Part I of this five part series focused on the national economic impact of the pending patent reform bills. These included the disincentive to invent, job losses, shifting jobs overseas, and loss of American wealth. Parts II, III and IV focus on the mechanisms of how the various provisions of the bills will make us poorer and kill jobs for ourselves and our children. In this Part II, we will discuss:
- Loser Pays
- Pay to Play
- Fee Shifting “Joinder”
The US House passed the Innovation Act (HR3309) in December 2013. The Senate is now well on its way to incorporating this legislation which will make Americans poorer. The bills have many problems that will inhibit small inventors, but the most insidious are “Loser Pays” and “Pay to Play”. It changes the law, singling out inventors as a class so onerous that only they must pay the other side’s legal fees if they don’t win every claim. Pay to Play makes inventors guarantee payment up-front. Some proposed Senate bills (e.g.: S.1013 & S.1612) make sure that almost all Americans and most small companies will never be able to afford to enforce their patents on their inventions.
- Loser Pays: American laws do not apply “loser pays” provisions to consumers, corporations, protected groups, or any other class of private litigants. This would induce these groups to tend to decline to enforce their legal rights. Why should inventors be singled out as the only class so onerous that inventors alone should face this burden, when it applies to no one else? The result will be that small inventors will be deterred from exercising their rights and that invention and resulting jobs will dwindle. More perniciously, the smaller firms will be further deterred from investing to develop such rights, as they will need a $5-10 million legal war-chest before they try to exercise any patents. The large multi-national companies know that smaller companies cannot afford to pay the larger business’s legal costs if they lose, and so small businesses will not take the chance. In contrast, the larger business can afford the risk. This is anti-small business, anti-technology development, and anti-US jobs.
- Pay to Play provisions require the inventor plaintiff to post a bond or certify that they can pay the alleged infringers legal fees should they not prevail. This puts enforcing a patent beyond the financial capability of all but the largest of small businesses. Patent litigation is already very expensive, highly risky and skewed unfairly in the favor of the infringer. Pay to Play will make almost all of the over 5,000 active SBIR companies lose most of their value, without any hope of being able to enforce their patents unless they give up the majority of their equity to a larger company (which would then put them out of the SBIR program).
- Fee Shifting “Joinder” makes investors and others personally liable for the legal fees of the alleged infringer if the plaintiff does not prevail (possibly on each and every claim). This provision eliminates a basic tenant of corporate law, protecting investors from personal liability, making patents a “toxic” asset. Why would investors risk personal assets beyond what is directly invested in a business? This provision is antagonistic to investment in new technologies. With no investment, this is fatal to most inventors. Why are inventing companies now so heinous that America would revise corporate law to eliminate personal liability protections only for patent holders? What have inventors done to be singled out as to not be deserving of the personal liability protections that all other Americans receive. Is it in America’s interest to so persecute its inventors, investors, and entrepreneurs?
Let’s look at these in more detail to see how they will work .
The SBTC believes Loser Pays, Pay to Play, Fee Shifting, and Joinder are the death knell for small inventors. But it is not just the little inventors who will suffer. It will also adversely affect university invention and spin-offs, a primary source for America’s innovation. One large company official commented to a university technology transfer group saying “what is the problem, you guys win most of your cases, so this should be an advantage,” which misses the point on a number of issues.
This is a retrospective argument, “after you have won, you get your attorney’s fees back.” The problem is, the entrepreneur needs to address this before the case is started (prospectively). The entrepreneur needs to answer the following questions up front, before making the decision to start the case:
- Can I afford to pay out an additional $5-$10 million to pay for the alleged infringer’s attorneys, on top of my own legal fees, if I don’t win the case? Do I have that in cash? Can I liquidate my assets (which are mostly pledged to my business anyway) and raise that money? All are highly unlikely for small inventors.
- This field is far from level. The large firm will look at the cost and put it into its contingency reserve. The small firm will review the same cost and decide it cannot risk corporate death on a court case, even when it only has a slight chance of failing.
- Can I get a bond? (Virtually all of my worth is in the company and totally illiquid.) Who would provide a bond to an individual and their company who will both likely go bankrupt if they lose the case? And what assets can now be monetized to pay off the bond if the patent(s) (usually the biggest asset for a small inventing company) is deemed to be worthless? Thus, few bonds will be issued, so the bond route is highly unlikely.
- Can I win the case? I now need to plead with detailed specificity before I do due diligence. Can I be sure I win each and every claim? How much do I have to leave off the table to improve my chances for winning each claim? The language is ambiguous as to who may be a losing party when there may be multiple claims and split decisions. Is it still worth enforcing my patent if I remove my higher risk claims, or do I just give up on enforcing the patent before I start?
- What will this do to my investors? Under the one Senate bill, S 1013, investors with any amount of stock in a company at the company’s “end-stage” (where the primary value is in the patent), would now be responsible for guaranteeing the legal fees of the other party if the inventor loses his suit. So, are universities willing to invest $5-10 million in each of the start-up companies in which they have stock; not for engineering, manufacturing, and marketing, but solely for legal fees? And not the legal fees of the company they helped found, but the legal fees of the alleged infringer. If not, their companies become worthless, not being able to enforce their patents. Will other wealthy people invest in a university technology spin-off or a new Kickstarter company if they know that if they give a start-up a few dollars to try and help it out; all of a sudden, they might be on the hook for $5M of legal fees? This will kill the angel community, and severely damage VC investments. This “chilling effect,” no, “freezing effect,” on investments happens years before a suit. One will never get to the suit as the invention and patent won’t have happened.
- What will this do to the licensees? If the inventor is lucky enough to license the product, usually licenses include a confidentiality agreement, so that the licensee’s business plans are not disclosed. Now, the entrepreneur will have to disclose to the world when the court orders the names of interested parties, or even earlier when a demand letter, which must include the licensee’s name, is issued. If that isn’t chilling enough on commercializing new inventions through licenses, the licensee will likely have to guarantee the $5M of legal fees in addition to the amount they paid up front in license payments (perhaps a few hundred thousand dollars). So why would any company want to license a product if the licensor must “publish” the licensees’ business plans (showing that they intend to incorporate the licensed technology into their product) and the guarantee may increase the cost of the deal, perhaps by as much as 2-100 times.
Providing the guarantee for the Pay to Play provisions is a disaster for small businesses, but putting up the $5M up front to guarantee the other side’s legal fees is minor, compared to the other issues and chilling effects they have on innovation and startups. This chilling (freezing) effect starts long before the law suit is ever envisioned.
- Why would any large business ever license a small business invention or buy a small company for their technology? They know the small company can never afford the $5M before the case goes to trial. So, why not just infringe (with impunity) as the inventor cannot afford to do anything to prevent it. These bills encourage infringement and punish invention.
- Inventors/entrepreneurs will no longer start invention related businesses. (These invention companies are the highest growth, biggest job producing companies. They have the greatest impact on the American economy.) When the pot of gold (selling the company or invention) is removed because large companies need not fear legal action for infringement; who would take the risk to start a company and invent. Every inventor/entrepreneur we have ever met says it is much harder and more expensive than they could have ever imagined. Does Congress believe that it is nowhere near hard enough? Do we need to punish inventors by making a new class of plaintiffs, so vile that only inventors/entrepreneurs/ patent holders need to routinely pay the other side’s legal fees if they lose a court case? And more importantly, they need to guarantee those fees up-front, even before the case is fully started.
- Even if an inventor is so dedicated or foolish to go ahead and spend time and money inventing and starting a company to try and create jobs, who would ever finance it? Fee Shifting and Joinder reverses hundreds of years of corporate law by eliminating the corporate veil for even minor, non-decision making investors. Making friends, family, associates, Angels, and Venture Capitalists personally liable for the legal fees of the infringer, if the plaintiff does not prevail (possibly on each and every claim), makes inventing companies toxic. The cost of investing increases significantly because of the added liability in case they have the desire (audacity) to try and enforce their patent. So there is little upside win to invest in new companies.
- The existing fallback position when an inventor does not have the capital to successfully commercialize is selling off the patents in the secondary market. Under the proposed legislation, this would be much less likely. This secondary market, considered “Trolls”, is purportedly the primary target of the legislation. [It is like legislating away used car sales. Although few people like used car salesmen, they serve a valuable place in the market, and their equivalent in the patent field also serve a function by allowing some value to be derived from inventions that don’t become blockbusters.]
Since Startups are to an economy what births are to a population; and small businesses are to an economy what children are to a population; we are at risk of “killing our economic ‘children’” by new artificial barriers to new invention and high-tech startups. Even if we get “births” (startups), we will stunt their growth by impediments to the capital supply for small high-tech businesses.
- Small businesses create 64% of private sector jobs and more than 25% of America’s most valuable patents (R&D 100 awards), American small businesses will likely stop creating a large percentage of the world’s most valuable patents and their corresponding jobs.
- Because high patenting areas create $4,300 more per paycheck than low patenting areas, Americans will likely lose this income if this legislation becomes law.
- Universities now collect $2.6 Billion annually with over 5,000 new licenses each year. Without a flow of new businesses attempting to commercialize university patents, this source of income will wither, drying up the foundation of America’s Innovation Ecosystem.
- Furthermore, since small high-tech businesses are frequently the feedstock of new products for large business, this action will affect America’s large companies over the next decade; making the large businesses less competitive in world markets.
All of these impediments to business formation and job growth are the results of a proposed policy which punishes invention and entrepreneurship. We will curtail the line of 220 years of American inventors. As intellectual property is worth well over $5 Trillion in the US  (>one-third of one year’s GDP), a significant percentage of this will be the likely loss to the economy if the pending patent “reform” legislation is passed.
About the Authors
Robert N. Schmidt is Chairman and CEO of Cleveland Medical Devices, Inc., a company that develops, manufactures and markets sleep disorder products. Schmidt is also the National Co-Chair of the Small Business Technology Counsel (SBTC), which is a Council of the National Small Business Association (NSBA).
Heidi Jacobus is Chairman and CEO of Cybernet Systems Corporation, which is a leader in American research and development in the medical and defense fields and is one of the country’s largest Small Business Innovative Research (SBIR) contract winners. Jacobus is also the National Co-Chair of the Small Business Technology Counsel (SBTC), which is a Council of the National Small Business Association (NSBA).
Jere W. Glover is Of Counsel to the Washington, DC, firm of Seidman & Associates. Glover is also the Executive Director of the Small Business Technology Counsel (SBTC), which is a Council of the National Small Business Association (NSBA).
 Intellectual Property and the U.S. Economy: Industries in Focus, Economics and Statistics Administration, April 10, 2012, pages 2-3.