EDITORIAL NOTE: What appears below is Part 2 of a 3-part series on the transformation of the American Patent System. To read from the beginning please see The Disintegration of the American Patent System, published on January 26, 2017.
The U.S. patent system, which functioned well for over two hundred years, has been eroded in the period from 2006 to 2016. Patent critics from the left and the right have attacked the patent system. Patentability tests, patent validity reviews and reduction of remedies have combined to narrow the scope of patent rights and to dramatically increase transaction costs for patent holders. When combined with reduced rewards, increased costs show that patent holders are caught in an economic squeeze. The combination of these changes to U.S. patent law has markedly decreased incentives to innovate.
Activist Supreme Court decisions in the last decade have been principally responsible for these changes, stimulated by aggressive technology company incumbent lobbying. The combination of these decisions has had a far greater effect on the patent system and the economy than the Court originally intended.
The U.S. is now in a compulsory licensing regime in which large technology incumbents that control at least 80% of collective market share employ an “efficient infringement” model of ignoring patents and forcing patent holders to enforce patent rights in the courts.
There are several categories of change in the American patent system in the last decade, notably to patentability, patent validity reviews, patent remedies, compulsory licensing and perpetuation of PAEs. Rather than solve the problems of the patent system, judicial decisions and congressional actions have generally made the patent system worse for key stakeholders, imposing unexpected costs and risks.
Regarding patentability, the Bilski-Mayo-Alice and Myriad Court decisions have collectively raised barriers to patent eligibility. In the main, the Bilski-Mayo-Alice decisions on the abstract ideas exception to patentable subject matter have tended to affect software technologies by restricting patentability to a relatively primitive Nineteenth century test of linking an invention to a machine. Interestingly, the Court failed to define the term “abstract.” Hundreds of thousands of software patents have been effectively rendered worthless, including perhaps half of IBM’s and Microsoft’s patent portfolios. Since software is a key strategic technology, weakening patent rights is likely to adversely affect software investment as well as broader industrial growth. On the other hand, some tech incumbents will benefit from higher barriers to patentability in software. For the most part, it is far easier to free ride another’s software invention than to invent new technology. Nevertheless, the two-step test for patentability has been reasonably salvaged by subsequent Federal Circuit decisions requiring a technical feature or inventive step to satisfy the criteria of patentability involving an abstract ideas.
In addition to software, the medical diagnostics industry has been affected by these patent eligibility decisions. In addition, Myriad limited the scope of inventions beyond natural phenomena. This has had the effect of constraining the personalized medicine revolution. Discoveries of genetic material are insufficient to justify patentability in medicine, with an artificial man-made inventive step required. In addition, the Bilski-Mayo-Alice abstract ideas test affects patent claims involving medical diagnostics. These changes to patent law place a higher barrier to the medical diagnostics field, effectively impeding development of medical diagnostics during a new epoch of genetic discovery.
In both the software and medical diagnostics fields, there is likely to be less investment in new technologies, with substantially higher costs, since patents for inventions in these industries are harder to obtain and protect.
Patent Validity Reviews
The AIA instituted a new regime in the PTAB for patent validity challenges in Inter Partes review (IPR), post-grant review (PGR) and covered business method (CBM) review. The PTO has instituted a hostile approach to post-grant patent review by refusing to equalize PTO standards with the Federal District Court standards of review, including the Phillips standard for claim language interpretation or the clear and convincing evidence standard for an institution decision. When combined with a very loose interpretation of obviousness, from an abuse of KSR, the majority of substantive patent claims in which reviews are instituted are discarded. Consequently, the PTAB accepts an unusually high number of patent review institution requests and cancels an unusually high percentage of patent claims originally issued by the PTO. In effect, the AIA did an end run about the Supreme Court’s i4i decision which clarifies standards of patent review in light of the presumption of patent validity (282).
The consequences of post-grant patent reviews in this hostile patent review regime is to impose an undue burden on patent holders, dramatically increase transaction costs on patent holders, move to a guilty-until-proven-innocent system, ignore the presumption of patent validity, eviscerate due process for patent holders, delay enforcement in the courts, reduce a patent to a liability rather than an asset, delegitimize the PTO and create different fora for adjudication of patent validity with different standards of review. The Supreme Court refusal to address any substantive issue in Cuozzo or to accept Sequenom suggests a contradiction with the Court’s decision in i4i. Patents are now perceived by the PTO not as a property right but a public benefit, with a politicized administrative agency rather than an Article III court governed with adjudicating the patent right. The Court needs to sort out these contradictions and anomalies by restoring property rights and equalizing common-sense standards of review in the different fora.
Reduction of Remedies
A combination of Court decisions affects patent remedies. Starting with eBay, the court has limited remedies by substantially raising the bar for injunctions to protect the exclusive right in a patent. The only time the term “right” is referenced in the Constitution is in the IP clause that refers to an “exclusive right” to protect intellectual property for “limited times.” This limited duration feature supplies a constraint on exclusivity, suggesting that the Founders would only tolerate a monopoly for a limited period in order to provide a strong incentive to invest in solving hard innovation problems. This exclusive right for a limited time approach thus represented a compromise and supplies a crucial tension in patent law, the balance of which is undermined by the restrictions on supporting the exclusive right with an injunction. A patent only gives the patent holder the right to exclude by enforcing the patent in a court. Absence of an injunction eviscerates this crucial right and undermines the patent system itself.
One of the concerns the Court addressed in eBay is the application of injunctions for a small invention in a larger device or system. In these cases, the application of the exclusive right tends to benefit the patent holder at the expense of the infringer, thereby supplying an unfair advantage by enabling the patent holder to hold up a larger device or system. The solution to this problem is simple. Rather than focus on an injunction for an entire device, the injunction should be narrowed to focus only on the component to which the patented invention applies. The courts need to apply imagination to develop a narrow injunction to restore the exclusive patent right.
The combination of eBay and Halo supply limited remedies with a high bar for both an injunction and enhanced monetary damages until a finding of infringement. With reduced remedies for patent infringement, infringers have reduced incentive to negotiate licenses since they can free ride and wait to be sued, with the worst case typically being settlement of a license for a reasonable royalty that the parties would have selected in a hypothetical voluntary license. eBay, in particular, promotes the business strategy of “efficient infringement” since there is little risk of being blocked from infringing without an injunction and, even if there is enforcement at the margins, there is little chance of enhanced damages, supplying infringers with little incentive not to continue infringing behaviors. With the recent addition of Samsung (apportionment), there is even less incentive not to infringe since the monetary damages are likely to be nominal in the case of an invention on a small component of a larger system. It would appear that the courts are supplying an invitation, or a license, to steal.
In addition to eBay, Samsung, though only limited to design patents, institutes an apportionment approach to establishing patent damages. The problem with narrowing monetary damages to only a single component is that this view ignores the weight or value of the component in an overall system. Applying a narrow view of attacking patent damages to a small portion of a larger device can have substantial consequences in limiting patent damage awards. If patent awards for a small component of a device falls below enforcement transaction costs, there is no incentive to enforce the patent, which enables a free ride for infringers for patented technologies at the margins.
The combination of IPRs, eBay and Samsung suggest that cost barriers and time to enforcement are higher thereby markedly increasing overall transaction costs for patent holders. Taken together, the Court appears to be favoring infringers over patent holders in cases involving patent remedies, with an effect of disrupting incentives to invent.
When the limits on injunctions and increasing chances of apportionment are combined with limitations on enhanced damages that are only restricted to the most egregious cases of willful infringement in Halo, patent holders are likely to receive reduced awards.
Reduced patent remedies enables technology company incumbents or Asian manufacturers to free ride on patent holders since the bar to enforce patents are much higher. With a higher bar to enforcement with limited remedies, the “efficient infringement” model has emerged in which infringers infringe first and then wait years for an occasional enforcement and only pay a reasonable royalty that they might have paid in a voluntary licensing negotiation.
The combination of substantially higher costs for patent validity reviews and enforcement in the courts and reduced remedies suggest that patent holders are caught in a squeeze that adversely affects incentives to invest in innovation.
One critical effect of eBay was to eliminate access to injunctions to stop continued infringement of a patented invention. The imposition of a “four-factor test” was not perhaps originally intended to eliminate the vast majority of injunctions, but the Federal Circuit application of a strict interpretation of the test has had this effect since most patent holders could not establish a still undefined “irreparable harm” standard. Since an injunction is crucial to enforce an exclusive right, the property right in a patent was reduced in many cases to liability rules in which the only remedy was monetary damages. This supplies a perverse incentive for infringers to infringe, wait to be sued and then pay a nominal fee in a compulsory license. This logic leads to the phenomenon of “efficient infringement” and practically invites infringers to pirate patented technology, particularly from small entities.
The U.S. has therefore been in a compulsory licensing paradigm for the last decade. A compulsory license enables anyone to use a patented invention as it also blocks an inventor from licensing exclusively (or selling) a patented invention to a single party. The patent holder loses control of patent monetization. Without the ability to license exclusively, the prices for a non-exclusive license are decreased precisely because anyone can use the invention.
Compulsory licensing tends to reduce licensing rates since more than one party can use the invention. With reduced royalty rates (and high enforcement costs), only high quality technologies or technologies that apply to large and established markets are enforceable since they justify higher awards.
When combined with a high bar to show enhanced damages from willful infringement, the lack of an injunction supplies an incentive to ignore patents altogether since the only expected penalty is a nominal license. With the expectation of only a nominal license, combined with high transaction costs to enforce a patent in the PTAB and the courts, there is no reason for companies to negotiate licenses in a voluntary licensing market. As Judge Michel, former chief judge of the CAFC, has commented, the era of the honor system between companies is long gone. All deals are now driven to the courts, leaving the pecuniary undercapitalized inventor or small business typically outgunned and reinforcing the asymmetry of economic power between the large technology companies and market entrants.
One of the Court’s main targets are business entities that acquire and assert patents with an aim to force quick patent licensing settlements with small companies by manipulating high transaction costs of patent litigation. Ironically, however, the combination of judicial decisions in recent years inadvertently appears only to have made the problem of patent abuse much worse. First, with higher transaction costs and lower patent damages, patents have generally been devalued, particularly for those without access of capital resources to apply to patent reviews or patent enforcement in the courts. This devaluation amid increased enforcement costs have forced inventors and universities to sell to or to partner with financial partners or (gasp!) “patent trolls” in order to realize any value for their work. Weakening the patent system has thus effectively transferred economic power from original inventors towards patent brokers and bad actors, precisely the opposite of the intended effect of judicial decisions.
By raising the bar to patentability and patent review, and limiting remedies, patent holders are put in a financial squeeze. The higher bar to enforce patents enables infringers are able to engage in efficient infringement without a risk of harm except for a few matters that meet a high threshold for enforcement. This forces matters to the courts, with high transaction costs. While large companies can bear the high transaction costs of patent infringement defense, for small entities, high enforcement costs require outside investors, which demand high returns on capital to cover their risks. In this way, the efficient market of a strong patent system and a voluntary licensing market turns into an inefficient market that benefits incumbents and harms market entrants.
Again, ironically, a limit of venue that benefits large incumbents will likely have the effect of enabling patent assertion entities to enforce patents against technology end-users, precisely the sort of behavior that further abuses the patent system. Although the FTC has sought to address these issues, there is no clear resolution to the problem.
The limited patent remedies and high enforcement transaction costs perversely force patent holders to partner with patent assertion entities to fund infringement enforcement despite the fact that the original inventors receive little benefits, technology end users are forced to pay for patented technologies for which large technology companies should be responsible, the funders receive the lion’s share of rewards and large incumbents must pay several times more than they would under a voluntary license because of the expenditure of high enforcement and defense costs.
By promulgating a patchwork of poorly thought out judicial decisions, the courts have inadvertently instituted a perverse system that increases inefficiencies, enables large technology incumbents to pirate with impunity and harms the original inventors that the system was originally intended to benefit.
TO BE CONTINUED… Up next is the final segment of this series, which will address the economic consequences of judicial decisions that have so significantly transformed the American patent system.