How to benchmark settlement terms in disputes with patent assertion entities? The US Federal Trade Commission provides useful data

• United Kingdom

• Technology, Media and Telecoms - General

15-02-2017

Precis

A recent report from the US Federal Trade Commission has shed light on the secretive business practices of patent assertion entities (PAEs). Also known as patent trolls, these controversial businesses acquire patents from third parties and then try to make money by licensing or suing accused infringers. The report gives valuable insights for a company facing a licensing demand anywhere in the world from a PAE.

What?

The report, Patent Assertion Entity Activity: An FTC Study, examines non-public information and data obtained by the FTC from 22 PAEs, 327 PAE affiliates, and more than 2100 holding entities. The FTC was able to penetrate the secrecy that typically surrounds PAEs by using its subpoena powers under US law to require compulsory provision of information and disclosure of documents from US-domiciled entities and individuals.

Types of PAE

As an initial matter, the FTC is careful to distinguish between PAEs and other types of so-called non-producing entities (“NPEs”) that develop and transfer patented technology, even if they do not practise the patents themselves. Examples of these latter types of NPEs include universities and semiconductor design houses (which for these purposes would include Interdigital, Rambus, Qualcomm etc). They are not covered by the report.

The report found two types of PAEs that use distinctly different business models. The first type, referred to in the report as Portfolio PAEs, typically have the following characteristics:

• they are strongly capitalized and purchase patents outright, frequently from manufacturing firms by making large up-front payments to the owner. They typically fund their initial patent acquisitions through capital raised from investors, including institutional investors or manufacturing firms.

• the value of each licence is typically in the millions of dollars.

• they negotiate broad licences, covering large patent portfolios often containing hundreds or thousands of patents.

• typically they engage in licensing discussions without first suing the alleged infringer for patent infringement. They employ dedicated management and licensing executives, who frequently have prior licensing experience. In lieu of litigation, licensing executives hired by Portfolio PAEs typically begin negotiations by reaching out to a large network of contacts and offering a portfolio licence. Portfolio PAE licensing executives typically contact a specific person in their network, with whom they appear to have had an introduction or a pre-existing relationship.

• where external counsel are required, for example to conduct patent infringement litigation, they typically retained counsel paid on an hourly basis.

• manufacturing firms may transfer patents to Portfolio PAEs for assertion because Portfolio PAEs enjoy lower costs, lack of reputational concerns, or licensing experience owing to their specialization in patent assertion. Also, since a manufacturing firm is potentially vulnerable to a counterclaim for patent infringement in relation to its own products when it sues on its own patents, transfer to a Portfolio PAE is a way for the firm to avoid this risk.

• the investors generally receive a share of the Portfolio PAE’s future revenue and a licence to the Portfolio PAE’s patents. In such cases, investors gain comfort that the patents would not be asserted against them, as well as the opportunity for potential financial gain.

The second type, referred to in the report as Litigation PAEs, are more common and have the following characteristics:

• they tended to be thinly capitalized, with little or no working capital. They rely on agreements to share future revenue with patent sellers (i.e. deferred consideration) to fund their acquisition of patents. Under some agreements, a percentage of gross proceeds, i.e., the payments received from licensees is shared with the patent seller. Many agreements, however, provided a percentage share of net proceeds after deducting costs. These costs often included both contingency fee payments to external counsel as well as other out-of-pocket litigation expenses, such as expert witness fees;

• many had between one and three individual owners, often with no other employees and no offices outside of their owners’ homes. In fact, several Litigation PAEs were simply individual entrepreneurs who relied entirely on outside attorneys and professionals to maintain records regarding their assertion activity;

• they typically sue potential licensees first and settled shortly afterwards by entering into licence agreements with the defendants. Indeed, Litigation PAEs filed 96% of the cases in the study, compared with only 4% filed by Portfolio PAEs;

• the licences typically cover small portfolios, often containing fewer than ten patents.

• the licences typically yielded total royalties of less than $300,000. According to the American Intellectual Property Law Association, which periodically surveys the costs of patent litigation in the US, early-stage litigation costs of defending a PAE patent infringement suit in the US are $300,000 - 2.5M, depending on the amount in suit, so a total royalty of $300k is consistent with defendants seeking the lowest-cost resolution of the dispute regardless of the merits (i.e. nuisance litigation);

• they frequently employ one or more affiliate entities, usually set up as limited liability companies, each created to acquire and assert a small portfolio of patents, without bundling or aggregating acquired patents into larger portfolios. The relationship between the various affiliates can be opaque, and hard for a defendant to unravel; and

• external counsel are generally instructed to conduct the patent infringement suits on a contingency fee basis.

The report does not mention any PAEs by name. However, we understand that Intellectual Ventures would be a good example of a Portfolio PAE, whilst Acacia, Rembrandt, IPNav, Olivo, Unwired Planet, IPCom and Sisvel are examples of Litigation PAEs.

Types of patent held by PAEs

The report examined the types of patents held by PAEs, and found that 88 percent were in the information and communications technology sectors; more than 75 percent of those patents were software-related patents. Fewer than 1% were standards essential patents.

Interestingly, the position in Europe appears to be different. The Joint Research Centre (JRC), the European Commission’s science and knowledge service, published a report on PAE activity in Europe around the same time as the FTC report. It agreed with the FTC that most PAE activity takes place in the TMT/ICT sector. However, unlike the FTC, it found that a large proportion of PAE activity in Europe involves standards essential patents and technical standards.

The focus on the ITC-sector is consistent with anecdotal experience that patent trolls have been much less active in other industry sectors, such as the life sciences. Entities such as the Campaign for Better Drugs, a so-called Hedge Fund troll, have targeted listed life science companies in the US whose share price is closely linked to the strength of their patent portfolio. However, this is a fundamentally different business model based around challenges to patent validity in the Patent Trial and Appeal Board of the US Patent and Trade Mark Office, rather than on patent infringement claims.

Benchmarking patent licensing terms

To gain a better understanding of how PAE behavior compares with the behavior of other firms that assert patents, the report looked in particular the wireless chipset sector as a case study. It examined how reported PAE licensing behavior compared to certain manufacturers and other NPEs. Key benchmarks identified include:

• Royalty structure. Litigation PAE licences invariably involve simple lump-sum payments. This is consistent with the Litigation PAE model because when royalties are paid as a lump sum, the PAE does not need to hire professionals to monitor or enforce the payment of royalties, and they can pass the proceeds along upfront to the patent seller/controlling entity, if any. In contrast, manufacturer licences frequently contain complicated payment terms (including running royalties). Portfolio PAE and NPE license characteristics fell between these two extremes.

• Royalty amount. PAEs reported receiving widely differing royalties from different licensees for the same set of patents, often differing by more than a factor of 20. There are many potential explanations for why the royalties paid for identical patents varied across licensees. Because the majority of licences reported lump-sum payments without breaking out the royalty rate and the base, it is possible that licensees paid similar royalty rates, but very different lump sums. However, licensees may also have differed in bargaining sophistication: some licensees may have been more successful in obtaining a licence at a lower royalty. In addition, licensees operating in different industries may have a different willingness to pay for identical patents. The lack of transparency over royalty rates, royalty base and lump-sum payments makes it hard for any company approached to take a licence to benchmark the proposed royalty with confidence.

• Cross-licensing. Few PAE licenses included cross-licences, which is not surprising because PAEs do not develop or produce technology, and therefore do not need licences to others’ patents, even if they concern improvements to the patented technology. Conversely, manufacturer licences frequently contain cross-licence provisions.

• Field of use and territorial restrictions. Litigation PAEs very rarely included field-of-use restrictions in their wireless patent licences, whereas Portfolio PAEs included field-of-use restrictions in the majority (69.6%) of their wireless patent licences. Wireless Manufacturer licences almost always included field-of-use restrictions. Litigation PAE licences typically do not contain either field of use or territorial restrictions. None of the categories of licensor typically included territorial restrictions, preferring to grant a global licence.

• Exclusivity. PAE licences in the wireless chipset sector are almost always non-exclusive. Again, this is consistent with an out-licensing model which seeks to target multiple industry players.

• Term of Licence. PAEs are typically prepared to grant a licence for the term of the last-to-expire licensed patent in the portfolio.

So What?

PAEs have been most active to date in the US market, but anecdotal evidence suggests that PAEs intend to ramp up their operations in Europe following the introduction of the Unitary Patent and Unified Patents Court (expected in December 2017). Not all features of the PAE business model in the US are transferable to Europe, due to differences in court procedure, costs-shifting and bar rules on contingency fees. Also, PAE business models tend to evolve rapidly, in response to changes in their operating environment. This means that the FTC report may to some extent already be out of date, as it focuses on data from 2009-2014. It has also be criticized as giving only a partial view of the range of PAE business models during that period. Nevertheless, the report gives valuable insights for a company facing a licensing demand anywhere in the world from a PAE and is a noteworthy contribution to the ongoing global debate about patent assertion entities.