Examining The Effects Of Patent-Troll Legislation On Startups

Editor’s note: Sid Venkatesan is an IP partner specializing in high stakes IP disputes and IP counseling for technology companies in the Silicon Valley office of Orrick, Herrington & Sutcliffe LLP.

Non-practicing entities (NPEs), or patent trolls, have largely stayed off the political radar for the 12 years since the term “patent troll” was coined. But the political winds have changed, and NPEs have become a favorite whipping boy of Congress — and the president, the FTC, the state of Vermont and the International Trade Commission.

There are six bills in committee in the House and Senate, with a seventh bill currently under discussion, all aimed at curtailing various practices by NPEs. The abundant NPE legislation could be a significant boon for startups. According to one study, startups face significant costs dealing with NPEs, even more so than large companies. What could all these bills mean for startups? Let’s look at the proposals.

Attorney Fee Shifting

HR 845, or the SHIELD Act — introduced in the House by Representatives Peter DeFazio, Peter Welch, Tim Walberg, Kerry Bentivolio and Jason Chaffetz, would permit a patent defendant to move early in a lawsuit to designate a patentee an NPE and to stay expensive civil discovery while the NPE motion is resolved. If the plaintiff is deemed an NPE it will be ordered to post a bond and to pay the defendant’s attorney fees should the NPE lose the litigation. Attorneys’ fees can run millions or even tens of millions of dollars for a heavily contested case litigated through trial.

The SHIELD Act would have a significant impact on NPE patent litigation if it passes. Potentially, NPEs would become gun-shy about initiating lawsuits where they could be ultimately required to pay the attorneys’ fees of their targets, and defendants may be emboldened to take NPEs to trial given the prospect of recovering attorneys’ fees. However, the SHIELD Act would not solve the problem of startups that can’t afford to litigate a case through trial in order to win and recover attorneys’ fees.

In addition, I would expect some political headwinds as this bill progresses, given that many technology companies have now purchased significant estates of historical patents (Google’s $12.5 billion purchase of the Motorola patent estate, for example), and the risk of being a loser that has to pay the attorneys’ fees of a patent defendant could seriously impact the value of these patents. Further, I would expect NPE business models to adapt if the SHIELD Act were to become law by, for example, focusing on litigation financing of individual inventors.

Transparency Measures

Congressman Ted Deutch introduced HR 2024, the “End Anonymous Patents Act,” on May 16. This bill targets a very particular aspect of NPE patent strategy – the use of shell companies to disguise the “real party in interest,” a practice that can help an NPE disguise its past activities, such as licensing practices, from patent defendants. This act would require any patent owner to identify the real party in interest of the patent, including the entity that has the right to assert the patent, as well as its parents and controlling entities, and to update this information when a patent is sold or transferred to another entity.

This bill is pretty narrow and, as a result, likely to face fewer obstacles to passing than bills like the SHIELD Act. However, though the bill may have some impacts on NPE litigation and would increase awareness of NPE activity (such as, for example, Intellectual Ventures’ connection to the notorious patent troll Oasis), it is unlikely that this measure alone would move the needle much in significantly curtailing NPE assertions.

Patent Litigation Reforms

Representatives Hakeem Jeffries and Blake Farenthold introduced the “Patent Litigation and Innovation Act,” on July 10, focuses on a variety of patent litigation tactics that NPEs use. For example, the proposed bill would require a patent plaintiff to add a significant amount of detail regarding the accused infringement than current case law requires. It also provides protections to “secondary parties,” such as customers and distributors in litigation (perhaps in reaction to Lodsys’ assertions against iOS developers); would permit “interested parties” that have an ownership stake in a patent to be joined in litigation; and has some provisions to limit discovery until preliminary motions are resolved. Finally, the bill would afford courts with greater latitude to award sanctions in cases involving unreasonable assertions.

A similar bill, entitled the “Patent Abuse Reduction Act,” was introduced in the Senate on May 22 by John Cornyn and Chuck Grassley. Though this bill does not include provisions protecting end users, it is similar to the House bill in that it would require additional detail in an NPE’s complaint and would streamline (and reduce the costs of) of civil discovery in various ways. Most significantly, the bill would shift the cost of discovery for anything other than “core document discovery” to the requesting party (the default rule is that producing party foots the bill for document collection and production).

Limiting the costs of discovery would make it easier for a startup to defend itself in litigation. One of the major reasons NPE litigation is unfair to startups is that a startup defendant may have a lot of documents and files to sift through in order to response to civil discovery, whereas an NPE may have minimal documents. Therefore startups (and defendants in general in NPE cases) face much higher discovery costs in the form of attorney and vendor time than NPEs. This cost asymmetry often forces startups to settle rather than litigate.

The proposed cost-shifting rule could significantly alter the course of patent litigation, since the current practice is for parties to serve each other with broad discovery requests in litigation to make sure they do not miss important evidence, which could end up being very costly for the requesting party if this bill becomes law. This bill would also provide that an NPE would have to pay the attorneys’ fees of a prevailing defendant if the court found that the NPEs assertions were unjustified, a less extreme attorney fee shifting measure than the SHIELD Act.

Both of these bills could offer significant relief for startups facing NPE litigation. The detailed pleading requirements would require the NPEs to incur more costs in preparing their complaints against individual companies while the discovery limits and protections for secondary users would reduce defensive costs for smaller technology companies. Both bills also increase the possibility of sanctions or attorneys fees, which could curtail the worst NPE tactics.

Despite all this though, significant asymmetries still exist between NPEs and small companies, particularly given that many NPEs use contingency-fee lawyers and therefore incur no legal expenses (other than expert witness fees) until a jury verdict or settlement, whereas defendants almost always have to pay their lawyers by the hour.

Improved USPTO Review Of Business-Method Patents

Most recently, California Representatives Darrel Issa and Judy Chu introduced the “Stopping Offensive Use of Patents Act” or “STOP Act,” on July 22, 2013. The STOP Act would expand the “transitional Covered Business Method program” to provide broader administrative defenses to business method patents. The CBM program is an administrative program that permits a patent defendant to challenge certain financial services’ business-method patents in the USPTO using more legal defenses and facing fewer downsides than is typically the case for post-grant challenges to patents in the USPTO.

the tailwinds for some kind of legislative reform are picking up.

The STOP Act would expand the transitional CBM program so as not to be limited to “financial products or services,” but rather to apply to patents claiming the management or administration of any “enterprise, product or service.” The STOP Act would also make the transitional CBM program indefinite. Senator Chuck Schumer had previously proposed a similar bill, entitled the “Patent Quality Improvement Act,” S. 866, on May 6, 2013.

The Federal Circuit’s decision in Versata v. SAP, suggests that the USPTO and Federal Circuit could be taking a hard look at business-method patents, so an expanded transitional CBM program could significantly impact NPEs that rely on such patents. This bill could particularly benefit Internet startups since many business-method patents relate to software and e-commerce applications and USPTO review is much cheaper than full-blown litigation.

A Multifaceted Approach Is Emerging

Finally, Representative Bob Goodlatte and Senator Patrick Leahy have circulated a 36-page “discussion draft” (and, helpfully, a summary) on May 23, 2013 in the House and Senate Judiciary committees. Senator Goodlatte chairs the Senate Judiciary Committee and Representative Leahy chairs the House Judiciary Committee. This draft is a working document that contains a grab bag of patent reforms that could evolve, as the bills described above are tossed around in committee.

Presently, the draft proposes a cost-shifting rule intended to promote settlement by forcing a nonsettling plaintiff to pay the defendants’ costs if it fails to settle and does worse than the settlement at trial, a measure that is not as extreme as the “loser pays” provisions of the SHIELD Act. It also proposes litigation reforms intended to provide a uniform set of case-management tools to federal judges to streamline patent litigation, as well as protections from end users to patent claims. It also contains proposals for public research and outreach initiatives, patent ownership transparency initiatives similar in concept to the Deutch bill, provisions to track entities that send many demand letters under a patent, and other technical USPTO initiatives.

What Does It All Mean?

At this point, with six bills hitting committee plus the bicameral Goodlatte/Leahy “discussion draft,” it’s not clear at all what legislative NPE patent reform will ultimately look like. However, given the bipartisan and bicameral nature of these proposals, the vociferous lobbying of many in the business community, and the president’s interest, the tailwinds for some kind of legislative reform are picking up. Some of the proposals (increased transparency in patent ownership) are relatively non-controversial and have a high chance of passing unmolested by the legislative process.

The potential game-changer provisions — “loser pay,” limited discovery and discovery cost-shifting, and protection of “secondary entities” — are substantial breaks from current practice and will likely garner significant discussion from constituents on all sides of this issue. Very likely, the bills that emerge from committee will incorporate multiple concepts from the current proposals in taking a multi-faceted approach to addressing NPEs.