Authored by Lionel M. Lavenue and Theresa M. Weisenberger
Responding to arguments that lawsuits filed by nonpracticing entities (NPEs) stifle innovation and cost the U.S. economy billions, Congress, the president and even the state of Vermont have recently proposed measures to reduce the number of NPE lawsuits.1 The most well-known recent proposal is HR 845, the Saving High-Tech Innovators from Egregious Legal Disputes Act (SHIELD Act), introduced on Feb. 27, 2013, by Rep. Peter DeFazio, D-Ore., and Rep. Jason Chaffetz, R-Utah, and currently pending review by the House Subcommittee on Courts, Intellectual Property and the Internet.
Under HR 845, if a defendant in a patent case filed by an NPE prevails on either noninfringement or invalidity, the NPE would have to pay the defendant's attorneys' fees and costs. Thus, this bill aims to shift the financial burden of patent litigation by instituting a loser-pays system, a shift these legislators expect will have a chilling effect on NPE lawsuits.
Referring to NPEs as "patent trolls," in HR 845, DeFazio and Chaffetz characterize the bill as a "targeted reform that will force patent trolls to take financial responsibility for their frivolous suits." But the bill does not clearly define an NPE (or patent troll). Instead, it identifies three exceptions for parties that are not NPEs and leaves it to the courts to sort things out.
The exceptions include inventors or original assignees, parties that have "substantial[ly] invest[ed] . . . in the exploitation of the patent through production or sale of an item covered by the patent" and universities and their technology-transfer organizations.
For HR 845 to apply to a patent case, the bill outlines a specific procedure to determine if the plaintiff is an NPE. To invoke the protections of the bill, a defendant in a patent case first files a motion asserting that the plaintiff is an NPE. If this motion is filed before initial disclosures are due, discovery is initially limited to the issues in the motion, and the court must rule within 120 days.
Even if the defendant does not file a motion before initial disclosures, it can still file one, but the court has no obligation to rule on the motion within 120 days (and the court may even wait until after final judgment to determine if the NPE provision will even apply). Yet, regardless of when the motion is filed, if it is filed, the court must eventually rule on whether the plaintiff is an NPE by determining if any of the exceptions apply.
If the court finds the plaintiff is an NPE, fee-shifting procedures apply. The court then sets a specified bond that is sufficient to cover the defendant's attorneys' fees and costs and that the NPE must then post to proceed. The bill does not explain how the bond will be calculated, so the specifics are left to the court's discretion. And, while typical bonding procedures appear to be applicable, estimating patent-litigation fees is a very complex exercise.
Although the motions practice to invoke HR 845 is simple, determining whether a plaintiff is an NPE will be complex as each exception presents particular issues. Exception 1 covers "inventors and original assignees" of the asserted patent, which includes inventors as well as the first assignee identified before the patent's issuance (as the term of art "original assignee" is understood). This exception may raise questions about the identity of the inventors and the propriety of the first assignment.
Exception 2 includes any plaintiff that has made a substantial investment in the manufacture or sale of an item covered by the asserted patent. This exception raises several issues: What was the type of investment? Was it substantial? Was the item allegedly within the scope of the patent manufactured and/or sold? And is the so-called item indeed within the scope of the patent?
Exception 3 includes universities and technology-transfer organizations. Identifying universities (or "an institution of higher education," as defined in the Higher Education Act of 1965) will not likely raise substantial issues, but this exception may very well require an inquiry into whether any technology-transfer organization's "primary purpose" is the "commercialization of technology developed by one or more institutions of higher education."
Soon after the bill's introduction, critics doubted the efficacy of the three exceptions to identify NPEs. Commentators noted that while some NPEs would be subject to the act, many infamous NPEs fall into the exceptions.
Others complained that the bill did not provide enough exceptions, especially as some "practicing entities" (or those that are not NPEs) could be subject to the act's fee-shifting requirements. Ultimately, both criticisms have some merit, as the SHIELD Act can indeed be both underinclusive and overinclusive.
On the issue of underinclusivity, the loudest critics of HR 845 have complained that exception 1 would exclude certain well-known NPEs, such as the largest intellectual ventures (IV). Indeed, IV would typically qualify as the "original assignee" of exception 1 because it uses a think-tank approach: obtaining and enforcing patents covering in-house developed technology.
The "inventor" prong of exception 1 could also apply to other well-known NPEs, such as Jens Sorenson and Ronald Katz. Jens Sorensen (through a trust) is one of the most frequent filers of patent lawsuits, all asserting injection-molding patents. Similarly, the inventor exception of exception 1 could also apply to Ronald Katz, who made billions by asserting patents against the call-center industry.
Thus, regardless of how one feels about NPEs, the criticisms of HR 845 as underinclusive have merit, at least if the most well-known NPEs are exempted by the exceptions.
On the issue of underinclusivity, commentators have argued that "university patent trolls" are improperly excluded under exception 3. Universities frequently generate revenue from patents through licensing, and many institutions, including the Massachusetts Institute of Technology and the University of California, have recently found that litigation encourages (or in some cases, forces) others to license the university's technology. Some have been particularly successful, like the University of California, which (along with its licensee, Eolas Technology) won a $300 million judgment against Microsoft.
On the issue of overinclusivity, one should note that HR 845 could apply to large corporations (de facto practicing entities) that were never intended to be covered by the bill because some exceptions, like exception 2, may be difficult to satisfy. Exception 2 requires that the district court determine whether the asserted patent covers the patent owner's technology and whether the business activity regarding that technology is "substantial." If a practicing entity fails to satisfy this exception, the bill could be used against a company that makes products but that may not be able to prove that those products are covered by the patent.
The bill has requirements similar to the International Trade Commission's two-pronged domestic-industry requirement (both prongs of which are fraught with danger for an ITC complainant), but unlike the ITC's domestic-industry requirement, licensing activities cannot satisfy the bill's "substantial investment" exception.
Unlike licensing activities, where the license is explicitly tied to a patent, one can always argue that a plaintiff's product is not within the scope of its own patent. This uncertainty poses significant difficulties for a practicing entity found to be a definitional NPE.
Even if a practicing entity has made "substantial investments," the corporate structure may foreclose the company from satisfying exception 2. Many companies form licensing entities for the purpose of holding and licensing patent portfolios, but HR 845 does not yet account for these companies that do in fact "substantially invest" in manufacturing items covered by the patent but only do so in an entity separate from the entity owning the patent.
Aside from inclusivity issues, HR 845's exceptions also provide possible loopholes for NPEs, and these loopholes can completely eliminate the risk of the NPE's having to pay attorneys' fees and costs. For example, one loophole for exception 1 is for NPEs to acquire patent applications rather than issued patents.
Another loophole is for NPEs to simply acquire the company with its patents. Acacia Research Corporation and other NPEs commonly use this acquire-and-file approach. For example, on the same day Acacia acquired ADAPTIX Inc., it filed multiple patent lawsuits under the name of its acquisition, ADAPTIX. Even when the company owning the portfolio was not the first assignee, for acquisitions like ADAPTIX, Acacia could rely on the acquisition's history of product manufacturing to evade the SHIELD Act.
Thus, if HR 845 is enacted, NPEs could simply change how they acquire patents to avoid the fee-shifting provisions. Some NPEs may focus on acquiring patent applications before issuance to satisfy the "original assignee" exception, while others may adopt Acacia's approach and acquire the original assignee itself.
Alternatively, others may turn to developing technology in-house, like IV, and then assert those patents without any risk of the fee-shifting provisions. NPEs may even be able to file lawsuits in conjunction with the inventors as an easy way to avoid the new law. These strategies—all already successful for NPEs—are easy for an NPE to adopt, which could render the SHIELD Act entirely toothless.
If the SHIELD Act were to become law, it would also likely increase litigation costs because almost every defendant may attempt to show that the patent plaintiff is an NPE. Given the high cost of patent litigation, if there is even a remote chance of success to shift to the "NPE loser-pays system," defendants will certainly consider this additional motion.
Just invoking the provisions of the SHIELD Act would have great benefits, even if unsuccessful. For example, if a motion is filed before initial disclosures are due, discovery is halted entirely, except discovery relevant to the patent owner's status, thus delaying discovery for the defendant while requiring patent owners to provide evidence that they should be exempt under the new law. HR 845 could increase litigation costs for all types of plaintiffs that will have to establish whether they are acting as an NPE in the lawsuit.
The SHIELD Act would likely affect the conduct of patent cases. After all, if a court finds that a plaintiff is an NPE, the defendant will be motivated to more aggressively litigate the case. If a defendant believes that the NPE plaintiff may have to pay fees and costs, then the defendant will certainly have more reason to fight each and every issue "to the death."
In addition to HR 845, there are four other bills in Congress that target NPEs, including the End Anonymous Patents Act, the Patent Quality Improvement Act, the Patent Abuse Reduction Act and the Patent Litigation and Innovation Act. Also, the White House recently released a report entitled, "Patent Assertion and U.S. Innovation," along with executive actions and legislative recommendations to combat the rise in NPE lawsuits.
And even Vermont has enacted a law to combat the bad faith assertions of patent infringements. These are all understandable responses to the perceived problems, but sometimes, more laws are not necessarily the solution.
Chief Judge Rader of the United States Court of Appeals for the Federal Circuit recent wrote a New York Times op-ed entitled, "Make Patent Trolls Pay in Court," asking district court judges to award fees and costs under 35 U.S.C. § 285 in cases in involving "patent trolls."2
In our view, Rader is correct. It is already within the discretion of district court judges to award fees for frivolous patent lawsuits, regardless of the status of the patent owner, and Rader's suggestion that they use that authority more—in 2011, courts awarded fees in only 20 of nearly 3,000 cases—is most likely the better solution to the perceived NPE problem.
Endnotes
1 James E. Besson & Michael Meurer, The Direct Costs from NPE Disputes, Boston U. School of Law, Law and Economics Research Paper No. 12-34, June 28, 2012.
2 Randall R. Rader, Op-Ed., Make Patent Trolls Pay in Court, N.Y. Times, June 5, 2013, at A25.
Originally printed in Law360 (www.law360.com). Reprinted with permission. This article is for informational purposes, is not intended to constitute legal advice, and may be considered advertising under applicable state laws. This article is only the opinion of the authors and is not attributable to Finnegan, Henderson, Farabow, Garrett & Dunner, LLP, or the firm's clients.
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