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Supporting Innovators The Case For Reforming The Patent

Litigation Process

Spring 2015

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•  The Internet Association supports commonsense reforms that will put an end to the abusive, harmful tactics patent trolls employ against businesses and reduce the "troll advantage." The patent system was designed to and has historically served innovators, but patent trolls continue to take advantage of the legal system to extract rents, punishing innovators and deterring investment. This deck outlines the case for meaningful patent reform.

•  Patent trolls abuse shortcomings in the patent litigation process to extort money from businesses, driving down innovation and investment. In 2011, lawsuits brought by patent trolls cost American businesses $29 billion. Additionally, increased legal fees caused by troll lawsuits have led to a 17 percent decrease in investment by VCs in startups.

•  The main goal of the Innovation Act (H.R. 9) as currently drafted is to achieve patent process reform, not to reform how patents are awarded or to lower the standards of protection that patents provide. These reforms would directly benefit inventors large and small. Inventors with a good patent claim would have cases decided faster and more efficiently, decreasing the cost for enforcing valid patents.

•  The Internet Association is focused on the following pillars of reform:

–  Set limits on discovery requests prior to the “Markman hearings” that determine the legitimacy of a patent claim prior to the discovery process

–  Implement heightened pleadings that would require the plaintiff to identify with some precision which patent, by number, has been infringed upon and which product or service is in violation of said patent

–  Increase the application of fee shifting, which is virtually non-existent in patent cases today, to reduce the incentive of trolls bringing frivolous lawsuits

•  Patent assertion entities (or patent trolls) are singularly responsible for the increase in patent lawsuits. Looking at all non-practicing entities bringing lawsuits in 2014, patent trolls account for 89 percent.

•  PAE's have a "troll advantage," in that they can bring patent suits with little costs to themselves, while inflicting exorbitant costs on defendants. This imbalance incentivizes settlements and does not represent legitimate patent enforcement.

Executive Summary

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Patent Reform Is Not About Changing Patents, But About Improving The Patent Litigation Process

Strong patents protect inventors rights, fostering economic growth and development •  IP-intensive industries provided 27.1 million

jobs in 2010, or 18.8 percent of all jobs in the economy.

•  Average weekly wages in IP-intensive industries were 42 percent higher than in other non-IP-intensive private industries.

But, current troll activity harms small businesses’ ability to reinvest capital for growth •  40 percent of small companies that

received a demand reported a “significant operational impact” including delayed hiring, pivot in business strategy, and even shut down of the entire business

Source: USPTO

Source: Colleen Chien, “Startups and Patent Trolls” Santa Clara Law School, 2012

Patent reform Is not about changing patents…

…It’s about commonsense reforms to the patent litigation process

Patent reform is process reform designed to reduce the “troll advantage” (cost mismatch) by implementing commonsense reforms to the litigation process •  Low costs for trolls: Trolls can bring

vague threats and legal complaints with lawyers to hundreds of companies at a time.

•  High costs for defendants: Defendants often have to respond to unreasonable discovery requests costing millions of dollars with virtually no chance of recouping costs through fee shifting.

Incentives are aligned for settlements, not legitimate enforcement of patent law.

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Patent Trolls

Innovative Businesses

Patent trolls face no costs or risks when filing a claim imposing immediate costs on defendants.

•  No limits on discovery

•  No standards for legal complaints (heightened pleadings)

•  Virtually no fee shifting

Without reform, trolls will continue to take advantage of a system designed to protect innovation, reducing investment for future breakthroughs.

The Patent Process Incentivizes Trolls

Patent Trolls Abuse The Inherent Bias In The Patent Lawsuit Process, Hurting Investment

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Patent Trolls Hold Patents With No Intent Of Using Them Except For Filing Patent Lawsuits

Patent Assertion Entities (PAEs), are "firms [that] use patents not as a basis for producing and selling goods but, instead, primarily for obtaining licensing fees," according to Supreme Court Justice Anthony Kennedy. PAEs are often synonymous with "patent trolls," but this does not necessarily include universities, inventors, or even all others who own patents but don't practice them. Not every PAE is a patent troll, but every troll is a PAE. Intermediaries can help protect patents from infringement and match investors with patent users. However, trolls rely on aggressive litigation tactics, not to improve innovation, but stomp it out for profit.

How To Spot A Troll

•  Often rely on threats to force settlements

•  Threaten to sue thousands of companies at once

•  Suits are vague with no specific allegation

•  Often create shell companies with empty offices

•  Assert that their patents cover inventions not imagined at the time they were granted

•  File claims in the Eastern District of Texas

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Profile Of A Patent Troll: Project Paperless

Beginning in 2012, a shell corporation called Project Paperless LLC began sending hundreds of businesses letters citing a patent infringement.

Background

Infringement Claim

The demand letters claimed that any companies’ use of basic office equipment such as scanners that can

Demand

send files to e-mail, infringed on a series of “distributed computer architecture” patents owned by Project Paperless.

The letters demanded various amounts from the different companies, typically ranging from $900 to $1,200 per employee.

Source: Joe Mullen, “Patent trolls want $1,000—for using scanners,” Ars Technica 2013

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Even Post Supreme Court Rulings, PAE Claims Remain High, Driven By Claims From Patent Trolls

5

4

3

2

1

0

+267%

2010

Pat

ent C

laim

s (T

hous

ands

)

2014

Non-Performing Entities Operating Company

Source: RPX Corporation

Patent Filings

100% University

Trolls

Inventor NCE

2014

100

89%

8% 2% 1%

Patent Filings By PAE Type

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These Claims Mostly Impact Main Street Companies, And Hit Sectors As Diverse As Energy, Autos, And Electronics

62%

12%

16%

7%3%

$100M-1B

100%

$0-100M

$1B-10B

$10-50B

2014

>$50B

Patent trolls tend to attack small businesses more than large…

…And patent troll claims hit all sectors, including auto, medical, semiconductors, energy, financial services, and consumer products.

Unique NPE Defendants By Company Revenue

Number Of Total NPE Cases In 2014 By Sector

Source: RPX Corporation

335

112

112

112

84

56

0 50 100 150 200 250 300 350

Financial Services

Consumer Products

Medical

Auto

Energy

Semiconductors

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Patent Trolls Drained $29 Billion In Direct Costs From American Businesses In 2011

Other Litigation

Costs

$29 Billion

Licensing Fees

Total Direct Costs In

2011

Outside Legal

Services

•  Direct costs resulting from lawsuits brought by trolls exceeded $29 billion for businesses in 2011.

•  These direct costs are tantamount to a tax on innovation, diminishing productivity and growth

•  The opportunity costs businesses endure from having to fight troll lawsuit are harder to assign a value to, but estimates range in the tens of billions of dollars.

Direct Costs Of Patent Litigation On Businesses

Source: Bessen, James and Michael J. Meurer, "The Direct Costs From NPE Disputes"

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The Average Litigation Cost For Small Businesses Is $1.75 Million, Reducing Investment.

$22B $109B

$131B

Baseline VC Investment

Actual VC Investment

Reduction Due To Frequent Litigators

In total, frequent litigators caused a 17 percent reduction in VC investment.

The direct costs for small businesses defending themselves against PAEs is nearly $2M per suit. This pales in comparison to the indirect costs in the form of reduced investment in startups and innovation.

Reduction In VC Investment Over Five Year Period

Source: Tucker, Catherine, "The Effect of Patent Litigation and Patent Assertion Entities on Entrepreneurial Activity"

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The Solution In The Innovation Act: Adjust Incentives To Deter Patent Trolls By Eliminating Their Cost Advantage

Fee-Shifting Troll Advantage

Heightened Pleading

Limits On Discovery

The Troll Advantage •  Trolls don't make anything so there is no

threat of a counter suit, and have no documents to produce in discovery;

•  Trolls hire lawyers on contingency, who face virtually no threat of fee shifting if their case is frivolous, driving down costs;

•  Trolls assert the same patents in same venues to capture scale;

Meanwhile, defendants are forced to: •  Respond to vague demand letters; •  Produce communications and millions of

pages often going back years, before a judge has even ruled on claim construction;

Yet, trolls at this stage may not have even produced specifics about the patent they are actually claiming is being infringed upon.

Through these cost advantages, trolls force companies to settle.

Balancing The Playing Field Against Trolls

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Heightened Pleadings Would Force Trolls To Specify What Patents Are Being Infringed And By Which Products

What are heightened pleadings?

•  Under current law, patent owners can be vague when filing patent infringement complaints.

•  Heightened pleadings would raise the standards for information needed when filing a complaint. Standards would increase enough to reduce incentives for trolls to file frivolous lawsuits, but not so much so that legitimate patents would be jeopardized.

How patent trolls exploit the current system

•  Patent trolls often file suit without specifying what products they think infringe their patents, or even which patent claims they are claiming have been infringed upon.

•  The details of a patent troll's infringement allegations often don't emerge until after the discovery process has been completed and significant money spent.

Heightened pleadings are a solution to the problem

•  The Innovation Act (H.R. 9) would require plaintiffs to provide the basic details of their case from the outset.

•  They must also reasonably identify which patent, by number, has been infringed upon. Each claim must also identify the product or service that infringes and how it does so.

Source: Daniel Nazer, Electronic Frontier Foundation

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Discovery Requests Can Force Companies To Produce Millions Of Documents Costing Between $1.4 and $3 Million

•  Discovery requests require a firm to supply relevant information, documents, and any electronic communication to the opposing party in a lawsuit.

What are discovery requests?

How patent trolls manipulate discovery requests

•  Patent trolls drive up the costs associated with discovery by requiring information they have no intention of using.

•  For SAS, discovery required them to retrieve 10 million electronic documents. Successful defense against a troll lawsuit cost them $8 million.

•  These costs are even more harmful to small businesses who have to divert limited resources to complying with frivolous discovery requests.

•  "Core Documentary Evidence" is created to limit the scope of discovery requests. Firms demanding information beyond the mandated discovery limits become responsible for the costs.

•  Discover is limited before the "Markman hearings”, which determine the legitimacy of a patent claim.

Innovation Act fixes to the discovery process

Source: Becker, "Baker Botts Intellectual Property Report"; American Intellectual Property Law Association, "Report of the Economic Survey 2013"

$25M+ $1M-25M

$1.4M

$3.0M

Median Discovery Costs By Dollar Risk Of Claim

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Fee Shifting, Applied Only In Frivolous Cases, Could Be Enough To Dissuade Trolls From Filing Such Claims

•  “Fee shifting” is a process for determining which party in a lawsuit pays legal fees that is designed to decrease the incentives of a patent troll to litigate illegitimate cases. Fee shifting would not be a universal "loser pays" system, but would only apply in frivolous cases in which the losing party's position and conduct is not reasonably justified.

–  Typically, the defendant is responsible for paying their legal fees. However, when fee shifting occurs, the loser of the case is responsible for paying the winning party's fees.

•  A slight increase in fee shifting frequency, applied in exceptional cases only, will deter patent trolls (but not legitimate patent holders) from bringing suit.

Most cases brought by trolls are frivolous

•  According to a 2011 study, PAEs only win 9.2 percent of their patent assertions that go to court. By comparison, producing companies win 50 percent of their patent cases.

•  Between 2003 and May of 2013, only 0.6 percent of all patent cases experienced fee shifting. This rate remains too low to have any sort of substantial impact in dissuading patent trolls from asserting illegitimate patent claims.

Fee shifting would level the playing field by increasing the costs for patent trolls to bring frivolous lawsuits

Fee shifting must be applied more frequently to be effective

Source: Allison, Lemley, & Walker, "Patent Quality and Settlement Among Repeat Patent Litigants"; Liang & Berliner, "Fee Shifting in Patent Litigation"

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Rebuttal Reality

•  Patent reform would not weaken the value of legitimate patents in university portfolios, nor would it harm the ability of universities to license legitimate patents to the private sector.

o  Fee shifting would not be a universal "loser pays" system, but would only apply in frivolous cases in which the losing party's position and conduct is not reasonably justified.

The Innovation Act would decrease private sector licensing of university owned patents

•  Maintaining the status quo is a deliberate choice to preserve a system benefitting patent trolls, incentivizing aggressive litigation and stifling innovation.

•  Congress must act.

Patent reform would have unintended consequences

The Innovation Act threatens inventors who deserve the rewards of their innovation

•  Patent reform does not weaken existing patents or standards for future patents.

•  The purpose of these reforms is to provide additional safeguards against those taking advantage of deficiencies in the patent enforcement process to extort money from both small and large businesses.

•  Reform is both the shield and the sword for inventors. Inventors with a good patent claim will have cases decided faster and more efficiently, decreasing the cost for enforcing valid patents. Trolls will be less able to extort inventors through the threat of frivolous litigation.

Common Rebuttals To The Innovation Act’s Reforms Rely On Fear Tactics, Not Facts

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Conclusion

•  Strong patents are critical to continued growth and prosperity for the Internet industry and the U.S. and global economy.

•  There are too many bad actors taking advantage of shortcomings in the current system for patent enforcement, preying on businesses and extorting money at will.

•  The activities of these patent trolls drives up legal costs, stifling growth and innovation across industries.

•  The Internet Association supports passage of the Innovation Act. As currently drafted, the bill represents a set of common sense reforms that will diminish the patent trolls unfair advantage and decrease their incentives to file frivolous patent claims.