Will Yahoo Feed the Patent Trolls?

Yahoo, like many tech companies, maintained a large portfolio of patents and patent applications.  However, when Verizon recently purchased Yahoo for about $5 billion, the sale only included a relatively small number of patents directed to Yahoo’s “core business.”  The remaining patents and applications, about 2600 in total, had been previously split off into a separate portfolio. Codenamed “Excalibur,” the portfolio would be put up for sale at a later date.

Yahoo’s proposed auction of the Excalibur portfolio is likely to be the largest sale of computer-related patents since the Alice Corp. v. CLS Bank Int’l ruling in June of 2014.  Alice may reduce the number of overly-broad patents in existence in the long run, but (ironically) in the short term the decision may have skewed patent value calculations in a way that encourages the kinds of behaviors it was supposed to negate.  A sale of the Excalibur patents will provide an important test of Alice’s effects in the short term.

A number of commentators have suggested that the Supreme Court was targeting non-practicing-entities (NPEs), sometimes referred to as “patent trolls,” when crafting the Alice decision.  NPEs are businesses that acquire others’ patents in order to license them or sue alleged infringers; they do not typically make the products or provide the services described in the patents they own.

Oftentimes, patents filed 15-20 years ago (early in the development of the modern Internet) include broad language that can be interpreted to read on a wide range of online activities.  NPEs have developed a reputation for acquiring such patents and using them to target ubiquitous behavior, such as maintaining a web site.  An NPE typically asks that the target company acquire a license to the NPE’s portfolio, often for a cut of the target’s revenues.  If the target refuses, the NPE may sue the target in the hopes that litigation costs will lead the target to settle.

By the time of the Alice decision in June 2014, NPEs had become a major nuisance for tech companies.  By one account, NPEs were responsible for 85% of high-tech patent lawsuits in the first half of 2014.  And for every lawsuit filed, an NPE would have sent out tens or hundreds of demand letters and likely would have extracted a number of settlements from both tech and non-tech companies.

Alice primarily targeted software and financial services patents (the favorite categories for NPEs), and impacted USPTO art units saw allowance rates drop precipitously and §101 rejections multiply. One theory is that, in the long term, the effect of Alice will be to reduce the number of overly-broad patents, thus providing fewer vehicles for NPE assertions.  Meanwhile, in the short term, NPEs would be less likely to assert such patents, because of the increased risk for invalidation.

However, if the Supreme Court was indeed targeting NPE activity with its decision, then Alice seems to have failed as a mechanism for change, at least in the short term.  By the first half of 2015, high tech patent lawsuits were up 35%, and the share attributable to NPEs had increased to 90%.

One reason for this trend is that Alice did not immediately invalidate the thousands of already-issued high tech patents owned by NPEs.  Those patents still must be challenged, one at a time. Invalidating an NPE’s portfolio is an expensive and risky proposition for a tech company. Thus, NPEs retain a significant number of patents to draw from – some owned by the NPEs themselves, and others owned by practicing entities like Yahoo.

For those practicing entities, Alice has decreased the value of their portfolios. For a practicing entity, asserting a patent now carries an increased risk of invalidation. If that patent is a foundational asset in a portfolio, invalidation could allow rival companies to make competing products. Since these foundational patents often serve as parent applications for entire patent families, invalidation of an important patent could raise uncertainty about the other patents in the portfolio. For the same reasons, if a practicing entity looks to sell their patents, other practicing entities are less likely to buy. Indeed, Alice does seem to have had an effect on patent sales in affected categories: one analysis showed a slowing (and, in the case of financial services patents, a significant drop) in the sales rates of Alice-affected patents.

In comparison to practicing entities, NPEs apply a different calculus when acquiring and using patents. NPEs would prefer to license their patents rather than litigate them in court; meanwhile, a practicing entity may be extremely hesitant to license a patent that covers a successful product. Furthermore, tech patents are, to a certain extent, fungible currency for an NPE. Because the goal is to target ubiquitous activity with early or ambiguous patents, the content of each patent is less important than the NPEs ability to interpret claim terms broadly. If one patent in an NPE portfolio is invalidated, a number of others can likely take its place.

Even a lawsuit in which an NPE fails or has its patent invalidated provides value for the NPE. The purpose of a lawsuit, in many cases, is to show potential targets that an NPE is willing to go to court and cost the target money in legal fees.  If that threat is credible, the target’s calculus changes. Although a significant victory can sway a target towards a higher settlement, even a loss can increase a target’s willingness to pay a nuisance fee to avoid litigation.

Thus, an NPE may be less sensitive to Alice invalidation, and therefore more likely to acquire or assert a business method or data structure patent, than a practicing entity. Accordingly, these types of patents remain in demand by NPEs at the same time that sales trends show less demand for high tech patents in general. Meanwhile, litigation statistics show that NPE patent assertions are stronger than ever.  These developments yield opportunities for NPEs to collect software and financial patents at lower prices and increase their assertion activities. Although there may be fewer new patents that are highly attractive to NPEs over the coming decades, there does remain a significant pool of existing patents from early internet pioneers. One such pool is Yahoo’s Excalibur portfolio.

The patents in the Excalibur portfolio date back to 1996, and many relate to early Internet, database, and online financial services developments.  Yahoo claims that the Excalibur patents are “foundational patents related to web search and advertising,” which might be particularly attractive to an NPE.

In theory, these early patents are at a higher risk of invalidation if anyone should try to assert them.  According to an analysis by TurboPatent, the Excalibur portfolio includes a large number of patents in categories likely to be impacted by Alice; more than 1500 of the about 2600 patents and applications were related to “database and file management” or “financial, business practice, cost/price determination,” prime candidates for Alice invalidation.  The TurboPatent review found that about 7% of the Excalibur portfolio was at “high risk” for Alice invalidation, with another 30% at low or medium risk.

That invalidation risk makes the Excalibur portfolio less attractive to a practicing entity. But, as discussed above, an NPE might still jump at the chance to acquire 2600 “foundational” patents relating to pervasive activities like web search and advertising.

Meanwhile, about a quarter of the Excalibur portfolio is made up of pending applications (requiring ongoing prosecution costs) and it is estimated that it will cost $20 million in USPTO maintenance fees. A large practicing entity might be wary of incurring such high costs to maintain a portfolio that would be a prime target for Alice invalidation, while a smaller tech company might not have sufficient cash flow to keep the applications alive. However, a large NPE may have the requisite financial heft (and the incentive) to maintain the Excalibur portfolio.

There’s also talk that the portion of Yahoo not acquired by Verizon might become (at least temporarily) an NPE itself by enforcing the Excalibur portfolio. Some outlets suggest that this may already be happening.  Four of Yahoo’s board members were put in place in April 2016 after a fight with an activist investor, Starboard Value. Starboard has a history of aggressively monetizing patents, either through sales or licensing.  One of those installed board members, Richard Hill, is also a board member of Tessera Technologies – an NPE.

Over the long term, several factors will work to reduce the number of broad internet related patents in existence. First, patents from the height of the dot-com bubble are beginning to expire on their own, reducing the number of patents available for early world wide web technologies. Second, if Alice remains law, invalidation will result in fewer of these types of patents being for assertion.  However, in the near future there remain a great number of broad or foundational software/financial patents in existence, like those in the Excalibur portfolio, that were issued long before Alice became law.  Until these pre-Alice patents expire or are invalidated, the primary market for those types of patents might be NPEs, who can use the threat of high litigation costs to aggressively license these patents without the need to necessarily assert them in court.