Scott Partridge and David Mika of Baker Botts analyse the future for US patent law, notably the curbing of lawsuits by non-practising entities:
"Of all the various legislative proposals made to date, some of which arguably harm traditional, legitimate enforcement activities in order to curtail the abusers, the customer suit problem is real and should be addressed."
At a time when partisanship in the US Congress is the norm, curbing lawsuits filed by non-practising entities (NPEs) may be one of the few issues uniting Washington. Over the past year, both Republicans and Democrats have introduced several bills in the House and Senate targeting NPEs. Proposals have been made to heighten pleading standards, shift attorneys’ fees to the non-prevailing party, limit pre-claim-construction discovery, increase the transparency of patent ownership, legislate stays for downstream customers and retailers, address so-called bad faith demand letters, and expand post-grant review opportunities. These patent proposals are gaining bipartisan support even though they are sweeping, ambitious and arguably doing too much too soon without necessarily solving the problems they hope to address.
Many of the reforms suggested by Congress are procedural, focusing on the day-to-day operations of federal district courts. Several pre-eminent jurists have expressed concerns regarding what they consider congressional interference, arguing that these proposals overstep the traditional boundaries in the US Constitution between the Article I powers of the legislature and the Article III prerogatives of the judiciary.
Even if the current legislative proposals do not run afoul of the Constitution’s separation of powers, the breadth of the proposals carries a high risk of unintended consequences – particularly for smaller entities, universities and research organisations. This is in large part due to the definitional problem surrounding NPEs. In many cases, the line between a patent “troll” and a small research entity is blurry at best. As a result, legislative action aimed at curbing extortive NPE behaviour may inadvertently create barriers for small entities and universities to legitimately assert their patent rights.
Moreover, some studies suggest that Congress is not only attempting to enact overly broad legislation, but it is doing so to solve a problem that does not exist. One study, which examined all patent cases between 2010 and 2012, found that, although the number of patent suits nearly doubled during that period, the number of patentees filing suit remained relatively constant. The study concludes that the recent spike in patent suits is caused not by the sudden appearance of a horde of NPEs but by changes to joinder rules under the America Invents Act.
Regardless of whether one considers “troll” litigation to be approaching critical mass or merely an after-effect of recent patent law reform, a growing likelihood exists that further changes in our patent laws will happen, perhaps as soon as the current session of Congress.
A REAL PROBLEM: CUSTOMER SUITS
Acquisition and enforcement of patents – the basic practice of NPEs – is not problematic in and of itself. Patents are freely transferrable, and their enforcement ensures that their value is preserved. However, problems do arise when NPEs are able to exploit the high costs of patent litigation to extract money from a patent whose worth might only be measured by the cost burden that patent litigation entails. This practice is most apparent in the context of customer suits.
Customer suits are filed by NPEs against consumers, end users and retailers for sale or use of allegedly infringing products. A recent example was a patent suit against the Whataburger restaurant because it installed third-party-supplied wireless capability in some of its restaurants, thereby allegedly infringing a wireless patent. In such cases, the NPE will often make an offer to settle and license the technology for well below the cost of litigation. The chance to settle a potential lawsuit for this “nuisance” value is one many customers understandably accept. By setting the price of settlement and licensing so low that challenging the validity of the patent is uneconomical, the NPE can continue extracting settlements from other customers, at least until the patent expires, a customer takes the risk involved in challenging the patent (and prevails) or the NPE runs out of customers to sue. In the Whataburger case, Whataburger simply removed the third-party wireless capability rather than incur the expense of a patent lawsuit.
The customer suit problem is one of incentives. Because the potential costs of fighting infringement outweigh the potential benefits to the customer, the customer’s only rational choices are to pay the settlement amount, stop buying or using the allegedly infringing product, or hope the supplier will step into the suit and provide full indemnification. Contributing to the customer’s costs is a general unfamiliarity with relevant prior art and the structure and operation of the accused product. This technical knowledge is important for an efficient and effective challenge to the asserted patents.
In addition to the high costs required to challenge infringement, the potential upside to a customer for a successful challenge is limited. Unlike a manufacturer or supplier, a customer has a limited stake in the long-term implications of the asserted patent’s continued validity. The customer need only pay a one-time fee to be free of harassment by the NPE. Indeed, once a customer has paid for a licence, it may prefer to keep the patent alive in the hopes that the NPE will turn around and foist similar claims and costs on the customer’s competition in order to even the playing field.
Compare each reality to those of a manufacturer. First, the manufacturer typically has the best knowledge of the technical area of the invention and any prior art, reducing the costs of research and “getting up to speed”. Second, as long as the patent remains valid, the manufacturer’s current and future business prospects are at risk. As a result, the long-term costs for the manufacturer could very well exceed the costs of the licensing fee faced by the customer as well as the cost of litigation. Finally, although the manufacturer may benefit from a competitor being sued under the patent, the potential loss of customers may outweigh any such benefits. Taken together, these factors position the manufacturer as a better-equipped and better-incentivised defendant in litigation.
How widespread is the customer suit problem? Although individual examples of suits filed by NPEs against customers and end-users abound, the available data is inconclusive as to whether there is a genuine customer suit epidemic or if the increase is a result of changes under the America Invents Act. That said, several statistics shed some light on the scope of the issue. Of all the suits filed in 2012, over 60 per cent were filed by NPEs. In those cases, 55 per cent of unique defendants had annual revenues of $10 million or less. With the average cost to defend a relatively low-stakes NPE lawsuit to judgment around $600,000, the decision to defend an infringement claim could come at a grievous relative cost to many small companies.
In addition to persistent targeting of small entities, the past five years have also seen a marked increase in the number of low-tech or non-tech defendants in NPE-related suits. For example, a US government study estimates that 84 per cent of all NPE lawsuits filed between 2007 and 2011 involved software patents. Among those cases, over 39 per cent were filed against non-technology entities like retailers and local governments. These factors – litigation costs as a high percentage of annual revenues and minimal technical knowledge –combine to make many defendants in NPE-related litigation easy targets for abusive litigation tactics.
Although the exact scope of the customer suit problem may be difficult to ascertain, the problem does exist and results in a waste of customer and judicial resources. Further, the practice of leveraging high litigation costs to extract excessive value from patents conflicts with the patent system’s primary objective of rewarding innovation. As a result, unlike the broad reforms proposed in recent legislation – many of which may have unforeseen and negative impacts – an approach targeted directly at the customer suit problem through an aggressive stay mechanism has promise in addressing the objective of legislators and rule-makers to reduce NPE abuse.
The existing customer suit exception
One of the most direct ways of minimising exploitation of the high cost of litigation by NPEs is to permit staying a customer suit while a suit against the manufacturer of the allegedly infringing product is pending. Doing so allows the customer to benefit from a finding of invalidity or non-infringement in the manufacturer suit without expending the resources required to see their own suit through to judgment. Of course, this may not work if the patent holder simply avoids ever suing the manufacturer. Thus, liberal allowance of intervention by a manufacturer would be a necessary corollary to a customer stay.
The idea of a customer stay is not new. Currently, under the so-called customer suit exception, a federal district court has the ability to stay an infringement suit filed against a customer pending the results of a later-filed declaratory judgment by a manufacturer. Unfortunately, case law surrounding the exception is rife with restrictions that limit the application of the exception.
The customer suit exception is rooted in the general power of courts to determine the order and priority of the cases before them. The sole criterion used by courts for exercising the customer suit exception is judicial economy. Considerations unique to the patent system, including the relative abilities of the customer and manufacturer to challenge validity of the patent, larger policy concerns regarding a robust patent system, and long-term effects on patent litigation, are not considered. So, unless the result of the suit involving the manufacturer would dispose of all issues in the current and any future customer suits, the exception will not be applied.
Customer stays under currently proposed legislation
Among the various legislative proposals, the Innovation Act and its Senate equivalent, the Patent Transparency and Improvements Act (PTIA), provide the most comprehensive attempt at curbing NPE litigation and include a customer stay provision.
In general, the Innovation Act allows a stay of customer suits if the following conditions are met:
• the customer and manufacturer consent to the stay;
• the manufacturer is “a party to the action or to a separate action involving the same patent or patents related to the same covered product or process;” and
• the covered customer “agrees to be bound by any issues that the covered customer has in common with the covered manufacturer and are finally decided as to the covered manufacturer”.
While the PTIA largely tracks the Innovation Act, it differs regarding the agreement to be bound. Among other differences, it allows a court to eliminate the agreement to be bound on a showing that not doing so would be manifestly unjust and unreasonably prejudice the customer. But, under both proposals, if a customer and manufacturer meet the necessary requirements, “The court shall grant a motion to stay at least the portion of the action against a covered customer related to infringement of a patent involving a covered product or process.”
Problems with and improvements to proposed legislation
As currently written, the customer stay provisions of both the Innovation Act and the PTIA have several problematic gaps. As a result, they have been slow to gain widespread approval.
• The “Same Patent” Requirement. Both the Innovation Act and the PTIA require the manufacturer to be a party in an action involving “the same patent or patents related to the same covered product or process”. A covered product or process is defined as “a product, process, system, service, component, material or apparatus, or relevant part thereof, that (A) is alleged to infringe the patent or patents in dispute; or (B) implements a process alleged to infringe the patent or patents in dispute”.
• By requiring manufacturers be sued under the same patent or patents, the proposed customer stay provisions are too narrow. Specifically, requiring the manufacturer and customer be sued under the same patent ignores the common practice of obtaining continuation patents. Continuation patents, while distinct from their parent patents, often include claims that are quite similar to the claims in their parents. As a result, an NPE could simply assert the parent patent against a customer and the continuation patent against the manufacturer to avoid a customer stay.
• To prevent this type of gamesmanship, consideration should be given to modifying the customer stay provision to account for patent families. A relatively straightforward way of addressing patent families would be to trace the lineage of the patents asserted against the customer and the manufacturer and determine whether they share a common parent application. If so, then the subject matter of the two patents is likely to be closely related enough to warrant intervention by the manufacturer.
• Binding Effects of Manufacturer Suits. The Innovation Act and the PTIA also require the customer’s agreement to be bound by any issue it has in common with the manufacturer. However, neither proposal clearly defines the legal issues that would trigger a binding effect. To address this ambiguity, the stay provision ought to identify the specific legal issues on which the customer may become bound by the outcome of the manufacturer suit.
• The nature of legal issues on which the customer may become bound should reflect the underlying purposes of the customer stay provision. Customer stays are advantageous because the manufacturer typically has superior knowledge and experience with the patented technology and prior art. This advantage is tied directly to the issues of validity and infringement, and, therefore, the binding effect of any stay should primarily focus on only those two issues.
• Defining the “Covered Customer”. One of the most critical aspects of the customer stay provision is the definition of a “covered customer,” ie, a customer who is able to take advantage of the stay provision. A customer stay provision must not be so overbroad that genuine infringers receive protection intended for the innocent. In their current state, the Innovation Act and the PTIA contain overly broad definitions for “covered customers”.
• Specifically, the definition of a covered customer is broad enough to include not only end-users, but also value-added resellers and other downstream manufacturers. These entities typically do not suffer from an end user or retailer’s lack of experience, knowledge, and resources and have a much stronger incentive to defend a patent infringement lawsuit. As a result, permitting all but an original equipment manufacturer (OEM) to benefit from a customer stay provision is unnecessary, and the customer stay provision ought to be limited to covering retailers, service providers, end-users and the like.
Changing court rules or changing the patent statute?
Although customer stay provisions are included in proposed legislation, the question remains whether a legislative approach provides the best solution to the customer suit problem. Some members of the judiciary have been outspoken in their view that the increase in NPE suits is a procedural issue in the courts rather than one of substantive patent law, and, thus, the proposed solutions fall outside the scope of Congress’s power.
If the NPE problem is characterised as a procedural problem, remedying the increase in NPE suits would not only be more practical for the judiciary to address but would also better conform to existing laws. For example, the Rules Enabling Act gives the judiciary the “power to prescribe general rules of practice and procedure and rules of evidence for cases in the United States district courts (including proceedings before magistrate judges thereof) and courts of appeals”. Further, when considering customer stays specifically, 28 USC § 1657 provides “each court of the United States shall determine the order in which civil actions are heard and determined.”
In light of these laws, a rule-based customer stay initiated by the Judicial Conference may be more appropriate than a statutory solution by Congress. Not only would a rule-based stay conform more closely with existing law regarding control of procedural matters within the courts, it would avoid a potential clash between the Article I and Article III responsibilities of the legislature and the courts. That said, the Judicial Conference is not immune to the problems and pitfalls of crafting an effective customer stay provision.
Regardless of whether a genuine NPE crisis exists, it is likely that the US Congress is going to take further action beyond the America Invents Act to address the perceived proliferation of patent litigation in the US. Of all the various legislative proposals made to date, some of which arguably harm traditional, legitimate enforcement activities in order to curtail the abusers, the customer suit problem is real and should be addressed. Whether implemented as legislation or through procedural rules, a customer stay provision offers an effective means of curbing customer suits. But currently proposed legislation is problematic in the way it defines who can take advantage of customer stays, how a customer and manufacturer suit need be related, and what effects a suit involving an intervening participant in a given channel of trade would have on the customer. If the current proposals become law, but do not sufficiently address abuses, it is likely that the current activity in Congress to “fix” US patent law, will continue into the future.