The U.S. Supreme Court rarely weighs in on patent law, so three of its recent decisions are noteworthy–and may even be historic. In effect, they address some unintended consequences of the 1982 act of Congress that created a new patent appellate court, the Federal Circuit, which brought uniformity to patent law and reduced the likelihood that a patent would be found “invalid.” Before 1982, there was always the risk that a prospective licensee would make a preëmptive strike, filing suit in a jurisdiction that routinely found patents to be “obvious” and therefore invalid. This correction spurred investments in technology and an increase in patenting to protect them. But over the past several years, the patent system’s high transaction costs have threatened to offset its benefits.

Established businesses have hotly argued that the patent system needs reform. Some charge that the U.S. Patent and Trademark Office is a major problem: because patent examiners are in short supply and have an evalua­tion system that favors allowances over rejections, unworthy patents are granted. But the angriest complaints are about unscrupulous ­patent-­licensing companies–known as “trolls”–that aggressively seek licensing fees.

Good patent-licensing companies have long helped individuals and small companies get compensation for their inventions. Trolls are different. They send demand letters to thousands of putative patent infringers, often without doing their due diligence. They sometimes file suits against dozens of defendants, or in jurisdictions viewed as friendly to plaintiffs. Legislation limiting such suits to jurisdictions where the defendants are located or do business, or where infringement has occurred, has gone nowhere. Some trolls will pull the trigger on everyone in sight and let the grind of litigation soften up the defendants for settlement, the merits of the cases be damned.

It wasn’t always like this. Until 25 years ago, most companies obtained patents to prevent competitors from copying their significant new inventions. Aggressive use of patents to sue others was infrequent, since having a patent declared invalid was a significant risk; former Supreme Court justice William O. Douglas, for example, wanted “inventive genius” to remain the standard for validity. Things changed significantly with the advent of the Federal Circuit. Previously, many appellate courts viewed patents as archaic and undesirable monopolies. But with patents more likely to be found valid, companies began to assert them. Technology-focused companies began demanding license fees under the implicit threat of litigation. Texas Instruments, for instance, garnered more than $1 billion in licensing fees.

Ebay V. Mercexchange;
Medimmune V. Genentech; KSR International v. Teleflex

In response, large companies bulked up their patent portfolios to ensure that any lawsuit by a competitor would result in patent infringement counterclaims. That put everyone on edge. After all, a successful claim concerning any one of hundreds or thousands of patents in a company’s portfolio could result in a patent injunction–a commandment by a judge to stop making, using, or selling goods or services infringing a patent. Having a war chest of patents gave a company leverage, and the possibility of negotiating a cross-license if a competitor sued. Then, in 1998, the Federal Circuit held that business methods could be patented. A flood of patent applications, some based on simple improvements in business operations, ensued. Many, because they were “obvious,” should have been denied but were not.

Trolls noticed all this–as well as the fact that some jurisdictions were very friendly to patent holders. Jurisdictions whose jurors favor strong private-­property rights were more inclined to find infringement; in the Eastern District of Texas, for instance, a company accused of infringement has only a one-in-six chance of winning at trial. Those odds, plus the threat of an injunction, plus the prospect of spending millions to defend even a small case, made the pressure to settle overwhelming.

To make matters worse, those who had business in court faced a systemic problem that had no malice behind it. Legal fees increased substantially, in part because of a 1996 Supreme Court decision requiring that trial judges hold focused hearings to determine the limits of litigated patent claims, a process called “claim construction.” According to the Court, claim construction is a matter of law–not a factual question that a jury could decide. This means the Federal Circuit can review a trial judge’s limit-setting decisions afresh; in fact, patent suits are reversed at a rate of 35 percent and rising. Trial judges trying to avoid reversals reacted by delaying limit-­setting rulings. So getting sued for patent infringement meant languishing for 18 months or more before the chance for a summary­-judgment hearing arose.

A Free-for-All Ends
By the late 1990s, patent trolls were finding it easy to attack companies at little risk to themselves. Unlike a company that makes products, a troll faces only the risk of a counterclaim to invalidate the patent it’s defending; it’s merely a shell that files lawsuits, collects money, and distributes that money to patent owners. Trolls also enjoy a significant cost asymmetry. They have few documents to produce during the ­document-­discovery phase of litigation, and much of their legal paperwork can be reused against new defendants in later cases. In many instances, trolls have sued upon patents that are very likely invalid. They then demand settlements, knowing that defending a lawsuit can be more expensive than settling. Many trolls took care to settle before courts could construe the boundaries of the patents in question and issue summary judgments dismissing their cases.

Even some publicly traded companies have covertly been trolling for license fees. Typically, they spin out their questionable patents to shell subsidiaries, which then transfer them to trolls. The public company and the troll have a secret agreement to split licensing fees. The troll is then directed to seek fees from the established company’s competitors. For the public company, it’s all risk-free: no counterclaim can be filed against it, and the legal work is done on a contingency basis.

Trolls are choking off economic growth. Small companies cannot afford millions in legal fees, so they pay tribute instead. As the English learned a thousand years ago, however, you can pay danegeld, but the Vikings still come back. Large companies can fight trolls, but they risk huge judgments.

Filings of patent suits increased from 2,112 in 1997 to 2,830 in 2006. That does not take into account any increase in the number of defendants per filing. Between 2001 and 2005, the average cost of litigating a large case through trial jumped from $3 million to $4.5 million. How much of that jump is due to the increase in filings–and thus in demand for lawyers–is unknown. At several million dollars a case, plus the costs of settlement and of the many expensive patent opinions sought, the direct costs mount. Indirect costs do, too: companies feel obliged to practice “defensive patenting” to protect against infringement claims, and litigation can disrupt a company’s operations.

In three quick strokes, the Supreme Court has made things better. Though the recent rulings did not necessarily involve trolls, they will affect them. In eBay v. MercExchange, decided in May 2006, ­MercExchange sought an injunction shutting down much of eBay’s operations. Absent exceptional circumstances, courts used to presume that an injunction should be issued in any instance of patent infringement. But in this case, the Supremes instructed lower courts to apply what’s called a traditional test before entering injunctions. The test gives a trial court more discretion to deny injunctions, since the court must assess what is “fair.” Trolls can no longer count on getting injunctions, even if they win their cases.

In January 2007, the justices made it harder for trolls to wage licensing campaigns. Before, trolls could send letters to targeted companies, putting them on notice–and in so doing putting them at risk of being found “willful” infringers facing triple damages. Companies that wanted to remove that potential liability, however, could not themselves file suit to get a court to declare that they were not liable. Now, according to ­MedImmune v. Genentech, as interpreted by the Federal Circuit, a company receiving a letter referencing its activities and offering a patent license may file a lawsuit where it resides.

And in April, in KSR International v. Teleflex, the Supreme Court made it easier to find that a patent should not have been issued in the first place, or that it should be declared invalid once sued upon. In KSR, the patentee claimed a patent on the combination of a gas-pedal accelerator and a sensor. The Court found the combination obvious and the patent consequently invalid. The Supremes have reëmphasized that “obvious” inventions are not entitled to patent protection. District-court judges may now use common sense to determine whether a patent for a combination of existing technologies merits protection.

My most cynical Berkeley law professor liked to point out the flaws in the professed values of any legal system. But he once made the enlightened observation that “there is a universal abhorring of waste.” It offends everyone’s sense of justice when sham plaintiffs shake down hapless victims on meritless claims. We need to cut back on patents that should never have been issued. Injunctions should be used sparingly. Ancient notions of natural law gave rise to equal protection, and forum shopping (filing suits in favorable jurisdictions) threatens that. With its recent decisions, the Supreme Court has put patent law on a sounder footing, to the benefit of us all.

Scott Feldmann is a partner in the Irvine, CA, office of the law firm Crowell and Moring.