Institutional Challenges to a Reliable Patent Regime for Inventors

EDITOR’S NOTE: On February 25, 2016, Brian O’Shaughnessy testified at a hearing before the Senate Committee on Small Business & Entrepreneurship. What follows is based on his prepared remarks. The views expressed here are those of LES, and are not necessarily those of each of its members, nor do they represent the views of RatnerPrestia, or any of its clients.

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Our patent system is the great equalizer. It levels the playing field. Properly balanced, it enables the nimble innovator, regardless of size or resources, to disrupt entrenched markets and bring forth new ideas, products, and services. And we, the public, are the beneficiaries. James Madison said of the patent and copyright clause of the Constitution [1] that the “utility of this power will scarcely be questioned,” and that the public good fully coincides with the claims of individual authors and inventors. [2]

It is important to bear in mind that when we talk of the patent system, we are talking of a property right. The Framers were influenced by the philosopher John Locke, who held that title to property resides in those who labor to bring it forth; it does not derive of the “fancy or covetousness of the quarrelsome and contentious,” who “ought not meddle with what was already improved by another’s labor.” [3]

Lately, our public discourse has been driven by the quarrelsome and contentious. Those who would derogate ancient principles of property upon which this country was built, and deprive inventors of their exclusive right. The U.S. small business community needs help.

The aptitude and penchant for invention runs deep in the American spirit, and is reflected both in the manner and degree to which we reward it. The exclusive patent right plays a laudatory role in specialization. By making innovation a tradeable commodity, small innovators need not perform all steps necessary to bring an invention to market. They can license their invention, and go back to the lab with the funds needed for more research. [4]

In addition to allowing inventors to do what they do best—invent—patents are critical to the financial success of any startup. According to a study recently conducted for the USPTO by faculty members at Harvard and New York University business schools, a startup’s first patent grant increases its likelihood of receiving venture capital funding by 2.3 percent—53 percent higher than a startup without a patent. [5] The authors found that this effect was strongest for startups that (1) had raised little capital before receiving a patent; (2) were founded by inexperienced entrepreneurs; (3) are located in areas where attracting investment is harder; and (4) operated in the IT sector. [6] Ultimately, patent “alleviate investors’ concerns regarding a startup’s ability to monetize its invention” and help them “signal their quality to investors” [7] — increasing their likelihood of success.

Unfortunately, our innovators and entrepreneurs are under attack. The vagaries of economic cycles are beyond our control. But, we must remember that with economic uncertainty comes lower tolerance for risk, and reduced investment, which changes the calculus for the entrepreneur. Coincident with the global economic downturn, the death rate of U.S. start-ups surpassed the birth rate for the first time in 40 years. Uncertainty disproportionately harms small businesses and entrepreneurs. And because startups are responsible for over 20 percent of gross job creation in the United States [8] the implications are profound.

In addition, changes to the “prevailing corporate ethos” may have a profound effect on startups and entrepreneurs. Modern companies and financial institutions are increasingly seeking to maximize short- term shareholder value, rather than make long-term investments. The “financialization” of the economy disfavors long-term investments in research and development that result in greater innovations, albeit without the short-term payoff. [9] Patents provide an asset for investors to back, and a more reliable promise of return on investment.

What we can, and should, address are institutional challenges. Regrettably, our institutional approach to patents has only further challenged small business and diminished innovation. Those challenges come from changes to our patent law in the America Invents Act (AIA), and precedent that has compromised the exclusive nature of the patent right (eBay v. MercExchange), and rewritten the law of patent eligible subject matter (Alice, Mayo and Myriad). Perhaps most significantly, pending legislation (S. 1137 and H.R. 9), if enacted, will further curtail the patentee’s ability to enjoy the rights granted and to seek just reward for infringement. On top of all this is profound uncertainty as the US Patent and Trademark Office (PTO) struggles to keep up with these changes.

One recent study looked specifically at the effect of the eBay decision on the durability of the exclusive right. The authors looked at all patent cases filed in U.S. district courts 2000-2012, and in which injunctive relief was requested. [14] Despite the Supreme Court’s explicit admonishment against an interpretation to find “expansive principles suggesting that injunctive relief could not issue in a broad swath of cases” [15], the authors found a dramatic decline in both requests for, and the grant of, injunctive relief, particularly preliminary relief. [16] If the exclusive right conferred in those terms by the U.S. Constitution does not, in fact, afford one the right to exclude others, then what, exactly, is the right being granted?

The FTC acknowledges the importance of the right to exclude:

Economists recognize that without patent protection, “innovators [that produce intellectual property] cannot appropriate the full benefits of their innovation; some of the benefits go to ‘free riders’ without payment.” If innovators know that they cannot exclude imitators and appropriate the fruits of their R&D efforts, then they may lack sufficient incentives to undertake the innovation in the first place. The problem is especially acute when the original innovator’s efforts entail substantial fixed costs, and the imitators can copy the innovation cheaply. Patent rights mitigate this problem by granting exclusive rights in innovations, enhancing appropriability. Economic theory suggests that by conferring such rights to exclude, the patent system increases incentives to innovate. [17]

The inability of any enterprise, especially a smaller enterprise, to reliably secure injunctive relief encourages the free-rider or, in the parlance of the standards essential world, “reverse hold-up”, or “hold- out.” That is, the accused infringer refuses to negotiate a license or a settlement, recognizing that the patentee’s position is compromised relative to the infringer because an injunction is unlikely. This, in turn, has given rise to the phenomena of the “efficient infringer”, i.e., the unscrupulous copyist who gambles infringement on the bet that the patentee will get no more than a reasonable royalty, and no injunction. If left unchecked, this phenomena will lead our patent system toward a de facto compulsory licensing regime, and the Framers of the U.S. Constitution and John Locke will roll over in their graves.

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FOOTNOTES

[1] U.S. Constitution, Article I, Section 8, clause 8: “The Congress shall have Power To…promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries….”

[2] Madison, J., Federalist No. 43 (1788) (“The utility of this power will scarcely be questioned. The copy right of authors has been solemnly adjudged in Great Britain to be a right at common law. The right to useful inventions, seems with equal reason to belong to the inventors. The public good fully coincides in both cases with the claims of individuals.”).

[3] Locke, J., The Works of John Locke, Book II (God gave the world to men in common; but since he gave it them for their benefit, and the greatest conveniences of life they were capable to draw from it, it cannot be supposed he meant it should always remain common and uncultivated. He gave it to the use of the industrious and rational, (and labour was to be his title to it;) not to the fancy or covetousness of the quarrelsome and contentious. He that had as good left for his improvement, as was already taken up, needed not complain, ought not to meddle with what was already improved by another’s labour: if he did, it is plain he desired the benefit of another’s pains, which he had no right to, and not the ground which God had given him in common with others to labour on, and whereof there was as good left, as that already possessed, and more than he knew what to do with, or his industry could reach to.”).

[4] See, U.S. Federal Trade Commission, “To Promote Innovation: The Proper Balance of Competition and Patent Law and Policy”, October 2003, Chapter 2, p. 6 (footnotes omitted).

[5] See Farre-Mensa, J., Deepak Hedge, & Alexander Ljungqvist, The Bright Side of Patents, USPTO Office of the Chief Economist, Working Paper No. 2015-2 (Jan. 2016), at 3.

[6] Id.

[7] Id. at 5.

[8] Elisabeth Jacobs, What Do Trends in Economic Inequality Imply for Innovation and Entrepreneurship? A Framework for Future Research and Policy, Washington Center for Equitable Growth (Feb. 2016), at 11.

[9] Id. at 21.

[10] eBay Inc. v. MercExchange, L.L.C., 547 U.S. 388 (2006).

[11] Alice Corp. v. CLS Bank Int’l, 134 S.Ct. 2347 (2014).

[12] Mayo v. Prometheus Labs, Inc., 132 S.Ct. 1289 (2012).

[13] Ass’n for Molecular Pathology v Myriad Genetics, Inc., 133 S.Ct. 2107 (2013).

[14] Gupta, Kirti and Kesan, Jay P., Studying the Impact of eBay on Injunctive Relief in Patent Cases (July 10, 2015). Available at SSRN: http://ssrn.com/abstract=2629399.

[15] Id. at 1 (citing Jones, Miranda, “Permanent Injunction, A Remedy by Any Other Name is Patently Not the Same: How eBay v. MercExchange Affects the Patent Right of Non-Practicing Entities.” Geo. Mason L. Rev. 14 (2006): 1035.).

[16] Id. at 12.

[17] U.S. Federal Trade Commission, “To Promote Innovation: The Proper Balance of Competition and Patent Law and Policy”, October 2003, Chap. 2, p. 4 (footnotes omitted); see also, id. at fn. 29 (noting remarks from panelists at hearings that: “in the raising of capital, the marginal importance of patent grows as the size of business declines”; that “smaller firms acquire patents to protect innovative technologies and ‘hopefully put them on a somewhat level playing field with larger competitors’”; and “patents are important to small new firms without reliable internal cash flow”).