A patent without enforcement value has no licensing value

The Patent Trial and Appeal Board (PTAB) recently “celebrated” its fifth anniversary, having come into existence one year after the signing of the America Invents Act (AIA) on September 16, 2012. To commemorate this anniversary I asked a distinguished panel for their thoughts on the PTAB, which we have published over the last ten days. One particular article authored by Ashley Keller – which I consider to be mandatory reading for all those interested in the topic – has created some questions within the industry.

“The value of a patent is the expected value it will produce in litigation, discounted to the present based on the time it will take to extract a judgment (or judgments),” Keller wrote.

I received a question about Keller’s article, and that quote in particular: Doesn’t that just turn patent litigation into zero-sum game? Doesn’t this approach to patent valuation distract from the very real benefit that licensing can provide, which is to inject liquidity into innovative activities by purchasing rights from inventors?

I don’t think so, and here’s why.

First, I don’t think it is appropriate to look at patent enforcement as a zero-sum game, whether it be licensing endeavors or when licensing fails litigation activities. Enforcement of patents through litigation occurs when licensing has failed to result in an arms length negotiated resolution. In other words, patent owners resort to litigation when there is a market failure. Unfortunately, because the laws and process have so significantly tilted in favor of infringers over the last 12 years fewer and fewer arms length deals can be achieved outside of litigation processes, which means there is a substantial market failure, not the market success that many incorrectly claim. See discussion of Coase Theorem.

In the face of a market failure patent owners must seek patent damages that can be obtained only through litigation. These patent damages are obtained as just compensation for infringement. Only in the most rare of cases will there be a punitive windfall bestowed upon a patent owner in order to punish truly egregious, sometimes even nefarious behavior by an infringer. These cases are characterized as exceptional and a kicker of up to treble damages can be applied to an award at the discretion of the district court, but this is almost never done. The district court judge can also award attorneys fees, which is more common than enhanced damages, but not common. Indeed, attorneys’ fees are more common than any enhancement of damages, but even then attorneys fees are far more common in small doses for inappropriate behavior in only one segment of a case (i.e., wasting the court’s time on a frivolous motion, ignoring a discovery order, etc.).

The simple reality of patent litigation is damages are paid by those found to be infringers – those who are adjudicated as wrongdoers – in order to pay fair and just compensation to the patent owner.

The damages that are obtainable in patent litigation are either: (1) a reasonable royalty; or (2) lost profits. Lost profits are very, very difficult to obtain and are realistically only possible in competitor versus competitor litigations. Even then the patent owner still must demonstrate the capacity to deliver on the quantity sold by the infringer, so lost profits are not guaranteed even in competitor versus competitor patent litigations. Overwhelmingly the damages obtained in patent litigation by a victorious patent owner are a reasonable royalty.

With the Federal Circuit having said the 25% rule is the incorrect starting point for a reasonable royalty rate, royalties that have been awarded over the last 5 to 10 years have been relatively low. Yes, damage awards can be very high – into the hundreds of millions or more – but that is because of the size of the market and the size of the infringements. Even a small percentage of a $10 billion (or more) market adds up to sometimes shocking amounts. Unfortunately, the media, Congress and even the Courts become shocked by the top line damages number rather than focusing on the percentage awarded as a reasonable royalty that is just compensating the innovator for the contribution made.

Why should the exorbitant profit of technology companies be relevant at all when determining the reasonable percentage to compensate the true innovator?

If you look past the large damage awards and focus on the royalty rates themselves one could ask whether they are so low that they really only giving the patent owner what would have been achievable in a fair arms length negotiation prior to the infringement (or perhaps little more). Changes to the law of patent damages alone made efficient infringement a wise calculation given that at the end of the day most patent owners could only ask for a reasonable royalty and would get at best close to what they would have achieved at an arms length negotiation with a willing licensee prior to infringement.

So when Keller says that the value of a patent is inextricably tied to the value obtainable through litigation that is just an economic truism. If the patent has no value when enforced in litigation, whether because the subject matter of the innovation has become patent ineligible, or because of a bias that tends toward finding practically everything obvious, the patent has no enforcement value. These litigation realities spill over into the business dealings because a patent that has no enforcement value will have necessarily have no licensing value.

If those who use technology do not fear liability there is no reason to take a license in the first place, which is why the downward pressure on patent enforcement created by the Patent Trial and Appeal Board has so dramatically, and negatively, impacted patent value.