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Tuesday, April 9, 2013

Bert Foer and Kexin Li on Patent Assertion Entities

Posted by Bert Foer and Kexin Li

Patent assertion entities (PAEs) are a new yet rapidly growing creature (likely of the genus monster) in the technology market. They have turned patents into commodities – they monetize, but do not practice, the patents they own. Their business model is simple and straightforward: to purchase and hold patents solely to use for asserting or threatening to assert them in court in order to obtain large license fees from operating companies that are already using the patents in their products. Irritated operating companies call PAEs “patent trolls.” It is an interesting metaphor – in the old folklore, a troll is a monster hiding under a bridge waiting to catch people on the bridge. President Obama described patent trolls as entities that “hijack somebody else’s idea and see if they can extort some money out of them.”

PAEs are not happy about the name of “patent trolls.” They probably prefer the old and seemingly harmless name “non-practicing entities” (NPEs), which would allow them to hide, camouflaged among a bevy of innocent NPEs (universities, research institutes, non-profit organizations, start-ups, and some individual inventors). They argue that they promote efficiency and liquidity in the technology market by facilitating technology transfer and patent enforcement. We acknowledge that it is highly important to facilitate technology transfer in order to promote innovation and benefit the public. For example, the Congress enacted the Bayh-Dole Act to “use the patent system to promote the utilization of inventions arising from federally supported research or development.” Also, there are companies like Ocean Tomo (which has existed for many years) offering financial products and services related to intellectual property. We can hardly perceive anything wrong with monetization of patents as long as the whole process is open and transparent.

However, PAEs are the opposite. They harm innovation and market competition not just because of their assertion of patents, but also because of the secrecy of their activities.[1] Intellectual Ventures (IV)’s Peter Detkin said during the workshop on PAEs (the PAE Workshop) jointly held by the Federal Trade Commission (FTC) and Department of Justice (DOJ) that, as no investor would like to disclose his or her investment portfolio, IV does not disclose the patents it owns.  What is more, IV has created more than 1,276 shell companies to hide its patents.  Another PAE, Acacia, controls 250 patent portfolios via its subsidiaries. As a result, a willing licensee-to-be will never be able to find where the patents are.[2]

Target companies often unwillingly surrender. Even if the target company surrenders to a PAE’s threats, the settlement may not bring peace due to this secrecy. A PAE may aggregate a massive portfolio, use it to threaten many potential infringers, and demand portfolio-wide licenses. However, it often at the same time refuses to disclose the patents it owns or even which patents it believes are being infringed. Without knowing if they are actually infringing anything or what they are paying for, the targets of these threats, especially the smaller start-up businesses but large operating companies as well, often see no attractive alternative to acquiescing in an expensive portfolio-wide license (in patent cases, settlement costs are usually much less than litigation costs). Moreover, the aggregation process typically combines many weak patents with a smaller number of strong patents; the net effect is to artificially boost the exclusionary power of the weak patents as if they were strong patents. If any standard-essential patents (SEPs) are within the portfolio, a portfolio-wide license demand may make the entire portfolio a de facto standard-essential portfolio. To make matters worse, after amassing a huge portfolio, the PAE may spin off several parts of it to several other PAEs. These PAEs may go to the same targets with infringement suits without disclosing what patents in the initial portfolio they each own and what patents they are asserting, which may give rise to the problem of royalty stacking. Also, each of them may again threaten to assert patents outside the licenses that the licensee previously accepted.

Besides the secrecy, PAEs make use of other advantages in patent assertion. As they do not make or sell any product, they do not confront any reputational constraint or risk of counterclaims normally faced by operating companies in patent litigation. Additionally, unlike the operating companies, PAEs produce few documents, do not incur heavy discovery burdens since they have no business other than patent licensing and litigation, and may pay only a contingency fee to their lawyers. If patent wars between operating companies can be called “mutually assured destruction,” in the PAE context, “mutually assured” has been separated from “destruction.”

PAEs are professional litigants. PAEs’ concentration on highly profitable patent litigation strategies attracts investment from third parties such as hedge funds to finance their lawsuits.  They operate “on similar terms to private equity and venture funds,” seek “to make most of [their] money on carried interest,” and “forge ahead with weak patents” to “reinforce their bargaining position with future targets.” PAEs often assert vague software patents, which are very difficult to defend against because the alleged infringers cannot identify the scope of those patents. They may concentrate on maximum lock-in and holdup situations by asserting patents late in the patent term. Moreover, PAEs not only approach operating companies that manufacture the allegedly infringing products, they may also target those companies’ downstream customers that use those products. The customers may be small businesses and often lack experience in patent litigation, so they are more likely to accept PAEs’ proposed unreasonable licensing terms. Since February 2011, a PAE named Innovatio IP Ventures has sent more than 8,000 letters to customers (mainly “hotels, coffee shops, restaurants, supermarkets, and other commercial users of wireless internet technology . . .”) of Cisco, Motorola and Netgear in all 50 states “alleging infringement of its patents and demanding that the [t]argets pay for a license.”

Many operating companies decide to transfer their patents to PAEs because of all the above reasons – to let professional PAEs attack their rivals without worries about counterattack or reputational restraints. For instance, MobileMedia was created by Nokia, Sony and a licensing group called MPEG-LA and holds their patents. It achieved a big victory in Delaware in December 2012, where a federal court found Apple infringed its patents. This trend has not stopped even after the PAE Workshop called public attention to abuses. On January 10, 2013, Ericsson announced its plan to transfer to a PAE called Unwired Planet 2,185 issued United States and international patents and patent applications. In addition to this portfolio, Ericsson is required to transfer 100 patent assets each year to Unwired Planet from 2014 through 2018. Unwired Planet, in return, will grant Ericsson a license to its expanding patent portfolio, among other benefits.

So is there any sign showing that the market may fix these PAE problems in the foreseeable future? Unfortunately, no. PAEs are becoming more and more aggressive. It is reported that the number of new patent cases initiated by PAEs increased from 569 in 2006 to 2,544 in 2012 (through December 1, 2012). More specifically, in the year of 2011, PAEs brought 1,509 cases in federal district courts against 2,995 companies – a 211% increase from the number of companies sued in 2005, when PAEs brought 453 cases against 933 companies.  PAE cases increased from 19% of all new patent suits in 2006 to more than 60% in 2012 (through December 1, 2012).  It is further reported that “PAE-generated revenue cost defendants and licensees $29 billion in 2011, a 400% increase from 2005,” and that “no more than 25% of this flowed back to innovation,” even though PAEs reportedly lose 92% of the time when cases are actually litigated. These figures suggest a move far away from the original purpose of patent protection – to reward and facilitate innovation.

PAE activities continue threatening the U.S. economy and innovation process. Because of the risk of unexpected and even baseless lawsuits by PAEs, market incumbents (especially small businesses) may have to bear significantly increased litigation, licensing and invent-around costs while potential new entrants (also especially small businesses) may hesitate to enter a market. The distractions caused by PAEs may significantly harm innovation. Small companies face a particularly difficult situation. They may not be able to find investors and may even have to exit the U.S. market because of the risk of PAE challenges. Even if they receive venture capital funding, they may have to avoid announcing it, because PAEs may begin to target them upon learning that information. They may not even want to speak publicly on the PAE problems they face for that same reason.

This situation has not become better after the PAE Workshop on December 10, 2012. For example, on February 25, 2013, a Texas patent holding company SmartPhone Technologies LLC (SmartPhone), in two separate actions sued AT&T, Apple, and LG for patent infringement. Apple and AT&T settled a month later. The terms of settlement were not disclosed. SmartPhone started its litigation journey in March 2010, and its other targets include Samsung, Research In Motion (Now Blackberry), Motorola and Sanyo. Facing the current situation, we applaud the efforts made by the antitrust agencies so far in addressing all the PAE problems, but we also call for more enforcement actions that can have real teeth.[3]



[1] In contrast, more and more operating companies seem to have become aware of the importance of openness and transparency in the patent system. Both Google and Microsoft have launched their patent pledges in the year of 2013 in order to reduce litigation and promote innovation, although some commentators suspect they are simply empty promises.

 

[2] The United States Patent and Trademark Office (PTO)’s pending real-party-in-interest (RPI) recordation proposal is a very desirable part of the solution, as we explained in our recent comments to the PTO. But we also encourage the FTC to use its own authority under the Section 5 of the Federal Trade Commission Act to impose disclosure requirements.

 

[3] Even the International Trade Commission (ITC) has taken some creative actions. It recently ordered an administrative law judge (ALJ) in a Section 337 case filed by a PAE to “hold an early evidentiary hearing, find facts, and issue an early decision, as to whether the complainant has satisfied the economic prong of the domestic industry requirement.” Also, it has given the ALJ 100 days to issue an initial determination with respect to “the economic prong of the domestic industry requirement.” If a PAE plaintiff fails its burden of proof, no further litigation will proceed.

 

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