Examining the Multi-Faceted Attack on Patent Assertion Entities

January 20, 2015Articles New York Law Journal

Reprinted with permission from the January 20 issue of New York Law Journal. (c) 2015 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

Although perhaps not ugly green creatures lurking under bridges, "patent trolls" have nevertheless haunted companies and patent practitioners for two decades.

Using extortive practices and preying on the inability of small companies to afford patent litigation, patent trolls have perfected the art of early settlement, requiring companies to pay tens or hundreds of thousands of dollars to avoid more significant litigation expenses. Such a practice can be quite lucrative when it involves hundreds of potential defendants. It has certainly not gone unnoticed. Both President Barack Obama and Congressional leaders called for patent reform in 2014 to curtail these practices. A recent patent reform bill focused on addressing abusive patent litigation tactics passed in the House but died in the Senate after failed negotiations. But patent trolls have not escaped unscathed. Rather, they have recently suffered a multi-faceted attack including executive and administrative actions and judicial decisions, which may have collectively succeeded in accomplishing at least some of the goals of the failed legislative reform. The following provides an overview of such attacks.

A patent assertion entity (PAE), or non-practicing entity, is a company or individual that owns and asserts patent rights but does not manufacture the products or provide the services covered by the patents. These entities are not all bad actors, but rather include research institutions, universities, and individual inventors who license or otherwise enforce their patents. The term "patent trolls" refers to non-practicing entities that acquire and assert patents of questionable validity in order to extort licensing revenue, or otherwise engage in abusive litigation tactics. Because the cost and risk of defending a patent infringement lawsuit are high, a target of a troll may choose to settle for tens or even hundreds of thousands of dollars even if the suit is without merit.

The America Invents Act (AIA),1 signed into law in 2011, made significant changes to U.S. patent law, some of which were intended to directly or indirectly affect patent troll strategies. In an attempt to curtail the PAE practice of filing multi-defendant patent infringement lawsuits with many unrelated defendants, the AIA changed the standard for joinder of defendants in patent infringement lawsuits. Joinder is governed by Rule 20(a) of the Federal Rules of Civil Procedure, which provides that multiple defendants can be joined in one action if the claims arise out of the same transaction or occurrence, and there are common questions of fact. Before the AIA, in cases in which multiple defendants were related only by allegations of infringement of the same patent, some district courts found that the Rule 20(a) requirement of the same transaction or occurrence was not satisfied. Other courts, most notably in the Eastern District of Texas, found that allegations of infringement of the same patent were sufficient for joinder. The Eastern District of Texas approach provided significant benefits to a PAE bringing a single suit against multiple defendants, including reduced litigation costs and the ability to file in a plaintiff-friendly venue with little risk of transfer.

The AIA attempted to curtail this practice by providing that multiple accused infringers may not be joined in one action "based solely on allegations that they have each infringed the patent or patents in suit."2 Not surprisingly, in the several days prior to the enactment of the AIA, there was a spike in multi-defendant patent infringement filings, particularly in the Eastern District of Texas. Subsequent to the passage of the AIA, however, it appears that PAEs have simply shifted strategies to avoid the new joinder provisions, and are now filing multiple parallel suits against single defendants. Because the joinder statute has been interpreted by district courts and the U.S. Judicial Panel on Multidistrict Litigation to permit consolidation for pretrial proceedings, the parallel suits filed post-AIA are often consolidated for pretrial issues under Rule 42(a) of the Federal Rules of Civil Procedure or 28 U.S.C. §1407. It thus appears that the AIA joinder statute will have a limited effect on PAEs, since the cost of suing multiple defendants has not substantially changed.

The AIA also created post-grant administrative proceedings before the U.S. Patent and Trademark Office (USPTO) that allow third parties to challenge the validity of issued patents. The new proceedings—inter partes review, post-grant review, and covered business method patent review—are intended to weed out "bad patents" that were improperly issued by the USPTO and are favored by patent trolls. Relative to district court litigation, the proceedings are speedier and less expensive, and are challenger-friendly in that the standard by which a challenger must prove patent invalidity is lower than in district court. In the first two years of the proceedings, challengers prevailed in the majority of the final decisions on granted petitions. Since a district court is more likely than not to grant a stay of district court litigation pending the administrative review, these proceedings often provide an accelerated and less costly alternative to litigation for defendants sued by PAEs. Although less costly than district court litigation, the cost and fees for an inter partes review can run in the hundreds of thousands of dollars, making this a cost-prohibitive alternative for some defendants.

"Our efforts at patent reform only went about halfway to where we need to go," stated President Obama in a Google+ Hangout hosted on YouTube on Feb. 14, 2013. Four months later, his administration announced five executive actions "designed to protect innovators from frivolous litigation and ensure the highest quality patents in our system."3 To address the issue of shell companies set up by PAEs to hide their identities, one action called for rulemaking by the USPTO to require patent applicants and owners to regularly update ownership information, and to designate the "ultimate parent entity" controlling the application or patent. Another action called for new training for USPTO Examiners to improve patent claim language in order to reduce a perceived problem of overly broad claims, particularly in software patents. Other actions directed the USPTO to publish education and outreach materials for entities facing demands from possible trolls, and to expand outreach efforts such as roundtables and workshops. Yet another order called for an interagency review to strengthen the enforcement process of exclusion orders by the International Trade Commission barring the importation of infringing goods.

In his State of the Union address in 2014, President Obama called on Congress to "pass a patent reform bill that allows our businesses to stay focused on innovation, not costly, needless litigation." The following month, the White House announced three additional executive actions.4 In another effort to improve patent quality, the USPTO was directed to explore ways for the public to submit prior art to the agency, and to train patent examiners to use crowd-sourced prior art during patent application examination. Other actions include utilization of volunteer technologists and engineers to train patent examiners, and dedication of resources to pro se patent applicants. The USPTO has undertaken initiatives to implement the 2013 and 2014 executive actions.

The Federal Trade Commission (FTC) entered the fray in 2014 using its consumer protection authority to issue an administrative complaint against the non-practicing entity MPHJ Technology Investments, and its law firm, relating to assertion of patents that MPHJ purchased for one dollar. The complaint alleged that MPHJ purchased patents covering network computer "scan-to-email" technology from another PAE, and sent letters to over 16,000 small businesses stating that the recipient was likely infringing its patents. The letters included an offer to engage in licensing discussions, and a suggested payment to MPHJ of $1,000 per employee. MPHJ sent the letters in the names of 81 different subsidiaries as its licensing agents. MPHJ allegedly sent a second wave of letters in the name of its law firm to over 10,000 of the small businesses, and finally a third wave of letters threatening a lawsuit for patent infringement to approximately 4,870 businesses. The FTC alleged that MPHJ was not prepared to initiate legal actions against the recipients of the letters, and thus the representations were false or misleading in violation of §5(a) of the Federal Trade Commission Act. MPHJ and its law firm agreed to settle the FTC charges under terms that would ban the company and its law firm from making false or deceptive representations when asserting patent rights.

MPHJ is also the subject of a consumer protection lawsuit brought by the Vermont attorney general. A similar suit in New York was settled under terms that bar MPHJ from using deceptive practices. In addition, 17 states have enacted legislation that prohibit a person from asserting a claim of patent infringement in bad faith, and/or establish a cause of action against a person or entity who has asserted a bad faith infringement claim.

A more substantial deterrent to patent trolls may result from several cases decided by the U.S. Supreme Court in the past year. These cases, while not directly focused on PAEs, could tremendously impact the desire of PAEs to enter into litigation.

The first, and perhaps most influential, decision is Alice v. CLS Bank Int'l., 134 S. Ct. 2347 (2014). The issue in Alice was patent eligibility of a software-based method and system for mitigating settlement risk in a financial exchange. The claims at issue related to a computerized scheme for facilitating the exchange of financial obligations between two parties using a computer system as a third-party intermediary—i.e., an intermediated settlement. The claims covered a (1) method, (2) computer system, and (3) computer-readable medium for accomplishing these steps. Each of these claim types was held invalid by the U.S. Supreme Court.

In its decision, the court first held that the concept of an intermediated settlement was an abstract one with roots prevalent throughout modern commerce.5 Thus, generally speaking, the idea itself was not patent eligible. The application of it through a software or computer-based medium was held to be insufficient to make it patent eligible. Specifically, functions performed by the computer (and recited in the claims) were held to be "purely conventional … [e]ach step does no more than require a generic computer to perform generic computer functions."6 The claims were held to "amount to 'nothing significantly more' than an instruction to apply the abstract idea of intermediated settlement using some unspecified, generic computer."7Alice is troublesome for PAEs because most of these companies litigate in the high-tech sector using software or computer-based patents. Alice provides a new and potentially powerful mechanism for defendants to invalidate the types of patents that PAEs typically assert. PAEs are thereby forced to consider increased risks and costs associated with such challenges, as well as the likelihood that the defendant will prevail.

The decision in this case was predicted to chill PAE litigation filings, and in fact it did. Unified Patent reported that in the third quarter of 2014 (the first three months post-Alice) there was a 35 percent decrease in high-tech sector PAE litigation filings, as compared to second quarter filings. While this drop-off may not be entirely due to the decision in Alice, it appears from the timing that this decision had some significant influence. At a minimum, PAEs appear to be more carefully considering downside litigation risks.

In an unrelated series of second opinions, the U.S. Supreme Court indirectly impacted patent troll litigation strategy by making it easier for a troll's opponents to be awarded attorney fees. These decisions include (1) Octane Fitness v. Icon Health & Fitness, 134 S. Ct. 1749 (2014) and (2) Highmark v. Allcare Health Management System, 134 S. Ct. 1744 (2014).

Under 35 U.S.C. §285, a court "in exceptional cases may award reasonable attorney fees to the prevailing party." Prior to Octane, such fees were awarded (1) if there was some material inappropriate conduct related to the matter in litigation, or (2) when the litigation was brought in subjective bad faith and was objectively baseless.8 This test was established by the Federal Circuit Court of Appeals in Brooks Furniture Mfg., v. Dutailier Int'l, 393 F.3d 1378 (2005).

In Octane, however, the U.S. Supreme Court held that this test was "unduly rigid, and it impermissibly encumbers the statutory grant of discretion to district courts."9 The court further held that "an 'exceptional' case [under the statute] is simply one that stands out from others with respect to the substantive strength of a party's litigating position."10 It is determined on a case-by-case basis at the discretion of the district court and based on the totality of the circumstances.11 The court went on to hold that the standard for patent litigants to establish entitlement to fees under 35 U.S.C. §285 is by preponderance of the evidence. This standard was lowered from the clear and convincing evidence standard of Brooks.

Highmark is a companion case co-issued with Octane that addresses a litigant's ability to obtain attorney fees under 35 U.S.C. §285. In its decision, the court took note of the opinion in Octane and ruled that the "district court 'is better positioned' to decide whether a case is exceptional [under this statute] because it lives with the case over a prolong period of time."12 Accordingly, the court held that review of these decisions by appellate courts should be for abuse of discretion.13

Collectively, Octane and Highmark are important because they relax the requirements for recouping attorney fees by a party willing to challenge a PAE's patent. Octane, in particular, lowers the burden of proof required to establish an "exceptional" case and widens the scope of attack supporting such arguments. Although establishing the "exceptional" case is still not easy, the lowering of this hurdle brings this possibility more into play than it would have otherwise been under Brooks. It further increases the incentive for a defendant to fight a PAE in litigation. It raises the risk for PAEs of not only losing the litigation, particularly in the shadow of Alice, but also incurring the defendant's costs. The Supreme Court may not have been specifically addressing PAEs in each of Alice, Octane, and Highmark, but the chilling effect that these three cases can have on such entities is evident.

The recent judicial and administrative developments have not been far-reaching enough to end abusive patent litigation practices, according to Congressional leaders who vow to advance patent reform legislation in the 114th Congress. Some innovators, however, believe that court decisions and USPTO actions have obviated the need for legislative reform, while others urge that any legislation be narrowly and carefully crafted. The developments of the past year may have set the stage for a compromise that targets abuses while protecting the interests of innovators.

Reprinted with permission from the January 20 issue of New York Law Journal. (c) 2015 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.