Predatory Litigation and the Smothering of Innovation
By William J. Watkins Jr.
The Independent Institute Copyright © 2013 The Independent Institute
All rights reserved.
THE EASTERN DISTRICT of Texas (U.S. District Court) is the American mecca of patent litigation. Plaintiffs with no connection to Texas head to Tyler, Marshall, or Texarkana to file suit. The rules are plaintiff friendly, the rocket dockets leave the plaintiffs' targets scrambling to mount a defense, and the verdicts are Texas-sized. Many of the plaintiffs holding patents and filing suit are not in the business of producing products or services but rather exist solely to sue. These "patent trolls" purchase overbroad patents based on dated technology and demand tribute. If the target does not acquiesce to the troll's demands, expensive litigation ensues.
Anyone who doubts that trolls stifle innovation need only look at the example of Brandon Shalton. In the late 1990s, Shalton and a group of nuns had developed technology that allowed clergymen to record messages that could be quickly digitized and posted on an Internet website. A number of churches expressed interest in the technology and participated in a testing program. On the verge of going live with their invention, Shalton and the nuns learned that a troll held a patent on the process of transferring audio and video content from a remote network server. Shalton developed his technology independent of the troll's patent and questioned the validity of that patent, but he did not have the funds to take the matter to court. He and the nuns decided to close up shop rather than risk becoming the target of a rapacious troll. Shalton is but one example of an innovator whose dreams were crushed because of our patent litigation dynamic.
Of course, innovation is the reason that governments grant patent rights. Patents are issued in return for a full disclosure of the underlying technology so that the innovation can enter the public domain quickly and be duplicated when the protection of the patent ends. A patent rewards an inventor with a temporary monopoly on an invention that he or she otherwise might be tempted to keep secret. A definite patent term allows the inventor to fully exploit the market for his or her intellectual property. Without patent protection, inventors may justly fear that others will copy their idea and deprive them of any pecuniary benefit from their work. Society benefits from the new invention as well as the inspiration the invention gives to others to improve it, or to develop alternatives.
Innovation, unfortunately, is now imperiled with recent trends in patent litigation. In too many instances, patents have become tools for litigation rather than mechanisms to create and market new products or processes. Researchers aver that our economy is the real loser in the patent litigation boom with the estimates ranging in the billions of dollars.
This book examines how rural East Texas has become the national hub for patent litigation and how recent trends affect the innovative aspects of the economy. The book begins with a brief historical background about letters patent in the Anglo-American tradition. It then discusses the first patent act in U.S. history and the basics of patent law. Next, the book introduces the emergence of patent trolls, the harm caused by trolls, and recent efforts aimed at curbing the power of the trolls. The focus then shifts to the Eastern District of Texas and the tremendous success that patent plaintiffs have enjoyed there. Finally, the book offers suggestions on how to restore a sense of fairness to American patent litigation. Among the possible reforms are modified venue rules, specialized or professional juries, and the creation of a federal court that handles only patent matters.
A Brief History
Grants of exclusive rights to inventors can be traced back to the late 1400s and the city-state of Venice. In Venice and other medieval cities, guilds developed a respect for what we call today intellectual property. The knowledge of how to do something, the guilds believed, was just as valuable — if not more so — than the finished product itself. In enacting an early patent statute, Venice delighted that its citizens had "among us men of great genius, apt to invent and discover ingenious devices" that buttressed the "grandeur and virtue of our city." Venetian rulers believed that "if provision were made for the works and devices discovered by such persons, so that others who may see them could not build them and take the inventor's honor away, more men would then apply their genius, would discover, and would build devices of great utility and benefit to our commonwealth." Accordingly, "every person who shall build any new and ingenious device in this City, not previously made in our Commonwealth, shall give notice of it to the office of our General Welfare Board when it has been reduced to perfection so that it can be used and operated." When this was done it was "forbidden to every other person in any of our territories and towns to make any further device conforming with and similar to said one, without the consent and license of the author, for the term of ten years."
In Anglo-American history, letters patent were associated with the monarch's prerogative powers and often had little to do with innovation. Elizabeth I was notorious for using her authority to grant monopolies via letters patent for such mundane matters as the sale of foodstuffs and playing cards. These patents had nothing to do with creating novel concepts or tools and instead were a mechanism to give economic privileges to the monarch's favorites.
The abuse of letters patent led Parliament to pass the Statute of Monopolies of 1623. The statute forbade monopolies, but it provided an important exception. Under the statute, the "true and first inventor" of a new manufacture was granted the sole making and using of the invention for up to fourteen years. Parliament decided on fourteen years because at least two apprentices could be trained in the new industry during this time. (Customarily, an apprentice served a seven-year term.) Hence, this was the first codified patent law in Anglo-American history.
The United States' first constitution, the Articles of Confederation, featured no national protection of intellectual property. Instead, such matters were left to the thirteen states. This changed with the Constitution of 1787. The Constitution grants to Congress the power "to promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries." In his expository writings on the Constitution, Joseph Story observed that for authors and inventors to have any property interest in their works, "it is manifest that the power of protection must be given to, and administered by, the General Government." Otherwise, a "patent, granted by a single State, might be violated with impunity." Story lamented that authors and inventors had often died in poverty and neglect even though the world "derived immense wealth from their labors." A patent for a limited time was a "poor reward" for their spirit of innovation, but Story concluded that this best balanced the interests of the intellectual property holder and society.
Thomas Jefferson, on the other hand, questioned the very idea that inventions could be the property of one person. "Inventions then cannot, in nature, be a subject of property," Jefferson wrote. "Society may give an exclusive right to the profits arising from them, as an encouragement to men to pursue ideas which may produce utility, but this may or may not be done, according to the will and convenience of the society, without claim or complaint from anybody." By law of nature, Jefferson believed, the moment an idea is divulged, "it forces itself into the possession of every one." Ideas were made to spread rapidly across the globe, Jefferson averred, and exist for the betterment of all mankind. Jefferson saw intellectual property as a prime example of a "pure public good."
The U.S. Patent Act of 1790, the first American statute on the topic, provided that a person who has "invented or discovered any useful art, manufacture, engine, machine, or device, or any improvement therein not before known" may apply for a patent. A critical requirement of the application, as set forth in the statute, was a specification or description of the invention. The specifications must enable people of ordinary skill in the art to which the patent pertains to make and use the invention after the patent term expires. The specification must contain a written description of the invention showing that the inventor was in possession of the invention at the time the application was filed. The specification must offer the "best mode" contemplated by the inventor of practicing the invention. If granted a patent, the inventor would enjoy for fourteen years "the sole and exclusive right and liberty of making, constructing, using, and vending to others to be used, the said invention or discovery."
Of course, not all scholars agree that patents properly reward innovation and benefit society. For example, Michael Kremer contends that "patents and copyrights create insufficient incentives for original research because inventors cannot fully capture consumer surplus or spillovers of their ideas to other researchers." Kremer also fears that patents "create static distortions from monopoly pricing and encourage socially wasteful expenditures on reverse engineering to invent around patents." To remedy these perceived flaws in the system, Kremer has suggested that "government could offer to buy out patents at their private value" and thus encourage greater innovation and prevent wasted funds on designing around a patented idea.
The U.S. Patent and Trademark Office
WE ARE CURRENTLY governed by the Patent Act of 1952, as amended. The act provides that "whoever invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent...." Like its predecessors, the act recognizes that patent rights do not automatically arise. The inventor must submit an application to the U.S. Patent and Trademark Office (USPTO). Inventors must thoroughly disclose and claim their inventions. If the patent examiners approve an application, a patent is issued and is good for twenty years. (Under prior law, the term was fourteen years. Lobbying by the pharmaceutical industry rightly claimed that fourteen years was not long enough to recover investments in research and development (R&D) owing to the long and expensive process of clinical trials and other requirements needed to secure the Food and Drug Administration's approval.)
Unfortunately, the USPTO has been short of funds and staff. This has led to a less than thorough examination of patent applications in recent decades. Data show that "between 1983 to 2003, the number of patent applications received by the USPTO more than tripled ... [while] the number of examiners has decreased by 20% over the last four years." It has not been uncommon for 3,000 patent examiners to handle "over 350,000 patent applications annually." These numbers lead to the issuance of "thousands of ambiguous patents" that invite expensive and costly litigation.
A patent holder may exclude other people or entities from making, using, selling, offering to sell, and importing into the United States the patented invention. In other words, the patent provides its holder with exclusive rights in the patented invention. Patent owners typically defend their rights by initiating infringement actions. Under the law, patent holders may file suit in federal district court and ask the court to enjoin the infringer and to award monetary compensation. Infringement is a strict liability tort; that is, relief is available even if the infringers did not act deliberately or even know that the patent existed. The tort system, as a whole, has been moving since the 1960s from punishing negligence and thus deterring future injuries to requiring producers to provide judicially enforced insurance to the general public. In a strict-liability regime, the courts do not ask if due care was used by the defendant but more often focus on how much the injured parties require to make them whole.
In the strict-liability patent regime, patents are presumptively valid, but an accused infringer may assert that the patent is invalid or unenforceable. The losing party may appeal a decision from the district court to the U.S. Court of Appeals for the Federal Circuit.
A company or person accused of infringement might raise a number of defenses. The most common defense is noninfringement; that is, the defendant may argue that its widget or process is not the same as the plaintiff's patented invention. A defendant might also assert that the plaintiff's patent is invalid based on the prior art. Typically, this means asserting that someone else came up with the patented idea first (anticipation) or that the claimed invention was no invention but obvious to anyone skilled in that particular art (obviousness). Another defense raised is inequitable conduct. In essence, this means that the patent holder committed a fraud on the USPTO by not disclosing full information or otherwise being candid when the patent was sought. Defendants can also claim to have an express or implied license from the plaintiff. If the defendant uses the product or process pursuant to a license, there can be no claim for infringement. Under the equitable doctrine of laches, a defendant can claim that the plaintiff delayed filing the lawsuit for an unreasonable length of time and that this delay prejudiced the defendant.
THE NORWEGIAN FAIRY tale of Three Billy Goats Gruff brings to mind the troll living under the bridge and attacking any person or thing who dares to cross. This is an accurate image of nonpracticing entities (NPEs), often called patent trolls. The NPEs obtain patents not for the purpose of producing an invention or a technology but to license and enforce the patents. The term patent troll was created by Peter Detkin when he was the assistant general counsel for Intel Corporation. According to Detkin, "a patent troll is somebody who tries to make a lot of money off a patent that they are not practicing and have no intention of practicing and in most cases never practiced." Critics point out that "trolls operate under a business model that seriously undermines the policy behind granting patents because they are currently allowed to extract all of the rights from a patent without conferring upon society any of the benefits" relative to expanding the store (or "stock") of knowledge.
Trolls seek broad patents likely to be infringed in a particular industry — they especially like software and related computer technologies. The trolls' attack on tech companies is borne out by the data in Table 1, "Most Pursued Companies," as compiled by Patent Freedom. Not surprisingly, Apple, Hewlett Packard, Samsung, Dell, and Sony round out the top five targets. Patent infringement suits are fairly common among the major information technology (IT) companies.
Trolls also scour the country for older patents on technology that might still be used in various modern products. Favorite haunts of trolls are bankruptcy auctions where patents of failed technology companies are offered for sale. These auctions have allowed many trolls to accumulate massive portfolios. (See Table 2, "NPEs with Largest Patent Holdings," as compiled by Patent Freedom.)
Once in possession of patent rights, trolls lie in wait until an industry is developed and thus has much to lose. The NPE will identify targets, raise the specter of expensive litigation, and then either collect license fees from the target or drag the target into court. Trolls prefer to receive protection money rather than jury verdicts, but they will do whatever is necessary to turn a profit. Thanks to trolls, "the rate of patent lawsuits is rising faster than any other type of litigation" and "Fortune 500 companies are being sued far more frequently by unknown non-product entities." (See Figure 1, "Patent Lawsuits Involving NPEs over Time," as compiled by Patent Freedom.) The results from this targeting are tangible and real. For example, the tech giants Google and Apple in recent years "have spent more on patent litigation and acquisition than on research and development."
There are undoubtedly a number of causes of the increase in NPE litigation in recent years, including the growth in a secondary market for patents. While our crystal ball is probably no more reliable than others, the continued rise in patents issued by the USPTO over the last few decades suggests that significant levels of patent enforcement by NPEs is likely to continue for the foreseeable future. (Ironically, much of this increase can be attributed to operating companies seeking to build patent portfolios to enable counterclaims against patent assertions from other operating companies.) (Continues...)
Excerpted from Patent Trolls by William J. Watkins Jr.. Copyright © 2013 The Independent Institute. Excerpted by permission of The Independent Institute.
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