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Patent assertion entities (PAEs or trolls) regularly engage in the practice of sending patent demand letters to unsuspecting startups and small businesses in preparation for going after much larger entities. A patent demand letter is typically sent by a patent holder to a company it believes is infringing the patent, and in the letter, PAEs offer a license to the patent. Typically, such demand letters ask for an upfront payment for past damages and royalties on sales going forward. Small businesses receiving such demand letters often lack the overhead necessary to determine and execute an effective strategy with which to respond, which can have serious ramifications on the operations and viability of a small business.

In a recent study entitled Startups and Patent Trolls, Professor Colleen Chien of Santa Clara University School of Law finds that PAEs have a strong effect on small companies and startups. Specifically, Professor Chien focused her study on the effect that receiving patent demand letters sent by PAEs has on these companies.

The findings of the study are based primarily on responses to a non-random survey of small tech companies and startups, as well as interviews with some key stakeholders. Of the 223 survey respondents, almost one-third (79) indicated that they had received a patent demand letter. Of those 79 respondents that received patent demand letters, 13 had revenue of under $100,000 showing howindiscriminate PAEs can be in their patent assertion campaigns. The study, using a comprehensive database of patent litigations developed by defensive patent aggregator RPX Corp., also revealed that at least 55 percent of defendants in lawsuits initiated by PAEs make under $10 million a year in revenue. In contrast, practicing entities (non-PAEs) only initiated patent litigation about 16 percent of the time against defendants making under $10 million a year.

Considering the expense of patent litigation, targeting companies with such small revenues would not ordinarily appear to be a wise strategy. However, such litigations against smaller targets, with less money on the line, allow PAEs to establish favorable royalty rates and run up a count of parties that have licensed prior to going after larger entities that will provide a more significant return. In this way, small business may be considered the appetizer to the large company entrée.

TROUBLING EFFECTS

While patent litigation is expected to affect a business, the study’s finding that PAE’s use of demand letters against small companies can have a significant operational impact on those companies is troubling. Professor Chien defines significant operational impact resulting from a demand letter as being a business strategy pivot, product change, delay in hiring or meeting operational milestone, reduction in value of the company, and/or shutdown of the business.

Among the survey respondents, about half of companies making less than $100 million in revenue reported that receiving a patent demand letter had a significant operational impact, while none of the companies with revenues above $100 million reported any significant operational impact as a result of receiving a patent demand letter.

Based on responses to Professor Chien’s survey, several strategies appear to be prevalent in response to receiving a demand letter: 22 percent of companies “do nothing”; 18 percent of companies settle; and 35 percent of small companies or startups fight either in court or out of court. The average settlement cost is $340,000 among 12 respondents, the average in-court cost of fighting is $857,000 among seven respondents, and the average out-of-court cost of fighting is $168,000 among 18 respondents.

In some cases, creative settlement terms have included giving up equity in the company, as well as graduated licensing fees.  Though the survey’s sample size is fairly small, the numbers for in-court costs of fighting are similar to the findings of the American Intellectual Property Law Association Report of the Economic Survey for 2011, which found that for litigations with less than $1 million in controversy, the average costs through the end of discovery are $490,000, and the average costs through trial are $916,000.

It should be no surprise that with such a potential impact on the business from receiving a patent demand letter, the common reaction for many business owners is to become concerned about the effect the patent demand may have on their business and their ability to get funding. Many small businesses simply lack the knowledge and information necessary to properly address the threat of a patent demand to their businesses.

(NON)RESPONSE RAMIFICATIONS

The result is that many companies still simply take a license in response to receiving the letter without fully understanding the ramifications of their actions, because it is often cheaper to take the offered license terms than it is to pay for legal analysis, negotiation and/or defense. Unfortunately, information about easy targets for patent assertion travels quickly among the PAE community in the absence of negotiated confidentiality agreements. Often, licensees of a PAE are even listed on thePAE’s website, giving the other PAEs a list of easy targets.

Those companies that respond without further research are putting themselves at a significant disadvantage.  Patents, and especially the claims of a patent, that define the legal scope of the patent are notoriously difficult to understand. PAEs take full advantage by providing little or no information regarding how the patent may apply to the targeted business. Furthermore, while there are obligations for a patent holder to perform a good-faith investigation of infringement prior to commencing a lawsuit, no such standard exists to merely fire off a demand letter to a target company.

Unfortunately, there is usually little reliable information that is freely available as to what a patent actually covers to help the company understand its potential liability. Since patent claims are often difficult to understand, companies usually do not have information about available prior art that may help show that the patent is invalid in the first place. Further compounding this problem is the fact that small businesses are often prohibited from discussing their strategies in responding (or not responding) to such patent demand letters in public by the license terms offered by the PAE. Thus, each company is left to fend for itself without understanding which strategy works best against the particular PAE they are dealing with.

As pointed out by Professor Chien, many of the currently proposed legal reforms do not address these problems that are unique to small businesses with limited resources to hire legal representation, such as their lack of relevant information and cooperation. While the new post-grant review provisions in the America Invents Act may help prevent “bad” patents from being issued or being enforced, this process may cost upwards of $100,000 to $400,000. Similarly, the proposedSHIELD Act may force patent trolls to pay the defendant’s legal fees, but the defendant must still first spend time litigating to invalidate or prove non-infringement, and then seek successful collection from the PAE.

STRATEGIES FOR DEALING WITH TROLLS

To address this knowledge and information gap, Professor Chien proposes “collective, self-help-based solutions such as joint defense efforts and industry association groups.” As she further commented for this article, “the costs of assertion have been driven down by PAEs, the costs of defense could also be reduced if companies worked together to promote their common interests, for example in invalidating a patent with which they are threatened.”

This is an excellent suggestion that may help reduce the attractiveness of small business to PAEs, but it relies on small businesses overcoming their reluctance to sharing information about being the target of PAEs. In fact, such public information about patent assertions is becoming more common on the technology blogs, and efforts to organize it and share it should be encouraged.

It is a patent holder’s right to enforce their patents against infringers and to choose who they target.  However, Professor Chien’s study confirms that in commencing attacks on companies, PAEs often choose to initially target companies that are not in a financial position to defend themselves. Returning to my appetizer/entrée analogy, since PAEs typically come after small businesses in preparation for litigation against larger entities, they are usually not looking for protracted battles with limited upside that may damage their chances against more lucrative targets.

For example, the threat of identifying strong prior art that is not yet of record in the patent (that may hurt the PAE’s chances against the more lucrative targets) may be an effective tool in responding to a PAE.  Therefore, small businesses need to understand the options and strategies available to them. Even a few hours of legal advice from a patent professional that understands the unique challenges of small businesses can be invaluable in formulating a strategy for responding (or not responding) to a patent demand letter.

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One of the main changes resulting from the passage of the America Invents Act (AIA) is the transition of U.S. patent law from a “first-to-invent” system to a “first-to-file” system on March 16. With the transition a mere four weeks away, it is important to understand what this change to the patent system means for inventors and companies.

FIRST-TO-INVENT

Before addressing first-to-file, it is important to understand how the first-to-invent system, which we’ve operated under for the last 200 years, works. Under the first-to-invent system, when two or more inventors file a patent application for the same invention, the patent office should identify and award the patent to the inventor who was first to conceive and diligently reduce the invention to practice, even if (subject to some limitations) the first inventor was not the first to file a patent application. An example helps illustrate this system:

In this scenario, inventor A would be entitled to receive the patent on her widget even though inventor A filed her patent application after inventor B. Inventor A may need to “swear behind” inventor B’s patent application by showing documentation regarding her earlier invention date of the widget, and that she diligently worked to actually or constructively “reduce the invention to practice” (constructive reduction to practice can be shown by preparing and filing the patent application). Under the first-to-invent system, inventor B would not receive a patent on the invention.

FIRST-TO-FILE

The first-to-file system being implemented on March 16, 2013, attempts to further harmonize U.S. patent law with that of most of the rest of the world by de-emphasizing the actual invention date.

A lot of informed people think that the change to first-to-file will be a boon to patent trolls because they will be able to file patent applications on inventions released, but not yet filed on, by underfunded startups. However, the term “first-to-file” is a bit of a misnomer. In the United States, whether under first-to-invent or first-to-file, an inventor can publicly disclose their invention, such as in a blog post, and still file a patent application within one year of that public disclosure.  The system being implemented under the AIA is not a true first-to-file system as in most foreign countries because this grace period on public disclosure will remain. Thus, the new system can really be considered a “first-to-disclose” system.

THE NEW SYSTEM CAN REALLY BE CONSIDERED A “FIRST-TO-DISCLOSE” SYSTEM.

Inventors can attempt to market and sell their inventions and still file for a patent in the United States within one year of the first public disclosure. However, they would not be able to pursue patents for the previously disclosed invention in most foreign countries, because foreign countries that operate on the first-to-file standard typically do not have this grace period for public disclosure. In these foreign countries, a public disclosure prior to filing a patent application is an absolute bar on receiving a patent on the disclosed invention.

Taking the disclosure grace period into account, under the first-to-file/first-to-disclose system being implemented on March 16, the key question to consider is not when an invention was first conceived as in the first-to-invent system, but rather when the invention was first publicly disclosed by another inventor or first filed with the USPTO. Thus, while an inventor can publicly disclose his invention and still file a patent application with the USPTO within one year of the disclosure, that disclosure would prevent any other inventor from receiving a patent on the same invention, even if the other inventor invented the same invention before the disclosure.

Similarly, if no previous disclosure was made, a filing at the USPTO by a later inventor would entitle that later inventor to a patent even though a second inventor came up with the invention earlier than the second inventor’s filing date. An example will better illustrate this scenario:

In this scenario, Inventor B would receive the patent, even though inventor A came up with the invention for the widget first. Inventor A would therefore be prohibited from practicing the invention patented by inventor B even though he came up with the invention before Inventor B did.

Now consider a second, somewhat modified scenario:

In this modified scenario, Inventor A would be entitled to the patent even though Inventor B filed his patent application first because Inventor A disclosed the invention before Inventor B filed his patent application.  Therefore, because Inventor A filed the patent application within one year of his public disclosure, Inventor A will be entitled to receive the patent. Inventor B would therefore be prohibited from practicing the invention patented by Inventor A.

In the case that a person learns of an invention that another inventor disclosed, copies the idea and attempts to file a patent application under first-to-file, the copier could not receive a valid patent on the invention by simply filing the patent application first because he did not “invent” the invention and is therefore not entitled to receive patent protection (though if the USPTO grants a patent to a non-inventor, the burden of proof would be on the other party to show that the non-inventor was not the true inventor of the patented technology).

Similarly, the non-inventor could not prevent the inventor from receiving a patent by publicly disclosing the invention based on information obtained from the inventor because in this case, the inventor will still retain the one-year grace period to file a patent application on the invention.

PREPARING FOR FIRST-TO-FILE

There are a number of ways companies can prepare for the implementation of first to file. While it is always best to file patent applications as soon as possible, prior to implementation of first-to-file, companies should consider whether provisional applications should be filed to secure first-to-invent filing dates. Companies should also develop processes for quickly identifying inventions, and deciding whether to patent, disclose or otherwise protect those inventions.

Filing a provisional or non-provisional patent application with the USPTO prior to March 16 is the only way to ensure that the application will be treated under the first-to-invent regime. While it is preferable to file non-provisional applications to ensure that the claims of the patent application are fully supported by the description in the specification, if budget and timing does not allow for a non-provisional application to be filed by March 16, great care should be taken in preparing provisional applications (which do not require claims) to ensure that the invention and any known variations are disclosed in full detail.

It is important to take great care to fully describe the technology and all known variations in detail, because if the provisional application is converted after the March 16 changeover date, any claim directed to disclosure that was not supported by the original “first-to-invent” provisional application will be treated under the first-to-file regime.

After its implementation on March 16, first-to-file will present unique challenges and opportunities for inventors and businesses. Well-timed disclosures of inventions can block better-funded competitors from receiving patents. However, delaying the patent application or disclosure process can result in forfeiting of patent rights by exposing the application to more prior art. Even worse, delaying disclosing or filing a patent application can allow a competitor to file a patent application on the same technology even though they invented it later.

Therefore, companies should look to establish processes to quickly and efficiently identify inventions, and to determine whether to file patent applications or to otherwise publicly disclose those inventions. If the technology is worthy of patent protection, filing a series of low-cost provisional applications during the course of development of the technology can be a cost-effective way to establish a series of early “first-to-file” filing dates for the technology.

On the other hand, if it is decided that an invention is not worth immediately filing a patent application for, publicly disclosing the invention should prevent others from receiving patents on the same technology. But the decision to publicly disclose an invention before filing a patent application should not be taken lightly. Public disclosure prior to filing a patent application will likely cause foreign patent rights to be forfeited. In the case of software, which is not patentable in most foreign patent systems, this is not a problem. Therefore, disclosures for software-based inventions can be an ideal way to create prior art for others without the trade-off of forfeiting any patent rights that a company would otherwise be entitled to.

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Here is what appears to be the broadest independent claim in the patent:

33. A system for encouraging customer patronage by providing awards to customers comprising:

• (a) one or more electronic data storage elements containing identifying information;
• (b) electronic data storage element readers capable of reading said identifying information from said electronic data storage elements;
• (c) an awards processing center that provides awards to one or more participant(s) in an awards program when said participant transmits the identifying information from said electronic data storage element to the awards processing center.

In the smartphone industry alone, according to a Stanford University analysis, as much as $20 billion was spent on patent litigation and patent purchases in the last two years — an amount equal to eight Mars rover missions. Last year, for the first time, spending by Apple and Google on patent lawsuits and unusually big-dollar patent purchases exceeded spending on research and development of new products, according to public filings.

many factors... go into pricing patents. Timing, competitive forces, regulation and court rulings all have an effect...“  Patents are a volatile, spot market,” he said. “This is a market, but a market that is more like art than stocks or oil."

While perusing the latest patent lawsuit filings on PriorSmart this week, I was drawn to a series of cases filed by a small company called PersonalWeb against RackSpace (possibly for hosting GitHub), Nexsan, Facebook, Apple, Yahoo, Microsoft, and IBM:

THE SHIELD ACT

RackSpace responded strongly on its blog to being sued by PersonalWeb, taking the opportunity to call support for the SHIELD Act. The SHIELD Act ostensibly aims to protect high-tech companies from patent-infringement suits from Non Practicing Entities (NPEs) by requiring unsuccessful plaintiffs in hardware and software patent cases to pay for the litigation costs of defendants. Its passage may lead to the end of the Non Practicing Entity business model, and, by extension, allow infringers of patents owned by NPEs to continue practicing patented technologies without fear of litigation.

The SHIELD Act may also have implications on startup companies. Shifting the cost burden of litigation to patent plaintiffs may result in startups having even less ability to protect their legitimate inventions from larger competitors. Which brings me back to PersonalWeb, a company that blurs the line between a traditional Non Practicing Entity and a startup technology company. Perusing PersonalWeb’s website, it is clear that this is a real company with real offices (in Tyler, Texas, the home of the famous Eastern District of Texas Federal District Court), real employees and at least one product. Did PersonalWeb hire a staff, furnish its offices, and make a product simply to give the appearance of being a real company? Certainly, having a real product would help make the case for seeking lost profits under the patent act and would help avoid the possibility of venue transfer. However, it’s possible that they are a small company with interesting products – like many startups. The point is that the line between NPE and operating company is so easily blurred – especially in today’s age of low-technology costs – that it is often difficult to tell what the true intentions of a company are.

WHY DOES IT MATTER THAT PERSONALWEB IS NOT A NPE IN ITS STRICTEST FORM?

It shows that the traditional Non Practicing Entity model is evolving. The strong public opinion against the traditional Non Practicing Entity business model has led to proposals, such as the SHIELD Act, admonitions from federal judges, and the like. At the same time, the cost of starting a software-based business has never been lower. These notions are clearly not lost on PersonalWeb, which can act as a startup with real employees and real products, while still attempting to enforce its patents in a friendly court. After all, it is  likely that a jury in the Eastern District of Texas, which would be drawn from a pool of jurors residing in and around Tyler, Texas, would be more kind to a local 15-person company battling against corporate giants.

In the long run, I expect this model of pairing a patent portfolio with a small, but operating, technology company to become more popular. The business model provides a mutually symbiotic relationship, as the entrepreneur may find it easier to receive funding when the technology business is paired with a patent monetization program, and the funding entity can continue patent monetization while covered by an operating technology company with real employees and a real business model.

WHAT DOES THIS MEAN FOR THE SHIELD ACT?

Certainly, there are compelling reasons for and against the Act and it is worth watching its progress in Congress. However, I am not sure that the answer to the Non Practicing Entity problem is to make patent lawsuits financially untenable for small entities, as there are plenty of legitimate examples of  small companies attempting to enforce patents against wrongdoers. Similarly, as the line between a traditional Non Practicing Entity and an operating company blurs or disappears, we should not assume that every small company attempting to enforce a patent is a patent troll.

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Ask Patents is a new Stack Exchange site launching today that allows anyone to participate in the patent examination process. It’s a collaborative effort, supported by Stack Exchange, the US Patent and Trademark Office, and the Google Patent Search team. It’s very exciting, because it is opening up a process that has been conducted behind closed doors for over 200 years.