costs on to the defendant. That should have a real effect and help in raising the bar for whether these suits will be pursued in the first place. But of course to get there, you have to go all the way through the trial which means that you still have risk on the defendant’s side, before any risk can be attributed and shifted to the plaintiff,’ says Grady.

‘The problem is that you still have significant risk on the defendant’s side, because you have to go through and prove that you were right and then the court has to agree to shift the fees to the plaintiff – so you’ve got a distance to go which costs you money upfront. The softer costs such as the interference with your business are still high, and companies face fatigue when deciding how long they want to fight this battle and continue paying money out the door, which affects current cash flow. Is it still easier to simply pay some amount of money to make it go away? If you do that then of course you’re not fee-shifting and you never get to that magic point.’

One criticism which has been levelled against the idea of fee-shifting, is that it increases the potential risk to small companies looking to enforce their own patent rights, particularly against large and well-capitalised entities, because a drawn out court case and the potential for having to pay their legal fees could disincentivise pursuing the claim in the first place. But Goodlatte says that the potential negative impact of this portion of the legislation has been overblown and largely misrepresented.

‘The Innovation Act includes an “abuser pays” provision which only applies to the most egregious cases. When parties bring lawsuits or claims that have “no reasonable basis in law and fact”, the Innovation Act requires judges to award attorneys’ fees to the victims of the frivolous lawsuit,’ explains Goodlatte.

That was a sentiment that Rosenn, who works with a large number of small innovators and companies on a daily basis, was supportive of.

‘I think that Goodlatte’s bill is drafted in such a manner that it’s really clear that only the most frivolous of claims would be subject to fee-shifting. Right now, the way that fee-shifting works, it’s essentially impossible to get attorney’s fees recovered in patent litigation cases regardless of how frivolous the case is. When you look at the overwhelming majority of patent litigation cases, it’s truly shocking how ridiculous many of the claims are, yet the current system sets the standard so high that it’s all but impossible to attain any form of recourse or reimbursement,’ says Rosenn.

‘What the proposed legislation would do is lower that standard not to a degree that would really impact anyone who is asserting legitimate patent claims, but simply bring that standard down to a more rational level that’s reflected in the rest of the legal system. It becomes a case of when a patent troll brings a suit that is truly frivolous, that is based on an entirely frivolous claim of infringement or validity, then in that case the court would say you forced the company to expend enormous resources in trying to defend this suit that should never have been brought up in the first place. As a lawyer knowing this standard, I would expect that many would not take a case like that – I don’t see anybody with a legitimate patent claim being caught up with negative consequences.’

The most important part says Goodlatte is the ‘No reasonable basis in law and fact. The bill allows judges to waive the award of attorneys’ fees in special circumstances. This provision applies to both plaintiffs and defendants who file frivolous claims.’

image of spider in middle of patents

But for Haber, the sheer notion of further reform is a case of too much too soon.

‘When you undertake a major reform as the United States did in 2011 with the America Invents Act, the responsible thing to do is to then wait and see what its effects are before you undertake any further reform,’ says Haber.

The Leahy-Smith America Invents Act was signed into law by President Barack Obama in 2011 and took effect in 2013. The new law undertook major reform to the patent system in order to harmonise intellectual property law in the United States with that of the rest of the world. Chief among the changes was a switch from a ‘first to invent’ to a ‘first to file’ system.

In essence, what that entails is a shift away from the United States Patent Office’s prior policy of granting a patent to whomever invented the idea first, to whomever files their patent application first. Previously, if someone was able to attain a patent for an idea that another inventor claims to have previously come up with, they were able to file interference proceedings with the Patent Office – which, if successful, would result in the transfer of the patent to the original inventor.

The purpose was to try to recalibrate the balance between major corporates with the resources to file patents effectively on a whim, with smaller entities to whom a patent application represented a significant investment.

‘If you undertake a major reform in a system in which there are long lag times between changes in the law and changes in how firms are going to respond, before you start piling on additional changes, you have to wait and see what the effect of the initial law is,’ says Haber.

Where to from here?

‘The real key here is that we have to do something. We’ve been in this situation for a very long time now and not doing anything has had consequences. This system of abuse has expanded and will continue to grow until we fix the system. We’ve passed the point where action is required and it’s imperative that we recognise that by not doing anything, we are making a conscious decision to maintain the status quo. There may not be a perfect solution, but it’s time to move on and try some of these new mechanisms,’ says Grady.

With Goodlatte’s proposed legislation being just one of a number of bills being debated and considered by United States legislators, the potential for genuine and meaningful reform to the patent system seems a case of when, not if. All that it appears is left to be decided is the form in which the new normal will take. With conflicting evidence, as to the true impact patent trolls have on the innovation ecosystem, the effects of a new system on American innovation in the long term is uncertain at best. Whatever the case, what remains abundantly clear is that as always, when the United States takes a position unique or perhaps even contrarian to the global status quo – the world will be watching and waiting.