Toxic Asset: The Gradual Demise of the American Patent

Not such a long time ago, owning a US patent was worth something! A patent was often the foundation for new and exciting startups, as well as a source of pride –and hopefully profits- for inventors. These assets promised competitive and strategic advantage in the market; conduits to new investment and deterrence to free riders. Remember, at essence patents are a reward in the form of a limited legal monopoly (20 years from filing), conferred by the government in exchange for the inventor publicly disclosing their inventions. The genesis of patents traces back to ancient Greece. Through a long history of societal adoption, “modern” patent systems has been in place for centuries in the industrialized world. Close to 180 countries adhere to the Paris Convention treaty, which lays the foundation for worldwide patent protection, from China to Zimbabwe.

Needless to say, if innovators want to share their inventions with the world at large -which then can assimilate and incorporate millions of improvements- it is because they stand to benefit from patents financially. The patent system is not an altruistic one; remove that incentive and people immediately revert to keeping things in secrecy, a behavior that the very patent system was created to suppress. Anyone working around innovators or who plays in the IP space has seen these forces at work and fully understands that adequate IP protection is a prerequisite for driving innovation. As a result, trillions of dollars have been invested this past century in R&D or transacted through various forms of licensing. In the modern technological era, the US has built and enjoyed the largest and strongest economy in the world based in large part on new and innovative economies that rely on patent protection. The companies you depend on most for your daily activities (Google, Samsung, J&J, Apple, Microsoft, Ford, Boeing, etc.) have all invested in tens of thousands of US patents for the same reason foreign governments buy US currency; the title has value.

Well, this world as we’ve come to know it may now be over. Recently, we have been witnessing the gradual erosion of our patent system, which culminated last week with a decision in Ultramercial v Hulu by the Court of Appeals for the Federal Circuit; looking at the same patent for the third time (yes, really), the court reversed itself from a previous finding of validity and declared a patent related to Internet advertising to be invalid, based on the recent Supreme Court in Alice. Through additional comments, the Court further set the stage for the generalized eradication of software patents, millions of which are currently in circulation. This was the patent equivalent to the Federal Reserve coming out to declare that the $1 bill will no longer be accepted!

How did we get here? In the past 2 years, there has been a multi-faceted attack on patent holders, primarily as a result of some real and perceived abuses of the system made by those who acquired patents from others and did not practice them, the so called Non Practicing Entities (NPEs) aka “patent trolls.” Unfortunately, shooting the messenger instead on focusing on the reprehensible behavior of a few has had unintended consequences that we now have to account for.

On the judicial front, in 2014 we saw no fewer than 5 Supreme Court decisions going against patent holders on the various subjects of obviousness (a key test for patent validity), what constitutes “abstract ideas” (which now undergo a more stringent test for patentability), business method patentability, indefiniteness (how you construe claims), reasonable royalty (how you calculate damages), willful infringement (how you punish the “bad actors”) and fee shifting (making losers pay for winners legal fees). All of these decisions have collectively made it harder for patent owners to: i) maintain the validity of duly issued patents (previously presumed by law), ii) pursue infringement claims, ii) prove damages (let alone treble damages), iv) have open discussions with potential infringers prior to litigating, and have left the unsuccessful patent owner at risks of paying millions in legal fees to the other side if the judges so decides.

Parallel to judicial reform at the federal courts, recent US patent reform with the American Invent Act (AIA) introduced a new post grant review mechanism called Inter Partes Review (IPR) which allows a party to challenge the validity of any issued patent before the Patent Trial & Appeals Board (PTAB). Strangely, despite the PTAB being an emanation of the same USPTO that delivered all these patents in the first place, there is no longer a presumption of validity before the PTAB for the patents being challenged while other rules make it easier to invalidate patents based on prior art.

Finally, on the political front, in 2013 the US House of Reps. passed the Goodlatte bill, which would erode rights conveyed to all patent holders despite being primarily directed at NPEs. It is now expected that the new Republican led Senate will revive the bill -currently on hold- in early 2015 and, with a rare showing of bipartisanship from the White House, it is expected to be signed into law. At the same time, 27 US States have passed or are in the process of passing laws that make it harder for people to assert the patents they own.

In short, the deck is now heavily stacked against patent owners. How bad is it? Well, let’s look at some recent statistics. In the past year, patent owners who litigate have had a winning rate of only about 35% (the rates doesn’t vary much between operating companies and NPEs by the way). But since June when the Alice decision came out, federal courts have invalidated patents in 15 out of 19 cases. Patent owners are obviously feeling the effects of recent Supreme Court precedence.

The most interesting statistics come from the PTAB because it only focuses on validity issues based on prior art; the very same prior art patent examiners are supposed to have found and analyze prior to issuing a patent. Since patents going through IPRs are usually the same ones that being litigated, you would assume that owners did a lot of due diligence before investing in a costly patent lawsuit. Well, the PTAB is declaring 77.5% of reviewed patents invalid! And this is not limited to “abstract” software; patents related to biotech and pharmaceuticals, medical and mechanical devices, are being invalidated at an even higher rate! Remember, this is an offspring of the very same agency that inventors paid thousands of dollars in the first place to review applications and issue their patents. Now, after having to pay a quarter to a half million dollars in legal fees (average cost of an IPR procedure for a patent holder), the same agency is telling patentees nearly 80% of the time: “Very sorry we made a mistake; we would not have allowed your application had we looked more carefully for existing prior art. And no, there is no refund available.”

Personally, I cannot think of any industry that could survive more than a month with a nearly 80% defective rate, let alone by forcing you to spend a fortune for the “privilege” to confirm that indeed your title was invalid in the first place! Only a government can come up with such a broken system and get away with it.

This leaves us in the current uncertain environment where, as a patent broker/VC/entrepreneur/IP strategist, I now hear questions like the following one from the various people I interact with everyday:

• Why should I bother filing for patent protection given where things are?
• Why should I buy or take a license to a patent if it is likely going to be invalid?
• How can I trust that my company will not be without remedies when it has to assert its rights?
• Do you mean we paid these fortunes over the years to build a huge house of cards?
• Why should I invest in this company/inventor if anyone can come and copy in total impunity?

Sadly, there is no clear answer. In short, US patents have become “toxic assets” just like subprime mortgages were only a few years ago. And we all know what happens when people stop believing in the integrity of a title. Not surprisingly, this also means that foreign companies can now enter the US market knowing that there is little risk of retribution in stealing our IP, thus eschewing a protection system that we always benefitted from, yet took for granted.

Meanwhile, the European Community is moving toward a unitary patent that will make it much easier for a small company based in Estonia for instance to enforce patents throughout all of the EC in a single suit. Germany has become the poster child of strong IP enforcement, with a swift, professional and relatively inexpensive patent litigation forum.

Even China, long a haven for IP infringement, has quietly incentivized its domestic companies (including a large Chinese patent troll) to file millions of patent applications with the Chinese patent office as part of its 12th Five Year Plan. The results? Chinese nationals have surpassed the US in filings since 2011, finishing 2013 with a whopping 825,000 new applications filed in China only! Recently, China also announced the creation of a specialized IP court system that will hear patent enforcement cases. And those who believe the financial risks for infringing patents in China is trivial should reacquaint themselves with the fact that a few years ago a local judge in Western China ordered French giant Schneider Electric to pay US $45M in damages to a domestic company for infringing one of its patent.

If the current trend is not soon reversed, others countries will become flagships for patent protection and the US might very well become the new China; an environment where innovation is no longer rewarded and where it pays more to follow than to lead. This would be a very sad and totally self inflicted demise “Made in America.”