RPX Blog

Not all patents are created equal. While all issued patents carry the presumption of validity, the functional and legal legitimacy of most asserted patents is almost always called into question. When a patent is identified in an assertion letter, the first reaction of even the most experienced corporate IP counsel is usually to fight the alleged infringement and challenge the validity of the asserted patent in court.

But in almost all cases, it’s better to resist that temptation. A defendant might win the case, but the victory is likely to be a Pyrrhic one because the validity of a patent is rarely ascertained until well into the litigation process (and that process can grow even longer in those instances where the patent is thrown into re-examination before the USPTO). In even a relatively fast-moving case, it can easily take many months and cost hundreds of thousands of dollars in legal fees alone to prove that a patent and/or particular claim is invalid.

And even though a single patent assertion often has multiple named defendants, companies rarely choose to mount a joint defense, meaning the legal costs are borne by each defendant separately. Settling with the asserter – while distasteful, particularly if they are asserting a likely invalid patent – is usually the financially prudent course.

So the choice between settling and fighting an “invalid” patent in litigation is fairly straightforward. Once an assertion letter arrives, the cost/benefit argument in favor of settling is compelling. When a questionable, but potentially dangerous patent becomes available on the open market, however, the equation is slightly different. There is time for careful analysis of the asset’s legal viability when deciding whether to purchase or pass.

Even so, at RPX our strategy is generally to err on the side of financial caution. Validity is a highly subjective concept under patent law. Most problem patents aren’t strictly invalid in their own right – they are just being asserted in way that is broader than the valid coverage of their claims. But establishing where that line of “valid coverage” is crossed is rarely clear and never easy in court. So, even for patents of highly doubtful validity, the buy-or-pass decision usually boils down to either RPX paying the inventor/owner now or our members paying their attorneys later. And it is far more cost-effective to pay the (appropriately discounted) purchase price.

For example, RPX recently acquired a patent covering a device with a graphical user interface for retrieving digital media for playback. This patent could likely have been asserted by the prior owner against an incredibly broad set of products. The broader the assertion, the more likely the patent is to be invalidated, but also the greater potential cost and risk for our member companies. And the purchase price for the patent was reasonable in light of the potential aggregate costs of discovery and litigation. A credible legal case could be made that this patent would be considered invalid in many infringement scenarios. A stronger financial case can be made to take it out of circulation.

There are, of course, instances where an available patent asset is of dubious validity and not available at an appropriately, reasonably discounted price. Recently we considered purchasing a patent covering music identification via a mobile device. After a careful analysis of the potential litigation value vs. cost of the patent, we chose not to purchase the asset. The courts may yet endorse the validity of this patent, but thus far it has not been successfully asserted or generated meaningful settlements.

Ultimately our goal at RPX is to bring a rigorous, market-based economic rationale to the buying and selling of intellectual property. In the long-term this will mean valuing patents purely on their functional merits. In the near-term, all of us will need to treat “invalid” patents as legitimate and high-risk legal assets that warrant prudent and rational consideration.

Warren Buffett once said, “Risk comes from not knowing what you’re doing.” He wasn’t talking about the dangers of portfolio manager inexperience; he was stressing the critical importance of information. For Buffet, the more you know, the more likely you are to make a reasonable, logical, low-risk decision. Conversely, without adequate information and market transparency it is impossible to make rational financial choices.

And yet that is what all of us in the patent market do on a daily basis. We accept unnecessary levels of risk simply because we don’t have established tools and venues for sharing industry information.

RPX recently hosted its first annual conference with a goal of changing the status quo and introducing transparency to our opaque industry. The conference brought together a broad cross-section of market participants and experts, and was a first step toward creating an environment and structures that would allow for easy sharing of data on patent pricing, acquisition activity, trends in IP litigation, developments in patent law and government policy, and more.

If history is a guide, the IP market has a good chance of successfully building such an environment. Three hundred years ago the international shipping industry was – like the patent market of today – in its infancy and facing the twin challenges of high risk and low information transparency.

Investors and underwriters that provided capital and risk management for commercial shippers were operating independently. There was little or no detailed information on shipping routes, sailing times, cargo manifests, weather, currents, reliability of captains and crew, or any of the myriad other data that would help make rational investment decisions. As a result, marine shipping and underwriting was an extremely volatile market.

But after Edward Lloyd opened a coffee house near the Thames in1687, things began to change. Lloyd’s quickly became the favored gathering place for ship owners, captains, marine underwriters, and insurance brokers. And just as quickly it became the central repository of and clearinghouse for the critical information they possessed.

Where underwriters and insurers had previously made financial decisions based on incomplete, inaccurate, or out-of-date information, they now had comprehensive and verifiable data on all aspects of commercial shipping. And where they had before made financial decisions unilaterally, they now had ready access to peers with whom they could collaborate, partner, and pool resources

And share risk. The greatest innovation to emerge from Lloyd’s wasn’t the expansion and greater transparency of information. It was how that information was used by market participants to rationalize the underwriting and insurance of vessels and cargo. The task of sailing from the Spice Islands with a cargo of nutmeg was just as difficult as it was before Lloyd’s was formed, but because investors and operators could efficiently share the risk of the voyage with multiple parties, they could focus on expanding their businesses without the risk of being financially ruined by a single unfortunate event.

Lloyd’s, of course, wasn’t an insurer, per se. It was a third party, an honest broker: a source of information to, and a disinterested enabler of, insurance underwriters. Without that innovation, insurance as we know it wouldn’t exist today.

Today the IP market is at the same early-stage inflection point the insurance industry was at 300 years ago. Our task now is to make our industry more efficient and less prone to risk, and building a 21^st century equivalent of Lloyd’s coffee house is a good place to start.

Our market needs reliable sources of pricing data; of asset descriptions and analysis; of like-minded investors or buyers or sellers; of potential collaborators; of declared competitors. We need the level playing field and trusted trading venue that Lloyd’s provided. RPX is certainly committed to providing that 21^st century version of Lloyd’s for the patent market, and other participants have also demonstrated a willingness to build structures to share information, mitigate risk, and rationalize the IP industry.

All of which is reason for optimism as our young, multi-billion dollar market continues to grow. To date we have all been operating largely in the dark, but as an industry we are beginning to control the risks in our financial decision making. We are starting to know what we’re doing. Continuing to expand that awareness will be crucial if our market is going to succeed in the long run.

Robert C. Pozen recently assessed Congressional patent reform efforts in a New York Times op-ed piece. Mr. Pozen is a professor at Harvard as well as the chairman of MFS Investment Management, and in his piece he suggests some excellent changes in how patents are evaluated, issued and protected. His proposed reforms would indeed help “weed out low quality patent claims … and reward our best innovators”, but they would not address the most serious problem faced by both owners and users of intellectual property, which is the increasing number of lawsuits filed by non-practicing entities, or NPEs.

As Mr. Pozen notes, patent law needs to be reformed. Patents are the legal catalyst for technology innovation, and thus largely responsible the tremendous social and economic value created by that innovation. It is precisely this value that has created a thriving secondary market for patents.

NPEs have invested billions of dollars to purchase patents. Their business model is to solicit royalty payments from companies that make or use products or services incorporating technologies covered by the patents in question. By thus seeking to ‘monetize’, or extract the financial value embodied by their intangible assets, NPEs are doing what literally thousands of companies have done since the formation of this country. However, the fact that NPEs often use litigation as a tool in their monetization efforts has not endeared them to the many technology-driven companies that have been their targets, as patent litigation is costly and time-consuming for all involved.

Mr. Pozen does not suggest legislating away the ability to assert for NPEs or any third party to assert patent rights. Nor should he. Patents are legitimate property, and in America, property rights are legal bedrock.

The NPE approach to monetizing the value of intellectual property is nonetheless inefficient due to the excessively high transaction costs; and for many companies, it is a very expensive problem. The optimal remedy, however, is not a legal solution; it is a market solution. And efficient, market-based solutions are historically how industries have responded when companies collectively face operating risk.

For example, the merchant banks and insurance underwriters that emerged in the 17^th and 18^th century allowed brokers, land owners, manufacturers, traders and shippers to offset the significant financial risks – shared by all participants – of changing market conditions or catastrophic weather. Today, similar market-based approaches to addressing the NPE problem are taking shape, lead by RPX’s Defensive Patent Aggregation service. By combining our expertise in patent assessment with the economic resources of our fee-paying members to buy patents strategically and defensively, our service is able to keep patents out of the hands of NPEs who might otherwise assert them.

This approach enables a free and open market for intellectual property and ensures that patent owners can extract fair value for their asset without resorting to legal methods. And it provides an efficient, cost-effective way for companies to share the risks inherent in using technologies that are based on high-value intellectual property. It is a market solution to a legal problem, and one that – like Mr. Pozen’s suggested reforms – goes a long way toward protecting and nurturing the innovation that is the driving force of the American economy.