On Friday, June 12, 2015, I co-hosted a program on patent reform with Bob Stoll at DrinkerBidde on K Street in Washington, DC. This event was conceived to offer a different take on patent reform. At this point going through the various pending proposals serves little use given that the major bills in the House (i.e. the Innovation Act – HR 9) and in the Senate (i.e., the PATENT Act – S. 1137) are continually in flux. Indeed, virtually everyone on both the Senate Judiciary Committee and on the House Judiciary Committee have acknowledged in open session that the bills passed by the Committees will be modified further before any action is taken on the floor, and that is before any amendments that will be offered on the floor. That being the case, we wanted to focus on two separate but equally important aspects of patent reform. First, the consequences of reform in the real world. Second, those issues that deserve attention if the goal is creating a better patent system.
Before attacking patent reform from the above mentioned points of view, Chief Judge Paul Michel (CAFC, ret.) provided a keynote presentation. Michel also participated in the first panel, which I moderated. Those familiar with Michel know that after spending a generation on the United States Court of Appeals for the Federal Circuit he retired so that he could publicly take public positions on patent legislation, patent reform proposals and the Supreme Court’s handling of patent cases.
Definition of DC
Quoting Chief Judge Howard Markey, who was the first Chief Judge of the Federal Circuit, Michel posed the following question: “What’s the definition of the District of Columbia?” Michel explained that Markey would always answer: “The District of Columbia consists of 10 square miles surrounded by reality.” Thus, the tone for the day was set. In the real world where innovation happens people are perplexed by the reforms being suggested because they will not lead to a better or improved patent system.
“So when we talk about patent reform we think about it as a Capitol Hill lobbying fest,” Michel explained. “If we think about it as changing all the rules for all the companies of all sizes all over the country and every technology, that gives us a little bit of a different perspective. I can only hope that the legislators will consider the longer term… all the companies and all of the impact, we’ll see.”
Michel is, of course, correct. Many of the reforms pending in the various bills will impact the bad actors in the industry, but only because they will impact all patent owners whether they are a part of the problem or not. Indeed, patent reform, which has become a perennial event, seems to be an exercise akin to taking out an elephant gun to kill a mosquito. In the real world that doesn’t make sense.
Uncertainty causing fear
Judge Michel also spent some time talking about the relatively new post grant challenges to patents ushered in by the America Invents Act (AIA), which came into being in September 2012. Michel explained that the challenges have had “a huge impact beyond the parties to these cases because it’s created a sense, an impression, of fear that an enormous percentage of the two million patents that are in force in America today may be subject to being invalidated.” Of course, uncertainty is toxic for businesses who absolutely require legal and regulatory certainty in order to thrive and ultimately maximize business opportunities. Uncertainty is the end of risk taking, and innovating is all about risk taking. As a result of fear created by all the uncertainty, “investment in many sectors has already fallen sharply,” Michel explained. “I’m not an investment person or expert, I’m not an economist… but I think the picture is clear that there’s been a huge impact in a very negative direction on investments just because of the AIA.”
And now Congress is considering even more reforms less than 3 years after the most dramatic changes in U.S. patent law and policy since at least 1952. The new burdens on innovators under the reforms brought into being by the AIA are just beginning to be understood and appreciated. It hardly seems a wise time for adding additional uncertainty.
It’s all about markets, not technology
As discussion of patent reform filters through the Capitol, in the press, at the Patent Office and in offices across the country, the focus is nearly universally on technology and innovation. Judge Michel explained, however, that even if every decision of the Patent Trial and Appeal Board (PTAB) is the same as would be reached by district courts, the climate created is still problematic “because it’s not really in the end about technology or even about law, it’s about markets, and the market for investment in R&D and commercialization.”
Showing his modesty, Michel went on to say that people who are “more knowledgeable” than he is say that the AIA and Supreme Court cases going all the way back to eBay v. MercExchange and up through Mayo v. Prometheus and Alice v. CLS Bank, are already having a significant impact on decisions where and whether to invest in R&D. But for Judge Michel the biggest problem relates to what he refers to as “a huge cultural change.” In recent speeches Judge Michel has talked about how the patent system has largely operated based on an honor system. Times have changed.
Judge Michel explained:
It used to be, in my opinion, that we had something you could call an honor system in this country. So, for example, in the 1990s IBM licensed to thousands of entities, tens of thousands of patents for important technologies and never had to file a lawsuit. Their program was so huge that it netted profits of several billion dollars a year and required no litigation at all. Why? Because the honor system was in effect then.
David Kappos and I became affiliated with something called the Intellectual Property Exchange International, which was an attempt to create something like the New York Stock Exchange for patent rights. It would be totally transparent, non-discriminatory, open market-based pricing and so forth. It went out of business on April 30th because despite having numerous portfolios that looked to me to be of very high value and that had been independently vetted for validity and economic impact, in the end every one of the apparent infringers declined to buy a license. In every one of the cases the business people in the infringing company wanted to buy a license and [it] would go right up the line, yes, we should take a license, it’s a good business deal and it was very good because they could buy not only a license very cheaply going forward but six years of backward immunity and most of them had been practicing these technologies for years and years. So the dollar amount of infringement damages could have been quite huge. So what happened in the end? What happened in the end was either at the CEO level or when they consulted outside counsel in every single case every perspective licensee was told by their outside lawyers do not negotiate, do not license, do not respond, throw away the letter, don’t answer the phone call, don’t do anything unless and until they sue you. If they sue you call us and we’ll defend you and … maybe we can invalidate some or all of the patents in an IPR and we can outlast almost any plaintiff. So in the end nobody took a license so the enterprise of creating a stock market for patent rights collapsed, went away.
I mention this story simply because it’s further illustration of what a complete sea change we’ve seen in this country already so to me that raises big questions about the risks of further negative changes if we have reform that’s not really well thought out.
Efficient infringement and the consequences
Judge Michel is certainly correct. One thing that all the changes in patent law over the last decade has accomplished is to make it a far better business decision to infringe. There has always been concern in the patent holder community about something called the efficient infringement theory. Under this theory it makes more sense to infringe rather than to negotiate and seek an amicable resolution. In the past this was a problem largely isolated to small businesses and independent inventors who simply didn’t have the resources to fight when their rights were being infringed by a large entity that was not interested in participating in a responsible way in the honor system that Judge Michel describes. Today, however, efficient infringement is alive and well, and is a problem for all patent owners regardless of size.
Later on during the event on June 12, Mike Remington, an attorney with DrinkerBiddle who participated in the first panel, explained that even well funded universities are seeing their negotiating leverage evaporate. Even with respect to the revolutionary technologies created at a place such as the University of Wisconsin, prospective licensees are saying “no thank you,” and existing licensees are seeking to renegotiate for a substantially lower royalty payment backed by a treat of challenging key patents in inter partes review at the United States Patent and Trademark Office. Remington, who has long represented the Wisconsin Alumni Research Foundation (WARF) knows the drill all too well. WARF is the entity that holds the patents on behalf of the University of Wisconsin.
“Now very knowledgeable people say that in the current environment to enforce a portfolio of patents the owner… needs to have a cash war chest of at least $30 million and they need to have a market capitalization, if they’re a private business, of over a billion dollars,” Michel explained. “Patent litigation today has become a sport of kinds, only the super rich can really afford.”
Patent deals go to Europe
Brad Olson, a partner at Barnes and Thornburg with 20+ years of patent litigation experience and a long-term friend of mine who similarly graduated a generation ago from Franklin Pierce Law Center, would later wholeheartedly agree with Judge Michel. Olson would point out that the money in the industry has historically been made through licensing, not litigation. The breakdown of the licensing economy leads to a greater number of disputes, which is great for attorneys if you have clients who are willing to pay for you to fight, Olson explained. “Licensing is an arms length transaction that shifts patent rights and quiets disputes long before they ever originate,” Olson said. “Licensing itself has really diminished, and that is unfortunate because agreements aren’t being made, money is not changing hands the way it should, and a potential irritation that may erupt into a dispute is certainly there.”
The fact that money is not changing hands is a topic I have talked with Olson about on several occasions recently. It is particularly problematic for the U.S. economy. Olson, who represents a number of European clients, has been advising clients that given the uncertainty and lack of a coherent, predictable set of patent laws it is better to shift the settlement of disputes and reach licensing agreements outside the United States, particularly in Germany, which provides a much more certain forum with far greater speed than is available in the U.S. “The economic opportunities over there are almost, or are, better than they are in the United States in many areas,” Olson explained. “Things are not normal here, not predictable, there are too many moving pieces, let’s avoid the United States for a while.” In fact, Olson has advised clients to engage in “money changing in Europe.”
Obviously, the move to push licensing overseas is not a positive development for the United States economy, which still hasn’t been able to shrug the affects of the Great Recession.
Sadly, there are those who will mistakenly believe that the U.S. is better off as the result of the drying up of the licensing market. Such a misguided view is driven by the myopic viewpoint that the licensing of patent rights is a zero sum game where the license fee is a cost or tax on innovation. Those who hold these views are hardly familiar with basic economic principles. The acquisition of rights is not a cost at all. To characterize licensing payments as a cost is simply incorrect in economic terms and completely ignores the transfer of rights obtained by the licensee.
Furthermore, without a thriving marketplace for the exchange of patent rights we will see far less innovation, not greater innovation as the critics erroneously claim. This truism should be self evident, but it is likely necessary to state the obvious. Innovation overwhelmingly occurs at the hands of individuals, small businesses, startups and universities. Innovation occurs when courageous risk-takers ask “what if” and chase solutions accordingly.
Commoditization versus Innovation
Inventing is a business model very different from a commoditization model employed by those companies who demand a weakening of patent rights.
The tech companies that want more patent reform use technology, they do not innovation technology. This is obvious in the definition of “innovation” they offer, which focuses on new products. But the fact that a product is new to you does not make it new in fact. Innovation requires a uniqueness, and those who copy simply do not innovate. Instead, those that copy take the innovation of others. In the past those who became too large to innovate would acquire technology through acquisition, licenses or cross licenses. Today technology is acquired primarily as the result of efficient infringement, which isn’t an “acquisition” at all. Technology rights are simply ignored with the technology embed it into the products they sell despite the existence of what is ostensibly an exclusive right – a patent.
Without the risk-taking entities that focus almost exclusively on R&D, net innovation will unquestionably decrease. Again, it should be self evident, but if an individual or company cannot make money doing R&D because any rights will simply be ignored that individual or company simply cannot engage in R&D. It is that simple.
“So this is a very unfortunate circumstance,” Judge Michel explained. “Historically patents have played an even bigger role for newer, smaller entities than for giant market incumbents because a giant market incumbent has all sorts of advantages of size and wealth and revenue stream and distribution channels and brand reputation and… market share, so patents are somewhat less important to them.”
It is hardly a surprise that large tech companies that struggle to innovate would want a weaker patent system and a collapse of the patent licensing market. There are some in Congress who understand the critical role that risk taking small entities play. With every draft the pending patent reform bills continue to get better from the patent holder perspective. Hopefully that trend will continue. Of course, it would be preferable if the pending bills were scrapped in favor of far more targeted reforms that laser focus on the relatively small number of patent owners who engage in abusive practices.