The Truth Behind Patent Trolls

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No agreed-upon definition of patent troll exists. The term patent troll is used interchangeably with the terms non-practicing entities (NPEs) and patent assertion entities (PAEs). Despite similar sounding names, several key differences exist between the three terms.

Non-practicing entities (NPEs) own patents, but do not necessarily create products out of these patents. This behavior is common; 95% of patents are never used commercially [1]. Universities are examples of non-practicing entities. Faculty members may file for patents based on their work in a laboratory and receive a patent. Then, those faculty move on to a different project and do not use the patent they hold.

Patent assertion entities (PAEs) are a type of non-practicing entity that generate a majority of their revenue through licensing patents they own. For example, a large firm may buy up a thousand patents. Instead of creating products derived from those patents, they license these patents to other firms that wish to create those products. If another firm infringes on a patent, the patent-assertion entity may send a demand letter to the company with a warning. The demand letter warns the infringer that they are subject to a lawsuit if they do not acquire proper licensing of a patent.

These demand letters serve as the tipping point between patent assertion entities and patent trolls. Whereas PAEs assert the fair value of their patent against the infringer, patent trolls inflate the amount of damages felt as a result of infringement. Patent trolls may threaten a firm with exorbitant lawsuit costs, and then provide a quick way out of a lawsuit through a license. The supposed infringer, fearful of a high lawsuit costs, may just pay the licensing fee. However, the supposed infringer may not even have infringed on any patent.

Patent trolls may also target a slew of companies that tangentially intersect the sphere of the patent. One famous example of a patent troll is MPHJ Technology Investment, who claimed to have patents that cover any networked "scan-to-email" function. MPHJ sent demand letters to more than 16,000 small businesses, each letter demanding license fees of at least $1000 per worker.

Top 10 PAEs in 2015, according to Unified

Patent Assertion Entities Filings, 2015
Company Name Total Lawsuits Filed¹ Lawsuits Filed in Eastern District of Texas¹
eDekka LLC 101 101
Data Carriers LLC 85 85
Shipping and Transit LLC 69
Cryptopeak Solutions LLC 66 66
Hawk Technology Systems LLC 61 3
Rothschild Connected Devices Innovations LLC 60 59
Wetro Lan LLC 56 55
Loramax LLC 50 50
Genaville LLC 50 50
Oberalis LLC 50 50

¹ Data aggregated via LexMachina

² 79% of cases filed in Southern District of Florida

Patent Assertion Entities and Small Business

The current U.S. patent system restricts the market for innovation with high transaction costs and legal risks. [2] Most small and medium-sized businesses are unable to afford the costs associated with patent litigation and are prevented from commercializing or licensing over 95 percent of current active patents. [3] Therefore, many smaller-sized businesses rely on patent assertion entities to protect their patents and defend against expensive litigation. Patent assertion entities aggregate and manage patents and have the expertise to legitimately protect patents from infringement. [4]

In illiquid markets where asets cannot be sold or exchanged easily, patent assertion entities can help match patent holders to patent buyers and transfer ideas and technology from inventors to manufacturers effectively. This allows inventors to focus on innovation while benefiting from the knowledge and connections that intermediaries possess. Patent assertion entities are able to incentivize innovation through the effective brokerage of patents. [5] They manage risks for small inventors and inform manufacturers or inventors of the usefulness of having another inventor's patent in their patent portfolio. [6]

According to the U.S. Census Bureau, small businesses with fewer than 20 employees made up 89.6 percent of employer firms in the United States in 2012. [7] Small firms produce more patents per employee than large companies and help drive innovation in the United States economy. The patents they develop have a greater impact and are often more technologically important than those of large firms. [8] The Small Business Administration reported that "although small firms account for only 8 percent of patents granted, they account for 24 percent of the patents in the top 100 emerging clusters." [9] Because small businesses and emerging companies are not always able to protect their patents on their own and account for much of the innovation driving emerging industries today, they need patent assertion entities who have the power to protect their patents for them.

An Illustration of Patent Troll Activity

There's no doubt that patent trolls exist. eDekka, widely considered one of the top patent trolls, filed lawsuits against 101 companies for patent infringement in 2015, 55% of which are considered small businesses under SBA regulations. There may be more companies eDekka sent threatening demand letters to, companies that decided to settle instead of bringing the case to court. Compare eDekka to Intellectual Ventures, which had only filed 6 patent lawsuits in all of 2015. Intellectual Ventures is considered by the public to be a legitimate patent monetization firm [10]. It is clear that there is a distinct difference between patent assertion entities and patent trolls. As of December 2015, eDekka had sued over 200 companies for infringing upon the US Patent no. 6,266,674 "Random Access Information Retrieval Utilizing User-Defined Labels", a patent on a form of household remote controls. 168 of these cases were later thrown out by US District Judge Rodney Gilstrap, who wrote that the "strikingly similar lawsuits" demonstrate "an aggressive strategy that avoids testing its case on the merits and instead aims for early settlements falling at or below the cost of defense" [11].

Evaluations of Proposed Regulations

Stricter Demand Letter Requirements

Supporters of current legislation against patent trolls claim that the huge increase in patent litigation cases proves that patent trolls, just like eDekka, are increasing in number and prevalence. Many of them point to stricter demand letter requirements as the solution. The Innovation Act that is currently under consideration in the House demands that any claims of patent infringement must be accompanied by a very specific initial complaint letter, including information such as the name, exact model number, and description of each alleged infringement.

There are two problems with this. First, the increase in patent litigation cannot be attributed to an increase in patent trolls. Patent litigation is increasing, but only because of the uncertain nature of technological advancements and the application of patent claims to these new developments. Patent litigation surges are consistent with major shifts in technological developments. There has been an increase in lawsuits, but it is proportional to the increased filings. Thus, patent trolls exist but their prevalence has been greatly exaggerated by the media.

Second, stringent demand letter requirements are not an efficient solution to curbing patent trolls. The proposed reforms against demand letters by the Innovation act are too broad; they have the potential to stifle innovation. Patent owners acting in good faith would not be able to legitimately enforce their patent rights, creating an ineffective patent system and reducing the incentives for innovation. Qualcomm Incorporated, one of the leading companies within the telecommunications sector, manages a portfolio that contains at least 13,000 US patents. As a company that relies on the current patent system to protect its innovations, Qualcomm stated that "the appropriate goal of the legislation should be to identify, and empower the FTC to address, only those demand letters that are sent in bad faith" [12].

Empowering the FTC

Skeptics of the Federal Trade Commission’s (FTC) effectiveness may question how well the commission would handle patent trolls that have heavy financial and litigation muscle. However, these skeptics should remember that the Federal Trade Commission has already demonstrated willingness and ability to address patent trolls. In the 2014 investigation regarding MPHJ Technology Investments, LLC, the FTC found more than 16,000 demand letters sent to small businesses. Subsequently, the FTC prohibited MPHJ from asserting "false or unsubstantiated representations" regarding a patent's licensing activity or the potentiality and imminence of a lawsuit. [13] However, the FTC did not award any damages to small businesses that fell victim to this patent troll.

The bad faith standard in legislation such as the Targeting Rogue and Opaque Letters (TROL) Act provides a high standard that the FTC must meet in its patent trolls investigations. Bad faith refers to "'clear and convincing evidence' that the infringement assertions are 'objectively baseless' to avoid dismissal on summary judgment or a motion to dismiss." [14] In the case of an FTC investigation, the commission would have to show that a demand letter written by an alleged patent troll demonstrated bad faith assertions. Some examples of these bad faith assertions include, but are not limited to, falsely claiming the existence of a pending lawsuit, previous patent infringements, and even the valid ownership of a patent. The authors of the issue brief will note that determining the bad faith nature of demand letters sets a high standard for the FTC. However, such a high standard will protect legitimate patent assertion entities against unreasonable investigations and sanctions.

Recommendations on Curbing Patent Troll Activity

Legislation that enacts sweeping reform of the patent system will not help curb patent troll activity. This type of reform only weakens patent protection for legitimate patent holders and patent trolls alike and does not deter patent trolls from engaging in abusive or frivolous litigation. The Innovation Act and PATENT Act would exceed what is needed to reduce the activity done by a small number of patent trolls by raising the costs and risks for all legitimate patent holders to enforce their patent rights in court or defend themselves from larger companies. Any legislation that would alter the current patent system should target the specific actions used by patent trolls and should not propose broad reforms that change the procedure used to enforce patents. For example, legislation like the recently proposed STRONG Patents Act gives the FTC the power to determine that certain demand letters are in "bad faith" and penalize the companies that issue these letters, but also specifically protects mistakes that were made in good faith.

Congress last passed comprehensive patent reform only five years ago, in 2011, and the unintended consequences from those changes are still appearing. [15] Without carefully analyzing the potential effects of broad reform, Congress should not rush to combat the small amount of abusive litigation activity with sweeping changes that negatively affect everyone.