Only patent owners are despicable enough to pierce the corporate veil

devil-pointing copyI’ve spoken on several panels on patent reform in the last few months. My feelings about it are mixed: I favor rules that decrease the cost of litigation (like limited discovery stays until claim construction), I think that some rules are well-meaning but ridiculous and costly (like putting a claim chart into a complaint), some seem to make sense but far more complicated than most people realize (end-user stays), and some are probably a good idea but won’t change much (like the transparency rules).

But my overarching comment throughout is that we should be very careful about discarding distinctly American institutions, like access to justice and independent inventorship, in attempts to implement solutions that are not directly tied to strong causal empirical evidence.

This brings me to the PATENT Act reform proposal for fee shifting. Everyone knows that it proposes a presumption of loser pays fee shifting. What few have focused on is a provision that allows “reach through” that pierces the corporate veil for those entities that must pay attorneys’ fees. This, to me, is a problem, because it would discard a longstanding American rule: limited liability for corporations. This important organizing rule is longstanding and long debated. I don’t mean to argue that it should never fall; I only wonder whether this an area where we should brazenly discard it.

I don’t want to minimize the concern that leads to the proposal. The protection offered limited liability companies is a real problem for those who want to collect against them. But it’s a problem for every creditor who wants to collect against every limited liability company. I haven’t seen any real data about how often fee awards go unpaid, so I don’t know just how much of a problem unpaid fees are in patent law. Of course, if there is more fee shifting, there will be more collection problems. Further, I’m not wholly opposed to fee shifting. I think there can be some benefit to reciprocal fee shifting, and I also think that the “objectively unreasonable” standard is better than a presumption.

Even so, the PATENT Act and all other veil-piercing fee proposals are not about under-capitalized shell companies — not really, anyway. If it were, we would see many more proposals to pierce the veil against defendants in all industries: construction, transportation, etc. Instead, this proposal is only floated in one direction: against patent plaintiffs that do not practice a patent, and not any other kind of patent plaintiff or the patent defendant. One-way veil piercing (against the plaintiff, no less) stands for the proposition that we hate patent enforcement by non-practicing entities so much that we’re just going to throw out all the rules that apply to everyone else, no matter how bad an actor all those other people are. Only patent plaintiffs are so despicable that they are no longer entitled to corporate status.  And this is not just about patent acquisition companies – this covers inventor operated companies, research companies and think tanks, failed startups, and anyone else who doesn’t make a product.

Indeed, if we are so worried about shells, why not require all patent plaintiffs to show that they have funds, rather than just those that are NPEs? Surely underfunded startups can file patent suits. And why not make all defendants guarantee they can pay damages or else we’ll pierce the veil? We hate shells and undercapitalized parties, right? The answer, of course, is that we only hate a shell this much if it is of a particular type, and that’s a non-practicing patent plaintiff. It’s not even anti-troll, really, because under the proposal, anyone that doesn’t make a product is on the hook, regardless of whether the plaintiff does the things that one would associate with a patent troll (whatever that definition is).

The reach of the veil piercing is also unprecedented. Under proposed 285(c)(1)(G)(2)(A), an interested party is anyone with an interest, including employees. The exception in (G)(2)(C) makes this clear, because it excludes professors that assign all rights to a university and only get a royalty. This implies that an inventor who assigns to other companies that make no products and stand to make a royalty is an interested party. Think about that – we are no longer considering charging just investors or shell company owners with attorneys’ fees. Instead, the proposal would pierce the veil all the way down to the inventor that assigned the patent to his or her employer. If this broad a reading seems unreasonable, consider the recent manager’s amendment, which clarifies to exclude lenders, because the language is so broad it might have included lenders before.

My concern about discarding old rules only when it suits is not limited to plaintiffs. Only a few short years ago, record companies sued a venture capital firm for investing in copyright defendant Napster, a company that had, at best, a crapshoot of winning its case. That investor suit was also unwarranted for the same reasons that this proposal is: targeted veil piercing to support substantive policy goals is not a great idea — the bell tolls for thee.

In another blog post, I highlight the implications of this proposal: more patents will obtained for a flat fee rather than royalties, stock, or other incentive based reward. This is the exact opposite of what we want patent policy to do, and yet those that complain too little of rewards of invention go back to the inventors seem to be sanguine about the veil piercing proposal.

The message is clear: If you plan to make money on patent enforcement, whether you are an inventor, shareholder, lender, employee, or otherwise, then there is no corporate veil for you. You are simply not entitled to the protections we give every other limited liability company, no matter how scummy they are, no matter how many people they rip off, no matter how putrid their business model. You are worse; for you, we make an exception, we make it non-mutually, and we only make it if you are small.

This last point bears special note: this proposal not only discards the corporate veil, it does so in an anti-competitive way. It will surely make it difficult to enter the market. Indeed, BIO has now come out in favor of this provision because it “deters shells.” As Ted Sichelman has noted, fee shifting likely just means consolidation to larger enforcement companies that can cover fees.

As a result, almost all of the pushback against patent reform has been focused on whether or not innovation will be affected. While I have views on this, I don’t know the outcome. But I do know this: almost no one has mentioned veil piercing because the big players don’t have to worry about it. But my research, along with the research of others, shows that there are many small players that obtain patents and will be affected.


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22 comments so far.

  • [Avatar for Night Writer]
    Night Writer
    June 25, 2015 07:49 am

    The other big point is that real people are not interested in any of these “fine” controls on the litigation. The conversation will go like, “So, the judge can make me pay if Google wins?” Attorney, “Yes, but…..” Start-up, “Uh, I think we are just going to stay away from these patent things and keep everything secret. Can you draw up some employment agreements with the strongest language for non-competes? We want non-disclosures for everything from the employees. We want to be able to sue the employees if they discuss the product on a blog. Can we make it so the employees have to disclose each time they write a blog post? Etc…..” That is the way it was in the early 1980’s.

    Also, VCs will ask a question now: OK, well what if we are successful, what big corporations may just copy what we did? What about the employees? Are they locked up? Etc……

    We are moving to a Google world.

  • [Avatar for Night Writer]
    Night Writer
    June 25, 2015 07:43 am

    This models of the real world that are used just do not correspond with my real-world experience.

    Start-ups typically use the patents to stop big corp’s from just copying what they have done or to help negotiate a better price for their company.

    What this new legislation is like is terrorism. All it will take is for a few start-ups to be pierced and the lives of a few of the founders to be destroyed and every start-up will say, I am just going to stay away from patents.

    What is going to happen is everything is going to become a secret. The start-ups will demand draconian employment contracts from their employees and the start-ups are going hide as best they can how their systems work. There is going to be a lot of innovation on hiding how systems work. Back in the 1980’s there were chips that enabled encryption of code and the decryption to occur only during execution so that it very difficult to impossible to reverse engineer the system. We are going to get these again. Probably companies like Google will adopt their own private programming languages. Many functions will be hidden behind layers of network security.

    This prediction comes from me being an employee of a cutting edge start-up, a patent attorney, and a corporate product manager that evaluated start-ups to buy for a large international corporation.

    The world right now is scratching its head wondering why the greatest innovation engine that the world has ever known is self-destructing.

  • [Avatar for Ken]
    June 24, 2015 05:44 pm

    Picking up on this post’s theme, it also appears that ‘only patent owners are despicable enough’ to warrant criminal prosecution if a case is deemed frivolous:

    Seriously, is there any other area of civil/tort/property law where plaintiffs face this sort of jeopardy if the state doesn’t like what they’re trying to do (even if a given case truly is frivolous)? Seems like in most cases we don’t even impose civil-level sanctions (e.g. Rule 11), for better or worse…

    If this was all part of a broad “tort-reform” effort or some such, at least it would be an honest and legitimate debate about where to draw the line, etc. But why pick on inventors and entrepreneurs?

    (Hopefully, patent “reform” might at least include some sort of preemption?)

  • [Avatar for Anon]
    June 23, 2015 12:10 pm

    The rules for attorneys ARE in place.

    You want different ones.

    Please don’t confuse the two.

  • [Avatar for Richard Falk]
    Richard Falk
    June 23, 2015 11:58 am

    No, it is not already in place. What is in place is sanctions for a bar set much higher for “frivolous” lawsuits. The “objectively unreasonable” standard is a lower one so if fee shifting is not paid within a certain timeframe, then sanctions against the attorney could be done, but that is not what Congress has written in their proposed law. Why shouldn’t an attorney have at least a high a standard of conduct as his/her client? See Eon-Net v. Flagstar Bancorp:

    “But an attorney, in addition to his obligation to his client, also has an obligation to the court and should not blindly follow the client’s interests if not supported by law and facts.”

    Clients seeking profit through extortionate use of the legal system due to its high costs of litigation only have a right to counsel that tells them that they cannot pursue a case with little or no merit. They do not have a right for their counsel to pursue objectively unreasonable cases which is what we are talking about here.

    The PATENT act reform proposal incorrectly targets (in some of its proposals) specific entities when it should focus solely on specific behaviors. The problem of patent litigation abuse is not solely practiced by PAEs nor is civil litigation abuse solely found with patents though that is the current hot spot. Congress or states have stepped in when the legal system (courts, bar associations) have failed to act (so the legal system is hypocritical to then complain about their “meddling”) and then the abuse simply shifts to another area of law as if one were playing the game of Whac-A-Mole®:

    Auto Insurance Fraud – stopped when insurance companies jointly stopped their practice of automatically settling even questionable cases for a fixed amount
    Securities Class Action – reduced some with Private Securities Litigation Reform Act of 1995 (PSLRA), reduced more when William Lerach went too far, but still at a rate of roughly 160 or so per year
    CA Section 17200 – multiple legislative and court actions somewhat reduced abuse but Proposition 64 reduced abuse the most
    CA Prop 65 – abuse reduced by legislative reform and more is forthcoming
    Federal ADA especially in CA – reduced some with legislation, but more with CA supreme court ruling on fee shifting
    Patent Marking – stopped with a Court ruling and with AIA
    Medical Malpractice – significantly reduced with legislation capping pain and suffering awards in some states

  • [Avatar for Anon]
    June 23, 2015 08:31 am

    You cannot impinge on attorneys in the manner that you outline without seriously impinging on the right to counsel.

    You seek the wrong pockets.

    That is not to say that there are other mechanisms – already in place – to dissuade attorneys from truly frivolous lawsuits. There are. The courts have to use those mechanisms though.

  • [Avatar for Richard Falk]
    Richard Falk
    June 23, 2015 12:13 am

    My apologies to Devious Dan who made the same point I was making (as my first point). I didn’t see his comment before writing.

  • [Avatar for Richard Falk]
    Richard Falk
    June 22, 2015 11:55 pm

    The disclosure of the real party of interest has other problems as well. It is far too easily worked around by simply having an off-shore foreign shell company own a domestic shell thereby creating a jurisdictional corporate veil that cannot be pierced (at least not easily).

    Furthermore, why isn’t this solved in a much simpler way which is to hold the attorneys bringing suit jointly and severally liable along with the plaintiff? The attorneys will make damn sure that their liability is covered and it doesn’t really matter who is going to cover that cost — the attorney will sort that out before a suit it brought forth. This has the advantage of not only making it more likely that someone will pay if fees are shifted, but is simultaneously discourages suits with little or no merit.

    A big problem in the current system is that contingency-fee lawyers and firms pay no penalty for the initiation or continued pursuit of weak cases. Shared liability solves that problem. It is not the only way — enforcing Rule 3.1 of the ABA “Meritless Claims and Contentions” in every state, a national point system for violations, and audits that can examine confidential settlements would also work, but would be more complicated and expensive.

  • [Avatar for Michael Risch]
    Michael Risch
    June 22, 2015 01:38 pm

    OK Ken – I see your point now – because it says the the business of the party who is enforcing, it wouldn’t apply to an investor of the startup if the enforcement company existed before the time of the startup.

    On the one hand, this is a problem and ought to be fixed. On the other hand, I suspect that it would be the least of problems if it did happen. First, the startup selling would have to keep a back-end interest. Second, a court would have to interpret it this way, which is a toss-up, but possible (after all, they are going after inventors who keep a back-end contingency). Third, and most important, this provision only applies to undercapitalized enforcers, which are most likely not going to exist (and be in the business of enforcement) at the time of the initial startup investment.

    But all it takes is one horror story, I suppose.

  • [Avatar for Ken]
    June 22, 2015 11:51 am

    Michael – I think the key is to look at *which* entity it is whose business model matters.

    You said, “if you invest when you think it’s going to succeed, then great,” but it seems that even in that case you could still be on the hook – e.g., if the company you invested in (say, company A) later ends up selling to or being acquired by some “longtime-troll” that you never even heard of (say, company B). An investor may have no way to foresee company B ever entering the picture, and there’s no safety to be gained based just on the business model of company A if company A isn’t the one who ends up doing the suing.

    (I’d love to be wrong here, but that’s my reading of the statute.)

  • [Avatar for Michael Risch]
    Michael Risch
    June 22, 2015 07:35 am

    Ken – I don’t know how what you’ve said is different from what I’ve said. The rule would look at the business model at the time of investment, and exempt investors of the model is not patent enforcement at that time.

  • [Avatar for Devious Dan]
    Devious Dan
    June 22, 2015 05:39 am

    Sounds to me like there’s a case to be made for ownership of US patents by non-US corporations, established in jurisdictions that won’t enforce a reach-through judgment from a US court, or which won’t reveal the identities of the actual owners. Good lawyers and good corporate planning can usually figure out a way to make someone judgement-proof.

    And what would happen if the ultimate owner is a not-for-profit corporation? Or something that doesn’t even qualify as a corporation under US laws but is a recognized form of organization in some other country?

  • [Avatar for Curious]
    June 22, 2015 01:18 am

    This allows them to achieve the aim they wanted all along, which, really, is to change the game from the first to invent/innovate (and contribute to the public advancement of science) to the first who can commercialize (and obtain private profit).
    I’m not sure if that is what the VCs want. Once the technology is known, in most instances, it can be easily reproduced. Thus, the first who can commercialize/monetize will likely be those entities with plenty of resources (e.g., engineers) and cash to throw at it. These entities will also have managerial expertise as well as supply chains (if needed) or purchasers for whatever product/service being offered. These types of companies don’t need VCs.

    However, you have touched upon a point that I have made many times. This point is that the weakening of the patent system makes winners of those the copy the best rather than those the innovate the best. Over time, the innovators will stop innovating (because there is no money in it) and the copiers won’t have anything to copy. The result is stagnant, non-innovative economy.

    I doubt this is what most in Congress intend — however, every time they make it more difficult to enforce a patent, this is where they are leading us.

  • [Avatar for Ken]
    June 21, 2015 04:18 pm

    Thank you for this article…of all the various debates surrounding patent “reform” (many valid), this issue always struck me as the most important…and it’s gotten shockingly little focus for how truly profound it is.

    Hopefully enough in Congress will take heed, before it’s too late.

  • [Avatar for Ken]
    June 21, 2015 04:15 pm

    “[T]he proposal exempts those who invest in companies before the business model becomes enforcement, which is better than nothing. So, if you invest when you think it’s going to succeed, then great, but if you invest as it’s failing, you have to convince the court that the business model hadn’t shifted yet.”

    Not quite, unfortunately…it’s even worse. It appears that, at the time you invest (or otherwise acquire the equity), the company that *ends up* enforcing the patent must not yet have been a “troll” (whatever that gets deemed to mean) at that point. The company in which the equity was *actually obtained* does not seem relevant in that provision.

    Hence, if you obtain equity in a “legitimate” entity, but some time later they ultimately sell to some firm that was always a “troll,” then you’re still on the hook. They only look at the business model for the firm enforcing the patent, but they judge it from the point in time the investment was made (regardless of whether it was made in the same or even a related entity).

  • [Avatar for nat scientist]
    nat scientist
    June 21, 2015 03:53 pm

    A case could be made that exports the entirety from Nixon’s whistleblower theory. The individual is dead meat in the eyes of a suitable-incented mob or even better a financially overwhelming and immortal force of a corporate or goverbrnment entity. Nixon got the last laugh in his 1960 loss to JFK who championed both science and empowered the young STEMers into the space race (not the vast array of dominant atomic weapons of latter-day NATO science) and knowledge contest. By July 1969 and the JFK predicted Lunar landing, Nixon and young Donald Rumsfeld had the ball, and the individual was thereafter groud to a fine sand well into the next Century…but how far into the future is this going? Only you can make the difference, Please keep your individual head down., because they know it only takes one and there are millions of you they need to watch, but more help is always needed. Please stay awake and stay tuned, but now a message from not-my-sponsor: Nixon’s the One!

  • [Avatar for JNG]
    June 21, 2015 12:26 pm

    As someone pointed out recently, there is a huge misunderstanding in the IP stakeholder crowd that these provisions are somehow “unintended” consequences of vague language. They are not. They are engineered to achieve the very end case you are describing.

    Why? The logic of this is still consistent with the entire rabid anti-SW patent crowd agenda. Someone recently pointed out that VCs could be on the hook if the company they fund gets a patent, and then later loses an enforcement case. The byproduct of this will not be less funding as some have speculated, rather, it will just be less PATENTING, because VCs will soon catch on make it a CONDITION that companies NOT apply for patenting lest they subject themselves to later liability. But the bulk of VCs in the hottest space right now are perfectly fine with advocating less patents. This allows them to achieve the aim they wanted all along, which, really, is to change the game from the first to invent/innovate (and contribute to the public advancement of science) to the first who can commercialize (and obtain private profit). This is an arena where they have all the $$ and hold control over the network and can sponsor the “winner” of their choice, instead of being forced to deal with pesky prior inventors of the technology they want to appropriate for private profit.

  • [Avatar for Anon]
    June 21, 2015 10:55 am

    nat scientist,

    The parallel is disturbing for its accuracy.

  • [Avatar for nat scientist]
    nat scientist
    June 21, 2015 10:13 am

    Spot-on observation. A deeper cultural analysis can point to the earlier practice of singling out those individual entities who would threaten the Crown or Church monopolies on Truth by burning at the stake. I suppose this is a more humaune version, sparing the rending of the flesh an all that, but hey, we’re civilized now. Single payer schemes for science allowance is what we’re getting from our sponsored representatives via Citizens United.

  • [Avatar for Michael Risch]
    Michael Risch
    June 21, 2015 09:56 am

    Edward Heller – the proposal exempts those who invest in companies before the business model becomes enforcement, which is better than nothing. So, if you invest when you think it’s going to succeed, then great, but if you invest as it’s failing, you have to convince the court that the business model hadn’t shifted yet. And if you invest to keep from losing the prior investment, then you are on the hook.

    I suppose that if you invest in a PIPCO like Acacia, then you are on the hook no matter what, even if it is publicly traded.

  • [Avatar for Anon]
    June 21, 2015 09:17 am

    As OI have stated previously, the idealogues that want to attack patents do not care if what they want to address occurs in other aspects of law.

    court costs —> the entire court system
    shell companies —> corporate structure law
    sales disguised as leases —> business transaction law

    On another recent thread, remedies was being discussed and the Court made the opposite mistake: in their desire to NOT treat patent law as some type of “special” area of law, and wanting “the law of remedies” to have a universal approach, the Court ignored the nature of the patent right and the alignment of that nature to the particular remedy of injunction.

    The contrast is important here as it highlights how to miss from coming at patent law from both angles.

    The Judiciary missed coming from the angle of “the law should be the same.”
    Proponents of the current changes are missing from the angle that “these problems are (strictly) from patents.”

    The first case misses on the nature of patents. The second misses on the nature of the problems.

  • [Avatar for Edward Heller]
    Edward Heller
    June 21, 2015 09:09 am

    Michael, I presume investors in startups who take equity positions are included.

    This is really, really going to hurt startups. How can anybody in their right mind support what is going on in congress. It appears from the outside that big companies are doing everything in their power to simply wreck the patent system for anyone other than big companies.