Authored by Justin N. Mullen and Aaron L. Parker
Last month, Tellus Fit LLC filed a lawsuit in Texas suing thirteen prominent companies for patent infringement. Notably, Tellus appears to match the characteristics of typical "patent trolls," having registered as a company in Texas just three months prior and by virtue of not offering legitimate products or services. While "patent trolls" have made headlines in the past years for their feverishly litigious behavior, sports and fitness companies have largely been immune, until now. The fact that Tellus primarily targeted sports companies—including Adidas, Nike, Fitbit, Polar Electronics, Suunto, and Timex—may come as a shock.
"Patent trolls," also known as patent assertion entities (PAEs) or non-practicing entities (NPEs), are known for filing patent infringement lawsuits targeting general-purpose internet services, such as technology relating to email and audio streaming. However, as sports companies begin to take advantage of technological advancements, such as by adding sensors or wi-fi connectivity to sports equipment, they too have become targeted by PAEs. Tellus is not alone.
SportBrain, who previously asserted patents against Nike, Adidas, and Fitbit, has unleashed a flurry of patent infringement suits in 2016. As of this writing, SportBrain Holdings has filed patent infringement suits against 42 defendants, including sports companies like Adidas, Under Armor, ICON Health, and Runtastic. Unlike Tellus, SportBrain appears to sell products on Amazon, although the company has been more prominently known for its litigious behavior than its products. Indeed, a product review from 2011 (reproduced below) suggests that the company has closed its consumer-facing business, and instead, like Tellus, SportBrain behaves like a PAE.
A recent screenshot of Amazon reviews for a SportBrain product. (Image via Finnegan)
The business model of PAEs, while not novel, has become progressively more prevalent across all industries. Rather than applying for patents to cover marketable products, a PAE aggregates patents with the goal of monetizing them for a quick return on investment. PAEs typically are not subject to patent infringement countersuits because they do not make products that could be covered by industry leaders’ patents. Therefore, PAEs face little downside in asserting its patents against industry leaders. In fact, a PAE may sue multiple defendants at a time, accumulating smaller royalties from many companies instead of focusing on extracting a large sum from a single manufacturer.
While asserting patents typically carries with it high legal fees, PAEs seek to minimize such fees by targeting larger groups of defendants at once with the same patent or groups of patents. Thus, the capital required by a PAE to assert patents can be reduced with economies of scale. And the statistics support this strategy. As a result, PAE litigation accounted for over 59% of all patent defendants in the first six months of 2015.
Additional cost reductions may be provided by a PAE engaging attorneys that are compensated on a contingency fee basis. Under such an arrangement, attorneys are typically paid a percentage of any damages, settlement, or licensing royalties resulting from the litigation. If, however, a PAE does not extract any royalties, settlement, or damages from target defendants, they may owe their attorneys no money.
While not impossible, mounting a successful legal defense to a PAE lawsuit can be difficult and highly costly for manufacturers and retailers. The costs associated with patent litigation average in the millions. Further, because the standard for fee shifting is high, defendants are likely to shoulder the burden of their own legal costs regardless of how poor a PAE’s case plays out in a particular situation. Therefore, even if the defense is successful and avoids payment of any damages for patent infringement, a company’s decision to challenge allegations of patent infringement could materially affect their financial health. For example, a smaller business’s ability to continue operating could be questioned, discouraging start-ups from entering the market.
Congress recently created new procedures for invalidating patents at the U.S. Patent and Trademark Office (USPTO), which are advertised as a lower-cost alternative to litigation. However, these procedures, known as post-grant proceedings, have request fees starting at $9,000; and legal fees to prepare such a request can easily reach $500,000. Therefore, even if a patent is clearly invalid, the best-case fee to fight a PAE will likely eclipse the potential licensing cost. PAEs, despite their bumbling “troll” moniker, employ complex strategies and can predict a defendant’s likely settlement amount based on these costs. Drawing on their nuanced understanding of patent law, PAEs can gauge their licensing offers such that it will be in a company’s financial interest to settle. Thus, in an individual allegation of infringement by a PAE, a company may view settlement as the most rational option.
However, despite the dire picture painted above all hope is not lost for sports companies. Successful and rational PAE defense strategies exist. Such strategies are based on expanding the time horizon for expected legal costs and using collaborative strategies to reduce an individual company’s defense costs.
In the short term, a company may think that putting up a capable defense may require financial loss. However, calculating the cost of a single suit may not paint an accurate picture of the PAE landscape. Yes, in a single suit a company may face high legal costs. On the other hand, fighting a PAE may create a reputation that will ward off future assertions by other PAEs. In the regular course of business, a company’s recurring dealings with another will naturally reinforce fair and cordial business between the two.
Defending a PAE suit instead of settling may deter future PAE suits.
For example, a business will behave fairly to avoid retaliatory unfair behavior from another business. In baseball, a pitcher may be less likely to throw a beanball at the start of a series to avoid vengeful behavior in subsequent games. Likewise, when large companies are subject to multiple allegations of patent infringement, reputational advantages are gained, albeit at the cost of a strong legal defense. The expected cost of a successful defense to a single PAE lawsuit should be compared to the expected licensing costs to settle the same lawsuit. While the expected defense costs will almost certainly far exceed the expected licensing costs, if the company’s reputation of aggressive defenses prevents additional claims of infringement by other PAEs in the future, then the avoidance of paying successive, similar patent licensing fees to other PAEs, may leave the company in a stronger financial position long-term.
While defending the lawsuit may cost more for a single suit, reputational advantages may produce long-term savings.
Additionally, the larger the company, the more likely a successful defense will be less costly than paying patent licensing fees. For example, Wal-Mart and several other retailers recently were sued over implementations of inventory tracking systems that used radio-frequency identification (RFID) technology. These companies may face settlement costs that ultimately favor litigation. Larger companies may be asked to pay higher royalties due to the increased scale of the lawsuit; however, the increased damages may outpace defense costs such that the ratio of defense costs to licensing fees favors fighting the suit. For instance, legal fees may double while settling costs increase tenfold. The legal fees to provide an adequate defense may increase slightly due to the size of the suit. However, because the retailer’s use of the technology scales orders of magnitude greater than that of a small business, the cost of a license to cover their use will increase at the same rate. Thus, larger companies may have an increased incentive to not settle with PAEs, even more so when broadening the time horizon for calculating expected values for each course of action.
Beyond looking at a macro scale for costs, companies may further reduce their defense costs by employing collaborative strategies. While sports industry leaders are typically used to being pitted against each other in branding and technology battles, they face a common enemy in PAEs. For example, Apple and Samsung, famous smartphone rivals in the marketplace and courtroom, have recently teamed up to fight a PAE in Europe. Similarly, rivals in the sports industry could draft a joint defense agreement to split costs to defend against a PAE’s challenge.
Splitting defense costs may allow companies to challenge the validity of a patent together and save money.
By forming joint defense groups, sports companies could pay a fraction of the total costs to invalidate a patent at the USPTO through post-grant proceedings. Moreover, like the individual reputational advantages discussed above, joint defense agreements could create a beneficial industry-wide reputation for sports technology companies when viewed on a macro scale, which may further ward off PAEs.
From a behavioral standpoint, a company may favor settling an individual patent infringement lawsuit when viewed in isolation. However, defeating a PAE is in the collective long-term interest of sports companies, and could be accomplished with pooled resources. Because, taken individually, rational companies will do exactly as the PAE wishes (i.e., purchase a license to practice the asserted patents), the practice of the PAE is self-reinforcing.
No individual company may actually have the personal interest to challenge the PAE behavior, because the expected cost of a single suit is likely minimized by settling. When viewed in this regard, the nature of PAE litigation creates a tragedy-of-the-commons scenario. For example, to some extent all defendants would benefit from one company’s rigorous defense. However, few, if any, individual defendants will want to invest in challenging a PAE alone. However, the individual economic incentives may shift when sports product manufacturers and fitness software companies take into account long-term reputational advantages and employ collaborative defense strategies to share legal costs.
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